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Category: Direct Taxes

Depreciation: Rate: Section 32: Gas cylinder including valves and regulators: Entry in schedule: Rate 100%: Liquefied petroleum gas cylinder mounted on chasis of truck: Gas cylinder entitled to depreciation at 100%: Cannot be treated as motor vehicle.

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[CIT v. Ananth Gas Supplies, 335 ITR 334 (AP)]

The assessee was dealing in liquefied petroleum gas which it transported in gas cylinders fitted to the chassis of transport vehicles. The assessee claimed depreciation on the cylinders at 100% as applicable to gas cylinders. The Assessing Officer held that the assessee was entitled to depreciation at 40% as applicable to transport vehicles on the ground that the vehicle on which the cylinder was mounted was registered as transport vehicle. The Tribunal allowed the assessee’s claim.

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

“(i) The container mounted on the chassis of the truck was nothing but a gas cylinder and it fits the description of gas cylinder in Appendix I, Part I, item III(ii)F(4) read with Rule 5 of the Rules as including valves and regulators.

(ii) The mere fact that the container was mounted on the chassis of the truck did not deprive it of the character of gas cylinder. It had all the attributes of the cylinder and was not divested of its basic character as cylinder on account of the fact that the item was registered as a transport vehicle.

(iii) The assessee was therefore entitled to claim depreciation at 100% on the liquefied petroleum gas cylinder mounted on the chassis of the truck.”

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Business expenditure: TDS: Disallowance u/s.40(a)(i) r.w.s 194A: Assessee exporting goods: Bills of exchange discounted abroad: Discounting charges not interest: Tax not deductible at source: Discounting charges allowable as deduction.

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[CIT v. Cargill Global Trading P. Ltd., 335 ITR 94 (Del.); 241 CTR 443 (Del.)]

The assessee was in the export business. On the exports to its buyers outside India, the assessee drew bills of exchange on those buyers. These bills of exchange were discounted by the assessee from CSFA which on discounting the bills immediately remitted the discounted amount to the assessee. CSFA was a company incorporated in Singapore and a tax-resident of Singapore. The discount charges were claimed by the assessee as expenses u/s.37. The Assessing Officer disallowed the claim for deduction of the discount charges treating the same as interest on the ground that tax was not deducted at source from the amount. 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) It is clear from the definition in section 2(28A) of the Income-tax Act, 1961, that before any amount paid is construed as interest, it has to be established that the same is payable in respect of any money borrowed or debt incurred.

(ii) The discount charges paid were not in respect of any debt incurred or money borrowed. Instead the assessee had merely discounted the sale consideration. Tax was not deductible at source on the amount. The amount was deductible.”

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Business expenditure: TDS: Disallowance u/s.40(a)(i) r.w.s 195: Payment of interest by branch (PE) to head office abroad: By virtue of convention head office not liable to pay any tax in India: No obligation on branch to deduct tax at source: Interest to be allowed as deduction in the hands of branch.

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[ABN Amro Bank v. CIT, 241 CTR 552 (Cal.)]

The assessee-foreign company incorporated in the Netherlands had its principal branch office in India. Indian branch remits funds to head office as payment of interest. The Indian branch had not deducted tax at source on such interest payment to the head office. The following two issues were for consideration by the Calcutta High Court:

“(i) Whether interest payment made by the Indian branch of the appellant to its head office abroad was to be allowed as a deduction in computing the profits of the appellant’s branch in India?

(ii) Whether in making such payment to the head office, the appellant’s said branch was required to deduct tax at source u/s.195 of the Income-tax Act, 1961?”

The Calcutta High Court held as under:

“(i) An unnecessary complication has been created by the interpretation made of section 40(a) (i) r.w.s 195 by both the appellant and the respondents. A proper meaning has to be ascribed to the expression ‘chargeable’ under the provisions of this Act. Section 195(1) says that if any interest is paid by a person to a foreign company, which interest is chargeable under the provisions of this Act, tax should be deducted at source. The word ‘chargeable’ is not to be taken as qualifying only the phrase ‘any other sum’, but it qualifies the word ‘interest’ also. Where the interest is not so chargeable, no tax is deducted.

(ii) In this case, by virtue of the convention, the head office of the appellant is not liable to pay any tax under the Act. Therefore, there was and still is no obligation on the part of the appellant’s said branch to deduct tax while making interest remittance to its head office or any other foreign branch.

(iii) Therefore, if no tax is deductible u/s.195(1), section 40(a)(i) will not come in the way of the appellant claiming such deduction from its income. Therefore, in the circumstances, the appellant would be entitled to deduct such interest paid, as permitted by the convention or agreement, in the computation of its income.”

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Deduction u/s.10A: A.Y. 2004-05: Export proceeds received beyond 6 months: RBI approval under FEMA: Sufficient compliance u/s.10A: Amount received late entitled to deduction.

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[CIT v. Morgan Stanley Advantage Services Pvt. Ltd. (Bom.), ITA No. 4027 of 2010, dated 30-8-2011]

The assessee was entitled to deduction u/s.10A of the Income-tax Act, 1961. For the A.Y. 2004-05, for availing benefit u/s.10A, the assessee was required to realise the export proceeds by 30-9-2004. The assessee received export proceeds of Rs.2.20 crores in December 2004. On 7-10-2004, the assessee had made an application to the RBI seeking extension of time for realisation of the export proceeds. Reminders were sent on 24-1-2007 and 30-3-2007. By its letter dated 25-4-2007, the RBI confirmed the realisation of the amount under the provisions of FEMA. There was no separate approval under the provisions of the Income-tax Act, 1961. The Assessing Officer disallowed the claim for deduction of the said amount of Rs.2.20 crores u/s.10A of the Act. The Tribunal held that once the assessee has applied for extension and has completed all the formalities and in response the RBI has taken the remittance on record, then non-issuance of a formal letter of approval by the RBI cannot be held against the assessee for none of its fault. The Tribunal further held that in the facts of the present case, it must be held that the extension has been granted in substance and, therefore, the benefit of section 10A has to be allowed to the assessee on the ground that the extension is deemed to have been granted.

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

“(i) In our opinion, no fault can be found with the decision of the Tribunal. In the present case, the note appended to the RBI’s letter dated 25-4-2007 no doubt records that the approval granted by the RBI is under FEMA and the said approval should not be construed as approval by any Authority or Government under any other laws/regulations. The question is, whether the extension of time for realisation of the export proceeds by the Competent Authority under FEMA can be said to be the approval granted by the Competent Authority u/s.10A(3) of the Income-tax Act, 1961.

(ii) ‘Competent Authority’ in section 10A means the RBI or such other Authority as is authorised under any law for the time being in force for regulating payments and dealings in foreign exchange. Admittedly, RBI is the Competent Authority under FEMA which regulates the payments and dealings in foreign exchange. Thus, what section 10A(3) of the Act provides is that the benefits u/s.10A(1) would be available if the export proceeds are realised within the time prescribed by the Competent Authority under FEMA. In the present case, the competent authority under FEMA, namely, the RBI, has granted approval in respect of the export proceeds realised by the assessee till December, 2004. Therefore, the approval granted by RBI under FEMA would meet the requirements of section 10A of the Income-tax Act, 1961. In other words, once the competent authority under FEMA which regulates the payments and dealings in foreign exchange has approved realisation of the export proceeds by the assessee till December 2004, then it meets the requirements of section 10A(3) and consequently the assessee would be entitled to the benefits u/s.10A(1) of the Act.

(iii) Moreover, in the present case, the RBI which is the Competent Authority under FEMA as also u/s.10A of the Income-tax Act, 1961 has neither declined nor rejected the application made by the assessee seeking extension of time u/s.10A of the Act. Therefore, the decision of the Income Tax Appellate Tribunal in holding that the approval granted under FEMA constitutes a deemed approval granted by the RBI u/s.10A(3) of the Act cannot be faulted.”

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Business income/House property income: Rent from leave and licence of office premises: Assessable as business income.

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[The Scientific Instrument Co. Ltd. v. CIT (All.), ITA No. 1 of 2003, dated 12-8-2011]

The assessee company was carrying on business of import and sale of scientific instruments. It purchased premises at Nariman Point, Mumbai in 1982 and had its regional office there. In November 1987, the assessee gave the property on leave-and-licence basis to Citibank. The rental income so received was offered to tax by the assessee as ‘business profits’. The Assessing Officer assessed the income as ‘income from house property’. The Tribunal upheld the assessment.

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

“(i) In Universal Plast Ltd. v. CIT, 237 ITR 454 (SC), tests were laid down as to when income from property is assessable as ‘business profit’ and as ‘income from house property’.

(ii) Applying these tests, the rental income has to be assessed as ‘business profits’ because

(a) All assets of the business were not rented out by the assessee and it continued the main business of dealing in scientific apparatus, etc.

(b) The property was being used for the regional office and was let out by way of exploitation of business assets for making profit.
(c) The assessee had not sold away the properties or abandoned its business activities. The transaction is a ‘commercial venture’ taken in order to exploit business assets and for receiving higher income from commercial assets.”

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Offences and prosecution — False verification in return — Since the signature on return was not disputed at the time of assessment and penalty proceedings, it amounted to admission and the accused could not have been acquitted for the reason that prosecution was not able to prove the signature of the accused.

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[ITO v. Mangat Ram Norata Ram Narwana & Anr., (2011) 336 ITR 624 (SC)]

M/s.
Mangat Ram Norata Ram is a partnership firm carrying on the business of
sale and purchase of machinery, iron pipes and spare parts. One Mr. Hem
Raj happened to be one of its partners. M/s. Mangat Ram Norata Ram
(hereinafter referred to as ‘the firm’) filed its income-tax return for
the A.Y. 1988-89 on July 14, 1988 through its counsel, which was signed
and verified by Hem Raj, its partner. The income-tax return showed the
income of the firm Rs.1,02,800. Return was accompanied by statement of
income, trading accounts, profit and loss account, partnership account
and balance sheet for the A.Y. 1988-89. The assessment was completed by
the then Income-tax Officer u/s.143(3) of the Income-tax Act for
Rs.1,47,370.

The books of account of the firm were taken into
possession by the Sales Tax Department, which were obtained by the
Income-tax Department and on its perusal, discrepancies relating to
entries of income, sale and purchase, bank account, etc., were noticed
and accordingly a notice u/s.148 of the Income-tax Act, 1961
(hereinafter referred to as ‘the Act’) was issued requiring the
respondents to furnish a revised return within 30 days. The respondents
did not comply with the notice and thereafter notice u/s.142(1) of the
Act was issued and the assessee-firm ultimately filed its incometax
return declaring its income of Rs.1,47,870. This return was said to be
duly signed and furnished by the accused Hem Raj, which was accompanied
by a revised statement of income, trading account and profit and loss
account. All these documents were also signed by the accused Hem Raj. On
consideration of the same, the Assistant Commissioner of Income-tax
made addition of Rs.1,28,000 with the trading account, Rs.1,10,000 in
the bank account and Rs.19,710 as additional income and assessed the
total income to Rs.3,68,200 and directed for initiating penalty
proceedings.

Ultimately, the minimum penalty of Rs.1,24,950 was
imposed u/s.271(1)(c) of the Act and further a sum of Rs.7,890 and
Rs.12,680 u/s.271(1)(a) of the Act. The respondent firm filed appeal
against the imposition of penalty which was dismissed by the
Commissioner of Income-tax (Appeals). The respondents had paid the
penalty inflicted on the firm.

A complaint was also lodged for
prosecution of the respondents u/s.276C(1), 277 and 278 of the Act. The
Trial Court on appraisal of the evidence held both the respondents
guilty and awarded a fine of Rs.1,000 each u/s.276C(1), 277 and 278 of
the Act to the firm, whereas, Hem Raj was sentenced to undergo rigorous
imprisonment for one year and to pay a fine Rs.1,000 on each count and
in default to suffer simple imprisonment for three months.

The
firm and Hem Raj aggrieved by their conviction and sentence preferred
appeal and the Appellate Court set aside the conviction and sentence on
the ground that sanction for prosecution was not valid. The Appellate
Court further held that the prosecution has not been able to prove the
signature of Hem Raj in the return filed, and hence, the conviction is
bad on that ground also. The Income-tax Officer aggrieved by the
acquittal of the accused preferred an appeal and the High Court by its
impugned judgment upheld the order of the acquittal and while doing so
observed that the sanction is valid but maintained the order of
acquittal on the ground that the prosecution has not been able to prove
that the return was signed/verified by Hem Raj.

On further
appeal, the Supreme Court observed that the prosecution had led evidence
to prove that the revised return was filed by the firm under the name
of the accused Hem Raj and on that basis assessment was made by the
assessing authority. There is further evidence to show that aggrieved by
the order of assessing authority, an appeal was preferred before the
Appellate Authority under the signature of the accused Hem Raj, which
was dismissed and the penalty was paid. At no point of time the accused
Hem Raj made any objection that the return did not bear his signature
and was not filed by him. It is trite that admission is the best
evidence against the maker and it can be inferred from the conduct of
the party. Admission implied by conduct is strong evidence against the
maker, but he is at liberty to prove that such admission was mistaken or
untrue. By proving conduct of the accused Hem Raj in not raising any
dispute at any point of time and paying the penalty, the prosecution has
proved his admission of filing and signing the return. Once the
prosecution has proved that, it was for the accused Hem Raj to
demonstrate that he did not sign the return. There is no statutory
requirement that signature on the return has to be made in the presence
of the income-tax authority. Nothing has been brought in evidence by the
accused Hem Raj that the signature did not belong to him on the return
and the penalty was paid mistakenly. The Supreme Court was of the view
that the Appellate Court had misdirected itself in not considering the
evidence in a right perspective and acquitting the accused, so also the
High Court which failed to correct the apparent error.

Accordingly,
the Supreme Court allowed the appeal and the impugned orders were set
aside and the judgment of conviction passed by the Chief Judicial
Magistrate was restored. However, the Supreme Court reduced the
substantive sentence from one year to six months on each count and they
were directed to run concurrently.

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BUSINESS RESTRUCTURING — IMPLICATIONS U/S.56(2)(viia)

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The Finance Bill, 2010 witnessed the introduction of a new provision in the Income-tax Act, 1961 (IT Act), being the insertion of clause (viia) to sub-section (2) of section 56 of the IT Act, with effect from 1st day of June 2010.

Until such time, only individuals and Hindu Undivided Families (HUF) were covered within the provisions of section 56(2). As explained in the Memorandum to the Finance Bill 2010, clause (viia) was inserted in section 56(2) to prevent the practice of transferring shares of an unlisted company without consideration or at a price lower than the Fair Market Value (FMV) and to bring it under the tax net.

The legislative intent behind introduction of this provision was to prevent laundering of unaccounted income under the pretext of gifts, especially after abolition of the Gift Tax Act. Hence, these provisions are in the nature of anti-abuse provisions.

These provisions apply only if the recipient of shares is a company and in which public are not substantially interested or a firm. The term ‘firm’ has now been inclusively defined u/s.2(23)(i) to include a Limited Liability Partnership as defined (LLP), under the LLP Act, 2008.

We reproduce below the relevant extract of section 56(2)(viia) of the IT Act:

“(viia) where a firm or a company not being a company in which the public are substantially interested, receives, in any previous year, from any person or persons, on or after the 1st day of June, 2010, any property, being shares of a company not being a company in which the public are substantially interested, —

(i) without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;

(ii) for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration:

Provided that this clause shall not apply to any such property received by way of a transaction not regarded as transfer under clause (via) or clause (vic) or clause (vicb) or clause (vid) or clause (vii) of section 47.

Explanation — For the purposes of this clause, ‘fair market value’ of a property, being shares of a company not being a company in which the public are substantially interested, shall have the meaning assigned to it in the Explanation to clause (vii);”

The provisions of section 56(2)(viia) of the IT Act are therefore, attracted upon fulfilling of the following conditions:

(a) Recipient is a firm or a company not being a company in which the public are substantially interested, as defined u/s.2(18) of the IT Act closely held company;
(b) Transferor can be any person;
(c) Recipient must ‘receive’ shares of a closely-held company; and
(d) Shares should be received without consideration or for inadequate consideration.

Therefore any receipt of shares of a closely-held company, without consideration or for inadequate consideration, is taxable in the hands of the recipient.

For the purposes of this section, consideration would be deemed to be inadequate, if the difference between the actual consideration and the FMV (to be determined as per prescribed Valuation Rules) of the property exceeds Rs.50,000.

As per Rule 11UA of the Income-tax Rules, 1962, the FMV of unquoted shares is to be determined as under:

(a) Equity shares: Book value of the shares to be computed as follows:

(A – L) x (PV)
—————-
(PE)

Where,
A = Book value of the assets in balance sheet as reduced by any amount paid as advance tax under the Income-tax Act and any amount shown in the balance sheet including the debit balance of the profit and loss account or the profit and loss appropriation account which does not represent the value of any asset.

L = Book value of liabilities shown in the balance sheet but not including the following amounts —

(i) the paid-up capital in respect of equity shares;

(ii) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the date of transfer at a general body meeting of the company;

(iii) reserves, by whatever name called, other than those set apart towards depreciation;

(iv) credit balance of the profit and loss account;

(v) any amount representing provision for taxation, other than amount paid as advance tax under the Income-tax Act, to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto;

(vi) any amount representing provisions made for meeting liabilities, other than ascertained liabilities;

(vii) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares.

PE = Total amount of paid-up equity share capital as shown in balance sheet.

PV = the paid-up value of such equity shares.

Please note, here FMV does not imply the actual market value of the shares at which shares may be transacted between parties. It is the value of shares as determined based on book value of the assets and liabilities of the company.

(b) Other than equity shares: Price which the shares will fetch in the open market, to be determined by a valuation report of a Merchant Banker or a Chartered Accountant.

If, in case the company has issued Compulsory Convertible Preference Shares (CCPS), then unless it has been actually converted to equity shares, it would be regarded as ‘other shares’. Thus, on any transfer of CCPS before its conversion, one will have to consider its market value, as stated above, to ascertain the implications u/s.56(2)(viia).

The tax officer is given the power to refer the questions of FMV of equity shares and other shares, to a valuation officer. For this purpose, necessary changes have been made u/s.142A(1) of the IT Act, with effect from 1st July 2010.

In order to avoid hardships in genuine cases, certain exceptions have been provided in the said provision as listed below:
(a) Receipt of shares in an Indian company by amalgamating foreign company from the amalgamated foreign company, in a scheme of amalgamation;

(b) Receipt of shares in an Indian company by resulting foreign company from the demerged foreign company, in a scheme of demerger;

(c) Receipt of shares in case of business reorganisations of a co-operative bank;

(d) Receipt of shares in the resulting company by the shareholders of the demerged company, under a scheme of demerger; and

(e) Receipt of shares in the amalgamated company by the shareholders of the amalgamating company, under a scheme of amalgamation.

Thus, the receipt of shares of a closely-held company, for reasons, other than as mentioned above, would attract the provisions of section 56(2)(viia) of the IT Act.

It is pertinent to note that corresponding amendments to section 49 by insertion of sub-section (4) have been incorporated, so as to provide that if provisions of section 56(2)(viia) are invoked, then the FMV of the shares so determined would be regarded as the ‘cost of acquisition’ in the hands of the recipient. This is to ensure that once the recipient is taxed on the differential value of the consideration, i.e., difference between FMV and the actual consideration, then such recipient is entitled to add such value towards its cost of acquisition of the shares.

The applicability of these provisions to certain transactions which are not specifically included in the list of exceptions will have to be judged by interpretation of the provisions as they read vis-à-vis the actual legislative intent. A strict interpretation may lead to absurd results while digging the legislative intent may lead to a liberal interpretation.

In this article, we have dealt with certain peculiar situations which may arise in corporate restructuring.

1.    Receipt of shares pursuant to fresh issue of shares at a price less than FMV or issue of bonus shares by the company

In case, where a closely-held company restructures its capital base, it may consider the option of further issue/rights issue to new/existing shareholders. Unlike listed companies which are subject to pricing guidelines on preferential allotment, closely-held companies are free to issue shares at a price as decided by its board of directors.

Thus, legally a closely-held company is entitled to issue shares at less than the book value of its existing shares, being the FMV for the purposes of section 56(2). Now, whether such an issue of shares at less than FMV can be covered within the ambit of section 56(2)(viia)? Also, would there be any taxability u/s.56(2)(viia) in case of bonus issue by a company which due to its very nature would always be received by the shareholders without any consideration?

The application of section 56(2)(viia) to allotment of bonus does not seem to be the legislative intent. This is supported by the Memorandum to the Finance Bill, 2010 which indicates that section 56(2)(viia) ought to apply only in case of ‘transfer’ of shares. In case of allotment of shares, there is no ‘transfer’ of shares. Further, even the meaning of the words ‘receives any property’ contemplates that the property should be in existence before it can be received. Whereas, in case of issue of shares by a company, shares come into existence only at the time of allotment.

Additionally, in case of bonus issue, it is a case of capitalisation of reserves which in any case belong to the shareholders. Therefore, the shareholders do not receive shares without consideration, rather what they receive is in lieu of an existing right in the profits of the company. Hence, 56(2)(viia) ought not to apply to a bonus issue.

2.    Conversion of debentures into equity shares at a pre-agreed value

Similar to issue of equity shares, it is common for companies to issue debentures which are convertible into equity shares of the company at a later date. At the time of issue of such instrument, the subscriber would have paid the entire value of the debenture and would have agreed to the terms and conditions regarding the conversion ratio of debentures into equity shares.

A question that arises is at the time of actual conversion of debentures, if the FMV of the equity shares is higher than the price paid by the debenture holders to acquire the debentures, would section 56(2)(viia) apply?

Similar to the issue of equity shares for cash, on conversion of debentures, the company would issue equity shares to debenture-holder in consideration of the value of the debentures being surrendered to the company. On allotment of shares by the company at the time of conversion of debenture, new shares are brought into existence at such point of time and hence section 56(2)(viia) ought not to apply on conversion of debentures into equity shares.

3.    Implications for non-resident recipients

Section    56(2)(viia) does    not make any distinction between resident and non-resident companies/ firms. Therefore, receipt of any shares of a closely held company by a non-resident without consideration or for an inadequate consideration would be taxable as ‘Income from other sources’ under the IT Act.

However, if the non-resident is a resident of a foreign country with which India has entered into a Double Tax Avoidance Agreement (DTAA), his taxability in India would depend on the relevant DTAA. Under the DTAA, the said income may be governed by the Article dealing with ‘Other Income’. It may be noted that the DTAAs entered by India with countries like Czech Republic, Germany, Hungary, Mauritius, etc., provide that ‘Other Income’ earned by a resident of a Contracting State shall be taxable only in the Contracting State where the taxpayer is resident, except if the tax-payer carries on business in the other Contracting State through a permanent establishment (PE) or the person provides independent personal services from a fixed base situated therein. In other words, section 56(2)(viia) may not apply to a non-resident, if he does not have a PE or fixed base in India.

If the non-resident is a resident of a foreign country with which India has not entered into a DTAA, then the provision of section 56(2)(viia) of the IT Act would apply and income earned by such non-resident would be subject to tax in India.

4.    Sale of an undertaking comprising of shares on a slump-sale basis

When a closely-held company acquires an ‘undertaking’ by way of a ‘slump sale’ and the undertaking, inter alia, comprises of shares of a company in which public are not substantially interested, whether it can be said that provisions of section 56(2)(viia) get attracted.

In such a case, can it be said that the transfer is of certain assets and liabilities as a whole for a lump sum consideration and that it would not be possible to artificially allocate consideration towards the shares, which form part of the undertaking?

Even if one were to ignore the practical difficulty, section 56(2)(viia) should not apply to sale of an undertaking, because the words used in section 56(2)(viia) are ‘receives any property, being shares of a company …….’ which means that the property being transferred/received should be shares of a company. In case of sale of an undertaking, the property being transferred would be an ‘undertaking’ and not ‘shares’ per se. To attract section 56(2)(viia), the subject matter of receipt should be ‘property being shares’ and not property being an undertaking which may include shares of a company in which public are not substantially interested. Several Court decisions have recognised ‘undertaking’ as a distinct capital asset or a distinct property. If sale of an undertaking on a slump sale is viewed as a sale of individual assets like plant and machinery, shares, etc. and subjected to section 56(2)(viia), it would go to diluting the meaning of slump sale.

However, the above argument may be looked at differently by the Revenue authorities, in case of transfer of an undertaking where the undertaking comprises only of shares of a company, i.e., an Investment Division.

5.    Capital reduction/Buyback of shares

Amongst others, companies resort to capital reduction u/s.100-103 of the Companies Act as part of their corporate restructuring. One of the ways of doing capital reduction is by way of cancellation of shares either partially or fully (in case a class of shares is being cancelled). Depending on the purpose of capital reduction and the liquidity in the company, the board of directors may decide to pay the shareholders certain amount of consideration per share. In case of closely-held companies, the FMV as defined for the purpose of section 56(2)(viia) of the shares may or may not be relevant in deciding the consideration on cancellation of shares. Post introduction of section 56(2)(viia), the issue is whether this section will get attracted in the hands of a company if the consideration paid is less than the FMV of the shares cancelled.

On the same lines, can it be said that a buyback of shares by a closely-held company u/s.77A of the Companies Act, 1956 will attract the provisions of 56(2)(viia) of the IT Act?

The key issue here is whether the meaning of the words ‘receives’ as used in the provision can extend to buyback or capital reduction for mere cancellation purposes? As the word ‘receives’ is not defined under the IT Act, it gives room to varied interpretations.

While the ‘transfer’ of shares pursuant to capital reduction/buyback are taxable transfers in the hands of the transferor, the tax authorities may contend that these would constitute ‘receipt’ in the hands of the company cancelling or buying back the shares and therefore should be subjected to section 56(2)(viia) if the consideration paid to the shareholders is less than the FMV.

A relevant point, that the company does not receive its shares, but only cancels its share capital pursuant to the powers conferred on it under the Companies Act. In fact, the Companies Act does not permit a company to hold its own shares. Even if one were to say that a company receives its own shares on buyback or cancellation of shares, it is for the limited purpose of cancellation of those shares and therefore the company does not actually ‘receive’ any property, in the nature of shares.

However, litigation on applicability of section 56(2)(viia) to buyback or reduction cannot be ruled out.

6.    Transfer of shares by a partner of a firm/LLP

When a partner of a firm/LLP transfers shares of a closely-held company by way of capital contribution to a firm/LLP, section 45(3) of the IT Act would apply. As per section 45(3), the amount recorded in the books of accounts is deemed to be the full value of the consideration for computing the capital gain in the hands the partner.

If, the value so recorded in the books of the firm/ LLP is less than the FMV as determined under the valuation rules, then it may be possible that the difference between the FMV and the price at which transfer is made by the partner, may be considered as income of the firm/LLP u/s. 56(2)(viia) of the IT Act.

While undertaking any business reorganisation, a closely-held company will have to evaluate the applicability and the possible implications u/s.56(2) (viia) of the IT Act. Since this is a recently introduced provision, various interpretations can emerge.  

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.

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Copy available for download on www.bcasonline.org

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Cross-border Secondments — Tax implications

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Just as the ambiguity over tax implications on secondment of expats to India appeared to be settling down, the Authority for Advance Rulings (‘AAR’) has vide its ruling in the case of Verizon Data Services1, reopened the Pandora’s box by holding that salary reimbursement of seconded employees is taxable in India as Fees for Included Services (‘FIS’)/ Fees for Technical Services (‘FTS’).

This article discusses key tax implications arising on Secondment of employees of Foreign Company to Indian Company, in light of the existing regulations and various judicial precedents.

Introduction
Increasing number of MNCs establishing business in India has led to a huge surge in the number of ‘Expatriates’ working in India. The term ‘expatriate’ has not been defined in the Act. However, as per various legal dictionaries2, expatriate means someone who is removed from/voluntarily leaves one’s own country to reside in or become a citizen of another country.

Typically, Foreign Companies (‘FCo’) depute their employees to India either in connection with some project or for rendering services to the Indian company (‘ICo’) or to safeguard their interest in India (stewardship functions). For this purpose FCo may enter into a contract to depute their employees to ICo for a predetermined time period. FCos also depute their employees to India as a part of a Foreign Collaboration Agreement (‘FCA’) under which they are obliged to provide complete support to ICo in carrying out business ventures.

‘Deputation’, in common parlance means appointment, assignment to an office, function. The dictionary meaning of the term ‘Second’ is to transfer temporarily to another unit or employment for a special task3. However, as a common practice, both these terms are used interchangeably.

Dual employment

To retain employment with FCo and safeguard the social security/retirement benefits in their home country, expats desire to continue to be on the payroll of FCo and receive salary in their home country. Accordingly, the foreign entity will be regarded as the ‘Legal Employer’. On the other hand, the expats function under the control and supervision of the ICo which eventually bears their salary costs by reimbursing the same to FCo. Thus, ICo can be regarded as the ‘Real’ or ‘Economic employer’.

The concept of ‘Dual Employment’ is also recognised in section 192(2) of the Income-tax Act, 1961 (‘Act’). The Section provides for withholding tax compliances in case of ‘Simultaneous employment’ or ‘Successive employment’ with an option to the employee to choose one of the employers who can consolidate the withholding tax obligations in respect of his salary.

With this background, let us understand the tax implications arising out of the said arrangements. Key tax implications on secondments

  • Expats — Salary received by expatriate employees could be subject to tax in India as such
  • Foreign Companies — FCo deputing expats could be subject to tax in India.

For the purposes of this article, we have only discussed the taxability of FCos in India.

Tax implications in the hands of FCo
Taxation of payments made to FCos in India, pursuant to secondment contracts has been a subject-matter of litigation since quite some time now. The Indian Revenue authorities have been contending that by sending their employees to India, the foreign entities are actually rendering services to the ICo or carrying out business in India. Accordingly, they hold that;

  • the payments made by Indian entities are in the nature of Fees for Technical Services (‘FTS’); or
  • the foreign entities have a Permanent Establishment (‘PE’) in India by virtue of the employees’ presence in India.

Consequently, ICo is held liable to withhold taxes u/s.195 of the Act, before making payments to FCo.

On the other hand, FCos believe that merely by seconding their employees to work under the supervision and control of ICo, they are not rendering any services in India. The amount recharged to ICo is mere recovery of salary costs of secondee paid by FCo in the home country and no taxable income arises in India.

Explanation 2 to section 9(1)(vii) and Article 12/13 dealing with FTS in many DTAAs specifically excludes ‘salaries’ from the scope of FTS. Thus, if it can be established that the secondee is the employee of ICo, then the salary cost recharged by FCo cannot be regarded as FTS.

As regards PE, by virtue of its employees’ presence in India, FCos are exposed to two types of PEs; (i) Service PE and (ii) Fixed Place PE. One of the most important factors to mitigate the PE risk in case of secondment arrangements is establishing the fact that the ICo is the real employer of the expats and FCo does not have any presence in India through them.

Thus, the moot question is whether the secondee, who renders services to ICo can be regarded as its employee, even though he continues to remain on the payroll of FCo.

Contract of service and contract for service

A contract, by virtue of which an employer-employee relationship is established, is regarded as a Contract of Service, whereas contracts which entail services to be rendered by one entity to another could be regarded as Contracts for Services. The importance of this distinction is also recognised by the OECD4 in their ‘Model Tax Convention on Income and on Capital’ published in July 2010 (‘hereinafter referred to as the OECD commentary’).

In order to draw distinction between ‘contract of service’ and ‘contract for service’, one needs to understand what constitutes an employment relationship in case of such contracts. Thus, interpretation of the term ‘employer’ assumes paramount significance.

Employer
The term ‘employer’ is not defined in the OECD model convention or in the Indian domestic law. However, the Hon’ble Supreme Court of India, in various decisions5 has laid down the following key tests to determine the existence of employment relationship.

  • Control and supervision over the method of doing work;
  • Payment of wages or other remunerations;
  • Power of selection of the employee;
  • Right of suspension or dismissal of the employee

Further, the OECD Commentary6 has also laid down the following key factors for determining an employer-employee relationship:

  • Authority to instruct the individual regarding the manner in which the work is to be performed
  • Control and responsibility for the place of work
  • Remuneration of the individual is directly charged by the formal employer to the enterprise to which the services are provided
  • Provision of tools and materials to employee
  • Determination of the number and qualifications of the individual seconded
  • Right to select the individual to perform work and to terminate contractual agreements with the employee for that purpose
  • Right to impose disciplinary sanctions related to the work of that individual
  • Determination of holidays and work schedule.

The OECD commentary7 also provides that the financial arrangement between the two enterprises would also be one of the relevant factors in determining the nature of the relationship.

Renowned author, Professor Klaus Vogel in his treatise on Double Taxation Conventions has provided his views on the term ‘employer’ as follows

“An employer is someone to whom an employee is committed to supply his capacity to work and under whose directions the latter engages in his activities and whose instructions he is bound to obey.”8

As per Prof. Vogel’s hypothesis9, the determination of employer rests with the degree of personal and economic dependence of the employee towards the enterprises involved. Thus, if the employee works exclusively for the ICo and was released for the period in question by the FCo, he may be regarded as an employee of the ICo.

Thus, the aforesaid criteria can be applied in determining the existence of an employer-employee relationship between the ICo and the Secondee.

Judicial precedents

Having discussed what constitutes an employer-employee relationship, let us now look at the stand adopted by Indian judicial authorities in case of such secondment contracts. The common issue before the judiciary is whether the reimbursement of salary cost by ICo to FCo could be regarded as income of the FCo (FTS or otherwise) and be subject to withholding tax u/s.195 of the Act?

Having regard to the terms of the secondment contracts and after applying the tests discussed above, the Indian judicial authorities, in various cases10  have held that reimbursement of salary costs of seconded employees cannot be regarded as income of the FCo. Consequently, there is no withholding tax requirement u/s.195 of the Act. Some of the key common observations in most of these decisions are discussed below:

  •   Expats are deputed to work under the control and supervision of the ICo. FCo is not responsible for the actions of the expats. Thus, FCo does not render any technical service to the ICo.

  •   Since payment by ICo is towards reimbursement of salary cost borne by FCo, no income can be said to accrue to FCo in India.
  •     Referring to Klaus Vogel’s commentary and the relevant facts, ICo could be regarded as an ‘economic employer’ of the secondees. Agreement constituted an independent contract of service.

  •     Since the deputed employees were not subject to the control and supervision of the FCo, there would be no Service PE.

However, in case of AT&S India Pvt. Ltd.11, it was held that compensation paid by ICo to FCo constituted FTS liable to withholding tax u/s.195 of the Act. While arriving at the said ruling, the AAR made the following key observations:

  •     FCo was the real employer of the secondees as it retains right over the employees and has power to remove/replace them

  •     Pursuant to foreign collaboration agreement, FCo had undertaken to render the services to ICo and hence, lent the services of its seconded employees on payment of compensation by ICo

  •     The recipient of the compensation was FCo and not the seconded employees. Further, the payment was not merely reimbursement of salary, it also included other costs

  •     Thus, compensation referred to in the secondment agreement was for rendering ‘services of technical or other personnel’ — hence taxable as FTS and liable to withholding of tax u/s.195.

Here the key fact noted by the AAR was that the secondment agreement was in connection with the foreign collaboration agreement, whereby FCO had undertaken to render services to ICo. Accordingly, payments made pursuant to the secondment agreement were held taxable in the nature of fees for services rendered by FCo.

Verizon ruling

This recent AAR ruling has reignited the somewhat settled position as regards secondment contracts.

Facts

The applicant, Verizon India (‘VI’) is engaged in providing software and allied services to its parent, Verizon US (‘VUS’). GTE Overseas Corporation (‘GTE’), another US-based affiliate is engaged in business activity similar to VI. VI entered into an agreement with GTE for secondment of its three employees to India. The structure of the arrangement is depicted below:

One of the secondees assumed the position of managing director of VI while the other two employees liaised between VI and VUS, and supervised its day-to-day operations.

The salient features of the agreement were:

  •     Employees would function exclusively under the control and supervision of VI;

  •     Employees would continue to remain on the payroll of GTE;

  •     GTE would be absolved from the responsibility/ liability of the work, actions performed and the quality of results produced by its employees;

  •     GTE had the authority to replace and terminate the employees;

  •     GTE would disburse the salary of the secondees and get the same reimbursed from VI without any mark-up;

  •     VI would be liable for the Indian withholding tax compliances and the payments to GTE would be made ‘Net of taxes’.

Key questions before the Authority

  •    Whether the amounts reimbursed to GTE would constitute income accruing to GTE and therefore the same is liable to deduction of tax in accordance with the provisions of section 195 of the Act?

  •     If yes, then whether the payment is taxable as Fees for Included Services (‘FIS’) under the Act read with the India-USA DTAA?

AAR Ruling12

The AAR held that the seconded employees are employees of GTE and not VI. The payments made for performing managerial services would be regarded as FIS under the India-USA DTAA. Also, managerial services are directly covered under FTS as defined under Explanation 2 to section 9(1)(vii) of the Act. Hence, the payment is taxable and VI would be liable to withhold tax u/s.195 of the Act. While arriving at the said conclusion, the AAR made the following key observations:

  •    Since the control and supervision of the company vests with the managing director, GTE has rendered managerial services to the applicant.

  •     The ‘net of tax’ payment clause in the agreement suggests that the services provided by GTE were liable to tax in India.

  •     Since the employees continue to be on the payroll of GTE, get their salaries from it and can be terminated only by GTE, GTE is the employer of the seconded employees.

  •     The nature of the two receipts, one in the hands of GTE and the other in the hands of employees by way of salaries spring from different sources and are of different character and represent different species of income.

  •     As per MOU of the DTAA it is clear that ‘make available’ clause would be applicable only to technical services. ‘Make available’ clause does not apply to managerial services, the payments for which are otherwise covered within the ambit of FIS under Article 12(4) of the DTAA.

  •     Since the amount reimbursed by the applicant is taxable as FIS, the question of PE is merely of an academic interest. Accordingly, the same was not delved into.

Analysis

  •     AAR has not appreciated that managing director is subject to the superintendence and control of Board of Directors and MOA/AOA of the company. The fact that a managing director can be regarded as an employee of the company has been discussed in several judicial precedents14. The AAR also failed to consider the Tribunal rulings in the cases of IDS Software and Karlstorz Endoscopy India, which dealt with similar facts.

  •     AAR failed to consider Circular No. 720 of the CBDT, dated 30th August 1995, which clarifies that each section relating to tax withholding under Chapter XVII of the Act deals with a particular kind of payment and excludes all other sections in that Chapter and that the payment of any sum shall be liable to deduction of tax only under one section. This Circular was duly relied upon in the case of HCL15. Withholding tax on reimbursements u/s.195 which have already suffered tax u/s.192 amounts to double taxation.

  •     While analysing whether the ICo is the real employer, the AAR ignored the key tests laid down by the Supreme Court, OECD guidelines and Klaus Vogel’s commentary on International Hiring Agreements.

  •    AAR has misinterpreted the FIS clause in the India-US treaty by holding that for services that are technical or consultancy in nature, the make-available clause would not apply. Various judicial precedents16 have held that services which are not technical in nature are not covered within the scope of FIS clause.

  •    The AAR ruling is also not in line with other decisions pronounced on similar issue by various authorities in the cases of HCL Infosystems, Cholamandalam MS General Insurance, IDS Software Solutions, etc.

Key takeaways

  •     Since the law is not yet settled and various judicial authorities have adopted different interpretations, drafting of the secondment agreement by clearly defining the nature of relationships between various parties assumes paramount significance.

  •    While drafting the agreement, the principles promulgated by the OECD and the tests laid down by the Apex Court which determine the existence of an employer-employee relationship should be kept in mind.

  •     The documentation and conduct of the seconded employees may also influence taxation of such transactions.

  •    A periodic review of the documentation and compliance process in line with the latest judicial precedents could help in mitigating risk.

Conclusion

The conflicting rulings by various authorities and the uncertainty on taxability of payments made pursuant to secondment contracts continue to create a dilemma in minds of Indian as well as multinational corporations deputing their employees in India. However, to put at rest the stir created by such rulings, concrete clarification from the Legislature17 or the final word from the Apex Court in the near future is the need of the hour. Till then it’s a wait-and-watch situation for all18.

1       Verizon Data Services India Private Limited v. CIT (AAR No. 865 of 2010)

2       a. Law Lexicon (2nd Edition, reprint 1999 on page 681) — ‘Renunciation of allegiance, one voluntary renunciation of citizenship in order to become a citizen of another country’

b.     Black’s law dictionary (Sixth Edition, page 576) — The voluntary act of abandoning renouncing one’s country and becoming the citizen or subject of another

c.     Webster — Residing in a foreign country

d.    Oxford — Remove onself from homeland

3       As noted by the AAR Cholamandalam MS General Insurance Co. (2009 TIOL 02 ARA-IT)

4       Para 8.4 of the Commentary on Article 15

5       Lakshminarayan Ram Gopal (25 ITR 449); Piyare Lal Adishwar Lal (40 ITR 17); Ram Prashad (86 ITR 122)
 
6. Para 8.14 of the Commentary on Article 15

7       Para 8.15 of the Commentary on Article 15

8       Page 899

9       Page 885

10     IDS Software Solutions v. ITO, 2009 TII 22 ITAT-Bang-Intl; Cholamandalam MS General Insurance Co. Ltd. (‘CM’)(2009 TIOL 02 ARA-IT) (Advance Rulings); Tekmark Global Solutions LLC (‘TLLC’) (131 TTJ 173) (Mumbai-ITAT); ACIT v. Karlstorz Endoscopy India Pvt. Ltd. (‘KI’) (ITA No. 2929/ Del/2009)

11     AT&S India Pvt. Ltd. — 287 ITR 421 (‘AAR’) — Distinguished in case of Cholamandalam MS General Insurance Co. Ltd.

12     AAR ruling is binding only on the applicant and the Income-tax officer in respect of transaction in relation to which the ruling is sought. However, persuasive value may be drawn in other similar cases.

13     DIT v. Morgan Stanley and Co. Inc. 292 ITR 416 (SC)

14     K. R. Kothandaraman v. CIT (1966) 62 ITR 345 (Mad), Scottish Court of Sessions in Anderson v. James Sutherland(1941) S.C. 203, Ram Prashad v. CIT (1972) 86 ITR 122 (SC)

15     In HCL Infosystems Ltd. v. DCIT, (76 TTJ 505, later affirmed by Delhi High Court in 272 ITR 261), Delhi ITAT held that reimbursement of salary cost of personnel seconded by Indian company to foreign company was not subject to tax withholding u/s.195

16     Raymonds Ltd. 80 TTJ 120 (Mum.), Boston Consulting Group – 93 TTJ 293, McKinsey & Co. Inc (Philippines) & others 99 TTJ 857 (Mum.)

17     The Legislature has recognised the ambiguity and has endeavoured to provide some clarity on the subject by defining the term employer in the proposed Direct TaxesCode, 2010.

18     Verizon has filed an appeal before the High Court against the said ruling. The outcome is eagerly awaited.

(2011) 57 DTR (Visakha) (Trib.) 299 Swaraj Enterprises v. ITO A.Y.: 1999-2000.

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Section 40(b) — Partners may choose not to provide depreciation in books and in such case AO is not entitled to deduct the cumulative depreciation from capital balances for working out interest u/s.40(b).

Facts:
The assessee paid interest to its partners and claimed the same as deduction. There was no dispute that the partnership firm had complied with the conditions prescribed u/s.40(b) of the Act. The dispute was related to the determination of the capital account balances of the partners on which the interest is payable. The assessee claimed interest on the capital account balances of the partners as disclosed in its books of account. However, during the course of assessment proceedings, the AO noticed that the firm did not provide for depreciation on the fixed assets in its books. However for the purpose of computing the total income, it has claimed depreciation in accordance with section 32 of the Act. Thus it was noticed that the net profits for book purposes have been shown at a higher figure by not charging depreciation, which would consequently increase the capital balances of the partners. In that case, the assessee would claim deduction of more amount of interest on the capital balances so inflated by not providing depreciation on the fixed assets. The AO felt that it is compulsory for the assessee to provide for depreciation in the books also.

Hence the AO reworked the capital balances of the partners by reducing the cumulative amount of depreciation therefrom and accordingly allowed the interest computed on such reduced capital balances. The learned CIT(A), confirmed the order of the A.O. The learned CIT(A) relied upon the decision of the SMC Bench of Visakhapatnam in the case of Arthi Nursing Home v. ITO, (2008) 119 TTJ (Visaka) 415 in order to reject the appeals filed by the assessee before him.

Held:
In the case of Arthi Nursing Home (supra), the SMC Bench, inter alia, placed reliance on the decision of the Supreme Court in the case of British Paints Ltd. (1991) 188 ITR 44, wherein it was held that the AO has a right and also duty to consider whether the books disclose the true state of accounts and the correct income can be deduced therefrom. The computation of total income is not affected by the amount of depreciation provided for in the books of account and the position remains the same even if no depreciation is provided for in the books. Hence, in our view, the ratio laid down in the case of British Paints Ltd. (supra) shall not apply in respect of depreciation, as it will not affect the computation of total income under the Income-tax Act.

Under the Partnership Act, there is no statutory compulsion to provide for depreciation in the books of account or to follow the accounting standards prescribed by the ICAI, though it may be in the interest of the partnership firms to follow the said accounting standards.

In Explanation 5 to section 32, the words ‘whether or not the assessee has claimed the deduction in respect of depreciation’ would show that the assessee has an option not to claim depreciation while computing his total income, but the said option shall be ignored by the AO and he will deduct depreciation from the total income of the assessee. Thus, there is no statutory compulsion for the partnership concerns to provide for depreciation in the books of account under Explanation 5 to section 32.

The AO is authorised only to verify whether the payment of interest to any partner is authorised by and is in accordance with the terms of partnership deed and also it relates to the period falling after the date of partnership deed. Besides the above, the AO should restrict the rate of interest, if the rate authorised in the partnership deed is more than the rate specified in section 40(b)(v) of the Act. Thus, it could be seen that nowhere it is provided that the AO is entitled to disallow the payment of interest to partners by reworking the capital account balances of the partners.

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Income: Interest: Accrual of: Mercantile system: Section 5 of Income-tax Act, 1961: NBFC; Interest on loans given: Loans became non-performing assets: Interest not received and possibility of recovery nil: Interest not accrued.

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[DIT v. Brahamputra Capital Financial Services Ltd., 335 ITR 182 (Del.)]

The assessee, a non-banking financial company, had given interest-bearing loans to group concerns. In the relevant year, the loans had become non-performing assets in terms of the guidelines issued by the Reserve Bank of India. In the relevant year, the assessee did not show the interest in the P&L A/c on the ground that it was unlikely to receive the interest thereupon and thus the interest had not accrued to the assessee in the relevant assessment year. The Assessing Officer held that since the assessee is following mercantile system of accounting the interest had accrued to the assessee and was to be treated as income of the assessee u/s.5. 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) The Tribunal had accepted the contention of the assessee that since the recovery of the principle amount of loan itself was doubtful, a decision was taken as a prudent businessman and interest was not accounted for in the books of account. According to the assessee, under these circumstances, there was no real accrual of interest and interest was not taxable in the hands of the assessee having regard to the principles of real income by holding that there was no accrual of real income and, therefore, it did not become income in the hands of the assessee u/s.5 of the Act.

(ii) The Tribunal had also held that merely because the assessee and the borrowers were known to each other, that would not be sufficient to render the financial position of borrower company better, so as to increase the likelihood of interest payment to the assessee.

(iii) On non-performing assets where the interest was not received and possibility of recovery was almost nil, it could not be treated to have been accrued in favour of the assessee.”

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

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Copy of the Instructions available on www.bcasonline.org

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Reassessment: Section 147 and section 148 of Income-tax Act, 1961: Reopening of assessment on reason to believe that certain items of income have escaped assessment: Finding in reassessment proceedings that such items of income have not escaped assessment: Reassessment proceedings not valid: AO cannot assess any other income.

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[Ranbaxy Laboratories Ltd. v. CIT (Del.), ITA No. 148 of 2008 dated 3-6-2011]

The assessee-company was engaged in the business of manufacturing and trading of pharmaceutical products. For the relevant year, the assessee filed the return of income on 31-10-1994, which was processed u/s.143(1)(a) of the Income-tax Act, 1961. Subsequently, a notice u/s.148 was issued on 23-1- 1998 for the reason that the items viz., club fees, gifts and presents and provision for leave encashment have escaped assessment. In reassessment proceedings the assessee explained that there is no escapement of income on account of these items and the explanation was accepted by the Assessing Officer. Accordingly, no addition was made on that count. However, the Assessing Officer reduced the claim for deduction u/s.80HHC and u/s.80I of the Act. The assessee challenged the validity of the assessment order and the additions. The Tribunal upheld the reassessment and the additions.

On appeal by the assessee, the Delhi High Court followed the decision of the Bombay High Court in the case of Jet Airways; 331 ITR 236 (Bom.), allowed the appeal and held as under:

“(i) Though Explanation 3 to section 147 inserted by the Finance Act, 2009 w.e.f. 1-4-1989 permits the Assessing Officer to assess or reassess income which has escaped assessment even if the recorded reasons have not been recorded with regard to such items, it is essential that the items in respect of which the reasons had been recorded are assessed.

(ii) If the Assessing Officer accepts that the items for which reasons are recorded have not escaped assessment, it means he had no “reason to believe that income has escaped assessment” and the issue of the notice becomes invalid. If so, he has no jurisdiction to assess any other income.”

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Appeals to the Appellate Tribunal, High Court and Supreme Court — Circular laying down monetary limit not to apply ipso facto.

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[CIT v. Surya Herbal Ltd., SLP (CC) No. 13694 of 2011 dated 29-8-2011]

By an Instruction No. 3/2011 [F. No. 279/Misc. 142/2007-IT] dated 9-2-2011, the Central Board of Direct Taxes specified the monetary limits and other conditions for filing departmental appeals (in income-tax matters) before the Appellate Tribunal, High Courts and Supreme Court were specified as under:

As per the instructions, the appeals should not be filed in cases where the tax effect does not exceed the monetary limits given hereunder:

Sr. No. Appeals in income-tax matters Monetary limit (in Rs.)
1. Appeal before Appellate Tribunal 3,00,000
2. Appeal u/s.260A before High Court 10,00,000
3. Appeal before Supreme Court 25,00,000

It was clarified that an appeal should not be filed merely because the tax effect in a case exceeds the monetary limits prescribed above. Filing of appeal in such cases should to be decided on merits of the case.

Paragraph 5 of the said Circular read as under:

5. “The Assessing Officer shall calculate the tax effect separately for every assessment year in respect of the disputed issues in the case of every assessee. If, in the case of an assessee, the disputed issues arise in more than one assessment year, appeal can be filed in respect of such assessment year or years in which the tax effect in respect of the disputed issues exceeds the monetary limit specified in para 3. No appeal shall be filed in respect of an assessment year or years in which the tax effect is less than the monetary limit specified in para 3. In other words, henceforth, appeals can be filed only with reference to the tax effect in the relevant assessment year. However, in case of a composite order of any High Court or Appellate Authority, which involves more than one assessment year and common issues in more than one assessment year, appeal shall be filed in respect of all such assessment years even if the ‘tax effect’ is less than the prescribed monetary limits in any of the year(s), if it is decided to file appeal in respect of the year(s) in which ‘tax effect’ exceeds the monetary limit prescribed. In case where a composite order/judgment involves more than one assessee, each assessee shall be dealt with separately.”

The Delhi High Court by its order dated 21st February, 2011 passed in ITXA No. 379 of 2011, dismissed the Revenue’s appeal for the reason that the tax effect was less than Rs.10 lakh.

On an appeal against the order of the Delhi High Court, the Supreme Court gave liberty to the Department to move the High Court pointing out that the Circular dated 9th February, 2011, should not be applied ipso facto, particularly, when the matter has a cascading effect. The Supreme Court held that there are cases under the Income-tax Act, 1961, in which a common principle may be involved in subsequent group of matters or large number of matters. The Supreme Court was of the view, that in such cases if attention of the High Court was drawn, the High Court would not apply the Circular ipso facto. For that purpose, liberty was granted to the Department to move the High Court in two weeks. The special leave petition was, accordingly, disposed of.

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Business expenditure: Revenue or capital: A.Y. 2002-03: Assessee in business of manufacture of steel wire rods, etc.: Paid Rs. 45,21,000 to Mahanagar Gas Ltd. towards CNG connection: Is revenue expenditure.

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[CIT v. TATA SSL Ltd. (Bom.), ITA No. 1321 of 2010 dated 8-6-2011] The assessee, a public limited company, was engaged in the business of manufacturing steel wire rods, wires, CR sheets and profiles. In the relevant year i.e., A.Y. 2002-03, the assessee had paid Rs. 45,21,000 to Mahanagar Gas Ltd. towards CNG connection. The assessee claimed the expenditure as revenue expenditure. The Assessing Officer disallowed the claim. The Assessing Officer held that expenditure is capital in nature on the ground that the payment was made as capital contribution towards the cost of acquiring service meter, twin steam regulator, meter regulating station and cost of pipelines up to meter regulating station and that the payment was made before commencement of the gas supply. The Tribunal allowed the assessee’s claim. The Tribunal held that by paying the impugned amount to Mahanagar Gas Ltd., the assessee did not acquire any right or control over the gas facility. The Tribunal held that the facilities served the sole purpose of supplying the gas to the assessee’s work and, therefore, it was an integral part of profitearning process and facilitated in carrying on the assessee’s business more efficiently without giving any enduring benefit to the assessee.

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

“(i) In the present case, the finding recorded by the Tribunal is that the assets remained the property of Mahanagar Gas Ltd. and that the sole object of payment was to get gas to facilitate the manufacturing activity carried on by the assessee.

(ii) In these circumstances, in our opinion, no fault can be found with the decision of the Tribunal.”

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Interest-tax — Supreme Court — Matter remanded for determining the questions that arose in accordance with the law.

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[Motor and General Finance Ltd. v. CIT, (2011) 334 ITR 33 (SC)] The assessee, a non-banking financial company registered with R.B.I., was engaged in the business of hirepurchase and leasing. In the return of income, 1961 it showed the following components of income:

Rs.
(A) Lease charges 40,86,85,186
(B) Hire-purchase charges 32,64,89,358
(C) Bill discounting charges 1,91,48,614

The assessee did not, however, file any return of interest under the Interest-tax Act, 1974 (for short ‘1974 Act’). The Assessing Officer served a letter on the assessee asking the assessee to explain the reasons for not filing the Interest-tax return for the A.Y. 1995-96. A reply was filed by the assessee requesting the Assessing Officer to withdraw his letter, as the assessee claimed that it was not liable to file returns under the 1974 Act. On 31st March, 2005, a notice u/s. 10 of the 1974 Act was served on the assessee calling upon it to file its return of interest. According to the Assessing Officer, the interest chargeable to tax had escaped assessment. According to the Assessing Officer, on a perusal of the income-tax return of the assessee for the A.Y. 1995-96, it was found that the assessee was engaged in financial activities; that it had income from net hire-purchase charges, lease charges and bill discounting charges as indicated hereinabove. Since the assessee did not file the required return of chargeable interest the Assessing Officer assessed the chargeable interest by way of best judgment assessment u/s. 8(3) of the 1974 Act. The total interest chargeable, according to the Assessing Officer, was Rs.75,43,23,158. One of the issues which arose for determination was whether the transactions undertaken by the assessee were in the nature of hire-purchase and not in the nature of financing transactions. According to the assessee, there is a dichotomy between financing transactions and hire-purchase transactions. According to the assessee, its principal business was of leasing. For the aforestated reasons, the assessee contended that it was not covered by the definition of ‘financial company’ u/s. 2(5B) of the 1974 Act. On examination of the facts of the case and looking into all the parameters, including the parameter of the principal business, such as turnover, capital employed, etc., it was held by the Commissioner of Income-tax (Appeals) that the assessee carried on hire-purchase business activity and bill discounting activity as the principal business and, therefore, the assessee constituted a ‘credit institution’ as defined u/s. 2(5A) of the 1974 Act and was, therefore, taxable under the 1974 Act. However, after coming to the conclusion that the reopening of the proceedings was valid and that the assessee constituted a credit institution, the Commissioner of Income-tax (Appeals) went into the merits of the case and came to the conclusion that the transactions entered into by the assessee were not financing transactions, as the ownership of the vehicle in each case remained with the assessee; that the hirer did not approach the assessee after purchasing the vehicles; that the vehicle stood purchased by the assessee and let out to the hirer for use on payment of charges. Consequently, the Commissioner of Income-tax (Appeals) held that the hire-purchase transactions of the assessee were not financing transactions or loan transactions and, therefore, the Assessing Officer, was not justified in bringing to tax hire-purchase charges of Rs.32,64,89,358. The Commissioner of Income-tax (Appeals), however, held that the Assessing Officer was justified in treating receipts from bill discounting charges of Rs.1,91,48,614 as ‘chargeable interest’ under the 1974 Act. Lastly the Commissioner of Income-tax (Appeals) held that the lease transaction undertaken by the assessee and the lease charges received by it did not fall within the ambit of section 2(7) of the 1974 Act because the Department had accepted the case of the assessee that it remained the owner of the leased assets for all times to come and, therefore, it was not open for the Department to say that charges received for leasing the vehicles are financial charges exigible to the Interest-tax Act, 1974. Consequently, the Commissioner of Income-tax (Appeals) came to the conclusion that the Assessing Officer had erred in bringing to tax lease rental charges of Rs.40,86,85,186 as chargeable interest under the 1974 Act.

Aggrieved by the decision of the Commissioner of Income-tax (Appeals) the assessee as well as the Department went in appeal(s) to the Tribunal which held that the Department was justified in confirming the validity of action u/s. 10 of the 1974 Act. On the question as to whether the assessee was a ‘financial company’ as defined u/s. 2(5B), it was held that the assessee was not a finance company and therefore it did not fall within the definition of ‘credit institution’ as envisaged in section 2(5A) of the 1974 Act and, therefore, it fell outside the purview of the 1974 Act. That, bill discounting charges was taxable under the 1974 Act. That the plea of the assessee that such charges were not covered by the definition of the word ‘interest’ was not acceptable. Consequently, the appeals filed by the assessee were partly allowed. In the Department’s counter-appeal the Tribunal held on examination of the transaction in question that the Commissioner of Income-tax (Appeals) was right in holding that the hire-purchase agreement in the present case was not a financing transaction. Similarly, on examining the lease transaction undertaken by the assessee, the Tribunal held that the asset owned by the lessor was given to the lessee for use only and therefore the Commissioner of Income-tax (Appeals) was fully justified in holding that the receipt on account of lease charges was not taxable as finance charges or interest under the 1974 Act.

Aggrieved by the decision of the Tribunal, the Department carried the matter in appeal to the Delhi High Court u/s. 260A of the Income-tax Act, 1961. The appeal was allowed by the High Court, it was held by the High Court that the Tribunal had erred in holding that for deciding the principal business of a taxable entity under the 1974 Act only the receipt from business is the criteria and the other parameters such as turnover, capital employed, the head count of persons employed, etc. were not relevant. Accordingly, the Tribunal’s decision stood set aside. The High Court also remitted the case to the Assessing Officer saying that it was not clear from the material produced before the Court as to whether the lease agreements entered into by the assessee were financial lease or operational leases or both.

Aggrieved by the decision of the High Court, the assessee went to the Supreme Court by way of civil appeals. The Supreme Court was of the view that the High Court had not examined whether the transaction entered into by the assessee constituted financial transactions so as to attract the provisions of the 1974 Act. The Supreme Court noted that the Commissioner of Income Tax had examined the nature of the transactions entered into by the assessee and the three components of the receipt of the assessee under 1974 Act. According to the Supreme Court the main question which arose for determination in this case was whether the receipt from lease charges, from net hire-purchase charges and bill discounting charges could be taxed under the 1974 Act. This was apart from the question as to whether the assessee which was a non-banking financial company was a credit institution u/s. 2(5A) of the 1974 Act. The Supreme Court was of the view that the matter needed reconsideration and hence set aside the judgment of the High Court with a direction to decide the matter in accordance with law.

levitra

The power of parliament to make law with respect to extra-teritorial aspects or causes — Part iI

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G. V. K. Industries Ltd. & Anr. v. ITO & Anr. — 228 ITR 564 (A.P.):

3.1 Brief facts in the above case were: main object of the company was to generate and sell electricity for which purpose it was constructing a power generation station designed to operate using natural gas as fuel near Rajahmundry in the State of Andhra Pradesh. For the purpose of raising funds for the said project, GVK Inds. Ltd. (Company) needed expert services of qualified and experienced professionals who could prepare a scheme for raising finance and tie-up the required loan. For this purpose, the Company had entered into an agreement with a non-resident company (NRC), namely, ABB-Project and Trade Finance (International) Ltd. Zurich, Switzerland. Under the agreement, the NRC was to act as financial advisor and render requisite services for a success fee. Accordingly, the NRC rendered professional services from Zurich by correspondence as to how to execute documents for sanction of loan by the financial institutions within and outside India on the basis of which the Company approached such institutions and obtained the requisite loan. For a successful rendering of services, the NRC sent an invoice to the Company for payment of success fee amounting to US$.17.15 lakh (Rs.5.4 crores). For the purpose of remittance of this amount, the Company approached the ITO for issuing NOC for remitting the amount without TDS u/s. 195 without any success. The Company also approached the CIT, u/s. 264, who ultimately took the view that the NOC can be issued only after making TDS and payment thereof to the Government. This was challenged by the Company before the Andhra Pradesh High Court.

3.2 After considering various contentions raised on behalf of the Company and various judgments of the Apex Court as well as High Courts and after considering the scope of the services/work undertaken by the NRC, the Court took the view that a ‘business connection’ between the Company and NRC has not been established. Hence what remains to be considered is whether the amount of success fee can be treated as FTS u/s. 9(1)(vii)(b). In this context, it was contended on behalf of the Company that the NRC merely rendered advice in connection with procurement of loan which does not amount to rendering technical or consultancy services and hence, amount in question is not FTS. The Revenue had taken a view that the success fee is FTS as the services rendered by the NRC fall within the ambit of both managerial and consultancy services as contemplated in the definition of FTS given in Explanation to section 9(1)(vii) (b) considering the scope of the services/work of the NRC, the Court took the view that the advice given to procure loan to strengthen finance would be as much a technical or consultancy service as it would be with regard to management, generation of power or plant and machinery. Accordingly, the Court held that the success fees in question fall within the ambit of section 9(1)(vii). In fact, it appears that this was not seriously disputed by the counsel appearing for the Company, but the main argument seems to be that if that is so, then, provisions would be unconstitutional for want of legislative competence. For this, reliance was placed on the commentary given in the book (i.e., Law of Income Tax and Practice) written by the learned authors Kanga and Palkhivala.

3.3 Dealing with the above-referred issue raised on behalf of the Company, the Court stated that having regard to the present liberalisation policy, it is for the Government to take steps to have clause (vii)(b) of section 9(1) either replaced or amended so as to make income by way of FTS chargeable only when territorial nexus exists. After making this observation, the Court upheld the validity of the provisions mainly relying the judgment of the same Court as well as of the Apex Court in the case of ECIL (referred to in para 2 in Part-1).

G. V. K. Industries Ltd. & Anr. v. ITO & Anr. — 332 ITR 130 (SC):

4.1 The judgment of the Andhra Pradesh High Court in the above case came up for consideration before the Apex Court at the instance of the Company (i.e., assessee). Considering the importance of the issue involving validity of section 9(1)(vii)(b), the matter was finally referred to the Constitutional Bench. For the purpose of deciding the issue, the Court noted that the High Court having held that section 9(1)(i) did not apply in the facts of the case of the Company, nevertheless upheld the applicability of section 9(1) (vii)(b) and also upheld the validity of the said provisions mainly relying on the judgment of three-Judge Bench of the Apex Court in the case of ECIL.

4.2 For the purpose of dealing with the issue, the Court noted that the Apex Court in the case of ECIL conclusively determined that clauses (1) and (2) of Article 245, read together, imposed requirement that laws made by the Parliament should bear a nexus with India and ask that the Constitution Bench be constituted to consider whether the ingredients of section 9(1)(vii)(b) indicate such a nexus. In the course of proceedings before the Constitution Bench, the Company (i.e., GVK Inds. Ltd.) withdrew its challenge to the constitutional validity of section 9(1)(vii)(b) and elected to proceed only on the factual matrix as to the applicability of the said section. However, the learned Attorney General (A.G.), appearing on behalf of the respondent, pressed upon the Bench to reconsider the decision of the three-Judge Bench in the case of ECIL. Considering the constitutional importance of the issue, the Court agreed to consider the validity of the requirement of relationship to or nexus with the territory of India as a limitation on the powers of the Parliament to enact laws pursuant to Article 245(1).

4.3 For the purpose of deciding the above issue, the Court noted that the central constitutional theme before the Court relate to whether the Parliament’s powers to legislate, pursuant to Article 245, include legislative competence with respect to aspects or causes that occurred, arise, or exist or may be expected to do so, outside the territory of India. For this purpose, the Court noted that there are two divergent and dichotomous views on this. First one arises from a rigid reading of the ratio in the case of ECIL which suggests that the Parliament’s powers to legislate, incorporate only competence to enact laws with respect to aspects or causes that occur, or exist, solely within India. In this context, the Court further observed as follows (page 133):

“….A slightly weaker form of the foregoing strict territorial nexus restriction would be that the Parliament’s competence to legislate with respect to extra-territorial aspects or causes would be constitutionally permissible if and only if they have or are expected to have significant or sufficient impact on or effect in or consequence for India. An even weaker form of the territorial nexus restriction would be that as long as some impact or nexus with India is established or expected, then the Parliament would be empowered to enact legislation with respect to such extra-territorial aspects or causes. The polar opposite of the territorial nexus theory, which emerges also as logical consequence of the propositions of the learned Attorney General, specifies that the Parliament has inherent powers to legislate ‘for’ any territory, including territories beyond India, and that no Court in India may question or invalidate such laws on the ground that they are extra-territorial laws. Such a position incorporates the views that the Parliament may enact legislation even with respect to extra-territorial aspects or causes that have impact on, effect in or consequence for India, any part of it, its inhabitants or Indians, their interest, welfare, or security, and further that the purpose of such legislation need not in any manner or form be intended to benefit India.”

4.4 After noting the above-referred divergent views, the Court framed the following two questions for the decision of the Constitutional Bench (pages 133/134):

“(1)    Is the Parliament constitutionally restricted from enacting legislation with respect to extra-territorial aspects or causes that do not have, nor expected to have any, direct or indirect, tangible or intangible impact(s) on, or effect(s) in, or con-sequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well-being of, or security of inhabitants of India, and Indians?

(2)    Does the Parliament have the powers to legislate ‘for’ any territory, other than the territory of India or any part of it?

4.5    Before proceeding to decide the questions framed, the Court noted the provisions of Article 245 of Constitution, which fall in part XI of Chapter 1 under the head ‘Extent of laws made by the Parliament and by the Legislatures of the States’. The Court also stated that many expressions and phrases that are used contextually in the flow of language, involving words such as ‘interest’, ‘benefit’, ‘welfare’, ‘security’ and the like in order to satisfy the purpose of laws and their consequences, can have range to meanings. The Court then, for the purpose of the judgment, decided to set forth the following range of meanings for such expressions and phrases (pages 134/135):

‘aspects or causes’, ‘aspects and causes’:

“events, things, phenomena (howsoever common place they may be), resources, actions or transactions, and the like, in the social, political, economic, cultural, biological, environmental or physical spheres, that occur, arise, exist or may be expected to do so, naturally or on account of some human agency.”

‘extra-territorial aspects or causes’:

“aspects or causes that occur, arise, or exist, or may be expected to do so, outside the territory of India.”

‘nexus with India’, ‘impact on India’, ‘effect in India’, ‘effect on India’, ‘consequence for India’ or ‘impact on or nexus with India’:

“any impact(s) on, or effect(s) in, or consequences for, or expected impact(s) on, or effect(s) in, or consequence(s) for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well being of, or security of inhabitants of India, and Indians in general, that arise on account of aspects or causes.”

‘benefit to India’ or ‘for the benefit of India’, ‘to the benefit of India’, ‘in the benefit of India’ or ‘to benefit India’ or ‘the interests of India’, ‘welfare of India’, ‘well-being of India’, etc.:

“protection of and/or enhancement of the interest or, welfare of, well-being of, or the security of India (i.e., the whole territory of India), or any part of it, its inhabitants and Indians.”

4.6 Dealing with the ratio of the judgment in the case of ECIL, the Court stated as under (pages 136/137):

“The requirement of nexus with the territory of India was first explicitly articulated in the decision by a three-Judge Bench of this Court in ECIL. The implication of the nexus requirement is that a law that is enacted by the Parliament, whose ‘objects’ or ‘provocations’ do not arise within the territory of India, would be unconstitutional. The words ‘object’ and ‘provocation’, and their plural forms, may be conceived as having been used in ECIL as synonyms for the words ‘aspects’ and ‘cause’, and their plural forms, as used in this judgment.”

4.6.1 The Court further noted that in the case of ECIL, while dealing with the validity of section 9(1) (vii)(b) of the Act and interpreting the provisions of Article 245(1) and (2), the Court, in that case, drew the distinction between the phrases ‘make laws’ and ‘extraterritorial operation’ — i.e., the acts and functions of making laws versus the acts and functions of effectuating a law already made. The Court also noted the conclusion of the Court in that case that the operation of the law can extend to persons, things and acts outside the territory of India. However, the principle enunciated in that case does not address the question as to whether a Parliament may enact a law ‘for’ a territory outside boundaries of India. The Court then observed as follows (page 138):

“….To enact laws ‘for’ a foreign territory could be conceived of in two forms. The first form would be, where the laws so enacted, would deal with or be in respect of extra-territorial aspects or causes, and the laws would seek to control, modulate or transform or in some manner direct the executive of the legislating State to act upon such extra-territorial aspects or causes because: (a) such extra-territorial aspects or causes have some impact on or nexus with or to India; and (b) such laws are intended to benefit India. The second form would be when the extra-territorial aspects do not have, and neither are expected to have, any nexus whatsoever with India, and the purpose of such legislation would serve no purpose or goal that would be beneficial to India.”

4.6.2 The Court then further noted that in the case of ECIL, it was concluded that the Parliament does not have the powers to mark laws that bear no relationship to or nexus with India. The obvious questions that arises from this is: “what kind of nexus?” According to the Court, in this context, the words used in that case (referred to in para 2.5.2 in Part-1) are instructive both as to principle and also the reasoning. The Court then opined that the distinction drawn in that case between ‘make laws ‘ and ‘operation of laws’ is a valid one and leads to a correct assessment of relationship between clauses (1) & (2) of Article 245.

4.6.3 Concluding on the possible effect of the rigid reading of the judgment of in the case ECIL, the Court stated as under (page 139):

“We are, in this matter, concerned with what the implications might be, due to use of the words ‘provocation’, ‘object’, ‘in’ and ‘within’ in connection with the Parliament’s legislative powers regarding ‘the whole or any part of the territory of India’, on the understanding as to what aspect and/or causes the Parliament may legitimately take into consideration in exercise of its legislative powers. A particularly narrow reading or understanding of the words used could lead to a strict territorial nexus requirement wherein the Parliament may only make laws with respect to objects or provocations — or alternately, in terms of the words we have used ‘aspect and causes’ — that occur, arise or exist or may be expected to occur, arise or exist, solely within the territory of India, notwithstanding the fact that many extra-territorial objects or provocations may have an impact or nexus with India. Two other forms of the foregoing territorial nexus theory, with weaker nexus requirements, but differing as to the applicable tests for a finding of nexus, have been noted earlier.

4.7 Having noted the implications of the judgment in case of ECIL and the issue arising therefrom, and the impact thereof on the powers of the Parliament to enact a law with respect to ‘extra-territorial aspects or causes’, the Court also noted that learned A.G. appeared to be concerned by the fact that the narrow reach of Article 245 in the context of the ratio in the case of ECIL would significantly incapacitate the Parliament, which is charged with the responsibility of legislating for the entire nation, in dealing with extra-territorial aspects or causes that have an impact on or nexus with India. The Court also noted the following propositions made by the learned A.G. with respect to the meaning, purport and ambit of Article 245 (pages 139/140), which, it seems, the Court found as moving to another extreme:

“(1)    There is a clear distinction between a Sovereign Legislature and a Subordinate Legislature.
(2)    It cannot be disputed that a Sovereign Legislature has full power to make extra-territorial laws.

(3)    The fact that it may not do so or that it will exercise restraint in this behalf arises not from a Constitutional limitation on its powers but from a consideration of applicability.

(4)    It does not detract from its inherent rights to make extra-territorial laws.

(5)    In any case, the domestic courts of the country cannot set aside the legislation passed by a Sovereign Legislature on the ground that it has extra-territorial effect or that it would offend some principle of international law.

(6)    The theory of nexus was evolved essentially from Australia to rebut a challenge to income-tax laws on the ground of extra-territoriality.

(7)    The principle of nexus was urged as a matter of construction to show that the law in fact was not extra-territorial because it has a nexus with the territory of the legislating State.

(8)    The theory of nexus and the necessity to show the nexus arose with regard to State Legislature under the Constitution since the power to make extra-territorial laws is reserved only for the Parliament.”

4.7.1 According to the Court, the main propositions are that the Parliament is a ‘Sovereign Legislature’ and that such a ‘Sovereign Legislature’ has full power to make extra-territorial laws. The Court, then, stated that this can be analysed in two ways. The first aspect of this is: the phrase ‘full power to make extra-territorial laws’ would implicate the competence to legislate with respect to extra-territorial aspects or causes that have an impact on or nexus with India, wherein the State machinery is directed to achieve the goals of such legislation by exerting the force on such extra-territorial aspects or causes to modulate, change, transform or eliminate their effects. The second aspect of this is: such powers would also extend to legislate with respect to the extra-territorial aspects or causes that do not have any impact on or nexus with India. The Court then noted that according to the learned A.G., both these forms of powers are within the legislative competence of the Parliament. The Court then assumed that the learned A.G. did not mean that the Parliament would have powers to enact extra-territorial laws with respect to foreign territories that are devoid of justice i.e., they serve no benefits to the denizens of such foreign territories. Considering historical background of establishment of India as a nation, the Court, in this context, observed as under (page 141):

“To the extent that extra-territorial laws enacted have to be beneficial to the denizens of another territory, three implications arise. The first one is when such laws do benefit the foreign territory, and benefit India too. The second one is that they benefit the denizens of that foreign territory, but do not adversely affect India’s interest. The third one would be when such extra-territorial laws benefit the denizens of the foreign territory, but are damaging to the interest of India. We take it that the learned Attorney General has proposed that all three possibilities are within constitutionally permissible limits of legislative powers and competence of the Parliament.”

4.7.2 The Court then also noted the propositions of the learned A.G. that the Courts do not have power to declare the extra-territorial laws enacted by the Parliament invalid on the grounds that they have an ‘extra-territorial effect’ whether such laws are with respect to extra-territorial aspects or causes that have any impact on or nexus with India, or that do not in any manner or form work to, or intended to be or hew to the benefit of India or that might even be detrimental to India. The Court then noted the far-reaching implications of this proposition including the one that the judiciary also has been stripped of its essential role even where such extra-territorial laws may be damaging to the interests of India.

4.8 For the purpose of considering the propositions made by the learned A.G., the Court referred to relevant principles of constitutional interpretation. In this context, the Court noted that under the scheme of Constitution the sphere of actions and extent of powers exercisable by various organs are specified. Such institutional arrangements made under the constitution are legal, inter alia, in the sense that they are susceptible to judicial review with regard to determination of vires of any of the actions of the organs of the State. The actions of such organisation are also judiciable, in appropriate cases, where the values or the scheme of the constitution may have been transgressed. The Court then dealt with the guiding principles for interpretation in the process of such review, the powers of the Parliament to amend the Constitution and also noted that such amending powers do not extend to the basic structure of the Constitution. The Court also referred to relevant principles of interpretation in this context and the methods to be adopted for the same.

4.9 The Court then proceeded to analyse the provisions of Article 245 and stated that under the clause

(1), the Parliament is empowered to enact a law ‘for’ the whole or any part of the territory of India. The word that links subject, ‘the whole or any part of the territory in India’, with the phrase that grants the legislative powers to the Parliament is ‘for’. After noting the range of meanings of the word ‘for’, the Court observed as under (page 146):

“Consequently, the range of senses in which the word ‘for’ is ordinarily used would suggest that, pursuant to clause (1) of Article 245, the Parliament is empowered to enact those laws that are in the interest of, to the benefit of, in defence of, in support or favour of, suitable or appropriate to, in respect of or with reference to ‘the whole or any part of the territory of India.”

4.9.1 The Court then noted that the problem with the manner in which Article 245 has been explained in the case of ECIL relates to the use of the word ‘provocation’, and ‘object’ as the principal qualifiers of laws and then specifying that they need to arise ‘in’ or ‘within’ India. Considering the effect of this, the Court took the view as under (page 147):

“Consequently, the ratio of ECIL could wrongly be read to mean that both the ‘provocations’ and ‘objects’ — in terms of independent aspects or causes in the world of the law enacted by the Parliament, pursuant to Article 245, must arise solely ‘in’ or ‘within’ the territory of India. Such a narrowing the ambit of clause (1) of Article 245 would arise by substituting ‘in’ or ‘within’, as prepositions, in the place of ‘for’ in the text of Article 245. The word ‘in’, used as a preposition, has a much narrower meaning, expressing inclusion or position within the limits of space, time or circumstances, than the word ‘for’. The consequence of such a substitution would be that the Parliament could be deemed to not have the powers to enact laws with respect to extra-territorial aspects or causes, even though such aspects or causes may be expected to have an impact on or nexus with India, and laws with respect to such aspects or causes would be beneficial to India.”

4.9.2 The Court then noted that the view that a nation/state must be concerned only with respect to persons, property events, etc. within it’s own territory emerged in the era when external aspects and causes were thought to be only of marginal significance, if at all. The Court also noted the earlier versions of sovereignty emerged in the context of global position and lesser interdependence of the nations at the relevant time. Having noted the earlier scenario, the Court stated that on account of scientific and technological developments, the magnitude of cross border travel and transactions has tremendously increased. Moreover, existence of economic, business, social and political organisations that operate across borders, implies that their activities, even though conducted in one territory, may have an impact on or in another territory. Global criminal and terror network are also example of how things and activities in a territory outside one’s own borders would affect interests, welfare, well being and security within. The Court then stated that within the international law, the principles of strict territorial jurisdiction have been relaxed, in the light of greater inter dependencies and other relevant reasons. At the same time, no State attempts to exercise any jurisdiction over matters, persons, or things with which it has absolutely no concern. After noting this position with regard to international law concerning power of making law with regard to extra-territory aspects and causes, the Court held as under (page 149):

“Because of interdependencies and the fact that many extra-territorial aspects or causes have an impact on or nexus with the territory of the nation/ state, it would be impossible to conceive legislative powers and competence of national parliaments as being limited only to aspects or causes that arise, occur or exist or may be expected to do so, within the territory of its own nation-state. Our Constitution has to be necessarily understood as imposing affirmative obligations on all the organs of the State to protect the interest, welfare and security of India. Consequently, we have to understand that the Parliament has been constituted, and empowered to, and that its core role would be to, enact laws that serve such purposes. Hence even those extra-territorial aspects or causes, provided they have a nexus with India, should be deemed to be within the domain of legislative competence of the Parliament, except to the extent the Constitution itself specifies otherwise.”

4.10 The Court then dealt with the extreme view canvassed by the learned A.G. that the Parliament is empowered to enact a law in respect of extra-territorial aspects or causes that have no nexus with India, and further more could such laws be bereft of any benefit to India? While rejecting such a proposition, the Court stated as under (pages 149/150):

“The word ‘for’ again provides the clue. To legislate for a territory implies being responsible for the welfare of the people inhabiting that territory, deriving the powers to legislate from the same people, and acting in a capacity of trust. In that sense the Parliament belongs only to India and its chief and sole responsibility is to act as the Parliament of India and of no other territory, nation or people. There are two related limitations that flow from this. The first one is with regard to the necessity, and the absolute base line condition, that all powers vested in any organ of the State, including the Parliament, may only be exercised for the benefit of India. All of its energies and focus ought to only be directed to that end. It may be the case that an external aspect or cause, or welfare of the people elsewhere may also benefit the people of India. The laws enacted by the Parliament may enhance the welfare of people in other territories too; nevertheless, the fundamental condition remains: that the benefit to or of India remain the central and primary purpose, That being the case, the logical corollary, and hence the second limitation that flows therefrom, would be that an exercise of legislative powers by the Parliament with regard to extra-territorial aspects or causes that do not have any, or may be expected not to have nexus with India, transgresses the first condition. Consequently, we must hold that the Parliament’s powers to enact legislation, pursuant to clause (1) of Article 245 may not extend to those extra-territorial aspects or causes that have no impact on or nexus with India.”

4.10.1 The Court further explained reasons for taking the above view and drew support from sources such as Directive Principle of State Policy, etc. The Court then stated that it is important to draw a clear distinction between the acts and functions of making laws and acts and functions of operating laws. Making laws implies the acts to changing or enacting laws.

The phrase ‘operation of law’, in its ordinary sense, means effectuation or implementation of the laws. The acts and functions of implementing laws already made fall within the domain of the executives. The essential nature of the act of invalidating a law is different from both the act of making a law, and act of operating a law. Invalidation of laws falls exclusively within the functions of the judiciary, and occurs after examination of vires of a particular of law.

4.11 Dealing with the powers of judiciary to invalidate a law, the Court stated that the only organ of State which may invalidate the law is judiciary and the provisions of Article 245(2) should be read to mean that it reduces the general and inherent. powers of the judiciary to declare a law ultra vires only to the extent of that one ground of invalidation. Explaining the effect of this provision, the Court stated as under (page 154):

“Clause (2) of Article 245 acts as an exception, of a particular and a limited kind, to the inherent poser of the judiciary to invalidate, if ultra vires, any of the laws made by any organ of the State. Generally, an exception can logically be read as only operating within the ambit of the clause to which it is an exception. It acts upon the main limb of the article — the more general clause — but the more general clause in turn acts upon it The relationship is mutually synergistic in engendering the meaning. In this case, clause (2) of Article 245 carves out a specific exception that law made by the Parliament, pursuant to clause (1) of Article 245, for the whole or any part of the territory of India may not be invalidated on the ground that such law may need to be operated extra-territorially. Nothing more. The power of judiciary to invalidate laws that are ultra vires flows from its essential functions, Constitutional structure, values and scheme, and indeed to ensure that the powers vested in the organs of the State are not being transgressed, and they are being used to realise a public purpose that subserves the general welfare of the people. It is one of the essential defences of the people in a constitutional democracy.”

4.12 Referring to various decisions, cited and relied on by the learned A.G. in support of his propositions, the Court stated that in none of these cases, the issue under consideration has been dealt with. The Court also noted that having gone through those decisions, none stand for the proposition that the powers of the Parliament are unfettered and the Parliament possesses a capacity to make laws that have no connection whatsoever with India. Having noted this factual position, the Court also dealt with some of the decisions.

4.13 Before answering the questions framed, the Court also decided to share its thoughts on some important concerns such as claims of supremacy or sovereignty for various organs to act in a manner that is essentially unchecked and uncontrolled. In this context, the Court also explained the misconception of the sovereignty and of power, and predilections to oust judicial scrutiny even at the minimum level, such as examination of the vires of the legislation or other type of state actions.

4.14 Finally, while answering the first question framed, the Court held as under (page 166):

“(1)    Is the Parliament constitutionally restricted from enacting legislation with respect to extra-territorial aspects or causes that do not have, nor expected to have any, direct or indirect, tangible or intangible impact(s) on or effect(s) in or con-sequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well-being of, or security of inhabitants of India, and Indians?

Answer to the above would be yes …..”

4.14.1 Explaining the effect of the above answer, the Court further held as under (page 166):

“However, the Parliament may exercise its legislative powers with respect to extra-territorial aspects or causes, -events, things, phenomena (howsoever commonplace they may be), resources, actions or transactions, and the like, that occur, arise, or exist or may be expected to do so, naturally or on account of some human agency, in the social, political, economic, cultural, biological, environmental, or physical spheres outside the territory of India, and seek to control, modulate, mitigate or transform the effects of such extra-territorial aspects or causes, or in appropriate cases, eliminate or engender such extra-territorial aspects or causes only when such extra-territorial aspects or causes have, or are expected to have, some impact on, or effect in, or consequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well-being of, or security of inhabitants of India, and Indians.”

4.14.2 While answering the second question framed (referred to in para 4.4 above), the Court also held that the Parliament does not have power to legislate ‘for’ any territory, other than the territory of India or any part of it.

4.15 After taking the above view, the Court has sent back the matter of GVK Inds. Ltd. (referred to in para 3 above) to the Division Bench for its decision in the light of judgment of the Constitution Bench.

Conclusion:

5.1 In the above case, the Constitution Bench has laid down the criteria to test the validity of the laws enacted by the Parliament or any provisions of such laws. Therefore, any law enacted by the Parliament (including tax laws) would be governed by the same.

5.2 The Court has held that the Parliament is constitutionally restricted from enacting legislation with respect to extra-territorial aspects or causes that do not have, nor expected to have any, direct or indirect, tangible or intangible impact(s) on or effect(s) in or consequences for: (a) the territory of India, or any part of India; or (b) the interests of, welfare of, well-being of, or security of inhabitants of India, and Indians. The Court has also held that any law enacted by the Parliament with respect to extra-territorial aspects or causes that have no impact on or nexus with India would be ultra vires as that would be law made “for” a foreign territory.

5.3 The Court also held that in all other respects (other than referred to in para 5.2 above), the Parliament has a power to enact a law with respect of extra-territorial aspects or causes and such power is not subject to test of ‘sufficiency’ or ‘significance’ or in any other manner requiring a pre-determined degree of strength. For this purpose, all that is required is that the connection to India be real or expected to be real, and not illusory or fanciful.

5.4 On the basis of the tests and principles laid down by the Apex Court in the above case, any issue arising under the IT Act relating to validity of any provision, will have to be decided. Accordingly, challenge if any, to the validity of the provisions of section 9(1)(vii)(b) will have to be tested on that basis.

5.5 Considering the meanings ascribed to various expressions, such as ‘aspects or causes’ ‘extra territorial aspects’, etc. (referred to in para 4.5 above), the scope of inclusion within the legislative competence is substantially wider and of such exclusion is much narrower. In this context, by and large, the Parliament has the power to enact any law in national interest with regard to extra territorial aspects or causes, once there in real connection thereof with India.

5.6 It seems that validity of the retrospective introduction/substitution (w.e.f. 1-4-1976) of Explanation to section 9(1) by the Finance Act, 2010 (referred to in para 1.5 in Part-1) may need to be separately considered.

Cost of acquisition in case of Property of Ex-Rulers

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Issue for consideration : Prior to independence,
India had a large number of native states, each having a separate Ruler.
Many of these ex-rulers owned substantial number of properties even
today, which were part of their princely possessions inherited by them
from their forefathers who had acquired such properties by way of
conquest or by way of jagir (grant).

The Supreme Court in the
case of CIT v. B. C. Srinivasa Setty, 128 ITR 294, held that no capital
gains tax is payable by an assessee where it was not possible to compute
the capital gains u/s.48 of the Act. It held that capital gains could
not be computed in cases where the cost of acquisition could not be
conceived at all. Of course, this position of law has been slightly
altered by the insertion of section 55(2)(a), which provides that the
cost of certain assets shall be deemed to be nil in cases of the assets
specified therein. Sale of such specified assets, though not having any
cost of acquisition, is now subjected to capital gains tax by virtue of
this amendment. Section 55(2)(a) however does not include such property
of ex-rulers.

The question has arisen before the courts as to
whether such property of ex-rulers acquired by their forefathers by way
of conquest or by way of jagir has no cost of acquisition, and the gains
arising on sale of such property is not subject to capital gains tax,
or whether such property has a cost of acquisition and the gains thereon
is subject to capital gains tax on sale. While the Madhya Pradesh,
Madras, and Gujarat High Courts have taken the view that the sale of
such property would not be subject to capital gains tax, the Full Bench
of the Punjab and Haryana High Court has recently taken a contrary view
that the provisions relating to capital gains tax do apply to such
properties. The decision, though rendered in the context of an ex-ruler,
has far-reaching implications inasmuch as it seeks to chart a new
course of thinking by relying on the provisions of section 55(3) for
bringing to tax gains arising even in cases not covered by section
55(2).

Lokendra Singhji’s case : The issue first came up before
the Madhya Pradesh High Court in the case of CIT v. H.H. Maharaja Sahib
Shri Lokendra Singhji, 162 ITR 93.

In this case, the assessee
was the ex-ruler of the erstwhile State of Ratlam, which was founded by
Maharaja Ratansinghji. A jagir of the entire state of Ratlam was
conferred on Ratansinghji in the 17th century by Emperor Shahjahan for
his daring feat of killing a mad elephant with a dagger. The assessee
sold certain land and building within the compound of Shri Ranjit Vilas
Palace, Ratlam during the relevant year, which property was a part of
the estate received as jagir, and which had been inherited by the
assessee in his capacity as the ruler.

The assessee initially
included the capital gains (loss) on sale of the property in his tax
return, by claiming the fair market value of the land and building on
1st January 1954 as the substituted cost of acquisition. The Assessing
Officer computed the assessment by taking such fair market value as on
1st January 1954 at a lower figure, which figure was slightly enhanced
by the Commissioner (Appeals).

Before the Tribunal, for the 1st
time the assessee raised an additional ground claiming that there was no
cost of acquisition of the asset and as such there could be no capital
gains as a result of the transfer of the property. The Tribunal admitted
the additional ground and came to the conclusion that no capital gains
arose as a result of the sale of the land and building.

Before
the Madhya Pradesh High Court, on behalf of the Revenue, it was argued
that the Tribunal was not justified in holding that no capital gains
arose, and that the main controversy was whether the sale proceeds of
the property were in the nature of capital receipts and whether such
receipts attracted the provisions of section 45. It was argued that as
the assessee had received the property by way of inheritance and himself
opted for substitution of the cost of the capital asset as on 1st
January 1954, the Tribunal was not right in concluding that there being
no cost of acquisition of the property to the initial owner, there was
no question of capital gains.

On behalf of the assessee, it was
submitted that though the property was a capital asset, there was no
gains because the forefathers of the assessee were not required to pay
any cost in terms of money for acquiring the property, given the history
of Ratlam State. It was argued that in the absence of any cost of
acquisition, no liability to capital gains could be fastened on the
assessee, though he might have accepted the valuation as on 1st January
1954 and had disclosed the capital loss in his return of income.
Reliance was placed on the decisions of the Bombay High Court in the
case of CIT v. Home Industries and Co., 107 ITR 609, of the Madhya
Pradesh High Court in CIT v. Jaswantlal Dayabhai, 114 ITR 798, and of
the Supreme Court in CIT v. B. C. Srinivasa Setty, 128 ITR 294, all of
which decisions were rendered in the context of goodwill, for the
proposition that the charging section and the computation provisions
together constituted an integrated code, and where the computation
provisions could not apply at all, such a case was not intended to fall
within the charging section. Reliance was also placed on the decisions
of the Delhi High Court in the case of Bawa Shiv Charan Singh v. CIT,
149 ITR 29, and the Bombay High Court in the case of CIT v. Mrs.
Shirinbai P. Pundole, 129 ITR 448 in the context of tenancy rights.

The
Madhya Pradesh High Court noted that though none of the cases cited by
the assessee related to the sale of an immovable property as was the
case before it, but the gist of all these decisions was that if there
was no cost of acquisition, then the gains on sale would not attract the
provisions of capital gains. According to the Madhya Pradesh High
Court, the liability to capital gains tax would arise in respect of only
those capital assets in the acquisition of which the element of cost
was either actually present or was capable of being reckoned and not in
respect of those assets in acquisition of which the element of cost was
altogether inconceivable, as in the case before it.

The Madhya
Pradesh High Court observed that a case where a person acquired some
property by way of gift or reward (for instance, jagirs from a ruler)
and the property passed on by inheritance to succeeding generations, and
was sold for a valuable consideration, because the initial owner had
not acquired it at some cost in terms of money, it would not attract
capital gains tax in such a transaction of sale, there being no gains
that could be computed as such. The Madhya Pradesh High Court therefore
held that the gains on sale of the property would not attract capital
gains tax.

This view taken by the Court in this case was
followed subsequently by the Court in the case of CIT v. Pushparaj
Singh, 232 ITR 754 (shares/securities transferred to the assessee by the
government as a moral gesture), by the Gujarat High Court in the case
of CIT v. Manoharsinhji P. Jadeja, 281 ITR 19 (property acquired by
forefathers by conquest), and by the Madras High Court in the case of
CIT v. H.H. Sri Raja Rajagopala Thondaiman, 282 ITR 126. The Punjab and
Haryana High Court also took a similar view in the case of CIT v. Amrik
Singh, 299 ITR 14, in the context of ownership acquired by the assessee
by Court’s sanction in terms of section 3 of the Punjab Occupancy
Tenants (Vesting of Proprietary Rights) Act, 1952.

Raja
Malwinder Singh’s case :

The issue again recently came up before the Full Bench of the Punjab and Haryana High Court in the case of CIT v. Raja Malwinder Singh, 334 ITR 48.    In this case the assessee was an ex-ruler of the Pepsu State, which state was acquired under an instrument of annexation. Certain plots of land which were part of that state were sold. The assessee claimed that since the cost of acquisition could not be ascertained, capital gains tax was not attracted.

The Assessing Officer assessed the capital gains by taking the cost of acquisition equal to the market value as on 1st January 1954/1964. The Commissioner (Appeals) rejected the assessee’s appeal and the contention that cost of acquisition was incapable of ascertainment, but the Tribunal reversed the decision, following the judgment of the Supreme Court in the case of B. C. Srinivasa Setty (supra). The Division Bench of the Punjab and Haryana High Court prima facie differed with the view taken by the same court in the case of Amrik Singh (supra), and therefore referred the matter to a large Bench.

On behalf of the Revenue, before the Full Bench, a distinction was sought to be drawn between the judgment of the Supreme Court in the case of B. C. Srinivasa Setty (supra) and the case before the Court, on the ground that in a newly started business the value of goodwill was not ascertainable, whereas in the case of acquisition of land, the same was either acquired at some cost or without cost, and under the scheme of the Act, there could be no situation where the cost was incapable of ascertainment.

The Punjab and Haryana High Court noted that in the case before it, the assessee acquired the property by succession from the previous owner. It also noted that according to the assessee, the cost of acquisition by the previous owner could not be ascertained and had failed to exercise the option of adopting the market value on the date of acquisition or the cost of the previous owner. Therefore, according to the Court, the only option available to the Assessing Officer was to compute capital gains by taking the cost of asset to be the fair market value on the specified date (1st January 1954/1964, as the case may be).

According to the Full Bench of the Punjab and Haryana High Court, even in a case where the cost of acquisition could not be ascertained, section 55(3) statutorily prescribed the cost to be equal to the market value on the date of acquisition. Therefore, capital gains was not excluded even on the plea that value of the asset in respect of which capital gains was to be charged was incapable of ascertainment.

The Full Bench of the Punjab and Haryana High Court therefore held that the view taken by it earlier in Amrik Singh’s case was not correct, being against the statutory scheme. The Court also held that the view taken by the Madhya Pradesh High Court in Lokendra Singhji’s case (supra) could not be accepted, as it did not give effect to the mandate of section 55(3), which provided for a situation where the value of the asset acquired could not be ascertained. According to the court, if the market value of an asset on the date of its acquisition could be ascertained, the cost of acquisition had to be taken to be equal to that, and if the value could not be so ascertained, the cost had to be equal to the market value on a specified date (for example, 1-4-1964 or 1-4-1981) at the option of the assessee. The Court observed that it was not the case of the assessee that the land had no market value on the date of its acquisition.

The Full Bench of the Punjab and Haryana High Court therefore held that once an asset had a market value, on the date of its acquisition, capital gains tax would be attracted by taking the cost of acquisition to be fair market value as on the specified date or at the option of the assessee, the market value on the date of acquisition where no cost was incurred. The Court accordingly held that the gains made on sale of the property of the ex-ruler was subject to capital gains tax.

Observations:

Computation of capital gains is possible where all of the following information is available :

  •     Date of acquisition,

  •     Cost of acquisition,

  •     Mode and manner of acquisition,

  •     Date of transfer,

  •     Consideration for transfer, and

  •     Mode and manner of transfer.

These requirements are sought to be taken care of by provisions of section 45(2) to (6), section 46 to 49, 50 and section 55(1) to (3) and section 2(42A). Further, the decision of the Supreme Court provides for the course of action, to be adopted, where the cost of acquisition and the date of acquisition are not known or cannot be determined. One dimension however, i.e., the mode and the manner of acquisition remains unexplored where no information is available about the mode of acquisition of the previous owner who had acquired the asset by any of the modes not specified by section 49(1). On a harmonious reading of the provisions of Chapter IVE, it appears that the capital gains cannot be brought to tax where the information in relation to any of the above referred dimensions is not available.

The Supreme Court in the case of B. C. Srinivasa Setty, 128 ITR 294 was concerned with the taxability of the receipts on transfer of goodwill. The Court in the context of the said case observed and held as under :

  •     It was impossible to predicate the moment of the birth of goodwill and there can be no account in value of the factors producing goodwill. No business possessed goodwill from the start which generated on carrying on of business and augmented with the passage of time.

  •     The charging section 45 and the computation provisions of section 48 together constituted an integrated code.

  •     All transactions encompassed by section 45 must fall under the governance of its computation provisions. A transaction that cannot satisfy the test of computation must be regarded as never intended to be covered by section 45.

  •     Section 48 contemplated an asset in the acquisition of which it was possible to envisage a cost, an asset which possessed the inherent quality of being available on the expenditure of money to a person seeking to acquire it.

  •     The date of acquisition of an asset was a material factor in applying the computation provisions and for goodwill, it was not pos-sible to ascertain such date.

  •     Taxing the goodwill amounted to taxing the capital value of the asset and not the profits or gains.

The Supreme Court in the above-referred case observed that what was contemplated for taxation was the gains of an asset in the acquisition of which it was possible to envisage a cost; the asset in question should be one which possessed the inherent quality of being available on the expenditure of money to a person seeking to acquire it. Importantly, it observed that it was immaterial that although the asset belonged to such a class it might have been acquired without the payment of money, in which case section 49 would determine the cost of acquisition for the
purposes of section 48. This finding is heavily relied by the taxpayers to canvass that the Court implied that an asset for which no payment is made and which is not covered by section 49 is outside the scope of section 48.

The Court on a reference to section 50 and section 55(2) as also section 49 gathered that section 48 dealt with an asset that was capable of being acquired at cost; these provisions indicated that section 48 excluded such assets for which no cost element could be identified or envisaged and the goodwill was one such asset.

Significantly the Court observed that it was impossible to determine the cost of acquisition of goodwill even in the hands of the previous owner who had transferred the same in one of the modes specified in section 49(1). It also held that section 55(3) could not be invoked in such a case, because the date of acquisition of the previous owner re-mained unknown. In cases where the cost of an asset cannot be conceived at all, it appears that the fair market value as prescribed by section 55(3) cannot be adopted even where the date of acquisition of the previous owner is known. Whether the cost of acquisition is ascertainable or not should be examined from the standpoint of the assessee or the previous owner, as the case may be and in doing so, due importance should be given to the mode of acquisition by the assessee. An asset may be the one which is capable of being acquired at cost and may have a fair market value, but in the context of the assessee, it may not be possible to conceive any cost for him on account of his mode of acquisition.

The observation, findings and the ratio of the decision in the said Srinivasa Setty’s case when applied to the issue under consideration, the following things emerge:

  •     It is essential to determine the cost of acqui-sition in the hands of previous owner where the asset was acquired in any of the modes specified in section 49(1). If such cost to the previous owner cannot be determined, there will be no liability to Capital Gains tax. It is impossible to determine the cost of acquisition of goodwill having regard to the nature of asset.

  •     S/s. 55(3) cannot be invoked in cases where the date of acquisition by the previous owner remains unknown.

The asset i.e., the immovable property, in the facts of the cases under consideration, is an asset that was originally acquired by the forefathers of the transferor on conquest and/or ascension. The assessee transferor acquired the asset by inheritance. In computing the capital gains of the transferor, it was essential to adopt the cost of the previous owner and also determine the date of acquisition of the previous owner. It is an admitted fact that the immediate previous owner of the asset did not incur any cost of acquisition. In such cases, by virtue of the Explanation to section 49(1), one was required to travel back in time to reach such an owner who had last acquired it by a mode of acquisition other than that, that is referred in clause (i) to (iv) of section 49(1). Following the mandate provided by the said Explanation, it was essential to find out the cost of acquisition of the persons from whom the asset was acquired by the forefathers of the assessee, on conquest. Admittedly this was not possible for scores of reasons and therefore the cost to the assessee could not have been ascertained by resorting to the provisions of section 49(1) for computing the capital gains. Accordingly, while it was possible to ascertain the date of acquisition and the period of holding of the asset, the cost of acquisition of such asset remains to be determined as it is unknown and therefore the capital gains could not be computed and be brought to tax in the facts of the case. Further, no cost could have been envisaged in the cases ‘of conquest and/ or ascension. Similarly, where the property was acquired by conquest in a war, it cannot be said that the cost incurred on the war is the cost of acquisition of the property. Therefore, in all such cases of property of ex-rulers, one cannot envisage a cost of acquisition at all, and it is not merely a case of difficulty of determination or ascertainment of cost of acquisition.

One has to at the same time examine whether the conclusion reached in the above paragraph meets the test provided by section 55(3) of the Act. The Full Bench of the Punjab & Haryana High Court has heavily relied on the provisions of section 55(3) for the purposes of overruling the decision of Madhya Pradesh High Court. The said section 55(3) reads as : “where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner”. Ordinarily, an assessee is required to ascertain his cost only and not of the previous owner unless where section 49(1) apply. From a reading of section 55(3), it is clear that the provision applies only in cases where an assessee is required to ascertain the cost of the previous owner which requirement arises only in cases where the asset is acquired by any of the modes specified in section 49(1) and not otherwise. Section 55(3) appears to take care of situations where the cost of previous owner can-not be ascertained.

On insertion of the said Explanation to section 49(1) w.e.f. 1-4-1965 by the Finance Act, 1965, an assessee is required to adopt that cost of acquisition which was the cost of the previous owner in time who had last acquired the asset under a mode other than the one specified in section 49(1). It appears that the said Explanation is specifically inserted to take care of the situations where it is difficult to ascertain the cost of the previous owner. It requires an assessee to travel back in time and adopt the cost of that owner, previous in time, who last acquired it by any of the mode not specified in section 49(1). It appears that the provisions of section 55(3) are rendered redundant on introduction of the said Explanation. The attention of the Full Bench of the Court was perhaps not invited to the presence of the said Explanation. Had that been done, the Court might not have relied solely on the provisions of section 55(3) for reaching the conclusion derived by it.

The said Explanation has the effect of defining the term ‘previous owner of the property’ to mean the last previous owner of the capital asset who acquired it by a mode of acquisition other than that referred to in section 49(1). The notes to clauses and the memorandum explaining the provi-sion of the Finance Bill, 1965 reported in 55 ITR 131 explain the objective behind the introduction of the said Explanation to section 49(1). Please also see Circular No. 31, dated 21-9-1962 and Circular No. 3-P, dated 11-10-1965.

The Supreme Court on page 301 specifically held that having regard to the nature of the asset, it was impossible to determine the cost of acquisition even of the previous owner for the purposes of section 49(1). It also held that section 55(3) could not be invoked because the date of acquisition by the previous owner remained unknown. It is relevant to note that the Court in that case was concerned with A.Y. 1966-67 and the said Explanation was inserted w.e.f. 1-4-1965. Even assuming that the provision of section 55(3) continues to be relevant, it may be difficult to substitute the fair market value prevailing on the date of conquest or ascension on account of the fact that the asset is acquired on conquest and due to the manner of acquisition of the asset no cost can be envisaged for acquisition of such an asset.

It is relevant to note that presently section 55(2) provides for adopting the cost of acquisition of certain specified assets, including the goodwill at Nil. It provides for cases of the goodwill, tenancy rights, loom hours, stage carriage permits, trade mark or a brand name associated with the business, no-compete rights, right to manufacture, etc. On a closer reading, it is seen that the assets specified for are the ones which are not acquired on a given day for a cost and whose value has been generated over a period of time on regular efforts made over a period. The cost of such an asset including the cost of the regular efforts cannot be identified and quantified. The said section does not provide for such a fiction in cases of the assets acquired on conquest and/or ascension. In the circumstances, it is fair for the assessee to contend that the capital gains in his case cannot be computed as the cost of an asset so acquired could not be taken to be Nil. Wherever the government has intended no cost assets to be subjected to capital gains tax, such assets have been specifically included in the provisions of section 55(2)(a). The very fact that such property of ex-rulers has not been included in this section over the years in spite of so many courts taking the view that the sale of such property is not subject to capital gains tax, clearly indicates that the intention is not to tax such sale proceeds. It is intriguing to note that the Revenue in the past has not relied on section 55(3) while defending the cases of tenancy rights and goodwill. The better view therefore is that such property of an ex-ruler acquired by way of conquest or grant by his ancestors does not have any cost of acquisition, and the capital gains on sale of such property is not subject to tax.

The Direct Tax Code, proposed to be introduced from Financial Year 2012-13, provides that the cost of acquisition will be taken as Nil in all cases where the asset is acquired for no cost in any of the modes for which the cost of the previous owner is not permitted to be adopted.

Neither section 49 nor section 55(3) shall apply in cases where no cost is paid for an asset by the assessee, and the asset is acquired by him by any of the modes not specified by section 49, inas- much as there is no previous owner. Even if there is one, his cost would be ascertainable and therefore section 55(3) does not apply in his case and that section 49(1) cannot apply as the asset is not acquired by any of the modes specified therein.

(2011) 137 TTJ 508 (Coch.) F.C.I. Technology Services Ltd. v. ACIT ITA No. 616 (Coch.) of 2008 A.Y.: 2003-04. Dated: 4-6-2010

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Section 10A — While computing deduction u/s.10A of an eligible unit, loss of non-eligible and other eligible unit cannot be set off against profit of such eligible unit.

The assessee was rendering services from its three units located at Chennai, Bangalore and Kochi. It claimed exemption of Rs.58.68 lakh u/s.10A in respect of income from the Bangalore unit. The Assessing Officer held that the loss from the other two units had to be set off first against the income of the Bangalore unit and since this set-off left the assessee with no positive income, the assessee was not entitled to any exemption u/s.10A. The CIT(A) upheld the order of the Assessing Officer.

The Tribunal, following the Special Bench decision of ITAT Chennai in the case of Scientific Atlanta India Technology (P.) Ltd. v. ACIT, (2010) 129 TTJ 223 (Chennai) (SB)/(2010) 37 DTR 46 (Chennai) (SB)/(2010) 2 ITR 66 (Trib.) (Chennai) (SB), held as under:

(1) The business loss of non-eligible unit(s) cannot be set off against the profits of undertaking(s) eligible for deduction u/s.10A.

(2) Any other income, including the losses arising to the assessee from other concerns, shall be computed as per the regular provisions of the Act, and, consequently, carried forward under and in terms of the regular provisions of the Act.

(3) That the unabsorbed claim u/s.10A, i.e., the income after deduction, having arisen from an eligible unit, cannot be carried forward in the like manner as a business loss or unabsorbed depreciation and would, therefore, be subject to tax.

(4) Deductions u/s.10A and u/s.10B, and also those u/s.80HH, u/s.80HHA, u/s.80-I, u/s.80-IA, etc. are unit-specific in contradiction to being assessee-specific.

(5) There is nothing in the section that suggests aggregation of profits from two or more undertakings so that the profit derived from each is to be considered separately i.e., as if it were the only income of the assessee, for the purpose of computation of deduction thereunder.

(6) In other words, the qualifying amount and, consequently, the deduction in its respect are to be worked out on a stand-alone basis, independently for each eligible unit.

(7) Loss of any other unit is not to be set off while computing deduction u/s.10A.

(8) Income that remains after the deduction u/s. 10A or the unabsorbed claim u/s.10A would stand to be taxed as such i.e., shall not be set off against any other loss or be carried forward.

levitra

(2011) 137 TTJ 249 (Jab.) (TM) ACIT v. Smt. Mukta Goenka IT (SS)A No. 23 (Jab.) of 2007 A.Ys.: 1-4-1996 to 12-12-2002 Dated: 28-5-2010

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Section 158BD — Satisfaction recorded u/s.158BD before initiation of block assessment proceedings of the person searched does not satisfy the requirement of law — Further, so-called satisfaction recorded by the Assessing Officer in the order sheet without even stating that undisclosed income pertaining to the assessees has been detected from the seized record of the persons searched was not in accordance with the provisions of section 158BD —Therefore, the block assessments of the assessees u/s.158BD are not valid.

During the search and seizure operations at the premises of SGL Ltd. and its director A, certain incriminating documents were found. Investigations revealed that SGL Ltd. had received large amount in the form of share capital from sister concerns through bogus shareholders and from agricultural income. Since assessee-trusts also made investment in SGL Ltd., the Assessing Officer framed block assessment u/s.158BD r.w.s 158BC. So-called satisfaction in the order sheet dated 4th September 2003 was recorded before the commencement of block assessment proceedings of the persons searched on 5th September 2003.

The assessees challenged the block assessment orders u/s.158BD before the learned CIT(A). The learned CIT(A) accepted the contention of the assessee and quashed the proceedings u/s.158BD because such notices were issued without any basis. The CIT(A) held that there is no satisfaction recorded objectively and that the same is without application of mind and, accordingly, annulled the block assessment orders u/s.158BD.

There was a difference of opinion between the members of the Tribunal. The Third Member, relying on the decisions in the following cases, upheld the CIT(A)’s order in favour of the assessee:

(a) Manish Maheshwari v. ACIT & Anr., (2007) 208 CTR 97 (SC)/(2007) 289 ITR 341 (SC)

(b) Manoj Aggarwal v. Dy. CIT, (2008) 117 TTJ 145 (Del.) (SB)/(2008) 11 DTR 1 (Del.) (SB) (Trib.)/ (2008) 113 ITD 377 (Del.) (SB).

The Tribunal noted as under:

(1) The so-called satisfaction in the order sheet dated 4th September 2003 has been recorded before the commencement of the block assessment proceedings of the persons searched on 5th September 2003. This satisfaction is not in accordance with the provisions of section 158BD. The satisfaction recorded u/s.158BD on 4th September 2003 i.e., before the initiation of block assessment proceedings of the person searched does not satisfy the requirement of law. The observation that the Assessing Officer has taken simultaneous action in the case of persons searched and in the cases of these assessee-trusts is factually incorrect, because in the cases of assessee-trusts the satisfaction was recorded on 4th September 2003, whereas the block assessment proceedings of the person searched were started subsequently on 5th September 2003.

(2) Similarly, the observation of the AM that it is immaterial whether the satisfaction was recorded in the file of the persons searched or in the case of assessee-trusts is legally incorrect and is not according to the provision of law. Similarly, the reason given by the AM that the Assessing Officer in the case of assessee-trusts and the persons searched is the same and, hence, it is immaterial whether the reasons recorded were in the file of the persons searched or in the case of assesseetrusts is incorrect and is contrary to law.

(3) Satisfaction should be recorded by the Assessing Officer of person searched as per the provisions of section 158BD. It is well-settled law that satisfaction recorded has to be objective/ judicious satisfaction and the order sheet dated 4th September 2003, in the cases of the present assessees, does not fulfil this condition, because the block assessment proceedings of the persons searched were started by issuing notice u/s.158BC on 5th September 2003 and hearing of the case of the persons searched was started on 13th October 2003.

(4) Hence, in no case, the Assessing Officer of the persons searched can examine the seized record on 4th September 2003 and ask the assessees’ explanation in respect of seized record of the persons searched.

(5) The so-called satisfaction recorded on 4th September 2003 by the Assessing Officer is based on assumption and presumption and is not based on seized record and is not a judicious satisfaction and, hence, the order sheet dated 4th September 2003 does not fulfil the requirement of section 158BD.

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Tax deduction at source.

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Tax deduction at source on the deposits in banks in the name of the Registrar/Prothonotary and Senior Master attached to the Supreme Court/ High Court, etc. during the pendency of litigation or claim/compensation — Circular No. 8 of 2011 [F.No. 275/30/2011-IT(B)], dated 14th October, 2011 — Copy available for download on www. bcasonline.org
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Tax Accounting Standards.

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The CBDT has released a discussion paper on Tax Accounting Standards for inviting comments/suggestions from all the stake-holders.

Copy of the discussion paper is available for download on www.bcasonline.org

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Notification No. 56 (F.No. 133/48/2011), dated 17-10-2011 — Income-tax (7th Amendment) Rules, 2011 to amend Rule 114 w.e.f. 1st November, 2011.

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As per the amendment, PAN application shall be made by following persons in Form 49AA:

(a) Individual not being a citizen of India
(b) LLP registered outside India
(c) Company registered outside India
(d) Firm formed or registered outside India
(e) Association of persons (trust) formed outside India
(f) Association of persons (other than trust) or body of individuals or local authority or artificial juridical person formed or any other entity by whatever name called registered outside India.

The amended Rule also prescribes various documents that are to be furnished along with the form as proof of identity and address.

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B. V. Kodre (HUF) v. ITO ITAT ‘B’ Bench, Pune Before I. C. Sudhir (JM) and D. Karunakara Rao (AM) ITA Nos. 834/PN/2008 A.Y.: 2004-05. Decided on: 4-10-2011. Counsel for assessee/revenue: D. Y. Pandit/ Ann Kapthuama

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Section 2(47)(v) — Since the assessee had not received full consideration nor handed over possession of the property, capital gains cannot be assessed in the year of execution of the development agreement.

Facts:
The assessee, B. V. Kodre (HUF), entered into a development agreement on 26-6-2003 with M/s. Deepganga Associates, whereby the HUF gave rights of development of an agricultural land to M/s. Deepganga Associates. The development agreement was stamped under Article 5(ga) of Schedule I of the Bombay Stamp Act, 1958. Under the said article stamp duty was leviable @ 1%. The said article applied if possession of the property was not handed over. In cases where possession of property is handed over, the instrument would be covered by Article 25 and the stamp duty leviable would be 5%. Clause 10 of the agreement provided that possession would be given to the developer on receipt of full payment of consideration. Of the total consideration of Rs.60 lakhs the amount of Rs.38,48,150 was given by the developers to the assessee.

The assessee submitted that since it has not handed over possession of the property and also entire consideration has not been received, there was no transfer. Mere registration of development agreement does not give rise to a transfer. It was contended that since there was no transfer, capital gain is not chargeable to tax in the year under consideration. The AO did not agree with the contentions of the assessee. He noted that transfer u/s.2(47)(v) is wider than that as per the Transfer of Property Act, 1882. He noted that clause 5 of the development agreement allowed the developer to amalgamate, divide, plan and construct. According to him, this indicated that it was a transaction u/s.2(47)(v) of the Act. He charged capital gain to tax.

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

Aggrieved, the assessee preferred an appeal to ITAT where it relied on the ratio of the following decisions:

(a) General Glass Company (P.) Ltd., 14 SOT 32 (Bom.)

(b) ITO v. Smt. Satyawati Devi Verma, (2010) 124 ITD 467 (Del.)

(c) Smt. Raja Rani Devi Ramna v. CIT, (1993) 201 ITR 1032 (Pat.) Held: The Tribunal noted that it has not been rebutted by the Revenue that the development agreement has been stamped under Article 5(ga) of Schedule I of the Bombay Stamp Act and not under Article 25. It also noted that clause 10 of the development agreement provides that property as stated in clause 1 of the agreement will be transferred and the purchase deed will be executed only after the receipt of the payment of entire consideration of Rs.60 lakhs and payment of stamp duty. The Tribunal held that registration is prima facie proof of an intention to transfer but it is no proof of an operative transfer, if there is a condition precedent as to payment of consideration. The transfer u/s.2(47) of the Act must mean any effective conveyance of capital asset to the transferee. Accordingly, where the parties had clearly intended that despite the execution and registration of the sale deed, transfer by way of sale would become effective only on payment of the entire sale consideration, it had to be held that there was no transfer made. Upon considering the ratio of the 3 decisions relied upon by the assessee, the Tribunal observed that the agreement in question does not establish that a transaction of sale of property was completed in terms of provisions of section 2(47)(v) of the Act r.w.s. 53A of the Transfer of Property Act, as neither the sale consideration was paid, nor the possession of the property was handed over to the vendor, and so, the capital gain worked out by the AO and added to the income of the assessee was not justified. The amount received out of the agreed consideration, during the year, at best can be treated as advance towards the agreed consideration of the transaction.

The Tribunal further held that it is an established proposition of the law that the AO is required to make just and proper assessment as per the law based on the merits of the facts of the case before it. Just assessment does not depend as to what is claimed by the assessee, but on proper computation of income deduced based upon the provisions of law. An AO cannot allow the claims of the assessee if the related facts and provisions of law do not approve it and similarly it is also the duty of the AO to allow even those benefits about which the assessee is ignorant but otherwise legally entitled to it.

The facts of the present case are distinguishable from the facts before the Apex Court in the case of Goetze (India) Ltd. v. CIT. In the case before the Apex Court the assessee subsequent to filing of return of income, claimed a deduction by filing a letter. The AO disallowed it on the ground that there was no provision in the Act to allow an amendment in the return without revising it. The action of the AO was upheld. In the present case the question is whether there was a transfer u/s.2(47) of the Act to make an assessee liable to pay capital gains tax. There is no estoppels against proper application of the law.

The Tribunal allowed the appeal filed by the assessee.

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Bennett Coleman & Co. Ltd. v. ACIT ITAT ‘B’ Bench, Mumbai Special Before D. Manmohan, (VP), R. S. Syal (AM) and T. R. Sood (AM) ITA No. 3013/Mum./2007 A.Y. : 2002-03. Decided on : 30-9-2011 Counsel for assessee Revenue : Arvind Sonde and S. Venkatraman/Pavan Ved

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Section 45 r.w.s. 48 — Reduction in share capital of an investee company — Whether the investor can claim proportionate sum of capital reduced as capital loss — Held, No.

Facts:
The assessee had made an investment of Rs.24.84 crore in equity shares of a group company viz., TGL. Pursuant to a scheme of reduction u/s.100 of the Companies Act, the face value of the said company’s shares was first reduced to Rs.5 from Rs.10 and thereafter two equity shares of Rs.5 each were consolidated into one equity share of Rs.10. The assessee claimed its value of investment in TGL got reduced by half to Rs.12.42 crore and hence, after applying the indexation, a sum of Rs.22.22 crore was claimed as long-term capital loss. For the purpose it relied on the decision of the Supreme Court in the case of Kartikeya V. Sarabhai (228 ITR 163) wherein it was held that reduction in face value of shares would amount to transfer, hence, such loss was allowable. According to the AO, the said decision was distinguishable as in that case, the shares involved were non-cumulative preference shares and further in terms of section 87(2)(i) of the Companies Act, 1956, the voting rights of the preference shareholders were also reduced proportionately. He further observed that in the present case the assessee had not received any consideration for reduction in the value of shares, nor any part of the shares had been passed to anyone else. Thus, according to him, there was no change in the rights of the assessee vis-à-vis other shareholders and, therefore, no transfer had taken place and, thus, the assessee was not entitled to the claim of long-term capital loss. On appeal the CIT(A) upheld the action of the Assessing Officer on similar reasoning.

Before the Tribunal the assessee contended that the transaction did amount to a transfer and in support made the following submissions:

ISIN Number, a unique identification number allotted to each security, had changed, meaning thereby that the new shares were different from the old;

old shares had been replaced with the reduced number of new shares, hence, it should be treated as ‘exchange’ of shares which is covered by the definition of ‘transfer’;

as per the decision of the Supreme Court, in the case of Kartikeya V. Sarabhai (228 ITR 163) the definition of transfer given in section 2(47) is an inclusive definition and, inter alia, provides that relinquishment of an asset or extinguishment of any right therein would also amount to transfer of a capital asset;

the principle laid down in the case of CIT v. G. Narsimhan (Decd) and Others, (236 ITR 327) squarely applies since the issue therein was regarding reduction of equity share capital;

as per the Supreme Court in the case of CIT v. Grace Collis & Ors., (248 ITR 323), the expression ‘extinguishment of any right therein’ can be extended to mean extinguishment of right independent of or otherwise than on account of transfer. Thus, even extinguishment of right in a capital asset would amount to transfer and since the assessee’s right got extinguished proportionately, to the reduction of capital, it would amount to transfer.

As regards the absence of consideration, the other ground on which the claim for long-term capital loss was denied by the lower authorities, the assessee contended as under:

In the case of B. C. Srinivasa Setty (128 ITR 294) the proposition was not that if no consideration was received, then no gain can be computed but the proposition was that if any of the element in computation provision could not be ascertained, then computation provision would fail and such gain could not be assessed to capital gains tax. However, in the case of the assessee consideration was ascertainable, in the sense that same should be taken as zero. In this regard he relied on the decision of the Bombay High Court in the case of Cadell Wvg. Mill Pvt. Ltd. v. CIT, (249 ITR 265).

If the idea was not to subject zero consideration transaction to capital gain tax u/s.45, then there was no need for clause (iii) for gifts in section 47.

The assessee concluded by submitting that during the process of reduction of share capital, transfer had taken place and consideration received by the assessee should be considered as zero and, therefore, capital loss should be allowed.

Held:
According to the Tribunal, in the case of Cadell Wvg. Mill Pvt. Ltd. relied on by the assessee, the Bombay High Court specifically declined to entertain the argument that the cost of tenancy right should be taken at zero because according to it, that would amount to charging of capital value of the asset to tax and not capital gain.

In the case of reduction of capital, the Tribunal noted that nothing moves from the coffers of the company and, therefore, it was a simple case of no consideration which cannot be substituted to zero. It further noted that after the decision of the Supreme Court in the case of B. C. Srinivasa Setty, the Legislature had introduced specific provision wherein cost of acquisition of goodwill was to be taken at nil. Similar amendments were made to specify the cost with reference to trademark, cost of right to manufacture or produce or process any article or thing, etc. Therefore, wherever the Legislature intended to substitute the cost of acquisition at zero, specific amendment has been made. In the absence of such amendment it has to be inferred that in the case of reduction of shares, without any apparent consideration, that too in a situation where the reduction has no effect on the right of shareholder with reference to the intrinsic rights on the company, the cost of acquisition cannot be ascertained and, therefore, the provisions of section 45 would not be applicable. For the purpose it also relied on the decisions in the cases of Mohanbhai Pamabhai and also in the case of Sunil Siddharthbhai.

Further with the help of example, the Tribunal explained that even after reduction of capital, the net worth of the company remained the same and the share of every shareholder also remained the same. There was no change in the intrinsic value of the shares and even the shareholder’s rights vis-àvis other shareholders as well as vis-à-vis company remained the same. There was thus no loss that can be said to have actually accrued to the shareholder as a result of reduction in the share capital. The Tribunal further observed that there would also no change even in the cost of acquisition of shares which the shareholder would be entitled to claim as deduction in computing the gain or loss as and when the said shares are transferred or sold in future as per section 55(v).

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(2011) 60 DTR (Chennai) (TM) (Trib.) 306 Sanghvi & Doshi Enterprise v. ITO A.Ys.: 2005-06 & 2006-07. Dated: 17-6-2011

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Section 80-IB(10) — Deduction is available to the builder even though he is not the owner of the land. Deduction is allowable on pro-rata basis if some flats were having built-up area exceeding 1,500 sq.ft.

Facts:
The assessee firm was engaged in the business of construction. In both assessment years, it derived profits from a housing project which was constructed on a land owned by Hotel Mullai (P) Ltd. (HMPL). The AO considered the agreement entered into between HMPL and the assessee. He observed that HMPL as the owner of the land decided to develop the project for which the assessee was nominated as its builder for construction. Further, the AO observed the fact that possession with the assessee of the land does not amount to possession as a part performance of the contract u/s.53A of the Transfer of Property Act. All permissions were obtained by HMPL, there was no outright purchase of land by the assessee and the assessee had sub-contracted the civil work to someone else. The AO was of the view that development includes many aspects and construction is only one of it. Based on the above facts, he concluded that the assessee is not eligible for deduction u/s.80-IB of the Act.

Besides the above, the AO noticed that certain other conditions were also violated like:

(a) The built-up area of certain flats exceeded the statutory limit of 1,500 sq.ft.

(b) In some cases, two flats were combined to make one unit which was exceeding 1,500 sq.ft.

(c) In one case, the purchaser had an exclusive right over the terrace and if built-up area of terrace included, then it would exceed 1,500 sq.ft.

(d) The project had to be completed on or before 31st March, 2008 and no completion certificate was on records.

The CIT(A) confirmed the order of the AO in toto in both the years.

Held:
1. The distinction between a ‘builder’, ‘developer’ and ‘contractor’ is quite blurred. As a matter of fact, different persons often use the expressions interchangeably and according to their own perceptions. The question is not who decided to develop the land, but the question is who actually developed the land. Obviously, since the land is owned by HMPL, permissions have to be in its name only. As per the agreement, the builder has the exclusive right to sell the flats to the persons of his choice. He has the exclusive right to determine the sale price of the flats. He has the exclusive right to collect the entire sales consideration of the flats. Out of the total sales consideration received by him, he has to make over only the cost of undivided share of land to the owner which is fixed at Rs.600 per sq.ft. of the super built-up area. Undoubtedly, HMPL as the owner of the land has ventured to realise the potentialities of the land. It has indeed realised the potentialities, not by developing the land, but by handing over the land for development to the builder. All these facts go to show that it is the builder who is responsible to develop the property, maintain it and satisfy the purchasers.

A distinction needs to be drawn between the expressions ‘developer and builder’ and ‘builder and contractor’. If a person is a contractor, then, his job would be merely to construct the building as per the designs provided by the owner and hand over the constructed building to the owner. Thus, the assessee is not a contractor simpliciter, he is not a builder simpliciter, he is not a developer simpliciter. He is all rolled into one i.e., he is a developer, a builder and also a contractor. Even though the assessee and HMPL are joint developers, the role of the assessee as a developer is greater than the role of HMPL as developer. In the final analysis, the assessee is a builder and a developer entitled to deduction u/s.80-IB(10) subject to fulfilment of other conditions mentioned in the section.

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. 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. Moreover, clause (e) and (f) of section 80-IB(10) are effective from 1st April, 2010 and they are not retrospective in operation.

3. The assessee has placed on record the completion certificate issued by the Corporation of Chennai by way of additional evidence. The certificate clearly mentions that the building was inspected on 23rd November, 2007 and that it was found to have satisfied the building permit conditions. However, Chennai Metropolitan Development Authority (CMDA) issued completion certificate on 13th June, 2008 in response to an application by the assessee on 13th March, 2006. When sanction is given normally the sanction would contain a date. In the present case the certificate issued is a completion certificate that is a certificate accepting the claim of the assessee that the project has been completed, i.e., the certificate is issued on an application given by the assessee. The assessee can give an application for completion certificate only when the completion of the project is done. Thus the grant of a completion certificate after verification by the competent authority even on a subsequent date would relate back to the date on which the application is made.

4. The terrace talked about here is not the rooftop terrace. It is the terrace, the access to which is through the flat of the purchaser and which is at the floor level and is the terrace of the immediately lower flat. The regular terrace is considered as part of the common area. The terrace that is sold and that is attached to the flat and which is having exclusive access is separate from the regular terrace. Consequently private terrace is to be considered as part of the builtup area of the flat for computing the built-up area of 1,500 sq.ft.

5. The Accountant Member followed the decision of the judgment of the Calcutta High Court rendered in the case of CIT v. Bengal Ambuja Housing Dev. Ltd. in IT Appeal No. 458 of 2006, dated 5th January, 2007 which was a judgment directly on the issue upholding the view of the Calcutta ‘C’ Bench of the Tribunal that a pro-rata deduction is permissible u/s.80-IB(10) when some flats were having built-up area exceeding 1,500 sq.ft. It was held that proportionate deduction should be allowed u/s.80-IB(10) with a caveat that the built-up area of flats measuring more than 1,500 sq.ft. should not exceed 10% of the total built-up area. The Judicial Member disagreed with the above view and held that no such proportional deduction is allowable following the decision of the Co-ordinate Bench in the case of Viswas Promotors (P) Ltd. Upon difference of opinion among the members regarding the last issue the matter was referred to the Third Member.

The third member was of the view that the Madras High Court had not considered the decision in Viswas Promotors (P) Ltd on merits. The Madras High Court in its writ order has dealt with only the writ application filed by the assessee against the order of the Tribunal dismissing the miscellaneous petition filed by the assessee. The Court has specifically mentioned that the writ petition was misconceived and therefore liable to be dismissed. The Madras High Court has not considered anything concerning the merit of the issue. The judgment of CIT v. Bengal Ambuja Housing Dev. Ltd. was a judgment directly on the issue. As there is no direct decision of the jurisdictional High Court available on the subject, the judgment of the Calcutta High Court was to be followed. The assessee was entitled for deduction u/s.80-IB(10) in respect of flats having built-up area not exceeding 1,500 sq.ft. on proportionate basis.

(2011) TIOL 662 ITAT-Mum. Sureshchandra Agarwal v. ITO & Sushila S. Agarwal v. ITO A.Y.: 2005-2006. Dated: 14-9-2011

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Sections 2(47)(v), 45, 54, — Receipt of full consideration coupled with handing over of possession without execution of a registered sale deed is good enough to treat a transaction as transfer. The amendment made in section 53A by which the requirement of registration has been indirectly brought on the statute need not apply while construing the meaning of the term ‘transfer’ with reference to the Income-tax Act.

Facts:
Each of the two assessees were 50% owners of a flat in a building known as Usha Kunj situated at Juhu, Mumbai which was stated to have been sold on 30-4-2004 for a total consideration of Rs.62,50,000 and share of each assessee was Rs.31,25,000. On this sale, capital gain of Rs.24,93,910 arose to each of the two assessees which capital gain was claimed to be exempt u/s.54 against the purchase of a new flat vide agreement dated 25-6-2003 which agreement was registered on 9-7-2003. The claim for exemption was made on the ground that the new flat was purchased within a period of one year before the date of transfer of the old flat which has been sold. In the course of assessment proceedings the assessee filed copy of agreement dated 23-4- 2004 which agreement was not registered. The AO made inquiry with the purchasers of this flat who filed agreement dated 26-8-2004 which agreement was registered on the same date. Upon inquiry with the society, it was found that the share certificate showed the date of transfer as 27-8-2004.

The assessee contended that simultaneous with the execution of the agreement dated 30-4-2004 the assessee received full consideration and handed over the possession of the flat to the purchasers along with all original documents including the share certificate and the application to the society for transfer of shares in favour of the transferee, application for transfer of electric meter to the name of the transferee and also NOC received from the society. The assessee submitted that there was delay on the part of the purchaser in getting the agreement stamped and subsequently when the agreement was presented for stamping the transferee was informed that some penalty was leviable for delay in presenting the same. The transferees, at this stage, requested the assessees to execute a fresh agreement and in these circumstances an agreement dated 26-8-2004 was executed which agreement was registered.

The AO denied exemption u/s.54 on the ground that after the amendment to section 53A of the Transfer of Property Act, the provisions of section 53A apply only to agreements which are registered. Since agreement dated 23-4-2004 was not registered, the date of transfer is not 23-4-2004 but 26-8-2004 and since the date of purchase of new flat is more than one year before 26-8-2004, the assessee was denied exemption u/s.54.

Aggrieved the assessee preferred an appeal to the CIT(A) who agreed with the AO and emphasised that since section 53A of the Transfer of Property Act has been amended, therefore, unless and until the agreement was registered, the same would not amount to transfer. He confirmed the action of the AO.

Aggrieved the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal considered the amendment to section 53A of the Transfer of Property Act and held that even after the amendment, it has not been specifically provided that such instrument of transfer is necessarily to be registered. To ascertain the true meaning in the context of clause (v) of section 2(47) the Tribunal considered the Circular No. 495, dated 22-9-1987 explaining the purpose of introduction of clauses (v) and (vi) to section 2(47). Thereafter, it observed that clause (v) in section 2(47) does not lift the definition of part performance from section 53A of the Transfer of Property Act. Rather, it defines any transaction involving allowing of possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of TOPA. This means such transfer is not required to be exactly similar to the one defined u/s.53A of the TOPA, otherwise, the Legislature would have simply stated that transfer would include transactions defined in section 53A of TOPA. But the legislature in its wisdom has used the words ‘of a contract, of the nature referred to in section 53A’. Therefore, it is only the nature which has to be seen. The purpose of insertion of clause (v) was to tax those transactions where properties were being transferred by way of giving possession and receiving full consideration. Therefore, in a case where possession has been given and full consideration received, then such transaction needs to be construed as ‘transfer’. The amendment made in section 53A by which the requirement of registration has been indirectly brought on the statute will not alter the situation for holding the transaction to be a transfer u/s.2(47)(v) if all other ingredients have been satisfied.

Referring to the decisions of the Apex Court in the case of CIT v. Podar Cement P. Ltd., (226 ITR 625) (SC) and Mysore Minerals Ltd. v. CIT, (239 ITR 775) (SC) it held that for the purpose of the Act the ground reality has to be recognised and if all the ingredients of transfer have been completed, then such transfer has to be recognised. Merely because the particular instrument has not been registered will not alter the situation.

The Tribunal held that the transfer deed dated 30- 4-2004 transferred all the rights of the assessee to the transferees and, therefore, this deed should be considered as the deed of transfer. It held the date of transfer for old property has to be reckoned as 30-4-2004 which is well within one year from the date of acquisition of the new property on 25-6- 2003. It held that the assessees are entitled to claim exemption u/s.54 of the Act.

The Tribunal set aside the orders of the CIT(A) and directed the AO to allow exemption u/s.54. Appeals of both the assessees were allowed.

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(2011) TIOL 648 ITAT-Mum. De Beers India Pvt. Ltd. v. DCIT A.Y.: 2005-06. Dated: 5-9-2011

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Sections 35E, 37(1), Matching concept — Only expenses incurred wholly and exclusively for exploring, locating or proving deposits of any minerals and including expenses on operations which prove to be infructuous or abortive are eligible for amortisation u/s.35E — Matching principle cannot restrict the quantum of deduction of expenses by relating the same to quantum of earnings as a result of incurring these expenses.

Facts:
The assessee, engaged in the business of prospecting, exploration and mining activities for diamonds and other minerals as also in the business of providing consultancy in the field of diamond prospecting and other related matters. The assessee filed a return of income declaring a loss of Rs.4,39,48,222. The AO noticed that the assessee has incurred expenditure of Rs.23,64,44,196 mainly on prospecting for minerals in India, commercial production of minerals has not commenced, the assessee has only capitalised Rs.17,04,80,638. He asked the assessee to show cause why the entire expenses should not be treated as capital expenses u/s.35E and be disallowed. The assessee submitted that apart from the expenses capitalised by the assessee, the assessee has suo moto disallowed Rs.1,20,06,438 and to this extent capitalisation of entire expenses will result in double disallowance. It was also submitted that expenses not capitalised are eligible for deduction u/s.37 and include expenses like property expenses, communication expenses, printing and stationery, travelling and conveyance, membership and subscriptions, etc., which expenses are not incurred wholly and exclusively for the purposes of prospecting. Further, the assessee has also carried consultancy business from which there were receipts of Rs.98,42,810 which receipts have been offered for taxation.

The AO was of the view that any expenditure incurred for the purpose of prospecting eligible minerals is to be capitalised u/s.35E and deduction is to be claimed only when commercial production starts. As regards earning of professional receipts he observed that “even applying the matching concept, it is not possible to accept that there can be expenditure of Rs.5,39,57,120 to earn consultancy income of Rs.98,42,810”. He allowed an ad hoc deduction of 30% for earning the income of Rs.98,42,810. The balance expenditure of Rs.5,10,04,277 was disallowed and treated as capital expenditure eligible for amortisation u/s.35E.

Aggrieved the assessee preferred an appeal to the CIT(A) who, on the basis of what he perceived as applicability of matching concept, restricted the deductibility of expenses and upheld the order passed by the AO.

Aggrieved, the assessee filed an appeal to the Tribunal.

Held:
The Tribunal upon going through the provisions of section 35E and also the CBDT Circular No. 56, dated 19th March, 1971 held that in order to be eligible for amortisation of expenses u/s.35E, the expenses must have been incurred wholly and exclusively for “exploring, locating or proving deposits of any minerals, and includes such operations which prove to be infructuous or abortive”. The Tribunal observed that the AO has proceeded on the basis that since the assessee is, inter alia, engaged in the business of prospecting minerals, all the expenses incurred by the assessee are to be treated as eligible for amortisation u/s.35E, unless he can demonstrate that the expenses are incurred for earning an income which is taxable in the hands of the assessee. The Tribunal held that this is an incorrect approach. The assessee even when he is engaged in the business of prospecting minerals is eligible for amortisation of such expenses as are eligible u/s.35E(2) r.w.s. 35E(5)(a). All other expenses are eligible for deduction as in the normal course of computation of business income.

As regards the restriction of allowability of expenses based on matching concept, the Tribunal held that the application of ‘matching principle’, based on the quantum of earnings, is wholly devoid of any merits. One cannot invoke the matching principle to restrict the deductibility of a part of expenses as a result of the expenses being too high in proportion to quantum of expenditure; it can at best be invoked to spread over the costs over the entire period in which revenues as a result of those costs are generated, such as in deferred revenue expenditure — but even in such cases the restriction on deductibility of expenses have not been upheld by the Co-ordinate Benches as indeed by the Courts. All that the matching principle states is that in measuring net income for an accounting period, the costs incurred in that period should be matched against the revenue generated in the same period, and that where costs result in a benefit over a period beyond one accounting period, the costs should be reasonably spread over the entire period over which the benefits accrue. As far as the position under the Income-tax Act is concerned, as long as expenses are incurred for the purposes of business, even if it turns out to be wholly unprofitable, the same is to be allowed as deduction in computation of business income. By no stretch of logic, matching principle can restrict the quantum of deduction of expenses by relating the same to the quantum of earnings as a result of incurring these expenses. Once the business has commenced, deduction of expenses in respect of that business cannot be declined on the ground that the earnings from consultancy income do not justify such high expenses. This kind of revenue mismatch, which cannot be a ground of disallowing the expenditure in anyway, is a normal commercial practice in the businesses which have long-term perspectives and larger business interests in their consideration.

The Tribunal held that the AO was in error in capitalising the expenses which were not directly attributable to the prospecting of diamonds, as also restricting the deductibility of expenses to 30% of consultancy revenues received by the assessee.

The appeal filed by the assessee was allowed.

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(2011) TIOL 583 ITAT-Kol. Sushil Kumar Das v. ITO A.Y.: 2005-06. Dated: 13-5-2011

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Sections 139(1), 148, Circular No. 14(XL-35), dated 11-4-1955 — Income assessed can be lower than the income returned by the assessee — A receipt returned by the assessee can be reduced at the Appellate stage if the same is, in law, not taxable.

Facts:
The assessee retired as a school teacher on 31- 7-1998. He received an amount of Rs.10,92,796 inclusive of interest of Rs.3,29,508. Interest was received by virtue of writ petition filed by the assessee. Since the amount received by the assessee included interest on which tax was deducted at source, the AO issued a notice u/s.148 of the Act upon noticing that income has escaped assessment (since assessee had not filed return of income). The assessee filed return of income returning income of Rs.6,19,392 and claimed relief u/s.89(1) of the Act. The AO restricted the relief u/s.89(1) to Rs.65,817 and assessed the total income at Rs.8,86,500.

The returned income as well as assessed income included interest received as per the order of the High Court. Upon completion of the assessment the assessee came to know that interest received pursuant to the order of the High Court, being non-statutory interest in the form of damages/ compensation, the same is not chargeable to tax. He filed an appeal to the CIT(A) and contended that interest wrongly returned by him be held to be not taxable in view of the decision of the Punjab & Haryana High Court in the case of CIT v. Charanjit Jawa, (142 Taxman 101). The CIT(A) rejected the same by stating that the assesse had offered the income in his return and the same cannot be reduced at the Appellate stage.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the moot question was whether the income determined by the AO on the basis of the return filed by the assessee can be a figure lower than the income returned by the assessee. It held that the principle for determining the taxable income of the assessee under the Act should be within the purview of the law in force. If the taxable income determined by the AO is not in accordance with such principle it is open to the assessee raise the contention to before the higher authorities for following the law to determine the actual taxable income of the assessee. The Tribunal held that the lower authorities cannot say that merely because the assessee has returned income which is higher than the income determined in accordance with the legal principles, such returned income can be lawfully assessed. An assessee is liable to pay tax only on his taxable income. The AO cannot assess an amount which is not taxable merely on the ground that the assessee has returned the same as its income. It is always open to the assessee to show before the higher authorities that income though returned as income is not taxable under law.

On merits, the Tribunal held that the case of CIT v. Charanjit Jawa, (supra) supports the view that interest received as a result of the order of the High Court was not a statutory interest and was in the form of damage/compensation and the same was not liable to tax. The Tribunal held that the interest of Rs.2,53,730 received by the assessee as per the order of the High Court was not taxable and the same is a capital receipt. The Tribunal also found support from the Circular issued by the CBDT being Circular No. 14 (XL-35) dated 11-4-1955 which has directed the officers not to take advantage of the ignorance of the assessees. The Tribunal directed the AO to treat the sum of Rs.2,53,730 as capital receipt.

The appeal filed by the assessee was allowed.

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Depreciation: Computation: Block of assets: WDV: S. 43(6)(c)(i)(B): Sale of flat forming part of block of assets: Apparent consideration and not its fair market value to be deducted.

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[CIT v. Cable Corporation of India Ltd., 336 ITR 56 (Bom.)]

The assessee had sold a flat forming part of block of assets for a consideration of Rs.9 lakh. The assessee deducted the said amount of Rs.9 lakh from the block of assets and computed the depreciation allowable on the balance amount. The Assessing Officer determined the fair market value of the flat at Rs.66,44,902 and reduced the said amount from the written down value of the block of assets while calculating the depreciation. The Tribunal accepted the assessee’s claim.

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

 “The Tribunal was right in holding that for the purpose of calculating depreciation allowable to a block of fixed assets, only the apparent consideration for which the flat was sold should be reduced from the block of the fixed assets being Rs.9 lakhs even though the fair market value of the flat was Rs.66,44,902 as determined by the Departmental Valuation Officer.”

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Business income: Section 28(iiia): A.Y. 1997- 98: U/s.28(iiia) only profit on sale of licence is chargeable and not profit which may come in future on sale of licence.

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[GKW Ltd. v. CIT, 200 Taxman 396 (Cal.); 12 Taxman. com 234 (Cal.)]

The assessee-company was making export under the Advance Licence Scheme of the Government. In the accounts for the A.Y. 1997-98, the assessee passed a book entry debiting export benefit receivable account and crediting miscellaneous income by a sum of Rs.228.34 lakh. The said amount represented the customs duty benefit which would have accrued to the assessee on the import of raw materials in future. The assessee claimed that the sum of Rs.228.34 lakh credited to the profit and loss account was a notional figure not liable to income-tax and, accordingly, the said amount was claimed as a deduction from the profits as per profit and loss account. The Assessing Officer treated the sum of Rs.228.34 lakh as the assessee’s income on the ground that the assessee had itself shown the same as such in its books of account. On appeal, the Commissioner (Appeals) and the Tribunal upheld the order of the Assessing Officer.

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

“(i) If the language employed in clause (iiia) of section 28 is compared with the next two clauses, i.e., clauses (iiib) and (iiic), it will appear that while in case of clause (iiia), it is the profit on actual sale of licence that will be chargeable to tax, but in the cases covered by clause (iiib) or (iiic), cash assistance (by whatever name called) received or receivable by any person against exports or any duty of customs or excise repaid or repayable as drawback to any person against exports are chargeable to tax.

(ii) Thus, the Legislature was conscious that in cases covered under clause (iiia), only profit on sale of licence should be chargeable, but not the profit which may come in future on sale of the licence, because the benefit of making import without payment of customs duty accrues to an assessee only at the time of actual import and if the domestic price of the raw materials is lower than the landed cost of the imported materials, it would not be sensible to import the raw materials under the advance licence. Moreover, at times, the advance licences may not be utilised within the period of validity thereof and in such cases, no actual benefit is available to an assessee, whereas in the cases covered by clause (iiib) or (iiic), there is no scope of non-utilisation of the cash assistance or drawback mentioned therein and, as such, those are automatically chargeable to tax.

(iii) So long as the profit had not actually accrued to the assessee on sale of the licence, the notional figure indicated in the profit and loss accounts of the assessee could not be chargeable to tax.

(iv) It is now a settled law that if a particular income shown in the account of profit and loss is not taxable under the Act, it cannot be taxed on the basis of estoppel or any other equitable doctrine. Equity is outside the purview of tax laws; a particular income is either liable to tax under the taxing statute or it is not. If it is not, the ITO has no power to impose tax on the said income.

(v) Therefore, the Tribunal committed substantial error of law in treating the amount of Rs.228.34 lakhs as chargeable to incometax notwithstanding the fact that the same did not come within the purview of section 28(iiia) when the licence had not been sold and no profit had come in the hands of the assessee.”

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Business expenditure: Section 37: A.Y. 2000- 01: Foreign business tour by managing director with wife: Company resolution authorising expenses: Travel expense is deductible.

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[J. K. Industries Ltd. v. CIT, 335 ITR 170 (Cal.)]

In May 1986, the assessee-company had passed a resolution stating that for the business of the company, the managing director was required to go on tours to countries abroad, that if on such tours he were accompanied by his wife, it would go a long way to benefit the company since warm human relations and social mixing promoted better business understanding, that the wife of the managing director was also sometimes required to accompany him on tours abroad as a matter of reciprocity in international business and that the company has decided to bear the expenses of such travel. In the A.Y. 2000-01, the assessee had sent its managing director and the deputy managing director abroad along with their wives for the purpose of the assessee’s business and claimed deduction of the expenses. The Assessing Officer disallowed the expenses on the two wives. The Commissioner (Appeals) and the Tribunal confirmed the disallowance.

On appeal by the assessee, the Calcutta High Court held as under : “

(i) The Income-tax authorities have to decide whether the expenditure was incurred voluntarily and on the grounds of commercial expediency. In applying the test of expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of the business, the reasonableness of the expenditure has to be adjudged from the point of view of the businessman and not of the Revenue.

(ii) When the board of directors of the assessee had thought it fit to spend on the foreign tour of the accompanying wife of the managing director for commercial expediency for reasons reflected in its resolution, it was not within the province of the Income-tax authority to disallow such expenditure.

(iii) However, there was no resolution authorising expenditure on the travel of the wife of the deputy managing director. The expenses on such travel were rightly disallowed.”

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Advance tax: Interest for short payment of advance tax: Sections 234B, 234C, 207, 208, 211: A.Y. 2001-02: Where assessee had no liability to pay any advance tax u/s.208 on any of due dates for payment of advance tax instalments and it became liable to pay tax by virtue of a retrospective amendment made close of financial year, no interest could be imposed upon it u/s. 234B and u/s.234C.

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[Emami Ltd. v. CIT, 200 Taxman 326 (Cal.); 12 Taxman. com 64 (Cal.)]

The assessee did not have any taxable income according to the normal computation provisions of the Income-tax Act, 1961 for the A.Y. 2001-02. It had also no liability u/s.115JB. Thus, the assessee had no liability to pay any advance tax u/s.208 for the A.Y. 2001-02.

By the Finance Act, 2002, section 115JB was amended with retrospective effect from 1-4-2001. In view of the aforesaid retrospective amendment, the assessee was not in a position to deduct the sum of Rs.26.51 crore withdrawn from the revaluation reserve. It recomputed the book profit u/s.115JB for the A.Y. 2001-02, worked out the amount of tax payable, paid the same on 31-8-2002 and it filed revised return on the basis of amended section. The Assessing Officer passed an order u/s.143(3)/115JB for the A.Y. 2001-02. The Assessing Officer computed the tax liability u/s.115JB at the same figure as shown in the assessee’s revised return. However, he charged interest u/s.234B and section 234C since the assessee did not pay any advance tax with reference to the liability for tax under the retrospective amended section 115JB.

The Commissioner (Appeals) allowed the assessee’s appeal holding that since the amended provision did not exist in the statute during the relevant previous year, the assessee’s contention that it had no liability u/s.208 to pay advance tax was well-founded. The Tribunal held that the assessee was liable to pay interest u/s.234B and u/s.234C.
 On appeal by the assessee, the Calcutta High Court reversed the decision of the Tribunal and held as under:

 “(i) A plain reading of sections 234B and 234C makes it abundantly clear that these provisions are mandatory in nature and there is no scope of waiving of the said provisions. However, in order to attract the provisions contained in sections 234B and 234C, it must be established that the assessee had the liability to pay advance tax as provided in sections 207 and 208 within the time prescribed u/s.211.

(ii) A mere reading of sections 207, 208 and 211 leaves no doubt that the advance tax is an amount payable in advance during any financial year in accordance with the provisions of the Act in respect of the total income of the assessee which would be chargeable to tax for the assessment year immediately following that financial year. Thus, in order to hold an assessee liable for payment of advance tax, the liability to pay such tax must exist on the last date of payment of advance tax as provided under the Act or at least on the last date of the financial year preceding the assessment year in question. If such liability arises subsequently when the last date of payment of advance tax or even the last date of the financial year preceding the assessment year is over, it is inappropriate to suggest that still the assessee had the liability to pay ‘advance tax’ within the meaning of the Act.

(iii) The amended provision of section 115JB having come into force with effect from 1-4-2001, the assessee could not be held defaulter of payment of advance tax. On the last date of the financial year preceding the relevant assessment year, as the book profit of the assessee in accordance with the then provision of law was nil, one could not conceive of any ‘advance tax’ which in essence was payable within the last day of the financial year preceding the relevant assessment year as provided in sections 207 and 208 or within the dates indicated in section 211, which inevitably fell within the last date of financial year preceding the relevant assessment year. Consequently, the assessee could not be branded as a defaulter in payment of advance tax as mentioned above and no interest could be imposed upon it u/s.234B and u/s.234C.”

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Dispute Resolution Panel (DRP): Powers: Deduction u/s.10A: AO allowed deduction u/s. 10A; DRP has no power to withdraw it..

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[GE India Technology Centre Pvt. Ltd. v. DRP (Kar.), WP No. 1010 of 2011 dated 5-7-2011.]

For the A.Y. 2006-07, the assessee had claimed deduction of Rs.32.58 crore u/s.10A. In the draft assessment order passed u/s.144C of the Act, the Assessing Officer allowed deduction u/s.10A, but he reduced the quantum by Rs.44.49 lakh. The assessee filed an objection before the Dispute Resolution Penal (DRP). The DRP held that the assessee was not entitled to deduction u/s.10A of the Act as it was engaged in ‘research and development’. On the alternative plea of the assessee that the assessee was engaged in providing ‘engineering design services’ the DRP directed the Assessing Officer to examining the claim on merits.

The assessee filed a writ petition before the Karnataka High Court claiming that the direction given by the DRP withdrawing the deduction u/s.10A was beyond jurisdiction. The Single Judge dismissed the petition. On appeal by the assessee, the Division Bench held as under :

“As the Assessing Officer had accepted that the assessee was eligible for section 10A deduction and had only proposed a variation on the quantum, the DRP had no jurisdiction to hold that the assessee was not eligible for section 10A deduction.”

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Transfer pricing — Foundational facts were not established — Assessee relegated to adopt proceedings that were pending before various authorities and each of the authorities to decide the matter uninfluenced by the observation of the High Court.

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[Coca Cola India Inc. v. ACIT & Ors., (2011) 336 ITR 1 (SC)]

The petitioner, a company incorporated under the laws of the United States of America and thus a foreign company u/s. 2(23A) of the Act, had a branch office in India. It was a part of the International Coca Cola corporate group. The said group had other companies operating in India incorporated under the Companies Act, 1956. The petitioner obtained permission u/s. 29(1)(a) of the Foreign Exchange Regulation Act, 1973, (FERA) to operate a branch office in India to render a services to the Coca Cola group companies, as per conditions mentioned in the application for the said permission. There is a service agreement between the petitioner on the one hand and Britco Foods Company Private Limited (Britco) on the other.

As per the said agreement, the petitioner provides advisory services to Britco to advise, monitor and co-ordinate the activities of bottlers, in consideration of which the petitioner receives fee calculated on the basis of actual cost plus 5%. The petitioner was assessed under the Act for the A.Y. 1998-99 on 31st March, 2004. The Assessing Officer, however, formed an opinion that income of the petitioner, chargeable to tax for the said year, had escaped assessment within the meaning of section 147 of the Act. A notice dated 30th March, 2005, was issued u/s. 148 of the Act, requiring the petitioner to file a return and thereafter, some further information was sought from the petitioner for the purpose of assessment. The petitioner filed reply to the said notice, seeking reasons for the proposed reassessment.

The reasons indicated that the Assessing Officer referred to section 92 of the Act, which enables the Assessing Officer to determine profits which may reasonably deemed to have been derived, when less than ordinary profits are shown to have been derived by a resident. It was further stated in the said reasons that as per the order dated 7th February, 2005, u/s. 92CA(3) for the A.Y. 2002- 03, passed by the Transfer Pricing Officer-1, the profit declared by the petitioner was abnormally low, on account of which arm’s-length price had been fixed. On that account, the income of the assessee had escaped assessment. Similar notices were issued for the A.Ys. 1999-2000, 2000-01 and 2001-02. On 14th July, 2005, notice u/s. 92CA(3) of the Act was issued by the Additional Commissioner of Income-tax acting as Transfer Pricing Officer, on a reference made by the Assessing Officer u/s. 92CA(1) of the Act for the A.Y. 2003-04, to determine arm’s-length price. Identical notices were issued for the A.Ys. 2004-05, 2005-06 and 2006-07.

The Assesssing Officer made assessment in respect of income of the petitioner for the A.Y. 2002-03, vide order dated 24th March, 2005, after getting determined arm’s-length price of services rendered by the petitioner to its associated company, thereby enhancing the income of the assessee. Against the said order, the petitioner preferred an appeal which is pending before the appropriate authority. The petitioner filed a writ petition before the Punjab & Haryana High Court on 19th October, 2005. On 21st October, 2005, notice was issued to the respondents and, vide order dated 18th November, 2005, stay of passing of final order for the A.Ys. 2003-04, 2004-05, 1998-99 to 2001-02 was granted. Similarly, on 15th December, 2006, stay of passing final order for the A.Y. 2005-06 was granted and permission to amend the petition was also granted to challenge the notice in respect of the said year.

Similarly, on 26th May, 2008, stay of passing of final order for the A.Y. 2006-07 was granted. The petitioner further amended the petition to challenge the notice in respect of the A.Y. 2006-07, which amendment had been allowed by a separate order. The main contention raised in the writ petition was that the provisions of Chapter X, i.e., section 92 to 92F of the Act have been enacted with a view to prevent diversion of profits in intra-group transactions leading to erosion of tax revenue. The said provisions have been incorporated, vide Finance Act, 2001, and further amended, vide Finance Act, 2002. Having regard to the object for which the provisions have been enacted, applicability of the said provisions has to be limited to situations where there is diversion of profits out of India or where there may be erosion of tax revenue in intra-group transaction. In the present case, there was neither any material to show diversion of profits outside India, nor of erosion of tax revenue. If the price charged was less and profit of the petitioner was less, there was corresponding lesser claim for deduction by Britco.

Question of diversion of profits out of India would arise only if price charged is higher and that too if the higher profit was not subject to tax in India, which was not the situation in the present case. Further contention was that there was no occasion for determining arm’s-length price as the price determined by the petitioner itself was as per section 92(1) and (2) of the Act, i.e., cost plus 5%. In such a situation, there was no occasion to make reference to the Transfer Pricing Officer. Even if the reference was sought to be made, the petitioner was entitled to be heard before such a decision is taken, so that it could show that reference to the Transfer Pricing Officer was not called for. In objecting to the notices for reassessment, contention raised was that the provisions of Chapter X having been introduced only from 1st April, 2002, there could be no reassessment for the period from April 1, 1997, to 31st March, 2001. It was pointed out that prior to the amendment with effect from April 1, 2002, u/s. 92 of the Act, there was a provision for determination of reasonable profits deemed to have been derived by a resident and not a ‘non-resident’.

The amended provision could not be applied to the petitioner for the period prior to 31st March, 2001. In the reply filed on behalf of the respondents, the impugned notices and orders were defended. As regards the period prior to the A.Y. 2002-03, when the amended provisions of Chapter X were not operative, the stand of the respondents was that the petitioner suppressed its profit in its transactions with its associated companies, which was clear from the proportion of amount of working capital employed to the declared profit and this resulted in escapement of income within the meaning of section 147 of the Act. As regards the period for and after the A.Y. 2002- 03, it was submitted that the said Chapter was applicable to the petitioner as the petitioner had entered into ‘international transaction’ within the meaning of the said provisions with its ‘associated enterprises’. There was no condition that the said Chapter could apply only if the parties were not subject to the tax jurisdiction in India. The only requirement is that at least one of the parties should be non-resident, apart from other requirements in the said Chapter.

According to the High Court the following questions arose for its consideration: “

(i) Whether inapplicability of the unamended provisions of section 92 of the Act (as it stood prior to 1st April 1, 2002) to the petitioner created a bar to reassessment of escaped income of the petitioner?

(ii) Whether the order passed by the Transfer Pricing Officer under Chapter X after 1st April, 2002, could be one of the reasons for reassessment for period prior to introduction of the amended Chapter X in the Act?

(iii) Whether the provisions of Chapter X are attracted when both the parties to a transaction are subject to tax in India, in the absence of allegation of transfer of profits out of India or evasion of tax?

(iv) Whether opportunity of being heard is required before referring the matter of determination of arm’s-length price to the Transfer Pricing Officer?”
The above questions framed by the High Court were dealt by it as under:

Re: Question No. (i)

The High Court noted that the objection of the petitioner was twofold: (a) Reference to inapplicable provisions of section 92 of the Act, as it stood prior to the amended with effect from 1st April, 2002, and (b) irrelevance of the order of the Transfer Pricing Officer under Chapter X passed in respect of a subsequent assessment year.

The High Court held that section 147 of the Act requires formation of opinion that income has escaped assessment. The said provision is not in any manner controlled by section 92 of the Act, nor is there any limit to consideration of any material having nexus with the opinion on the issue of escapement of assessment of income. Interference with the notice for reassessment is called for only where extraneous or absurd reasons are made the basis for opinion proposing to reassess. Apart from the fact that the Assessing Officer had given other reasons, it cannot be held that the material relied upon by the Assessing Officer for proposing reassessment was irrelevant. Whether or not the said material should be finally taken into account for reassessment was a matter which had to be left open to be decided by the Assessing Officer after considering the explanation of the assessee. The High Court was of the view that having regard to the relationship of the petitioner to its associate company, it could not be claimed that the price mentioned by it must be accepted as final and may not be looked at by the Assessing Officer.

Reg: Question No. (ii)

As regards the question whether order of the Transfer Pricing Officer could be taken into account, the High Court was of the view that there could not be any objection to the same being done. Requirement of section 147 of the Act is fulfilled if the Assessing Officer can legitimately form an opinion that income chargeable to tax has escaped assessment. For forming such opinion, any relevant material can be considered. The order of Transfer Pricing Officer can certainly have nexus for reaching the conclusion that income has been incorrectly assessed or has escaped assessment. The High Court observed that in the present case, the said material came to the notice of the Assessing Officer subsequent to the assessment. There was no grievance that the provisions of section 148 to 153 of the Act had not been followed. In such a situation, it could not be held that the notice proposing reassessment was vitiated merely because one of the reasons referred to the order of the Transfer Pricing Officer.

Reg: Question No. (iii)

The High Court did not find any ambiguity or absurd consequence of application of Chapter X to persons who were subject to jurisdiction of taxing authorities in India, nor could find any statutory requirement of establishing that there was transfer of profits outside India or there was evasion of tax. The only condition precedent for invoking provisions of Chapter X was that there should be income arising from international transaction and such income had to be computed having regard to arm’s-length price. ‘International transaction’ as defined u/s. 92B of the Act, stood on different footing than any other transaction. Arm’s -length price was nothing but a fair price which would have been normal price. There was always a possibility of transaction between a non-resident and its associates being undervalued and having regard to such tendency, a provision that income arising out of the said transaction could be computed having regard to arm’s-length price, would not be open to question and was within the legislative competence to effectuate the charge of taxing real income in India.

The High Court did not find any merit whatsoever in the contention that provisions of Chapter X could not be made applicable to parties which were subject to jurisdiction of taxing authorities in India, without there being any material to show transfer of profits outside India or evasion of tax between the two parties. The contention that according to the permission granted by the Reserve Bank of India under the Foreign Exchange Regulation Act, the assessee could not charge more than particular price, could also not control the provisions of the Act, which provides for taxing the income as per the said provision or computation of income, having regard to arm’s-length price in any international transaction, as defined.

Reg: Question No. (iv)

The High Court held that when it is a matter of assessment by one or other officer and the assessee is to be provided opportunity, in the course of the assessment, there was no merit for inferring further opportunity at the stage of decision of the question, whether the Assessing Officer himself is to compute the arm’s-length price or to make a reference to the Transfer Pricing Officer for the said purpose.

On an appeal, the Supreme Court observed that the issue in the Special Leave Petition concerned the
 

application of the principle of transfer pricing. In this case a notice was issued u/s. 148 of the Act for some of the assessment years. On the question of jurisdiction, a writ petition was filed by the assessee, which was disposed of by the High Court in the writ jurisdiction. The Supreme Court, however, on going through the papers, found that foundational facts were required to be established, which could not have been done by way of writ petition. For the aforestated reasons, the Supreme Court was of the view that the assessee should be relegated to adopt proceedings, which were pending, as of date, before various authorities under the Act.

The Supreme Court accordingly, directed the authorities to expeditiously hear and dispose of pending proceedings as early as possible. If the petitioner- assessee was aggrieved by the orders passed by any of these authorities, it would have to exhaust the statutory remedy provided under the Act. It was made clear that each of the authorities would decide the matter uninfluenced by any of the observations made by the High Court.

The special leave petition was disposed of accordingly.

International transactions — Transfer price — Arm’s-length price — Order of remand of the High Court modified so that the TPO would be uninfluenced by the observations given by the High Court.

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[Maruti Suzuki India Ltd. v. ACIT, (2011) 335 ITR 121 (SC)]

The petitioner before the Delhi High Court, formerly known as Maruti Udyog Limited (hereinafter referred to as ‘Maruti’), was engaged in the business of manufacture and sale of automobiles, besides trading in spares and components of automotive vehicles. The petitioner launched ‘Maruti 800’ car in the year 1983 and thereafter launched a number of other models, including Omni in the year 1984 and Esteem in the year 1994. The trade mark/logo ‘M’ was the registered trade mark of the petitioner-company.

Since Maturi wanted a licence from Suzuki for its SH model and Suzuki had granted licence to it, for the manufacture and sale of certain other models of Suzuki four-wheel motor vehicles, Maruti, on 4th December, 1992, entered into a licence agreement, with Suzuki Motor Corporation (thereinafter referred to as ‘Suzuki’) with the approval of the Government of India.

Prior to 1993, the petitioner was using the logo ‘M’ on the front of the cars manufactured and sold by it. From 1993 onwards, the petitioner started using the logo ‘S’, which is the logo of Suzuki, in the front of new models of the cars manufactured and sold by it, though it continued to use the mark ‘Maruti’ along with the word ‘Suzuki’ on the rear side of the vehicles manufactured and sold by it.

A reference u/s. 92CA(1) was made by the Assessing Officer of the petitioner, to the Transfer Pricing Officer (hereinafter referred to as ‘TPO’) for determination of the arm’s-length price for the international transactions undertaken by Maruti with Suzuki in the financial year 2004-05. A notice dated 27th August, 2008, was then issued by the TPO, to the petitioner with respect to replacement of the front logo ‘M’, by the logo ‘S’, in respect of three models, namely, ‘Maruti’ 800, Esteem and Omni in the year 2004-05, which, according to the TPO, symbolised that the brand logo of Maruti had changed to the brand logo of Suzuki. It was stated in the notice that Maruti having undertaken substantial work towards making the Indian public aware of the brand ‘Maruti’, that brand had become a premier car brand of the country. According to the TPO, the change of brand logo from ‘Maruti’ to ‘Suzuki’, during the year 2004-05, amounted to sale of the brand ‘Maruti’ to ‘Suzuki’. He noticed that Suzuki had taken a substantial amount of royalty from Maruti, without contributing anything towards brand development and penetration in Indian Market. It was further noted that Maruti had incurred expenditure amounting to Rs.4,092 crore on advertisement, marketing and distribution activity, which had helped in creation of ‘Maruti’ brand logo and due to which Maruti had become the number one car company in India. Computing the value of the brand at cost plus 8% method, he assessed the value of the brand at Rs.4,420 crore. Maruti was asked to show cause as to why the value of Maruti brand be not taken at Rs.4,420 crore and why the international transaction be not adjusted on the basis of its deemed sale to Suzuki.

Maruti, in its reply dated 8th September, 2008, stated that at no point of time had there been any transfer of the ‘Maruti’ brand or logo by it to Suzuki, which did not have any right at all to use that logo or trade mark. It was submitted by Maruti that a registered trade mark could be transferred only by a written instrument of assignment, to be registered with the Registrar of Trade Marks, and no such instrument had been executed by it, at any point of time. It was also brought to the notice of the TPO that Maruti continued to use its brand and logo ‘Maruti’ on its products and even on the rear side of the models Esteem, ‘Maruti 800’ and ‘Omni’ , the ‘Maruti’ trade mark was being used along with the word ‘Suzuki.’ It was further submitted that Maruti continued to use the trade mark/logo ‘Maruti’ in all its advertisements, wrappers, letterheads, etc. It was also submitted by Maruti that Suzuki, on account of its large shareholding in the company and because of strong competition from the cars introduced by multinationals in India, had permitted them to use the ‘Suzuki’ name and logo, so that it could face the competition and sustain its market share, which was under severe attack. It was also submitted that Suzuki had not charged any additional consideration for use of their logo on the vehicles manufactured by Maruti and there was no question of any amount of revenue being transferred from the tax net of the Indian exchequer to any foreign tax jurisdiction. It was submitted that Maruti had, in fact, earned significantly larger revenue on account of the co-operation extended by Suzuki and that larger revenue was being offered to tax in India.
The jurisdiction of the TPO was thus disputed by ‘Maruti’ in the reply submitted to him. He was requested to withdraw the notice and drop the proceedings initiated by him.
Since Maruti did not get any response to the jurisdictional challenge and the TPO continued to hear the matter on the basis of the notice issued by him, without first giving a ruling on the jurisdiction issue raised by it, a writ petition was filed before the High Court seeking stay of the proceedings before the TPO. Vide interim order dated 19th September, 2008, the High Court directed that the proceedings pursuant to the show-cause notice may go on, but, in case any order is passed, that shall not be given effect to.

Since the TPO passed a final order on 30th October, 2008, during the pendency of the writ petition and also forwarded it to the Assessing Officer of the petitioner, the writ petition was amended so as to challenge the final order passed by the TPO.

In the final order passed by him, the TPO came to the conclusion that the trade mark ‘Suzuki’, which was owned by Suzuki Motor Corporation, had piggy-backed on the Maruti trade mark, without payment of any compensation by Suzuki to ‘Maruti’. He also came to the conclusion that the trade mark ‘Maruti’ had acquired the value of super brand, whereas the trade mark ‘Suzuki’ was a relatively weak brand in the Indian market and promotion of the co-branded trade mark ‘Maruti Suzuki’ had resulted in: “
(a) Use of ‘Suzuki’ — trade mark of the AE.
(b) Use of ‘Maruti’ — trade mark of the assessee.
(c) Reinforcement of ‘Suzuki’ trade mark which was a weak brand as compared to ‘Maruti’ in India.
(d) Impairment of the value of ‘Maruti’ trade mark due to branding process.”

The TPO noted that Maruti had paid royalty of Rs.198.6 crore to Suzuki in the year 2004-05, whereas no compensation had been paid to it by Suzuki, on account of its trade mark having piggy-backed on the trade mark of Maruti. Since Maruti did not give any bifurcation of the royalty paid to Suzuki towards licence for manufacture and use of trade mark, the TPO apportioned 50% of the royalty paid in the year 2004-05, to the use of the trade mark, on the basis of findings of piggy-backing of ‘Maruti’ trade mark, use of ‘Maruti’ trade mark on co-branded trade mark ‘Maruti Suzuki’, impairment of ‘Maruti’ trade mark and reinforcement of ‘Suzuki’ trade mark, through co-branding process. The arm’s-length price of royalty paid by Maruti to Suzuki was held as nil, using the CUP method. He also held, on the basis of the terms and conditions of the agreement between Maruti and Suzuki, that Maruti had developed marketing intangibles for Suzuki in India, at its costs, and it had not been compensated for developing those marketing intangibles for Suzuki. He also concluded that non-routine advertisement expenditure, amounting to Rs.107.22 crore, was also to be adjusted. He, thus, made a total adjustment of Rs.2,06,52,26,920 and also directed that the Assessing Officer of Maruti shall enhance its total income by that amount, for the A.Y. 2005-06.

The High Court set aside the order dated 30th October, 2008 of TPO and the TPO was directed to determine the appropriate arm’s-length price in respect of the international transactions entered into by the petitioner Maruti Suzuki India Limited with Suzuki Motor Corporation, Japan, in terms of the provisions contained in section 92C of the Income-tax Act and in the light of the observations made in the judgment and the view taken by it therein. The TPO was to determine the arm’s-length price within three months of the passing of this order [(2010) 328 ITR 210 (Del.)].

On an appeal by Maruti Suzuki India Ltd., the Supreme Court noted that the High Court had remitted the matter to the TPO with liberty to issue fresh show-cause notice. The High Court had further directed the TPO to decide the matter in accordance with the law. The Supreme Court observed that the High Court had not merely set aside the original show-cause notice but it had made certain observations on the merits of the case and had given directions to the Transfer Pricing Officer, which virtually concluded the matter. In the circumstances, on that limited issue, the Supreme Court directed the TPO, who, in the meantime, had already issued a show-cause notice on 16th September, 2010, to proceed with the matter in accordance with law uninfluenced by the observations/directions given by the High Court in its judgment dated 1st July, 2010.

The Supreme Court further directed that the Transfer Pricing Officer would decide this matter on or before 31st December, 2010.
    

Use of Borrowed Funds for Reinvestment

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1. Issue for consideration

A benefit of exemption from tax on capital gains tax, is conferred on certain specified persons, subject to reinvestment of the capital gains or the net sales consideration, as the case may be, in specified assets, particularly vide sections 54, 54B, 54EC, 54ED and 54F of the Income-tax Act.

The reinvestment in the specified assets is required to be made within the time prescribed under the respective sections. The prescribed amount is required to be deposited in a designated bank account maintained under the Capital Gains Scheme. In a case where the reinvestment is not made by the due date of filing return of income for the year of capital gains, to be utilised for ultimate reinvestment in specified asset within the stipulated time.

It is common to come across cases, where an assessee has, for the purposes of reinvestment, utilised the funds other than the funds realised on sale of capital assets, borrowed or otherwise, leading to a question about his eligibility for exemption from tax for not having used the sale proceeds directly for reinvestment in specified asset. Conflicting decisions, delivered on the subject, require consideration by the taxpayers and their advisors to enable them avoid any unintended hardship in matters of daily recurrence.

 2. V. R. Desai’s case

The issues recently came up for consideration before the Kerala High Court in the case of CIT v. V. R. Desai, 197 Taxman 52. An appeal in this case was filed by the Revenue u/s.260A of the Act for challenging the order of the Tribunal under which an exemption u/s.54F was granted from paying tax on long-term capital gains. In the peculiar and interesting facts of the case, the assessee was the managing partner of a firm, namely, M/s. Desai Nirman, which was engaged, among other things, in real estate business, including construction and sale of flats. During the previous year relevant to the A.Y. 1995-96, the assessee transferred 12.876 cents of land to the said partnership firm treating it as his contribution to the capital of the firm. The firm in turn credited the capital account of the assessee with an amount of Rs.38,62,800, being the full value of the land brought into the firm by him as his share of capital contribution. The assessee availed a loan from HDFC Bank for the construction of a house and within three years from the date of transfer of land to the firm, he got a new house constructed by another firm of M/s. Desai Home, in which also he was a partner.

There was no dispute that the transfer of the land by the assessee to the partnership firm towards his capital contribution to the firm was a transfer within the meaning of section 2(47) resulting into long-term capital gains as per section 45(3) of the Act. In the return filed for the A.Y. 1995-96, the assessee had in fact offered tax on capital gains on the very same transaction of contribution of the above land towards his capital contribution as managing partner, subject however, to his claim for exemption from capital gains tax u/s.54F of the Act, for investment made in the construction of the new building, out of the loan from HDFC Bank, within three years from the date of transfer of the land to the firm.

The AO noticed that the assessee had not invested the sale consideration in full or part in any of the designated bank accounts maintained under the Capital Gains Scheme prior to the date of filing return in terms of section 54F(4) of the Act. He therefore, completed the assessment and issued intimation u/s.143(1)(a) of the Act, holding that the assessee was not entitled to exemption u/s.54F of the Act. The intimation u/s.143(1)(a) was challenged by the assessee before the first Appellate Authority, who dismissed the appeal. In the second appeal filed by the assessee, the assessee took the contention that disallowance of exemption u/s.54F could not be made while issuing an intimation u/s.143(1)(a) of the Act. In the alternative, the assessee contended that the facts established the construction of a new house within three years from the date of sale of land, and so much so, the assessee was entitled to exemption in terms of section 54F of the Act. The Tribunal upheld the claims of the assessee on both the grounds raised.

The Revenue filed an appeal before the Kerala High Court, challenging the order of the Tribunal. The Revenue contended that in order to qualify for exemption u/s.54F, the assessee should have purchased a residential house within one year before or two years after the date of transfer or should have constructed a residential house within a period of three years from the date of transfer, in either case, by utilising the sale proceeds of land; that, for qualifying for exemption, the assessee should have, before the date of filing return, deposited the net sale consideration received in a nationalised bank in terms of section 54F(4) and the receipt should have been produced along with the return filed.

The assessee on the other hand, contended that in order to qualify for exemption, there was no need to directly utilise the sale consideration in constructing the house and it was enough if during the period of three years, an equivalent amount was invested in the construction of the house, from whatever sources; that the assessee admittedly had constructed a new house within three years from the date of transfer of the property and therefore was eligible for exemption.

The Court observed that the assessee allowed the firm to which the property was transferred to retain and use it as a business asset and towards consideration he got only credit of land value in his capital account and as a result the sale consideration was not received by the assessee in cash, nor could it be deposited in terms of clause 4 of section 54F with any nationalised bank or institution; that the assessee did not have the sale proceeds available for investment in the account under the scheme u/s.54F(3) of the Act. The Kerala High Court, on going through the provisions of section 54F, particularly sub-section (4), held that in order to qualify for exemption from tax on capital gains, the net sale consideration should have been deposited in any bank account specified by the Government for this purpose, before the last date for filing of the return and the assessee should have produced along with the return, a proof of deposit of the amount under the specified scheme, in a nationalised bank.

The Court further observed and held that in order to qualify for exemption u/s.54F(3), the assessee should have first deposited the sale proceeds of the property in any specified bank account, and the construction of the house, to qualify for exemption u/s.54F, should have been completed by utilising the sale proceeds that also were available with the assessee; that in the case before them, though the assessee constructed a new building within the period of three years from the date of sale, it was with the funds borrowed from HDFC. By allowing credit of value of transferred property in the capital account of the assessee in the firm, the assessee conceded that the sale proceeds was neither received, nor was going to be utilised for construction or purchase of a house.

The Court finally held that the assessee was not entitled to exemption u/s.54F, because the assessee neither deposited the sale proceeds for construction of the building in the bank in terms of s/s. (4) before the date of filing return, nor was the sale proceeds utilised for construction in terms of section 54F(3) of the Act and that the assessee was not entitled to claim exemption from tax on capital gains u/s.54F of the Act, which the AO had rightly declined.

3.    P. S. Pasricha’s case

The Bombay High Court vide an order dated 7th October, 2009 passed in ITA 1825 of 2009 in the case of CIT v. Dr. P. S. Pasricha, dismissed the Revenue’s appeal against the order of the Tribunal reported in 20 SOT 468 (Mum.). The facts in the Revenue’s appeal before the Tribunal were that;

  •     the assessee had acquired a residential flat in the building known as ‘Dilwara’ at Cooperage, Mumbai at cost of Rs.3,22,464. The said flat was sold during the year relevant to A.Y. 2001-02 for a total consideration of Rs.1,40,00,000. After claiming deductions for the expenses incurred for sale and the cost of acquisition of the said flat, the long-term capital gains was worked out by the assessee at Rs.1,24,02,738,
  •    subsequent to the sale of the said flat, the assessee purchased a commercial property at Kolhapur out of the sale proceeds of the said flat for a total consideration of Rs.1,25,28,000 and gave the said property on rent to Hughes Telecom Ltd.,

  •     thereafter, within the period specified u/s.54(1) of the Act, the assessee purchased two adjoining residential flats at Mumbai for a total consideration of Rs.1,04,78,750, on the strength of which the assessee claimed exemption u/s.54(1) of the Act from tax on capital gains on the sale of the said flat,

  •    the assessee claimed an exemption u/s.54(1) of the Act to the extent of Rs.1,04,78,750 and returned the taxable capital gains at Rs.19,23,988,

  •     the AO disallowed the claim of deduction u/s.54 on two grounds; that the sale proceeds from original asset were not deployed fully in the new asset and that the assessee had not purchased one single property, but, two units,

  •     the assessee preferred an appeal before the CIT(A) and submitted that he had purchased the residential property within the specified period, as such, he was entitled to the exemption u/s.54(1) of the Act. With regard to two residential flats, it was contended that these flats were adjoining flats and they could be used as a single unit, and

  •     the CIT(A) held that the assessee was entitled to exemption u/s.54(1) of the Act, even where the capital gains was invested in more than one flat and with regard to investment of sale proceeds, he further held that since the entire sale proceeds was utilised for purchase of both the flats in question, as such, exemption was to be allowed at Rs.1,04,78,750 as claimed by the assessee.

The Revenue, in the context of the discussion here, contended that the sale proceeds received on account of sale of flat in the building known as ‘Dilwara’ was utilised in purchase of commercial properties at Kolhapur; that the assessee had later on, purchased two residential flats in Lady Ratan Tower, Worli, Mumbai for a sum of Rs.1,04,78,750 out of the funds received from different sources; that to avail the benefit of section 54(1), the assessee was required to invest the sale proceeds received on transfer of long-term capital asset in purchase of another residential house, but, in the instant case, the said sale proceeds from earlier capital asset, were utilised to purchase the commercial property; that a residential house was purchased out of the funds obtained from different sources; that alternatively, the identity of the funds should not be changed and in the instant case, the identity was lost once the sale proceeds were exhausted in purchase of a commercial property; as such, the assessee was not entitled for deduction u/s.54(1) of the Act.

On behalf of the assessee, in the context, it was contended that no doubt the sale proceeds received on sale of residential flat in the building known as ‘Dilwara’ were utilised to purchase a commercial property at Kolhapur, but the assessee had purchased another residential house within the period specified u/s.54(2) of the Act; that the provisions of section 54 nowhere provided that the same sale proceeds, received on transfer of long-term capital asset, must be utilised for the purchase of another residential house; that the assessee was simply required to acquire the residential house within a period of one year before or two years after the date on which the transfer took place and in the instant case, the assessee had purchased the residential flat before the due date of filing of the return and as such, his claim was not hit by ss.(2) of section 54 of the Act and that the proposition propounded by the Revenue about the identity of the funds was without any basis as it could not be applied where the assessee acquired/purchased the residential house before the transfer took place.

The Tribunal observed that the Revenue’s main dispute was about the utilisation of the sale proceeds for purchase of a commercial property and the purchase of residential house out of the funds obtained from different sources, as such, losing the identity of funds. On an analysis of section 54, the Tribunal did not find much force in the Revenue’s contention as, in the opinion of the Tribunal, the requirement of section 54 was that the assessee should acquire a residential house within a period of one year before or two years after the date on which transfer took place and that nowhere, it had been mentioned that the same funds must be utilised for the purchase of another residential house, only that the assessee should purchase a residential house within the specified period, and source of funds was quite irrelevant. Since the assessee had purchased the residential house before the due date of filing of the return of income, his claim was found to be not hit by sub-section (2) of section 54 of the Act and the Tribunal therefore was of the view that assessee was entitled for deduction u/s.54(1) of the Act.

4.    Observations

The wording of the section makes it clear that the law does not insist that the sale consideration obtained by the assessee itself should be utilised for the purchase of house property. The main part of section 54 provides that the assessee has to purchase a house property for the purpose of his own residence within a period of one year before or two years after the date on which the transfer of his property took place or he should have constructed a house property within a period of three years after the date of transfer. A reading of clauses (i) and (ii) of section 54 would also make it clear that no provision is made by the statute that the assessee should utilise the amount which he obtained by way of sale consideration for the purpose of meeting the cost of the new asset.

The assessee has to construct or purchase a house property for his own residence in order to get the benefit of section 54. The statutory provision is clear and does not call for a different interpretation.

There is no ambiguity in understanding the provisions of section 54 and section 54F. The purpose of these provisions is to confer exemption from tax on investment in residential premises. The Legislature itself has appreciated the fact that it would not always be possible to invest the sale proceeds immediately after the sale transaction and therefore, two years’ or three years’ time is given for reinvestment. Neither it is expected, nor is it prudent to keep the sale proceeds intact and keep the said proceeds unutilised till such time.

The fact that these provisions permit the invest-ment in residential premises even before the date of sale, within one year before the sale, and such an investment qualifies for exemption puts it beyond doubt that the Legislature does not intend to have any nexus between the sale proceeds and the investment that is made for exemption. For the purposes of section 54E, even the earnest money or advance is qualified for exemption as clarified by the CBDT’s Circular No. 359, dated 10th May, 1983.

The provisions of sub-sections (2) of section 54 and (4) of section 54F do not, anywhere mandate that there should be a direct nexus between the amount reinvested and the amount of sale consideration or a part thereof, in any manner. A bare reading of these provisions confirm that they use the same language as is used by the sub-section (1) and therefore to infer a different meaning form reading of these provisions, as is done by the Revenue, to obstruct the claim for exemption in cases where the reinvestment was made out of the borrowed funds or funds other than the sales proceeds, is unwarranted and not desirable.

The issue had first arisen before the very same Kerala High Court in the case of CIT v. K. C. Gopalan, 162 CTR 566 wherein, in the context of somewhat similar facts, the Court in principle held that in order to get benefit of section 54, there was no condition that the assessee should utilise the sale consideration itself for the purpose of acquisition of new property. The ratio of this decision was not brought to the attention of the Kerala High Court in V. R. Desai’s case, neither was this case cited. We are of the view that the decision of the Court would have been quite different had this decision and its ratio been brought to the attention of the Court.

In Prema P. Shah v. ITO, 100 ITD 60 (Mum.), the assessee’s claim for benefit of exemption u/s.54 was allowed by the Tribunal, following the said decision of the Kerala High Court in the case of K. C. Gopalan (supra) by rejecting the argument of the Revenue that the same amount should have been utilised for the acquisition of new asset and holding that, even if an assessee borrowed the required funds and satisfied the conditions relating to investment in specified assets, she was entitled to the exemption.

The decision in the case of K. C. Gopalan (supra), though cited, was erroneously distinguished and not followed by the Tribunal in the case of Milan Sharad Ruparel v. ACIT, 121 TTJ 770 (Mum.) wherein it was held that for exemption u/s.54F, utilisation of borrowed funds for purchase of house was detrimental and that the exemption u/s.54F was not available where the assessee purchased a residential house out of funds borrowed from bank. It was held that for the purposes of section 54F, residential property should either be acquired or constructed by the assessee out of his personal funds or the sale proceeds of the capital asset on which the benefit was claimed. Even here, the Tribunal has agreed that the assessee would be entitled to the exemption, which could not be denied to him on the ground of use of borrowed funds, if he is otherwise in possession of his own funds. Once this is conceded, the reference to sub-sections (3) and (4) and reliance thereon for denial of the exemption appears to be incongruous. Either they prohibit the use of other funds or they do not — there cannot be a third meaning assigned to the existence of these provisions.

Similarly, the claim for exemption was denied by the Tribunal in the case of Smt. Pramila A. Parikh in ITA No. 2755/Mum./1997, in which case the assessee had constructed a residential house out of the loans and thereafter the sale proceeds of shares of M/s. Hindustan Shipping & Weaving Mills were utilised for repayment of loans raised for the construction of a residential house. The assessee claimed exemption u/s.54F of the Act. The Tribunal had held that the assessee was not entitled to exemption u/s.54F as she had constructed the house by taking loans from other persons for the purpose of construction of the house and there-after sold the capital asset and repaid the loan out of the sale proceeds of the same.

The Ahmedabad Tribunal, when asked to exam-ine a similar issue in the context of section 54E, in the case of Jayantilal Chimanlal HUF, 32 TTJ 110, held that for claiming exemption u/s.54E, it was sufficient if sale proceeds were invested in Rural Bonds and that the source of funds was immaterial. Similar was the view in the case of Bombay Housing Corporation v. ACIT, 81 ITD 545, wherein it was held that the condition relating to investment in specified assets u/s.54E was satisfied even where the investment was made by the assessee by borrowing funds instead of a direct investment out of consideration received by it for transfer of capital asset. In that case, it was held that the exemption u/s.54E was available for investment in specified assets out of borrowed funds and that the requirement of section 54E was only that the assessee must invest an amount which was arithmetically equal to the net consideration in the specified assets and that no distinction could be made between an assessee who was forced to borrow for the purpose of making the investment and another assessee who effected the borrowing, not because of forced circumstances, but because he consciously or deliberately used the sale consideration for a different purpose. The fact that instead of making a direct investment in the bonds, the borrowed amount was invested in the bonds should not make any difference. These decisions are sought to be distinguished by the Revenue as was done by the Tribunal in the case of Milan Ruparel (supra) on the ground that the said section 54E did not contain a provision similar to section 54F(4) which required an assessee to deposit the sale proceeds in a designated bank account failing the reinvestment before the due date of return of income.

The provisions in any case are meant to be interpreted liberally in favour of the assessee, being incentive provisions, even where it is assumed that there is some doubt in their interpretation. The Courts have always adopted such liberal interpretation of sections 54 and 54F when there is substantial compliance with the provisions of the section.

Even if one looks at the object of sections 54 and 54F, the intention clearly is to encourage investment in residential housing. So long as that purpose is achieved, the benefit of the exemption should not be denied on technical grounds that the same funds should have been utilised.

Income: Deemed profit: Section 41(1): A. Y. 2007-08: Unclaimed liabilities of earlier years which are shown as payable in the accounts are not taxable as income u/s. 41(1) even if the creditors are untraceable and liabilities are non-genuine:

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CIT vs. Bhogilal Ramjibhai Atara (guj); tax appeal no. 588 Of 2013 dated 04-02-2014:

For the A. Y. 2007-08, in the return of income, the assessee had shown an amount of Rs. 37,52,752/- as outstanding debt and the same was shown in the accounts as payable. The Assessing Officer summoned all the creditors and questioned them about the alleged credit to the assesee. In the assessment order he gave a finding that a number of parties were not found at the given address, many of them stated that they had no concern with the assessee and some of them conveyed that they did not even know the assessee. On the basis of such findings and considering that the debts were outstanding since several years, the Assessing Officer applied section 41(1) of the Income-tax Act, 1961 and added the entire sum as income of the assessee. The Assessing Officer held that liabilities have ceased to exist within the meaning of section 41(1) and therefore, the same should be deemed to be the income of the assessee. The Tribunal allowed the assessee’s appeal and deleted the addition.

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

“i) We are in agreement with the view of the Tribunal. Section 41(1) of the Act would apply in a case where there has been remission or cessation of liability during the year under consideration subject to the conditions contained in the statute being fulfilled. Additionally, such cessation or remission has to be during the previous year.

ii) In the present case, both elements are missing. There was nothing on record to suggest that there was remission or cessation of liability that too during the previous year relevant to the A. Y. 2007-08 which was the year under consideration.

iii) It is undoubtedly a curious case. Even the liability, itself, seems under doubt. The Assessing Officer undertook the exercise to verify the records of the so-called creditors. Many of them were not found at all in the given address. Some of them stated that they had no dealings with the assessee. In one or two cases, the response was that they had no dealing with the assessee nor did they know him. Of course, these inquiries were made ex parte and in that view of the matter, the assessee would be allowed to contest such findings. Nevertheless, even if such facts were established through bi parte inquiries, the liability as it stands perhaps holds that there was no cessation or remission of liability and that therefore, the amount in question cannot be added back as a deemed income u/s. 41(1) of the Act.

vi) This is one of the strange cases where even if the debt itself is found to be non-genuine from the very inception, at least in terms of section 41(1) of the Act there is no cure for it. Be that as it may, insofar as the orders of the Revenue authorities are concerned, the Tribunal not having made any error, this Tax Appeal is dismissed.”

levitra

Income: Accrual in India: Non-resident: Fees for technical services: Section 9(1)(vii): A. Y. 1991-92: Sale of design and engineering drawings outside India: Sale of plant: Income does not accrue in India: Not taxable in India:

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DIT vs. M/s. Nisso Lwai Corporation, Japan (AP); ITA No. 612 of 2013 dated 04-02-2014:

The assessee is a non-resident company and it is represented by RINL Visakhapatnam. The assessee company had provided design and engineering services, manufacture, delivery, technical assistance through supervision of erection and commissioning etc., to establish compressor house-I for RINL. The payments were made by RINL separately for each of the services/ equipments provided/supplied by the assessee. It, inter alia, included payment made towards supply of design and engineering drawings. The assessee company claimed that the said payment is not taxable in India as the transaction was of a sale of goods outside India. The Assessing Officer rejected the claim and assessed it as income. The Tribunal allowed the assessee’s claim, deleted the addition and held as under:

“We are of the view that the amount received by the assessee for supply of design and engineering drawings is in the nature of plant and since the preparation and delivery has taken place outside Indian territories, the same cannot be taxed in India.”

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

“i) It appears, the learned Tribunal, on fact, found that there has been no accrual of income in India and this accrual of income has taken place in Japan. As such, the Income-tax Act, cannot be made applicable.

ii) We feel that the decision is legally correct and we do not find any element of law to be decided in this appeal. The appeal is accordingly dismissed.”

levitra

Power to call for information – Powers u/s. 133(6) are in nature of survey and general enquiry to identify persons who are likely to have taxable income and whether they are in compliance with provisions of Act – The notice seeking information from a cooperative Bank in respect of its customers which had cash transactions on deposits of Rs. 1,00,000 and above for a period of three years without reference to any proceeding or enquiry pending before any authority under the Act was valid.

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Kathiroor Service Co-operative Bank Ltd. vs. CIT (CIB) & Ors. [2014] 360 ITR 243 (SC)

The appellant-assessee before the Supreme Court was a service co-operative rural bank. The Incometax Officer (CIB), Calicut, issued a notice on 2nd February, 2009 to the assessee u/s. 133(6) of the Act calling for general information regarding details of all persons (whether resident or non-resident) who have made (a) cash transactions (remittance, transfer, etc.) of Rs. 1,00,000 and above in any accounts and/or (b) time deposits (FDs, RDs, TDs, etc.) of Rs. 1,00,000 or above for the period of three years between 1st April, 2005 and 31st March, 2008. It was expressly stated therein that failure to furnish the aforesaid information would attract penal consequences. The assessee objected to the said notice on grounds, inter alia, that such notice seeking for information which is unrelated to any existing pending proceedings against the assessee could not be issued under the provisions of the Act and requested for withdrawal of the said notice.

The assessing authority addressed to the objections raised by the assessee and accordingly rejected them by letter dated 5th March, 2009. The assessing authority relied on the decision of the jurisdictional High Court in M.V. Rajendran vs. ITO [(2003) 260 ITR 442 (Ker) ] wherein it was held that the Department is free to ask for information about any particular person or to call for general information in regard to any matter they consider necessary. Section 133(6) does not refer to any enquiry about any particular person or assessee, but pertains to the information in relation to ‘such points or matters’ which the authority issuing notices needs. This clearly shows that information of a general nature can be called for and names and address of the depositors who hold deposits above a particular sum is certainly permissible. In fact, as the section presently stands, section 133(6) is a power of general survey and is not related to any person and no banking company including a nationalised bank is entitled to claim any immunity from furnishing such information.

The assessee, aggrieved by the aforesaid, filed Writ Petition before the High Court challenging the notice dated 2nd February, 2009. The learned single judge held that the impugned notice was validly issued under the provisions of the Act and, therefore, dismissed the said petition.

Thereafter, the assessee approached the Division Bench of the High Court by way of Writ Appeal questioning the said notice on grounds, inter alia, that the issuance of such notice u/s. 133(6) was bad in law as section 133(6) only provides for power to seek information in case of pending proceedings under the Act and does not contemplate the powers to seek fishing information which is unrelated to any existing proceedings or which may enable the assessing authority to decide upon institution of proceedings under the Act. The Division Bench has observed that the questions raised therein was no longer res integra in view of the decision of the Supreme Court in Karnataka Bank Ltd. vs. Secretary Government of India [2002] 9 SCC 106, and, accordingly dismissed the said appeal.

Aggrieved by the aforesaid, the assessee went before the Supreme Court in appeal.

The Supreme Court observed that before the introduction of amendment in section 133(6) in 1995, the Act only provided for issuance of notice in case of pending proceedings. As a Consequence of the said amendment, the scope of section 133(6) was expanded to include issuance of notice for the purposes of enquiry. The object of the amendment of section 133(6) by the Finance Act, 1995 (Act 22 of 1995), as explained by the Central Board of Direct Taxes in its circular showed that the legislative intention was to give wide powers to the officers, of course with the permission of the Commissioner of Income-tax or the Director of Investigation to gather particulars in the nature of survey and store those details in the computer so that the data so collected can be used for checking evasion of tax effectively.

The assessing authorities are now empowered to issue such notice calling for general information for the purposes of any enquiry in both cases: (a) where a proceeding is pending, and (b) where proceeding is not pending against the assessee. However, in the latter case, the assessing authority must obtain the prior approval of the Director or the Commissioner, as the case may be, before issuance of such notice. The word ‘enquiry’ would, thus, connote a request for information or questions to gather information either before the initiation of proceedings or during the pendency of proceedings; such information being useful for or relevant to the proceeding under the Act.

The Supreme Court referred to its decision in Karnataka Bank Ltd. vs. Secretary, Government of India [2002] 9 SCC 106, wherein it had examined the proposition whether a notice us/. 133(6) could be issued to seek information in cases where the proceedings are not pending and construed section 133(6) of the Act.

In that case, it was held that it was not necessary that any inquiry should have commenced with the issuance of notice or otherwise before section 133(6) could have been invoked. It is with the view to collect information that power is given u/s. 133(6) to issue notice, inter alia, requiring a banking company to furnish information in respect of such points or matters as may be useful or relevant. The second proviso makes it clear that such information can be sought for when no proceeding under the Act is pending.

In view of the aforesaid, the Supreme Court held that the powers u/s. 133(6) were in the nature of survey and a general enquiry to identify persons who are likely to have taxable income and whether they are in compliance with the provisions of the Act. It would not fall under the restricted domains of being ‘area specific’ or ‘case specific’. Section 133(6) does not refer to any enquiry about any particular person or assessee, but pertains to information in relation to “such points or matters” which the assessing authority issuing notices requires. This clearly illustrated that the information of general nature could be called for and requirement of furnishing names and addresses of depositors who hold deposits above a particular sum is certainly permissible.

In the instant case, by the impugned notice the assessing authority sought for information in respect of its customers which had cash transactions or deposits of Rs. 1,00,000 or above for a period of three years, without reference to any proceeding or enquiry pending before any authority under the Act. The notice was issued only after obtaining approval of the Commissioner of Income-tax, Cochin. The Supreme Court therefore held that the assessing authority has not erred in issuing the notice to the assessee-financial institution requiring it to furnish information regarding the account holders with cash transactions or deposits of more than Rs. 1,00,000.

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Search and Seizure – Section 132B(4)(b) as it stood dealt with pre-assessment period and there is no conflict between this provisions and section 240 or 244A which deals with post-assessment period after the appeal – Assessee is entitled to interest for the period from expiry of period of six months from the date of the order u/s. 132(5) to the date of the regular assessment order in respect of amounts seized and appropriated towards tax but which became refundable as a result of appellate orde<

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Chironjilal Sharma HUF vs. Union of India & Ors. [2014] 360 ITR 237 (SC)

In the search conducted in the house of the appellant on 31st January, 1990, a cash amount of Rs. 2,35,000 was recovered. On 31st May, 1990, an order u/s. 132(5) came to be passed. The Assessing Officer calculated the tax liability and cash seized from appellant’s house was appropriated. However, the order of the Assessing officer was finally set aside by the Tribunal on 20th February, 2004. The Revenue accepted the order of the Tribunal. Consequently, the appellant was refunded the amount of Rs. 2,35,000 along with interest from 4th March, 1994 (date of last of the regular assessments by the Assessing Officer) until the date of refund.

The Appellant (assessee) claimed that he was entitled to interest u/s. 132B(4)(b) of the Act which was holding the field at the relevant time for the period from expiry of period of six months from the date of order u/s. 132(5) to the date of regular assessment order. In other words, the order u/s. 132(5) of the Act having been passed on 31st May, 1990, six months expired on 30th November, 1990, and the last of the regular assessment was done on 4th March, 1994, the assessee claimed interest u/s. 132B(4)(b) of the Act from 1st December, 1990 to 4th March, 1994.

The Supreme Court observed that close look at the provisions of section 132(5) and 132B, and, particularly, clause (b) of u/s. 132B(4) of the Act showed that where the aggregate of the amounts retained u/s. 132 of the Act exceeded the amounts required to meet the liability u/s. 132B(1)(i), the Department is liable to pay simple interest at the rate of 15% on expiry of six months from the date of the order u/s. 132(5) of the Act to the date of the regular assessment or reassessment or the last of such assessments or reassessments, as the case may be. The Supreme Court noted that though in the regular assessment done by the Assessing Officer, the tax liability for the relevant period was found to be higher and, accordingly, the seized cash u/s. 132 of the Act was appropriated against the assessee’s tax liability but the order of the Assessing Officer was overturned by Tribunal finally on 20th February, 2004 and in fact, the interest for the post-assessment period, i.e., from 4th March, 1994, until refund on the excess amount was paid by the Department to the assessee. The Department denied the payment of interest to the assessee u/s. 132B(4)(b) on the ground that the refund of excess amount was governed by section 240 of the Act and section 132B(4)(b) had no application. According to the Supreme Court, however, section 132B(4)(b) dealt with pre-assessment period and there was no conflict between this provision and section 240 or for the matter section 244A. The former dealt with pre-assessment period in the matters of search and seizure and the latter deals with post-assessment period as per the order in appeal.

The Supreme Court held that the view of the Department was not right on the plain reading of section 132B(4)(b) of the Act as indicated above.

The Supreme Court, accordingly, allowed the appeal and set-aside the impugned order holding that the appellant was entitled to the simple interest at the rate of 15% p.a. u/s. 132B(4)(b) of the Act from 1st December, 1990 to 4th March, 1994.

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‘Income’ includes ‘loss’ – a revisit

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‘Income includes loss’ is a phrase found in various judicial precedents in the context of Indian Incometax laws, although commercially ‘income’ and ‘loss’ have always been understood to be antonyms. The gap between the commercial and tax-understanding is intentional. In this context, it is important to know the meaning of the terms ‘income’ and ‘loss’ (along with difference between them).

Income is a term though commonly used; is seldom understood. It has always triggered more questions rather than answers. It cannot be understood with recourse to some accepted tenets, beliefs and established class of propositions. To limit income exclusively to one or any specific sphere would be an unjustified arrest of its reach. Possibly, this is the reason that Income-tax statute also has left the definition of income open-ended.

There are various principles concerning ambit of ‘income’. One among them is ‘income includes loss’. A number of decisions including the Apex Court ruling in the case of CIT vs. J.H. Gotla (1985) 156 ITR 323 (SC) and CIT vs. Harprasad & Co. Pvt. Limited (1975) 99 ITR 118 (SC) has flagged this canon. The attempt in this write-up is to revisit and discern the meaning of the phrase ‘income includes losses’. In this journey, the write-up touches upon various instances in the Act when this principle ‘appears’ to be inapplicable or unworkable. The write-up attempts to initiate a thought whether this principle is to be applied in every situation or this has a restricted application?

Definition of income in the Income-tax Act, 1961 (‘the Act’)

Section 2(24) of the Act provides an inclusive definition of the term ‘income’. It does not define ‘income’ per se. Section 2(24), if paraphrased, would read as under:

(24) “income” includes

• profits and gains
• dividend
• voluntary contributions received by a trust
• the value of any perquisite or profit in lieu of salary taxable
• any special allowance or benefit, other than perquisite included under sub-Clause (iii), specifically granted to the assessee
• any allowance granted to the assessee either to meet his personal expenses at the place where the duties of his office or employment of profit are ordinarily performed or to compensate him for the increased cost of living
• the value of any benefit or perquisite, whether convertible into money or not, obtained from a company or by a representative assessee
• any sum chargeable to Income-tax under Clauses (ii) and (iii) of section 28 or 41 or 59
• any sum chargeable to Income-tax under Clause (iiia) of section 28(iiia)/ (iiib)/ (iiic)
• the value of any benefit or perquisite taxable under clause (iv) of section 28
• any sum chargeable to Income-tax under clause (v) of section 28
• any capital gains chargeable u/s. 45
• the profits and gains of any business of insurance carried on by a mutual insurance company or by a co-operative society
• the profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members
• any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature whatsoever
• any sum received from employees towards ESIC contribution
• any sum received from Keyman Insurance policy
• Gifts or receipts for inadequate consideration.

Section 2(24) enlists various instances of income. First among them is ‘profits and gains’. The terms ‘profits’ and ‘gains’ have not been defined in the Act. It is trite to state that in the absence of statutory definition one could place reliance on the dictionary meaning or normal connotation of term(s). If dictionary meanings are referred, ‘profits’ means excess of revenue over expenditure and ‘gains’ as an increase in amount, degree or value. These twin concepts are indicative of a positive figure. There are judicial precedents to indicate that gains include ‘negative gains’ and we would keep these judicial precedents aside for the time being [and restrict ourselves to terminologies used in the Act].

Other terms used in the definition are ‘received’, ‘granted’, ‘winnings’, ‘obtained’. All these terms also have an element of ‘positivity’ inbuilt in them. Can these terms be used along with ‘losses’? A loss is something different. It is not something which is received or won or granted or obtained. It comes ‘ab-extra’ from outside. The term ‘loss’ generally accompanies verbs such as ‘incurred’, ‘sustained’, ‘computed’, ‘suffered’ etc. The use of these terms in section 2(24) appears to indicate that the law does not visualise any losses to be listed therein. This becomes more evident on a reading of the remaining instances in the definition which confine themselves to incomes which are chargeable to tax. These are obviously not concerned with losses. To conclude, although section 2(24) is an inclusive definition, the instances listed therein do not seem to accommodate ‘losses’ within its stride.

Although section 2(24) is an inclusive definition and its normal meaning should not be curtailed by various items listed therein in its inclusive sweep, it is interesting to observe that the legislature has consciously not included a ‘single’ instance to suggest that income may possibly include a negative face also.

Scope and charge of total income

Section 4 is the charging provision under the Act. The charge is in respect of the total income of a person for any year. The scope of total income is outlined by section 5 which has two sub-sections – one, dealing with residents and other with nonresidents. It enlists incomes which are includible in total income. It recognises those incomes which are to be included in total income on ‘receipt’ or ‘accrual’ or ‘deemed accrual’ basis. Cumulatively, these sections seek to include income within the scope of total income to levy a charge of tax. The question is whether losses can be charged to tax? Can losses be accrued or received or deemed so? The answer is negative in my view.

This is because, the term(s) ‘accrue or arise’ connotes ‘legal right to receive’. It is generally a stage prior to actual receipt (except for advances). The gap between accrual and actual receipt is only a matter of timing difference. It needs no explanation to state that losses cannot be ‘received’. When they cannot be received; how can there be a right to receive them? – Readers may deliberate.

Provisions of clubbing of income

Explanation 2 to section 64 reads – ‘For the purposes of this section, ‘income includes loss.’ This explanation was inserted by Finance Act 1979 whose objective is explained by Circular No. 258, dated 14-06-1979; relevant portion of which is as under:

“17.2 Under the provisions of section 64, the income of the specified persons is liable to be included in the total income of the individual in certain circumstances. The Finance Act, 1979 has inserted a new Explanation 2 below section 64(2) to provide that the term “income” for the purposes of section 64 would include a loss. Hence, for example, where the individual and his spouse are both partners in a firm carrying on a business and the firm makes a loss, the share of loss attributable to the spouse will be included in determining the total income of the individual.”(emphasis supplied)

The intention of the aforesaid amendment/insertion was to include losses in determining total income of the person in whose hands the income gets clubbed.  The inclusion was, therefore, sought to be made in ‘total income’ determination.  Losses of one person (whose income/loss get clubbed) were sought to be set-off against the income of another person (in whose hands the income is getting clubbed).  The explanation seeks to enable set-off of losses of one person in another’s hand. To effectuate this principle the legislature inserted explanation 2 WHEReby income for the purposes of this section includes loss. The important aspect here is the limited scope of this explanation.  The content of this explanation is limited to the context of section 64 only.  It does not travel beyond this. The explicit mention of such an aspect goes on to substantiate that under general principles income does not include losses.  This is a unique provision with a special purpose.

Some of the circulars on the aspect of considering losses for the purpose of set-off against income provide some insight into the purpose of such leg- islation.  In addition to Circular 258 dated 14-06-1979 (referred above) one may refer the C. B. R. Circular No. 20 of 1944 – C. No. 4(13)-I.T/ 44 dated the 15TH July, 1944 which reads as under:
Subject : Section 16(3)(a) – Loss incurred by wife or minor child – Right of set off under section 24(1) and (2).

Attention is invited to the Boards Circular No. 35 of 1941, on the above subject. It was laid down therein that where the wife or minor child of an individual incurs a loss which if it were income would be includ- ible in the income of that individual u/s. 16(3), such loss should be set-off only against the income, if any, of the wife or minor child and if not wholly set-off should be carried forward, subject to the provisions of section 24(2). The Board has reconsidered the question and has decided that, although this view may be tenable in law, the other and more equitable view is at least equally tenable that such loss should be treated as if it were a loss sustained by that individual. Thus, if the wife or minor child has a personal income of Rs. 5,000 which is not includible in the individuals income and sustains a loss of Rs. 10,000 from a source the income of which would be includible in the income of the individual, the loss should be set-off against the income of the individual under section 24(1), and if not wholly set-off should be carried forward u/s. 24(2). The wife or the minor child, would, therefore, be assessable on the personal income of Rs. 5,000. If, in any case, the wife or minor child claims a set-off of the loss against the personal income, it should be brought to the notice of the Board. Boards Circular No. 35 of 1941 is hereby cancelled.” (emphasis supplied)

Thus, losses are included to enable set-off against income. The inclusion is in the total income computation and not in income as such. The inclusion is for the limited purpose of computation. The Direct Tax Law Committee 1978, in its final report, also made some observations on this provision:

“The provisions for aggregating income of the spouse under clause (i) of section 64(1) has led to a dispute in regard to the treatment of losses which may fall to the share of the spouse from the partnership. The Gujarat High Court in Dayalbhai Madhavji Vadera vs. CIT [1966] 60 ITR 551 has ruled that the section contemplates inclusion of income and, accordingly, the share of loss arising to the spouse cannot be set-off against the total income of the other spouse. The Karnataka High Court in Kapadia vs. CIT [1973] 87 ITR 511 has dissented from this view and has held that income in this section includes a loss. On general principles, income from membership in a firm would include a loss and the context of clause (i) of sub-section (1) does not warrant the contrary construction. The liability to assessment cannot alternate from year to year between the individual and the spouse depending on whether there is a profit or a loss…” (emphasis supplied)

The Committee has categorically said that income ‘in this section’ includes loss. To state negatively, otherwise (or under normal circumstances) income does not include loss. The reason for such inclusion is to ensure consistency in the process of aggre- gating the profit or loss with the spouse’s income. It does not indicate income to include loss in all circumstances.

The scope of clubbing section is limited. It provides for clubbing of one’s income in the total income of another. By defining income to include loss, it is suggesting that loss of one person (along with income) may also be included in the total income of another person. The inclusion of loss is expanding the scope of ‘clubbing’ and not ‘income’.

Set-off and carry forward of losses

Chapter VI of the Act deals with aggregation of income and set-off of loss. Section 70 provides for set off of ‘loss’ from one source of income against ‘income’ from another source under the same head. If the losses cannot be fully set-off against income under the same head, they may be set-off against incomes under other heads (section 71). The balance losses remaining after set off against the incomes computed under other heads is carried forward to the succeeding years as per the relevant provisions of the Act. Thus, the Act recognises loss to be different from income. Loss has an effect of reducing income in the process of set-off against income. An increase in loss would reduce the income. They are inversely proportional. The opening portion of section 70 and 71 is broadly similar language which is reproduced below:

Section 70

(1) Save
as otherwise provided in this Act,
where the net
result for any assessment year
in respect of any source
falling under any
head of income, other
than “Capital gains”, is a loss,
the assessee shall
be entitled to have
the amount of such loss
set-off against his
income from any other
source under the
same head.

Section 71

(1) Where
in respect of
any assessment year
the net result of the computation under any
head of income, other than “Capital gains”, is a loss and the assessee has no income
under the head “Capital gains”, he shall, subject to the provisions of this Chapter, be entitled to have
the amount of such loss
set-off against his
income, if any, assessable for that assessment year under any other head.


to absorb the costs/expenditures/ other outlays; an assessee ends up with a situation of unabsorbed costs/ expenditures. This event of income falling short of outflows is called ‘loss’. Can such a situation be termed as ‘in- come’? Loss and Income are names of opposite fiscal situation(s) and cannot be equated with one another. Both the sections deal with set off of loss against income. The legislature itself recognises income and loss to be different and distinct. They are different outcomes having opposite characters. They cannot co-exist. This being the case, can one say that income includes loss?

The term ‘include’ means – ‘to comprise or contain as part of a whole’. Say for instance, if A includes B, then, A either consists of B wholly or partially. On the contrary, if the presence of B negates or diminishes the existence of A, then can we say that A includes B? In the context of clubbing, the legislature required losses (of one person) to be clubbed along with income (of another). This clubbing is to facilitate total income computation. Thus, the inclusion is only ‘quantitative’ and not ‘qualitative’. This being the case, such limited quantitative inclusion of the legislature cannot be understood to be ‘qualitative’ to paint all the incomes with such understanding.

In the context of section 70 and 71, ‘loss’ is a mere outcome in the process of computing income. This is apparent from the language used in these twin sections which read – ‘where the net result….’. Loss is a net result or consequence. The other alternative outcome is ‘income’. To elucidate further, one may look at the structure of the Income-tax Act.

Section 4 creates a charge on total income.  Section 5 (read with section 7 and 9) outline the scope for such total income.  While computing total income certain incomes are excluded by section 10 (along with 11).  Section 14 classifies income into 5 heads for the purpose of total income computation (and charge of Income-tax).  Sections 15 to 59 compute incomes under various heads.   Section 60 to 64 include (or club) certain incomes to assessee’s total income.  The focus is thus on total income computa- tion since the charge u/s. 4 is on it.  While making such computation, when the income is insufficient ‘Loss’ is conceptually different from income.  It is not defined in the Act.  Black’s law dictionary de- fines ‘loss’ as – ‘An undesirable outcome of a risk; disappearance or diminution in value; usually in an unexpected or relatively unpredictable way’.  The definition appears to reflect attributes of involuntary happening.  Although Companies Act of 1956 does not define ‘loss’ there is an indirect inference one could draw from section 210(2) therein which reads :

(2)IN the case of a company not carrying on business for profit, an income and expenditure account shall be laid before the company at its annual general meeting instead of a profit and loss account, and all references to “profit and loss account”, “profit” and “loss” in this section and elsewhere in this Act, shall be construed, in relation to such a company, as references respectively to the “income and expenditure account”, “the excess of income over expen- diture”, and “the excess of expenditure over income”. (emphasis supplied)

The meaning of loss has been explained to be ‘excess of expenditure over income’. It is a differential between expenditure and income. It is an outcome when income is unable to absorb all the expenditure/ costs. In other words, unabsorbed cost is loss. The interplay between income and expenditure results in loss. While computing income, loss could arise if the income falls short of expenditure. Loss is thus a status or situation wherein expenditure exceeds income. It is not a part of income. Something to be included in income, it should be a part of it. Income (net) or losses are two alternatives. They are outcomes. One denotes surplus and other is an epitome of deficit. From an Income-tax standpoint, marriage of these two extremes is impossible sans specific situations such as clubbing or set-off provi- sions (referred above).

Accounting standards also differentiate the two. Accounting Standard 22 [Disclosure and computation of deferred tax] defines taxable income (tax loss) as the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which Income-tax payable (recoverable) is determined.  Income and loss have been recognised as alternatives.  Loss is an antonym of income.  The question is whether such parallel and unlike concepts overlap under the Income-tax regime?

As stated in the beginning of this write-up, various courts held that income includes ‘losses’. It appears to be a fairly settled proposition. Whether this proposition is applicable in every situation?  Does ‘income’, which is inherently positive, include losses?

In my opinion, the term ‘income’ is not a polymor- phous term having an open texture. Income which indicates ‘coming in’ is an embodiment of positivity. It signifies pecuniary enrichment or accumulation. Loss is indicative of opposite emotions (to income). Loss may take various forms but would always result in deterioration. Indian tax provisions (keeping the judicial precedents aside) actually do not seek to hold these contradictory terms synonymous in every situation. At best, loss can be defined to be ‘loss of income’ and not ‘loss includes income’.

Having gone through the various instances and indications in the Act, the question still persists. The mystery around relationship between income and loss still lingers. Can these instances in the statute shake the law of land (Apex Court rulings)? Readers may deliberate whether INCOME REALLY INCLUDES LOSS?

If this proposition is accepted, can a daring attempt be made to claim that ‘losses emanating from sources of income which are exempt can be set-off against other income?’  Although this proposition is well settled by the Apex Court in the case of CIT vs. Harprasad & Co. Pvt. Limited (1975) 99 ITR 118 (SC), the attempt is to just explore an alternate school of thought:

Loss is not a part of total income

Section 2(45) defines total income to mean total amount of income referred to in section 5 and computed in the manner laid down in the Act. The definition thus contains two limbs which are
as follows:

(a)    The income includible in total income must be ascertained as per section 5; and

(b)    The income must be computed as per provisions of the Act.

‘Total income’ defined in section 2(45) presupposes an existence of ‘income’ referred to in section 5. For the reasons mentioned above, section 5 does not appear to cover losses.   Therefore, section 2(45) can never include loss (since they cannot be ascertained as per section 5).  Section 10 seeks to exclude certain incomes from total income.  When a loss is never included in total income, how can section 10 exclude something which never existed?

Section 10 can never exempt a loss

Section 10 contains provisions for exemption of certain incomes.  It never exempts a loss.  Infact, courts have held that exemptions provided by the legislature itself may furnish an infallible clue to the income character of a particular receipt [Refer All India Defence Accounts Association, In re: Shailendra Kumar vs. UOI (1989) 175 ITR 494 (All)]; although not conclusive.

The apex court in the case of UOI vs. Azadi Bachao Andolan and Another 263 ITR 706 (SC) held that the ‘liability to tax’ is a legal situation; whereas ‘payment of tax’ is a fiscal fact.   A taxing statute does not always proceed to charge and levy tax.  Exemption provisions provide exemption from payment of tax.  One among them is section 10.  The incomes enumerated therein exclude income from the total income.  However, it does not annul the charge of tax.  An exemption cannot dispense with the very levy created under the Act [Refer B.K. Industries vs. UOI (1993) 91 STC 548].  Support for this proposi- tion can be drawn from the Apex Court decision in the case of Peekay Re-Rolling Mills vs. Assistant Commissioner – 2007 (219) ELT 3 (SC) – In this case, the court observed:

“In our opinion, exemption can only operate when there has been a valid levy, for if there is no levy at all, there would be nothing to exempt. Exemption does not negate a levy of tax altogether.” “Despite an exemption, the liability to tax remains unaffected, only the subsequent requirement of payment of tax to fulfill the liability is done away with.” (emphasis supplied)

Taking cue from the aforesaid decision (although rendered in the context of central excise), one could argue that exemption section could operate on only those income which can come within the ambit of Income-tax levy. Loss can never be subject to Income-tax levy; so there is no occasion to take relief of exemption provisions. Moreover, it is a settled principle that exemption provisions have to be construed liberally.  The tax relief granted by a statute should not be whittled down by importing limitations not inserted by the legislature [Refer CIT vs. K E Sundara Mudaliar (1950) 18 ITR 259 (Mad) and others].

With utmost respect for the Apex Court decision in the case of Harprasad & Co. Pvt. Limited case and many other cases which have concurred or followed this proposition, the aforesaid write-up is an attempt to take a deeper insight into these landmark judgments and may be challenge the obvious.

(2011) 137 TTJ 188 (Mumbai) Inter Gold (India) P. Ltd. v. JCIT ITA No. 441 (Mum.) of 2004. A.Y.: 1998-99. Dated: 5-1-2010

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Sections 4 and 28(i) of the Income-tax Act, 1961 — Compensation received for loss of goodwill/ reputation is a capital receipt.

The assessee received a sum of Rs.41.58 lakh from Union Bank of Switzerland (UBS) towards loss of reputation and goodwill and claimed the same as capital receipt not chargeable to tax. The Assessing Officer and the CIT(A) held the said amount as revenue receipt chargeable to tax.

The Tribunal, relying on the decision of the ITAT Pune in the case of Serum Institute of India Ltd. v. Dy. CIT, (2007) 12 TTJ (Pune) 174/111 ITD 259 (Pune), upheld the assessee’s claim.

The Tribunal noted as under:

(1) It is evident that the compensation was awarded to the assessee ‘against loss of reputation and goodwill’. It was not on account of the failure on the part of UBS to supply the quantity ordered or some loss caused to the assessee in a particular trading transaction.

(2) It was on account of injury caused to the reputation of the assessee, albeit such injury was caused due to some business transaction.

(3) Had the amount been awarded to make good the loss caused due to excess or short supply of the material or some other trading deficiency, it would certainly have been regarded as a revenue receipt.

(4) Since the nexus of the compensation is with reputation and goodwill and not with the trading operations, it cannot be held to be a revenue receipt.

(5) The main criterion to judge as to whether the compensation is capital or revenue is to ascertain the purpose for which such compensation is awarded. If the compensation is to recoup the loss suffered by the assessee in its business activity, then it will be a revenue receipt. If, however, the purpose is unrelated to the trading activity of the assessee, it will be in the nature of a capital receipt.

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(2011) 128 ITD 108/ (2010) 8 taxmann.com 209 (Delhi) Escorts Heart Institute & Research Centre Ltd. v. ACIT A.Y.: 2005-06. Dated: 9-10-2009

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Section 37(1) — Key personnel, on whose life keyman insurance policy is taken must include, not only the person responsible for the turnover of the business (Chief Cardiac Surgeon), but also the person responsible for managing the business and to make the same profitable (Chairman and Managing Director). Accordingly the premium paid on their policy is allowable.

Facts:
The assessee was a super-specialty hospital dealing with cardiac and cardio vascular diseases. It had taken insurance policies on life of its key personnel — Chief Surgeon, Chairman and Managing Director, the premium on which was claimed as deduction.

The Assessing Officer disallowed the deduction on grounds that the benefit of policy was assigned to key personnel and therefore was not incurred wholly for business purpose.

On appeal, the learned CIT(A) held that since the surgeon had the requisite skill and knowledge of the field, therefore he was responsible for the turnover of the company and accordingly only the premium paid on his policy is deductible and that on the policy of the Chairman and the Managing Director is not.

Held:
(1) The assessee’s activity cannot be said to be solely depending on the surgeon. Though, he may be responsible for the turnover of the company, he may not be responsible for the profits of the company, due to lack of competence necessary for a businessman.

(2) Further, since the business is carried on with the ultimate motive of earning profits, it cannot be said that profits could not be taken as guiding factor to analyse the business.

(3) It was also not argued that the salaries paid to these persons were not allowable.

(4) Further, on their resignation in the subsequent year, the profits of the assessee reduced substantially.

(5) All the above factors led to the conclusion that the Chairman and the Managing Director were key personnel and accordingly the premium paid on their policy is allowed.

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

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

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Anil G. Puranik v. ITO ITAT ‘A’ Bench, Mumbai Before R. S. Syal (AM) and R. S. Padvekar (JM) ITA No. 3051/Mum./2010 A.Y.: 2006-07. Decided on: 13-5-2011 Counsel for assessee/revenue: Soli Dastur/ Rajeev Agarwal

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Section 49(1), section 50C — Once a particular amount is considered as full value of consideration at the time of its purchase, the same shall automatically become the cost of acquisition at the time when such capital asset is subsequently transferred — Section 50C applies to a capital asset being ‘land or building or both’ and not to ‘any right in land or building or both’ — Leasehold rights in plot of land is not ‘land or building or both’ — Section 50C does not apply to leasehold rights.

Facts:
On 16-8-2004, the assessee was allotted leasehold rights in a plot of land for a period of 60 years under ‘12.50% Gaothan Expansion Scheme’. The allotment was in lieu of agricultural land owned by the assessee’s father which land was acquired by the Government of Maharashtra. The lease agreement, in favour of the assessee, was executed on 8-8-2005. On 25-8-2005, the assessee transferred its rights in the said plot for a consideration of Rs.2.50 crore. In the return of income, the assessee took the stand that since the plot which was transferred by the assessee was received in consideration for agricultural land which was not a capital asset, this plot is also not a capital asset and hence gain on its transfer is not chargeable u/s.45 of the Act. Alternatively, it was contended that the market value of the plot on the date of its allotment to the assessee be taken to be its cost of acquisition. The Assessing Officer (AO) held that though the original land was agricultural, the allotted land was not agricultural and therefore the land transferred was capital asset. He held that by virtue of section 49, the cost of acquisition of original land in the hands of the assessee’s father has to be regarded as the cost of acquisition of the land transferred by the assessee. Also, he invoked the provisions of section 50C and considered the market value of land as per stamp valuation authorities to be full value of consideration.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
(1) There were two distinct transactions — the first was the acquisition by the Government of land belonging to the assessee’s father, against which the assessee, as legal heir, was given lease of plot on 16-8-2004. This transaction got completed when the assessee got the leasehold rights viz. on 16-8-2004. The second transaction was transferring, on 25-8-2005, leasehold rights in the plot for a consideration of Rs.2.50 crores. The second asset i.e., leasehold rights in the plot cannot be categorised as agricultural land within the meaning of section 2(14)(iii) of the Act.

(2) The sole criteria for considering whether the asset transferred is capital asset u/s.2(14) or not is to consider the nature of asset so transferred in the previous year and not the origin or the source from which such asset came to be acquired. The second asset i.e., the leasehold rights in the plot cannot be categorised as agricultural land within the meaning of section 2(14)(iii) of the Act. Hence, gains arising on transfer of leasehold rights were chargeable to tax u/s.45 of the Act.

(3) Section 49(1) provides that where a capital asset becomes the property of the assessee by any of the modes specified in clauses (i) to (iv), such as gift or will, succession, inheritance or devolution, etc., the cost of acquisition of such capital asset in the hands of the assessee receiving such capital asset shall be deemed to be the cost for which it was acquired by the person transferring such capital asset in the prescribed modes. In order to apply the mandate of section 49(1), it is a sine qua non that the capital asset acquired by the assessee in any of the modes prescribed in clauses (i) to (iv) should become the subject matter of transfer and only in such a situation where such capital asset is subsequently transferred, the cost to the previous owner is deemed as the cost of acquisition of the asset. Once such capital asset is transferred and another capital asset is acquired, there is no applicability of section 49(1) to such converted asset. The lower authorities erred in applying the provisions of section 49(1) to transfer of leasehold rights.

(4) Since the market value of the leasehold rights, on the date of allotment, constituted full value of consideration for transfer of lands belonging to the assessee’s father, the cost of acquisition of leasehold rights will be its market value on the date of allotment. Once a particular amount is considered as full value of consideration at the time of its purchase, the same shall automatically become the cost of acquisition at the time when such capital asset is subsequently transferred.

(5) Section 50C is a deeming provision which extends only to land or building or both. Deeming provision can be applied only in respect of the situation specifically given and hence cannot go beyond the explicit mandate of the section. The distinction between a capital asset being ‘land or building or both’ and any right in land or building or both is well recognised under the Income-tax Act. The deeming fiction in section 50C applies only to a capital asset being land or building or both, it cannot be made applicable to lease rights in land. As the assessee had transferred lease rights for sixty years in the plot and not land itself, the provisions of section 50C cannot be invoked.

The appeal filed by the assessee was allowed.

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ITO v. Radha Birju Patel ITAT ‘D’ Bench, Mumbai Before N. V. Vasudevan (JM) and Pramod Kumar (AM) ITA No. 5382/Mum./2009 A.Y.: 2006-07. Decided: 30-11-2010 Counsel for revenue/assessee: Jitendra Yadav/Shalin S. Divatia

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Section 14 — Heads of income — Income out of investments in shares of listed companies through Portfolio Management Scheme —Whether the AO was justified in taxing income under the head business income — Held that the income was taxable as capital gains.

Facts:
The assessee had made investment in shares through the Portfolio Management Scheme. She had disclosed a short-term capital gain of Rs.11.61 lakh and short-term capital loss of Rs.0.5 lakh in respect of purchase and sales of shares of various companies. According to the AO based on CBDT Circular No. 4 of 2007, dated 15-6-2007, the case of the assessee falls in the case of trading in shares. A reference was also made to the Supreme Court decision in the case of G. Venkataswami Naidu & Co v. CIT, (35 ITR 594), wherein the had laid down a principle that where purchases had been made solely and exclusively with intention to resell at a profit and the purchaser had no intention of holding property for himself or otherwise enjoying or using it, presence of such an intention was a relevant factor and unless it was offset by presence of other factors, it would raise a strong presumption that the transaction was in the nature of trade. He also noted that dividend earned during the year amounted to Rs.0.94 lakh, which according to him indicated that the intention of the assessee was to hold shares only for such period as may enable her encashing the appreciation in its value. On appeal by the assessee, the CIT(A) held in favour of the assessee. Being aggrieved, the Revenue appealed before the Tribunal and relied on the order of the AO.

Held:
The Tribunal noted that the assessee was doing investment activities through the Portfolio Manager. Such activities were for maximisation of wealth rather than encashment of profits on appreciation in value of shares. It further noted that the very nature of the Portfolio Management Scheme was such that the investments made by the assessee were protected and enhanced. Therefore, according to it, in such a circumstance, it cannot be said that Portfolio Management was a scheme of trading in shares and stock. Accordingly, it upheld the order of the CIT(A).

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(2011) 52 DTR (Jab.) (TM) (Trib.) 346 DCIT v. Vishwanath Prasad Gupta A.Y.: 2004-05. Dated: 15-6-2010

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Merely on the basis of non-maintenance of stock register it cannot be inferred that the account books are false — Also mere low Gross Profit (GP) rate by itself cannot justify an addition. Gifts received by cheques which have been confirmed by the donors in affidavits and disclosed in their respective returns could not be treated as non-genuine gifts.

Facts:
The assessee derives income from sale of motor parts, tractor parts, tyres, etc. The assessee had shown GP at 10.84% which was less than previous year GP of 14.17%. To support the reduction in GP, the assessee submitted regular books of accounts which were audited. As no quantitative details of  purchases, sales, closing stock, etc. were maintained, the book results were rejected by the AO applying provisions of section 145. The AO thereafter added an estimated amount of Rs.50,000 to total income.

Held:
The assessee had maintained inventory of opening and closing stock and vouchers for purchases and sales which were also audited. Mere non-maintenance of stock register cannot mean that the books of accounts maintained are false. Also, low GP may justify an enquiry but cannot justify an addition to the profit shown. In the present case, the AO had not shown any mistake in books of accounts. Furthermore, rate of GP in a particular year depends on many factors and the same need not be constant from year to year. Therefore addition to income is not justified.

Facts:
The assessee received gift from two parties vide cheques. To prove the gifts are genuine, the assessee submitted affidavits of donors. However, the assessee’s claim was rejected as the AO was also not satisfied with the relationship between donor and donee. Further the AO observed that the assessee did not produce donors for verification and also did not prove financial capacity. The CIT(A), however, upheld the contention of the assessee.

On Revenue’s appeal, there was a difference of opinion between the members, and the matter was referred to the Third Member.

Held II:
The gifts received by the assessee were to be considered genuine as the gift was made through cheque and also disclosed in the books of accounts of the donees. Also the donees have admitted the gift given in their respective affidavits and hence there was no reason in disbelieving the genuineness of the gift.

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(2011) TIOL 266 ITAT Mum.-SB ITO v. United Marine Academy ITA No. 968/Mum./2007 A.Y.: 2003-2004. Dated: 25-4-2011

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Sections 48, 50, 50C, Circular 8 of 2002 — Provisions of section 50C can be invoked in case of depreciable assets where the provisions of section 50 are applicable.

Facts:
The assessee, a partnership firm, engaged in business of running a marine training institute, filed its return of income declaring the total income of Rs.1,86,466. During the previous year relevant to the assessment year under consideration the assessee sold a building, on which depreciation was claimed in earlier years, for a consideration of Rs.49,43,525. Since the amount of consideration was the same as its WDV, the assessee did not offer short-term capital gains on sale of the building. The value of this building as per stamp valuation authorities was Rs.76,49,000. The Assessing Officer (AO) was of the view that one of the office building i.e., office No. 101 having a WDV of Rs.13,14,425 was not sold by the assessee during the year under consideration. The Assessing Officer (AO) held that in view of the provisions of section 50 r.w.s 50C, the value of the building adopted by the stamp valuation authorities needs to be taken as full value of consideration. He, accordingly, made an addition of Rs.20,44,900, being the difference between value of the office sold (excluding office No. 101) as per stamp valuation authorities (Rs.56,74,000) and the WDV of the said office (Rs.36,29,100), to the total income of the assessee.

Aggrieved the assessee preferred an appeal to the CIT(A), where it contended that the provisions of section 50C cannot be invoked in the case of an assessee wherein section 50 is applicable. It contended that it is not permissible to impose a supposition on a supposition of law. The CIT(A) held that the deeming provisions of section 50C could not apply to depreciable assets. He also held that the block of assets had ceased to exist. He deleted the addition made by the AO.

Aggrieved the Revenue preferred an appeal to the Tribunal.

The President, ITAT constituted a Special Bench to consider the following question:

“On a proper interpretation of sections 48, 50 and 50C of the Income-tax Act, 1961, was the Assessing Officer right in law in applying section 50C to capital assets covered by section 50 (depreciable assets) and in computing the capital gains on the sale of depreciable assets by adopting the stamp duty valuation?”

Held:
(1) There are two deeming fictions created in section 50 and section 50C. The first deeming fiction modifies the term ‘cost of acquisition’ used in section 48 for the purpose of computing the capital gains arising from transfer of depreciable assets, whereas the deeming fiction created in section 50C modifies the term ‘full value of the consideration received or accruing as a result of transfer of the capital asset’ used in section 48 for the purpose of computing the capital gains arising from the transfer of capital asset being land or building or both.

(2) The deeming fiction created in section 50C operates in a specific field which is different from the field in which section 50 is applicable. It is not a case where a supposition has been sought to be imposed on other supposition of law. Going by the legislative intentions to create the said fictions, the same operate in different fields.

(3) The harmonious interpretation of the relevant provisions makes it clear that there is no exclusion of applicability of one fiction in a case where other fiction is applicable.

(4) The assessee’s alternate argument that as the AO had held that the block of asset had not ceased to exist in the year and was in existence, section 50C could not apply as held in Roger Pereira Communications 34 SOT 64 was not acceptable, since the assessee itself had considered the entire block of buildings as having been sold/transferred during the year and the same was upheld by the CIT(A). The assessee is not entitled to take a stand with regard to facts, inconsistent with the stand that he had taken before the Revenue Authorities to obtain a decision in his favour. He cannot be heard to say that the stand on facts so taken by him is not correct just to raise a new legal plea.

The question referred to the Special Bench was answered in the affirmative i.e., in favour of the Revenue and against the assessee. The appeal filed by the Revenue was allowed.

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(2011) TIOL 262 ITAT-Mum. Purvez A. Poonawalla v. ITO ITA No. 6476/Mum./2009 A.Y.: 2006-07. Dated: 9-3-2011

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Section 56(2)(v) — ‘Consideration’ referred to in the provisions of section 56(2)(v) has to be understood as per the definition of consideration as given in section 2(d) of The Indian Contract Act, 1872 — Amount received in consideration of the assessee abstaining from contesting the will is not covered by section 56(2)(v).

Facts:
One Mrs. Mani Cawas Bamji (the deceased) was a childless widow who died in Mumbai on 6-1-2001. She possessed considerable movable properties in the form of shares, debentures and fixed deposits and immovable property known as Avasia House in her sole name at Nepean Sea Road, Mumbai. During her lifetime, she had allegedly executed a will dated 2-5- 1997. The only legal heirs entitled to her property in the event of her intestacy were the assessee, being the son of a pre-deceased sister of the deceased, and Mr. Dinshaw Jamshedji Mistry, being brother of the deceased. Under her will dated 2-5-1997, the deceased had bequeathed all her properties to her brother Mr. Dinshaw Jamshedji Mistry (DJM), who was also appointed as one of the executors in the will. There were three executors to the will but the other two (other than Mr. Dinshaw Mistry) renounced their executorship. DJM filed a petition before the Bombay High Court for grant of probate of the last will of the deceased. The assessee, as a legal heir of the deceased, received a citation from the Bombay High Court in the petition for grant of probate in respect of the last will of the deceased. The assessee filed a caveat against the grant of probate in respect of the last will of the deceased. In the affidavit filed in support of the caveat the assessee set out reasons as to why the alleged will was not valid. On such objection, the petition for grant of probate was converted into a testamentary suit. The Bombay High Court restrained DJM from dealing with the properties of the deceased. On 28-9-2002, DJM died leaving behind his will dated 29-10-2001 appointing Mr. Rajesh K. Bhavsar (RKB) as the sole executor and legatee. RKB got himself impeded as plaintiff in place of DJM in the testamentary suit for grant of probate of the last will of the deceased.

RKB and the assessee entered into a compromise agreement dated 22-11-2002, whereby the assessee agreed to receive a sum of Rs.5,08,80,000 in consideration for agreeing to the Court granting probate in respect of the last will of the deceased. This sum of Rs.5,08,80,000 was later reduced by Rs.30,00,000 and the sum of Rs.4,78,80,000 was received by the assessee in the following manner:

F.Y. 2003-04 : Rs.1,04,77,032 by various cheques
F.Y. 2005-06 : Rs.3,73,95,335 by various cheques
F.Y. 2006-07 : Rs.7,633 by cash

RKB and the assessee had on 12-12-2002 signed consent terms which consent terms were identical to the agreement dated 22-11-2002. The Court recorded the consent terms and modified the earlier order restraining DJM from alienating any part of the estate of deceased and permitted RKB to alienate some of the properties to enable him to raise funds to discharge the obligation to pay the assessee. The assessee on receipt of the agreed sum was to withdraw his caveat to enable issue of letters of administration with the Will annexed in respect of the estate of the deceased.

The assessee did not offer these amounts for taxation in the A.Y. 2006-07. The AO taxed on substantive basis the sum of Rs.3,73,95,335 (in the year of receipt) and the sum of Rs.1,04,77,032 (received in previous year relevant to A.Y. 2004-05 on a protective basis).

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

Aggrieved the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted section 56(2)(v) has been introduced w.e.f. 1-9-2004. Thus, prior to 1-9-2004, receipts of any sum of money would not be income u/s.56(2)(v). A sum of Rs.1,04,77,032 was received between 3-4-2003 to 14-10-2003. Therefore, these receipts could not be taxed as income u/s.56(2)(v). As regards the sum of Rs.3,73,95,334, the Tribunal held that the sum in question was received by the assessee in consideration of giving up his rights to contest the will of late Mrs. Mani Cawas Bamji. The consideration referred to in the provisions of section 56(2)(v) of the Act have to be understood as per the definition of consideration as given in the Indian Contract Act, 1872 in section 2(d). The assessee has abstained from contesting the will and this constitutes the consideration for payment by RKB to the assessee. Thus, the amount received by the assessee is not without any consideration. Therefore the provisions of section 56(2)(v) were not applicable. The additions made by the AO were directed to be deleted.

The appeal filed by the assessee was allowed.

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(2011) TIOL 251 ITAT-Mum. Capgemini Business Services (India) Ltd. v. DCIT ITA No. 1164/Mum./2010 A.Y.: 2006-07. Dated: 26-11-2010

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Section 246A — The expression ‘amount of tax
determined’ in section 246A(1)(a) refers also to the determination of
the sum finally payable by the assessee and not merely to calculation of
incometax on the amount of total income by applying the rates of tax.

Facts:
The
assessee company, engaged in the business of providing IT-enabled
services and BPO services, e-filed its return of income declaring total
income of Rs.98,90,146 and claiming therein a refund of Rs.22,76,152.
The Assessing Officer in an order passed u/s.143(3) assessed the total
income to be Rs.98,90,146. While calculating the amount of tax payable
by the assessee/refund due to it, the AO in form ITNS 150A granted
credit for TDS and advance tax as claimed by the assessee, but did not
grant credit of Rs.8,38,764 claimed by the assessee u/s.90 and u/s.91 of
the Act.

Aggrieved, the assessee preferred an appeal to the
CIT(A) who held that the appeal was not maintainable since he was of the
view that section 246A did not permit such issues within its ambit.
Referring to the provisions of section 246A(1) (a), he held that the
reference to ‘tax’ is only for calculation of tax on total income and
not beyond that. He also made a reference to the definition of ‘tax’
u/s.2(43) and held that since the assessee was not challenging the
calculation of tax on total income, the grounds raised were several
steps beyond this calculation. He held that the issue of granting of
credit for advance tax or TDS could not be agitated in an appeal.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The
Tribunal noted that the AO had in form ITNS 150A not granted credit of
withholding tax of Rs.8,38,764 u/s.90/91 and also that he had left the
column 18 of ITNS-150A, which specifically provides for DIT relief
u/s.90/91, blank. Upon going through the provisions of section
246A(1)(a) of the Act, the Tribunal observed that the assessee’s case
can be considered only under the second part of section 246A(1)(a) viz.
‘to the amount of tax determined’ and not under the remaining parts as
non-granting of benefit in respect of withholding tax u/s.90 /91 can
neither be considered as ‘the income assessed’, nor ‘the loss computed’,
nor ‘the status under which he is assessed’. Having so observed the
Tribunal proceeded to examine whether non-granting of refund in respect
of withholding tax u/s.90/91 can be considered under the expression
‘amount of tax determined’ and held:

(1) From the ratio
decidendi of the decisions of SC, in the case of Auto and Metal
Engineers and Others v. Union of India and Others, 229 ITR 399 (SC) and
Kalyankumar Ray v. CIT, 191 ITR 634 (SC), it is discernible that the
‘determination of tax’ refers to finding out the amount finally payable
by the assessee for which notice of demand is issued.

(2) The
expression ‘amount of tax determined’ in section 246A(1)(a) also refers
to the determination fo the sum finally payable by the assessee. Not
only the calculation of tax on the total income but also the adjustment
of taxes paid by or on behalf of the assessee is also covered within the
determination of sum payable by the assessee u/s.156 of the Act.

(3)
The expression ‘amount of tax determined’ as employed in section
246A(1)(a) encompasses not only the determination of the amount of tax
on the total income but also any other thing which has the effect of
reducing or enhancing the total amount payable by the assessee. As the
question of not allowing relief in respect of withholding tax u/s.90/91,
has the direct effect of reducing the refund or enhancing the amount of
tax payable, such an issue is squarely covered within the ambit of
section 246A(1)(a).

(4) Accepting the view-point of the CIT(A)
that the appeal is not maintainable in respect of non-allowing of relief
for tax withheld u/s.90/ 91 would amount to violating the language of
section 246A, which has otherwise given the right to the assessee to
appeal broadly against on any aspect of the ‘amount of tax determined’.

(5)
The CIT(A) was not justified in dismissing the appeal of the assessee
as not maintainable on the aspect of not allowing of credit by the AO of
tax withheld on behalf of the assessee u/s.90 and 91. The AO was
directed to modify ITNS 150A and grant the consequential refund due,
which has not been allowed.

The appeal filed by the assessee was allowed.

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(2011) 137 TTJ 741 (Del.) ACIT v. Bulls & Bears Portfolios Ltd. ITA No. 2727 (Del.) of 2008 A.Y.: 2005-06. Dated: 28-1-2011

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Sections 28(i) and 45 of the Income-tax Act, 1961 — If the assessee has maintained the investment portfolio separately and income from which was offered as capital gains and was also assessed as capital gains in successive assessments, then the income will be assessed as capital gains and not as business income.

For the assessment years 2005-06 and 2006-07, the Assessing Officer treated income from sale of shares as business income as against income from capital gains. The CIT(A) held in favour of the assessee.

The Tribunal also held in favour of the assessee. The Tribunal noted as under:

(1) The assessee is a broker as well as an investor. It has maintained the investment portfolio separately, income from which was liable to be taxed as capital gains, since the intention in respect of this was to hold the investment as investment only and was shown as such in the books of account and income therefrom was shown and treated as capital gains in the successive assessments.

(2) The schedule of investments was duly appended in the balance sheet.

(3) The assessee has also maintained separate D-mat accounts for investment and for trading. Therefore, the assessee has distinctly maintained investment account and trading account.

(4) The assessee was holding certain stock for the purpose of doing business of buying and selling and at the same time it was holding other shares as its capital for the purpose of dividend income.

Therefore, the CIT(A) has rightly held that the income is to be treated as capital gains and not as business income.

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(2011) 137 TTJ 573 (Mumbai) ACIT v. Safe Enterprises Misc. Application No. 413 (Mum.) of 2010 in ITA No. 2278 (Mum.) of 2009 A.Y.: 2005-06. Dated: 4-11-2010

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Section 254(2) of the Income-tax Act, 1961 — Where the Tribunal specifically observed that it was in agreement with the reasons given by CIT(A), mere non-production of the reasons and the conclusions of the CIT(A) in the body of the order of the Tribunal does not give rise either to a mistake of law or fact, nor can it be considered as an irregular order for being rectified u/s.254(2).

For the relevant assessment year, certain additions were made by the Assessing Officer against which the assessee filed an appeal. The CIT(A) considered the issue in great detail and passed an elaborate order in favour of the assessee. Aggrieved by this, the Department preferred an appeal before the Tribunal. The Tribunal passed a short order since it was in agreement with the CIT(A)’s order.

The Department filed a miscellaneous application on the ground that the Tribunal was not justified in passing a short order without elaborating on the issues and, thus, it gives rise to a ‘mistake apparent from record’ since it has to be presumed that the Tribunal has not applied its mind on the contentions and issues raised by the Department. In this regard, the applicant has taken a support from para 11 of the guidelines issued by the then President of the Tribunal.

Rejecting the miscellaneous application, the Tribunal observed as under:

(1) Internal guidelines issued by the then President were only to prod the Members to give detailed reasons, as far as practicable, implying thereby that whenever an order of the lower forum is based on two reasons out of which an Appellate Authority agrees only with one reason which would ultimately have an effect of upholding the order of the lower authority, it is the duty of the Tribunal to give detailed reasons to satisfy as to the basis for coming to such conclusion. In a given case, where the appellant raises some additional issues and relies upon some additional case laws which were not considered by the lower authority, even though they are not applicable to the facts of the instant case, the Tribunal may have to give its reasons rejecting such arguments while upholding the order of the CIT (A).

(2) However, when the facts and circumstances are not disputed before the Tribunal and no additional arguments were advanced by the learned Departmental Representative and, in addition to that, when the Tribunal is fully agreeing with the reasons given by the learned CIT(A), as rightly observed by the Apex Court in the case of K. Y. Pilliah & Sons (1967) 63 ITR 411 (SC), it may not be necessary to repeat the reasons given by the first Appellate Authority and an order passed by the Tribunal under such circumstances cannot be said to be illegal.

(3) In para 3 of the order of the Tribunal this Bench has specifically observed that it was in agreement with the reasons given by the CIT (A). Thus, mere non-production of the reasons and the conclusions of the CIT(A) in the body of the order of the Tribunal do not give rise either to a mistake of law or fact, nor can it be considered as an irregular order.

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[2013] 154 ITD 455 (Pune – Trib.) Bharat Forge Ltd. vs. Addl. CIT A.Y. 2007-08 & 2008-09 Date of Order : 31st January, 2013

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Section 194J – A.Y.2007-08 & 2008-09 – Provisions of section 194J do not apply to sitting fees paid to directors. However, provisions of section 194J(1) (ba) w.e.f. 1st July, 2012 will apply to sitting fees paid to Directors.

Facts
The assesse had paid sitting fees to its resident directors on which no tax was deducted. The assessee had deducted tax from salary and commission paid to non-executive directors and contended that provisions of section 194J are not applicable to sitting fees paid to directors. The AO held that 194J would be applicable on such payments since director is also manager under the provisions of the Companies Act, 1956 and therefore, a technical personnel and thus sitting fees paid to him shall be liable to TDS.

Held
As per Explanation to section 194J, professional services mean services rendered by a person in the course of carrying legal, medical, engineering or architectural profession or the profession of accountancy or technical consultancy or interior decoration or advertising or such other profession notified by the Board. Therefore, sitting fees paid to directors do not amount to fees paid for any professional services mentioned in explanation to section 194J. Further, section 194J(1)(ba), effective from 1st July, 2012 states that TDS should be deducted on any remuneration or fees or commission by whatever name called, other than those on which tax is deductible u/s. 192, paid to a director of a company. However, these provisions shall not apply to A.Y. 2007-08 & 2008-09. Thus, no tax is required to be deducted u/s. 194J out of such directors sitting fees for AY 2007-08 & 2008-09.

Tax on payments made by assessee towards testing and inspection charges will be covered u/s. 194C and will not be considered as professional services as per section 194J.

Facts
The assessee had incurred testing and inspection charges on which TDS was done u/s. 194C. The charges were paid for getting the jobs done like testing, inspection of materials, etc., and were in the nature of material and labour contract. However, according to AO, the assessee should have deducted TDS u/s. 194J since the services rendered by the said parties are in the nature of technical/professional service. The CIT(A) upheld the action of AO.

Held
It was held that the nature of expenditure made by the assessee cannot be considered as payment for technical consultancy. The Pune Bench of the Tribunal in the case of Glaxosmithkline Pharmaceuticals Ltd. vs. ITO [2011] 48 SOT 643/15 taxmann.com 163 has held that any payment for technical services in order to be covered u/s. 194J should be a consideration for acquiring or using technical know-how simpliciter provided or made available by human element. There should be direct and live link between the payment and receipt/use of technical services/information. If the conditions of 194J r.w.s. 9(1), Explanation 2 Clause (vii) are not fulfilled, the liability under this section is ruled out. Therefore, it was held that payment by the assessee towards testing and inspection charges cannot be considered as payments towards professional services as per provisions of section 194J and the assessee has rightly deducted tax u/s. 194C.

Payments made for the use of cranes (cranes provided along with driver/operator) is covered under 194C and not under 194-I.

Facts
The assessee had made payments for hire of cranes for loading and unloading of material at its factory. The cranes were provided by the parties along with driver/operator and all expenses were borne by the owners only. The assessee had deducted the tax under 194C. The assessee contended that the hire charges are paid in terms of a service contract and do not amount to rent contract. The AO argued that definition of rent u/s. 194I means ‘any payment, by whatever name called, under any lease, sublease, tenancy or any other agreement or arrangement for the use of (either separately or together) any machinery, plant, equipment, fittings whether or not any or all of the above are owned by the payee’. Thus, AO held that the assessee should have deducted tax u/s. 194I and not 194C. The same was upheld by the CIT(A).

Held
Section 194C of the Act makes provision for deduction of tax at source in respect of payments made to contractors whereas section 194I makes provision for deduction of tax at source in respect of income by way of rent.

The Tribunal, relying on the decisions of the Hon’ble Gujarat High Court in cases of CIT (TDS) vs. Swayam Shipping Services (P.) Ltd. [2011] 339 ITR 647/199 Taxman 249 and CIT vs. Shree Mahalaxmi Transport Co. [2011] 339 ITR 484/211 Taxman 232/ (Guj.), held that provisions of section 194C should be applicable and not section 194I.

Payment towards windmill operation and maintenance, being comprehensive contract, will attract TDS u/s. 194C of the Act and not u/s. 194J.

Facts
The assessee company had made payments towards maintenance of windmill, replacement of parts, implementing safety norms, conduct of training programmes, prevention of damage, etc. at windmill site. The contract was a comprehensive contract for material and labour services required. The AO held that the operation and maintenance of windmill requires technical skills and knowledge and is covered u/s. 194J. The CIT(A) held that the assessee had correctly deducted tax u/s.194C.

Held
The Tribunal upheld the order of CIT(A). Mere fact that technical skill and knowledge was required for rendering services, did not render the amount paid by the assessee company for a comprehensive contract as ‘fees for technical services’. The said payment was of the nature of payment for a comprehensive contract on which the appellant company had rightly deducted tax u/s. 194C and not section 194J. This view is also supported by the decision of Tribunal, Ahmedabad in Gujarat State Electricity Corpn. Ltd. vs. ITO [2004] 3 SOT 468 (Ahd.) wherein it was held that a composite contract for operation and maintenance would come within the ambit of 194C and not 194J.

Payments towards annual maintenance contract (AMC) for software maintenance attracts TDS u/s. 194C and not 194J.

Facts
The assessee had made TDS u/s. 194C on payments for annual maintenance contracts. The AO held that these payments were towards technical, managerial and professional services and hence TDS u/s. 194J will be applicable. The CIT(A) decided the issue in favour of the assessee.

Held
As per the CBDT Circular No. 715, dated 8th August, 1995 routine/normal maintenance contract including supply of spares covered u/s. 194C. Following the decision of Ahemdabad Tribunal in case of Nuclear Corpn. of India Ltd. vs. ITO [IT Appeal No. 3081 (Ahd.) of 2009, dated 30-09-2011] and CBDT circular, the Tribunal held that payments made for AMC cannot be considered as fees for technical services within the meaning of section 194J.

Also refer decision of the Hon’ble Madras High Court in case of Skycell Communications Ltd. vs. Dy. CIT [2001] 251 ITR 53/119 Taxman 496 (Mad.)

Training and seminar expenses do not fall under definition of professional services and hence tax to be deducted u/s. 194C and not 194J.

Facts
The assessee had made payments towards training programmes and seminars organised by various entities including CII towards attending training and seminars by its employees. The assessee had deducted tax at source u/s. 194J. The AO held that the payments made on this account are covered u/s. 194J as the employees were getting training from experts in various fields having professional knowledge to give training and lectures to the employees for the benefit of the company. The CIT(A) held that training and seminar expenses do not    fall    under    the    definition    of    professional    services and accordingly decided the issue in favour of of the assessee.

Held
It was held that the payments made to various organisations towards attending seminars by the
employees of the assessee company cannot be considered as towards rendering of professional services by those training institutes as per the provisions of section 194J. Thus the order of CIT(A) was upheld.

Transfer pricing: International transaction: Arm’s length price: A. Ys. 2004-05 and 2005-06: Marketing services to associated enterprise: Different from services in nature of engineering services rendered by four companies taken as comparables by TPO: Functionally different and not comparable: Addition made by AO on basis of adjustment made by TPO not justified:

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CIT vs. Verizon India Pvt. Ltd.; 360 ITR 342 (Delhi):

The assessee company had entered into a service agreement with its associated enterprise in Singapore for rendering marketing services. The Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) for determining the arm’s length price. TPO compared the services provided by the assessee to its associated enterprise with four companies rendering engineering services for determining the arm’s length price and made adjustments which resulted in the Assessing Officer making additions in respect of both the years. CIT(A) and the Tribunal held that the two services, that is, marketing services and engineering services, were functionally different and were, hence, not comparable and deleted the addition.

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

“(i) The services rendered by the assessee to its associated enterprise were in the nature of marketing services which were entirely different from the set of services in the nature of engineering services rendered by the four comparables.

ii) Consequently, the adjustment arrived at by the TPO and the additions made by the Assessing Officer could not be sustained on the basis of the transfer pricing study with regard to the four companies which were clearly functionally not comparable.

iii) So, no question of law arises for our consideration. The appeals are dismissed.”

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Speculative transaction: Loss: Set off: Section 73: A. Y. 1991-92: Loss on account of purchase and sale of shares from solitary transaction: Transaction not constituting business carried on by assessee: Loss can be set off against profits from other sources:

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CIT vs. Orient Instrument P. Ltd.; 360 ITR 182 (Del):

The assessee company was engaged in the business of trading in crafts paper, installation, job work, consultancy and commission. In the relevant year it incurred loss of Rs. 5,53,500/- on account of a transaction whereby it purchased and sold shares. The assessee claimed set off of the said loss against other income. The Assessing Officer disallowed the claim for set off of the loss holding that the loss is speculation loss. 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) The transaction whereby the assessee purchased the shares and incurred loss on account of fall in the value of the shares was a solitary one.

ii) The finding of the Tribunal that the transaction did not constitute the business carried on by the assessee, could not be termed perverse and unreasonable. The appeal is accordingly dismissed.”

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Speculative transaction: Speculative loss: Section 43(5)(c): Share trading business on own behalf is “jobbing”; Jobbing is not speculative in view of proviso(c) to section 43(5): Loss from jobbing business is not speculative loss:

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CIT vs. Ram Kishan Gupta; [2014] 41 taxmann.com 363 (All):

The assessee is a Member of the U.P. Stock Exchange Association Ltd., and is registered as Stock Broker and carries on the purchase and sale of shares and securities. On scrutiny of the trading profit and loss account filed along with the return of income of Rs. 81,050/-, the Assessing Officer found that a sum of Rs. 8,53,030/- is debited for which the claim of the assessee was that it incurred loss in respect of transactions done by him on the floor of stock exchange with other brokers. The Assessing Officer rated the same as speculation loss as the loss of Rs. 8,53,030/- was on account of transactions for which there was no physical delivery. The assessee submitted before the Assessing Officer that the delivery had been effected on net basis as per the Stock exchange guidelines and no forward trading was allowed therefore there was no question of any speculation loss. The assessee’s plea was also that otherwise the assessee’s transaction was covered u/s. 43(5)(c) of the Income-tax Act , therefore, the transaction carried out by the assessee were specifically exempted to be treated as speculative transactions. However, the Assessing Officer disallowed the loss of Rs. 8,53,030/- treating the same to be speculative loss. The Tribunal allowed the assessee’s appeal and held that the allegation that transactions were settled without actual delivery was not fully established by the Revenue. It was held that if the system provides settlement at net basis in respect of jobbing and the appellant-assessee had been found paying turnover fee on such transactions ever since 1991-92 the assessee’s entire business was of non-speculative nature. The Tribunal also relied on the judgment of the Allahabad High Court in CIT vs. Shri Sharwan Kumar Agrawal; 249 ITR 233 (All) wherein it was held that the assessee who was a share broker was entitled for the exception covered by proviso (c) to section 43(5).

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

“i) We have already observed that purchase or sale of shares periodical or ultimately settled otherwise than by the actual delivery is a speculative transaction as provided u/s. 43(5). The assessee’s categorical case is that losses were suffered on account of non-delivery transactions. Whether the assessee is still entitled to protection under proviso (c) to subsection (5) of section 43, which transactions are non delivery transactions and what is the scope of the proviso in context of speculative transaction have to be examined.

ii) The Tribunal having returned finding that the details of each and every transaction were disclosed by the assessee which were part of the paper book. No discrepancy in any of the transactions can be pointed out by the Assessing Officer nor the bonafide of the transactions were doubted, the transaction thus carried out were part of the ‘jobbing’ within the meaning of proviso (c) to section 43(5).

iii) We are thus of the view that the order of the Tribunal allowing the appeal of the assessee is to be upheld although confined to the ground that the losses suffered by the assessee cannot be termed to be speculative loss by virtue of proviso (c) to section 43(5).”

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Refund: Section 237: A. Y. 2004-05: Belated revised return filed on 08-09-2011 claiming refund on basis of CBDT Circular dated 08- 05-2009: Condonation of delay: Delay to be condoned:

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Assessee entitled to refund: Devdas Rama Mangalore vs. CIT; [2014] 41 taxmann.com 508 (Bom)

The
petitioner, who was an employee of RBI had opted for the Optional Early
Retirement Scheme and had received an amount as per the Scheme in the
year 2004. The RBI had deducted TDS of Rs. 1,64,117/- treating the said
payment as taxable. In the return of income for the A. Y. 2004-05 filed
on 15th October 2004 the petitioner did not claim any refund of tax as
TDS paid by RBI on his behalf nor was the credit on tax utilised to
discharge tax payable on any other income.

On 08-05-2009, CBDT
issued a Circular clarifying that the employees of RBI who had opted for
early retirement scheme during the year 2004-05 would be entitled for
benefit of exemption u/s. 10(10C) of the Income-tax Act, 1961. The
Supreme Court also in Chandra Ranganathan and Ors. vs. CIT; (2010) 326
ITR 49 (SC) held that the amounts received by retiring employees of RBI
opting for the scheme are eligible for exemption u/s. 10(10C) of the
Act. In view of the above, the petitioner filed a revised return of
income on 08-11-2011 claiming benefit of exemption available to the
Scheme u/s. 10(10C) of the Act which consequently would result in refund
of Rs.1.64 lakh paid by RBI as TDS. However, there was no response to
the above revised return of income from the respondent-revenue. The
petitioner in the meantime, also, filed an application with the CIT u/s.
119(2) (b) of the Act seeking condonation of delay in filing his
application for refund in the form of revised return of income for A. Y.
2004-05. The CIT by an order dated 04-02-2013 dismissed the application
u/s. 119(2)(b) of the Act on the ground that in view of Instruction No.
13 of 2006 dated 22nd December, 2006 by the CBDT an application
claiming refund cannot be entertained if the same is filed beyond the
period of 6 years from the end of the assessment year for which the
application is made. In the affidavit in reply dated 19th November 2013
the Commissioner of Income Tax states that he is bound by the above
instructions issued by the CBDT and consequently the claim for refund
cannot be considered.

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

“i)
It is not disputed by the respondent revenue that on merits the
petitioner is entitled to the benefit of refund of TDS as the payment
received under the scheme is exempted u/s. 10(10C) of the Act. The
decision of the Apex Court in the matter of Chandra Ranganathan and Ors.
(supra) concludes the issue. This is also the view of the revenue as
clarified in CBDT Circular dated 8th May, 2009. The application u/s.
119(2)(b) of the Act is being denied by adopting a very hypertechnical
view that the application for condonation of delay was made beyond 6
years from the date of the end of the A. Y. 2004-05. In this case, the
revised return of income filed on 8th September, 2011 should itself be
considered as application for condonation of delay u/s. 119(2)(b) of the
Act and refund granted.

ii) It is to be noted that the
respondent revenue does not dispute the claim of the petitioner for
refund on merits but the same is being denied only on hypertechnical
view of limitation. It will be noted that on 8th May, 2009 the CBDT
issued a circular clarifying and reviewing its earlier decision to
declare that the employees of RBI who opted for early retirement scheme
under the Scheme will be entitled to the benefit of section 10(10C) of
the Act. Soon after the issue of circular dated 8th May, 2009 by the
CBDT and the decision of the Apex Court in Chandra Ranganathan (supra)
the petitioner filed a revised return of income on 8th September, 2011
seeking refund of TDS paid on his behalf by RBI.

iii) In the above view, we allow the petition and direct respondent-revenue to grant refund due to the petitioner.”

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Reassessment: TDS: S/s. 143(3), 147 proviso and 148: A. Y. 2005-06: Disclosure in return of cancellation of assessee’s banking licence: Assessment u/s. 143(3): Reopening of assessment beyond four years on the ground that the assessee was no longer in the banking business is not valid: No failure to disclose truly and fully material facts:

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Charotar Nagrik Sahakari Bank Ltd. vs. Dy. CIT; 360 ITR 373 (Guj):

The petitioner is a co-operative bank in liquidation. For the A. Y. 2005-06, the petitioner had filed its return of income on 31-10-2005, declaring a total loss of Rs. 7,95,82,108/-. Assessment was completed u/s. 143(3) of the Income-tax Act, 1961 by an order dated 27-12-2007 accepting the returned loss. On 15-03-2012, the Assessing Officer issued notice u/s. 148 for treating the loss of Rs. 7,95,82,108/- as non-business loss on the ground that the assessee’s banking licence was cancelled by the RBI on 30-07-2003.

The Gujarat High Court allowed the writ petition filed by the assessee challenging the validity of notice u/s. 148 and held as under:

“i) The fact that the assessee’s licence had been cancelled by the RBI was clearly and in no uncertain terms was brought on record in the return filed by the assessee. The assessee, in fact, asserted that in view of such cancellation of the licence, the banking activities of the assessee were carried out only for the purpose of recovery of advances and payment to the depositors. It was further conveyed that in view of such facts, the profit and loss account was prepared on certain conditions and guidelines indicated therein.

ii) Apart from the declaration and disclosure on the part of the assessee, in the reasons recorded by the Assessing Officer also, he started with the narration, “on verification of the case records, it was found that the assessee’s banking licence was cancelled by the RBI on 30-07-2003”. Thus the Assessing Officer gathered this fact from the verification of the case record and not from any other source.

iii) The crucial fact that the banking licence of the assessee had been cancelled by the RBI was disclosed in the original return itself. Thus, there was no failure on the part of the assessee to disclose truly and fully all material facts. The averment of the Revenue that despite such cancellation of the banking licence, the assessee lodged a false claim, even if it were to be corrected, would not per se indicate that there was any failure on the part of the assessee to disclose truly and fully all material facts. As long as this requirement was satisfied, it was simply not open for the Assessing Officer to reopen the assessment beyond the period of four years from the relevant assessment year.

iv) In the result, the impugned notice is quashed and set aside.”

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Method of accounting: System of accounting: Cash basis: Section 145: Block period 1987-88 to 1995-96: Assessee maintaining accounts on actual receipt basis: Interest income must be taken on receipt basis:

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CIT vs. Dr. K. P. Singh; [2014] 41 taxmann.com 406 (All):

The assessee was following the cash method of accounting. Accordingly, he offered the interest income on FDRs on receipt basis. The Assessing Officer assessed the interest on accrual basis. The Tribunal allowed the assessee’s claim and directed the Assessing Officer to assess the interest on receipt basis.

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

“i) We find no infirmity in the Tribunal’s order, where the Tribunal observed that the interest income must be taken on receipt basis shown by the assessee from the F.D.Rs., Sahara and L.I.C. mutual funds. The assessee is maintaining the accounts on actual receipt basis and he is not maintaining any account on mercantile basis, as appears from the record.

ii) When it is so, then the answer to the substantial question of law is in favour of the assessee and against the Department.”

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Income: Capital or revenue: A. Y. 1985-86: Subsidiary of Government company receiving subsidy from holding company to protect capital investment of parent company: Subsidy is capital receipt and not income:

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CIT vs. Handicrafts and Handlooms Export Corporation of India Ltd.; 360 ITR 130 (Del):

The assessee, a Government company was a subsidiary of the State Trading Corporation of India. It operated as channelising agency for sale of handicrafts and handlooms abroad. In the relevant year, it received subsidy of Rs. 25 lakh from its holding company. The Assessing Officer rejected the claim of the assessee that the receipt is a capital receipt and not income. He held that it is income assessable to tax. The Tribunal held that it was a capital receipt.

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

“i) The sum of Rs. 25 lakh was not paid by a third party or by a public authority but by the holding company. It was not on account of any trade or a commercial transaction between the subsidiary and the holding company. The holding company was a shareholder and the shares were in the nature of capital. Share subscription received in the hands of the assessee was a capital receipt.

ii) The intention and the purpose behind the payment was to secure and protect the capital investment made by the holding company in the assessee. The payment of the grant by the holding company and receipt thereof by the assessee was not during the course of trade or performance of trade, and could be categorised or classified as a gift or a capital grant and did not partake of the character of trading receipt.”

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(2011) TIOL 323 ITAT-Mum. ITO(TDS) v. Moraj Building Concepts Pvt. Ltd. ITA No. 1232/Mum./2010 A.Y.: 2006-07. Dated: 18-3-2011

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Sections 200(3), 206C, 273B — Non-availability of PAN of payees who were ordinary labourers constitutes reasonable cause for delay in filing TDS returns.

Facts:
The assessee, a private limited company, deducted tax at source from payments made to labour contractors from many unorganised sectors. The amount of tax deducted at source was paid, but the TDS returns for the four quarters of financial year 2005-06 were delayed by a period ranging from 733 days to 1031 days. The Assessing Officer (AO) rejected the explanation furnished by the assessee and levied a penalty of Rs.2,14,550 for failure to comply with section 206/206C of the Act.

Aggrieved the assessee preferred an appeal to the CIT(A) who recorded the following findings and cancelled the penalty levied:

(a) The applicable provision is section 200(3) which provision has been inserted w.e.f. 1-4-2005 and this was the first year after the introduction of the provision;

(b) Under Rule 31A of the Income-tax Rules, the assessee has to obtain PAN from deductees. Since the deductees were small-time labourers, there was difficulty in collecting those details from them;

(c) The nature of contract was such that the assessee had to employ labour contractors from many unorganised sectors, which made it more difficult to collect the PAN;

(d) The Chief Accountant of the assessee company who was working with it for past ten years and was looking after TDS and IT-related compliances resigned. He was replaced by another accountant who also resigned and had to be replaced;

(e) Every corporate assessee has faced similar difficulties in preparing the statements or in filing them in electronic form;

(f) Despite all the difficulties, the quarterly TDS returns were ultimately filed voluntarily without being prompted by any notice from the Department;

(g) There is no revenue loss since the tax deducted has been paid to the Government. Only paperwork was delayed, which is only a technical breach.

Aggrieved, the Revenue filed an appeal to the Tribunal.

Held:
The Tribunal noted that though the penalty order refers to section 206/206C, the default, as found by the CIT(A) and as explained to the Bench, is u/s.200(3). It also noted that the penalty order was in a cyclostyled form without referring even to the appropriate section. This may show non-application of mind. The only question which arose was whether the delay on the part of the assessee was due to a reasonable cause within the meaning of S. 273B. The Tribunal held that the findings of the CIT(A), which were not disputed by the Revenue, constituted a reasonable cause for delay in filing the TDS returns. The Tribunal upheld the order passed by the CIT(A).

The appeal filed by the Revenue was dismissed.

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Interest on refund of tax: Section 244: A. Ys. 1982-83 to 1990-91: Whether whole of interest taxable in the year of grant – No: Has to be spread over the respective AYs to which it relates:

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Shri M. Jaffer Saheb(Decd) vs. CIT (AP); R. C. No. 127 of 1997 dated 19-12-2013:

For the A. Y. 1982-83 the Assessing Officer made additions and raised a demand which the assessee paid. The Tribunal deleted the additions. The Assessing Officer gave effect to the order of the Tribunal and refunded the tax paid by the assessee together with interest of Rs. 79,950/- for the period from 30- 10-1985 to 31-08-1989. The Assessing Officer brought to tax the whole of the interest amount in the A. Y. 1990-91 ignoring the claim of the assessee to spread over the said amount over the respective years. The CIT(A) allowed the assessee’s claim but the Tribunal upheld the decision of the Assessing Officer.

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

“i) The stand of the Department that interest u/s. 244(1A) accrues to the assessee only when it is granted to the assessee along with the order issued u/s. 240 is not correct. Interest accrues on a day to day basis on the excess amount paid by the assessee.

ii) The entitlement of interest is a right conferred by the statute and it does not depend on the order for the refund being made. An order for the refund is only consequential order which in law is required to be made more in the nature of complying with the procedural requirement, but the right to claim interest of the assessee is statutory right conferred by the Act. Accordingly, interest has to be spread over and taxed in the respective years.”

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(2011) 129 ITD (Ahd.) Tarika Exports v. ACIT A.Y.: 1994-95. Dated: 30-11-2010

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Section 234A — Taxes paid after the end of the previous year but before the due date of filing of return are to be considered while calculating interest u/s.234A.

Facts:
The Assessing Officer had charged interest u/s.234A, u/s.234B and u/s.234C amounting to Rs.2,64,400, Rs.4,38,592 and Rs.1,31,588, respectively upon a total tax liability of Rs. 34,05,610.

Assessee had paid an amount of Rs.7,61,600 up to the last day of the previous year and further a sum of Rs.25,00,000 after the end of the previous year but before the due date of filing of return and Rs.4,38,592 after the due date of filing of return but before filing return.

However, for the purpose of calculation of interest u/s.234A, the Assessing Officer had treated an amount of Rs.7,61,600 only, that was paid up to 15-3-1994, as advance tax. He ignored the payment of Rs.25,00,000 though the same was paid before the due date of filing of return.

On appeal the Commissioner (Appeals) upheld that taxes paid after the financial year could not be treated as advance tax and therefore cannot be reduced from assessed tax for purpose of calculating interest u/s.234A.

Aggrieved by the decision of the CIT(A), the assessee preferred an appeal before the Appellate Tribunal.

Held:
Interest u/s.234A is compensatory in nature and not penal. It aims to compensate the Government for not getting its dues within the time limit provided u/s.139(1).

Therefore, if entire tax amount is paid before the due date of filing of return, though the assessee has delayed in filing the return, no interest is leviable u/s.234A.

The same view was also held by the Apex Court in the case of CIT v. Pranoy Roy & Anr., (309 ITR 231).

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Professional misconduct: Section 22, read with clause 7 of part 1 of Second Schedule, of the Chartered Accountants Act, 1949: In order to attract clause 7 of part 1 of Second Schedule, act or omission must be in connection with duties cast upon a chartered accountant in such capacity which no person other than a chartered accountant can perform:

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[Council of ICAI v. Dipak Kumar De Sarkar, 201 Taxman 203 (Cal.);

12 Taxman.com 476 (Cal.) The institute (ICAI) received a complaint against the respondent, a chartered accountant that the respondent, while holding position of auditor of a company, agreed to act as an arbitrator/mediator in transaction of shares of the said company which constituted professional misconduct and further, he did not even perform duties imposed upon him under the agreement. The council held the respondent guilty of professional misconduct falling within the meaning of clause 7 of part 1 of the Second Schedule to the Act and recommended to the Court that the name of the respondent should be removed from the register of members for a period of three months.

The Calcutta High Court held as under:

“(i) A plain reading of the provisions contained in sections 21 and 22 and the Schedules annexed thereto indicates that for the purpose of the Act, the expression ‘professional misconduct’ includes an act or omission specified in the Schedules. In the instant case, the council had found the respondent guilty under clause 7 of part 1 of the Second Schedule, i.e., grossly negligent in the conduct of his professional duties.

(ii) In order to hold the respondent guilty under the aforesaid charge, it must be established that the alleged act or omission on the part of the respondent related to his professional duty as a chartered accountant. In the instant case, he was made an arbitrator or mediator by the parties and the duty cast upon him as such arbitrator could be done by any person and it is not necessary that only a chartered accountant can do such duties.

(iii) It was true that the respondent was an auditor of the company with which the parties were connected and for acting as such auditor, the parties had confidence in him and that was probably the reason for making him the arbitrator. In such circumstances, even if the contention of the council was accepted that he did not act fairly as such arbitrator, such betrayal of confidence reposed in him did not come within the purview of professional misconduct. The duties conferred upon the respondent, by virtue of the agreement between the parties, were not the duties of a chartered accountant and, thus, by no stretch of imagination, the alleged act or omission could be brought within the purview of the clause 7 of part 1 of the Second Schedule.

(iv) In order to attract the aforesaid clause, the act or omission must be in connection with the duties cast upon a chartered accountant in such capacity which no person other than a chartered accountant can perform.

(v) Thus, the respondent was not at all guilty of any professional misconduct as charged under clause 7 of part 1 of the Second Schedule and, consequently, no action was called for against the respondent.”

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(2011) 22 STR 41 (Tri.-Ahmd.) — Aditya Birla Nuvo Ltd. v. CCEx., Vadodara.

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Marketing of goods manufactured by client — Taxable under business auxiliary service — Not a commission agent, therefore not entitled for exemption.

Demand and penalty — Time-barred for part period — As bona fide intention proved — Matter remanded for quantification.

Facts:
The appellants had entered into a ‘Marketing agreement’ with its joint venture to sell, distribute, market, advertise and promote the products of joint venture. The appellants had a belief that the services rendered by them during the period 1-7-2003 to 8-7-2004 were of a commission agent and were fully exempt under Notification No. 13/2003-S.T., dated 20-6-2003. Therefore, they did not pay any Service tax on the services rendered by them. However, the said Notification was withdrawn w.e.f. 9-7-2004 and as a consequence of which the appellants got themselves registered with the Service Tax Department in August 2004.

The Revenue contended that the services provided by the appellants were taxable under business auxiliary service and benefit of exemption Notification cannot be availed as the appellants were not the commission agents. Commission agent meant a person who causes sale or purchase of goods on behalf of another person for a consideration. The commission agents usually charge a fixed percentage of sale price, but the appellants were not charging a fixed percentage. Additionally, the scope of activities undertaken by the appellants is far beyond the activities of commission agent and fall within the purview of definition of business auxiliary service.

The extended period of limitation was invoked. However, the appellants contended that the limitation of five years cannot be invoked as the intention of the appellants was bona fide since they had immediately registered themselves when the relevant exemption Notification was withdrawn.

Held:
The services were to be taxable under business auxiliary service. However, due to reasonable cause for failure to pay Service tax, the penalties levied on the appellants were set aside. Further, the matter was remanded for quantification of demand within the period of limitation.

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ITO v. Chheda Construction Co. (Joint Venture) ITAT ‘C’ Bench, Mumbai Before R. S. Padvekar (JM) and Rajendra Singh (AM) ITA No. 2764/Mum./2009 A.Y.: 2005-06. Decided on: 27-4-2011 Counsel for revenue/assessee: Ajit Kumar Sinha/K. Shivram

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Section 80IB(10) — Amendment to section 80IB(10) w.e.f. A.Y. 2005-06 restricting the commercial area to 5% is not applicable to projects commenced prior to 1-4-2005.

Facts:
The assessee, a builder and land developer, had entered into an agreement to develop and construct a building project on land situated at Mira Taluka, Dist. Thane. For A.Y. 2005-06, the assessee filed a return of income in which it claimed deduction u/s.80IB(10) of the Act. The AO noted that the housing project which consisted of 94,255 sq. ft had shopping area to the extent of 7,935 sq. ft. The AO denied the deduction on the ground that in view of the amendment to section 80IB(10) w.e.f. 1-4- 2005, the assessee was not entitled to deduction u/s.80IB(10) of the Act.

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

Aggrieved by the order passed by the CIT(A) the Revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the assessee’s project had commenced prior to 1-4-2005. It also noted that in the case of Brahma Associates, the High Court has held that the amendment to section 80IB is prospective in operation. Since the assessee’s project had commenced in December 2003, the Tribunal held the amendment to be not applicable to the assessee’s case.

The Tribunal dismissed the appeal filed by the Revenue.

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Pyare Mohan Mathur HUF v. ITO ITAT Agra Bench Before P. K. Bansal (AM) and H. S. Sidhu (JM) ITA No. 471/Agra/2009 A.Y.: 2005-06. Decided on: 21-4-2011 Counsel for assessee/revenue: Rajendra Sharma/ Vinod Kumar

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Section 2(22B), section 50C, section 55(2)(b)(i) — Cost of acquisition of the property u/s.55(2) (b)(i) will be its fair market value as on 1-4-1981 as determined by the registered valuer and not the circle rate.

Facts:
The assessee sold property acquired by him prior to 1-4-1981. The assessee computed capital gains by considering fair market value of the property on 1-4-1981 to be its cost of acquisition. The fair market value adopted by the assessee was on the basis of a valuation report of a registered valuer. The Assessing Officer (AO), on the basis of Inspector’s Report, took circle rate list dated 8-6-1981 and valued the land on 1-4-1981 on the basis of circle rate and regarded this value to be the fair market value to be considered as cost of acquisition for computing capital gains.

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

Aggrieved, by the order of the CIT(A), the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the term ‘fair market value’ is defined in section 2(22B) and no rules have been made for purpose of determining fair market value. The assessee had relied on the valuation report which he obtained from the registered valuer who is technical person and duly approved by the Department, whereas the AO had deputed the Inspector who brought the circle rate of the village where the land was situated and had adopted the circle rate to be fair market value. There is no provision under the chapter relating to capital gains which states that circle rate will be treated as cost of acquisition. Circle rates are notified by the State Government for levy of stamp duty for registration of sale deeds. The circle rates are deemed to be full value of consideration received or accruing as a result of transfer u/s.50C. But this section nowhere states that circle rates as notified will be the fair market value. The Tribunal held that in view of the provisions of section 55A once the assessee has submitted the necessary evidence by way of valuation report made by the Registered Valuer, the onus gets shifted on the AO to contradict the report of the Registered Valuer. The registered valuation officer is a technical expert and the opinion of an expert cannot be thrown out without bringing any material to the contrary on record. In case the AO was not agreeable with the report of the Registered Valuer, he was duty bound to refer the matter to the DVO for determining the fair market value of the land as on 1-4-1981 which he failed to do so. The Tribunal held that the Revenue has not discharged the onus but merely rejected the fair market value taken by the assessee. It set aside the order of the CIT(A) and directed the AO to re-compute the capital gain after taking the fair market value of the land as on 1-4-1981, as claimed by the assessee.

This ground of appeal filed by the assessee was allowed.

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Income: Capital or revenue: Refund of excise duty under subsidy scheme and interest subsidy, etc.,: Capital receipts and not taxable.

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[M/s. Shri Balaji Alloys v. CIT, 333 ITR 335 (J&K)]

Pursuant to the new industrial policy announced by the State of J&K the assessee received excise refund and interest subsidy, etc. The assessee claimed it to be capital receipt. Alternatively, the assessee claimed that the subsidy amount was eligible for deduction u/s.80-IB. The Assessing Officer, CIT(A) and the Tribunal rejected the assessee’s claim and held that the receipt was a revenue receipt on the ground that (i) the subsidy was for established industry and not to set up a new one, (ii) it was available after commercial production, (iii) it was recurring in nature, (iv) it was not for purchasing capital assets, and (v) it was for running the business profitably.

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

“(i) The ratio of Sahney Steel, 228 ITR 253 (SC), Ponni Sugar 306 ITR 392 (SC) and Mepco Industries, 319 ITR 208 (SC) is that to determine whether incentives and subsidies are revenue or capital receipts, the purpose underlying the incentives is the determinative test. If the object of the subsidy scheme is to enable the assessee to run the business more profitably, then the receipt is on revenue account. On the other hand, if the object of the subsidy scheme is to enable the assessee to set up a new unit or to expand the existing unit, then the receipt of the subsidy is on capital account. It is the object for which the subsidy/assistance is given which determines the nature of the incentive subsidy. The form or mechanism through which the subsidy is given is irrelevant.

(ii) On facts, the object of the subsidy scheme was (a) to accelerate industrial development in J&K, and (b) generate employment in J&K. Such incentives, designed to achieve a public purpose, cannot, by any stretch of reasoning, be construed as production or operational incentives for the benefit of the assessee alone. It cannot be construed as mere production or trade incentives.

(iii) The fact that the incentives were available only after commencement of commercial production cannot be viewed in isolation. The other factors which weighed with the Tribunal are also not decisive to determine the character of the incentive subsidies in view of the stated objects of the subsidy scheme.

(iv) The finding of the Tribunal that the incentives were revenue receipt is, accordingly, set aside, holding the incentives to be capital receipt in the hands of the assessee.”

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Appeal to Tribunal: Appeal by Department against order of CIT(A): Department seeking adjournment to file paper book: Tribunal allowing appeal without paper book: Order of Tribunal set aside: Assessee to be given opportunity to submit paper book.

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[Krishan Kumar Sethi v. CIT, 333 ITR 16 (Del.)]

The addition of cash credit made by the Assessing Officer u/s.68 was deleted by the CIT(A). The Revenue filed appeal before the Tribunal against the said deletion. At the time of hearing, the Department sought adjournment for filing paper book. On the adjourned date, paper book was not filed by the Department, but the Tribunal heard and allowed the appeal without the paper book.

The assessee filed appeal before the Delhi High Court and contended that even if the Department had not filed the paper book, in those circumstances a chance should have been given to the assessee to file a paper book. The Delhi High Court allowed the appeal and held as under:

“(i) There was substance in the submission of the assessee. The order of the Tribunal was to be set aside giving liberty to the assessee to file the paper book containing the documents on which the appellant wanted to rely in support of his submissions.

(ii) The Tribunal to hear the parties afresh and take into consideration the material to decide the issue again.”

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(2011) 128 ITD 24/ (2010) 8 taxmann.com 286 (Mum.) Ms. Nita A. Patel v. ITO A.Y.: 2004-05. Dated: 15-7-2009

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Section 48 — (i) Indexed cost of acquisition of a property has to be calculated with reference to date when assessee acquires ownership rights over property and physical possession of property is not relevant — (ii) Amount paid to tenant for getting the possession of the property can be taken as cost of improvement and accordingly indexation can be applied.

Facts:
The assessee sold a property, being a flat, for consideration of Rs.1.68 crore. The assessee acquired the property at Rs.46.38 lakh on 27- 12-1990. However, he got the possession of the property only on 6-1-1992 and that too after paying the tenant Rs. 18,00,000 to vacate the same.

The Assessing Officer was of the view that since the assessee got possession only on 6-1-1992, it could be said that the assessee held the property from that date in view of section 48. The AO, accordingly, calculated the indexed cost of acquisition and capital gains. AO also disallowed the payment made to the tenant for vacating the property which was claimed by the assessee as indexed cost of improvement.

On appeal, the CIT(A) upheld the assessment order.

Held:
(1) Assets which are referred under the capital gains include not only the property which is tangible, but also intangible rights whose physical possession cannot be taken. The word ‘held’ used in the Explanation (iii) to section 48 does not mean physical ownership or physical possession of the property, but it refers to ownership rights only.

(2) The ownership has been passed by virtue of the agreement. Possession of property was delayed only due to the adverse possession of a tenant which subsequently got vacated and so, the assessee was deemed to be holding the property with effect from the agreement date. Accordingly claim of indexation from 27-12-1990 was correct.

(3) Further the assessee was entitled to consider the amount paid to the tenant as cost of improvement.

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(2011) 128 ITD 1 (Delhi) ITO v. Dharamshila Cancer Foundation and Research Centre A.Y.: 2002-03. Dated: 27-3-2009

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Section 2(15) — Quantum of profit is no test in itself for determining the charitable nature of a society and that too after finding the facts that the profits were applied for charitable purpose only.

Facts:
(1) The assessee was a society registered u/s.12A, established with the main object of carrying out research and to run the hospital and care centres with special emphasis on cancer detection and cure and general public welfare.

(2) The assessee had filed NIL return, claiming exemption u/s.11.

(3) The Assessing Officer denied the benefits u/s. 11 and u/s.12 on two grounds, namely:

(a) Hospital charges were on higher side and were comparable to hospitals run on commercial basis, and

(b) The alleged subsidised treatment was only given to doctors, relatives/friends of the doctors and employees of the hospital.

(4) On appeal, the assessee proved the facts to the satisfaction of the CIT(A) that its charges were in line with those hospitals who were claiming benefits of sections 11 and 12 and also that the patients have come from farflung areas and that the second ground was altogether baseless. Consequently the CIT(A) set aside the order passed by the AO. Thereupon the Revenue went into second appeal.

Held:

(1) Profitability is not the sole criterion to assess the charitable nature of a society. Charitable activity can also result in profits and that does not conclude that the activity carried on was not charitable in nature.

(2) Further, profits accruing to the society were utilised for charitable purpose only, which was also affirmed by the AO.

(3) Thus, the appeal of the Revenue was dismissed.

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Search and seizure: Block assessment: Assessment of third person: Limitation: Section 158BC, section 158BD and section 158BE(2)(b) of Income-tax Act, 1961: Notice issued u/s.158BC: Later fresh notice issued u/s.158BD: Time for making assessment to be reconed from first notice.

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[CIT v. K. M. Ganesan, 333 ITR 562 (Mad.)]

Pursuant
to a search, notice u/s.158BC was issued to the assessee on 27-7-1999.
After noticing that the warrant was not issued in the name of the
assessee, a fresh notice u/s.158BC r/w.s. 158BD was issued on the
assessee on 7-2-2001. The assessee filed the block return on 29-1-2003
admitting ‘nil’ undisclosed income. The assessment was made on
27-2-2003. The assessee claimed that the assessment is invalid being
made beyond the period of limitation of two years from the date of
issuance of notice on 27-7-1999. The CIT(A) and the Tribunal accepted
the assessee’s claim.

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

“(i)
The assessee knew very well the purpose for which the notice was issued
on 27-7-1999. The warrant was not issued in the name of the assessee
was admitted. In the circumstances, notice issued u/s.158BC was in
accordance with the requirement of section 158BD.

(ii)
Non-mentioning of section 158BD would not ipso facto invalidate the
earlier notice. Therefore, the assessment made against the assessee was
beyond the period prescribed u/s. 158BE(2)(b).”

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Industrial undertaking: Deduction u/s.80-IB of Income-tax Act, 1961: A.Y. 2004-05: Assessee not claiming deduction for initial years: Does not disentitle the assessee to claim benefit for remaining years if conditions are satisfied.

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[Praveen Soni v. CIT, 333 ITR 324 (Del)]

The assessee was engaged in the business of manufacturing and exports of readymade garments. For the first time the assessee claimed deduction u/s. 80-IB in the A.Y. 2004-05 pleading that even if he had not claimed the benefit for the past years, it should be allowed to him from A.Y. 2004-05 for the remaining period of 10 years, i.e., up to A.Y. 2007-08. The Assessing Officer denied the benefit on the ground that the assessee had not availed the deduction in the first year in question, i.e., A.Y. 1998-99. The Assessing Officer also held that since the assessee was not registered as a small-scale industry under the provisions of the Industries (Development and Regulation) Act, 1951 the assessee was not entitled to claim the benefit u/s.80-IB of the Act. The Tribunal upheld the decision of the Assessing Officer.

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

“(i) Merely because though the assessee was eligible to claim the benefit, he did not claim it in that year that would not mean that he would be deprived from claiming this benefit till the A.Y. 2007-08, which was the period for which his entitlement would accrue. The provisions contained in section 80-IB of the Act nowhere stipulated any condition that such a claim had to be made in that first year, failing which there would be forfeiture of such claim in the remaining years.

(ii) It was not the case of the assessee that he should be allowed to avail of the claim for 10 years from A.Y. 2004-05. The assessee had realised his mistake in not claiming the benefit from the first assessment year, i.e., A.Y. 1998-99. At the same time, the assessee forwent the claim up to the A.Y. 2003-04 and was making the claim only for the remaining period. There was no reason not to give the benefit of the claim to the assessee if the conditions stipulated u/s.80-IB of the Act were fulfilled.

(iii) The registration under the 1951 Act would be of no consequence for availing of the benefit u/s.80-IB of the Act. Clause (g) of sub-section (14) of section 80-IB of the Act only mandates that such an industrial undertaking should be regarded as small-scale industrial undertaking u/s.11B of the 1951 Act.

(iv) Thus, insofar as extending the provisions of section 80-IB of the Act was concerned, the only aspect which was relevant was whether the conditions stipulated under Notification issued u/s.11B of the 1951 Act for regarding it as small-scale industrial undertaking were fulfilled or not. There was no dispute that the assessee fulfilled the eligibility conditions prescribed u/s.80-IB of the Act and was to be regarded as small-scale industrial undertaking.

(v) The Assessing Officer was directed to give the benefit of deduction claimed by the assessee u/s.80-IB of the Act for the A.Y. 2004-05.”

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Business expenditure: Disallowance u/s. 40(a)(iii) A.Y. 2002-03: Salary paid to nonresidents outside India in Netharlands: Not chargeable to tax in India: Not liable for TDS: Disallowance u/s.40(a)(iii) not justified.

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[Mother Dairy Fruit, Vegetable (P) Ltd. v. CIT, 240 CTR 40 (Del.)]

The assessee-company has a marketing office in Rotterdam in the Netherlands to support its export business in India. It remits funds in foreign currency to its Netherlands office to meet the expenses of that office. During the previous year relevant to the A.Y. 2002-03, the aggregate of the amount of salaries paid to the employees of that office was Rs.19,29,632. The employees were non-residents and were subject to tax in the Netherlands as per DTAA between India and the Netherlands. As such tax was not deducted at source on such salary payment. The Assessing Officer disallowed the claim for deduction of the said amount of Rs. 19,29,632 relying on the provisions of section 40(a)(iii) on the ground that tax was not deducted at source on such salary payment. The CIT(A) allowed the assessee’s appeal and deleted the addition. The Tribunal reversed the decision of the CIT(A) and restored that of the Assessing Officer.

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

“Salary to non-resident employees of the assessee paid in the Netherlands was not chargeable to tax in India as per section 5(2) and section 9(1)(ii) as also as per Article 15 of DTAA between India and the Netherlands and therefore, provisions of section 40(a)(iii) were not applicable for non-deduction of tax at source.”

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Export profit: Deduction u/s.80HHC of Income-tax Act, 1961: A.Y. 1994-95: Assesseecompany in business of manufacture and sale of automobile parts: Amount received as fees for development work from foreign party: 90% of such amount not to be excluded under Expln. (baa) to section 80HHC for computing profits of the business.

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[CIT v. Motor Industries Co. Ltd., 239 CTR 541 (Kar.)]

The assessee-company was in the business of manufacture of automobile parts. For the A.Y. 1994-95, the assessee had received an amount of Rs.64,75,373 as fees towards developmental work from M/s. Robert Bosch, Germany. In respect of this amount, the assessee had claimed deduction u/s.80-O of the Income-tax Act, 1961, which was granted. For the purpose of computing the amount deductible u/s.80HHC of the Act, the Assessing Officer excluded 90% of the above amount for computing the profits of the business by applying Explanation (baa) to section 80HHC. The assessee objected to such exclusion. The Tribunal accepted the assessee’s claim.

In appeal, the Revenue contended that the assessee had already availed the benefit of the said income u/s.80-O of the Act and accordingly that the said income is in the nature of ‘charges’ as contemplated under clause (i) of Explanation (baa) to section 80HHC. The Karnataka High Court upheld the decision of the Tribunal and held as under:

“(i) It is clear that such incomes which have no direct nexus with the export turnover are liable to be deducted in arriving at the profits of the business. It was only when the assessee has an independent income which has no nexus with the income derived from export, which is in the nature of brokerage, commission, interest, rent or charges, and by inclusion of that income to the profits of the business, results in distortion, then, such income should be excluded.

(ii) In the instant case, it is not in dispute that the assessee is in the business of export of goods and merchandise. The disputed income is earned by the assessee for his fees towards developmental work from RB. The developmental work is intimately connected with the business of manufacturing and sale of goods by the assessee. There is immediate nexus between the activity of export and the developmental work.

(iii) Admittedly, for the services rendered by way of these developmental work, the assessee has been given the benefit of deduction u/s. 80-O. The receipt of consideration from the foreign enterprise is not in dispute. From the very same business that the assessee is carrying on, he is having an income under two heads and therefore, it is not a case of any independent income unrelated to or unconnected with the business carried on by the assessee is sought to be included in the profits of the business.

(iv) In these circumstances, the Tribunal was justified in holding that the said consideration received for developmental work is not liable to be deducted under clause (baa) in computing the profits of the business.”

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Sections 28(iv) and 41(1) — Remission of loan liability — Loan utilised for the purpose of acquisition of capital assets — Whether loan liability remitted taxable — Held, No.

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Terra Agro Technologies v. ACIT ITAT ‘C’ Bench, Chennai Before Dr. O. K. Narayanan (VP) and Hari Om Maratha (JM) ITA No. 1503/Mds./2010 A.Y. : 2004-05. Decided on : 9-6-2011 Counsel for assessee/revenue: Percy Pardiwala and Jitendra Jain/Dr. I. Vijaykumar
During the year under appeal, the assessee had shown Rs.13.54 crore as extra ordinary income in the profit and loss account. It represented Rs.6 crore as unsecured loan from corporate written back and Rs.7.61 crore, being concession given by banks towards waiver of principal amount of loan. According to the AO, the said income, which was taxable u/s.28(iv), had escaped assessment. Hence, the case was reopened and income was assessed u/s.143(3) r.w.s. 147.

On appeal, the CIT(A) confirmed the order of the AO. Before the Tribunal the assessee challenged the reopening of the case and contended that the facts were known to the AO while passing the original order and it was merely a change of opinion. It was further contended that even if all the procedures are considered to be correctly followed by the AO, the reopening made on the basis of a reason was not sustainable in law. According to it, in all cases of remission of liability, it was section 41(1) which would be applicable and not section 28(iv). The Revenue supported the orders of the lower authorities and relied on the order of the Supreme Court in the case of T. V. Sundaram Iyengar & Sons v. CIT, (222 ITR 344) and the decision of the Bombay High Court in the case of Solid Containers v. DCIT, (308 ITR 417).

According to it, the loans availed by the assessee were utilised for the purpose of carrying on of the business and therefore the AO was right in holding that it was the benefit which arose to the assessee during the course of its business and taxable u/s.28(iv).

Held:

The Tribunal agreed with the assessee and relying on the decision of the Supreme Court in the case of Commissioner of Agricultural Income Tax v. Kerala Estate Mooriad Chalapuram, (161 ITR 155) held that since the loan received was utilised for acquiring capital assets, the amount remitted was not taxable u/s.41(1).

According to the Tribunal the decision of the Chennai High Court in the case of Iskraemeco Regent Ltd. v. CIT, (196 Taxman 103) was also directly applicable to the case of the assessee. According to it, the said decision had considered the decisions of the Bombay High Court not only in the case of Solid Containers Ltd. v. DCIT, (308 ITR 417), but also that of Mahindra & Mahindra Ltd. v. CIT, (261 ITR 501). Further it was noted that the said decision had also distinguished the decision of the Supreme Court in the case of T. V. Sundaram Iyengar & Sons, which was relied on by the Revenue. Accordingly, the appeal of the assessee was allowed.

Errata: Note below a Tribunal decision (Sr. No. 21 on page 24 of August issue of BCAJ) may be read as under: 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 cannot be imposed. The full text of the decision is available in the office of the Society.

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Reference to Special Bench cannot be withdrawn on the ground that the High Court has admitted an identical question of law — Mere fact that a superior authority is seized of an issue identical to the one before the lower authority, there cannot be any impediment on the powers of the lower authority in disposing of the matters involving such issue as per prevailing law.

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DCIT v. Summit Securities Ltd. (SB) ITAT Special Bench, Mumbai Before D. Manmohan (VP), R. S. Syal (AM) and N. V. Vasudevan (JM) ITA No. 4977/Mum./2009 A.Y.: 2006-07. Decided on: 10-8-2011 Counsel for revenue/assessee: Sanjiv Dutt/S. E. Dastur & Niraj Seth

Facts :

The assessee transferred its power transmission business for an agreed consideration of Rs.143 crore and offered the equal amount as capital gain arising out of slump sale. The net worth of the business transferred was determined by the auditors to be negative Rs.157.19 crore. The Assessing Officer (AO) held that the sale consideration should have been taken as Rs.300 crore (agreed sale consideration + additional liabilities taken over). Aggrieved the assessee preferred an appeal to CIT(A). The CIT(A) relying on the two decisions of the Tribunal in Zuari Industries Ltd. v. ACIT, 105 ITD 569 (Mum.) and Paperbase Co. Ltd. v. CIT, 19 SOT 163 (Del.) held that negative net worth has to be treated as zero in the context of the provisions of section 50B. He decided this issue in favour of the assessee. Aggrieved the Revenue preferred an appeal to the Tribunal. When the matter came up for hearing before the Division Bench (DB) and the DB expressed its tentative view that it was not convinced with the view taken by the co-ordinate Bench in the case of Zuari Industries Ltd. (supra) it was submitted on behalf of the assessee that the issue may be referred to the Special Bench. The President, on request of the DB, constituted SB for giving an opinion on the following question.

 “Whether in the facts and circumstances of the case, the Assessing Officer was right in adding the amount of liabilities being reflected in the negative net worth ascertained by the auditors of the assessee to the sale consideration for determining the capital gains on account of slump sale?”

On receipt of the notice for hearing before the SB the assessee vide his letter addressed to the President submitted that since the Bombay High Court has admitted an appeal involving the same issue in the case of Zuari Industries Ltd. (supra) the reference made to the Special Bench be withdrawn. The assessee pointed out that in the past reference to SB was withdrawn when the High Court had taken steps to decide the issue. The President disposed of this application with the remarks “Place before the Special Bench for consideration”. The Special Bench, heard the above issue and held as under:

Held:

The SB, having noted that the High Court has neither decided the point on merits, nor blocked hearing of cases involving identical question of law by the Tribunal till the disposal of the appeal pending before it, held that the mere fact that a superior authority is seized of an issue identical to the one before the lower authority, there cannot be any impediment on the powers of the lower authority in disposing of the matters involving such issue as per law. The consequences of such a course of action would lead to a chaotic situation. The entire working of the Tribunal will come to a standstill if a reference to the Special Bench is withdrawn simply on the ground that identical question of law has been admitted by the High Court. Also, the SB having noticed that the SB was constituted at the request of the assessee, held that when the SB has actually been constituted at the plea of the assessee, now the assessee cannot turn around and argue that the SB be deconstituted. Such vacillating stand of the assessee did not find approval of the SB.

The SB observed that the assessee’s interest is not affected in any manner, whether the case is heard by the DB or the SB. The SB held that the reference to the SB cannot be withdrawn merely for the reason that the High Court has admitted the identical question of law in another case. The preliminary objection of the assessee was not acceptable. The SB finally observed that it has not touched upon, nor does it have jurisdiction to call in question the powers of the President to constitute or deconstitute any SB. He has abundant powers in the matter of constituting or withdrawing reference to the SB in the facts and circumstances of each case. The observations in this case should not be construed in any manner as eclipsing his powers in this regard.

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Section 40(a)(ia) — Disallowance of expenditure on account of non-deduction of TDS — Non-deduction was on account of non-allotment of TAN — Whether the disallowance was justified — Held, No.

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Inder Prasad Mathura Lal v. ITO ITAT ‘A’ Bench, Jaipur Before R. K. Gupta (JM) and N. L. Kalra (AM) ITA No. 1068/JP/2010 A.Y.: 2005-06. Decided on: 27-5-2011 Counsel for assessee/revenue: Mahendra GargieyaG. R. Pareek

Facts:

For non-deduction of tax at source the AO disallowed the sum of Rs.4.62 lakh paid by the assessee towards brokerage and commission. The non-payment was on account of the non-receipt of TAN. The assessee pointed out that he had immediately applied for TAN when the bank refused to accept tax payment without TAN. However, till 31-3-2005 TAN was not allotted. Hence, he again applied for TAN which was finally allotted on 15- 4-2005 and the tax was paid on 25-4-2005. Since the tax was not paid by the year-end, the amount paid by way of brokerage and commission was disallowed by the AO u/s.40(a)(ia). On appeal, the CIT(A) confirmed the order of the AO.

Held:

The Tribunal noted that the assessee was depositing TDS in time up to 7-12-2004. He had also applied for TAN and since the bank refused to accept TDS without TAN, he was unable to pay tax. Thus, according to it, the assessee was prevented from performing his obligations under the law despite his bona fide efforts and he cannot be regarded as defaulter. For the purpose, it also relied on the decisions of the Calcutta High Court in the case of Modern Fibotex India Ltd. & Another v. DCIT, (212 ITR 496) which was approved by the Apex Court in the case of CIT v. Hindustan Electro Graphites Ltd., (243 ITR 48) and also on the Hyderabad Tribunal decision in the case of ACIT v. Jindal Irrigation Systems Ltd., 56 ITD 164 and Nagpur Bench of Tribunal decision in the case of Canara Bank v. ITO, (121 ITD 1). The Tribunal further noted that the provisions of section 40(a)(ia) are amended by the Finance Act, 2010 w.e.f. 1-4-2010 to provide that the expenditure shall not be disallowed if TDS is paid on or before the due date specified in section 139(1). According to it, if the amendment is curative or is intended to remedy unintended consequences or to render the statutory provisions workable, the amendment was to be construed to relate back to the provisions in respect of which it applies to the remedy. It referred to the following decisions where it was held that the amendments were retrospective though such retrospectivity was not mentioned by the Legislature while introducing the provisions.

The cases relied on were:

  •  Allied Motors Pvt. Ltd. v. CIT, (139 CTR 364) (SC);

  •  CIT v. Alom Extrusion Ltd., (319 ITR 306) (SC);

  •  CIT v. Podar Cements Pvt. Ltd., (226 ITR 625) (SC); and
  •  CIT v. Gold Coin Health Food Pvt. Ltd., (304 ITR 308) (SC).

Further, relying on the decisions of the Ahmedabad Tribunal in the case of Kanubhai Ramjibhai v. ITO, (135 ITD 364) and of the Mumbai Tribunal in the case of Bansal Parvahan India Pvt. Ltd. v. ITO, (137 TTJ 319), where it was held that the amendment in section 40(a)(ia) was curative in nature, it allowed the appeal of the assessee.

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Creation of a new Directorate of Incometax (Criminal Investigation) — Notification No. 29/2011 [F.No. 286/179/2008-IT(INV.II)], dated 30-5-2011.

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This new Directorate has been formed in the CBDT with immediate effect to investigate criminal matters having any financial implication punishable as an offence under any direct tax law viz.

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Press Release — Central Board of Direct Taxes — No. 402/92/2006-MC (10 of 2011), dated 28-5-2011.

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The Double Tax Avoidance Agreement is signed between India and Tanzania on 27th May, 2011.

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Press Release — Central Board of Direct Taxes — No. 402/92/2006-MC (09 of 2011), dated 27-5-2011.

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The Double Tax Avoidance Agreement is signed between India and Ethiopia on 25th May, 2011.

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Double Tax Avoidance Agreement between India and Republic of Mozambique — Notification No. 30, dated 31-5-2011.

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The Double Tax Avoidance Agreement signed between India and Republic of Mozambique on 30th September, 2010 has been notified to enter into force on 28th February, 2011. The treaty shall apply from 1st April, 2012 for India.

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Agreement for Exchange of Information with respect to Taxes with Isle of Man — Notification No. 26/2011 [F.No. 503/01/2009], dated 13-5-2011.

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The Tax Information Exchange Agreement (TIEA) with Isle of Man signed on 4th February, 2011 has been notified to enter into force on 17th March, 2011. All the provisions of this Agreement shall be given effect to, in India on or after 4th February, 2011.

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Agreement for Exchange of Information with respect to Taxes with Commonwealth of Bahamas — Notification No. 25/2011 [F.No. 503/6/2009], dated 13-5-2011.

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The Tax Information Exchange Agreement (TIEA) with the Bahamas signed on 11th February, 2011 has been notified to enter into force on 1st March, 2011. All the provisions of this Agreement shall be given effect to, in India on or after 11th February, 2011.

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Amendment in Rule 114B relating to furnishing of PAN for certain transactions — Notification No. 27/2011 [F.No. 149/122/2010- SO(TPL)], dated 26-5-2011.

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The Rule is amended to provide that in addition to transactions prescribed in the Rule, every person shall quote his PAN in the following trans-actions:

(a) Payment in cash for travel to an authorised person as defined in clause (c) of section 2 of FEMA, 1999.

(b) Making an application to any banking company or to any other company or institution for issue of a debit card.

(c) Payment of an amount aggregating to Rs. 50,000 or more in a year as life insurance premium to an insurer.

(d) Payment to a dealer of an amount of Rs.5 lakh or more at any one time or against a bill for an amount of Rs.5 lakh or more for purchase of bullion or jewellery.

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CBDT Instructions No. 7, dated 24-5-2011 regarding standard operating procedure on filing of appeal to the High Court u/s. 260A and related matters.

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Copy of the Instructions is available on www.bcasonline.org

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Tricon Enterprises Ltd. v. ITO ITAT ‘E’ Bench, Mumbai Before Pramod Kumar (AM) and V. Durga Rao (JM) ITA No. 6143/Mum./2009 A.Y.: 2006-07. Decided on: 31-5-2011 Counsel for assessee/revenue: B. V. Jhaveri/ Ashima Gupta

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Section 36(1)(vii) — Bad debts — Assessee’s claim, who was an exporter, for allowability of bad debts was rejected on the grounds that the assessee was allowed deduction u/s.80HHC as also that it had not obtained RBI’s permission for write-off — Whether the lower authorities justified — Held, No.

Facts:
The assessee was 100% exporter. Its claim for allowability of Rs.33.6 lakh as bad debts was disallowed by the AO on the grounds amongst others that it was allowed deduction u/s.80HHC. The CIT(A) dismissed the appeal for the reason that the assessee had not taken RBI’s permission for writing off of debts.

Held:
The Tribunal noted that the assessee had not included the unrealised export bills while claiming deduction u/s.80HHC. Further, relying on the decision of the Delhi High Court in the case of CIT v. Nilofer I. Singh, (309 ITR 233), it held that obtaining RBI’s permission for write-off of dues on a foreign importer was an irrelevant factor, so far as admissibility of deduction as bad debt was concerned. Relying on the Supreme Court decision in the case of TRF Ltd. v. CIT, (323 ITR 397), the Tribunal allowed the appeal of the assessee.

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Gajendra Kumar T. Agarwal v. ITO ITAT ‘G’ Bench, Mumbai Before D. Manmohan (VP) and Pramodkumar (AM) ITA No. 1798/Mum./2010 A.Y.: 2006-07. Decided on: 31-5-2011 Counsel for assessee/revenue: S. L. Jain/ Pavan Vaid

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Sections 43(5), 72, 73 — Assessee is entitled to set off the loss incurred in the business of dealing in derivatives in the assessment years prior to A.Y. 2006-07 against the profits earned in the same business in the A.Y. 2006-07 and later assessment years.

Facts:
During the A.Y. 2006-07 the assessee earned profit of Rs.1,91,48,060 from dealing in derivatives. He had brought forward losses, for A.Y. 2001-02 to 2005-06, from this activity amounting to Rs.4,68,75,320. The assessee in his return of income claimed set-off of brought forward losses against the current years profit and the balance amount of losses amounting to Rs.2,77,27,260 was claimed to have been carried forward to subsequent years. The set-off and also the carry forward as claimed was allowed. Subsequently, the CIT was of the view that the setoff granted by the AO rendered the assessment order erroneous and prejudicial to the interest of the Revenue to the extent of carry forward of losses. The CIT, in view of the amendment to S. 43(5) which he held to be prospective, declined the set-off of past losses (which he considered to be as speculative in nature) in dealing in derivatives against the profits in dealing in derivatives in the current year (which were considered to be non-speculative).

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
(1) The business loss, speculative or nonspeculative, incurred by an assessee in one assessment year can be set off against the profits of the same business, speculative or non-speculative, or any other business in the same category.

(2) The ratio of the decision of the Supreme Court in the case of CIT v. Manmohan Das, (59 ITR 699) (SC) read with the ratio of the decision of the Bombay High Court in the case of Western Oil Distributing Ltd. v. CIT, (126 ITR 497) (Bom.) is an authority for the following significant propositions viz.:

(a) Whether a particular business loss, speculative or non-speculative, incurred by the assessee in an earlier year is eligible for set-off against business income in a subsequent year, is to be taken in the course of proceedings in the subsequent assessment year, i.e., the assessment year in which set-off is claimed;

(b) Section 73(2) confers a statutory right upon the assessee who sustains a loss of profits in any year in any business, profession or vocation to carry forward the loss as is not set off under sub-section (1) to the following year, and to set it off against his profits and gains, if any, from the same business for that year. Once this statutory right is recognised, it is a natural corollary of that recognition that when an assessee incurs a loss in a business, speculative or non-speculative, in any year, such loss has to be, subject to the fulfilment of other pre-conditions, to be set off against profits of the same business in subsequent year;

(c) In the course of proceedings of the subsequent assessment year, i.e., the assessment year in which set-off of loss is claimed, it is open to even decide the true nature and character of loss incurred in the earlier relevant assessment year. Even a finding about the nature of loss, in the assessment year in which loss is incurred, does not bind the assessee, and that aspect of the matter can be decided afresh in the course of proceedings in the assessment year in which set-off is claimed.

(3) The question whether the losses incurred in dealing in derivatives are eligible for set-off has to be determined as per the law prevailing in the year of set-off. As in the year of set-off, derivatives transactions are not, pursuant to the amendment to section 43(5), treated as ‘speculative transactions’, the losses incurred prior to the amendment have to be treated as normal business losses and are eligible for setoff against all business income in accordance with section 72.

(4) The provisions of carry forward and set-off are to be construed in a manner so as not to defeat the plain and unambiguous intention of the Legislature. This amendment was to provide relief to the taxpayers and is to be viewed as beneficial provisions, as such, one cannot possibly proceed on the basis that the object of making amendment in section 43(5) was to kill the brought forward losses of dealing in derivatives or make them ineligible for being set off against the profits of the same business in subsequent years. Whatever may be the characterisation of income for the purpose of intra-assessment year set-off in the relevant assessment year, and irrespective of the fact that such a characterisation has achieved finality in assessment, the losses and profits from dealing in derivatives must be characterised on a uniform basis in the assessment year in which set-off is claimed.

The Tribunal allowed the appeal filed by the assessee and held that there was no infirmity in the AO granting set-off and the order of the AO could not be held to be erroneous and prejudicial to the interest of the Revenue. The revision proceedings were quashed.

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ITO v. Laxmi Jewel Pvt. Ltd. ITAT Mumbai Bench Before R. V. Easwar (President) and B. Ramakotaiah (AM) ITA No. 2165/Mum./2010 A.Y.: 2004-05. Decided on: 29-4-2011 Counsel for revenue/assessee: Shravankumar/K. A. Vaidyalingam

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CBDT Instruction No. 3/2011, dated 9-2-2011 — CBDT Circular fixing monetary limits for filing appeals by the Department applies to pending appeals as well.

Facts:
This was an appeal filed by the Revenue against the order of the CIT(A) directing the AO to allow deduction u/s.10A amounting to Rs.5,78,432 in respect of interest income, which according to the AO was not derived from the business or profession. On behalf of the assessee, relying on the decision of the Bombay High Court in the case of CIT v. Madhukar K. Inamdar, (318 ITR 149) (Bom.) and also on the ratio of the decision of the Delhi High Court in the case of CIT v. Delhi Race Club Ltd., (ITA No. 128 of 2008 dated 3-3-2011), it was argued that the tax effect is only Rs.2,07,512 and as per Instruction No. 3/2011, the Revenue should not contest appeal up to Rs.3,00,000.

Held:
Considering the similar situation where tax limits were modified by the CBDT Instruction No. 5 of 2008, the Jurisdictional High Court in the case of CIT v. Madhukar Inamdar, (HUF) (supra) held that the Circular will be applicable to the cases pending before the Court either for admission or for final disposal.

The Tribunal dismissed the appeal filed by the Revenue on issue of tax effect involved.

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Speculation loss: Section 43(5): A.Y. 2003-04: Loss from trading derivatives is speculative loss: Clause (d) inserted to the proviso to section 43(5) w.e.f. 1-4-2006 is prospective and not retrospective.

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[CIT v. Shri Bharat R. Ruia (HUF) (Bom.), ITA No. 1539 of 2010, dated 18-4-2011]

In the A.Y. 2003-04, the assessee had entered into certain transactions in exchange-traded derivatives which resulted in loss amounting to Rs.28,37,707. The assessee claimed the loss as business loss. The Assessing Officer held that the loss is speculation loss covered u/s.43(5). The Tribunal allowed the assessee’s claim. Following the decision of a Coordinate Bench, the Tribunal held that clause (d) to the proviso to section 43(5) of the Act being retrospective in nature, the losses incurred from the derivative transactions could not be treated as speculation losses incurred by the assessee in the A.Y. 2003-04.

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

“(i) Clause (d) inserted to the proviso to section 43(5) w.e.f. 1-4-2006 is prospective and not retrospective.

(ii) The futures contract being an article of trade created by an authority under the 1956 Act, the transactions in futures contracts would constitute transaction in commodity u/s.43(5) of the Act. In the result, we hold that the exchange-traded derivative transactions carried on by the assessee during the A.Y. 2003-04 are speculative transactions u/s.43(5) of the Act and the loss incurred in those transactions are liable to be treated as speculative loss and not business loss.”

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Deductibility of Discount on Employee Stock Options — An analysis, Part 2

PART C(4) — Deductibility of ESOP
discountu/s.28 of the Act

If for any reason ESOP discount cannot be claimed u/s.37, it would alternatively be allowable u/s.28 of the Act.

Business loss is different from expenditure

Disbursement or expenses of a trader is something ‘which goes out of his pocket’. A loss is something different. That is not a thing which he expends or disburses. That is a thing which comes upon him ‘ab-extra’ from outside.

There is a distinction between the business expenditure and business loss. Finlay J said
in the case of Allen v. Farquharson Bros., 17 TC 59, 64 observed

“…expenditure or disbursement means something or other which the trader pays out; I think some sort of volition is indicated. He chooses to pay out some disbursement; it is an expense; it is something which comes out of his pocket. A loss is something different. That is not a thing which he expends or disburses. That is a thing which so to speak, comes upon him ab-extra”

Certain judicial principles have held that section 37 does not envisage losses. The Supreme Court in the case of CIT v. Piara Singh, (1980) 124 ITR 40 (SC) held —

“The confiscation of the currency notes is a loss occasioned in pursuing the business; it is a loss in much the same was as if the currency notes had been stolen or dropped on the way while carrying on the business.”

In the case of Dr. T. A. Quereshi v. CIT, (2006) 287 ITR 547 (SC), the Supreme Court relied on the aforesaid judgment and held —

“The Explanation to section 37 has really noth-ing to do with the present case as it is not a case of a business expenditure, but of business loss. Business losses are allowable on ordinary commercial principles in computing profits. Once it is found that the heroin seized formed part of the stock-in-trade of the assessee, it follows that the seizure and confiscation of such stock-in-trade has to be allowed as a business loss.”

If ESOP discount is not held to be expenditure, its deductibility will have to be examined u/s.28 of the Act.

Business loss allowable u/s.28

Sections 30 to 37 are not exhaustive of the type of permissible deductions. Non deductibility u/s.30 to 37 does
not mar the claim for business loss as a deduction. These are to be allowed in section 28 itself.

“The list of allowances enumerated in sections 30 to 43D is not exhaustive. An item of loss incidental to the carrying on of a business may be deducted while computing the profits and gains of that business, even if it does not fall within any of the specified sections”.

The above observations have been quoted with approval in CIT v. Chitnivas, AIR 1932 PC 178; Ram-chander Shivnarayan v. CIT, (1978) 111 ITR 263, 267 (SC); Motipur Sugar Factory Ltd. v. CIT, (1955) 28 ITR 128 (Pat.); Tata Iron & Steel Co. Ltd. v. ITO, (1975) 101 ITR 292, 303 (Bom.).

As mentioned earlier, the charge u/s.28 is on ‘profits’. This term has to be understood in a commercial sense. Expenditure incurred or loss suffered in the course of business or which is incidental to the carrying of business would be allowed as a deduction even in the absence of any statutory provision granting such deduction.

The concept of ‘profit’ in section 28 and the provisions of sections 30 to 43D correspond to section 10(1) and section 10(2) respectively of the Indian Income Tax Act, 1922. The interrelation of these sections was explained by the Supreme Court in Badridas Daga v. CIT, (1958) 34 ITR 10 (SC), in the following words:

“It is to be noted that while section 10(1) imposes a charge on the profits and gains of a trade, it does not provide how those how profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions, but it is settled that they are not exhaustive of all allowances which could be made in ascertaining profits taxable u/s.10(1). The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2) whether it is admissible or not will depend on whether having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed provided of course there is no prohibition against it, express or implied in the Act.”

Accordingly, a loss suffered in the course of business and incidental to the carrying of business is allowable as a deduction even in the absence of any specific provision conferring the said deduction.

Conditions for claim of loss u/s.28

In order to claim a loss u/s.28, such loss should fulfill the following conditions:

  •     It should be a real loss, not notional or fictitious
  •     It should have actually arisen and been incurred, not contingent upon a future event
  •     It must be incidental to business and arise out of an operation therefrom and not on capital account

A.    ESOP discount is real loss and not notional or fictitious

Under the general principles of tax laws, artificial and/ or fictitious transactions are disregarded. In order to be deductible, the loss must be a real loss and not merely notional or anticipatory.

In an ESOP, the loss is the sum that the company could have derived, if it had issued the shares at the premium prevailing in the market. It is the quantum of money forgone, as a result of the employer choosing not to issue shares at market value.

A fair measure of assessing trading profits in such circumstances is to take the potential market value at one end and the actual proceeds at the other. The difference between the two would be the loss since loss is not notional or fictional.

Section 145(1) is enacted for the purpose of determining profits under the head ‘Profits and gains of business or profession’. In the present case, section 28 is relevant and hence, section 145(1) is attracted. Under the principles of mercantile system of accounting on which section 145 is founded, ‘prudence’ is an extricable part. Under this principle, the expenditure is debited when a legal liability has been incurred. Any ‘delay in actual disbursement’ or ‘non occurrence of disbursement’ does not mar the liability so created. In other words, expenses ought to be recognised in the year of incurrence of liability irrespective of the time of actual disbursement.

The recognition of the said loss is supported by the corresponding benefit enjoyed by an employee.
The enjoyment of a benefit by an employee and the corresponding suffering of a pecuniary detriment by the employer are two sides of the same coin. Being inter-related, the nature of benefit should influence the characterisation of the sufferance by the other.

ESOP is nothing but a bonus or an incentive paid in the form of company stocks. From an employee perspective, it is an election made by him by opting to have the bonus/incentive received in the form of shares. Alternatively, the employee may opt for actual payment of salary and subsequently, pay it back to the company as subscription to share capital. If such a mode is adopted the salary payment would be deductible. The receipt of subscription monies thereafter would be on capital account. The character of the subsequent transaction would not impact the allowability of the earlier payment. This conclusion should not alter merely because the two-stage transaction is accomplished through a unified act. One may rely on the principles underlined in Circular No. 731 [(1996) 217 ITR (St.) 5], dated December 20, 1995, in relation to claim u/s.80-O of the Act.

Circular No. 731, dated 20-12-1995 reads as follows:

“1. Under the provisions of section 80-O of the Income-tax Act, 1961, an Indian company or a non-corporate assessee, who is resident in India, is entitled to a deduction of fifty per cent. of the income received by way of royalty, commission, fees, etc., from a foreign Government or foreign enterprise for the use outside India of any patent, invention, model, design, secret formula or process, etc., or in consideration of technical or professional services rendered by the resident. The deduction is available if such income is received in India in convertible foreign exchange or having been converted into convertible foreign exchange outside India, is brought in by or on behalf of the Indian company or aforementioned assessee in accordance with the relevant provisions of the Foreign Exchange Regulation Act, 1973, for the time being in force.

2. Reinsurance brokers, operating in India on behalf of principals abroad, are required to collect the re-insurance premia from ceding insurance companies in India and remit the same to their principals. In such cases, brokerage can be paid either by allowing the brokers to deduct their brokerage out of the gross premia collected from Indian insurance companies and remit the net premia overseas or they could simply remit the gross premia and get back their brokerage in the form of remittance through banking channels.

3. The Reserve Bank of India have expressed the view that since the principle underlying both the transactions is the same, there is no difference between the two modes of brokerage payment. In fact, the former method is administratively more convenient and the reinsurance brokers had been following this method till 1987 when they switched over to the second method to avail of deduction u/s.80-O of the Act.

4. The matter has been examined. The condition for deduction u/s.80-O is that the receipt should be in convertible foreign exchange. When the commission is remitted abroad, it should be in a currency that is regarded as convertible foreign exchange according to FERA. The Board are of the view that in such cases the receipt of brokerage by a reinsurance agent in India from the gross premia before remittance to his foreign principals will also be entitled to the deduction u/s.80-O of the Act.”
(Emphasis supplied by us)

The Apex Court relied on the aforesaid circular, in the case of J. B. Boda and Company Private Limited v. CBDT, (1996) 223 ITR 271 (SC); and held —

“It seems to us that a ‘two-way traffic’ is unneces-sary. To insist on a formal remittance to the foreign reinsurers first and thereafter to receive the commission from the foreign reinsurer will be an empty formality and a meaningless ritual, on the facts of this case.”

Applying this principle in the present case, insisting for actual payment of salary to employees and taking it back as subscription to capital is unnecessary. The purpose is short circuited by issue of ESOP shares instead of initial salary payment and deployment of salary by the employees to buy stocks.

Hypothetically, it could be assumed that employees are paid remuneration with an attached compulsion/ condition to appropriate such payments mandatorily towards Company’s shares. In such cases, whether the deductibility of salary payments could be questioned? — The answer obviously is no. Disallowing ESOP discount on the ground that there is no actual payment of salary, but only profit forgone may not be a correct proposition of law.

B.    Whether ESOP expenses have actually arisen/ incurred, not contingent upon future events?

A loss is allowable in the year in which it is incurred. In a commercial sense, trading loss is said not to have resulted so long as reasonable chances of obtaining restitution is possible. Losses can be claimed in the year in which they occur if there are no chances of recovery/restitution.

If one follows the mercantile system, the loss becomes deductible at the point when it occurs. Lord Russell in the case of CIT v. Chitnavis, 6 ITC 453, 457 (PC) stated

“You may not, when setting out to ascertain the profits and gains of one year, deduct a loss which had, in fact, been incurred before the commencement of that year. If you did you would not arrive at the true profits and gains for the year. For the purposes of computing yearly profits and gains, each year is a self contained period of time in regard to which profits earned or losses sustained before its commencement are irrelevant.”

The accounting treatment of a contingent loss is determined by the expected outcome of the contingency. If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statements.

The term ‘contingent’ has not been defined in the Act. Section 31 of the Indian Contract Act, 1872 defines ‘contingent contract’ as

A ‘contingent contract’ is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen.

A contract which is dependent on ‘happening’ or ‘not happening’ of an event is a contingent contract. In an ESOP, the loss contemplated is the discount on issue of shares. The quantum of loss would depend on the number of employees accepting the offer. This however does not render the loss ‘contingent’. In other words, the aggregate obligation to discharge discount to all the employ-ees in a year cannot be regarded as contingent merely because some employees may forfeit their rights. Accordingly, ESOP discount is not a contingent loss.

Support can be drawn from Owen v. Southern Railway of Peru Ltd., (1956) 36 TC 602 (HL) which dealt with a liability arising on account of gratuity benefit. It was held —

“where you are dealing with a number of obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision.”

ESOP discount is thus an ascertained loss. ESOP discount is actuarially calculated. The Black-Scholes model or the Binomial model is generally used in quantifying the discount. The method of ascertaining the loss is scientific. It is not adhoc or arbitrary.

C.    Whether ESOP discount is incidental to business and not on capital account

It is only a trading loss that is allowable and not capital loss. The loss should be one that springs directly from carrying on of the business or is incidental to it. From section 28 it is discernible that the words ‘income’ or ‘profits and gains’ should be understood as including losses also. In other words, loss is negative profit. Thus, trading loss of a business is deductible in computing the profits earned by the business. The loss for being deductible must be incurred in carrying out business or must be incidental to the operation of business. The determination of whether it is incidental to business is a question of fact.

For the reasons already detailed, ESOP discount should be treated as a revenue account. Business income is to be computed based on the general commercial principles. In the application of these commercial principles, reckoning a loss is an integral part.

In summary, ESOP discount is a loss incidental to business which is incurred by the company. This loss is incurred on account of forgoing the right to issue shares at a higher value. The company abdicates such right in favour of employees as a part of employee recognition and compensation strategy. It is an act which is consistent and justified by the business interest of the employer. Accordingly, a claim of ESOP discount should be allowable u/s.28 of the Act, if it is, for any reason, not allowable u/s.37.


PART C(5) — Year of deductibility

After ascertaining that the ESOP discount is a deductible expense, the year of deductibility needs to be determined. As per section 145, provision should be made for all known liabilities and losses, even though the amount cannot be determined with certainty. Section 145(1) regulates the method of accounting for computing incomes under the ‘Business income’ and ‘Income from other sources’ head. It provides:

“(1)    Income chargeable under the head ‘Profits and gains of business or profession’ or ‘Income from other sources’ shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.”

Assessees therefore have a choice in selecting the system of accounting to be followed in maintenance of the books of account. However, u/s.209 of the Companies Act, 1956, companies are bound to maintain their accounts on the accrual or mercantile basis only. If companies fail to follow the accrual system of accounting, it will be deemed that no proper books have been maintained by them.

Under the mercantile or accrual system of accounting, income and expenditure are recorded at the time of their accrual or incurrence. For instance, income accrued during the year is recorded whether it is received during the year or during a year preceding or following the relevant year. Similarly, expenditure is recorded if it becomes due during the previous year, irrespective of the fact whether it is paid during the previous year or not. The profit calculated under the mercantile system is profit actually earned during the previous year, though not necessarily realised in cash.

There can be no computation of profits and gains until the expenditure necessary for earning the receipts is deducted therefrom. Profits or gains have to be understood in a commercial sense. Whether the liability was discharged at some future date, would not be an impediment in the claim as a deduction. The difficulty in the estimation of expenditure would not convert the accrued liability into a conditional one. This was upheld by the Apex Court in the case of Calcutta Co. Limited v. CIT, (1959) 37 ITR 1 (SC).

The use of the words ‘laid out or expended’ in section 37 along with the word ‘expenditure’ indicates that the expenditure may either be an actual outgo of money irretrievably (expended as per the cash system of accounting) or a putting aside of money towards an existing liability (laid out as per the mercantile system of accounting) . The decisions in 3 CIT v. Nathmal Tolaram, (1973) 88 ITR 234 (Gauhati) and Saurashtra Cement and Chemical Industries Ltd. v. CIT, (1995) 213 ITR 523 (Guj.) support this proposition.

The ESOP discount is an expenditure incurred for the purpose of business. In accordance with section 145, business income has to be computed in accordance with the method of accounting regularly followed by the assessee. As discussed earlier, the choice of ‘method’ of accounting is with the assessee. The computation of income and expenses should be in accordance with the ‘method of accounting’ so followed by the assessee. The term ‘method’ is defined in the Oxford Dictionary as ‘procedure for attaining an object’.

The operative portion of section 145 uses the phrase ‘system of accounting regularly employed’. The term ‘regularly’, as defined in Concise Oxford Dictionary means ‘following or exhibiting a principle, harmonious, constituent, systematic’. Such system/method of accounting for ESOP discount is prescribed by SEBI. The SEBI guidelines mandates the ESOP discount to be spread over the period of vesting. The company is therefore obliged to follow the guidelines and that forms its ‘regular system of accounting’ (for the purposes of section 145). Income-tax statute follows the system so mandated. A method/system of accounting may be disregarded only when the assessing officer is not satisfied about the correctness or completeness of accounts or where the method of accounting has not been regularly followed. Such system which is based on guidelines prescribed by the regulatory bodies cannot be negated on the grounds that there are alternative methods/systems possible. An aliquot portion of the ESOP discount may be allowed in each of the years and this is the position recommended by SEBI as well.

Part D — Judicial pronouncements
Certain favourable judicial pronouncements

The honorable Chennai Tribunal in the case of S.S.I. Limited v. DCIT, (2004) 85 TTJ 1049 (Chennai) held that the ESOP discount is an allowable expenditure. In the aforesaid case, the assessee amortised the ESOP discount over a period of three years and claimed it as staff welfare expense. The Assessing Officer (AO) allowed this claim of expenditure. The Commissioner of Income-tax initiated proceedings u/s.263 of the Act holding the AO’s order to be prejudicial to the interests of the Revenue. It enlisted various grounds in support of this. Specifically, ground number 5 reads as below:

“…..The Assessing Officer has allowed this claim without any application of mind inasmuch as no details have been called for. What was the basis of arriving at the difference has also not been ex-amined. The difference between the market value of the shares and the discounted value at which these were allotted to the employees cannot be a revenue expenditure.”

The CIT directed the AO to disallow the ESOP discount. The assessee appealed against such order before the Chennai Tribunal. The Tribunal’s decision is therefore with reference to appeal against the revision order passed by the CIT u/s.263 and not the basis of regular appeal.

The basis of the assumption of the jurisdiction u/s.263 by the CIT is that the AO had not applied his mind in deciding on the issues in his order. Typically, the Tribunal would examine this aspect and decide whether the exercise of such jurisdiction is justified or not. In the SSI’s case, the Tribunal gave its decision by discussing merits of each of the issues in detail. An extract of discussion on the ESOP discount is as follows :

“…..It was a benefit conferred on the employee and a benefit, which could not be taken back by the company. So far as the company is concerned, once the option is given and exercised by the employee, the liability in this behalf is ascertained. This fact is recognised even by SEBI and the entire ESOP scheme is governed by the guidelines issued by SEBI. It is not the case of contingent liability depending upon various factors on which the assessee had no control…. There can be no denial of the fact that in respect of ESOP, SEBI had issued guidelines and assessee-company had followed these guidelines to the core and the claim of expenditure was in accordance with the guidelines of SEBI…. ”
(Emphasis supplied by us)

The ESOP discount was held as an employee benefit. It was an ascertained liability which was recognised in the books of account. Reliance was placed on the SEBI regulations. The regulations mandated charge of such expense to profit and loss account.

In the case of Consolidated African Selection Trust v. Inland Revenue Commissioners, (1939) 7 ITR 442 (CA), the Court dealt with the issue of shares be-ing an alternate mode of liability discharge. It was observed:

“If an employer having two receptacles, one containing cash and the other containing goods, chooses to remunerate his employee by giving him goods out of the goods receptacle instead of cash out of the cash receptacle, the expenditure that he makes is the value of those goods, not their purchase price or anything else but their value, and that is the amount which he is entitled to deduct for income-tax purposes.”

Distinguishing certain judicial precedents

In this part, we discuss why the decisions of the Delhi Tribunal in Ranbaxy’s case (2009) 124 TTJ 771 (Del.) and Lowry’s case 8 ITR 88 (Supp) are distinguishable where the ESOP discount was held as not an allowable expenditure.

It is a trite law that a judgment has to be read in the context of a particular case. A judgment cannot be applied in a mechanical manner. A decision is a precedent on its own facts. In State of Orissa v. Md. Illiyas, AIR 2006 SC 258, the Supreme Court explained this principle in the following words:

“…..Reliance on the decision without looking into the factual background of the case before it is clearly impermissible. A decision is a precedent on its own facts. Each case presents its own features.”

The following words of Lord Denning in the mat-ter of applying precedents have become locus classicus:

“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 Cardozo) by matching the colour of one case against the colour of another. To decide therefore, on which side of the line a case falls, the broad resemblance to another case is not at all decisive…..”

Precedent should be followed only so far as it marks the path of justice, but you must cut the dead wood and trim off the side branches, else you will find yourself lost in thickets and branches. My plea is to keep the path to justice clear of obstructions which could impede it.”

Ranbaxy case has largely relied on this decision of the House of Lords and accordingly, we have not provided any specific comments on this case. Here-inbelow are our comments/rebuttal on contentions raised in the Lowry’s case. These would apply for the Ranbaxy case also apart from what has been outlined hereinbefore.

Lowry’s case based on foreign law

The decision of the Court in Lowry’s case was based on the then prevailing English law. Before dwelling on the specific arguments/contentions in this case, it may be relevant to discuss the principle of interpretation in case of foreign judicial precedents.

  •     Aid from foreign decisions in interpretation

The words and expressions in one statute as judicially interpreted do not afford a guide to the construction of the same words or expressions in another statute unless both the statutes are pari materia legislations. English Acts are not pari materia with the Indian Income-tax Act. In some cases, English decisions may be misleading since the Act there may contain provisions that are not found in the Indian statute or vice versa. As a result, foreign decisions are to be used with great circumspection. They are not to be applied unless the legal and factual backgrounds are similar.

The Supreme Court in the case of Bangalore Water Supply and Sewerage Board v. A. Rajappa, AIR 1978 SC 548 held — “Statutory construction must be home-spun even if hospitable to alien thinking.”

The Supreme Court in the case of General Electric Company v. Renusagar Power Co., (1987) 4 SCC 213 held — “When guidance is available from binding Indian decisions, reference to foreign decisions may become unnecessary.”
 
The rationale of the ESOP discount being capital expenditure is largely based on the Lowry’s case. This was a landmark judgment by the House of Lords in the year 1940. However, the applicability of this judgment in the present age, case and context is debatable.

The Lowry’s case was adjudged on the principles prevailing then before the House of Lords. Lord Viscount Maugham (one of the judges who held the ESOP discount to be capital in nature) observed:

“The problem which arises under Schedule D seems to me to be a very different one, since it concerns profits of a trade and is subject to a large number of prohibitions as to the deductions which alone are permissible and no other statutory rules of some complexity.”
(Emphasis supplied by us)

From the above observation, one can infer that deductibility of any business expenditure was subject to strict prohibitions. An expense would not be a deductible unless specifically allowed. This is in total contrast to the provisions of deductibility under the Income-tax Act (as discussed earlier) which allows any business expenditure unless specifically prohibited. The provisions of law applied in the case of Lowry are not pari materia with the Act. Accordingly, the judgment cannot and should not be relied upon.

  •     Updation of construction

It is presumed that Parliament intends the Court to apply to an ongoing Act a construction that continuously updates its wording to allow for changes. The interpretation must keep pace with changing concepts and values and should undergo adjustments to meet the requirements of the developments in the economy, law, technology and the fast changing social conditions. The Supreme Court decisions in the cases of Bhagwati J. Gupta v. President of India, AIR 1982 SC 149 and CIT v. Poddar Cements, 226 ITR 625 (SC) can be referred in this regard.

In the treatise ‘The Principles of Statutory Interpre-tation’ by Justice G. P. Singh, (9th edition — page 228) the learned author observes:

“It is possible that in some special cases a statute may have to be historically interpreted “as if one were interpreting it the day after it was passed.” But generally statutes are of the “always speaking variety” and the court is free to apply the current meaning of the statute to present-day conditions. There are at least two strands covered by this principle. The first is that the court must apply a statute to the world as it exists today. The second strand is that the statute must be interpreted in the light of the legal system as it exists today.”
(Emphasis supplied by us)

The Apex Court in the case of CIT v. Poddar Cements, 226 ITR 625 (SC) relied on the treatise ‘Statutory Interpretation’ by Francis Bennion, (2nd edition — section 288) with the heading ‘Presumption that updating construction to be given’ (page 617, 618, 619) and observed as follows:

“It is presumed that Parliament intends the Court to apply to an ongoing Act a construction that continuously updates its wording to allow for changes since the Act was initially framed (an updating construction). While it remains law, it is to be treated as always speaking. This means that in its application on any date, the language of the Act, though necessarily embedded in its own time, is nevertheless to be construed in accordance with the need to treat it as current law.

In construing an ongoing Act, the interpreter is to presume that Parliament intended the Act to be applied at any future time in such a way as to give effect to the true original intention. Accordingly the interpreter is to make allowances for any relevant changes that have occurred, since the Act’s passing, in law, social conditions, technology, the meaning of words, and other matters…. That today’s construction involves the supposition that Parliament was catering long ago for a state of affairs that did not then exist is no argument against that construction. Parliament, in the wording of an enactment, is expected to anticipate temporal developments. The drafter will try to foresee the future, and allow for it in the wording.

An enactment of former days is thus to be read today, in the light of dynamic processing received over the years, with such modification of the current meaning of its language as will now give effect to the original legislative intention. The reality and effect of dynamic processing provides the gradual adjustment. It is constituted by judicial interpretation, year in and year out. It also comprises process-ing by executive officials.”

The Supreme Court in the case of Bhagwati J. Gupta v. President of India, AIR 1982 SC 149 held:

“The interpretation of every statutory provision must keep pace with changing concepts and values and it must, to the extent to which its language permits or rather does not prohibit, suffer adjustments through judicial interpretation so as to accord with the requirements of the fast changing society which is undergoing rapid special and economic transformation. The language of a statutory provision is not a static vehicle of ideas and concepts and as ideas and concepts change, as they are bound to do in a country like ours with the establishment of a democratic structure based on egalitarian values and aggressive developmental strategies, so must the meaning and content of the statutory provision undergo a change. It is elementary that law does not operate in a vacuum. It is not an antique to be taken down, dusted admired and put back on the shelf, but rather it is a powerful instrument fashioned by society for the purpose of adjusting conflicts and tensions which arise by reason of clash between conflicting interests. It is therefore intended to serve a social purpose and it cannot be interpreted without taking into account the social, economic and political setting in which it is intended to operate. It is here that the Judge is called upon to perform, a creative function. He has to inject flesh and blood in the dry skeleton provided by the Legislature and by a process of dynamic interpretation, invest it with a meaning which will harmonise, the law with the prevailing concepts and values and make it an effective, instrument for delivery of justice….”

In case of ESOP, the primary issue revolves around the character of discount — whether capital or revenue? In this context, it may be relevant to quote one of the observations of the Apex Court in the case of Alembic Chemical Works Co. Ltd. v. CIT, (1989) 177 ITR 377 (SC). The Court observed:

“The idea of ‘once for all’ payment and ‘enduring benefit’ are not to be treated as something akin to statutory conditions; nor are the notions of ‘capital’ or ‘revenue’ a judicial fetish. What is capital expenditure and what is revenue are not eternal verities, but must be flexible so as to respond to the changing economic realities of business. The expression ‘asset or advantage of an enduring nature’ was evolved to emphasise the element of a sufficient degree of durability appropriate to the context.”

Interpretation must be with reference to the law and circumstances as it exists when tax has to be paid. This helps in keeping the meaning updated with changing times. In the present eco-nomically advancing modern world, the purpose of ESOP should not be defeated by the narrow interpretation of colouring the transaction as a mere transaction of ‘issue of shares’. The approach of the present-day taxes is to recognise ESOP as a tool of employee compensation.

In Lowry’s case, as per the then prevailing law, a claim of deduction was subject to a large number of prohibitions which alone were permissible. This contradicts the rules of deductibility under the Act. This law is not pari materia with the Act. Accordingly, the binding nature of the Court is diluted. Even otherwise, the Court’s decision could be rebutted on the following points:

  •    Intention implied from erroneous documents

Intention of the parties to the transaction and objective were discerned by placing a huge reliance on the terms and conditions in the employee letters. However, Lord Russell (judge of the majority view) has himself acknowledged:

“The transactions as evidenced by the documents does not, I think, warrant the terminology.”

Any conclusion drawn by placing reliance on badly drafted document is not valid. Reliance was placed on employee letters which were tainted by erroneous drafting/wrong language and nomenclatures. The majority view that ESOP is primarily to issue shares and not employee remuneration (by deriving support from the impugned letters), is thus not a correct statement of fact. The Court seems to have given weightage to form over substance of the transaction.

  •     Impact on financial statements

The Court held that the ESOP discount is not an item of profit/trading transaction and there was no impact on the financial position.

This write -up has examined the treatment of the ESOP discount from various angles, namely, commercial accounting, international practices, statutory guidelines and from an income-tax perspective. All lead to the same conclusion that ESOP is a revenue item which needs to be treated as a charge against profits. It is a part of the financial statements.

  •     Reliance on some judicial precedents

All the judges deliberated on some of the judicial precedents (primarily, Usher’s case and Dexter case).

These cases are not applicable in the present case — they are factually distinguishable. Even otherwise, these judgments relate to foreign law which is not pari materia with the Act and hence are inconsequential.

  •     No monies worth given up by either the Company or the employees

Company’s perspective: The Court held that no money’s worth had been given up by the Company.

The ESOP discount is the difference between the strike price paid and the value of the share at the date the option is exercised. This difference is certainly a charge against the profits — as an expense, profit forgone or a loss. There is a loss of opportunity of issue of shares at the prevailing market price. It is certainly a money’s worth given up. In fact Lord Viscount (judge from majority view) said:

“If this House had regarded the transaction as one in which the company was giving “money’s worth” in the sense of an equivalent for cash in consider-ation of the promise to subscribe for shares the decision would have been the other way.”

In case of the ESOP discount, the Company has for-gone share premium receivable. The Company has given up a portion of money receivable on issue of its shares. Accordingly, the aforesaid contention is rebutted.

Employee’s perspective: ESOP was held to be gift to the employees and that employees had not given up anything for procuring these shares.

ESOP is a form of employee remuneration. It is a remuneration paid either for his past services or with intent to retain his services for the future. Thus it is an award in lieu of his services to the organisation rendered/expected to be rendered. This truth has been acknowledged by the regulatory bodies — OECD, SEBI and ICAI. The Karnataka High Court has acknowledged ESOP as an employee remuneration tool.

  •     Hypothetical proposition of ESOP being an application of salary

The Court held that ESOP being an application of salary to employees for share subscription — is only a hypothetical proposition.

The ESOP discount is amount notionally received on capital account and utilised on revenue account. Instead of salary being paid and inturn application of employees to ESOP, this two-way transaction has been short-circuited. Support can be drawn from Circular 731, dated 20-12-1995 and Apex Court decision in the case of J. B. Boda and Company Private Limited v. CBDT, (1996) 223 ITR 271 (SC).

  •     Share premium forgone is a capital item and hence ESOP discount is capital in nature

The Court held that share premium is a capital receipt. Forbearance of such capital receipt is not deductible.

It has been sufficiently put forth that the ESOP discount is a revenue item. The ESOP discount is not a capital receipt. The determination of capital v. revenue should be done based on the utilisation of expense. The ESOP discount is incurred for employee benefit and hence revenue in nature.
    

  •     Employee paying tax is inconsequential

The Court held that the fact that the employee paid tax on ESOP (on benefit of discount on share premium) was inconsequential in determining the allowability of the ESOP discount.

It is an accepted principle that ‘Income charge-ability’ is not the basis for ‘expenditure allowability’. The fact that amount receivable has the character of income in the hands of recipient, is not relevant for determining the expense allowability. 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.

Additionally, comments of Lord Wright (judge from minority view) are worth men-tioning which held that ESOP was held taxable in employee’s hands, but was not correspondingly entitled to deduction in the hands of employer:

“….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….”

  •     Discount on shares is a ‘choice’ and not an ‘obligation’

The Court held that the Company was entitled to issue shares at a lesser/discounted value and it did so. It was a matter of election or choice and not a discharge of any liability/debt.

It may be relevant to note that ESOP is a form of employee remuneration/salary. Salary is a consideration for services rendered by the employees. It is an obligation/liability incurred for the business. Accordingly, the ESOP discount is allowable expenditure. In fact Lord Viscount (judge of majority view) held as follows:

“….If in this case the employees were paying the par value of the shares and also releasing to the company some amounts of salary due to them, the case would be very different from what it is….”

This observation supports the view that the ESOP dis-count in discharge of salary due to employees could have been held deductible by the Court itself.

To summarise, there are judicial precedents supporting the ESOP discount to be an allowable revenue expenditure and judgments with contrary view can be distinguished on law and facts.

Closing comments

Typically, a payment to an employee is called as ‘Salary’. This payment may be ‘paid in meal or malt’. ESOP is just another form of such salary given to employees. Etymologically, the term ‘Salary’ owes it origin to the Latin term ‘salarium’ which means ‘money allowed to Roman soldiers for purchase of salt’. One could therefore trace back the concept of payment in kind to the Roman age. This payment of salary in kind has taken various forms over a period of time. Employees have been rewarded with assets such as gold, accommodation, motor vehicles; facilities such as personal expense reimbursement, insurance and medical facilities, etc.; sometimes not only for employees but for their family members as well. Employee rewards in kind have taken various shapes. ESOP is one among them. It is an employee welfare measure. Such measures need a boost from the income-tax authorities. Such support would only escalate into a supportive social measure.

The Karnataka High Court in the case of CIT and Anr. v. Infosys Technologies Ltd., (2007) 293 ITR 146 (Kar.) had an occasion to comment on the same issue of ESOP discount. It held:

“India is a growing country. The technological development of this country has resulted in economical prosperity of this country. Several giant undertakings have shown interest in this great country after taking note of the manpower and the intelligence available in this country. Stock option is nothing new and it is being continued in the larger interest of industrial harmony, industrial relations, better growth, better understanding with employees, etc. It is a laudable scheme evolved and accepted by the Government. Good old days of only master and only servant is no longer the mantra of today’s economy. Today sharing of wealth of an employer with his employees by way of stock option is recognised, respected and acted upon. Such stock option is way of participation and it has to be encouraged…. The Department, in our view, must approve such welfare participatory pro-labour activities of an employer. Of course, we do not mean that if law provides for taxation, no concession is to be shown. But wherever there are gray areas, it is preferable for the Department to wait and not hurriedly proceed and arrest the well-intended scheme of welfare of the employer. We would be failing in our duty if we do not note the Directive Principles of the Constitution in the matter of labour participation. Article 43A provides that the State shall take steps by suitable legislation or by any other way to secure participation of workers in the management of undertakings, establishment or other organisation engaged in other industries…. We would ultimately conclude by saying that any welfare measure has to be encouraged, but of course within the four corners of law. We do hope that other employers would follow this so that the economic and social justice is made available to the weaker sections of society also.”

Human resource management has evolved as a separate field of study. Today this study is not restricted populating a concern with right people. The challenge is not mere correct staffing. This human resource need to be nurtured, trained and developed. They should be transformed from ‘people in the organisation’ to ‘people for and of the organisation’. This transformation is not automatic. It is a result of the committed effort from the concern/company. It is a commitment to reward for the past services of its employees as well as their future endeavours. This reward kindles motivation in employees; seemingly the only antidote to attrition. ESOP is just another employee motivation tool. No statute or fiscal law should discourage an employee motivation/welfare measure. Our attempt in this write-up has been to uphold this very thought.

Refund: Interest on: Section 244A: Block period 1-4-1995 to 21-3-2002 — Assessee deposited cheque on 29-12-2003: Amount debited to assessee’s bank account on 30-12-2003: Assessee entitled to interest for December 2003.

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[CIT v. Asian Paints Ltd., 12 Taxman.com 484 (Bom.)]

The assessee deposited cheque for amount of tax demanded with authorised agent of the Central Government on 29-12-2003 and account of assessee was debited to that extent on 30-12-2003. On appeal, assessment was set aside and the assessee became entitled to refund of tax paid. The Assessing Officer refunded tax with interest u/s.244A from January, 2004 till grant of refund and declined to grant interest for month of December, 2003 on ground that tax paid by the assessee was credited to the Central Government account on 12-1-2004. The Tribunal held that the assessee was entitled to interest for the month of December 2003.

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

“(i) According to the Counsel for the Revenue, though the assessee had deposited the cheque towards the tax demand on 29-12-2003, the amount was actually credited to the Central Government account on 1-1-2004 and therefore, on grant of refund, the assessee was entitled to interest from January, 2004. In support of the above contention, counsel for the Revenue relied upon a decision of the Rajasthan High Court in the case of Rajasthan State Electricity Board v. CIT, (2006) 281 ITR 274 and the decision of the Delhi High Court in the case of CIT v. Sutlej Industries Ltd., (2010) 325 ITR 331/190 Taxman 136.

(ii) U/s.244A(1)(b) of the Act, interest on refund is payable from the date of payment of tax to the date on which refund is granted. In the present case, admittedly the cheque for the amount of tax demanded was deposited with the authorised agent of the Central Government on 29-12-2003 and the account of the assessee was debited to that extent on 30-12-2003. The question therefore, to be considered is, whether debiting the tax amount from the bank account of the assessee by the authorised agent of the Central Government account viz. the authorised bank constitutes payment of tax under section 244(A)(i)(b) of the Act?

(iii) Once the authorised agent of the Central Government collects the tax by debiting the bank account of the assessee, the payment of tax to the Central Government would be complete. The fact that there is delay on the part of the authorised agent to credit that amount to the account of the Central Government, it cannot be said that the payment of tax is not made by the assessee, till the amount of tax is credited to the account of the Central Government. For calculating interest u/s.244A(1)(b) of the Act the relevant date is the date of payment of tax and not the date on which the amount of tax collected is credited to the account of the Central Government by the agent of the Central Government.

(iv) Therefore, in the facts and circumstances of the present case, the decision of the ITAT in holding that the assessee had paid the taxes on 30-12- 2003 cannot be faulted.

(v) Once it is found that the tax was paid on 30-12- 2003, then as per the Rule 119A(b), of the Incometax Rules, on the tax becoming refundable, the assessee had to be refunded tax with interest for the entire month of December, 2003. Thus, in the facts of the present case, no fault can be found with the decision of the ITAT in holding that the tax was paid on 30-12-2003 and therefore, the tax was liable to be refunded with interest for the entire month of December, 2003.

(vi) The decision of the Rajasthan High Court, as also the decision of the Delhi High Court relied upon by the counsel for the Revenue are distinguishable on the facts as in both the above cases, the Courts were not called upon to consider the scope of the expression ‘payment of tax’ contained u/s.244A(1)(b) of the Act. In fact, the Circular No. 261, dated 8-8-1979 issued by the Board to the effect that the date of presenting the cheque should be the date of payment supports the contention of the assessee.”

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Salary: Interest u/s.234B: Employee is not liable to pay interest u/s.234B for failure to pay advance tax on salary.

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[DIT v. M/s. Maersk Co. Ltd. (Uttarakhand) (FB), ITA No. 26 of 2009, dated 7-4-2011]

Pursuant
to an agreement with ONGC, the assessee, a foreign company, had
supplied technicians to ONGC. The Assessing Officer treated the assessee
as an agent of the technician-employees and assessed their income under
the head salaries. Interest u/s.234B, was levied on the ground that the
employees had not paid advance tax. The Tribunal allowed the assessee’s
claim that employees were not liable to pay advance tax as the tax was
deductible at source u/s.192, and accordingly set aside the levy of
interest.

On appeal by the Revenue, the issue was referred to
the Full Bench. The Full Bench of the Uttarakhand High Court upheld the
decision of the Tribunal and held as under:

“(i) Advance tax on
the salary of an employee is not payable u/s.208 of the Act by the said
assessee inasmuch as the obligation to deduct tax at source is upon the
employer u/s.192 of the Act. The assessee cannot foresee that the tax
deductible under a statutory duty imposed upon the employer would not be
so deducted. The employee-assessee proceeds on an assumption that the
deduction of tax at source has statutorily been made or would be made
and a certificate to that effect would be issued to him. Consequently,
the liability to pay interest in respect of such deductible amount is
therefore clearly excluded to that extent.

(ii) The statute has
taken care of the liability to pay tax by the assessee u/s.191 of the
Act directly if the tax has not been deducted at source. The assessee
only became liable to pay the tax directly u/s.191 of the Act since it
was not deducted at source. The stage of making payment of tax could
only arise at the stage of self-assessment which is to be made in a
later assessment year.

(iii) The liability to pay interest
u/s.234B of the Act is different and distinct inasmuch as the interest
could only be imposed on the person who had defaulted, which in the
present case is the employer for not making deduction of tax at source
as required u/s.192 of the Act.

(iv) The assessee-employee would
not be liable to pay interest u/s.234B of the Act since he was not
liable to pay advance tax u/s.208 of the Act.”

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Deemed dividend: Section 2(22)(e): Advance or loan received by the assessee from a company is not to be assessed as ‘deemed dividend’ u/s.2(22)(e) if the recipient is not a shareholder.

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[CIT v. Ankitech Pvt. Ltd. (Del.), ITA No. 462 of 2009, dated 11-5-2011]

The assessee-company received advances of Rs. 6.32 crore by way of book entry from Jackson Generators Pvt. Ltd, a closely-held company. The shareholders having substantial interest in the assessee-company were also having 10% of the voting power in Jackson Generators Pvt. Ltd. The Assessing Officer assessed the said advance of Rs. 6.32 crore as deemed dividend u/s.2(22)(e) in the hands of the assessee-company. The Tribunal deleted the addition and held that though the amount received by the assessee was ‘deemed dividend’ u/s.2(22)(e), it was not assessable in the hands of the assesseecompany as it was not a shareholder of Jackson Generators Pvt. Ltd.

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

“(i) U/s.2(22)(e), any payment by a closely-held company by way of advance or loan to a concern in which a substantial shareholder is a member holding a substantial interest is deemed to be ‘dividend’ on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance. The legal fiction in section 2(22)(e) enlarges the definition of dividend but does not extend to, or broaden the concept of, a ‘shareholder’. As the assessee was not a shareholder of the paying company, the dividend was not assessable in its hands.

(ii) As the condition stipulated in section 2(22) (e) treating the loan or advance as deemed dividend are established, it is open to the Revenue to take corrective measure by treating this dividend income at the hands of the shareholders and tax them accordingly.”

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The power of parliament to make law with respect to extra-territorial aspects or causes — Part i

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1.1 Article 245 of the Constitution of India deals with the extent of laws made by the Parliament and by the Legislatures of States. Clause (1) of the said Article, inter alia, provides that subject to the provisions of the Constitution, the Parliament may make laws ‘for’ the whole or any part of the territory of India. Clause (2) of the said Article further provides that no law made by the Parliament shall be deemed to be invalid on the ground that it would have extra-territorial operation.

1.2 Section 9(1) of the Income-tax Act, 1961 (the Act) provides a deeming fiction to effectively treat foreign income of an assessee as deemed to accrue or arise in India under certain circumstances in the situations provided therein. Technically, section 9 applies to resident as well as the non-resident assessees. However, applicability thereof to a resident is not of much relevance in the context of taxability of income in India, except in case of an assessee, who is not ordinarily resident. Where income actually accrues or arises in India, such a fiction is not needed to create a situation which exists in reality and therefore, in such cases, this fiction has no relevance. This also effectively does not apply to the income received in India, as such income are chargeable u/s. 5 in case of resident as well as non-resident assessees irrespective of the place of accrual of income. Therefore, effectively, a foreign income of a non-resident assessee, which is not received in India would not be chargeable to tax under the Act, unless it accrues or is deemed to accrue in India.

1.3 Clauses (i) to (iv) of section 9 provide for such deeming fiction in respect of certain income under the circumstances specified therein, such as income accruing or arising, directly or indirectly, through or from any business connection in India or from any property in India, etc. These provisions are considered valid as varieties of nexus set out therein are based on sufficient and real territorial connection. This is mainly based on the general principle that once there is a sufficient territorial connection or nexus between the persons sought to be taxed and the country seeking to tax, the income-tax may appropriately be levied on that person in respect of his foreign income. Primarily, we are not concerned with these provisions in this write-up, though they have continued in section 9(1) with some changes even after introduction of clauses (v) to (vii).

1.4 Clauses (v) to (vii) were inserted by the Finance Act, 1976 (w.e.f. 1-6-1976) deeming interest, royalty and Fees for Technical Services (FTS) to accrue or arise in India effectively making the non-resident recipient of such income chargeable to tax in cases where such non-resident had no tax liability in respect of such income under the pre-existing provisions (hereinafter income specified in these clauses is referred to as the Specified Income). Under these provisions, the law also seeks to charge a non-resident in respect of his income outside India merely because the payment thereof is made by Indian resident with some exceptions. Accordingly, the residential status of the payer became relevant to detriment the situs of income. Further, under these provisions, the law also seeks to charge Specified Income arising from transactions between two non-residents outside India under certain circumstances and so on. This had raised doubts as to the validity of these provisions which came up for consideration before the Courts in India, mainly in the context of provisions relating to FTS.

1.5 In the context of taxability of FTS under clause (vii)(b) of section 9(1), a new dimension was given by the Apex Court in the case of Ishikawajima- Harima Heavy Industries Ltd. (288 ITR 408) wherein while dealing with the taxability of income from offshore services, the Court, inter alia, held that for such income to be regarded as accruing or arising in India, it is necessary that services not only are utilised within India, but also are rendered in India. Such a condition for taxability of such income was by and large not considered as relevant prior to this judgment and the same was also found against the very object for which these provisions were introduced by the Finance Act, 1976. Accordingly, Explanation to section 9 has been inserted/sustituted by the Finance Act, 2010 with retrospective effect from 1-6-1976 to overcome the possible effect of the position emerging from this part of the judgment of the Apex Court. Some doubts have also been raised with regard to validity of this new Explanation.

1.6 In the context of validity of the provisions contained in clauses (v) to (vii) of section 9(1), the debate continued with regard to extent of the Parliament’s powers to enact a law having extra-territorial operations.

1.7 Recently, the Constitution Bench of the Apex Court has dealt with this issue and decided the scope of powers of the Parliament to enact a law having extra-territorial operations. In this context, this has settled the general principle in this regard. This judgment will have implications not only with regard to the Income-tax Act, but also with regard to other laws enacted by the Parliament. In this write-up, we are only concerned with the effect of this judgment in the context of the above-referred deeming fiction provided in the Act in respect of the Specified Income.

Electronics Corporation of India Ltd., (ECIL) v. CIT & Anr. — 183 ITR 44 (SC):

2.1 The issue referred to in para 1.6 above came up before the Andhra Pradesh in the context of section 9(1)(vii). In this case, the brief facts were:

The assessee company (ECIL) had entered into an agreement with Norwegian Co. (NC) under which, for the agreed consideration, the N.C. was to provide technical services including facilities for training of personnel of the ECIL in connection with the manufacture of computers by ECIL. For the purpose of remitting the amount payable to NC, the ECIL had approached the Income Tax Officer (ITO) for grant of No Objection Certificate (NOC) as contemplated in section 195(2) of the Act for remittance without deduction of tax at source (TDS). When ITO expressed inability to issue such NOC, the ECIL approached the Commissioner of Income Tax (CIT) for directing ITO to issue the NOC. The CIT declined to issue such direction as according to him, the said payment was income which is deemed to accrue or arise in India u/s.9(1)(vii) and was liable to TDS u/s.195. Against this, ECIL had filed a writ petition before the High Court.

2.2 Before the High Court, various contentions were raised including validity of provisions of section 9(1)(vii) on the ground that it has extraterritorial operation without any nexus between the persons sought to be taxed (i.e., NC) and the country (i.e., India) seeking to tax under a fiction of deemed income arising in India. In this write-up, we are not concerned with the other contentions raised in this case. For the purpose of deciding the issue, the Court referred to historical background of the Income-tax Act and noted that the Indian Income-tax Act, 1922 was passed by the Indian Legislature in exercise of its powers conferred by the British Parliament under the Government of India Act, 1915-1919 which was replaced by the Government of India Act, 1935. The Court then noted that section 99 of the Government of India Act, 1935, inter alia, empowered the Federal Legislatures to make law for the whole or any part of British India. Comparing these provisions with provisions of Article 245 of the Constitution, the Court noted that there was no provision like Article 245(2) in the Government of India Act. The Court then pointed out that the Income-tax Act, 1961 is a post-Constitution law made by the Parliament.

2.3 It was contended on behalf of the ECIL that the NC does not have any Office in India, nor does it have any business activity in this country. The Parliament is not competent to enact section 9(1)(vii)    as it has extra-territorial operation by creating a fiction of income accruing in India without any nexus between the NC and India. For this, reliance was placed on various judgments including the judgment of the Apex Court in the case of Carborandum Co. (108 ITR 335) as well on the commentary given in the book (i.e., Law and Practice of Income Tax) written by the learned authors Kanga & Palkhivala.

2.4 For the purpose of deciding the issue, the Court stated that various judgments relied on by the counsel of the petitioner were rendered under the Indian Income-tax Act, 1922. The Court also noted that the facts of the case under consideration show that the payment is made by an Indian company to a foreign company for FTS and know-how, which is to be used by the Indian company in its business in India. For the purpose of the Income-tax Act, the fiction of income deemed to arise in the country where tax is levied is not uncommon. The narrow test of territorial nexus evolved by the courts in England may not be suitable for application by a developing country like India in the developments which are taking place. The language and spirit of Article 245(2) of the Constitution is clear. The Court will be slow in striking down the law made by the Parliament merely on the ground of extra-territorial operation. India has entered into agreements with several other nations providing for double taxation relief and if there is a real apprehension of deterrence to foreign collaborations as contended on behalf of the petitioner, it will be expected that the Government will take suitable action. Finally, the Court did not agree with the contention of the petitioner that the impugned provisions are beyond the legislative competence of the Parliament.

2.5 When the above judgment of the High Court came up for consideration before the Apex Court, the Court noted that the Revenue is proceeding on the basis that the NC is liable to tax and therefore, the ECIL is obliged to deduct tax at source while making the payment. The case of the Revenue rests on section 9(1)(vii)(b) of the Act and the question is whether, on the terms in which the provision is couched, it is ultra vires.

2.5.1 To decide the issue, the Court noted the constitutional scheme to make laws which operate extra-territorially and referred to the provisions contained in Article 245 and stated that considering provisions of Article 245(2), which provides that no law made by the Parliament shall be deemed to be invalid on the ground that it will have extra-territorial operation, a Parliamentary statute having extra-territorial operation cannot be ruled out from contemplation. Therefore, according to the Court, the operation of the law can extend to persons, things and acts outside the territory of India and for this purpose, the Court also noted the judgment of the Privy Council in the case of British Colombia Electric Railway Co. Ltd. wherein it was held that the problem of inability to enforce the law outside the territory cannot be a ground to hold such law invalid. The nation enacting a law can order that the law requiring any extra-territorial operation be implemented to the extent possible with the machinery available. This principle clearly falls within the ambit of pro-visions of Article 245(2). The Court then observed as under (page 55):

“In other words, while the enforcement of the law cannot be contemplated in foreign State, it can, none the less, be enforced by the courts of the enacting State to the degree that is permissible with the machinery available to them. They will not be regarded by such courts as invalid on the ground of such extra-territoriality.”

Accordingly, the Court drew the distinction between the power to ‘make Laws’ and ‘operation’ of laws. The Court also took the view that the operation of the law enacted by the Parliament can extend to persons, things and acts outside the territory of India.

2.5.2 Finally, the Court felt that the issue should be decided by the Constitution Bench considering its implications and held as under (page 55):

“But the question is whether a nexus with some-thing in India is necessary. It seems to us that, unless such nexus exists, the Parliament will have no competence to make the law. It will be noted that Article 245(1) empowers the Parliament to enact laws for the whole or any part of the territory of India. The provocation for the law must be found within India itself. Such a law may have extra-territorial operation in order to subserve the object and that object must be related to something in India. It is inconceivable that a law should be made by the Parliament in India which has no relationship with anything in India. The only question then is whether the ingredients, in terms of the impugned provision, indicate a nexus. The question is one of substantial importance, specially as it concerns collaboration agreements with foreign companies and other such arrangements for the better development of industry and commerce in India. In view of the great public importance of the question, we think it desirable to refer these cases to a Constitution Bench, and we do so order.”

2.5.3 From the above, it would appear that the Court held the view that the Parliament does not have power to make extra-territorial law unless a nexus exists with something in India. In the context of Article 245(1), the observations of the Court that the provocation for the law must be found within India itself and the object for which the law having extra -territorial operation is made must be related to something in India, raised an issue as to whether this could mean that such provocation and object must arise only within India.

2.5.4 It seems that the petitioner (i.e., ECIL) did to pursue the above matter further and hence the issue remained to be decided by the Constitution Bench.

REINVESTMENT IN OVERSEAS PREMISES

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1. Issue for consideration:

1.1 Section 54 of the Income-tax Act grants an exemption from payment of tax on capital gains, arising on transfer of a residential house on fulfilment of the conditions specified therein. One of the conditions requires an assessee to re-invest the capital gains in purchasing or constructing a residential house within the prescribed period.

1.2 Section 54F of the Act grants a similar exemption from payment of tax on capital gains, arising on transfer of a capital asset other than a residential house on fulfilment of the conditions specified therein. This Section also amongst other conditions requires an assessee to re-invest the net consideration in purchasing or constructing a residential house within the prescribed period.

1.3 Both these provisions restrict the benefit of exemption to individuals and Hindu Undivided Families and grant exemption, irrespective of the residential status of the assessees. These provisions do not confer or deny the exemptions for tax on the basis of the location of the residential house.

1.4 In the advent of the globalisation, it is not uncommon, that the new residential house is acquired by an assesse at a place located outside India. Such overseas acquisitions have, in turn, triggered a controversy in taxation involving the eligibility of an assessee for exemption based on re-investment of capital gains outside India.

2. Leena J. Shah’s case:

2.1 The issue arose in the case of Smt. Leena J. Shah v. ACIT, 6 SOT 721 (Ahd.) where an assessee perhaps for the first time, contested the action of the CIT(A) in confirming the denial of exemption u/s.54F of the Income-tax Act, 1961 inter alia on the ground that the investment was made by the assessee in purchasing the residential house outside India.

2.2 The assessee, a non-resident sold some plots of land located in India for a total consideration of Rs.44,92,170 and earned the capital gains of Rs.43,80,454 after reducing the indexed cost of Rs.1,11,760. She claimed an exemption for investment in residential house and purchased a residential house in the USA, outside India. The AO denied the exemption by observing that the sale proceeds of the plot of land had not been utilised in acquiring the residential house in India and moreover, the residential house purchased/ constructed in the USA is not subject to tax in India within the meaning of section 54 of the Act. The AO therefore, did not allow the claim of deduction of Rs. 43,80,454 and brought the said amount to tax.

2.3 The CIT(A) confirmed the action of the AO by holding that section 54F was introduced in the Act by the Finance Bill, 1982 and the Memorandum explaining the provisions of the Finance Bill, 1982 explained that the exemption u/s.54F was granted with a view to encourage the construction of the house which naturally meant that the house was constructed in India and not outside India.

2.4 The assessee submitted before the Tribunal that; section 54F which was similar to section 54 did not make any distinction between a resident and a non-resident unlike several other sections in which the benefit was clearly and unambiguously denied to a non-resident; the benefit of section 54 and section 54F was intended to be available to both the categories of assessees without any discrimination; any interpretation which militated against the basic principle would not be a just and fair interpretation of the statute and would amount to doing injustice to all nonresidents in general and the appellant in particular who had invested the net consideration in a residential house, though outside India.

2.5 It was further explained that; there was no such stipulation u/s.54F that the new residential house must be located in India; wherever the Legislature found requirement of such stipulation, the same was provided in that section; the language of section was clear, the same was to be read accordingly. The decisions in the case of Padmasundra Rao v. State of Tamil Nadu, Kishore B. Setalvad v. CWT, and Orissa State Warehouseing Corpn. v. CIT were relied upon.

2.6 The honourable Tribunal concurred with the view that the legislative intent behind introduction of section 54F was to be gathered form the Notes, Memorandum and the Circular which in the Tribunal’s view provided that the investment was to be in the residential house located in India. The Tribunal cited several decisions in support of the view that the external aids like Notes, etc. were available for interpretation of the law and the meaning of the provision of section 54F could be gathered from such aids. In the light of the above settled rulings of interpretation of tax statutes, the Tribunal found appropriate that a residential house purchased/constructed must be in India and not outside India, in the USA. It noted that the interpretation put forth by it was strongly supported by the marginal note to section 54F.

3. Prema P. Shah’s case:

3.1 The issue again arose in the case of Prema P. Shah v. ITO, 100 ITD 60 (Mum.) where the question before the Tribunal was whether the exemption contemplated u/s.54(1) could be extended to the capital gains that was reinvested in a residential house purchased in a foreign country on selling the property that was situated in India.

3.2 In that case the brief facts available are that the assessee sold a jointly held residential property located in India for Rs.60 lakh on 4-4-1992 which was purchased for Rs.14 lakh on 29-3-1983. The capital gains was reinvested in purchasing residential house outside India, in London, the UK. The assessee claimed exemption u/s.54, showing long-term capital gains as Nil. The AO denied the exemption claimed on a few grounds including for the fact that the property was located outside India and in his opinion the same was required to be located in India for a valid claim of exemption from taxation.

3.3 The CIT(A) upheld the action of the AO and did not approve the view canvassed by the assessee. While disallowing the assessee’s claim, the CIT(A) observed:

(a) the assessee had taken loan from Barclays Bank and used the assessee’s foreign earning to purchase/lease the property. In other words, the receipts which gave rise to capital gains, were not utilised for the purchase of the property,

(b) the assessee had not purchased the property in India and the Income-tax Act extended to the ‘whole of India’ only,

(c) The lease for 150 years, though perpetual, the benefit of long-term lease obtained in the UK could not be treated as purchase under the Indian laws for the purpose of income taxation.

3.4 The assessee before the Tribunal contended that there was nothing in the statute to show that the property purchased should exist in India so as to claim the benefit contemplated under the Act; that the only stipulation for a valid claim of exemption was that the income should have arisen in India and it was not necessary that it should also be invested in India. For the above proposition, the assessee drew the attention to section 11 of the Income-tax Act, 1961 and it was further submitted that if the Legislature had such an intention, it would have been definitely and specifically mentioned, as it had been mentioned in section 11 which provided that any income from property held for charitable or religious purposes was exempt from tax u/s.11(1)(a) only to the extent it applied it to such purposes in India; if the Legislature wanted investment of the capital gains in India itself for exemption, the Legislature would have specifically stated so in the section itself.

3.5 The Tribunal on consideration of the submissions made by the parties was of the considered view that the assessee was entitled to the benefit of exemption form taxation under the Act which did not exclude the right of the assessee to claim the property purchased in a foreign country. The Tribunal held that if all other conditions laid down in the section were satisfied, merely because the property acquired was located in a foreign country, the exemption claimed would not be denied.

4.    Girish M. Shah’s case:

4.1 The issue recently arose in the case of ITO v. Dr. Girish M. Shah, ITA No. 3582/M/ 2009 before ‘G’ Bench of ITAT, Mumbai. In that case, the assessee, non-resident Indian settled in Canada since 1994, sold his flat in Mumbai in 2003, for Rs.16 lakh, that was purchased in April, 1984, for Rs.1,31,401. The assessee claimed the benefit of indexation and reported a net capital gain of Rs.797,801. The entire sale consideration was repatriated to Montreal for a joint purchase of a house for Rs.64.75 lakh. The benefit of section 54 was claimed on the ground that sale proceeds were utilised for purchasing property.

4.2 The AO held that the provisions of the Act were applicable to India only. When a non-resident could not be taxed in India in respect of income received outside India, deduction could in the AO’s view could not be granted in respect of an activity outside India. He also noted that there was no undertaking that capital gains would be paid should the new property be disposed of. The AO, placing reliance on the decision of the Ahmedabad Tribunal in the case of Leena J. Shah v. ACIT in ITA No. 2467 (Ahm.) (supra), denied the benefit of section 54 to the assessee and recomputed the long-term capital gains at Rs.13,51,803.

4.3 On appeal the CIT(A) found that the entire sale proceeds had been utilised in the purchase of the new asset and hence capital gains was not chargeable u/s.54 of the Act. He also held that section 54F did not specify that the new as-set should be situated in India. As there was no specific restriction on location of new asset, the benefit of section 54F could not be denied to the assessee who had satisfied all other conditions, observed the CIT(A). The CIT(A) relied on the decision of the jurisdictional Tribunal in the case of Mrs. Prema P. Shah v. ITO (supra) for allowing the exemption that was claimed by the assessee.

4.4 The Tribunal vide order dated 17-2-2010 relying on the decision in the cases of Mrs. Prema P. Shah and Sanjiv P. Shah v. ITO (supra) upheld the action of the CIT(A) by holding as follows: “In short, we are of the considered view, for the reasons stated hereinabove, that the assessee is entitled to the benefit u/s.54 of the Act. It does not exclude the right of the assessee to claim the property purchased in a foreign country, if all other conditions laid down in the section are satisfied, merely because the property acquired is in a foreign country”. The Tribunal noted that the jurisdictional High Court had dismissed the Revenue’s appeal against the above order of the Tribunal in the case of Prema P. Shah and Sanjeev P. Shah on account of the tax effect being less than Rs.4 lakh.

4.5 The Tribunal noted that in Leena J. Shah’s case, the issue was for the claim u/s.54F, while in the case before them, it was section 54. It noted that the decision of the jurisdictional Tribunal had a greater binding effect.

4.6 Lastly, the Tribunal observed that it was the settled law that if there were two views, the Court had to adopt the interpretation that favoured the assessee.

5.    Observations:

5.1 A bare reading of the provisions of sections 54 and 54F make it abundantly clear that there are no express conditions that require that the capital gains or the net consideration is reinvested in a residential house located in India. There are several provisions of the Income-tax Act which specifically require an investment to be made in India or for an act to be carried out in India. In the circumstances, for denying the claim of exemption, one will have to read the location-based condition in to these provisions, so as to insist on the new house being in India.

5.2 Section 54F was introduced by the Finance Act, 1982 for the purpose of conferring exemption from tax on capital gains in certain cases on investment of the consideration in residential premises. The said provision nowhere mandates that the exemption is conditional and is subjected to investment in residential premises located in India. The language of the law is very clear and does not leave any scope for ambiguity or misunderstanding.

5.3 It is the settled position in law that nothing is to be read in the provisions of the Act or added thereto where the language of the law is clear. In case of section 54 and section 54F the language in the context of location of the premises is clear and unambiguous leaving no scope for application of any external aids of interpretation like, FM’s speech or Notes to clauses or Memorandum explaining the provisions and the Circular explaining the same. It is significant to note that even the Circular, heavily relied upon by the learned AO, at no point or place requires that the construction of residential premises should be in India before an exemption u/s.54F is granted.

5.4 The main plank for denying the exemption is based on the Notes to Clauses, 134 ITR 106 (St.) Memorandum to the Finance Act, 1982, 134 ITR 128 (St) and the Circular of the CBDT bearing Circular No. 346, dated 30-6-1982 issued on introduction of section 54F by the Finance Act, 1982 The relevant paragraph of the Circular is reproduced as under:

“20.1 Under the existing provisions of the IT Act, any profits and gains arising from the transfer of a long-term capital asset are charged to tax on a concessional basis. For this purpose, a capital asset which is held by an assessee for a period of more than 36 months is treated as a ‘long-term’ capital asset.

20.2 With a view to encouraging house construction, the Finance Act, 1982, has inserted a new section 54F to provide that where any capital gain arises from the transfer of any long-term capital asset, other than a residential house, and the assessee purchases within one year before or after the date on which the transfer took place or constructs within a period of three years after the date of transfer, a residential house, the capital gains arising from the transfer will be treated in a concessional manner as under ……”

5.5 The Finance Minister’s speech on introduction of the Finance Act of 1982, 134 ITR (St.) 23, does not prescribe any such condition for exemption based on the location of the new asset-neither the speech suggest that the provision is introduced for promotion of the construction of houses, leave alone in India. The Circular No. 346 appears to have supplied the legislative intent without being authorised to do so.

5.6 Such an ‘Indian’ insistence by the authorities appears to be misplaced, more so when the language of these provisions is clear and leave no room for ambiguity. Even the Circular relied upon by the authorities does not mandate that the construction of houses sought to be promoted is India-specific. Significantly, even the analogy based on the said Circular is not available for rejecting the claim for exemption u/s.54 which provision surely is not handicapped by any Circular explain-ing the alleged intention behind its introduction.

5.7 The law undoubtedly overrides the Circular where the language of the law is clear. The unambiguous language of the law i.e., sections 54 and 54F does not restrict its scope based on the location of the asset. It is a sheer fallacy to read the condition of investment in India in the provisions and assume that exemption u/s.54F from capital gains is intended to give a boost to the construction of residential houses in the country and this objective will not be achieved if the property is acquired or constructed in a foreign country. It is clear that the Circular has presumed that section 54F is introduced for construction of house. Assuming that such presumption of the board is right, it nowhere requires that the house construction should be in India.

5.8 Section 54F is introduced mainly for facilitating purchase of house by the people on sale of other assets. Therefore the exemption at best can be said to be introduced to enable the purchase of house by an individual or HUF without payment of tax. Had it been for the promotion of construction industry, the exemption would have been conferred on all assessees and would not have been restricted to individual and HUF.

5.9 The decision in the case of Leena J. Shah, has been delivered without detailed reasons, in one paragraph, after citing several decisions of the courts to suggest that in interpretation of the law, it is permissible to rely on the external aids of interpretation including the Notes, Memorandum and the Circular. While there cannot be two opinions on this wisdom, what is perhaps overlooked, with full respect, is the established position in law which requires and permits the use of external aids only in cases where the language of the law is unclear and ambiguous and as noted the language here is clear. It is for this reason that the subsequent decisions of the Tribunal have chosen to not follow the ratio of the said decision in Leena J. Shah’s case and have proceeded to allow the exemption in cases of overseas investment. Moreover, the later decisions of the Mumbai Tribunal, being the latest shall prevail over Leena J. Shah’ decision, more so because the said decisions have not only considered the ratio of Leena J. Shah’s decision but have also analysed the law in detail in concluding that the benefit of exemption is available for overseas investment.

5.10 A resident assessee is entitled to and is not denied exemption u/s.54F on purchase of residential premises anywhere in the world. If that is so, in the absence of any specific or implied prohibition, such an investment any-where in the world by a non-resident cannot be denied.

5.11 Once the Income-tax Act, 1961 assumes the power to tax the Income of a non-resident, then the logical consequence of such a power is to confer upon such a person all the benefits that flow from the provisions of the Act unless specifically prohibited.

5.12 The Income-tax Act, wherever required has specifically stipulated in writing that the investment should be made in India, like in sections 10(20A) and 10(20B) 10(22) and 10(24), 10(26) and section 11(1)(a) which reads as under:

“11. (1) Subject to the provisions of sections 60 to 63, the following income shall not be included in the total income of the previous year of the person in receipt of the income —

(a)    income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India; and, where any such income is accumulated or set apart for application to such purposes in India, to the extent to which the income so accumulated or set apart is not in excess of 15% of the income from such property; ……”

5.13 Likewise even Chapter XIIA, vide section 115C(f), clearly provides that the investment should be in specified asset of Indian company or Central Government for a person to claim exemption u/s. 54F. Similarly, section 54E to 54ED requires investment in Indian assets for claiming exemption.

5.14 In American Hotel and Lodging Association Educational Institute, 301 ITR 86 (SC), the Court confirmed that the words ‘in India’ could not be read into section 10(23C)(vi). Again, the Supreme Court in the case of Oxford University Press, 247 ITR 658 (SC), wherein the Court was required to examine whether for claiming exemption, it was necessary to carry out any activity in India, in the context, held that it was impermissible to read in the Act, the words ‘in India’ into section 10(22) of the Income-tax Act.

5.15 Article 26 of the Model Convention provide for non-discrimination. According to the said Article, persons who are non-residents of India, residing in the other contracting state, shall not be subjected to taxation provisions that are different or more burdensome than the provisions applicable to residents of India. It is clear that a non-resident Indian being resident of other state should not be discriminated while being taxed in India and should be conferred with the same benefits including of sections 54 and 54F as are available to a resident while being taxed in India under the Income-tax Act, 1961.

5.16 In cases where two views are possible, the benefit of doubt should be given to the assessee. sections 54 and 54F, being a beneficial provision, the Court has to adopt the interpretation that favours the assessee importantly where these provisions are incentive provisions.

DEDUCTIBILITY OF FEES PAID FOR CAPITAL EXPANSION TO BE USED FOR WORKING CAPITAL PURPOSES — AN ANALYSIS— Part II

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In the first part of this article we had discussed why fees paid to a syndicating agency for assisting capital expansion for the purpose of working capital needs would be allowed as a revenue expenditure in the hands of a companyassessee. In this part, we are discussing why the decisions of the Supreme Court in Punjab Industrial Development Corporation’s case 225 ITR 792 and Brooke Bond India’s case 225 ITR 798 are distinguishable where expenditure has been incurred for the purpose of working capital needs in connection with capital expansion.

Decisions in Punjab Industrial Development Corporation Ltd. and Brooke Bond India are distinguishable:

It is a trite law that a judgment has to be read in the context of a particular case. A judgment cannot be applied in a mechanical manner. A decision is a precedent on its own facts. In State of Orissa v. Md. Illiyas, AIR 2006 SC 258, the Supreme Court explained this principle in the following words:

“. . . . . Reliance on the decision without looking into the factual background of the case before it, is clearly impermissible. A decision is a precedent on its own facts. Each case presents its own features.”

In Goodyear India Ltd v. State of Haryana, 188 ITR 402, the Supreme Court held that a precedent is an authority only for what it actually decides and not what may remotely or even logically follow from it. The Supreme Court further held that a decision on a question which has not been argued cannot be treated as a precedent.

In CIT v. Sun Engineering Works P. Ltd., 198 ITR 297, the Supreme Court held as under:

“It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. A decision of this Court takes its colour from the questions involved in the case in which it is rendered and while applying the decision to a latter case, the Courts must carefully try to ascertain the true principle laid down by the decision of this Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this Court, to support their reasonings. In H.H. Maharajadhiraja Madhav Rao Jiwaji Rao Scindia Bahadur v. Union of India, (1971) 3 SCR 9, this Court cautioned:

“It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment.”

In Bharat Petroleum Corporation Ltd. v. N. R. Vairamani, 8 SCC 579, the Supreme Court held that “Courts should not place reliance on decisions, without discussing as to how the factual situation fits in with the fact situation of the decision on which reliance is placed. Observations of Courts are neither to be read as Elucid’s theorems nor as provisions of a statute and that too taken out of their context. These observations must be read in the context in which they appear to have been stated. Judgments of Courts are not be construed as statutes.” The Supreme Court quoted the following observations of Lord Morris in Herrington v. British Railways Board, 2 WLR 537 with approval:

“There is always peril in treating the words of a speech or a judgment as though they were words in a legislative enactment, and it is to be remembered that judicial utterances made in the setting of the facts a particular case.

11. Circumstantial flexibility, one additional or different fact may make a world of difference between conclusions of two cases. Disposal of cases by blindly placing reliance on a decision is not proper.

12. The following words of Lord Denning in the matter of applying precedents have become locus classicus:

“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 Cardozo) by matching the colour of one case against the colour of another. To decide therefore, on which side of the line a case falls, the broad resemblance to another case is not at all decisive.” . . . . .

Precedent should be followed only so far as it marks the path of justice, but you must cut the dead wood and trim off the side branches, else you will find yourself lost in thickets and branches. My plea is to keep the path to justice clear of obstructions which could impede it.”

The Full Bench of the Delhi Court recently in L.D. Bhatia Hingwala (P.) Ltd v. ACIT, 330 ITR 243 after quoting the above decisions of the Supreme Court held as under:

“From the aforesaid authorities, it is luculent that a judgment has to be read in the context, and discerning of factual background is necessary to understand the statement of principles laid down therein. It is obligatory to ascertain the true principle laid down in the decision and it is inappropriate to expand the principle to include what has not been stated therein.”

In Punjab Industrial Development Corporation Ltd. case and Brooke Bond India’s case, the question before the Supreme Court was whether filling fees paid to the Registrar of Companies for enhancement of capital constituted revenue expenditure? The Supreme Court was not concerned with a case where the object of capital expansion was to have working funds for carrying on business activities. In the former case, after quoting various contrary decisions of the High Courts, the Supreme Court held as under:

“We do not consider it necessary to examine all the decisions in extenso because we are of the opinion that the fee paid to the Registrar for expansion of the capital base of the company was directly related to the capital expenditure incurred by the company and although incidentally that would certainly help in the business of the company and may also help in profit-making, it still retains the character of a capital expenditure since the expenditure was directly related to the expansion of the capital base of the company. We are, therefore, of the opinion that the view taken by the different High Courts in favour of the Revenue in this behalf is the preferable view as compared to the view based on the decision of the Madras High Court in Kisenchand Chellaram (India) (P.) Ltd.’s case (supra). We, therefore, answer the question raised for our determination in the affirmative, i.e., in favour of the Revenue and against the assessee.”

In the latter case, viz., Brooke Bond India’s case, the Supreme Court placed reliance on its decision in Punjab Industrial Development Corporation Ltd. case to reiterate that fees paid to the Registrar of Companies for enhancement of capital constitutes capital expenditure. In this case the counsel raised an argument that the case of the assessee is not covered by the decision in Punjab Industrial Development Corporation Ltd. case as the object of capital expansion was to have more working funds for the assessee to carry on its business and to earn more profits. The Supreme Court while dealing with the said argument held that it is unable to accept the said argument for the reason that the statement of case sent by the Tribunal does not indicate a factual finding in that connection. The relevant portion of the decision is as under:

“Dr. Pal has, however, submitted that this decision does not cover a case, like the present case, where the object of enhancement of the capital was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. In this connection, Dr. Pal has invited our attention to the submissions that were urged by learned counsel for the assessee before the Appellate Assistant Commissioner as well as before the Tribunal. It is no doubt true that before the Appellate Assistant Commissioner as well as before the Tribunal it was submitted on behalf of the assessee that the increase in the capital was to meet the need for working funds for the assessee-company.

But the statement of case sent by the Tribunal does not indicate, that a finding was recorded to the effect that the expansion of the capital was undertaken by the assessee in order to meet the need for more working funds for the assessee. We, therefore, cannot proceed on the basis that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for working funds for the assessee to carry on its business. In any event, the above-quoted observations of this Court in Punjab State Industrial Development Corpn. Ltd.’s case (supra) clearly indicate that though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making, the expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company.” (emphasis supplied)

The decision of the Supreme Court in Brooke Bond India’s case (wherein principle laid down in Punjab Industrial Development Corporation Ltd. case has been reiterated), has to be seen in the light of the context and questions involved. It is a settled proposition that a decision takes colour from the questions involved in the case in which it is rendered. [Refer among others Prakash Amichand Shah v. State of Gujarat, AIR 1986 SC 468 (SC), Union of India v. Dhanwanti Devi, (1996) 6 SCC 44] The question before the Supreme Court was whether fees paid to the Registrar of Companies in relation to expansion of capital base is in the nature of revenue expenditure? The Supreme Court was called upon to render its verdict without an occasion to consider the aim or object for which the expenditure had to be incurred. In fact, the Supreme Court was concerned with the fees paid to the Registrar of Companies for increasing the authorised capital as a prelude to infusion of funds. There was no actual receipt of funds during the year. The expenditure towards the increased ability to raise capital was in these circumstances held to be capital. The Supreme Court had no occasion to examine the ‘two stages’ of deployment of funds. In fact the Supreme Court was concerned with a stage anterior to both the stages as funds had not yet been raised/received; such a potential only had been created. The decision of the Supreme Court therefore has to be seen in that context and cannot be extended beyond.

One may note that the Supreme Court in these decisions had not referred to its earlier decisions wherein principles with respect to characterisation of an expenditure into revenue or capital have been outlined. Some of the decisions are of larger Bench viz., Assam Bengal Cement’s case 27 ITR 34 etc. In such circumstances, it is the principles laid down by the larger Bench of Supreme Court which have to be kept in mind while characterising the nature of any expenditure into revenue or capital. The ratio of the decisions of the Supreme Court in Punjab Industrial Corporation Ltd.’s case and Brooke Bond India’s case should therefore be limited to facts similar as in these two cases.

In Lakshmi Auto Ltd. v. DCIT, 101 ITD 209, the Chennai Tribunal had an occasion to explain the scope of the decision in Brooke Bond India’s case; especially the observations made by the Supreme Court in the context of the argument made by Dr. Pal. In the case before the Chennai Tribunal, the assessee claimed deduction u/s. 37(1) towards expenditure on issuance of right shares. The Assessing Officer processed the return u/s. 143(1)(a). The assessee’s claim was disallowed on the grounds that the said expenditure was capital in nature. On appeal to the Commissioner (Appeals), the assessee raised a specific plea that expenses incurred on rights issue was for raising working capital. The Commissioner (Appeals) held that the decision of the Supreme Court in Brooke Bond (India) Ltd. v. CIT (supra) squarely applied to the case of the assessee and, therefore, the prima facie adjustment was held to be valid.

On further appeal to the Tribunal, the Judicial Member held that the Supreme Court in Brooke Bond India Ltd.’s case (supra) had not decided the issue as regards the expenditure incurred on increase of capital to meet the need for more working funds. The Judicial Member further held that the Assessing Officer was not correct in making prima facie adjustment on the grounds that the expenditure was capital in nature as no facts were available on record as to whether the assessee required the funds to increase capital to meet the need of work-ing capital or not. Not agreeing with the conclusions and findings of the Judicial Member, the Accountant Member held that the Assessing Officer was within his jurisdiction to make adjustment as no debate was involved after pronouncement of the decision in case of Brooke Bond (India) Ltd. (supra). The third Member on reference concurred with the views of the Judicial Member. The relevant observations of the third Member are as under:

“9. Having heard both the parties on the point and after perusing the various precedents relied upon, I find that the issue in question is a debatable issue. It is not directly covered by the decision of the Apex Court rendered in the case of Brooke Bond (India) Ltd. v. CIT, (1997) 225 ITR 798.    In this case the Supreme Court has held that expenditure incurred by a company in connection with issue of shares, with a view to increase its share capital, is directly related to the expansion of the capital base of the company, and is capital expenditure, even though it may incidentally help in the business of the company and in the profit-making. It was contended before the Supreme Court that where the enhancement was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. On this the Supreme Court has held that the statement of case sent by the Tribunal did not record the finding to the effect that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for more working funds for the assessee to carry on its business.

From this it can be concluded that if the expansion of capital is in order to meet the need for more working funds, in that eventuality the expenditure could partake the nature of revenue expenditure. De hors examination in this regard, it is not possible to apply the ratio.

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 as said by Cordozo by matching the colour of one case against the colour of another. I am reminded of Heraclitus who said “you never go down the same river twice”. What the great philosopher said about time and flux can relate to law as well. It is trite that a ruling of superior Court is binding law. It is not of scriptural sanctity, but is of ratiowise luminosity within the edifice of facts where the judicial lamp plays the legal flame. Beyond those walls and de hors the milieu we cannot impart eternal vernal value to the decision, exalting the doctrine of precedents into a prison house of bigotry, regardless of varying circumstances and myriad developments. Realism dictates that a judgment has to be read subject to the facts directly presented for consideration.

I have considered the entire conspectus of the case. In my opinion, the decision of the Apex Court in the case of Brooke Bond (India) Ltd. (supra) can be applied only after examining the object of the capital enhancement. This decision is not applicable if enhancement of the capital was made for gearing up funds for working capital. The object of gearing up of the capital was not looked into. Total amount was disallowed without examining the details. Even applicability of section 35D was not considered. In my opinion, this is not correct. I have gone through the reasoning adduced by the ld. Judicial Member. In my opinion he took a correct view in the matter. I concur with his decision on this issue.” (emphasis supplied)

In view of all the above, one may argue that the expenditure incurred in connection with issuance of shares for augmenting working capital needs should be allowed as deduction u/s. 37(1) of the Act. The decisions of the Supreme Court in Punjab Industrial Corporation case and Brooke Bond India case (supra) would not be applicable to cases where the object of enhancement of the capital expansion is to have more working funds. As a result, fees paid to XY bank by ABCL in the present case should be allowed as revenue expenditure u/s. 37(1) of the Act.

Partner’s interest — On capital:

Interest paid on partner’s capital by a partnership firm is allowed as a business deduction subject to the limit specified u/s. 40(b) of the Act. Under the Act, a partnership firm is regarded as a taxable entity distinct and separate from partners constituting it. Interest paid is deducted while computing the total income of the firm. Such deduction is admissible, irrespective of whether the capital is used for acquiring an asset or for working capital purposes. The admissibility of interest on partner’s capital account is in one sense a measure of avoiding double taxation on the same income. It is also an acknowledgement of separate existence of the firm and the partners.

A company is also regarded as a separate and distinct person from its shareholders. A company and a partnership firm thus stand on the same pedestal on this count. If in the eyes of Legislature expenditure connected with capital of a firm (viz., interest on capital introduced by a partner into a partnership firm) is allowable as a business deduction, it would be unreasonable to disallow expenditure incurred by a company in connection with share capital of a company. This is especially in view of the fact that there are no specific provisions in the Act restricting the admissibility of such an expenditure; the disallowance only being sustained on the premise of it being a capital expenditure u/s. 37.

What could be/is ‘working capital/funds’:

In Advance Law Lexicon 3rd edition 2005, the term ‘working capital’ is defined as ‘the funds available for conducting day-to-day operations of an enterprise; the money in circulation, acquired through cash balances, daily cash sales or short-term borrowings and used to run day-to-day affairs of a business organisation; capital available for day-to-day running of a company, used to pay expenses such as salaries, purchases, etc.’. The word web defines it as assets available for use in the production of further assets. In CIT v. IBM World Trade Corporation, 161 ITR 673, the Bombay High Court held that working capital is that which is utilised in a business and is another expression for circulating capital. In CIT v. Modern Theatres Ltd., 50 ITR 548, the Madras High Court held that circulating capital is a capital which is turned over and in the process of being turned over yields profit or loss. The Kerala High Court in Kerala Small Industries Development Corporation Ltd. v. CIT, 270 ITR 452 held that ‘Circulating capital’ means capital employed in the trading operations of the business and the dealings with it comprise trading receipts and trading disbursement. The term ‘working capital’ thus implies funds which an organisation must have to finance its day-to-day business operations. It is that part of the total capital which is employed in the trading/current assets.

What could be a trading/current asset for a particular business may be a fixed/capital asset for another business. There are no fixed rules with regard to characterisation of assets into current asset and fixed asset. One has to determine under what circumstances the asset has been acquired? What is the purpose for which the assets are acquired? If the asset is related to day-to-day business operations, then it would be regarded as current asset. It would be part of the circulating capital. Expenses incurred in connection with such acquisitions are to be allowed as business deduction. In this connection one may refer to the decision of the Supreme Court in Bombay Steam Navigation Co. v. CIT (supra). In the said decision, the Supreme Court held that if transaction of acquisition of the asset is closely related to carrying on of the assessee’s business, the expenditure incurred in connection therewith is to be regarded as revenue expenditure. The Supreme Court in CIT v. Bombay Dyeing and Mfg. Co. Ltd., 219 ITR 521 applying the ratio of Bombay Steam Navigation Co. v. CIT (supra) held that ex-penses incurred in connection with amalgamation of companies could be characterised as revenue expenditure if amalgamation is essential for smooth and efficient conduct of business.

The expense under discussion (viz., fees paid to XY bank) is incurred in connection with raising of funds for working capital purposes and for securing distribution rights, licences and brands in European, African and Asia-pacific countries. Securing distribution rights, licences and brands are essential for running business in such countries. ABCL acquires these intangibles for smooth and efficient conduct of business in such countries. It is on such rationale [and following rationale of the Supreme Court’s decision in Bombay Dyeing and Mfg Co.’s case (supra)] that associated expenses may be argued to be revenue in nature. Otherwise, it would be argued that licences, brands, etc. are intangible assets (see the definition of ‘block of assets’) necessitating the branding of associated expense as capital in nature.

Recovery of tax: Certificate proceedings: Section 222: Assessee’s leasehold property (DDA lessor) auctioned by TRO for recovery of tax: DDA demanded 50% unearned increase for mutation: Not a condition of auction notice: Amount payable by Department and not by the purchaser.

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[CIT v. Monoflex India (P.) Ltd., 12 Taxman.com 499 (Del.)]

The assessee’s leasehold property was put to auction by the TRO for realisation of income-tax dues. The DDA was the lessor. The purchasers called upon the DDA to mutate the property and called upon the TRO to get the sale certificate registered. The DDA demanded 50% unearned increase for mutation of the property in favour of the purchasers. Disputes arose as to the liability to pay unearned increase and whether the same was payable by the purchasers or by the Income-tax Department or by the original sub-lessee, i.e., the defaulter assessee. As the disputes could not be resolved, the purchasers filed writ petition which was allowed by the Single Judge of the Delhi High Court by issuing a direction that the Department would deposit unearned increase with the DDA.

On appeal by the Revenue the Division Bench of the Delhi High Court held as under:

“(i) The deed of the sub-lease clearly stipulates that 50% unearned increase is payable on the transfer of the leasehold rights in the property and the decision of the lessor in respect of market value shall be final and binding. The second proviso gives pre-emptive right to the lessor to purchase the property after deducting 50% unearned increase. Unearned increase is also payable in case of involuntary sale or transfer, whether it is by or through an executing or insolvency Court.

(ii) The terms of the lease are binding upon the lessor and the lessee. Under section 108(j) of the Transfer of Property Act, 1882 a lessee is entitled to transfer leasehold right, which he enjoys, to a third party, subject to a contract to the contrary. However, the lessee continues to be liable for the terms and conditions of the lease.

(iii) Rule 4 of the Second Schedule to the Act permits and allow the TRO to recover the arrears of tax by attachment and sale of defaulter’s immovable property. Thus, what can be sold and attached is a defaulter’s immovable property, i.e., the interest of the defaulter in the immovable property and not interest of a third person in the immovable property. Obviously, DDA’s interest could not have been sold or transferred for recovery of the defaulter’s dues. The right of the defaulter in the immovable property could be sold and transferred.

(iv) What the Act permits and allows is that the TRO can sell the right, title and interest of the defaulter assessee and nothing more. If the said right, title and interest is hedged with the conditions or fetters, the sale will be made subject to the said conditions/fetters. The rights of the lessor do not get affected. Thus, unearned increase is payable. (v) The second question is who is liable to pay the unearned increase. The plea of the Department is that 50% unearned increase is payable by the original sub-lessee and not by the Department or the TRO.

(vi) The Single Judge has, in the impugned judgment, specifically referred to and has quoted the public notice by which sale was made. The terms and conditions of said notice did not stipulate that the bidder would have to pay 50% unearned increase or bear such burden. There was no such stipulation. The sub-lease deed or copy thereof was with the Department and it had finalised the terms of sale. In case 50% unearned increase was to be paid separately by the purchaser, it should have been so indicated and mentioned. This would have resulted in a lower bid amount. It is not the case of the Department that sale consideration paid by the purchasers was less than the market price.

(vii) The terms of auction did not stipulate that the original sub-lessee shall pay 50% unearned increase. The TRO had agreed and promised to issue sale certificate to the auction purchaser, whose bid was accepted. It is only on payment of 50% unearned increase that an effective transfer can be made by the said sale certificate. In these circumstances, it is for the Department to make payment of unearned increase. Of course, in case its dues are still payable, it is open to them to take appropriate proceedings against the defaulter assessee in accordance with law.”

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(2011) TIOL 330 ITAT-Mum. DCIT v. Telco Dadajee Dhackjee Ltd. MA No. 509/Mum./2010 A.Y.: 1998-1999. Dated: 11-3-2011

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Sections 254(2), 254(4) and 255 — No miscellaneous application lies against the order of the Third Member since as per the scheme of Sections 254(1), 254(2) and 255 every case adjudicated by the Third Member should go back to the regular Bench for final decision.

Facts:
The appeal filed by the assessee was originally heard by the Division Bench. Upon there being a difference of opinion between the two Members who originally heard the appeal, the points of difference were referred to the Third Member u/s. 255(4) of the Act. The Third Member answered both the questions referred to him in favour of the assessee.

Against the order of the Third Member, the Revenue filed a miscellaneous application on the ground that there were mistakes apparent from the record which require rectification.

Held:
(1) The decision rendered by the Third Member is one which does not finally dispose of the appeal till the point or points are decided according to the opinion of the majority of the Members for which another order is to be passed by the Tribunal and it is this order which finally disposes of the appeal. An application u/s.254(2) would lie only when that order is passed and not before.

(2) When there is a difference between the Members while disposing of the appeal it cannot be said that the appeal has been finally disposed of. The point of difference has to be referred to the President of the Tribunal for nominating a Third Member. The Third Member hears the parties on the point of difference and renders his decision. His decision creates the majority view, but it is not a final order disposing of the appeal because he is not seized of the other points in the appeal, if any, on which there was no difference of opinion between the Members who heard the appeal originally. Even if there were no other points in the appeal, still his order is not one finally disposing of the appeal. S/s. (4) of section 255 requires that after the opinion of the Third Member, the point of difference ‘shall be decided’ according to the majority opinion and this clearly suggests that a final order has to be passed disposing of the appeal in its entirety which order alone would be an order passed by the Tribunal u/s.254(1).

(3) In the present case the Revenue has missed the distinction between a finding on a point of difference and the final order of the Tribunal u/s.254(1).

(4 ) The decision of the Third Member is not a final order disposing of the entire appeal as contemplated by section 254(1), it is difficult to appreciate how an application would lie u/s. 254(2) against his decision.

The miscellaneous application filed by the Revenue was held to be not maintainable.

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