BCAJ | Bombay Chartered Accountant Journal

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:

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:

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:

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

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:

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

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:

[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.

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

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

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.

[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.

[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

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

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.

[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.

[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.

[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.

[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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

(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.

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

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

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

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.

[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.

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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.

[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.

[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.

[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

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.

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REINVESTMENT IN OVERSEAS PREMISES

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.

shailesh.kwebmaker

DEDUCTIBILITY OF FEES PAID FOR CAPITAL EXPANSION TO BE USED FOR WORKING CAPITAL PURPOSES — AN ANALYSIS— Part II

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:

“. . . . . 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:

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.

shailesh.kwebmaker

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.

[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

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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TDS: Jurisdiction of Ao: Sections 201(1) and 201(1A) of Income-tax Act, 1961: Assessee assessed at New Delhi having PAN and TAN allotted by AO at New Delhi: Ao at mumbai has no jurisdiction to pass an order u/s.201 r.w.s. 201(1A), treating the assessee as assessee in default.

[Indian Newspaper Society v. ITO, 247 CTR 193 (Bom.)]

The assessee-company’s operational, administrative and management activities were controlled and directed from New Delhi. The assessee-company has consistently filed its returns of income at New Delhi and has been assessed by the Assessing Officer at New Delhi. The PAN and TAN issued u/s.139A and u/s.203A were allotted by the Assessing Officer at New Delhi. The assessee-company lodged TDS returns at New Delhi. The assessee was allotted certain land in Mumbai by MMRDA for which the assessee had paid lease premium. The Assessing Officer at Mumbai passed order u/s.201(1) r.w.s. 201(1A) dated 29-3-2011 holding the assessee to be an assessee in default.

On a writ petition challenging the order, the Bombay High Court quashed the order and held as under:

“(i) Evidently, on the facts and circumstances, it cannot be denied that jurisdiction would lie not with the Assessing Officer at Mumbai, but with the competent authority at New Delhi.

(ii) The petitioner’s contention that the jurisdiction lies with the authorities at New Delhi was brushed aside on the ground that the assessment was getting time barred on 31-3-2011 and it is not possible to transfer the case papers to the authorities at New Delhi. This could be no ground whatsoever valid in law to pass an order us.201/201(1A) when there is complete absence of jurisdiction on the part of the Assessing Officer at Mumbai.

(iii) The impugned order of 29-3-2011 is set aside only on the aforesaid ground. The order shall not preclude the competent authority having jurisdiction over the case from adopting such proceedings as are available in law.”

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(2011) 132 ITD 338 (Del.) Innovative Steels Pvt. Ltd vs. ITO A.Y. : 2006-07 Dated: 31-05-2011

Section 115WC – The word ‘construction’ used in the section will have to be given its ordinary meaning, and cannot be restricted to civil constitution.

Facts:
1. The assessee company was engaged in the business of manufacturing of specialised equipment of solid waste and a liquid waste treatment for industries.

2. The A.O was of the opinion that assessee is not engaged in the business of construction hence the benefit of 5% value of fringe benefit should not be given to the assessee. The CIT(A) upheld the order of the A.O.

3. Aggrieved the assessee filed an appeal to the Hon’ble ITAT.

Held:
1. The word used in section 115WC(2)(b) is ‘construction’ and not ‘civil construction’.

2. The word ‘construction’ is not defined in the Act. Hence, the ordinary meaning of the word construction shall be considered.

3. The dictionary meaning of the word construction and construct are:
Construction: A bridge under construction building, erection, elevation, assembly, framework, manufacture, fabrication. Construct: Construct a housing estate/construct a bridge, build, erect, put up, set up, raise, elevate, establish, assemble, manufacture, fabricate, make.

4. Referring to the above definitions, it was clear that it refers to not only construction of a building but it also includes activities of assessee i.e manufacturing of specialised equipment which included fixation of some equipment to land and certain degree of civil construction.

5. Thus it was held, the assessee was said to be engaged in the business of construction and therefore covered by section 115WC(2)(b).

Note: Though the above decision relates to fringe benefit tax, it brings out an important difference between ‘construction’ and ‘civil construction’.

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Circular No. 3/2012, dated 12-6-2012 giving gist of the official amendments to the Finance Bill, 2012.

Circular No. 3/2012, dated 12th June, 2012 giving gist of the official amendments to the Finance Bill, 2012 as reflected in the Finance Act, 2012 (Act No. 23 of 2012) which was enacted on 28th May, 2012

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Notification No. 20/2012, dated 12-6-2012 — DTAA between India and Nepal notified.

The Double Tax Avoidance Agreement signed between Nepal and India on 27th November, 2011 has been notified to be entered into force on 16th March, 2012. The treaty shall apply from 1st April, 2013 in India.

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Notification No. 21/2012 [F. No. 142/10/2012- SO(TPL], dated 13-6-2012.

The following specified payments can be made after 1st July, 2012 without deduction of tax at source u/s.194J of the Act: Payment by a person for acquisition of software from another resident person, where —

(i) the software is acquired in a subsequent transfer and the transferor has transferred the software without any modification,

(ii) tax has been deducted — (a) u/s.194J on payment for any previous transfer of such software; or (b) u/s.195 on payment for any previous transfer of such software from a non-resident, and

(iii) the transferee obtains a declaration from the transferor that the tax has been deducted either under sub-clause (a) or (b) of clause (ii) along with the Permanent Account Number of the transferor.

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CBDT has issued a clarification [F. No. 500/111/2009-FTD-1(Pt.)], dated 29-5-2012.

The CBDT has issued a clarification [F. No. 500/111/2009-FTD-1(Pt.)], dated 29-5-2012 stating that in case where assessment proceedings have been completed u/s.143(3) of the Act, before the first day of April, 2012, and no notice for reassessment has been issued prior to that date, then such cases shall not be reopened u/s.147/148 of the Act on account of the clarificatory amendments in section 2(14), section 2(47), section 9 and section 195 introduced by the Finance Act, 2012. However, assessment or any other order which stand validated due to the said clarificatory amendments in the Finance Act 2012 would of course be enforced. Copy of the letter is available on www.bcasonline. org.

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India has entered into a Tax Information Exchange Agreement (TIEA) with Bahrain for sharing of information.

India has entered into a Tax Information Exchange Agreement (TIEA) with Bahrain for sharing of information, including banking information between the tax authorities of the two countries. The Agreement was signed on 1st June, 2012.

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Notification No. 19/2012 (F. No. 506/69/81- FTD.1), dated 24-5-2012.

Amendments to Article 11 of India-Japan Double Tax Avoidance Agreement have been notified. The amendment is effective from 1st April, 2012.

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The Finance Bill, 2012.

The Finance Bill 2012, received the Presidential Assent on 28th May, 2012.

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Circular No. 2/2012 [F. No. 142-01-2012- SO(TPL)], dated 22-5-2012 regarding Explanatory notes to the provisions of the Finance Act, 2011.

Copy of the Circular available on www.bcasonline. org

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Annual Statement to be filed by liaison offices — Notification No. 5/2012, dated 6-2-2012.

The Finance Act, 2011 has directed all liaison offices to submit an annual statement to the Tax Department in the prescribed form and manner. The CBDT has inserted a new Rule 114DA vide Income-tax (2nd Amendment) Rules, 2012 wherein a Form 49C has been prescribed for filing such annual statement within 60 days from the end of the financial year. This Form needs to be verified by a CA or a person authorised by the non-resident to sign such form. It needs to be furnished electronically, digitally signed and the related rules shall be formed by the DGIT (Systems).

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Direct Tax Instruction No. 1/2012, dated 2-2- 2012 — F.No. 225/34/2011-ITA.II — Instructions for processing returns for A.Y. 2011-12 (reproduced).

The issue of processing of returns for the A.Y. 2011- 12 and giving credit for TDS has been considered by the Board. In order to clear the backlog of returns, the following decisions have been taken:

(i) In all returns (ITR-1 to ITR-6) where the difference between the TDS claim and matching TDS amount reported in AS-26 data does not exceed Rs.1 lac, the TDS claim may be accepted without verification.

(ii) Where there is zero TDS matching, TDS credit shall be allowed only after due verification. However, in case of returns of ITR-1 and ITR-2, credit may be allowed in full, even if there is zero matching, if the total TDS claimed is Rs.5000 or lower.

(iii) Where there are TDS claims with invalid TAN, TDS credit for such claims are not to be allowed.

(iv) In all other cases, TDS credit shall be allowed after due verification.

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Notification No. 18/2012 (F. No. 142/5/2012- TPL), dated 23-5-2012 — Income-tax (6th Amendment) Rules, 2012 — Insertion of Rule 10AB.

For the purpose of computation of arm’s length price, section 92C(1) of the Act provided for five methods and the sixth method was ‘such other method as may be prescribed by the Board’.

Rule 10AB is inserted to provide the ‘other method’. Rule 10AB shall come into force with effect from 1st April, 2012 and shall apply to A.Y. 2012-13 and subsequent years.

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Akber Abdul Ali v. ACIT ITAT ‘B’ Bench, Mumbai Before J. Sudhakar Reddy (AM) and V. Durga Rao (JM) ITA No. 5538/Mum./2008 A.Y.: 2005-06. Decided on: 28-12-2011 Counsel for assessee/revenue: N. R. Agarwal/P. K. B. Menon

Section 40(a)(ia) r.w. section 194A — Disallowance of interest for failure to deduct tax at source — Payment of disputed amount with interest as per the Court order — Interest paid without deduction of tax at source — Whether AO justified in disallowing the same — Held, No.

Facts:
The assessee was liable to pay the sum of Rs.68.54 lakh to one of its creditors. On account of his failure to pay, the suit for recovery was filed by the said creditor. The Court passed the decree settling the amount at Rs.55 lakh, which also included the sum of Rs.18.5 lakh towards interest.

In the return of income filed by the assessee, the amount paid by way of interest was claimed as deduction. Since the assessee had not deducted tax at source, the AO disallowed the claim u/s.40(a)(ia). The CIT(A) on appeal upheld the order of the AO.

Before the Tribunal, the assessee contended that the amount was paid in accordance with the decision of the High Court. The interest payable under the decree of the Court was a judgment debt, therefore, he was not obliged to deduct tax at source.

Held:
In view of the ratio laid down by the Bombay High Court in the case of Madhusudan Shrikrishna v. Emkay Exports, (188 Taxman 195), the Tribunal agreed with the assessee and held that the assessee had no obligation to deduct tax at source on the interest amount of Rs.18.5 lakh paid to the creditor.

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Direct Tax Instruction No. 4/2012, dated 25- 5-2012 — F. No. 225/34/2011-ITA.II — Instructions for processing of returns of A.Y. 2011-12 — Steps to clear backlog.

The Board has decided to withdraw Instruction No. 01/2012 issued on 2nd February, 2012 on the above subject with immediate effect. The following decisions have been taken in this regard:

(i) In all returns (ITR-1 to ITR-6), where the difference between the TDS claim and matching TDS amount reported in AS-26 data does not exceed Rs.5,000, the TDS claim may be accepted without verification.

(ii) Where there is zero TDS matching, TDS credit shall be allowed only after due verification.

(iii) Where there are TDS claims with invalid TAN, the TDS credit for such claims is not to be allowed.

(iv) In all other cases TDS credit shall be allowed after due verification.

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HV Transmissions Ltd. v. ITO ITAT ‘H’ Bench, Mumbai Before R. V. Easwar (President) and P. M. Jagtap (AM) ITA No. 2230/Mum./2010 A.Y.: 2001-02. Decided on : 7-10-2011 Counsel for assessee/revenue: Dinesh Vyas/ Goli Sriniwas Rao

Section 147 — Even an assessment completed u/s.143(1) cannot be reopened unless there is fresh material

Facts:
The assessee company, engaged in the business of manufacturing heavy gear boxes, filed its return of income, on 31-10-2001, declaring a loss of Rs. 73,57,95,273. This return of income was processed u/s.143(1) on 28-1-2003. The assessee filed a revised return of income on 27-3-2003 declaring a loss of Rs.74,22,78,281 after revising its claim u/s.35DDA in respect of employee separation cost. The AO, from the balance sheet filed by the assessee along with its return of income observed that the assessee had incurred expenses towards ERP software amounting to Rs.95,14,000 and although 20% of the said expenses were only debited in P&L account, the entire amount of Rs.95,14,000 was claimed as a deduction in computation of total income. He, accordingly, entertained a belief that to this extent income has escaped assessment and the assessment was reopened by issuing a notice u/s.148 on 3-3- 2006.

In an order passed u/s.143(3) r.w.s. 147, the AO assessed the loss to be Rs.50,17,47,153 after making addition inter alia on account of disallowance of expenses incurred on ERP software treating the same as of capital nature. He also disallowed claim for depreciation at 100% in respect of pollution control and energy saving devices at 100% valued at Rs.29.27 crore holding that the same had been earlier used by sister concern of the assessee-company.

Aggrieved the assessee preferred an appeal to the CIT(A) challenging the validity of the said assessment and also the various additions/disallowances made therein. The CIT(A) upheld the validity of reassessment proceedings and also the addition on account of disallowance of expenses incurred on ERP software treating the same as capital in nature. He, however, allowed relief in respect of depreciation at the rate of 100% on pollution control and energy saving devices.

Aggrieved, the assessee preferred an appeal to the Tribunal challenging inter alia the validity of the assessment on the ground that initiation of reassessment proceedings was bad in law.

Held:
The Tribunal on perusal of the reasons recorded by the AO noted that there was no new material coming to the possession of the AO on the basis of which the assessment completed u/s.143(1) was reopened. The Tribunal also noted that in the case of Telco Dadaji Dhackjee Ltd. v. DCIT, (ITA No. 4613/ Mum./2005, dated 12th May, 2010) (Mum.) (TM), the Third Member, had relying on the decision of the Supreme Court in the case of CIT v. Kelvinator of India, (256 ITR 1) (SC), held that while resorting to section 147 even in a case where only an intimation had been issued u/s.143(1)(a), it is essential that the AO should have before him tangible material justifying his reason that income has escaped assessment. The Tribunal held that the TM decision of the Tribunal in the case of Telco Dadaji Dhackjee Ltd. (supra) is squarely applicable to the present case. Following this decision, it held that the initiation of reassessment proceedings by the AO itself was bad in law and reassessment completed in pursuance thereof is liable to be quashed being invalid.

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DCIT v. Pioneer Marbles & Interiors Pvt. Ltd. ITAT ‘A’ Bench, Kolkata Before Mahavir Singh (JM) and C. D. Rao (AM) ITA No. 1326/Kol./2011 A.Y.: 2008-09. Decided on: 17-2-2012 Counsel for revenue/assessee: Amitava Roy/ J. N. Gupta

Section 271AAA — Immunity u/s.271AAA cannot be denied only because entire tax, along with interest, was not paid before filing of income-tax return or, for that purpose, before concluding the assessment proceedings.

Facts:
The assessee was subjected to search u/s.132 of the Act on 30-8-2007. During the course of the search, the assessee declared Rs.50,00,000 as undisclosed income. This sum was included in the return filed by the assessee after the search. The Assessing Officer (AO) initiated penalty proceedings while finalising the assessment u/s.143(3) on the ground that the assessee has not paid full taxes and interest on disclosure made u/s.132(4).

In the penalty proceedings, the assessee submitted that while filing the return of income due to an inadvertent error, the assessee had not computed interest u/s.234C, as a result self-assessment tax was underpaid by Rs.46,132 and this shortfall was paid within the time mentioned in notice of demand issued u/s.156 of the Act. This contention was rejected by the AO. He levied penalty u/s.271AAA.

Aggrieved the assessee preferred an appeal to the CIT(A) who deleted the penalty levied by the AO.

Aggrieved the Revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that under the scheme of section 271AAA there is a complete paradigm shift so far as penalty in respect of unaccounted income unearthed as a result of search operation carried out on or after 1st June, 2007 is concerned. Section 271AAA levies penalty @ 10% of undisclosed income. This levy, unlike section 271(1)(c), is without any reference to findings or presumptions of concealment of income or the findings or presumptions of furnishing of inaccurate particulars. S.s (2) grants immunity from levy of penalty u/ss (1), subject to satisfaction of conditions mentioned therein. While payment of taxes, along with interest, by the assessee is one of the conditions precedent for availing the immunity u/s.271AAA(2), there is no time limit set out for such payments by the assessee. Once a time limit for payment of tax and interest has not been set out by the statute, it cannot indeed be open to the AO to read such a time limit into the scheme of the section to infer one. The Tribunal held that there is no legally sustainable basis for the stand of the AO that in a situation in which due tax and interest has not been paid in full before filing of the relevant income-tax return, the assessee will not be eligible for immunity u/s.271AAA(2).

Section 271AAA does not require any subjective satisfaction of the AO to be arrived at during the assessment proceedings, and, therefore, the outer limit of payment before the conclusion of assessment proceedings will not come into play.

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Vijay Corporation v. ITO ITAT ‘F’ Bench, Mumbai Before N. V. Vasudevan (JM) and R. K. Panda (AM) ITA No. 1511/Mum./2010 A.Y.: 2005-06. Decided on : 20-1-2012 Counsel for assessee/revenue: Ashok J. Patil/ Shantam Bose

Section 143(3), section 292B — Assessment order without AO’s signature is void. The omission to sign the order of assessment cannot be explained by relying on the provisions of section 292B of the Act.

Facts:
The assessment of total income of the assessee-firm was completed u/s.143(3) of the Act by making various additions. While the notice of demand, computation form, etc. attached with the assessment order were signed, the assessment order was not signed by the AO.

The assessee filed an appeal before the CIT(A) challenging the additions and also raised a ground that the order of assessment is not valid in law since the AO did not sign the same. On this objection the CIT(A) called for the remand report from the AO. The AO did not dispute the fact that the assessment order was not signed. The CIT(A) observed that the notice of demand, computation form, etc. attached along with the assessment order were signed and carried proper stamp and seal of the AO. He held that the omission in signing the order cannot invalidate the order and the irregularity is curable in terms of the provisions of section 292B of the Act.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The case of the assessee is squarely covered by the decision of the Apex Court in the case of Smt. Kilasho Devi Burman (219 ITR 214) (SC), in favour of the assessee. In the absence of a signed order of assessment, the assessment is invalid. The provisions of section 292B cannot come to the rescue of the Revenue. Provisions of section 143(3) contemplate that the AO shall pass an order of assessment in writing. The requirement of signature of the AO is therefore a legal requirement. The omission to sign the order of assessment cannot be explained by relying on the provisions of section 292B of the Act. Tax computation is a ministerial act as observed by the SC in the case of Kalyankumar Ray v. CIT, (191 ITR 634) (SC) and can be done by the office of the AO if there are indications given in the order of assessment. But the notice of demand signed by the office of the AO without the existence of a duly signed order of assessment by the AO cannot be said to be a omission which was sought to be covered by the provisions of section 292B of the Act. If such a course is permitted to be followed, then that would amount to delegation of powers conferred on the AO by the Act. Delegation of powers of the AO u/s.143(3) of the Act is not the intent and purpose of the Act. An unsigned order of assessment cannot be said to be in substance and effect in conformity with or according to the intent and purpose of the Act. The Tribunal held the order of assessment to be invalid.

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TDS: Assessee in default: Section 195(2). A.Y. 1987-88: Assessee entered into technical assistance agreement with a Japanese company: The assessee was granted no objection certificate u/s.195(2) permitting it to make payments without deduction of tax at source: The assessee could not be treated as assessee in default for not deducting tax at source.

[CIT v. Swaraj Mazda Ltd., 245 CTR 521 (P&H)]

The assessee entered into a technical assistance agreement with a Japanese company. The assessee had filed an application u/s.195(2) and the requisite no objection certificate was granted permitting nondeduction of tax at source. However, the Assessing Officer held that the payments attracted provisions for deduction of tax at source and treated the assessee as assessee in default u/s.201(1) of the Act, for not deducting tax at source. The CIT(A) and the Tribunal allowed the assessee’s claim.

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

“(i) The Tribunal has recorded a clear finding that the certificate granted u/s.195(2) was never cancelled u/s.195(4), in absence of which the assessee was not required to deduct tax at source and could not be treated as assessee in default. On the said finding, no question of law has been claimed or referred.

(ii) If the assessee was not required to deduct tax at source and could not be declared as assessee in default, question of whether the payment was in nature of fee for technical services or in nature of reimbursement for expenses incurred or whether DTAA overrides the provisions of the Act, need not be gone into.”

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Penalty – Furnishing inaccurate particulars of income – Assessee inadvertently claiming a deduction though in tax audit report it was clearly stated that the amount debited to Profit & Loss Account was not allowable as deduction indicated that the assessee made a computation error in its return of income – Imposition of penalty was not justified.

[Pricewaterhouse Coopers Pvt. Ltd. v CIT & Another (2012) 348 ITR 306 (SC)]

The assessee, engaged in providing multidisciplinary management consultancy services having a worldwide reputation, filed its return of income for the assessment year 2000-01 on 30-11-2000 accompanied by tax audit report u/s. 44AB of the Act. In column 17(i) of the Form No.3CB, it was stated that the provision for payment of gratuity of Rs.23,70,306/- debited to the Profit & Loss Account was not allowable u/s 40A(7). Even though the statement indicated that the provision towards payment of gratuity was not allowable, the assessee inadvertently claimed a deduction thereon in its return of income. On the basis of return, the assessment order was passed u/s.143 (3) on 26-3-2003 allowing the aforesaid deduction.

A notice u/s. 148 of the Act was issued on 22-1-2004 reopening the assessment for the assessment year 2000-01 for disallowing the provision of gratuity of Rs.23,70,306/- u/s. 40A(7). The reason recorded for reopening the assessment was communicated to the assessee on 16-12-2004.

Soon after the assessee was communicated the reasons for reopening the assessment, it realised that a mistake had been committed and accordingly by a letter dated 20-1-2005, it informed the Assessing Officer that there was no willful suppression of facts by the assessee, but that a genuine mistake or omission had been committed. The assessee filed a revised return on the same day. The assessment order was passed on the same day and the assessee paid the taxes due, as well as the interest thereon.

The Assessing Officer however initiated penalty proceedings u/s. 271(1)(c), and after obtaining response from the assessee, levied penalty of Rs.23,37,689 being 300% on the tax sought to be evaded. The Commissioner of Income Tax (Appeals) upheld the penalty imposed on the assessee. The Tribunal upheld the imposition observing that though the mistake could be described as silly it could be not be expected from the assessee which was a high calibre and competent organisation. However, the Tribunal reduced the penalty to 100%. The High Court dismissed the appeal of the assessee.

The Supreme Court allowed the appeal, observing that the assessee was undoubtedly a reputed firm and had great expertise available with it. Notwithstanding this, it was possible that even the assessee could make a “silly” mistake and this was acknowledged both by the Tribunal as well as by the High Court. The fact that the tax audit report was filed along with the return and that it unequivocally stated that the provision for payment was not allowable u/s. 40A(7) of the Act, indicated that the assessee made a computation error in its return of income. Apart from the fact that the assessee did not notice the error, it was not noticed even by the Assessing Officer who framed the assessment order. In that sense, even the Assessing Officer had made a mistake in overlooking the contents of the tax audit report. According to the Supreme Court, the contents of the tax audit report suggested that there was no question of the assessee concealing its income. There was also no question of the assessee furnishing any inaccurate particulars. In the opinion of the Supreme Court through a bona fide and inadvertent error, the assessee while submitting its return, failed to add the provision for gratuity to its total income. This could only be described as a human error, which everyone is prone to make. The calibre and expertise of the assessee had little or nothing to do with the inadvertent error. That the assessee should have been careful cannot be doubted, but the absence of due care, in a case such as the present one, did not mean that the assessee was guilty of either furnishing inaccurate particulars or had attempted to conceal its income.

According to the Supreme Court, the assessee had committed an inadvertent and bona fide error and had not intended to or attempted to either conceal its income or furnish inaccurate particulars.

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Reassessment: Sections 147 and 148, 1961: In spite of repeated request reasons for reopening not furnished to assessee before completion of assessment: Reassessment not valid.

[CIT v. Videsh Sanchar Nigam Ltd., 340 ITR 66 (Bom.)]

In this case the assessment was reopened u/s.147. The assessee had requested for the reasons recorded, but the same were not furnished till the passing of the reassessment order. Following the judgment in the case of CIT v. Fomento Resorts and Hotels Ltd., (Bom.); ITA No. 71 of 2006, dated 27-11- 2006, the Tribunal held that though the reopening of the assessment is within three years from the end of the relevant assessment year, since the reasons recorded for reopening the assessment were not furnished to the assessee till the completion of the assessment, the reassessment order cannot be upheld.

The Bombay High Court dismissed the appeal filed by the Revenue and observed that the special leave petition filed by the Revenue against the decision of the Bombay High Court in the case of Fomento Resorts and Hotels Ltd. has been dismissed by the Apex Court.

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Principle of mutuality: Club: A.Y. 2003-04: Principle of mutuality applies to interest on fixed deposits, dividend, income from Government securities and profit on sale of investments.

[CIT v. Delhi Gymkhana Club Ltd., 339 ITR 525 (Del.)]

The assessee-club was granted exemption from paying income-tax on the income from its members on the basis of the principle of mutuality. On the same basis the assessee also claimed exemption in respect of income from fixed deposits, dividend, income from Government securities and profit on sale of investment. The Assessing Officer did not allow the claim. The Tribunal allowed the assessee’s claim and held that the principle of mutuality would apply even on these incomes.

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

“We are of the opinion that the aforesaid finding of the Tribunal is correct on facts and in law, which does not call for any interference.”

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Educational institution: Section 10(23C)(vi): A.Y. 2010-11: Petitioner-society was engaged in teaching all forms of music and dance with no profit motive: Run like a school or educational institution in a systematic manner: Not recognised by any university or Board: Is eligible for exemption u/s.10 (23C)(vi).

[Delhi Music Society v. DGIT, 17 Taxman.com 49 (Delhi)]

The petitioner-society was established in 1953 with the aim and object of teaching music and dancing in all its forms. It was allotted government land and was claiming tax exemption u/s.10(22) of the Income-tax Act, 1961. During the financial year 2008- 09, gross receipts of the petitioner exceeded Rs.1 crore and thus, it had to comply with the condition prescribed in section 10(23C)(vi), as to procurement of approval from the prescribed authority, to continue enjoying the tax exemption. Accordingly, the petitioners moved an application before the prescribed authority, i.e., DG (Exemption) for approval. The prescribed authority rejected the claim for exemption on ground that it did not satisfy criteria of being an ‘educational institution’. As per prescribed authority the petitioner was not awarding any degree or certificate and was merely imparting coaching/training in India as per norms of foreign colleges; that it was not an institution recognised by the UGC or by any board constituted by government for imparting formal education in the field of western music. The prescribed authority observed that the petitioner could not be distinguished from any coaching or training institute preparing the students for appearing in any examination for obtaining a formal degree by a formally recognised institution. The prescribed authority, therefore, held that the petitioner was not entitled to be characterised as an ‘educational institution’ within the meaning of section 10(23C)(vi).

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

“(i) The Supreme Court in the case of Sole Trustee, Loka Sikshana Trust v. CIT, (1975) 101 ITR 234 interpreted the word ‘education’ in section 2(15) and held that the word has been used to denote systematic instruction, schooling or training given to the young in preparation for the work of life and it also connotes the whole course of scholastic instruction which a person has received. It has further been observed that the word also connotes the process of training and development of knowledge, skill, mind and character of students by normal schooling.

(ii) It is seen that the petitioner is being run like any school or educational institution in a systematic manner with regular classes, vacations, attendance requirements, enforcement of discipline and so on. These provisions in the rules and regulations satisfy the condition laid down in the judgment of the Supreme Court in Sole Trustee, Loka Sikshana Trust (supra). It cannot be doubted that having regard to the manner in which the petitioner runs the music school, that there is imparting of systematic instruction, schooling or training given to the students so that they attain proficiency in the field of their choice — vocal or instrumental in western classical music.

(iii) The Calcutta High Court in CIT v. Doon Foundation, (1985) 154 ITR 208/22 Taxman 9 has observed that section 10(22) does not impose a condition that an educational institution to be eligible for exemption thereunder should be affiliated to any university or any board. As per the High Court, so long as the income is derived from an education institution existing solely for educational purposes and not for purposes of profit, such income is entitled to exemption u/s.10(22). This judgment takes care of the objection of the prescribed authority that the petitioner is not affiliated to, or recognised by any university or board in India and that it merely awards certificates or grades which are issued by the Trinity College and Royal School of Music, London. Since section 10(23C)(vi) also uses the same language as section 10(22), the same principle should govern the interpretation of that provision also.

(iv) The Supreme Court in S. Azeez Basha v. Union of India, AIR 1968 SC 662 has considered the nature of an educational institution. It was held by the Supreme Court that there is a good deal in common between educational institutions which are not universities and those which are universities in the sense that both teach students and both have teachers for the purpose. It was further observed by the Supreme Court that what distinguishes a university from any other educational institution is that a university grants degrees of its own, whereas other educational institutions cannot. These observations of the Supreme Court support the stand of the petitioner that the fact that it does not conduct its own examination or awards degrees of its own is not decisive of the question whether it is an educational institution or not. It also lends support to the petitioner’s stand before the prescribed authority that it is not a mere coaching centre preparing students for competitive examinations.

(v) For the above reasons, it is held that the petitioner meets the requirements of an educational institution within the meaning of section 10(23)(c)(vi).

(vi) Accordingly, the impugned order passed by the prescribed authority is quashed. The prescribed authority will now deal with the asses-see’s application for approval afresh in accordance with law. The writ petition is accordingly allowed.”

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Deduction u/s.10A/10B: FTZ: A.Y. 2007-08: Assessee received pure gold from a nonresident, converted same into jewellery and exported it to said non-resident: Activity amounted to ‘manufacture or production’ which qualified for deduction u/s.10A/10B.

[CIT v. Lovlesh Jain, 204 Taxman 134 (Del.); 16 Taxman. com 366 (Del.)]

The assessee had received pure gold supplied by ‘R’ Jewellery, Dubai, and the same after conversion into jewellery was ‘exported’ by the assessee to ‘R’ Jewellery, Dubai. In the meantime ‘R’, Jewellery Dubai continued to remain the legal owner of the gold and had not sold the gold to the assessee. The assessee was paid conversion charges or production/ manufacturing charges for converting the gold into jewellery. The Assessing Officer held that the assessee was not manufacturing ornaments/ jewellery and was not an exporter as he was paid making charges for the job work/services for making ornaments as per specification of third parties. Accordingly, the AO held that the assessee was not entitled to deduction u/s.10A. The Commissioner (Appeals) and the Tribunal allowed the assessee’s claim for deduction.

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

“(i) Section 10A/10B is applicable when an undertaking manufactures, or is engaged in production of articles or things. The term ‘production’ has a larger magnitude and is more expansive and liberal than the term ‘manufacture’.

(ii) In the present case, manufacture as well as production of goods, articles or things is covered u/s.10A/10B. The activity for converting gold bricks, biscuit or bars, into jewellery amounts to ‘production or manufacture’ of a new article and, therefore, qualifies for deduction u/s.10A/10B.

(iii) Case of the Revenue is that the assessee had not exported jewellery as the assessee was not owner of the imported gold or the exported jewellery and was paid making charges. Thus, the income earned does not qualify for deduction u/s.10A/10B.

(iv) The expressions/terms, ‘importer’ and ‘exporter’ are wide and not restricted to the owner of the goods at a particular point of time. Owner is treated as the importer/ exporter but a person who holds himself out as an importer or exporter is also an importer or exporter. The activity undertaken i.e., export/import is important and the person involved and associated with the said activity is important/relevant, mere ownership is not the sole criteria to determine whether a person is an importer or exporter. Further the expression ‘exported’ or ‘imported’ goods has reference to the nature of the goods as in the case of expressions ‘import’ or ‘export’ and not a person/owner.

(v) In the present case, the standard gold was imported into India and then converted into jewellery or ornaments and was sent out of India i.e., jewellery and ornaments were exported. When the import was made, the assessee was shown as a consignee and an importer and when the export was made the assessee was shown as a consignor i.e., the exporter. The assessee complied with the various formalities, when the standard gold was imported and then again when the jewellery/ornaments were exported. The assessee was in actual physical possession of the gold when it remained in India and would have been liable in case of loss, etc. The concept of and the term ‘ownership’, has various jurisprudential connotations. For all practical purposes, the assessee was in possession of gold and had a right, dominance and dominion over it. They were liable to pay Customs duty, etc. in case export was not made. Keeping in view the nature of transactions in question, it is not possible to hold that the assessee did not ‘export’ the jewellery/ornaments and that the transactions in question cannot be regarded as export for the purpose of section 10A/10B. Thus, when the assessee had exported the ornaments, it was exporting articles or things. The assessee were exporters or had exported articles/things as understood in common parlance.

(vi) Section 10A does not apply to export income earned by an assessee from merely trading the goods and postulates that the assessee must be an undertaking, which manufactures or produces articles or things, which are exported.

(vii) This condition in the present case is satisfied. Accordingly, the contention raised by the Revenue fails and has to be rejected. Appeals are accordingly dismissed.”

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CIT(A): Power to issue directions against third party: Sections 153C and 251(1)(c) of Income-tax Act, 1961: In the matter of lis between the assessee and the Revenue before it, it is not open to the CIT(A) to proceed to determine the rights or liabilities of a third party, who is not before it.

[CIT v. Krishi Utpadan Mandi Samiti, 245 CTR 591 (All.)]

The assessee, a charitable institution transferred development cess to Mandi Parishad and claimed deduction of the said amount. The Assessing Officer disallowed the claim for deduction. The CIT(A) allowed the assessee’s claim and held that the payment treated as expenditure or application by the assessee shall be treated as business receipt by Mandi Parishad and directed the Assessing Officer to make a reference to the Assessing Officer of Mandi Parishad to take remedial measures, if necessary, in the relevant assessment years to tax the relevant receipts in the hands of the Mandi Parishad. The Tribunal held as under:

“The learned CIT(A) while referring to the cases of Mandi Parishads had not afforded any opportunity to the said assessees and it is also noticed that the learned CIT(A) made these observations in spite of the fact that no such material relating to Mandi Parishads was available to him. In our opinion, these observations of the learned CIT(A) are unnecessary, because the facts of the case which is pending for adjudication are only to be considered. However, in the instant case, neither the material relating to other issues was available to the learned CIT(A) nor opportunity of being heard was given to the said assessee whose cases have been referred by the learned CIT(A). We, therefore, modify the order of the learned CIT(A) to this extent that the impugned observations made by him are unwarranted in the case of present assessees.”

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

“(i) It is not open to another quasi-judicial authority of limited jurisdiction, in the matter of lis between the assessee and Revenue before it to proceed to determine the rights or liabilities of the third party, who is not before it, in the assessment of the assessee.

(ii) The CIT(A) had no jurisdiction to direct the Assessing Officer to make a reference to the Assessing Officer of Mandi Parishad, to whom the assessee used to pay cess and claim it as deduction, to take a remedial action and, if necessary, to tax the receipts in the hands of Mandi Parishad.”

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Capital gain: Exemption: Sections 54 and 139(1), (4): A.Y. 2006-07: Condition precedent: Profit to be used for purchase of residential property or deposited in specified account before due date for furnishing return: Due date can be u/s.139(4).

[CIT v. Ms. Jagriti Aggarwal, 339 ITR 610 (P&H); 245 CTR 629 (P&H)]

The assessee had sold a house property on 13-1-2006 and had purchased another house property on 2-1- 2007. The Assessing Officer disallowed the assessee’s claim for deduction u/s.54 of the Income-tax Act, 1961 holding that the assessee failed to deposit the amount in the capital gains account scheme and also failed to purchase house property before the due date for filing the return of income. The Commissioner (Appeals) allowed the assessee’s claim and held that the assessee had complied with the provisions of section 54 as she had purchased the new residential property on 2-1-2007 i.e., before the due date u/s.139(4) of the Act. The Tribunal affirmed the order of the Commissioner (Appeals).

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

“(i) The sale of the asset had taken place on 13- 1-2006, falling in the previous year 2006-07, the return could be filed before the end of the relevant A.Y. 2007-08 i.e., 31-3-2007. Thus, s.s(4) of section 139 provides the extended period of limitation as an exception to s.s(1) of section 139 of the Act.

(ii) S.s (4) was in relation to the time allowed to an assessee u/ss.(1) to file the return. Therefore, such provision is not an independent provision, but relates to the time contemplated u/ss.(1) of section 139. Therefore, s.s(4) had to be read along with s.s(1).

(iii) Therefore, due date for furnishing return of income according to section 139(1) of the Act was subject to the extended period provided u/ss.(4) of section 139 of the Act.”

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Business expenditure: Capital or revenue: A.Y. 2003-04: Assessee stopped manufacturing and continued trading: Severance cost paid to employees is revenue expenditure.

[CIT v. KJS India P. Ltd., 340 ITR 380 (Del.)]

The assessee-company was manufacturing soft drinks. In the A.Y. 2003-04, the assessee-company stopped manufacturing soft drinks as it was found to be non-profitable. Many employees who were directly in the manufacturing activity were laid off and severance cost of these employees of Rs. 93,91,706 was paid. The assessee’s claim for deduction of this amount was disallowed by the Assessing Officer holding that it is capital in nature. The Tribunal found that apart from manufacturing soft drinks, the assessee was also trading in soft drinks. The Tribunal held that suspension of one of the activities did not amount to closure of business and allowed the assessee’s claim.

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

“Since the assessee had been doing other business activity also, namely, ‘trading’, it could not be said that the assessee had closed its business with the suspension of manufacturing soft drinks. The expenditure was deductible.”

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Reassessment — Assessee allowed to raise all contentions on merits in the reassessment proceedings

The assessment for the A.Y. 2000-01 was re-opened after the expiry of four years from the end of the relevant assessment year for the reason that though in the tax audit report an amount of Rs.107.70 lakh had been shown u/s.41 of the Act, only Rs.9.23 lakh on account of provision for warranties no longer required was written back under the head ‘Other sources of Income’ leaving a balance of Rs.98.46 lakh resulting in escapement of income. The other reason for reopening was that though dividend income of Rs.188.73 lakh was earned which was exempt u/s.10(33), no disallowance was made of the expenses related to purchase/sale of the investment.

In fact the balance amount of Rs.98.46 lakh was added back under different heads, but was not separately indicated and in its objection the assessee did not take this specific plea. It only stated that Rs.1,07,69,936 was added back/credited to the profit and loss account and one item of Rs.9,23,471 was reflected on the credit side of the profit and loss account. As regards, disallowance of expenses incurred for earning tax-free income it was contended that section 14A was introduced in the statute by the Finance Act, 2001, with retrospective effect from April 1, 1962 and the return was filed on 30-11-2000 and therefore it was not obligatory to make a disallowance and there was no failure on the part of the assessee in disclosing fully and truly the material facts in respect of the expenditure incurred for earning the tax-free income. The assessee also relied upon the proviso to section 14A which prohibited reopening of assessment for any assessment year beginning on or before 1-4-2001.

On a writ challenging the notice issued u/s.148 for want of jurisdiction, the Delhi High Court noted that in reply to the notice issued u/s.154 of the Act the assessee had given the full break-up and specific details with regard to credit/adjustment of Rs.98.46 lakh into profit and loss account and hence it found some merit in the contention of the assessee. However, it did not dwell further on this aspect since the notice was sustainable on the ground of section 14A. According to the High Court the proviso to section 14A only barred the reassessment/rectification and not the original assessment on the basis of retrospective amendment. Since the Assessing Officer had failed to apply section 14A when he passed the original assessment order, it had prima facie resulted in escapement of income. According to the High Court there was an omission and failure on the part of the assessee to point out the expenses incurred relatable to tax-free/exempt income which prima facie have been claimed as a deduction in the income and expenditure account and hence there was omission and failure on the part of the petition to disclose fully and truly the material facts.

On an appeal, the Supreme Court held that in its view the reopening of the assessment was fully justified on the facts and circumstances of the case. However, on merits of the case, it would be open to the assessee to raise all contention with regard to the amount of Rs.98.46 lakh being offered for tax as well as its contention on section 14A of the Act.

[Honda Siel Power Products Ltd. v. Dy. CIT and Others, (2012) 340 ITR 53 (SC)]

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Eligibility of Contractual workers for inclusion in Number of Workers

Issue for consideration

Section 80I(2)(iv) (effective up to 31-3-1991) of the One finds that similar language and expression has been used under the Act of 1922 and has been continued to be used by the Legislature even under the provisions of the 1961 Act while stipulating one of the conditions for the ‘tax holiday’. For ready reference, the language and expressions as used in different provisions over the period are tabulated below:

Comparison of incentive provisions where employment of workers is mandated.

Section

Language
and Expression used

15C(2)(iii) of the

Employs ten or more workers in manufacturing process carried on with
the aid

1922 Act

of power, or employs twenty or more workers in a manufacturing
process carried on

without the aid of power.

84(2)(iv)
of the

It
employs ten or more workers in a manufacturing process carried on with the

1961 Act

aid of power, or employs twenty or more workers in a manufacturing
process carried

on without the aid of power.

80J(4)(iv)
of the

In
a case where the industrial undertaking manufactures or produces articles,
the

1961 Act

undertaking employs ten or more workers in a manufacturing process
carried on with

the of power, or employs twenty or more workers in manufacturing
process carried

on without the aid of power.

80HH(2)(iv)
of the

It
employs ten or more workers in a manufacturing process carried on with the

1961 Act

aid of power, or employs twenty or more workers in a manufacturing
process carried

on without the aid of power.

80I(2)(iv)/

In
a case where the industrial undertaking manufactures or produces articles,
the

80IB(2)(iv) of the

undertaking employs ten or more workers in a manufacturing process
carried on

1961 Act

with the of power, or employs twenty or more workers in manufacturing
process

carried on without the aid of power.

10BA(2)(e) of the

It employs twenty or more workers during the previous year in the
process of

1961 Act

manufacture or production.

Income-tax Act, 1961, analogous to present section 80IB(2)(iv) of the Act, requires employment of certain number of workers by the new industrial undertaking as one of the conditions for the undertaking to qualify for the ‘tax holiday’. The industrial undertaking should employ ten or more workers in a manufacturing process where the manufacture or production of articles or things takes place with the aid of power or employ twenty or more workers in a manufacturing process if manufacture or production is undertaken without the aid of power.

It appears that one of the aims and objects of the Legislature under the scheme of ‘tax holidays’ over the period is to generate employment in the country.

The language and expression as used in the aforesaid sections have been subject of the judicial interpretation by Courts on different counts viz., the determination of period for which the aforesaid condition needs to be satisfied in a financial year, interpretation of the expression ‘employs’, meaning of the word ‘workers’, etc.

The controversy, sought to be discussed here, revolves around the issue whether the contractual workers or the workers supplied by a contractor for manufacture or production of articles or things could be treated as ‘workers’ employed by the assessee undertaking for the purpose of deduction u/s.80IB/u/s.80I of the Act.

The Bombay High Court recently had an occasion to deal with the aforesaid issue under consideration, wherein the High Court held that it was immaterial as to whether the workers were directly employed or employed by hiring them from a contractor. What was relevant was the employment of ten or more workers and not the mode and the manner in which the said workers were employed. In deciding the issue, the Bombay High Court dissented with the findings that were given on the subject by the Allahabad High Court.

Jyoti Plastic’s case The issue came up recently before the Bombay High Court in the case of CIT v. M/s. Jyoti Plastic Works Private Limited, [339ITR 491 (Bom)]

Jyoti Plastic Works Private Limited (‘Jyoti Plastic’) was engaged in the manufacture of plastic parts which were excisable and had claimed deduction u/s.80IB of the Act. In the reassessment proceedings, the AO disallowed the deduction u/s.80IB of the Act for the following two reasons:

(1) Jyoti Plastic was not a manufacturer, as the goods were manufactured at the factory premises of the job worker; and

(2) The total number of permanent employees employed in the factory were less than ten and thereby the condition as required u/s.80IB (2)(iv) was not satisfied.

The first Appellate Authority and the Mumbai Tribunal allowed the claim of Jyoti Plastic and the Revenue, being aggrieved, carried the issue to the Bombay High Court. As regard the first issue, the Court held in favour of Jyoti Plastic. With respect to the second issue, the Court, in the absence of the meaning of the word ‘worker’ under the Act, referred to the following external aids of construction to determine the meaning of the word ‘worker’:

(1) Black Law Dictionary — ‘worker’ means a person employed to do work for another;

(2) Section 2(L) of the Factories Act, 1948 — ‘worker’ is a person employed directly or by or through any agency (including a contractor) with or without the knowledge of the principal employer, whether for remuneration or not, in any manufacturing process, or in any other kind or work incidental to or connected with the manufacturing process.

The Court further relied on its earlier judgment in the case of CIT v. Sawyer’s Asia Limited (122 ITR 259) (Bom.), wherein the Court while considering the provisions of section 84(2)(iv) of the Act had observed that the word ‘workers’ should also include ‘casual workers’.

The Revenue relied on the following decisions of the Allahabad High Court to submit otherwise :

(1) R and P Exports v. CIT, (279 ITR 536); and

(2) Venus Auto Private Limited v. CIT, 321 ITR 504.

The Bombay High Court distinguished the decision of the Allahabad High Court in the R and P Exports’ case on the ground that the Tribunal in the case before the Bombay High Court had recorded a specific finding of fact that the agreement between Jyoti Plastic and the contractor was a ‘contract of service’ and not ‘contract for service’, whereby the contractual workers were under direct control and supervision of Jyoti Plastic as against the facts which were to the contrary in the case of R and P Exports (supra).

With regard to the decision of Venus Auto Private Limited (supra), the Court acknowledged that the facts in the said case were similar to the facts of the case before the Court; it dissented with the ratio of the decision in the said case and chose to rely on its own decision in the case of Sawyer’s Asia Limited (supra).

The Court finally concluded that since the agreement with the contractor was a ‘contract of service’ i.e., of employer-employee relationship and just because it differed with terms of contract of service with regular employees, that could not be a ground to deny the deduction u/s.80IB of the Act. In other words, so long as the agreement between the parties was a ‘contract of service’ and not ‘contract for service’, it would satisfy the condition prescribed u/s.80IB(2)(iv) of the Act.

Venus Auto’s case

The issue had come up earlier before the Allahabad High Court in the case of Venus Auto Private Limited v. CIT, (321 ITR 504).

Venus Auto Private Limited (‘Venus Auto’) was engaged in the manu-facturing activity of the scooter seat and claimed deduction u/s.80HH and u/s.80I of the Act. In the assessment and appellate proceedings up to the Tribunal stage, Venus Auto’s claim for deduction was rejected on the ground that the condition u/s.80I(2) (iv) of workers employed was not satisfied as the workers employed through the contractor were not to be treated as the workers employed in the industrial undertaking.

On appeal by Venus Auto before the High Court, the Allahabad High Court observed that the word ‘employment’ meant employment of workers by Venus Auto. There should be a relationship of employer and employee between the workers and Venus Auto. The Court observed that with regard to the contractual employees, there was no such employer-employee relationship between Venus Auto and the contractual employees; such relationship existed between the contractor and the contractual employees. The Court on facts and in law distinguished the reliance of Venus Auto on the following decisions:

(1)    Aditya V. Birla v. CBDT, (170 ITR 137) (SC);
(2)    CIT v. K. G. Yediyurappa, (152 ITR 152) (Kar.);
and
(3)    CIT v. V. B. Narania & Co., (252 ITR 884) (Guj.)

Further, the Court observed that vide word ‘it employs’, the Legislature sought to limit the relationship between employer and employee only i.e., between Venus Auto and the workers and therefore, it would not include the workers employed by the contractor.

Observations

‘Tax holidays’ have been provided from time to time vide various sections, viz., section 15C of the Act of 1922 section 84, section 80J, section 80HH, section 80I, section 80IA and section 80IB of the Act of 1961. The intention of the Legislature has been all along to encourage the setting up of new industrial undertakings with a view to expanding industries, employment opportunities and production of goods. The Courts have acknowledged the intention of the Legislature in introducing the said deduction/exemption/relief provisions of the Act and have held that such provisions should be interpreted liberally and reasonably and they should be so construed as to effectuate the object of the Legislature and not to defeat it.

The purpose of ‘tax holiday’ provisions has been apparently to provide tax incentives to stimulate the industry and manufacture of articles, resulting in more employment and economic gain for the country. The element of ‘number of workers to be employed’ being consistently present in all the ‘tax holiday’ provisions justifies the intention of the Legislature to promote and create employment opportunities in the country, thereby reducing unemployment.

In the case of CIT v. P. R. Alagappan, (173 ITR 522) (Mad.), the Court for the purpose of section 80J (4) of the Act explained that a ‘worker’ was a person who worked relying on the definition of ‘worker’ in the Factories Act.

The Court approved of the reference to the definition of ‘worker’ under the Factories Act and also observed that the expression ‘employs’ contemplated ‘contract of service’.

The Karnataka High Court in the case of CIT v. K. G. Yediruppa & Co., (152 ITR 152) in context of section 80HH(2)(iv) of the Act has held that in absence of definition of the word ‘worker’, the ordinary meaning of the word ‘worker’ meant casual, permanent or temporary workers.

Similarly, in the case of CIT v. Sawyer’s Asia Ltd. (supra), the Bombay High Court for the purpose of deduction u/s.84(2)(iv), observed as under:

“………The undertaking is not required to have ten or more regular workers and it may be said to have satisfied that requirement if the aggregate actual number of workers engaged in the manufacturing process, both regular and normal, is ten in number……….If it chooses to have less than 10 regular workers on its muster roll, it runs the risk of not satisfying the requirement on such days on which the necessary number of casual workers is not available.”

The Court also considered even persons employed on casual basis as eligible to be ‘workers’ for the purpose of satisfaction of condition u/s.84(2)(iv) of the Act.

Similarly, in the case of CIT v. V. B. Narania & Co., (252 ITR 884), the Gujarat High Court, in context of provisions of section 80HH(2)(iv) and section 80J(2) (iv), held by relying on the decision of Apex Court in the case of Harish Chandra Bajpai v. Triloki Singh, (AIR 1957 SC 444), that a contract of employment may be in respect of either piece work or time work. It held that the real test of deciding whether the contract was one of employment or not was to find whether the agreement was for the personal labour of the person engaged, and if that was so, the contract was one of employment and the rest of the facts were immaterial like, whether the work was time work or piece work, or whether the employee did the whole of the work himself, or whether he obtained the assistance of other persons also for the work.

In interpretation of the analogous provisions to sec-tion 80IB(2)(iv)/section 80I(2)(iv) the Courts have interpreted the word ‘worker’ to also include ‘casual and temporary workers’ and the expression ‘employ’ has been interpreted to mean a contract of service, where the requirement of personal labour of the person employed is of importance as against whether the employee is in normal employment of the undertaking or otherwise. The stress is upon the substance of the arrangement rather than its legal form.

Looking from the perspective of intention of the Legislature in creating employment and supported by the above-referred decisions, the better view appears to be that the casual and contractual workers employed directly or through the contractor are to be treated as the ‘workers’ for the purposes of the ‘tax holiday’. The decision in the case of Venus Auto (supra) may require reconsideration.

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Legitimacy of Reference to OECD Commentary for Interpretation of Income Tax Act and DTAs

Recently, in the case of Gracemac Corporation and Others v. ADIT, (47 DTR 65) (Del.) (Tri.), the appellant had relied on the Commentary of OECD Model Tax Convention (‘the OECD Commentary’) in order to differentiate between ‘copyright’ and ‘copyrighted article’ for interpretation of the term ‘royalty’ in respect of computer software. The Tribunal rejected the reliance on the OECD Commentary after referring to the decision of the Apex Court in the case of CIT v. P.V.A.L. Kulandagan Chettiar, (137 Taxman 460) for the following reasons:

The phrase ‘copyrighted article’ is not used under the Income-tax Act, 1961 (‘the Act’) or in the Double Taxation Avoidance Agreements (‘DTAA’) or even under the Copyright Act, 1957; and

As held by the Apex Court in the aforesaid decision, OECD Commentary is not a safe or acceptable guide or aid for interpretation of provisions of the Act or DTAAs between India and other countries.

The Tribunal concluded that royalty in respect of computer software has to be decided on the basis of provisions of the Act or relevant DTAA under consideration.

On the other hand, the Delhi High Court recently in the case of Asia Satellite Telecommunications Co. Ltd. v. DIT and vice versa, (332 ITR 340) upheld the reliance on OECD Commentary while interpreting the definition of ‘royalty’ in respect of leasing out transponder capacity on a satellite. The Court held that the technical terms used in DTAA are the same which appear in section 9(1)(vi) and for better understanding of the terms, OECD Commentary can always be relied upon. The Court relied on the decision of the Apex Court in the case of UOI and Anr v. Azadi Bachao Andolan & Anr., (263 ITR 706) and other catena of decisions1 to emphasise that the international accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed by the Courts in India when it comes to construing similar terms occurring in the Act.

On a combined reading of the findings of the aforesaid decisions, one may reconcile that for better understanding of the terms used in the Act or DTAAs, one may refer to the OECD Commentary provided and subject to:

The technical terms as sought for interpretation are ambiguous; and

Technical terms as used in the Act or DTAAs are identical or similar to terms employed in OECD Commentary.

The true significance however, lies in the practical implementation of the aforesaid principle while interpreting the provisions of the Act and DTAAs, which may be subject to criticisms or limitations similar to reliance on English decisions and other international decisions and/or statutes. In addition, India not as a ‘Member’ of OECD but as ‘Observer’ has expressed its position/views on the Articles of OECD Model Convention and its commentary thereon, which has been published in the OECD Model Tax Convention on Income and on Capital 2010 (version dated 22 July 2010). The position is presented qua the Articles under the Tax Convention as regard to its disagreement with the Text of the Article or disagreement with an interpretation given in the commentary in relation to the Article. It would be further necessary to highlight that while nations like Indonesia and China, (non-OECD economies like India) have expressly clarified that in the course of negotiations with other countries, they will not be bound by their stated positions in the OECD Commentary; India has not expressly clarified as such. Therefore, one may suggest that India may be bound by its stated positions in respect of the OECD Commentary in its course of negotiation and interpretations of DTAAs with other countries.

In the backdrop of the aforesaid discussion, it may then be necessary to consider the legitimacy in relying on OECD Commentary for interpretation of provisions of the Act and DTAAs entered into by India with other countries.

Reliance on OECD Commentary in interpreting provisions of the Act

Reference to English and other International decisions for interpretation and construction of the provisions of the Act have been subject of concern and criticism, time and again by the Courts2 since the provisions of the Act are not in pari materia with the provisions of the other statues, as well as the fundamental concepts and the principles on which the provisions are incorporated under the Act are different vis-à-vis the other statues. The provisions of the Act though may at times appear to be similar to the provisions of OECD Tax Convention, on deeper scrutiny may reveal differences not only in the wording but also in the meaning of a particular expression which has been acquired in the context of the development of law in those countries. Reliance on OECD Commentary in interpreting the provisions of the Act may therefore be subject to similar criticisms and concerns.

OECD is a 31 Member country organisation where the respective governments work together to address the economic, social and environmental challenges of globalisation. The OECD Model Tax Convention on Income and on Capital was designed and developed by the member countries as a means to settle on a uniform basis the most common problems that arise in the field of International juridical double taxation. India while negotiating its tax treaties maintains a balance and follows either OECD Model or UN Model on Tax Convention or a mix of the two. So, the provisions and terms as used in the Act may not confirm to the same language, interpretation and meanings as used in the DTAAs by India with other countries. Observations have been made by various Courts in catena of decisions3 with respect to various provisions of the Act as being wider/narrower in scope to the analogous provisions of DTAAs.

One may therefore say that the provisions of the Act should be construed on their own terms without drawing any analogy of the OECD Commentary, subject to principles as drawn above.

Reliance on OECD Commentary in interpreting provisions of DTAAs

Though, India is not a signatory to Vienna Convention on the Law of Treaties (‘VCLT’), but the judicial forums4 in India have acknowledged its importance in interpreting the provisions of DTAAs and have observed as under:

“The DTAAs are international agreements entered into between States. The conclusion and interpretation of such convention is governed by public international law, and particularly, by the Vienna Convention on the Law of Treaties of 23 May 1969. The rules of interpretation contained in the Vienna Convention, being customary international law also apply to the interpretation of tax treaties. . . . .”

The principles governing the interpretation of tax treaties can be broadly summed up as follows:

(i) A tax treaty is an agreement and not a taxing statute, even though it is an agreement about how taxes are to be imposed.

(ii) The principles adopted in the interpretation of statutory legislation are not applicable in interpretation of treaties.

(iii) A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose.

(iv) A tax treaty is required to be interpreted as a whole, which essentially implies that the provisions of the treaty are required to be construed in harmony with each other.

(v) The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not examined in precise grammatical sense or in literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty ut res magis valeat quam pereat i.e., in such a manner as to make it workable rather than redundant.

(vi) A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated insofar as particular items under consideration are concerned.

(vii) Words are to be understood with reference to the subject-matter, i.e., verba accopoenda sunt secundum subjectum materiam.

(viii) When a tax treaty does not define a term employed in it, and if the context of the treaty so requires, the terms can be given a meaning different from its meaning in the domestic law. The meaning of the undefined terms in a tax treaty should be determined by reference to all of the relevant information and the context.

The rules of interpretation in VCLT can be found in Article 31 to 33 of the Convention. Article 32 of the Convention provides recourse to supplementary means of interpretation, which in turn should confirm to the broad principles of Article 31 as summarised above. According to Article 32 of VCLT, the ‘supplementary means of interpretation’ include the preparatory work of the treaty and the circumstances of its conclusion. The word ‘include’ indicates that the rule is not exhaustive and there may be other supplementary means of interpretation. One such means is provided by the commentaries appended to the OECD Model Tax Convention. To the extent, the provisions of DTAAs are similar to OECD Model Convention, the OECD commentaries may become relevant to interpretation of DTAAs.

The Kolkata Tribunal in the case of Graphite India Ltd. v. DCIT, (86 ITD 384) while deciding whether the services rendered by an American Consultant to an Indian Company are covered under the Article 15, being in the nature of professional services or under Article 12, being in the nature of Fees for Technical services, observed as under as regard to interpretation of OECD and UN Model Commentaries:

“17. The aforesaid interpretation is clearly in harmony with the OECD and UN Model Conventions’ official commentaries, ………….. Andhra Pradesh High Court has, in the case CIT v. Visakhapatnam Port Trust, (1984) 38 CTR (AP) 1: (1983) 144 ITR 146 (AP), referred to OECD commentaries on the technical expressions and the clauses in the model conventions, and referred to, with approval, Lord Radcliffe’s observations in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480: (1960) 39 ITR 210, 219 (HL), which have described the language employed in these documents as the ‘international tax language’. In view of the observations of Andhra Pradesh High Court, in Visakhapatnam Port Trust’s case (supra), these model conventions and commentaries thereon constitute international tax language and the meanings assigned by such literature to various technical terms should be given due weightage. In our considered view, the views expressed by these bodies, which have made immense contribution towards development of standardisation of tax treaties between various countries, constitute ‘contemporanea expositio’ inasmuch as the meanings indicated by various expressions in tax treaties can be inferred as the meanings normally understood in, to use the words employed by Lord Radcliffe, ‘international tax language’ developed by bodies like OECD and UN.”

As discussed earlier, India by giving its stance on the text of the Article of OECD Model Tax Convention and commentaries thereon has helped in confirming an interpretation, in resolving ambiguities and obscurities and in displacing interpretation which appears absurd or unreasonable from India’s point of view. India’s position qua the text of the Articles and commentaries thereon as stated in the OECD Model Tax Convention — July 2010 version under the chapter ‘Non -OECD Economies’ positions on the OECD Model Tax Convention’ is tabulated below:

Relevant
Article

OECD
— India’s position

Text
of the Article

Commentary
of the Article

Article 1 – Persons
covered

No disagreement5

Disagreement6

Article 2 – Taxes
Covered

No disagreement

Article 3 – General
Definitions

Reservations7

No disagreement

Article 4 – Resident

Reservations

Disagreement

Article 5 – Permanent
Establishment

Reservations

Disagreement

Article 6 – Income
from Immovable Property

Reservations

No disagreement

Article 7 – Business
Profits (position after 22-7-2010)

Reservation and

Disagreement

disagreement

Article 7 – Business
Profits (position before 22-7-2010)

Reservations

Disagreement

Article 8 – Shipping,
Inland Waterways Transport and

Air Transport

Reservations

Article 9 –
Associated Enterprises

No disagreement

Article 10 –
Dividends

Reservations

Disagreement

Article 11 – Interest

Reservations

Disagreement and
Reservations

Article 12 – Royalties

Reservations

Disagreement and Reservations

Article 13 – Capital
Gains

Reservations

No disagreement

Article 14 –
Independent Personal Services

Article and
commentary thereon has been deleted by OECD

Article 15 – Income
from Employment

Reservations

Disagreement

Article 16 – Director’s
Fees

No disagreement

Article 17 – Artists
and Sportsmen

Reservations

No disagreement

Article 18 – Pensions

No disagreement

Article 19 –
Government Service

No disagreement

Disagreement

Article 20 – Students

Reservations

No disagreement

Article 21 – Other
Income

Reservations

No disagreement

Article 22 – Taxation
of Capital

Reservations

No disagreement

Article 23A –
Exemption Method

Reservations

No disagreement

Article 23B – Credit
Method

Article 24 – Non
Discrimination

Reservations

Article 25 – Mutual
Agreement Procedure

No disagreement

Disagreement

Article 26 – Exchange
of Information

Reservations

No disagreement

Article 27 –
Assistance in the Collection of Taxes

Article 28 – Members
of Diplomatic Missions and

There are no disagreements which India has
raised as regard to Text

Consular Posts

Article 29 – Territorial Extension

of the Article and
Commentary thereon.

Article 30 – Entry
into Force

Article 31 –
Termination

However, a question that arises is whether the position by India with respect to provisions of OECD Model Tax Convention is binding on taxpayers, tax authorities and more so, on the judicial forums of India.

To begin with, it is necessary to find the statutory force or lack of it, under which India has provided its position to the OECD Model Tax Convention, since its nature will determine the legitimacy of reference to OECD Commentary for interpreting the provisions of DTAAs.

After considering the OECD Commentary — ‘Non-OECD Economies’ Positions on the OECD Model Tax Convention’ Chapter, one understands that these are official statements made by Government of India as regard its interpretation of the Tax Convention. The clarifications or comments provided to OECD are not issued as a rule u/s.295, Circular or order u/s.119 of the provisions of the Income-tax Act, 1961. A pos-sible conclusion which can then be drawn is that even though such clarification may not be binding on taxpayers, they shall have high persuasive value considering contemporary official statements made by the Government of India on the subject of interpretation.

One also needs to consider whether these official statements can be considered as an aid for construction of the DTAAs entered into by India and which are based on OECD Model Tax Convention.

The aforesaid explanations received from the Indian Government could be considered as an aid for construction, which is in accordance with the Latin Maxim Contemporanea expositio. The Indian Courts8 have time and again held that Contemporaneous Exposition by the administrators entrusted with the task of executing the statute is extremely significant in interpretation of the statutory instruments. The rule of contemporanea expositio provides that “administrative construction (i.e., contemporaneous construction placed by administrative or executive officers) generally should be clearly wrong before it is over-turned; such a construction commonly referred to as practical construction, although non-controlling, is nevertheless entitled to considerable weight, it is highly persuasive.” [Crawford on Statutory Construction, 1940 Ed, as in K. P. Varghese (supra)]. However, generally, such expositions from the administrators are subject to the following limitations:

The plain and unambiguous language of the statutory instruments shall hold

good against such expositions; and

Such expositions even though binding on the Income-tax Department, are not binding on the Tribunal and Courts.

Therefore, based on the aforesaid discussion and doctrine of Contemporanea exposition, one may hold that provisions of DTAAs could be construed based on the explanation as received from the Indian Government on the OECD Model Tax Convention, provided the said exposition adheres to the broad principles of Article 31 of the VCLT, even though the applicability of VCLT to India may be a question in itself.

So, besides, decisions delivered by the various Indian judicial forums interpreting the provisions of DTAAs, one can now rely on India’s position on the Articles of the OECD Model Tax Convention and commentary thereon.

Lastly, the relevant extracts of the decision of the Apex Court in the case of UOI v. Azadi Bachao Andolan and Anr. (supra) as regard to interpretation of DTAAs are reproduced below:

“………… Interpretation of Treaties

96. The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation. While commenting on the interpretation of a treaty imported into a municipal law, Francis Bennion observes:

“With indirect enactment, instead of the substantive legislation taking the well-known form of an Act of Parliament, it has the form of a treaty. In other words the form and language found suitable for embodying an international Agreement become, at the stroke of a pen, also the form and language of a municipal legislative instrument. It is rather like saying that by Act of Parliament, a woman shall be a man. Inconveniences may ensue. One inconvenience is that the interpreter is likely to be required to cope with disorganised composition instead of precision drafting. The drafting of treaties is notoriously sloppy, usually for very good reason. To get Agreement, politic uncertainty is called for.

…… This echoes the optimistic dictum of Lord Widgery CJ that the words “are to be given their general meaning, general to lawyer and layman alike… the meaning of the diplomat rather than the lawyer.” [Francis Bennion, Statutory Interpretation, p. 461 (Butterworths) 1992 (2nd Ed.)]

An important principle which needs to be kept in mind in the interpretation of the provisions of an international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on this aspect of the matter, David R. Davis in Principles of International Double Taxation Relief, p. 4 (London Sweet & Maxwell, 1985), points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions”

On a more practical front, one finds that since the publication of India’s position on OECD Model Tax Convention, the Courts have not acknowledged much, the said publication as an aid for construction in interpreting the provisions of DTAAs. The taxpayers could however look forward to taking re-course to the India’s position on OECD Commentary as an aid for construction, for the favourable interpretations with respect to provisions of DTAA.

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Appeal to Supreme Court – Special Leave Petition – Delay by the Government bodies – Unless there is a reasonable and acceptable explanation for the delay and there is bona fide effort, the usual explanation regarding procedural delay should not be accepted.

[Office of the Chief Post Master General and Others v. Living Media India Ltd. and Anr. (2012) 348 ITR 7 (SC)]

Living Media India Ltd., a company incorporated under the Companies Act, 1956, publishes the magazines Reader’s Digest and India Today. These magazines are registered newspapers, vide Registration Nos. DL 11077/03-05 and DL 11021/01-05 respectively issued by the Department of Posts, Office of the Chief Post-Master General, Delhi Circle, New Delhi (in short “the Postal Department”) under the provisions of the Indian Post Office Act, 1898 (in short “the Act”), read with the Indian Post Office Rules, 1933 (in short “the Rules”), and the Post Office Guide and are entitled for transmission by post under concessional rate of postage.

On 14th October, 2005, the manager (circulation), Living Media India Ltd., submitted an application to the Postal Department seeking permission to post December, 2005, issue of Reader’s Digest magazine containing the advertisement of Toyota Motor Corporation in the form of booklet with calendar for the year 2006 at concessional rates in New Delhi. By letter dated 8th November, 2005, the Postal Department denied the grant of permission for mailing the said issue at concessional rates on the ground that the booklet containing advertisement with calendar is neither a supplement nor a part and parcel of the publication. On 17th November, 2005, the Director (Publishing), Living Media India once again submitted an application seeking the same permission which was also denied by the Postal Department by letter dated 21st November, 2005.

In the same way, the Postal Department also refused to grant concessional rate of postage to post the issue dated 26th December, 2005, of India Today magazine containing a booklet of Amway India Enterprises titled “Amway”, vide their letter dated 18th February, 2006, and 17th March, 2006, stating that the said magazine was also not entitled to avail of the benefit of concessional rate available to registered newspapers.

Living Media India Ltd., being aggrieved by the decision of the Postal Department filed a Writ Petitions before the High Court. The learned single judge of the High Court, by order dated 28th March, 2007, allowed both the petitions filed by Living Media India Ltd.

Being aggrieved, the Postal Department filed LPA’s before the High Court. The Division Bench of the High Court, vide common final judgment and order dated 11th September, 2009, while upholding the judgment of the learned single judge, dismissed both the appeals.

Challenging the said order, the Postal Department preferred appeals by way of special leave before the Supreme Court. There was a delay of 427 days in filing the above appeals.

The learned senior counsel for Living Media India Ltd., seriously objected to the conduct of the appellants in approaching the Supreme Court after the enormous and inordinate delay of 427 days in filing the above appeals.

The Supreme Court, after noting the various judgments cited by both the parties and the affidavits filed by the Postal Department dismissed the applications, holding that the Postal Department had itself mentioned and was aware of the date of the judgment of the Division Bench of the High Court as 11th September, 2009. Even according to the department, their counsel had applied for the certified copy of the said judgment only on 8th January, 2010, and the same was received by the department on the very same day. There was no explanation for not applying for certified copy of the impugned judgment on 11th September, 2009, or at least within a reasonable time. The fact remained that the certified copy was applied only on 8th January, 2010, i.e., after a period of nearly four months. In spite of affording another opportunity to file better affidavit by placing adequate material, neither the Department nor the person in-charge had filed any explanation for not applying the certified copy within the prescribed period. The other dates mentioned in the affidavit clearly showed that there was delay at every stage and there was no explanation to why such delay had occurred. The Supreme Court observed that, though it was stated by the Department that the delay was due to unavoidable circumstances and genuine difficulties, the fact remained that from day one, the Department or the person/persons concerned had not evinced diligence in prosecuting the matter to the court by taking appropriate steps. The person(s) concerned were well aware or conversant with the issues involved including the prescribed period of limitation for taking up the matter by way of filing a special leave petition in the court. The Postal Department cannot claim that they have separate period of limitation when the Department was possessed with competent persons familiar with court proceedings. According to the Supreme Court in the absence of plausible and acceptable explanation, the delay could not to be condoned mechanically merely because the Government or a wing of the Government was a party before it. The Supreme Court held that though it was conscious of the fact that in a matter of condonation of delay when there was no negligence or deliberate inaction or lack of bona fide, a liberal concession had to be adopted to advance substantial justice, but in the facts and circumstances, the Department could not be allowed to take advantage of various earlier decisions. The claim on account of impersonal machinery and inherited bureaucratic methodology of making several notes could not be accepted in view of the modern technologies being used and available. According to the Supreme Court, the law of limitation undoubtedly binds everybody including the Government.

In the opinion of the Supreme Court, unless all the Government bodies, their agent and instrumentalities have reasonable and acceptable explanation for the delay and there was bona fide effort, there is no need to accept the usual explanation that the file was kept pending for several months/ years due to considerable degree of procedural red-tape in the process. The Government departments are under a special obligation to ensure that they perform their duties with diligence and commitment. Condonation of delay is an exception and should not be used as an anticipated benefit for Government departments. The law shelters everyone under the same light and should not be swirled for the benefit of a few.

According to the Supreme Court, there was no proper explanation offered by the Department for the delay except mentioning of various dates; the Department had miserably failed to give any acceptable and cogent reasons sufficient to condone such a huge delay. The Supreme Court dismissed the appeals on the ground of delay.

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Business Expenditure – Where payment is for acquisition of know-how to be used in the business of the assessee, deduction is to be allowed u/s. 35AB and section 37 has no application.

[Drilcos (India) Pvt. Ltd. v. CIT (2012) 348 ITR 382 (SC)]

The assessee, a manufacturer of mining equipments, entered into an agreement with an American company on 7th June, 1990. The agreement with the American company was called “licence and technical assistance agreement” under which the American company was required to transfer technical know-how to the assessee for consideration of $ 25,000 to be paid in three instalments. The first instalment in convertible Indian currency amounting to Rs.17,49,889 was paid on 29th November, 1990. Subsequently, disputes arose between the contracting parties and the know-how was not transferred by the American company.

The short question which arose for determination before the Supreme Court was, whether the amount of Rs.17,49,889 could be claimed by the assessee as a deduction u/s. 37 of the Income-tax Act, 1961.

The claim of the assessee u/s. 37 of the Income Tax Act, 1961 was rejected by the Department. However, the Department allowed the expenditure to be amortised u/s. 35AB of the Act.

The contention of the assessee was that section 35AB of the Act was not applicable to this case. The Supreme Court found no merit in the said contention.

The Supreme Court observed that s/s. (1) of section 35AB of the Act clearly states that, where the assessee has paid in any previous year any lump sum consideration for acquiring any knowhow for use for the purpose of his business, then one-sixth of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year and the balance amount shall be deducted in equal instalments for each of the five immediately succeeding previous years. The Explanation to the said section says that the word “know-how” means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine. According to the Supreme Court if one carefully analyses section 35AB of the Act, it would be clear that prior to 1st April, 1986, there was some doubt as to whether such expenditure could fall u/s. 37 of the Act. To remove that doubt, section 35AB of the Act stood inserted. In s/s. (1) of section 35AB of the Act, there is a concept of amortisation of expenditure. The Supreme Court observed that in the present case, it was true that on account of certain disputes which arose between the parties, the balance amount was not paid by the assessee to the American company. However, the word “for” in section 35AB of the Act, which is a preposition in English grammar, has to be emphasised while interpreting section 35AB of the Act. Section 35AB of the Act says that the expenditure should have been incurred for the purposes of the business of the assessee. In the present case, the technical assistance agreement was entered into between the assessee and the American company for acquiring know-how which was, in turn, to be used in the business of the assessee. Once section 35AB of the Act comes into play, then section 37 of the Act has no application.

According to the Supreme Cour,t there was no error in the impugned judgment of the High Court. The Supreme Court dismissed the civil appeal filed by the assessee.

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Valuation of stock – In valuing the closing stock the element of excise duty is not to be included.

[CIT v. Dynavision Ltd. (2012) 348 ITR 380 (SC)]

The assessee, a private limited company, carried on the business of manufacture and sale of television sets. For the assessment year 1987-88, the Assessing Officer while completing the assessment u/s. 143(3) found that the assessee had not included in the closing stock the element of excise duty. Accordingly, he added a sum of Rs.16,39,000 to the income of the assessee on the ground of undervaluation of closing stock.

The question before the Supreme Court was whether the Department was right in alleging that the closing stock was undervalued to the extent of Rs.16,39,000/-.

The Supreme Court noted that, it was not in dispute that the assessee had been following consistently the method of valuation of closing stock which was “cost or market price, whichever is lower.” Moreover, the Assessing Officer had conceded before the Commissioner of Income Tax (Appeals) that he revalued the closing stock without making any adjustment to the opening stock. According to the Supreme Court though u/s. 3 of the Central Excise Act, 1944, the levy of excise duty in on the manufacture of the finished product, the same is quantified and collected on the value (i.e. selling price). The Supreme Court referred to the judgment in the case of Chainrup Sampatram v. CIT reported in [1953] 24 ITR 481 (SC) in which it has been held that, “valuation of unsold stock at the close of the accounting period was a necessary part of the process of determining the trading results of that period. It cannot be regarded as source of profits. That the true purpose of crediting the value of unsold stock is to balance the cost of the goods entered on the other side of the account at the time of the purchase, so that on canceling out the entries relating to the same stock from both sides of the account, would leave only the transactions in which actual sales in the course of the year has taken place and thereby showing the profit or loss actually realised on the year’s trading. The entry for stock which appears in the trading account is intended to cancel the charge for the goods bought which have remained unsold which should represent the cost of the good”.

The Supreme Court for the above reasons, held that, the addition of Rs.16,39,000 to the income of the assessee on the ground of undervaluation of the closing stock was wrong.

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Commencement of Activity – whether pre-requisite for registration u/s.12AA

Issue for Consideration

Section 12A r.w.s. 12AA of the Income-tax Act, 1961 provides the procedure for grant of registration of a trust or institution (“trust”). According to this procedure, the trust has to make an application for registration in Form No. 10A prescribed under Rule 17A of the Income-tax Rules, 1962 within one year from the date of creation of the trust or the establishment of the institution. Upon receipt of the application, the Commissioner (SIT) shall call for documents and information and conduct inquiries to satisfy himself about the genuineness of the trust or institution.

After he is satisfied about the charitable or religious nature of the objects and genuineness of the activities of the trust, he will pass an order granting registration. If he is not satisfied, he will pass an order refusing registration. The order granting or refusing registration has to be passed within six months from the end of the month in which the application for registration is received by the Commissioner.

Section 12AA, inserted by the Finance (No. 2) Act, 1996 with effect from assessment year 1997-98, reads as under:

“12AA Procedure for registration.

(1) The Commissioner, on receipt of an application for registration of a trust or institution made under clause (a) or clause (aa) of ss. (1) of section 12A, shall—

(a) call for such documents or information from the trust or institution as he thinks necessary in order to satisfy himself about institution and may also make such inquiries as he may deem necessary in this behalf; and

(b) after satisfying himself about the objects of the trust or institution and the genuineness of its activities, he—

(i) shall pass an order in writing registering the trust or institution;

(ii) shall, if he is not so satisfied, pass an order in writing refusing to register the trust or institution, and a copy of such order shall be sent to the applicant :

Provided that no order under sub-clause (ii) shall be passed unless the applicant has been given a reasonable opportunity of being heard……

(2) Every order granting or refusing registration under clause (b) of subsection (1) shall be passed before the expiry of six months from the end of the month in which the application was received under clause (a) or clause (aa) of sub-section (1) of section 12A.

(3) Where a trust or an institution has been granted registration under clause (b) of sub-section (1) or has obtained registration at any time under section 12A as it stood before its amendment by the Finance (No. 2) Act, 1996 (33 of 1996) and subsequently the Commissioner is satisfied that the activities of such trust or institution are not genuine or are not being carried out in accordance with the objects of the trust or institution, as the case may be, he shall pass an order in writing cancelling the registration of such trust or institution:

Provided that no order under this sub-section shall be passed unless such trust or institution has been given a reasonable opportunity of being heard.”

Section 12AA therefore, details the provisions for registration of a trust for which an application has been filed u/s 12A. A reading of sub-clauses (a) and (b) of Section 12AA(1) makes it clear that the CIT has to satisfy himself about the genuineness of the activities of the trust and also about the objects of the trust.

As regards the objects of the trust, these can be determined from a perusal of the Memorandum or the deed of the trust, which is filed along with the registration application. If the objects of the trust are not for any charitable or religious purpose, registration may be refused by the CIT.

On the other hand, in order to determine the genuineness of the activities of the trust or the institution, the CIT has powers to make inquiries, call for documents or information. In cases where application is made after the activity is commenced, the CIT would exercise such powers of inquiry.

Given the time limit prescribed for making application for registration of a trust, in many cases, the application is made before the commencement of any activity by the applicant-trust. A controversy has arisen as to whether the CIT can reject the registration application of a trust, which has not commenced any activity, on the ground of non-determination of genuineness of activities of the trust. While the Delhi, Karnataka and Allahabad High Courts have taken a view that registration u/s. 12AA of the Act cannot be rejected by the CIT on the ground that it had not yet commenced any activity, the Kerala High Court has held that until the activity is commenced by the applicant trust/institution, registration should not be granted by the CIT.

Grant of Registration to a trust u/s. 12AA of the Act is important, since it is one of the conditions for grant of exemption u/s. 11 and 12 for the income of a trust.

Self Employers Service Society’s Case

The issue first came up before the Kerala High Court in the case of Self Employers Service Society v CIT 247 ITR 18.

The society was registered as a charitable society under the Travancore Cochin Literary Scientific and Charitable Societies Registration Act, 1955. The members of the society were mainly merchants. Though it had a large number of charitable objects, it had not commenced any of them during the first year of its functioning. It was accepting recurring deposits from its members and fixed deposits from the public. Loans were being given to its members at 21 % interest. The Commissioner found that in spite of the reference to a large number of charitable objects in its bye-laws, the activity carried on by the society was confined to its members, numbering about 150. Since such activities could not be regarded as charitable in nature, the Commissioner refused registration u/s.12AA.

The High Court noted that though several charitable activities were included in the objects of the society, it had not been able to do any of such charitable activities during the first year of its functioning. The proposal to start a technical educational institution itself was taken after the order of the CIT, rejecting the registration. The Court observed, that in the present case, the charitable society had not done any charitable work during the relevant period, but the activity which was undertaken during the said period was only for the generation of income for its members. It also noted that there were no materials before the Commissioner to be satisfied of the genuineness of the activities of the trust or institution. The Court therefore held that the rejection of the application could not be termed as illegal or arbitrary.

Foundation of Opthalmic and Optometry Research Education Centre’s Case

The issue under consideration again recently arose before the Delhi High Court in the case of DIT vs. Foundation of Ophthalmic and Optometry Research Education Centre 210 Taxman 36.

In this case, the assessee, a society registered under the Society Registration Act on 30th May 2008 with charitable objects of Optometry and Ophthalmic Education applied for registration before the Director of Income-tax (Exemption) [‘DIT(E)’] and filed other documents as sought by DIT(E)’s office from time to time. The DIT(E) refused to grant registration to the assessee by relying on the decision of Kerala High Court in the case of Self Employers Service Society vs CIT (supra), on the ground that no charitable activity was undertaken by the newly established assessee society.

On appeal by the assessee, the Tribunal, following the decision of the Allahabad High Court in the case of Fifth Generation Education Society (185 ITR 634), held that non-commencement of charitable activity cannot be a ground for rejection of application of registration filed by the assessee u/s. 12AA of the Act and thereby upheld the contention of the assessee.

Aggrieved with the judgement of the Tribunal, the Revenue filed an appeal before the High Court reiterating its arguments as placed before the Tribunal. The assessee-applicant on the other hand, relied on the decision of the Karnataka High Court in the case of DIT(E) v. Meenakshi Amma Endowment Trust (2011) (50 DTR 243) , wherein the High Court while considering similar facts of the assessee applicant held that when no activities are undertaken by the newly established trust/institution, then in such a scenario, the objects of the trust have to been taken into consideration by the CIT for determination of question of registration.

The High Court, after hearing the arguments of both the parties, upheld the contention of the assessee. The Court distinguished the judgements of Self Employers Service Society (supra) and Aman Shiv Mandir Trust (Regd.) v. CIT (296 ITR 415)(P&H) relied on by the Revenue on the ground that reasons for refusal of registration in the aforesaid decisions were not that the Trusts were newly registered, but that the activities of the Trusts under consideration were not charitable.

The High Court, after referring to the provisions of section 12AA, further held that the provision did not prohibit or enjoin the CIT from registering a trust solely based on its objects, without any activity, in the case of a newly registered trust. It also observed that the statute did not prescribe a waiting period for a trust to qualify itself for registration. Based on the said observations and following the decision of the Karnataka High Court of Meenakshi Amma Endowment Trust (supra), the appeal of the Revenue was rejected.

The Karnataka High Court in the case of Meenakshi Amma Endowment Trust (supra ) had earlier interpreted the provisions of section 12A r.w.s. 12AA of the Act and opined in context of registration of a newly established trust without undertaking any activity, as under:

“….When the trust itself was formed in January 2008 with the money available with the trust, one cannot expect them to do activity of charity immediately…. In such a situation, the objects of the trust could be read from the trust deed itself. In the subsequent returns by the trust, if the Revenue comes across that factually trust has not conducted any charitable activities, it is always open to the authorities concerned to withdraw the registration already granted or cancel the said registration u/s. 12AA of the Act.

A trust can be formed today and within a week registration u/s. 12A could be sought as there is no prohibition under the Act seeking such registration…..… the objects of the trust for which it was formed will have to be examined to be satisfied about its genuineness and activities of the trust cannot be the criterion, since it is yet to commence its activities.”

In other words, the High Court held that where a trust has not commenced its activities, then the CIT is required to examine the objects of the trust in order to ascertain the genuineness of its activities.

The Allahabad High Court in the case of Fifth Generation Education Society (supra) also had opined on the issue. The Court, while considering the provisions of registration of trust/institution u/s. 12A of the Act relating to assessment years prior to Finance (No. 2) Act, 1996, held that at the time of considering the application for grant of registration u/s. 12A, the CIT was not required to examine the application of income or carrying on of any activity by the trust. The Court further held that the CIT may at this stage examine whether the application was made in accordance with the requirements of section 12A r.w. Rule 17A, Form 10A was properly filled, along with determination of whether the objects of the trust were charitable or not.

Observations

On perusal of the decisions as discussed above, one may find that the Delhi, Karnataka and Allahabad High Courts have rightly interpreted the procedural provisions of section 12AA of the Act and rejected the contention of the Revenue to read in the condition of actual conduct of charitable activities for grant of registration of trusts, who have not commenced their charitable activities. Instead, in such situations, where trusts are yet to commence their activities, the Courts have sought to ascertain the genuineness of the activities of the trust by relying on their objects.

The Courts have also acknowledged that, injecting such subjectivity of satisfaction of conduct of charitable activities may be susceptible to varied interpretations by the relevant authorities, wherein some may be satisfied with activities of a month or few months, while others may wish to examine the activities of the applicant for a longer time.

The plain and simple procedures laid down in section 12AA do not empower the CIT to reject the grant of registration to trust, until the actual charitable activities are undertaken by the trust. On the contrary, in case of any abuse of procedures of section 12AA by any non-genuine trust, the Act provides for a safeguard by empowering the CIT u/s. 12AA(3) of the Act to cancel the registration of such trusts.

Further, the decision of the Kerala High Court was rightly distinguished by the Delhi High Court, wherein the refusal of registration of trust was not on account of non-commencement of activities of the newly constituted trust, but was for undertaking non-charitable activities. So, the view taken by the Kerala High Court that there had to be some material before the CIT showing the genuineness of activities actually carried on by the trust does not seem to be justified, and the view taken by the other high courts, that carrying on of activity is not a prerequisite for grant of registration u/s.12AA, seems to be the better view of the matter.

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Doctrine of merger — If for any reason an appeal is dismissed on the grounds of limitation and not on merits, that order would not merge with the orders passed by the Appellate Authority.

[Raja Mechanical Co. (P) Ltd. v. CCE, (2012) 345 ITR 356 (SC)]

The Supreme Court noted that the facts were not in dispute and could not be disputed that there was a delay in filing the prescribed forms before the assessing authority. Therefore, the assessing authority had rejected the claim of the assessee and accordingly, had directed him for payment of the excise duty credit availed of by the assessee. Aggrieved by that order, the assessee had belatedly filed an appeal before the proper Appellate Authority. Since there was delay in filing the appeal and since the same was not within the time that the Appellate Authority dismissed the same. It is that order which was questioned before the Tribunal. Before the Tribunal, the assessee had requested the Tribunal to first condone the delay and next to decide the appeal on the merits, i.e., to decide whether the adjudicating authority was justified in disallowing the benefit of the MODVAT credit that was availed of by the assessee. The Tribunal had not conceded to the second request Kishor Karia Chartered Accountant Atul Jasani Advocate Glimpses of supreme court rulings made by the assessee and only accepted the findings and conclusions reached by the Commissioner of Appeals, who had rejected the appeal.

The question that fell for the consideration and decision of the Supreme Court was whether the Tribunal was justified in not considering the case of the assessee on merits. The assessee’s stand before the Tribunal and before the Supreme Court was that the orders passed by the adjudicating authority would merge with the orders passed by the first Appellate Authority and the Tribunal ought to have considered the appeal filed by the assessee on merits also. According to the Supreme Court such a stand of the assessee could not be accepted in view of the plethora of decisions of the Supreme Court, wherein it has been categorically observed that if for any reason an appeal is dismissed on the ground of limitation and not on merits, that order would not merge with the orders passed by the first Appellate Authority. In that view of the matter, the Supreme Court was of the opinion that the High Court was justified in rejecting the request made by the assessee for directing the Revenue to state the case and also the question of law for its consideration and decision. According to the Supreme Court there was no merit in the appeal.

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Section 37(1) — Whether payments towards noncompete fees can be claimed as deferred revenue expenditure — Held, Yes.

31. (2011) 131 ITD 385 (Chennai) Orchid Chemicals & Pharmaceuticals Ltd. v. ACIT A.Y.: 2003-04. Dated: 18-6-2010

Section 37(1) — Whether payments towards non-compete fees can be claimed as deferred revenue expenditure — Held, Yes.

Facts:

The assessee was engaged in the business of manufacture and export of bulk drugs and other pharmaceuticals. The assessee in the previous year paid a sum of Rs.24 crore to three of the parties for acquiring the Intellectual property rights, brands and drug licences. The above payment also included a sum of Rs.2 crore paid towards non-compete clause. The assessee claimed the above expense as revenue expenditure. The Assessing Officer refused the claim on the basis that the expenditure incurred for non-compete agreement was for a fairly long period of four years and as it was of enduring nature, it cannot be treated as revenue. On appeal the Commissioner (Appeals) upheld the order. The assessee thus appealed to the Tribunal. The assessee raised additional grounds which were alternative to other grounds. The assessee contended that the sum paid may be allowed as deferred revenue expenditure or alternatively depreciation on the same should be allowed.

Held:

(1) The payment made for non-compete fee cannot certainly be treated as revenue expenditure in view of decisions in the case of Hatsum Agro Products Ltd. (ITA No. 1200/Mad./1999, dated 27th July, 2005), Asianet Communications (P) Ltd. (ITA No. 4437/Mad./2004, dated 3th January, 2005) (ITA No. 615/Mad./1999, dated 10th February, 2005) and Act India Ltd. No doubt section 28(va) of the Act considers a receipt of non-compete fee as income but it would not by itself lead to a conclusion that any payment of like nature would be on revenue account only. (2) Further, relying on the decision of the Apex Court in the case of Madras Industrial Investment Corporation Ltd. (225 ITR 802) (SC), the expenses should be held in the nature of deferred revenue expenses since the noncompete agreement precluded the sellers from engaging in a competing activity for a period of four years. (3) Hence, the payment made for non-compete fee should be allowed as deferred revenue expenses over a period of four years.

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Section 40(b) and Interest to partners

The present section 40(b) of the Income-tax Act has
been introduced by the Finance Act, 1992 w.e.f. 1-4-1993 to coincide
with the introduction of the new scheme of taxation of the firm and the
partners. The section provides for the conditions, on compliance of
which the remuneration and the interest to partners, by the firm, shall
not be disallowed in the hands of the firm. In other words the claim of
the firm, for deduction of remuneration and interest to partners, shall
be allowed where it satisfies the conditions stipulated in section
40(b).

For allowance of an interest to the partner, it is
essential that the payment is authorised by and is in accordance with
the terms of the partnership deed and relates to a period falling after
the date of partnership deed and the amount does not exceed the amount
calculated at the rate of 12% simple interest per annum.

It is
usual that the interest is paid to a partner on the capital introduced
by him as increased by the deposits made by him and the share of profits
credited to his account and as reduced by the amounts withdrawn by him
and the share of losses debited to his account. At times, the account is
credited with the share of notional profits arising on revaluation or
is debited with the transfer to reserves created to meet certain
contingencies.

Section 40(b) is silent about the ‘base amount’,
with reference to which the interest of 12% is to be calculated. It also
does not specify the manner in which such base amount is to be
calculated. In the circumstances, issues regularly arise about the
determination of the base amount, with reference to which the interest
payable to a partner is to be ascertained so as to face no disallowance.
Unlike section 115JB, it does not provide for the manner of preparation
of the profit & loss account, nor does it lay down any guidelines
for ascertaining the book profit of the firm, the share of which is to
be credited to the partner’s account.

A controversy has arisen
about the need and necessity to provide depreciation by the firm in its
books of account, while ascertaining the amount of the profit or loss of
the year, to be shared amongst the partners and credited to their
respective accounts. Providing no depreciation or a lower depreciation
results in higher profits being credited to partners’ accounts which in
turn helps in payment of higher interest to them. Is this practice of
not providing depreciation in the books in accordance with the
provisions of the Act, for allowance of interest in the hands of the
firm, is a question that has been addressed by the different benches of
the Tribunal to arrive at the different and conflicting views.

The relevant part of section 40(b), pertaining to interest to partners, reads as under:

“Amounts not deductible.

40.
Notwithstanding anything to the contrary in sections 30 to 38, the
following amounts shall not be deducted in computing the income
chargeable under the head ‘Profits and gains of business or profession’,
—

(b) in the case of any firm assessable as such:

(i) ……………..

(ii)
any payment ………….., or of interest to any partner, which, in
either case, is not authorised by, or is not in accordance with, the
terms of the partnership deed; or

(iii) any payment
……………. , or of interest to any partner, which, in either case,
is authorised by, and is in accordance with, the terms of the
partnership deed, but which relates to any period (falling prior to the
date of such partnership deed) for which such payment was not authorised
by, or is not in accordance with, any earlier partnership deed, so,
however, that the period of authorisation for such payment by any
earlier partnership deed does not cover any period prior to the date of
such earlier partnership deed; or

(iv) any payment of interest
to any partner which is authorised by, and is in accordance with, the
terms of the partnership deed and relates to any period falling after
the date of such partnership deed insofar as such amount exceeds the
amount calculated at the rate of twelve per cent simple interest per
annum; or………………”

The Visakhapatnam Bench of the
Tribunal had an occasion to deal with the issue, wherein the Tribunal
held that the Assessing Officer (‘AO’) was not entitled to recompute the
balance of capital account of the partners, so determined by the
assessee firm. In deciding the said issue, the Bench did not follow the
findings to the contrary of another Bench of the Visakhapatnam Tribunal
on the subject.

Arthi Nursing Home’s case

The
issue under consideration was examined by the Visakhapatnam Tribunal in
the case of Arthi Nursing Home v. ITO, 119 TTJ 415 (Visakha).

In
that case, Arthi Nursing Home, a partnership firm, had claimed
deduction of interest paid to partners on their respective capital
accounts. Consequent to the findings in the course of the survey
operations conducted on the firm and during the course of assessment
proceedings, it was noticed by the AO that the firm was not providing
for depreciation in the books of account, but was claiming depreciation
in computation of taxable income. The AO was of the view that the firm
by following the practice of not providing the depreciation was
inflating the capital accounts of the partners on which higher interest
was paid. He observed that the said practice was for the purposes of
claiming higher deduction, towards payment of interest, in the hands of
the firm. He was of the view that the firm was required to draw its
profit & loss account by debiting the depreciation. The AO
recomputed the balances in capital accounts of the partners after
charging depreciation. Consequently, the claim for deduction of interest
to partners was disallowed u/s.40(b) as the balance in the capital
accounts of the partners had turned negative after apportioning the
recomputed profits and losses.

On appeal before the CIT(A), the
action of the AO in disallowing the deduction of interest to partners
u/s.40(b) was confirmed for the following reasons:

The
assessee claimed benefit of depreciation in computing the total income,
but did not provide the same in computing the profit of the firm to be
shared amongst the partners. The said practice led to showing higher
amount of profits in the books of account which inflated the capital
balances of the partners and the consequent interest to partners;
Depreciation,
like any other head of expenditure, was required to be debited to the
profit and loss account to arrive at the real profits of the business;
Debiting of depreciation was a cardinal principle of mercantile system of accounting; and
The
figures of accretion to the capital balances, were exaggerated and
fictitious, not in accordance with any principles of accountancy.

The
assessee firm’s contention that the AO could not have rewritten books
of account of the firm based on the decisions in the cases of Ambica
Chemical Products v. Dy. CIT, (ITA No. 612/Vizag./1999, dated 31st May,
2005 and 9/Vizag./1999) dated 9th January, 2009, respectively; and ACIT
v. Sant Shoe Store, 88 ITD 524, (Chd.) (SMC) was negatived by the CIT(A)
by holding that the AO had only undertaken an exercise of discovery of
correctness of accounts which was not an exercise of rewriting the books
of account.

Aggrieved with the order of the CIT(A), on appeal
before the Tribunal, the following additional arguments were made by the
firm:

Section 40(b) did not provide for the manner of
computing the profit of the firm for the year and did not have any
relevance to the claims made in computing the total income; and

The firm had been consistently over the years not charging depreciation
in the books of account, but had claimed depreciation in computing the
taxable income, which had been accepted by the Revenue authorities.

Likewise, the following additional contentions were raised by the Revenue:

Explanation 5 to section 32 of the Act and the Accounting Standards
prescribed by ICAI required charging of depreciation in the books of
account; and

The Apex Court in the case of CIT
v. British Paints India Ltd., (188 ITR 44) held that the books disclosed
the true state of accounts and the correct income.

The Tribunal after considering the rival submissions upheld the contention of the Revenue authorities for the following reasons:

In light of the Apex Court decision in the case of British Paints Ltd.
(supra), the AO was duty bound to recompute the profit/accretion to the
capital account of the partners after charging depreciation to the
profit and loss account;

Explanation 5 to
section 32 and the Accounting Standards prescribed by the ICAI required
mandatory charging of depreciation to determine profit and loss of the
firm for the year; and

The profit and loss
account prepared without charging depreciation did not reflect the true
and correct state of affairs of the partnership firm.

The
Tribunal concluded that the AO was justified in correcting the aforesaid
error, thereby disallowing the interest claimed by the assessee firm
u/s.40(b).

Swaraj Enterprises case

The issue under consideration subsequently came up before the Division Bench of the Visakhapatnam

Tribunal in the case of Swaraj Enterprises v. ITO, 132 ITD 488.

In
this case, the assessee firm, like in the case of Arthi Nursing Home
(supra), did not charge depre-ciation in the books of account, but
claimed depre-ciation in computing the total income. As a result the
partners’ accounts were credited with higher share of profits on which
interest was paid to the partners. The AO, by relying on the several
decisions of the High Courts, held that the depreciation was a charge on
profits of the firm and the same should be provided for in computing
the profit that was distributed amongst the partners. He recomputed the
capital account balances of the partners and interest thereof.

On
appeal the CIT(A) relying on the decision in the case of Arthi Nursing
Home (supra) upheld the action of the AO of recomputing the interest to
partners for the purposes of section 40(b).

Aggrieved with the order of the CIT(A), the assessee firm filed an appeal before the Tribunal and contended that:

There was no provision under the Act that allowed an AO to rework the
capital balances of the partners and to recompute the interest to
partners u/s.40(b);

There was no statutory compulsion for partnership firms to provide for depreciation under the Indian Partnership Act, 1932;

The determination of profit for the purposes of the books of account
and the computation of total income for income tax were two different
exercises and hence the allowance or disallowance made in computing the
total income under the Act did not in any way affected the balances in
the capital accounts of the partners disclosed in the books of account;
and

Without prejudice, the firm in any case had
the discretion to select the method of charging depreciation and also
the rates at which such depreciation was charged, which discretion was
not vested in the AO.

The Revenue contended that the
depreciation was a charge on the profits of the year and it was a must
for the firm to provide for depreciation to arrive at the true profits
of the firm; that the AO following the British Paints’ case was duty
bound to rework the profit; that action of the firm was not in
accordance with the Accounting Standards and principles and that the
Explanation 5 to section 32 required that the depreciation was charged
to the accounts.

After considering the rival submissions and the decision in the case of Arthi Nursing Home (supra), the Tribunal held as under:

The findings of the Apex Court in the case of British Paints Ltd.
(supra) for reworking the profits were in context of determination of
taxable income and could not be employed for recomputing the capital
account of the partners;

The total taxable
income of the firm remained the same, since the depreciation was already
claimed in computing the taxable income;

Under, the Partnership Act, 1932, there was no statutory compulsion to
provide for depreciation in the books of account or to follow the
Accounting Standards prescribed by ICAI;

The
Companies Act that required an enterprise to follow the mercantile
method of accounting and employ the Accounting Standards did not apply
to a partnership firm;

Explanation 5 to section
32 provided for compulsory depreciation for the purpose of computation
of taxable income under the Act and nowhere it was provided that it was
to be applied even in preparing the books of account;

U/s.40(b), the AO was allowed only to verify whether the payment of
interest to any partner was authorised by and was in accordance with the
terms of partnership deed and whether the period of interest so paid
fell after the date of partnership deed. The AO could not have reworked
or redetermined the balance in the capital accounts of the partners; and

Even if the depreciation was required to be charged in the books of
account, the choice to determine the method and the rate of depreciation
would be at the discretion of the assessee firm and not of the AO.

Based
on the aforesaid findings, the Tribunal ignored its own findings in the
case of Arthi Nursing Home (supra) and upheld the claim of deduction of
inter-est to partners.

Observations

Section 40(b)
is silent as to the amount on which the interest to partners is to be
calculated. As noted, the ‘base amount’ remains to be defined by the
provision. In the context of interest, it has no reference to the books
of account, nor to the book profit unlike the provisions of section
115JB or even those within the section that provide for calculating the
quantum of remuneration payable to the partners. It may not be incorrect
to state that the claim of interest, in the context, is independent of
the books of account.

Unlike section 115JB, this section does not
provide for the method of accounting to be followed, the method of
depreciation to be employed and the rates at which the assets are
required to be de-preciated.

Section 40(b) provides that no
disallowance shall take place where the interest to partners is;
authorised by the partnership deed; in accordance therewith; for the
period falling after the date of partnership deed and the rate of
interest does not exceed 12%. In the circumstances, what is of paramount
importance is that the interest to partners should be authorised by the
deed and if it is so what remains to be seen is that such interest is
paid in the manner provided by the said deed which of course should be
in conformity with the other stipulations stated above. Nothing, beyond
these simple rules, is required to be read in to the provision.

The
computation of total income, under the Act, is largely independent of
the books of account. A debit or credit does not decide the taxability
or allowance of an income or an expenditure. Unless otherwise expressly
stated, the books of account do not determine the taxability or
otherwise under the Act. The allowance or a deduction and the taxability
of an income is governed by the provisions of the Income-tax Act and
not the books of account.

Explanation 5 to section 32 has a very
limited relevance and its application is mainly restricted to the
provisions of section 32(1) and section 43(6) which provide for
determination of the written down value of an asset or a block of
assets. The said provision, at the most, has the effect of altering the
total income that is computed under the Act and does not travel beyond,
to the computation of the book profit, not even for the purposes of
section 115JB.

The Partnership Act, 1932 does not prescribe the
manner in which the books of account are to be maintained, nor do they
provide for the method of accounting to be followed by the firm for
determining its profit or loss. They also do not prescribe for
compulsory depreciation and the rate thereof.

The Companies Act
has no application to the partnership firms and the provisions therein
for mercantile system of accounting, true and fair profit and the
mandatory application of the Accounting Standards do not apply to the
partnership firms.

The Chandigarh Bench of the Tribunal in Sant
Shoe Store’s case was concerned with the allowance of interest on the
capital account of the partners which included credits on revaluation of
the assets, not involving any inflow of funds. The Tribunal even in
such a case approved of the claim of interest made by the firm. Again,
the Tribunal in Ambica Chemical Products approved of the claim of
interest in circumstances where the firm had not provided for
depreciation in the books of account; the claim was allowed to the firm
in two different appeals vide orders passed after a gap of four years
and one of it was passed after the decision in the case of Aarthi
Nursing Home was rendered. A useful reference may be made to the
decision of the Pune Bench in the case of Deval Utensils Factory, 98 TTJ
501 wherein the action of the AO in reworking the capital account
balance, on the basis of which interest was paid to partner was
disapproved.

The rewriting of the books by either side should
be discouraged. If permitted, it may invite the tax-payers to indulge
in creative accounting, for example; by adding back the provision for
taxation where debited to the profit & loss account so as to enhance
the amount of share of profit that is credited to the capital accounts
by holding out that the tax is not an allowable deduction in computing
the total income. The example amplifies the need to stick to the books
of account and the need to avoid importing the computation provisions in
calculation of interest.

The interest to the partners, where
allowed in the hands of the firm, is taxable in the hands of the
partners as business income by virtue of section 28(v). The one that is
disallowed in the hands of the firm, is not taxable in the hands of the
partners by virtue of the proviso to the said section 28(v) of the Act.
The disallowance largely does not result in any loss or gain of revenue
for either side.

This essentially leaves us with the conclusion
that no disallowance shall take place under the provisions of section
40(b) in cases where the interest to partners is authorised by the
partnership deed and the same is calculated as per the terms of the
partnership deed. The case of the firm gets forti-fied where the deed
does not make it mandatory for the firm to charge depreciation in
computing the profit for the year.

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Why income from sale of computer soft ware not taxable as royalty?

While best efforts were made from world over to persuade the then Finance Minister of India to have second thoughts on the retrospective proposals introduced in the Finance Bill, 2012, nothing seems to have appealed. The retrospective amendments as were proposed in the Finance Bill, 2012 have received the President’s assent. In this backdrop, an effort is made to consider whether the Income-tax Department under the so retrospectively amended section 9(1)(vi) of the Act would be able to tax, income from sale of computer software as royalty under the Income-tax Act, 1961 (‘the Act’) and/or Double Taxation Avoidance Agreements (‘DTAAs’) entered in by India with other countries?

From the following three Circulars issued by the Central Board of Direct Taxes at different points in time, one understands that the intention of the Legislature was very clear to tax any income from ‘right for use’ or ‘right to use’ any copyright (viz., computer program) as royalty under the Act:

Circular No. 152, dated 27th November 1974;
Circular No. 588, dated 2nd January 1991; and
Circular No. 621, dated 19th December 1991.

However, the controversy whether income from sale of computer software is taxable as royalty under the Act or not, developed only from the year 2005, with the judgment of the Special Bench of Delhi Tribunal in the case of Motorola Inc. v. DCIT, (95 ITD 269). The decision pertained to A.Ys. 1997-98 and 1998-99, though the first Circular justifying the taxability of income as royalty under the Act was issued in 1974.

Such an unusual scenario could be the result of imperfect drafting of section 9(1)(vi) to support the taxability of sale of computer software as royalty. This article examines whether the retrospective introduction of Explanation 4 to section 9(1)(vi), achieves the object of the Legislature to tax the income from sale of computer software as royalty under the Act. The said retrospective amendment in section 9(1)(vi) reads as under:

“Explanation 4 — For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of licence) irrespective of the medium through which such right is transferred.”

Section 9(1)(vi) provides that any income payable by way of royalty in respect of any right, property or information is deemed to accrue or arise in India. So, to determine the taxability of income u/s.9(1)(vi), an income needs to satisfy the following twin conditions, apart from the principle of ‘source rule of taxation’ in section 9(1)(vi): The income should be covered under the definition of ‘royalty’ i.e., under Explanation 2 to section 9(1) (vi); and
l It has to be in respect of any right, property or information.

The expression ‘any right, property or information’ is explained in the definition of ‘royalty’ viz., intellectual properties, equipments, know-how, experience or skills, etc. In other words, the definition of ‘royalty’ gives colour to or limits the scope of, the expression, which is otherwise very wide in scope.

Explanation 4 retrospectively includes, ‘right for use or right to use computer software’ under the expression ‘any right, property or information’. The text of Explanation 4, however, does not include the said rights of a computer software under the definition of ‘royalty’, which is specifically required as discussed, for applicability of section 9(1)(vi). Even though, the Memorandum explaining the amendments relating to Direct Taxes in the Finance Bill, 2012 mentions that ‘transfer of all or any right in respect of any right, property or information’ used in Explanation 4 defines the rights, property or information referred to in Explanation 2 to section 9(1)(vi), the text of Explanation 4 does not refer to Explanation 2. Therefore, one may argue that until the language of Explanation 4 is amended to include the aforesaid rights of computer software under Explanation 2, section 9(1)(vi) may not apply to the said rights of computer software.

The said argument also draws support from the Karnataka High Court judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT, (321 ITR 31). The High Court while considering the retrospective amendment in context of Explanation to section 9(2) r.w.s. 9(1)(vii) held that since the purport of Explanation 2 is plain in its meaning, it is unnecessary and impermissible to refer to the Memorandum Explaining the provisions. Apart from the above or assuming that the Legislature amends Explanation 4 on the lines as suggested above or the Courts hold otherwise, the question that arises is, what is the meaning of the expression ‘right for use’ or ‘right to use’ a computer software? The provisions of the Act do not define ‘right for use’ or ‘right to use’.

Broadly, there are two schools of thought emerging for interpretation of the aforesaid rights of computer software. One school of thought suggests that the said expression should be construed in its general sense. Whereas, the other school of thought suggests the said expression should be construed in the light of the meaning as given in 2010 OECD Commentary on Model Tax Convention on Income and on Capital.

First school of thought

The Memorandum justifies the retrospective insertion, so as to restate the intention of the Legislature to tax the income from use or right to use computer software as royalty under the Act, which was interpreted otherwise by some judicial authorities. The judicial authorities1 in India have given conflicting findings on different questions relating to taxability of income from sale of computer software as royalty. Out of these questions, the Legislature has by Finance Act, 2012 sought to address only the question whether the expression ‘transfer of all or any rights’ includes ‘right for use’ or ‘right to use’?

The Memorandum does not refer to the conflicting judgements. The findings of these conflicting judgements were summarised in a Table in the feature Direct Tax Controversy in the BCAS Journal for the month of December 2011, (page no. 54).

In such a scenario, it would be relevant to understand the meaning of the expression ‘right for use’ or ‘right to use’ a computer software in the light of the findings of Heydon’s case (1584) (3 Co Rep 7a, 7b), better known as Mischief Rule. The Heydon’s case requires that to construe a provision of a statute, it would be just and proper to see what was the position before an amendment and find out what was ‘the mischief’ sought to be remedied and then discover the true rationale for such remedy. The aforesaid rule which is more than four hundred years old requires the following four questions to be answered in order to construe the provisions of section 9(1)(vi):

1. What was the common law before making the amendment in section 9(1)(vi)?

Judicial authorities were divided as regard the taxability of the subject. Some of the findings of the said decisions are:

— Passing on the right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to copyright and therefore, consideration to authorise the end-user to have an access to and make use of the licensed computer software, does not amount to royalty under the Act.

— On the other hand, some judicial authorities, held that payments made by end-users or distributors for granting of licence to use copyright i.e., computer program in respect of sale of computer software is royalty under the Act. Right of user of computer software involves right to use the computer program. When the right for user is given, right to use copyright is also given and therefore, consideration amounts to royalty under the Act.

2. What was the mischief and defect for which the Act did not provide?

The mischief and the defect for which the Act did not provide and which seems to be the intent of the Legislature was to tax ‘right for use’ or ‘right to use’ computer program [involved in a sale of/ licence to use computer software] as royalty under the Act.

3. What remedy the Legislature/Parliament has resolved and appointed to cure the defect?

The remedy effected by the Legislature to cure the aforesaid defect is retrospective insertion of Explanation 4.

4. What is the true reason for the remedy?

The true reason for the remedy seems that the Legislature wanted to subject ‘right for use’ or ‘right to use’ computer program involved in sale of computer software as royalty under the Act. The Legislature instead of using the expression to achieve its remedy to tax “right for use or right to use computer program embedded in a computer software” has chosen to use the expression “right for use or right to use computer software”, in a way suggesting that words ‘computer software’ and ‘computer program’ are used interchangeably.

In other words, the true expression ‘right for use or right to use a computer software’ is referred to as having a general meaning of act of using the property i.e., computer program embedded in a computer software and right to transfer such usage, respectively. Therefore, if one agrees with the conclusion of first school of thought, then purchase of any computer software viz., either shrinkwrap, bundled, canned or customised software, would be taxable as ‘royalty’ under the Act.

Second school of thought

The second school of thought suggests that the impugned expression should be construed in the light of the meaning as given in 2010 OECD Commentary on Model Tax Convention on Income and on Capital. The Para 2 of Article 12 of 2010 OECD Model defines ‘royalty’ as under:

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

The expressions ‘right for use’ or ‘right to use’ as referred in Explanation 4 to section 9(1)(vi) is also found in Article 12(2). Paras 12 to 17 of the OECD Model Commentary on Article 12 cover the various facets of taxability of computer software as royalty. Para 13.1 of the Commentary explains the meaning of the expression ‘right for use’ or ‘right to use’ any copyright in the context of a computer software. This is similar to rights referred to in section 14 of the Copyright Act, 1957 (‘the Copyright Act’) and India has not raised any reservations or disagreements to such construction. The rights referred in section 14 of the Copyright Act for computer program are reproduced below:

to reproduce the work in any material form including the storing of it in any medium by electronic means;

to issue copies of the work to the public not being copies already in circulation;

to perform the work in public, or communicate it to the public;

to make any cinematograph film or sound recording in respect of the work;

to make any translation of the work;

to make any adaptation of the work;

to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in any of the points mentioned above; and

to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer program.

So, it is the transfer or granting of licence of rights in section 14 of the Copyright Act which refers to use or right to use the copyright in context of computer software.

Further, there is a case to presume that the expression ‘right for use’ and ‘right to use’ in the context of taxability of computer software as royalty, has acquired a particular meaning, when India has accepted the meaning of that expression as explained in the 2010 OECD Model Commentary. Therefore, it is worth arguing that when India has accepted the meaning of the expression in a particular sense, then the use of the said expression subsequently should also be given similar meaning. The Courts also have in a catena of decisions2 held that internationally accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed when construing similar terms occurring in the Act. However, the said reference/is subject to certain limitations, and for better understanding of the subject, one may refer to the Article ‘Legitimacy of References to OECD Commentary for interpretation of provisions under the Act and DTAAs’ published in BCAJ, February 2012, (page no. 9).

Therefore, if one agrees with the conclusion of the second school of thought, then it is only the income from the transfer or granting of licence of rights in section 14 of the Copyright Act which means use or right to use copyright in the context of computer soft-ware and accordingly will be taxable as royalty under the Act. In other words, purchase of any computer software viz., either shrinkwrap, bundled, canned or customised software would still continue to remain non-taxable as ‘royalty’ under the Act.

Analysis

Based on the above discussion, if the text of the Explanation 4 to section 9(1)(vi) is brought to test then one feels that the Legislature may still fail to pass the muster to tax the income from sale of computer software as royalty under the Act for want of the following broad reasons:

In Explanation 4, the Legislature has used the words ‘all or any’ which are prefixed to expression ‘right for use’ or ‘rights to use’ computer software. The expression ‘transfer of all or any right for use or right to use a computer software (including granting of licence)’ gives an impression of there being many ‘rights for use’ or ‘rights to use’ a computer software, which can either be transferred or licensed. However, as concluded under the first school of thought, ‘right for use’ or ‘right to use’ computer software in its general sense refers to only a simple case of ‘usage’ of property. One fails to determine the various rights ‘for use’ or rights ‘to use’ involved in context of a computer software and is forced to doubt whether the Explanation 4 supports the construction of the expression as sought under the first school of thought. On the contrary, considering the multiple rights referred in section 14 of the Copyright Act, one may agree that the expression ‘all or any’ could be construed as referring to those multiple rights u/s.14 of the Copyright Act, thereby supporting the meaning as drawn under the second school of thought.

Further, Explanation 3 to section 9(1)(vi) of the Act defines ‘computer software’ to mean computer program recorded on any medium. In a sense, suggesting that even though the Copyright Act distinguishes between ‘original copyrighted computer program’ and ‘copy of said computer program embedded in computer software’, the Income-tax Act, 1961 does not recognise such a distinction for the purpose of taxation and the words ‘computer software’ and ‘computer program’ may be used interchangeably. The same conclusion is also drawn under question no. 4 – What is the true reason for remedy, while discussing the findings of Heydon’s case in the context of computer software, under the first school of thought? So, the expression ‘right for use or right to use a computer software’ may be read as ‘right for use or right to use a computer program’ in respect of computer software.

Conclusion

Considering the above, one may conclude that Explanation 4 to section 9(1)(vi) of the Act, in its present form, may fail to achieve its object for want of the following broad reasons:

Expressions viz., ‘transfer of all or any rights in respect of any right, property or information’, ‘all or any’, ‘rights for use’ or ‘right to use’ are neither defined nor properly referenced in section 9(1)(vi) of the Act;

Expression ‘right for use’ or ‘right to use’ referred to in Explanation 4 to section 9(1)(vi) may suggest a meaning different than meaning in general sense of usage of property and transfer thereof; and

Explanation 4 to section 9(1)(vi) supports the construction of the expressions ‘right for use’ or ‘right to use’ to cover the rights referred to in section 14 of the Copyright Act.

Apart from the above, it would be possible for non-resident taxpayers to take recourse to the beneficial provisions of DTAAs entered in by India with other countries. The Article on taxability of ‘royalty income’ generally defines “royalty as payment of any kind from ‘use or right to use’ any copyright”. It thus restricts the scope of royalty income and one may rely on the 2010 OECD Model Commentary and India’s position thereof for non-taxability of computer software as royalty.

Further, the Central Government has recently issued a Notification giving relief from multiple level of tax deduction at source (‘TDS’) u/s.194J in the context of computer software. The said Notification No. 21 of 2012, dated 13rd June 2012 is issued u/s.197A(1F) effective from 1st July 2012 and provides as under:

The transferee has been defined to be a person who acquires the software. He may be a resident or a non-resident of India and the transferor is defined to be a person from whom the software is acquired, but he has to be a resident of India (as a precursor for applicability of section 194J of the Act).

Acquisition of the software has to be in the course of transfer of software (referred to as ‘subsequent transfers’) and tax should have been deducted at source either u/s.194J or section 195 of the Act, as the case may be, in any of the previous transfers;

The software so acquired under subsequent transfer should not have been modified; and

The transferee should obtain a declaration from the transferor that the tax has been deducted in any of the previous transfers along with PAN of the transferor.

This Notification has a narrow scope and has several limitations, which are as under:

The exemption from multiple level of deduction of tax has only been provided to payments subject to tax deduction as royalty u/s.194J of the Act and not u/s.195 of the Act; and

The acquisition of software under subsequent transfers should be without modification. One generally finds that in a direct arrangement between a copyright owner and end-user, the standard End-User Licence Agreement (‘EULA’) specifically prevents the end-user for resale of acquired software and therefore, the question of multiple level of deduction of tax will not arise in such a scenario. However, in case of copyright owner-distributor- end -user chain, it may be possible to undertake the benefit of the said Notification.

A fact pattern which is generally involved in the case of copyright owner-distributor-end user chain of transfer of software and its TDS implications thereof are explained in the Diagram for ease of understanding and ready reference:

Generally, the copyright owner of a computer program assigns/licenses rights to commercially exploit the copyright to the distributor. The rights to commercially exploit copyright provide for making multiple copies of software along with rights to sell and/or rent computer software qua a geographical location i.e., in the given example could be India. Pursuant to aforesaid rights, the end-user in India acquires the software copy from the distributor, subject to terms and conditions as provided in a EULA.

(Note: It is assumed that under the Scenario 1 and 2, the income from sale of computer software is taxable as ‘royalty’ under the Act and respective DTAAs between India and other countries. The analysis has been limited with respect to TDS implications, which arise in the light of aforesaid notification.)

The important question which is relevant to determine the TDS implications in context of non-residents transferors that is discussed here is ‘Can a non-resident transferor take recourse to Article on ‘Non-discrimination’ under the DTAAs as regard the discriminatory treatment sought by the Notification by limiting the benefit to only resident transferors u/s.194J of the Act?’

Section 40a(ia) r.w.s. 194J and Notification No. 21 of 2012 provides for deduction of royalty expenses for payment to resident transferor for acquisition of software without any deduction of tax. On the other hand, for similar payment to non-resident transferor, if the transferee has not deducted tax u/s.195, then the said expense will not be allowed as deduction u/s.40a(i). Such discrimination is addressed in an indirect manner by Article 24(3) of the respective DTAAs entered in between India and other countries. Article 24(3), generally reads as under:

“Except where the provisions of para 1 of Article 19, para 7 of Article 11, or para 8 of Article 12 apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State, shall for the purposes of determining the taxable profits of the first mentioned person, be deductible under the same conditions as if they had been paid to a resident of the first mentioned State.”

Article 24(3) deals with the treatment of the enterprises of Contracting State under the tax laws of that State. The said Article provides that interest, royalties and other disbursements paid to a resident of the other contracting State should be deductible to the same extent as would be deductible if paid to a resident of the same State. The said para of the Article is designed to end a particular form of discrimination resulting from a fact that in certain countries the deduction of interest, royalties and other disbursements is allowed without restriction when the recipient is a resident, but is restricted or prohibited when the recipient is non-resident4.

A similar discriminatory treatment is sought by Notification No. 21 of 2012. Therefore, by taking recourse to Article 24(3) of DTAAs read with Notification No. 21 of 2012, similar exemption from multiple level of TDS may be claimed on payment to non-resident transferors.

Given the aforesaid situation, one is reminded of the proverb, ‘Once burnt is twice shy.’ But the hard lesson of consequences from imperfect drafting do not seem to have learnt and therefore, the Income-tax Department may still fail to tax income from sale of computer software as ‘royalty’ under the Act and may also fail to simultaneously impose onerous and discriminatory treatment of multiple level of TDS u/s.195 of the Act.

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Undisclosed investment: Section 69B: Search revealed that assessee had purchased a flat for Rs. 17.55 lakh: Said flat was fetching an income of Rs. 7.02 lakh per annum: AO estimated the value and made an addition of Rs. 65.32 lakh u/s. 69B: No incriminating material found: Addition not justified.

[CIT Vs. Dinesh Jain HUF ;25 taxmann.com 550 (Delhi)]

During a search at the residential and business premises of the assessee, certain material was seized which, inter alia, revealed investment in various properties by the assessee. One such property was a flat, which was purchased for Rs. 17.55 lakh. The Assessing Officer noticed that it was a commercial property which was fetching rent of Rs. 7.02 lakh per annum. He was of the view that a property which was fetching such a substantial rental income could not have been acquired for Rs. 17.55 lakh. He concluded that the fair market value of the property should be estimated in accordance with Rule 3 of Schedule III to the Wealthtax Act, 1957. The difference between value of the property calculated in accordance with the said rule and the amount shown in the sale document came to Rs. 65.32 lakh which was assessed as unexplained investment u/s. 69B of the Income-tax Act, 1961. The Tribunal deleted the addition.

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

“i) Section 69B in terms requires that the Assessing Officer has to first ‘find’ that the assessee has ‘expended’ an amount which he has not fully recorded in his books of account. It is only then that the burden shifts to the assessee to furnish a satisfactory explanation. Till the initial burden is discharged by the Assessing Officer, the section remains dormant.

ii) A ‘finding’ obviously should rest on evidence. In the instant case, it is common ground that no incriminating material was seized during the search which revealed any understatement of the purchase price. That is precisely the reason why the Assessing Officer had to resort to Rule 3 of Schedule III to the Wealth Tax Act.

iii) Section 69B does not permit an inference to be drawn from the circumstances surrounding the transaction that the purchaser of the property must have paid more than what was actually recorded in his books of account for the simple reason that, such an inference could be very subjective and could involve the dangerous consequence of a notional or fictional income being brought to tax contrary to the strict provisions of article 265 of the Constitution of India and Entry 82 in List I of the Seventh Schedule thereto which deals with ‘Taxes on income other than agricultural income’.

iv) Applying the logic and reasoning in K.P. Varghese v. ITO [1981] 131 ITR 597/7 Taxman 13 (SC) , for the purposes of section 69B, it is the burden of the Assessing Officer to first prove that there was understatement of the consideration (investment) in the books of account. Once that undervaluation is established as a matter of fact, the Assessing Officer, in the absence of any satisfactory explanation from the assessee as to the source of the undisclosed portion of the investment, can proceed to adopt some dependable or reliable yardstick with which to measure the extent of understatement of the investment. One such yardstick can be the fair market value of the property determined in accordance with the Wealth Tax Act.

v) Since the entire case has proceeded on the assumption that there was understatement of the investment, without a finding that the assessee invested more than what was recorded in the books of account, the decision of the Income-tax Authorities cannot be approved.

vi) Section 69B was wrongly invoked. The order of the Tribunal is upheld.”

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Unexplained expenditure: Section 69C: A. Ys. 2000-01 to 2003-04: Hospital: Search disclosed unaccounted collection of fees in the name of doctors and distribution thereof to doctors: Explanation that amount was collected and distributed to doctors: Doctors not examined: Amount not assessable in hands of hospital.

[CIT Vs. Lakshmi Hospital; 347 ITR 367 (Ker):]

The assessee is a hospital. In the course of search, the Department discovered unaccounted collection of fees in the name of doctors and distribution thereof to doctors in the relevant period. The assessee hospital contended that it had distributed the entire amount to the doctors in whose names the collections were made and no part of the collections was retained as its income. The Assessing Officer assessed the entire amount as unexplained expenditure falling u/s. 69C. The Tribunal deleted the addition.

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

“i) Cases falling u/s. 69C are of essentially expenditure accounted as such by the assessee. The entire amount was collected without bringing it into the regular accounts and the payments were also made by the assessee without accounting for them.

ii) This was not a case of failure of the assessee to explain the expenditure. In fact the assessee, on being confronted with the accounts seized from it, conceded that the entire amounts were collected by it for payment to doctors serving the hospital. The assessee, prima facie, discharged its burden or at least shifted the burden to the Revenue when it gave particulars of payments made to the doctors.

iii) The Department should have issued notice to the doctors for confirmation of the payments and if they confirmed receipts, made assessments on doctors and if they denied the receipts, proceeded against the assessee and direct it to prove assessment of the amount u/s. 69C. Since this exercise had not been done, the addition u/s. 69C was not justified. ”

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Refund: Delay in claiming refund: Power to condone delay: Section 119: A. Ys. 1995-96 to 1998-99: Refund due to charitable trust: Trust not under obligation to file return: Delay in filing return claiming refund due to bifurcation of trust: Delay had to be condoned.

[North Eastern Electric Power Corporation Employees Provident Fund Trust Vs. UOI; 348 ITR 584 (Gauhati):]

The petitioner was a trust recognised under the Income-tax Act. For the relevant period, the petitioner was not required to file return of income u/s. 139. However, in order to claim refund of TDS, the petitioner filed returns claiming refunds. Since the returns were filed beyond the time limit, they were treated as invalid returns and the Assessing Officer rejected the application for the refunds. The petitioner filed applications before the Chief Commissioner u/s. 119(2) of the Act requesting to condone the delay in filing the returns claiming refunds. The petitioner explained that the delay was caused due to bifurcation of the trust. The application was rejected by the Chief Commissioner.

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

“i) The Revenue authorities did not dispute the entitlement of the petitioner for refund of the deducted amount. The Trust in this case was being deprived of a sum of Rs. 8,93,773/- for which it could not be blamed at all. It had no liability whatsoever to pay this amount to the Revenue. Yet, the Revenue had refused to refund the sum taking a hypertechnical view of the matter.

ii) The petitioner was entitled to condonation of delay in filing the claim for refund.”

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Recovery of tax: S/s. 156 and 220: A. Y. 1985-86: Service of demand notice u/s. 156 is condition precedent for recovery proceedings: Demand notice not received by assessee: Recovery proceedings not valid.

[Saraswati Moulding Works Vs. CIT; 347 ITR 161 (Guj):]

For the A. Y. 1985-86, the petitioner did not receive the assessment order and the demand notice u/s. 156. However, the Department served recovery notice. In response to the recovery notice, the petitioner had objected to the initiation of the recovery proceedings pointing out that it had not received the assessment order and the demand notice u/s. 156 of the Act. Thereafter, over the years, from time to time, recovery notices were issued to the petitioner and on each occasion, the petitioner had responded to the notice by requesting the Assessing Officer to serve the assessment order and the demand notice u/s. 156 of the Act on the petitioner. However, the assessment order and the demand notice u/s. 156 was not served on the petitioner.

In the circumstances, the petitioner filed a writ petition before the Gujarat High Court requesting to quash the recovery notices and the recovery proceedings. Gujarat High Court allowed the petition and held as under:

“I) In the absence of service of demand notice u/s. 156 of the Act on the petitioner, which was a basic requirement for invoking the provisions of section 220 of the Act, the petitioner could not have been treated to be an assessee in default. The subsequent proceedings u/ss. 220 to 226 of the Act were without jurisdiction.

ii) The impugned notice and the recovery proceedings are hereby quashed and set aside.”

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Recovery of tax: Adjustment of refund against demand: S/s. 220(6) and 245: A. Y. 2006-07: Appeal pending before Tribunal: Tribunal has power to stay recovery and not permit adjustment of refund.

[Maruti Suzuki India Ltd. Vs. Dy. CIT; 347 ITR 43 (Del):]

For the A. Ys. 2003-04 and 2004-05, the assessee was entitled to refund of Rs. 122.57 crore and Rs. 107.42 crore respectively. In the normal course, refund should have been paid by the authorities to the petitioner. However, the refund amount was not paid to the petitioner. The refund was adjusted against the demand for A. Y. 2006-07 in respect of which the assessee was in appeal before the Tribunal. The petitioner had made an application before the Assessing Officer u/s. 220(6) for stay of recovery till the disposal of the appeal by the Tribunal. The petitioner had also made a stay application before the Tribunal. The Tribunal held that the Assessing Officer should first dispose of the application u/s. 220(6) of the Act.

The petitioner therefore filed a writ petition before the Delhi High Court, requesting for the stay of the recovery and refund of the amounts. Delhi High Court allowed the petition and held as under:

“i) Section 220(6) which permits the Assessing Officer to treat the assessee as not in default is not applicable when an appeal is referred before the Tribunal, as it applies only when an assessee has filed an appeal u/s. 246 or 246A.

ii) As per Circular No. 1914 dated 2nd December, 1993, the Assessing Officer may reserve a right to adjust, if the circumstances so warrant. In a given case, the Assessing Officer may not reserve the right to refund. Further, reserving a right is different from exercise of right or justification for exercise of a discretionary right/power. Moreover, the circular is not binding on the Tribunal.

iii) The Tribunal has power to grant stay as an inherent power vested in the appellate authority as well as u/s. 254 and the rules. The Tribunal is competent to stay recovery of the demand and if an order for “stay of recovery” is passed, the Assessing Officer should not pass an order of adjustment u/s. 245 to recover the demand. In such cases, it is open to the Assessing Officer to ask for modification or clarification of the stay order to enable him to pass an order of adjustment u/s. 245 of the Act.

iv) Different parameters can be applied when a stay order is passed, against use of coercive methods for recovery of demand and when adjustment is stayed. Therefore, the Tribunal can stay adoption of coercive steps for recovery of demand but may permit adjustment u/s. 245. When and in what cases, adjustment u/s. 245 of the Act should be stayed would depend upon the facts and circumstances of the case.

v) The discretion should be exercised judiciously. The nature of addition resulting in the demand is a relevant consideration. Normally, if the same addition/ disallowance/issue has already been decided in four of the assessee by the appellate authority, the Revenue should not be permitted to adjust and recover the demand on the same ground. In exceptional cases, which include the parameters stated in section 241 of the Act, adjustment can be permitted/allowed by the Tribunal.

vi) The action of the Revenue in recovering the tax in respect of additions to the extent of Rs. 96 crore on issues which were already covered against them by the earlier orders of the Tribunal or the Commissioner (Appeals) was unjustified and contrary to law.

vii) Accordingly, directions are issued to the respondents to refund Rs. 30 crore, which will be approximately the tax due on Rs. 96 crore.”

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Reassessment: S/s. 54EC, 147 and 148: A. Y. 2006-07: Benefit of section 54EC granted taking into account investment before date of transfer: Reopening of assessment to deny benefit: change of opinion: Reopening not valid.

[Mrs. Pravin P. Bharucha Vs. Dy.CIT; 348 ITR 325 (Bom):]

For the A. Y. 2006-07, the assessee had claimed deduction u/s. 54EC of the Income-tax Act, 1961. On the request of the Assessing Officer, the assessee had filed the details of the investment u/s. 54EC. The Assessing Officer considered and allowed the deduction to the extent of Rs. 7.40 crore. Subsequently, the Assessing Officer issued notice u/s. 148 for withdrawing the deduction. Assessee’s objections were rejected.

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

“i) While granting the benefit, the Assessing Officer took a view that investment made out of earnest money/advance received as a part of the sale consideration before the date of the transfer of the assets would also be entitled to the benefit of section 54EC. This view was possible, in view of Circular No. 359 dated 10-05-1983, and the decision of the Tribunal.

ii) The reasons recorded did not state that the deduction u/s. 54EC was not considered in the assessment proceedings. In fact, from the reasons, it appeared that all facts were available on record and, according to the Revenue, the deduction was only erroneously granted. This was a clear case of review of an order.

iii) The application of law or interpretation of a statute leading to a particular conclusion, cannot lead to a conclusion that tax has escaped assessment, for this would then certainly amount to review of an order which is not permitted unless so specified in the statute.

iv) The order disposing of the petitioner’s objections also proceeded on the view that there had been non-application of mind during the original proceedings for assessment. This was unsustainable and a fresh application of mind by the Assessing Officer on the same set of facts amounted to a change of opinion and did not warrant reopening.

v) In view of the above, the notice u/s. 148 is without jurisdiction and we set aside the same.”

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Reassessment: Section 17 of W. T. Act, 1957: Notice in the name of person who did not exist i.e. a company which is wound up and amalgamated with another company: Notice and subsequent proceedings not valid.

[I. K. Agencies Pvt Ltd. Vs. CWT; 347 ITR 664 (Cal):]

A company AP was wound up by virtue of the order of the company court and was amalgamated with the assessee company w.e.f. 01-04-1995. On 20-01-1997, the Assessing Officer issued notice u/s. 17 of the Wealth-tax Act, 1957 on AP directing it to file its wealth tax return in respect of a period prior to 01-04-1995 i.e. prior to amalgamation. Pursuant to the notice, reassessment order was passed. The notice and the reassessment was upheld by the Commissioner (Appeals) and the Tribunal.

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

“i) Section 17 of the Wealth-tax Act, 1957, is similar to the provisions contained in section 148 of the Income-tax Act, 1961, and section 34 of the Indian Income-tax Act, 1922. The jurisdiction to reopen a proceeding depends upon issue of a valid notice under the provisions, which gives power to the Assessing Officer to reopen a proceeding. A notice to a person who is not in existence at the time of issuing such notice is not valid. The fact that the real assessee subsequently filed its return with the objection that such notice is invalid and cannot cure the defects which go to the root of the jurisdiction to reopen the proceedings.

ii) The authorities below totally overlooked the fact that initiation of the proceedings for reassessment was vitiated for not giving notice u/s. 17 of the Act to the assessee and the notice issued upon AP which was not in existence at that time, was insufficient to initiate proceedings against the assessee which had taken over the liability of AP prior to the issue of such notice.

iii) Reassessment proceedings were not valid and were liable to be quashed.”

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Export: Deduction u/s. 10A: Gain from export on account of fluctuation in rate of foreign exchange is eligible for exemption.

[CIT Vs. Pentasoft Technologies Ltd.; 347 ITR 578 (Mad):]

The assessee was an exporter and was eligible for deduction u/s. 10A. Due to diminution in rupee value, the assessee gained a higher sum in rupee value while earning the export income. The assessee claimed the deduction of the whole of the export profit u/s. 10A including the gains on account of fluctuation in rate of foreign exchange. The Assessing Officer disallowed the claim in respect of the gains on account of rate of foreign exchange. The Tribunal allowed the assessee’s claim.

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

“In order to allow a claim u/s. 10A, what is to be seen is whether such benefit earned by the assessee was derived by virtue of export made by the assessee. When fluctuation in foreign exchange rate was solely relatable to the export business of the assessee and the higher rupee value was earned by virtue of such exports carried out by the assessee, the benefit of section 10A should be allowed to the assessee.”

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Reassessment: S/s. 147 and 148: A. Y. 2005-06: Notice u/s. 148 issued by AO not having jurisdiction to assess: Notice and reassessment proceedings invalid: Disgraceful and deplorable conduct of ACIT and CIT in seaking to circumvent law condemned.

[Fiat India Automobiles Ltd. V/s. ACIT (Bom); W. P. No. 8657 of 2012 dated 16-10-2012:]

On shifting the registered office of the petitioner from Mumbai to Pune, the petitioner in June-July 2009 had applied for transfer of assessment records from Mumbai to Pune. After exchange of several letters, by his order dated 22-11-2011, the CIT-10 Mumbai transferred the powers to assess the petitioner from ACIT-10(1) Mumbai to DCIT, Circle-1(2) Pune. However, on 30-03-2012, ACIT-10(1) Mumbai issued notice u/s. 148 with a view to reopen the assessment for the A. Y. 2005-06.

The Bombay High Court allowed the writ petition filed by the petitioner and quashed the impugned notice u/s. 148 dated 30-03-2012 and held as under:

“i) In the affidavit-in-reply filed by the DCIT-10(1) Mumbai, it is stated that by a corrigendum order dated 27-03-2012, the CIT-10 Mumbai has temporarily withdrawn/cancelled the earlier transfer order dated 22-11-2011 for the sake of administrative convenience and therefore, the notice dated 30-03-2012 would be valid. It is the case of the petitioner that neither any notice to pass a corrigendum order was issued to the petitioner nor the alleged corrigendum order dated 27-03-2012 has been served upon the petitioner.

ii) The question therefore to be considered is, when the CIT-10 Mumbai has transferred the jurisdiction to assess/reassess the petitioner from ACIT-10(1) Mumbai to DCIT Circle-1(2) Pune u/s. 127 of the Act after hearing the petitioner on 22-11-2011, whether the CIT-10 Mumbai at the instance of ACIT-10(1) Mumbai is justified in issuing a corrigendum order on 27/03/2012 behind the back of the petitioner and whether the ACIT-10(1) Mumbai is justified in issuing the impugned notice u/s. 148 of the Act dated 30-03-2012 on the basis of the said corrigendum order dated 27-03-2012 which was passed without issuing a notice to the petitioner, without hearing the petitioner and which is uncommunicated to the petitioner.

iii) The conduct of the ACIT and CIT is highly deplorable. Once the jurisdiction to assess the assessee was transferred from Mumbai to Pune, it was totally improper on the part of ACIT Mumbai to request the CIT to pass a corrigendum order with a view to circumvent the jurisdictional issue. Making this request was in gross abuse of the process of law. If there was any time barring issue, the ACIT Mumbai ought to have asked his counterpart at Pune to whom the jurisdiction was transferred to take appropriate steps in the matter instead of taking steps to circumvent the jurisdictional issue.

iv) It does not befit the ACIT Mumbai to indulge in circumventing the provisions of law and his conduct has to be strongly condemned. Instead of bringing to book persons who circumvent the provisions of law, the CIT has himself indulged in circumventing the provisions of law which is totally disgraceful. The CIT ought not to have succumbed to the unjust demands of the ACIT and ought to have admonished the ACIT for making such an unjust request.

v) The CIT ought to have known that there is no provision under the Act which empowers the CIT to temporarily withdraw the order passed by him u/s. 127(2) for the sake of administrative convenience or otherwise. If the CIT was honestly of the opinion that the order passed u/s. 127(2) was required to be recalled for any valid reason, he ought to have issued notice to that effect to the assessee and passed an order after hearing it.

vi) Writ petition is allowed by quashing the impugned notice dated 30-03-2012. Though the CCIT agrees that the actions of CIT and ACIT are patently unjustified and not as per law, he has expressed his helplessness in the matter. It is expected that the CCIT shall take immediate remedial steps to ensure that no such incidents occur in the future. Department shall pay a cost of Rs. 10,000/- which may be recovered from CIT and ACIT.”

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Charitable Purpose – Application of income – Amounts transferred by the Mandi Samiti to the Mandi Parishad in accordance with the Adhiniyam constitutes application of income for charitable purposes.

[CIT v. Krishi Utpadan Mandi Samiti (2012) 348 ITR 566 (SC)]

Krishi Utpadan Mandi Samiti, a market committee incorporated and registered u/s. 12 of the Uttar Pradesh Krishi Utpadan Mandi Adhiniyam, 1964 (“the 1964 Adhiniyam” for short), carried out its activities in accordance with section 16 of the 1964 Adhiniyam, under which it is required to provided facilities for sale and purchase of specified agricultural produce in the market area. The members of the said market committee consisted of producers, brokers, agriculturists, traders, commission agents and arhatiyas. The source of income of the assessee was in the form of receipt collected as market fee from buyers and their agents, development cess on sale and purchase of agricultural products and licence fees from traders. U/s. 17(iv), the Mandi Samiti has to utilise the market committee fund the purpose of the 1964 Adhiniyam.

Under the 1964 Adhiniyam, broadly there are two distinct entities or bodies. One is Mandi Samiti (assessee) and the other is Mandi Parishad.

Section 26A of the 1964 Adhiniyam deals with establishment of the Mandi Parishad (Board). Under the 1964 Adhiniyam, the Board shall be a body corporate. Section 26A, inter alia, states that the Mandi Parishad (Board) shall have its own fund which shall be deemed to be a local fund and in which shall be credited all monies received by or on behalf of the Board, except monies required to be credited in the State Marketing Development Fund u/s. 26PP. U/s. 26PP, the State Marketing Development Fund has been established for the Mandi Parishad (Board) in which amounts received from the market committee u/s. 19(5) shall be credited. Section 19(5), inter alia, states that every market committee shall, out of its total receipts realised as development cess, shall pay to the Mandi Parishad (Board) contribution at a specified rate. The said payment from the Market Committee (Mandi Samiti) shall be credited to the State Marketing Development Fund u/s. 26PP. The State Marketing Development Fund shall be utilised by the Mandi Parishad (Board) for purposes indicated u/s. 26PP(2). Section 26PPP deals with establishment of Central Mandi Fund to which amounts specified in s/s. (1) shall be credited. Section 26PPP(2), inter alia, states that the Central Mandi Fund shall be utilised by the Mandi Parishad (Board) for rendering assistance to financially weak and underdeveloped market committees; that the funds would be used for construction, maintenance and repairs of link roads, market yards and other development works in the market area and such other purposes as may be directed by the State Government or the board.

The short question that arose before the Supreme Court was, whether transfer of amounts collected by Mandi Samiti to Mandi Parishad would constitute application of income for charitable purposes.

The Supreme Court noted that, both the Mandi Samiti and the Mandi Parishad were duly registered u/s. 12AA of the Income-tax Act, 1961 (“the 1961 Act”, for short). That, after the amendment of section 10(20) and section 10(29) by the Finance (No.2) 2 of 2002 with effect from 1st April, 2003, the words “local authority” had lost its restricted meaning and, therefore, the assessee (market committee) had to satisfy the conditions of section 12AA read with section 11(1)(a) of the 1961 Act, like any other body or person.

According to the learned senior counsel for the Department, in view of the said amendment, vide the Finance (No.2) Act of 2002, the assessee had to show that, during the relevant assessment year, income had been derived from property held under trust and that the said income stood applied to charitable purposes. According to the learned counsel, if one analysed the scheme of the 1964 Adhiniyam, it would become clear that the amounts transferred by the assessee to the Mandi Parishad could not constitute application of income for charitable purposes within the meaning of section 11(1)(a) of the 1961 Act in view of the fact that the assessee (Mandi Samiti) was only a conduit which collected Mandi shulk (fees) whereas utilisation of the said Mandi shulk was not by the assessee but is made by another entity, i.e., Mandi Parishad whose accounts were not verifiable and, therefore, according to the Department, such income would not get the benefit of exemption u/s. 11(1)(a) of the 1961 Act.

The Supreme Court held that u/s. 19(2) of the 1964 Adhiniyam, all expenditure incurred by the assessee in carrying out the purposes of the 1964 Adhiniyam (which includes advancing credit facilities to farmers and agriculturists as also construction of development works in the market area) had to be defrayed out of the market committee fund and the surplus, if any, had to be invested in such manner as may be prescribed. This was one circumstance in the 1964 Act to indicate application of income. Similarly, u/s. 19B(2) of the 1964 Adhiniyam, the assessee was statutorily obliged to apply the market development fund for the purposes of development of the market area. U/s. 19B(3), the assessee was statutorily obliged to utilise the amounts lying to the credit in the market development fund for extending facilities to the agriculturists, producers and payers of market fees. The market development fund was also to be statutorily utilised for development of market yards. Similarly, all contributions received by the market committee (Mandi Samiti) from the members u/s. 19(5) were to be statutorily paid by the market committee (assessee) to the Uttar Pradesh State Marketing Development Fund. These provisions indicated application of income of the assesee to the statutory funds set up under the 1964 Adhiniyam. According to the Supreme Court, keeping in mind the statutory scheme of the 1964 Adhiniyam, whose object falls u/s. 2(15) of the 1961 Act, there was no doubt that the assessee satisfied the conditions of section 11(1)(a) of the 1961 Act. The income derived by the assessee (which was an institution registered u/s. 12AA of the 1961 Act) from its property had been applied for charitable purposes, which includes advancement of an object of general public utility.

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Deduction of tax at sources – The Transaction of purchase of stamp papers at discount by the Stamp Vendors from the State Government is a transaction of sale and there is no obligation on the State Government to deduct tax at source u/s. 194 H on the amount of discount.

[CIT v Ahmedabad Stamp Vendors Association (2012) 348 ITR 378 (SC)]

The registered association of the stamp vendors of Ahmedabad approached the Gujarat High Court to quash the communication received from the Income Tax Department calling upon the State Government to deduct tax at source u/s. 194 H on commission or brokerage to the person carrying the business as “Stamp Vendors” and for a declaration that section 194H was not applicable to an assessee carrying on business as a stamp vendor.

The principal controversy before the High Court was whether the stamp vendors were agents of the State Government who were being paid commission or brokerage or whether the sale of stamp papers by the Government to the licensed vendors was on principal to principal basis involving the contract of sale.

The High Court after considering the Gujarat Stamps and Sales Rules, 1987, Gujarat Sales Tax Act, 1969 and the authorities cited held that the stamp vendors were required to purchase the stamp papers on payment of price less the discount on the principal to principal basis and there was no contract of agency at any point of time and that the discount made available to the licensed stamp vendors under the provisions of the Gujarat Stamps and Supply and Sales Rules, 1987, does not fall within the expression ‘commission’ or ‘brokerage’ u/s. 194H of the Act.

On appeal by the Department, the Supreme Court held that 0.50 % to 4 % discount given to the stamp vendors was for purchasing the stamps in bulk quantity and the said discount was in the nature of the cash discount. The Supreme Court concurred with the judgement of the High Court that the impugned transaction was a sale and consequently, section 194H had no application.

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(2012) 26 taxmann.com 265 (Mumbai Trib) Shrikant Real Estates (P.) Ltd. v ITO Assessment Year: 2008-09. Dated: 19-10-2012

Section 143(1), 154 – Keeping in mind the present system of e-filing, application u/s. 154 is maintainable in a case where assessee has not shown Short Term Capital Gain u/s. 111A in Schedule CG of e-return.

Facts:
For assessment year 2008-09, the assessee e-filed return which was revised by filing another e-return on 05.01.2009.

During the said year the assessee had short term capital gain of Rs. 2,65,853 which was chargeable at special rates u/s. 111A. In the returns, the assessee had at Item No. 3(a)(i) inadvertently/due to clerical error mentioned the amount as Nil but at the same time in item no. 3(a)(ii) and 3(a)(iii) short term capital gain of Rs. 2,65,853 was shown. Also in Schedule CG–Capital Gains on page 19 of e-return shown short term capital gain at item no. 6 but due to inadvertence/clerical error at item No. 7 – Short Term Capital Gain u/s. 111A included in 6 above the amount was stated to be Nil.

In the intimation received by the assessee, short term capital gain was charged to tax at normal rates instead of rate mentioned u/s. 111A. The assessee’s application u/s. 154 to rectify this was rejected on the ground that the assessee ought to have rectified the mistake in the returns by filing a revised return and this mistake is not rectifiable u/s. 154 of the Act.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that in the present system of e–filing of return which is totally dependent upon usage of software, it is possible that some clerical errors may occur at the time of entering the data in the electronic form. The return is prepared electronically which is converted into an XML file either through the free downloaded software provided by CBDT or by the software available in the market. In either of the case, there is every possibility of entering incorrect data without the expert knowledge of preparing an XML file. The Tribunal also noted that the assessee had under Schedule SI – income chargeable to income-tax at special rate IB which is at internal page 24 of the return shown short term capital gains at Rs 2,65,853 and tax thereon @ 10% to be Rs 26,585. The Tribunal directed the AO to rectify intimation u/s. 143(1) and to charge tax on short term capital gains @ 10%.

The appeal filed by the assessee was allowed.

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(2012) 27 taxmann.com 104 (Chennai Trib) ACIT v C. Ramabrahmam Assessment Year: 2007-08. Dated: 31-10-2012

Section 24, 48 – Interest on loan taken for acquisition of property can be regarded as cost of acquisition even though the same has been claimed as deduction u/s. 24 in earlier years.

Facts:
During the previous year relevant to the assessment year under consideration, the assessee returned capital gain arising on transfer of house property. While computing such capital gain, the assessee had regarded interest on loan taken in 2003 for purchasing the property as forming part of cost of acquisition of the property. In the course of assessment proceedings, the Assessing Officer (AO) noticed that the amount of interest which has been regarded as cost of acquisition had already been claimed as deduction u/s. 24(b). He was of the view that since the amount of interest was already claimed u/s. 24(b) the same could not again be allowed u/s. 48. He added the amount of interest to the income of the assessee from short term capital gains.

Aggrieved, the assessee preferred an appeal to the CIT(A) who allowed the assessee’s appeal and held that the assessee was entitled to include interest amount for computation u/s. 48 despite the fact that the same had been claimed u/s. 24(b) while computing income from house property.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that admittedly the loan was taken to acquire house property and the deduction allowed u/s. 24(b) was in accordance with the statutory provisions. Upon going through the provisions of section 48 the Tribunal held that the deduction u/s. 24(b) and computation of capital gains u/s. 48 are altogether covered by different heads of income i.e. `income from house property’ and `capital gains’. A perusal of both the provisions makes it unambiguous that none of them excludes operation of the other. The Tribunal held that it did not have the slightest doubt that interest in question was indeed an expenditure in acquiring the asset. Since both the provisions are different, the assessee was held to be entitled to include interest amount at the time of computing capital gains u/s. 48 of the Act. CIT(A) was right in accepting the contention of the assessee and deleting the addition made by the AO.

The appeal filed by the revenue was dismissed.

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Controversy on taxability of cross-border software payments

Introduction:

Section 4 and section 5 r.w.s. 9(1)(vi) of the Incometax Act, 1961 (the Act) provide for taxability of income from royalty in India. Section 9(1)(vi) of the Act by a deeming fiction provides for the taxation of income from royalty in India. Explanation 2 to section 9(1)(vi) of the Act defines the word ‘royalty’, which is wide enough to cover both industrial royalties as well as copyright royalties, both being forms of intellectual property. Computer software is regarded as an ‘industrial royalty’ and/or a ‘copyright royalty’. Industrial properties include patents, inventions, process, trademarks, industrial designs, geographic indicators of source, etc. and are generally granted for an article or for the process of making such article, on the other hand, copyright property includes literary and artistic works, plays, films, musical works, knowledge, experience, skill, etc. and are generally granted for ideas, principles, skills, etc.

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

The controversy on taxability of cross-border software payments basically relates to characterisation of the income in the hands of the non-resident payee. The controversy, sought to be discussed here, revolves around the issue “whether the payment received by non-resident for giving licence of the computer software, popularly known as ‘sale of software’, is chargeable to tax as ‘royalty’, or it is a ‘sale’. The Revenue holds such sales to be royalty on the ground that during the course of sale of computer software, computer program embedded in it is also licensed and/or parted with the end-user of the software, and as against the claim of the taxpayers who treat the transaction as one of transfer of ‘copyrighted article’ and not transfer of the right in the copyright or licence of the software. Typically the tax authorities seek to tax these payments in the hands of non-residents as royalty and subject the same to withholding taxes. The non-resident payees seek to label such receipts as business income not chargeable to tax, in the absence of a Permanent Establishment in India. Taxability of software-related transaction depends upon the nature and extent of rights granted or transferred under the particular arrangement regarding use and exploitation of the program.

Determining the taxability of any cross-border software transaction involves an understanding and analysis of the following aspects:

I. Definition and classification of Computer Software;
II. Definitions of Royalty under the Act and Double Tax Avoidance Agreement (DTAA);
III. Relevant provisions of the Copyright Act, 1957;
IV. OECD Commentary on Software Payments; and
V. Key judicial and advance rulings.

I. Definition and classification of Computer Software

Definition: Income-tax Act: Explanation 3 to Section 9(i)(vi) of the Act defines ‘Computer Software’ to mean any computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program or any customised electronic data.

Copyright Act: Under the Indian Copyright law (Copyright Act, 1957), computer program and computer databases are considered literary works.

Section 2(ffc) defines ‘Computer Programme’ as a set of instructions expressed in words, codes, schemes or any other form, including a machine-readable medium, capable of causing a computer to perform a particular task or achieve a particular result.

Commentary on Article 12 of the OECD Model Convention describes software as a program, or series of programs, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software).

The New Oxford Dictionary for the Business World defines ‘software’ as programs used with a computer (together with their documentation), including program listings, program libraries, and user and programming manuals.

Typical Business Model relating to computer software:

Single End-user model — Foreign Company supplies a single copy of the software to the end-user.

Distributor Model — Foreign Company either supplies soft copies to an independent distributor in India for onward distribution to Indian customers either directly or through distribution channels or supplies a single copy of the software to a distributor in India who is given the licence to make copies and distribute soft copies to the customers.

Multiple-user licence model — Foreign Company supplies a single disk containing the software program to an Indian Company with a right to make copies of the software and distribute to in-house end users.

Customised model — Foreign Company customises the software as per Indian buyer’s requirements/ specifications — Enterprise Resource Planning software.

Software embedded in hardware — Foreign Company supplies integrated equipment (software bundled with hardware).

Cost contribution model — Foreign Company incurs expenditure for installation and maintenance of software system for the benefit of the group companies. It provides access to such Indian group company to use the system and recharges the cost on the basis of use of the system.

Electronic model — Payment to Foreign Company for purchase of software through electronic media.

Payment to Foreign Company for provision of services for development or modification of the computer program (incl. for upgradation, training, installation, maintenance, etc.).

Payment to Foreign Company for know-how related to computer programming techniques.

Definition of Royalty

Under the Act:Explanation 2 to Section 9(i)(vi) of the Act defines the term ‘Royalty’ to mean consideration for:(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trademark or similar property;

(ii) …………….
(iii) …………….
(iv) …………….
(v) …………….
(vi) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or

(vii) the rendering of any services in connection with the activities referred to above in subclauses (i) to (iv), (iva) and (v).

Under the DTAA:
Most DTAAs define the term ‘royalty’ to mean:

(i) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience; and

(ii) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise of a Contracting State from the operation of ships or aircraft in international traffic.

III. Relevant provisions of the Copyright Act, 1957

Section 2(o): Literary Work

includes computer programs, tables and compilations including computer databases.

Section 14: Meaning of Copyright:

Copyright means the exclusive right, subject to the provisions of this Act, to do or authorise the doing of any of the following acts in respect of a work or any substantial part thereof, namely;

(i) in the case of a literary, dramatic or musical work, not being a computer program —

(a)    to reproduce the work in any material form including the storing of it in any medium by electronic means;
(b)    to issue copies of the work to the public and not being copies already in circulation;
(c)    to perform the work in public, or communicate it to the public
(d)    to make any cinematograph film or sound recoding in respect of the work
(e)    to make any translation of the work
(f)    to make any adaptation of the work
(g)    to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses

(i) to (vi).

(ii) in the case of computer program —

(a)    to do any of the acts specified in clause (a) above;
(b)    to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer program
(c)    No copyright except as provided in this Act, i.e., Copyright does not extend to any right beyond the scope of section 14.

Section 52: Certain acts not to be infringement of copyright.

(1) The following act shall not constitute an infringement of copyright, namely:

(a) …………

(aa) The making of copies or adaptation of a computer program by a lawful possessor of a copy of such computer program, from such copy —

a) In order to utilise the computer program for the purpose for which it was supplied; or
b) To make back-up copies purely as a tem-porary protection against loss, destruction or damage in order only to utilise the computer program for the purpose for which it was supplied.

IV. OECD on Software Payments

The 1992 OECD Model Convention (MC):

(1)    Following a survey in the OECD member states, the question of classification of computer software was first considered in 1992 and accordingly revision made in the Commentary to the OECD Model Convention on Article 12.
(2)    Software was generally defined as a program, or a series of program, containing instructions for a computer either for the computer itself or accomplishing other tasks. Modes of media transfer were also discussed.
(3)    Acknowledged that OECD member countries typically protect software rights under copyright laws.
(4)    Different ways of transfer of software rights e.g., Alienation of entire rights, alienation of partial rights (sale of a product subject to restrictions on the use).

The taxability was analysed under 3 situations:

First situation: Payments made where less than full rights in the software are transferred:

In a partial transfer of rights the consideration is likely to represent a royalty only in very limited circumstances.

One such case is where the transferor is the author of the software and alienates part of his right in favour of a third party to enable the latter to develop or exploit the software itself commercially — for example by development and distribution of it.

In other cases, acquisition of the software will generally be for personal or business use of the purchaser and will be business income or independent personal services. The fact that software is protected by copyright or there are end use restrictions is of no relevance.

Second situation: Payments made for alienation of Complete Rights attached to the software:

Payments made for transfer of a full ownership cannot result in royalty.

Difficulties can arise where there are extensive transfer of rights, but partial alienation of rights involving:

exclusive right of use during a specific period
or in a limited geographical area.
additional consideration related to usage.
consideration in the form of substantial lump-sum payment.

Subject to facts, generally such payments are likely to be commercial income or capital gains rather than royalties.

Third situation: Software payments under mixed contracts:

Examples include sale of computer hardware with built-in software with concessions of the right to use software with provision for services.

In such a scenario, it was felt that the consideration be split on the basis of information contained in the contract or by a reasonable apportionment with the appropriate tax treatment being applicable to each part.

Thus for the first time these three situations were envisaged by the OECD in its 1992 MC.

2000 OECD MC brought in further refinements to the earlier positions.

It acknowledged that software can be transferred as an integral part of computer hardware or in independent form available for use with various hardware. For the first time, the 2000 MC suggested a distinction between a copyright in the program and software which incorporates a copy of the copyrighted program. The transferee’s rights will in most cases consist of partial rights or complete rights in the underlying copyright or they may be rights partial or complete in a copy of the program. — It does not matter, if such copy is provided in a material medium, or electronically. Payments made for acquisition of partial rights in the copyright will represent ‘royalty’ only if consideration is for granting of rights to use the program that would, without such licence, constitute an infringement of copyright.

The 2000 MC also throws light on rights to make multiple copies for operation within its own business and these are commonly referred to as ‘site licences’, ‘enterprise licences’, or ‘network licences’. If these are for the purposes of enabling the operation of the program on the licensee’s computers/network and reproduction for any other purpose is not permitted, payments for such arrangements would not be reckoned as royalty, but may be business profits.

2008 MC to the OECD Model expanded the scope of software payments by including transactions concerning digital products such as images, sounds or text. The downloading of images, sounds or text for the customers own use or enjoyment is not royalty as the payment is essentially for acquisition of data transmitted digitally. However, if the essential consideration for the payment for a digital product is the right to use that digital product, such as to acquire other types of contractual rights, data or services, then the same would be characterised as royalty.

Example a book publisher, who would download a picture and also acquire the right to reproduce that picture on the cover of a book that it is producing.

India’s position on OECD: India reserves its position on the interpretations provided in the OECD MC and is of the view that some of the payments referred therein may constitute royalties.

Issues in the controversy:
(1) Whether payment for purchase of computer software is payment for ‘goods’ or payment for ‘royalty’?

(2) Whether payment for computer software can be said to be payment for ‘use of process’ as referred to in clauses (i), (ii) and (iii) of the royalty definition in the Act?

(3) Whether payment for computer software is for ‘right to use the copyright in a program’ or ‘right to use the program only’? [Copyright v. Copyrighted Article]

(4) Whether mere grant of non-exclusive licence would fall within the ambit of ‘royalty’ definition under the Act? [Ref. clause (v) of the royalty definition in the Act which also includes the phrase ‘granting of a licences’]

(5) Whether payment for computer software can be said to ‘impart information concerning technical, industrial, commercial or scientific knowledge’ and hence falling under clause (iv) of the royalty definition under the Act?

(6) Section 115A prescribes the rate of tax applicable to a foreign company on income by way of ‘royalty’ or ‘fees to technical services’. Whether as per section 115A(1A) of the Act, it is not necessary that copyright therein should be specifically transferred as consideration in respect of any computer software is stated to be taxable u/s.115A?

V. Key judicial and advance rulings

CIT v. Samsung Electronics Co. Ltd., 64 DTR (Kar.) 178

Facts:

The assessee was engaged in the development and export of computer program. The assessee imported ‘shrinkwrapped’/‘off-the-shelf’ software from suppliers in foreign countries for use in its business and made payment for the same without deducting tax at source u/s.195.

Ruling of the High Court:

U/s.9(1)(vi) of the Act and Article 12 of the DTAA, “payments of any kind in consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work” is deemed to be ‘royalty’.

It is well settled that in the absence of any definition of ‘copyright’ in the Act or DTAA with the respective countries, reference is to be made to the respective law regarding definition of Copyright, namely, the Copyright Act, 1957, in India, wherein it is clearly stated that ‘literary work’ includes computer programs, tables and compilations including computer (databases).

On reading the contents of the respective agreement entered with the non-resident, it is clear that under the agreement, what is transferred is a right to use the copyright for internal business by making copies and back-up copies of the program.

The amount paid to the supplier for supply of the ‘shrinkwrapped’ software is not the price of the CD alone nor software alone nor the price of licence granted. It is a combination of all. In substance unless a licence was granted permitting the end-user to copy and download the software, the CD would not be helpful to the end-user.

There is a difference between a purchase of a book or a music CD, because while these can be used once they are purchased, software stored in a dumb CD requires a licence to enable the user to download it upon his hard disk, in the absence of which there would be an infringement of the owner’s copyright. Therefore, there is no similarity between the transaction of a computer program and books.

The decision of the Supreme Court in case of TCS v. State of AP, (271 ITR 404) distinguished as being in the context of sales tax.

Thus, held that the payments made in respect of computer program would constitute ‘royalty’ under the applicable DTAA and would also fall within the ambit of ‘royalty’ under the broader definition in the Act. Thus, the assessee would be required to deduct tax on the payment made in respect of computer programs.

Further, the Karnataka High Court in case of CIT v. M/s. Wipro Ltd., (ITA No. 2804 of 2005) has also held that payment for subscription/access to database is payment for licence to use the copyright hence taxable as ‘royalty’.

Director of Income-tax v. Ericsson Radio System AB, (ITA No. 504 of 2007) (Delhi High Court)

Facts:

The assessee, a Swedish company, entered into con-tracts with ten cellular operators for the supply of hardware equipment and software. The installation and testing were done in India by the assessee’s group entities.

The contracts were signed in India. The supply of the equipment was on CIF basis and the assessee took responsibility thereof till the goods reached India. The assessee claimed that the income arising from the said activity was not chargeable to tax in India.

The Assessing Officer and the Commissioner of Income-tax (Appeals) held that the assessee had a ‘business connection’ in India u/s.9(1)(i) and a ‘permanent establishment’ under Article 5 of the DTAA. It was also held that the income from supply of software was assessable as ‘royalty’ u/s.9(1)(vi) and Article 13. On appeal, the matter was referred to Special Bench of the Tribunal. The Tribunal held that as the equipment had been transferred by the assessee offshore, the profits therefrom were not chargeable to tax. It also held that the profits from the supply of software were not assessable to tax as ‘royalty’ either under the Act or DTAA with Sweden.

Aggrieved by the common order of the Special Bench in case of Motorola Inc. 95 ITD 269 (Del.) (SB), which also covered the case of Ericsson, the Tax Authority filed an appeal before the High Court.

Ruling of the High Court:

The profits from the supply of equipment were not chargeable to tax in India because the property and risk in goods passed to the buyer outside India. The assessee had not performed installation service in India.

The argument that the software component of the supply should be assessed as ‘royalty’ is not acceptable because the software was an integral part of the GSM mobile telephone system and was used by the cellular operator for providing cellular services to its customers.

Software was embedded in the equipment and could not be independently used. It merely facilitated the functioning of the equipment and was an integral part thereof. The Tax Authority accepts that it could not be used independently. The fact that in the supply contract, the lump -sum price was bifurcated is not material. The same was only because differential customs duty was payable.

To qualify as royalty, it is necessary to establish that there is transfer of all or any right (including the granting of any licence) in respect of copy right of a literary, artistic or scientific work. Section 2(o) of the Copyright Act makes it clear that a computer program is to be regarded as a ‘literary work’. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the present case, this has not been established. It is not even the case of the Revenue that any right contem-plated u/s.14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the supply contract.

A distinction has to be made between the acquisition of a ‘copyright right’ and a ‘copyrighted article’. The submissions made by the assessee on the basis of the OECD commentary are correct.

Even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below section 9(1)(vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in Article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what are contemplated are a payment that is dependent upon user of the copyright and not a lump-sum payment as is the position in the present case.

The payment received by the assessee was towards the title of the equipment of which software was an inseparable part incapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment could be classified as payment towards royalty.

Solid Works Corporation, ITA No. 3219/Mum./2010 (Mum. Tribunal), dated 8-2-2012

Recently the Mumbai ITAT on the issue of characterisation of shrinkwrapped computer software in the case of Solid Works Corporation (Taxpayer) has held that the consideration received by the taxpayer for the shrinkwrapped software is not ‘royalty’ under the provisions of the India-USA DTAA, but business receipts.

While arriving at its decision, the ITAT relied on the favourable view taken by the Delhi High Court in the case of Ericsson, after considering the decision of the Karnataka High Court in the case of Samsung (supra).

It may be noted that the ITAT has also accepted the argument of the taxpayer that when two views are available, the one favourable to the taxpayer should be followed. This principle should apply even to a non-resident in view of the non-discrimination article in the DTAA.

This ruling should be helpful, especially to taxpayers coming within the jurisdiction of the Mumbai ITAT, and is likely to have persuasive value in case of other neutral jurisdictions (i.e., other than the jurisdiction of the Karnataka High Court), in defending the tax position that is taken based on whether a transaction is a ‘copyright right’ or a ‘copyrighted article’.

Further, the Mumbai Tribunal in the following cases had ruled the issue in favour of the taxpayer by following the Special Bench decision in case of Motorola Inc.:

Kansai Nerolac Paints Ltd. v. Addl. DIT, 134 TTJ 342 (Mum.)

DDIT v. M/s. Reliance Industries Ltd., 43 SOT 506 (Mum.)

Addl. DIT v. Tata Communications Limited, 2010 TII 157 ITAT-Mum.

Controversy before the AAR:

The Authority for Advance Rulings (‘AAR’) recently in its ruling in the case of Citrix Systems Asia Pacific Pty. Limited (AAR No. 882 of 2009) and Millennium IT Software Ltd., 338 ITR 391 had an occasion to deal with the aforesaid issue under consideration, wherein the AAR while deciding against the taxpayer’s contention, held that the income from the transaction be regarded as a royalty, liable to tax in India. In deciding the issue in this case the AAR gave findings that were contrary to its own findings on the subject given in the earlier decisions in the cases of Dassault Systems K. K., 322 ITR 125 and FactSet Research Systems Inc., 317 ITR 169.

Citrix Systems Asia Pacific Pty. Limited (AAR):

In this case, the AAR held that the payment received from Indian distributor under software distribution agreement is taxable as royalty u/s.9(1)(vi) of the Act as well as Article 12 of the India-Australia DTAA. It also observed that sale/licence to use software entails transfer of rights in copyrights embedded in software. The AAR took a contrary view to its earlier ruling in the case of Dassault Systems and refused to rely on the Delhi HC ruling in the case of Ericsson (supra), thereby following the ruling in the case of Millennium IT Software and the Karnataka HC in the case of Samsung (supra).

It is interesting to note that the Chairman of the AAR has mentioned in the ruling of Citrix that the differing views on the issue can get resolved and the matter can be set at rest only by a decision of the Supreme Court, laying down the law finally, to be followed by all the Courts and Tribunals including the AAR. Only an authoritative pronouncement by the Apex Court can settle this controversy.

Millennium IT Software’s case:

In this ruling, the AAR held that the licence fees paid for use of ‘Licenced Program’ is taxable as ‘royalty’ under clause (v) of Explanation 2 to section 9(1)(vi) of the Act and Article 12 of the India-Sri Lanka DTAA. Thus the provisions of withholding tax u/s.195 are applicable to the applicant. The AAR’s ruling was based on the ruling of the Delhi ITAT in the case of Gracemac Corporation v. DIT, (42 SOT 550).

The said Delhi ITAT ruling has been distinguished by the Mumbai ITAT in the case of TII Team Telecom Inter-national Pvt. Ltd., 60 DTR 177. Also, the Mumbai ITAT has distinguished the AAR ruling of Millennium in the case of Novel Inc. (ITA No. 4368/Mum./2010) where income of non-resident from re-selling of software via Indian distributor was held as not taxable.

Conclusion:

The issue under consideration is otherwise a multi-faceted issue and has several dimensions which are sought to be addressed through a few questions and answers thereon. An analysis of the above-discussed important decisions rendered in the context of software/ use of technology-related payments give rise to the following open-ended questions before the taxpayers:

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

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

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

Whether the payment made in relation to shrink-wrapped/off-the-shelf software would constitute payment for a copyright, would need to be determined as per section 14 of the Copyright Act, 1957?

Where there is any distinction between a copyright v. copyrighted article in light of the decision of the Karnataka High Court in the case of Samsung Electronics?

Whether in case of bundled contract i.e., software supplied along with hardware, any bifurcation can be made between the payments made for software and hardware?

Whether every payment made by the taxpayer for use of computer program would constitute ‘royalty’ under the Act and relevant DTAA?

Is the position under the DTAA stronger than un-der the Act as the definition of royalty under the DTAA is restrictive than under the Act?

What would be the position, where the DTAA between two Contracting States specifically cover the payments for computer software program within the ambit of taxation as royalty, vis-à-vis the DTAA where such inclusion is not there.

Key takeaways:

The ruling of the Karnataka High Court in the case of Samsung would have significant tax implications on the industries operating under jurisdiction of the Karnataka High Court dealing in computer software/ other technology. The Delhi High Court in the case of Ericsson Radio System A.B., New Delhi having upheld the decision of the Special Bench on this issue, could help the taxpayers to reinforce its position on this contentious issue before various Tribunals (except Bangalore Tribunal). Although, the AAR rulings in the case of Dassault, Geo quest, Citrix’s and Millennium are applicable only to the applicant and Tax Department, they have persuasive value.

Analysis of Finance Bill, 2012 — Proposals:

Controversy revolving around the tax-ability of software payments, is sought to be resolved by amendment to section 9(1)(vi) of the Act. The Finance Bill, 2012 has proposed to insert Explanation 4 and Explanation 5 to the section 9(1)(vi) with retrospective effect from 1st June 1976. The definition of the royalty in Explanation 2 is sought to be expanded by these two explanations.

Explanation 4 clarifies that the transfer of all or any rights in respect of any right, property or information includes transfer of all or any right for use or right to use a computer software (including granting of a licence), irrespective of the medium through which such right is transferred.

Implications of Explanation 4:

By insertion of proposed Explanation 4 to section 9(1) (vi) the controversy surrounding taxability of software payment by characterising it as royalty is sought to be put at rest. The main issue would be whether by inserting Explaination and expanding the scope of the definition ‘royality’ by way of clarificatory retro-spective amendment, can a payment for software be brought to tax?

The dispute was whether by making a payment for software, the licensee gets rights in the ‘copyright’ of the software. It appears that it is felt by the law-makers that by specifically inserting payment for software itself in the definition of royalty, this purpose will be achieved. The moot question however is, whether it can be done retrospectively from 1 June 1976?

Further, Explanation 5 clarifies that royalty includes consideration in respect of any right, property or information whether or not the payer has the possession or control of it, the payer is using it directly or such right, etc. are located outside India.

Implications of Explanation 5:

Explanation 5 seeks to clarify that once a right, property or information is deemed to be covered under Explanation 2 read with Explanation 4 to the section 9(1)(vi), the interpretation would continue to remain so, irrespective of possession or control of the right, property or information, direct or indirect use of the right, property or information or location of the right, property or information.

While it remains to be seen how Explanation 5 will be interpreted by the Courts. It would not be correct to say that on fulfilment of the situations laid down in Explanation 5, the taxability of sale of software is, per se, attracted.

Existence of beneficial treaty provisions:

As mentioned above, the payment for the sale or licence of software, would now get covered u/s. 9(1) (vi), if provisions of the Act are to be applied. However, if the provisions of the treaty are beneficial than the provisions of section 9(1)(vi), still it will be possible to contend that payment for software as per the provisions of the treaty is not liable to tax in India. Further, out of several treaties signed by India, only in 4 to 5 treaties, namely, Morocco, Rus-sia, Turkmenistan, Malaysia and Tobago specifically payment for software is covered as part of royalty. Therefore, it will still be a good case to argue that in case of, off-the-shelf or standardised software are not chargeable to tax in India except where as per treaty it is specifically covered.

It is, therefore, important to note here that the taxpayers who are entitled to claim benefit of tax treaty will still be able to take shelter under the beneficial treaty provisions as the scope of provisions (generally Article 12) under the treaty is restricted than under the Act.

Way forward:

It is learnt that the taxpayer has filed an SLP against the Karnataka High Court ruling in the case of Samsung Electronics Company Ltd. in December 2011 which is yet to be admitted. The SC has reacted that adjudication on this issue is going to be the next big thing after Vodafone judgment.

The proposed amendment, as mentioned above, may resolve the controversy in respect of future transactions, however, whether the amendment will apply retrospectively or not will be a matter of debate and litigation. So in cases where applicable the treaty does not specifically cover the software, the non-taxability could be claimed.

Hence, till the time, the issue gets settled at the highest level, litigation over taxability of software payments is likely to continue. So let’s WAIT & WATCH.

Year of	Decision in the case of	Authority	Jurisdiction	Favourable	Against
judgment

2004	Tata Consultancy Services	Supreme	—	3
		Court

2004	Wipro Ltd.	ITAT	Bangalore	3

2005	Motorola Inc.	Special	Delhi	3
		Bench ITAT

2005	Lucent Technologies Hindustan Ltd.	ITAT	Bangalore	3

2005	Samsung Electronics Company Ltd.	ITAT	Bangalore		3

2005	Sonata Software Ltd.	ITAT	Bangalore	3

2006	Hewlett-Packard (India) (P) Ltd.	ITAT	Bangalore	3

2006	Sonata Information Technology Ltd.	ITAT	Bangalore	3

2006	IMT Labs (India) Pvt. Ltd.	AAR	—		3

2006	Metapath Software International Ltd.	ITAT	Delhi	3

2008	Airports Authority of India	AAR	—		3

2009	FactSet Research Systems Inc.	AAR	—	3

2009	Samsung Electronics	High Court	Karnataka		3

2010	Lotus Development (Asia Pacific) Ltd. Corp.	ITAT	Delhi	3

2010	Microsoft Corporation and
	Gracemac Corporation	ITAT	Delhi		3

2010	Reliance Industries Ltd.	ITAT	Mumbai	3



2010	M/s. Tata Communications Ltd.	ITAT	Mumbai	3

2010	M/s. Daimler Chrysler AG	ITAT	Mumbai	3

2010	Dassault Systems K.K.	AAR	—	3

Year of	Decision in the case of	Authority	Jurisdiction	Favourable	Against
judgment

2010	GeoQuest Systems BV	AAR	—	3

2010	Velankani Mauritius Ltd.	ITAT	Bangalore	3

2010	Kansai Nerolac Paints Ltd.	ITAT	Mumbai	3

2010	Bharati AXA General Insurance Co. Ltd.	AAR		3

2011	Asia Satellite Co. Ltd.	High Court	Delhi	3

2011	Dynamic Vertical Software India Pvt. Ltd.	High Court	Delhi	3

2011	Standard Chartered Bank Ltd.	ITAT	Mumbai	3

2011	ING Vysya Bank Ltd.	ITAT	Bangalore		3

2011	TII Telecom International Pvt. Ltd.	ITAT	Mumbai	3

2011	M/s. Abaqus Engineering Pvt. Ltd.	ITAT	Chennai	3

2011	Millennium IT Software	AAR	—		3

2011	Samsung Engineering Company Limited	High Court	Karnataka		3

2011	Novel Inc. (Mum.)	ITAT	Mumbai	3

2011	Lucent Technologies	High Court	Karnataka		3

2011	Ericsson Radio System AB	High Court	Delhi	3

2012	Solid Works Corporation	ITAT	Mumbai	3

2012	Citrix Systems Asia Pacific Pty. Limited	AAR			3

2012	Acclerys K. K.	AAR	—		3

2012	People Interactive (I) P. Ltd.	ITAT	Mumbai	3

shailesh.kwebmaker

Sections 200(3), 272(2)(k), Rule 31A — When assessee derives no benefit from failure to file e-TDS return, no penalty is called for. In a case where assessee has deposited TDS on time but failed to file e-TDS return because of delay in collecting PANs from landowners, such breach is only technical in nature and no penalty is warranted.

38. (2012) TIOL 399 ITAT-Mum.
The Collector, Land Acquisition Department of Industries and Commerce v. Addl. CIT (TDS)
A.Ys.: 2007-08 to 2010-11. Dated: 9-3-2012

Sections 200(3), 272(2)(k), Rule 31A — When assessee derives no benefit from failure to file e-TDS return, no penalty is called for. In a case where assessee has deposited TDS on time but failed to file e-TDS return because of delay in collecting PANs from landowners, such breach is only technical in nature and no penalty is warranted.

Facts:

The Person Responsible (PR) in respect of Collector, Land Acquisition, Department of Industries & Commerce, Punjab Chandigarh (PR) had not filed e-TDS quarterly returns on respective due dates and so had defaulted u/s.200(3) of the Act. In response to the show-cause notice issued by the Assessing Officer, the PR submitted that the delay was due to landowners not having submitted their PAN numbers and therefore the delay was for a reasonable cause and no penalty could be levied. The AO rejected this explanation and held PR to be an assessee in default and levied penalty u/s.272A(2) (k) of Rs.6,11,600.

Aggrieved, the PR filed an appeal to the CIT(A) and contended that the interest on compensation was disbursed to landowners not directly but was deposited in the District/High Courts and as per guidelines issued for submission of e-TDS quarterly returns Form No. 26Q with less than 70% PAN data was not accepted for quarter ended 30-9-2007. Since PAN data was not available with PR, the quarterly returns could not be filed. The CIT(A) upheld the order passed by the AO. Aggrieved, the assessee preferred an appeal to the Tribunal

Held:

The Tribunal noted that the Collector, Land Acquisition, Department of Industries is a government organisation acquiring land on behalf of Punjab Government. The land compensation is paid by the organisation to the landowners through the District/High Courts. The tax is deducted at source on the interest payment to the landowners, but the compensation and interest is deposited in the Court and not paid directly to the landowners. The landowners/agriculturists do not have PAN numbers. The Department was not able to find PAN numbers of these landowners.

Letters written to the landowners to furnish their PAN Numbers, at the available address, but no response was received due to improper addresses. The amount of tax was deducted at source and paid to the credit of the Government on time. The Tribunal held that the assessee was prevented by sufficient cause from filing the returns within the statutory period. Nonfiling of quarterly returns was only a technical and venial breach to the provisions contained in Rule 31A(2). Even otherwise also, the assessee did not derive any benefit whatsoever by not filing the e-TDS returns in time, as the amount of TDS was duly deposited in the Government Treasury within prescribed time. Such delay has not caused any loss to the Revenue/ Income-tax Department. The Tribunal cancelled the penalty levied by the AO. The appeals filed by the assessee were allowed.

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shailesh.kwebmaker

Sections 143(3), 147, 254 — In an assessment completed u/s.143(3) r.w.s. 254, the AO should confine himself to the directions issued by the Tribunal. He does not have jurisdiction to go beyond the directions given by the Tribunal.

37. (2012) TIOL 383 ITAT-Mum.
Ambattur Flats Ltd. v. ITO
A.Y.: 2001-02. Dated: 22-5-2012

Sections 143(3), 147, 254 — In an assessment completed u/s.143(3) r.w.s. 254, the AO should confine himself to the directions issued by the Tribunal. He does not have jurisdiction to go beyond the directions given by the Tribunal.

Facts:

For A.Y. 2001-02, the original assessment of the assessee-firm, engaged in the business as builder and developer, was completed by estimating the income at 8% of the total contract receipts of Rs.94,57,500.

The assessment was subsequently reopened and in an order passed u/s.143(3) r.w.s. 147 of the Act, the total income was determined at Rs.28,11,700. This income was determined by the AO by adopting a profit rate of 20% of the gross profit. Aggrieved by the order passed u/s.147, the assessee preferred an appeal to the CIT(A) who gave a deduction of Rs.20,00,000 towards cost of land. The total income was modified at Rs.16,12,679. The assessee accepted the order of the CIT(A) but the Revenue preferred an appeal to the Tribunal.

The Tribunal found that the issue about cost of land was never raised before the AO and there was no discussion in the order of the AO on this issue. The Tribunal remitted the issue of deducting the cost of land to the AO and directed him to make necessary adjustments in accordance with law. In proceedings initiated u/s.254 and completed u/s.143(3), the AO collected evidences from sellers and accepted the contention of the assessee that it has incurred Rs.20 lakh towards purchase of land. However, he went further and reworked the profit and ultimately determined the income of the assessee at Rs.32,69,228.

Aggrieved by the order passed u/s.143(3) r.w.s. 254, the assessee preferred an appeal to the CIT(A) who held that the AO was justified in estimating the profit at 12%, which was also the rate adopted by the CIT(A) earlier.

Aggrieved the assessee preferred an appeal to the Tribunal.

Held:

The Tribunal noted that the single issue was remitted back by the Tribunal to the file of the AO. Having examined the issue remitted and having concluded that the assessee’s contention on the issue remitted was to be accepted the AO should have stopped there. The Tribunal observed that the action of the AO in going further and reworking the profit was against law. It held that in an order passed u/s.143(3) r.w.s. 254, the AO should confine himself to the directions issued by the ITAT. He does not have jurisidction to go beyond the direction given by the Tribunal.

Since the AO had gone beyond the direction of the Tribunal and had redetermined the income, the Tribunal held the order passed by the AO to be contrary to law and set aside the same. The order of the CIT(A) was vacated. The Tribunal remitted the matter to the AO to determine the income at Rs.16,12,679 as detemined by the CIT(A) and to close the file. The Tribunal allowed the appeal filed by the assessee.

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shailesh.kwebmaker

Section 194C — Where the arrangement was more of a sharing of fees under contract, provisions of section 194C cannot be applied. Section 36(1)(ii) — Bonus paid to directors could not have been otherwise paid as dividend. Hence provisions of section 36(1)(ii) cannot be applied. Income v. receipt — Only that part of the receipt as has accrued during the year should be taxed as income.

36. (2011) 131 ITD 414 (Delhi)
Career Launcher (India) Ltd. v. ACIT,
Circle 3(1), New Delhi
A.Ys.: 2005-06 & 2006-07. Dated: 27-12-2010

Section 194C — Where the arrangement was more of a sharing of fees under contract, provisions of section 194C cannot be applied.

Section 36(1)(ii) — Bonus paid to directors could not have been otherwise paid as dividend. Hence provisions of section 36(1)(ii) cannot be applied.

Facts:

The assessee was into the business of running coaching classes. The assessee had entered into standardised agreements with various persons willing to run similar coaching classes in form of franchisees. The franchisees were allowed to use the trademark, tradename and course material belonging to the assessee, in lieu of which assessee received an amount equal to 25% of the net value earned from the operations. The assessee showed ‘Franchisee payments’ under the head ‘administrative and other expenses’. The Revenue held that payment made by the assessee to the franchisees was in nature of payment to contractor/sub-contractor and hence provisions of section 194C were applicable. Resultantly, the expenses were disallowed u/s.40(a) (ia). The CIT(A) upheld the order.

Held:

As per the agreement, the franchisees make payment to the assessee and not the other way round. However, the accounts of the assessee have been drawn in a manner which shows that the assessee pays to franchisees. This anomaly between the agreement and the accounts has not been explained by either party. This matter has also not been dealt with by the lower authorities. At this juncture, the matter has to be decided as per law and not merely as per entries in the books of account, which may only be indicative in nature, but not conclusive of the matter.

The franchisees set up the premises, equipment and infrastructure at their own cost as per specifications of the assessee. The assessee was to provide entire study material, upgradation thereof, technical knowhow and product details. The franchisee collected fees from students and taxes/duties leviable were borne by them. They retained 75% of the profit from operations and handed over 25% to assessee. Hence, from the facts of the terms, it clearly emerges that the franchisee is not doing work for the assessee and it is a case of running a study centre and apportionment of profits thereof between the assessee and the franchisee. The agreement is not regarding work done on behalf of the assessee rather it is a case of sharing fees under the contract.

Though the term ‘work’ in explanation of section 194C is wide enough, it does not cover the case of the assessee. Thus, the ground was allowed in favour of the assessee. Facts: The assessee paid bonus to directors who were also the shareholders of the assessee-company. The AO held that bonus was paid instead of dividends so as to avoid payment of dividend distribution tax. Hence, by invoking provisions of section 36(1)(ii) bonus was disallowed. The CIT(A) also upheld action of the AO. Held: Section 36(1)(ii) provides that any sum paid to an employee as bonus or commission for services rendered is to be deducted in computing the total income, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission.

Taking the example of director A, it is clear that if the amount of Rs.7,02,231 had not been paid to him as bonus, the same amount would not have been paid to him as dividend, because he would have got 40.93% as dividend from the total dividend declared. In other words, he would have received higher dividend than the bonus. The position in case of S would be opposite. He was paid bonus of Rs.4,13,077 although his sharehold-ing is only 1.09%. Relevant facts are similar in case of other directors. Thus, it can be said that none of the directors would have received the bonus as dividend in case bonus was not paid. Also the bonus was paid as per resolution of Board of Directors. Therefore, the provision of 36(1)(ii) was not applicable. Facts: Being a coaching class, the assessee received nonrefundable fees in a year. However, the coaching was to be rendered in current year and subsequent year. Hence, the obligation was to be discharged in two accounting years. The assessee booked part fees in this year and part in the subsequent year. However, the AO added the entire amount to income.

The CIT(A) also upheld AO’s observation. Held: The decision as held in case of K. K Khullar v. Dy. CIT, (2008) 304 ITR (AT) 295 was considered. It was held that a distinction has to be made between the terms ‘receipt’ and ‘income’. Income is liable to be taxed and not receipt. Hence, only that part of receipt was taxable to assessee which accrued as income. Thus, the accounting policy followed by the assessee was correct. The CIT(A) erred in treating the nonrefundable deposit as income.

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shailesh.kwebmaker

Section 80-IB(10) — There is no precondition that the assessee should be the owner of the land for claiming deduction — Terrace in front of penthouse should not be considered while measuring built-up area.

35. (2011) 131 ITD 142
Amaltas Associates v. ITO
A.Y.: 2006-07. Dated: 21-1-2011

Section 80-IB(10) — There is no precondition that the assessee should be the owner of the land for claiming deduction — Terrace in front of pent-house should not be considered while measuring built-up area.

Facts:

The assessee was a builder and developer of housing projects and claimed deduction u/s.80-IB. During the relevant year under consideration, it constructed a housing project and claimed deduction u/s.80-IB. The AO disallowed the deduction u/s.80-IB on the ground that the builder was not the owner of the land and various permissions and approvals were granted in the name of the co-operative society. Further, based on the DVO report, the AO observed that, out of 110 flats, the penthouses on the top floor of each building had a built-up area of more than 1500 sq.ft.

Held:

The contention of the Revenue authorities that the assessee must be the owner of the land to claim deduction u/s.80-IB has no force. There is no such condition for claiming deduction u/s.80- IB. Further, the agreement to sell showed that assessee purchased the property in question for a consideration of Rs.3 lakh. All the responsibilities for carrying out the construction, permission and development of the project lie with the assessee. The dominant control over the land was with assessee. The real owner was only to co-operate with the assessee. Also the assessee was only entitled to enrol members for selling the units within its own rights. Further, the deduction u/s.80-IB is not exclusively to an assessee but to an undertaking developing and building housing project, be it by a contractor or by an owner. Hence, the assessee cannot be denied deduction u/s.80-IB on this ground.

The next issue was of ‘built-up area’ exceeding the prescribed limits of 1500 sq.ft. in case of some of the flats. The AO, based on DVO’s report, had included the area of open terrace in front of the penthouses on the top floor of each building in the total builtup area, thereby increasing the maximum limits. The contention of assessee was that the definition of built-up area means inner measurement of residential unit at floor level including projections and balconies. But open terrace in front of penthouse, not being a covered area and open to sky, should not be considered as a part of built-up area. This contention was accepted by the Tribunal and hence the assessee’s appeal was allowed.

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Section 254(2) and Rules 23 and 25 of Income Tax (Appellate Tribunal) Rules, 1963 — Assessee’s chartered accountant having filed an affidavit stating that he did not appear at the time of hearing as he had wrongly recorded the date of hearing in his diary and also furnished a photocopy of the diary showing the wrong noting, it has to be accepted that there was sufficient cause for his non-appearance on the date of hearing.

34. (2012) 145 TTJ 537 (Delhi) (TM)
Five Star Health Care (P.) Ltd. v. ITO A.Y.: 2006-07. Dated: 2-3-2012

Section 254(2) and Rules 23 and 25 of Income Tax (Appellate Tribunal) Rules, 1963 — Assessee’s chartered accountant having filed an affidavit stating that he did not appear at the time of hearing as he had wrongly recorded the date of hearing in his diary and also furnished a photocopy of the diary showing the wrong noting, it has to be accepted that there was sufficient cause for his non-appearance on the date of hearing.

The assessee filed a miscellaneous application for recalling the said order against the exparte order passed by the Tribunal. The only ground taken by the assessee in its miscellaneous application was that there was a bona fide reason for non-appearance on the part of the assessee on the fixed date of hearing. There was a difference of opinion between the members of the Tribunal and, therefore, the matter was referred to the Third Member u/s.255 (4). The agreed point of difference was

“Whether on facts and in the circumstances of the case, it will be appropriate in law to recall order dated 8th Oct., 2010 passed in ITA No. 1063/Del./2010”. The Third Member held that it would be appropriate to recall the ex-parte order of the Tribunal. It noted as under:

(1) Though in the miscellaneous application there is neither the mention of Rule 25, nor section 254(2), but, from the contents of the application, it is evident that it was under Rule 25 only because u/s.254(2) the assessee can request the rectification of an apparent mistake while under Rule 25, the assessee can request for the recalling of the order of the Tribunal which has been passed ex-parte due to non-appearance of the assessee.

(2) A perusal of Rule 25 shows that, as per proviso, where an appeal has been disposed of as provided in the rule and the respondent appears afterwards and satisfies the Tribunal that there was sufficient cause for his non-appearance on the date of hearing, the Tribunal is at liberty to recall the ex-parte order passed by it and restore the appeal.

(3) In the present case, the chartered accountant has given an affidavit. In support of the affidavit, he has also furnished the photocopy of his diary in which the hearing of the assessee’s appeal was wrongly noted as 9th September, 2010, instead of 7th September, 2010.

(4) Therefore, there was sufficient cause for nonappearance by the assessee on the date of hearing i.e., 7th September, 2010. Proviso to Rule 25 was squarely applicable and the Tribunal was justified in recalling the order of the Tribunal.

(5) Rule 23 provides the procedure to be adopted at the time of hearing the appeal. Tribunal having effectively decided the matter against the respondent-assessee by setting aside the order of the CIT(A) and restoring the matter back to the Assessing Officer without hearing the assessee, the ex-parte order of the Tribunal must be recalled as required by Rule 23 of ITAT Rules.

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Section 40(a)(ia) — Disallowance can be made only in respect of an amount which is sought to be deducted u/ss.30 to 38 and not in respect of reimbursement simplicitor which is profit neutral and not routed through the P & L a/c.

33. (2012) 145 TTJ 1 (Kol)
Sharma Kajaria & Co. v. Dy. CIT
A.Y.: 2006-07. Dated: 17-2-2012

Section 40(a)(ia) — Disallowance can be made only in respect of an amount which is sought to be deducted u/ss.30 to 38 and not in respect of reimbursement simplicitor which is profit neutral and not routed through the P & L a/c.

In the re-assessment proceedings, the Assessing Officer noted that the assessee had made payments to various lawyers for their professional services but had not deducted tax at source u/s. 194J from the same. The Assessing Officer was of the view that the assessee was under statutory obligation to deduct tax at source u/s.194J and, since the assessee had failed to perform this obligation, such payments were disallowed u/s. 40(a)(ia).

The CIT(A) rejected the assessee’s contention that expenditure which is not claimed in and did not appear in the Return and the P & L a/c should not be disallowed by application of section 40(a)(ia). The CIT(A) upheld the Assessing Officer’s order. The Tribunal, setting aside the orders of the lower authorities, noted as under:

(1) Unless a deduction is claimed in respect of the said amounts u/ss.30 to 38, the disallowance u/s.40(a)(ia) cannot come into play at all. The question of disallowance u/s.40(a)(ia) can arise only when something is claimed as a deduction in computation of business income; reimbursements simplicitor, being profit neutral, are not routed through the P & L a/c.

(2) Whether the assessee had claimed the fees paid to outside lawyers as a reimbursement from its clients or not was simply a matter of fact which will be evident from the bills raised on the clients and there was no need for making any inferences in respect of the same.

(3) If in the bills raised on its clients, the assessee had separately itemised the payments made to the outside counsel and claimed reimbursements in respect of the same, then these expenses cannot be of such a nature as to seek deduction in respect of the same. When the expenses are being reimbursed by the clients, these expenses cease to be expenses of the assessee and, therefore, there is no question of deduction in respect of the same.

(4) However, if the assessee has raised composite bills for professional services, on gross basis and without giving details of payouts to outside lawyers on behalf of his clients, the payments to outside lawyers will be in the nature of deduction to be claimed by the assessee.

(5) Without there being any categorical finding to the effect that the payments to outside lawyers were claimed as deductions in computation of profits, the disallowance u/s.40(a)(ia) in respect of such payments is not legally sustainable.

The matter was remanded back to the Assessing Officer for adjudication de novo in light of the above observations.

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