Direct Taxes Archives

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………)

shailesh.kwebmaker

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

shailesh.kwebmaker

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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Advance tax: Interest u/ss.234B and 234C: A.Y. 2007-08: Search and seizure: Cash seized of Rs.18 lakh and Rs.1.98 crore deposited by assessee on 31-1-2007 could be adjusted against advance tax liability for computing interest u/ss.234B and 234C.

[CIT v. Shri Jyotindra B. Mody (Bom.), ITA No. 3741 of 2010, dated 21-9-2011] In the course of the search proceedings on 10th, 11th and 12th January, 2007 cash amounting to Rs.18 lakh was found and seized. The assessee offered an income of Rs.6,32,79,857 and paid an additional amount of Rs.1.98 crore on 31-1-2007. Thereafter, by a letter dated 14-3-2007, the assessee requested to adjust the said amounts of Rs.18 lakh and 1.98 crore towards the advance tax liability. The Assessing Officer accepted the offered income. However, while computing interest u/ss.234B and 234C, he did not take into account the said amounts of Rs.18 lakh and 1.98 crore paid by the assessee towards the advance tax liability. The CIT(A) allowed the assessee’s claim. 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) The basic argument of the Revenue is that u/s.132B(1)(i), the amount seized during the course of search can be dealt with for discharging the existing liability under the Acts set out therein. In the present case, the tax liability in relation to the assessment year in question would get crystallised only after the assessment is completed and therefore, the request of the assessee for adjustment of the amounts in question towards the advance tax liability could not be entertained.

(ii) We see no merit in the above contention, because once the assessee offers to tax the undisclosed income including the amount seized during the search, then the liability to pay advance tax in respect of that amount arises even before the completion of the assessment. Section 132B(1)(i) of the Act does not prohibit utilisation of the amount seized during the course of search towards the advance tax payable on the amount of undisclosed income declared during the course of search.

(iii) In the present case, the assessee, prior to the last date for payment of last instalment of advance tax, had in fact by a letter dated 14-3-2007 requested the Assessing Officer to adjust the amount towards the existing advance tax liability. Since advance tax liability is to be computed and paid in accordance with the provisions of the Act even before the completion of the assessment, no fault can be found with the decision of the ITAT in holding that in the facts of the present case, the amounts in question were liable to be adjusted towards the existing advance tax liability.”

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Strictures by a Judicial Forum — Need for Restraint

“The knowledge that another view is possible on the evidence adduced in a case acts as a sobering factor and leads to the use of temperate language in recording judicial conclusions. Judicial approach in such cases should always be based on the consciousness that one may make a mistake; that is why the use of unduly strong words in expressing conclusions or the adoption of unduly strong, intemperate or extravagant criticism, against the contrary view, which are often founded on a sense of infallibility should always be avoided.”

These are the observations of the Supreme Court in the case of Pandit Ishwari Prasad Misra v. Mohammad Isa, (1963) BLJR 226; AIR 1963 SC 1728, 1737(1).

The Patna High Court in CIT v. Shri Krishna Gyanoday Sugar Ltd., (1967) 65 ITR 449 referring to the ruling of the Apex Court, held that the use of strong language and the passing of strictures against the officers concerned of the Incometax Department were, to say the least, unwarranted and uncalled for and that it was not safe and advisable to make the remarks as made by the Tribunal in that case.

In my opinion, the conclusion of the Patna High Court is applicable while commenting on the conduct of the assessee as well. In the matter relating to penalty, the Delhi Bench of the ITAT in ACIT v. Khanna & Annadhanam, (2011) 13 Taxmann.com 94 (Delhi-Trib.) while conforming penalty u/s.271(1)(c) held:

“The assessee can harbour any number of doubts, however, the law postulates that the assessee should file a return which is correct, complete and truthful. The law of Income-tax prescribes allowability of various kinds of incomes and expenses and in respect of professional income mandate is clear. The need of proper verification clearly indicates that law wants the assessee to be very vigilant while making a claim and not to make a claim which is not in accordance with law. If the receipt is prima facie revenue in nature, there is no gainsaying that the assessee harboured doubt in respect of earning fruits of the tree though not from the same branch of the tree.”

Doubts can always result into a mistake and that therefore this needs to be tolerated with humility and calmness, rather than by severe criticism of the person who held any such doubt or commits mistake.

In this case the assessee, a firm of chartered accountants, was a partner of Deloitte Haskins & Sells (DHS) and had nominated partners in DHS and was a member of Deloitte Touche Tohmatu International (DTTI), a non-resident professional firm. The assessee rendered services to clients of DHS in India in the name of DHS. DTTI was keen that all the firms constituting DHS should merge into one firm. The merger would have resulted in losing national identity of the constituent firms. As this was not acceptable to the assessee, it was decided that DTII would ask the assessee to withdraw from the membership of DHS/DTII. The assessee received a compensation of Rs.1.15 crores on its withdrawal, which was treated as capital receipt by the assessee and was credited to partners’ accounts. This was disclosed in the computation and the balance sheet by way of a note.

The Tribunal held that if the assessee had continued as the member of DTII, the earning would have been professional receipt and the alternate receipt also takes the same analogy and has no trapping of having any doubt about its being a purely professional receipt or revenue receipt. The Bench went further on to pass the following strictures in this case against the assessee:

“The assessee is a firm of chartered accountants and it is not understandable that for such an issue about a clearly professional receipt, which is very basic in character, the assessee had any doubt about its nature. If it is so, we are unable to understand how the assessee can discharge its role as a professional consultant, auditing number of clients, giving them valuable advices on the accounting and taxation aspects. It is unimaginable that a professional firm like the assessee, will tend to have any doubt on such a simple proposition of professional receipt. There is no whisper in the agreement between DTTI and the assessee which creates any doubt at all. In our view, the issue never called for any doubt or ambiguity, the same has been created by the assessee and not by the law. The assessee has ventured into an adventure which was fraught with obvious risks which it has preferred to take. The assessee has pleaded that payment of advance tax does not amount to admission and the assessee is free to change its stand. In our view, advance tax payment may not be conclusive, but it is an indication to the mindset of the assessee. While construing strict civil liability, it becomes imperative to correlate the assessee’s various activities and explanations.”

In this case the assessee also held with it three legal opinions to defend its case, but their content did not yield any help, nor find discussion in the order for the reason that these were not presented to the assessing authorities either during the assessment or penalty proceedings.

The criticism against the assessee firm in this case is: “How the assessee can discharge its role as a professional consultant, auditing number of clients, giving them valuable advices on the accounting and taxation aspects can view a professional receipt as a capital receipt. It is unimaginable that a professional firm like the assessee will tend to have any doubt on such a simple proposition of professional receipts.”

Even though the assessee may be well versed on the subject, it gathered opinion of three independent experts out of which two headed the CBDT forum. The Bench countered the professional firm doubting its competencies even in areas that have nothing to do with the subject of taxation. With due respect, the thing that is of utmost concern here is whether it is appropriate for the Tribunal to demean a firm of professional chartered accountants of repute. It must be appreciated that the profession of law and accountancy are noble professions and it is only in keeping with this notion that the Benches are formed of judicial and accountant members who hold expertise in their respective discipline. In keeping with the observations of the Supreme Court, it is submitted with respect that perhaps it is desirable that the Honourable members of the Tribunal exercise restraint and avoid excessive criticism. This will only postulate and protect the rule of law as well as the dignity of the great forum of the Income Tax Appellate Tribunal.

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Rectification of mistake — Tribunal should have regard to all the facts — Capital or revenue expenditure — Business loss — Loss incurred due to fluctuation of foreign exchange rate — To be decided in the light of CIT v. Woodward Governor India P. Ltd.

[Perfetti Van Melle India (P) Ltd. v. CIT, (2011) 334 ITR 259 (SC)]

The assessment order for A.Y. 1998-99 was passed on 10th January, 2001, in which foreign exchange fluctuation loss amounting to Rs.38,30,000 was disallowed by the Assessing Officer.

The assessee filed an appeal before the Commissioner of Income-tax (Appeals) who upheld the disallowance on the ground that the exchange fluctuation related to long-term loan, and it could not be allowed as revenue expenditure.

Against the order of the Commissioner of Incometax (Appeals), the assessee filed an appeal before the Tribunal. The Tribunal vide order dated 22nd April, 2004, upheld the disallowance of loss of Rs.38,30,000.

Thereafter, the assessee filed an appeal before the High Court. While disposing of the appeal, it was observed by the High Court on 6th December, 2004, that:

“In view of paragraphs 13 and 14 of the Tribunal’s order, it is not possible for us to accept the contention that the assessee had produced books of account. It is for the Tribunal, which is a fact-finding authority, to examine the same and to record a finding. If the appellant had produced all the necessary documents in this behalf, then the Tribunal should have examined the same. In fact, in such a situation, instead of approaching this Court, the assessee ought to have moved the Tribunal u/s.254(2) of the Income-tax Act, 1961. It would be open to the appellant to move the Tribunal within 15 days from today. The appeal is disposed of accordingly.”

Thereafter, the assessee filed an application u/s. 254(2) of the Act, before the Tribunal and that application was dismissed by the Tribunal vide its order dated 15th June, 2005.

On an appeal, the High Court was of the view that ex facie, the appeal challenging two different orders passed by the Tribunal dated 22nd April, 2004, and 15th June, 2005, in one single appeal was not maintainable.

The High Court held that as far as the order dated 22nd April, 2004 was concerned, the same was challenged by the assessee by the way of appeal and vide order dated 6th December, 2004, that appeal had been disposed of by the High Court. The assessee could not reagitate the same issue again.

Coming to the order dated 15th June, 2005, passed by the Tribunal, the High Court noted that the Tribunal while dismissing the application for rectification, vide impugned order had held that:

“Our attention was invited to para 13 of the order in which the Tribunal has observed that it was for the assessee, which possesses exclusive knowledge as to the utilisation of the loan, to prove the same by leading evidence to that effect by producing the books of account and showing the entries made therein and that the assessee has not discharged this burden either before the Commissioner of Income-tax (Appeals) or before the Tribunal. It is stated that the Tribunal has noted in para 14 of the order that in A.Y. 1997-98 the assessee had filed some details and documents on the basis of which the Commissioner of Income-tax (Appeals) accepted the claim, but has gone further to record that for the year under appeal no such details were filed. The submission of the assessee before us is that the loss was allowed by the income-tax authorities in the A.Ys. 1996-97 and 1997-98 and a different treatment for the same is not warranted since the facts were the same for the year under appeal also. It is submitted that inasmuch as the Tribunal has overlooked this aspect of the matter, there is an error apparent from the record. It was alternatively submitted that the Tribunal should give a finding about the nature of the loss, whether it is capital or revenue. However, it was fairly admitted before us that this claim was not made before the income-tax authorities or before the Tribunal.”

The High Court observed that according to this order, it had been admitted before the Tribunal that the claim was not made before the incometax authorities or before the Tribunal. The Tribunal further held that:

“We have considered the matter. Given the findings of the Tribunal in paras 13 and 14 of its order, the present application cannot be accepted. It may perhaps be that the evidence produced in the earlier years was relevant for the purpose of deciding the merits of the assessee’s claim, but when the Departmental Authorities have held that for the year under appeal there was no evidence brought on record to show the utilisation of the loan, and where such a finding has been upheld by the Tribunal, the provisions of section 254(2) of the Act cannot be invoked. We do appreciate the assessee’s anxiety and it may even be open to the assessee to argue that the evidence adduced by the assessee for the earlier years would be sufficient to discharge the assessee’s burden for the year under appeal, but even if there is grievance on this score, it could not perhaps be redressed by resorting to section 254(2) of the Act. At best it may amount to an error of judgment or may even amount to the Tribunal insisting on the same evidence being formally placed on record for the year under appeal, which may appear to be ritualistic, but since the Tribunal has gone on the basis of the question of burden, it is not possible for us to accept the present application. We are also unable to give a finding as to the nature of loss, keeping in view the very fair admission that the question was not raised before the Tribunal or the income-tax authorities.”

According to the High Court, the appeal was wholly misconceived and without any basis and there was no reason to disagree with the findings given by the Tribunal and there was no infirmity in the impugned order passed by the Tribunal. The Supreme Court held that having examined the facts and circumstances of the case, which pertained to the A.Y. 1998-99, and particularly in the light of the order passed for the earlier A.Ys. 1996-97 and 1997-98, as also having regards to the assessment orders passed in the following year (1999-2000) and in view of its judgment in the case of CIT v. Woodward Governor India P. Ltd. reported in (2009) 315 ITR 254 (SC), the Tribunal was wrong in refusing to rectify its own order u/s. 254(2) of the Income-tax Act, 1961, particularly when it had failed to appreciate that in any event the expenditure could have fallen on the capital account, which was specifically pleaded by the assessee as an alternate submission.

For the aforestated reasons, the Supreme Court set aside the judgment of the High Court and the matter was remitted to the Tribunal. The Tribunal was directed to decide the matter de novo in accordance with the law laid down by the Supreme Court in the case of Woodward Governor India P. Ltd. (2009) 312 ITR 254 (SC) as well as on the merits of this case.

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Section 51 — Treatment of advance money received — Pursuant to a transaction of sale of property the assessee received advance money — Whether AO justified in reducing the advance money received from cost of acquisition of the property — Held, No.

Upendrakumar Shah v. ITO
ITAT ‘F’ Bench, Mumbai
Before D. Manmohan (VP) and T. R. Sood (AM)
11 ITA No. 1730/Mum./2009
A.Y.: 2004-05. Decided on: 30-8-2011 Counsel for assessee/revenue: Jayesh Dadia/ A. K. Nayar

Section 51 — Treatment of advance money received — Pursuant to a transaction of sale of property the assessee received advance money — Whether AO justified in reducing the advance money received from cost of acquisition of the property — Held, No.

Facts:

The assessee was the co-owner of an immovable property acquired prior to 31-3-1981. Both the coowners had agreed to sell the property by entering into agreement in November, 1994 for a total consideration of Rs.1.3 crore. The assessee and the co-owner received sales consideration in several instalments during the financial years 1998-99 to 2003-04 and the transfer of the property took place only in the year under consideration. The issue before the Tribunal was whether advance received in connection with the transfer of the property could be reduced from the cost of acquisition of the property. According to the AO as well as the CIT(A), as per the provisions of section 51, the advances received by the assessee should be deducted the from the value of the property as on 1-4-1981 while computing cost of acquisition.

Held:

The Tribunal noted that clause (iii) below the Explanation to section 48 does not provide for reduction of the advance amount from the cost of acquisition as against which, the clause (iv) below the said Explanation, which explains ‘indexed cost of improvement’, states that “the cost inflation index for the year in which the improvement to the asset took place” should be taken as the basis. Further, referring to the Apex Court decision in the case of Travancore Rubber & Tea Co. Ltd. (243 ITR 158), where it was held that advances received and forfeited by the assessee would be reduced from the 11 cost of acquisition u/s.51, the Tribunal held that the provisions of section 51 are applicable to an aborted transaction only. In the case of the assessee, the advances were received from a transaction which was not aborted. According to the Tribunal, the decision of the Bombay High Court in the case of Sterling Investment Corpn. Ltd. (123 ITR 441) also supports the case of the assessee. Accordingly, the appeal filed by the assessee was allowed on the point.

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Shree Cement Ltd. vs. Addl. CIT In the Income Tax Appellate Tribunal Jaipur Bench, Jaipur Before Hari Om Maratha (J.M.) and N.K. Saini (A.M.) ITA No. 503/JP/2012 Assessment year: 2007-08. Decided on 27th January, 2014 Counsel for Assessee/Revenue: D.B. Desai/A.K. Khandelwal

Section 80IA(8) – Where more than one market value/Arm’s Length Value is available and the assesse is entitled to adopt the market value of its choice. Section 2(24) – Receipt on account of Carbon credit is capital receipt not liable to tax.
(1) Re: Claim u/s. 80IA:

Facts:
The assessee claimed deduction u/s. 80IA in respect of its Power generation undertaking. Power generated by the power undertaking is predominantly used by the assessee captively at its cement unit. For computing the profitability of the power captively consumed, in terms of provisions of section 80IA(8), the assessee considered the market value or Arm’s Length Value being the value at which independent power supplier had sold power to Power Distribution Companies (DISCOMs) in the State of Rajasthan. While the AO applied the rate at which power is supplied by the State Electricity Grid to assessee’s cement unit and accordingly, re-computed the deduction eligible u/s. 80IA. The CIT(Appeals) upheld the action of the AO.

Before the tribunal, the revenue justified the orders of the lower authorities on the grounds amongst others, that:

• the assessee has adopted market price of its choice in computing the transfer price and such discretion cannot be allowed to the assessee;
• On the point of selection of price from the basket of market values, it submitted that there is no such provision in the act which gives assessee such prerogative.
• Since, the assessee itself is drawing power from the State grid on regular basis, Grid rate is the best market price available which should be adopted for computing deduction u/s. 80IA.

Held:
According to the tribunal, the issue before it is where there are two or more market values available and if the assessee has adopted a ‘value’ which is ‘market value’, whether it is permissible for the Revenue to still replace the same by another ‘market value’. The tribunal, on perusal of section 80IA(8) noted that the statute provides that the assessee must adopt ‘Market Value’ as the transfer price. In the open market, where a basket of ‘Market Values’ are available, the Act does not put any restriction on the assessee as to which ‘Market Value’ it has to adopt. It is purely assessee’s discretion. As long as the assessee has adopted a ‘Market Value’ as the transfer price, that is sufficient compliance of law. Even if assessee’s cement unit has purchased power, also from the Grid or that assessee’s Power Unit has also partly sold its power to grid or third parties that by itself, does not compel the assessee or permit the Revenue, to adopt only the ‘grid price’ or the price at which the Eligible Unit has partly sold its power to grid or third parties, as the ‘market value’ for captive consumption of power to compute the profits of the eligible unit. Any such attempt is clearly beyond the explicit provisions of section 80IA(8) of the Act. The above principles are also supported by the decision of Special Bench of Bangalore Tribunal in Aztec Software & Technology Services Ltd. vs. ACIT 107 ITD 141 as well as Mumbai Tribunal decision in the case of ACIT vs. Maersk Global Service Centre (I) Pvt. Ltd. 133 ITD 543. Since the assesse had adopted a rate at which actual transactions had been undertaken by the unrelated entities and the volumes of transaction as relied upon were also substantial, the appeal filed by the assesse on this ground was allowed.

Re: Receipt from Carbon Credit is capital receipt or revenue receipt:

Facts:
The assessee’s project ‘Optimum Utilisation of Clinker’ had generated CER or Carbon Credit by reducing emissions from clinkerisation and from power generation. The said project generated CERs against which the assessee received Rs. 16,02 crore which has been claimed as ‘capital receipt’. In the assessment order, the Assessing Officer held that cost of acquisition of Carbon Credit is NIL & the entire receipt is taxable as capital gain. However, in the computation, it has been added as Business income. The CIT (Appeals) on appeal held that the receipt was in the nature of benefit arising from the business of the assessee and is taxable as ‘Business Income’ u/s. 28(iv) of the Act.

Before the tribunal the revenue submitted that the receipt on account of carbon credit was related to the business of the assessee and the assessee had undertaken activities which had resulted in the receipt on account of carbon credits. Hence, the amount so received had to be considered as related to the business of the assessee and should either be considered as revenue receipts chargeable to tax as business income, or the net amount after deduction of expenditure if any, incurred for the same should be considered as chargeable to tax under the head capital gains.

Held:
The tribunal relied on the decisions of the Hyderabad Tribunal in the case of My Home Power Ltd. vs. DCIT 151 TTJ 616 (Hyd), the Chennai Tribunal in the cases of Sri Velayudhaswamy Spinning Mills (P.) Ltd. vs. DCIT 40 taxmann.com 141 and Ambika Cotton Mills Ltd. vs. DCIT I.T.A. No. 1836/Mds/2012 and held that receipt on account of Carbon Credit is capital in nature and neither chargeable to tax under the head Business Income nor liable to tax under the head Capital Gains. In its above view, the tribunal also drew support from the decision of the Supreme Court in the case of Vodafone International Holdings vs. UOI 341 ITR 1 wherein the Supreme Court held that treatment of any particular item in different manner in the 1961 Act and DTC serves as an important guide in determining the taxability of said item. Since DTC by virtue of the deeming provisions specifically provides for taxability of carbon credit as business receipt and Income Tax Act does not do so, the tribunal held in favour of the assessee and the addition made by the AO was deleted.

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(2014) 98 DTR 281 (Hyd) Fibars Infratech (P) Ltd. vs. ITO A.Y.: 2007-08 Dated: 03-01-2014

Section 2(47)(v): Under the development agreement, since no construction activity had taken place on the land in the relevant previous year, it cannot be said that the transferee has performed or was willing to perform its obligation under the agreement in the relevant year and, therefore, provisions of section 2(47)(v) did not apply.

Facts:
During the F.Y. 2006-07, the assessee company transferred certain property for development to M/s MAK Projects (P) Ltd. The development agreement was executed on 15th December, 2006. As per the development agreement, the assessee was entitled to receive 16 villas comprising 9,602 sq. yards of plotted area along with 58,606 sq. ft. of built up area.

However, there was no development activity until the end of the previous year ending 31st March, 2007. Commencement of building process had not been initiated as the building approval was provided only on 6th March, 2007. The Assessing Officer alleged that the transaction under development agreement was a transfer u/s. 2(47)(v) as on the date of entering into the agreement.

Though possession of the property was handed over to the developer, the assessee contended that since there is no amount of investment by the developer in the construction activity during the F.Y. 2006-07, it would amount to non-incurring of required cost of acquisition by the developer. Hence, no consideration can be attributed to the F.Y. 2006-07. As there is no quantification of consideration to be received by the assessee, section 2(47)(v) would not apply.

Held:
The handing over of the possession of the property is only one of the conditions u/s. 53A of the Transfer of Property Act, but it is not the sole and isolated condition. It is necessary to go into whether or not the transferee was ‘willing to perform’ its obligation under these consent terms. When transferee, by its conduct and by its deeds, demonstrates that it is unwilling to perform its obligations under the agreement in this assessment year, the date of agreement ceases to be relevant. In such a situation, it is only the actual performance of transferee’s obligations which can give rise to the situation envisaged in section 53A of the Transfer of Property Act.

In the given case, nothing is brought on record by the authorities to show that there was development activity in the project during the assessment year under consideration and cost of instruction was incurred by the developer. Hence, it is to be inferred that there was no amount of investment by the developer in the construction activity during the assessment year in this project and it would amount to non-incurring of required cost of acquisition by the developer. The developer in this assessment year had not shown its readiness in making preparations for the compliance of the agreement. On these facts, it is not possible to hold that the transferee was willing to perform its obligations in the financial year in which the capital gains are sought to be taxed by the Revenue. This condition laid down u/s. 53A of the Transfer of Property Act was not satisfied in this assessment year. Consequently, section 2(47) (v) did not apply.

Further, it cannot be said that there is any sale in terms of section 2(47)(i). To say that there is an exchange u/s. 2(47)(i) both the properties which are subject matter of the exchange in the transaction are to be in existence at the time of entering into the transaction. It is to be noted that at the time of entering into development agreement, only the property i.e., land pertaining to the assessee is in existence. There is no quantification of consideration or other property in exchange of which the assessee has to get for handing over the assessee’s property for development.

It cannot be said that the assessee carried on the adventure in the nature of trade so as to bring the income under the head ‘Income from business’. This is so, because the assessee has not sold any undivided share in the property to the developer in the year under consideration. The assessee remains to be the owner of the said property and the land was put for development for the mutual benefit. Even if the transaction is considered as business transaction, it would be taxed only when the undivided share in the land is transferred.

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(2013) 96 DTR 220 (Del) ACIT vs. Meenakshi Khanna A.Y.: 2008-09 Dated: 14-06-2013

Section 56(2)(vi): Lump sum alimony received by a divorcee as a consideration for relinquishing all her past and future claims is not chargeable u/s 56(2) (vi).

Facts:
During A.Y. 2008-09, the assessee received lump sum alimony from her ex-husband. The divorce agreement between the assessee and her exhusband was made in the F.Y. 1989-90. Pursuant to this agreement, the ex-husband of the assessee was required to make monthly payments to his wife over a period of time. However the ex-husband did not pay the same and hence the assessee threatened to take legal action against him. The exhusband, therefore, paid a lump sum amount as full and final settlement in lieu of assessee’s past and future claims. The Assessing Officer held that exhusband was not covered under the definition of relative as provided in exceptions to section 56(2) (vi). He, therefore, treated the amount received by the assessee as income from other sources taxable under the provisions of section 56(2)(vi) and added the same to the income of the assessee. The assessee however contended that she had received the amount against consideration of extinguishing her right of living with her husband. It was further argued that the amount was a capital receipt.

Held:
Though the assessee was to receive monthly alimony which was to be taxable in each year from conclusion of divorce agreement, but the monthly payments were not received and, therefore, were not offered to tax. The receipt by the assessee represents accumulated monthly installments of alimony, which has been received by the assessee as a consideration for relinquishing all her past and future claims. Therefore, there was sufficient consideration in getting this amount. Therefore, section 56(2)(vi) is not applicable. Secondly, amount was paid by way of alimony only because they were husband and wife and the assessee was spouse of the person who has paid the amount and, therefore, payment received from spouse did fall within the definition of relative. Moreover even if it is accepted that the monthly payments of alimony are liable to tax then also in the present case the amount received represents past monthly payments and hence cannot be taxed in the year under consideration. Therefore, it was held that amount received was a capital receipt and not liable to tax.

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Legislation by incorporation — Schedule VI vis-à-vis MAT

Schedule VI to the Companies Act, 1956 (‘the Companies Act’) prescribed under section 211 of the Companies Act, sets out the form and contents for disclosure of the profit and loss account and balance sheet of a company. Schedule VI to the Companies Act originally notified by the Central Government vide Notification No. 414, dated 21st March 1961 was divided into 4 parts (referred to as ‘the Old Schedule VI’). Recently, the Central Government has by Notification No. 447(E), dated 28th February 2011, and Notification No. 653(E), dated 30th March 2011, revised Schedule VI to the Companies Act, which shall come into effect for the financial years ending on or after 1st April 2011 (referred to as ‘the Revised Schedule VI’).

Section 115JB of the Income-tax Act, 1961 (‘the Act’) requires every assessee-company to prepare its profit and loss account in accordance with Part II and Part III of the Schedule VI for the purpose of determining net profit, for the computation of ‘book profit’. In other words, Part II and Part III of the Schedule VI are legislatively incorporated under the provisions of section 115JB of the Act.

Legislation by incorporation is a legislative device by which certain provisions of a particular Act are incorporated by reference into another Act, such that the provisions so incorporated become part and parcel of the later Act, as if they had been ‘bodily transposed into it’. In other words, the legal effect of such incorporated provisions are often held to be actually written in the later Act with the pen, or printed in it. The said observations were made by Lord Esher, M. R. while explaining the aforesaid principle in one of the earliest decisions on the subject1.

However, the aforesaid incorporated provisions in MAT, only prescribe the contents of the profit and loss account of the company and the principles for recognition, measurement, presentation, etc. of financial items are prescribed under the Accounting Standards as applied by the company in adopting the accounts at its annual general meeting.

A question which requires attention is whether the Revised Schedule VI as amended by the Central Government can be said to be legislatively incorporated under the provisions of section 115JB of the Act and accordingly net profit for the purpose of computation of book profit will be determined based on the format of profit and loss account as prescribed under the Revised Schedule VI.

The answer to this question depends upon the manner of construction and interpretation of whether Part II and Part III of the Old Schedule VI are introduced in MAT provision of the Act merely as reference/citation or have been incorporated under section 115JB. Legislation by incorporation may be undertaken by either merely citing a provision of one statute in another statute or by incorporating the said provision in another statute.

Therefore, before embarking upon answering the question under consideration, it is necessary to understand the principles of identifying the differences between the two and implications on the construction of a provision of a particular statute, which is merely referred to in another statute vis-à-vis being incorporated. In the former case, a modification, repeal or re-enactment of the statute that is referred will also have the effect in the statute in which it is referred, but in the latter case any change in the incorporated statute by way of amendment or repeal shall have no repercussion on the incorporating statute. The legal decisions have time and again tried to differentiate between the two, but the distinction is one of difference in degree and is often blurred2. There are no clear-cut guidelines which have been spelt out.

However, there are four exceptions which have been observed by the Courts3 to the implications on the construction of a provision as discussed above, wherein a repeal or amendment of an Act which incorporated in a later Act shall have effect on the later Act, irrespective of whether the said provision was merely referred or incorporated in the other statute. These exceptions are as under:

where the later Act and the earlier Act are supplemental to each other;

where the two Acts are in pari materia;

where the amendment of the earlier Act if not imported in the later Act would render the later Act wholly unworkable; and

where the amendment of the earlier Act either expressly or by necessary intendment also applies to the later Act.

On the touchstone of the aforesaid exceptions applied to the case under consideration, one may observe as under:

the Income-tax Act, 1961 and the Companies Act, 1956 are not supplemental to each other i.e., existence of either of the said Acts is not dependant of each other;

? the two Acts are not in pari materia i.e., both the Acts legislate in two different fields of law;

? the non-incorporation of the Revised Schedule VI under MAT provisions would not make the said provisions unworkable, since one would be able to compute net profit based on the Old Schedule VI; and

there is no mention by the Central Government of simultaneous amendment of MAT provisions, when Schedule VI was replaced under the Companies Act.

Considering this, one may observe that none of the four exceptions are applicable to the impugned issue.

Though it makes a case stronger to tilt the balance of construction that Part II and Part III of the Old Schedule VI are incorporated and not referred under MAT provisions, yet one may not conclude such construction without further discussion. It is necessary to understand the factors which may help in answering the aforesaid question. A matter of probe into the semantics of the provision along with the legislative intention and/ or taking an insight into the working of the enactment may help in determining which of the view is to be adopted. Part II and Part III of the Old Schedule VI are incorporated in all its phases from section 115J to section 115JB of the Act.

Reference is invited to the relevant provisions of section 115JB of the Act, which are reproduced below for ready reference:

“ ……………….. (2) Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956):

Provided that while preparing the annual accounts including profit and loss account, —

(i) the accounting policies;

(ii) the accounting standards followed for preparing such accounts including profit and loss account;

(iii) the method and rates adopted for calculating the depreciation,

shall be the same as have been adopted for the purpose of preparing such accounts including profit and loss account and laid before the company at its annual general meeting in accordance with the provisions of section 210 of the Companies Act, 1956 (1 of 1956):” (Emphasis supplied)

From the perusal of the aforesaid provisions of section 115JB(2), one would notice that the Legislature by applying the principle of legislation by incorporation introduced two provisions of the Companies Act, 1956. The differences in the language used for incorporating the said provisions highlight the mechanism of merely citing a provision vis-à-vis incorporating the provision.

The accounting policies, accounting standards and the method and rate of depreciation as considered while preparing the annual accounts of the company u/s.210 of the Companies Act are legislatively incorporated by reference for the purpose of calculation of book profit u/s.115JB of the Act and whereas Part II and Part III of the Old Schedule VI to the Companies Act are legislatively incorporated under the mechanism of incorporation.

The distinction lies in the usage of words ‘shall be the same’, which makes a case of a provision merely referred and not being incorporated. The usage of those words highlight the intention of the Legislature of applying the same policies, standards and depreciation rate and method under the Companies Act as used for preparation of annual accounts, also for the purpose of computation of book profit. Therefore, in case there are amendments to, repeals of provisions of Accounting Standards and method and rate of depreciation under the provisions of the Companies Act, the same effects will have to be considered for the computation of book profit.

One finds that similar usage of words, being ‘shall be the same’ is missing under the incorporation of Part II and Part III of Schedule VI to the Companies Act. Therefore, such similar construction and mechanism may not hold good for the purpose of interpretation of Part II and Part III of the Schedule VI to the Companies Act, which have been incorporated and not merely referred under the provisions of section 115JB(2) of the Act.

In a recent decision of the Supreme Court in the case of M/s. Dynamic Orthopedics Pvt. Ltd. v. CIT, (321 ITR 300), the Apex Court while referring the matter relating to the computation of book profit under MAT provisions to the Larger Bench, made following observations with respect to the semantics of MAT provisions under the Act. These observations on legislation by incorporation which may hold good for all the three avatars of MAT provisions viz. section 115J, section 115JA, and section 115JB are reproduced below:

“….Section 115J of the Act legislatively only incorporates provisions of Parts II and III of Schedule VI to 1956 Act. Such incorporation is by a deeming fiction. Hence, we need to read section 115J(1A) of the Act in the strict sense. If we so read, it is clear that by legislative incorporation, only Parts II and III of Schedule VI to 1956 Act have been incorporated legislatively into section 115J of the Act. Therefore, the question of applicability of Parts II and III of Schedule VI to 1956 Act does not arise….

…. It needs to be reiterated that once a company falls within the ambit of it being a MAT company, section 115J of the Act applies and, under that section, such an assessee-company was required to prepare its profit and loss account only in terms of Parts II and III of Schedule VI to 1956 Act ….. Hence, what is incorporated in section 115J is only Schedule VI and not section 205 or section 350 or section 355 ….. ” [Emphasis supplied]

The aforesaid decision reiterates the understanding that Part II and Part III of Schedule VI only are legislatively incorporated under the provisions of MAT. Therefore, any repeal, amendment or revision of Part II and Part III of Schedule VI to the Companies Act may not have effect on the operation of computation of book profit, until the Revised Schedule is incorporated under the MAT provisions of the Act.

Based on the aforesaid discussions, one may conclude that the Revised Schedule VI to the Companies Act cannot be taken into consideration, until necessary amendments are made requiring the assessee companies to determine the net profit for the purpose of computation of book profit under MAT provisions as per the Revised Schedule VI to the Companies Act.

This conclusion and article may be incomplete if the significant in-principle differences between the Old Schedule VI and the Revised Schedule VI are not highlighted. These differences are touched upon only in brief:

The Revised Schedule only contains Part I and Part II. It does not have Part III of the Old Schedule VI which provided for interpretation of the various expressions such as ‘provision’, ‘reserve’, ‘liability’, etc. and Part IV of the Old Schedule VI which dealt with balance sheet abstract and company’s general business profile.

The Revised Schedule VI prescribes the format of profit and loss account for the company, as against the Old Schedule VI, which did not provide for such format; and

The Old Schedule VI prescribed the principles on which the profit and loss account of the company was required to be prepared for the purpose of disclosure, which one fails to find under the Revised Schedule VI;

This issue is of importance from the perspective of the Direct Tax Code Bill, 2010 (draft) (‘DTC’) which in Clause 104 has provision analogous to section 115JB of the Act. Clause 104 of DTC provides reference to Clause 105 of DTC for the purpose of determination of net profit as shown in the profit and loss account prepared in accordance with Part II and Part III of Schedule VI to the Companies Act. Assuming Clause 104 and Clause 105 of draft DTC come into effect in their present form, one may interpret that Part II and Part III of the Revised Schedule VI are incorporated in the said clauses, considering the fact that the Revised Schedule VI to the Companies Act will be existing on the statute when draft DTC becomes an Act. However, it may be intriguing to notice that the Revised Schedule VI does not have Part III and therefore, the Legislature may have to make necessary amendments; otherwise the formula may become unworkable. Similar consequences may also be envisaged for companies subjected to MAT provisions for financial years ending on or after 1st April 2011, if we propose that Part II and Part III of the Old Schedule VI are merely referred to in section 115JB of the Act. This subject may require further attention with the intention of the Government to introduce different set of Accounting Standards (i.e., Ind-AS and otherwise) applicable to different categories of companies and thereby leading to different tax bases of net profit as shown in the profit and loss account prepared in accordance with Part II and Part III of the Schedule VI to the Companies Act.

If the above discussion and conclusions are drawn to their logical end, then one envisages that companies subjected to MAT provisions of the Act may have to prepare two sets of their profit and loss account, wherein net profit as shown in the profit and loss account will have to be prepared in accordance with:

Part II and Part III of the Revised Schedule VI for the compliance of provision of Companies Act, 1956; and

Part II and Part III of the Old Schedule VI for the computation of book profit under the Act.

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Taxation of Capital Gains under Direct Taxes Code

1. Background

1.1 Direct Taxes Code Bill, 2010, (DTC) introduced in the Parliament on 27-8-2010 is now under consideration of the Standing Committee for Finance. After its report is submitted, the Parliament will consider the Bill and the proposals of the Standing Committee before enacting the Code. Therefore, if DTC is enacted by the Parliament in 2011, the income for the F.Y. 1-4-2012 to 31-3-2013 and onwards will be assessed as provided in the Code. There are 319 sections divided into 20 Chapters and 22 Schedules in DTC. Chapter III-D containing sections 46 to 55 deals with provisions for computation of income under the head ‘Capital Gains’. Further, Schedule 17 provides for determination of cost of acquisition in certain cases.

1.2 Prior to introduction of the DTC Bill, 2010, the Government had issued the DTC Bill, 2009 with a Discussion Paper for public debate on 12-8-2009. The DTC Bill, 2009, proposed to introduce several changes in the provisions relating to capital gains. There was a proposal to do away the present distinction between short-term and long-term capital gains. It was also proposed to abolish the present exemption/concession available to capital gains on sale of listed securities on which STT is paid. The concessional rate for long-term/short-term capital gains was also proposed to be abolished and there was a proposal to levy tax on capital gains at the normal rate applicable to other income.

1.3 Several representations were made to the Government objecting to these proposals. Based on the above representations, a Revised Discussion Paper was issued by the Government on 15-6-2010 and the revised DTC Bill, 2010, was introduced in the Parliament in August, 2010.

1.4 In the revised Discussion Paper of June, 2010, it was clarified that the original proposals of DTC – 2009 for taxation of capital gains have been modified as under:

(a) Income from capital gains will not be considered as income from ordinary sources.

(b) Asset held for more than one year from the end of the financial year will be considered as long-term capital asset.

(d) For long-term capital gains indexation benefit will continue. The existing date of 1-4-1981 will now be fixed as 1-4-2000.

(e) Capital Gains Savings Scheme will be introduced.

(f) A new scheme for taxation of capital gains on investment assets has been proposed to reduce the burden of tax.

(g) Income of FIIs from share trading will be considered as capital gains and not business income.

2. Concept of capital gains

The existing concept of capital gains is significantly changed in the Code. The word ‘asset’ is defined in section 314(24) to mean (a) a business asset or (b) an investment asset. ‘Business asset’ is defined in section 314(38) to mean ‘business trading asset’ or ‘business capital asset’. ‘Business trading asset’ is defined in section 314(42) to mean stock-in-trade, consumable stores or raw materials held for the purpose of the business. ‘Business capital asset’ is defined in section 314(39) to mean a tangible, intangible or any other capital asset, other than land, which is used for the purpose of business. ‘Investment asset’ is defined in section 314(141) to mean (a) any capital asset which is not a business capital asset, (b) any security held by a FII or (c) any undertaking or division of a business. Any surplus on transfer of a business capital asset is to be treated as business income. Hence, the provisions for computation of capital gains apply in respect of surplus (loss) on transfer of ‘investment asset’ only.

3. Computation of capital gains

3.1 Section 49 of the Code provides that the computation of capital gains on transfer of an investment asset shall be made by deducting from the full value of the consideration on transfer of such asset, the cost of acquisition of such asset. The gains (losses) arising from the transfer of investment assets will be treated as capital gains (losses). The net gain will be included in the total income of the financial year in which the investment asset is transferred, irrespective of the year in which the consideration is actually received. However, in the case of compulsory acquisition of an asset, capital gains will be taxed in the year in which the compensation is actually received.

3.2 It may be noted that the word ‘Transfer’ is defined in section 314(267). This definition is very elaborate as compared to section 2(47) of the Income-tax Act (ITA). The above definition provides that ‘Transfer’ in relation to a ‘Capital Asset’ includes the following:

(i) Sale, exchange or extinguishment of any asset or any rights in it;

(ii) Compulsory acquisition under any law;

(iii) Conversion of capital asset into stock-intrade;

(iv) Buyback of shares u/s.77A of the Companies Act;

(v) Contribution of any asset towards capital in a company or unincorporated body;

(vi) Distribution of assets on liquidation of a company or dissolution of unincorporated body;

(vii) Any transaction allowing possession or enjoyment of an immovable property. This provision is more or less similar to section 2(47) (v) and (vi) of ITA with the only difference that if enjoyment of any immovable property is given to participant of unincorporated body it will be considered as a transfer under DTC;

(viii) Amount received/receivable on maturity of Zero Coupon Bond, on slump sale or on damage/ destruction of any insured asset;

(ix) Transfer of securities by a person having beneficial interest in the securities held by a depository as registered owner;

(x) Distribution of money or asset to a participant in an unincorporated body on his retirement;

(xi) Any disposition, settlement, trust, covenant, agreement or arrangement.

3.3 The capital gains arising from the transfer of personal effects and agricultural land is exempt from income tax. The term ‘personal effects’ is defined in section 314(190) and the term ‘agricultural land’ is defined in section 314(12). This definition states that the land, wherever situated, if used for agricultural purposes will be treated as agricultural land.

3.4 In general, the capital gains will be equal to the full consideration from the transfer of the investment asset minus the cost of acquisition, cost of improvement thereof and transfer-related incidental expenses. However, in the case of an investment asset which is transferred anytime after one year from the end of the financial year in which it is acquired, the cost of acquisition and cost of improvement will be adjusted on the basis of cost inflation index.

3.5 Capital gains from all investment assets will be aggregated to arrive at the total amount of current income from capital gains. This will, then, be aggregated with unabsorbed capital loss at the end of the preceding financial year to arrive at the total amount of income under the head ‘Capital gains’. If the result of the aggregation is a loss, the total amount of capital gains will be treated as ‘nil’ and the loss will be treated as unabsorbed current capital loss at the end of the financial year. This unabsorbed loss will be carried forward for adjustment against capital gains in subsequent years. There is no time limit for such carry forward and set-off of losses.

4. Exemption from capital gains tax
4.1 Section 47 of the Code provides that certain transfers of investment assets will not be consid-ered as a transfer and no capital gains tax will be payable. This section is on the same lines as existing section 47 of ITA. However, it is significant to note that clause (xiii) of existing section 47 of ITA which provides for exemption from tax when a partnership firm is converted into a company, subject to certain conditions, is absent in section 47 of the Code. This will mean that if the Code is enacted without this clause in section 47, a partnership firm which is converted into company after 1-4-2012 will not be entitled to claim this exemption. It may also be noted that section 47 (1)(J) of the Code provides for exemption from tax when a non-listed company converts itself into an LLP, on the same lines as provided in section 47 (xiii b) of ITA. Again, 47(1)(n) of the Code provides for exemption from tax when a sole proprietary concern is converted into a limited company. This provision is similar to section 47(xiv) of ITA.

4.2 Section 46 of the Code provides that the exemption granted u/s.47 of the Code in respect of certain transfers of investment assets and u/s.55 of the Code in respect of certain rollover of investment assets will become taxable in the F.Y. in which the conditions specified in section 47 or 55 are violated. This provision is on the same lines as in the existing sections 47A, 54, 54B, 54F, 54EC, etc. of ITA.

4.3 Section 48 of the Code explains about the F.Y. in which the income arising on non-compliance with the conditions laid down in section 47 will become taxable. This section also explains about the F.Y. in which enhanced additional compensation received on compulsory acquisition of property will be taxable. Further, the section also explains as to when an immovable property will be considered to have been transferred. These provisions are similar to sections 45(1), 45(4), 45(5) and 46 of ITA with some modifications.

4.4 It is significant to note that the existing sec-tion 45(4) of ITA provides that if any capital asset is transferred by way of distribution of capital as-sets to any partner or partners on dissolution of a firm or AoP or otherwise, the difference between the market value of the asset and its cost will be taxable as capital gains in the hands of the Firm or AoP. This position will continue under the Code in view of item 6(ii) of the table below section 48(1) r.w.s 50(2)(d) of the Code. However, in the case of retirement of a partner, the Courts have held that the word ‘otherwise’ in the existing section 45(4) applies when a partner retires from the Firm or AoP and takes away any asset of the Firm or AoP as part of the amount due on retirement. Now, section 48(2)(b) of the Code, read with item 7 of the table below section 48(1) and section 50(2) (f), provides that “Any money or asset received by a participant (Partner/Member) on account of his retirement from an unincorporated body (Firm, LLP, AoP, BoI) shall be deemed to be the income of the recipient of the F.Y. in which the money or asset is received”. This will mean that if the amount due to the retiring partner as per the books of the Firm, AoP or BoI is Rs.1.5 crore but the amount received and market value of the asset received on his retirement is Rs.2.5 crore, the retiring partner will have to pay tax on capital gains under the Code.

4.5 Under section 51(2) of the Code, in the case of equity shares of a company and units of equity-oriented fund of a M.F., held for more than one year, the capital gain will be exempt from tax if STT is paid. It may be noted that there is difference in the wording of section 51(2) and 51(3). U/s.51(2) the requirement is holding of shares, etc. for more than one year, whereas u/s.51(3) the period for holding other assets is at least one year after the end of the F.Y. in which the asset is acquired.

4.6 In the above case if the STT is paid and the shares/units are held for less than one year, 50% of the capital gain will be exempt and tax at normal rate will be payable on the balance of 50%.

4.7 It may be noted that under item No. 32 of Schedule 6 it is provided that the capital gain arising from transfer of the following assets will not be liable to tax under DTC:

(i) Agricultural land in a rural area as defined in section 314(221)r.w.s 314 (284). This definition is similar to the definition in section 2(14)(iii) of ITA.

(ii) Personal effects as defined in section 314 (190) which is similar to section 2(14)(ii) of ITA.

(iii) Gold Deposit Bonds.

5. Full value of consideration
5.1 The provisions relating to computation of capital gains on transfer of an investment asset and determination of the full value of the consideration are contained in sections 49 and 50 of the Code. These provisions are similar to the provisions of sections 45(2), 45(3), 45(5), 48 and 50C of ITA with certain modifications. In the case of sale of land or building, section 50(2)(h) of the Code provides that stamp duty value of the asset will be considered as full value of the consideration. The term ‘Stamp duty value’ is defined in section 314(246) on the same lines as in section 50C of ITA with the exception that there is no provision for refer-ence to valuation officer in the event such value is disputed by the assessee. Further, section 50(2) r.w.s 314(267) and 314(93) of the Code provides that in respect of conversion of investment asset into stock-in-trade, distribution of assets to partici-pants on dissolution of the unincorporated body or retirement of a participant, etc. the fair market value of the asset on the date of transfer will be determined according to the method prescribed by the CBDT.

5.2 It may be noted that u/s.45(3) of the ITA it is provided that when the partner/member of a firm, LLP, AoP or BoI in which he becomes a partner/ member and contributes a capital asset as his capital contribution in the entity, the amount credited to this account in the entity will be considered as full value of the consideration and capital gain tax will be payable by him on this basis. This benefit is not available at present when a person becomes a shareholder in a company and he is allotted shares in the company against any transfer of any asset to the company. Now, section 50(2)(c) of the Code provides that the amount recorded in the books of the company or an unincorporated body as value of the investment asset contributed by the shareholder or participant will be the full value of the consideration and the capital gain will be computed in the hands of the transferor on that basis.

6. Cost of acquisition and indexation
6.1 As stated earlier, section 49 of the Code provides that capital gain on transfer of an investment asset is to be computed by deducting from the full value of the consideration, the cost of acquisition and the cost of improvement. The term ‘Cost of acquisition’ is defined in section 53 read with the 17th Schedule. The term ‘Cost of improvement’ is defined in section 54. These provisions are more or less on the same lines as sections 48, 49 and 55 of ITA. It may, however, be noted that when the investment asset is received by way of gift, will, inheritance, etc., it is provided that the cost will be the cost of acquisition in the hands of previous owner. However, the period during which the previous owner held the asset cannot be added in computing the total period for which the assessee has held the asset, as there is no provision for this purpose corresponding to the provision in section 2(42A) of ITA. Existing section 55(3) of ITA provides that if the cost of the asset in the hands of the previous owner cannot be ascertained, the market value on the date on which the previous owner acquired the asset will be considered as his cost. Now, section 53(7)(c) of the Code provides that if the cost of investment asset in the hands of the previous owner cannot be determined or ascer-tained, the said cost will be taken as ‘nil’. Similarly, in the case of the assessee if a self-generated asset or any other investment asset is acquired and the cost of such asset cannot be determined or ascertained for any reason, it shall be considered as ‘nil’.

6.2 Section 52 of the Code gives mode of computation of indexation of certain investment assets in specified cases. The method prescribed in this section is similar to the provision in the existing section 48 of ITA. However, some modification in the scheme under the Code is made as under:

(i) Under section 2(29A)r.w.s 2(42 A) of ITA, a capital asset which is held for more than three years is considered as a ‘long-term asset’. U/s.51(3) of the Code, it is provided that if the investment asset is held for more than one year from the end of the financial year in which the asset is acquired, the benefit of indexation of cost will be available.

In other words, if the investment asset is acquired on 1-5-2010, it will be considered as long-term capital asset if it is sold on or after 1-4-2012 under the Code. In the following discussions such investment asset is referred to as a ‘long-term asset’.

(ii) In the case of any investment asset, if it is a long-term asset as explained in (i) above, the assessee will be entitled to deduct indexed cost of the asset as provided in section 52 of the Code from the full value of the consideration for computation of capital gain. The method for working out indexed cost is the same as in section 48 of ITA. However, the base date for determining the indexed cost will be 1-4-2000 under DTC instead of 1-4-1981 provided in ITA.

(iii) At present, section 55(2)(b) of ITA provides that if a capital asset is acquired before 1-4-1981, the assessee has an option to substitute the fair market value of the asset as on 1-4-1981 for its cost.

Now, section 53(1)(b) of the Code provides that if the investment asset is acquired before 1-4-2000, the assessee will have the option to substitute fair market value on 1-4-2000 for its cost.

7. Relief on reinvestment of consideration
Section 55 of the Code provides for relief for roll-over of long-term investment asset in the case of an Individual or HUF. This provision is similar to the existing provisions for relief on reinvestment of capital gains in sections 54, 54B and 54F of ITA with the following modifications:

(i) At present, the exemption is available if ‘capital gain’ on sale of a capital asset is reinvested in the specified assets u/s.54, 54B or 54EC of ITA. In case of section 54F of ITA, the ‘Net consideration’ on sale is required to be reinvested. Now, u/s.55 of the Code, the benefit of exemption is available on reinvestment of ‘Net consideration’ in all the cases.

(ii) The rollover relief is available for only two categories of long-term assets viz. (a) agricultural land, and (b) any other investment asset.

(iii) In the case of agricultural land there is no distinction between rural and urban land. The only condition is that it is assessed to land revenue or local cess and used for agricultural purposes. Further, this land should be an agricultural land during two years prior to the F.Y. in which it is transferred and was acquired by the assessee at least one year before the beginning of the F.Y. in which it is transferred. If these conditions are satisfied and the assessee invests the net consideration on sale of such agricultural land for the purchase of one or more pieces of agricultural land within a period of three years from the end of the F.Y. in which the original agricultural land was sold, he will get exemption in proportion to the amount so invested.

(iv) In the case of any other long-term investment asset, the above rollover benefit will be available, if the net consideration is invested in the purchase or construction of a residential house within a period of three years from the end of the F.Y. in which the original asset was sold. For getting this benefit there are two conditions as under:

(a) The assessee should not be the owner of more than one residential house (other than the residential house in which such investment is made) on the date of sale of original asset.

(b) The residential house in which the above investment is made to get rollover benefit should not be transferred within one year from the end of the F.Y. in which such investment is made.

It is also provided in section 55 of the Code, that the above rollover benefit will be available if the investment in the new asset is made within a period of one year before the sale of the original asset.

(vi) It is also provided in the above section that the net consideration on sale of the original asset should be reinvested for acquiring the new asset, as stated above, before the end of the F.Y. in which the original asset is sold or within six months from the date of such sale, whichever is later. If this is not done, the net consideration or balance thereof should be deposited with Capital Gains Deposit Scheme to be framed by the Government. The amount so deposited should be used within three years from the end of the F.Y. in which the original asset is sold. If it is not so used, the same will be taxable in F.Y. in which the period of three years expires.

(vii)   From the above, it will be evident that the present concession of investing the capital gain on sale of residential house for purchase of another residential house even if the assessee is owner of more than one residential house u/s.54 of the ITA will not be available. Further, the benefit of investment in approved bonds up to Rs.50 lakh u/s.54EC of ITA will also not be available.

8.   Income of FII
As stated earlier, definition of investment asset u/s.314(141) of the Code includes any shares or securities held by a Foreign Institutional Investor (FII). In view of this, FII engaged in trading of shares or securities in India will not be entitled to claim exemption under the applicable DTAA on the ground that it is carrying on business in India and has no permanent establishment in India. Under the Code, the surplus from these transactions will be considered as income from capital gains.

9.   Slump sale
The definition of investment asset also includes any undertaking or division of a business. Section 53(5) provides that if there is any slump sale of any undertaking or division of a business, the cost of acquisition of such asset will be the ‘net worth’ of such undertaking or division. If such undertaking or division is sold after the end of one year from the end of the financial year in which it was acquired or established, the benefit of indexation u/s.51 and 52 of the Code will be available. Net worth of such undertaking or division will be worked out as may be prescribed by the CBDT u/s.314(166). The term ‘Slump sale’ is defined in section 314(234) on the same lines as section 2(42C) of ITA.

10.   Aggregation of capital gains and losses
10.1 Income from capital gains (short-term or long-term) from various investment assets, whether positive or negative, shall be first aggregated and any carried forward loss under this head from earlier years shall be deducted therefrom. If the net result is loss, it shall be carried forward to next year. There is no time limit for such carry forward of losses. If the net result is positive, it shall be aggregated with income under other heads. It may be noted that there is a departure from the provisions of ITA where income from long-term capital gains is taxed at a separate lower specified rate. Under DTC long- term or short-term capital gains is taxable at the normal rate applicable to other income.

10.2 It may be noted that there is no provision for adjustment of short-term or long-term capital losses carried forward from F.Y. 2011-12 (A.Y. 2012-13) and earlier years against capital gains for F.Y. 2012-13 and subsequent years under DTC.

11. Treatment of losses in certain specified cases

11.1   Section 64 and 65 of DTC provide for treatment of losses in specified cases as under:

(i)   On conversion of unlisted company into LLP — It may be noted that as stated earlier, u/s.47(1) (J) exemption from capital gain is given in the case of conversion of an unlisted company into a LLP. There are certain conditions for this purpose which are similar to section 47(xiii b) of ITA. Section 64(1) provides that unabsorbed current loss from ordinary sources in the case of an unlisted company shall be available for set-off in the case of LLP against its current aggregate income from ordinary sources of subsequent years. Similarly, unabsorbed current capital loss of the company shall be set off against current capital gains in the case of LLP in the subsequent years. This section is similar to section 72A(6A) of ITA. If the conditions laid down in section in section 47(1)(J) of DTC are not complied with, the set-0ff of loss so allowed in any F.Y. can be withdrawn by rectification of the assessment order.

(ii)   On Business Reorganisation — It may be noted that as stated earlier, u/s.47(1)(n) exemption from capital gain is given in the case of conversion of sole proprietary concern into a limited company. There are certain conditions for this purpose which are similar to section 47(xiv) of ITA. U/s.64(2) it is provided that unabsorbed current loss from ordinary sources in the case of sole proprietor shall be set off against current income from ordinary sources of the company. Similarly, unabsorbed current capital loss in the case of sole proprietor will be set off against current capital gain in the subsequent year in the case of the company. If the conditions laid down in section 47 (1)(n) of DTC are not complied with, the set-off of loss so allowed in any F.Y. can be withdrawn by rectification of assessment order.

11.2 Treatment of unabsorbed losses on change in Constitution

(i) Changes in constitution of unincorporated body — Section 65 provides that in the case of change in the constitution of an unincorporated body (i.e., Firm, LLP, AoP or BoI) on account of death/retirement of a participant, the unabsorbed loss of that entity (including capital loss) shall be reduced in proportion of the loss attributable to the deceased/retiring participant and allowed to be carried forward and set off in the subsequent years as under:

(a) Proportionate unabsorbed loss from ordinary sources shall be carried forward and set off against current income from ordinary sources in the subsequent years.

(b) Proportionate unabsorbed capital loss shall be carried forward and set off against current capital gain in the subsequent year.

This section is similar to section 78 of ITA with the difference that section 78 of ITA applies to a Firm or LLP, whereas section 65 of DTC applies to a Firm, LLP, AoP or BoI.

(ii) Changes in shareholding of closely-held companies — Section 66 of DTC is similar to section 79 of ITA. It provides that in the case of a closely-held company, if the persons holding not less than 51% of voting power on the last day of the F.Y. when the loss under the ordinary sources or capital gains was incurred, are not holding this voting power on the last day of the F.Y. when the income from such sources is earned, such unabsorbed loss cannot be the set-off against the income from such sources in that F.Y. The only difference between section 79 of ITA and section 66 of DTC is that section 79 does not apply to set off of unabsorbed depreciation, whereas u/s.66 of DTC loss includes depreciation.

12. Filing return of loss
Section 67 provides that if the return of tax bases showing loss is not filed before the due date for filing the return, the loss under the head ordinary sources, special sources, capital gains, speculation, horse races activities, etc. shall not be allowed to be carried forward or set off in the subsequent years. This section is similar to section 80 of ITA. Here also it may be noted that section 80 does not refer to unabsorbed depreciation, but u/s.67 loss will include depreciation also.

13. Some issues
From the above discussion about provisions relating to taxation of capital gains proposed to be introduced in DTC w.e.f. 1-4-2012, it is evident that the existing provisions will stand substantially modified. Some of the following issues require consideration.

(i) The word ‘Asset’ is defined to mean (a) a business asset or (b) an investment asset. Again, a business asset is further classified as business trading asset and business capital asset. So far as business trading asset is concerned, it will be allowed as revenue expenditure in computing business income. As regards business capital asset, only depreciation will be allowed. Thus, only investment asset will form part of the computation of capital gains.

(ii) The existing distinction between long-term and short-term capital asset is now proposed to be modified. It an investment asset is held for more than one year after the end of the F.Y. in which it is acquired, it will be considered as a long-term capital asset.

(iii) The existing concept of determination of indexed cost for computing long-term capital gain has been retained. The base date for this purpose will be 1-4-2000, instead of 1-4-1981.

(iv) The existing provision for granting exemption in respect of long-term capital gain on sale of securities, where STT is paid, will continue. As regards short-term capital gain in such transactions, only 50% of such capital gain will be taxable at normal rate. Therefore, the effective tax rate shall not exceed 15%.

(v) If net result under the head capital gain (long-term or short-term) is positive, it will be added to income under other heads and tax will be payable at normal rate of tax applicable to the total income. If the net result is capital loss, the same will be carried forward without any time limit. There is no concessional rate for taxation of long-term capital gain as provided in section 112 of ITA.

(vi) There is, however, no provision in DTC for adjustment of short-term or long-term capital losses carried forward under ITA from F.Y. 2011-12 (A.Y. 2012-13) and earlier years against capital gains for F.Y. 2012-13 and subsequent years.

(vii) Existing section 47(xiii) of ITA provides that conversion of a partnership firm into limited company does not attract any capital gains tax if certain conditions are complied with. There is no corresponding provision in DTC. Similarly, there is no provision in DTC for such exemption when a partnership firm is converted into an LLP.

(viii) As discussed in para 5.1 above, there is no provision in DTC for reference to valuation officer if the assessee objects to the stamp duty valuation in respect of sale of immovable property. Therefore, stamp duty valuation will now become mandatory.

(ix) As discussed in para 7(vii) above, there is no provision in DTC similar to section 54EC of ITA to enable an assessee to deposit up to Rs.50 lakh, out of long-term capital gains in notified Bonds. Thus, assessees selling small value investment assets will not be able to claim exemption from long-term capital gains tax to this extent.

Let us hope that some of the above anoma-lies are removed before DTC is enacted by the Parliament.

shailesh.kwebmaker

Business expenditure: Section 37(1) While on business tour, the whole-time director of assessee-company was kidnapped by a dacoit: Ransom money paid to dacoit for releasing the director is allowable business expenditure.

[CIT v. Khemchand Motilal Jain, Tobacco Products (P) Ltd., 13 Taxman.com 27 (MP)]

The assessee-company was engaged in manufacturing and sale of bidis. ‘S’ was a whole-time director of the assessee-company and was looking after the purchase, sales and manufacturing of bidis. During his business tour to Sagar for purchase of tendu leaves, ‘S’ was kidnapped by a dacoit for ransom. The assessee lodged complaint with the police and awaited the action of the police, but the police was unsuccessful to recover ‘S’ from the clutches of dacoit. Ultimately after 20 days, the assessee paid certain amount by way of ransom for release of ‘S’ and got him released. The assessee claimed deduction of that amount as business expenditure. The Assessing Officer disallowed the claim of the assessee on the ground that the ransom money paid to the kidnappers was not an expenditure incidental to business. The CIT(A) and the Tribunal allowed the assessee’s claim for deduction.

On appeal by the Revenue, the Revenue contended that the amount of ransom could not have been claimed by way of expenditure as the Explanation to s.s(1) of section 37 prohibits such expenditure.

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

“(i) Section 364A of the Indian Penal Code, 1860, provides that kidnapping a person for ransom is an offence and any person doing so or compelling to pay is liable for the punishment as provided in the section, but nowhere it is provided that to save a life of the person if a ransom is paid, it will amount to an offence. There is no provision that payment of ransom is prohibited by any law. In the absence of it, the Explanation to s.s(1) of section 37 will not be applicable in the instant case.

(ii) In the instant case, ‘S’ was on business tour and was staying at a Government rest-house, from where he was kidnapped. As he was on business tour, to get him released, if the aforesaid amount was paid to the dacoits as ransom money and because of this, he was released, the assessee claimed it a business expenditure.

(iii) The entire tour of ‘S’ was for purchase of tendu leaves of quality and for this purpose, he was on business tour and during his business tour, he was kidnapped and for his release the aforesaid amount was paid.

(iv) In these circumstances, the reasoning of the Commissioner (Appeals) and the Tribunal allowing the aforesaid expenditure as business expenditure is to be confirmed.”

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Appeals by Revenue: Small tax effect: CBDT circular dated 15-5-2008 providing that notional tax effect could be taken in loss cases is prospective: Applicable to appeals filed on or after 15-5-2008.

[CIT v. Continental Construction Ltd., 336 ITR 394 (Del.)]

The CBDT Circular dated 15-5-2008, provided that the Circular is applicable to the appeals filed on or after 15-5-2008. The Circular also clarified the terms ‘tax effect’ to include the notional tax effect in loss cases. It is the case of the Department that the Circular is clarificatory and therefore, in loss cases the notional tax effect has to be considered even in respect of appeals filed prior to 15-5-2008.

The Delhi High Court held that the notional tax effect in loss cases does not apply to appeals filed prior to 15-5-2008.

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Representative assessee: Section 163: Liability of representative assessee is limited to connected income: No liability for assessment of unconnected income.

[General Electric Co. v. DDIT (Del.), WP No. 9100 of 2007, dated 12-8-2011]

Genpact India is an Indian company. The whole of the share capital of Genpact India was held by a Mauritius company. The whole of the share capital of the Mauritius company was in turn held by General Electric Co., USA. The Assessing Officer found that the shares of Genpact India were transferred outside India. He held that the transaction of transfer of shares of Genpact India has resulted in capital gains to General Electric, USA. Therefore, he issued a notice u/s.163 of the Income-tax Act, 1961 proposing to treat Genpact India as an agent of General Electric and to assess the capital gain in its hands as a representative assessee. General Electric Co. filed writ petition challenging the notice.

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

“(i) The mere fact that a person is an agent or is to be treated as an agent u/s.163 and is assessable as ‘representative assessee’ does not automatically mean that he is liable to pay taxes on behalf of the non-resident.

(ii) U/s.161, a representative assessee is liable only ‘as regards the income in respect of which he is a representative assessee’. This means that there must be some connection or concern between the representative assessee and the income.

(iii) On facts, even assuming that Genpact India was the ‘agent’ and so ‘representative assessee’ of General Electric, there was no connection between Genpact India and the capital gains alleged to have arisen to General Electric. Genpact India is sought to be taxed as representative assessee when it had no role in the transfer of shares. Merely because these shares relate to Genpact India that would not make Genpact India as agent qua deemed capital gain purportedly earned by General Electric Co.

(iv) Consequently, the section 163 proceedings seeking to assess Genpact India for the capital gains of General Electric were without jurisdiction.”

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Shipping business of non-residents: Section 172 of Income-tax Act, 1961: A.Y. 1987-88: Tug towing ship which could not sail by itself: No carriage of goods: Section 172 not applicable.

[CIT v. Oceanic Shipping Service of M. T. Suhail, 334 ITR 132 (Guj.)] A merchant vessel came to an Indian port for discharging cargo. While at the Indian port it developed engine trouble and hence it had to be towed away. It entered into an agreement with the assessee, a non-resident for towing away the ship. The agreement was made outside India and payment was also made outside India. The assessee received US $ 1,00,000 as towing charges. The Assessing Officer held that the towing charges was assessable u/s.172 of the Income-tax Act, 1961. The Tribunal held that section 172 was not applicable. On appeal by the Revenue, the Gujarat High Court upheld the decision of the Tribunal and held as under: “(i) Section 172 requires in the first instance that a ship should belong to or be chartered by a non-resident; secondly, the ship should carry passengers, livestock, mail or goods; and thirdly, such cargo of passengers, etc., should be shipped at a port in India. (ii) The provision stipulates a ship which carries passengers, livestock, mail or goods. Therefore, the term ‘goods’ has to take colour from the preceding words/terms and one cannot visualise either passengers or livestock or mail being towed away and they have to be carried by a ship aboard a ship. Thus, goods also have to be carried by ship aboard a ship. (iii) The term ‘goods’ as used in the provision has to be understood in ordinary commercial parlance and usage, i.e., as articles or things which can be bought and sold. A vessel which due to mechanical fault that it has developed, cannot propel itself on its own, does not become ‘goods’ for the purpose of being carried by a ship for the purpose of trade. Therefore, it cannot be stated that a tug, though a vessel/ship for a limited purpose, carries goods when it pulls a ship by way of tow. (iv) The Tribunal was right in law in holding that the provisions of section 172 were not applicable and hence tax was not leviable u/s. 172(2) in respect of US $ 1,00,000 received by the assessee for towing away the merchant vessel.”

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TDS: Disallowance of business expenditure: Sections 40(a)(ia) and 194C of Income-tax Act, 1961: A.Y. 2006-07: Assessee-firm engaged in transportation business, secured contracts with oil companies for carriage of LPG, executed the contracts through its partners retaining 3% commission as charges: Sections 194C and 40(a)(ia) not applicable.

[CIT v. Grewal Bros., 240 CTR 325 (P&H)]

The assessee, a partnership firm, was engaged in the business of transport. It entered into contracts with oil companies for carriage of LPG. From the payment made to it, the companies deducted tax. The assessee firm passed on the transportation work to its partners and made the payment received from the said companies to its partners after deducting 3% commission as charges for the firm having secured the contract. The Assessing Officer held that in giving the contract of transportation by the firm to the partners there was a sub-contract and the firm was liable to deduct TDS [u/s.194C(2)] out of the payment made to the partners. Since the tax was not deducted at source on payments made to the partners, the Assessing Officer disallowed the amounts paid by the firm to the partners resulting in addition to the income. The CIT(A) and the Tribunal accepted the assessee’s plea and deleted the addition.

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

“(i) No doubt the firm and the partners may be separate entities for income-tax and it may be permissible for a firm to give a contract to its partners and deduct tax from the payment made as per section 194C, it has to be determined in the facts and circumstances of each case whether there was any separate sub-contract or the firm merely acted as agent as pleaded in the present case.

(ii) The case of the assessee is that it was the partners who were executing transportation contract by using their trucks and payment from the companies was routed through the firm as agent. The CIT(A) and the Tribunal accepted this plea on facts.

(iii) Once this plea was upheld, it cannot be held that there was a separate contract between the firm and the partners in which case the firm was required to deduct tax from the payment made to its partners u/s.194C.

(iv) The view taken by the Tribunal is consistent with the view taken by the Himachal Pradesh High Court in CIT v. Ambuja Darla Kashlog Mangu Transport Co-operative Society, 227 CTR 299 (HP) and the judgment of this Court in CIT v. United Rice Land Ltd., 217 CTR 332 (P&H).

(v) The matter being covered by earlier judgment of this Court, no substantial question of law arises.”

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Search and seizure: Interest u/s.132B(4) of Income-tax Act, 1961: Period for which interest is payable on seized amount: Search assessment resulting in no additional tax liability: Interest payable up to the date of refund and not up to the date of the assessment order.

[Mohit Singh v. ACIT, 241 CTR 244 (Delhi)]

In the course of search u/s.132 of the Income-tax Act, 1961 on 11-9-2003, an amount of Rs.17 lakhs was seized. Block assessment order for the block period 1998-99 to 2003-04 was passed on 23-3-2006 which resulted in no additional tax liability. The seized amount of Rs.17 lakhs was paid on 15-4-2008. Thereafter on 16-5-2008, interest amount of Rs.1,91,704 was paid covering the period from 7-5-2004 to 23- 3-2006. No interest was paid for the period from 23-3-2006 to 15-4-2008 i.e. date of refund.

On a writ petition filed by the assessee the Delhi High Court directed the Revenue to pay the interest at the rate of 7.5% for the period from 23-4-2006 to 15-4-2008 i.e., the date of the refund.

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Loss return: Carry forward of unabsorbed depreciation: Section 32(2), section 80 and section 139(3) of Income-tax Act, 1961: A.Ys. 2000-01 and 2001-02: Section 80 and section 139(3) apply to business loss and not to unabsorbed depreciation covered by section 32(2): Period of limitation for filing loss return not applicable.

[CIT v. Govind Nagar Sugar Ltd., 334 ITR 13 (Del.)]

For the A.Y. 2001-02, the assessee filed loss return belatedly on 31-3-2003. The AO computed the loss at Rs.6,03,14,560, but did not allow the assessee to carry forward the loss including the depreciation by relying on the provisions of sections 80 and 139(3) of the Income-tax Act, 1961. The Tribunal allowed the carry forward of the depreciation of the relevant year and also of the A.Y. 2000-01.

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

“(i) Sections 80 and 139(3) of the Act apply to business losses and not to unabsorbed depreciation which was exclusively governed by section 32(2) of the Act. That being so, the period of limitation for filing loss return as provided u/s.139(1) would not be applicable for carrying forward of unabsorbed depreciation and investment allowance.

(ii) U/s.32(2), unabsorbed depreciation of a year becomes part of depreciation of subsequent year by legal fiction and when it becomes part of the current years depreciation it was liable to be set off against any other income, irrespective of whether the earlier years return was filed in time or not.”

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Capital gain: Exemption u/s.54E of Incometax Act, 1961: A.Y. 2007-08: Long-term capital gain on transfer of depreciable asset: Investment of net consideration in Capital Gains Deposit Account Scheme: Assessee entitled to exemption u/s.54F.

[CIT v. Rajiv Shukla, 334 ITR 138 (Del.)]

In the A.Y. 2007-08, the assessee had long-term capital gain on transter of depreciable assets. The assessee invested the net capital gain in the Capital Gains Deposit Account Scheme and calimed exemption u/s.54F of the Income-tax Act, 1961. The AO disallowed the claim on the ground that the capital gain arising from transfer of a depreciable asset shall be deemed to be capital gain arising from transfer of a short-term capital asset. 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 under: “The income earned by the assessee on sale of depreciable asset was to be treated as long-term capital gain, entitling him to the benefit of section 54F.”

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Business expenditure: Deduction only on actual payment: Section 43B of Income-tax Act, 1961: A.Y. 1989-90: Excise duty paid in advance: Assessee entitled to deduction: AO not right in holding that deduction allowable only on removal of goods from factory.

[CIT v. Modipon Ltd., 334 ITR 106 (Del.)]

For A.Y. 1989-90, the assessee had claimed a deduction of Rs.14,71,387 as business expenditure on account of excise duty paid in advance. Reliance was placed on section 43B of the Income-tax Act, 1961. The Assessing Officer disallowed the claim holding that the deduction can be claimed only on removal of goods from the factory. 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 under:

“(i) With regard to the deduction of Rs.14,71,387 on account of excise duty paid in advance as business expenditure, the procedure envisaged for payment of excise duty envisages such duty to be deposited in advance with the treasury before the goods were removed from the factory premises. The duty, thus, already stood deposited in the accounts of the assessee maintained with the treasury and the amount, thus stood paid to the State.

(ii) The submission of the Department that it was only on removal of goods that the amount credited to the personal ledger account could be claimed as deductible u/s.43B of the Act, could not be accepted.”

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Appeal to Commissioner: Tax recovery by auction sale of property: Income-tax Act, 1961 Sch. II, RR. 63, 65 and 86: TRO confirming sale in recovery proceedings: Order confirming sale is not conclusive: Appeal is maintainable: Period of limitation runs from the date of knowledge of the order.

[Vijay Kumar Ruia v. CIT, 334 ITR 38 (All.)]

A property belonging to one I was sold by auction on 22-3-1988 by the TRO for recovery of tax dues. The auction was confirmed by the TRO by order dated 25- 4-1988 and certificate of sale was issued in favour of the auction purchaser on the same day. The executor of the will of I preferred an appeal before the Commissioner purporting to be u/r. 86 of Schedule II to the Income-tax Act, 1961. The appeal was dismissed as not maintainable and being barred by time.

The Allahabad High Court allowed the writ petition challenging the order of the Commissioner and held as under:

“(i) An appeal u/r. 86 lies against the original order of the TRO, provided such an order was not conclusive in nature. The relief claimed in the appeal was to cancel and set aside the sale of property. Rule 63 did not contemplate the order of confirmation of sale to be conclusive order. The appeal was maintainable.

(ii) The intention was to challenge the order of sale confirmation and the order issuing the sale certificate. What was intended to be challenged was the sale of the immovable property also and not only the sale certificate. Mere mentioning of a wrong provision in appeal would not take away the statutory right of the petitioner, if the appeal was otherwise provided under the statute and was maintainable.

(iii) The limitation for filing appeal u/r. 86(2) was 30 days from the date of the order. The petitioner acquired the knowledge of the auction sale, the order of sale confirmation and issuance of sale certificate for the first time on 18-8-1988. The appeal was filed on 19-9-1988, within limitation from the date of knowledge.

(iv) If the party aggrieved was not made aware of the order it could not be expected to take recourse to the remedy available against it. Therefore, the fundamental principle was that the party whose rights were affected by an order must have the knowledge of the order. Thus, the appeal was within limitation both from the date of knowledge of the order and its service.”

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Press Release — Central Board of Direct Taxes — No. 402/92/2006 (MC) (17 of 2011) dated 26-7-2011

Press Release — Central Board of Direct Taxes — No. 402/92/2006 (MC) (17 of 2011)
dated 26-7-2011.

The Double Tax Avoidance Agreement is signed between India and Lithuania on 26th July, 2011.

CBDT Instructions No. 8, dated 11-8-2011 regarding streamlining of the process of filing appeals to ITAT.

Copy of the Instructions available on www.bcasonline.org

Annual detailed Circular on Deduction of tax from salaries during the Financial Year 2011-12 — Circular No. 5 of 2011

[F.No.275/192/2011-IT(B)], dated 16-8-2011. Copy available for download on www.bcasonline.org

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Sudhir Thackersey Charitable Trust v. DIT ITAT ‘H’ Bench, Mumbai Before Pramod Kumar (AM) and R. S. Padvekar (JM) ITA No. 5031/Mum./2010 Decided on: 26-8-2011 Counsel for assessee/revenue: A. H. Dalal/ V. V. Shastri

Section 12AA — Registration of Trust — Delay in application for registration — Refusal to grant registration on the ground that the trust was claiming exemption u/s.11 even though it was not registered — Whether the refusal was on the valid ground — Held, No.

Facts:
The assessee trust came into existence vide trust deed dated 24th August, 2006. It had not applied for registration till 30-10-2009. However, all along the trust was carrying on its activities and duly filing its return of income with claims for exemption u/s.11. The DIT refused to grant registration for the reason that the assessee was claiming exemption u/s.11 even though it had not complied with the mandatory provisions of registration. According to him the assessee had concealed its income by claiming exemption which otherwise it was not entitled to.

Held:
According to the Tribunal the reason for refusal to grant registration as given by the DIT was not relevant to the consideration on which an application for registration of a trust or charitable institution is to be examined. Further, it also noted that the assessee had admitted an inadvertent lapse in nonfiling of registration application and also the fact that the trust had not accepted any donation, other than corpus donation at the time of formation of the trust. According to it, the lapse by the assessee cannot be visited with the consequence of its being declined registration later also, which approach was not supported either by any specific legal provisions or plain logic or rationale. The DIT was only required to examine if the objects of the trust were charitable and the activities were bona fide. Further noting that the assessee had placed enough relevant details and supportive evidences in support of the trust objects being charitable and the activities being bona fide, the Tribunal directed the DIT to grant registration.

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Krishna Land Developres Pvt. Ltd. v. DCIT ITAT ‘G’ Bench, Mumbai Before J. Sudhakar Reddy (AM) and Asha Vijay Raghavan (JM) ITA No. 1057/Mum./2010 A.Y.: 2005-06. Decided on : 12-8-2011 Counsel for assessee/revenue: Rakesh Joshi/ A. K. Nayak

Sections 22, 28 — Rental income for letting out premises, which are duly notified as IT Park and can be used only for a specific purpose along with provision of complex service facilities and infrastructure for operation such business is chargeable to tax under the head ‘Income from Business’.

Facts:
The assessee had let out on leave and licence basis for a period of 33 months property purchased by it along with the infrastructure, equipment and facilities, which were prescribed both by the Ministry of Commerce as well as the CBDT. The I.T. Park was duly notified by the Ministry of Commerce and also by the CBDT. The assessee offered licence fees in respect of this activity, for taxation, under the head ‘Income from Business’. The Assessing Officer (AO) relying on the decision of the Apex Court in the case of Shambhu Investments P. Ltd. v. CIT, 263 ITR 143 (SC) held that the income is assessable under the head ‘Income from House Property’. Aggrieved the assessee preferred an appeal to the CIT(A).

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

Held:
The Tribunal noted that the property in question was not a simple building but an I.T. Park with all infrastructure facilities and services. It observed that the Ministry of Commerce and Industries, notifies certain buildings as I.T. Park only if various facilities and infrastructure, as specified by the Department, are provided. It noted that all the technical requirements, infrastructures, facilities and services were being provided for in the building and it was for this reason that not only the Ministry of Commerce & Industries but also the CBDT notified the same as an I.T. Park which entitles the assessee to earn certain incentives. It also observed that the intention of the assessee while purchasing the property is to participate in the I.T. Park and it cannot be said that the intention is only to invest in property. The Tribunal observed that:

“The assessee is offering complex services by way of providing operation place in a notified I.T. Park, with all services and amenities such as infrastructure facilities, waiting room, conference room, valet parking, reception, canteen, 24 hours’ securities, internal facilities, high-speed lift, power back-up, etc. Just because a sister concern incurred this expenditure and claims reimbursement from the assessee, it cannot be said that the facilities are not provided for by the assessee. Whoever maintains them, the fact remains that it is the assessee who ultimately bears such expenditure for the services and undertakes to provide such services. The facilities are made available by the assessee to the person occupying the premises.”

The Tribunal noted that the Gujarat High Court has in the case of Saptarshi Services Ltd. 265 ITR 379 (Guj.) held that the income earned from business centre is to be assessed under the head ‘Income from Business and Profession’ and SLP filed by the Revenue against this judgment was rejected by the Supreme Court [264 ITR 36 (St)]. It also noted that the Mumbai Bench of ITAT has in the case of ITO v. Shanaya Enterprises, (ITA No. 3648/Mum./2010, A.Y. 2006-07, order dated 30th June, 2011) held that when the property is used for specific purposes and in the nature of providing complex services, the income is taxable under the head ‘Income from Business’.

Applying the propositions laid down in the abovementioned decisions, the Tribunal held that since the property can be used only for a specific purpose i.e., I.T. operation and the assessee has provided complex service facilities and infrastructure for operating such business, the income in question be assessed under the head ‘Income from Business & Profession’. It set aside the order passed by the CIT(A) and allowed this ground of the assessee’s appeal.

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Mahalaxmi Sheela Premises CHS Ltd. v. ITO ITAT ‘B’ Bench, Mumbai Before J. Sudhakar Reddy (AM) and Vijay Pal Rao (JM) ITA Nos. 784, 785 & 786/Mum./2010 A.Ys.: 2000-01 to 2002-03 Decided on: 30-8-2011 Counsel for assessee/revenue: Hiro Rai/ P. C. Maurya

Sections 22, 28 and 58 — Income received on lease of a portion of terrace of the building and a wall of the building for the purpose of fixing of hoarding, neon sign, etc., is assessable under the head ‘Income from House Property’.

Facts:
The assessee leased out portion of terrace of the building and a wall of the building to one Mrs. Sudha Vora, for the purpose of fixing of hoarding, neon sign, etc. The Assessing Officer, while assessing the total income for A.Y. 2000-01, assessed the income under the head ‘Income from Other Sources’ on the ground that the amount received by the assessee was not for letting of a building or terrace or any land appurtenant thereto but on account of allowing Mrs. Sudha Vora to display the advertisement of neon sign, illuminated hoarding, of a size 60 ft x 20 ft on the terrace and also illuminated hoarding of size 20 ft x 50 ft on a vertical wall of a building facing Pedder Road. Aggrieved, the assessee preferred an appeal to the CIT(A).

The CIT(A) held that the terrace has not been let out but merely permission has been granted to use the terrace only to set up the hoarding and to display the hoarding. He also observed that the lessee could use only a portion of the terrace and the purpose of utilisation was not for stay, etc. He upheld the action of the AO.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
Before the Tribunal, the assessee relied on the following case laws:

(1) ITO v. Cuffe Parade Sainara Premises Co-op. Society Ltd., (ITA No. 7225/Mum./2005, order dated 28-4-2008)

(2) Dalamal House Commercial Complex Premises Co-op. Society Ltd. v. ITO, (ITA No. 2286/ Mum./2008, order dated 29-5-2009)

(3) Sharda Chambers Premises Co-op. Society Ltd. v. ITO, (ITA No. 1234/Mum./2008, order dated 1-9-2009)

(4) Matru Ashish CHS Ltd. v ITO, (ITA No. 316/ Mum./2010, order dated 27-8-2010)

(5) S. Sohan Singh v. ITO, (16 ITD 272) (Del.); and

(6) CIT v. Bajaj Bhavan Owners Premises Co-op. Society Ltd., (ITA No. 3183 of 2010/Mum.).

The Tribunal noted that in the case of Bajaj Bhavan Owners Premises Co-op. Society Ltd. v. ITO, Mumbai ‘B’ Bench of the Tribunal in ITA No. 5048/Mum./2004, A.Y. 2001-02 and ITA No. 1433/Mum./2007, for A.Y. 2002-03 and ITA No. 1434/Mum./2007, for A.Y. 2003- 04, order dated 4-11-2009, the facts were that the assessee had allowed a telecom company to erect the tower on their terrace in consideration of an amount of Rs.5,93,700 and claimed it as being chargeable under the head ‘Income from House Property’. The Tribunal following the decision in the case of Sharda Chamber Premises v. ITO, (supra) and ITO v. Cuffe Parade Sainara Premises Co-op. Society Ltd. held such income to be chargeable under the head ‘Income from House Property’.

The Tribunal further noted that the jurisdictional High Court in ITA No. 3183 of 2010 in para 3 of judgment dated 16th August, 2011 confirmed the findings of the Tribunal in the case of Bajaj Bhavan Owners Premises Co-op. Society Ltd.

In view of the aforesaid binding judgment of the jurisdictional High Court, the Tribunal set aside the impugned order of the CIT(A), allowed the ground raised by the assessee and directed the AO to assess the income in question under the head ‘Income from House Property’.

The Tribunal allowed the appeal filed by the assessee.

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Press Release — Central Board of Direct Taxes — No. 402/92/2006-MC (15 of 2011) dated 24-6-2011.

The Governement of India has signed a protocol amending the DTAA with the Government of Singapore for effective exchange of information in the tax matters.

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Salaried employees exempted from filing tax returns — Notification No. 36/2011, dated 23-6-2011.

Salaried employees having total taxable income of less than Rs.5 lac have been exempted from filing the tax returns for A.Y. 2011-12, subject to the fulfilment of the following conditions:

The only source of income is salary and income from savings bank interest does not exceed Rs. 10,000.

The PAN of the employee is available with the employer and is mentioned in the Form 16 issued by the employer.

The bank interest income is disclosed to the employer, and is included in employee’s total income, and tax is duly deducted thereon and paid to the Government.

Total tax liability of such person is discharged by way of TDS deducted by the employer which has been duly paid to the Government.

The employee does not derive salary from more than one employer.

The employee has no claim of refund.

No specific notice is issued under the Act to the employee for filing a return of income.

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Requirement to file digitally signed tax returns in certain cases — Notification No. 37/2011, dated 1-7-2011.

The CBDT has notified that partnership firms filing return in ITR-5 or individuals and HUFs filing returns in ITR-4 and subjected tax audit u/s.44AB would require to digitally sign and submit their income tax returns for A.Y. 2011-12 and onwards.

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IS IT FAIR TO EXPECT AN INDIVIDUAL TO DO TDS (EVEN WITH PRESENT EXEMPTIONS)?

Introduction It is an accepted fact that the provisions relating to tax deduction at source (TDS) under the Income-tax Act, 1961 (the Act) are very cumbersome, ambiguous and irrational. No amount of input can give you an assurance that the compliances are flawless. There would hardly be any organisation that can claim perfection in compliance with these provisions. As regards the Government organisations — including statutory corporations, nationalised banks, etc., the less said the better.

The law-makers in their wisdom have by and large exempted individuals and HUFs from complying with these provisions. However, there is still much to desire in this respect.

The unfairness In sections 194A (Interest), 194C (Contracts), 194H (Commission), 194I (Rent) and 194J (Professional fees), there are clear provisions that ordinarily, an individual and HUF are not required to deduct tax at source. However, either a sub-section or a proviso in these sections makes an exception that if the individual or the HUF is required to get his/its accounts audited u/s.44AB for the preceding financial year, on the basis of turnover-criterion, then the said individual/HUF would be required to comply with the provisions of TDS.

Again section 194C and 194J provide that if the individual/ HUF is making a payment for personal purpose, then TDS provisions are not applicable. Thus, when a businessman is making a payment to a doctor/ lawyer, etc. for personal matters (non-business), no tax needs to be deducted.

The unfairness lies in not providing similar exemption in section 194A, 194H, 194I. Therefore, if a businessman with tax audit makes personal borrowings for buying a house, he may be required to deduct tax on interest. So also, on brokerage for sale/purchase of house. The same difficulty may arise for rent.

Difficulties in respect of section 195 are too well known. A typical case of an individual buying a house from a non-resident — entails so much of a nightmarish exercise! Either to comply with all formalities for just one single transaction or to obtain exemption u/s.195(2)/ 195(3), involves tremendous hardship.

It can be well understood that the main intention of the statute, to exclude individual and HUF from complying with the requirements for TDS u/s.194C and 194J, was to cover only business transactions and to exclude personal transactions from the ambit of TDS. However, the same logic is not made applied in case of sections 194A, 194H and 194I.

Nevertheless, there is some solace to the individuals and HUF viz. non-applicability of the provisions of section 40(a)(ia). The provisions of section 40(a)(ia) are applicable to any business expense, thus saving the personal expense. But there is an exception to this solace — section 25 which disallows the deduction of interest on housing loan made to a non-resident if TDS requirements are not fulfilled.

The test for deciding, whether individuals and HUFs have to comply with the provisions of TDS, is based on the turnover of the business or professional receipts (same limit as for tax audit u/s.44AB) (i.e., 60 lakh for business and 15 lakh for profession)? However, is it fair that this turnover must be a conclusive criterion for deciding TDS requirement?

Further even compliance procedure of TDS viz. taking TAN, deducting and making TDS payment, filing quarterly returns, issuing TDS certificates, can prove to be extremely cumbersome for individuals and HUFs.

Solution:
One solution that can be thought of may be to lay down a separate criterion which is not based on limits laid down in section 44AB for deciding the TDS compliance by individual or HUF. For instance, the monetary limit for applicability of TDS can be gross payments of Rs.1 crore for individuals and HUFs.

Also, similar exclusion (as in section 194J and 194C) should be provided in case of section 194A, 194H, 194I. Hence, in case of personal expenses none of the provisions dealing with TDS should not apply to individuals and HUFs.

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Raman Gupta Prop. M/s. Raman & Co. v. ACIT ITAT Amritsar Bench, Amritsar Before C. L. Sethi (JM) and Mehar Singh (AM) ITA No. 05/ASR/2010 A.Y.: 2003-04. Decided on: 31-1-2011 Counsel for assessee/revenue: P. N. Arora/ Tarsem Lal

Section 271D r.w.s 269SS — Penalty for acceptance of loan/deposit otherwise than by account payee cheque/draft — Assessee’s bona fide belief and conduct established a sufficient and reasonable cause — Penalty deleted.

Facts: The assessee had taken cash deposit from three persons amounting to Rs.2.5 lakh from each, aggregating to Rs.7.5 lakh. In response to showcause notice, the assessee explained that on account of urgency, as otherwise the cheque issued by him to the third party would have bounced, he took the cash deposit. Further it was pleaded that he was under the genuine impression that the provisions of section 269SS applied only to the business transactions and not to the personal transactions. However, according to the ACIT, the cheque issued to the third party by the assessee was not for payments to a creditor or discharge of any liability, but the same was issued for payment of a loan to the third party. The ACIT further did not agree with the assessee that the personal transactions were not covered and pointed out that the provisions of section 269SS do not make such distinction. Thus, he imposed a penalty u/s.271D of Rs.7.5 lakh.

According to the CIT(A) none of the exceptions provided u/s.269SS apply to the case of the assessee and the assessee had no compelling reasons to violate the provisions of section 269SS. Accordingly, he confirmed the order imposing penalty.

Held:
The Tribunal noted that the assessee was under bona fide belief that the provisions of section 269SS do not apply to the personal transactions and this belief had not been found to be false or untrue. Secondly, it was noted that the loan so taken was immediately deposited in the bank account and the transactions were duly recorded by the assessee in his books of accounts. According to the Tribunal, the assessee had not consciously disregarded the provisions of section 269SS of the Act. Therefore, relying on the decisions of the Punjab & Haryana High Court in the case of CIT v. Speedways Rubber Pvt. Ltd., (326 ITR 31), it held that the assessee had been able to establish a sufficient and reasonable cause for not accepting the loan by account payee cheque/ draft, and accordingly the penalty imposed was deleted.

Note:
In Hemendra Chandulal Shah v. ACIT, (ITA No. 1129/Ahd./2010), where on a direction of the bank a father had taken cash loan from his son to clear the debit balance in his bank account, according to the Ahmedabad Tribunal, there was reasonable cause and penalty u/s.271D could be imposed. The full text of the decision is available in the office of the Society.

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Vineetkumar Raghavjibhai Bhalodia v. ITO ITAT Rajkot Bench, Rajkot Before A. L. Gehlot (AM) and N.R.S. Ganesan (JM) ITA No. 583/RJT/2007 A.Y.: 2005-06. Decided on: 17-5-2011 Counsel for assessee/revenue: Manish Shah/ N. R. Soni

Explanation to proviso to clause (v)/(vi) of subsection (2) of section 56 — Gifts from relatives exempt from tax — Whether the gift received from HUF is exempt from tax — Held, Yes — Also held that the amount is exempt u/s.10(2) of the Act.

Issue: The issues before the Tribunal were as under:

1. Whether gift received from HUF by a member of HUF falls under the definition of ‘relative’ as provided in the Explanation to clause (vi) of sub-section (2) of section 56 of the Act?

2. Whether amount received by the assessee from his HUF is covered by section 10(2) of the Act?

The Assessing Officer was of the view that HUF is not covered in the definition of ‘relative’. Therefore, the gift received from the HUF was taxable. On appeal, the CIT(A) confirmed the view of the AO and further observed that if the Legislature wanted, it would have specifically mentioned so in the definition of ‘relatives’. According to him, the exemption u/s.10(2) was available only if the amount was received on partial/total partition and secondly to the extent of share in the assessed income of the current year. Before the Tribunal, the Revenue supported the orders of the lower authorities.

Held:
The Tribunal noted that a Hindu Undivided Family is a person within the meaning of section 2(31) of the Income-tax Act and is a distinctively assessable unit under the Act. Further, it observed that the Act does not define the expression ‘Hindu Undivided Family’, hence, it must be construed in the sense in which it is understood under the Hindu Law. According to it, HUF constitutes all persons lineally descended from a common ancestor and includes their mothers, wives or widows and unmarried daughters. All these persons fall in the definition of ‘relative’ as provided in Explanation to clause (vi) of section 56(2) of the Act. It did not agree with the views of the CIT(A) that HUF is as good as ‘a body of individuals’ and cannot be termed as ‘relative’. According to it, an HUF is ‘a group of relatives’. Further, from a plain reading of section 56(2)(vi) along with the Explanation to that section and on understanding the intention of the Legislature from the section, the Tribunal found that a gift received from ‘relative’, irrespective of whether it is from an individual relative or from a group of relatives is exempt from tax as a group of relatives also falls within the Explanation to section 56(2) (vi) of the Act. It pointed out that the Act does not provide that the word ‘relative’ represents a single person. Accordingly, the Tribunal held that the ‘relative’ explained in Explanation to section 56(2)(vi) of the Act includes ‘relatives’ and as the assessee received gift from his ‘HUF’, which is ‘a group of relatives’, the gift received by the assessee from the HUF should be interpreted to mean that the gift was received from the ‘relatives’ and therefore, the same was not taxable u/s. 56(2) (vi) of the Act.

As regards the alternative claim for exemption u/s.10(2) — the Tribunal did not agree with the CIT(A) and held that the assessee was entitled to exemption u/s.10(2). According to it, the assessee was a member of HUF and had received the amount out of the income of the family. There was no material on record to hold that the gift amount was part of any assets of HUF. It was out of income of family to a member of HUF, therefore, the same is exempt u/s.10(2) of the Act.

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(2011) 128 ITD 345 (Mum.) Smt. Bharati Jayesh Sangani v. ITO A.Y.: 2005-06. Dated: 4-11-2010

Section 50C — AO is bound to apply the valuation given by DVO in the valuation report.

Facts:
The assessee purchased a flat for Rs.30,00,000 on 22-10-2003. This property was then sold on 29- 9-2004 for a total consideration of Rs.35,00,000. The stamp duty valuation of the said flat was Rs.1,18,07,180. The assessee was asked to show cause as to why the provisions of section 50C should not be applied. The assessee explained that the value of the property sold within a period of less than one year could not be expected to be as high as 1.18 crore. Further, the building was an old one and in dilapidated condition. The members of the society had resolved to construct a new building by demolishing the old one. Accordingly, the construction contract was entered with builders. As per the contract, the members were to pay certain amounts towards the construction cost and purchase of TDR. Since the assessee did not have money, she sold the flat to a third party with an agreement that the purchaser shall pay the construction cost and purchase cost of TDR to the builder. Further, the assessee explained that when the flat was sold, the building was already demolished and only the plinth was laid for the purpose of construction of new building.

Without prejudice to this main argument, the assessee also requested the Assessing Officer to refer the matter to the Valuation Officer. The DVO valued the said flat at Rs.46.48 lakh. The AO did not concur with the view of DVO as according to him the valuation done by the DVO was very low and further no deduction was required towards TDR. Further, according to the AO, section 50C(2) and section 16A of the Wealth-tax Act, 1957 do not bind the AO to follow the valuation done by the DVO.

Held:
Sub-section (2) of section 50C states that “……..where any such reference is made, the provisions of sub-sections (2), (3), (4), (5) and (6) of section 16A of wealth tax shall apply, with necessary modifications.

Sub-section (6) of section 16A of the Wealth-tax Act states that on receipt of order from the Valuation Officer, the Assessing Officer shall “proceed to complete the assessment in conformity with the estimate of the Valuation Officer”. Hence the AO has no option but to go by the estimate of the Valuation Officer.

The DVOs are experts in the matter of valuation by virtue of special qualification held by them in this field. The AO cannot ignore the report of the DVO.

The words used in sub-section (2) of section 50C that where reference is made to the DVO the provisions of sub-section (6) of section 16A of the Wealth-tax Act shall apply with necessary modifications. The ambit of expression ‘with necessary modifications’ implies striking out the inapplicable fractions of the provision which align strictly with the specifics of the Wealth-tax Act. This will not enable the AO to completely disregard the valuation report by the DVO.

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(2011) 56 DTR (Ahd.) (Trib.) 89 Valibhai Khanbhai Mankad v. DCIT A.Y.: 2006-07. Dated: 29-4-2011

Section 40(a)(ia) — Payment of hire charges to sub-contractors after obtaining Form 15-I cannot be disallowed u/s.40(a)(ia) on the ground that Form 15J was not filed in time as per Rule 29D.

Facts:
The assessee had made payment of Rs.7,93,34,193 to sub-contractors to whom it awarded subcontract for hiring and from whom he obtained Form 15-I and hence TDS was not deducted. The AO, however, noted that even though the Forms 15-I were obtained from the transporters, the same were not furnished to the CIT in Form 15J as per Rule 29D of the IT Rules, 1962. He therefore, quoting from section 194C(3) as applicable to the relevant assessment year, held that once the assessee failed to furnish Form 15J enclosing therewith Form 15-I to the CIT before 30th June, 2006, he failed to fulfil the conditions laid down u/s. 194C(3)(ii). He accordingly added back the sum paid without TDS u/s.40(a)(ia).

The learned CIT(A) confirmed the addition by holding that responsibility after non-deduction does not stop just at collecting Forms 15-I from the sub-contractors, but also extends to requiring the contractor to furnish Form 15J to the CIT on or before 30th June of the following financial year. It was contended before the learned CIT(A) that Form 15J was submitted to the CIT on 26th February 2009 i.e., after the completion of assessment. The learned CIT(A) rejected this contention holding that such delay defeats the very purpose of the section.

Held:
Once the assessee has obtained Forms 15-I from the sub-contractors, and contents thereof are not disputed or whose genuineness is not doubted, then the assessee is not liable to deduct tax from the payments made to sub-contractors. Once the assessee is not liable to deduct tax u/s.194C, then addition u/s.40(a)(ia) cannot be made.

Non-furnishing of Form 15J to the CIT is an act posterior in time to payments made to subcontractors. This cannot by itself, undo the eligibility of exemption created by second proviso. Third proviso to section 194C(3)(i) which requires the assessee to submit Form 15J is only a procedural formality and cannot undo what has been done by second proviso.

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(2011) 55 DTR (Mumbai) (Trib.) 241 Porwal Creative Vision (P) Ltd. v. Addl. CIT A.Ys.: 2006-07 & 2007-08. Dated: 18-3-2011

Section 272A(2)(k) — Penalty for failure to file TDS return is leviable only for the delay from the date of payment of taxes by the assessee.

Facts:
There was delay in submitting quarterly statement in Form No. 26Q and for such delay the AO imposed penalty u/s.272A(2)(c) and (k) @ Rs.100 per day of delay. Before the CIT(A), the assessee contended that it was incurring losses and there was financial crisis and therefore due to non-availability of funds there were delays in making the payments and filing the returns. However, the CIT(A) confirmed the penalty levied.

Held:
The clause (c) of section 272A(2) is not applicable as the same related to return/statement u/s.133, 206 and 206C. The case of the assessee is that it had deducted the TDS at the time of crediting amounts in the books of account and the payment could not be made due to financial difficulties and since the payments had not been made, the TDS returns could not be filed, as the same required data relating to payment of TDS.

As regards the default in not paying the tax to the Central Government in time or for non-deducting the tax at source, there are other provisions for ensuring compliance. In case the assessee fails to deduct tax at source or after deducting fails to pay the same to the Central Government, the assessee is deemed to be in default u/s.201(1) and is liable for penalty. The assessee is also liable to pay interest for the period of default till the payment of tax u/s.201(1A). Therefore, the period for levying the penalty has to be counted from the date of payment of tax, because the delay in filing the return till the date of payment of tax is already explained on the ground that the assessee could not pay the taxes for which separate penal provisions exist.

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Bhumiraj Homes Ltd. v. DCIT ITAT ‘B’ Bench, Mumbai Before R. S. Syal (AM) and Asha Vijayaraghavan (JM) ITA No. 2170/Mum./2009 A.Y.: 2004-05. Decided on : 25-3-2011 Counsel for assessee/revenue: Pradip Kapasi/ Naresh Kumar Balodia

Section 80IB(10) — Deduction in case of housing project — (1) For computation of built-up area for commercial purpose whether proportionate area covered by staircase, passage, lift area and liftroom, etc. is also to be considered — Held, No. (2) While considering the size of the plot whether the unbuilt-up area should be bifurcated in proportion to commercial as well as residential area — Held, No.

Facts:
The assessee, a builder developer had claimed a deduction of Rs.2.55 crore u/s.80IB(10) representing the profits of the housing project. In the original assessment deduction u/s.80IB(10) was disallowed to the extent it was relatable to profits of the commercial area. In the re-assessment proceeding u/s.147, the AO disallowed the remaining part of the deduction which was earlier allowed as in his opinion only the projects approved as ‘housing projects’ were eligible and not those approved as ‘residential as well as commercial projects’ by the local authority.

Before the Tribunal the Revenue contended that the commercial area exceeded 10% of the total built-up area computed on the following basis, hence, the order of the AO was to be upheld. It was submitted that:

Built-up area for commercial purpose should include proportionate area covered by staircase, passage, lift area and lift-room;
While considering the size of the plot, unbuiltup area should be bifurcated in proportion to commercial as well as residential area. Plot size so calculated was less than 1 acre. It also relied on the decision of the Kolkata Tribunal decision in the case of Bengal Abuja Housing Development Ltd. v. DCIT, (ITA No. 1595/Kol./2005, dated 24-3-2006).

Held:
The Tribunal did not agree with the Revenue’s contention that unbuilt-up area should be bifurcated in proportion to commercial as well as residential area. According to it, in any project there would always be some portion of the area which remains unbuilt and is required to be kept open as per the plans approved. According to the Tribunal the decision of the Kolkata Tribunal was not on the point advocated by the Revenue. As regards the contention to include proportionate area covered by staircase, passage, lift area and lift-room, the Tribunal noted that since all shops and commercial establishments were in the ground floor, such areas cannot be considered to compute built-up area for commercial purpose. Further, relying on the decision of the Bombay High Court in the case of Brahma Associates (ITA No. 1194 of 2010), it allowed the appeal of the assessee.

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(2011) 128 ITD 459/ 9 taxmann.com 121 (Mum.) ACIT v. Safe Enterprises A.Y.: 2005-06.

Section 143 r.w.s. 133A — Assessee can retract the admission made during survey in respect of concealed income with sufficient evidence and hence no addition of the said amount can be made.

Facts:
The assessee-firm was engaged in the business of civil contracts. During the course of survey, it was noticed that three invoices amounting to Rs. 76,33,179 were not entered into the books of accounts. The AO hence concluded that the labour receipts were suppressed. The partner of the firm agreed to the above findings and offered Rs.76 lakhs as additional income on that account.

However, in the immediate post-survey proceedings, the assessee was able to produce all the related documents before the assessing authority, thus retracting his earlier admission. The Assessing Officer made addition of the impugned amount despite retraction by the assessee. On appeal to the CIT(A) by the assessee the learned CIT(A) considered the matter in great detail and ultimately deleted the said additions. Aggrieved the Revenue preferred an appeal before the Appellate Tribunal.

Held:
1. Survey is essentially an evidence gathering exercise. It is an established position of law that if a disclosure is made by the assessee either under mistaken belief of facts and law due to mental pressure from the survey party or under coercion, he can retract the statement and the admission so made.

2. Reliance was placed on the Supreme Court decision in Pullan Gode Rubber Produce Co. Ltd. v. State of Kerala that admission was an extremely important piece of evidence, but it cannot be said to be conclusive. It is open to the person who made the admission to show that it is incorrect.

3. Also it was held in CIT v. Ramdas Motor Transport and Jaikishin R. Agarwal v. ACIT that if the admission in the statement is not supported by any asset or document, the retraction may be genuine.

4. The assessee, in the post-survey proceedings as well as assessment proceedings had amply demonstrated through credible evidence the source of labour receipts.

Consequently, the ITAT upheld the order of the CIT(A).

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(2011) TIOL 530 ITAT-Kol. ITO v. Rajesh Kr. Garg A.Y.: 2006-2007.

Sections 40(a)(ia), 194C — When tax was not deducted at source on the basis of Form 15I received by the assessee from the payee and the assessee failed to file Form 15J with the jurisdictional CIT, disallowance cannot be made merely on the basis that the Form 15J was not filed in time with the jurisdictional CIT.

Facts:
The assessee, engaged in business of transportation of goods through hired trucks, made payments aggregating to Rs.28.01 lakhs in respect of 42 vehicles and actual payment was exceeding Rs.50,000 per vehicle, without deduction of tax at source since it had received declarations from the payees in Form 15I. However, the assessee did not file Form 15J within the prescribed time to the jurisdictional CIT. The Assessing Officer disallowed the sum of Rs.28.01 lakhs u/s.40(a)(ia), though the declarations were produced before him in the course of assessment proceedings, on the ground that the authenticity of receiving Form 15I is not discharged due to non-filing of Form 15J with the jurisdictional CIT. Aggrieved the assessee preferred an appeal to the CIT(A).

The CIT(A) stated that the Act does not say that Form 15I is to be treated as non-est due to non-filing of Form 15J by the assessee with the jurisdictional CIT. He held that Form 15I comes into effect before the actual payment or crediting to the account takes place, whereas the due date for furnishing the particulars in Form 15J is 30th June following the financial year. The appellant was to stop deduction of tax on payments as and when he received Form 15I from the sub-contractor. He also observed that the AO had not doubted the existence of Form 15I at the time of making the payment by the assessee. He deleted the addition made by the AO.

Aggrieved the Revenue preferred an appeal to the Tribunal.

Held:
Before the Tribunal, it was contended on behalf of the assessee that this issue is squarely covered in favour of the assessee by the decision of ITAT, Mumbai ‘F’ Bench in the case of Shri Vipin P. Mehta v. ITO, (ITA No. 3317/Mum./2010, A.Y. 2006-07, order dated 20th May, 2011) and also by the decision of Ahmedabad ‘A’ Bench in the case of Valibhai Khanbhai Mankad v. Dy. CIT, (OSD) (ITA No. 2228/Ahd./2009, A.Y. 2006-07, order dated 29-4-2011).

The Tribunal found that the assessee had obtained Form 15I and filed during the course of assessment proceedings but failed to file Form 15J with the jurisdictional CIT. The Tribunal found the issue to be covered in favour of the assessee by the decision of the Mumbai Bench of ITAT in the case of Vipin P. Mehta (supra). Following the ratio laid down by the said decision, the Tribunal confirmed the order of the CIT(A) and deleted the addition made by the AO.

The Tribunal decided this ground of appeal in favour of the assessee.

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(2011) TIOL 511 ITAT-Mum. Manali Investments v. ACIT A.Y.: 2005-06.

Sections 2(29A), 2(29B), 2(42A), 2(42B), 48, 49, 50 and 74 — Brought forward long-term capital loss can be set-off against capital gain computed u/s.50 in respect of a long-term capital asset.

Facts:
The assessee, engaged in the business of finance and investments, sold meters and transformers, which were its depreciable assets, for a consideration of Rs.1,45,99,988. The gain arising on such sale was shown as long-term capital gain. The AO noticed that these meters and transformers were purchased in earlier years for a consideration of Rs.8,75,99,928 and on these 100% depreciation was claimed and allowed in the respective first year itself. The AO invoked the provisions of section 50 and regarded the gain to be short-term capital gain. The assessee, placing reliance on the decision of the Bombay High Court in the case of CIT v. Ace Builders Pvt. Ltd., (281 ITR 210) (Bom.) contended that such profit on sale of meters and transformers, which were otherwise long-term capital assets, was required to be considered as long-term capital gain for the purposes of set-off against brought forward loss arising on transfer of long-term capital assets. The AO rejected this contention of the assessee and treated the amount of Rs.145.99 lakhs as short-term capital gain on sale of assets which resulted into not allowing set-off against brought forward loss from the long-term capital assets.

Aggrieved the assessee preferred an appeal to the CIT(A) who upheld the order passed by the AO.

Aggrieved, the assessee filed an appeal to the Tribunal.

Held:
The effect of section 50 is that once depreciation has been allowed under this Act on a capital asset which forms part of a block of assets, then capital gain on the transfer of such assets shall not be computed in accordance with the provisions of sections 48 and 49, but the income so resulting shall be deemed to be the capital gains arising from the transfer of short-term capital assets in the manner provided in the latter section. Section 50 is a deeming provision and only by legal fiction income from the transfer of otherwise long-term capital assets (held for a period of more than 36 months) is treated as capital gains arising from the transfer of short-term capital assets. Such deeming provision has to be restricted only up to the point which has been covered within the provisions of section 50. The prescription of section 50 is to be extended only up to computation of capital gains. Once the amount of capital gain is determined in case of depreciable assets as per this section, ignoring the mandate of sections 48 and 49 which otherwise deal with the mode of computation of capital gains, the function of this provision shall come to an end and the capital gain so determined shall be dealt with as per the other provisions of the Act. If the assessee is otherwise eligible for any benefit under the Act which is attached to a longterm capital asset, the same shall remain intact. It cannot be denied simply for the reason that on the transfer of such a long-term capital asset, the short-term capital gain has been computed as per section 50.

There can be two stages, viz. firstly, the computation of capital gain on the transfer of otherwise longterm capital assets u/s.50 and secondly, when such capital gain has been so computed, the applicability of other provisions dealing with the short-term or long-term capital assets.

As has been held in the case of Ace Builders (supra), the view that by virtue of the operation of section 50, the capital gain so computed becomes that arising from the transfer of a short-term capital asset for all purposes is incorrect.

The effect of provision of section 74 is that the brought forward loss from long-term capital assets can be set off only against long-term capital gain within the period prescribed in s.s(2) of section 74.

In the instant case, capital gain has arisen from the transfer of an asset which was held for a period of more than three years and no long-term capital gain has entered into the computation of total income of the assessee on this transaction. This amount would also retain the character of long-term capital gain for all other provisions and consequently qualify for set-off against the brought forward loss from the long-term capital assets.

The appeal filed by the assessee on this ground was allowed.

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Insurance business: Section 44: A.Y. 2002-03: The amount set apart by insurance company towards solvency margin as per directions given by IRDA is to be excluded while computing actuarial valuation surplus: Pension fund like Jeevan Suraksha Fund would continue to be governed by provisions of section 44, irrespective of fact that income from such fund is exempted.

[CIT v. Life Insurance Corporation of India Ltd., 201 Taxman 115 (Bom.); 12 Taxman.com 388 (Bom.)]

The assessee was engaged in the life insurance business. In its return of income for the A.Y. 2002-03, it computed actuarial valuation surplus by excluding the provision for reserve on account of solvency margin amounting to Rs.3,500 crores and loss in Jeevan Suraksha Fund. The Assessing Officer disallowed the claim of the assessee and passed the assessment order by adding the amount on account of the provision for solvency margin and loss from Jeevan Suraksha Fund, inter alia, on the ground that the provision for solvency margin was not an ascertained liability; and that income from Jeevan Suraksha Fund being exempt u/s.10(23AAB), the loss incurred from the said fund could not be adjusted against the taxable income. The Tribunal deleted the additions.

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

“(i) A plain reading of Rule 2 of the First Schedule to the Act, makes it clear that the annual average of the surplus from the insurance business has to be arrived at by adjusting the surplus or deficit disclosed by the actuarial valuation made in accordance with the Insurance Act, 1938.

(ii) In the instant case, the Chairman of IRDA had directed that the solvency calculations of the assessee did not conform to the requirements of the Regulations that have been stipulated by the Regulatory Authority. It was further directed that the deficiency in the solvency margin was to the extent of Rs.10,000 crores and the assessee was directed to set right the said deficiency over a period of three years by making a provision which would be kept apart in the policy-holders’ fund and no part of the said provision would be available for distribution either to the policy-holders or to the Government of India. Accordingly, the assessee had set apart Rs.3,500 crores towards solvency margin in the assessment year in question.

(iii) The Tribunal, after considering various decisions of the Apex Court as also, the High Court and section 64(VA) of the Insurance Act, 1938, held that the amounts set apart towards the solvency margin as per the directions given by the IRDA was ascertained liability which was required to be set apart as per the Regulations framed by IRDA and, hence, liable to be excluded while computing the actuarial valuation surplus.

(iv) In those circumstances, the decision of the Tribunal in holding that the funds set apart as solvency margin had to be excluded while determining the distributable profits of the assessee could not be faulted.

(v) So far as loss incurred by the assessee from Jeevan Suraksha Fund was concerned, the Jeevan Suraksha Fund is a pension fund approved by the Controller of Insurance appointed by the Central Government to perform the duties of the Controller of Insurance under the Insurance Act. The loss incurred in the Jeevan Suraksha Fund has been considered by the actuary as a business loss, as per the valuation report as on the last day of the financial year, allowable u/s.44 read with the First Schedule to the Act. The fact that the income from such fund has been exempted u/s.10(23AAB) w.e.f. 1-4-1997, does not mean that the pension fund ceases to be insurance business, so as to fall outside the purview of the insurance business covered u/s.44.

(vi) In other words, the pension fund like Jeevan Suraksha Fund would continue to be governed by the provisions of section 44, irrespective of the fact that the income from such fund is exempted, or not. Therefore, while determining the surplus from the insurance business, the actuary was justified in taking into consideration the loss incurred under Jeevan Suraksha Fund.

(vii) The object of inserting section 10(23AAB) as per the Board Circular No. 762, dated 18-2-1998 was to enable the assessee to offer attractive terms to the contributors. Thus, the object of inserting section 10(23AAB) was not with a view to treat the pension fund like Jeevan Suraksha Fund outside the purview of insurance business, but to promote insurance business by exempting the income from such fund.

(viii) Therefore, in the facts of the instant case, the decision of the Tribunal in holding that even after insertion of section 10(23AAB), the loss incurred from the pension fund like Jeevan Suraksha Fund had to be excluded while determining the actuarial valuation surplus from the insurance business u/s.44 could not be faulted.”

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Section 115F — Bonus shares received on account of original investments made in foreign currency are ‘foreign exchange asset’ covered by provisions of section 115F.

Sanjay Gala v. ITO ITAT ‘L’ Bench, Mumbai Before P. M. Jagtap (AM) and V. Durga Rao (JM) ITA No. 2989/Mum./2008 A.Y.: 2005-06. Decided on : 15-7-2011 Counsel for assessee/revenue: Vijay Mehta & Umesh K. Gala/R. S. Srivastava

Facts:

For the A.Y. 2006-07, the assessee, a non-resident Indian, filed his return of income declaring the income of Rs.60,000. The Assessing Officer (AO) while assessing the total income u/s.143(3) of the Act did not treat the bonus shares as foreign exchange assets and denied the benefits available u/s.115C of the Act. He assessed the total income to be Rs.11,23,265. There was no dispute that the original shares in respect of which bonus shares were received were acquired with convertible foreign exchange. Aggrieved, the assessee preferred an appeal to the CIT(A). The CIT(A) held that the provisions of section 115(C)(b) define the term ‘foreign exchange asset’ to mean an asset which the assessee has acquired or purchased or subscribed to in, convertible foreign exchange. He held that the bonus shares were neither acquired nor purchased nor subscribed by the assessee and consequently the same were held to be not ‘foreign exchange asset’. He upheld the order passed by the AO. Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:

(1) The assessee acquired the original shares by investing in convertible foreign exchange and, therefore, it cannot be said that the bonus shares are acquired in isolation without taking into consideration the original shares acquired by the assessee.

(2) The Tribunal observed that the Supreme Court and various High Courts have considered the issue with regard to value of the bonus shares and held that “the method of spreading over on both the bonus and original shares the cost of acquisition of the original shares would appear to be the proper method of determining the value of the asset. For, there is no doubt that on the issuance of the bonus shares, the value of the original shares is proportionately diminished. In simple language it is ‘split up’. As such, the cost of acquisition of the original shares and their value is closely interlinked and interdependent on the issue of bonus shares. Therefore, once the bonus shares are issued, the averaging out formula has to be followed with regard to all the shares.”

(3) In view of the above proposition, the bonus shares were held to be covered by section 115C(b) of the Act, and the same are eligible for benefit u/s.115F of the Act. The Tribunal allowed the appeal filed by the assessee.

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Project Completion Method, AS-7 — In the case of an assessee following project completion method of accounting, receipts arising from sale of TDR received, directly linked to the execution of the project, will go to reduce the cost of the project.

(2011) TIOL 400 ITAT-Mum. ACIT v. Skylark Build ITA Nos. 4307 & 4308/Mum./2010 A.Ys.: 2006-07 and 2007-08. Dated: 17-6-2011

Facts:

The assessee, a builder, had
taken up a slum rehabilitation project at Worli, Mumbai. The project
started with the construction of a transit building on land provided by
Municipal Corporation of Greater Mumbai (MCGM) at Worli. In financial
year 2005-06, the MCGM came up with a proposal that if the assessee was
ready to handover possession of transit buildings it would grant TDRs.
In terms of the said scheme, the assessee received TDR measuring 15308
sq.mts. vide certificate No. SRA 526, dated 2-10-2005 and another TDR
measuring 46909 sq.mts. vide certificate No. SR 594, dated 3-6-2006.
These TDR were sold by the assessee for Rs.9,92,04,469 and
Rs.5,55,86,123, respectively. Both the TDRs were sold in the same
financial year in which they were received. Since the project was not
complete and the assessee was following project completion method, the
assessee had reduced these receipts against work-in-progress.

The
Assessing Officer (AO) did not accept the explanation given. He held
that TDR was nothing but FSI granted by SRA which could be used by
recipient for construction of flats/premises in Mumbai. Therefore, the
income had accrued to the assessee on account of TDR which was required
to be shown as income in the year of receipt. The AO rejected the method
followed by the assessee and assessed the amounts received on sale of
TDR as income of the respective years under consideration.

Aggrieved,
the assessee preferred an appeal to the CIT(A) who observed that TDRs
were directly related to the project undertaken by the assessee,
therefore, sale proceeds could be taxed only in the year of completion,
which was A.Y. 2007-08. The CIT(A) also referred to the decision of the
Tribunal in the case of ITO v. Chembur Trading Corporation, (2009) in
ITA No. 2593/Mum./2006, dated 21-1-2009 in which it was held that TDRs
have to be recognised as revenue receipts in the year in which project
was completed. He, accordingly, deleted the addition made by the AO.
Aggrieved, the Revenue filed an appeal to the Tribunal.

Held:

The
approach adopted by the AO for assessing the income from TDR
independently without deducting the expenses incurred is not justified.
The assessee has been following project completion method which is an
accepted method of accounting in construction business and also
recommended as per AS-7 of ICAI. Therefore, in such cases the income
from the project has to be computed in the year of completion. The TDRs
received are directly linked to the execution of the project and
therefore, before the completion of the project the income from TDR or
any other receipt inextricably linked to the project will only go to
reduce the costs of the project. Therefore, the assessee had rightly set
off TDR received against work-in-progress. Even if TDR receipt is
assessed as an independent item, deduction has to be allowed on account
of the expenses incurred. The TDRs have been received in lieu of handing
over of constructed transit buildings and therefore, cost of those
buildings has to be deducted against income from sale of TDR. The cost
of the buildings is claimed to be more than income from TDR, full
details of which were given to the CIT(A) and therefore, even on this
ground no income can be assessed in case of the assessee. For A.Y.
2006-07, there was no dispute that the project was not complete.

The
Tribunal held that for A.Y. 2006-07, the receipts from sale of TDR have
to be reduced from WIP. The Tribunal noted that the AO had not given
any finding about the year of completion of the project. The CIT(A) had
held that the project was completed in A.Y. 2007-08, but had not given
any basis of such finding. The Tribunal restored the matter to the file
of the AO to verify the year of completion of the project and directed
the AO to compute income from project after taking into account entire
expenditure and the receipts from the beginning of the year including
TDRs as directed by the AO, if he comes to the conclusion that the
project was complete. In case he comes to a conclusion that the project
was not complete, then the AO shall set off TDR receipts against WIP and
no income will be assessed on account of TDR receipts separately.

The Tribunal dismissed the appeals filed by the Revenue.

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Sections 40(a)(ia), 194C — Service contracts have not been specifically included in Explanation III below section 194C. Provisions of section 194C are not applicable to the payments to C & F agents. Payments made by the assessee to C & F agents towards reimbursement of statutory liability paid by C & F agent on behalf of the assessee cannot be considered to be covered by section 194C as they are not for any work of the nature mentioned in Explanation III.

(2011) TIOL 440 ITAT-Mum. ACIT v. P. P. Overseas ITA No. 733/Mum./2010 A.Y.: 2006-07. Dated: 18-2-2011

Facts:

The assessee had paid C & F agency charges to Vidhi Enterprises and Jayashree Shipping being their charges as agent of the assessee. These payments were made without deducting tax at source. Also, no tax was deducted from payments debited under the head ‘C & F Expenses; being reimbursement of expenses such as customs duty, food stuffing charges, DEPB licence/miscellaneous expenses, conveyance and other charges. The Assessing Officer rejected the contention of the assessee that considering the nature of payment, no tax was required to be deducted. He, accordingly, added a sum of Rs.4,02,252 to the total income by invoking the provisions of section 40(a)(ia) of the Act.

Aggrieved the assessee preferred an appeal to CIT(A) where relying on the decision of the Bombay High Court in the case of East India Hotels Ltd. v. CBDT, 179 Taxman 17 (Bom.) it was contended that section was not applicable to a service contract which is not specifically included in the section under Explanation III. Reliance was also placed on the decision of Visakhapatnam Bench of the Tribunal in the case of Mythri Transport Corporation v. ACIT, 124

TTJ 970, where it was held that when the risk of the main contract is not passed on to the intermediary, then the provisions of section 194C do not apply. The CIT(A) accepted these contentions and directed the AO to delete the disallowance of Rs.4,02,252. Aggrieved, the Revenue filed an appeal to the Tribunal.

Held:

The contract between the assessee and the C & F agent is a service contract which has not been specifically included in Explanation III below section 194C. In this view of the matter, the provisions of section 194C are not applicable to the payments to C & F agents. If that is so, there was no obligation on the part of the assessee to deduct tax from the payment made to C & F agents.

In respect of payments to agents towards reimbursement of statutory liabilities such as customs duty, DEPB licence, etc., the Tribunal observed that these are actually the liabilities of the assessee and noted that the receipt for the payment is issued by the concerned authority only in the name of assessee. The C & F agents merely collected the payments from the assessee for payment to concerned authorities. The Tribunal held that such payments cannot be considered to be covered by section 194C as they are not for any work of the nature mentioned in Explanation III. These amounts are not subject to TDS, even if it is assumed that section 194C is applicable to the payments in question.

The Tribunal upheld the order of CIT(A) by observing that the basic question as to whether the payments of the nature made by the assessee are covered by Explanation III below section 194C has been answered in favour of the assessee by the judgment of the Bombay High Court cited above and on this ground alone the decision of the CIT(A) has to be upheld. The appeal filed by the Revenue was dismissed.

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Section 194C — As per explanation III(c) to section 194C(2) payment made by assessee for using facility for movement of goods should be categorised as payment for carriage of goods and not as technical fees u/s.194J.

(2011) 129 ITD 109 (Mum.) ACIT v. Merchant Shipping (P) Ltd. A.Y.: 2004-05. Dated: 24-11-2010

Section 194C — As per explanation III(c) to section 194C(2) payment made by assessee for using facility for movement of goods should be categorised as payment for carriage of goods and not as technical fees u/s.194J.

Section 201(1) & 201(1A) — Person responsible to deduct tax at source cannot be treated as assessee in default in respect of tax u/s.201(1), if payee has paid tax directly — However, payee is liable to pay interest u/s.201(1A), from date of deduction to actual payment of tax.

Facts

Payment was made by the assessee to the NSICT for movement of containers to the vessel and from the vessel. On payment to NSICT the assessee deducted tax u/s.194C.

However the AO rejected the same on the ground that services received by the assessee are in the nature of technical services. Therefore, tax should be deducted u/s.194J. Subsequently the AO raised the demand for short deduction u/s.194J of Rs.36,08,701 and interest u/s.201(1A) of Rs.24,90,004.

Aggrieved by the order of the AO the assessee filed the appeal before CIT(A).

The CIT(A) up held the contention of the assessee of deducting tax under 194C. However the CIT(A) upheld the order of AO u/s. 201(1) and 201(1A).

Held

In order to be covered by sec 194J, there should be consideration for acquiring/using technical know-how provided/made available by human intervention. Section 194J is to be read with explanation 2 to section 9(1)(vii) which defines fees for technical services. Involvement of human element is essential to bring any service with in the meaning of technical service.

In the present case payment was made by the assessee for using a facility and not for availing any technical service which may have gone into making of the facility.

In order to be covered by section 194J, there should be direct link between the payment and receipt of technical service/information. Technical service does not include service provided by machines/robots. (CIT v. Bharti Cellular Ltd.) Held that the assessee had rightly deducted tax u/s.194C and the AO had erred in applying provisions of section 194J.

Facts

The AO considering the deduction to be a short deduction of the raised demand for the interest u/s.201(1A) of Rs.29,00,004.

On appeal by the assessee to the CIT(A), the learned CIT(A) held that the assessees’s liability for deducting tax at source was not washed away by payment of tax by recipient. The CIT(A) upheld order of the AO passed u/s. 201(1) and 201(1A).

The assessee filed appeal before the ITAT for payment of interest u/s.201(1A) and for treating order of the AO u/s.201(1) and 201(1A) as time-barred.

Held

1. Payment of interest u/s.201(1A) of Rs.2490004:

(a)   As there was no liability on the assessee to deduct tax u/s.194J, demand of interest u/s.201(1A) is incorrect.
(b)   However from a legal and academic point of view, the liability of payer to pay interest u/s.201(1A) exists for the period between the date on which tax was deductible till date of actual payment.
(c)   Any demand u/s.201(1) of the Act should not be enforced after the tax deductor has satisfied AO that taxes due have been paid by the payee.

2. Treating order as time-barred:

(a) Held that, time limit for initiating and completing the proceeding u/s.201(1) has to be at par with the time limit available for initiating and completing the reassessment. Thus the order passed by the AO is within the time limit.
(b) Thus appeal of the Revenue was dismissed and cross-objection of the assessee was partly allowed.

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Educational institution: Exemption u/s. 10(23C)(vi): Assessee-society was running a school: Its application for exemption u/s. 10(23C)(vi) was rejected on ground that its objects, viz., to manage/maintain a library, reading-room, and conduct classes of stitching, embroidery, weaving, centre for adult education and to make necessary arrangements for overall development and growth of children when required, were non-educational in nature: Rejection not proper.

[Little Angels Shiksha Samiti v. UOI, 199 Taxman 237 (MP)(Mag), 11 Taxman.com 37(MP)]

The assessee-society was running a school. Its objects were:

(a) establishment of a school for the intellectual development of children;
(b) to conduct the classes and activities for all the levels of study and education;
(c) to manage/maintain a library, reading-room, and conduct classes of stitching, embroidery, weaving centre for adult education and education in the field of entertainment, arts, etc.; and
(d) To make necessary arrangements for the overall development and growth of children when required.

For the A.Ys. 2005-06 and 2006-07, the assesseesociety had been granted exemption u/s. 10(23C) (vi). It filed application for grant of approval for exemption u/s.10(23C)(vi) for A.Y. 2007-08. The Commissioner rejected the assessee’s application on the ground that the objects of the society mentioned in clauses (c) and (d) of the object clause were non-educational and, thus, the society did not exist solely for educational purpose.

The Madhya Pradesh High Court allowed the writ petition filed by the assessee-society and held as under:

“(i) In view of the judgment of the Supreme Court in the case of Sole Trustee, Loka Shikshana Trust v. CIT, (1975) 101 ITR 234 the word ‘education’ used in clause (15) of section 2 means the process of training and developing the knowledge, skill, mind and character of the students by normal schooling.

(ii) In the instant case, clause (c) of the objects was to manage and maintain a library, reading-room and conduct classes of stitching, embroidery, weaving and schooling, adult education and education in the field of entertainment, arts, etc. The assessee-society had followed the instructions issued by the Board of Secondary Education in regard to practical examinations for home science and in the aforesaid instructions, stitching, embroidery, weaving subjects had been mentioned. The adult education is also a part of education. If the assessee-society introduced the aforesaid object, it could not be said that the object of the assessee-society was not of educational purpose.

(iii) Clause (d) of the objects was to make necessary arrangement for the complete development of the children. That object was also in consonance with the modern concept of education, because the education is not only to impart education through book reading, but it also includes sports activities and other recreational activities, dance, theatre and even having educational tour within the country and abroad, so that the children can develop their overall talent. It could not be said that the said object was not for educational purpose.

(iv) Apart from that, from the audited accounts of the society, it was clear that it had not used the amount and income for any other business activities. In such circumstances, rejecting the application of the assessee-society at threshold was arbitrary and illegal.

(v) It was also a fact that for prior two years, the assessee-society was granted exemption and after the year 2006-07, the assesseesociety had deleted the clauses (c) and (d) in its memorandum of association. In such circumstances, the order passed by the authority was illegal and against the provisions of section 10(23C)(vi).

(vi) Consequently, the petition was to be allowed. The impugned order was to be quashed. The application filed by the assessee for grant of approval u/s. 10(23C)(vi) was to be accepted.”

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