BCAJ | Bombay Chartered Accountant Journal

Charitable purpose: Exemption u/s. 11: A. Y. 2008-09: Accumulation of income: Notice u/s. 11(2)(a) to be furnished in Form 10: Information furnished in form of letter with full detail as required in Form 10: Sufficient compliance: Assessee entitled to exemption u/s. 11:

CIT vs. Moti Ram Gopi Chand Charitable Trust; 360 ITR 598 (All):

The assessee, a charitable Trust was registered u/s. 12A. For the A. Y. 2008-09, the Assessing Officer disallowed the claim for exemption u/s. 11 of the Act in respect of the accumulated income inter alia on the ground that the notice u/s. 11(2)(a) was not in the specified Form 10 as prescribed by Rule 17. The Tribunal found that the information with full details as required in Form 10 was furnished by the assessee by a letter. The Tribunal held that the assessee had made an investment in the next year amounting to Rs. 1,25,17,086/- and thus the purpose of the provisions of the Act had been achieved. The Tribunal accordingly allowed the claim of the assessee.

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

“i) We do not find any error of law in the order of the Tribunal. When a request by way of a letter, which complies with the requirement and furnishes all the information required in Form 10 was made available on record and there was sufficient proof before the Assessing Officer that the amount was not only kept apart but was also spent in the next year, the adherence to the form and not substance was not valid exercise of power by the Assessing Officer.

ii) The questions of law are decided in favour of the assessee and against the Department.”

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Capital gain: Cost of acquisition: Market value as on 01-04-1981: Section 55A: Reference to DVO only when value of capital asset shown by assessee less than its FMV:

CIT vs. Daulal Mohta (HUF); 360 ITR 680 (Bom):

In the relevant year, the assessee had sold a property called Laxmi Niwas which was owned by it since prior to 01-04-1981. For computing the capital gain, the assessee got the value of the property as on 01-04-1981 determined at Rs. 2,13,31,000/- from a Government approved valuer. The Assessing Officer referred the case to the DVO u/s. 55A who determined the value at Rs. 1,35,40,000/-. The Assessing Officer adopted the value determined by the DVO and computed the capital gain. The Tribunal allowed the assessee’s claim and held that the cost of acquisition should be taken at Rs. 2,13,31,000/- as determined by the Government approved valuer.

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

“i) Reference to the DVO can only be made in cases where the value of the capital asset shown by the assessee is less than its fair market value as on 01-04-1981. Where the value of the capital asset shown by the assessee on the basis of the approved valuer’s report was more than its fair market value, reference u/s. 55A of the Income-tax Act, was not valid.

ii) The Tribunal was right in law in reversing the decision of the Commissioner (Appeals) on valuation of the property at Rs. 1,35,40,000/- made by the DVO as against the valuation done by the Government approved valuer at Rs. 2,13,31,000/-.”

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Business expenditure: Section 37: A. Y. 2006- 07: Tribunal noticing assessee’s books of account as well as sales tax records of seller and finding purchase genuine transaction: No rejection of books of account: Deletion of addition on account of purchase transactions justified:

CIT vs. Sunrise Tooling System P. Ltd.; 361 ITR 206 (Del):

For the A. Y. 2006-07, the assessee had claimed deduction of Rs. 43,34,496/- towards the purchases from S. On the basis of the statement of a director of the assessee in the course of survey that the amount represented a non-existent or bogus transaction, the Assessing Officer disallowed the claim for deduction and made the addition. The Tribunal took note of the statement of the director and the retraction of that statement on 21st February, 2008. The Tribunal noticed that the statement was recorded in the course of survey u/s. 133A and did not have any evidentiary value. The Tribunal also took note of the fact that no copy of the statement was given to the assessee to enable it to cross-examine the director and accordingly deleted the addition.

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

“i) The Tribunal could not be faulted in its approach in rendering the findings of fact. Although the Revenue endeavoured to submit that the Tribunal fell into error in overlooking and discounting the statement of the director on the ground that it was retracted, the discussion in the order of the Tribunal would show that the Tribunal took note of the materials before the Assessing Officer and the Commissioner (Appeals), which included the assessee’s books of account as well as the sales tax records of S. This established firmly and conclusively that the claim of the assessee that it had purchased goods from S were borne out.

ii) The Tribunal also noted that the Income-tax Authorities had not even rejected the books of the assessee even while finding the claim bogus.

iii) The impugned order of the Tribunal does not disclose any error, warranting framing of substantial questions of law.”

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Assessment: S/s. 143 and 144: A. Y. 2002-03: Assessment order passed without serving notice on the assesee is not valid: Burden of Revenue to prove service of notice: No evidence of service by Revenue: Assessment not valid:

CIT vs. Gita Rani Ghosh; 361 ITR 17 (Gau):

For the A. Y. 2002-03, the Assessing Officer passed best judgment assessment order u/s. 144 claiming that the assessee did not respond to the notices issued u/s. 143(2) and 142(1) of the Act. The assessee challenged the validity of the assessment order on the ground that no such notices were served on the assessee in respect of the assessment proceedings of the assessee for the relevant year. The Tribunal allowed the assessee’s appeal and held that the assessment order was illegal and void ab initio as no notice u/s. 143(2) or section 142(1) was served on the assessee. The Tribunal accordingly cancelled the assessment order.

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

“i) It is settled law that to establish service of a notice upon the assessee, the initial onus is on the Revenue and unless and until this onus is discharged, the service of a notice simply, on the basis of presumption and assumption, cannot be accepted, so as to justify an ex parte best judgment assessment u/s. 144 of the Act.

ii) When the assessee had denied the receipt of the notices u/s. 142(1) and section 143(2) for the A. Y. 2002-03, it was for the Revenue to prove, by bring ing materials on record including witnesses, if any, that the notices sent to the assessee were for the A. Y. 2002-03. This was, however, not done.

iii) It was not the case that after the Assessing Officer had come to know of having issued notices in the wrong name, he had corrected the same by issuing a second set of notices. Similarly, the fact of service of notice had also not been mentioned in the order-sheet, meaning thereby that there was no evidence with the Revenue to establish its case that it was the second set of notices which were served upon the assessee as per acknowledgment.

iv) The Tribunal is correct in cancelling the best judgment assessment passed u/s. 144.”

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Appeal to CIT(A): Condition precedent to pay admitted tax before filing appeal: Section 249(4)(a): A. Y. 1996-97: Amount belonging to assessee available with Revenue far in excess of admitted tax: Requirement of section 249(4)(a) met: Appeal should be admitted:

CIT vs. Pramod Kumar Dang; 361 ITR 137 (Del):

The Commissioner (Appeals) dismissed the appeal filed by the asessee relying on the provisions of section 249(4)(a) on the ground that the assessee appellant has failed to pay admitted tax. The Tribunal found that Rs. 4.6 lakh seized from the assessee was lying with the Department. The Tribunal held that the amount of Rs. 4.6 lakh should be treated against the payment of due tax on the returned income and directed the Commissioner (Appeals) to decide the appeal on merits.

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

“i) The rationale behind section 249(4) is that where an assessee has filed a return, the tax which is admittedly payable by the assessee should be paid prior to the hearing of any appeal filed by the assessee. The rationale is very logical for the reason that no assessee can be heard in an appeal where the tax which is admittedly payable by the assessee is outstanding. It is to enforce payment of tax on the admitted income.

ii) When an assessee files the return of income then at least the tax which is payable on the returned income should be paid by the assessee. But where the assessee either has paid the tax on the returned income or sought adjustment admittedly lying with the Revenue towards the tax payable on the returned income, the assesee cannot be denied a hearing.

iii) The amount of Rs. 4.6 lakh belonging to the assessee which was admittedly available with the Department was far in excess of the amount of tax payable in terms of the returned income and even in excess of the demand of Rs. 2,15,926 created u/s. 143(1)(a). The assessee could not have been denied a hearing merely on the ground of non-payment of tax due on the returned income. Therefore, the requirements of section 249(4)(a) of the Act, were duly complied with.”

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Reassessment: S/s. 147 and 148: A. Ys. 199-00 to 2002-03: Reasons for reopening recorded after issuing notice u/s. 148: Notice u/s. 148 and reassessment proceedings are invalid:

CIT vs. Baldwin Boys High School; [2014] 45 taxmann. com 33 (Karn):

The assessee trust, was running educational institution. For the relevant assessment years, the assessee had declared income ‘Nil’, claiming exemption u/s. 10(23C) (vi) of the Income-tax Act, 1961. Assessments were completed allowing the claim. Subsequently, the assessments were reopened by issuing notices u/s. 148 of the Act dated 30-01-2004, on the ground that the assessee was not registered u/s. 12A nor had requisite approval u/s. 10(23C)(vi) of the Act. The Tribunal set aside reassessment proceedings taking a view that notices u/s. 148 to reopen assessment was issued without recording reasons as contemplated by s/s. (2) of section 148 which vitiated the whole proceedings.

On appeal by the Revenue, the following question was raised:

“Whether on the facts and in the circumstances of the case and in law, the notice issued by the Assessing Officer u/s. 148 of the Income-tax Act, 1961 without recording reasons as contemplated by s/s. (2) of section 148 of the Act would vitiate the whole proceedings? In other words, whether the reasons as contemplated by s/s.(2) of section 148 of the Act, in the present cases, were recorded after issuance of notice u/s. 148 of the Act and, therefore, the whole proceedings are bad in law?”

The Karnataka High Court upheld the decision of the Tribunal and held as under:

“i) F rom bare perusal of section 148, it is clear that the Assessing Officer is obliged to record reasons before issuing notice u/s. 148. It is true that in one of the files, there was a draft of reasons purportedly prepared by the Assessing Officer on 20-01-2004. It was not signed by the Assessing Officer. The reasons recorded by the Assessing Officer were typed, as is clear from the printout of the original reasons, on 04-02-2004. The typed date was struck off with pen and the date 30-01- 2004 was written by hand with the same pen. Though the original date (typed) was struck off with pen still the typed date is visible/could be read or is clearly seen, and it was typed as 04-02-2004.

ii) Before the Tribunal, a controversy was raised that the printout of the reasons was computer generated and it was printed with the date of printing automatically by the Computer. Be that as it may, the fact remains that the typed date or the date of printout was 04-02-2004 and that it was changed to 30-01-2004 as the date of reasons recorded under s/s. (2) of section 148.

iii) Thus, the record was set right by showing that the date of the notice and the date on which the reasons were recorded was same. Why and how the date 04- 02-2004 is appearing on the original reasons recorded under s/s. (2) of section 148 is not explained by the Assessing Officer.

iv) On perusal of the original records, it is clear that the reasons were prepared on 04-02-2004 whereas the notice was sent on 30-01-2004. It is also pertinent to note that the contents of draft reasons and the original reasons recorded by the Assessing Officer do not tally.

v) Thus, from perusal of the order passed by the Tribunal and so also the other materials placed on record, it is clear that it is a finding of fact recorded by the Tribunal holding that notice was issued even before the reasons were recorded. In such circumstances, there was no reason to interfere with the finding of facts recorded by the Tribunal.”

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DTAA: India-Singapore: Royalty: Section 9(1) (vi)(c): PE: Assessee, resident of Singapore made payment to GCC in Singapore for acquiring rights of telecasting cricket matches from Singapore: Had no connection with the marketing activities carried out through alleged PE in India: Payments could not be deemed as royalty in view of Article 12(7) of India Singapore DTAA:

DIT vs. Set Satellite (Singapore) Pvt. Ltd.; [2014] 45 taxmann.com 100 (Bom):

The assessee is a Singapore based company engaged in the business of acquiring rights in television programmes, motion pictures and sports events and exhibiting the same on its television channels from Singapore. The assessee is a tax resident of Singapore. The assessee entered into an agreement on 25th January, 2002 with Global Cricket Corporation Private Limited (GCC), also a tax resident of Singapore. Under that agreement, GCC granted rights to the assessee throughout the licence territory. The licence territory, inter alia, included India. The assessee paid consideration to GCC for acquisition of such rights. The Assessing Officer made an addition of the amount so paid to GCC by way of disallowance on the ground that the tax was not deducted at source on such payment. The Tribunal deleted the addition. On appeal by the Revenue, the following questions were raised: “

i) Whether the payment to GCC (a Singaporean Company)for acquisition of telecasting rights were in the nature of ‘royalty’ covered by Explanation 2 to section 9(1)(vi)(c)?

ii) Even if payments would be deemed as royalty, whether they would not be chargeable to tax as per Article 12(7) of India-Singapore DTAA ?

The Bombay High Court upheld the decision of the Tribunal and held as under:

“i) The appellate authorities had already held that payment was made only for broadcasting operations carried out from Singapore, which had no connection with the marketing activities carried out through alleged Permanent Establishment (‘PE’) of assessee in India.

ii) Thus, there was no economic link between the payments. The payer was not a resident of India and the liability to pay royalty had not been incurred in connection with and was not borne out by the PE of the payer in India.

iii) The absence of economic link was thus the foundation on which the Tribunal’s conclusions were based. Thus, the Appeal was to be dismissed as no substantial question of law was involved.

iv) Once it does not raise any substantial question of law, then, the Appeal deserves to be dismissed. It is also dismissed because the view taken by the Tribunal in the given facts and circumstances cannot be said to be perverse or based on no material.”

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TDS on Premium Paid for Grant of Lease

Synopsis U/s. 194-I of the Income Tax Act, 1961, an assessee is required to deduct tax at source from payment of rent made to a resident. In some lease transactions, particularly when land is taken on a lease for a long period of time, a one-time premium is paid for the grant of lease. In addition to the premium, an annual lease rent of a nominal amount may be charged. The issue is whether the payer needs to deduct tax at source from the one-time premium paid.

The issue has been the subject matter of adjudication in various cases and judgment largely depends on the facts of the case. In this article, the authors have analysed various judicial pronouncements in this regard and have made several observations that will help the reader understand the issue in its entirety.

Issue for Consideration

Section 194-I of the Income-tax Act, 1961 requires deduction of tax at source from payment of any income by way of rent to a resident. For this purpose, ‘rent’ has been defined to mean any payment, by whatever name called, under any lease, sub-lease, tenancy or any other agreement or arrangement for the use of (either separately or together) any, land, or building (including factory building), or land appurtenant to a building (including factory building), ……………….. whether or not any one or all of the above are owned by the payee.

Very often, when land is taken on lease for a long period of time, say for 30 years, 50 years or 99 years, a premium is paid for such grant of lease, particularly when the lease is being taken from a Government Authority, such as an Industrial Development Corporation or a Regional Development Authority. In addition to the premium, annual rent may also be charged, which at times may be a nominal amount. The payment of such a premium has been the subject matter of several controversies, under the tax laws, surrounding the liability of the payer to deduct tax at source u/s. 194-I and his eligibility to claim deduction for such payment in computing his total income.

One of the issues is whether such a premium is really in the nature of rent for the purposes of section 194-I, and whether tax is deductible at source from such premium, or whether such premium is in the nature of a capital expenditure for the grant of lease of the land and no tax is deductible from such payment. While the Chennai bench of the Tribunal has taken the view that tax is required to be deducted at source u/s. 194-I from the payment of lease premium, the Delhi and Mumbai benches of the Tribunal have taken a contrary view that payment for such premium is a capital expenditure and no tax is required to be deducted at source thereon.

Foxconn India’s case

The issue first arose before the Chennai bench of the tribunal in the case of Foxconn India Developer (P) Ltd. vs. ITO 53 SOT 213.

In this case, the assessee was engaged in the business of developing a Special Economic Zone (SEZ) and had taken on lease, a plot of land of 151.85 acre for a period of 99 years from SIPCOT Ltd., a Tamil Nadu State Government Corporation engaged in industrial development, which was the nodal agency for development of land for SEZ at Sriperumbudur. The assessee paid an amount of Rs. 28.41 crore as upfront charges for the lease. The annual lease rent was Rs. 1 per year for 98 years and Rs. 2 in the 99th year, such rent also being paid in advance. The upfront fee was non-refundable and consisted of Rs. 27.09 crore towards non-refundable upfront charges and Rs. 1.32 crore for payment towards provision of water and pipeline up to the boundary limit.

The Assessing Officer (TDS) took the view that such payment came within the definition of rent as per the explanation to section 194-I, and that the assessee had failed to deduct tax at source thereon. He therefore treated the assessee as in default for non-deduction of TDS and raised a demand for the amount of TDS and interest thereon.

The Commissioner (Appeals) was of the view that the upfront fee was nothing but advance rent, since the annual rent was very small. According to the Commissioner (Appeals), such upfront payment obviated the problem of SIPCOT in collecting the rent annually. He therefore held that the assessing officer was justified in applying section 194-I and holding that the assessee had failed to deduct TDS. However, since the lessor had included upfront and water connections charges received by it as its income and paid tax thereon, he held that the TDS could not be recovered from the assessee following the decision of the Supreme Court in the case of Hindustan Coca-Cola Beverages 293 ITR 226, but that interest could be levied u/s. 201(1A) up to the date of payment of final installment of advance tax by SIPCOT Ltd.

Before the Tribunal, it was argued that the upfront fee was a capital outgo, and that by such payment, the assessee derived the right of possession of the land for 99 years; that the right was an asset, giving rise to an enduring benefit; that the assessee had reflected this right acquired by such payment as an asset in its balance sheet; that no tax was deductible on a capital outgo. SIPCOT Ltd. had treated the entire amount received by it as a revenue receipt and part of its business income from the area development activity, and had accordingly treated the transaction as a deemed sale of land. Reliance was placed on the decision of the Patna High Court in the case of Traders and Miners Ltd. vs. CIT 27 ITR 341, for the proposition that lease of land was a transfer of a capital asset.

The Tribunal agreed with the assessee’s contention that it had received a benefit of enduring nature, that the outgo was on capital account and that it had acquired an asset by making such payment. It noted that the assessee had derived an interest in the property since leasehold interest was a valuable right.

However, according to the Tribunal, the question was not as to whether the outgo was capital or revenue, but as to whether the upfront fee fell within the definition of ‘rent’ under the Explanation to section 194-I. According to the Tribunal, section 194-I did not differentiate between a capital outgo and a revenue outgo. It rejected the assessee’s argument that the payment was made before the date of signing of the lease agreement, as not being relevant. According to the Tribunal, it was an accepted position that the payments were for the lease of the land, that the lease was already in contemplation and that the payment would not have been made unless the lease was at least orally agreed to between the parties. Therefore, according to the Tribunal, the payment, by whatever name called, was made under a lease agreement.

According to the Tribunal, the definition of rent would definitely include payments of any type under any agreement or arrangement for the use of land. For the purposes of section 194-I, the Tribunal was of the opinion that the normal meaning of the term rent could not be used, but that the specific definition of rent had to be applied, which, in the opinion of the Tribunal, would squarely cover the payment made by the assessee to SIPCOT Ltd.

The Tribunal therefore upheld the order of the Commissioner (Appeals), holding that tax was deductible at source. Having held that the tax was deductible at source, the Tribunal however proceeded to hold that such tax could not be recovered from the assessee as the relevant taxes had already been paid by SIPCOT Ltd., and that only interest u/s. 201(1A) could be recovered from the assessee.

Navi Mumbai SEZ’s case

The issue again came up before the Mumbai bench of the Tribunal in the case of ITO vs. Navi Mumbai SEZ (P) Ltd., 147 ITD 261.
in this case, the assessee was a special purpose vehicle constituted by the maharashtra Government Corporation, City and industrial development Corporation of maharashtra ltd. (CidCo) and dronagiri infrastructure Private Limited for developing and operating an SEZ at navi mumbai. CidCo was the town development authority for navi mumbai, and had acquired privately owned lands in that area for development work. CidCo was also appointed as the nodal agency for setting up the SeZ at navi mumbai.

a development agreement, followed by the lease deed, was entered into between CidCo and the assessee, whereunder the assessee agreed for payment of lease premium, in respect of land acquired by CidCo and allotted to the assessee, from time to time. accordingly, the assessee paid lease premium of rs. 50 crore in assessment year 2006-07, rs. 946.06 crore in assessment year 2007-08, Rs. 1,033.61 crore in assessment year 2008-09, and rs. 146.82 crore in assessment year 2009-10.

By virtue of the lease, the assessee had acquired lease- hold rights in the land for the purpose of developing, designing, planning, financing, marketing, developing necessary infrastructure, providing necessary services, operating and maintaining infrastructure, and administering and managing the SEZ to be known as the navi mumbai SEZ. the assessee had also acquired the rights to determine, levy, collect, retain, and utilise user charges, fees for provision of services and/or tariffs under the lease deed. the lease deed and development agreement assigned to the assessee the right to develop, construct and dispose of residential and commercial spaces. the assessee was also entitled to grant a sub-lease in respect of portions of the lease land, in accordance with applicable laws and as per the lease deed. the assessee was granted the power to assign its rights, title or interest or create a security interest in respect of its right, either fully or in part thereof, in favour of lenders, including the grant of step in rights in the event of default under the financing arrangements for the purposes of obtaining finance for the SEZ. under the development agreement, the assessee acquired sole rights for marketing of the SEZ and the industrial/commercial projects to potential tenants.

The assessing officer took the view that the lease premium was ‘rent’ within the meaning of the said term u/s. 194-i and that the assessee ought to have deducted tax at source from such payment. according to the assessing Officer, almost any and every payment in relation to property under lease transactions was to be treated as rent for the purposes of section 194-i and hence lease premium partook of the character of rent. according to the ao, the various restrictive clauses in the lease agreement negated the assessee’s contention that it had acquired rights in the land and not merely rights to use the land. the ao therefore held that the assessee was in default for non-deduction of tax at source on such payment.

The Commissioner (appeals) noted that the assessee had been allotted land for a period of 60 years on the payment of lease premium and that the lease deed and the development agreement assigned to the assessee leasehold rights, which included a bundle of rights. he held that the payment of lease premium by the assessee was for acquiring the lease and it could not be equated with rent. The Commissioner (Appeals) noted that the definition of the term ‘rent’ specifically used the term ‘for the use of,’ and that the usage was of the utmost importance in any transaction for it to be treated as rent. according to the Commissioner (appeals), a transaction of lease might have stipulations which make it a transaction identical to the transactions between a landlord and a tenant and that was why various terms like sub-lease, tenancy, etc. had been used in the section. however, in many cases, a lease transaction might not necessarily be similar or identical to a transaction between a landlord and tenant, and instead might indicate a sale transaction, in the sense that certain more valuable rights in the property were transferred.

The Commissioner (appeals) also drew a distinction be- tween a case where the tenant or lessee used the proper- ty for his own purposes or employed it for his own benefit, in which case the consideration would be in the nature of rent, as against a situation where the property was exploited in a manner that its identity did not remain the same and thereafter it was sold, by the lessee, for a profit, which was the situation in the assessee’s case and hence could not be termed as a transaction between a landlord and a tenant. according to the Commissioner (appeals), the latter was a case where the lessee acquired a capital right to develop the land and exploit it. the Commissioner (appeals) therefore held that the assessee had acquired rights in land and had not paid for the use of the land, and that therefore the provisions of section 194-i were not attracted.

On further appeal by the revenue, the tribunal noted that the word ‘rent’ as defined u/s. 194-I had a wider meaning than that in common parlance. the tribunal also noted that the assessee however had paid the lease premium to acquire the leasehold land and that there was no provi- sion for refund of the lease premium paid by the assessee. it took note of the decision of the Supreme Court in the case of A. R. Krishnamurthy vs. CIT 176 itr 417, wherein the apex Court held that a lease of land was a transfer of interest in the land, that involved a transfer of title in favour of the lessee, though the lessor had the right of reversion after the period of lease terminated. it also took note of the decision of the delhi high Court in the case of Bharat Steel Tubes Ltd. vs. CIT 252 itr 622, wherein the court held that amount paid for acquiring leasehold rights was premium, which was capital in nature, and that periodical payments made for the continuous enjoyment of the benefits under the lease amounted to rent, which was revenue in nature.

The tribunal also noted the decision of the jurisdictional Bombay high Court in the case of CIT vs. Khimline Pumps Ltd. 258 itr 459, wherein it was held that the payment made for acquiring leasehold rights from a lessee was capital in nature, and could not be treated as an advance rent. according to the tribunal, in the assessee’s case, there was a transfer of substantive interest of the lessor in the leasehold land in favour of the assessee and that the lease premium was a capital expenditure to acquire a capital asset and not for the use of the land.

The tribunal observed that in the case of foxconn in- dia developers (supra) the Chennai bench of the tribu- nal had observed that the payment was made under the lease agreement, and had held that the payment was for use of land and not for acquisition of leasehold land. the tribunal in navi mumbai SeZ’s case therefore, was of the view that the decision of the Chennai bench in foxconn’s case was not applicable to the case before it. the tribu- nal preferred to follow the decision of the delhi tribunal in ITO vs. Indian Newspapers Society 144 itd 668, wherein it was held that the payment of the lease premium was not liable to deduction of tax at source. it also took note of the ratio of the decision of the special bench of the tribunal at mumbai in the case of Jt. CIT vs. Mukund Ltd. 13 Sot 558, where the special bench had held that premium paid for acquiring leasehold rights in land was a capital expenditure.

The mumbai bench of the tribunal therefore held that the premium paid by the assessee did not attract the provisions of section 194-i, and that no tax was required to be deducted at source on such lease premium.

A similar view had been taken earlier by the mumbai bench of the tribunal in the case of ITO vs. Wadhwa & Associates Realtors (P) Ltd. 146 itd 694, in the context of lease of land from mumbai metropolitan regional development authority.

Observations
An immovable property comprises of a bundle of rights, each of them can be separately conveyed for varied consideration to different people. for example, right to own, right to use, right to mine, right to let, right to manage and control, etc. under the general law, sale consideration is received for conveyance of absolute rights in a property while a premium is received for transfer of the partial in- terest of the owner of the property and rent is received for grant of the right to use the property for a period. each of these transfers operate in different fields and the payments there under have different implications.the receipt of the rent is in the revenue field and of the premium is in the capital field. The payment of the rent is revenue expenditure and of the premium is a capital outlay. there may be cases where it may be difficult to draw a precise line between the premium and the rent. there may also be the cases that the parties for convenient reasons chose to use such nomenclatures that do not reveal the true nature of the transactions. the distinction between premium and rent and the norms for identifying each of them is noted by the Supreme Court in the case of CIT vs. Panbari Tea Co. Ltd. 57 itr 422 in the following words:

“The real test of a salami or premium is whether the amount paid, in a lump sum or in instalments, is the consideration paid by the tenant for being let into possession. When the interest of the lessor is parted with for a price, the price paid is premium or salami. But the periodical payments made for the continuous enjoyment of the benefits under the lease are in the nature of rent. The former is a capital receipt, and the latter are revenue receipts. There may be circumstances where the parties may camouflage the real nature of the transaction by using clever phraseology.

This section (section 105 of the Transfer of Property Act), therefore brings out the distinction between the price paid for transfer of right to enjoy the property and the rent to be paid periodically to the lessor. When the interest of the lessor is parted with for a price, the price paid is premium or salami. But the periodical payments made for the continuous enjoyment of the benefits under the lease is in the nature of rent. The former is a capital income and the latter a revenue receipt.

In some cases, the so-called premium is in fact advance rent and in others, rent is deferred price. It is not the form, but the substance of the transaction that matters. The nomenclature used may not be decisive conclusion, but it helps the court, having regard to the other circumstances, to ascertain the intention of the parties.”

It is therefore appropriate to hold that the issue that whether a payment is a premium or a rent is largely a question of fact. the facts will decide as to what has been paid is a premium or a rent, no matter what nomenclature the parties have chosen to use; the facts will decide the character of the payment, no matter it has been paid in one go or in installments. the facts that are relevant for deciding the character are whether the payer’s interest in the property are transferred or whether the payment is for the limited purpose of use of the property for a period. Where the payment is for use of the property, the same would be on revenue account even where paid in one go for a period exceeding one year. in contrast where the payment is for acquiring a part of the interest of the owner, the same will be on capital account even where paid in installments.

Usually in the long lease, the transaction involves a transfer of interest of the owner in part and of the right to use the property as well as the separate payment being made for each of them. in such circumstances, it is fair for the parties and also for the authorities to respect the contents of the lease deed unless they do not reveal the facts but camouflage them.

An yardstick that can be safely used, in a case where the contents of the lease deed do not clearly reveal the true nature of the transaction and of the payment, is to look for the value of the property in the open market and if the premium matches such value, with a difference attributable to the limited title, it can be said that the payment was made for transfer of interest in the property.

An additional issue is whether the distinction between the two terms is to be ignored while interpreting section 194-i, given the specific definition contained in the Explanation to that section. On the first glance, one may be tempted to hold, like what was done by the Chennai bench in foxconn’s case, that any payment made under a lease, is subjected to the provisions of tax deduction at source as such payment should be termed as ‘rent’ within its extended meaning u/s. 194-I. We are afraid that the view of the bench requires reconsideration in as much as the term ‘rent’, even u/s. 194-I, covers a payment only where it is for the use of the properties listed therein. The definition of rent in section 194-i uses the term “for the use of” clearly indicating that it is intended to cover the subsequent periodical payments, which are meant for continuous subsequent usage of the property, and not initial capital payment, meant for acquisition of the right to use the property. had section 194-i intended to also cover payments made for acquisition of the right to use property, it would have used the term “for acquisition of the right to use, or for the use of”.

The Chennai bench of the tribunal took the view that it did not matter as to whether the payment of premium was capital in nature or revenue in nature. it proceeded on the footing that the definition of ‘rent’ in section 194-I was broad enough to cover even capital payments. however, given the use of the term “for use of” in the definition, it is clear that what is covered by the definition is only a revenue expenditure, and not a capital expenditure. the distinction, as observed by the Supreme Court in Panbari tea’s case (supra), between rent (revenue) and premium (capital) also does not seem to have been taken into account by the Chennai bench of the tribunal.

In fact, if one takes the Chennai bench’s decision to its logical conclusion, even payment for outright purchase of land or building will be covered by section 194-i, as purchase of land or building includes acquisition of the right to use the land or building. this would be an absurdity, more particularly as there is a separate provision u/s. 194-ia for deduction of tax at source from payments for acquisition of immovable property.

As rightly analysed by the Special Bench of the tribunal in mukund’s case (supra), if the premium is non-refundable and there is a provision for termination of the lease prior to the end of the lease term, without refund of any part of the lease premium for the unexpired lease term, the payment of premium cannot be regarded as a payment of advance rent. unless the agreement shows that the amount of premium was paid as advance rent for all future years and that a lump sum payment of future years’ rent was paid to avail of some concession in rent, the premium paid is to be regarded as a price for obtaining the leasehold rights. in that case, the tribunal also relied upon the Supreme Court decision in the case of Durga Das Khanna vs. CIT 72 ITR 796, where the Supreme Court took a similar view in relation to a lease agreement for a cinema hall.

The delhi high Court, in the case of Krishak Bharati Co- Operative Ltd. vs. DCIT 350 ITR 24, has pointed out that payment of lease premium is a precondition for securing possession. Where the tenure of the lease is quite substantial and the lease virtually creates ownership rights in favour of the assessee, who is at liberty to construct upon the plot, and exclusive possession has been handed over to the assessee at the time of creation of the lease, the lease premium could not be regarded as advance rent to be amortised over the period of the lease.

In the case of R. K. Palshikar HUF vs. CIT 172 ITR 311 (SC), where the lease was for a long period, namely 99 years, the assessee had parted with an asset of an enduring nature, namely, the rights to possession and enjoyment to the properties leased for a period of 99 years subject to certain conditions on which the respective leases could be terminated, and a premium had been charged by the assessee in all the leases, the Supreme Court held that the grant of the leases amounted to transfer of the capital assets.

In Krishak Bharati’s case (supra), the delhi high Court observed that all the cases where the lease premium was held to be in the nature of advance rent were fact dependent. in the case of DCIT vs. Sun Pharmaceutical Industries Ltd. 329 ITR 479 (Guj), the lease premium was held to be deductible as the annual lease rent was a token amount of rs. 40. in CIT vs. Gemini Arts (P) Ltd. 254 itr 201 (mad), the rent was a nominal amount and there was no provision for increase in rent during the period of lease.

As observed by lord Greene m.r. in henriksen vs. Grafton Hotel Ltd. 24 TC 453:

“A payment of this character appears to me to fall into the same class as the payment of a premium of a lease, which is admittedly not deductible. in the case of such a premium, it is nothing to the point to say that the parties, if they had chosen, might have suppressed the premium and made a corresponding increase in the rent. no doubt they might have done so, but they did not do so in fact.” importantly, the Supreme Court in the case of durga das Khanna (supra) held that the onus is on the revenue to demonstrate that the advance rent has been camouflaged as premium and that the premium has been inflated. According to the Supreme Court, where an arm of the government is a party to the lease agreement, the burden on the Assessing Officer to prove such camouflage would be very heavy and onerous.

Therefore, in a situation where an assessee obtains substantial domain over the immovable property by payment of the lease premium, particularly where the lease premium is paid to a Government authority, the premium would be regarded as a payment for acquisition of the property for the lease period, and not as a payment for the user of the property. therefore, the provisions of section 194-I should not be attracted to such payment of lease premium. the ratio of the decisions of the mumbai and delhi benches of the tribunal, to the effect that no tax is deductible at source in respect of such premium, therefore seems to be the better view of the matter.

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The Aayakar Seva Kendra, situated at Ground Floor, Aayakar Bhavan, Mumbai will accept the Dak/Tapal of the charges of Commissioner of Income Tax-I to Commissioner of Income Tax -13 from assesses/their representatives between 10.30 a.m. to 4.00 p.m. (Lunch Time 1.30 to 2.00 p.m.). Copy of the order available at www.bcasonline.org

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A Press Note bearing No.402/92/2006-MC dated 17th April, 2014 has been issued by CBDT giving instructions to Assessing Officers, laying down Standard Operating Procedure (‘SOP’) for verification and correction of tax-demand. The taxpayers can get the outstanding tax demand reduced/ deleted by applying for rectification along with documentary evidence of tax/demand already paid. The SOP also makes special provisions for dealing with the tax demand upto Rs. 1,00,000/- in the case of Individuals a<

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Intervention application opposing amalgamation – Direct Tax Circular No. 279-Misc.-M-171- 2013-ITJ dated 11th April 2014 –

CBDT has directed the Commissioners to send comments/ objections of the Income tax department to the scheme of amalgamation, if the same is found to be prejudicial to the interest of the revenue. The comments/objections be sent to Regional Director, MCA for incorporating them in its response to the Court.

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New tax returns forms notified – Notification no- 24/2014 [S.O. 997(E) dated 1 April, 2014 – Income tax (Fourth amendment) Rules, 2014

New forms SAHAJ (ITR-1), ITR-2, SUGAM (ITR-4S) and ITR-V” have been notified. Further Rule 12 has been amended with effect from 1st April, 2014 and provides as under :

a) Every partnership firm is required to file its return of income for A.Y. 2014-15 and in subsequent years electronically.

b) Every political party (if its income exceeds the maximum amount not chargeable to tax) is required to file its return of income for A.Y. 2014-15 and in subsequent years electronically.

c) Every Charitable officer by filing form 10. It is now provided that Form 10 is required to be filed electronically.

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Certificate of Lower deduction or non-deduction of tax at source under section 197 of the Income-tax Act, 1961 – matter regarding. – INSTRUCTION NO 1/2014, Dated: 15th January, 2014 (reproduced)

All the Chief Commissioners & Directors General of Income Tax, As per the Citizens Charter the time line prescribed for a decision on application for no deduction of tax or deduction of tax at lower rate is one month. Instances have been brought to the notice of the Board, about considerable delay in issuing the lower/ non deduction certificate u/s. 197 by the jurisdictional Assessing Officers.

2. I am directed to say that the commitment to tax payers as per the Citizens Charter must be scrupulously adhered to by the Assessing Officers and all applications for lower or no deduction of tax at source filed u/s. 197 of the Income-tax Act, 1961 must be disposed of within the stipulated time frame as above.

3. This may be brought to the notice of all officers in the field for compliance. 4. Hindi version will follow. F.No.275/03/2014-IT(B)

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No TDS to be deducted on Service tax component – Circular no. 1/2014 dated 13th January 2014

CBDT has clarified that where as per the terms of contract, service tax is indicated to be charged separately to a resident, TDS would not be deductible on such component of service tax for all items covered under Chapter XVII-B of the Act.

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Clarification on conflicting views of Courts on the issue of disallowability under Section 40(a)(ia) of the Act – CIRCULAR NO.10/ DV/2013 [F.NO.279/MISC./M-61/2012-ITJ(VOL. II)], dated 16-12-2013

There are conflicting judgments of the High Courts, on the issue of applicability of provisions of section 40(a)(ia) of the Act. Various High Courts have taken divergent views on whether the section applies to amounts payable at the end of the year or also to the payments made during the year. CBDT has issued a circular clarifying the provision of section 40(a) (ia) of the Act would cover not only the amounts which are payable as on 31st March of a previous year but also amounts which are payable at any time during the year. For the purpose of section 40(a) (ia) of the Act, the term “payable” would include “amounts which are paid during the previous year”.

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New forms 49A and 49AA prescribed for allotment of PAN – Income –tax (19th Amendment) Rules, 2013 dated 23rd December 2013

For Individuals who are citizens of India, HUF, company, firms (including LLPs), AOPs and BOIs formed and registered in India – Form no 49A has been prescribed and Form 49AA is prescribed for others. Specific requirements have been spelled out for each category in these Rules for documents to be considered as proof of identity, address and date of birth/incorporation.

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CBDT issues Instructions to Assessing Officers advising them to follow the Circular issues on section 10A, 10AA and 10B – Instruction No. 17/2013 (F.NO.178/84/2012-ITA.I) dated 19-11-2013 (reproduced)

A clarificatory Circular No. 01/2013, dated 17-01-2013 (hereinafter referred to as ‘Circular’) was issued by CBDT to address various contentious issues leading to tax disputes in cases of entities engaged in export of computer software which are availing tax-benefits u/s. 10A, 10AA and 10B of the Income-tax Act, 1961.

2. Instances have been reported where the Assessing Officers are not following the clarifications so issued and are taking a divergent view even in cases where the clarifications are directly applicable.

3. The undersigned is directed to convey that the field authorities are advised to follow the contents of Circular in letter and spirit. It is also advised that further appeals should not be filed in cases where orders were passed prior to issue of Circular but the issues giving rise to the disputes have been clarified by the Circular.

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ITO vs. Haresh Chand Agarwal (HUF) ITAT Agra Bench Before A. Mohan Alankamony (AM) and Kul Bharat (JM) ITA No. 282/Agra/2013 A.Y.: 2004-05. Decided on: 20th December, 2013. Counsel for revenue/assessee: K. K. Mishra/ Deependra Mohan.

S/s. 50C, 147 – Failure to apply provisions of section 50C does not lead to escapement of income. Section 50C is not final determination to prove that it is a case of escapement of income.

Facts:
While assessing the total income of the assessee the Assessing Officer (AO) lost sight of the provisions of section 50C of the Act and computed long term capital gains, arising on transfer of property, by adopting agreement value of Rs. 6 lakh to be the sale consideration. The stamp duty value of this property was Rs. 25,89,000.

Subsequently, the AO recorded reasons and reopened the assessment on the ground that income has escaped assessment. In reassessment proceedings, the AO rejected the contentions of the assessee that the property was rented and since the assessee was in need of funds he had to sell the property to its tenants. The AO adopted the stamp duty value to be full value of consideration. He also did not accept cost of construction declared by the assessee at Rs. 6,42,558 for computation of capital gains.

Aggrieved, the assessee filed an appeal to CIT(A) where it challenged the reopening and also the additions on merits. The CIT(A) held that reopening was bad in law since it was based on change of opinion as the AO did not have any tangible material in his possession except the sale deed which has already been produced before the AO at the stage of original assessment proceedings.

Aggrieved, the revenue preferred an appeal to the Tribunal. Held: The Tribunal after considering the ratio of the various decisions of the Apex Court and the High Courts held that it is clear that AO is not justified in reopening the assessment on mere change of opinion. It is admitted fact that there is no material available with the AO to form his opinion that income has escaped assessment. All material evidences were available at the stage of original assessment proceedings and the AO merely following the provisions of section 50C, as was not considered in the original assessment proceedings, reopened the assessment. The assessee has disclosed all the facts which were known all along to the Revenue. Section 50C is not final determination to prove that it is a case of escapement of income. The report of approved valuer may give estimated figure on the basis of facts of each case. Therefore, on mere applicability of section 50C would not disclose any escapement of income in the facts and circumstances of the case. The AO at the original assessment stage considered all the documents and material produced before him and has accepted the cost of property as was declared by the assessee. Therefore, on mere change of opinion, the AO was not justified in reopening the assessment. The CIT(A) on proper appreciation of facts and law correctly quashed the reassessment proceedings.

The appeal filed by the revenue was dismissed.

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Business expenditure: Disallowance u/s. 14A: 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. M/s. Shivam Motors (P) Ltd.(All); ITA No. 88 of 2014 dated 05-05-2014: A. Y. 2008-09):

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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Search and seizure – Block assessment – Assessment of third person – For the purpose of section 158BD of the Act a satisfaction note is sine qua non and must be prepared by the assessing officer before he transmits the records to the other assessing officer who has jurisdiction over such other person. The satisfaction note could be prepared at either of the following stages: (a) at the time of or along with the initiation of proceedings against the searched person u/s. 158BC of the Act;

CIT vs. Calcutta Knitwears
(2014) 362 ITR 673 (SC)

A search operation u/s. 132 of the Act was carried out in two premises of the Bhatia Group, namely, M/s. Swastik Trading Company and M/s. Kavita International Company on 05-02-2003 and certain incriminating documents pertaining to the respondent assessee firm engaged in manufacturing hosiery goods in the name and style of M/s. Calcutta Knitwears were traced in the said search.

After completion of the investigation by the investigating agency and handing over of the documents to the assessing authority, the assessing authority had completed the block assessments in the case of Bhatia Group. Since certain other documents did not pertain to the person searched u/s. 132 of the Act, the assessing authority thought it fit to transmit those documents, which according to him, pertain to the “undisclosed income” on account of investment element and profit element of the assessee firm and require to be assessed u/s. 158BC read with section 158BD of the Act to another assessing authority in whose jurisdiction the assessments could be completed. In doing so, the assessing authority had recorded his satisfaction note dated 15-07-2005.

The jurisdictional assessing authority for the respondentassessee had issued the show cause notice u/s. 158BD for the block period 01-04-1996 to 05-02-2003, dated 10- 02-2006 to the assessee inter alia directing the assessee to show cause as to why should the proceedings u/s. 158BC not be completed. After receipt of the said notice, the assessee firm had filed its return u/s. 158BD for the said block period declaring its total income as Nil and further filed its reply to the said notice challenging the validity of the said notice u/s. 158BD, dated 08-03-2006. The assessee had taken the stand that the notice issued to the assessee is (a) in violation of the provisions of section 158BD as the conditions precedent have not been complied with by the assessing officer and (b) beyond the period of limitation as provided for u/s. 158BE read with section 158BD and therefore, no action could be initiated against the assessee and accordingly, requested the assessing officer to drop the proceedings.

The assessing authority, after due consideration of the reply filed to the show cause notice, had rejected the aforesaid stand of the assessee and assessed the undisclosed income as Rs. 21,76,916/- (Rs.16,05,744/- (unexplained investment) and Rs. 5,71,172/- (profit element)) by order dated 08-02-2008. The assessing officer was of the view that section 158BE of the Act did not provide for any limitation for issuance of notice and completion of the assessment proceedings u/s.158BD of the Act and therefore a notice could be issued even after completion of the proceedings of the searched person u/s. 158BC of the Act.

Disturbed by the orders passed by the assessing officer, the assessee firm had carried the matter in appeal before the Commissioner of Income-tax (Appeal- II) (for short ‘the CIT(A)’. The CIT(A), while rejecting the stand of the assessee in respect of validity of notice issued u/s. 158BD, had partly allowed the appeal filed by the assessee firm and deleted the additions made by the assessing officer in its assessments, by his order dated 27-08-2008.

The Revenue had carried the matter further by filing appeal before the Income-tax Appellate Tribunal (for short ‘the Tribunal’) and the assessee has filed cross objections therein. The Tribunal, after hearing the parties to the lis, had rejected the appeal of the Revenue and observed that recording of satisfaction by the assessing officer as contemplated u/s. 158BD was on a date subsequent to the framing of assessment u/s. 158BC in case of the searched person, that is, beyond the period prescribed u/s. 158BE(1)(b) and thereby the notice issued u/s. 158BD was belated and consequently the assumption of jurisdiction by the assessing authority in the impugned block assessment would be invalid.

Aggrieved by the order so passed by the Tribunal, the Revenue had carried the matter in appeal u/s. 260A of the Act before the High Court. The High Court, by its impugned judgment and order dated 20-07-2010, had rejected the Revenue’s appeal and confirmed the order passed by the Tribunal.

On appeal, the Supreme Court observed that section 158BD of the Act is a machinery provision and inserted in the statute book for the purpose of carrying out assessments of a person other than the searched person u/s. 132 or 132A of the Act. U/s. 158BD of the Act, if an officer is satisfied that there exists any undisclosed income which may belong to a other person other than the searched person u/s. 132 or 132A of the Act, after recording such satisfaction, may transmit the records/ documents/chits/papers etc., to the assessing officer having jurisdiction over such other person. After receipt of the aforesaid satisfaction and upon examination of the said other documents relating to such other person, the jurisdictional assessing officer may proceed to issue a notice for the purpose of completion of the assessments u/s. 158BD of the Act, the other provisions of XIV-B shall apply.

The opening words of section 158BD of the Act are that the assessing officer must be satisfied that “undisclosed income” belongs to any other person other than the person with respect to whom a search was made u/s.132 of the Act or a requisition of books were made u/s. 132A of the Act and thereafter, transmit the records for assessment of such other person. Therefore, according to the Supreme Court the short question that fell for its consideration and decision was at what stage of the proceedings should the satisfaction note be prepared by the assessing officer: Whether at the time of initiating proceedings u/s. 158BC for the completion of the assessments of the searched person u/s. 132 and 132A of the Act or during the course of the assessment proceedings u/s. 158BC of the Act or after completion of the proceedings u/s. 158BC of the Act.

The Supreme Court noted that the Tribunal and the High Court were of the opinion that it could only be prepared by the assessing officer during the course of the assessment proceedings u/s. 158BC of the Act and not after the completion of the said proceedings. The Courts below had relied upon the limitation period provided in section 158BE(2)(b) of the Act in respect of the assessment proceedings initiated u/s. 158BD, i.e., two years from the end of the month in which the notice under Chapter XIV-B was served on such other person in respect of search initiated or books of account or other documents or any assets are requisitioned on or after 01-01-1997.

The Supreme Court held that before initiating proceedings u/s. 158BD of the Act, the assessing officer who has initiated proceedings for completion of the assessments u/s. 158BC of the Act should be satisfied that there is an undisclosed income which has been traced out when a person was searched u/s. 132 or the books of accounts were requisitioned u/s. 132A of the Act. U/s. 158BD the existence of cogent and demonstrative material is germane to the assessing officers’ satisfaction in concluding that the seized documents belong to a person other than the searched person is necessary for initiation of action u/s. 158BD. The bare reading of the provision indicated that the satisfaction note could be prepared by the assessing officer either at the time of initiating proceedings for completion of assessment of a searched person u/s. 158BC of the Act or during the stage of the assessment proceedings. According to the Supreme Court, it did not mean that after completion of the assessment, the assessing officer could not prepare the satisfaction note to the effect that there exists income belonging to any person other than the searched person in respect of whom a search was made u/s. 132 or requisition of books of accounts were made u/s. 132A of the Act. The language of the provision is clear and unambiguous. The legislature has not imposed any embargo on the assessing officer in respect of the stage of proceedings during which the satisfaction is to be reached and recorded in respect of the person other than the searched person.

Further, section 158BE(2)(b) only provides for the period of limitation for completion of block assessment u/s. 158BD in case of the person other than the searched person as two years from the end of the month in which the notice under this Chapter was served on such other person in respect of search carried on after 01-01-1997. According to the Supreme Court, the said section does neither provides for nor imposes any restrictions or conditions on the period of limitation for preparation of the satisfaction note u/s. 158BD and consequent issuance of notice to the other person.

In the result, the Supreme Court held that for the purpose of section 158BD of the Act a satisfaction note is sine qua non and must be prepared by the assessing officer before he transmits the records to the other assessing officer who has jurisdiction over such other person. The satisfaction note could be prepared at either of the following stages: (a) at the time of or along with the initiation of proceedings against the searched person u/s. 158BC of the Act; (b) along with the assessment proceedings u/s. 158BC of the Act; and (c) immediately after the assessment proceedings are completed u/s. 158BC of the Act of the searched person.

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‘Additional Depreciation’ where assets used for less than 180 days

Issue for Consideration
An assessee, in addition to the claim of the depreciation, is entitled to a claim of depreciation u/s. 32(1)(iia) (‘additional depreciation’), on purchase of new plant and machinery and installation thereof, at the rate of 20% of the actual cost of such plant and machinery that is used by the assessee in his business of manufacture or production of articles or things.

Under the second proviso to section 32(1), the depreciation allowed to an assessee is reduced to 50% of the depreciation otherwise allowable, in cases where the asset is put to use for less than 180 days in a year.

Depreciation remaining to be absorbed is carried forward to the following year and is allowed to be set off against the income of such year in accordance with the provisions of section 32(2) of the Income-tax Act.

An interesting issue has arisen, in the context of the above provisions, specifically for additional depreciation, in cases where the new plant and machinery is used for less than 180 days. The issue is about whether, in the circumstances narrated above, an assessee has the right to set off the balance 50% of additional depreciation in the year subsequent to the year of purchase and installation of new plant and machinery. While the Delhi, Mumbai and Cochin benches of tribunal have held that the balance additional depreciation can be set-off in the subsequent year, the Chennai bench of tribunal has taken a contrary view, leading us to take notice of this controversy.

Cosmo Films Ltd .’s case
The issue first came up for consideration in the case of DCIT vs. Cosmo Films Ltd., 13 ITR(T) 340 (Delhi), involving the disallowance of arrears of additional depreciation of Rs. 3,34,78,825 and negating an alternate claim for deduction of additional depreciation for assessment year 2004-05.

The assessee company had purchased new plant and machinery during the financial year 2002-03 which were eligible for additional depreciation. They were put to use in that year for less than 182 days. The company had claimed additional depreciation at 50% of the total additional depreciation for assessment year 20003-04 and the balance 50% for the assessment year 2004-05. The claim of the company was disallowed by the AO for assessment year 2004-05 and his action was confirmed by the Commissioner(Appeals).

In the appeal to the Tribunal, the assessee reiterated that, as per the provisions of section 32(1)(iia), the assessee was entitled for a further sum of depreciation equal to 15% of the actual cost of new plant and machinery acquired during the year and installed; that the assessee had been granted a statutory right by provisions of section 32(1) (iia) to claim a further sum equal to 15% of the actual cost in the year of acquisition; that it had claimed additional depreciation during the year which pertained to the additions to the fixed assets during the preceding previous year; the said additions were made during the second half of the financial year 2002-03 relevant to Assessment Year 2003-04 and the additional depreciation was claimed only for 50% of the eligible additional depreciation otherwise available on all the additions made after 30th September, 2002 on account of the second proviso to section 32(1) (ii). Hence, the same was being claimed during the assessment year 2004-05 as it was the balance of the additional depreciation.

The company further explained that the expression “shall be allowed” made it clear that the assessee was entitled to claim an overall deduction equivalent to 15 % of the actual cost of the said additions to the plant and machinery. It contended that the second proviso to section 32(1)(ii) restricted the allowance to 50% in cases where the assets were used for less than 180 days based on the period of usage and such a restriction could not have abrogated the statutory right provided to the assessee by section 32 (1)(iia). It claimed that nowhere in the Act it was prohibited that remaining balance of additional depreciation on the assets added after 30th September, should not be allowed and the second proviso to section 32(1)(ii) could not overlook the one time allowance, which was a statutory right earned in the year of acquisition; had there been intention to restrict the one time allowance to 50%, then it could have been provided in the proviso to clause (iia), as provided in respect of the second hand machines and those used in office, etc. or in respect of office appliances or road transport vehicles.

It was pointed out that the scope of the additional depreciation u/s. 32(1)(iia) introduced by the Finance (No. 2) Act, 2002 w.e.f. 01-04-2003 was explained by Circular No. 8 of 2002 dated 27-08-2002 reported in 258 ITR (St.) 13 as being ‘a deduction of a further sum’ as depreciation. Therefore what was proposed to be allowed was depreciation simplicitor though it was called as additional depreciation. Therefore, any balance of the amount of additional sum of depreciation was to be considered to be available for being carried forward and set off in terms of s/s. (2) of section 32 of the Act which provided that where, in the assessment of the assessee, full effect could not be given to any allowance u/s/s. (1) of section 32 in any previous year, then the allowance should be added to the amount of allowance for depreciation for the following previous year and deemed to be part of that allowance, or if there was no such allowance for that previous year, then it would be deemed to be the allowance for that previous year, and so on for the succeeding previous year.

The company, relying on the decision of the Supreme Court in the case of Bajaj Tempo Ltd. vs. CIT 196 ITR 188, claimed that a provision for promoting economic growth had to be interpreted liberally and that additional depreciation, being an incentive provision, had to be construed so as to advance the objective of the provision and not to frustrate it. The additional depreciation as provided in Clause (iia) of s/s. (1) of section 32 was a one time benefit whereas the normal depreciation was a year to year feature.;If the benefit was restricted only to 50% then it would be against the basic intention to provide incentive for encouraging industrialisation, which would be unfair, unequitable and unjust. There was no restriction provided in law which restricted the carry forward of the additional sum of depreciation which was a one time affair available to assessee on the new machinery and plant. It was also pleaded that what was expressly granted as an incentive could not be denied through a pejorative interpretation of second proviso to section 32(1)(ii), when such provision by itself did not bar consideration of the balance u/s. 32(2) of the Income-tax Act. Alternatively, it was pleaded that the provisions of section 32(1)(iia) did not stipulate any condition of put to use. Therefore, full deduction was allowable in the year of purchase itself and had to be allowed in full in the assessment year 2003-04, itself.

In reply, the Revenue submitted that the full additional depreciation could be allowed as per section 32(1) (iia) only when the assets were put to use for more than 180 days in the year of acquisition; that the additional depreciation on the assets which were put to use by the assessee for less than 180 days was restricted to 50% of the amount by the second proviso to section 32(1)(ii); that there could not be any carried forward additional depreciation to be allowed in subsequent year; and that compliance of the condition to put to use, in the year of claim, was necessary for allowing any type of depreciation.
On hearing both the sides the tribunal observed and held as under;

• Additional depreciation was introduced for promoting investment in industrial sector.

• The intention was clarified by the Finance Minister, the Memorandum explaining the provisions and the Circular explaining the amendments.

• The provision contained in section 32(1)(iia) wherever desired had placed restriction on the allowance of additional depreciation.

• The said provision did not contain any restriction on allowance of the unabsorbed additional depreciation in the subsequent year.

• The intention was not to deny the benefit to the assesses who had acquired or installed new machinery or plant. The second proviso to section 32(1)(ii) restricted the allowance only to 50% where the assets had been acquired and put to use for a period less than 180 days in the year of acquisition which restriction was only on the basis of period of use. There was no restriction that balance of one time incentive in the form of additional sum of depreciation should not be available in the subsequent year.

• Section 32(2) provided for a carry forward and set off of unabsorbed depreciation. The additional benefit in the form of additional allowance u/s. 32 (1)(iia) was a one time benefit to encourage industrialisation and in view of the decision in the case of Bajaj Tempo Ltd. (supra), the provisions related to it had to be constructed reasonably, liberally and purposively to make the provision meaningful while granting the additional allowance.

• The assessee deserved to get the benefit in full when there was no restriction in the statute to deny the benefit of balance of 50% when the new plant and machinery were acquired and used for less than 180 days.

• One time benefit extended to assessee had been earned in the year of acquisition of new plant and machinery. It has been calculated at 15% but restricted to 50% only on account of period of usage of these plant and machinery in the year of acquisition.

• The expression “shall be allowed” confirmed that the assessee had earned the benefit as soon as he had purchased the new plant and machinery in full but was restricted to 50% in that particular year on account of period of usage. Such restriction could not divest the statutory right.

• The extra depreciation allowable u/s. 32(1)(iia) was an extra incentive which had been earned and calculated in the year of acquisition but restricted for that year to 50% on account of usage. The incentive so earned must be made available in the subsequent year.

BRAKES INDIA LTD.’S CASE

The issue had again come up for consideration before the Chennai Tribunal in the case of Brakes India Ltd. DCIT(LTU), 144 ITD 0403.

In this case, the assessee company contested the disallowance of additional depreciation of Rs. 4,91,39,749 by the AO and confirmed by the Commissioner (Appeals), which was the balance of its claim carried forward from the preceding assessment year. The company had claimed additional depreciation for machinery newly added by it during the preceding assessment year 2006-

7. Since the machinery were used for a period less than 180 days in the preceding assessment year, the assessee had to restrict its claim to 50% of the normal rate of additional depreciation allowed under the Act. However, for the subsequent assessment year 2007-08, the company claimed carry forward of the balance 50% of the additional depreciation. The AO was of the opinion that additional depreciation could be allowed only for new assets added during the year and since the claim of the assessee related to additions to assets made in the preceding assessment year, it could not be allowed. In other words, as per Assessing Officer, residual additional depreciation from earlier year could not be allowed for carry forward to a subsequent year. The Commissioner (Appeals) confirmed the action of the AO following the decision of the tribunal for the preceding assessment year in the company’s own case, wherein the Tribunal had confirmed the disallowance of such a claim.

In appeal before the Tribunal, the company supported its claim on several grounds on the lines of the contentions raised by it before the tribunal for assessment year 2006-07 (copy of unreported decision not available) besides contending that section 32(1 )(iia) was amended with effect from 01-04-2006. and under the amended provision, the only condition for the claim was installation of the asset on which additional depreciation was claimed and that such additional depreciation was statutorily allowable, once assets were installed.

The Tribunal noted and held as under;

• The first requirement for being eligible for a claim of additional depreciation was that the claim should be for a new machinery or plant. A machinery was new only when it was first put to use. Once it was used, it was no longer a new machinery.

• Admittedly, the machinery, on which carry forward additional depreciation had been claimed, was already used in the preceding assessment year, though for a period of less than 180 days.

• Therefore, for the impugned assessment year, it was no more a new machinery or plant. Once it was not a new machinery or plant, allowance u/s. 32(1 ) (iia) could not be allowed to it.

• Additional depreciation itself was only for a new machinery or plant. Carry forward of any deficit of additional depreciation which, as per the assessee, arose on account of use for a period of less than 180 days in the preceding year, if allowed, would not be an allowance for a new machinery or plant.

• A look at the second proviso to section 32(1)(iia) clearly showed that it restricted a claim of depreciation to 50% of the amount otherwise allowable, when assets were put to use for a period of less than 180 days, irrespective of whether such claim was for normal depreciation or additional depreciation.

• The intention of the Legislature was to give such additional depreciation for the year in which assets were put to use and not for any succeeding year.

• There was nothing in the statute which allowed carry forward of such depreciation. There could not be any presumption that unless it was specifically denied, carry forward had to be allowed. What could be carried forward and set off had been specifically mentioned in the Act.

• The Tribunal in the assessee’s own case in I.T.A. No. 1069/Mds/2010 dated 6th January, 2012, at para 15, held as under:-

“15. We have considered the rival submissions. A perusal of the provisions of section 32 as applicable for the relevant assessment year clearly shows that additional depreciation is allowable on the plant and machinery only for the year in which the capacity expansion has taken place, which has resulted in the substantial increase in the installed capacity. In the assessee’s case, this took place in the assessment year 2005-06 and the assessee has also claimed the additional depreciation during that year and the same has also been allowed. Each assessment year is separate and independent assessment year. The provisions of section 32 of the Act do not provide for carry forward of the residual additional depreciation, if any. In the circumstances, the finding of the learned CIT(A) on this issue is on a right footing and does not call for any interference. Consequently, ground No.1 of the assessee’s appeal stands dismissed.”

The tribunal upheld the orders of the AO and the Commissioner (Appeals) and held that the Commissioner (Appeals) was justified in following the view taken by co-ordinate Bench of the Tribunal for the preceding assessment year.

OBSERVATIONS

Section 32(1)(iia) was inserted by Finance (No. 2) Act, 2002 with effect from 01-04-2003. The Finance Minister, in his budget speech, stated that the provision for additional depreciation was introduced to provide incentives for fresh investment in industrial sector and that the clause was intended to give impetus to new investment in setting up a new industrial unit or for cases where the installed capacity of existing units is expanded by at least 25%. The section provided, initially, for additional depreciation at the rate of fifteen percent in respect of the new plant and machinery acquired and installed after 31st March, 2002. These provisions were substituted by the Finance (No. 2) Act of 2004 w.e.f. 01-04-2005 and in its present addition provides for additional depreciation at the rate of twenty percent in respect of the new plant and machinery acquired and installed after 31st March, 2005 by an assessee engaged in the business of manufacture or production of any article or thing. The benefit of additional depreciation is not allowed in respect of the second hand assets, assets installed in office or residence or guest-house, ship, aircraft, vehicles, etc.

The view that an assessee is entitled to claim the deduction for the balance additional depreciation in the succeeding year has been upheld by the Cochin Tribunal in the case of Apollo Tyres Ltd., 45 taxmann.com 337, the Mumbai Tribunal in the case of MITC Rolling Mills (P) Ltd., ITA No. 2789/M/2012 dated 13.05.2013 and again by the Delhi Tribunal in the case of SIL Investments, 54 SOT 54. The Chennai bench of the Tribunal however held that the claim for additional depreciation was not allowable every year but only in the year of the installation of the new asset, CRI Pumps, 58 SOT 154. It is therefore clear that but for the lone decision of the Chennai bench in Brakes India Ltd’s case, the overwhelming view is in favour of the allowance of the balance depreciation in the subsequent years.

The original provision for grant of additional depreciation, operating during the period 01-04-2003 to 31-03-2005, contained a very specific provision in the form of first Proviso, to allow a deduction in a previous year in which the new industrial undertaking began to manufacture or produce any article or thing. A specific reference was therefore made to the previous year in which the deduction was allowed. Significantly, under the new provision, no such restriction based on the year is retained, and this again confirms that the new provision effective from A.Y 2006-07, has no limitation concerning the year or years of claim.

The controversy boils down to insignificance when the Revenue realises that the assessee in no case, over a period of life of the asset, can claim a deduction on account of the depreciation as well as the additional depreciation higher than the actual cost of the asset. It perhaps needs to appreciate that there is no loss of revenue at all over a period of time, confirming the fact that the attempts of the Revenue are misdirected when it is contesting the claim of the assessee for the allowance of the balance additional depreciation.

It is true that Clause (iia) of section 32(1) does not contain any restriction or prohibition for claiming the balance additional depreciation in the subsequent year. At the same time, it is also true that the said clause does not expressly provide for such a claim. There neither is an enabling provision nor a disabling provision. In the circumstances a view favourable to the assessee is preferable, more so when the proviso to the said Clause lists several exclusions, and none of them limit the right of an assessee to claim additional deprecation in full nor deny the right of carry forward of the balance amount.

The provision admittedly has been directed towards encouraging industrialisation by allowing additional benefit for acquisition and installation of new plant and machinery. The incentive is aimed to boost new investments in preferred direction. A construction which frustrates the basic purpose of the provision should be avoided in preference of a pragmatic view.

The Finance Minister in his budget speech and the Finance Bill in the Memorandum and the CBDT in its Circular have amplified that the grant of additional depreciation is for incentivising the promotion of capital goods industry. In the circumstances, it is in the fitness of the scheme that the Revenue Department rises to supplement the intentions of the legislature, instead of frustrating the same. It is a settled position in law that an incentive provision should be liberally construed in favour of grant of the deduction. (see Bajaj Tempo Ltd., 196 ITR 188 (SC)). Even otherwise, an interpretation favourable to the assessee should be adopted in cases where two views are possible, Vegetable Products Ltd. 88 ITR 192 (SC), and for the case under consideration, surely two views are possible, as is confirmed by the conflicting decisions of the tribunal on the subject.

In our opinion, the issue under consideration has moved in a narrow compass and in the process, the larger controversy has remained to be addressed, which is, whether there ever was a need to restrict the claim of additional deprecation to 50%, of the eligible amount under the second proviso, in cases where the new asset in question was used for less than 180 days. Had this aspect been addressed by the concerned parties, the understanding of the issue on hand would have been more clear.

Our understanding of the larger issue is as under:

• The claim for regular depreciation is made possible vide clauses (i) and (ii) of s/s. (1) of section 32 of the Act.
• The quantum of regular depreciation, so allowed, has been circumscribed to 50% of the deprecation, otherwise allowable, by virtue of the second proviso to the said provision contained in clauses (i) and (ii) of s/s. (1) of section 32 of the Act.

• The claim for additional depreciation is allowed under a separate Clause namely, Clause (iia) of section 32(1) of the Act, which Clause is otherwise independent of clauses (i) and (ii) above, though it does refer to clause (iia), and therefore, the claim for additional depreciation is independent of the said restrictive second proviso that has application only to the regular depreciation claim made under the said Clauses (i) and (ii).

• The limitation contained in the said second proviso to Clauses (i) and (ii) should have no application to clause (iia) while claiming additional depreciation.

• Clause(iia) operates in an altogether different field than that of Clauses (i) and (ii).

• The claim for additional deprecation therefore shall be allowed in full in the first year itself, irrespective of the number of days of use and should be set off against the income of the year and importantly, to the extent not so set-off, should be carried forward to the subsequent year for being set off against the income for the succeeding year as per the provisions of s/s. (2) of section 32 of the Act.

In our respectful opinion, the additional depreciation is investment based, while the regular depreciation is period based and both are unrelated to each other. For a valid claim of additional depreciation, it is sufficient to establish that new assets are acquired and installed, and once that is proved, the claim has not to be restricted on account of use of such asset for a period of less than 180 days. The additional depreciation, in full, should be allowed, where possible, in the first year itself, and the balance, where remaining to be absorbed, should be carried forward to the succeeding year and should be allowed to be set off against the income of that year.

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Interest expenditure: Section 57(iii): Money borrowed for investing in shares in company owning immovable property: Dividend not received: Interest not disallowable on ground that investment was not made for purpose of earning dividend:

Sri Saytasai Properties and Investment P. Ltd. vs. CIT; 361 ITR 641 (Cal):

The assessee borrowed money for investment in shares of a company P owning an immovable property the value of which was much higher than the book value. The assessee had not received dividend. The assessee’s claim for deduction of interest on borrowed funds u/s. 57(iii) of the Income-tax Act, was disallowed by the Assessing Officer on the ground that the investment could not be said to have been made for earning dividend. The Tribunal upheld the disallowance.

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

“i) Even though the language of section 37(1) of the Income-tax Act, 1961, is a little wider than that of section 57(iii), that cannot make any difference in the true interpretation of section 57(iii). The language of section 57(iii) is clear and unambiguous and it has to be construed according to its plain natural meaning and merely because a slightly wider phraseology is employed in another section which may take in something more, it does not mean that section 57(iii) should be given a narrow and constricted meaning not warranted by the language of the section and, in fact, contrary to such language.

ii) There was no reason why a proper expenditure should have been disallowed only because the investment was not made for the purpose of earning dividend. There is no finding that the investment was made otherwise than for the purpose of making an income. The Tribunal and the Assessing Officer were wrong in disallowing the expenditure.”

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Housing project: Deduction u/s. 80-IB(10): A. Y. 2007-08: Amendment w.e.f. 01/04/2005 requiring certificate of completion of project within four years of approval: Not applicable to projects approved prior to that date: Assessee entitled to deduction:

CIT vs. CHD Developers Ltd.; 362 ITR 177 (Del):

The assessee, a real estate developer obtained approval for a housing project on 16-03-2005 from the Development Authority. It completed the project in 2008 and by a letter dated 05-11-2008 applied to the Competent Authority for the issue of the completion certificate. The assessee’s claim for deduction u/s. 80-IB(10) was denied inter alia, on the ground that the completion certificate was not obtained within the period of four years as prescribed by the Finance Act, 2004 w.e.f. 01-04-2005. The Tribunal allowed the assessee’s claim for deduction accepting the assessee’s claim that, since the approval was granted to the assessee 16-03-2005 i.e., prior to 01-04-2005, the assessee was not expected to fulfill the conditions which were not on the statute when such approval was granted to the assessee.

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

“i) The approval for the project was given by the Development Authority on 16-03-2005. Clearly, the approval related to the period prior to the amendment, which insisted on the issuance of the completion certificate by the end of the four year period, was brought into force. The application of such stringent conditions, which are left to an independent body such as the local authority who is to issue the completion certificate, would have led to not only hardship but absurdity.

ii) As a consequence, the Tribunal was not, therefore, in error of law while holding in favour of the assessee.”

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CBDT Circular: Binding on Revenue: S/s. 119 and 143(2): A. Y. 2004-05: Circular prescribing time limit of three months from date of filing of return for issuing notice u/s. 143(2): Return filed on 29-10-2004: Notice u/s. 143(2) issued on 14-07-2005: Not valid

Amal Kumar Ghosh vs. ACIT; 361 ITR 458 (Cal):

For the A. Y. 2004-05, the assessee had filed return of income on 29-10-2004. The Assessing Officer issued the notice u/s. 143(2) of the Income-tax Act, 1961 on 14-07-2005. The assessee claimed that the notice u/s. 143(2) was not valid since it has been issued beyond the period of three months of date of filing of the return as prescribed by the CBDT Circulars Nos. 9 and 10. The Tribunal rejected the assessee’s contention and dismissed the appeal filed by the assessee. The Tribunal accepted the contention of the Revenue that the Assessing Officer was competent to issue notice u/s. 143(2) after the expiry of period of three months from the date of filing of the return.

In the appeal by the asessee before the High Court, the Revenue contended that such a notice u/s. 143(2) could have been issued within 12 months from the date of filing of the return and, therefore, the notice was well within time. The Calcutta High Court allowed the assessee’s appeal, reversed the decision of the Tribunal and held as under:

“i) Even assuming that the intention of the CBDT was to restrict the time for selection of the cases for scrutiny to a period of three months, it could not be said that the selection in the case of the assessee was made within the period. The return was filed on 29-10-2004, and the case was selected for scrutiny on 06-07-2005. By any process of reasoning, it was not open to the Tribunal to come to the finding that the Department acted within the four corners of Circular No.s 9 and 10 issued by the CBDT. The Circulars were evidently violated. The Circulars were binding upon the Department u/s. 119.

ii) Even assuming that the circulars were not meant for the purpose of permitting unscrupulous assessees from evading tax, it could not be said that the Department, which is the State, can be permitted to selectively apply the standards set by itself for its own conduct. When the Department has set down a standard for itself, the Department is bound by that standard and cannot act with discrimination. If it does that, the act of the Department is bound to be struck down under Article 14 of the Constitution. In the facts of the case, it was not necessary to decide whether the intention of the CBDT was to restrict the period of issuance of the notice from the date of filing of the return laid down u/s. 143(2).

iii) Thus, the notice u/s. 143(2) was not in legal exercise of jurisdiction.”

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Charitable trust: Exemption u/s. 11 : A. Y. 2009-10: Where assessee-trust, failing to use 85 % of income from property, wrote letter conveying department for option available under Clause (2) of Explanation to section 11(1) to allow it to spend surplus amount to next year, no disallowance was to be made merely on ground that declaration was not made in a prescribed manner:

CIT vs. Industrial Extension Bureau; [2014] 43 taxmann. com 392 (Guj)

The assessee, a registered public charitable trust, being unable to utilise income from property to extent of 85 % wrote a letter conveying department to exercise option available under Clause (2) of Explanation to section 11(1) for allowing accumulation of income. The Assessing Officer added to the income of assessee on ground that for claiming exemption the assessee had to give declaration in the prescribed form which was not done by the assessee. While exercising option a mistake was committed by the assessee, as the amount was wrongly mentioned to a lower figure, but later on the same was rectified. On appeal, the Commissioner (Appeals) allowed only that part which was declared by the assessee in original letter before due date and disallowed remaining revised amount by observing that the revision option was not exercised within due date. On cross appeals, the Tribunal allowed the assessee’s claim and deleted entire amount on ground that the mistake was bona fide and the requirement of exercising option within prescribed time was only directory in nature.

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

“i) U/s. 11, a charitable trust unable to utilise its income derived from property held under trust wholly for charitable or religious purposes to the extent of 85 % would have an option either in terms of clause (2) of Explanation to s/s. (1) thereof, or as provided u/s/s. (2). When such an option is covered u/s/s. (2) i.e., the income is sought to be accumulated or set apart for the period prescribed, that the requirement of making a declaration in the prescribed manner arises. In case of an option under Clause (2) of Explanation to s/s. (1), there is no such requirement of making declaration but the requirement is exercising of such option in writing before the expiry of the time allowed u/s/s. (1) of section 139 for furnishing the return of income.

ii) In the present case, the assessee did exercise such option as is apparent from the letter dated 22-09-2009. In such letter, the assessee conveyed to the department that the assessee gave a notice of option exercised by the trust to allow to spend surplus amount of Rs. 59,17,600 that may remain at the end of the previous year ended on 31-03-2009, during the immediately following the previous year, i.e., 2009-10. In the caption, the assessee referred to as the subject-notice of option exercised as required under Clause (2) of Explanation to section 11(1). These things are thus abundantly clear – firstly, that such option was exercised before last date of filing the return, which was 30-09-2009 and secondly, that such option was exercised in terms of clause (2) of Explanation to section 11(1). That was clearly not an option u/s/s. (2) of section 11. The caption of the said communication dated 22-09–00- as well as the contents of the letter make this clear. If that be so, the assessee cannot be precluded from pursuing such option on the ground as was done by the Assessing Officer that no declaration in the prescribed form was made. As we have noticed that such declaration was required only if the assessee’s option was to be covered by the provision of section 11(2).

iii) It is true that in such option exercised on 22/09/2009, the assessee indicated a smaller figure of Rs. 57,17,600 and it was only later that the same was corrected to Rs. 1,05,67,047. However, the Tribunal has taken note of facts on record namely that the option in fact was exercised within the time permitted under the statute. It was a bona fide error to indicate a wrong figure. The intention to avail carry over of the un-spend income to the next year was clear.

iv) The requirement of exercising an option within the time permitted under Clause (2) of Explanation to section 11(1) is directory and not mandatory. Substantial compliance thereof would therefore be sufficient.

v) Even otherwise, without going to the extent of holding such time limit as directory and not mandatory, in the facts of the present case, the Tribunal committed no error in granting the benefit to the assessee for the entire amount since it was a mere oversight or bona fide error in not indicating the correct and full amount for the option under clause (2) of Explanation to section 11(1).”

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Business expenditure: Disallowance: TDS: Commission/trade discount: S/s. 40(a)(ia) and 194H: A. Y. 2005-06: Assessee in business of manufacture and trade of pharmaceutical products: Incentive to dealers, distributors, stockists under different schemes: Not commission: Section 194H not applicable: Disallowance u/s. 40(a)(ia) not proper:

CIT vs. Intervet India Pvt. Ltd. (Bom); ITA No. 1616 of 2011 dated 01/04/2014:

The assessee was engaged in the business of manufacture and trading of pharmaceutical products. The assessee gave incentives to its distributors/dealers/ stockists under different schemes. In the relevant year, i.e. A. Y. 2005-06, the incentive so given of Rs. 70,67,089/- was disallowed by the Assessing Officer u/s. 40(a)(ia) of the Income-tax Act, 1961, treating the same as commission, on the ground that the assessee has not deducted tax at source u/s. 194H of the Act. CIT(A) and the Tribunal deleted the addition holding that the payment was not commission and the provisions of sections 194H and 40(a)(ia) were not applicable.

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

“i) The assessee had undertaken sales promotion scheme viz., product discount scheme and product campaign under which the assessee had offered an incentive on case to case basis to its stockists/ dealers/agents. An amount of Rs. 70,67,089/- was claimed as deduction towards expenditure incurred under the said sales promotional scheme. The relationship between the assessee and the distributors/ stockists was that of principle to principle and in fact the distributors were the customers of the assessee to whom the sales were effected either directly or through the consignment agent. As the distributors/ stockists were the persons to whom the product was sold, no services were offered to the assessee and what was offered to the distributor was a discount under the product distribution scheme or product campaign scheme to buy the assessee’s products.

ii) The distributors/stockists were not acting on behalf of the assessee and that most of the credit was by way of goods on meeting the sales target, and hence, it could not be said to be a commission payment within the meaning of Explanation (i) to section 194H of the Act. The contention of the Revenue in regard to the application of Explanation (i) below section 194H being applicable to all categories of sales expenditure cannot be accepted. Such reading of Explanation (i) below section 194H would amount to reading the said provision in abstract. The application of the provision is required to be considered to the relevant facts of every case.

iii) We are satisfied that in the facts of the present case that as regards sales promotional expenditure in question, the provisions of Explanation (i) below section 194H of the Act are rightly held to be not applicable as the benefit which is availed by the dealers/ stockists of the assessee is appropriately held to be not a payment of any commission in the concurrent findings as recorded by the CIT(A) and the Tribunal.

iv) We do not find that the appeal gives rise to any substantial question of law. It is accordingly dismissed.”

II. REPORTED:

1. Business Expenditure: Disallowance: Ss. 40(a)(ia), 40A(3) and 194C(2): A. Ys. 2005-06 and 2009-10: ONGC acquiring lands from farmers and others: Land losers forming society for enabling to survive by way of alternate means of plying vehicles on rent to the ONGC: Society receiving amounts from ONGC and distributing to farmers/members: Payments not expended by society and would not come within the meaning of expenditure either u/s. 40(a)(ia) or section 40A(3): No disallowance can be made: ITO vs. Ankleshwar Taluka ONGC and Land Loser Travellers Co-operative Society; A. Y. 2005-06; 362 ITR 87 (Guj): CIT vs. Ankleshwar Taluka ONGC and Land Loser Travellers Co-operative Society; A. Y. 2009-10; 362 ITR 92 (Guj):

ONGC acquired lands in a particular area from farmers and other persons. Land losers formed the assessee society to enable them to earn a source of livelihood by means of plying vehicles on rent to ONGC. The assessee society received the amounts from ONGC on behalf of the members and distributed the same amongst the members. ONGC deducted the tax at source on such payment to the assessee society.

A. Y. 2005-06:

In the A. Y. 2005-06, the assessee society received Rs. 2,57,62,253 and distributed the same to the members. The Assessing Officer was of the view that the society was a sub-contractor and that it ought to have deducted tax at source on payments made to each of the farmers u/s. 194C(2) and disallowed the whole of the amount of Rs. 2,57,62,253/- u/s. 40(a)(ia) of the Income-tax Act, 1961. He made a further addition of Rs. 51,47,250/- being 20% of the said amount by way of disallowance u/s. 40A(3) on the ground that the said amount was paid to the members in cash. The Commissioner (Appeals) deleted the addition. He held that there was no element of works contract in terms of the provisions of section 194C in the activities performed by the society and, accordingly, set aside the disallowance u/s. 40(a)(ia). He also held that there was no case for disallowance u/s. 40A(3) as no expenditure was incurred by the society in distributing the rentals to the members. The Tribunal concurred with the findings of the Commissioner (Appeals) and dismissed the appeal filed by the Revenue.

In appeal before the High Court, the Revenue raised the question of disallowance u/s. 40(a)(ia) but did not raise the question of disallowance u/s. 40A(3) of the Act. The Gujarat High Court upheld the decision of the Tribunal and held as under:

“i) In the light of the concurrent findings of fact recorded by the Tribunal upon appreciation of evidence on record, the reasoning adopted by the Tribunal was just and reasonable.

ii) Thus, it was not possible to state that there was any infirmity in the order of the Tribunal so as to give rise to any question of law, much less, a substantial question of law so as to warrant interference.” A. Y. 2009-10: In this year, the assessee society had received an amount of Rs. 3.79 crore from ONGC and the same was distributed by the assessee society to its members. The Assessing Officer made an addition of 20% of the said amount by way of disallowance u/s. 40A(3) of the Act, on the ground that the assessee had paid these amounts to its members in cash. The Tribunal deleted the addition.

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

“The view of the Commissioner (Appeals) and the Tribunal that the payments were not expended by the assessee and that, therefore, would not come within the meaning of expenditure (be it based on section 40(a)(ia) or section 40A(3) of the Act) was to be confirmed.”

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Income from property held for charitable or religious purposes – A charitable and religious trust which does not benefit any specific religious community would not be covered by section 13(1)(b) of the Act and would be eligible to claim exemption u/s. 11 of the Act.

The respondent, a registered Public Trust under the M. P. Public Trusts Act, 1951, filed an application for registration before the Commissioner of Income Tax (for short, “the Commissioner”) as envisaged u/s. 12A read with section 12AA of the Act for availing the exemption u/s. 11 of the Act. The Commissioner, after affording an opportunity of hearing to the applicant, came to the conclusion that the respondent was a charitable trust but since the object and purpose of the trust was confined only to a particular religious community the same would attract the provisions of section 13(1)(b) of the Act and therefore, declined the prayer made for registration of the trust by his order dated 14-09-2007.

Aggrieved by the order so passed, the respondent carried the matter by way of an appeal before the Tribunal. The Tribunal after going through the objects of the respondent-trust came to the conclusion that the respondent was a public religious trust as the objects of the trust were wholly religious in nature and thus, the provisions of section 13(1)(b) which are otherwise applicable, in the case of the charitable trust would not be applicable and therefore, held that the respondent-trust was entitled to claim registration u/se. 12A and 12AA and accordingly, allowed the appeal and set aside the order passed by the Commissioner and further directed the Commissioner of Income-tax to grant registration u/s. 12A read with section 12AA of the Act to all the applicant-trust.

Aggrieved by the aforesaid decision passed by the Tribunal, the Revenue approached the High Court u/s. 260-A of the Act. The court primarily, was of the view that the decision of the Tribunal was rendered purely on the factual matrix of the case and therefore, it would be improper to disturb the finding of fact so arrived by the Tribunal. Secondly, the court observed that the provisions of section 13(1)(b) would not be applicable to the respondent-trust as the trust was not created or established for the benefit of any particular religious community or caste. Consequently, the court has dismissed the appeal filed by the Revenue by judgment and order dated 22-06-2009.

Disturbed by the aforesaid ruling, the Revenue approached the Supreme Court.

According to the Supreme Court, the determination of the nature of trust as wholly religious or wholly charitable or both charitable and religious under the Act was not a question of fact. It was a question which required examination of legal effects of the proven facts and documents, that is, the legal implication of the objects of the respondent-trust as contained in the trust deed. It is only the objects of a trust as declared in the trust deed which would govern its right of exemption u/s. 11 or 12. It is the analysis of these objects in the backdrop of fiscal jurisprudence which would illuminate the purpose behind the creation or establishment of the trust for either religious or charitable or both religious and charitable purpose. The Supreme Court therefore held that the High Court had erred in refusing to interfere with the observations of the Tribunal in respect of the character of the trust.

Having said so, the Supreme Court proceeded to examine the question, whether the Courts below were justified in coming to the conclusion that the respondent-trust was a public religious trust and therefore, outside the purview of section 13(1) (b) and eligible for exemption u/s. 11 of the Act.

The Supreme Court noted that the Tribunal had analysed the objects of the trust in the light of the holy scriptures and the Quran and recorded its satisfaction as follows: “16… The objects of the assessee-trust reproduced above clearly refer to the religion and are supported by reference made to different pages of Holy Quran. The learned Counsel for the assessee referred to the true copies of several pages of Holy Quran written by two of the authors referred to above in which giving of food in days of hunger or orphan is considered as highly religious ceremony. Reference is also made that who will give to the people or poor then Allah will give them in return and, i.e., who will give loan then Allah will give double to them. Likewise, for helping the needy people for religious activities and to carry out religious activities or spend for good, spending wealth in the way of Allah, bestowing mercy, teaching were considered to be highly religious activities. On going through several true pages of Holy Quran written by the authors referred to above, we are satisfied that the learned Counsel for the assessee was justified in contending that all the objects of the assesee-trust are solely religious in nature because each of them refers to religious occasions, religious education or to religious activities. The learned Counsel for the assessee also explained that the words ‘Shariat-e- Mohammadiyah’ means the path shown by prophet Mohammed. Therefore, the objects of Shariat-e- Mohammadiyah are identical with those of ‘Dawate- Hadiyah’. For Dawoodi Bohras, true path shown by the prophet is the one indicated and shown by their living guide Dai-al-Mutlaq of the time who is the living and visible guide for Dawoodi Bohras. It is an undisputed fact that for the people believing in Islam, writings in Quran are words of Allah for them. The directions given in the Holy Quran are considered by the people of Islamic faith as orders from Allah and the people of Islamic faith obey such orders as holy and religious. The learned Counsel for the assessee has been able to demonstrate that all the objects of the assessee-trust, as noted above, came out from the writings in Quran and as such these are the orders for them while observing Islamic faith.”

The Supreme Court observed that unquestionably, objects (c) and (f) which provide for the activities completely religious in nature and restricted to the specific community of the respondent-trust are objects with religious purpose only. However, in respect to the other objects, in our view the fact that the said objects trace their source to the Holy Quran and resolve to abide by the path of godliness shown by Allah would not be sufficient to conclude that the entire purpose and activities of the trust would be purely religious in colour. The objects reflects the intent of the trust as observance of the tenets of Islam, but do not restrict the activities of the trust to religious obligations only and for the benefit of the members of the community. The Privy Council in Re The Tribune, 7 ITR 415 has held that in judging whether a certain purpose is of public benefit or not, the Courts must in general apply the standards of customary law and common opinion amongst the community to which the parties interested belong to. Therefore, it is pertinent to analyse whether the customary law would restrict the charitable disposition of the intended activities in the objects.
The provision of food to the public on religious days of the community as per object (a) and (b), the establishment of Madrasa and organisations for dissemination of religious education under object
(d) and rendering assistance to the needy and poor for religious activities under object (e) would reflect the essence of charity. The objects (a) and
(b) provide for arrangement for nyaz and majlis (lunch and dinner) on the religious occasion of the birth anniversary and Urs Mubarak of Awliya-e- Quiram (SA) and the Saints of the Dawoodji Bohra community and for arrangement of lunch and din- ner on religious occasions and auspicious days of the Dawoodi Bohra community, respectively. Nyaz refers to the food a person makes and offers to others on any particular occasion on the occasion of the death of a saint and Majhlis implies a place of gathering or meeting. The activity of providing for food on certain specific occasions and other religious and auspicious events of the Dawoodi Bohra community do not restrict the benefit to the members of the community. Neither the religious tenets nor the objects as expressed limit the service of food on the said occasions only to the members of the specific community. Thus, the activity of Nyaz performed by the respondent-trust does not delineate a separate class but extends the benefit of free service of food to the public at large irrespective of their religious, caste or sect and thereby qualifies as a charitable purpose which would entail general public utility.

Further, the establishment of the Madrasa or institutions to impart religious education to the masses would qualify as a charitable purpose qualifying under the head of education under the provisions of section 2(15) of the Act. The institutions established to spread religious awareness by means of education though established to promote and further religious thought could not be restricted to religious purposes. The House of Lords in Barralet vs. IR, 54 TC 446, has observed that “the study and dissemination of ethical principles and the cultivation of rational religious sentiment” would fall in the category of educational purposes. The Madrasa as a Mohommedan institution of teaching does not confine instruction to only dissipation of religious teachings but also contributes to the holistic education of an individual. Therefore, it cannot be said the object (d) would embody a restrictive purpose of religious activities only. Similarly, assistance by the respondent-trust to the needy and poor for religious activities would not divest the trust of its altruistic character.

Therefore, the objects of the trust, according to the Supreme Court, exhibited dual tenor of religious and charitable purposes and activities. Section 11 of the Act shelters such trust with composite objects to claim exemption from tax as a religious and charitable trust subject to pro- visions of section 13. The activities of the trust under such object would therefore be entitled to exemption accordingly.

According to the Supreme Court, the second issue which arose for its consideration and decision was, whether the respondent-trust was a charitable and religious trust only for the purposes of a particular community and therefore, not eligible for exemption u/s. 11 of the Act in view of provisions of section 13(1)(b) of the Act.

The Supreme Court held that in the present case, the objects of the respondent-trust were based on religious tenets under the Quran according to the religious faith of Islam. As already noticed, the perusal of the objects and purposes of the respondent-trust clearly demonstrated that the activities of the trust though both charitable and religious were not exclusively meant for a particular religious community. The objects, as explained in the preceding paragraphs, did not channel the benefits to any community if not the Dawoodi Bohra Community and thus, would not fall under the provisions of section 13(1)(b) of the Act.

In that view of the matter, the Supreme Court held that the respondent-trust was a charitable and religious trust which did not benefit any specific religious community and therefore, it could not be held that section 13(1)(b) of the Act would be attracted to the respondent-trust and thereby, it would be eligible to claim exemption u/s. 11 of the Act.

shailesh.kwebmaker

Year of Taxability of Interest on Refund of Tax

Synopsis

Section 244A of the Income Tax Act,
entitles an assessee to receive interest on amount of refund of tax due
to him. For an assessee, following the mercantile system of accounting,
the issue arises on the year of accrual of such interest and taxability
thereon.

The issue being whether such interest is accrued in each year
and hence to be taxed by spreading it over the number of years for which
it is granted or should it be taxed in the year in which it is granted.
This issue had been a subject matter of adjudication before various
courts. Here, the author has analysed various judicial pronouncements in
this regard.

Issue for Consideration:

An assessee is entitled to
receive simple interest, on the amount of refund of tax that becomes due
to him, at the specified rate, for the period commencing from the date
of payment of tax to the date on which the refund is granted, as per the
provisions of section 244A of the Income-tax Act.

Such interest is
usually chargeable to tax under the head “Income From Other Sources” and
is computed in accordance with the method of accounting regularly
employed by the assessee. This interest is taxed in the year of receipt,
in case of an assessee following the cash system of accounting, and in
case of an assessee following the mercantile system of accounting, is
taxed in the year of the accrual of such interest.

The period for which
such interest is granted usually exceeds 12 months. The quantum of
interest also varies in many cases on passing of orders from time to
time, subsequent to the intimation or the first order, ranging from
assessment orders to appellate orders. Again, in many cases, the
assessees are forced to pay taxes towards demands raised in pursuance of
orders that finally do not stand the scrutiny of the appellate
authorities. In all these cases, barring a few cases, the assessee
receives interest only on the final settlement of the disputes
concerning computation of the total income by the highest appellate
authority.

The issue that arises, for consideration, in all such cases
of receipt of interest, is about the year or years of taxation of such
interest, for the period exceeding 12 months, in the hands of the
assessees following the mercantile system of accounting. The issue in a
nutshell is about ascertaining the year of accrual of such interest.
Does such interest, under the mercantile system, accrue from year to
year from the date of payment of tax till the date of the receipt of
such interest or does it accrue only when the refund is ordered by an
authority and interest thereon is granted to the assessee? In the first
case, the interest so received is taxable in more than 1 year, on the
understanding that the interest accrues on a daily basis and is taxable
in more than 1 assessment year while in the later case, it is taxed only
in the year of the passing of an order grating interest.

The courts
have been asked to adjudicate as to whether such interest accrued form
year to year and is therefore to be taxed by spreading it over the
number of years for which it is granted or should it be taxed in the
year in which it is granted. Recently, the Andhra Pradesh High Court has
held that such interest accrued from year to year and for taxation, it
should be spread over the number of years for which interest is granted
dissenting from the decisions of the Kerala, Orissa and Allahabad High
Court.

Smt. K. Devayani Amma’s case

The issue of years of accrual of
interest on refund, granted u/s. 244, was examined by the Kerala High
Court in the case of Smt. K. Devayani Amma vs. DCIT, 328 ITR 10. In that
case, the Court was asked, by the assessee, to decide whether the
Tribunal was justified in holding that interest received by the assessee
on refund was assessable in the assessment year in which such interest
was granted. In that case, the Assessing Officer granted an amount of
interest of Rs. 2,87,537, u/s. 244, on refund of tax computed in
pursuance of the order passed to give effect to an appellate order for
A.Y. 1983-84, that was decided in favour of the assessee. The order of
refund was passed in the previous year relevant to A.Y. 1994-95 and the
refund together with interest was also received in the said year. The
Assessing Officer taxed the entire interest of Rs. 2,87,537 in the A.Y.
1994-95, by treating such interest as the income of A.Y. 1994-95, on the
ground that interest had accrued during that year.

The assessee
however, contested the liability for tax on the entire interest in one
assessment year on the ground that the interest in question accrued from
year to year, from the date of payment of excess tax till the date of
refund. The contention of the assessee was upheld by the CIT(A), but the
Tribunal agreed with the Assessing Officer by holding that the said
interest accrued in A.Y. 1994-95, only, following the decisions in the
case of CIT vs. Sri Popsingh Rice Mill, 212 ITR 385 (Orissa) and J.K.
Spinning and Weaving Mills Co. vs. Addl. CIT, 104 ITR 695 (All.). The
assessee, in the appeal before the High Court, contended that interest
income was assessable on a year to year basis, spread over the period
commencing from the year in which the tax was paid and ending with the
year in which it was refunded together with interest thereon, by relying
on the decision of the Supreme Court in the case of Rama Bai vs. CIT,
181 ITR 400.

In reply, the standing counsel for the Income-tax
Department submitted that the interest income accrued only on passing of
the order for granting refund. He also submitted that the decision in
Rama Bai’s case (supra) was delivered in respect of an interest received
under the Land Acquisition Act and was not relevant for determining the
year of taxation of interest received under the Income-tax Act. He also
pointed out that the decision in the case of Sri Popsingh Rice Mill
(supra), delivered by the Orissa High Court, had followed the subsequent
decision of the Supreme Court in preference to its decision in Rama
Bai’s case to hold that the interest was taxable in the year of grant
thereon.

The Kerala High Court noted that the decision in Rama Bai’s
case(supra) concerned itself with taxation of interest under the Land
Acquisition Act and was not binding for deciding an issue of taxation of
interest, granted under the Income-tax Act and that the issue therefore
was required to be considered in light of the statutory provisionsof
the Income-tax Act. The court also observed that the law declared by the
Supreme Court was neutralised by the amendments in section 145A(b) and
section 56(viii) by the Finance (no.2) Act, 2009 concerning the year of
taxation of interest received on compensation or enhanced compensation
for compulsory acquisition .

The Kerala High Court found that the
assessee’s eligibility for interest arose only when the effect was given
to the appellate order and till such time the assessee was not entitled
to any refund at all; that the right to interest on refund arose only
when the refund was ordered in favour of the assessee. Accordingly, in
view of the Court, interest accrued only when the assessee was found to
be eligible for refund of the excess tax, based on the revision of the
assessment order. The Court took notice of the fact that not only the
interest was granted during A.Y. 1994-95, but was also paid during the
said assessment year. The assessee’s appeal was dismissed and the order
of the Tribunal was confirmed by the Court by holding that interest on
refund of tax accrued in the year of passing the order granting refund .

M. Jaffersaheb (Decd.)’s case
The issue once again arose recently, before the Andhra Pradesh High Court, in the case of Shri M. Jaffer Saheb (Decd.) vs. CIT, 43 taxmann.com,123. The facts in this case were that for the assessment year 1982-1983, an assessment was completed with substantial additions resulting into a huge demand for payment of taxes. The assessee paid the de- manded tax and thereafter availed the appellate remedies and in that process the appellate tribunal finally passed an order granting substantial relief to the assessee on 16-06-1989. The AO gave effect to the order of the Tribunal by an order dated 18-09- 1989, refunding the excess amount paid along with interest of Rs. 79,950/- for the period 30-10-1985 to 31-08-1989 which was received thereafter. The AO brought to the tax the amount of interest in the assessment year 1990-1991, ignoring the claim of the assessee to spread over the said amount for the assessment years starting with assessment orders 1985-1986 to 1988-1989. The Appellate Commissioner allowed the claim of the assessee and directed that the interest, other than the part pertaining to the assessment year 1990-91, be taxed in the preceding previous years. The Tribunal, on further appeal by the Revenue, reversed the order of the Appellate Commissioner and restored the assessment order passed by the A.O.

At the instance of the assessee, the following two questions of law for the assessment year 1990-1991 were referred to the Andhra Pradesh High Court :

1) “Whether on the facts and in the circumstances of the case, is the Appellate Tribunal correct in law in holding that interest U/S.244(1A) of the Income-tax Act on the refund due accrues on the date when the Appellate Tribunal passed order and did not accrue on any day anterior to the date of the Tribunal order?”

2) “Whether on the facts and in the circumstances of the case, the Appellate Tribunal is correct in law; in refusing to accept the contention of the applicant that interest on the refund accrued from the previous year relevant to the assessment year 1982-1983 and interest is chargeable to tax in the respective years for which interest is paid?”

The assessee submitted before the High Court that he was entitled to the refund from the date of payment of the tax till the date of granting of the refund and that such interest accrued on day to day basis on the excess amount paid. He submitted that the entitlement of the interest was a right conferred by the statute that did not depend on the order for the refund being made which was only consequential and in law was required to be made more in the nature of complying with the procedural requirement, but his right to claim interest was a statutory right conferred by the Act and in that view of the matter, it was but fair to spread the interest amount in the respective years in issue. He relied on the judgment of the Calcutta High Court in the case of CIT vs. Hindustan Motors Ltd., 202 ITR 839 for the proposition that “Accrual of interest takes place normally on day to day basis. Where there is no due date fixed for payment of interest, interest accrues on the last day of the previous year. Accrual of interest does not depend upon making up of the accounts.” He also relied on the judgment of the Kerala High Court in the case of Peter John vs. CIT, 157 ITR 711 (Ker)(FB) for the proposition that “Interest is separate from refund. Interest whether statutory or contractual represents profit the creditor might have made if he had used that money or loss he suffered because he had not that use. It is something in addition to the refund (capital amount) though it arises out of it.” He also relied on the judgment of the Supreme Court in the case of Ramabai vs. CIT, 181 ITR 401 (SC).

On the other hand, the Income-tax Department submitted that the right to claim interest by the assessee was dependent on an orders being passed u/s. 240 and section 244 of the Income-tax Act and in that view of the matter, the right to claim interest accrued to the assessee only on the date of consequential order passed pursuant to the order of the Appellate Authority and as such, the interest income was assessable in the assessment year 1990- 1991. Reliance was placed on the judgments of the Orissa, Kerala and Allahabad High Courts in the cases of Commissioner of Income-Tax vs. Sri Popsingh Rice Mill, 212 ITR 385 (Orissa), Smt. K. Devayani Amma vs. Deputy Commissioner of Income-Tax and Another 328 ITR 10 (Ker),)and J.K. Spinning and Weaving Mills Co., vs. Additional Commissioner of Income-Tax, Kanpur104 ITR 695 (Allahabad).

The Andhra Pradesh High Court examined the provisions of sections 237, 240, 244 and 244A for ascertaining the statutory position relating to grant of refund and interest thereon. A close scrutiny of the sections 237 and 240, revealed to the Court that the statutory right was conferred on the assessee to get refund of the excess tax paid and such refund was made available to the asssessee even without his having to make any claim in that behalf in as much as section 244A of the Act entitled the assessee to get interest on the refund amount and such interest was payable from the date of payment of tax or payment of penalty from the date till refund was granted.

It was clear to the High Court, from the statutory provisions as applicable to the relevant assessment years, that there was no requirement of the assessee for making a claim either for refund or for interest. As a matter of fact, the Court noticed that sections 243 and 244, were made inapplicable in respect of any assessment for the assessment year commenc- ing on the first day of April, 1989 or any subsequent assessment years.

On a detailed analysis of the decisions of the various Courts in the cases of Rama Bai vs. CIT, 181 ITR 401 (SC), CIT vs. Sankari Manickyamma 105 ITR 172 (AP).

Mrs. Khorshed Shapoor Chinai vs. ACED 90 ITR 47 (AP), CIT vs. Govindarajulu Chetty (T.N.K.) 165 ITR 231 (SC),T.N.K. Govindarajulu Chetty vs. CIT 87 ITR 22 (Mad.), CIT vs.Dr. Sham Lal Narula, 84 ITR 625 (P&H), and CIT, Mysore vs. V.Sampangiramaiah, 69 ITR 159 (Kar), the court significantly noted that the principle which could be culled out was that once the income had legally accrued to the assessee, i.e., the assessee had acquired a right to receive the same, though its valuation might be postponed to a future date, the determination or quantification of the amount did not postpone the accrual. In other words, if the right had legally accrued to the assessee, then the right should be deemed to have accrued in the relevant year, even though the dispute as to the right was settled in the later year, by the one or the other of the authorities in the hierarchy.

The Andhra Pradesh High Court expressly dissented with the decision of the Kerala High Court in the case of Smt. K. Devayani Amma (supra) by observing that;

• though the Kerala High Court, in the said judge- ment, referred the case of Rama Bai (supra), there was no discussion about the principles that were approved in the judgment of the Supreme Court;

• though the provisions of sections 240 and 244(1A) of the Act were referred to, the Kerala High Court held that interest on refund arose only on passing an order in favour of the assessee;

• the eligibility of interest u/s. 244(1A) of the Act arose on an order of revision of assessment passed pursuant to the appellate order which led to grant of refund of excess tax paid by the assessee;

• the reading of sections 237, 240 and 244(1A) cast a duty on the AO to charge that much of tax which the assessee was liable to pay and mandated the refund of the excess amount along with interest;

• the hierarchy of appeals provided were only to ensure that the tax authorities adhere to strict rules of taxation and the statutory provisions. Even the final order that might be passed by the higher authority in the hierarchy of authorities provided under statue was also an order of assessment only for the simple reason that the final order passed was nothing but a correction of the original assessment order, which was erroneous.

• the opinion expressed by the Kerala High Court that interest u/s. 244(1A) of the Act accrued to the assessee only, when it was granted to the assessee along with the refund order issued u/s. 240 of the Act was not correct, especially, in view of the law laid down by the Supreme Court as quoted in the judgment of the Madras High Court in T. N. K. Govindarajulu Chetty’s case (supra).

• The court was unable to accept the judgment of Kerala High Court reported in K. Devayani Amma’s case (supra) on the issue.

The judgment of the Allahabad High Court in J.K. Spinning and Weaving Mills Co. (supra) was found to be distinguishable and not applicable in view of the variance in the statutory scheme contained in the provisions contained in Indian Income-tax Act, 1922, with the statutory scheme under the Income-tax Act, 1961 and the Allahabad High Court had taken into consideration that interest became payable to the assessee only when the assessments for the years in dispute were made which were in fact made in 1956, though the assessments were 1951-1952 and 1952-1953.

The Andhra Pradesh High Court was unable to agree with the reasoning of the judgment of the Orissa High Court in Sri Popsingh Rice Mill case (supra), as the question considered by the Orissa High Court was in relation to section 244 of the Act and not in relation to section 244A of the Act and the Orissa High Court had failed to notice the judgments of the Supreme Court and instead relied on three judgments which were not dealing with interest. Likewise, the other two judgments referred to in the said judgment also were found to be not relevant for the purpose of deciding the issue.

The court accordingly answered the questions referred to it in favour of the assessee and against the revenue by holding that the interest on refund accrued from year to year and was not to be taxed in the year of the order granting refund.

Observations
An assessee, following the mercantile system of accounting, is taxed on his income, including interest income, in the year in which the income accrues or arises. An income, in ordinary circumstances, is said to have been accrued on vesting of a legal right to receive such income irrespective of whether it is received or not. Such accrual, based on a right to receive, is independent of the order of any Court or an authority passed for confirming such right to receive, for the reason that such right to receive arises to a person on the basis of the terms of the agreement or the statutory provisions of any law.

It is an accepted position in law that interest accrues from day to day, in case of a person maintaining books of account and accrues on yearly basis in case of a person not maintaining the books of account. In both the cases, the interest income is spread over number of years and is taxed on year to year basis.

The Supreme Court in E.D. Sassoon Company Ltd. vs. CIT, 26 ITR 51, observed that the computation of the profits, whenever it may take place, cannot possi- bly be allowed to suspend its accrual. The accrual happens irrespective of the quantification of the profits, and is not always linked to computation. For attracting the charge of taxation, what has however got to be determined is whether the income, profits or gains accrued to the assessee; before it can be said to have accrued to him, it is necessary that he must have acquired a right to receive the same or that a right to the income, profits or gains has become vested in him though its valuation may be postponed or its material station depends on some contingency.

The Supreme Court in Rama Bai (supra)’s case was concerned with the taxability of interest received on account of enhanced compensation, where the assessee’s lands were acquired and not being satis- fied with the compensation awarded by the Land Acquisition Officer, the assessee appealed to the higher Courts and finally received enhanced com- pensation along with interest payable u/s. 28 and 34 of the Land Acquisition Act. The said amounts were received in the year 1967 and were sought to be assessed in the year 1968-1969. The assessee claimed that interest was allocable and assessable in different assessment years as it accrued from year to year and only that portion of the interest relating to the period April, 1967 to March, 1968 was assessable for the assessment year 1968-1969. The Tribunal referred the following question to the Supreme Court: “Whether, on the facts and in the circumstances of the case, the interest received by the assesses as per the City Civil Court’s award for the period commencing from the date of possession till 31st March, 1968, was entirely assessable for the assessment year 1968-1969?” The Supreme Court answered the question in favour of assessee and against the revenue by following its earlier judgment in the case of CIT vs. Govindarajulu Chetty (T.N.K.) 165 ITR 231 (SC) wherein in a short judgment, the Apex Court approved the judgment of the Madras High Court in the case of T. N. K. Govindarajulu Chetty vs. CIT, 87 ITR 22 (Mad.). The Madras High Court held that; “11. In this case the liability to pay interest would arise when the compensation amount due to the assessee had not been paid, in each of the relevant years. Therefore, the accrual of interest has to be spread over the years between the date of acquisition till it was actually paid. We are not in a position to accept the contention of the revenue that …………… basis for assessing the income. When a statute brings to charge certain income, its intention is to enforce the charge at the earliest point of time.”

The Supreme Court has pointed out in Laxmipat Singhania vs. CIT,72 ITR 291, that: “Again, it is not open to the Income-tax Officer, if income has accrued to the assessee, and is liable to be included in the total income of a particular year, to ignore the accrual and thereafter to tax it as income of another year on the basis of receipt.” Similar view was taken by the Panjab & Haryana High Court in the case of CIT vs. Dr. Sham Lal Narula, 84 ITR 625 and by the Karnataka High Court in the case of CIT, Mysore vs. V. Sampangiramaiah, 69 ITR 159 where under the question which was considered was “Whether, on the facts and in the circumstance of the case, the Appellate Tribunal was right in law in holding that the entire interest amount of Rs. 87,265/- was not assessable in the assessment year 1962-63 and that only the proportionate interest referable to the assessment year 1962-63 was assessable in that year?” The Karnataka High Court answered the question in the affirmative and in favour of the assessee and against the revenue.

The right to receive interest u/s. 244A is entirely based on the right to refund u/s. 240 of the Act. Unless an assessee is entitled to a refund of taxes, no right to receive an interest arises in his favour. The key consideration therefore is the right to a refund of excess taxes paid. Whether such a right to refund arises on passing of an order by an Income-tax Authority, for granting a refund, or that such a right arises with payment of taxes and is independent of the order of the authority. The fact that interest u/s. 244A, whenever granted and paid, is paid for the period commencing with the date of payment of tax, apparently conveys that such a right is associated with the payment of excess taxes and only its (interest) payment is deferred to the year of grant by an authority. This prima facie understanding is, further confirmed by the amendments in section 145A(2)(B) and section 56(2)(Viii) of the Act by the Finance (NO.2) Act, 2009, that expressly provide that interest on compensation shall be taxed in the year of receipt only. In other words, in the absence of any provision for taxing the interest income in the year of receipt, interest will be taxed in the year of accrual and when such interest pertains to a period exceeding 12 months, its accrual happens on year to year basis in more than 1 assessment year.

On a conspectus reading of the scheme of refund, contained in Chapter XIX u/s. 237 to 245, it is gathered that the right to refund of excess taxes paid is independent of any requirement to claim such refund. While it is true that an assessee is entitled to a refund of the excess taxes paid, only on satisfaction of the A.O that the taxes paid by him exceeds the amount of tax payable by him, it none the less is independent of any order section 237 does not require an Assessing Officer to pass an order of refund, it rather requires an Assessing Officer to refund the excess taxes. Likewise, section 244A entitles an assessee to simple interest on the amount of refund that becomes due to him.

An assessee is entitled to receive interest u/s. 244A(1) where refund of any amount becomes due to him. The language of section 244A (1) may convey that unless an assessee becomes entitled to a refund, he is not entitled to interest and as a consequence of such an understanding, entitlement to interest is postponed to the time when a refund becomes due to him; no interest therefore accrues to him till such time an order of refund is passed. Such an understanding, we feel, is not supported by the scheme of the Act and in particular by the scheme of the refund and the grant of interest thereon. Under the scheme, the moment an excess tax is paid, the refund thereof becomes due to him and the entitlement to interest runs with the right to receive refund which right arises with payment of taxes, irrespective of an order of refund. This understanding is fortified with the decision of the Andhra Pradesh High Court in Jaffersaheb’s case, in as much as the issue therein concerned taxation of interest received u/s. 244A in assessment year 1990-91 and the Court while deciding the issue of the year of taxation, examined the implications of the provisions of section 244A w.r.t to the scheme of refund and applied the ratio of the decision of the Supreme Court in Rama Bai’s case. In our considered view, no material difference exists between the interest that was granted u/s. 244 r.w.s 240 and the one now being granted u/s. 244A r.w.s 240 of the Act as regards the time of entitlement. In conclusion, it is safe to hold that the right to refund and the right to interest thereon are statutory rights which rights arise on payment of excess taxes.

The case for the taxation of interest, received under the Income-tax Act, on the year to year basis, by yearly spread over, is greater as compared to the interest received under the Land Acquisition Act for the reason under the scheme of taxation, an amount of refund becomes due, the moment an assessee pays excess tax which is neither dependent on the claim for refund nor on the order of the authorities. Accordingly the decisions of the courts, holding that the interest under the Land Acquisition Act is taxable on the year to year basis, shall apply with greater force, to the cases of receipt of interest, under the Income-tax Act.

Having so concluded that interest is taxable on year to year basis, an assessee is placed in an unenviable position in a case where an Assessing Officer makes substantial additions to the returned income and demands additional tax instead of granting refund. The issue that is required to be considered is about the liability to pay tax on interest that could be said to have accrued, even though the eligibility to refund and consequent interest thereon depends on the outcome of the appeal filed to contest the aforesaid additions to the returned income. While the assessee may not be asked to make the payment of regular taxes but may be required to pay taxes on the accrued interest, which is included in the assessed income, in the hope that he will suc- ceed in the appeal and will be entitled to refund and interest thereon. Nothing could be more confusing than this in as much as, it leads to an inference that interest on refund accrues, even before the finality of refund itself. This confusion is aptly conveyed by Palkhivala’s words when he states that ‘one of the delights of income tax law is occasional incongruities’. The Bombay High Court noticing the confusion in the case of CIT vs. Abbasbhoy, 195 ITR 28, arising on account of the contrasting decisions of the Supreme Court in the case of Govindarajulu Chetty (supra) and the earlier decision in the case of CIT vs. Hindustan Housing , 161 ITR 524, with the hope that the Su- preme Court will resolve the controversy observed that “the incongruity does not end here. Despite the conclusion that interest in such cases accrues from year to year, it is doubtful whether it will be possible to hold the assessee responsible for not disclosing interest income in the past on accrual basis.” Kanga & Palkhivala in the 4th edition of their book titled The Law and Practice of Income tax have commented on the assessee’s obligation to return income, on account of accrued interest, where the refund is in dispute in the following words ,”the assessee can always take a stand that the amount of compensation including enhanced compensation or damages having been determined subsequently, he could not possibly anticipate accrual of interest”. Kindly also see, pg. 1085 of volume 1 of the 10th edition of Sampath Iyengar’s Law of Income Tax.

This unenviable situation may however be remitted by resorting to rectification proceedings u/s. 154 for amending the order where such interest on disputed refund is taxed on accrual basis. Please see Garden Silk Mills Ltd., 221 ITR 861(Guj.)

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Sunder Deep Education Society vs. ACIT In the Income Tax Appellate Tribunal Delhi Bench ‘ G’ New Delhi Before Rajpal Yadav (J. M.) and T. S. Kapoor (A. M.) ITA No. 2428/Del/2011 Assessment Year: 2007-08. Decided on 6th December, 2013 Counsel for Assessee / Revenue: Rakesh Gupta / N. Srivastava

Sections 11, 12 and 68 – Failure to present donors on being summoned – Donations cannot be taxed as income under section 68.

Facts
The assessee is registered under the Societies Registration Act, 1860 and u/s. 12AA of the Income tax Act, 1961. It also enjoys exemption u/s. 80G. The assessee runs educational institutions conducting various professional courses. In respect of the voluntary contribution aggregating to Rs. 1.97 crore received during the year, the assessee was not able to produce the donors when summoned by the AO who, as claimed by the assessee, had made the said donations. Therefore, the AO held that the same were anonymous and unexplained cash credit and added the said amount as the assessee’s total income as per section 115BBC and section 68.

Before the CIT(A) the assessee submitted the name and address of the persons who had made donations alongwith other particulars prescribed by the Act. The CIT(A) agreed that the donations could not be treated as ‘anonymous’. However, according to him, since the assessee could not prove the donations amount of Rs. 1.97 crore the same was treated as unaccounted income by him and brought to tax u/s. 11(4) read with section 68/69/69C. Before the tribunal, the revenue did not challenge the CIT(A)’s finding that the donations were not anonymous but contended that as held by the CIT(A), the same were taxable u/s. 68 and 69 as income from other sources and the benefit of section 11 and 12 would not be available to the assessee.

Held
The tribunal referred to the decision of the Delhi tribunal in the case of Shri Vivekanand Education & Welfare Society (ITA No. 2592 / Del / 2012) which was based on the decision of the Delhi high court in the case of DIT(Exem) vs. Keshav Social & Charitable Trust (278 ITR 152) where the Court observed that the fact that complete list of donors was not filed or that the donors were not produced, does not necessariiy lead to the inference that the assesse was trying to introduce un-accounted money by way of donation receipts. The Court further observed that as the assesse had disclosed the donation as income, the provisions of section 68 cannot be applied. Applying the ratio, the tribunal held that the said receipts of Rs. 1.97 crore would be governed by the provisions of sections 11 and 12 of the Act and if 85% thereof is applied towards the objects of the trust, then the income assessable would be nil.

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S/s. 43(6), 50 – The term `acquired’ used in section 50 is not synonymous with acquisition of title to the property. Use of asset is not a condition for availing the benefits of section 50. In a case where amounts are paid and registration had been complete, though possession was not received, it can be said that the assessee has acquired the property for the purpose of section 50.

6. ITO vs. D. Chetan Kumar & Co.
ITAT Mumbai `D’ Bench
Before Rajendra (AM) and Dr. S. T. M. Pavalan (JM)
ITA No. 6886/Mum/2011
Assessment Year : 2008-09.
Decided on: 5th March, 2014.
Counsel for revenue/assessee: Sanjeev Jain/Hiro Rai.

S/s. 43(6), 50 – The term `acquired’ used in section 50 is not synonymous with acquisition of title to the property. Use of asset is not a condition for availing the benefits of section 50. In a case where amounts are paid and registration had been complete, though possession was not received, it can be said that the assessee has acquired the property for the purpose of section 50.

Facts:

The assessee had, vide agreement dated 05-04-2007, sold business premises, whose stamp duty value was Rs. 48,47,850, for a consideration of Rs. 39,00,000. Depreciation was claimed on the premises sold and they constituted part of block of asset. The assessee had purchased two new galas vide agreements dated 28-03-2008 for Rs. 27,28,462 and Rs. 12,71,538. The building in which the galas were situated were under construction and possession of these galas was not with the assessee as on 31-03-2008.

The Assessing Officer held that since the possession of new galas purchased were not with the assessee as on 31–03-2008, they could not be said to be forming part of block of assets for financial year 2007-08 and therefore when the sale consideration of the property sold is reduced from the block of assets, the block would cease to exist and the sale consideration in excess of the opening written down value would be taxed u/s. 50. Since the stamp duty value was not disputed by the assessee, the AO adopted stamp duty value to be the sale consideration. He charged Rs. 47,69,046 as short term capital gains.

Aggrieved, the assessee preferred an appeal to CIT(A) who held that a reading of Clause (c) of section 43(6) would reveal that the written down value had to be adjusted by actual cost of any asset falling within the block acquired during the year. The assessee had purchased two galas and the entire amount of Rs. 40 lakh had been paid, registration had been completed, therefore, the assessee had acquired the assets as per section 43(6)(c). The term used in section 50 was “acquired during he previous year”. Referring to the decision of the jurisdictional Tribunal in the case of Orient Cartons Ltd. (60 ITD 87), he held that the use of the asset was not a condition precedent for making an adjustment in block of asset. There was no explicit requirement in the statutory provision to the effect that the new asset should also be used in a business carried on by the assessee and that if there was no business carried on by him, the deduction could not be given. He also held that the word “acquired” in section 50 was of a very amorphous word and the acquisition of the property in that section was not synonymous with acquisition of title to the property. Accordingly, he held that the assessee had acquired the premises within the meaning of section 50 of the Act and therefore was entitled for adjustment of cost of the property with that of WDV of the block of assets for the purposes of capital gains. He allowed the appeal filed by the assessee. Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:

The Tribunal noted that a similar view had been taken in the case of Lalbhai Kalidas & Co. Ltd. (ITA No. 5832/Mum/2011, AY 2007-08 dated 08-11-2013). Following the said decision, the Tribunal upheld the order of the CIT(A) on this ground. This ground of appeal of the revenue was dismissed.

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Business expenditure: Section 37: A. Y. 2006- 07: Expenditure on foreign education of employee (son of director) is deductible if there is business nexus:

Kostub Investment Ltd. vs. CIT (Del); ITA No. 10 of 2014 dated 25-02-2014:

In the relevant year, the assessee company had claimed the deduction of an expenditure of Rs. 23,16,942/- being expenditure on higher education of an employee, who happens to be the son of directors, for undertaking an MBA course in the UK. The Assessing Officer disallowed the claim for deduction and the Tribunal upheld the disallowance.

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

“i) Whilst there may be some grain of truth that there might be a tendency in business concerns to claim deductions u/s. 37, and foist personal expenditure, such a tendency itself cannot result in an unspoken bias against claims for funding higher education abroad of the employees of the concern. As to whether the assessee would have similarly assisted another employee unrelated to its management is not a question which this court has to consider. But that it has chosen to fund the higher education of one of its director’s son in a field intimately connected with its business is a crucial factor that the Court cannot ignore.

ii) It would be unwise for the Court to require all assesses and business concerns to frame a policy with respect to how educational funding of its employees generally and a class thereof, i.e., children of its management or directors would be done. Nor would it be wise to universalise or rationalise that in the absence of such a policy, funding of employees of one class – unrelated to management – would qualify for deduction u/s. 37(1). We do not see such a intent in the statute which prescribes that only expenditure strictly for business can be considered for deduction. Necessarily, the decision to deduct is to be case dependent.

iii) In view of the above discussion, having regard to the circumstances of the case, this Court is of the opinion that the expenditure claimed by the assessee to fund the higher education of its employee to the tune of Rs. 23,16,942/- had an intimate and direct connection with its business, i.e., dealing in security and investments. It was, therefore, appropriately deductible u/s. 37(1).

iv) The Assessing Officer is thus directed to grant the deduction claimed.”

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Offences and Prosecution – Section 276CC applies to situations where an assessee has failed to file a return of income as required u/s. 139 of the Act or in response to notice issued to the assessee u/s. 142 or section 148 of the Act.

Sasi Enterprises vs. ACIT (2014) 361 ITR 163(SC)

M/s.
Sasi Enterprises was formed as a partnership firm by a deed dated 6th
February, 1989, with N. Sasikala and T. V. Dinakaram as its partners,
which was later reconstituted with effect from 4th May, 1990, with J.
Jayalalitha and N. Sasikala as partners. The firm did the business
through two units, namely, M/s. Fax Universal and M/s. J. S. Plan
Printers, which, inter alia, included the business in running all kinds
of motor cars, dealing in vehicles and goods, etc.

The
Partnership deed dated 4th May, 1990, stated that the partners, are
responsible and empowered to operate bank accounts, have full and equal
rights in the management of the firm in its business activities, deploy
funds for the business of the firm, appoint staff, watchman, etc., and
to represent the firm before Income-tax, sales tax and other
authorities.

M/s. Sasi Enterprises, the firm, did not file any returns for the assessment years 1991-92 and 1992-93.

J.
Jayalalitha and N. Sasikala filed their individual returns for the
assessment years 1991-92 and 1992- 93, though belatedly on 20th
November, 1994, and 23rd February, 1994, respectively. In those returns
it was mentioned that the accounts of the firm had not been finalised
and no returns of the firm had been filed. J. Jayalalitha and N.
Sasikala did not file returns for the assessment year 1993-94.

In
the complaint E.O.C.C. No. 202 of 1997 filed before the Chief
Metropolitan Magistrate Egmore, M/s. Sasi Enterprises was shown as the
first accused (A-1) and J. Jayalalitha and N. Sasikala were shown as
(A-2) and (A-3), respectively, who were stated to be responsible for the
day-to-day business of the firm during the assessment years in question
and were individually, jointly and severally made responsible and
liable for all the activities of the firm.

The Assistant
Commissioner of Income-tax in his complaint stated that the firm through
its partners ought to have filed its returns u/s. 139(1) of the Act for
the assessment year 1991-92 on or before 31st August, 1991, and for the
assessment year 1992-93 on or before 31st August, 1992, and A-2, in her
individual capacity, also should have filed her return for the year
1993-94 u/s. 139(1) on or before 31st August, 1993, and A-3 also ought
to have filed her return for the assessment year 1993-94 on or before
31st August, 1993, as per section 139(1) of the Act. The accused
persons, it was pointed out, did not bother to file the returns even
before the end of the respective assessment years, nor had they filed
any return at the outer statutory limit prescribed u/s. 139(4) of the
Act, i.e., at the end of March of the assessment year. It was also
pointed out the a survey was conducted in respect of the firm u/s. 133A
on 24th August, 1992, and following that a notice u/s. 148 was served on
the partnership firm on 15th February, 1994, to file the return of
Income-tax for the years in question. Though notice was served on 16th
February, 1994, no return was filed within the time granted in the
notice. Neither the return was filed, nor were particulars of the income
furnished. For the assessment year 1991-92, it was stated that
pre-assessment notice was served on 18th December, 1995, notice u/s.
142(1)(ii) giving opportunities was also issued on 20th July, 1995. The
Department made the best judgment assessment for the assessment year
1991-92 u/s. 144 on a total income of Rs. 5,84,860 on 8th February,
1996, and tax was determined as Rs. 3,02,434 and demand notice for Rs.
9,95,388 was issued as tax and interest payable on 8th February, 1996.

For
the assessment year 1992-93, the best judgment assessment u/s. 144 was
made on 9th February, 1996, on the firm on a total income of Rs.
14,87,930 and tax determined at Rs. 8,08,153, a demand notice was issued
towards the tax and interest payable.

So far as A-2 was
concerned, the due date for filing of return of income as per section
139(1) of the Act for the assessment year 1993-94 was 31st August, 1993.
Notice u/s. 142(1)(i) was issued to A-2 calling for return of income on
18th January, 1994. The said notice was served on her on 19th January,
1994. Reminders were issued on 10th February, 1994, 22nd August, 1994
and 23rd August, 1995. No return was filed as required u/s. 139(4)
before 31st March, 1995. The Department on 31st July, 1995, issued
notice u/s. 142(1)(ii) calling for particulars of income and other
details for completion of assessment. Neither the return of income was
filed nor were the particulars of income furnished. Best judgment
assessment u/s. 144 was made on 9th February, 1996 on a total income of
Rs. 1,04,49,153 and tax determined at Rs. 46,68,676 and demand of Rs.
96,98,801, inclusive of interest at Rs. 55,53,882 was raised after
adjusting pre-paid tax of Rs. 5,23,759. The Department then issued
show-cause notice for prosecution u/s. 276CC on 14th June, 1996. Later,
sanction for prosecution was accorded by the Commissioner of Income-tax
on 3rd October, 1996.

A-3 also failed to filed return of income
as per section 139(1) for the assessment year 1993-94 before the due
date, i.e., 31st August, 1993. Notice u/s. 142(1)(i) was issued to A-3
calling for filing of return of income on 8th November, 1995. Further,
notice was also issued u/s. 142(1)(ii) on 21st July, 1995, calling for
particulars of income and other details for completion of assessment.
Neither the return of income was filed nor the particulars of income
were furnished. Best judgment assessment u/s. 144 was made on 8th
February, 1996, on a total income of Rs. 70,28,110 and tax determined at
Rs. 26,86,445. The total tax payable, inclusive of interest due was Rs.
71,19,527. After giving effect to the appellate order, the total income
was revised by Rs. 19,25,000, resulting in tax demand of Rs. 20,23,279,
inclusive of interest levied. Later, a show-cause notice for
prosecution u/s. 276CC was issued to A-3 on 7th August,1996. A-3 filed
replies on 24th November, 1996, and 24th March, 1997. The Commissioner
of Income-tax accorded sanction for prosecution on 4th August, 1997.

The
final tax liability, so far as the firm was concerned, was determined
as Rs. 32,63,482 on giving effect to the order of the Income-tax
Appellate Tribunal (B-Bench), Chennai dated 1st September, 2006 and
after giving credit of prepaid tax for the assessment year 1991-92. For
the assessment year 1992-93 for the firm, final tax liability was
determined at Rs.52,47,594 on giving effect to the order of the
Income-tax Appellate Tribunal (B-Bench), Chennai dated 1st September,
2006, and after giving credit of pre-paid tax. So far as A-2 was
concerned for the assessment year 1993-94 final tax liability was
determined at Rs. 12,54,395 giving effect to the order of the Income-tax
Appellate Tribunal (B-Bench), Chennai dated 11th October, 2008, after
giving credit to pre-paid tax. So far as A-3 was concerned, for the
assessment year 1993-94, the final tax liability was determined as Rs.
9,81,870 after giving effect to the order of the Income-tax Appellate
Tribunal (B-Bench), Chennai dated 14th September, 2004, and after giving
credit to pre-paid tax.

For not filing of returns and due to
non-compliance with the various statutory provisions, prosecution was
initiated u/s. 276CC of the Act against all the accused persons and the
complaints were filed on 21st August, 1997, before the Chief
Metropolitan Magistrate which the High Court by its order dated 2nd
December, 2006 had permitted to go on by dismissing the revision
petitions filed by the firm and the two partners against the dismissal
of their discharge petitions by the Chief Metropolitan Magistrate.

On appeal, the Supreme Court held that section
276CC applies to situations where an assessee has
failed to file a return of income as required u/s.
139 of the Act or in response to notice issued to
the assessee u/s. 142 or section 148 of the Act.
The proviso to section 276CC gives some relief to
genuine assessees. The proviso to section 276CC
gives further time till the end of the assessment
year to furnish return to avoid prosecution. In
other words, even though the due date would be
31st August of the assessment year as per section
139(1) of the Act, as assessee gets further seven
months time to complete and file the return and
such a return though belated, may not attract
prosecution of the assessee. Similarly, the proviso
in Clause (ii)(b) to section 276CC also provides
that if the tax payable determined by regular assessment
as reduced by advance tax paid and tax deducted at source does not exceed Rs. 3,000,
such an assessee shall not be prosecuted for
not furnishing the return u/s. 139(1) of the Act.
Resultantly, the proviso u/s. 276CC takes care of
genuine assessees who either file the returns belatedly
but within the end of the assessment year
or those who have paid substantial amounts of
their tax dues by pre-paid taxes, from the rigour
of the prosecution u/s. 276CC of the Act.

Section 276CC, takes in s/s. (1) of the section 139,
section 142(1)(i) and section 148. But the proviso
to section 276CC takes in only s/s. (1) of section
139 of the Act and the provisions of section 142(1)
(i) or section 148 are conspicuously absent. Consequently,
the benefit of the proviso is available
only to voluntary filing of return as required u/s.
139(1) of the Act. In other words, the proviso
would not apply after detection of the failure to
file the return and after a notice u/s. 142(1)(i) or
section 148 of the Act is issued calling for filing
of the return of income. The proviso, therefore,
envisages the filing of even belated return before
the detection or discovery of the failure and issuance
of notice u/s. 142 or section 148 of the Act.

The Supreme Court referred to s/s. (4) of section
139 wherein the Legislature has used an expression
“whichever is earlier”, and observed that
both section 139(1) and s/s. (1) of section 142 are
referred to in s/s. (4) to section 139, which specify
time limit, therefore, the expression “whichever is
earlier” has to be read within the time if allowed
under s/s. (1) of section 139 or within the time allowed
under notice issued under s/s. (1) of section
142, whichever is earlier. The Supreme Court held
that so far as the present case was concerned, it
was noticed that the assessee had not filed the
return either within the time allowed under s/s. (1)
of section 139 or within the time allowed under
notice issued under s/s. (1) of section 142.

The Supreme Court noted that on failure to file
the returns by the appellants, the Income-tax Department
made a best judgment assessment u/s.
144 of the Act and later show-cause notices were
issued for initiating prosecution u/s. 276CC of the
Act. The Supreme Court held that the proviso to
section 276CC nowhere states that the offence
u/s. 276CC has not been committed by the categories
of assesses who fall within the scope of
that proviso but it is stated that such a person
shall not be proceeded against. In other words,
it only provided that under specific circumstances
mentioned in the proviso, prosecution may not be
initiated. An assessee who comes within Clause
(2)(b) of the proviso, no doubt he has also committed
the offence u/s. 276CC but is exempted
from prosecution since the tax falls below Rs.
3,000. Such an assessee may file belated return
before the detection and avail of the benefit of
the proviso. The proviso cannot control the main
section, it only confers some benefit to certain
categories of assesses. In short, the offence u/s.
276CC is attracted on failure to comply with the
provisions of section 139(1) or failure to respond
to the notice issued u/s. 142 or section 148 of the
Act within the time limit specified therein.

Applying the above principles to the facts of
the case in hand, the Supreme Court held that
the contention of the learned senior counsel for
the appellant that there has not been any willful
failure to file their return could not be accepted
and on facts, offence u/s. 276CC of the Act had
been made in all these appeals and the rejection
of the application for the discharge called for no
interference by it.

The Supreme Court also found no basis in the
contention of the learned senior counsel for the
appellant that pendency of the appellate proceeding
was a relevant factor for not initiating prosecution
proceedings u/s. 276CC of the Act. According
to the Supreme Court, section 276CC contemplates
that an offence is committed on the non-filing of
the return and it is totally unrelated to the pendency
of assessment proceedings except for the
second part of the offence for determination of
the sentence of the offence, the Department may
resort to best judgment assessment or otherwise
to past years to determine the extent of the
breach. If it was the intention of the Legislature
to hold up the prosecution proceedings till the
assessment proceedings are completed by way of
appeal or otherwise the same would have been
provided in section 276CC itself.

The Supreme Court was also of the view that the
declaration or statement made in the individual
returns by partners that the accounts of the firm
were not finalised, hence no return had been
filed by the firm, would not absolve the firm in
filing the statutory return u/s. 139(1) of the Act. The firm was independently required to file the
return and merely because there had been a best
judgment assessment u/s. 144 would not nullify
the liability of the firm to file the return as per
section 139(1) of the Act.

The Supreme Court further held that, section
278E deals with the presumption as to culpable
mental state, which was inserted by the Taxation
Laws (Amendment and Miscellaneous Provisions)
Act, 1986. The question is on whom the burden
lies, either on the prosecution or the assessee,
u/s. 278E to prove whether the assessee has or
not committed willful default in filing the returns.
The court in a prosecution of offence, like section
276CC has to presume the existence of mens rea
and it is for the accused to prove the contrary
and that too beyond reasonable doubt. Resultantly,
the appellants have to prove the circumstances
which prevented them from filing the returns as
per section 139(1) or in response to notice u/s.
142 and 148 of the Act.

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Taxability of Long Outstanding Liability Not Written Back

Synopsis

Section 41(1) applies when an assessee gets a remission or benefit in respect of trading liability cessation thereof,or by a unilateral act by the assessee by way of writing back of such liability in his accounts.

The question that arises is if any benefit has been obtained in respect trading liability by remission or cessation, when a creditor’s balance has remained unpaid for a long period of time, though it has not been written back to the profit and loss account, particularly if the recovery of such amount is barred by the law of limitation.

Issue for Consideration

Section 41(1) of the Income Tax Act, 1961 provides that where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee and subsequently during any previous year, the assessee has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits and gains of business or profession and accordingly chargeable to Incometax as the income of that previous year.

The provisions of this section, therefore, come into play only when the assessee has “obtained any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation of such liability”.

Explanation 1 to this section, inserted with effect from Assessment Year 1997-98, further provides that the expression “loss or expenditure or some benefit in respect of any such trading liability by way of remission or cessation thereof” shall include the remission or cessation of any liability by a unilateral act by the assessee by way of writing off such liability in his accounts.

The question has arisen before the courts as to whether any benefit has been obtained in respect of trading liability by way of remission or cessation when a creditor’s balance has remained unpaid and outstanding for a long period of time, though it has not been written back to the profit and loss account, particularly if the recovery of such amount is barred by the law of limitation.

The Delhi High Court has taken two different views of the matter, one in the case of sundry creditors, and the other in the case of unpaid dues of employees. In one case, it has held that the amount is not taxable u/s. 41(1), while in the other, it is held that such outstanding amount of liability is taxable.

Shri Vardhman Overseas’ Case
The issue first came up before the Delhi High Court in the case of CIT vs. Shri Vardhman Overseas Ltd. 343 ITR 408.

In this case, relating to the Assessment Year 2002- 03, the assessee was a company engaged in the manufacture of rice from paddy. It also sold rice after purchasing it from the local market. The Assessing Officer, while verifying the sales and sundry debtors, decided to verify the sundry creditors shown in the books of account. He asked the assessee to submit confirmation letters from the sundry creditors. The assessee did not submit the confirmation letters, on the ground that it was not aware of the present whereabouts of the creditors after a lapse of 4 years, and whatever addresses were available had been given by the suppliers at the time that the purchases were made from them. The assessing officer added the amount of sundry creditors to the assessee’s income.

On appeal, the Commissioner (Appeals) held that the assessee’s conduct clearly showed that the liability shown in the sundry creditors account in its books did not exist. He, therefore, held that the liabilities had ceased to exist, and therefore, the addition made by the assessing officer was held to be justified, but confirmed as taxable u/s. 41(1).

The Tribunal held that since the amounts payable to the sundry creditors were not credited to the profit and loss account for the year but continued to be shown as outstanding as at the end of the year, the tribunal held that the provisions of section 41(1) were not attracted, in the light of the decision of the Supreme Court in the case of CIT v Sugauli Sugar Works (P) Ltd. 236 ITR 518. According to the Tribunal, this decision of the Supreme Court applied with greater force since, in that decision, the assessee had credited the profit and loss account with the amount standing to the credit of the sundry creditors, whereas in the case before the Tribunal, the amounts payable to the sundry creditors were not credited to the profit and loss account for the year and were still shown as outstanding as at the end of the year. The Tribunal, therefore, deleted the addition made by the assessing officer.

Before the Delhi High Court, on behalf of the revenue, attention was drawn to the fact that the assessee itself had admitted that the amount was outstanding for more than 4 years, and therefore, the assessee had obtained a benefit in the course of its business, which was assessable u/s. 41(1). It was argued that it would make no difference that the liabilities were not written back to the profit and loss account for the year under consideration, because what was to be seen was whether the assessee had obtained a benefit in a practical sense. It was claimed that since the amounts remained unpaid for 4 years, there was a reasonable inference that the assessee was no longer liable to pay those parties. According to the revenue, the benefit arose on account of the fact that the debts were more than 3 years old, and were, therefore, not recoverable from the assessee in view of the law of limitation.

It was argued that Explanation 1 to section 41(1) was not relied upon by the revenue, but the writing back of the accounts of the sundry creditors in the profit and loss account was only one of the many unilateral acts which could be done by the assessee, and even in the absence of such a write back, there could be remission or cessation of the trading liability which resulted in a benefit to the assessee.

The Delhi High Court agreed that the Explanation 1 was not applicable, but observed that it must be established that the assessee had obtained some benefit in respect of the trading liability which had earlier been allowed as a deduction. It noted that there was no dispute that the amounts due to the sundry creditors have been allowed in the earlier assessment years as purchases in computing the business income of the assessee. The question was whether by not paying them for a period of 4 years and above, the assessee had obtained some benefit in respect of the trading liability allowed in earlier years. It observed that the revenue’s argument that, non-payment or non-discharge of liability resulted in some benefit in respect of such trading liability in a practical sense or common sense overlooked the words “by way of remission or cessation thereof”. It observed that it was not enough that the assessee should derive some benefit in respect of such trading liability, but it was also essential that such benefit should arise by way of remission or cessation of the liability.

Analysing the meaning of the terms “remission” and “cessation”, the Delhi High Court noted the decision of the Supreme Court in the case of Bombay Dyeing and Manufacturing Company Ltd. vs. State of Bombay AIR 1958 SC 328, where the Supreme Court held that when a debt becomes time-barred, it does not become extinguished, but only unenforceable in a court of law. The Supreme Court had also held that modes in which an obligation under contract becomes discharged were well-defined, and the bar of limitation was not one of them. This was the view also taken by the Supreme Court in the case of Sugauli Sugar Works (supra), which was a case where the credits were outstanding for almost 20 years and were written back by credit to the profit and loss account. The Delhi High Court noted that in the Sugauli Sugar Works case, a contention was advanced before the Supreme Court on behalf of the revenue that since the liability remained unpaid for more than 20 years, there was practically a cessation of the debt, which resulted in a benefit to the assessee, which should be brought to tax u/s. 41(1). This argument was not accepted by the Supreme Court in that case.

The Delhi High Court, therefore, held that, as there was no write back of the accounts of the sundry creditors to the profit and loss account, the amount of outstanding liabilities was not taxable u/s. 41(1).

This decision was followed by the Delhi High Court on the same date in the case of CIT vs. Hotline Electronics Ltd. 205 Taxman 245, taking an identical view.

Chipsoft Technology’s Case

The issue again came up before the Delhi High Court in the case of CIT vs. Chipsoft Technology (P) Ltd. 210 Taxman 173 (Del)(Mag). In this case, relating to assessment year 2006-07, the assessee had outstanding liabilities on account of employee dues, some of which pertained to salary for the Assessment Year 2005-06, and the balance related to earlier years, extending to as far back as Assessment Year 2000-01.

The Assessing Officer called for confirmations from the employees. The assessee was able to furnish confirmations from only 3 employees out of 170 employees whose dues were outstanding. The Assessing Officer held that there was a cessation of the assessee’s liabilities and that he had obtained benefit in respect of these amounts, and he, therefore, added these amounts to the assessee’s income u/s. 41(1).

The Commissioner (Appeals) allowed the assessee’s appeal, holding that the liability was outstanding in the books of account, and that it did not, therefore, amount to cessation of liability. The Tribunal upheld the Commissioner(Appeals) order.

Before the Delhi High Court, on behalf of the Revenue, it was argued that the amount due to 170 employees remained unchanged and static for about 6 or 7 years and no payment was made during the intervening period. It was pointed out that the assessee did not claim that the employees were actively pursuing their claims and had taken any steps to recover their dues. No correspondence with the employees was filed to substantiate its argument that the amount was still outstanding, and even in the assessment proceedings it was unable to furnish full particulars about its employees. It was, therefore, argued that the liability had ceased. It is further argued that even if it was assumed that at some point the liability existed, the lapse of time and the resultant defence available to the assessee under the Limitation Act justified inclusion of these amounts as the income of the assessee on the ground of cessation of liability. It was claimed that the tribunal had not appreciated that the benefit had accrued to the assessee by virtue of the wage liability becoming time-barred.

The Delhi High Court noted the decisions cited on behalf of the revenue in the case of Kesoram Industries and Cotton Mills Ltd vs. CIT 196 ITR 845 (Cal), and in the case of CIT vs. Agarpara Co. Ltd. 158 ITR 78, where the Calcutta High Court had held, in the context of bonus payable to workmen which had remained outstanding for several years, that once bonus had been offered by the employer, but remained undrawn, it cannot be said that the liability subsisted even after the expiry of the time prescribed by the statute, particularly when there was no dispute pending regarding the payment of bonus. The Calcutta High Court had observed that under these circumstances, it may be inferred that unclaimed or unpaid bonus was in excess of the requirement of the assessee, and therefore, to that extent, the liability had ceased.

The Delhi High Court observed that the view that the liability did not cease as long as it is reflected in the books and that mere lapse of the time given to the creditor or the workmen to recover the amount due did not efface the liability though it barred the remedy, was an abstract and theoretical one and did not ground itself in reality. According to the Delhi High Court, interpretation of laws, particularly fiscal and commercial legislation, was increasingly based on pragmatic realities, which meant that even though the law permitted the debtor to take all defences and successfully avoid liability, for abstract dualistic purposes, he would be shown as a debtor. According to the Delhi High Court, it would be illogical to say that the debtor or an employer holding
onto unpaid dues should be given the benefit of his showing the amount as a liability, even though he would be entitled in law to say that the claim for its recovery was time-barred, and continue to enjoy the amount.

The Delhi High Court also observed that Explanation 1 to section 41(1) used the term “shall include” and not the term “means”, which meant that there could be other means of deriving benefits by way of cessation or remission of liability. According to the Delhi High Court, even omission to pay over a period of time and the resultant benefit derived by the employer/assessee would qualify as a cessation of liability, though by operation of law. The Delhi High Court rejected the assessee’s argument that no period of limitation was provided for under the Industrial Disputes Act, by referring to the Supreme Court decision in the case of Nedungadi Bank Ltd. vs. K. P. Madhavankutty AIR 2000 SC 839, when the Supreme Court held that even though no period of limitation had been prescribed under that Act, a stale dispute where the employee approached the forum under the said Act after an inordinate delay could not be entertained, or adjudicated.

The Delhi High Court, therefore, held that there was a benefit derived by the employer by cessation or remission of liability and that the amount of outstanding workmen dues was taxable u/s. 41(1).

Observations
Section 3 of the Limitation Act, 1963 provides that every suit instituted, appeal preferred, and application made after the prescribed period shall be dismissed, although limitation has not been set up as a defence. Section 18(1) of that Act provides that where, before the expiration of the prescribed period for a suit or application in respect of any property or right, an acknowledgment of liability in respect of such property or right has been made in writing signed by the party against whom such property or right is claimed, or by any person through whom he derives his title or liability, a fresh period
of limitation shall be computed from the time when the acknowledgment was so signed.

Therefore, the law of limitation merely bars filing of a suit for recovery of debts beyond the period of limitation. It does not bar payment of such amounts, where the debtor is willing to pay the liability.

As rightly observed by the Delhi High Court in Vardhaman Overseas’ case, as well as by other Courts, including the Supreme Court, the mere fact that recovery of a liability has been barred by limitation does not mean that the liability has ceased to exist. The assessee may still have the intention of paying off the liability, as and when demanded. Under such circumstances, taxing such liability would not be justified. Further, if such liability is subsequently paid off, the assessee would not be able to claim a deduction in the year of payment. Therefore, taxation of such outstanding amount, which is not written back, does not seem to be justified.

The Delhi High Court, in Chipsoft’s case, did not consider various other decisions of its own High Court, where the High Court had observed that disclosure of a liability in its Balance Sheet has the effect of extending the period of limitation, since it amounts to an acknowledgement of debt by the company for the purposes of section 18 of the Limitation Act. Further, it’s attention was also not drawn to its own earlier decisions in the case of Vardhaman Overseas and Hotline Electronics, where it had held that such amounts, suits for recovery of which may be barred by limitation, did not result in a benefit due to cessation or remission of liability.

Given the express observations of the Supreme Court in Bombay Dyeing’s and Sugauli Sugar Works’ cases, to the effect that a remission of a liability can only be granted by a creditor, and a cessation of the liability can only occur either by reason of operation of law, or by the debtor unequivocally declaring his intention not to honour his liability
when payment is demanded by the creditor, or by a contract between the parties or by discharge of the debt, the Delhi High Court does not seem justified in preferring to follow decisions of another High Court in preference to the decisions of the Supreme Court.

In Chipsoft’s case, the Delhi High Court relied to a great extent on the decisions of the Calcutta High Court in Agarpara’s and Kesoram’s cases. If one looks at the logic behind Agarpara’s case, it proceeds on the footing that the unpaid provision for bonus was an excess provision than that required under the law, and that it was, therefore, no longer
payable. Kesoram’s case dealt with unpaid wages, which were written back to the Profit & Loss Account. Following Agarpara’s case, the Calcutta High Court in Kesoram’s case held that considering the facts that the employer himself came to the conclusion that the unpaid amount of wages would not be claimed by the concerned employees, that it proceeded to forfeit such amount and wrote it back to the credit of the Profit & Loss Account, the reasonable inference that would follow from these facts and circumstances and the conduct of the assessee was that the amount which was provided for was not necessary and was an excess provision.

These facts were not present in Chipsoft’s case, as neither the employer had credited the amounts to the Profit & Loss Account nor were there any actions of the assessee to indicate that such amounts were no longer payable. In Chipsoft’s case, it was not proved by the revenue that such provision was an excess provision. Therefore, the application of the ratio of Agarpara’s and Kesoram’s cases to Chipsoft’s case does not seem to have been justified.

The decision of the Bombay High Court in the case of Kohinoor Mills Ltd. vs. CIT 49 ITR 578, which was also a case dealing with unpaid wages, though these were written back to the Profit & Loss Account, was not brought to the attention of the Delhi High Court. The Bombay High Court, in that case, held:

“Where wages are payable but they are unclaimed and their recovery is barred by limitation, the position in law is that the debt subsists, notwithstanding that its recovery is barred by limitation. There is in such a case no ‘cessation of trading liability’ within the meaning of section 10(2A) and the amount of such wages cannot be added to the income.”

This view had been also confirmed by the Bombay High Court in the case of J. K. Chemicals Ltd. vs. CIT 62 ITR 34.

It also needs to be kept in mind that Explanation 1 to section 41(1) was inserted to expressly cover amounts written back by credit to the Profit & Loss Account. If the intention was to cover all liabilities outstanding beyond the period of limitation or beyond a particular period of time, whether written back or not, the explanation would have read differently. It would have provided for the specific year in which such debt, barred by limitation, is deemed to be income.

The view taken by the Delhi High Court in Vardhaman Overseas’ case, that such long outstanding amounts continuing as liabilities in the accounts, cannot be taxed u/s. 41(1), therefore, seems to be the better view of the matter.

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DCIT vs. Swarna Tollway Pvt. Ltd. In the Income Tax Appellate Tribunal Hyderabad Bench ‘A’, Hyderabad Before Chandra Poojari, (A. M.) and Asha Vijayaraghavan, (J. M.) ITA No. 1184 to 1189/Hyd/2013 Asst. Years : 2005-06 to 2010-11. Decided on 16.01.2014 Counsel for Revenue/Assessee: P. Soma Sekhar Reddy/I. Rama Rao

Facts:
The assessee was awarded the contract by the NHAI for widening, rehabilitation and maintenance of the existing two-lane highway into a four-lane on BOT basis. The entire cost of construction of Rs. 714.61 crore was borne by the assessee. The assessee claimed depreciation for the years under appeal. The AO held that no ownership, leasehold or tenancy rights were ever vested with the assessee for the assets in question, i.e., roads, in respect of which it had claimed depreciation and, therefore, disallowed the depreciation claimed on the highways.

On appeal by the assessee, the CIT(A) observed that though the NHAI remained the legal owner of the site with full powers to hold, dispose of and deal with the site consistent with the provisions of the agreement, the assessee had been granted not merely possession but also right to enjoyment of the site and NHAI was obliged to defend this right and the assessee has the power to exclude others. In view thereof and relying on certain decisions he held that the assessee was entitled for depreciation. Against this, the Revenue went in appeal before the tribunal.

Held:
The tribunal referred to the decision of the Apex court in the case of Mysore Minerals Ltd. vs. CIT (239 ITR 775) wherein the meaning of word “owner” was explained. In the said case, the Court had allowed the assessee’s claim for depreciation where the title deeds were not executed and possession was given. Further, the tribunal referred to the case of CIT v. Podar Cement (P.) Ltd. (226 ITR 625) (S.C.) where the Court considered the meaning of the word “owner” in section 22 and held that the owner is a person, who is entitled to receive income from the property in his own right. Further, relying on the decision of the Apex Court in the case of R.B. Jodha Mal Kuthiala vs. CIT (82 ITR 570), the Allahabad High Court in the case of CIT vs. Noida Toll Bridge Co. Ltd. (213 Taxman 333) and of the Hyderabad tribunal in the case of M/s. PVR Industries Ltd. (ITA No. 1171, 1175/Hyd/07 and 1176, 1196/Hyd/08 dated 08-06- 2011), dismissed the appeal filed by the revenue.

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[2013] 145 ITD 491(Mumbai- Trib.) Capital International Emerging Markets Fund vs. DDIT(IT) A.Y. 2007-08 Order dated- 10-07-2013

i. Capital Loss from share swapping is allowed.

Facts:
Assessee-company, a Foreign Institutional Investor, was engaged in business of share trading.

The assessee received shares in ratio of 1 : 16 shares held by it in a company. This resulted in long term capital loss. AO disallowed the assessee’s claim of long term capital loss, on swap transaction. When the matter was referred to DRP, it was held that no sound reason was furnished by the assessee to explain as to why it entered in an exchange transaction that resulted in huge loss, that no prudent businessman would enter in to such a transaction, that swap ratio of shares transacted was not done by the competent authority i.e. a merchant banker.

Held:
Swapping of shares was approved by an agency of Govt. of India i.e. FIPB and it had approved the ratio of shares to be swapped. In these circumstances to challenge the prudence of the transaction was not proper. Even if the transaction was not approved by the Sovereign and it was carried out by the assessee in normal course of its business, the Ld AO/DRP could not question the prudence of the transaction. Genuiuness of a transaction can be definitely a subject of scrutiny by revenue authorities, but to decide the prudence of a transaction is prerogative of the assessee. A decision as to whether to do / not to do business or to carry out/not to carry out a certain transaction is to be taken by a businessman. If it is proved that a transaction had taken place, then resultant profit or loss has to be assessed as per the tax statutes. Therefore by casting doubt about the prudence of the transaction, members of the DRP had stepped in to an exclusive discretionary zone of a businessman and it is not permissible.

ii. Set off of short term capital loss subject to STT allowed against short term capital gain not subjected to STT

Facts:
Assessee has claimed set off of short-term capital loss subjected to Securities Transaction Tax(STT) against the short-term capital gains that was not subjected to STT. The AO held that as both the transactions were subject to different rates of tax, the set off of loss is not correct. He held that in order to set off the short term capital loss, there should be short term capital loss and short term capital gain on computation made u/s. 48 to 55. The assessee was entitled to have the amount of such short term capital loss set off against the short term capital gain, if any, as arrived under a similar computation made for the assessment year under consideration.

Held:
The phrase “under similar computation made” refers to computation of income, the provisions for which are contained u/ss. 45 to 55A of the Act. The matter of computation of income was a subject which came anterior to the application of rate of tax which are contained in section 110 to 115BBC. Therefore, merely because the two sets of transactions are liable for different rate of tax, it cannot be said that income from these transactions does not arise from similar computation made as computation in both the cases has to be made in similar manner under the same provisions. The Tribunal therefore, held that short term capital loss arising from STT paid transactions can be set off against short term capital gain arising from non SIT transactions.

Note: Readers may also read following decisions of Mumbai Tribunal:

• DWS India Equity Fund [IT Appeal No. 5055 (Mum.) of 2010]

• First State Investments (Hong Kong) Ltd. vs. ADIT [2009] 33 SOT 26 (Mum)

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[2013] 145 ITD 111 (Hyderabad – Trib.) SKS Micro Finance Ltd. vs. DCIT A.Y. 2006-07 & 2008-09 Order dated- 21-06-2013

Section 32 – Assessee acquired entire business of ‘S’ – Depreciation claimed by assessee on acquisition of rights of clients of ‘S’ contending that consideration paid towards transfer of clients was an intangible asset eligible for depreciation – AO and CIT(A) disallowed the claim holding that the right acquired was not an intangible asset – Tribunal held that by acquiring the customer base the assessee has acquired business and commercial rights of similar nature and hence eligible for depreciation.

Facts:
The assessee was engaged in the business of Micro Financial Lending Services through small joint liability groups and direct micro loans. The assessee entered into memorandum of understanding (MOU) with ‘S’, another company which was also engaged in the business of micro finance and acquired the entire business of ‘S’. This also included the acquisition of rights over more than 1.10 lakhs existing clients of ‘S’. The assessee claimed depreciation on the amount contending that the consideration paid to ‘S’ towards transfer of clients was for an intangible asset eligible for depreciation. It was contended that the customers were a source of assured economic benefits over the next 5 years and in that process, the assessee capitalised the cost in the books and amortised the cost over a period of 5 years.

The AO disallowed depreciation holding that the intangible asset claimed to have been acquired by the assessee does not come under any of the identified assets appearing in the depreciation schedule (intangible asset) i.e. know-how, patents, copy rights, trade marks, licenses, franchises or any other business or commercial rights of similar nature. The AO held that as the assessee had acquired part of the already existing business of ‘S’, the said asset had not been created during the course of business of the assessee and hence cannot be considered to be a business or commercial rights of similar nature.

The CIT (A) held that the customer base acquired by the assessee cannot be considered a licence or business or commercial right of similar nature as it does not relate to any intellectual property whereas section 32(1)(ii) contemplate depreciation in respect of those licenses or rights which relate to intellectual property.CIT(A) relied on decision of the Hon’ble Bombay High Court in case of CIT vs. Techno Shares & Stocks Ltd. [2009] 184 Taxman 103.

Held:
The customer base acquired by the assessee has provided an impetus to the business of the assessee as the customers acquired are with proven track record since they have already been trained, motivated, credit checked and risk filtered. They are source of assured economic benefit to the assessee and certainly are tools of the trade which facilitates the assessee to carry on the business smoothly and effectively. Therefore, by acquiring the customer base the assessee has acquired business and commercial rights of similar nature.

The Hon’ble Delhi High Court in the case of Areva T & D India Ltd. ([2012] 345 ITR 421) while interpreting the term “business or commercial rights of similar nature” has held that the fact that after the specified intangible assets the words “business or commercial rights of similar nature” have been additionally used, clearly demonstrates that the Legislature did not intend to provide for depreciation only in respect of specified intangible assets but also to other categories of intangible assets. In the circumstances, the nature of “business or commercial rights” cannot be restricted to only know-how, patents, trade marks, copyrights, licences or franchisees. All these fall in the genus of intangible assets that form part of the tool of trade of an assessee facilitating smooth carrying on of the business.

The CIT(A) while coming to his conclusion had relied upon the decision of the Bombay High Court in case of CIT vs. Techno Shares & Stock Ltd. wherein the High Court while considering the issue of transfer of membership card of Bombay Stock Exchange has held that it does not Constitute an intangible asset. However, this decision of the High Court has been reversed by the Supreme Court in the case of Techno Shares and Stocks Ltd. vs. CIT [2010] 327 ITR 323. The SC has held that intangible assets owned by the assessee and used for the business purpose which enables the assessee to access the market and has an economic and money value is a “licence” or “akin to a licence” which is one of the items falling in section 32(1) (ii) of the Act.

Based on all the above decisions, it was held that the specified intangible assets acquired under slump sale agreement were in the nature of “business or commercial rights of similar nature” specified in section 32(1)(ii) of the Act and were accordingly eligible for depreciation under that section.

Readers may also read Mumbai Tribunal decision in case of India Capital Markets (P.) Ltd. vs. Dy. CIT [2013] 29 taxmann.com 304/56 SOT 32 (Mum.)

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2013-TIOL-802-ITAT-AHD Kulgam Holdings Pvt. Ltd. vs. ACIT ITA No. 1259/Ahd/2006 Assessment Years: 2002-03. Date of Order: 21.06.2013

S/s. 28, 45 – For the purpose of deciding whether the Deep Discount Bond is a short term capital asset or a long term capital asset the holding period has to commence from the date of allotment of the DDB and not from the date of its listing on the National Stock Exchange.

Income does not accrue on a day to day or year to year basis on Optionally Fully Convertible Premium Notes where the terms of the issue provide that the holder of OFCPN could only in the last quarter of the 5th year decide to convert or not to convert the OFCPN into equity shares and in the event of his deciding not to convert the OFCPN into equity shares becomes entitled to Face value being a sum greater than issue price.

Facts I:
On 18-03-2002, the assessee sold 330 Deep Discount Bonds (DDBs) Series A of Nirma Ltd. of Rs. 330 lakh for a consideration of Rs. 4,02,92,630. The DDBs were allotted to the assessee vide letter of allotment dated 28-07-2000. The debenture trust deed was dated 27-04-2001 and certificate of holding to the assessee was issued on 10-05-2001. These DDBs were made available for dematerialisation on 24-09- 2001 and were listed in NSE on 20-09-2001.

The surplus arising on sale of DDBs was returned by the assessee as long term capital gain and benefit of section 54EC was claimed.

The Assessing Officer held that for deciding whether the DDBs are long term capital asset or short term capital asset the holding period should commence from the date of listing of the DDBs on NSE and not from the date of allotment as was the case of the assessee. He, accordingly, considered the gain to be short term capital gain and denied the benefit of section 54EC of the Act.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held I :
The Tribunal observed that in the case of Karsanbhai K. Patel (HUF) (ITA No. 1042/Ahd/2006 dated 09-10- 2009; assessment year 2002-03) the Tribunal was considering an identical issue on identical facts. In the said case, the Tribunal held that the period of holding has to be counted from the date of allotment. Following the ratio of the said decision, the Tribunal held that the holding period be counted from the date of allotment. If the holding period was counted from the date of allotment, in the present case, the gain arising on transfer of DDBs would be long term capital gain and the assessee would be entitled to claim benefit of section 54EC. The Tribunal decided the issue in favor of the assessee.

Fact II:
The assessee held Optionally Fully Convertible Preference Notes (OFCPN) of Nirma Industries Ltd. which were acquired by the assessee on 25- 03-2002 i.e. after the date of issue of CBDT Circular No. 2 dated 15-02-2002. The assessee was following mercantile system of accounting.

The OFCPN were of the face value of Rs. 33,750 and were issued for Rs. 25,000. The Tenure was five years from the date of allotment. The terms of the issue provided that the investor had an option to put the OFCPN in the last quarter of 5th year. The investor also had an option to convert each of the OFCPN at the end of 5th year from the date of allotment into 2,500 equity shares of Rs. 10 each at par but no interest would be payable till maturity. If the assessee opts for conversion, it would get 2,500 equity shares of Rs. 10 each at par in lieu of one OFCPN of issue price of Rs. 25,000 and the assessee will not get any monetary gain in the form of interest or otherwise and only if the assessee does not exercise this option then the assessee will get Rs. 33,750 after the expiry of the period of 5 years from the date of allotment.

In view of the terms of the issue, the assessee was of the view that no interest accrued on day to day basis or on year to year basis. However, the Assessing Officer (AO) made an addition of Rs. 47,812 to the total income of the assessee on account of notional accrued interest on OFCPN.

This issue was raised as an additional ground and was admitted. The Tribunal observed that since this issue was not raised before the lower authorities normally it would be restored to the file of the CIT(A) or the AO but since a legal issue had to be decided as to whether as per the terms of the OFCPN of Nirma Industries Ltd., it can be said that any income is accruing on year to year basis or not and since the terms of the issue were before the Tribunal and also before the authorities below the Tribunal decided to decide the issue rather than restore it back to the file of the lower authorities.

Held II:
The Tribunal noted that, as per the terms of issue, in the initial 4 years, the assessee is not eligible to decide as to whether he is going to exercise the option of convertibility or not and such option is to be exercised only in the last quarter of the 5th year and the assessee will get shares at the end of the period of 5 years and no interest as such is payable till maturity even if the assessee does not opt for conversion. If the assessee does not opt for conversion into equity shares he will get Rs. 33,750 for each OFCPN after the expiry of period of 5 years from the date of allotment. The debentures are transferable during the period of 5 years and company is also eligible to purchase debentures at discount, at par or at premium in the open market or otherwise. Hence, in the earlier period also, if the assessee is not opting for conversion in the equity shares, the assessee can sell the debentures in the open market or to the issuer company and it is quite natural that in the open market, such debentures will command such price which will include offer price plus proportionate accretion on account of difference in the issue price and the face value which can be considered as interest although no such nomenclature is given for accretion in the issue details.

The Tribunal held that the issue details suggest that no income is guaranteed to the assessee even after 5 years period from the date of allotment if the assessee opts for conversion and the assessee will get the income being difference between the face value and the issue price only if such option of conversion is not exercised by the assessee which he can exercise only in the last quarter of 5th year. There was an argument forwarded by the learned DR that before the last quarter of the 5th year, the assessee has an option to sell these OFCPNs because these OFCPNs are transferable and in that situation, the assessee will get at least issue price plus proportionate accretion till date of transfer over and above the issue price. This may be correct but in our considered opinion, even in the light of these facts, it cannot be said that any income is accruing to the assessee on day to day or year to year basis. The OFCPN may be held by the assessee as investment or trading item. If the assessee is holding OFCPN as a trading item and till the same is sold by the assessee, it has to be considered by the assessee as closing stock which has to be valued at the cost or market price whichever is lower and in that situation, even if the market price is more than the cost price i.e. issue price, then also this income is not taxed till the sale takes place. Although, if the market price goes down below the cost price i.e. issue price then in that situation, the assessee can claim loss to that extent by valuing the closing stock of OFCPN at market price but in case the market price is more than the cost price, no income is accruing to the assessee till the same is sold.

In another situation, where the assessee is holding these OFCPNs as investment then also, the income if any in respect of such capital asset is taxable only as capital gain and that too after the capital asset in question is transferred by the assessee. Till the actual transfer takes place, neither any income is taxable in the hands of the assessee even if the market value of the asset has gone up nor any loss is allowable to the assessee even if market value of the asset has gone down. It is not the case of the AO that the assessee has sold or transferred these OFCPNs in the present year. In the absence of this, it cannot be said that any income has accrued to the assessee even if it is accepted that the market value of these OFCPNs till the last date of the present year is more than cost price i.e. issue price which can be issue price plus proportionate accretion and the difference between the face value and issue price.

We have already discussed that the nature of OFCPN is not that of a fixed deposit and it is also not of the nature of DDB because of convertibility option and uncertainty about receipt of any extra amount over and above the issue price. Even on conversion, shares are to be allotted at par and not at premium i.e. face value.
Considering all these facts, we hold that in the facts of the present case, it cannot be said that any income has accrued to the assessee on account of these OFCPNs of Nirma Industries Ltd. because no sale has taken place and there is no guaranteed income to the assessee even after 5 years in case the assessee opts for conversion into shares at par.

The Tribunal allowed this ground of appeal of the assessee.

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2013-TIOL-885-ITAT-MUM Citicorp Finance (India) Ltd. vs. Addl. CIT ITA No. 8532/Mum/2011 Assessment Years: 2007-08. Date of Order: 13-09-2013

Form 26AS – Department is required to give credit for TDS once valid TDS certificate had been produced or even where deductor has not issued TDS certificates on the basis of evidence produced by the assessee regarding deduction of tax at source and on the basis of indemnity bond.

Facts:
For assessment year 2007-08 the assessee claimed total credit for TDS of Rs. 21,51,63,912 – claim of Rs 16,52,09,344 was made in the original return and further claim of Rs 1,42,71,296 was made in revised return filed on 13-04-2009 and a claim of Rs. 3,56,83,272 was made vide letter, dated 28-12-2010, filed in the assessment proceedings. The Assessing Officer (AO) granted credit of TDS only to the tune of Rs. 11,89,60,393. The AO did not grant credit claimed because of discrepancy with respect to credit shown in Form No. 26AS.

Aggrieved, the assessee preferred an appeal to CIT(A) who directed the assessee to furnish all TDS certificates in original before the AO and directed the AO to verify the claim of credit of TDS and to allow TDS as per original challans available on record or as per details of such TDS available on computer system of the department.

Aggrieved, the assessee preferred an appeal to the Tribunal where it was contended that credit of TDS has to be given on the basis of TDS certificates and in case TDS certificates are not available, on the basis of details and evidence furnished by the assessee regarding deduction of tax at source. Reliance was placed on the decision of Bombay High Court in the case of Yashpal Sawhney vs. ACIT (293 ITR 593). Reference was also made to the decision of the Delhi High Court in the case of Court on its own Motion vs. CIT (352 ITR 273).

Held:
The Tribunal noted that the credit of TDS has been denied to the assessee on the ground that the claim for TDS was not reflected in computer generated Form No. 26AS. It observed that the difficulty faced by the tax payer in the matter of credit of TDS had been considered by the Hon’ble High Court of Bombay in the case of Yashpal Sawhney vs. DCIT (supra) in which it has been held that even if the deductor had not issued TDS certificate, the claim of the assessee has to be considered on the basis of evidence produced for deduction of tax at source as the revenue was empowered to recover the tax from the person responsible if he had not deducted tax at source or after deducting failed to deposit with Central Government. The Hon’ble High Court of Delhi in case of Court on its Own Motion v. CIT (supra) have also directed the department to ensure that credit is given to the assessee, where deductor had failed to upload the correct details in Form 26AS on the basis of evidence produced before the department. Therefore, the department is required to give credit for TDS once valid TDS certificate had been produced or even where the deductor had not issued TDS certificates on the basis of evidence produced by the assessee regarding deduction of tax at source and on the basis of indemnity bond.

The Tribunal modified the order passed by the CIT(A) on this issue and directed the AO to proceed in the manner discussed above to give credit of tax deducted at source to the assessee.

This ground of appeal filed by the assessee was allowed.

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2013-TIOL-959-ITAT-DEL ITO vs. Tirupati Cylinders Ltd. ITA No. 5084/Del/2012 Assessment Years: 2004-05. Date of Order: 28.06.2013

S/s. 148, 151, 292B – U/s. 151 approval for issue of notice u/s. 148 has to be granted only by the Joint Commissioner or the Additional Commissioner. If the approval is not granted by the Joint Commissioner or the Additional Commissioner but is instead granted/taken from the Commissioner of Income-tax then notice for reassessment issued u/s. 148 would not be valid and assessment done pursuant to such notice would be liable to be quashed.

Facts:
For the assessment year 2004-05, the assessee filed a return declaring income of 31-08-2004. The return was processed u/s. 143(1) of the Act. Subsequently a notice was issued u/s. 148 of the Act. In response to this notice, the assessee filed a letter asking the Assessing Officer (AO) to treat the return filed u/s. 139 to be a return in response to the said notice. In an order passed u/s. 143(3) r.w.s. 147 of the Act, the AO made an addition of Rs. 10 lakh u/s. 68. In the order passed u/s. 143(3) r.w.s. 147 the AO mentioned that no notice u/s. 143(2) of the Act was served to the assessee within the statutory time limit during the original assessment proceedings. In the reassessment proceedings, the AO had mentioned that as a matter of precaution permission of CIT was obtained.

Aggrieved, the assessee preferred an appeal to CIT(A) who held that the reassessment to be null and void, since it was not in accordance with the provisions of the Act.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the Delhi High Court has in the case of CIT vs. SPL’s Siddhartha Ltd. (345 ITR 223)(Del) held that u/s. 151 of the Act it was only the Joint Commissioner or the Additional Commissioner who could grant the approval of the issue of notice u/s. 148 of the Act. The court has further held that if the approval was not granted by the Joint Commissioner or the Additional Commissioner and instead taken from Commissioner of Income-tax, then the same was not an irregularity curable u/s. 292B of the Act and consequently notice issued u/s. 148 was not valid.

Following this decision of the Delhi High Court, the Tribunal decided the issue in favor of the assessee and held that the reopening of assessment was not in accordance with law and was liable to be quashed.

The appeal filed by revenue was dismissed.

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Recovery of tax: Reduction of period for payment: Section 220(1) proviso: A. Y. 2010-11: Budget deficit of Income Tax Department is not a ground for reduction of period:

Amul Research and Development Association vs. ITO; 359 ITR 549 (Guj):

The assessee is a charitable trust which enjoyed exemption u/s. 11 of the Income-tax Act, 1961. For the A. Y. 2010-11 exemption u/s. 11 was denied by an order u/s. 143(3) of the Act and a demand of Rs. 1,41,07,755/- was raised. A period of seven days was granted instead of statutory period of 30 days from the date of service of the notice as prescribed u/s. 220 of the Act. Assessee preferred an appeal and also filed stay application before Commissioner(Appeals). In the mean time, the Assessing Officer recovered a sum of Rs. 1,39,70,275/- from the bank account of the assessee on 28th March, 2013.

The Gujarat High Court allowed the writ petition filed by the assessee, set aside the demand notice dated 13/03/2013, with a formal direction to the Revenue to refund the amount of Rs. 1,39,70,275/- by way of a cheque to be issued in favour of the assessee within two weeks and held as under:

“i) S/s. (1) of section 220 of the Income-tax Act, 1961, any amount otherwise than by way of advance tax, specified as payable in a notice of demand to be issued u/s. 156 of the Act, needs to be paid within 30 days of the service of the notice. However, the proviso to section 220(1) of the Act gives discretionary powers to the Assessing officer to reduce such period.

ii) Two conditions are required to be fulfilled before the Assessing officer resorts to this exception of the statutory period of 30 days. Firstly, he must have a reason to believe that the grant of the full period of 30 days would be detrimental to the interest of the Revenue and, secondly, prior permission of the Joint Commissioner requires to be obtained. The words “reason to believe” must have the same flavor as one finds in the case of exercise of powers by a reasonable man acting in good faith, with objectivity and neutrality based on material on record or exhibited in the order itself. The prior permission of the superior officer is to ensure that the powers are not exercised arbitrarily and there is a safeguard of a higher officer applying his mind independently to the issue in question when such belief is communicated by the Assessing Officer.

iii) If the demand is not likely to be defeated by any “abuse of process by the assessee”, belief cannot be sustained on the ground that availing of the full period would be detrimental to the interest of the Revenue.

iv) The reason given for reduction of the period for payment of taxes was that in the assessee’s place of assessment there was a budget deficit in the Income-tax Department. It was the budget deficit which was the very basis for making such a formation of belief. Another reason given was that the assessee had a rich cash flow and if the period of 30 days was reduced, the budget deficit would be met and the target set by the Department would be achieved.

v) The reasoning was contrary to the very object of introducing the proviso for giving discretion to the Assessing Officer. It clearly and unequivocally indicated that the Assessing Officer had completely misread the provision and his belief was neither of a reasonable man nor at all based on a rational connection with the conclusion of reduction of the period on account of it being detrimental to the Revenue.

vi) While issuing notice to the bank u/s. 226(3) of the Act for making payment, a notice has also to be given to the assessee which in this case was on the very day when the notice was issued to the bank. No opportunity had been given to the assessee for meeting such a notice issued to the bank. The sizeable amount of Rs. 1.39 crore had been withdrawn and deposited in the account of the Revenue on the very same day. Notice was an illusory and empty formality. This arbitrary exercise of withdrawal of amount from bank also required interference.

vii) Moreover, when the very action of the Assessing Officer was held to be contrary to the provisions of the law, the assessee’s not resorting to note (3) of the demand notice u/s. 156 of the Act or its having resorted to an alternative remedy was not bar to the court exercising the writ jurisdiction.”

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Cash credits: Section 68: A. Y. 1989-90: Meaning of “any sum”: No explanation regarding particular amount: Addition of sum in excess of such particular amount is not permissible u/s. 68:

D. C. Rastogi vs. CIT; 359 ITR 513 (Del):

For the A. Y. 1989-90 the assessee could not satisfactorily explain cash entry to the tune of Rs. 15,17,060/-. The Assessing Officer was of the opinion that even the profits returned were not truly disclosed as were other sources of income. He, therefore, proceeded to reject the accounts and complete the assessment on an estimate basis. Accordingly, the Assessing Officer made an addition of Rs. 25 lakh over and above the specific amount of Rs. 15,17,060/-. The Commissioner (Appeals) reduced the estimation to Rs. 17 lakh. This was upheld by the Tribunal.

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

“i) In the case of section 68 of the Income-tax Act, 1961, there cannot be any estimate even if for the rest of the accounts, such an exercise is validly undertaken. This is for the simple reason that the expression “any sum” refers to any specific amount and nothing more.

ii) U/s. 68 any amount other than one found credited in the account books of the assessee could not be estimated and charged to tax.”

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Capital gain: Business profits vs. Capital gains: S/s. 45, r.w.s. 28(i): A. Y. 2006-07: Conversion of stock-in-trade (shares) into investment in 2002 and 2004: Sale of such shares in relevant year: Profit is capital gain and not business income:

Yatish Trading Co. (P.) Ltd. vs. CIT; 359 ITR 320 (Bom):

218 Taxman 316 (Bom): The assessee was engaged in the business of investments and also dealing in shares and securities. In the A. Y. 2006-07, the assessee declared income under the heads ‘profits and gains of profession’ and also under the head ‘capital gains’. The Assessing Officer noted that a part of the capital gains declared was in respect of transfer of shares/securities which were held by the assessee originally as stock-intrade as a dealer in shares/securities which were converted into investment by the assessee on 1st April, 2002 and 1st October, 2004. He held that the short term and long term gains arising out of the sale of shares which were held originally as stock in trade and converted into investments was to be treated as business income. The CIT(A) and the Tribunal allowed the assessee’s claim. The Tribunal held that it is not in dispute that the conversion of its stock in trade into investment was accepted by the Department in A. Ys. 2003-04 and 2005-06. It is also not in dispute that the shares which were sold and gains from such sales were offered under the head capital gains from the date of conversion from stock in trade into investments and prior thereto as business profits. Further in its books of account the assessee showed the shares on which tax is levied under the head capital gain as investments. Further the fact that the assessee was trading in the shares would not estop the assessee from dealing in shares as investment and offer the gain for tax under the head capital gains. Thus, it is open to the trader to hold shares as stock in trade as well as investments.

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

“i) Once the finding of fact is recorded that the shares sold were held by assessee as investments, the gains arising out of the sale of investment were to be assessed under the head capital gains and not under the head business profits.

ii) In view of the above, we see no question of law arises for our consideration. Accordingly, the appeal is dismissed.”

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Capital gain: Exemption u/s. 54F: A. Y. 2009- 10: Construction of new house commenced before the sale of ‘original asset’: Denial of exemption u/s. 54F not proper:

CIT vs. Bharti Mishra; [2014] 41 taxmann.com 50 (Delhi):

The assessee, an individual, had sold shares and thereafter the sale proceeds of Rs. 54,86,965/- were invested in construction of house property. Exemption was claimed u/s. 54F of the Income Tax Act, 1961. The Assessing Officer rejected the claim on the ground that the construction of the house had commenced before the date of sale of shares. The Tribunal allowed the claim of the assessee.

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

“i) Section 54F(1) if read carefully states that the assessee being an individual or Hindu Undivided Family, who had earned capital gains from transfer of any long-term capital asset not being a residential house could claim benefit under the said section provided, any one of the following three conditions were satisfied; (i) the assessee had within a period of one year before the sale, purchased a residential house; (ii) within two years after the date of transfer of the original capital asset, purchased a residential house and (iii) within a period of three years after the date of sale of the original asset, constructed a residential house.

ii) For the satisfaction of the third condition, it is not stipulated or indicated in the section that the construction must begin after the date of sale of the original/old asset. There is no condition or reason for ambiguity and confusion which requires moderation or reading the words of the said s/s. in a different manner.

iii) Section 54F is a beneficial provision and is applicable to an assessee when the old capital asset is replaced by a new capital asset in form of a residential house. Once an assessee falls within the ambit of a beneficial provision, then the said provision should be liberally interpreted.

iv) In view of the aforesaid position, we do not find any merit in the present appeal and the same is dismissed.”

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Business expenditure: TDS: Disallowance: Royalty: Section 9(1) Expl. (2), 194J and 40(a)(ia): A. Y. 2009-10: Consideration for perpetual transfer for 99 yrs of copyrights in film is not “royalty”:

Mrs. K. Bhagyalakshmi vs. Dy. CIT; 2013] 40 taxmann. com 350 (Mad):

The assessee is a person carrying on business in the purchase and sale of Telugu films. For the A. Y. 2009-10, the Assessing Officer, made a disallowance of Rs.7,16,15,000/- for non-deduction of TDS u/s. 194J of the Income-tax Act,1961 by invoking section 40(a) (ia) of the Act on the ground that the purchase of film rights fell under the term “Royalty” and that the agreement entered into between the assessee with respect to purchase of film rights was termed as an assignment agreement and the assignee of the satellite rights and the person who transferred such rights was the assignor and such rights were given for a period of 99 years. Therefore, the Assessing Officer held that it is not a sale but a mere grant of satellite right in the movie produced by the assignor and the payments made for transfer of such rights fall within the meaning of “Royalty”. The CIT(A) allowed the assessee’s appeal and held that the payments made by the assessee could not be termed as ‘Royalty’ as they are not covered by Explanation 2 to Clause (vi) of section 9(1) of the Act and the payment were covered by section 28 of the Act as trading expenses and there was no scope for invoking section 40(a)(ia) of the Act and therefore the CIT(A) held that the payments for acquiring of the film rights were not exigible for deduction of Tax at Source u/s. 194J of the Act as they did not qualify as ‘Royalty’. The Tribunal reversed the decision of the CIT(A) and upheld the disallowance.

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

“i) We have seen the various conditions contained in the sample transfer deed and there is a transfer of copy right in favour of the assessee. Though the agreement speaks of perpetual transfer for a period of 99 years, in terms of section 26 of the Copy Right Act, 1957, in the case of cinematographic film, copy right shall subsist until 60 years from the beginning of the calendar year next following the year in which the film is published. Therefore, the agreement in the case on hand, is beyond the period of 60 years, for which the copy right would be valid, the document could only be treated as one of sale.

ii) We have no hesitation to hold that the findings of the First Appellate Authority was perfectly justified in holding that the transfer in favour of the assessee as sale and therefore, excluded from the definition of “Royalty” as defined under clause (v) to Explanation (2) of section 9(1) of the Act.

iii) In the result, the order of the Income Tax Appellate Tribunal shall stand set aside and the Tax Case(Appeal) is allowed.”

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Business expenditure: Capital or revenue: A. Ys. 1994-95 to 2004-05: Media cost paid for the import of a master copy of Oracle Software used for duplication and licensing is an expenditure of a revenue nature and as such is an allowable deduction:

Oracle India (P.) Ltd. vs. CIT; [2013] 39 taxmann.com 150 (Delhi):

The Appellant company is a subsidiary of Oracle Corporation USA. The Appellant company entered into a licence agreement with its parent/holding company under which the Appellant was granted non-exclusive non-assignable right and authority to duplicate on appropriate carrier media software products or other products and sub-licence the same to third parties in India. The holding company retained the ownership of the copyright. For the relevant years the Assessing Officer disallowed the claim for deduction of the royalty paid to the holding company treating the same as capital expenditure. The Tribunal upheld the disallowance.

The Delhi Court reversed the decision of the Tribunal, allowed the assessee’s appeal and held that the expenditure was of revenue nature and as such an allowable deduction.

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Assessee in default: TDS: S/s. 194B and 201: A. Ys. 2001-02 and 2002-03: Non-deduction of TDS from lottery winnings in kind: Assessee not in default: Not liable u/s. 201:

CIT vs. Hindustan Lever Ltd.; 264 CTR 93 (Kar):

The assessee company was engaged in manufacture and sale of certain consumer products. Under its sales promotion scheme the purchasers were entitled to prizes as indicated on the coupons inserted in the packs/containers of their products. The prizes were Santro car, Maruti car, gold chains, gold coins, gold tablas, silver coins, emblems etc. The total amount of prizes distributed valued at Rs. 6,51,238/- for A. Y. 2001-02 and Rs. 54,73,643 for A. Y. 2002- 03. The Assessing Officer held that what has been paid by the assessee as prize in kind is a lottery on which tax was deductible u/s. 194B of the Income-tax Act, 1961 and treated the assessee as an assessee in default on the ground that the assessee neither deducted the tax nor ensured payment thereof before the winnings were released. Accordingly, the Assessing Officer raised a demand of Rs. 3,78, 550/- for the A. Y. 2001-02 and Rs. 17,73,902/- for A. Y. 2002-03 u/ss. 201(1) and 201(1A). The Tribunal cancelled the demand and held that there was no obligation on the assessee to deduct tax at source in respect of prizes paid in kind and in absence of any such obligation no proceedings u/s. 201 could be taken against the assessee.

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

“i) From the plain reading of the proviso to section 194B, it is clear that it does not provide for deduction of tax at source where the winnings are wholly in kind and it simply puts a responsibility to ensure payment of tax, where winnings are wholly in kind. In the present case, admittedly the winnings were wholly in kind.

ii) The combined reading of sections 194B and 201 would show that if any such person fails to “deduct” the whole or any part of the tax or after deducting, fails to pay the tax as required by or under this Act, without prejudice to any other consequences, which he may incur, be deemed to be an assessee in default in respect of the tax. In other words, the provisions contained in these sections do not cast any duty/responsibility to deduct the tax at source where the winnings are wholly in kind. If the winnings are wholly in kind, as a matter of fact, there cannot be any deduction of tax at source.

iii) The proceedings against the person u/s. 201, such as the assessee in the present case, who fails to ensure payment of tax, as contemplated by proviso to section 194B, before releasing the winnings, are not maintainable or the proceedings against such person are without jurisdiction.”

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Assessee in default: TDS: S/s. 192, 201(1) and 201(1A) : A. Y. 1992-93: Short deduction on account of bona fide belief: Assessee not in default: Not liable u/s. 201(1) and 201(1A):

CIT vs. ITC Ltd.; 263 CTR 241 (All):

Assessee believed that conveyance allowance is exempt and accordingly computed TDS u/s. 192 excluding conveyance allowance. The Assessing Officer treated the assessee as assessee in default and raised demand u/s. 201(1) and also levied interest u/s. 201(1A). The Tribunal allowed the assessee’s appeal and cancelled the demand.

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

“Assessee was under bona fide belief that the conveyance allowance was exempt u/s. 10(14) and tax was not deductible at source and therefore assessee could not be treated as assessee in default for charging interest u/s. 201(1A) of the Act.”

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Export – Deduction u/s. 80HHC – DEPB credit – Matter remanded to the Assessing Officer in accordance with the law laid down in Topman Exports.

The assessee was a manufacturer-exporter. For the assessment year 2003-04, the assessee filed return of income on 28th November, 2003, showing a total income of Rs. 1,79,80,000. The assessee also claimed deduction u/s. 80HHC of the Act. The claim of the assessee for such deduction included consideration of Rs. 1,54,67,000 upon transfer of the DEPB credit. The Assessing Officer was of the opinion that 90 % of such sum had to be excluded for the purpose of deduction u/s. 80HHC of the Act. He framed the assessment accordingly.

The assessee approached the Commissioner of Income Tax (Appeals), who confirmed the decision of the Assessing Officer, holding that the entire amount received by the assessee towards consideration on transfer of the DEPB credits would be covered u/s. 28(iiid) of the Act. Ninety per cent of the such amount, therefore, had to be excluded for the purpose of working out of the deduction u/s. 80HHC of the Act. The Commissioner of Income Tax (Appeals) observed that the treatment to the DEPB amount should be the same as that of duty draw back. In other words, the entire amount of the DEPB credit would be covered under section 28(iiid) of the Act. The Commissioner of Income Tax (Appeals) was of the opinion that the cost of acquiring the DEPB credit to the assessee was nil.

The assessee carried the issue in appeal before the Tribunal. The Tribunal in the detailed judgment considered various aspects including the interpretation of various clauses of section 28, and in particular, clause (iiid) of section 28 and its co-relation to section 80HHC of the Act. The Tribunal was of the opinion that the face value of the DEPB would be the cost of its acquisition by the assessee. If the assessee sold such DEPB credit at a price higher than the face value, the difference would be the profit of the assessee which would be covered u/s. 28(iiid) of the Act. It is only this element which to the extent of 90 per cent be excluded for the purpose of working out section 80HHC deduction. The Tribunal also referred to Explanation (baa) to section 80HHC, by virtue of which, 90 % of the income referred to in section 28(iiid) of the Act is to be excluded from the total turnover of the assessee for the purpose of working out section 80HHC deduction.

The Revenue carried the matter to the High Court, which on combined reading of the Government of India policy providing for the DEPB benefits, the decision of the Bombay High Court in Kalpataru Colours and Chemicals (2010) 328 ITR 451 (Bom.) and the apex court, in Liberty India vs. CIT (2009) 317 ITR 218 (SC) concluded that the face value of the DEPB credit cannot be taken to be its cost of acquision in the hands of the assessee-exporter.

According to the High Court, the Tribunal committed an error in coming to the conclusion that on transfer of the DEPB credit by an assessee only the amount in excess of the face value therefore would form part of profit as envisaged in clause (iiid) of section 28.

Before the Supreme Court, the learned Additional Solicitor General for the Revenue, fairly submited that in view of the decision of the Supreme Court in Topman Exports vs. CIT [2012] 342 ITR 49 (SC), the civil appeal deserved to be allowed and the matter should be sent back to the Assessing Officer.

The Supreme Court for the reasons given in Topman Exports (supra) set aside the judgement and order of the Gujarat High Court and directed the Assessing Officer to compute the deduction u/s. 80HHC of the Income-tax Act, 1961, in the light of the observations made by it in Topman Exports.

Note: A similar decision was delivered by the Supreme Court in the case of Global Agra Products vs. ITO (2014) 360 ITR 117 (SC)

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MAT – A Conundrum unsolved..

Synopsis

Minimum Alternate Tax (‘MAT’) was introduced as an alternative mode of tax with an intent to maintain minimum quantum of tax to be paid by the assessee – company which made profits but offered little or negligible income to tax by virtue of various deductions. While the methodology for computing MAT appears simple , the same has been under the subject matter of controversy due to interpretation of terms contained in section 115JB.

In the following article, the authors have analysed the treatment of a provision for the purposes of MAT and brought out the various dimensions of the issue.

1. Introduction

The era of MAT began as an ‘alternative mode’ of tax. With the efflux of time, the MAT regime has actually left us with no ‘alternative’ but to ‘tax’. Its objective is well known; although the text and content is vexed which often keeps the tax doyens perplexed. This complex provision has thrown out innumerable issues from its Pandora box. In this article, we have attempted to address one such issue through a case study.

2. Case Study

X Limited is an Indian company which acquired 1,00,000 equity shares of Y Limited for a consideration of Rs. 60 crore. In Year 1, X Limited created a “Provision for investment loss” amounting to Rs. 16 crore [by debiting the profit and loss account]. Cost of investment in the balance sheet was reduced to the extent of the provision (ie, Rs. 16 crore). The net loss as per the profit and loss account was Rs. 17 crore.

While computing the book profit under the provisions of section 115JB of the Income-tax Act, 1961 (“the Act”), the Provision for investment loss (i.e. Rs 16 crore) was “added back” to net the loss as per the profit and loss account. The book loss (u/s. 115JB) for Year 1 was accordingly computed at Rs. 1 crore. The loss computed under the regular provisions of the Act was Rs. 50 lakh. The loss computed under regular provisions being lower than the book loss, the return of income for Year 1 was filed with the loss of Rs. 50 lakh.

Subsequently, in Year 2, X Limited sold the 100,000 equity shares in Y Limited for Rs. 68 crore. The sale resulted in a gain of Rs. 8 crore. X Limited recognised this gain as “Profit on sale of investment” in the Profit and loss account along with reversal of Provision for investment loss (pertaining to shares sold during the year) amounting to Rs. 16 crore. Cumulatively, profit on sale of investment recognised in financial statements added up to Rs. 24 crore [ie, 8 crore + 16 crore]. The company paid tax under the provisions of MAT (section 115JB) amounting to Rs. 2 crore [after reducing Rs. 16 crore from the net profit].

In this background, the write-up discusses the appropriateness of the MAT computation carried out by X Limited.

3. Case Analysis

MAT – General principles

Minimum Alternate Tax (“MAT”) computed u/s. 115JB is an alternative regime of taxation. The section provides for an alternate, nay an additional mechanism, of ‘computing the tax liability’ of an assessee apart from the normal computation. A comparison is made between tax payable under the normal provisions of the Act and the tax payable on “book profit”. The higher of the tax payable from out of the two computations would have to be discharged by the assessee company.

S/s. (1) to section 115JB requires a tax (at 18.5%) on book-profit to be compared with income-tax payable on the total income as computed under the Act. Section 115JB is an alternative tax mechanism. This is evident from the section heading which reads – “Special provision for payment of tax by certain companies”. It is thus a special provision for payment of tax. The intent of section 115JB is to maintain the minimum quantum of tax (at 18.5% on book profit) that an assessee-company should be liable to pay. If the tax u/s. 115JB is higher, the “book-profit” is deemed to constitute the total income of the Company.

‘Book Profit’ is defined in Explanation 1 to section 115JB. It is defined to mean the net profit as shown in the profit and loss account prepared as per s/s. (2) to section 115JB as reduced or increased by certain sums specified in the section. S/s. (2) requires the profit and loss account to be prepared in accordance with Parts II & III of Schedule VI of the Companies Act, 1956. In arriving at the net profit, therefore, the principles outlined in Parts II & III of schedule VI of the Companies Act, 1956, shall be followed [Apollo Tyres Ltd (2002) 255 ITR 273(SC) and CIT vs. HCL Comnet Systems & Services Ltd. (2008) 305 ITR 409 (SC)].

Explanation 1 outlines a process of additions and deletions of certain sums to the ‘net profit’ disclosed in the Profit and loss account. Judicial precedents indicate that these adjustments are exhaustive. No other adjustments apart from those outlined in the explanation can be made to the ‘net profit’ to arrive at the “book profit”.

Characteristics of book-profit

S/s. (1) to section 115JB envisages a comparison of taxes. If the tax on book profit is higher than the tax payable under the normal provisions of the Act, then, (i) such book-profit would be deemed to be the total income and (ii) the tax payable shall be the tax on book profit (at 18.5%). A two-fold deeming fiction is envisaged. The total income under the normal provisions is replaced with book profit and the tax payable under the normal provisions paves way for ‘tax on book-profit’. Thus, s/s. (1) visualises a 3 step-approach:

(i) The book profit should be an outcome of the computation envisaged in Explanation 1 wherein, net profit as per the profit and loss account is adjusted by the adjustments specified therein;

(ii) Tax on such book profit should exceed the tax on income under the normal provisions; and

(iii) On satisfaction of the twin characteristics above, the book profit is deemed as the total income and the tax on book profit shall be the tax payable by the assessee.

Step ‘(iii)’ is a natural consequence of steps ‘(i)’ & ‘(ii)’. S/s. (1) of section 115JB is operative only when steps (i) and (ii) result in step (iii). In other words, in the absence of book profit or if tax on income under the normal provisions exceeds or is equal to the tax on the book profit, the deeming fiction in step (iii) is not to be invoked. If step (i) and (ii) do not culminate in step (iii), the computation in step (i) [book profit computation] becomes relevant only for step (ii) [comparison] and not step (iii). This is because, the computation of total income under normal provisions is sustained and the occasion of its replacement by book profit does not occur/ arise.

In case the computation [of book profit] under step (i) results in a negative number (or book loss, step (ii) becomes inapplicable or irrelevant. The comparison envisaged in step (ii) is between ‘tax on total income’ and ‘18.5% on book profit’. A negative book profit will invariably result in tax on total income under the normal provisions not being lower than tax on book profits. This can be explained by looking at the twin possibilities below:

Case 1 – Positive total income and book loss

In the above case, tax on total income under the normal provisions (being a positive number) exceeds the “tax payable” on the negative book profit (or book loss) and consequently results in tax on total income under the normal provisions being higher than 18.5% of book profit. Accordingly, section 115JB(1) is not satisfied.

Case 2 – Nil total income and book loss

Particulars

Amount (Rs)

Total income under the normal provisions

Nil

Tax on total income (@ 30%) – (A)

Book loss

(20)

18.5% on book loss – (B)

(3)

Tax payable by the
assessee (Higher of A and B)

In the above case, tax on total income (being nil) exceeds the negative tax on the book profit (or book loss) and consequently results in tax on total income being higher than 18.5% of book profit. Accordingly, section 115JB(1) is not satisfied.
In both the situations, “tax” on total income un-der the normal provisions would exceed 18.5% on book loss (or negative book profit). It is a trite to state that ‘total income ’ could either be ‘positive’ or ‘nil’.There cannot be negative total income. Consequently, there cannot be a ‘tax in negative’. For section 115JB to operate, ‘18.5% of book profit’ should be higher than such tax. Even if ‘18.5% on book loss’ is taken to be ‘nil’ in both the aforesaid examples, tax on total income under the normal provisions would not be lower which is the primary condition for section 115JB to be invoked.

Creation of provision for investment loss

In the given case study, X Limited created ‘Provi-sion for investment loss’ which was added back (or adjusted) while computing the book profit u/s. 115JB. The company had filed its return of income in Year 1 with loss (computed under normal provisions of the Act) amounting to Rs. 50 lakh. This loss was lower than the book loss (u/s. 115JB) for Year 1 which was Rs. 1 crore.

Being a book loss, there was no occasion to compute ‘tax on book profit’. Comparison of taxes u/s/s. (1) was not possible. The total income and tax payable could not be deemed as ‘book profit’ and ‘tax on book profit’ respectively for Year 1. Accordingly, operation of section 115JB was not triggered. For Year 1, the ‘Provision for investment loss’ was added back (or adjusted) while computing the “book profit” u/s. 115JB. The net result of the computation was a loss.

The appropriateness of this treatment (i.e, adding back of the provision) can be examined by traversing through the various adjustments housed in Explanation 1. These adjustments can be bisected into ‘upward adjustments’ and ‘downward adjustments’ which increase and decrease the net profit respectively. The opening portion of the Explanation 1 reads – “For the purposes of this section, “book profit” means the net profit as shown in the profit and loss account for the relevant previous year prepared u/s/s. (2), as increased by…”.

The phrase used is ‘net profit’. The expression ‘net profit’ and ‘net loss’ are not synonymous and can-not be used interchangeably. One could argue that the Explanation 1 visualises only a ‘net profit’ and not a ‘net loss’. In other words, the adjustments contemplated under Explanation 1 are not operative where the net result of operation is a loss. This is because the threshold condition to ignite section 115JB, viz. ‘net profit’, is not satisfied.

Further, the opening portion of the Explanation 1 deals with ‘increase’ of ‘net profit’ by certain adjustments. The second portion which deals with downward adjustments deals with reduction of the net profit by certain adjustments. The phrase used therein is “reduced by”. Thus, the law envisages an ‘increase’ and ‘decrease’ of net profits. The legislature has not employed the phrase “adjusted by”. The phrases used in the Explanation 1 have specific connotations. They cannot be understood in any modified manner. This aspect is important because an adjustment which ‘increases’ a ‘net profit’ would arithmetically ‘decrease’ if the start point were to be a ‘net loss’. This opposite numerical consequence indicates that the adjustments in the first portion have to necessarily result in an increase in the base figure and the ones in the latter portion should cause a reduction. Accordingly, the law visualises only ‘net profit’ to be the start point or base figure [and not ‘net loss’].

In the present case study, the net loss as per Profit and loss account in the Year 1 was Rs. 17 crore. Existence of net loss thus excludes X Limited from the clutches of section 115JB. Accordingly, it could be argued that there was no need to carry out any computation u/s. 115JB.

Alternative view

If one were to adopt the aforesaid position [that MAT is operative only on ‘net profit’], then all loss making companies would be excluded from the gamut of MAT computation. Such interpretation, although may be literally correct, would defy the objective of MAT computation. This could encourage the practice of ‘skewing of profits’ or ‘window dressing’ of financial statements.

Having accepted that loss making companies are also subject to MAT provisions (like in the present case), one needs to understand whether the book profit computation carried out by X Limited for Year 1 is in accordance with Explanation 1.

Two adjustments which could be relevant in the present context are clause (c) and (i) of the first part of the Explanation 1. These clauses read as under:

(c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities

……

(i) the amount or amounts set aside as provision for diminution in the value of any asset

As per clause (c) of Explanation 1, any provision for liability other than ‘ascertained liability’ is to be added to the net profit in order to arrive at the book profit for the purpose of section 115JB. A liability may be capable of being estimated with reasonable certainty though the actual quantification may not be possible. Even though estimation is involved, it would amount to a provision for ascertained liability. The intention of the legislature in inserting clause (c) is to possibly prohibit provision for contingent liability helping in reduction of the book profit. A provision for loss on investment should not be regarded as provision for meeting unascertained liability.

Prior to insertion of clause (i), there was no express provision which dealt with provision for diminution in the value of asset. It amply clarified by the Apex Court in the case of CIT vs. HCL Comnet Systems & Services Ltd. (2008) 305 ITR 409 (SC) that clause
(c) does not deal with diminution in value of as-sets. The Court observed (although the decision was in the context of provision for doubtful debts) that a provision for doubtful debts is to cover up the probable diminution in value of asset (debtors) and is not provision for a liability. Thus, provision for diminution in value of assets cannot be equated with provision for liabilities. Consequently, clause (c) in Explanation 1 cannot be applied in cases where a diminution in value of investments is contemplated.

Subsequently, clause (i) in second part under Explanation 1 was inserted by the Finance (No. 2) Act, 2009, with retrospective effect from 01-04-2001. Acknowledging that clause (c) was not suitable to rope in provision for loss in the value of assets, clause (i) was inserted to achieve this objective. Clause (i) statutorily affirms the Apex Court decision that provision for diminution in value of assets is different from provision for liabilities.

Clause (i) employs the expression “provision for diminution in the value of any asset”. Both clause (c) and

(i) use the term ‘provision’. This is possibly because a provision need not necessarily be for a liability and it could also be for diminution in the value of assets or for loss of an asset. This is discernible from the definitions/ description given in the ICAI literature and Company Law provisions. The word “provision” has not been defined in the Act. The Guidance Note on “Terms Used in Financial Statements” issued by the Institute of Chartered Accountants of India defines the term ‘provision’ as under:

“an amount written off or retained by way of providing for depreciation or diminution in value of assets or retained by way of providing for any known liability, the amount of which can-not be determined with substantial accuracy.”

Paragraph 7(1) of Part III of old Schedule VI to the Companies Act, 1956 defines the term ‘provision’ as under:

“the expression ‘provision’ shall, subject to sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.”

From the above, one can discern that a provision need not necessarily be for a liability. It can also be provision for depreciation or diminution in value of assets. The Mumbai Tribunal in the case of ITO vs. TCFC Finance Limited (ITA No.1299/Mum/2009) held that provision for diminution in the value of investment has to be added for computing book profit, regardless of the fact whether or not any balance value of the asset remains. The Tribunal also defined the meaning of the term “diminution” in the following manner:

“In common parlance the word “diminution” indicates the state of reduction. The Shorter Oxford Dictionary gives the meaning of the word “diminution” as “the action of making or becoming less; reduction “. Accordingly, any provision made for diminution in the value of any asset, is to be added for computing book profit under the provisions of section 115JB”

In the present case-study, the provision was created against loss due to decrease in the realisable value of investment (i.e, shares in Y Limited). It signifies preparedness for a dip in the value of the asset (Y Limited shares). The provision for investment loss after the amendment to the statute would be covered within the precincts of clause (i).

Reversal of provision for investment loss in Year 2

In the present case study, X Limited sold 100,000 equity shares in Y Limited in Year 2 for a gain of Rs. 8 crore. The company reversed the provision for investment loss amounting to Rs. 16 crore. Conse-quently, Rs. 16 crore was included in net profits while computing the MAT liability. After reducing Rs. 16 crore from the net profit, the company discharged its tax liability under MAT.

There is no dispute around inclusion of Rs. 8 crore in the book profit [being gain from the sale of shares]. The question is whether while computing book prof-its under MAT, reversal of “Provision for investment loss” was to be ‘retained’ or ‘reduced’ from the net profits in ascertaining tax on book profit.

As already detailed, Explanation 1 outlines the computation of book profit involving certain additions and deletions (or adjustments) to the ‘net profit’. The start point of such computation is ‘Net Profit as shown in the Profit & Loss Account’. The adjustments contemplated in the definition include ones which increase such net profit (‘Upward Adjustments’) and items which reduce the net profit (‘Downward Adjustments’). One such ‘Downward Adjustment’ is amount withdrawn from any Reserve or Provision, if any such amount is credited to the Profit & Loss Account and had been instrumental in increasing the book profit for any earlier year. Clause (i) of the second part of Explanation 1 which houses this adjustment, reads as under:

(i) the amount withdrawn from any reserve or provision (excluding a reserve created before the 1st day of April, 1997 otherwise than by way of a debit to the profit and loss account), if any such amount is credited to the profit and loss account:

Provided that where this section is applicable to an assessee in any previous year, the amount withdrawn from reserves created or provisions made in a previous year relevant to the assessment year commencing on or after the 1st day of April, 1997 shall not be reduced from the book profit unless the book profit of such year has been increased by those reserves or provisions (out of which the said amount was withdrawn) under this Explanation or Explanation below the second proviso to section 115JA, as the case may be;

Clause (i) read with the proviso appended to it mandates reduction of net profits by the amount withdrawn from any reserves/provisions if – (a) it is credited to the profit and loss account and (b) the book profit u/s. 115JA / 115JB for year in which such provision was created had been increased by the amount of such provision. In other words, reduction as per Clause (i) is permissible only on satisfaction of twin conditions. Firstly, the amount withdrawn is credited to profit and loss account and secondly at the time of ‘creation’ of reserve, the ‘Book Profit’ had been increased by the amount of the said with-drawal. This was the mandate of the Apex Court in the case of Indo Rama Synthetics (I) Limited vs. CIT (2011) 330 ITR 363 (SC). The ruling advocates a strict reading of the downward adjustment for withdrawal from reserve. The Supreme Court held that if the reserves created are not referable to the profit and loss account and the amount had not gone to increase the book value at the time of creation of the reserve; the question of deducting the amount (transferred from such reserve) from the net profit does not arise at all. The Apex Court held that the objective of clauses (i) to (vii) is to find out the true and real working result of the assessee company.

In the present case, X Limited had credited the re-versal of provision for investment loss to its profit and loss account in Year 2. The reversal of the pro-vision to the profit and loss account satisfies the first condition referred to above. On this, there is no dispute. The doubt is regarding the compliance of the second condition. X Limited has excluded such reversal while computing the MAT liability. To enable such exclusion, the said reversal (of provi-sion) should have ‘decreased’ the book losses in the year of its creation (i.e, Year 1). A reduction of book loss has the same effect as increase in book profit. Accordingly, the second condition is satisfied. The question is whether the said treatment is tenable? Can increase in book profits (in the year of creation) to the extent of provision created by itself, satisfy the stipulated condition? Does such increase necessarily have to culminate in tax being payable under the MAT regime? Should an increase in book profit (on creation of provision) necessarily be accompanied with a tax liability u/s. 115JB?

The answer to this issue has both ‘for’ as well as ‘against’ view points. The analysis would not be complete, unless both the possible views are captured. The following paragraphs discuss these viewpoints:

View I – Increase in book profits should result in payment of tax under MAT

As per this view -point, the increase in book profit should result in tax liability under the MAT provisions. If such increase does not culminate in tax being payable u/s. 115JB, then the reversal of such provision should not be reduced while computing the book profit.

In this regard, it may be relevant to peruse circular no.550 issued by the Central Board of Direct Taxes explaining amendments to Income-tax Act vide Finance Act, 1989. The relevant portion of the same is as under:

“Amendment of the provisions relating to levy of minimum tax on ‘book profits’ of certain companies

24.4 Further, under the existing provisions certain adjustments are made to the net profit as shown in the profit and loss account. One such adjustment stipulates that the net profit is to be reduced by the amount withdrawn from reserves or provisions, if any, such amount is credited to the profit and loss account. Some companies have taken advantage of this provision by reducing their net profit by the amount withdrawn from the reserve created or provision made in the same year itself, though the reserve when created had not gone to increase the book profits. Such adjustments lead to unintended lowering of profits and consequently the quantum of tax payable gets reduced. By amending section 115J with a view to counteract such a tax avoidance device, it has been provided that the “book prof-its” will be allowed to be reduced by the amount withdrawn from reserves or provisions only in two situations, namely :—

(i) if the reserves have been created or provisions have been made in a previous year relevant to the assessment year commencing before 1st April, 1988; or

(ii) if the reserves have been created or provisions have been made in a previous year relevant to the assessment year commencing on or after 1st April, 1988 and have gone to increase the book profits in any year when the provisions of section 115J of the Income-tax Act were applicable.” (emphasis supplied)

The Circular clarifies that clause (i) is an anti-abuse provision. It was introduced to prohibit unintended lowering of profits and consequent reduction of tax payable. The intent was to induce parity in tax treatment in the year of creation and withdrawal of reserves. The objective is to plug-in tax leakage. The emphasis is on the payment of correct quantum of tax. The amendment seeks to impact the tax liability under MAT and not the mere arithmetic adjustment of book profit. In this background, it may be pertinent to observe the closing portion of the above quoted circular. It is clarified that the amount withdrawn from reserves or provisions is deductible in MAT computation only if (a) the reserves have been created or provisions have been made for the year on or after 1st April, 1988 and (b) have gone to increase the book profits in any year when the provisions of section 115J of the Income-tax Act were applicable. Twin conditions are visualised by the circular. The first relates to year of creation being on or after 01-04-1998 and the second mandates that the book profits should have been increased in the year in which section 115J is applicable. The latter condition thus requires not only enhancement of book profit but such increment has to occur in the year in which section 115J is applicable. MAT is “applicable” when the final discharge of tax happens under the regime of section 115J. The phrase “is applicable” has to be read in such context. Otherwise, it would have no meaning, as section 115J being a part of the statute would in any way be “applicable” to any company. The circular issued in the context of section 115J should also be applicable to section 115JB purposes, as in substance, the provisions are the same (More on ‘applicability’ of section 115JB later).

The latter condition of book profit enhancement accordingly has to occur in the year in which section 115JB is applicable. Section 115JB is an alternate tax regime. It is applicable only when the tax on book profits exceeds the tax on total income. If the tax on book profits does not ‘exceed’ tax on total income, section 115JB is not applicable.

To conclude, amount withdrawn from reserves or provisions is deductible in MAT computation only if (a) provisions have been made for the year on or after 01-04-1988; (b) such amount has gone to increase the book profit in the year in which taxes were payable under MAT regime (or section 115JB).

This view is supported by the Hyderabad tribunal in Vista Pharmaceuticals Ltd vs. DCIT (2012) 6 TaxCorp (A.T.) 27449 (Hyd). The issue before the tribunal was with regard to direction of the CIT to consider the interest waived to be included in the computation of book profit under section 115JB. The facts of the case were that the assessee computed its book profit u/s. 115JB at ‘nil’ after reducing the amount of interest waived by bank on the ground that it is the amount withdrawn from provision for interest to financial institutions debited to Profit and Loss account in earlier year now credited. The tribunal held as under:

“In the case of the present assessee, the amount withdrawn from reserve or provision i.e., waiver of interest cannot be considered as part of book profit since it was never allowed in the computation of book profit of the company in any of the earlier years since the company never had any book profit being sick industrial undertaking…….

It is also an admitted fact that in the earlier years there is no computation of book profit ex con-sequentia, there was no assessment with regard to computation of book profit u/s. 115JB of the Act. It was held in the case of Narayanan Chettiar Industries vs. ITO (277 ITR 426) that in respect of remission of liability no addition can be made un-less an allowance or deduction is allowed to the assessee in the previous year. Further in the case of Rayala Corporation Pvt. Ltd. vs. ACIT, 33 DTR 249, wherein it was held that returns for earlier years have been found defective by the Assessing Officer and declared to be nonest, as the assessee had failed to rectify the defect in spite of notice issued u/s. 139(9) of the Act, deduction of interest claimed in such returns cannot be deemed to have been allowed and, therefore, interest waived by bank cannot be charged u/s. 41(1) of the Act.

6. Taking the clue from the above judgments, similarly, unless the provision created by the assessee towards interest liability is allowed as a deduction while computing the book profit u/s. 115JB, when the assessee writes back the same to the Profit and Loss A/c, then it should be considered for determining the book profit. It is nobody’s case that interest liability has been allowed as deduction in earlier years. In other words, an allowance or deduction has been made in earlier years in respect of interest liability while computing the book profit and writing back the same could be added to the book profit. A reading of clause (i) to Explanation 1 to section 115JB(2) gives the above meaning.” (emphasis supplied)

The Hyderabad Tribunal ruled that unless the provision increased the “book profit” in an earlier year, the write back of such provision should continue to be considered for determining the “book profit”. The Tribunal departed from the literal reading of clause (i) and the proviso therein. The clause (and the proviso) stipulates the increase in book profit in the year of creation of provision/reserve. The “increase” is not an exercise in vacuum but one which results in attraction and enhancement of book profit tax. The Tribunal opted to place reliance on the rationale in circular no.550.

In the present case, while computing book profit u/s. 115JB for Year 1, X Limited had decreased the net loss by the provision of Rs. 16 crore made for diminution in the value of investment. In Year 2, the company reversed Rs. 16 crore out of the above referred provision for investment loss.

The provision for investment loss was “added back” while computing book profit (in Year 1). However, there was no net profit as per Profit and loss account in that year. As already explained, in the absence of net profit, it could be argued that section 115JB is not applicable. Tax was also not discharged in that year u/s. 115JB. In effect, there is no addition of provision for diminution in value of investment allowance. Applying the principles of the circular and the Hyderabad Tribunal, X Limited has not suffered tax under MAT on creation of provision for investment loss. Consequently, reversal of such provision would continue to be included in book profits computation. Once section 115JB is not applicable in the year of creation of reserve, reversal of such provision cannot be excluded from book profit computation.

Further, the provision for diminution in value of investments did not result in any additional tax liability under the MAT computation. On the contrary, such provision has decreased/reduced income while computing the total income under the normal provisions of the Act. It is an ‘erosion of capital’ which resulted in a loss. Such loss was claimed as a charge against income chargeable to tax. Subsequently, these investments were sold at a price over and above the original cost of investments/ shares. To clarify:

X Limited purchased shares at Rs. 6,000. A provision for diminution was created to the extent of Rs. 1,600. This reduced the value of shares to Rs. 4,400. On sale of shares at Rs. 6,800, X Limited made a capital gain of Rs. 2,400 [i.e, 6,800-4,400]. This gain of Rs. 2,400 consists of Rs. 800 (being its gain over and above the original cost of the asset) and Rs. 1,600 (being proceeds over and above the revised/ reduced cost of the asset). By creating a provision for Rs. 1,600, X Limited acknowledged and recognised that the value of investment had been eroded or vanished to such extent. Any consideration exceeding the reduced value but not exceeding the actual cost would amount to ‘recoupment of loss’. It is a refurbishment of losses which were claimed as a charge against the profits in the earlier years. Such refurbishment (of losses) would amount to income (in the year of reversal of provision).

Accordingly, one possible view is that reversal of provision for diminution in value of investment cannot be excluded under Clause (i) of the second part of Explanation 1 while computing book profits.

View II – Increase in book profits need not result in payment of tax under MAT

Literal interpretation
Clause (i) is permissible only on satisfaction of twin conditions – (i) amount withdrawn is credited to profit and loss account and (ii) at the time of ‘creation’ of reserve, the ‘Book Profit’ was increased by the amount of the said withdrawal. The mandate of the law is clear and unambiguous. Modern judicial approach to interpretation of statutes is often driven by literal rule. Laws and regulations are the intentions of legislators captured in words. Every statute must be read according to the natural construction of its words. The words of a statute are to be understood in their natural and ordinary grammatical sense. The aspect of allowance or deduction discussed by the Hyderabad Tribunal is deviation from the literal reading of the law. Nothing prevented the legislature to lay down law to this effect.

View-I could result in absurd results Even otherwise, View I appears to revolve around whether the adjustment of provision for investment loss in the year of creation results in a positive book profits. It could never be the intent of the law to discriminate between companies which have only a nominal value of book profits (post set-off of provision for investment loss) with those companies where the net loss is not completely wiped off by the provision for investment loss in the computation. This can be understood through the below explained illustration:

Particulars

Company A

Company B

Net loss as per Profit and loss

(10,000)

account for Year 1

Add: Provision for investment

10,100

9,900

loss

Book
profit/ (Loss)

100

(100)

If the aforesaid provision was reversed in Year 2, Company B would not be able to claim reduction in that year (if View I were to be followed). On the contrary, Company A which has a nominal book profit of Rs. 100 may be allowed reduction of pro-vision reversal in Year 2 (although one could argue that only proportionate reduction will be allowed). Such interpretation would result in unintended consequence.

View I results in tax on capital

In the present case study, consideration received on sale of shares (by X Limited) was over and above the historical or original cost of such shares. The differential between such sale consideration and original cost is a gain and has to be necessarily offered to tax. There is no dispute on this aspect. One could argue that consideration to the extent of reversal of provision is ‘capital’ in nature. This is because, such consideration (i.e, to the extent of reversal of provision) refills the vacuum created by provision. Levying a tax on such consideration would amount to a ‘tax on capital’. In essence, it would culminate in higher effective rate of tax on capital gains. The philosophy of MAT taxation was to provide for an alternate tax regime and not double taxation. A denial of reduction from book profit would compel the taxpayer to pay taxes on income which he never earned.

Section 115JB – wider applicability

Circular no. 550 clarified that the amount withdrawn from reserves or provisions is deductible in MAT computation only if (a) the reserves have been created or provisions have been made for the year on or after 1st April, 1988 and (b) have gone to increase the book profits in any year when the provisions of section 115J of the Income-tax Act were applicable. The latter condition thus requires not only enhancement of book profits but such increment has to occur in the year in which section 115J is applicable.

S/s. (1) to section 115JB deals with the ‘applicability’ of the provision. It is applicable to every “company”. If 18.5% of book profit of such company exceeds tax on its total income then, such amount (i.e, 18.5%) would be the tax payable and book profit would be the total income. Thus, section 115JB is applicable to every company but the liability to pay tax is only in case of certain companies. The ‘certain companies’ are those which are liable to tax under MAT. This is supported by the section heading which reads – “Special provision for payment of tax by certain companies”. Section 115JB deals thus deals with payment of tax ‘by certain companies’. In other words, section 115JB is ap-plicable to all companies but renders only ‘certain companies’[whose tax under MAT exceeds normal tax computation] as liable to tax u/s. 115JB.

Applying this proposition in the present case, section 115JB was applicable to X Limited in Year 1 [although there was a book loss]. The provision for investment loss was “added back” while computing book profits for that year. The adjustment resulted in a reduction of loss. A “reduction of loss” is effectively the same as “increase in profits”. Accordingly, reversal of such provision in Year 2 should be excluded from while computing book profits for the year.

One may, in this connection, refer to the decision of the Kolkata Tribunal in the case of Stone India Limited vs. Department of Income-tax [ITA Nos. 1254/ Kol/2010]. The Tribunal in this case had an occasion to deal with treatment of “Provision for diminution in value of investment” for the purposes of book profits u/s. 115JB. In this case, the assessee debited its Profit and Loss A/c for the year ended 31.03.2001 with certain provision for diminution in the value of investment. In computation of book profit u/s. 115JB of the Act the said provision for diminution in the value of investment was not added back to the book profit. Subsequently, out of the said provision, the assessee wrote back certain amount in the accounts for the year ended 31-03-2006. The question was whether the reversal of provision for diminution in the value of investment was deductible in computation of book profit for AY 2006-07. The Court observed –

“It is also observed that clause (i) of Explanation to section 115JB of the Act says that the amount withdrawn from any reserves or provisions created on or after 01- 04-1997, which are credited to the profit and loss account, shall not be reduced from the book profits, unless the books profits were increased by the amount transferred to such reserves or provisions in the year of creation of such reserves (out of which the said amount was withdrawn). In this case, provision for diminution in the value of investment Rs. 7,05,73,000/ – was created in the financial year 2000-01 relevant to assessment year 2001-02 but book loss of the said year was not appreciated by the said amount in the computation filed u/s. 115JB along with the return. As there is a loss of Rs. 30,008/- prior to providing of prior year adjustment and diminution in the value of investment, no addition has been made u/s. 115JB by the assessee in the assessment year 2001-02 on account of diminution in the value of investment….. and the

exceptional item on account of diminution in the value of investment has not been adjusted while computing the book profit u/s. 115JB. Therefore, we are of the considered opinion that the observation of the Ld. CIT(A)was not justified in directing the assessee…” (emphasis supplied)

In the aforesaid case, provision for investment loss was not added back to the net loss while computing the book profits. The same had been reversed in subsequent year. In the year of provision, there was a net loss. The assessee did not carry out any adjustment. The Tribunal therefore ruled that reversal cannot be reduced from the book profits. The basis or rationale for such decision is that the book profits were not adjusted or appreciated by the provision created.

The Tribunal appears to have laid emphasis on the ‘adjustment or appreciation’ of book profits. The conclusion of the tribunal was driven by the non-adjustment of book profits in the initial year. Applying the ratio of the Tribunal ruling, it appears that if an adjustment of “book profit” had been made in the year of creation of the reserve, it would suffice to exclude the reversal of provisions while computing book profit for a subsequent year.

4. To conclude

X Limited had a net loss as per Profit and loss ac-count for Year 1. A view could be taken that MAT computation is not applicable in the year of loss and no adjustment contemplated u/s. 115JB is required. A better view would be that MAT provisions are applicable even in the year of loss and accordingly, adjustment of adding back provision for diminution in the value of investment in the Year 1 was appropriate.

As regards, exclusion of reversal of provision from book profit computation in Year 2, there are two views possible. View II appears to be appropriate and therefore reversal of provision should be excluded while computing book profits for Year 2.

5. Fall out of view-ii

In the present case, there was a provision created for diminution in investment amounting to Rs. 16 crore in Year 1. Such provision reduced the profits (or increased the losses) for the year. Subsequently, in Year 2, such provision was reversed and credited to Profit and loss account. Such credit ‘enhanced’ the profits for the year. While computing book profit for MAT purposes, X Limited reduced such reversal of provision. Thereby ‘enhancement of profit’ was nullified. By this, MAT liability was reduced.

Due to the provision entry in Year 1, the brought forward loss of Year 2 was increased. This enhanced loss translated into an ‘(increased) deduction’ from book profits while computing MAT liability for Year 2.

This is due to a ‘downward’ adjustment as per clause
(iii) of Explanation 1 to section 115JB which reads –
“the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of ac-count.” In this adjustment, the amount of brought forward losses (or business loss) is compared with unabsorbed depreciation loss; lower of the two is reduced in the book profits computation. The brought forward losses are to be adopted from the books of account. Consequently, an expense/ charge in the earlier years enhances the brought forward losses of the current year.

To sum-up, if View-II were to be adopted, X Lim-ited would avail dual benefit by – (i) reducing the book profits by amount of reversal in provision for diminution in value of investment and (ii) availing accelerated losses (depreciation or business loss whichever is less).

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Penalty – Concealment of Income-Voluntary disclosures do not release the assessee from the mischief of penal proceedings.

Mak Data P. Ltd., vs. CIT (2013) 358 ITR 593 (SC)

Penalty – Concealment of Income – The Assessing Officer during the assessment proceedings, is not required to record his satisfaction for initiation of penalty proceeding in a particular manner.

The appellant-assessee filed his return of income for the assessement year 2004-05 on 27th October, 2004, declaring an income of Rs. 16,17,040 along with tax audit report. The case was selected for scrutiny and notices were issued u/s. 143(2) and 142(1) of the Income-tax Act, 1961.

During the course of the assessment proceedings, it was noticed by the Assessing Officer that certain documents comprising share application forms, bank statements, memorandum of association of companies, affidavits, copies of income-tax returns and assessment orders and blank share transfer deeds duly signed had been impounded. These documents had been found in the course of survey proceedings u/s. 133A conducted on 16th December, 2003, in the case of M/s. Marketing Services (a sister concern of the assessee). The Assessing Officer then proceeded to seek information from the assessee and issued a show-cause notice dated 26th October, 2006. By the showcause notice, the Assessing Officer sought specific information regarding the documents pertaining to share applications found in the course of survey, particularly, blank transfer deeds signed by persons, who has applied for the shares. Reply to the show-cause notice was filed on 22nd November, 2006, in which the assessee made an offer to surrender a sum of Rs. 40.74 lakh with a view to avoid litigation and buy peace and to make an amicable settlement of the dispute. Following were the words used by the assessee :

“The offer of surrender is by way of voluntary disclosure and without admitting any concealment whatsoever or any intention to conceal, and subject to non-initiation of penalty proceedings and prosecution”

The Assessing Officer after verifying the details and calculation of the share application money accepted by the company completed the assessment on 29th December, 2006 and a sum of Rs. 40,74,000 was brought to tax, as “income from other sources” and the total income was assessed at Rs. 57,56,700.

The Department initiated penalty proceedings for concealment of income and not furnishing true particulars of its income u/s. 271(1)(c) of the Income-tax Act. During the course of the hearing, the assessee contended that penalty proceedings are not maintainable on the ground that the Assessing Officer has not recorded his satisfaction to the effect that there has been concealment of income/furnishing of inaccurate particulars of income by the assessee and that the surrender of income was a conditional surrender before any investigation in the matter. The Assessing Officer did not accept those contentions and imposed a penalty of Rs. 14,61,547 u/s. 271(1)(c) of the Act. The assessee challenged that the order before the Commissioner of Income-tax (Appeals), which was dismissed.

The assessee filed as appeal before the Income-tax Appellant Tribunal, Delhi. The Tribunal recorded the following findings:

“The assessee’s letter dated November 22, 2006, clearly mentions that the offer of the surrender is without admitting any concealment whatsoever or any intention to conceal.”

The Tribunal took the view that the amount of Rs. 40,74,000 was surrendered to settle the dispute with the Department and since the assessee, for one reason or the other, agreed or surrendered certain amounts for assessment, the imposition of penalty solely on the basis of the assessee’s surrender could not be sustained. The Tribunal, therefore, allowed the appeal and set aside the penalty order.

The Revenue took up the matter in appeal before the High Court. The High Court accepted the plea of the Revenue that there was absolutely no explanation by the assessee for the concealed income of Rs. 40,74,000. The High Court took the view that in the absence of any explanation in respect of the surrendered income, the first part of clause (A) of Explanation 1 was attracted.

On appeal to the Supreme Court by the assessee, the Supreme Court fully concurred with the view of the High Court that the Tribunal has not properly understood or appreciated the scope of Explanation 1 to section 271(1)(c) of the Act.

According to the Supreme Court, the Assessing Officer should not be carried away by the plea of the assessee like “voluntary disclosure”, “buy peace”, “avoid litigation”, “amicable settlement”, etc., to explain away its conduct. The question is whether the assessee has offered any explanation for concealment of particulars of income or furnishing inaccurate particulars of income. The Explanation to section 271(1) raises a presumption of concealment, when a difference is noticed by the Assessing Officer, between reported and assessed income. The burden is then on the assessee to show otherwise, by cogent and reliable evidence., that income was not concealed or inaccurate particulars were not furnished. When the initial onus placed by the explanation, has been discharged by him, the onus shifts on the Revenue to show that the amount in question constituted the income and not otherwise.

The assessee has only stated that he had surrendered the additional sum of Rs. 40,74,000 with a view to avoid litigation, buy peace and to channelise the energy and resources towards productive work and to make amicable settlement with the Income-tax Department. The statute does not recognise those types of defences under Explanation 1 to section 271(1)(c) of the Act. It is a trite law that the voluntary disclosures do not release the appellant assessee from the mischief of penal proceedings. The law does not provide that when an assessee makes a voluntary disclosure of his concealed income, he had to be absolved from penalty.

The Supreme Court was of the view that the surrender of income in this case was not voluntary in the sense that the offer of surrender was made in view of detection made by the Assessing Officer in a survey conducted 0n the sister concern of the assessee. In that situation, it could not be said that the surrender of income was voluntary. The Assessing Officer during the course of assessment proceedings has noticed that certain documents comprising share application, forms, bank statements, memorandum of association of companies, affidavits, copies of income-tax returns and assessment orders and blank share transfer deeds duly signed, had been impounded in the course of survey proceedings u/s. 133A conducted on 16th December, 2003, in the case of a sister concern of the assessee. The survey was conducted more than 10 months before the assessee filed its return of income. Had it been the intention of the assessee to make full and true disclosure of its income, it would have filed return declaring an income inclusive of the amount which was surrendered later during the course of the assessment proceedings. Consequently, it was clear that the assessee had no intention to declare its true income. It is the statutory duty of the assessee to record all its transactions in the books of account, to explain the source of payments made by it and to declare its true income in the return of income filed by it from year to year. In the opinion of the Supreme Court, the Assessing Officer, had recorded a categorical finding that he was satisfied that the assessee had concealed true particulars of income and was liable for penalty proceedings u/s. 271 read with section 274 of the Income-tax Act, 1961.

According to the Supreme Court, the Assessing Officer has to satisfy whether the penalty proceedings be initiated or not during the course of the assessment proceedings and the Assessing Officer is not required to record his satisfaction in a particular manner or reduce it into writing.

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Ghatkopar Jolly Gymkhana vs. Director of Income tax (E) In the Income Tax Appellate Tribunal “G” Bench, Mumbai Before D. Karunakara Rao, (A. M.) and Sanjay Garg (J. M) ITA No.882/Mum/2012 Assessment year:2009 -10. Decided on 23/10/2013 Counsel for Assessee / Revenue : A. H. Dalal / Santosh Kumar

Section 2(15), 12A and 12AA – Charitable trust carrying on the activities which are in the nature of trade, commerce or business receipts therefrom exceeding the limit prescribed under second proviso to section 2(15) – Action of the AO in cancellation of registration by treating the trust as non-genuine not justifiable.

Facts
The assessee is a club registered u/s. 12A as a charitable trust. The DIT(E) noticed that the assessee was carrying on activities in the nature of trade, commerce or business and its gross receipts there from during the year were in excess of Rs.10 lacs, the limit then prescribed under second proviso to section 2(15). According to him since the activities of the assessee did not fall within the definition of charitable purpose as defined u/s. 2(15), the assessee trust became non-genuine and as such the provisions of section 12AA(3) got attracted. He accordingly cancelled the registration w.e.f assessment year 2009-10 and declared the assessee as non-charitable trust. Before the tribunal the revenue justified the order of the DIT(E).

Held
According to the tribunal, before the insertion of the second proviso from 01-04-2009, the definition of charitable purpose when read with first proviso was very restrictive. However, by the insertion of the second proviso the rigour of the first proviso has been diluted and is not applicable if the trust carries on business activities and the gross receipts therefrom is Rs. 10 lakh or less. Thus, according to the tribunal, from 01-04-2009 the carrying out of the activities of trade, commerce or business by a charitable trust is not barred so as to exclude its activities from the definition of charitable purposes. However, a limitation has been imposed to the effect that the gross receipts from such activities should not be more than Rs.10 lacs. The tribunal further noted that the use of the term “previous year” in the second proviso is also more relevant. It means the benefits will not be available to the assessee for the assessment year in which the gross receipts exceed the limit of Rs. 10 lakh. It does not mean that such benefits will not be available to the trust in the years during which its receipts does not exceed Rs. 10 lakh. According to the tribunal, in cases where the receipts from the activities in the nature of trade, commerce or business exceed the limit of Rs. 10 lakh, the registration of the trust as the charitable institution does not get affected, rather, it is the eligibility of the said trust to get tax exemption/benefits which gets affected that too for the relevant year during which the gross receipts of the trust crosses the limit of Rs. 10 lakh. For the said proposition, the tribunal also relied on the decision of the Jaipur bench of the Tribunal in the case of Rajasthan Housing Board vs. CIT (2012) 21 Taxmann.com77.

Accordingly, the tribunal held that the action of the CIT(A) in relying upon the second proviso to section 2(15) for cancelling the registration of the trust was not correct or justified. The only effect will be that the Assessee will not be entitled for exemption or tax benefits which otherwise would have been available to it being registered as charitable institution, for the relevant year during which its income has crossed the limit of Rs. 10 lakh. Subject to the same, the tribunal ordered the restoration of the registration granted to the trust.

(Editorial Note: By the Finance Act, 2011 the limit prescribed under second proviso to section 2(15) has been revised to Rs. 25 lakh w.e.f. 01.04.2012)

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Interpretation of Provisions of section 10(2A) in cases where income of the firm is exempt -Circular No. 8 dated 31st March 2014 [F.No. 173/99/2013-ITA]

CBDT has clarified that ‘total income’ of the firm for s/s. (2A) of section 10 of the Act, includes income which is exempt or deductible under various provisions of the Act. The income of a firm is to be taxed in the hands of the firm only and the same can under no circumstances be taxed in the hands of its partners. Accordingly, the entire profit credited to the partners’ accounts in the firm would be exempt from tax in the hands of such partners, even if the income chargeable to tax becomes NIL in the hands of the firm on account of any exemption or deduction as per the provisions of the Act.

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Appeal before Tribunal: Rectification of mistake: Section 254(2): A. Y. 1996-97: Application for rectification: Period of limitation commences from the date of receipt of the order and not the date of the order:

Peterplast Synthetics P. Ltd. vs. ACIT; 364 ITR 16 (Guj):

The assessee had received the order of the Tribunal dated 20-02-2007 on 19-11-2008. The assessee made an application for rectification u/s. 254(2) of the Incometax Act, 1961 on 09-05-2012. The Tribunal dismissed the application on the ground that the same is barred by limitation u/s. 254(2) as the application has been made beyond the period of four years from the date of the order.

The Gujarat High Court allowed a writ petition filed by the assessee and held as under:

“i) Section 254(2) of the Income-tax Act, 1961, is in two parts. Under the first part, the Tribunal may, at any time, within four years from the date of the order, rectify any mistake apparent from the record and amend any order passed by it under s/s. (1).

ii) Under the second part, the reference is to the amendment of the order when the mistake is brought to its notice by the assessee or the Assessing Officer. The statute has conferred the right in favour of the assessee or even the Revenue to prefer a rectification application within a period of four years and, therefore, even if a rectification application/ miscellaneous application is submitted on the last day of completion of four years from the date of receipt of the order, which is sought to be rectified, it is required to be decided on merits and in such a situation the assessee is not required to give any explanation for the period between the actual date of receipt of the order, which is sought to be rectified and the date on which the miscellaneous application is submitted.

iii) The order of the Tribunal sought to be rectified was received by the assessee on 19-11-2007. The assessee preferred the application on 09-05-2012. The application was not barred by limitation.”

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ITO vs. Theekathir Press ITAT Chennai `B’ Bench Before Dr. O. K. Narayanan (VP) and V. Durga Rao (JM) ITA No. 2076/Mds/2012 A.Y.: 2009-10. Decided on: 18th September, 2013. Counsel for revenue/assessee: Guru Bhashyam/J. Prabhakar

Section 40(a)(ia)– Since there is a judicial controversy on whether section 40(a)(ia) applies to amounts that have already been “paid” or it is confined to amounts “payable” at the end of the year, the rule of judicial precedence demands that the view favorable to the assessee must be adopted.

Facts:
The Assessing Officer disallowed the claim of certain expenditure u/s. 40(a)(ia) on the ground that the tax has not been deducted at source. Aggrieved, the assessee preferred an appeal to the Commissioner of Income-tax (Appeals) who allowed the appeal by stating that the amounts `payable’ only attract disallowance u/s. 40(a)(ia) and the amounts already paid would not attract the provisions of section 40(a) (ia).

Aggrieved, the Revenue preferred an appeal to the Tribunal where it relied on three decisions of Calcutta High Court and Gujarat High Court which have held that the law stated by the Special Bench in Merilyn Shipping & Transports vs. Addl CIT is not acceptable.

Held:
The Tribunal noted that the judgment of the Allahabad High Court is in favour of the assessee but the orders of the Calcutta High Court and the Gujarat High Court are against the assessee. It held that in such circumstances, the rule of judicial precedence demands that the view favourable to the assessee must be adopted, as held by the Hon’ble Supreme Court in the case of CIT vs. Vegetable Products Ltd. 88 ITR 192 (SC). In view of the fundamental rule declared by the Hon’ble Supreme Court, the Tribunal following the judgment of the Allahabad High Court, which is in favor of the assessee, held that the disallowance u/s. 40(a)(ia) applies only to those amounts which are `payable’ and not to those amounts which are `paid’.

The appeal filed by the revenue was dismissed.

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Deduction u/s.80IB of Income-tax Act, 1961: A.Y. 1999-00: Condition of employing ten or more workers: ‘Worker’ means person employed by assessee directly or by or through any agency including a contractor.

[CIT v. M/s. Jyoti Plastic Works Pvt. Ltd. (Bom.), ITA No. 5045 of 2010, dated 15-11-2011]

The assessee was engaged in the manufacture of goods by using job workers. Its total number of permanent employees was less than ten. If the job workers are taken into account, the number was more than ten. The assessee’s claim for deduction u/s.80IB was rejected on the ground that the total number of workers (permanent) was less than ten and the condition in section 80IB(2)(iv) was not satisfied. The Tribunal allowed the assessee’s claim. The following question was raised in the appeal filed by the Revenue:

“Whether the Tribunal was justified in holding that the workers supplied by the contractor are also to be treated as workers employed by the assessee for the purposes of section 80IB(2)(iv) of the Income-tax Act, 1961?”

The Bombay High Court upheld the decision of the Tribunal and held as under:

“(i) Section 80IB(2)(iv)(iii) provides that an industrial undertaking must ‘employ’ ten or more workers in a manufacturing process carried on with the aid of power. The expression ‘worker’ which is not defined in the Act means any person employed by the assessee directly or by or through any agency (including a contractor).

(ii) What is relevant is the employment of ten or more workers and not the mode and the manner of employment. The fact that the employer-employee relationship between the workers employed by the assessee differs cannot be a ground to deny deduction u/s.80IB.”

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Deduction u/s.80HHE in case of MAT assessment is to be worked out on the basis of adjusted book profit u/s.115JA and not on the basis of profit computed under regular provisions of the law applicable to the computation of profits and gains of business or profession.

[CIT, Chennai v. Bhari Incomation Tech. Sys P. Ltd., {SLP (Civil) No.33750/2009 dated 20-10-2011}]

The assessee filed its return of income for A.Y. 2000- 01. The assessee claimed deduction u/s.80HHE to the extent of Rs.1,56,33,719 against net profit as per profit and loss account amounting to Rs.3,07,84,105 to arrive at the book profit of Rs.1,51,50,386 u/s.115JA of the Income-tax Act, 1961. This claim for deduction made by the assessee was rejected by the AO.

According to the AO, since in the present case in normal computation no net profit was left after brought-forward losses of the earlier years got adjusted against the current year’s profit, the assessee was not entitled to deduction u/s.80HHE to the extent of Rs.1,56,33,719 for computing book profit u/s.115JA. In Appeal, the CIT(A) upheld the order of the AO. The assessee went in appeal, against the order of the CIT(A), before the Tribunal which, following the judgment of the Special Bench of the Tribunal in the case of Deputy Commissioner of Income-tax, Range 8(3) v. Syncome Formulations (1) Limited, [(2007) 106 ITD 193], took the view that the MAT scheme which includes section 115JA did not take away the benefits given u/s.80HHE. The said judgment of the Special Bench was with regard to computation of deduction u/s.80HHC which, like section 80HHE, fell under Chapter VI-A of the Income Tax Act, 1961.

The High Court upheld the judgment of the Tribunal. On further appeal, the Supreme Court observed that in the said judgment of Special Bench, which Kishor Karia Chartered Accountant Atul Jasani Advocate Glimpses of supreme court rulings squarely applied to the facts of the present case, the Tribunal had held that the deduction u/s.80HHC (section 80HHE also fell in Chapter VI-A) had to be worked out not on the basis of regular income tax profits, but it had to be worked out on the basis of the adjusted book profits in a case where section 115JA was applicable. In the said judgment the dichotomy between the regular income tax profits and adjusted book profits u/s.115JA was clearly brought out. The Tribunal in the said judgment had rightly held that in section 115JA relief had to be computed u/s.80HHC(3)/3(A).

According to the Tribunal, once law itself declared that the adjusted book profit was amendable for further deductions on specified grounds, in a case where section 80HHC (80HHE in the present case) was operational, it became clear that computation for the deduction under those sections needed to be worked out on the basis of the adjusted book profit. The Supreme Court noted that in the present case it was concerned with section 80HHE which was referred to in the Explanation to section 115JA, Clause (ix).

According to the Supreme Court, the judgment of the Special Bench of the Tribunal in Syncome Formulations (supra) squarely applied to the present case. Following the view taken by the Special Bench in Syncome Formulations (supra), the Tribunal in the present case had come to the conclusion that deduction claimed by the assessee u/s.80 HHE had to be worked out on the basis of adjusted book profit u/s.115JA and not on the basis of the profits computed under regular provisions of law applicable to computation of profits and gains of business. According to the Supreme Court there was no reason to interfere with the impugned judgment. The Supreme Court agreed with the view taken by the Special Bench of the Tribunal in the case of Syncome Formulations (supra). The Supreme Court dismissed the special leave filed by the Department. Note: In the above context, reference may also be made to the judgment of the Apex Court in the case of Ajanta Pharma Ltd., which has been analysed by us in the column ‘Closements’ in November, 2010 issue of the Journal.

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Taxability of Income from ‘sale of computer software’ as ‘royalty’

Issue for consideration

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

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

On similar lines, monetary gains arising from exploitation of computer program, an intellectual property, which subsists in computer software is sought to be taxed as royalty under the Act. Explanation 3 to section 9(1)(vi) defines computer software as computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program or any customised electronic data. The Supreme Court in the case of Tata Consultancy Services v. State of AP, 271 ITR 401 held that shelf software were ‘goods’ for the purpose of Sales tax and that there was no distinction between the branded and unbranded software. Without prejudice to the applicability of the aforesaid conclusions as drawn by the Apex Court in context of indirect tax laws, to the provisions of the Act, at least one may refer to the aforesaid decision for a proper understanding as to what software is and what is the nature and character of software, which is also advised by the Apex Court in the decision. The controversy, sought to be discussed here, revolves around the issue whether the income from a sale of the computer software is a ‘royalty’, or is a ‘sale’.

The Revenue holds such sales to be royalty on the ground that during the course of sale of computer software, computer program embedded in it is also licensed and/ or parted with the enduser of the software, and as against the claim of the taxpayers who treat the transaction as one of sale of computer software and not of the computer program embedded in it. The Authority for Advance Rulings (‘AAR’) recently in its ruling in the case of Millennium IT Software Ltd., in re, 62 DTR 1 had an occasion to deal with the aforesaid issue under consideration, wherein the AAR while deciding against the taxpayer’s contention, held that the income from the transaction be regarded as a royalty, liable to tax in India. In deciding the issue in this case the AAR gave findings that were contrary to its own findings on the subject given in the earlier decisions in the cases of Dassault Systems K. K., in re, 322 ITR 125 and FactSet Research Systems Inc, in re, 317 ITR 169.

Millennium IT Software’s case

Millennium IT Software Ltd. (‘Millennium’), a Sri Lankan company, had entered into a software licence and maintenance agreement (‘SLMA’) with Indian Commodity and Exchange Ltd. (‘ICEL’), an Indian company, on 27 March 2009. Under the agreement, Millennium had allowed ICEL to use the software product ‘licensed program’, owned by it. As per the SLMA, an ‘implementation fee’ of Rs.4 crores was agreed to be paid by ICEL to Millennium for licence to use the ‘licensed program’ for 4 years and its installation, with a clause to extend the licence period at the discretion of ICEL. The other relevant terms of SLMA are provided as under:

— Millennium had granted ICEL a ‘right to use’ the licensed program for its business operation;

— Rights granted under the SLMA were nonexclusive, non-transferable, non-assignable, indivisible;

— Millennium had granted rights to make copies of the licensed program to be installed on equipments only at designated sites of ICEL and each copy of licensed program was to carry copyright, trademark and other notice relating to proprietary rights of Millennium;

— ICEL had no right to sell, distribute or disclose the licensed program or associated documents to any third party;

— No intellectual property right or licence was granted to ICEL.

Use of source code and reverse engineering of the licensed program was strictly prohibited; Based on the aforesaid clauses in SLMA, Millennium submitted before the AAR that the implementation fee was not chargeable to tax under the provisions of the Act or under the DTAA with Sri Lanka relying on some of the earlier favourable legal decisions on the subject. The Income-tax Department objected to the said contention of Millennium and submitted before the AAR, that consideration towards implementation fee should be termed as industrial intellectual property that was covered under the vires of the definition of ‘royalty’ under Explanation 2 to section 9(1)(vi).

The AAR however, to begin with, chose to classify computer software as a copyright intellectual royalty as against the Revenue’s contention that it was an industrial intellectual property. The AAR observed that ICEL under SLMA was granted a ‘licence to use’ the computer program which was owned and developed by Millennium and that the consideration paid as ‘implementation fee’ was to enable ICEL to have a ‘right to use’ the licensed program. Further, the AAR held that as per SLMA, Millennium had not only conveyed the ‘right to use’ the software to ICEL but along with the said right had also enabled ICEL to ‘use’ copyright embedded in the program though limited in nature. The AAR in addition to above, held that the second proviso to section 9(1)(vi) of the Act was substantive in nature and if the conditions of second proviso to section 9(1)(vi) were not satisfied, then the intention of the Legislature was to tax even the income from sale of a computer software as a royalty under the Act.

Distinguishing its earlier decision on the facts in the case of Dassault Systems K. K. (supra), the AAR concluded that the consideration received for ‘right to use’ the software is embedded with right or interest in computer program and therefore, would be termed as royalty under the provisions of the Act as well as Article 12.3 of the DTAA with Sri Lanka and made the following observations as regard to DTAA with Sri Lanka:

“The DTAA involved herein is the one between India and Sri Lanka. The definition of royalty contained in this treaty in Article 12.3 shows that it is a payment of any kind received as consideration for the ‘use of or the right to any copyright’. This is seen to differ from some of the later treaties like the one with USA wherein royalty is payment of any kind received as consideration for the ‘use of, or the right to use, any copyright’. The definition in the India-Sri Lanka DTAA is wider than the one found in the IT Act. For, it takes in even the consideration received for permitting another to use a copyright. Even a right to use need not be conferred.

…. It is not necessary even to grant the right to use the copyright if one were to look at it literally, though the grant of a right to use could be said to be included in the grant of a right in the copyright.”

The AAR concluded that the consideration received by Millennium from ICEL be termed as a royalty under the DTAA and u/s.9(1)(vi) of the Income-tax Act.

Dassault Systems’ case

Dassault Systems K. K., (‘Dassault’), a Japanese Company, is engaged in the business of providing ‘Product Lifecycle Management’ software solutions, applications and services. Dassault marketed the aforesaid licensed products mostly through a distribution channel comprising of Value Added Resellers (‘VAR’). VARs are independent third-party resellers who are in the business of selling software products to end-users. As per the business model, Dassault entered into General Value Added Resellers Agreement (‘GVA’) with VARs and sold the software product to VARs for a consideration based on the standard list less discount. The VARs in turn sold the products to end-users at a price independently determined by VARs. The end-users then entered into End User Licence Agreement (‘EULA’) with Dassault and VARs for the product supplied.

Based on the abovementioned facts, Dassault had sought for a ruling from the AAR as to whether the consideration received by Dassault from VARs, from sale of software products would be termed as a business income or a royalty under the Act and/or DTAA between India and Japan. Further, the AAR was explained the modus operandi of the transactions undertaken between Dassault, VARs and the end-users. Dassault submitted before AAR that the end-users including VARs in the sale of software products were only transferred copyrighted software containing computer program but not the copyright therein. It was further contended that consideration was paid for ‘use of copyrighted product and not for use of copyright in computer program’. The end-users/VARs did not avail any of the rights referred to in section 14 of the Copyright Act, 1957 (‘the 1957 Act’). The Income-tax Department objected to the contention of Dassault and submitted that consideration received by Dassault from VARs was on account of rights conferred u/s.14(b) of the 1957 Act and therefore, would be termed as a royalty under the Act.

The AAR to begin with, considered the ordinary meaning of ‘copyright’, reference was made to various definition provisions, modes of transfer of copy-right under the 1957 Act and to the earlier decision of the AAR in the case of FactSet Research Systems Inc., 317 ITR 169. It referred to various clauses of GVA and EULA agreements and the provision of section 14 of the 1957 Act and observed that passing of a ‘right to use’ and facilitating the use of a product for which the owner had a copyright was not the same thing as transferring or assigning rights in relation to the copyright. Further, it observed that “use of a copyrighted product does not entail enjoyment of rights referred in section 14 of the 1957 Act” for computer program and therefore no copyright was transferred and/or parted in the course of said transaction. Merely authorising or enabling a customer to have the benefit of data or instructions therein without any further right to deal with them independently did not entail transfer of rights in relation to copyright or conferment of the right of using the copyright. After negating the objections of the Revenue and in light of the aforesaid observations and references to some of earlier favourable legal decisions on the subject, the AAR held that considering the facts of the case no rights in relation to copyright had been transferred, nor any right of using the copyright as such had been conferred on VARs/end-users in the course of transactions.

In deciding the application, the AAR referred to the provisions of Article 12.3 of the DTAA with Japan which read as under:

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

On due consideration of the said Article 12 of the DTAA and the provisions of section 9(1)(vi) of the Act, the AAR concluded that the income from the transaction under consideration was not a royalty.

Observations

The Income-tax Act, 1961 defines royalty in relation to computer program under Explanation 2(v) to section 9(1)(vi) as ‘transfer of all or any rights (including granting of license) in respect of any copyright ………..A question which requires consideration is therefore, whether the expression ‘transfer of all or any rights’ under the said Explanation can be read to implicitly cover ‘use’ or ‘right to use’.

Observations here are restricted to the provisions of the Act and no references are sought to the text of respective DTAAs, for following reasons:

The definition of royalty and the text of the provisions on royalty under the respective DTAAs are different;

Once the nature of income being discussed here fails to be termed as a ‘royalty’ under the provisions of the Act, then one may not be required even to refer to the provisions of the respective DTAAs, considering the fact that recourse to DTAA is envisaged only for any reliefs and benefits, not conferred by the Act.

The issue under consideration is otherwise a multi- faceted issue and has several dimensions which are sought to be addressed through a few questions and answers thereon.

Does the expression ‘transfer of all or any rights’ under Explanation 2(v) to section 9(1)(vi) include ‘use or right to use’?

A construction of definition of royalty under the Act explains that different actions qua the type of intellectual properties are covered and subjected to tax according to the scheme of the Act, which is tabulated below:

The Legislature in its wisdom has distinguished between the royalty for industry intellectual properties and copyright intellectual properties. It appears that the distinction is in sync with the available means through which each type of intellectual property is exploited for earning a monetary gain. To take an illustration, a technical design which belongs to industrial intellectual property type can be exploited for earning monetary gain in any of the ways as mentioned in Explanation 2(i), (ii) and (iii) of section 9(1)(vi) of the Act, but the same test may fail for films, artistic work, etc., a part of copyright intellectual property type, and vice versa.

When different provisions are made depending upon the type of intellectual property, then the part relevant thereto only should be applied while determining whether or not that part shall fall under the definition of royalty. Such a construction is in accordance with the Latin legal maxim ‘Expresso unius est exclusive alterius’. The general meaning of the maxim is that the express mention of one thing implies the exclusion of another. As a fallout of the said construction, it is possible to hold that rights as prescribed in Explanation 2(i) to (iva) of section 9(1)(vi), as in the nature of right to share information and the use or right to use thereof cannot be covered by the expression ‘transfer of all or any right (including granting of licence)’ under Explanation 2(v) of the Act. In other words, the Legislature did not seek to consider ‘use or right to use’ of computer program embedded in computer software as royalty under the Act.

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

Though the Act defines the word ‘royalty’, but the expressions viz., ‘all or any’, ‘or’ are uncertain as regard to their scope. Similarly, the terms patents, copyrights, process, invention, skill, etc., remain undefined. In such circumstances, one is required to scrutinise the legislative history to ascertain the principal intention of the Legislature. The above-referred terms are defined in their respective governing special Acts on the subject viz., Copyrights Act, 1957 (‘the 1957 Act’); Patents Act, 1970; Trade Marks Act, 1999, etc.

Section 14 of the 1957 Act defines a copyright in the computer program as a list of rights granted to the author of computer program. The Act also provides for the modes for transfer of the said list of rights in computer program viz. assignment and licence of rights. References to other types of intellectual properties provide for similar provisions under the respective Acts. The intention of the Legislature can therefore be considered as referring to the rights as listed in section 14 of the 1957 Act. The aforesaid construction is also supported by the decision of the Special Bench of the Delhi Tribunal in the case of Motorola Inc v. DCIT, 95 ITD 269.

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

To answer this pertinent question, one requires to appreciate the nature of the transaction which generally takes place in a sale of computer software to end-users. A sale of computer software to end-users either takes place directly from the author of the computer program to end-users or through the channel of distributors. In either case, the computer program embedded in the computer software may or may not be parted and/or licensed with the computer software. Generally, in such sale transactions, what is sought to be parted with the end-users is the copy of copyrighted program embedded in the computer software and not the copyrighted computer program.

Therefore, it requires to be seen whether in a standard End-user License Agreement (‘EULA’) of computer software between the author and end-users, any of the rights mentioned in section 14 r.w.s. 52 of the 1957 Act are made available to the end-users. A table summarising the rights u/s.14 for computer program, as available to each party, generally, to exercise after the transaction of sale of computer software is reproduced below:

Whereas the author of the computer program, as observed in the Table, has all the rights, the end-user does not have any rights under Section 14. Further, the distributors have rights to sell or give on commercial rental a copy of computer program or give limited right to reproduce and store the said computer programs. In other words, the end-users cannot exercise any rights in respect of copyrights in computer program and therefore, any consider-ation paid to the authors/ distributors by the end-user towards sale of computer software may not qualify for being termed as a ‘royalty’ under the Act. In contrast, under the agreement between the author and distributor, since the right to sell or give on commercial rental is conferred on the distributors, any consideration received by the author from a distributor in such a scenario may qualify to be termed as a ‘royalty’ under the Act.

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

Though it may sound ironical, but all the contrary judgments on the subject confirm to the proposition that ‘computer program’ is a literary work and qualifies to be termed as a copyright intellectual property. However, the difference of opinion stems in considering the computer program as industrial intellectual property, not being limited to patents but also as process, invention and secret formula. Since, ‘invention’, and ‘patents’ are not defined under the Act it shall be necessary to rely on the respective special Acts governing the law on the subject. Section 3(k) of the Patents Act, 1970 (‘the 1970 Act’) which defines ‘invention’ specifically excludes computer program from being regarded as invention. Section 2(m) of the 1970 Act defines ‘patent’ as an invention, thereby indirectly excluding computer program from its purview. Further, since the end-users do not have any access to the computer program embedded in computer software, they cannot be said to have rights in relation to a process. Lastly, to classify computer program as a secret formula shall be too far-fetched, considering the fact that a secret formula is placed as genus of ‘technical know-how’ under the provisions of the Act.

As a result, computer program embedded in computer software may only be termed as a copyright intellectual property under Explanation 2(v) to section 9(1)(vi).

Without prejudice to aforesaid discussions, recently the Delhi High Court in a judgement delivered in the case of CIT v. Dynamic Vertical Software India (P) Ltd., 332 ITR 222, has based on the facts and circumstances of the case where the assessee, a dealer of Microsoft, had been purchasing the on the subject software from Microsoft and selling it further in Indian market held that the payment made by the assessee to Microsoft could not be termed as a ‘royalty’. Therefore, it can be said that computer software is not a copyright intellectual property.

Lastly, if the rights to use intellectual property are capable of and are allowed to be transferred in sale of computer software to end-users, then every second person would have been capable of developing softwares like Microsoft, Oracle, etc. The general understanding of the word ‘royalty’ in the context of copyright refer to a consideration received by the author from the publisher, who published his work and not as a consideration received by the publisher from the end-user on sale of copy of work.

Based on the aforesaid discussions and observations made in the decision in the case of Dassault Systems (supra), it appears that the ratio of the recent decision of the AAR in the case of Millennium IT Systems (supra) may require reconsideration.

Adding to the bandwagon of major judgments, the AAR has recently in the case of Upaid Systems Limited, In re, 885 of 2010, dated 12th October 2011, based on the facts and circumstances of the case, held that the consideration paid by Satyam to Upaid for perpetual licence of right to use computer software shall be taxable as ‘royalty’ under section 9(1)(vi) of the Act.

1    Facts in the case of Dassault Systems K. K. (supra) were different then generally prevailing in the industry or found in the case of Gracemac Corporation v. ADIT, (supra)
2    For limited purpose as provided in section 52 of the Copyright Act, 1957
3    Facts in the case of Dassault Systems K. K. (supra) were different then generally prevailing in the industry or found in the case of Gracemac Corporation v. ADIT, (supra)
4    Motorola Inc v. DCIT, (95 ITD 269) (Del.) (SB)
5    Gracemac Corporation vs ADIT (47 DTR 65) (Del)
6    Sonata Information Technology Ltd vs ACIT (103 ITD 324) (Bang.)
7    Frontline Soft Ltd vs DCIT (12 DTR 131) (Hyd)

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Section 148 — Reassessment proceedings — Assessee’s appeal allowed by the CIT(A) on merits — In the appellate proceedings whether the assessee can challenge the validity of the reassessment proceedings — Held, Yes.

Dy. CIT v. Duratex Export
ITAT ‘D’ Bench, Mumbai
Before Pramod Kumar (AM) and Asha Vijayaraghavan (JM)
ITA Nos. 3088 & 3089/Mum./2010 (C.O. Nos. 19 & 20/Mum./2011) A.Ys.: 2001-02 & 2002-03 Decided on: 15-6-2011 Counsel for revenue/assessee: R. K. Gupta/ K. Shivaram

Section 148 — Reassessment proceedings — Assessee’s appeal allowed by the CIT(A) on merits — In the appellate proceedings whether the assessee can challenge the validity of the reassessment proceedings — Held, Yes.

Facts:

The assessee firm was engaged in the business of manufacturing and trading in fabrics. Pursuant to the scrutiny assessment proceedings, the assessment for the A.Y. 2001-02 was finalised on 19-12-2003. In its return the assessee had claimed deduction u/s.80HHC amounting to Rs.3.18 crores which was computed after considering the sum of Rs.24.03 lac received on account of sale of DEPB licence. The assessment for A.Y. 2002-03 was made u/s.143(1). By the Taxation Laws (Amendment) Act, 2005, the receipt on account of the sale of DEPB licence was excluded from the definition of the term ‘total turnover’. The amendment made was retrospective from April 1, 1998. In view thereof, the AO reopened the assessment u/s.147 and issued the notice dated 28-3-2008 u/s.148. The assessee challenged validity of the action of the AO.

On appeal, the CIT(A) treated the grievance against reopening of assessment as not pressed but gave relief to the assess on merits in respect of additions made on account of the sale of DEPB licence by following the Special Bench decision of the Mumbai Tribunal in the case of Topman Exports [318 ITR (AT) 87]. Before the Tribunal, the Revenue relied on the decision of the Bombay High Court in the case of Kalpataru Colours & Chemicals (328 ITR 451) whereunder the Special Bench decision of the Mumbai Tribunal in the case of Topman Exports was reversed. As regards the validity of reopening of assessment, it was contended that since the assessee did not object to reopening of assessment before the CIT(A), it was not open to do so now.

Held:

According to the Tribunal, the mere fact that the assessee was not allowed to, or did not, press the grievance against the reopening of assessment before the CIT(A), particularly in a situation in which the resultant addition on merits could not have been sustained because of binding judicial precedent then holding at the relevant point of time, the assessee cannot be deprived of his rights to adjudicate the reopening of assessment at a later stage. Accordingly, it proceeded to decide the validity of the reassessment proceedings. Relying on the Mumbai Tribunal decision in the case of Dharmik Exim Pvt. Ltd. v. ACIT, (ITA No. 232/ Mum./2009), the Tribunal observed that it was a settled legal position that when the assessment is reopened beyond four years from the end of the relevant previous year and unless it cannot be established that the assessee had failed to disclose all the material facts necessary for the purpose of assessment, such reassessment proceedings cannot be upheld under the law. In the case of the assessee, the assessment for the A.Y. 2001-02 was made u/s.143(3) on 19-12-2003 while the notice u/s.148 was issued after 4 years on 28-3-2008. Therefore, the Tribunal upheld the grievance raised by the assessee in its cross-objection and allowed the same.

According to it, the fact that the assessment for A.Y. 2002-03 was framed u/s.143(1) would not have any impact on the validity of reassessment proceedings. As per the decision of the Mumbai Tribunal in the case of Pirojsha Godrej Foundation v. ADIT, [133 TTJ (Mumbai) 194] where it was held that irrespective of whether the assessment was finalised u/s.143(1) or section 143(3), the requirements of section 147 have to be fulfilled, the Tribunal allowed the cross-objection of the assessee challenging the reassessment proceedings and the appeals filed by the Revenue was dismissed as infructuous.

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Section 271B r.w.s 44AB — Penalty for failure to get accounts audited — Assessee following project completion method of accounting — Whether advances received from the customers could be considered as part of turnover — Held, No.

Siroya Developers v. DCIT
ITAT ‘I’ Bench, Mumbai
Before S. V. Mehrotra (AM) and Asha Vijayaraghavan (JM)
ITA No. 600/Mum./2010
A.Y.: 2005-06. Decided on: 12-1-2011 Counsels for assessee/revenue: B. V. Jhaveri/ S. K. Singh

Section 271B r.w.s 44AB — Penalty for failure to get accounts audited — Assessee following project completion method of accounting — Whether advances received from the customers could be considered as part of turnover — Held, No.

Facts:

The assessee, a property developer, was following project completion method. During the year the opening work in progress was Rs.4.35 crore and the closing work in progress was Rs.10.07 crore. Besides the assessee had also received advances against sale of flats of Rs.4.03 crore. According to the AO, the assessee was required to obtain and file report u/s.44AB by 31-10-2005. For failure to do so, he levied a penalty u/s.271B. On appeal the CIT(A) confirmed the AO’s order.

Held:

According to the Tribunal, when the assessee was following the project completion method of accounting, the advances received against booking of flats cannot be treated as sale proceeds or a turnover or as part of gross receipt because the same was not received by the assessee unconditionally. For the purpose it relied on views expressed by the Institute of Chartered Accountants of India and on the Pune Tribunal decision in the case of ACIT v. B. K. Jhala & Associates, (69 ITD 141). Accordingly, the penalty levied was deleted and the appeal filed by the assessee was allowed.

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Section 14A — Rule 8D can be invoked only after AO records his satisfaction on how the assessee’s calculation is incorrect. Onus is on the AO to show that expenditure has been incurred for earning taxfree income. Disallowance u/s.14A cannot be made on the basis of presumptions.

DCIT v. Jindal Photo Limited ITAT ‘D’ Bench, Delhi
Before G. E. Veerabhadrappa (VP) and A. D. Jain (JM)
ITA Nos. 814/Del./2011
A.Y.: 2008-09. Decided on: 23-9-2011 Counsel for revenue/assessee: R. S. Negi/ Rupesh Saini

Section 14A — Rule 8D can be invoked only after AO records his satisfaction on how the assessee’s calculation is incorrect. Onus is on the AO to show that expenditure has been incurred for earning tax-free income. Disallowance u/s.14A cannot be made on the basis of presumptions.

Facts:

The AO disallowed a sum of Rs.31.01,542 u/s.14A of the Act by invoking Rule 8D. However, he did not record satisfaction as to how the assessee’s calculation was not correct. Aggrieved, the assessee preferred an appeal to the CIT(A). The CIT(A) upheld the applicability of Rule 8D but he reduced the amount of disallowance to Rs.19,43,022 by reducing the amount of disallowance on account of interest but as regards disallowance of administrative expenses he upheld the action of the AO. He also upheld the applicability of Rule 8D. Aggrieved, the Revenue preferred an appeal to the Tribunal and the assessee filed cross-objections.

Held:

The Tribunal noted that the assessee has suo motu made a disallowance u/s.14A. The Tribunal also noted that the AO has invoked Rule 8D without recording satisfaction as to how the assessee’s calculation is incorrect. Upon considering the ratio of various decisions of the Tribunal and the decision of the Punjab & Haryana High Court in the case of CIT v. Hero Cycles, (323 ITR 518), the Tribunal held that for invoking Rule 8D the AO must record satisfaction as to how the claim of the assessee is incorrect. If that is not done, provisions of Rule 8D cannot be invoked. An ad hoc disallowance cannot be made under Rule 8D. The onus is on the AO to establish that expenditure has been incurred for earning exempt income. Disallowance u/s.14A cannot be made on the basis of presumption that the assessee must have incurred expenditure to earn tax-free income.

Since the AO had not recorded satisfaction regarding the assessee’s calculation being incorrect and since such satisfaction is a pre-requisite for invoking Rule 8D, the CIT(A) erred in partially approving the action of the AO. The Tribunal dismissed this ground of the appeal filed by the Department. Cases referred:

1. CIT v. Hero Cycles, (323 ITR 518) (P&H)

2. ACIT v. Eicher Ltd., (101 TTJ 369) (Del.)

3. Maruti Udyog v. DCIT, (92 ITD 119) (Del.)

4. Wimco Seedlings Ltd. v. DCIT, (107 ITD 267) (Del.) (TM)

5. Punjab National Bank v. DCIT, (103 TTJ 908) (Del.)

6. Vidyut Investment Ltd. (10 SOT 284) (Del.) 7. D. J. Mehta v. ITO, (290 ITR 238) (Mum.) (AT)

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Capital gains v. Business Income: Section 28(va) of Income-tax Act, 1961: A.Y. 2006- 07: Consideration received on transfer of rights of trade mark, brands and copy rights: Business given up distinct from business continued: Consideration not arising out of business: Not business income, but is longterm capital gain.

[CIT v. Mediworld Publications Pvt. Ltd., 337 ITR 178 (Del.), 244 CTR 387 (Del.)]

The assessee was engaged in the business of healthcare, print media and electronic media communications. The assessee entered into a specified assets transfer agreement with one CMP for sale of all its rights, title and interest in specified assets of its healthcare journals and communications business. In consideration of the transfer the assessee had received Rs.3.80 crores. In the return of income the receipt was shown as the long-term capital gain. The Assessing Officer taxed it as business income u/s.28(va) of the Income-tax Act, 1961. The CIT(A) and the Tribunal accepted the assessee’s claim that it is long-term capital gain.

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

(i) By the agreement, the assessee had transferred the rights of trade marks, brands, copyrights, etc., in the journals and publications. The clinical trials business which the assessee continued to carry on was distinct and separate from the business of healthcare journals and communications. As far as the healthcare journals and communication business is concerned, it had been given up in entirety in favour of the transferee.

(ii) Thus section 28(va) was not applicable to any sum received on account of transfer of right to carry on any business which was chargeable under the head ‘Capital gains’. In the specified asset transfer agreement, ‘business’ was to mean the business of publishing, distributing and selling the periodicals and products as carried on by the seller (assessee).

(iii) There was a transfer of exclusive assets and on the transfer it was the transferee which had become the sole and undisputed owner of these assets which were the business assets of the assessee.

(iv) We find no merit in this appeal and dismiss the same.”

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Business expenditure: Interest on borrowed capital: Section 36(1)(iii) of Income-tax Act, 1961: Assessee invested borrowed funds in the shares of subsidiary company to have control over that company: Interest on borrowed funds allowable as deduction u/s.36(1)(iii).

[CIT v. Phil Corporation Ltd., 244 CTR 226 (Bom.)]

The assessee had invested the borrowed funds in the shares of the subsidiary company. The assessee’s claim for deduction of interest u/s.36(1)(iii) of the Income-tax Act, 1961 was rejected by the Assessing Officer. 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 Tribunal found that the assessee had invested the amount in question in subsidiary company for the acquisition of its shares i.e., to have a control over majority shares but not to earn dividend or interest. Before the Tribunal, it was not disputed that such an investment is an integral part of the business.

(ii) We find that the reasoning of the Tribunal that the overdraft was not operated only for investing in shares of subsidiary company to have control over that company and, therefore, the element of interest paid on the overdraft was not susceptible of bifurcation and, therefore, the respondent no. 1 is entitled to the deduction u/s.36(1)(iii) of the Income-tax Act is correct and deserves to be accepted.

(iii) In the result we hold that Tribunal was right
in deleting the addition.”

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Business expenditure: Deduction u/s.35AB of Income-tax Act, 1961: A.Ys. 1993-94 to 1995-96: Agreement for supply of technical knowhow: Assessee obliged to pay income-tax under the agreement: Assessee entitled to deduction of income tax paid u/s.35AB.

[Tata Yodogawa v. CIT, 243 CTR 263 (Jharkhand)]

The assessee entered into a collaboration agreement with ESW for acquiring know-how for use in the business. Under the agreement, the assessee was required to pay a fixed sum and also the tax payable on such sum. Jharkhand High Court considered the following question of law: “Whether deduction u/s.35AB was permissible only in respect of the remittances made by the assessee to ESW or it was permissible in respect of the income-tax paid by the assessee on the said remittances in terms of the collaboration agreement? To be more specific the question is whether the phrase ‘lump sum consideration’ used in section 35AB(1) would include the taxes paid by the assessee under the agreement for acquisition of know-how?” The High Court held as under:

“(i) Deduction u/s.35AB is permissible in respect of any lump sum consideration for acquiring any know-how for use for the purpose of assessee’s business. The word ‘consideration’ include the entire obligation of the assessee, without which the assessee would not be able to acquire the know-how.

(ii) On the facts of the case the obligation of the assessee under the agreement with ESW extended not merely to remitting the amount of two million DM to ESW, but also extended to payment of taxes which would include the income-tax as well as the R&D cess. It seems quite obvious that if the assessee had not paid the tax or the R&D cess, and had merely made payment of two million DM to ESW, the latter would not be obliged to part with the knowhow in view of the terms of the collaboration agreement. Therefore, payment of these taxes are as integral a part of the ‘consideration’ as the payment of two million DM.

(iii) There is no logical reason for not treating the income-tax paid by the assessee in terms of the collaboration agreement as part of the ‘consideration’ for acquisition of the knowhow. The word ‘lump sum’ as used before the word ‘consideration’ in section 35AB only excludes periodical or turnover based payments like royalty, etc., and any one-time payment for the know-how would fall within the expression ‘lump sum’ if it is fixed and specified in the agreement, although it may be payable in installments.”

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Appellate Tribunal: Power to examine validity of search: Sections 132(1), 253(1)(b) and 254(1) of Income-tax Act, 1961: B. P. 1985-86 to 5-12-1995: The Tribunal has power to examine the validity of the search in an appeal against the assessment order passed pursuant to search.

[C. Ramaiah Reddy v. ACIT, 244 CTR 126 (Kar.)]

On the scope of the power of the Appellate Tribunal to examine the validity of search u/s.132 of the Income-tax Act, 1961, the Karnataka High Court held as under:

“(i) A search u/s.132 as contemplated by Chapter XIV-B has to be a valid search. An illegal search is no search and in such a case Chapter XIV-B would have no application.

(ii) If the conditions for the exercise of power are not satisfied, the proceeding is liable to be quashed and consequently the block assessment cannot be sustained. Thus, when the assessee challenges the order of assessment and contends that the search is illegal and void, the said question goes to the root of the matter. If the said search and seizure results in determination of liability and levy of tax, then the assessee can be said to be an aggrieved person. Though he cannot prefer an appeal against the authorisation of search and seizure, once such unauthorised or illegal search and seizure culminates in an assessment order, he gets a right to challenge the assessment on several grounds including the validity of authorisation and initiation of search and seizure.

(iii) If he has not challenged the validity of initiation of the proceedings by way of a writ petition under Article 226 of the Constitution, he would not lose his right to challenge the same in the appeal. Specific words used in clause (b) of s.s (1) of section 253 i.e., “an order passed by the AO under clause (c) of section 158BC in respect of search initiated u/s.132” tend to show that this appeal provision specifically applies to an assessment order consequent to search initiated u/s.132. Thus, the subjectmatter of the appeal under the provision is not only the assessment order made by the AO, but also ‘a search initiated’ u/s.132.

(iv) Therefore, if the assessee contends that the search initiated u/s.132 is not in accordance with law, the said contention has to be considered and adjudicated upon by the Tribunal in the appeal filed by the assessee against the assessment order. It is obligatory on the part of the Tribunal first to go into the jurisdictional aspect and satisfy itself that the search was valid and legal. It is only then it can go into the correctness of the order of block assessment.

(v) Therefore, in the absence of a specific provision under the Act for appeal against illegal search, the Tribunal is not estopped from going into such question in the appeal filed against the assessment order.”

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Reassessment: Sections 143(3), 147 and 148 of Income-tax Act, 1961: A.Y. 1999-00: Assessment u/s.143(3): Subsequent reopening of assessment (beyond 4 years): The recorded reasons must indicate as to how there was a failure on the part of the assessee to disclose the facts fully and truly: Lapse on the part of the AO cannot be a ground for reopening when the primary facts are disclosed.

[M/s. Atma Ram Properties Pvt. Ltd. v. DCIT (Del.), ITA No. 87 of 2010 dated 11-11-2011]

For the A.Y. 1999-00, the case was taken up for scrutiny and the assessment was completed u/s.143(3) of the Act. Subsequently, (beyond the period of 4 years) the assessment was reopened and an addition of Rs.79,23,834 was made u/s.2(22)(e) of the Act, in the reassessment. The reopening and the addition were confirmed by the Tribunal.

On appeal by the assessee, the following question was framed : “Whether the Assessing Officer was justified and correct in law in initiating the reassessment proceedings for reasons recorded in Annexure A2?” The Delhi High Court answered the question in favour of the assessee and held as under: “

(i) In the regular assessment the Assessing Officer had inquired into the details of the advances received, but did not make any addition u/s.2(22)(e). If the Assessing Officer fails to apply legal provisions, no fault can be attributed to the assessee. The assessee is merely required to make a full and true disclosure of material facts, but is not required to disclose, state or explain the law.

(ii) A lapse or error on the part of the Assessing Officer cannot be regarded as a failure on the part of the assessee to make a full and true disclosure of material facts.

(iii) Though the recorded reasons state that the assessee had failed to fully and truly disclose the facts, they do not indicate why and how there was this failure. Mere repetition or quoting the language of the proviso is not sufficient. The basis of the averment should either be stated or be apparent from the record.

(iv) Explanation (1) to section 147 which states that mere production of books is not sufficient does not apply to a case where the Assessing Officer failed to apply the law to admitted facts on record.

(v) The allegation that the assessee did not disclose the true and correct nature of the payment received from the sister concerns, nor disclosed the extent of holding of the sister concern so as to enable the Assessing officer to apply his mind regarding section 2(22)(e) is not acceptable. The assessee had filed statement of accounts of each creditor and indicated them to be sister concerns. The primary facts were furnished. The law does not impose any further obligation of disclosure on the assessee.

(vi) Appeal is accordingly allowed and the reassessment proceedings are set aside.”

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Demed Dividend — Loans or Advances to Related Concerns

Issue for consideration

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

“(e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than 10% of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits;”

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

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

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

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

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

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

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

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

National Travel Services’ case

The issue again recently came up before the Delhi High Court in the case of CIT v. National Travel Services, (ITA Nos. 223, 219, 1204 & 309 of 2010) dated 11th July 2011 (available on www.itatonline. org).

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

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

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

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

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

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

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

Observations

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

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

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

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

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

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

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

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

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

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

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

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Deductibility of Discount on Employee Stock Options – An analysis, Part1

Introduction

It is an accepted fact that employees if recognised will reciprocate in a thousand ways. By acknowledging employee efforts, organisations can increase employee satisfaction, morale and self-esteem leading to increased business and income. Employee Stock Option Plan [commonly known as ESOP(s)] is a fallout of this thought.

Sustained competitiveness by any company hinges upon the quality of its human resources. This in turn has much to do with employee loyalty and commitment. A widely acknowledged method of giving the right incentive signals and rewarding loyalty is through an ESOP.

ESOP is a share-based payment to an employee in lieu of remuneration for his services. The philosophy behind ESOP is to imbibe a ‘sense of belongingness’ to the company. It is to enable them to participate in the organisation’s growth and prosperity. This is achieved by inviting them to be part owners of the company.

ESOP has evolved as a very potent tool to employee compensation. Variants to ESOP have also evolved. ESOP guidelines issued by the Central Government of India (reported in 251 ITR [st] 230) has enlisted various kinds of ESOP(s) – Employee Stock Option Plan, Employee Stock Ownership Plan, Employee Stock Purchase Plan, Stock Appreciation rights etc.

In an ESOP scheme, the company issues shares to its employees at a price lesser than its prevailing market value. To achieve this, a plan is put in place. The plan is approved and adopted by the company. Regulatory approvals, if required, are obtained. The plan generally provides for a compensation committee for evaluating performance of employees and recommending the allotment of options. These options entitle employees to become shareholders of the company. The difference between the price at which the company could have issued the shares in the “open market” and the reduced price is the benefit to the employees. The employee is compensated by the concession.

In other words, the company/ employer forgoes it ability, of getting higher money for the shares. The discussion in the ensuing paragraphs is whether such amount forgone or ‘loss’ suffered can be claimed as a deduction from an Income-tax standpoint.

This write-up is classified into the following segments:

A. Accounting Principles
B. Claim of ESOP under General Tax Principles
C. Claim of ESOP under specific provisions of Income-tax Act, 1961(the Act)
D. Some judicial pronouncements

PART A – Accounting Principles
Accounting/ regulatory aspects of ESOP(s) in India

When a company receives a sum which is lesser than the fair value of the share, it suffers a ‘loss’. This loss needs to be accounted for. A determination of the ‘nature of loss’ is important to enable the addressal of many issues. Whether this loss is compensation, and hence is to be accounted for in the profit and loss account? Or is it a premium on shares forgone and hence is a balance sheet item? Does it partake the character of benefit, hence a perquisite and thereby salary? Or is it in the nature of enabling employees to become shareholders of the company and hence a transaction inextricably linked to the share capital? Is the ‘discount’ a form of compensation? Or is the sufferance an abatement of the ability to get full value of shares? These are some questions associated with an ESOP.

A reference to the accounting principles or guidelines statutorily prescribed could help in ascertaining the nature of loss. Securities and Exchange Board of India (“SEBI”) and Institute of Chartered Accountants of India (“ICAI”), two of the premier regulatory and statutory bodies have issued guidelines in this matter.

ICAI has issued a Guidance Note on “Accounting for Employee Share-based payments”. The Guidance Note specifies the treatment of discount on issue of ESOP (hereinafter referred as ‘ESOP discount’).

A. Guidance Notes issued by ICAI

ICAI is empowered to issue Guidance Notes. These are designed to provide guidance to its members on matters arising in the course of their professional work. Guidance notes resolve issues which may pose difficulty or are debatable. The Guidance Notes are recommendatory in nature. Any deviation from such guidance mandates an appropriate disclosure in the financial statements or reports.

Financial statements form the substratum for income-tax laws. These Financial statements of corporates have to be mandatorily prepared in accordance with accounting system/ standards prescribed by the ICAI. Thus the role of ICAI assumes significance. The courts have also recognised the importance of ICAI prescriptions in various cases.

The Gauhati High court in the case of MKB Asia (P) Limited v CIT (2008) 167 Taxman 256 (Gau) held that the income-tax authority has no option/ jurisdiction to meddle in the matter either by directing the assessee to maintain its accounts in a particular manner or adopt different method where the accounting system is approved by the ICAI.

The Madhya Pradesh High Court in the case of CIT v State Bank of Indore (2005) 196 CTR 153 (MP) held –

“it involves the manner and methodology of accountancy in claiming deduction. In cases of like nature, their Lordships of Supreme Court have always taken the help of methods adopted/ prescribed/recognised by the Indian Institute of Chartered Accountants as in the opinion of their Lordships, they are the best guide. In one of the cases CCE v. Dai Ichi Karkaria Ltd. (1999) 7 SCC 448, their Lordships while supporting their conclusion while examining the case of Central Excise, made following observations in para 26:

“Para 26-The view we take about the cost of the raw material is borne out by the guidance note of the Indian Institute of Chartered Accountants and there can be no doubt that this Institute is an authoritative body in the matter of laying down accountancy standards.”
(Emphasis supplied)

The Supreme Court in the case of British Paints India Ltd. (1991) 188 ITR 44 (SC) relied on the guidance note issued by ICAI while adjudging a matter on stock valuation. Other instances are available of courts relying on guidance note. For example, guidance note on section 44AB has been relied on in understanding the total turnover of an agent (Kachha Arhatiya).

The Hyderabad Tribunal (Special Bench) in the case of DCIT v Nagarjuna Investment Trust Ltd (1998) 65 ITD 17 (Hyd) SB relied on the Accounting standard (IAS 17) and the guidance note issued by the ICAI while upholding the accounting methodology of lease equalisation.

As mentioned earlier, ICAI issued Guidance note on Accounting for Employee Share-based Payments (“ESOP Guidance note”). In the ESOP Guidance note, the discount on issue of shares is described as “Employee Compensation expense”. As the name suggests, this is viewed as ‘employee remuneration’ to be expensed in the Profit and loss account of the relevant year. It concurs with SEBI on the aspect of charge of such discounts against the profits. The Guidance Note acknowledges and thus approves the loss to be an item on revenue account.

The aforesaid accounting recommendations are guided by the principles of “Conservatism”, “Prudence” and “Matching Concept”. Conservatism and Prudence are concepts for recognising expenses and liabilities at the earliest point of time even if there is uncertainty about the outcome; and to recognise revenues and assets only when they are assured of being received. The concept of Prudence is now statutorily recognised by an explicit mention in Accounting Standard 1 issued u/s. 145 of the Income-tax Act, 1961 (“the Act”). ‘Matching principle’ signifies that in measuring the income for a period, revenue is to be adjusted against expenses incurred for producing that revenue.

Income referable to employee efforts gets captured in the ordinary course of accounting applying the principles of revenue recognition (Accounting Standard 9) . It is essential that the associated expenditure is also booked. ESOP discount is an associated cost. Non-recognition of ESOP discount in the Profit and Loss Account could inflate the reported profits for the year. The accounts would then not be reflective of a true and fair position of the performance of an entity. From an accounting standpoint therefore, ESOP discount needs to be charged against the business income. It is an item on revenue account.

Some of the relevant portion of the Guidance note is highlighted below –

Preface

“Employee share-based payments generally involve grant of shares or stock options to the employees at a concessional price or a future cash payment based on the increase in the price of the shares from a specified level….The basic objective of such payments

is to compensate employees for their services and/ or to provide an incentive to the employees for remaining in the employment of the enterprise and for improving their performance…”

Recognition (para 10)

“An enterprise should recognise as an expense (except where service received qualifies to be included as a part of the cost of an asset) the services received in an equity-settled employee share-based payment plan when it receives the services, with a corresponding credit to an appropriate equity account, say, ‘Stock Options Outstanding Account.”

Measurement (para 15)

“Typically, shares (under ESPPs) or stock options (under ESOPs) are granted to employees as part of their remuneration package, in addition to a cash salary and other employment benefits… Furthermore, shares or stock options are sometimes granted as part of a bonus arrangement, rather than as a part of basic pay, eg, as an incentive to the employees to remain in the employment of the enterprise or to reward them for their efforts in improving the performance of the enterprise…”

B. SEBI guidelines

SEBI is a regulatory body established to protect the interests of investors in securities, regulate the securities market and for matters connected therewith. Newer types of financial instruments are emerging. Financial intermediaries have emerged performing a slew of complex functions. The implications of dealing/ investing in securities are continuously evolving, giving rise to a multitude of tax consequences. There is therefore an imperative need for such governing bodies to be involved in the matters of tax also. The increased interplay of SEBI and Income-tax Act is evidenced by SEBI provisions being incorporated in the Act. For instance the erstwhile proviso to section 17(2)(iii) [which was one of the sections on ESOP taxation] read –

“Provided that nothing in this sub-clause shall apply to the value of any benefit provided by a company free of cost or at a concessional rate to its employees by way of allotment of shares, debentures or warrants directly or indirectly under any Employees Stock Option Plan or Scheme of the company offered to such employees in accordance with the guidelines issued in this behalf by the Central Government”.

The Central Government issued the guidelines referred to in the proviso above by Notification No. 323/2001 dated October 11, 2001, effective from April 1, 2000. The Guidelines enumerate various aspects that ought to be included in any Employees Stock Option Plan or Scheme. The guidelines, inter alia, provided that the plan or scheme shall be as per the SEBI Guidelines.

SEBI has also evidenced interest in ESOP taxation (although indirectly), by prescribing accounting guidelines. These guidelines require ESOP discount to be charged off to the profit and loss account over the period of vesting. Such prescriptions are bound to impact “total income” for tax purposes.

The SEBI guidelines prescribe not merely the accounting policies but also the precise accounting entries to be passed over the life of ESOP. As per the SEBI guidelines, discount associated with grant of stock options can be worked out by various methods. SEBI has prescribed its own method of calculation of the discount. It mandates deferring and spreading this discount over the vesting period. The aliquot share of discount required to be spread over is recognised as expenditure in the profit and loss account.

C. OECD recommendations

Organisation for Economic Co -operation and Development (“OECD”) is set up to promote policies that will improve the economic and social well-being of people around the globe. OECD provides a forum in which governments can work together to share experiences and seek solutions to their common problems. This organisation has framed its model tax convention and commentaries. The commentary is modified from time to time and is considered by tax authorities across the globe. From an income-tax standpoint, they are relevant in interpreting and applying the provisions of bilateral tax conventions between countries.

Though India is not a member of the OECD, the model conventions and commentaries on OECD have been used as guidance in interpretation of the statute. The OECD Model Convention and commentary thereto though primarily meant for use by the OECD countries is often referred to and applied in interpreting Agreements of non-OECD countries also.

The Calcutta Income Tax Tribunal, in the case of Graphite India Ltd v DCIT (2003) 86 ITD 384 (Cal) acknowledged the importance and relevance of views of OECD. It observed as follows:

“In our considered view, the views expressed by these bodies, which have made immense contribution towards development of standardisation of tax treaties between various counties, constitute contemporanea expositio inasmuch as the meanings indicated by various expressions in tax treaties can be inferred as the meanings normally understood in, to use the words employed by Lord Radcliffe, international tax language developed by bodies like OECD and UN.”

In connection with ESOP also, the OECD convention and commentaries have made various observations. Some of the relevant portions are as follows:

– Commentary to Model Tax Convention on Income and Capital (2010) has housed the ESOP income under Article 15 (Taxation of Income from Employment). It states that ESOP is a reward for the employment services. It reads as follows:

“While the Article applies to the employment benefit derived from a stock option granted to an employee regardless of when that benefit is taxed, there is a need to distinguish that employment benefit from the capital gain that may be derived from the alienation of shares acquired upon exercise of the option.”

– ESOP impact on transfer pricing (page 7 & 8): “b) Equity ownership vs. Remuneration

The analysis in this study starts with the premise that the granting of stock options is an element of remuneration just like performance-related bonuses or benefits in kind, even when stock options are issued by an entity that is distinct from the employer. In fact in many MNE groups the shares subscribed to or purchased by employees under stock option plans are sold as soon as authorised by the plan and applicable regulations, i.e. employees do not seek to exercise their prerogative as shareholders, apart from benefiting from an increase in value between the strike price paid and the value of the share at the date the option is exercised. Moreover, a stock option is a financial instrument which is valuable and which can be exercised in order to realise such value. Although, upon exercise, the holders of such options may acquire and decide to retain a share in the capital of an enterprise, this investment decision made by each employee is a distinct step from that of the remuneration, one that is occurring at a different point in time and that is of no relevance to the transfer pricing issue under consideration…..”
(Emphasis supplied)

Thus, there are various accounting and statutory bodies governing the accounting and preparation of financial statements in India. Compliance with such prescribed norms is mandatory. The judicial precedents also have repeatedly respected such guidelines. This being the prevailing position, the tax treatment of ESOP discount should be in compliance with guidelines prescribed by ICAI and SEBI, as also OECD.

International practice

The international practices in relation to treatment of discount on ESOP to employees are on similar lines.

Statement of Financial Accounting Standards

Financial Accounting Standards Board (FASB) is a designated organisation whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States. These principles are recognised as authoritative by the Securities and Exchange Commission (SEC) and the American Institute of Certified Public Accountants. Statement of Financial Accounting Standards is a formal document issued by the FASB, which details accounting standards and guidance on selected accounting policies set out by the FASB. All reporting companies listed on American stock exchanges have to adhere to these standards. Accounting Standard No. 123 details share based payments to employees. Some relevant portions from the same are as below:

Statement of Financial Accounting Standards No. 123 (revised 2004)

Para 1 – This Statement requires that the cost resulting from all share-based payment transactions be recognised in the financial statements. This Statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. However, this Statement provides certain exceptions to that measurement method if it is not possible to reasonably estimate the fair value of an award at the grant date. A nonpublic entity also may choose to measure its liabilities under share- based payment arrangements at intrinsic value. This Statement also establishes fair value as the measurement objective for transactions in which an entity acquires goods or services from nonemployees in share-based payment transactions. This Statement uses the terms compensation and payment in their broadest sense to refer to the consideration paid for goods or services, regardless of whether the supplier is an employee.

Para 9 – Accounting for Share-Based Payment Transactions with Employees

The objective of accounting for transactions under share-based payment arrangements with employees is to recognise in the financial statements the employee services received in exchange for equity instruments issued or liabilities incurred and the related cost to the entity as those services are consumed.

(Emphasis supplied)

International Financial Reporting Standard (IFRS)

The International Accounting Standards Board (IASB) is an independent, privately funded accounting standard-setter based in London, England. IFRS is a set of accounting standards developed by the IASB. IFRS 2 deals with the share based payment to employees.

IFRS 2 on Share-based payment

“Para 1 – The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, it requires an entity to reflect in its profit or loss and financial position the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees.

Para 12 – Typically, shares, share options or other equity instruments are granted to employees as part of their remuneration package, in addition to a cash salary and other employment benefits. Usually, it is not possible to measure directly the services received for particular components of the employee’s remuneration package. It might also not be possible to measure the fair value of the total remuneration package independently, without measuring directly the fair value of the equity instruments granted. Furthermore, shares or share options are sometimes granted as part of a bonus arrangement, rather than as a part of basic remuneration, eg as an incentive to the employees to remain in the entity’s employ or to reward them for their efforts in improving the entity’s performance. By granting shares or share options, in addition to other remuneration, the entity is paying additional remuneration to obtain additional benefits. Estimating the fair value of those additional benefits is likely to be difficult. Because of the difficulty of measuring directly the fair value of the services received, the entity shall measure the fair value of the employee services received by reference to the fair value of the equity instruments granted.”

(Emphasis supplied)

The above extracts demonstrate the consensus that ESOP discount is a charge against profits and hence a Profit and Loss Account item. This ensures true and correct disclosure of the financial performance of the Company.

Based on the aforesaid discussion, one could discern that from an accounting perspective ESOP is a revenue item. This is the understanding of the accounting and regulatory bodies in India. The same view is shared by some of the international bodies/ practices as well.

PART B – Claim of ESOP discount under general tax principles

Income-tax relies on the general commercial and accounting principles in determining the taxable income. As a general principle, any expenditure incurred for the purposes of business is a ‘deductible expenditure’ for income-tax purposes.

Reliance of Income-tax laws on general/ commercial principles

“Tax accounting” is not essentially different from commercial accounting. Tax accounting recognises and accepts accounting which is consistent and statute compliant. Profit as per such commercial accounting is the base from which the taxable income is determined.

Tax laws may incorporate specific rules and departures from commercial accounting in determining the taxable income. To the extent, there are no specific departures, commercial accounting norms would prevail for tax purposes also. The earliest acknowledgement by the Courts of the relevance of appropriate accounting practices (while explaining the concept of accrual) can be found in the decision of the Privy Council in the decision CIT v Ahmedabad New Cotton Mills Co. Ltd (1930) 4 ITC 245 (PC). The Apex Court has thereafter upheld the significance of accounting practices on various occasions. Some of such judicial precedents and the relevant observations therein are as follows:

P.M. Mohammed Meerakhan v CIT (1969) 73 ITR 735 (SC) –

“In the case of a trading adventure the profits have to be calculated and adjusted in the light of the provisions of the Income-tax Act permitting allowances prescribed thereby. For that purpose it was the duty of the Income-tax Officer to find out that profit the business has made according to the true accountancy practices.”

Challapalli Sugars Limited v CIT (1975) 98 ITR 167 (SC) –

“As the expression “actual cost” has not been defined, it should, in our opinion, be construed in the sense which no commercial man would misunderstand. For this purpose it would be necessary to ascertain the connotation of the above expression in accordance with the normal rules of accountancy prevailing in commerce and industry.”

CIT v U.P. State Industrial Development Corporation (1997) 225 ITR 703 (SC) –

“for the purposes of ascertaining profits and gains, the ordinary principles of commercial accounting should be applied so long as they do not conflict with any express provision of the relevant statute”.

Badridas Daga v CIT (1958) 34 ITR 10 (SC) –

“Profits and gains which are liable to be taxed under section 10(1) of the 1922 Act are what are understood to be such according to ordinary commercial principles”

Other judgments {Kedarnath Jute Mfg. Co. Ltd. v CIT (1971) 82 ITR 363 (SC)/ Madeva Upendra Sinai v Union of India (1975) 98 ITR 209 (SC)} –

“The assessable profits of a business must be real profits and they have to be ascertained on ordinary principles of trading and commercial accounting. Where the assessee is under a liability or is bound to make a certain payment from the gross profits, the profits and gains can only be the net amount after the said liability or amount is deducted from the gross profits or receipts”

The Act requires business income computation to be based on accounting practices and principles. Section 145 of the Act mandates business income for income-tax purposes to be computed under the ‘ordinary principles of commercial accounting’ regularly employed. The Gujarat High Court in the case of CIT v Advance Construction Co P Limited (2005) 275 ITR 30 (Guj) held –

“Section 145 is couched in mandatory terms and the department is bound to accept the assessee’s choice of method regularly employed, except for the situation wherein the Assessing officer is permitted to intervene in case it is found that the income, profits and gains cannot be arrived at by the method employed by the assessee. The position is further well settled that the regular method adopted by an assessee cannot be rejected merely because it gives benefit to an assessee in certain years.”

Subsection 2 to section 145 empowers Central Government to notify accounting standards to be followed by an assessee. Central Government has till date notified two accounting standards. Accounting Standard I (relating to disclosure of accounting policies) requires accounting policies to be adopted so as to represent true and fair view of the state of affairs of the business. The concepts of “prudence” and “conservatism” have been injected into the income-tax laws through this standard. The standard defines ‘Prudence’ to be provision made for all known liabilities and losses, even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.

The considerations of prudence and conservatism have been adopted and accepted for tax purposes in several judicial precedents of late. Tax laws have also veered towards the adoption of the concept of matching principles in determining the quantum of income to be offered to tax. The case of Madras Industrial Investment Corporation v CIT (1997) 225 ITR 802 (SC) acknowledges the concept of matching expenses and revenues. The matching principle is applied by matching expenditure against specific revenues – ‘as having been used in generating those specific revenues’ or by matching expenses against the revenues ‘of a given period in general on the basis that the expenditure pertains to that period’. The former is termed as “matching principle on revenue basis” and the latter is termed as “matching principle on time basis”. The concept of ‘matching principle’ was again dealt with in detail by the Supreme court in the case of J K Industries Ltd v UOI (2008) 297 ITR 176 (SC).

As mentioned earlier, ESOP discount is an employee welfare measure. The income referable to the employee effort is recognised in the Profit and loss account. Matching principles would warrant the corresponding expenditure and/ or loss to be accounted in the Profit and loss account. Such discount when recognised in the Profit and loss account would also uphold the principle of prudence and conservatism.

Placing reliance on the commercial principles has been one of the elements of statutory interpretation. Interpretation postulates the search for the true meaning of the words used in the statute. It is presumed that a statute will be interpreted so as to be internally consistent. In other words, a section/ provision of the statute shall not be divorced from the rest of the Act. Similarly, a statute shall not be interpreted so as to be inconsistent with other contemporaneous statutes. Where there is an inconsistency, the judiciary will attempt to provide a harmonious interpretation.

A statute is an edict of legislature. The Government enacts laws to regulate economic, social behaviors and conduct. A series of legislation may be passed for this purpose. These laws have specific objectives. Their interplay helps in determining the larger purpose. When such is the interdependence, the tax laws must operate in tandem with other prevailing statutes. Income-tax law has to be interpreted taking cognizance of other statutes.

Aid from other statutes in interpreting Income-tax law

Income-tax Act is an integrated code. The interpretation of a taxing statute has to be on the basis of the language employed in the Act unless the words/ phrases are ambiguous or gives scope for more than one interpretation. The Act being
a forward-looking statute does not operate in isolation.

With the modernisation and evolution of business, there could be occasions where one may have to refer other statutes to better understand certain terms or arrangements. This is done when the terms in the statute are technical in nature or dealing with a specialised matter. In such cases, the interpretation of income -tax law cannot be limited to the words in the Act itself. The Kerala High Court in the case of Moolamattom Electricity Board Employees’ Co-Operative Bank Ltd In re (1999) 238 ITR 630 (Ker) held –

“Resort to a different provision of another Act may also be permissible in the absence of a definition or where the term is technical in nature.”

There could also be situations where certain provisions in the Act lean or depend upon other laws in a particular matter/ context. In such cases, the provisions of such other laws will have to be considered. The Apex court in the case of CIT v Bagyalakshmi & Co (1965) 55 ITR 660 (SC) held –

“The income-tax law gives the Income-tax Officer a power to assess the income of a person in the manner provided by the Act. Except where there is a specific provision of the Income-tax Act which derogates from any other statutory law or personal law, the provision will have to be considered in the light of the relevant branches of law.”

ESOP discount involves forgoing of share premium receivable by the company. In the absence of any specific provision in the Act dealing with such discount, one may have to dwell into the commercial understanding of such discount. In doing so, one may take guidance (even if not strict compliance) from other statutes and regulatory guidelines prescribed in this regard.

In ACIT, Delhi v Om Oils And Oil Seeds Exchange Ltd (1985) 152 ITR 552 (Delhi) the High Court acknowledged the treatment of share premium by placing reliance on the Companies Act, 1956 (“Companies Act”)

“Such a payment and the right can properly be regarded as a capital asset and the money paid as on capital account. This is more so in view of the provisions of s. 78 of the Companies Act, 1956. The effect of s. 78 of the said Act is to create a new class of capital of a company which is not share capital but not distribution of the share premium as dividend is not permitted and it is taken out of the category of the divisible profit.”

The court relied on the principles in the Companies Act to conclude that share premium is a capital receipt.

One may therefore look at the guidance note issued by ICAI and SEBI regulations for treatment of ESOP expenses as well along with the treatment under the OECD convention.

In summary, Income-tax relies on the general commercial and accounting principles in determining the taxable income. This principle has got a statutory mandate through section 145 of the Act. Further, one may refer other statutes for appropriate interpretation of the Income-tax statute. Accordingly, the guidelines prescribed by the regulatory bodies such as the SEBI, ICAI, OECD need to be reckoned in computing the taxable income.

Bagyalakshmi & Co (1965) 55 ITR 660 (SC) held –

The court relied on the principles in the Companies Act to conclude that share premium is a capital receipt.

One may therefore look at the guidance note issued by ICAI and SEBI regulations for treatment of ESOP expenses as well along with the treatment under the OECD convention.

PART C(1) – Claim of ESOP expense under specific provisions of the Act

Income-tax is a charge on income. The term ‘Income’ is defined in section 2(24) of the Act. The definition is an inclusive one and enlists various items which are to be regarded as income under the Act. Section 4 is the charging provision under the Act. The charge is defined vis-à-vis a person who is the recipient of income. The charge is in respect of the total income of a person for any year.

The scope of income chargeable to tax in India is dealt in section 5 of the Act. The income that is referred to in section 5 as chargeable to tax would have to be classified into 5 heads, by virtue of section 14. For each head of income, the law provides for a separate charging section and computation mechanism. Though section 5 is an omnibus charging section; for being taxed, the income would also have to satisfy, the separate charging and computation mechanism under the respective heads.

In the present case, the claim of ESOP expense is under the head “Income from profits and gains of business or profession” (“business income”). Section 28 outlines the charge in relation to such income. As per section 29, the income referred to in section 28 would be computed in accordance with the provisions contained in sections 30 to 43D.

As regards claim of deductions in business income, Lord Parker in the case of Usher’s Witshire Brewery Limited v Bruce 6 TC 399, 429 (HL) said –

“Where a deduction is proper and necessary to be made in order to ascertain the balance of profits and gains it ought to be allowed… provided there is no prohibition against such an allowance.”

Income connotes a monetary return ‘coming in’ from definite sources. It is a resultant figure derived after considering the receipts and payments made there for. Not every receipt of business is income. A receipt could be capital or a revenue receipt. The Privy Council in the case of CIT v Shaw Wallace and Co 6 ITC 178 (PC) laid out tests to find out whether a particular receipt is ‘income’. According to that test, income connotes a periodical monetary return coming in with some sort of regularity or expected regularity from definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be one whose object is the production of a definite return excluding anything in the nature of a mere windfall. ‘Capital receipts’ are not to be brought into account in computing profits under business head, apart from express statutory provisions like section 28(ii) and section 41. Section 28 envisages revenue profits which arises or accrues in the course of business.

Similarly, a disbursement is not allowable if it is of a capital nature. Capital items can be deducted from receipts only when the statute expressly provides so. Generally, the criteria which are invoked in distinguishing capital receipts and revenue receipts will also serve to distinguish between capital and revenue disbursements. This view was expressed by the learned authors Kanga and Palkiwala and was upheld by the High Court in the case of Dalmia Dadri Cement Ltd v CIT (1969) 74 ITR 484 (P&H).

Accordingly, there is no single yardstick to determine whether an item (income or deductions therefrom) would be capital or revenue. There is no explicit statement or provision in the Act in this regard. This would be a fact specific exercise. What is generally an established fact is that disbursement of capital nature is not allowed/ deductible unless specifically provided for in the Act.

PART C(2) – Whether ESOP discount is capital in nature (not allowable)?

Claim of ESOP discount as a deduction is to be examined under the head “Profits and gains of business or profession”. This head of income is housed in sections 28 to 44DB. Under section 28(i) the profits and gains of any business or profession carried on by the assessee at any time during the previous year is chargeable to tax. As per section 29, the income referred to in section 28 should be computed in accordance with the provisions contained in sections 30 to 43D. Sections 30 to 36 confer specific deductions. Section 37 deals with expenditure which is general in nature and not covered within sections 30 to 36. The remaining sections enlist various categories of non-deductible expenditure (not relevant for the present discussion).

Sections 30 to 36 dealing with specific deductions do not deal with ESOP discount. The allowability of ESOP discount would have to be examined under section 37 – the residuary section. To examine eligibility of ESOP discount u/s. 37, the character of discount needs to be examined. If the discount is regarded as capital in nature, section 37 would prohibit its deduction. It is expenditure on revenue account that qualifies for deduction. From an accounting perspective ESOP discount is a revenue item (as discussed earlier). From an income-tax view point, whether such discount is capital or revenue in nature is the issue for consideration?

In the absence of an express definition of capital or revenue expenditure in the Act, one may have to rely on the various judicial precedents on this matter; the rationale adopted and the interpretation adjudged therein.

In the treatise ‘The Law and Practice of Income Tax’ by Kanga and Palkiwala, (9th edition – page 225) the learned authors observe –

“The problem of discriminating between capital receipts and income receipts, and between capital disbursements and income disbursements, has very frequently engaged the attention of the courts. In general, the distinction is well recognised and easily applied, but from time to time cases arise where the item lies on the border line and the task of assigning it to income or capital becomes much of refinement. As the Act does not define income except by way of adding artificial categories, it is to be decided cases that one must go in search of light.”

(Emphasis supplied)

In the context of ESOP discount, one notices two contradictory judgments – in the case of S.S.I. Limited v DCIT (2004) 85 TTJ 1049 (Chennai) and Ranbaxy Laboratories Limited (2009) 124 TTJ 771 (Del). The Chennai Tribunal held ESOP discount to be a revenue and allowable/ deductible business expenditure. The Delhi Tribunal however gave a contrary judgment. The Delhi Tribunal placed it reliance on the decision of the House of Lords in the case of Lowry v Consolidated African Selection Trust Ltd (1940) 8 ITR 88 (Supp) [This is discussed in detail later in the write-up].

Before application of tests whether ESOP discount is a revenue (and therefore deductible) expenditure, one needs to enlist the arguments put forth in some of the decisions which held that ESOP discount is NOT an allowable expenditure (largely for the reason that it is a capital expenditure).

– ESOP discount are incurred in relation to issue of shares to employees. They are not relatable to profits and gains arising or accruing from a business/ trade. The Apex Court decision in the case of Punjab State Industrial Dev Corporation Ltd (1997) 225 ITR 792 (SC) and Brooke Bond India Ltd (1997) 225 ITR 798 (SC) have held that expenditure resulting in ‘increase in capital’ is not an allowable deduction even if such expenditure may incidentally help in business of the company.

– ESOP discount does not diminish trading/ business receipts of the issuing company. The company does not suffer any pecuniary detriment. To claim a charge against income, it should inflict a detriment to the financial position. ESOP is a voluntary scheme launched by the employers to issue shares to employees. The intention is to only give a ‘stake’ to the employees in the organisation.

– This discount is not incurred towards satisfaction of any trade liability as the employees have not given up anything to procure such ESOP.

– Share premiums obtained on issue of shares are items of capital receipt. When such premium is forgone, it cannot be claimed as an ‘expenditure wholly and exclusively laid out or expended for the purposes of the trade’.

Each of these points has been addressed in the following paragraphs and specifically in Part D (Judicial pronouncements).

PART C(3) – Deductibility of ESOP
discount under section 37

As discussed earlier, sections 30 to 36 enumerate specific deductions. The remaining deductions/ expenditure fall to be governed under the residuary section 37. Section 37 permits deduction of an “expenditure” (not being personal or capital in nature), which is wholly and exclusively incurred for the purpose of business of the assessee. ESOP discount is not specifically covered under sections 30 to 36. The allowability of such discount is therefore to be considered under section 37 of the Act.

Section 37, to the extent material reads as follows-“37( 1) – Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”……”

In order to be eligible for a deduction under section 37, the following conditions should be cumulatively satisfied:

(i)    The impugned payment must constitute an expenditure;
(ii)    The expenditure must not be governed by the provisions of sections 30 to 36;
(iii)    The expenditure must not be personal in nature;
(iv)    The expenditure must have been laid out or expended wholly and exclusively for the purposes of the business of the assessee; and
(v)    The expenditure must not be capital in nature.
Each of the above is examined in seriatim except point (ii) which is satisfied (as mentioned before).

Condition 1 – Payment must constitute expenditure

Claim of ESOP discount as “expenditure”

The existence of an “expenditure” is the sine qua non for attracting section 37. The phraseology “expenditure……laid out or expended wholly and exclusively for the purpose of such business, profession or vocation” in section 10(2)(xv) of the Indian Income-tax Act, 1922, is identical to the phraseology used in section 37 of the Act.

The term “expenditure” is not defined in the Act. In the absence of a definition, one may rely on the commercial understanding of the term; the definition in other enactments and deduce a meaning suitable to the context. Section 2(h) of the Expenditure Act, 1957 defines expenditure as follows:

“Expenditure: Any sum of money or money’s worth spent or disbursed or for the spending or disbursing of which a liability has been incurred by an assessee. The term includes any amount which, under the provision of the Expenditure Act is required to be included in the taxable expenditure.”

In the landmark decision of the Supreme Court in Indian Molasses Company (P) Ltd. v. CIT (1959) 37 ITR 66, the term “expenditure” was defined in the following manner:

“`Expenditure’ is equal to `expense’ and `expense’ is money laid out by calculation and intention though in many uses of the word this element may not be present, as when we speak of a joke at another’s expense. But the idea of `spending’ in the sense of `paying out or away’ money is the primary meaning and it is with that meaning that we are concerned. Expenditure’ is thus what is `paid out or away’ and is something which is gone irretrievably.”
(Emphasis supplied)

The expression ‘lay out’ is defined in the Oxford Dictionary as ‘to spend, expend money’. The use of these words ‘laid out’ before ‘expenditure’ emphasise the irretrievable character of the expenditure.

In common usage, expenditure would mean outflow of money in satisfaction of a liability. This liability may be imposed or voluntarily agreed upon. A mere liability to satisfy an obligation is not “expenditure”. When such obligation is met by delivery of property or by settlement of accounts, there is expenditure.

However, ‘Expenditure’ may not always involve actual parting with money or property; actual disbursement of legal currency. For instance, if there are cross-claims, each constitutes an admitted liability qua the other party. When one of them pays to the other the difference between the two counter liabilities, the payer in effect pays the value of his/ her liability against payment due to him from the other party. In making payment of that difference, the payer in fact lays out expenditure equal to the liability due by him.

Satisfaction of cross-claims to a transaction involves both retention/ payment of money. The amount which is debited/ adjusted in the account settlement would constitute expenditure. This principle was upheld by the Apex court in the case of CIT v Nainital Bank Ltd. (1966) 62 ITR 638 (SC). It is a ‘net off’ of receivables against payables. This ‘netting off’ effectively discharges the entire payables.

Stock options are issued to employees at discount. This discount represents the difference between the market value of the shares and the strike price on exercise of options. The company forbears from receiving the full value on its shares. The primary meaning of expenditure no doubt involves monies going away irretrievably. In its indirect connotation it would also include amount forgone. Forbearance of profit could also thus be covered within the gamut of section 37.

Claim of expense under section 37 as “amount forgone”

The question whether expenditure can be said to be incurred when an assessee ‘forgoes profit’ out of commercial considerations must be determined upon facts of the case. Amount forgone represents an act of relinquishment. It is a relinquishment of commercial or pecuniary prospect. If the relinquishment is for the purposes of business it would fall to be considered under section 37.

In the case of Usher’s Wiltshire Brewery Ltd. v Bruce (1914) 84 L. J. KB 417; (1915) AC 433 a brewery company acquired freehold or leasehold interest in several premises in the ordinary course of its trade and let them to publicans who were tied to purchase their beer from the company. In consideration, the company charged the publicans a rent less than the full value of the licensed premises. The House of Lords held that the company was entitled to deduct the difference between the actual rent which it received from its tied tenants and the bonafide annual value as money wholly and exclusively laid out or expended for the purposes of trade. Lord Loreburn said –

“on ordinary principles of commercial trading, such loss arising from letting tied houses at reduced rents is obviously a sound commercial outlay”

The above was upheld by Supreme Court in the case of CIT v S.C. Kothari (1971) 82 ITR 794. The Apex court in the case of CIT v Chandulal Keshavlal & Co (1960) 38 ITR 601 held that amount forgone for the purpose of business is an allowable expenditure. Section 10(2) (xv) of the 1922 Act required that the expenses must be laid out for the purpose of business of the assessee, and further that they should not be in the nature of capital expenditure. In Chandulal Keshavlal’s case, the managing agent’s commission was agreed at ` 309,114. However, at the oral request of the board of directors of the managed company the managing agent agreed to accept a sum of `100,000 only as its commission. The question before the Supreme Court was whether the commission amount forgone constituted expenditure for the managing agents. The Supreme Court held:

(i) that in cases such as this case, in order to justify deduction the sum must be given up for reasons of commercial expediency: it might not be voluntary, but so long as it was incurred for the assessee’s benefit the deduction was allowable;

(ii) that as the Appellate Tribunal had found that the amount was expended for reasons of commercial expediency, and was not given as a bounty but to strengthen the managed company so that if the financial position of the managed company became strong the assessee would benefit thereby, the Appellate Tribunal rightly came to the conclusion that it was a deductible expense under section 10(2)(xv).

Based on the aforesaid, one could claim the ESOP discount u/s. 37 as allowable. Such discount –

– Is an amount forgone for the purposes of employee welfare

– Is not a bounty/ gratuitous expense, but paid in lieu of employee service

– Is aimed at retaining and encouraging the employees thereby benefitting the business of the Company

Claim of expense under section 37 as “losses”

As stated earlier, section 37 presupposes expenditure. Per contra, expenditure does not always mean that an amount should have gone out from one’s pocket. It could include a ‘loss’. A loss may be allowed as expenditure under section 37.

The Supreme Court in the case of CIT v Woodward Governor India (P) Ltd. and Honda Siel Power Products Ltd. (2009) 312 ITR 254 (SC) held that, loss arising on account of fluctuation in the rate of exchange in respect of loans taken for revenue purposes was allowable as deduction u/s. 37 of the Act.

In the case of M.P. Financial Corporation v CIT (1987) 165 ITR 765 (MP) the Madhya Pradesh High Court held that the expression “expenditure” as used in Section 37 may, in the circumstances of a particular case, cover an amount which is a “loss” even though the amount has not gone out from the pocket of the assessee.

Thus, ESOP discount satisfies the first condition irrespective of whether it is characterised as ‘expenditure’, ‘amount forgone’ or ‘loss’. Non-capital expenditure incurred for the purposes of business should be covered under the omnibus residuary section

37. Even otherwise, the same would be allowable under section 28. The deduction is founded on ordinary commercial principles of computing profits.

Condition 2 – Expenditure should not be personal in nature

A company is an artificial juridical person. It is a distinct assessable entity under the Act. A company being an artificial juridical person cannot have personal expenses. The ‘personal’ facet is associated with human beings. It is concerned with human body or physical being.

The Supreme Court in State of Madras v. G.J Coelho (1964) 53 ITR 186 (SC) held that personal expenses would include expenses on the person of the assessee or to satisfy his personal needs such as clothes, food, etc. Needs such as clothes, food are associated with human beings and not with any artificial juridical person. The Gujarat High court in the case of Sayaji Iron & Engineering Company v. CIT (2002) 253 ITR 749 held that a company cannot have any personal expenditure. Accordingly, ESOP discount cannot be disallowed branding it to be personal expenditure.

Condition 3 – Expenditure to be laid out wholly and exclusively for business

This is one of the most important and debated conditions of section 37. To qualify as a deduction u/s. 37:

– The expense must be wholly and exclusively incurred; and

– Such incurrence must be for the purposes of business.

Meaning of ‘wholly and exclusively’

The words “wholly and exclusively for the purposes of the business” have not been defined in the Act. Judicial precedents have explained the meaning of this phrase. “The adverb ‘wholly’ in the phrase ‘laid out or expended. . . for business’ refers to the quantum of expenditure. The adverb ‘exclusively’ has reference to the object or motive of the act behind the expenditure. Unless such motive is solely for promoting the business, the expenditure will not qualify for deduction” – C.J. Patel & Co. v. CIT (1986) 158 ITR 486 (Guj). ESOP discount concerns wholly and exclusively with employee welfare measures.

Meaning of ‘For the purposes of business’

The expression ‘for the purpose of business’ in section 37(1) of the Act (corresponding to section 10(2)(xv) of the 1922 Act) is wider in scope than the expression ‘for the purpose of earning profits’. The Apex court in the case of CIT v. Malayalam Plantations Ltd (1964) 53 ITR 140 (SC) elucidating the concept “for the purpose of business” held –

“Its range is wide; it may take in not only the day-to-day running of a business but also the relationship of its administration and modernisation of its machinery, it may include measures for the preservation of the business and for the protection of its assets and property from expropriation or coercive process; it may also comprehend payment of statutory dues and taxes imposed as a pre-condition to commence or for carrying on of a business; it may comprehend many other acts incidental to the carrying on of a business.”
(Emphasis supplied)

This decision of the Apex court upheld the wide scope of the phrase ‘for the purposes of business’. It covers within its ambit all expenditure which enables a person to carry on and maintain the business, including any incidental or ancillary activities thereto. The range of this phrase is broad to encompass not only routine business expenses but also incidental expenses.

The wide scope of this phrase can also be appreciated by contrasting with the language used in section 57 of the Act. Section 57 of the Act enlists deduction allowable under the head “Income from other sources”. Similar to section 37, clause (iii) of section 57 is a residuary deduction available in case of “Other sources” income. However, there is a difference in the language – section 57 requires expenditure to be incurred wholly and exclusively for the purpose of making or earning such income.

In the treatise ‘The Law and Practice of Income Tax’ by Kanga and Palkiwala, (9th edition – page 1211) the learned authors observe –

“There is a marked difference between the language of section 37(1) and section 57(iii), both of which are residuary provisions under the respective heads; whereas this section [section 57(iii)] allows expenditure ‘laid out or expended wholly and exclusively for the purposes of making or earning such income’, the allowance under section 37 is in wider terms – ‘laid out or expended wholly and exclusively for the purposes of business or profession’.

“For the purposes of business” alludes to business expediency. ‘Business expediency’ is a broad term. The best person to judge the business expediency is the businessman himself. Courts have consistently held that the necessity or otherwise of the commercial expediency is to be decided from the point of view of the businessman and not by the subjective standard of reasonableness of the revenue. The absence of business connection should not mar the application of the test of business expediency.

The Apex court in the case of S.A. Builders Limited v CIT (2007) 288 ITR 1 (SC) explaining the meaning and scope of the phrase “commercial expediency”, held –

“The expression “commercial expediency” is an expression of wide import and includes such expenditure as a prudent businessman incurs for the purpose of business. The expenditure may not have been incurred under any legal obligation, but yet it is allowable as business expenditure if it was incurred on grounds of commercial expediency.”

The test of the “need for expenditure” is alien to section 37. Any expenditure made on ground of commercial expediency is to be allowed even though there is no legal necessity or even if it is not for direct or immediate benefit of trade. A sum of money voluntarily expended indirectly to facilitate business is entitled to be allowed as expenditure on grounds of commercial expediency.

The following are some of the observations from judicial precedents which further explain “Commercial expediency”:

In the case of Atherton v British Insulated & Helsby Cables Limited 10 TC 155, 191 (HL), the court held –

“A sum of money expended, not necessarily and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of trade.”

The Supreme Court in the case of CIT v Panipat Woollen & General Mills Co. Ltd. [1976] 103 ITR 66 (SC) observed –

“The test of commercial expediency cannot be reduced in the shape of a ritualistic formula, nor can it be put in a water-tight compartment so as to be confined in a strait-jacket. The test merely means that the Court will place itself in the position of a businessman and find out whether the expenses incurred could be said to have been laid out for the purpose of the business or the transaction was merely a subterfuge for the purpose of sharing or dividing the profits ascertained in a particular manner. It seems that in the ultimate analysis the matter would depend on the intention of the parties as spelt out from the terms of the agreement or the surrounding circumstances, the nature or character of the trade or venture, the purpose for which the expenses are incurred and the object which is sought to be achieved for incurring those expenses”
(Emphasis supplied)

Loss due to ESOP discount is necessitated by business expediency. The business expediency is the compensation and recognition to its employees. Over the years the concept of master-servant relationship is fading. Sharing of wealth of an employer with his employee is the order of the day. Stock option is one such mode of employee participation deserving fiscal encouragement. The Directive Principles of State Policy, enshrined in the Indian Constitution, lays down that “the State shall take steps by suitable legislation or in any other way, to secure the participation of workers in the management of undertakings, establishment or other organisations engaged in any industry” (Article 43A).

ESOP is an employee retention and recognition strategy. It enables the company to beat the pace of attrition. There is a direct nexus between incurrence of this expenditure and the business of the Company. The expenditure so incurred wholly and exclusively for the purpose of business and necessitated by commercial expediency, would satisfy the aforesaid condition.

Condition 4 – The expenditure must not be a capital expenditure

The demarcation between revenue and capital is not a straight jacket exercise. One may have to get into the facts of each case for such determination.

In Assam Bengal Cement Co. Ltd. v CIT (1955) 27 ITR 34, the Supreme Court held that due to diversity in the nature of business, a particular test cannot determine the nature of expenditure. The Supreme Court held that it is the object of expenditure which determines its nature. As per the Supreme Court “The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or revenue expenditure. The source or the manner of the payment would then be of no consequence.”
(Emphasis supplied)

The nature of expenditure must be determined from the point of view of the payer. The Madras High Court in CIT v Ashok Leyland Ltd (1969) 72 ITR 137, 143 (affirmed by Supreme Court in (1972) 86 ITR 549) pointed out that the generally accepted distinction between ‘capital expenditure’ and ‘revenue expenditure’ is susceptible to modification under peculiar circumstances of a case. The relevant observations are as follows:

“A clear-cut dichotomy cannot be laid down in the absence of a statutory definition of “capital and revenue expenditure”. Invariably it has to be considered from the point of view of the payer. In the ultimate analysis, the conclusion of the admissibility of an allowance claimed is one of law, if not a mixed question of law and fact. The word “capital” connotes permanency and capital expenditure is, therefore, closely akin to the concept of securing something tangible or intangible property, corporeal or incorporeal rights, so that they could be of a lasting or enduring benefit to the enterprise in issue. Revenue expenditure, on the other hand, is operational in its perspective and solely intended for the furtherance of the enterprise. This distinction, though candid and well accepted, yet is susceptible to modification under peculiar and distinct circumstances”.

(Emphasis supplied)

The nature of business and expenditure are decisive factors in determining the answer to the controversy. Temptation to use decided cases must be avoided in answering the question whether a particular expenditure constitutes capital or revenue expenditure. The Supreme Court in Abdul Kayoom (KTMKM) v CIT (1962) 44 ITR 689 (SC) held –

“Each case depends on its own facts, and a close similarity between one case and another is not enough, because even a single significant detail may alter the entire aspect. In deciding such cases, one should avoid the temptation to decide cases (as said by Cordozo) by matching the colour of one case against the colour of another. To decide, therefore, on which side of the line a case falls, its broad resemblance to another case is not at all decisive. What is decisive is the nature of the business, the nature of the expenditure, the nature of the right acquired, and their relation inter se, and this is the only key to resolve the issue in the light of the general principles, which are followed in such cases.”

The aim and object of the expenditure is thus the decisive factor for determining whether a particular expenditure constitutes revenue or capital expenditure. This is ascertained by examining all aspects and surrounding circumstances. The nature of the business has to be seen. The issue must be viewed from the point of a practical and prudent businessman.

One has to determine ‘why’ the expenditure has been incurred by a businessman and not ‘how’ the expenditure has been funded by him. As observed by Supreme Court in Assam Bengal Cement Co. Ltd. case (supra), the source and manner of the payment is inconsequential for determining the nature of a particular expenditure. It is the aim and object of the expenditure that would determine its character. The Madras High Court in India Manufactures (P) Ltd v. CIT (1985) 155 ITR 770 held that for determining the nature of a particular expenditure, the manner of payment is not relevant. The Calcutta High Court in Parshva Properties Ltd v CIT (1976) 104 ITR 631 held

“…in order to determine whether the expenditure was deductible or not, it is necessary to find out in what capacity the expenditure was incurred.”

If the examination is limited to “how” the funds have been secured, the answer (to all share capital issue expenses) would be the same. It is the aspect of “why” that would help in appreciating the underlying difference in the motive, object and aim of the expenditure. The question “why” may involve determination whether the funds are for:

– future expansion of the business;
– the prolongation of life of an existing business;

– forming a conceivable nucleus for posterior profit earning;

– conduct of the business;

– avoiding inroads and incursions into its concrete presence;

– commercial expediency;

– profit earning enhancement.

All of the above do not have the same purpose. The involvement and intensity with the business or its existence may not be uniform. The degree of association with the business or its conduct may vary. Some have their objective of profit earning or enhancement. Others concern the substratum of business. It would be unwise to characterise expenses associated with all the above as same. If the characterisation is not uniform, the associated expenditure is not to be branded in the same light. The attendant circumstances would have to be examined. These circumstances influence the characterisation of the associated payments.

The expenditure under discussion [viz., ESOP discount] would be allowed as business deduction only if the aim and object of the expenditure falls in the revenue field. As discussed repeatedly, the test of determining a disbursement to be ‘revenue’ in nature is fact specific. Characterisation of amounts as ‘income’ or ‘capital’ is determined as a matter of commercial substance, and not by subtleties of drafting, or by unduly literal or technical interpretations. The Apex Court in the case of Dalmia Jain and Co. Ltd. v CIT (1971) 81 ITR 754 (SC) while holding that expenditure incurred for maintenance of business is revenue in nature, observed – “The principle which has to be deduced from decided cases is that, where the expenditure laid out for the acquisition or improvement of a fixed capital asset is attributable to capital, it is a capital expenditure, but if it is incurred to protect the trade or business of the assessee then it is a revenue expenditure. In deciding whether a particular expenditure is capital or revenue in nature, what the courts have to see is whether the expenditure in question was incurred to create any new asset or was incurred for maintaining the business of the company. If it is the former it is capital expenditure, if it is the latter, it is revenue expenditure.”

As a general principle, an amount spent by an assessee for labour/ employee welfare would be deductible as revenue expenditure. Even if such expense results in an asset to the employees or third party – it is ‘revenue’ as far as it does not result in creation of capital asset for employer. Employee emoluments are revenue in nature. The Calcutta High Court in the case of CIT v Machinery Manufacturing Corporation Ltd (1992) 198 ITR 559 (Cal) held –

“In our view, the question is now well settled. If the employer pays any amount to the employee which is by way of an incentive, in that event such amount shall be treated as additional emoluments and such payment is inextricably connected with the business and necessarily for commercial expediency. It cannot be said that the claim which has been made is de hors the business of the assessee. As will appear from the narration of facts, it was found that it was the payment made by the assessee for better performance and, accordingly, it must be held that such payment was for commercial expediency and incurred wholly and exclusively for the purpose of business.”

The following points support the proposition that ESOP discount is an employee welfare measure and is bonafide revenue expenditure:

1. Support in the Income-tax statute

ESOP benefit is taxable in the hands of the employees as ‘perquisites’ under section 17(2) of the Act. There is no dispute that salary is bona fide revenue expenditure eligible for deduction. Salary and its components would remain on revenue account whether it is paid in cash or in kind.

ESOP is remuneration in kind. It is a perquisite. It is a benefit or amenity. It is consideration for employment. The concept of ESOP evolves/ springs out from the employer-employee relationship.

Consideration for employment in the form of amenity, benefit was the subject matter of levy of fringe benefit tax. The circular of CBDT explaining and clarifying various aspects of ESOP is relevant in the context of the issue under consideration.

Fringe Benefit Tax Circulars

The Central Board of Direct Taxes released a circular No 9/2007 dated September 20, 2007 containing frequently asked questions on ESOP. A number of issues had been raised by trade and industry at different fora after the presentation of the Finance Bill, 2007, after its enactment and also after the notification of Rule 40C.

In answer to question no. 9, the Board observed “Therefore, an employer does not have an option to tax the benefit arising on account of shares allotted or transferred under ESOPs as perquisite which otherwise is to be taxed as fringe benefit.”

FBT is a charge on expenditure. The circular acknowledges the fact that ESOP is a salary expense from the employer/ payer’s perspective. Once the payment is established as a salary, its deductibility should be unquestioned. ESOP discount is an allowable expenditure – being perquisite paid by the employer.

The FBT regime was amended to make the ESOP benefit, as susceptible to a levy of FBT. FBT by definition was a ‘consideration for employment’ in certain specified forms. ESOP discount thus constituted ‘employment related expenditure’ by the Act itself.

Section 115W(1)(b) provided for a levy of FBT on the value of concession in the context of travel. A ‘concession’ was thus conceptually encompassed within FBT since 2006. Finance Act 2008 extended the regime to cover “ESOP concession”.

As discussed earlier, section 37 is not limited to actual expenditure but also covers amount forgone. ESOP being a concession given to the employees, the same is squarely covered within the ambit of section 37.

Initially ESOP benefit was held to be outside the ambit of FBT due to the absence of computation mechanism. The law was amended and ESOP was subjected to FBT. The essence of ESOP continuing to remain a benefit or amenity to an employee and constituting a consideration for employment was confirmed.

Various questions and answer thereto in the Board circular have upheld the concept of determining nature of expenditure based on the proximate purpose. If the same yardstick is used in the case of ESOP discount, the proximate purpose is salary disbursement, incidentally resulting in increased share capital. ESOP discount thus remains revenue in nature.

Tax withholding on salary payments under section 192

Section 192 in the Act imposes a responsibility on the employer to withhold taxes on salary payments. Salary includes perquisites. Perquisites would include benefit granted to an employee as ESOP(s). Section 192(1) of the Act reads –

“Any person responsible for paying any income chargeable under the head “Salaries” shall, at the time of payment, deduct income tax on the amount payable at the average rate of income-tax computed on the basis of the rates in force for the financial year in which the payment is made, on the estimated income of the assessee under this head for that financial year.”
(Emphasis supplied)

On a perusal of the above definition it is apparent that accrual of income and the act of payment must co-exist for the purposes of withholding tax under this provision. In the case of CIT v Tej Quebecor Printing Limited (2006) 281 ITR 170 (Del), it was held that if the salary due to the employee is not paid, there is no obligation to deduct tax at source. Conversely, if section 192 is applicable, then the law presumes a payment to have been made to an employee. Section 192 requires deduction of tax at the time of payment.

The Board issues a circular each year outlining the obligations of an employer relating to the deduction u/s. 192. Circular No. 8/2010, dated 13-12-2010 outlines such obligations for the financial year 2010-11.

Paragraph 5 of the circular mandates an employer to consider the “ESOP benefit” to an employee as a part of perquisite. Once it is a part of perquisites, it forms part of salary on which the liability to deduct tax at source fastens. The allotment of shares triggering the perquisite would constitute the act as well as the fact of payment. The circular reinforces the conclusion that ESOP benefit constitutes salary to an employee. Being a part of the salary, it should be regarded as revenue in nature and allowable as a deduction much like other perquisites.

2. Nexus between benefit and expenditure

Under general principles, allowability of a deduction is not dependent upon character of income in the hands of the payee. In other words, the fact that a certain payment constitutes an income or capital in the hands of the recipient is not material in determining whether the payment is a revenue or capital disbursement qua the payer.

Macnaghten J said in Racecourse Betting Control Board v Wild 22 TC 182 “The payment may be a revenue payment from the point of view of the payer and a capital payment from the point of view of the receiver, and vice-versa.”

The Calcutta High Court in the case of Anglo-Persian Oil Co. (India), Ltd. v CIT (1933) 1 ITR 129 (Cal) held -“The principle that capital receipt spells capital expenditure or vice versa is simple but it is not necessarily sound. Whether a sum is received on capital or revenue account depends or may depend upon the character of the business of the recipient. Whether a payment is or is not in the nature of capital expenditure depends or may depend upon the character of the business of the payer and upon other factors related thereto.”

Income is taxable unless and otherwise exempt under the Act. However, expenditure operates on the principles of commercial expediency – it is allowable unless specifically prohibited by the Act. Based on commercial principles, ESOP discount should be an allowable expenditure in the hands of employer/ company. The fact that it does not get taxed or is taxed at a later point of time or is taxed under a different head in the hands of the employee would not be relevant.

The function of the ESOP discount forming part of employee’s income (and suffering tax accordingly) would thus support and sustain a claim for the same being reckoned as a revenue deduction in the hands of the employer. This principle has been supported by the courts on various occasions. Some of them are as below:

The Calcutta High court in the case of CIT v Britannia Industries Co Ltd (1982) 135 ITR 35 (Cal) held –

“We are fully in agreement with the view of the Tribunal that there cannot be any two different standards for assessment in respect of the employee and the employer. It is also equitable that what the payer gives is what the receiver receives.”

In the case of Weight v Salmon (1935) 19 Tax Case 174; 153 L.T.55, E.Lord Atkin said –

“..it would be a startling inconsistency to say that the director was to be taxed because he was receiving by way of remuneration money’s worth at the expense of the company, and yet that the company which was incurring the expense for purposes of its trade to remunerate the directors was not entitled to deduct that expense in ascertaining the balance of its profits and gains..”

3. The ‘Act of giving’ and ‘act of receiving’ are two separate events

Issue of shares under ESOP scheme involves two actions. One is the giving of benefit to the employee (in the form of discount on share premium) and the other is receipt of premium by the employer/ company. They are distinct and separate from each other. The discount emerging out of the transaction is revenue in nature. It is different from the ‘premium receipt activity’ which is a capital item. Although they are inter-linked, they are two independent transactions. The act of giving a benefit would precede the act of receipt of premium. One cannot receive premium unless, the benefit is parted with. The sequence of occurrence of these two events is thus critical.

The purpose of ESOP discount has proximity to giving of benefit and not receipt of premium. Such discount emerges out of the act of giving benefit. The mere fact that subsequent receipt of premium is ‘capital’ in nature, should not militate the revenue character of the ESOP discount.

4. There is no creation of capital asset

The expenditure is to be attributed to capital if it be made ‘with a view’ to bringing an asset or advantage, although it is not necessary that it should always result in an asset or advantage. Lord Viscount LC, in the course of the case [10 TC 155 (1926) AC 205] said –

“When an expenditure is made, not only for once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.”

The test of enduring benefit or advantage cannot be reduced to a straight jacket formula. There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on revenue account. The test of enduring benefit may break down. Every advantage of enduring nature does not render the expenditure to be capital in character. It is only where the advantage is in the capital field that the expenditure would be disallowed for income-tax purposes. If the expenditure is incurred only to facilitate and promote business, then it would necessarily have to be considered revenue in nature and allowed as a deduction.

ESOP is a share-based payment of employee remuneration. Issue of ESOP(s) creates an ‘asset’ for the employees (in form of share investment in the Company). From a Company’s standpoint, such issue of ESOP results in emergence of a liability. It is an acknowledgment by the Company of an increase in the amount due to the shareholders. There is no capital asset created out of this transaction.

5. ESOP – a consideration for employment services

An offer made to employee under ESOP is a mode of employee remuneration. This offer has direct nexus with the employment of a person with the organisation. Evidences of linkage with employee can be evidenced through terms of the ESOP agreement. Some of the typical clauses/ conditions are:

Eligibility criterion – wherein the person eligible for an ESOP would be employee of a particular class, or could be employee serving a certain span of time in the organisation; or could be employee who meets certain thresholds/ targets etc.

Vesting Schedule – The vesting of stock options is generally spread over a number of years of service. There could be different vesting schedule depending on the caliber and hierarchy of the employees in the organisation ladder, as also the philosophy adopted by the employee.

Transfer Restrictions or Lock in – Transfer of vested stock options are generally restricted and subject to particular occasions. The employees are not allowed to transfer options freely to others.

Termination/ Exit Clause – This clause generally provides the lapse of options on termination of employment.

The various conditions in the ESOP agreement provide the employment nexus to such stock options. The stock options are generally in appreciation of their past performances and an incentive to stay with the organisation on its growth path. They represent payment for services of the employees. These are payments/ losses borne by the employer. The discounts are offered in the course of employment. They are a form of salary payments for the services rendered. Accordingly, they are business expenditure allowable under the Act.

6. Documentation

Documentation of any transaction is critical. Documents serve as the proof to decipher the intent of any transaction. These documents need to be interpreted based on the intention of the parties contained therein. The Apex Court in the case of Ishikawajma-Harima Heavy Industries Ltd v Director of Income-tax (2007) 288 ITR 408 (SC) commented on interpretation of documents. It held:

“In construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the taxing provisions.”

Commercial expediency and business intentions can be better understood when supported with appropriate and adequate documentation. A company is mandatorily required to maintain various documents.

An ESOP scheme also entails a huge amount of documentation. Most of these are available in the public domain. Commencing from the preliminary intent of the Board resolution, to issue of employee share certificate – there are various documents that are exchanged/ maintained.

The significance of documentation has been upheld by the Apex court in the case of CIT v Motors & General Stores (1967) 66 ITR 692 (SC) which quoted another landmark decision in the case of Lord Russell of Killowen in Inland Revenue Commissioners v Duke of Westminster. It held –

“It is therefore obvious that it is not open to the income-tax authorities to deduce the nature of the document from the purported intention by going behind the documents or to consider the substance of the matter or to accept it in part and reject it in part or to re-write the document merely to suit the purpose of revenue.”

The Kerala High Court in the case of CIT v. M. Sreedharan (1991) 190 ITR 604 (Ker) held –

“Ground realities cannot be ignored. Existence of contemporaneous evidence and agreements should also be considered and interpreted having regard to the factual matrices.”

Documentation helps in determining tax incidence. They act as an evidence of the fact. Indian courts have repeatedly upheld the role of an agreement in the interpretation of the legal rights and obligations. A document has to be read as a whole. Neither the nomenclature of the documents nor any particular activity undertaken by the parties to the contract alone would be decisive.

It is an established principle of law that commercial documents must be construed in commercial parlance. These are business agreements and must be read as business men would read them. This principle was upheld by W T Suren & Co. v CIT (1971) 80 ITR 602 (Bom). In all taxation matters, emphasis must be placed on the business aspect of a transaction rather than the purely legal and technical aspect. This principle has been upheld in various judicial precedents; few of which are as follows:

–    CIT v Kolhia (1949) 17 ITR 545 (Bom)
–    Suren v CIT (1971) 80 ITR 602 (Bom)
–    Nilkantha v CIT (1951) 20 ITR 8 (Pat)

The following documents would assist in determining the nature of ESOP transaction:

Director’s report

The intentions of the company are disclosed through the director report. Through their report, the directors spell out the impact on the revenue on account of ESOP. The reason to accommodate the loss is accounted to the shareholders. They are an intrinsic evidence to show that the shares were allotted by way of remuneration to compensate the services rendered in promoting, forming or running the company.

ESOP agreement

This is an agreement between the company/ employer and the employee detailing the objectives, terms and conditions of the ESOP issue. This agreement details the aspects of scheme eligibility, terms, time-frames, rights and duties of each of the parties etc. This serves as a primary document of the ESOP transaction.

It is the drafting of this agreement and the nomenclature employed herein that has been the subject of a severe scrutiny of the Revenue authorities. ESOP is essentially an employee remuneration contract (in addition to the employee contract). However, as per the Revenue’s interpretation, the emergence of shares is to be superimposed on the employee remuneration element, coloring and converting the entire transaction as a “share issue” transaction.

The mere fact that the agreement intends to make the employees the stakeholders does not dilute or dilate the character of the transaction. The intent is to remunerate. It is recognition tool. The transaction is not to be re-written to say that it is a “share issue” transaction. By describing the allotment of ESOP as “towards giving equity stake”, the motive for conferring the benefit cannot be confounded.

It is a trite saying that remuneration need not generally be effected by systematic and recurring monetary payments. There could also be compensation in kind. ESOP is a typical example of a payment in kind.

7. Utilisation of expenditure is important – not the source

A reason why ESOP discount is not regarded as revenue is possibly the attribute of ‘resultant permanency’. Share capital and the company’s existence are inseparable. Shares survive as long as the company exists. Possibly therefore, expenditure referable to increase in share capital is regarded as ‘capital in nature’.

The question is – whether the aspect of life of share capital is determinative? Or is it the purpose of utilisation that is decisive? Share capital may be utilised for creating a profit making apparatus. It may, on the other hands be utilised for a profit making activity. In the latter utilisation, the capital is churned over. It keeps changing form. In the former, the form remains largely unimpaired – save the depletion in value due to lapse of time or usage. This distinction should govern characterisation for tax purposes also.

It is not that every expenditure involving/ pertaining to the subject of share capital that is to be pigeonholed as not allowable as a deduction under section 37. The Supreme Court in its decision in CIT v General Insurance Corporation (2006) 286 ITR 232 held that expenses by way of stamp duty and registration fee for issue of bonus shares are revenue in nature. The Supreme Court held that the allotment of bonus shares did not result in the acquisition of any benefit or advantage of an enduring nature. In this decision, the Supreme Court no doubt approved the principle in the cases Brooke Bond India Limited v CIT (supra) and Punjab Industrial Development Corporation Ltd v. CIT (supra). However, it recognised that every expenditure connected with share capital is not necessarily capital in nature.

The Supreme Court in General Insurance Corporation’s case approved the decision of Bombay High Court in Bombay Burmah Trading Corpn Ltd v CIT (1984) 145 ITR 793. In the said decision, the Bombay High Court held it is not essential or mandatory that an expenditure incurred in connection with the raising of additional capital requires disallowance. The Bombay High Court in Shri Ram Mills Ltd v. CIT 195 ITR 295 interpreting its decision in Bombay Burmah Trading Corporation’s case made the following observation:

“In the case of Bombay Burmah Trading Corpn Ltd. v. CIT [1984] 145 ITR 793, this Court held that it was not that every expenditure incurred in connection with the raising of additional capital that required disallowance. Expenditure such as legal expenses, printing expenses, which a trader is expected, to incur in the course of its capacity as trader have to be allowed as revenue expenditure even though a part of them might relate to the raising of the additional capital”

It is to be noted that the Supreme Court in Brooke Bond India Limited v. CIT (supra) and Punjab Industrial Development Corporation Ltd v. CIT (supra) had affirmed the decision of Bombay High Court in Bombay Burmah Trading Corporation’s case.

The Jodhpur bench of Rajasthan High Court in CIT v. Secure Meters Ltd (2008) 321 ITR 611 held that expenses incurred in connection with issue of quasi equity viz., convertible debentures would constitute revenue expenditure. The Karnataka High Court recently in CIT v ITC Hotels Ltd. (2010) 190 Taxman 430 has held to the same effect.

The Andhra Pradesh High Court in Warner Hindustan Ltd v CIT (1988) 171 ITR 224 was called upon to adjudicate on two issues. The first issue was whether claim of the assessee-company that the legal and consultation fees in connection with the issue of bonus shares is an allowable business expenditure is correct or not? The second issue was whether the amount spent by the assessee-company by way of fees paid to Registrar of Companies for increasing its authorised capital was deductible as revenue expenditure? The High Court held that both would constitute revenue expenditure in the hands of the assessee-company. It is to be noted that the Supreme Court in Punjab Industrial Development Corporation Ltd v CIT (supra) disapproved the decision of Andhra Pradesh High Court only with regard to the second issue and not the first issue. In other words, the Supreme Court had not questioned the revenue character of legal and consultation fees paid in connection with issue of bonus shares.

Besides, one could look at various instances wherein the utilisation of expenditure is important – the form or source is irrelevant. Today’s fast track business world does not intend to issue shares only for increasing the capital base. The Department of Industrial Policy and Promotion (DIPP) has released Discussion Papers on various aspects related to Foreign Direct Investment. In a series of these Discussion Papers, ‘Issue of shares for considerations other than cash’ has also been included. This discussion paper enlists some of the instances wherein shares are issued on non-cash considerations towards the following:

–    Trade Payables
–    Pre-operative expenses/ pre-incorporation expenses (including payment of rent)
–    Others

These transactions when viewed from the income-tax standpoint, leaves us with the question – whether these are allowable expenses, when discharged in the form of shares. Would it be possible to hold that payment of ‘rent’ is not an allowable expenditure as the same has been discharged through issue of shares? Rent is certainly allowable for tax purposes. So would be fee for technical services which is paid for in shares. The same analogy should be extended to ESOP discount. ESOP discount arising on discharge of salary liability should be allowable in the hands of the employer/ company.

In summary, ESOP discount satisfies all the conditions stipulated for claim of expense under section 37 based on the following counts:

– ESOP discount is a forbearance of profit and hence would qualify as an ‘expenditure’;

– Even if such discount does not qualify as ‘expenditure’, it may be allowed as ‘profit forgone’;

– It is not a an expenditure of personal nature;

– Being an employee remuneration, the expenditure is laid out or expended wholly and exclusively for the purposes of the business of the assessee – employee retention and recognition; and

– The expenditure is not capital in nature.

(to be continued………)

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What does ‘settlement’ mean?

Recently one of the tax journals reported a judgment delivered by the Madras High Court in its writ jurisdiction on the powers of the Income Tax Settlement Commission.2 The honourable High Court in this judgment has held that the Settlement Commission does not have power to settle the case at the income higher than what is disclosed by the applicant in the settlement application, as the Law does not authorise the Commission to assess the applicant’s income. The High Court delivered this judgment following its similar decisions given in the cases of Ace Investments3 and Canara Jewellers.

The Court has reasoned that according to the provisions of the section 245C(1)5, the Settlement Commission can admit only such assessee’s settlement application who has made ‘full and true disclosure’ of its income before the Commission. The Court has held that making of ‘full and true disclosure’ is one of the pre-condition for valid application. Therefore, settling income higher than income disclosed by the applicant would amount to holding firstly, that the applicant’s income disclosure in the application was not ‘full and true’ and secondly, it would also amount to assessing the applicant’s income. The Court further held that the Commission should dismiss such application leaving the option to the applicant to work out the legal remedies when it becomes clear to the Commission that the disclosure of the applicant is not full and true. However, in any case, the Commission cannot proceed to assess the income of the applicant, as the Commission is not empowered to assess the income. Hence, the settlement order assessing the applicant’s income is without jurisdiction, bad in law and void ab initio.

In the backdrop of the above judgment, this article discusses some of the arguments on the powers of the Settlement Commission particularly as to whether the Commission has power to assess the applicant’s income. It also discusses the pre-condition of ‘full and true’ disclosure for the admission of the case before the Settlement Commission. It may be mentioned that the honourable Court did not have the occasion to consider and give its findings on many of the arguments advanced in this article, as the parties did not place the same before the Court.

Concept of ‘Settlement’ After this judgment, many have wondered and have raised a question as to if the Settlement Commission is not empowered to assess the income then what is the job of the Settlement Commission ? The obvious known answer to this question is that the job of the Settlement Commission is to ‘settle’ the income of the applicant. However, this answer leads to more fundamental questions as to what is the meaning of ‘settlement’ ? Does ‘settlement’ includes assessment ? Answer to these questions will vary; as the Act does not define the word ‘settlement’, nor does it provide clear answer to the second question. This article makes a humble attempt to answer these questions.

According to the Black’s Law Dictionary, ‘settlement’ means ‘an agreement ending a dispute or lawsuit’. However, it also may be worthwhile to discuss ‘settlement’ conceptually rather than discussing only its legal meaning. The concept of ‘settlement’ may be a better-appreciated form the familiar occurrence of ‘out of the court settlement’6. The parties resolve the dispute among them possibly with the spirit of ‘give and take’ in the ‘settlement out of the court’. From it, one may infer that; ‘settlement’ is a resolution of the dispute possibly in the spirit of compromise shown by both the sides.

The Settlement Scheme in the Income-tax Act envisages a settlement incorporating the elements of compromise, according to which an applicant pays tax on the income not disclosed before the Income-tax Department and the Department in return may have to forego levying penalty and initiating prosecution. Further, both the sides give up their right to further appeal on the issues decided against them by the Settlement Commission. It may be recalled that the Supreme Court in Brijlal’s7 case has equated the dispute resolution method adopted by the Commission with arbitration. The similarity with the arbitration is not only with the Settlement Commission’s method of the dispute resolution but due to the fact that there is finality in the decision of the Commission and also due to the fact that the applicant cannot withdraw after he submits himself to the Settlement Commission. There is no provision under which the Department also can withdraw from the proceedings before the Commission. Finality of the order and submission without the possibility of the withdrawal thereafter, are essential ingredients of the alternate dispute resolution methods.

In the case of B. N. Bhattachargee8, the Supreme Court has held that the Settlement Commission is a Tribunal. It is obvious that the function of the Tribunal is to adjudicate the dispute between two parties. Based on these positions it becomes clear that the work before the Commission is limited to the resolution of dispute between two sides by way of arbitration on the issues raised by the applicant in its application and the issues raised by the Commissioner in its report on the applicant’s application. This jurisdiction of the Settlement Commission is provided in the section 245D(4) which reads as follows:

‘the Settlement Commission may, in accordance with the provisions of this Act, pass such order as it thinks fit on the matters covered by the application and any other matter relating to the case not covered by the application, but referred to in the report of the Commissioner u/ss.(1) or u/ss.(3)’

‘Settlement’ includes limited power of assessment The Supreme Court has held that the Settlement Commission passes the ‘Order’, but does not ‘assess’ income and its ‘Order’ is not described either as original assessment or reassessment.9 However, The Supreme Court in Brijlal’s case10 has mentioned that ‘When Parliament uses the word “as if such aggregate would constitute total income”, it presupposes that under the special procedure the aggregation of the returned income plus income disclosed would result in computation of total income, which is the basis for levy of tax on the undisclosed income is nothing but ‘assessment’.’ These decisions may appear to be contradictory on the Commission’s power of assessing income, however it is not so.

It may be necessary to understand the term ‘assessment’ for appreciating the above judgments. The Supreme Court has explained this term in the judgment delivered by the three-Member Bench in the case of S. Sanakappa11 as under:

‘. . . . the word ‘assessment’ is used in the IT Act in a number of provisions in a comprehensive sense and includes all proceedings, starting with the filing of the return or issue of notice and ending with determination of the tax payable by the assessee. Though in some sections, the word ‘assessment’ is used only with reference to computation of income, in other sections it has more comprehensive meaning mentioned by us above.’

The Act has entrusted the work of assessing income to the Assessing Officer by providing procedural machinery provisions and providing enabling powers such as carrying out enquiries and verifications. On the contrary, the Law has not empowered the officers of the Commission to carry out verifications to arrive at settled income although the Settlement Commission enjoys all the powers of the Income-tax Authority u/s.245F(1). Further, time provided to the Commission for settling the case is not the same as provided for completing the assessment. Therefore, the Act does not envisage the Commission the work of the assessing applicant’s income in the same way as the Law has entrusted it to the Assessing Officer in view of its limited jurisdiction, lesser time available, and in absence of the powers of carrying out enquiries and verification to the Officers of the Commission. Therefore the term of ‘assessment’ cannot have a comprehensive meaning as mentioned in the above judgment of the Supreme Court with respect to the work done by the Commission. This aspect is clarified by the Supreme Court in the case of Brijlal12 by holding that, ‘It contemplates assessment by settlement and not by way of regular assessment or reassessment u/s.143(1) or u/s.143(3) or u/s.144 of the Act.’

However, the Commission is required to settle the issues before it in a fair manner taking assistance of the Officers of the Commission when necessary and by taking independent view of the issues which are required to be settled. The Commission in this process may determine income, which would amount to assessment as held by the Supreme Court. Therefore, the Commission does have power to assess the applicant’s income, although limited to the issues before it.

This conclusion is also supported by the provisions of the section 245D(6). It provides that ‘Every order passed u/ss.(4) shall provide for the terms of settlement including any demand by way of tax, penalty or interest, the manner in which any sum due under the settlement shall be paid and all other matters to make the settlement effective…’ This provision does not make sense, if the Commission is not empowered to settle the case at the income higher than what is disclosed by it in the settlement application. The demand can only be raised if the Commission decides any issue against the applicant based on the records and evidence before it.

The Settlement Scheme is in favour of Revenue

The arbitration scheme of the Settlement Commission is different in certain aspects from the arbitration method provided in the Arbitration and Conciliation Act, 1996. Unlike the arbitration method provided in the Arbitration and Conciliation Act, the Commission has powers to call and examine records of one of the parties before it — i.e., Income-tax Department, it also has suo motto power to have the issues investigated by the Commissioner, even when the Commissioner does not request for it. Moreover, it may be interesting to note that the Commission assumes all the powers of the Income-tax Authority after filing of the application before the Commission, but it does not assume the powers of the Court. Further, preconditions for the filing of application, such as requirement of disclosure of additional income not disclosed before the Assessing Officer and requirement of disclosure of the manner in which it was derived show that the scheme is designed in favour of the Revenue.

The legal provision that all the Members of the Commission are ex-Revenue Service senior officers and are not accounting professionals from outside the Department also support this proposition. Moreover, the Law does not create distinction among Members of the Commission, such as ‘Accountant Member’ and ‘Judicial Member’ as provided in the case of the Members of the Income-tax Appellate Tribunal. Therefore, considering powers of the Income-tax Authority given to the Commission, power to have investigation conducted, nature of pre-conditions for the valid application before the Commission and the composition of the Commission, it is clear that the Settlement Scheme is in favour of the Revenue. These aspects of the Settlement Scheme as against the provisions in the Arbitration and Conciliation Act, 1996 otherwise do not make sense, but seem to have been provided with the object mentioned above.

Disclosure of ‘full and true’ income according to the applicant

In the case of the Ajmera Housing Corporation13, the Supreme Court has held that ‘full and true disclosure’ is one of the basic requirements for valid settlement application. The Supreme Court in this case has further held that unless the Commission records its satisfaction on this aspect, it will not have any jurisdiction to pass any order on the matters covered by the application. This judgment as understood by me, lays down the Law in the facts of the case, in which the applicant after disclosing Rs.1.94 crore before the Commission had revised its disclosure by filing revised application containing confidential annexure and related papers and offering additional income of Rs.11.41 crore. On these facts, the Supreme Court in para 36 of its order has held that the disclosure of the applicant could not be considered as ‘full and true’.14

It may be pointed out that the Act does not provide for fulfilment of this requirement at the satisfaction of the Settlement Commission. Therefore, in absence of the statutory requirement of ascertaining ‘full and true’ disclosure at the satisfaction of the Commission, fulfilment of this condition should be viewed from the applicant’s perspective. For example, applicant’s disclosure without including income on a legal issue may be ‘full and true’ according to the best of his knowledge and belief. However, merely because the Settlement Commission settling the case takes a view against the applicant on such an issue the applicant’s disclosure made in the application would not cease to be ‘full and true’. Therefore, the Supreme Court’s judgment in the case of Ajmera should be read as the Commission should record its satisfaction that the disclosure is ‘full and true’ to the best of knowledge and belief of the applicant at the stage of the admission of the application.

Moreover, the Law does not intend that the Commission arrive at satisfaction of ‘full and true’ disclosure at the stage of the admission of the case. Such a provision would not only make the entire process of the settlement redundant which is followed after the admission of the case, but also it is practically impossible to arrive at such a judgment without hearing both the sides at length and examining the records. It is settled that the Law does not require achieving the impossible.

The requirement of making ‘full and true disclosure’ is provided to ensure that the applicant honestly and with the bona fide intentions invokes the jurisdiction of the Settlement Commission without playing the game of hide and seek. It is held in many Court judgments that the facility of the Settlement Commission for resolution of disputes is not available to the dishonest assessees.

Revival of the abated proceedings

Presently, neither the section 245HA of the Income-tax Act, nor the Clause 280 of the proposed Direct Taxes Code (DTC) allow revival of the abated proceedings before the Assessing Officer when the Court annuls the settlement order passed u/s.245D(4) or holds the settlement order void. It may be mentioned that the Finance Act 2008 had inserted such a provision in the section 153A on the search assessment to provide revival of the assessment or reassessment proceedings in case of the annulment of assessment or reassessment. Therefore, it would not be surprising that the Government would introduce such an amendment in the near future on similar lines in the Chapter-XIX-A of the Income-tax Act on the Settlement Commission to prevent the assessees taking the advantage by getting declared the Settlement Order void on technical grounds. At the same time, such annulment also prevents the reassessment of income due to lapse of the time permitted by law. The Government may find it difficult to accept such a situation, in which the assessees would get away by paying lesser revenue than what was due from it.

To conclude, this author is of the view that the Settlement Commission is empowered to settle the case at the income above what is disclosed before the Commission as the concept of ‘full and true disclosure’ should be viewed from the applicant’s perspective.

It is besides the point that an enactment of the Law is a dynamic process. Once the Law is amended as discussed above, the arguments and discussion on the topics such as this become irrelevant.

1. The author is Commissioner of Income-tax. The
views expressed in the article are personal views of the author and not
necessarily of the Government of India.

2. G. Jayaraman v. Settlement Commission (Additional Bench) (2011) 196 TAXMANN 552 (Mad.).

3. Ace Investments v. Settlement Commission (2003) 264 ITR 571 (Mad.), (2004) 186 CTR (Mad.) 486.

4. Canara Jewellers v. Settlement Commission (2009) 315 ITR 328 (Mad.), (2009) 226 CTR (Mad.) 79.

5 Section 245C(1).

‘An
assessee may, at any stage of a case relating to him, make an application in
such form and in such manner as may be prescribed, and containing a full and
true disclosure of his income which has not been disclosed before the Assessing
Officer, the manner in which such income has been derived, the additional
amount of income-tax payable on such income and such other particulars as may
be prescribed, to the Settlement Commission to have the case settled and any
such application shall be disposed of in the manner hereinafter provided:

6. Section 89(1) of the Civil
Procedure Code deals with the ‘Settlement outside the Court’

7 Bij Lal v. CIT, (2010) 328
ITR 477 (SC) at p-506, (2010) 235 CTR (SC) 417

8 CIT v. B. N. Bhattacgagee,
(1979) 118 ITR 461 (SC) at p-480, (1979) 10 CTR (SC) 354

9 Para-12, CIT v. Hindustan
Bulk Carriers, (2003) 259 ITR 449 (SC) at p-463, (2003) 179 CTR (SC) 362

10 Para-11, Bij Lal v. CIT,
(2010) 328 ITR 477 (SC) at p-501, (2010) 235 CTR (SC) 417

11 Para-2, S. Sankappa v. ITO, (1968) 68 ITR 760
(SC)

12 See note 9

13 Ajmera Housing Corporation
v. CIT (2010) 326 ITR 642 (SC), 234 CTR (SC) 642

14 At p 659, see note 12

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Section 40(a)(ia) — If tax has been deducted at source and paid to the Government, then no disallowance u/s.40(a)(ia) can be made on the ground that the deduction was at a wrong rate or under an incorrect section.

DCIT v. S. K. Tekriwal
ITAT ‘B’ Bench, Kolkata
Before Mahavir Singh (JM) and
C. D. Rao (AM)
ITA Nos. 1135/Kol./2010
A.Y.: 2007-08. Decided on: 21-10-2011
Counsel for revenue/assessee: Niraj Kumar/Sanjay Bajoria

Section 40(a)(ia) — If tax has been deducted at source and paid to the Government, then no disallowance u/s.40(a)(ia) can be made on the ground that the deduction was at a wrong rate or under an incorrect section.

Facts:

The assessee was engaged in the business of construction of bridges, roads, dams and canals and heavy earth-moving activities in contract with government and semi-government bodies such as BRO, PWD, NTPC, etc. The assessee filed return of income showing total income at Rs.45,49,360. In the course of assessment proceedings, the Assessing Officer (AO) noted that the assessee had debited Rs.3,37,37,464 in the P & L Account under the head ‘machine hire charges’ and on this tax was deducted at source @ 1%. The AO held that these payments attracted TDS u/s.194I @ 10%. He rejected the submissions of the assessee that the payments were made to sub-contractors for completion of specific work and therefore, tax was deducted @ 1% u/s.194C(2) of the Act and also that the payments were not made for hiring of machines, but the same were wrongly grouped under the head ‘Machine hire charges’. He made a proportionate disallowance u/s.40(a)(ia) of the Act with respect to machinery hire charges. Aggrieved, the assessee preferred an appeal to the CIT(A) who examined the agreements entered into by the assessee and found that the quantity of work was fixed and the rate was fixed with reference to the quantity of work. He found merit in the argument that hire charges depend on the time period for which the machines are used. But in the present case, time consumed by the subcontractors or the period for which machines were used was not at all a factor in deciding the payments to be made to sub-contractors. It was only on the basis of quantity of work that the payments were made. He held that the payments were covered by S. 194C(2) and therefore provisions of S. 40(a)(ia) are not attracted. He deleted the addition made by the AO. Aggrieved, the Revenue preferred an appeal to the ITAT.

Held:

The Tribunal after examining the provisions of S. 40(a)(ia) observed that in the present case tax has been deducted at source, although u/s.194C(2) of the Act, it is not a case of non-deduction of tax or no deduction of tax as is the import of the section. It observed that even if it is considered that the sum under consideration falls u/s.194I, it may be considered that tax has been deducted at lower rate and it cannot be considered to be a case of non-deduction or no deduction. It noted that the C Bench of Mumbai ITAT in the case of Chandabhoy & Jassobhoy (ITA No. 20/Mum./2010, order dated 8-7-2011) the Tribunal was dealing with a case where the assessee deducted tax u/s.192 of the Act, whereas the Revenue contended that the tax should have been deducted u/s.194J of the Act, the Tribunal in that case held that the provisions of S. 40(a)(ia) of the Act can be invoked only in the event of nondeduction of tax but not for lesser deduction of tax. S. 40(a)(ia) has two limbs, one is where inter alia the assessee has to deduct tax and the second where after deducting tax, inter alia, the assessee has to pay the same into Government account. There is nothing in the said section to treat, inter alia, the assessee as a defaulter where there is a shortfall in deduction. S. 40(a)(ia) refers only to the duty to deduct tax and pay to Government account. If there is any shortfall due to any difference of opinion as to the taxability of any item or the nature of payments falling under various TDS provisions, the assessee can be declared to be an assessee in default u/s.201 of the Act and no disallowance can be made by invoking the provisions of S. 40(a)(ia) of the Act.

The Tribunal confirmed the order of the CIT(A) allowing the claim of the assessee. The Tribunal dismissed the appeal filed by the Revenue.

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Section 41(1) — Remission or Cessation of Trading Liability — On settlement of dispute the cost of machinery had reduced by two crore — Depreciation allowed in earlier years on two crore cannot be taxed u/s.41(1) or 41(2).

130 ITD 46 (Hyd.) Binjrajka Steel Tubes Ltd. v. ACIT A.Y.: 2005-06. Dated: 30-9-2010

Section 41(1) — Remission or Cessation of Trading Liability — On settlement of dispute the cost of machinery had reduced by two crore — Depreciation allowed in earlier years on two crore cannot be taxed u/s.41(1) or 41(2).

Facts:

The assessee company was carrying on the business of manufacturing of steel tubes. In its assessment, the Assessing Officer observed that as per disclosure in the Notes of Accounts, the auditors had stated that by virtue of settlement of dispute with Tata SSL Ltd., the cost of machinery was reduced by Rs.2crore and the excess depreciation that was claimed on these Rs.2 crore in the earlier years had been adjusted in current year’s depreciation.

The Assessing Officer issued a show-cause notice demanding an explanation as to why the depreciation allowed in the earlier years should not be added back u/s.41(1).

In response to the above notice the assessee furnished an explanation stating that section 41(1) was applicable in respect of trading liabilities. Not satisfied with assessee’s reply, the Assessing Officer treated Rs.2 crore as income u/s.41(1).

On appeal, the Commissioner (Appeals) confirmed the decision of the Assessing Officer. On second appeal, the Tribunal held as follows.

Held:

It is clear from the reading of section 41(1) that where any allowance or deduction has been made in the assessment year in respect of loss, expenditure or trading liability incurred and subsequently the assessee, during any previous year, has obtained/ recovered such loss, expenditure or trading liability by way of remission or cessation thereof, the amount obtained by him, shall be deemed to be the income of that previous year. However the purpose of having section 41(2) in addition to section 41(1) implies that depreciation is neither loss nor expenditure nor a trading liability as referred to in section 41(1). It is only remission of liability incurred on capital goods. Hence the benefit of depreciation obtained by the assessee cannot be termed as an allowance or expenditure claimed by him and therefore will not be taxed u/s.41(1). The alternate contention of Revenue was that amount in question could be brought to tax u/s.41(2) and the same was also not upheld. (However the depreciation claimed by the assessee on Rs.2 crore was taxed u/s.28(iv) as value of benefit arising from business.)

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Section 154, read with section 68 — Rectification of mistakes and unsatisfactory explanation given by the assessee about the nature and source of income.

129 ITD 469 (Mum.) DCIT v. Waman Hari Pethe Sons A.Y.: 2005-06. Dated: 25-3-2010

Section 154, read with section 68 — Rectification of mistakes and unsatisfactory explanation given by the assessee about the nature and source of income.

Facts:

The assessment of the assessee was completed u/s.143(3). Subsequently, the Assessing Officer initiated proceedings u/s.154 in respect of gold deposits received from customers. The Assessing Officer was of the view that the assessee had failed to establish the identity of customers who had given gold deposits. The Assessing Officer rejected the objection of the assessee and enhanced the assessment by making the addition u/s.68.

Held:

It was held that the power of the Assessing Officer is limited to rectify the mistakes that are apparent on the face of the record. The Assessing Officer does not have the power to go into the debatable issues and determine taxability. According to section 68, where any sum is found credited in the books of an assessee and the assessee offers no explanation about the nature and source of the same or the explanation offered by him is not satisfactory in the opinion of the Assessing Officer, the sum so credited may be charged to income-tax as the income of the assessee of that previous year. On the other hand, section 154 deals with rectification of mistakes apparent from record. In the course of rectification proceedings u/s.154, the Assessing Officer cannot go into debatable issues to determine taxability of unexplained cash credits.

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Section 10(23C) read with section 12A — Rejection of an application u/s.10(23C)(vi) cannot be a reason to cancel registration u/s.12A.

129 ITD 299/ (All.) Sunbeam English School Society v. CIT A.Y.: N/A. Dated: 6-10-2010

Section 10(23C) read with section 12A — Rejection of an application u/s.10(23C)(vi) cannot be a reason to cancel registration u/s.12A.

Facts:

The assessee-society was duly registered under the Societies Registration Act, 1860. It was granted registration u/s.12A. Subsequently, the assessee applied for exemption u/s.10(23C) to the CCIT. However, the CCIT rejected application since he was of the view that certain payments made by the assessee to one ‘R’ were bogus. Relying on the said order, the Commissioner cancelled the assessee’s registration u/s.12A, holding that the activities of the society had ceased to remain charitable in nature as defined u/s.2(15).

Held:

The CBDT in its Circular No. 11 of 2008, dated 12-12- 2008 has clarified that an entity with a charitable object is eligible for exemption from tax u/s.11 or alternatively u/s.10(23C) which clearly shows that both the proceedings are independent of each other. Therefore the rejection of application for grant of the exemption u/s.10(23C)(vi) cannot be the basis for cancelling the registration u/s.12A.

The Commissioner while granting the registration u/s.12A is only required to see as to whether objects are charitable and the activities are genuine and are carried out in accordance with the objects of the trust or institution. As regards exemption u/s.11, the Assessing Officer is required to verify the records as to whether the assessee has fulfilled the conditions and the income derived is utilised for charitable purpose. The Assessing Officer had done this and granted exemption in all the assessment years. In the instant case, the Commissioner mainly relied on the order of the CCIT, wherein it had been observed that the payments made to ‘R’ for construction purpose were bogus and not for charitable purpose. On the contrary, the contention of the assessee was that ‘R’ was filing returns of income regularly and the payments were made to him for constructing a building through cheques on the basis of bills submitted by him. Even TDS had been made u/s.194C. The said contention has not been rebutted.

Further, it was not the case of the Commissioner that the building constructed was not used for the objects of the trust. Furthermore, there was no change in the objects of the trust. Hence, the only reason for cancellation of registration u/s.12A was rejection of application u/s.10(23C)(vi). As already mentioned, this cannot be the ground for cancellation of registration u/s.12A.

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Section 80-IB(10) of the Income-tax Act, 1961 — Once flats were sold separately and two flat owners themselves combined separate flats whereby the total area exceeded 1,500 sq.ft., deduction u/s.80-IB(10) cannot be denied to the assessee-developer on this ground.

(2011) 141 TTJ 1 (Chennai) (TM) Sanghvi & Doshi Enterprise v. ITO A.Ys.: 2005-06 & 2006-07. Dated: 17-6-2011

Section 80-IB(10) of the Income-tax Act, 1961 — Once flats were sold separately and two flat owners themselves combined separate flats whereby the total area exceeded 1,500 sq.ft., deduction u/s.80-IB(10) cannot be denied to the assessee-developer on this ground.

For the relevant assessment years, the Assessing Officer noticed that in the project developed by the assessee-developer the deduction u/s.80-IB(10) could not be allowed because, in some cases, two flats were combined to make a single dwelling unit with a single entrance and, hence, the built-up area of the combined flats worked out to be more than 1,500 sq.ft. The CIT(A) confirmed the disallowance.

Since there was a difference of opinion between the Members, the matter was referred to the Third Member u/s.255(4). The Third Member allowed the deduction u/s.80-IB(10). The Third Member noted as under:

(1) The assessee has placed on record the confirmation given by the purchasers of the flats stating that they had combined the two flats after taking possession for their own convenience.

(2) Once the flats are sold separately under two separate agreements, the builder has no control unless the joining of the flats entails structural changes. Nothing is brought on record to evidence such structural changes.

(3) Therefore, it is quite clear that the two flat owners have themselves combined the flats whereby the area has exceeded 1,500 sq.ft. The project as a whole and the assessee cannot be faulted for the same.

(4) Moreover, clauses (e) and (f) of section 80-IB (10) are effective from 1st April, 2010 and they are not retrospective in operation. Therefore, they do not apply to the present case which pertains to the years prior to 1st April, 2010.

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(a) Section 40(b) r.w.s 36(1)(iii) and 14A of the Income-tax Act, 1961 — The section for allowing deduction of interest is section 36(1)(iii) and, therefore, payment of interest to partners is also an expenditure only and same is also hit by provisions of section 14A if it is found that the same has been incurred for earning exempt income. (b) Section 28(v) of the Income-tax Act, 1961 — Proviso to section 28(v) comes into play only if there is some disallowance in hands of firm under clause (b)<

(2011) 47 SOT 121 (And) Shankar Chemical Works v. Dy. CIT A.Y. : 2004-05. Dated : 9-6-2011

(a) Section 40(b) r.w.s 36(1)(iii) and 14A of the Income-tax Act, 1961 — The section for allowing deduction of interest is section 36(1)(iii) and, therefore, payment of interest to partners is also an expenditure only and same is also hit by provisions of section 14A if it is found that the same has been incurred for earning exempt income.

(b) Section 28(v) of the Income-tax Act, 1961 — Proviso to section 28(v) comes into play only if there is some disallowance in hands of firm under clause (b) of section 40 and it is not applicable in case of disallowance made u/s.14A.

For the relevant assessment year, the Assessing Officer observed that the firm had made investment in mutual funds, shares, etc. out of capital of the partners. The Assessing Officer disallowed u/s.14A some amount of interest paid to partners on the ground that the capital was employed for the purpose of investment in mutual funds, shares, etc. and not for the business of the assessee-firm for which the partnership deed was formed. The CIT(A) upheld the disallowance of interest u/s.14A.

Before the Tribunal the assessee, inter alia, contended as under:

(a) Section 14A talks of disallowing expenditure incurred by the assessee in relation to exempt income and interest paid to partners is not an expenditure at all and it is a special deduction allowed to the firm u/s.40 (b).

(b) If at all any disallowance had to be made in the hands of the firm, direction should be given that, to that extent, interest income should not be taxed in the hands of concerned partners in terms of provisions of section 28(v). The Tribunal held in favour of the Revenue.

The Tribunal noted as under:

(1) Section 40(b) is a section that only restricts the amount of interest payable to partners — the section which allows the deduction of interest is section 36(1)(iii).

(2) The payment of interest to partners is also expenditure only and, therefore, the same is also hit by the provisions of section 14A, if it is found that the same has been incurred for earning exempt income.

(3) From the proviso to section 28(v), it is seen that if there is any disallowance of interest in the hands of the firm due to clause (b) of section 40, income in the hands of the partner has to be adjusted to the extent of the amount not so allowed to be deducted in the hands of the firm. Hence, the operation of the proviso to section 28(v) will come into play only if there is some disallowance in the hands of the firm under clause (b) of section 40.

(4) In the instant case, the disallowance is u/s.14A and not u/s.40(b) and, therefore, the proviso to section 28(v) is not applicable and the partner of the firm did not deserve any relief on this account.

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Section 48 of the Income-tax Act, 1961 — Benefit of indexation is available in respect of preference shares.Section 48 of the Income-tax Act, 1961 — Benefit of indexation is available in respect of preference shares.

(2011) 47 SOT 62 (Mum) G. D. Metsteel (P.) Ltd. v. ACIT A.Y. : 2005-06. Dated : 8-4-2011

Section 48 of the Income-tax Act, 1961 — Benefit of indexation is available in respect of preference shares.

For the relevant assessment year, the Assessing Officer declined to grant indexation benefit in terms of second proviso to section 48, to the assessee on the ground that since prices of preference shares do not fluctuate, and these shares cannot be treated at par with equity shares, indexation benefits cannot be granted in respect of the same. The CIT(A) confirmed the action of the Assessing Officer. The Tribunal allowed the benefit of indexation to the assessee.

The Tribunal noted as under:

(1) The only exception to the second proviso to section 48 is that it shall not apply to the long-term capital gain arising from the transfer of a long-term capital asset being bond or debenture other than capital indexed bonds issued by the Government.

(2) Once shares are specifically covered by indexation of cost, and unless there is a specific exclusion clause for ‘preference shares’, it cannot be open to the Assessing Officer to decline indexation benefits to preference shares.

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Sections 143(3), 144, — Non-refundable amounts received for services to be provided in future cannot be taxed as income in the year of receipt. Such amounts received cannot be regarded as debt due till such time as services are provided.

(2011) TIOL 706 ITAT-Del. BTA Cellcom Limited v. ITO A.Y.: 2002-03. Dated: 30-6-2011

Sections 143(3), 144, — Non-refundable amounts received for services to be provided in future cannot be taxed as income in the year of receipt. Such amounts received cannot be regarded as debt due till such time as services are provided.

Facts:

The assessee was engaged in the business of providing cellular mobile telecommunication services. It had received advances from customers against prepaid calling services, sim processing fees and recharge fees. The amounts received as advances were reflected in the balance sheet under the head Current Liabilities. Since these amounts were not refundable to the customers, the AO taxed them as income. Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the AO. Aggrieved the assessee preferred an appeal to the Tribunal. Held: The Tribunal noted that the Delhi High Court has in the case of CIT v. Dinesh Kumar Goel come to a conclusion that the fees paid by the students, at the time of admission, for the entire course was only a deposit or advance. It held that it could not be said that this fee had become due at the time of deposit. It also noted that the ITAT has in the case of ACIT v. Mahindra Holidays & Resorts India Ltd. come to a conclusion that two conditions are necessary to say that income has accrued or earned by the assessee viz.

(i) it is necessary that the assessee must have contributed to its accruing or arising by rendering services or otherwise and

(ii) a debt must have come into existence and the assessee must have acquired a right to receive the payment. In that case, according to the ITAT, a debt was created in favour of the assessee immediately on execution of the agreement for becoming the member of resort under the policy, but the assessee had not fully contributed to its accruing by rendering services. Having noted the ratio of these two decisions, the Tribunal held that if the services are to be rendered for a future period, then the amount received by an assessee cannot be said as debt due. It held that the right to enforce the debt is subject to ifs and buts. It is not crystallised.

The Tribunal also noted that the AO was disturbing the accounting policy consistently followed by the assessee. Disturbing the accounting policy would disturb the accounts of all other years. It also noted that the amount has ultimately been offered for tax at the time of rendering of the services by the assessee. The Tribunal held that the Revenue should not have disturbed the method of accountancy adopted by the assessee in one assessment year when it is accepted in the earlier assessment year and also in the subsequent assessment years. The appeal filed by the assessee was allowed.

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Section 45 — Gain arising on sale of shares, acquired under an ESOP Scheme whereby right was conferred on the assessee, but the purchase price of shares was to be paid at the time of sale of shares or their redemption, after a period of 3 years from the date of grant of right under ESOP Scheme is chargeable as long-term capital gain.

(2011) TIOL 664 ITAT-Del. 11 Abhiram Seth v. JCIT A.Y.: 2004-05. Dated: 30-9-2011

Section
45 — Gain arising on sale of shares, acquired under an ESOP Scheme
whereby right was conferred on the assessee, but the purchase price of
shares was to be paid at the time of sale of shares or their redemption,
after a period of 3 years from the date of grant of right under ESOP
Scheme is chargeable as long-term capital gain.

Facts:

The assessee was an employee of M/s. Pepsico India Holdings (P) Ltd. (PIHL). Consequent to employment with PIHL, the assessee was granted valuable rights in shares of Pepsico Inc. The rights were conferred on various dates from 27-7-1995 to 27-1-2000. The assessee sold these shares on 25-2- 2004 i.e., A.Y. 2004-05. Consequent to sales, the assessee claimed the gains as long-term capital gains as the assessee held the rights for more than 3 years. The assessee also claimed deduction u/s. 54F. In reassessment proceedings the AO held that since the shares were actually held by a trustee i.e., Barry Group at USA and the assessee received the differential amount between gross sale consideration and cost price, the AO taxed the gain as short-term capital gain and consequently he denied deduction claimed u/s.54F. According to the AO, the earlier right of allotment does not constitute purchase of shares. Aggrieved the assessee preferred an appeal to the CIT(A) who upheld the order passed by the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal, where the following facts relating to the ESOP scheme were pointed out. The shares were offered to the employee at prices which were commensurate with US market. Upon the employee accepting the offer an agreement was signed for eligible shares and he became the owner. Distinctive shares were not issued by Pepsico Inc in the name of the employee, but the shares in the form of stock were held by an appointed trustee who held the shares on behalf of the employee and the employer. Shares were encashable within a period of ten years after a lapse of initial period of 3 years from the date of acceptance of the ESOP offer. The employee was to pay consideration for shares at the time of sale /redemption. The ESOP agreement provided for transferability in case of death, etc. from the employee to his legal heirs. It also provided that after option became exercisable, the Trustees at their sole discretion and without the assessee’s consent could sell such an option and pay the difference between the option price and the prevalent fair market value of the shares by giving written notice called as the ‘Buy-out notice’. Payments of such buy-out amounts pursuant to this provision was to be effected by Pepsico and could be paid in cash, in shares of capital stock or partly in cash and partly in capital stock, as the trust deemed advisable.

Held:

A perusal of the clauses of the allotment clearly reveal that the particular number of shares were allotted to the assessee in different years at different prices; only distinctive numbers were not allotted. The apparent benefit to the assessee out of the ESOP scheme was that it had not to pay the purchase price immediately at the time of allotment, but the same was to be deducted at the time of sale or redemption of shares. Since there was an apparent fixed consideration of ESOP shares, the right to allotment of particular quantity of shares accrued to the assessee at the relevant time. The benefit of deferment of purchase price cannot lead to an inference that no right accrued to the assessee. The sale of such valuable rights after three years is liable to be taxed as ‘long-term capital gains’ and not as ‘short-term capital gains’. The CIT(A) has not considered that the acquisition of valuable rights in a property amounts to a capital asset. In the case under consideration, there was a fixed price of allotment of right to fixed quantity of shares and the indistinctive shares were held by a trust on behalf of the assessee. Non-allotment of distinctive number of shares by trust cannot be detrimental to the proposition that the assessee’s valuable right of claiming shares was held in trust and stood sold by Pepsico. Therefore, there was a definite, valuable and transferable right which can be termed as capital asset. The claim of taxability of gains as ‘long-term capital gains’ is justified.

The Tribunal allowed the appeal filed by the assessee.

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Set-off of long-term capital loss against short-term capital gains u/s.50 — U/s.74(1)(b) the assessee is entitled to the claim of set-off of long-term capital loss against the income arising from the sale of office premises, the gain of which is short-term due to the deeming provision, but the asset is longterm.

(2011) 62 DTR (Mum.) (Trib.) 196 Komac Investments & Finance (P) Ltd. v. ITO A.Y.: 2005-06. Dated: 27-4-2011

Set-off of long-term capital loss against short-term capital gains u/s.50 — U/s.74(1)(b) the assessee is entitled to the claim of set-off of long-term capital loss against the income arising from the sale of office premises, the gain of which is short-term due to the deeming provision, but the asset is long-term.

Facts:

The assessee-company is engaged in the business of investment, finance and brokerage. The assessee had derived income from capital gain on account of sale of office premises owned by it on which depreciation was claimed. The assessee had set off the capital gain of the year with the brought forward capital loss of the earlier year.

The AO disallowed such set-off on the ground that in view of section 50(2), the income received or accruing as a result of such transfer shall be deemed to be capital gains arising from the transfer of shortterm capital asset. The CIT(A) also upheld the action of AO stating that in view of section 50 r.w.s 2(42A) which defines the term ‘short-term capital assets’ meaning an asset held by assessee for not more than 36 months preceding the date of its transfer, contention that the said assets were held for more than 36 months has become inconsequential as deeming provisions of section 50 would treat such asset as short-term assets and resultant gains as short-term gains.

Held:

The fiction created u/s.50 is confined to the computation of capital gains only and cannot be extended beyond that. It cannot be said that section 50 converts a long-term capital asset into a shortterm capital asset. Therefore, the brought forward long-term capital C. N. Vaze, Shailesh Kamdar, Jagdish T. Punjabi, Bhadresh Doshi Chartered Accountants Tribunal news loss can be set off against the capital gain on account of transfer of the depreciable asset which has been held by the assessee for more than 36 months, thereby making the asset a long-term capital asset. The gain of the asset is short term due to the deeming provision, but the asset is a longterm asset. The decision of CIT v. Ace Builders (P) Ltd., 281 ITR 210 (Bom.) was relied upon.

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Reassessment: Sections 147 and 148 of Income-tax Act, 1961: A.Y. 2003-04: Notice u/s.148 based on report from Director of Income-tax that credit entry in accounts of assessee was an accommodation entry: AO not examining evidence: Notice not valid.

[Signature Hotels P. Ltd. v. ITO, 338 ITR 51 (Del.)]

For the A.Y. 2003-04, the return of income of the assessee company was accepted u/s.143(1) of the Income-tax Act, 1961 and was not selected for scrutiny. Subsequently, the Assessing Officer issued notice u/s.148 which was objected by the assessee. The Assessing Officer rejected the objections. The assessee company filed writ petition and challenged the notice and the order on objections. The Delhi High Court allowed the writ petition and held as under:

“(i) Section 147 of the Income-tax Act, 1961, is wide but not plenary. The Assessing Officer must have ‘reason to believe’ that income chargeable to tax has escaped assessment. This is mandatory and the ‘reason to believe’ are required to be recorded in writing by the Assessing Officer.

(ii) A notice u/s.148 can be quashed if the ‘belief’ is not bona fide, or one based on vague, irrelevant and non-specific information. The basis of the belief should be discernible from the material on record, which was available with the Assessing Officer, when he recorded the reasons. There should be a link between the reasons and the evidence/material available with the Assessing Officer.

(iii) The reassessment proceedings were initiated on the basis of information received from the Director of Income-tax (Investigation) that the petitioner had introduced money amounting to Rs.5 lakhs during F.Y. 2002-03 as stated in the annexure. According to the information, the amount received from a company, S, was nothing but an accommodation entry and the assessee was the beneficiary. The reasons did not satisfy the requirements of section 147 of the Act. There was no reference to any document or statement, except the annexure. The annexure could not be regarded as a material or evidence that prima facie showed or established nexus or link which disclosed escapement of income. The annexure was not a pointer and did not indicate escapement of income.

(iv) Further, the Assessing Officer did not apply his own mind to the information and examine the basis and material of the information. There was no dispute that the company, S, had a paid up capital of Rs.90 lakhs and was incorporated on January 4, 1989, and was also allotted a permanent account number in September 2001. Thus, it could not be held to be a fictitious person. The reassessment proceedings were not valid and were liable to the quashed.”

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Reassessment: Sections 147 and 148 of Income-tax Act, 1961: A.Y. 1997-98: Notice u/s.148 issued without recording in the reasons that there was failure on the part of the assessee to disclose fully and truly all material facts: Notice not valid.

[Titanor Components v. ACIT, 243 CTR 520 (Bom.)]

For the A.Y. 1997-98, the assessment was completed u/s.143(3) of the Income-tax Act, 1961 on 29-12-1999. Thereafter, on 18-3-2004 (beyond the period of 4 years), the Assessing Officer issued notice u/s.148 for reopening the assessment.

The assessee challenged the notice by filing a writ petition. The Bombay High Court allowed the petition and held as under: “

(i) Having regard to the purpose of section 147, the power conferred by section 147 does not provide a fresh opportunity to the Assessing Officer to correct an incorrect assessment made earlier unless the mistake in the assessment so made is the result of the failure of the assessee to fully and truly disclose all material facts, it is not open for the Assessing Officer to reopen the assessment on the ground that there is a mistake in assessment.

(ii) Moreover, it is necessary for the Assessing Officer to first observe whether there is a failure to disclose fully and truly all material facts necessary for assessment and having observed that there is such a failure to proceed u/s.147. It must follow that where the Assessing Officer does not record such a failure he would not be entitled to proceed u/s.147.

(iii) The Assessing Officer has not recorded the failure on the part of the petitioner to fully and truly to disclose all material facts necessary for the A.Y. 1997-98. What is recorded is that the petitioner has wrongly claimed certain deductions which he was not entitled to. There is a well-known difference between a wrong claim made by an assessee after disclosing all the true and material facts and a wrong claim made by the assessee by withholding the material facts. It is only in the latter case that the Assessing Officer would be entitled to proceed u/s.147.

(iv) In the circumstances, the impugned notice is not sustainable and is liable to be quashed and set aside.”

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Deemed dividend: Section 2(22)(e) of Incometax Act, 1961: A.Ys. 1992-93 and 1993-94: Advance on salary received by managing director: Not assessable as deemed dividend.

[Shyama Charan Gupta v. CIT, 337 ITR 511 (All.)]

The assessee, the managing director of a company, received advances of salary and commission on profits. The Assessing Officer treated them as deemed dividend u/s.2(22)(e) of the Income-tax Act, 1961. The Tribunal held that the assessee was not entitled to claim receipt of advance against commission and directed the Assessing Officer to redetermine the deemed dividend in the hands of the assessee after adjusting the salary.

On appeal by the Revenue, the Allahabad High Court upheld the decision of the Tribunal and held as under: “We do not find any error in the findings recorded by the Tribunal that the advance towards salary, which was due to the assessee and was credited to his account every month could not be treated as deemed dividend, but the advance of commission on profits over and above that amount drawn during the course of the years before the profits were determined and accrued to him would be treated as deemed dividend subject to tax. The amount was not treated as a separate addition in the hands of the assessee.”

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Deduction u/s.80-IB of Income-tax Act, 1961: A.Y. 2005-06: Assembling of different parts of windmill: Amounts to ‘manufacture’ as well as ‘production’: Assessee entitled to deduction u/s.80-IB.

[CIT v. Chiranjjeevi Wind Energy Ltd., 243 CTR 195 (Mad.)]

The assessee was engaged in procuring different parts and assembling wind mills. For the A.Y. 2005- 06, the Assessing Officer disallowed the assessee’s claim for deduction u/s.80-IB holding that the activity of assembling the parts of the wind mill does not amount to ‘manufacture’ or ‘production’ of any article or thing. The Tribunal allowed the assessee’s claim.

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

(i) The different parts procured by the assessee by themselves cannot be treated as a windmill. Those different parts bear distinctive names and when assembled together, it gets transformed into an ultimate product which is commercially known as ‘windmill’.

(ii) There can, therefore, be no difficulty in holding that such an activity carried on by the assessee would amount to ‘manufacture’ as well as ‘production’ of a thing or article as set out u/s.80-IB(2)(iii). (iii) In such circumstances, the conclusion of the Tribunal in accepting the plea of the assessee cannot be found fault with.”

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(2011) 52 DTR (Mumbai) (Trib.) 295 Sri Adhikari Brothers Television Networks Ltd. v. ACIT A.Y.: 2000-01. Dated: 22-9-2010

Section 32 — Amount paid for purchase of shares as well as for construction contribution which entitled the assessee to obtain, use and occupy the premises eligible for depreciation.

Facts:
The assessee made payment to M/s. Westwind Realtors (P) Ltd. (WRPL) towards purchase of shares amounting to Rs.2,76,92,000 and construction contribution amounting to Rs.1,67,55,000 totalling to Rs.4,44,47,000. Depreciation was claimed on such amount. On being called upon to justify the claim of depreciation, the assessee stated that such shares were purchased with a view to become owner of floor area, basement parking and terrace of building called Oberoi Chambers from WRPL.

The AO noted that as per copies of agreement the assessee had purchased only shares in the possession of some shareholders. Since the building was stockin- trade in the hands of WRPL, the AO held that the same could not form part of block of the assessee’s assets. He, therefore, disallowed depreciation on the same.

The assessee argued before the learned CIT(A) that in the regular assessment of WRPL, the acquisition of shares by the assessee had been treated as sale of the premises by WRPL and in its support the balance sheet of WRPL as on 31st March, 2000 was also filed. The CIT(A) held that the payment of Rs.2.76 crore could not be considered as part payment for acquisition of premises. He, therefore, granted depreciation on Rs.1.67 crore representing contribution towards construction. Both the sides were in appeal against their respective stands.

Held:
There is a definite scheme floated by the company under which premises have been divided into various classes such as Class A, Class B, Class C or Class D or Class E. In order to be eligible for obtaining, occupying and using the property in a specific class, it is incumbent upon the member to purchase requisite number of shares and also deposit nonrefundable construction contribution again of the requisite amount.

On going through various clauses of articles of association it becomes apparent that on becoming member by purchasing requisite number of shares and making non-refundable construction contribution, the member becomes entitled to hold, use and occupy the definite premises. Further such shares are transferable and when there is transfer of shares, the rights and benefits of the transferor stand transferred in favour of the transferee.

By holding the requisite number of shares and giving construction contribution, the assessee got the right to obtain, use and occupy the premises. The situation is somewhat akin to that of a co-operative housing society which is legal owner of building and the members get right to use and occupy the premises by virtue of their shareholding in the society. Even though the assessee is not a registered owner of the premises but it has got all such rights which enable others to be excluded from the ownership of the property. WRPL treated the acquisition of shares by the assessee and other members as sale consideration of its premises.

Both the payments are directed towards acquiring one composite right. As such it is not possible to view these two payments separately and consider the construction contribution as part of block of assets leaving aside the consideration for shares. By making total payment of Rs.4.44 crore, the assessee became entitled to obtain, use and occupy the requisite premises and hence became owner of the premises for the purpose of section 32(1).

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(2011) 52 DTR (Del.) (Trib.) 14 DCIT v. Select Holiday Resorts (P) Ltd. A.Ys.: 2004-05 & 2005-06. Dated: 23-12-2010

Section 79 is not applicable if there is no change in control and management, even if there is change in more than 51% of share holding due to merger of two companies.

Facts:
The assessee had claimed set-off of brought forward loss and unabsorbed depreciation of Rs. 5,99,88,612. The AO noted that there has been major change in the shareholding pattern due to merger of M/s. Indrama Investment (P) Ltd. (IIPL) with the assesseecompany.

The issued share capital of the assessee-company was Rs.15 crore. Out of the share capital of Rs.15 crore, the share capital worth Rs.14.70 crore was held by IIPL. After the merger the share capital of the assessee company became Rs.6 crore. Shareholding of IIPL had been cancelled pursuant to the merger. As a result of merger more than 51% of the share capital which was held earlier by IIPL was reduced to nil. The AO held that the above change in the shareholding pattern had resulted in violation of conditions laid down in section 79 of the Income-tax Act for allowability of set-off of carried forward business loss.

In the present case it may be noted that IIPL was holding 98% of the shares of the appellant-company. On the other hand 100 per cent shares of IIPL were held by four persons of the family who were having the control and management of the IIPL as well as of the appellant-company. Because of the merger of IIPL into the appellant-company, the former came to an end, as a result of which the shares of amalgamated company were allotted to the shareholders of IIPL.

Thus, it is clear that there is no change in the management of the company which remained with the same family (set of persons) which was earlier exercising control. The assessee submitted a list of directors on the board of the two companies prior to the merger as well as the directors on the board of merged company. It remained in the same hands. Thus, the learned CIT(A) is correct in holding that the change in more than 51% was due to merger in two companies. There was no change in control and management. The CBDT vide Circular No. 528 clarified that set-off of brought forward losses will not be denied where change in shareholding takes place due to death of any shareholder. The case of the present merger is akin to death of shareholder. In the case death of a living person the shares held by him get transferred to his legal heirs. Similarly when existence of a company is legally finished, the benefit of assets held by it (including shares of other company) will pass on to its shareholders. Therefore, the provision of section 79 were not applicable in the facts of the present case.

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(2011) 128 ITD 275 (Mum.) Piem Hotel Ltd. v. Dy. CIT A.Y. 2004-05. Dated: 13-8-2010

Non-examination and non-verification by AO regarding allowability of depreciation on intangible assets does not mean that order passed by AO is erroneous and prejudicial to the interest of Revenue.

Facts:
The assessee acquired licence/approval for operating hotel business and included the amount paid in respect of the same under the head goodwill forming part of block of assets under the head intangible assets. While completing original assessment u/s.143(3), the AO had raised queries about claim of depreciation on goodwill and asked the assessee to provide details of the same with detailed working. The assessee provided all the necessary details along with the working of depreciation on intangible assets to the AO. On being satisfied, the AO allowed the claim of depreciation on intangible assets, but failed to discuss it in the assessment order. However, the CIT issued notice u/s.263 on the ground that the AO has not obtained bifurcation and details of assets on which depreciation was claimed. The CIT held that the AO has failed to apply his mind in determining whether these licences/approvals bring into existence any new asset/or not.

Held:
Licence/approval can be said to be intangible assets as defined in Clause (b) to explanation 3 to section 32(1)(ii). In the order of the AO, claim of depreciation on goodwill was not discussed even though the AO had examined the detailed explanation presented before him. The same claim was allowed in earlier year also.

Held that the AO’s decision of not rejecting the claim, after having an opportunity to peruse the detailed submission, cannot by itself imply that there was no application of mind.

It is well-settled law that when two views are possible and the AO has taken one view, then his order cannot be subjected to revisions, merely because other view is also possible.

Therefore view taken by the AO was a possible view in allowing depreciation and cannot be held to be erroneous and prejudicial to the interest of the revenue.

Therefore, order passed by the CIT u/s.263 was to be quashed.

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(2011) 128 ITD 81 (Cochin) V. K. Natesan v. Dy. CIT (TM) Third Member A.Y.: 2004-05. Dated: 14-7-2010

Section 263 is invoked when order is erroneous and prejudicial to interest of Revenue. It’s well-settled provision of law that where there are two views possible, the view adopted by AO cannot be held to be erroneous. The Commissioner cannot invoke provision of section 263 merely because AO kept in abeyance penalty proceedings till the dispute of appeal.

Facts:
Assessment was completed u/s.143(3) and shortterm capital gain of Rs.13,99,528 (undisclosed income) was added to the returned income of assessee for non-production of evidence. Assessee filed appeal to the CIT(A) and ITAT. Both authorities confirmed the addition. The assessee filed appeal before the High Court. Penalty proceeding were initiated u/s.271(1)(c) in the order itself; but order imposing penalty was not passed by the AO as the assessee preferred appeal before the High Court. The AO kept penalty proceeding in abeyance till the matter was decided by the High Court. However, the CIT, set aside the order of the AO u/s.263 on the ground of it being erroneous and prejudicial to the interest of the Revenue.

Both the members (i.e., judicial members and accountant members) upheld jurisdictional powers of the CIT u/s.263 but, they differed on merits of the case. Hence, a reference was made to the Third Member to determine whether the AO was justified in relying on section 275(1A) for keeping in abeyance the penalty proceedings.

Held:
The order is prejudicial to interest of the Revenue only when lawful revenue due to the state is not/ realised. Mere keeping in abeyance of penalty proceeding by the AO till the matter is decided in the High Court/Supreme Court cannot be treated as prejudicial to the interest of the Revenue.

Provisions of section 275(1A), state the course of action when quantum appeal is pending. Therefore, when two views are possible, view adopted by the AO can not be held to be erroneous. Held that the order making revision u/s.263 should be quashed.

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Business expenditure: Deduction only on actual payment: Section 43B: Provision for pension: Liability accrues from year to year: Payable on retirement/resignation: Assessee entitled to deduction.

[CIT v. Ranbaxy Laboratories Ltd., 334 ITR 341 (Del.)] The assessee followed the mercantile system of accounting. It had a super-annuation scheme for its employees. In order to retain managerial employees, the assessee also introduced a pension scheme for such managerial employees which was over and above the benefits available under the super-annuation scheme of the company. This scheme was non-funded and applicable to all managerial employees. The liability on this account for the A.Y. 2001-02 of Rs.3,61,63,024 was provided following AS-15 based on actuarial valuation. The assessee claimed deduction of this amount. The AO disallowed the claim relying on the provisions of section 43B of the Income-tax Act, 1961 on the ground that even if it was an ascertained liability, the deduction could not be allowed in the absence of contribution to the pension fund. The Tribunal allowed the assessee’s claim.

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

“(i) The Commissioner (Appeals) correctly viewed that the pension scheme of the assessee did not envisage any regular contribution to any fund or trust or entity. The pension scheme provided that pension would be paid by the assessee to its employee on his or her attaining the retirement age or resigning after having rendered services for a specified number of years.

(ii) Thus, where the liability on this account accrued from year to year, it was payable on retirement/resignation of the eligible employees. It could not be disallowed u/s.43B.”

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Accrual of income in India: Salary: Section 5: Assessee a non-resident Indian, was employee of a Hong Kong-based ship management company: For services rendered in international waters outside country he was paid salary which was received by him on board of ship: As per his instructions, a portion of his salary, in form of ‘allocation’, had been remitted to NRE account of assessee in India: No portion of salary liable to tax in India.

[DIT (International Taxation), Bangalore v. Dylan George Smith, 11 Taxman.com 348 (Kar.)]

The assessee was an individual. For the relevant years i.e., A.Ys. 2003-04 and 2004-05 he was a non-resident Indian. He was employed with a foreign company engaged in the management of crew and vessels. He was working on the ships of the foreign company. Payments towards salary was first received by the assessee on board the ship and later on as per his instructions, remittance of a portion of salary in the form of ‘allocation’ had been made to the NRE account of the assessee in India. The assessee claimed that his income had accrued outside India and was also received outside India on board the ships belonging to the Hong Kong Company and as the income had not arisen within India, he was not liable to pay tax in India. The Assessing Officer rejected the assessee’s claim and held that the income fell under the purview of section 5(2) of the Act. The CIT(A) and the Tribunal accepted the assessee’s claim. The Tribunal held that the assessee was an employee of the Hong Kongbased ship management company. He never had any contractual relationship with any Indian Company. He received the salary from Hong Kong for services rendered in their agent’s ships, namely, M V Vergina and M T Tamyara in international territorial waters. Payments towards salary was first received by the assessee on board the ships and later on as per his instructions, remittance of a portion of salary in the form of ‘allocation’ had been made to the NRE account of the assessee in India. The Tribunal followed its order in ITA 1137(B)/2008 that the salary accrued outside India could not be taxed in India merely because it was received in India.

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

“(i) In the instant case, though the assessee was an Indian, at the relevant point of time he was a non-resident. He was working for a foreign company. For the services rendered in the international waters outside the country he was paid salary. He received the salary on board the ships. A particular amount was allocated to be transferred to his NRE account in India. Merely because a portion of his salary was credited to his account in India, that would not render him liable to tax in India when the service was rendered outside India, salary was paid outside India and his employer was a foreign employer.

(ii) The provisions of the Act were not attracted to the salary of the assessee. Therefore, the Tribunal was justified in upholding the order passed by the CIT(A) and in setting aside the order passed by the Assessing Officer.

(iii) Hence, there was not any merit in the instant appeal. Accordingly, the appeal was to be dismissed.”

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Accrual of income: A.Y. 1997-98: Interest: Waiver of interest before end of accounting year: Interest does not accrue.

[Bagoria Udyog v. CIT, 334 ITR 280 (Cal.)] The assessee had advanced an amount to a party H. The assessee claimed that it had agreed to waive the interest and therefore no interest accrued for the A.Y. 1997-98. The Assessing Officer held that interest had accrued. Before the Commissioner (Appeals) the assessee produced the agreement dated 28-2-1997, whereby the assessee had agreed not to charge interest to H w.e.f. 1-4-1996. The Commissioner (Appeals) accepted the contention of the assessee and deleted the addition. The Tribunal restored the addition on the ground that the assessee had submitted that there was no business connection with H.

In appeal by the assessee, the assessee clarified that no such concession was made by the assessee. The Calcutta High Court allowed the assessee’s claim and held as under:

“(i) The Tribunal accepted the position of law that a waiver of interest was permissible. It further accepted the finding of the Commissioner (Appeals) that sufficient cause was shown by the assessee for non-production of the agreement before the Assessing Officer.

(ii) The addition of deemed interest was not justified.”

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Revision: Section 263: Block assessment: Addition made on basis of seized documents deleted by ITAT: Appeal pending before High Court: Revision directing the AO to consider the tax implications of the same seized documents not valid.

[CIT v. Mukesh J. Upadhyaya (Bom.), ITA No. 428 of 2010 dated 13-6-2011] In the instant case, in the block assessment order dated 31-12-2002, the Assessing Officer made an addition of Rs.90 lakh on the basis of the documents seized from the premises of Vishwas R. Bhoir. The said addition was deleted by the Tribunal. Against the said order of the Tribunal the Revenue preferred an appeal before the Bombay High Court, which was pending. In the meantime, the CIT passed a revision order u/s.263 on 16.03.2005 directing the Assessing Officer to consider the tax implication of the page Nos. 1 to 13 of Bundle No. 12, seized from the residence of Vishwas R. Bhoir. The Tribunal set aside the order of the CIT on the ground that the addition of Rs.90 lakh was made after due consideration of both the documents referred to by the CIT. The Tribunal recorded a finding of fact that the two documents cannot be read independent of each other. The Tribunal held that once the taxability under both the documents has been considered by the Assessing Officer and also by the CIT(A), it is not open to the CIT to invoke the jurisdiction u/s.263 of the Act and direct the Assessing Officer to consider the taxability under those two documents once again.

On appeal by the Revenue, the Bombay High Court held as under: “In our opinion, no fault can be found with the decision of the Tribunal in setting aside the order of the CIT u/s.263 of the Act.”

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Closing stock: Value: Section 145A: Excise duty on sugar manufactured but not sold is not to be included in the value of the closing stock.

[CIT v. Loknete Balasaheb Desai S. S. K. Ltd., (Bom.); ITA No. 4297 of 2009 dated 22-6-2011]

The assessee was engaged in the business of manufacture and sale of white sugar. In the A.Y. 2001-02, the Assessing Officer held that the excise duty on sugar manufactured but not sold and lying in closing stock was a liability incurred by the assessee u/s.145A(b) ought to have been considered for valuation and disallowed u/s.43B of the Act. Following the judgment of the Madhya Pradesh High Court in ACIT v. D & H Secheron Electrodes P. Ltd.; 173 Taxman 188 (MP), it was held that the Assessing Officer was not justified in adding excise duty to the price of the unsold sugar lying in stock on 31-3-2001.

On appeal by the Revenue the following question was raised before the Bombay High Court:

“Whether in the facts and in the circumstances of the case and in law, the ITAT was justified in holding that u/s.145A of the Income-tax Act, 1961 the excise duty element cannot be added to the value of unsold sugar lying in stock on the last day of the accounting year?”

The High Court held as under:

“(i) The argument of the Revenue is that the excise duty liability is incurred on manufacture of sugar and since section 145A(b) specifically used the expression ‘incurred’, the Tribunal ought to have held that the excise duty liability has to be taken into consideration in valuing the unsold sugar in stock on the last day of the accounting year.

(ii) The expression ‘incurred by the assessee’ in section 145A(b) is followed by the words ‘to bring the goods to the place of its location and condition as on the date of valuation’. Thus the expression incurred by the assessee’ relates to the liability determined as tax, duty, cess or fee payable in bringing the goods to the place of its location and condition of the goods. Explanation to section 145A(b) makes it further clear that the income chargeable under the head ‘profits and gains of business’ shall be adjusted by the amount paid as tax, duty, cess or fee. Therefore, the expression ‘incurred’ in section 145A(b) must be construed to mean the liability actually incurred by the assessee.

(iii) The Apex Court in the case of CCE v. Polyset Corporation & Anr.; 115 ELT 41 (SC) has held that the dutiability of excisable goods is determined with reference to the date of manufacture and the rate of excise duty payable has to be determined with reference to the date of clearance of the goods. Therefore, though the date of manufacture is the relevant date for dutiability, the relevant date for the duty liability is the date on which the goods are cleared. In other words, in respect of excisable goods manufactured and lying in stock, the excise duty liability would get crystallised on the date of clearance of the goods and not on the date of manufacture.

(iv) Therefore, till the date of clearance of the excisable goods, the excise duty payable on the said goods does not get crystallised and consequently the assessee cannot be said to have incurred the excise duty liability. In respect of the excisable goods lying in stock, no liability is determined as payable and consequently, there would be no question of incurring excise duty liability.

(v) In the present case, it is not in dispute that the manufactured sugar was lying in stock and the same were not cleared from the factory. Therefore, in the facts of the present case, the ITAT was justified in holding that in respect of unsold sugar lying in stock, central excise liability was not incurred and consequently the addition of excise duty made by the Assessing Officer to the value of the excisable goods was liable to be deleted.”

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Reassessment: Section 147 and section 148: Development agreement dated 17-9-2004 terminated in view of default of developer: Suit filed by developer ultimately settled by order of High Court dated 2-5-2011: Capital gain not taxable in A.Y. 2005-06: Notice u/s.148 for taxing the capital gain in A.Y. 2005-06 is not valid.

[Amar R. Shanbhag v. ITO (Bom.); W.P. No. 552 of 2011 dated 18-7-2011] The assessee individual had entered into development agreement with a developer on 17-9-2004. The agreed consideration was Rs.4 crore. As the developer failed to pay the amount of Rs.30 lakh before 31-10-2004, the assessee petitioner on 28-3-2005 terminated the development agreement. Thereafter, on the developer issuing the cheques for Rs.30 lakh on 30-6-2005, the development agreement was restored. In view of the further default on the part of the developer, on 19-5-2010, the petitioner once again terminated the development agreement. Thereupon, the developer filed a suit in the Bombay High Court, which was ultimately settled on 2-5-2011, wherein the consideration was enhanced from Rs.4 crore to Rs.7.5 crore. It was also ordered that the petitioner delivers the possession of the property to the developers as on the date of the order i.e., 2-5-2011.

In the meanwhile, the Assessing Officer issued notice u/s.148 dated 25-3-2010 proposing to tax the capital gain arising from the development agreement in the A.Y. 2005-06. The Bombay High Court allowed the writ petition filed by the petitioner-assessee and quashed the said notice u/s.148 and held as under:

“(i) It cannot be said that there was any reason to believe that income chargeable to tax has escaped assessment in the A.Y. 2005-06, so as to initiate reassessment proceedings u/s. 147 r.w.s 148 of the Act.

(ii) So long as the consent terms filed on 2-5-2011 hold the field, the question of bringing to tax the capital gains under the development agreement dated 17-9-2004 in A.Y. 2005-06 does not arise at all.

(iii) In the result, the impugned notice dated 25-3-2010 issued u/s.148 of the Act is quashed and set aside.”

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Appeal to the High Court — Delay in filing the appeal — High Court to examine the cases on merits and should not dispose of cases merely on the ground of delay.

[CIT v. West Bengal Infrastructure Development Finance Corporation Ltd., (2011) 334 ITR 269 (SC)] Looking to the amount of tax involved in the case, the Supreme Court was of the view that the High Court ought to have decided the matter on the merits. According to the Supreme Court, in all such cases where there is delay on the part of the Department, the High Court should consider imposing costs, but certainly it should examine the cases on the merits and should not dispose of cases merely on the ground of delay, particularly when huge stakes are involved.

Accordingly, the order of the High Court was set aside and the matter was remitted to the High Court to decide the case de novo in accordance with law.

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Natural Justice — Order passed in violation of principles of natural justice should not be quashed, but the matter should be remanded to grant an opportunity of hearing.

[ITO v. M. Pirai Choodi, (2011) 334 ITR 262 (SC)] The assessee had preferred a writ appeal against the order of the learned Single Judge dated 21st February, 2007, made in writ petition No. 3247 of 2007, where the learned Judge refused to quash the assessment order dated 29th December, 2006, for the A.Y. 2004-05 made u/s.143(3) of the Incometax Act, on the ground that the assessee had got an alternative remedy to prefer a statutory appeal before the Appellate Tribunal.

The Division Bench of the High Court observed that it is a general rule that it may not be proper to entertain the writ petition when effective alternative remedy by way of statutory appeal is available. But, the above general rule is subject to exceptions as laid by the Apex Court in Harbanslal Sahnia v. Indian Oil Corporation Ltd., (2003) 2 SCC 107, where the Apex Court has held that in spite of availability of the alternative remedy, the High Court may still exercise its writ jurisdiction in at least three contingencies: viz., (i) where the writ petition seeks enforcement of any of the fundamental rights; (ii) where there is failure of the principles of natural justice; or (iii) where the orders or proceedings are wholly without jurisdiction or the vires of an Act is challenged.

According to the High Court, the present case rightly attracted the second exception, viz., the failure of the principles of natural justice in the sense that the respondent-Department refused to admit the agricultural income of Rs.11,32,232.42 for the A.Y. 2004-05 of the assessee by placing reliance on the statement of the Village Administrative Officer, overlooking the materials furnished by the assessee to substantiate his agricultural activity, viz., (1) Chitta Adangal for the relevant periods, (2) Proof for purchase of agricultural inputs and sale of agricultural products, (3) Yearwise chart showing the expenses incurred for the agricultural activities, (4) Application of capital in the crops/herb, and (5) Books of account for business activities for the relevant period.

According to the assessee, in spite of the documentary evidence furnished to substantiate the agricultural income to the tune of Rs.11,32,232.42 for the A.Y. 2004-05, the respondent/assessing authority had chosen to overlook the same and refused to admit the said agricultural income for the A.Y. 2004-05, merely based on a statement alleged to have been obtained from the Village Administrative Officer behind the back of the assessee.

Admittedly, the assessee was not present when the statement of the Village Administrative Officer was obtained by the assessing authority. The High Court found some force in the contention of the assessee that such a statement obtained from the Village Administrative Officer behind the back of the assessee, depriving him of an opportunity to cross-examine the Village Administrative Officer, would amount to violation of the principles of natural justice and, therefore, would vitiate the assessment order.

Hence, the High Court was satisfied that there was a glaring violation of the principles of natural justice apparent on the face of the records, which fact was not properly appreciated by the learned Single Judge while dismissing the writ petition on the ground of alternative remedy. Accordingly, the High Court allowed the writ appeal and the order of the learned Single Judge was set aside. Consequently, the impugned assessment order was quashed.

On an appeal, the Supreme Court observed that in this case, the High Court had set aside the order of assessment on the ground that no opportunity to cross-examine was granted, as sought by the assessee. The Supreme Court was of the view that the High Court should not have set aside the entire assessment order. At the highest, the High Court should have directed the Assessing Officer to grant as opportunity to the assessee to cross-examine the concerned witness. The Supreme Court was of the view that even on this particular aspect, the assessee could have gone in appeal to the Commissioner of Income-tax (Appeals). The assessee had failed to avail of the statutory remedy. In the circumstances, the Supreme Court was of the view that the High Court should not have quashed the assessment proceedings vide the impugned order.

Consequently, the Supreme Court set aside the impugned order.

Liberty was however granted to the assessee to move the Commissioner of Income-tax (Appeals).

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Charitable purpose: Exemption u/s.10(23C) (iv) r.w.s 2(15) of Income-tax Act, 1961: A.Y. 2009-10 and onwards — Holding of classes and giving diploma/degrees by ICAI to its members is only an ancillary part of activities or functions performed by it and this, by itself, does not mean that ICAI is an educational institute:

[ICAI v. DGIT, (2011) 13 Taxman.com 175 (Del.)]

The assessee, the Institute of Chartered Accountants of India (ICAI), had filed an application in Form No. 56 for grant of exemption u/s.10(23C) (iv) of the Income-tax Act, 1961 for the A.Y. 2009- 10 onwards. It claimed that the institution was/ is established for charitable purpose as defined u/s.2(15); and that it was/is complying with all conditions/ pre-requisites and, therefore, was entitled to exemption u/s.10(23C)(iv). The application was rejected mainly on the following grounds. Firstly, the assessee-institute was holding coaching classes and, therefore, was not an educational institution as per the interpretation placed on the word ‘education’ used in section 2(15). Secondly, it was covered under the last limb of charitable purpose, i.e., advancement of any other object of general public utility and in view of the amendment made in section 2(15) with effect from 1-4-2009 for the A.Y. 2009-10 onwards, the assessee-institute was not entitled to exemption as it is an institution which conducts an activity in nature of business and also charges fee or consideration. It was earning huge profits in a systematic and organised manner and, therefore, it was not an institute existing for charitable purposes under the last limb of section 2(15). Thirdly, the assessee institute had advanced an interest-free loan to a sister concern, namely, ICAI Accounting Research Foundation and, thus, had violated the third proviso to section 10(23C) as the accumulated funds have not been invested in one or more specified funds/institutions stipulated in sub-section (5) to section 11.

The Delhi High Court allowed the writ petition filed by the assessee ICAI, set aside the order of rejection and remanded the matter back to the DGIT with directions. The High Court held as under:

“(i) A scrutiny of section 2(15) elucidates that charitable purpose for the purpose of the Act has been divided into six categories. The assessee-institute will fall under the sixth category, i.e., advancement of any other object of general public utility. The assesseeinstitute cannot be regarded as an educational institute as its main or predominant objective is to regulate the profession of and the conduct of Chartered Accountants enrolled with it. It is a statutory authority under the Chartered Accountants Act, 1949 (the ‘CA Act’) and its fundamental or dominant function is to exercise overall control and regulate the activities of the members/enrolled as chartered accountants.

(ii) No doubt, the assessee holds classes and provides coaching facilities for candidates/ articled and audit clerks who want to appear in the examinations and want to get enrolled as chartered accountants as well as for members of the assessee-institute who want to update their knowledge and develop and sharpen their professional skills, but this is not the sole or primary activity. The assessee-institute may hold classes and give diploma/degrees to the members of its institute in various subjects, but this activity is only an ancillary part of the activities or functions performed by the assessee-institute. This one or part activity, by itself, does not mean that the assessee is an educational institute or is predominantly or exclusively engaged in the activity of education. It is engaged in multifarious activities of diverse nature, but the primary and the dominant activity is to regulate the profession of chartered accountancy.

(iii) Section 2(15) defines the term ‘charitable purpose’. Therefore, while construing the term business for the said section, the object and purpose of the said section has to be kept in mind. A very broad and extended definition of the term ‘business’ is not intended for the purpose of interpreting and applying the first proviso to section 2(15) to include any transaction for a fee or money.

(iv) The real issue and question is whether the assessee-institute pursues the activity of business, trade or commerce. The DGIT, while dealing with the said question, has not applied his mind to the legal principles enunciated above and has taken a rather narrow and myopic view by holding that the assesseeinstitute is holding coaching classes; and that this amounts to business.

(v) The assessee-institute provides education and training in their post-qualification courses, corporate management, tax management and information system audit. It awards certificates to members of the institute who successfully complete the said courses. The conduct of these courses cannot be equated and categorised as mere coaching classes which are conducted by private institutes to prepare students to appear for entrance examination or for pre-admission or examinations being conducted by the universities, school-boards or other professional examinations. The courses of the institute, per se, it does appear, cannot be equated to a private coaching institute. There is a clear distinction between coaching classes conducted by private coaching institutions and the courses and examinations which are held by the assessee-institute. A private coaching institute has no statutory or regulatory duty to perform. It cannot award degrees or enrol members as chartered accountants. These activities undertaken by the assessee-institute satisfy the requirement of the term ‘education’.

(vi) The question, which remains unanswered in spite of the aforesaid finding that the assesseeinstitute also undertakes educational activity, is whether it is carrying on any business, trade or commerce. This question requires an answer but remains unanswered as it was not addressed and examined in the impugned order in proper perspective. The reasoning given in the order is with reference to the fee charged, expenditure and profit earned. The impugned order is cryptic and a myopic view has been taken without examining the legal principles.

(vii) In view of the aforesaid, the instant writ petition is allowed and a writ of certiorari is issued quashing the impugned order passed by the DGIT (Exemptions) with a direction to reconsider the application filed by the assessee-institute u/s.10(23C)(iv) in the light of the findings and observations made above. While setting aside the impugned order the DGIT is to be directed to examine the said aspect in the light of the observations and findings made above.”

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Charitable purpose: Exemption u/s.10(23C) (iv) r.w.s 2(15) of Income-tax Act, 1961: A.Y. 2005-06: CBDT approved ICAI for exemption u/s.10(23C)(iv) since A.Y. 1996-97: For A.Y. 2005-06 AO allowed exemption in assessment order u/s.143(3): DIT(E) passed order u/s.263 holding that the assessee is not entitled to exemption on the ground that coaching activity undertaken by ICAI amounted to business and no separate accounts are maintained: Order u/s.263 not sustainable.

[DIT (Exemption) v. ICAI, (2011) 14 Taxman.com 5 (Del.)]

The assessee-institute, Institute of Chartered Accountants of India (ICAI), is a statutory body established under the Chartered Accountants Act, 1949 (‘the 1949 Act’) for regulating the profession of Chartered Accountants in India. The CBDT, had approved the ICAI for exemption u/s.10(23C)(iv) of the Income-tax Act, 1961 since A.Y. 1996-97. For the A.Y. 2005-06, the Assessing Officer completed the assessment u/s.143(3) of the Act, granted exemption u/s.10(23C) (iv) of the Act and computed the total income at Rs.Nil. Subsequently, the DIT (Exemption) passed an order u/s.263 on two grounds, namely, coaching activity was undertaken by the institute and the said activity was ‘business’ and not a charitable activity. In those circumstances, the institute was required to maintain separate books of account and, thus, there was violation of section 11(4A). Secondly, it was held that the institute had incurred expenses on overseas activities including travelling, membership of foreign professional bodies, etc., without permission from the CBDT as required u/s.11(1)(c) and, thus, income of the institute was not entitled to exemption as a charitable institution. On appeal, the Tribunal held that the power u/s.263 was wrongly exercised and the DIT was not justified in giving the directions on the two grounds relied upon by him.

On appeal, the Revenue questioned the findings of the Tribunal on the first ground, i.e., in respect of coaching classes, whether the same amounted to business and whether separate books of account were required to be maintained by the institute.

The Delhi High Court upheld the decision of the Tribunal and held as under:

“(i) The Tribunal examined the provisions of the 1949 Act and the role assigned to and undertaken by the institute. It was held that the institute has been created to regulate the profession of chartered accountancy and for this purpose the institute can and is required to provide education, training and monitor professional skills of the members. It is also required to provide education and training to students/articled clerks who are appearing in the examinations and aspire to be enrolled as member of the institute.

(ii) The aforesaid findings as to the object, purpose and role of the institute cannot be disputed. The DIT has taken a very narrow and myopic view and has not examined the question of object and role of the institute in proper and correct perspective. The order passed by him is devoid of reasoning. This has resulted in the error made by the DIT, which has been corrected by the Tribunal.

(iii) The second question which arises for consideration is whether activities of the institute mentioned above including those of holding classes for students/articled clerks/ members and charging fee for classes and for providing literature/material can be regarded as a business activity. Again, the order passed by the DIT is devoid of any reasons and relevant consideration on the aspects like of what is meant and understood by the term ‘business’. He proceeded on an erroneous basis that mere holding of classes amounts to business and the same was outside the scope, ambit and object of the institute. The last aspect is not correct. The order passed by the DIT is bereft of reasons and does not meet the requirement of section 263.

(iv) In these circumstances, the order passed by the DIT u/s.263 cannot be sustained and was, therefore, rightly upset and set aside by the Tribunal.”

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Appeal to High Court: Scope and power: Limitation: Section 260A of Income-tax Act, 1961, r.w.s 14 of the Limitation Act, 1963: Finding given in an appeal, revision or reference arising out of an assessment must be a finding necessary for disposal of that particular case and must also be a direction which authority or Court is empowered to pass while deciding case before it: AO cannot apply section 14 of Limitation Act, to initiate time-barred reassessment proceedings.

[Dheeraj Construction and Industries Ltd. v. CIT, 13 Taxman.com 32 (Cal.)]

In this case, the main point involved in the appeal filed before the Calcutta High Court u/s.260A was whether the addition of certain amount based on alleged bogus purchase could be made in block assessment notwithstanding the fact that those findings were based on no material recovered from search and seizure. The Court held that the aforesaid findings were not based on any material unearthed on search and seizure and, thus, was not liable to be assessed on the block assessment under Chapter XIV-B, but should be subject to regular assessment. The assessee filed review application challenging the observation ‘but should be subject to regular assessment’.

The assessee contended that the Court should not have made such observation when such observation was beyond the scope of the subject-matter of the questions framed in the appeal. The assessee contended that the regular assessment proceedings u/ss.143/147/148 were already barred by limitation as contained in section 149(1) and, as such, the aforesaid observation should be deleted.

The Revenue opposed the application contending that there was no bar in proceeding afresh for regular assessment, if a direction to that effect was given by the Court while disposing of an appeal u/s.260A notwithstanding the fact that period of limitation for initiating fresh assessment had since expired; and that in such circumstances, the provisions of section 14 of the Limitation Act, 1963 would apply.

The Calcutta High Court held as under: “ (i) The question before the Court was whether those two transactions could form subjectmatter of block assessment when findings in support of those transactions were based on no material recovered from search and seizure and, thus, within the narrow scope of section 260A, there was no necessity of considering whether the transactions in question could be assessed under regular assessment. Aforesaid observation was not meant for giving direction upon the Assessing Officer because there was neither any scope of passing such direction for effective disposal of the dispute, nor could any such direction be passed while answering questions formulated by the Division Bench admitting the appeal.

(ii) The expressions ‘finding’ and ‘direction’ contained in section 153(3) are limited in meaning. A finding given in an appeal, revision or reference arising out of an assessment must be a finding necessary for the disposal of that particular case and must also be a direction which the authority or the Court is empowered to pass while deciding the case before it. Similarly, under the Act, there is no scope of applying the provisions of the Limitation Act as would appear from the fact that in section 260A itself, the power of condonation of delay in filing the appeal has been incorporated by the Legislature by introducing sub-section (2A) with effect from 1-4-2010 only and if the Limitation Act, on its own, had the application to such an appeal, there was no necessity of incorporation of such a provision in section 260A and that too with effect from 1-4-2010 and, consequently, the benefit of section 14 of the Limitation Act also cannot be availed of by the Assessing Officer, if under the Incometax Act, the regular assessment is barred and even the period of limitation for reopening the regular assessment had expired.

(iii) Sub-section (7) of section 260A merely provides that save as otherwise provided in the Act, the provisions of the Code of Civil Procedure, 1908, relating to appeals to the High Court shall, as far as may be, apply in the case of appeals under this section. Thus, such an appeal must be limited to substantial questions of law and not like an ordinary appeal u/s.96 of the Code.

(iv) Thus, there was no basis of the apprehension that by taking advantage of impugned observations, the Assessing Officer could reopen the regular assessment by taking aid of section 14 of the Limitation Act.

(v) Consequently, it was to be clarified that the Court never intended to direct the Assessing Officer to bring those transactions within regular assessment after the expiry of the period of limitation prescribed under the Income-tax Act by taking aid of section 14 of the Limitation Act which was not even applicable.”

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Advance tax: Interest u/s.234B: A.Y. 1991-92: Assessee claimed exemption u/s.47(v) on sale of capital assets to holding company owning 100% shares: Reduction in holding to 43% in subsequent year: Exemption withdrawn as per section 47A: Assessee not liable to interest u/s.234B.

[Prime Securities Ltd. v. ACIT, 243 CTR 229 (Bom.)]

In the return of income filed for the A.Y. 1991- 92, the assessee had claimed an exemption of Rs.2,04,99,060 u/s.47(v) of the Income-tax Act, 1961 being profit on sale of capital assets to the holding company which had owned 100% shares of the assessee-company. The Assessing Officer found that in the subsequent year the shareholding of the holding company was reduced from 100% to 43%. Therefore he withdrew the exemption in accordance with section 47A of the Act. The Assessing Officer also levied interest u/s.234B on this amount. The Tribunal upheld the levy of interest.

The assessee had challenged the levy of interest by filing a writ petition. The assessee also filed appeal against the order of the Tribunal. The Bombay High Court reversed the decision of the Tribunal and held as under:

“(i) The amount of advance tax is to be decided by the assessee after estimating his current income and then applying law in force for deciding the amount of tax. It is an admitted position in the present case that the date on which the appellant paid the advance tax it had estimated its income and liability for payment of advance tax in accordance with law that was in force. Therefore, it is obvious that there was no failure on the part of the appellant to pay advance tax in accordance with the provisions of sections 208 and 209.

(ii) For charging interest u/s.234B, committing a default in payment of advance tax is condition precedent. In the present case, it is nobody’s case that the appellant at the time of payment of advance tax has committed any default or that payment of advance tax by the appellant was not in accordance with law.

(iii) Insofar as the observations in the order of the Tribunal that the appellant should have anticipated the events that took place in March, 1992 are concerned, they have no substance. It is rightly submitted that it was not possible for the appellant to anticipate the events that were to take place in the next financial year and pay advance tax on the basis of those anticipated events.

(iv) The amount of interest recovered from the petitioner is directed to be refunded to the petitioner with interest as per law.”

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Interest u/s.234D: A.Ys. 1992-93 to 1998-99: No refund u/s.143(1): Interest u/s.234D not leviable.

[DIT v. M/s. Delta Airlines Inc. (Bom.), ITA No. 1318 of 2011, dated 5-9-2011.]

For the relevant years, the Assessing Officer passed assessment orders u/s.143(3) r.ws 147 of the Incometax Act, 1961 disallowing the benefit under Article 8 of the DTAA between India and USA. The CIT(A) allowed the assessee’s claim and that resulted into refund. The Tribunal set aside the orders of the CIT(A) and restored the orders of the Assessing Officer. While giving effect to the order of the ITAT, the Assessing Officer levied interest u/ss.234A and 234B and also u/s.234D. CIT(A) found that no refund was granted u/s.143(1) and therefore he held that section 234D was not attracted. The CIT(A) also found that section 234D was introduced w.e.f. 1-6-2003 and therefore he held that section 234D is not applicable to the relevant period. Accordingly he set aside the levy of interest u/s.234D of the Act. The Tribunal dismissed the appeal filed by the Revenue.

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

“(i) In the present case, admittedly refund was not granted to the assessee u/s.143(1) of the Act. In fact, the refund was not granted even under the assessment order u/s.143(3) r.w.s 147 of the Act, but the same was granted pursuant to the orders passed by the CIT(A). Therefore, the decision of the ITAT in holding that in the facts of the present case, section 234D is not applicable cannot be faulted.

(ii) We make it clear that we have upheld the order of the ITAT not on the ground that section 234D has no retrospective operation, but on the ground that section 234D has no application to the facts of the present case, because, in none of these cases, refunds were granted u/s.143(1) of the Act. The question as to whether section 234D applies retrospectively is kept open.”

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Income: Notional income: A.Y. 2003-04: Assessee in business of Asset Management of Mutual Funds: Charged investment advisory fees less than prescribed ceiling: Differential amount cannot be added as income.

[CIT v. M/s. Templeton Asset Management (India) (Bom.), ITA No. 1043 of 2010, dated 12-9-2011]

The assessee, a private limited company was engaged in the business of asset management of mutual funds. In the A.Y. 2003-04, the Assessing Officer found that the assessee had charged investment advisory fees less than the ceiling prescribed under Regulation 52 of the Securities and Exchange Board of India (Mutual Fund) Regulations, 1996. He added the differential amount to the income of the assessee. The Tribunal held that the SEBI Regulation 52 provides for the maximum limit towards the fees that could be charged by an Asset Management Company from the Mutual Funds and that if, due to business exigencies, the assessee collects lesser amount of fees than the ceiling prescribed, it is not open to the Assessing Officer to make addition on the notional basis.

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

“(i) It is not the case of the Revenue that the assessee has recovered investment advisory fees more than what is said to have been claimed by the assessee. Therefore, the fact that the SEBI Regulation provides for a maximum limit on the investment advisory fees that could be claimed, it cannot be said that the Asset Management Companies are liable to be assessed at the maximum limit prescribed under the SEBI Regulations, irrespective of the amount actually recovered.

(ii) In these circumstances, the decision of the ITAT in deleting the additions made by the Assessing Officer on notional basis cannot be faulted.”

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