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Dear Members …

Dear Members
It gives me immense pleasure to share the e-copy of magazine "Corporate Professionals Today" published by Taxmann for the current month.

The main focus of the magazine is on controversies in the matters of income-tax, service tax and accounts and audit. In addition to these, it covers various articles analyzing the recent developments.

I am encapsulating the articles covered in this magazine under following heads to give you an idea about the in-depth nature and extent of range of our article:
1) Controversy of taxability of capital gain under MAT - By Mr. S. Rajaratnam
2) Controversies wrt TDS - By Narayan Jain and Gaurav Pahuja
3) Controversies on allowability of charitable status to facilitating NGO\'s (If parent trust is just supporting its member trust, the parent trust is entitled for benefit under Section 11 and 12 and many more issues) - By Manoj Fogla;
4) The uncharitable face of charity - Analyzing the amendment of expression "any activity of rendering any service in relation to any trade, commerce or business" - By Mr. G. N. Gupta;
5) Controversies on allowability of treatment of expenditure incurred before commencement of business (i.e. preliminary expenses and pre-operative expenses) - By Naveen Wadhwa (it\'s me)
6) Fair value accounting - By Mr. Dolphy D\'Souza
7) Issues in CARO reporting and Schedule VI - By. Srinivasan Anand G
8) Synchronization of AS 11 and AS 16 - By Varun Kumar
9) Controversies on service tax in form of FAQ - By Mr. V.S. Datey
10) Shamiana and Pandal - By Mr. T.N. Pandey
11) Conversion of CA firm into LLP, investment planning, stock market, etc.

I feel the copy of magazine will serve as a collectors\' item for yourself, as it it the special annual issue on the 7th anniversary of this magazine.
(Just want to clarify, this e-magazine is meant especially for circulation without violating the copyright)

Copy and paste the following link & Get your free copy of Corporate professional Today.

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  • Thanks for sharing this content. Let me also share what I found http://goo.gl/SXKGjb a pdf editing tool online without downloading any software. A great find indeed!
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  • thank you ...very much slideshare......for providing such a valuable e magzine...pls upload every month...
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  • 1. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 1 i
  • 2. CONTENTSii December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 2
  • 3. VOLUME 22 • ISSUE 7 • DECEMBER 1-15, 2011 contentsFOUNDER EDITOR :U.K. BHARGAVA Direct Tax LawsEDITOR : 605 Treatment of Capital GainsRAKESH BHARGAVA under the provisions ofHON. COORDINATING EDITOR : MAT//S. RAJARATNAMDR. VINOD K. SINGHANIA 610 A Critical Analysis of theCorporate Professionals Today comes in three provisions of sectionVolumes, Annual subscription from January - 40(a)(ia)//NARAYAN JAINDecember 2011 is Rs. 3200. Single copy Rs. 200only. 617 Concept of Facilitating NGOs//MANOJ FOGLACorporate Professionals Today is published onevery 10th & 25th of the month. Non-receipt of 621 Uncharitable Face ofpart must be notified within 60 days of the due Charity//G.N. GUPTAdate. 625 Tax Accounting Standard onAddress your editorial and subscription Government Grants andcorrespondence to : Accounting Standard 12 -TAXMANN ALLIED SERVICES (P.) LTD., A comparative study//59/32, New Rohtak Road, New Delhi- DINDAYAL DHANDARIA110 005. Phones : +91-11-45562222Fax : +91-11-45577111 630 An insight into expenditurePRINTED AND PUBLISHED BY : before commencement ofAMIT BHARGAVA on behalf of Taxmann Allied business//NAVEEN WADHWAServices (P.) Ltd. and Printed at Tan Prints (India) 638 TDS Issues//GAURAV PAHUJAPvt. Ltd., 44 Km. Mile Stone, National Highway,Rohtak Road, Village Rohad, Distt. Jhajjar, Haryana 641 Landmark Rulings(India) and Published at 59/32, New Rohtak Road,New Delhi-110 005 (India).EDITOR : RAKESH BHARGAVAMaterial published in this part is the exclusive copyrightedproperty of Taxmann Allied Services (P.) Ltd. and cannot Accounts & Auditbe reproduced or copied in any form or by any meanswithout written permission of the Publisher. 659 Fair value accounting -Editors do not necessarily agree with the views expressedby authors of articles/features. Views so expressed are the Integral to IFRS//DOLPHYpersonal views of author(s). D’SOUZAThis publication is sold with the understanding that authors/ 664 Issues in CARO reporting ineditors and publishers are not responsible for the result ofany action taken on the basis of this work nor for any error Audit report of companies//or omission to any person, whether a purchaser of this SRINIVASAN ANAND G.publication or not. All disputes are subject to jurisdictionof the Delhi High Court. 672 AS-11 and AS-16 – Dusting the dilemma for treatmentEmail : sales@taxmann.comWebsite : http//www.taxmann.com of exchange rate differencesMODE OF CITATION [2011] 22 CPT. . . on borrowing cost during construction period//VARUNTOTAL PAGES INCLUDING COVER 136 KUMAR December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 3 iii
  • 4. CONTENTS677 Accounts & Audit in Brief//RAJESH GOSAIN Service Tax684 Carbon credits : A new dimension to the accounting and taxation methods//DR. SUSHMA 694 Some Controversies in Service Tax//V.S. DATEY BAREJA 701 The Ongoing Battle on Validity of Levy of Service Tax on Renting of Immovable Property for Commercial/Business use//V. PATTABHIRAMAN 708 Hindu marriage is a religious ceremony besides being a social function//T.N. PANDEYCorporate Laws688 Conversion of Chartered Accountant (“CA”) Firms into Limited Liability Partnerships (“LLP”) //SARIKA GOSAIN 713 Service Tax Penalty & Reasonable Cause// GAURAV GUPTA Investment Planning 721 Recent changes in PPF & Small Saving Schemes w.e.f. 1-12-2011 Stock Market 727 How shareholders are cheated by some promot- ers//ARUN K. MUKHERJEE •••iv December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 4
  • 5. DIRECT TAX LAWS INTRODUCTION 1. Mr. N. A. Palkhivala, the eminent jurist, described the tax on book profits as "constitutionally illegal, economically unsound and morally repugnant". But such tax has marched ahead with liability becoming stiffer with the each Finance Act. The tax liability now referred to as Minimum Alternate Tax (MAT) has been in vogue in different garbs in sections 115J, 115JA and now in section 115JB, mutilating the book profits with many deeming provisions out distancing book profits computed under the company law with the liability further enhanced with the progressive hike in rates of taxes. One of the outstanding issues, which is awaiting decision of the Apex Court is regarding the treatment of capital gains in the computation of the book profits. 2. RELEVANT JUDICIAL PRECEDENTS 2.1 The Ruling in Sutlej Cotton Mills Ltd.’s case - The assessee-company had taken the amount of sale proceeds of capital assets directly to reserves without routing it through the Profit & Loss Account (P&L). The Assessing Officer questioned the computation in view of the fact that the treatment of gains in the accounts did not accord with the requirements of Parts II and III of Schedule VI of the Companies Act, and that, therefore, it had to be added to the disclosed book profits so that liability for tax S. RAJARATNAM on capital gains was not avoided. This treatmentAdvocate & Tax Management was affirmed in first appeal and the matter Consultant came before the Special Bench of the Tribunal in Sutlej Cotton Mills Ltd. v. Asstt. CIT [1993] 45 ITD 22 (Cal.)(SB). The Tribunal did not question the right of the Assessing Officer to recast the profit and loss account. It did not agree with the contention December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 5 605
  • 6. DIRECT TAX LAWSon behalf of the assessee, that whatever is assessee was entitled to treat the accretion toshown in the books is bound to be accepted fixed assets, when realised, as capital reserve,by the Assessing Officer "without questioning", particularly when the realised amount issince acceptance of such a view would mean reinvested in another asset and not availablethat the Assessing Officer is bound to accept for distribution as profits following the rulebook profits even in case of fraud or of ‘purposive interpretation’ in the light ofmisrepresentation or where there has been a objects expressed in the Finance Minister’s speechtotal disregard of the provisions of Parts-II and Memorandum explaining the provision inand III of the Schedule VI of the Companies the absence of any allegation of fraud orAct, which is the subject-matter of cross reference misrepresentation. In other words, the disclosedin section 115J as well. There can be no inference, book profit cannot be lightly disturbed. Thethat accounts approved by the Board of Directors Assessing Officer has got a right to makehave been prepared according to the requirements adjustments but only those specifically authorisedof company law. There is an implied authority under section 115J and not any other adjustment,for the Assessing Officer to verify and satisfy where the profits in the profit and loss accounthimself, whether the net profit as shown in are rightly computed as found in the instantthe P&L account is based upon accounts prepared case.in accordance with Parts-II and III of the The decision of the Supreme Court in McDowellSchedule VI. & Co. v. CTO [1985] 154 ITR 148/22 TaxmanThe Tribunal would not, however, accept the 1, which was pressed into service by the revenue,argument of the Revenue that the assessee was also considered by the Tribunal, butknowing fully well, that it would be caught concluded that a mere tax mitigation cannotwithin the mischief of section 115J, if capital be tax avoidance as decided by the Privy Councilgains had been credited to the P&L Account, in Challenge Corporation 187-(1) AC 155, wheretook it to the capital reserve with the sole for revaluation of shares in the facts of theobject of avoiding tax. The Tribunal found case, it was held, cannot be treated as a colourablethat considering the objective of the provision action. A permissible accounting treatment withinto tax zero tax companies and the requirement the frame work of law with the incidental taxof the Companies Act as regards computation advantage cannot be dismissed by characterisingof income as required under the company law, it as a "device".the transaction relating to capital structure of The ruling in Sutlej Cotton Mills Ltd.’s casethe company could not and need not form (supra) was followed in GKW Ltd. v. Jt. CITpart of Profit and Loss Account, which normally [2000] 74 ITD 161 (Cal.), where it was decidedrepresents operating profits from trading that profit on sale of capital assets cannottransactions and not transactions relating to form part of the book profits. In coming to theinvestments. The need for disclosure of the conclusion, the Tribunal cited two decisions inprofit on sale of investments is satisfied, if the Pandit Deo Sharma v. CIT [1953] 23 ITR 226information relating to them is available as a (All.) and CIT v. Sugauli Sugar Works (P.) Ltd.part of the accounts and not necessarily by [1983] 140 ITR 286/[1981] 7 Taxman 163 (Cal.).credit to the profit and loss account. There is In the latter case, it was decided in the contextsupport for such a view in Spicer and Pegler’s of section 41(1), that a mere credit in the‘Book Keeping and Accounts’ and also in the accounts does not justify taxation, if it was notlanguage of Parts-II and III of Schedule VI of normal business profit. The decision of thethe Companies Act itself. Calcutta High Court has since been affirmedIt was felt by the Tribunal as a matter of in CIT v. Suguali Sugar Works (P.) Ltd. [1999]sound accepted accounting practice, that the 236 ITR 518/102 Taxman 713 (SC).606 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 6
  • 7. 2.2 The ruling in Veekaylal Investment’s case - loss account but also as equally, if not moreThe well-reasoned decision of the Special Bench importantly, in the balance sheet with Schedulesof the Tribunal in Sutlej Cotton Mills Ltd.’s case and Notes on Accounts.(supra) has been specifically overruled by the In Needle Industries (I) Ltd. v. CIT [1990] 183Bombay High Court in CIT v. Veekaylal Investment ITR 393/[1989] 46 Taxman 93 (Mad.), whereCo. (P.) Ltd. [2001] 249 ITR 597/116 Taxman the company had credited insurance monies104. The main reason, though not the sole for loss of stocks due to fire directly to thereason of the High Court, runs as under : reserves, the inference was that it was sufficient “The important thing to be noted is that disclosure, so that jurisdiction even within the while calculating the total income under shorter time-limit under section 147(b) was the Income-tax Act, the assessee is required held to be not available. The High Court found to take into account income by way of that the credit to the reserves in the balance capital gains under section 45 of the Income- sheet is sufficient information. tax Act. In the circumstances, one fails One has only to point out that moneys received to understand as to how in computing towards share capital, for example, is always the book profits under the Companies disclosed in the balance sheet and is not expected Act, the assessee-company cannot consider to be routed through profit and loss account. capital gains for the purposes of computing book profits under section 115J of the There is also a direct authority in CIT v. N. Act.” Guin & Co. (P.) Ltd. [1979] 116 ITR 475/1 Taxman 124 (Cal.) for the view, that capitalThere is a clear misdirection, in law, in the gains cannot be equated with commercial profitsabove reasoning, because section 45 could have in the context of additional tax under sectionno application, because of the non obstante 23A (now deleted) for inadequate distributionclause with which section 115J (now sections of dividend. It was decided with reference to115JA and 115JB) is prefaced. Capital gain is Palmer’s Company Law and Spicer and Pegler’sa class of income deemed as income for purposes Book Keeping and Accounts, that divisible profitsof computation of statutory income and cannot, in business sense cannot include reserves andtherefore, be part of taxable book profits. capital profits for purposes of distribution ofAccounting of book profits has to conform to dividend by businessmen and accountants. Theaccounting principles, mandatory accounting Legislature itself had made a sharp distinctionstandards and requirements of company law. between profits and gains of business on oneThe High Court has, no doubt, also justified hand and capital gains on the other. At anyits decision on the further argument, that clause rate, it is for the directors to decide, whether(2) of Part II of Schedule VI of the Companies the surplus realised on sale of capital assetAct would require disclosure of non-recurring should be treated as profits of the companytransactions of an exceptional nature, so that and where it is channelised to reserves, "it issuch disclosure is necessary, whether it is on not for the Income-tax Officer to lay downcapital or revenue account. What had been that it should have been treated as profits".overlooked is that, disclosure does not mean Where the admitted position is that the directorsthat it should be shown as income in profit have taken the surplus to reserves, it was heldand loss account, even where it does not have in this case, that such treatment is bound tothe character of income as is commonly be accepted. This law should have an equalunderstood. Information relating to capital gains application for purposes of book profit tax,is bound to be reported in the final accounts the object of which is also to tax income,of the assessee like various other items relating which is not distributed as dividend. It is not,to any company required to be given to the therefore, surprising that the Special Bench ofshareholders not only by way of profit and December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 7 607
  • 8. DIRECT TAX LAWSthe Tribunal in Sutlej Cotton Mills Ltd.’s case therefore, would be, what is not required to(supra) relied upon this decision. be included in the case of deemed income like capital gains, should not form part of book2.2.1 Aftermath of Veekaylal’s case - The Tribunal profits irrespective of accounting treatment.in Kopran Pharmaceuticals Ltd. v. Dy. CIT [2009]119 ITD 355 (Mum.) upheld the inclusion of In another case dealing with capital gains, thecapital gains as taxable book profits, though assessee had sold a rubber estate and claimedit was taken by the assessee directly to the that the surplus was exempt as an agriculturalreserves following the decision in Veekaylal income, so as to be outside the purview ofInvestment Co. (P.) Ltd.’s case (supra) as the taxation, whether it be in computation of statutorydecision was that of the jurisdictional High income or book profits. The Tribunal in HarrisonsCourt. Same view was taken by the Tribunal Malayalam Ltd. v. Asstt. CIT [2009] 315 ITRin Growth Avenue Securities (P.) Ltd. v. Dy. CIT (AT) 1/32 SOT 497 (Cochin) decided the issue[2010] 126 ITD 179 (Delhi). on the basis that the sale of rubber estate by way of slump sale of agricultural land hasWhere the capital gains were credited to profit character of an agricultural income and thatand loss account, it was treated as the only the surplus is not, therefore, includible as ajustification for inclusion in CIT v. Indo Marine part of taxable book profits. The TribunalAgencies (Kerala) (P.) Ltd. [2005] 279 ITR 372 adverted to the decisions of the several High(Ker.), so that the controversy as to whether Court’s including that of the Supreme Courtaccounting treatment will make a difference in Singhai Rakesh Kumar v. Union of India [2001]to liability persists. This view was adopted by 247 ITR 150/115 Taxman 101 for its inference.the Tribunal in ITO v. Frigsales (India) Ltd. Being exempt under section 10, it fell outside[2005] 4 SOT 376 (Mum.), where capital gains the purview of the Minimum Alternate Taxwere credited to profit and loss account. Where under section 115JB. In the view taken by thethe assessee had credited the gains in the P&L Tribunal, it was not necessary to consider theAccount, the High Court in N.J. Jose & Co. (P.) larger question, whether capital gains couldLtd. v. Asstt. CIT [2010] 321 ITR 132/[2008] be treated as part of income for purposes of174 Taxman 141 (Ker.) found that there is no MAT steering clear of the subsisting controversy.provision for exclusion of such income in thelist of adjustments permitted under the Where the assessee had availed of the benefitExplanation to section 115J. The same view of tax exemption for capital gains by investingwas taken in respect of capital gains on transfer the proceeds in approved bonds under sectionof business by way of slump sale in CIT v. 54E, the issue was whether even in such aBrindavan Beverages Ltd. [2010] 321 ITR 197/ case, non-taxable capital gains on account of186 Taxman 233 (Kar.), in the light of the the relief, could be treated as liable for bookpreponderant view in favour of including capital profits tax. Where capital gains are includedgains, where it is taken into account in the as part of the book profits, there is no entitlementP&L account by the assessee. to concessions for such capital gains as was found in Nafab India (P.) Ltd. v. Dy. CIT [2005]Weight of evidence on the basis of decision 92 ITD 343 (Delhi).in Apollo Tyres Ltd. v. CIT [2002] 255 ITR 273/122 Taxman 562 (SC) would appear to favour A view adverse to the taxpayer relying uponthe inference of liability on the basis of accounting decision in Veekaylal Investment Co. (P.) Ltd.’streatment, but the non-controversial inference, case (supra) was taken by the Special Benchin law, is that mere accounting treatment cannot of the Tribunal in Rain Commodities Ltd. v. Dy.create a liability in the context of computation CIT [2010] 4 ITR (Trib.) 551/40 SOT 265 (Hyd.)of income. Should such a law be inapplicable (SB) in respect of long-term capital gains infor book profits tax? The better reasoning, the view that exemption under section 47(iv)608 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 8
  • 9. available for transfer of asset to wholly owned treated as part of book profits. Any other viewsubsidiary, normally available, will not be would make the tax on book profits a mockeryavailable for purposes of computation of book by making the taxable book profits even moreprofits under section 115JB overlooking the different from the real book profits.fact that the question of section 47 would ariseonly where section 45 itself is applicable, and CONCLUSIONthat both the section 45 or 47 should not beapplicable because of the non obstante clause 3. The decision in Veekaylal Investment Co. (P.)prefacing section 115JB. If section 45 is applicable, Ltd.’s case (supra) would need review in thethere should be no reason why exemption under light of reasoning in Sutlej Cotton Mills Ltd.’ssection 47 should not be applicable. But in this case (supra) and in the view that it is superseded,case, the assessee had included the capital where capital gains is not credited to the profitgains by crediting the same to the profit and and loss account, so that it may not be openloss account but claimed it as a deduction in to the Assessing Officer to treat it as bookthe computation of book profits, so that the profits, because of the bar against distortiondecision in Apollo Tyres Ltd.’s case (supra) was of accounts, which have become final, byalso relied upon. Where the assessee unwittingly adjustments not authorised by the Explanationor under the wrong impression that the audit to the provision. If this could be the finalguidelines which require disclosure are view, it would make a difference between twounderstood as requiring credit to the profit companies with different accounting treatmentand loss account, such credit invites liability, of such capital gains, so that a clarification orwhere the accounting entries are treated as review may well be required as regardsbinding. It is an unsatisfactory position of law, application of Apollo Tyre Ltd.’s case (supra) asif this is the law. Incidentally, audit guidelines well, whether the income as per profit andare sometimes understood as requiring every loss account is so sacrosanct as to be unalterable,credit to the reserves to be routed through a point dealt with more satisfactorily in Sutlejprofit and loss account, but such guidelines Cotton Mills Ltd.’s case (supra), when it did notdo not bind the company, so that such take a rigid view on accounting treatment, butunderstanding at best may only require the based its decision on merits of the case.Auditor to record his qualification. Now that this tax has to be carried over toIn case of depreciable assets, accounting the Direct Taxes Code with the same uncertaintyprinciples require the surplus to the extent of relating to treatment of capital gains, one woulddepreciation allowed to be credited back to wish the reasonable interpretation confiningprofit and loss account, so that the tax on the tax to real book profits which would findcapital gains relating to that extent cannot official acceptance too, by necessary amendmentpossibly avoid liability, but even in such a to the Bill before it becomes a law.case, the surplus over original cost cannot be ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 9 609
  • 10. DIRECT TAX LAWSDIRECT TAX LAWS INTRODUCTION A Critical 1. Section 40(a)(ia) was introduced in the Income- tax Act, 1961 by the Finance Act, 2004. The said provision was introduced for better Analysis of compliance of TDS provisions. It has resulted in augmenting the revenue through the disallowance of various expenses on which TDS is not deducted by the assessees. Under the provisions the provisions of section 40(a)(ia), read with TDS provisions the A.O. can disallow the expenses where TDS is not deducted or paid of section in time with respect to the expenses claimed by the assessee. It disallows the claim of even genuine and admissible expenses claimed by an assessee under the head “Income from 40(a)(ia) Business & Profession”, if the assessee does not deduct TDS on such expenses. The default in deduction of TDS or its non-payment would also result in levy of interest or penalty as provided for under section 201, under section 221 and under section 271C. The Act also provides for prosecution proceedings under section 276B. The hue and cry over such a harsh provision, is in continuum, especially when the High Courts of Madras and Punjab & Haryana have upheld the vires of the provision. However, in view of hardship faced by the assessees and different representations made, the Finance Act, 2010 has liberalised the provisions of section 40(a)(ia) w.e.f. AY 2010- 11 as per which the assessee will be entitled to deduction of expenses if he has deposited the TDS on or before the due date of filing of return under section 139(1). In this article some of the related aspects and recent cases have been discussed. NARAYAN JAIN Advocate & Tax Consultant EXPENSES WHICH ARE ALLOWED SUBJECT TO DEDUCTION AND DEPOSIT OF TDS (WHERE THE PAYMENT IS MADE TO A RESIDENT) 2. As per section 40(a)(ia), the following payments made to a resident shall be allowed as deduction610 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 10
  • 11. only if tax is deducted at source as per the during the previous year but paid after theprovisions of Chapter XVII-B and is deposited due date specified under section 139(1), suchas per the provisions of section 200(1) : an expenditure shall be allowed as a deduction in computing the income of the previous year (a) Interest - section 193 or section 194A (w.e.f. in which such tax has been paid. Asst. Year 2005-06) (b) Payment to contractors/sub-contractors - section 194C (w.e.f. Asst. Year 2005-06) AMENDMENT MADE BY THE FINANCE ACT, 2010 W.E.F. ASST. YEAR 2010-11 (c) Commission or brokerage - section 194H (w.e.f. Asst. Year 2005-06) 3. Relaxing the provisions of section 40(a)(ia) - Whether clarificatory in nature and with a (d) Fees for technical services, fees for pro- retrospective effect? fessional services under section 194J (w.e.f. Asst. Year 2005-06) and The matter was dealt with by the Mumbai Special Bench of ITAT in Bharati Shipyard Ltd. (e) Rent under section 194-I [w.e.f. Asst. Year v. Dy. CIT [2011] 132 ITD 53/13 taxmann.com 2007-08] 101 wherein it was held that any amendment (f) Royalty under section 194J [w.e.f. Asst. which has not been given retrospective effect Year 2007-08] by the Legislature, cannot be construed as retrospective on solitary ground that originalHowever, in view of hardship faced by the provision caused some hardship to assessees.assessees and different representations made, Relevant criteria to be taken into considerationthe Finance Act, 2010 has liberalised the for arriving at decision about retrospective orprovisions of section 40(a)(ia) w.e.f. Asst. Year prospective effect of a later provision, is to2010-11. As per the amended provisions the unearth intention of the Legislature at time ofassessee will be entitled to deduction of introducing original provision and not whetherexpenses if the assessee has paid the tax it caused hardship to taxpayers. If it was verydeducted at source (which was deducted/ well known at time of inserting original provisiondeductible anytime during the previous year) that it is going to be harsh, then any subsequenton or before the due date of filing of return relaxation in it will not be retrospective unlessunder section 139(1). expressly so stated. The amendment broughtThe Finance Act, 2008 had earlier granted out by Finance Act, 2010 to section 40(a)(ia)marginal relief with retrospective effective from w.e.f. 1-4-2010 has only extended time forthe Asst. Year 2005-06 by providing that where depositing tax deducted at source by due datethe tax is deducted in the last month of the under section 139(1) from earlier lesser timeprevious year, i.e., March, then the deduction available for compliance; other consequencesof expenses was allowed if the payment was of section 40(a)(ia) are still present in provision.made within the due date of filing of return Thus, amendment by Finance Act, 2010 is notof income under section 139(1). However, if aimed at removing any unintended hardship to assessee, but to relax intended hardship tothe deduction was made between April to some extent by increasing time available forFebruary and the tax was not paid within the deposit of tax. When the amendment does notprevious year, deduction for such expenses remove unintended hardship or is notwas not available. explanatory, same cannot be held to be2.1 If the TDS is paid after the due date of retrospective unless it is specifically providedfiling the return - In this connection it has now for. Therefore, amendment brought out bybeen clarified by proviso to section 40(a)(ia) Finance Act, 2010 to section 40(a)(ia) w.e.f.that where tax has been deducted after the 1-4-2010 being not remedial and curative inend of previous year or has been deducted nature cannot be declared as having December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 11 611
  • 12. DIRECT TAX LAWSretrospective effect from date of insertion of liability. No exception can be taken toprovision, i.e., 1-4-2005. incorporation of a provision which excludes right to seek permissible deduction in the eventEarlier decisions : The Mumbai Bench of ITAT of failure of the assessee to deduct or to depositin the case of Bansal Parivahan (India) (P.) Ltd. the deducted tax. Moreover, the proviso relaxesv. ITO [2011] 43 SOT 619 and Ahmedabad Bench the rigour. If in the subsequent years, onein the case of Kanubhai Ramjibhai Makwana v. makes the deduction or makes the deposit,ITO [2011] 44 SOT 264/9 taxmann.com 55 had one gets the benefit of deduction. The provisionheld that the amendment by Finance Act, 2010 cannot be held to be harsh. There is no inherentis remedial in nature, designed to eliminate lack of jurisdiction on the part of the Legislatureunintended consequences which may cause in enacting the provision providing for penaltyundue hardship to taxpayers and which made for evasion of statutory liability.the provision unworkable or unjust in a specificsituation is clarificatory in nature. The Earlier also at the time of introduction of sectionamendment has to be treated as retrospective 40(a)(ia) into the statute book, the constitutionalityw.e.f. 1-4-2005. of the said provision was challenged before the Madras High Court in the case of TubeThe above decisions have been followed in Investments of India v. Asstt. CIT [2010] 325 ITRKulwant Singh v. ITO [2011] 10 taxmann.com 610/[2009] 185 Taxman 438. The Court rejected25 (Ahd.) wherein Interest, commission, etc., the said challenge and upheld the validity ofwere paid without deduction of tax at source section 40(a)(ia) and the competence of thefor the Asst. Year 2005-06 and it was held that Legislature in enacting such a provision onamendments made in provisions of section the ground that the said provision had been40(a)(ia) by the Finance Act, 2008 and Finance introduced in order to augment tax throughAct, 2010, being curative in nature, would the mechanism of TDS and section 40(a)(ia)apply with retrospective effect from was in furtherance to the said objective.1-4-2005 and held that where assessee deductedtax at source from payments on account oftransportation charges for FY ending 31-3-2005 DISALLOWANCE OF FREIGHT CHARGESand paid same to the credit of Government FOR NON-DEDUCTION OF TDSbefore due date of filing of return, provisionsof section 40(a)(ia) could not be invoked for 5. Where there is no oral or written contractdisallowing those payments. with the transporter: Where there is no contract, oral or written, with the transporter, the provisions of section 194C do not apply. Hence,CONSTITUTIONALITY OF no disallowance under section 40(a)(ia) isSECTION 40(a)(ia) permissible - CIT v. Bhagwati Steels [2010] 326 ITR 108/[2011] 198 Taxman 275/9 taxmann.com4. Recently in Rakesh Kumar & Co. v. Union 266 (Punj. & Har.), CIT v. United Rice Land Ltd.of India [2010] 325 ITR 35/[2009] 178 Taxman [2008] 174 Taxman 286 (Punj. & Har.), R.R.481 (Punj. & Har.) wherein there was case of Carrying Corporation v. ACIT [2009] 30 DTRbusiness disallowance of Interest, commission, 569 (Ctk.); Also refer Mrs. Kavita Chug v. ITOetc., paid from which no TDS was deducted [2011] 44 SOT 95 (Kol.).and it was held that provisions of section40(a)(ia) cannot be declared ultra vires on theground of being harsh and discriminatory. The DISALLOWANCE UNDER SECTION 40(a)(ia)Legislature, in exercise of its taxing power, 6. Where assessee paid interest outside Indiacannot only provide for levying tax, but it canalso provide for penal action for enforcing the for delayed payment for the purchase of machinery without deduction of tax:charge, if there is any evasion of tax or statutory612 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 12
  • 13. The interest paid by assessee is not interest prescribed in section 139(1), disallowance couldon loan but for delayed payment for the purchase not be made under section 40(a)(ia). In theof machinery, therefore, the provisions of section result, the appeal filed by the assessee was40(a)(i) are not attracted. Therefore, no dis- allowed.allowance can be made under section 40(a)(i) - 7.3 In Dy. CIT v. Choice Sanitaryware IndustriesCIT v. India Pistons Ltd. [2006] 282 ITR 632 [2011] 9 taxmann.com 120 (Rajkot) the case(Mad.); CIT v. India Pistons Ltd. [2007] 295 ITR related to Asst. Year 2005-06 where the assessee550 (Mad.). had paid certain sum to Clearing and Forwarding, (C&F) agents besides payment of agency7. SOME RECENT JUDGMENTS commission. The amounts consisted of reimbursement of various expenses claimed7.1 In Raja & Co. v. CIT (Central) [2011] 335 by C&F agents. The A.O. relying on BoardsITR 381/196 Taxman 461 (Ker.) the assessee Circular No. 715, dated 8-8-1995 held thatdid not make any payment of tax at source assessee was required to deduct tax onin respect of inward freight charges paid for reimbursement of expenses as well and madegoods purchased. The A.O. passed an assessment impugned disallowance. Hon’ble ITAT heldorder without considering disallowance under that the circular in question is applicable onlysection 40(a)(ia). The CIT in exercise of power in cases where bills are raised for gross amountunder section 263, set aside assessment order inclusive of professional fees as well asand directed the A.O. to consider whether any reimbursement of actual expenses. Since C&Fdisallowance was required to be made under agent raised two separate bills, one forsection 40(a)(ia). Since the assessee had not commission and other for reimbursement ofdeducted any tax at source while making expenditure, CBDT’s Circular No. 715, datedpayments to transport contractors, impugned 8-8-1995 would not be applicable in such caseorder of the CIT issued under section 263 for and assessee would not be liable to deduct taxconsidering disallowance under section 40(a)(ia) on said payment. Also refer to ITO v. Dr.was to be upheld. Willmar Schwabe India (P.) Ltd. [2005] 3 SOT7.2 In H.S. Mohindra Traders v. ITO [2011] 44 71 (Delhi).SOT 43 (Delhi)(URO), assessee paid interest, 7.4 In Dy. CIT v. Divi’s Laboratories Ltd. [2011]commission, etc., without deduction of tax at 131 ITD 271/12 taxmann.com 103 (Hyd.) itsource for Asst. Year 2007-08. Assessee was was held that no tax is deductible under sectionrequired to deduct tax on clearing charges, 195 on commission payable to non-residentfreight cartage inward and shipping expenses. for services rendered outside India. Therefore,A.O. found that tax was required to be deducted payment of commission made to overseas agenton these expenditures in month of February, without deduction of TDS does not attract2007 and assessee had deducted tax only in disallowance under section 40(a)(ia).month of March, 2007 and, thereupon, tax sodeducted was paid on 9-4-2007 and 12-6-2007. 7.5 In ITO v. UAN Raju Constructions [2011]A.O. relying on provisions of section 40(a)(ia) 48 SOT 178/14 taxmann.com 184 (Visakha.)held that since tax was not deducted and the case related to section 40(a)(ia), read withdeposited within stipulated time, the expenditure section 194C. In this case the assessee was acould not be allowed. On appeal, CIT(Appeals) ‘Joint venture’ formed by a company and aupheld disallowance. Hon’ble Delhi ITAT held proprietary concern with an objective tothat in view of fact that assessee having participate in tender process for constructiondeducted tax in month of March, 2007 paid of highways and bridges. The assessee obtainedthe same before due date of filing return as a contract from KRC. The said contract was December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 13 613
  • 14. DIRECT TAX LAWSnot executed jointly by both parties but total payment is made to a group concern undercontract was divided between two parties in a cost sharing arrangement and the paymentan agreed ratio. The returns of income were is thus not for services but as reimbursementfiled for both years in status of ‘association of expenses. Therefore, TDS requirements doof persons’, declaring NIL income. The A.O. not come into play at this stage. The disallowancewas of view that assessee should be treated was deleted.as main contractor and members to whomwork was allotted should be treated as sub- 8. ‘PAYABLE’ OR ‘AMOUNTS/SUMScontractor and, therefore, assessee should havecollected sub-contract commission from sub- PAYABLE’, CONNOTATION OFcontractors. Accordingly, A.O. computed income 8.1 Appellate Courts inundated with appealsof assessee by treating 1 per cent of gross against provisions of section 40(a)(ia).Thereceipt as income of assessee by way of sub- appellate courts have been inundated withcontract commission in both assessment years. appeals against AOs action in invoking theThe A.O. also observed that assessee had provisions of section 40(a)(ia) of the Act. Onededucted TDS at 1 per cent under section of the grounds agitated by assessees is that194C on major portion of value of contract the section is applicable only to amounts whichallotted to its members but in Asst. Year 2005- are outstanding at the end of the year, i.e., the06, TDS was not deducted. Accordingly, A.O. amounts payable and that the provision cannotdisallowed relatable amount by invoking be applied to the expenses actually “paid”provisions of section 40(a)(ia). Held that, since during the year. This argument is accepted byconsortium of joint venture had been formed few Courts and Tribunals. However, recentonly to procure contract work and in reality, trend of the judgments is to the contrary, whichboth parties had divided contract work between seems to be the correct view. Some precedentsthemselves and declared income derived from in this respect are given hereunder.their respective share of contract work intheir hands, there was no merit in presumption 8.2 Interpretation of the words ‘payable’ ormade by A.O. that assessee was main contractor ‘sums payable’:and members were sub-contractors. Hence, 8.2.1 The provision reads as hereunder:the question of estimation of income by wayof sub-contract commission did not arise; further “40. Notwithstanding anything to thequestion of deduction under section 194C(2) contrary in sections 30 to 38, the followingand disallowance under section 40(a)(ia) also amounts shall not be deducted in computingdid not arise. the income chargeable under the head “Profits and gains of business or profession”,—7.6 In Emersons Process Management India (P.)Ltd. v. Addl. CIT [2011] 47 SOT 157 (Mum.)(URO), (a) in the case of any assessee-it was held that TDS requirements do not ** ** **come into play in case of reimbursement of (ia) any interest, commission or broker-expenses and is a settled law. Undoubtedly, age, rent, royalty, fees for profes-these payments are made for the services sional services or fees for technicalrendered but the TDS requirements would come services payable to a resident, orinto play at the point of time when payments amounts payable to a contractor orare made to the person who is rendering the sub-contractor, being resident, forservices or to the person with whom contract carrying out any work (includingfor rendering of these services is entered into. supply of labour for carrying outHere the issue dealt with a situation in which614 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 14
  • 15. any work), on which tax is deduc- “An amount may be payable without being tible at source under Chapter XVII-B due. Debts are commonly payable long and such tax has not been deducted before they fall due.” or, after deduction, has not been paid (c) According to West’s Legal Thesaurus/Dic- on or before the due date specified tionary: Paid means pay to discharge a in sub-section (1) of section 139,- debt. Payable : means Justly or legally Provided that where in respect of any due (payable immediately). Uncollected such sum, tax has been deducted in any (Outstanding debts). Unpaid, undischarged, subsequent year, or has been deducted unsatisfied, unsettled, mature, owed, ripe, during the previous year but paid after collectable, in arrears, redeemable. the due date specified in sub-section (1) 8.2.3 Comparison of the provision as initially proposed of section 139, such sum shall be allowed to be enacted and after its enactment - On a as a deduction in computing the income comparison between the provision as initially of the previous year in which such tax proposed to be enacted and the one after its has been paid.” enactment it can be noticed that the Legislature (emphasis supplied) consciously replaced the word “amounts credited or paid” with the word “payable”. By changingThe provision clearly uses the term “payable” the words from “credited or paid” to “payable”and not “paid”. Hence, as per the literal the legislative intent has been made clear thatconstruction no word can be substituted in only the outstanding amount or the provisionplace of the said word nor can any new word for expense liable for TDS is sought to bebe supplied in the provision by the Courts. disallowed in the event there is a default inThe language of the provision has thrown open making compliance of the obligation laid underthe two terms “paid” and “payable” for judicial Chapter XVII-B of the Act.interpretation. 8.2.4 Decisions in favour of assessee - One of the8.2.2 Meaning of terms “payable” and “paid” as first decisions on this point was dealt in theper judicial dictionaries: case of Teja Constructions v. Asstt. CIT [2010] (a) Oxford dictionary defines the terms “pay- 39 SOT 13 (Hyd.)(URO) wherein the provisions able” and “paid” as under: of section 40(a)(ia) were interpreted by applying payable (pay-a-ble) adjective [predic.] Rule of Literal Construction and it was held that only those expenses can be disallowed 1. (of money) required to be paid; due: which are “payable” at the end of the year, interest is payable on the money owing because the provision of section 40(a)(ia) uses send a check, payable to the ASPCA the term “amounts payable” and not “amounts 2. able to be paid: it costs just $195, paid”. It was held that only those expenses payable in five monthly instalments can be disallowed, for default in deducting tax at source, which have not been actually Noun (payables) spent by the assessee, though claimed in its debts owed by a business; liabilities. books of account maintained on mercantile system of accounting. Also refer to K. Srinivas Paid: Past and past participle of PAY. Naidu v. Asstt. CIT [2010] 131 TTJ 17 (Hyd.) (b) According to Black’s Law Dictionary (Sev- (UO) and Mrs. Shah Charulata Milind vide ITA enth Edition) at p. 1150, the term ‘pay- No. l318/PN/2008 (Pune Bench). able’ is defined as a sum of money that In the case of Jaipur Vidyut Vitran Nigam Ltd. is to be paid. Another meaning to the v. Dy. CIT [2009] 123 TTJ 888, the Jaipur ITAT term “payable” is given as under: relying on CBDT’s Circular No. 5 of 2005, December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 15 615
  • 16. DIRECT TAX LAWSdated 15-7-2005 held that the purpose of taxmann.com 7 (Kol.), the assessee madeintroducing section 40(a)(ia) was to augment certain payments to contractors withoutTDS compliance and to curb bogus payments. making any TDS and the A.O. disallowedHence, the payments which have been made those payments by invoking provisions ofand not found to be bogus cannot be disallowed section 40(a)(ia). On instant appeal, asses-by invoking section 40(a)(ia) of the Act. The see contended that section 40(a)(ia) wasITAT held that the bare provisions of section not applicable in a case where sum had40(a)(ia) provide for disallowance of expenses been paid, as impugned section was withfor non-deduction of amount which remains reference to ‘sums payable’. The Hon’blepayable to a resident in respect of certain Kolkata ITAT rejected the contention ofexpenses. It is not applicable where expenditure the assessee and held that the issue hadis paid and is applicable only in cases where been considered by the ITAT, Kolkatapayments are due and outstanding. The word, Benches, Kolkata in ITA No. 1418 (Kol.)/‘payable’ is not defined, though the word ‘paid’ 09 vide order dated 15-1-2010 in the caseis defined under section 43(2) to mean actually of Poddar Son’s Ex.L (P.) Ltd. v. ITOpaid or incurred. Hence, by implication the where it had been held as per para 6.6,word “payable” does not include paid or that even if the sum payable or paid toincurred. It placed reliance upon the decision the contractors or sub-contractors on whichof Teja Constructions’ case (supra). tax is deductible at source as per the provisions of the Act, section 40(a)(ia) will8.2.5 Decisions against the assessee - There are be attracted. Since assessee has not de-following 2 decisions against the assessee and ducted TDS as per provisions of sectionin favour of Revenue which have been 194C of the Act, it was held that thepronounced by the Hon’ble Kolkata ITAT: CIT(A) had rightly confirmed the action (a) Matrix Glass & Structures (P.) Ltd. [ITA of the A.O. in making disallowance. No. 658 (Kol.) of 2010] - It was held that Disallowance made by A.O. was upheld. the plea that disallowance under section 40(a)(ia) can be made only on “payable” amount cannot be accepted. It held that CONCLUSION such an interpretation would defeat the 9. The law has developed in the recent times very purpose of enacting the said provi- with respect to the provisions of section 40(a)(ia). sion. Even if the sum payable is paid and While as the Constitutionality of the section TDS is not deducted and/or deposited, has been upheld, the ‘crack-down’, in law, the provisions of section 40(a)(ia) would and the new ‘centre-point’ has been the be attracted. Hon’ble ITAT further held interpretation of words ‘paid’, ‘payable’ and that when the literal construction pro- ‘amounts payable’. There are differing views duces unjust or unwarranted or absurd of various Tribunals on the point. The air may result, then such, literal construction has be cleared now by either by a High Court’s to be given a go by for the sake of verdict or by the CBDT’s intervention. implementing the provision. (b) Very recently, in Dy. CIT v. Ashika Stock ••• Broking Ltd. [2011] 44 SOT 556/9616 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 16
  • 17. DIRECT TAX LAWS Concept INTRODUCTION of 1. In the current milieu of corporatisation of the charities sector and the increasing influence of CSR various new models of NGOs areFacilitating emerging. One of the new models of charitable work is the concept of Mother NGO or a Facilitating NGO which does not implement programmes directly but generates funds and NGOs resources for its downstream NGOs. The issue here is whether such NGOs can be considered as charitable in nature and whether they can charge a facilitation fee without being deemed as a commercial entities? The judicial precedents on these issues have been given as FAQs in the following paras: 2. A CHARITABLE ORGANISATION WORKING THROUGH OTHERS ONLY 2.1 Can a Charitable Organisation be said to be existing for a particular purpose when it is not directly engaged in such a purpose but is working through various other charitable organisations? - In the case of Aditanar Educational Institution v. Addl. CIT [1997] 90 Taxman 528 the Hon’ble Supreme Court laid down the ratio for determining the purpose for which an organisation exists. In this case the assessee was registered solely for the educational purposes but it imparted education through various registered schools and colleges. The department contended that the assessee itself was not MANOJ FOGLA providing any education directly, therefore, it CA could not be considered as existing solely for educational purposes. The Court observed that it would rather be unreal and hyper-technical to hold that the assessee-society was only a financing body and would not come within the scope of ‘other educational institution’ as December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 17 617
  • 18. DIRECT TAX LAWSspecified in section 10(22). The relevant [2011] 198 Taxman 63. In this case the assesseeobservation of the Court is as under : had received ` 2 crores as donation during the year and had donated ` 2.07 crore to various "It will be rather unreal and hyper-technical NGOs and institutions. The Assessing Officer to hold that the assessee-society is only argued that giving money to various a financing body and will not come within organisations could not be considered to be a the scope of ‘other educational institution’ charitable activity. He further argued that the as specified in section 10(22). The object funds given as inter-charity donation might of the society is to establish, run, manage not have been applied for charitable purposes. or assist colleges or schools or other It was held that the Assessing Officer had not educational institutions solely for pointed out violation of any provision of section educational purposes and in that regard 13 by the assessee. The Commissioner (Appeals) to raise or collect funds, donations, gifts, as well the Tribunal, both had found that the etc. Colleges and schools are the media organisations to which donations were given through which the assessee imparts by the assessee during the assessment year in education and effectuates its objects. In question, were genuine charitable organisations. substance and reality, the sole purpose There was absolutely no material before the for which the assessee has come into Assessing Officer to show that the funds given existence is to impart education at the to those NGOs/institutions were used for levels of colleges and schools and so, personal benefit of the donor or any of its such an educational society should be directors. regarded as an ‘educational institution’ coming within section 10(22)." 3.2 Can inter-charity donation be treated on par with direct implementation of Charitable2.2 The other relevant cases - The other relevant Activities? - ‘End justifies the means’ is whatcases in this regard are: Addl. CIT v. Aditanar the Courts have consistently held in determiningEducational Institution [1979] 118 ITR 235/[1980] the charitable nature of an organisation. In3 Taxman 56 (Mad.); CIT v. Rajagopal Educational CIT v. J.K. Charitable Trust [1992] 196 ITR 31/Trust [Special Leave Petition No. 6281 of 1986]; [1991] 59 Taxman 602 (All.), it was held aKatra Education Society v. ITO [1978] 111 ITR charitable purpose may be served in more420 (All.); CIT v. Doon Foundation [1985] 154 than one way. One is to directly contribute forITR 208/22 Taxman 9 (Cal.); Agarwal Shiksha the promotion of that cause; the other is toSamiti Trust v. CIT [1987] 168 ITR 751/[1988] contribute money to another charitable36 Taxman 165 (Raj.); Governing Body of Rangaraya organisation which advances that cause. InMedical Colleges v. ITO [1979] 117 ITR 284 other words, the Allahabad High Court laid(AP); and Secondary Board of Educations v. ITO down the principles of treating the work done[1972] 86 ITR 408 (Ori.). through another charity on par with doing the work directly. The Supreme Court in CIT v.3. A CHARITABLE ORGANISATION Thanthi Trust [1999] 239 ITR 502, has alsoMOBILISING DONATIONS AND THEN upheld the treatment of inter-charity donationsGIVING THEM AS INTER-CHARITY as valid application of funds. In this case the Supreme Court further held that the AssessingDONATIONS Officer cannot deny exemptions even if the3.1 Can a Charitable Organisation be considered donee-trust has not expended the amountsas charitable in nature when the entire donation received in the year of receipt. Similar viewsmobilised is given as inter-charity donation? - were also taken in CIT v. Aurobindo MemorialThis issue was brought before the Delhi High Fund Society [2001] 247 ITR 93/[2000] 108 TaxmanCourt in CIT v. HPS Social Welfare Foundation 271 (Mad.) and CIT v. Matriseva Trust [2003]618 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 18
  • 19. 128 Taxman 261 (Mad.). To sum up, inter- of Income-tax (Exemptions) [2009] 183 Taxmancharity donations have been held as valid 462 (Delhi), the assessee was a foundation set-applications for the purposes of section 11(1)(a). up by the Institute of Chartered Accountants of India (ICAI) with the main objective to make it an academy for imparting, spreading4. NGOs PROVIDING NON-FINANCIAL and promoting knowledge, learning, educationSUPPORT ONLY and understanding in various fields related to4.1 Is it possible to create a Charitable Orga- profession of accountancy. It was a deemednisation which acts as a support organisation company under section 25 of the Companiesto another Charitable Organisation? (Such Act, 1956 and was having status of an academy.support need not be financial in nature) - The assessee filed an application for claimingCharitable purpose has never been confined exemption under section 10(23C)(iv) taking aor given a narrow interpretation of expecting plea that it was covered by the expressioncharities to physically implement the programmes ‘charitable purposes’ as defined in section 2(15).themselves. The Courts have always held that The application was rejected on the grounds :any activity which directly or indirectly supports (i) that the assessee had undertaken threecharitable activities or even charitable organi- research projects on behalf of the localsations should be considered as a charitable bodies and had also received remunera-activity. There was an interesting case in the tion for those projects which amounted toDelhi High Court where one NGO formed a doing business of providing professionalcharitable trust to manage its properties. The services; andCIT denied it’s registration because accordingto him managing the properties of another (ii) that the assessee had received monies fromNGOs was not a charitable purpose. The Delhi Infosys Technologies Limited in the formHigh Court in the case of DIT (Exemption) v. of Infosys Fellowship Fund and, thoughPradan Property Holding Trust [IT Appeal No. it was for grant of fellowship to deserv-361/2007, dated August 16, 2010, ruled that ing candidates for undertaking researcha trust constituted for the management of projects, yet if a fellow would leave in theproperties of another charitable society should middle of the programme or would finishbe considered as charitable in nature. The Court his research early with funds left in theobserved that the stated fact that the assessee account, only Infosys would decide howdoes not carry on any independent charitable money was to be spent and, hence, theactivity was not enough to deny it registration assessee could not be said to be doingunder section 12AA. It further observed that any charitable activity in that regard. Thethere was no reason why holding of properties issue raised was, whether merely oncannot be said to be a charitable object. undertaking research projects at the in- stance of the Government/local bodies and taking remuneration for such projects,5. CHARGING OF REMUNERATION OR essential character of assessee-foundationADMINISTRATIVE COST IN CASE OF A could be said to have been converted intoCHARITABLE PROJECT one which carried on commerce or busi- ness or activity or rendering any service5.1 Can any remuneration or fee charged against in relation to trade, commerce or busi-any Charitable Project be considered as a ness? It was held that the charitable characterCommercial Activity? - In the case of ICAI would not change even if the foundationAccounting Research Foundation v. Director General had charged fees against various projects. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 19 619
  • 20. DIRECT TAX LAWS6. THE SUPREME COURT ON P.A. Inamdar v. State of Maharashtra AIR 2005COMMERCIALITY AND EXISTENCE SC 3226.OF PROFIT FOR CHARITABLEORGANISATIONS CONCLUSION6.1 Courts decision in some of the cases - 7. In the light of the various judicial precedantsWith regard to the issue of surplus generated it can be said that the term ‘charitable purpose’by charitable organisation it is important to is very broad one and is not confined to astudy the observations of the Hon’ble Supreme narrow interpretation, i.e., the charitable workCourt in T.M.A. Pai Foundation v. State of Karnataka has to be directly implemented by the NGO.[2002] 8 SCC 481. The 11-Judge Constitution To sum up, the following ratios emerge fromBench has held that the private educational these judicial precedents :institutions are bound to generate funds for u A charitable organisation can be said tobetterment and growth of the institutions for be existing for a particular purpose, evenwhich there may be a surpluses for furtherance if it is not directly engaged in such aof education. Therefore, it is not only permissible purpose but is working through variousbut an important requirement to run the other charitable organisations.institutions of such strength. Further, in AditanarEducational Institution’s case (supra), the Hon’ble u Inter-charity donation is treated on parSupreme Court has observed that when surplus with direct implementation of the chari-is utilized for educational purposes i.e., for table activities.infrastructure development, it cannot be said u A charitable organisation can be consid-that the institution was having the object to ered as charitable in nature, even if themake profit. The Hon’ble Supreme Court has entire donation mobilised is given as anrightly observed time and again that surpluses inter-charity donation.used for management and betterment of theinstitutions could not be termed as profit. If u The revenue cannot argue that the fundsthe stand of the Department/revenue is accepted given as inter-charity donation might notto be correct, especially in the wake of the have been applied for charitable purposesmethodology adopted by the Assessing Officer in the absence of any evidence.in ascertaining profits, then no educational u It is possible to create a charitableinstitution like the petitioner-society could be organisation which acts as a supportsaid to be existing solely for educational purposes, organisation to another charitableas in every case of an educational institution organisation. Such support needs not bethere is possibility of a profit. The Court further financial in nature.held that no profiteering does not imply that u Reasonable remuneration or fee chargedthe institutions cannot have a reasonable surplus against any charitable project cannot befor future sustenance and expansion of the considered as a commercial activity.institute. It was held that upto 6-15 per centof the profit could be considered as reasonable u Existence of a surplus or profit as a partand legitimate. This issue was further reaffirmed of charitable activity is permissible.by the Supreme Court’s ruling in the case of •••/SEC. 11620 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 20
  • 21. DIRECT TAX LAWS INTRODUCTION 1. Before amendment by the Finance Act, 2008Uncharitable with effect from 1-4-2009, the definition of ‘charitable purpose’ contained in section 2(15) of the Income-tax Act, 1961 (hereinafter called ‘the Act’) included “relief of the poor, education, medical relief and the advancement of any Face of other object of general public utility.” The newly substituted section 2(15), however, is as follows: “Charitable purpose” includes “relief of the poor, education, medical relief, preservation of environment (including watersheds, forests Charity and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility : Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention of the income from such activity. [Emphasis supplied]. PROFESSIONAL ASSOCIATIONS NO LONGER CONSIDERED AS CHARITABLE G.N. GUPTA INSTITUTIONS BY THE REVENUE Advocate, Chairman CBDT (Retd.) 2. Till the assessment year 2008-09 most of the professional associations were successfully claiming that they were engaged in the advancement of objects of general public utility, despite the fact that they were charging membership fees, selling professional journals to members and public, deriving considerable income from seminars and conferences and often, from educational activities as well. However, from the assessment year 2009-10 onwards, the revenue is more or less consistently holding that such professional associations are December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 21 621
  • 22. DIRECT TAX LAWSnow hit by the mischief of the provisions 2.2 CBDT’s Circular no. 11 of 2008 on thiscontained in the proviso to section 2(15) and, issue - Similarly, it has been stated in thetherefore, are no longer entitled to be considered CBDT’s Circular No. 11 of 2008, dated 19thas charitable institutions. This matter is likely December, 2008 [reported in 308 ITR (St.) 5]to spawn a lot of litigation as the underlying that an entity with a charitable object, interissue is highly debatable and the stand hitherto alia, consisting of advancement of any objecttaken by the revenue, to say the least, is rather of general public was eligible for exemptionsimplistic in view of the following reasons & under section 11 of the Act. “However, it wascase laws : seen that a number of entities who were engaged in commercial activities were also claiming2.1 Rationale behind amendment to section exemption on the ground that such activities2(15) - At the very outset, it would be useful were for the advancement of objects of generalto understand the rationale behind the public utility in terms of the fourth limb ofamendment to section 2(15) by the Finance the definition of “charitable purpose”. Therefore,Act, 2008. The best way to do so would be section 2(15) was amended vide Finance Act,to refer to the relevant portion of the 2008, by adding a proviso.” (emphasis supplied).Memorandum explaining the provisions in the Further, para 3 of the said circular read as :Finance Bill, 2008 reported in 298 ITR (St) 200- “The newly inserted proviso to section 2(15)201 which read as “It has been noticed that will apply to entities whose purpose isa number of entities operating on commercial “advancement of any other object of generallines are claiming exemption on their income public utility”, i.e., the fourth limb of the definitioneither under section 10(23C) or section 11 of of “charitable purpose” contained in sectionthe Act on the ground that they are charitable 2(15). Hence, such entities will not be eligibleinstitutions. This is based on the argument for exemption under section 11 or under sectionthat they are engaged in the “advancement of 10(23C) of the Act if they carry on commercialan object of general public utility” as is included activities. Whether such an entity is carryingin the fourth limb of the current definition of on an activity in the nature of trade, commerce“charitable purpose”. Such a claim, when made or business is a question of fact which will bein respect of an activity carried out on commercial decided based on the nature, scope, extentlines is contrary to the intention of the provision. and frequency of the activity.With a view to limiting the scope of the phrase“advancement of any other object of general 2.3 Facts emerging from conjoint reading ofpublic utility”, it is proposed to amend section the memo and CBDT’s circular - A conjoint2(15) so as to provide that “the advancement reading of the Memo Explaining the provisionsof any other object of general public utility” of Finance Bill, 2008 & CBDT’s Circular datedshall not be a charitable purpose if it involves 19-12-2008 will make it abundantly clear thatthe carrying on of following activities : firstly, an entity not engaged in commercial activities will not be hit by the mischief of (a) any activity in the nature of trade, com- proviso to section 2(15) of the Act and secondly, merce or business or, whether an entity is carrying on an activity (b) any activity of rendering of any service in the nature of trade, commerce or business in relation to any trade, commerce or busi- is a question of fact. ness, for a fee or cess or any other con- 2.4 The issue is no longer res integra after the sideration, irrespective of the nature of decision in DIT (Exemptions) v. ICAI - In fact, use or application of the income from this issue is no longer res integra in view of such activity, or the retention of such the decision of the Hon’ble Delhi High Court, income, by the concerned entity.” [Em- dated 19th September, 2011 in the case of DIT phasis supplied] (Exemptions) v. Institute of Chartered Accountants622 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 22
  • 23. of India [2011] 14 taxmann.com 5. Briefly stated, of law which arose for consideration beforethe facts in that case were that for assessment the Delhi High Court was “Whether theyear 2005-06, the ICAI filed its return of income ITAT was justified in the eyes of law in thedeclaring its income as Nil and this was accepted facts and circumstances of the present casein an assessment framed under section 143(3) in passing the impugned order that runningof the Act. Later on, on the grounds, inter alia of the coaching classes is a business activity and, therefore, is in violation of the provisionsthat coaching activity undertaken by the ICAI of Income-tax Act as also supported byamounted to “business” and not a charitable judgment of the Patna High Court cited inactivity and, therefore, the ICAI was required 208 ITR 608 ?” The Hon’ble Delhi Highto maintain separate books of account and, Court after taking into consideration a largethus, there was a violation of section 11(4A) number of cases dealing with the question,of the Act, the Director of Income-tax what constitutes “business”, came to the(Exemptions) (hereinafter called DI) set aside conclusion that DI was not justified in holdingthe assessment order under section 263 of the that the ICAI was carrying on business byAct. On appeal by the ICAI, the Income-tax holding coaching classes and programmesAppellate Tribunal examined the provisions for which fees were charged was like doingof the Chartered Accountants Act, 1949 and “business” and, therefore, dismissed thefound as follows : appeal filed by the revenue. (i) that ICAI was created to regulate the pro- 2.5 Landmark decision of Supreme Court in CST visions of Chartered Accountancy and for v. Sai Publication Fund - There is a landmark this purpose the Institute was required to decision of the Hon’ble Supreme Court of India in the case of CST v. Sai Publication Fund [2002] provide education, training and monitor 258 ITR 70/122 Taxman 437. Sai Publication Fund professional skills of the members and to was a trust created with the object of spreading provide education and training to stu- the message of Saibaba. In furtherance of and dents/article clerks, to accomplish said object, the trust published (ii) the fees charged from students/article clerks books, pamphlets and other literature containing were not excessive. Expenditure was in- the messages of Saibaba, which were made available curred for preparation of the study pack- to the devotees on nominal charges to meet the age, CD, etc., salary of the faculty and costs. The issue before the Hon’ble Supreme Court of India was whether Sai Publication Fund was other professionals, printing and statio- a ‘dealer’ engaged in carrying out ‘business’ nery, research and development. Study within the meaning of those words in section package included large question bank for 2(11) and section 2(5A) of the Bombay Sales Tax which no separate cost was charged. “The Act, 1959 which run as follows : students registered for chartered accoun- tancy are also provided on-line guidance Section 2(5A) ‘business’ includes any trade, through institute’s own Website. At a very commerce or manufacture or any adventure nominal cost, these services are provided or concern in the nature of trade, commerce to the students. The institute also pro- or manufacture whether or not such trade, vides computer training to the students commerce, manufacture, adventure or concern registered with it, at a very low fee”. is carried on with a motive to make gain or ITAT, therefore, held that the ICAI was profit and whether or not any gain or profit not doing any ‘business’ by running coaching accrues from such trade, commerce, manufacture, classes. Accordingly, the order passed by adventure or concern; and any transaction in the DI under section 263 of the Act was connection with, or incidental or ancillary to, cancelled. such trade, commerce, manufacture, adventure or concern. The DI filed an appeal before the Hon’ble Delhi High Court where one of the questions December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 23 623
  • 24. DIRECT TAX LAWSSection 2(11) ‘dealer’ means any person who fall under the first category referred towhether for commission, remuneration or earlier”.otherwise carries on the business of buying or The Supreme Court in this case held “Thisselling goods in the State, and includes the decision is directly on the point supportingCentral Government, or any State Government the case of the respondent after noticing awhich carries on such business, and also any number of decisions on the point includingsociety, club or other association of persons the decisions cited by the learned counsel beforewhich buys goods from or sells goods to its us. It may be stated that the question of profitmembers. motive or no profit motive is relevant onlyThe Supreme Court cited and relied upon the where person carries on trade, commerce,following two observations in the case of Board manufacture or adventure in the nature ofof Revenue v. A.M. Ansari [1976] 3 SCC 512. trade, commerce, etc. On the facts and in the circumstances of the present case, irrespective (a) “The words ‘carrying on business’ require of the profit motive, it could not be said that something more than merely selling or the trust either was a “dealer” or was carrying buying, etc. Whether a person ‘carries on on trade, commerce, etc. The trust is not carrying a business’ in a particular commodity must on trade, commerce, etc., in the sense of depend upon the volume, frequency, occupation to be a “dealer”, as its main object continuity and regularity of transactions is to spread the message of Saibaba of Shirdi, of purchase and sale in a class of goods and the transactions must ordinarily be as already noticed above. Having regard to all entered into with a profit motive. Such aspects of the matter, the High Court was profit motive may, however, be statuto- right in answering the question referred by rily excluded from the definition of ‘busi- the Tribunal in the affirmative and in favour ness’ but still the person may be ‘carrying of the respondent-assessee. We must, however, on business”. add here that whether a particular person is a “dealer” and whether he carries on “business” (b) In our view, if the main activity was not are matters to be decided on the facts and in ‘business’, then the connected, incidental the circumstances of each case”. or ancillary activities of sales would not normally amount to ‘business’ unless an independent intention to conduct ‘busi- CONCLUDING REMARK ness’ in these connected, incidental or 3. The logical corollary which inexorably flows ancillary activities is established by the from a careful perusal of the aforesaid decision revenue. It will then be necessary to find of the Supreme Court is that in the cases of out whether the transactions which are many professional institutions whose main connected, incidental or ancillary are only activity is not ‘business’, the connected incidental an infinitesimal or small part of the main or ancillary activities of sales carried out in activities. In other words, the presump- furtherance of and to accomplish their main tion will be that these connected, inciden- objects would not, normally, amount to business, tal or ancillary activities of sales are not unless an independent intention to conduct ‘business’ and the onus of proof of an ‘business’ in these connected, incidental or independent intention to do ‘business’ in ancillary activities is established by the revenue. these connected, incidental and ancillary Therefore, the issue whether a professional sales will rest on the department. If, for institution is or is not hit by the mischief of example, these connected, incidental or the proviso to section 2(15) of the Act will ancillary transactions are so large as to essentially depend upon the facts in the case render the main activity infinitesimal or very small, then of course the case would of the professional institutions. •••624 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 24
  • 25. DIRECT TAX LAWS Tax Accounting Standard on Government Grants and Accounting Standard 12 - A comparative study I n this article, the author points out the similarities and differences between the TAS on ‘Government Grants’ and the Accounting Standard (AS) 12 of ICAI and observes that TAS would have no material impact upon the computation of taxable income of a person as the accounting treatments prescribed by both the Standards are almost similar. TAS on Government grants only fulfils its object of doing away with alternative accounting DINDAYAL DHANDARIA treatment in AS. CACOMPARATIVE STUDY OF ‘TAS’ ON down the method for computation of income‘GOVERNMENT GRANTS’ AND AS - 12 chargeable under the head “Profits and gains of business or profession” or “In-1. Some of the similarities and differences on come from other sources”. Thus, the ‘TAS’the important issues between the two are would not require any change in the financialsummarised hereunder: statements prepared in accordance with (i) Objectives & Scope - In view of the sig- AS 12. While computing the income from nificance of the receipt of a Government Government Grants, reconciliation between grant by an enterprise, the objective of the income as per the financial statements the Accounting Standard (AS) 12 has been and the income computed as per the ‘TAS’ to lay down an appropriate method of would be required to be presented. This accounting for such grants so that the will ensure that a taxpayer is not required financial statements give an indication of to maintain two sets of books of account the extent to which the enterprise has - one in accordance with the Accounting benefited from such grant during the Standards issued by the ICAI/notified under reporting period. On the other hand, Tax the Companies Act, 1956 and another in Accounting Standard (TAS) on “Tax accordance with the Accounting Standards Accounting for Government Grants” lays notified under the Act. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 25 625
  • 26. DIRECT TAX LAWS(ii) Definitions - Both the Standards, viz., ‘TAS’ Where a grant has not been received but and ‘AS’ 12 define the terms ‘Govern- earned, ‘AS’ stipulates that an appropriate ment’ and ‘Government Grants’. The amount in respect of such earned benefits, definitions of these two words in both the estimated on a prudent basis, should be Standards are same except that: credited to the income for the year even though the actual amount of such benefits (a) While defining the word ‘Govern- may be finally settled and received after ment’ ‘TAS’ expressly refers to both the end of the relevant accounting period. the Central Government and the State Such an accounting treatment is in Governments. In ‘AS’ 12 also, the accordance with the concept of ‘accrual’ word ‘Government’ means both the of income. Central and State Governments – though it is not specifically stated. (iv) Various purposes of Government Grants and accounting treatment therefor - ‘TAS’ (b) ‘TAS’ uses the word ‘person’ instead prescribes different accounting treatments of ‘enterprise’ used in ‘AS’. for Government Grants considering the(iii) Recognition of Government Grants - ‘TAS’ purposes of the grants, viz.: provides that the Government grants should (a) Where it relates to a depreciable fixed not be recognised until there is reason- asset; able assurance that (i) the person shall comply with the conditions attached to (b) Where it relates to a non-depreciable them, and (ii) the grants shall be received. fixed asset; It further provides that recognition of (c) Where it does not relate directly to Government grant shall not be postponed the asset acquired; beyond the date of actual receipt. [Para 4]. (d) Where it is receivable as compensa- tion for expenses or losses; ‘AS’ makes a similar provision that the Government grants available to the enter- (e) Where it is in the form of non-monetary prise should be considered for inclusion assets, given at a concessional rate. in accounts where there is reasonable as- ‘AS’ stipulates accounting treatment for surance that the enterprise will comply all the above types of Government Grants with the conditions attached to them and except the one mentioned in (c) above. In it is reasonably certain that the ultimate addition, ‘AS’ stipulates accounting treat- collection will be made. But ‘AS’ stipu- ment for Grants received in the nature of lates a further condition that such grants Promoters’ contribution. ‘TAS’ does not should be recognised where such benefits deal with this kind of Grant – meaning have been earned by the enterprise and that it does not make any change in the states that mere receipt of a grant is not accounting treatment prescribed by ‘AS’. necessarily a conclusive evidence that con- ditions attaching to the grant have been (v) Accounting treatment where a Grant or will be fulfilled. relates to a depreciable fixed asset - ‘TAS’ [Para 6 of ‘AS’]. stipulates that where the Government grant relates to a depreciable fixed asset or assets Thus, the two Standards differ on the of a person, the grant shall be deducted issue of recognition of a grant where the from the actual cost of the asset or assets receipt thereof is not pursuant to earning concerned or from the written down value of the same by the enterprise, i.e., where of block of assets to which concerned asset the same is received in advance. or assets belonged to. [Para 5].626 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 26
  • 27. On the other hand, ‘AS’ stipulates two Para 8.4 of ‘AS’ contains similar stipula- methods of presentation in financial tion and there is no difference between statements of grants for the appropriate the two Standards. portions of grants related to specific fixed (vii) Accounting treatment where a Grant does assets are regarded as acceptable not relate directly to the asset acquired - alternatives, as follows: ‘TAS’ stipulates that where the Govern- “(a) Under one method, the grant is shown ment grant is of such a nature that it as deduction from the gross value of cannot be directly relatable to the asset the asset concerned in arriving at its acquired, so much of the amount which book value. The grant is, thus, bears to the total Government grant, the recognised in the profit and loss same proportion as such asset bears to all statement over the useful life of a the assets in respect of or with reference depreciable asset by way of a re- to which the Government grant is so duced depreciation charge. Where the received, shall be deducted from the actual whole, or virtually the whole, of the cost of the asset or shall be reduced from cost of the asset, the asset is shown the written down value of block of assets in the balance sheet at a nominal to which the asset or assets belonged to. value. [Para 7]. (b) Under the other method, grants related Thus, ‘TAS’ envisages proportionate re- to depreciable assets are treated as duction in the actual cost of the various deferred income which is recognised assets collectively acquired. in the profit and loss statement on ‘AS’ deals with Grants related to specific a systematic and rational basis over fixed assets in its paragraph 8. It does not the useful life of the asset. Such specifically deal with grants which do not allocation to income is usually made relate directly to the asset acquired and over the periods and in the propor- are collectively received for a number of tions in which depreciation on assets. related assets is charged.” Thus, by making specific provision for [Paras 8.2 to 8.4 of AS] proportionate reduction in the actual cost Thus, ‘TAS’ does away with alternative of such assets, ‘TAS’ removes any scope methods and stipulates only one method for confusion in the matter of accounting which is similar to the first method stated treatment of grants collectively received in AS. However, this difference between for a number of assets. ‘TAS’ and ‘AS’ does not have any impact (viii) Accounting treatment where a Grant is on the financial results of a person. receivable as compensation for expenses or losses - ‘TAS’ stipulates that the(vi) Accounting treatment where a Grant relates to a non-depreciable fixed asset - Government grant that is receivable as ‘TAS’ stipulates that where the Govern- compensation for expenses or losses in- curred in a previous financial year or for ment grant relates to a non-depreciable asset or assets of a person requiring the purpose of giving immediate financial support to the person with no further fulfilment of certain obligations, the grant shall be recognised as income over the related costs, shall be recognised as in- come of the period in which it is receiv- same period over which the cost of meeting such obligations is charged to revenue. able. [Para 8]. [Para 6]. ‘AS’ states that Grants related to revenue are either presented as a credit in the December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 27 627
  • 28. DIRECT TAX LAWS profit and loss statement (either separately want to make any change in the accounting or under a general heading such as ‘Other treatment prescribed by ‘AS’. Income’) or alternatively, they are deducted (xi) Accounting treatment of Refund of Gov- in reporting the related expense. ernment Grants - ‘TAS’ provides that the The alternative treatment envisaged in amount refundable in respect of a Gov- the above paragraph is possible only when ernment grant referred to in paragraphs the grant is received in the same year in 6, 8 and 9 (i.e. grants related to a non- which the expense is incurred. depreciable asset and as compensation for expenses or losses) shall be applied first It may be noted that while ‘TAS’ prescribes against any unamortized deferred credit accounting treatment where the incurring remaining in respect of the Government of expenditure and the receipt of the grant grant. To the extent that the amount falls in two separate reporting periods refundable exceeds any such deferred credit, and permits accounting on cash basis, or where no deferred credit exists, the ‘AS’ does not prescribe any accounting amount shall be charged to profit and treatment for such a situation. loss statement. [Para 11].(ix) Accounting treatment where a Grant is ‘TAS’ provides that the amount refundable receivable as non-monetary assets, given in respect of a Government grant related at a concessional rate - ‘TAS’ stipulates to a fixed asset or assets shall be recorded that the Government grants in the form by increasing the actual cost or written of non-monetary assets, given at a down value of block of assets by the concessional rate, shall be accounted for amount refundable. Where the actual cost on the basis of their acquisition cost. of the asset is increased, depreciation on [Para 10]. the revised actual cost or written down Para 7.1 of ‘AS’ contains similar stipula- value shall be provided prospectively at tion and there is no difference between the prescribed rate. [Para 12]. the two Standards. ‘AS’ provides for similar accounting ‘AS’ further provides that non-monetary treatment vide its Paragraphs 11.2 and assets given free of cost are recorded at 11.3. a nominal value. Thus, there is no difference between the(x) Accounting treatment where a Grant is in two Standards on this issue. the nature of Promoter’s contribution - (xii) Disclosure - Para 13 of ‘TAS’ provides Para 10.1 of ‘AS’ stipulates that where the that the following disclosures shall be made Government grant is in the nature of pro- in respect of Government grants: moters’ contribution, i.e. they are given with reference to the total investment in (a) Nature and extent of Government an undertaking or by way of contribution grants recognised during the previ- towards the total capital outlay (for ex- ous year by way of deduction from ample, central investment subsidy scheme) the actual cost of the asset or assets and no repayment is ordinarily expected or from the written down value of in respect thereof, the grants are treated block of assets during the previous as capital reserve which can be neither year. distributed as dividend nor considered as (b) Nature and extent of Government deferred income. grants recognised during the previ- Since ‘TAS’ has not dealt with this issue, ous year as income. it may be concluded that ‘TAS’ does not628 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 28
  • 29. (c) Nature and extent of Government in the statement computing the income grants not recognised during the of a person as ‘TAS’ does not require a previous year by way of deduction person to maintain books of account on from the actual cost of the asset or the basis of ‘TAS’. assets or from the written down value of block of assets and reasons thereof. CONCLUSION (d) Nature and extent of Government 2. The gist of the above study is that: grants not recognised during the previous year as income and reasons (a) Both the standards provide similar thereof. accounting treatment for Government grants received for different purposes.On the other hand, Para 23 of ‘AS’ providesthat the following should be disclosed: (b) There are changes in words, reduction in paragraphs, omission of examples, (a) the accounting policy adopted for re-arrangement of paragraphs without hav- Government grants, including the ing any effect on the main principles stated. methods of presentation in the financial statements. (c) ‘TAS’ does away with some of the alter- native accounting treatments prescribed (b) the nature and extent of Government by ‘AS’. grants recognised in the financial state- ments, including grants of non-mone- (d) ‘TAS’ does not make any difference in tary assets given at a concessional computation of income of a person except rate or free of cost. where a Government Grant is received in advance (i.e. before a person earns it).It seems that the aforesaid disclosuresrequired by ‘TAS’ would have to be made ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 29 629
  • 30. DIRECT TAX LAWSDIRECT TAX LAWS An insight into expenditure before commencement of business INTRODUCTION 1. Expenditure incurred before commencement of business is combination of following two expenses: (a) Pre-incorporation expenses (or preliminary expenses); and (b) Pre-operative expenses. PRE-INCORPORATION EXPENSES NAVEEN WADHWA 2. Pre-incorporation expenses or preliminary CA expenses are the expenses incurred before the630 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 30
  • 31. incorporation of the company and these are (f) Expenditure on relocating or re-organiz-borne by the promoters of the company. These ing part or all of an enterprise.expenses relate to the formation of an enterprise 2.1.2 Further, in view of section 78 of Companiesand are huge in amount, non-recurring and Act, 1956, the share premium received by thenot related to the day-to-day operations. company on issue of securities can be used forIn case of a company, preliminary expenses writing off the preliminary expenses. The saidgenerally include following: section does not compel the company rather it gives an option to the company to write off (a) Charges for drafting of legal agreement; the preliminary expenses against security (b) Charges for drafting and printing of memo- premium. randum and article of association; To sum up, the preliminary expenses can be (c) Preparation of feasibility-cum-project re- written off against security premium or port; alternatively it can be debited to the profit (d) Payment of statutory fees for registration and loss account. of company; 2.1.3 Allocation of pre-incorporation expenses - In this regard, Expert Advisory Committee of (e) Stamp duty for the documents; ICAI has given an opinion on the query raised (f) Advertisement expenses and; by a company “whether preliminary expenses (g) Any other expenses incurred to bring into can be capitalized with actual cost of fixed existence the corporate structure of the asset” that –”the start-up costs of the nature of company. incorporation expenses incurred for bringing the enterprise into existence in its corporate form cannot2.1 Accounting treatment of pre-incorporation be said to be attributable to bringing an asset/expenses project into existence. Accordingly, the same cannot2.1.1 Accounting treatment of preliminary be capitalized even as an indirect element of costexpenditure is dealt with by “Accounting of the asset/project.”Standard (AS)-26: Intangible assets”. As per 2.2 Tax treatment of pre-incorporation expenses -para 56 of AS-26, expenditure on start-up Section 35D of the Income-tax Act, 1961 (“theactivities (start-up costs) shall be written off Act”) provides for deduction of preliminaryto the profit and loss account in the year in expenses. These expenses are bifurcated intowhich it is incurred, unless this expenditure two parts by virtue of section 35D of Act:is included in the cost of an item of fixed assetunder AS 10. Start-up costs may consist of: (i) expenditure incurred before commence- ment of business; and (a) Preliminary expenses incurred in estab- lishing a legal entity such as legal and (ii) expenditure incurred after commencement secretarial costs; of business, in connection with the exten- sion of the undertaking or in connection (b) Expenditure to open a new facility or with setting up a new unit. business (pre-opening costs); However, only specified expenditures, as (c) Expenditures for commencing new opera- mentioned in section 35D(2), are eligible for tions or launching new products or pro- deduction under this section, namely: cesses (pre-operating costs); (a) expenditure in connection with: (d) Expenditure on training activities; (i) preparation of feasibility report; (e) Expenditure on advertising and promo- tional activities; and (ii) preparation of project report; December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 31 631
  • 32. DIRECT TAX LAWS (iii) conducting market survey or any other exclusive list of expenditure eligible for deduction survey necessary for the business of under this provision. the assessee; Any expenditure incurred before commencement (iv) engineering services relating to the of business, notwithstanding it is recognized business of the assessee. in the books of account as preliminary expenditure, shall not be allowed as deduction (b) legal charges for drafting any agreement under section 35D unless it is provided between the assessee and any other per- specifically under section 35D(2). son for any purpose relating to the setting up or conduct of the business of the assessee; 2.2.2A Expenditure on Private Placement of equity shares - Not falling in purview of section 35D - (c) where the assessee is a company, also In the case of Beautex (India) (P.) Ltd. v. ITO expenditure: [2009] 34 SOT 465 (Delhi), the assessee-company (i) by way of legal charges for drafting claimed that it had incurred certain preliminary the Memorandum and Articles of expenses for increasing share capital by way Association of the company; of private placement and, accordingly it was (ii) on printing of the Memorandum and claimed as deduction under section 35D. The Tribunal held that the expenditure had been Articles of Association; incurred for raising capital by private placement. (iii) by way of fees for registering the Therefore, the expenditure incurred could not company under the provisions of the be said to have been incurred in connection Companies Act, 1956; with extension of an existing undertaking or (iv) in connection with the issue, for public setting up of a new unit. Accordingly, expenditure subscription, of shares in or deben- incurred could not be allowed under section tures of the company, being under- 35D. writing commission, brokerage and Under section 35D(2)(c)(iii) only fees paid for charges for drafting, typing, print- registration of a company is deductible. Fees ing and advertisement of the pro- paid for increase in share capital is not fees spectus; for registration of the company and, hence, is (d) such other items of expenditure (not being not allowed as deduction under section 35D 1. expenditure eligible for any allowance or 2.2.3 Section 35D does not override Section 37(1) - deduction under any other provision of Section 35D grants a deduction in respect of this Act) as may be prescribed. expenditure which may otherwise be disallowable2.2.1 It must be noted that preliminary on the ground that it is of capital nature orexpenditure shall be allowed as deduction in is incurred prior to the setting up of the business.5 equal instalments beginning with the previous In other words, the expenditure which isyear in which the: otherwise allowable as revenue expenditure (for example, debenture issue expenses) cannot (a) business commences; be brought within the purview of this section. (b) the extension of the undertaking is com- However, if any capital expenditure or pleted; or expenditure incurred before commencement (c) the new unit commences production or of business is not claimed as deduction under operation. section 35D (provided it is allowable under said section), it cannot be claimed as deduction2.2.2 Exclusive list of specified expenditure - Section under section 37(1).35D - Section 35D of the Act provides the632 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 32
  • 33. Section 35D cannot be regarded as a specific As there are contrary decisions on allowabilityprovision, overriding the general provision of of expenses on the issue of debentures, it issection 37(1). Both section 35D and section advisable to claim the said expenditure under37(1) are enabling provisions and are not mutually section 37(1). Otherwise, assessee shall loseexclusive. the time value of money because debenture issue expense is allowed as deduction upfront2.2.3A Fees paid to increase the share capital is under section 37(1), whereas under sectionnot deductible at all - Where fees paid to increase 35D it is allowed in equal instalments inthe share capital is not allowed as deduction 5 previous years.under section 35D because it is not connectedwith either: 2.2.4 Allowability of expenditure for extension of undertaking - Any capital expenditure incurred (a) registration of company; or after commencement of business, which is (b) issue of shares for public subscription, otherwise not allowable as deduction under section 37(1), may be claimed as deductionthe alternative claim of the assessee undersection 37(1), on the ground that increase was under section 35D, provided such expendituremeant to provide additional finance for is:company’s activities and as such payment of (a) specifically provided under section 35D;fees was incidental to its business, shall not andbe entertained. (b) incurred in connection with the extensionSince the expenditure incurred in connection of an undertaking or in connection withwith issue of shares with a view to increase setting up a new unit.share capital was directly related to expansion The expression used in the statute is ‘extensionof capital base of company and was capital of undertaking’. A great emphasis has to beexpenditure, it shall not be allowed as deduction given on the expression ‘undertaking’. Businesseither under section 35D or section 37(1) 1. expansion and market expansion of an existing2.2.3B Debenture issue expenses can be claimed business will not amount to extension of theunder section 37(1) or section 35D - In Shree ‘undertaking’. An undertaking is always havingSynthetics Ltd. v. CIT [2008] 303 ITR 451 (MP), an area of physical structure which producesthe High Court held that expenditure incurred goods and services by utilising the necessaryby the assessee towards execution of debenture factors of production. Enhancement of theissue was in the nature of preliminary expenses geographical area of marketing does not amountthereby falling within the four corners of section to expansion or extension of the undertaking.35D and hence, should be allowed as deduction It clearly manifests that an apparent extensionin the manner provided in the said section, or expansion must take place in the physicali.e., section 35D. undertaking2.However, in the case of Dy. CIT v. Modern Therefore, any capital expenditure incurredSyntex (India) Ltd. [2005] 3 SOT 27, the Jaipur by an assessee shall not be allowed as deduction,ITAT held that expenditure incurred on issue unless:of partly convertible debentures and fully (a) such expenditure is specifically mentionedconvertible debentures is allowable as revenue in section 35D; anddeduction notwithstanding provisions containedin section 35D. (b) it is incurred in connection with actual extension of an undertaking. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 33 633
  • 34. DIRECT TAX LAWSPRE-OPERATIVE EXPENSES Example - A newly incorporated company intends to start a power generation plant. It engaged3. Pre-operative expense, on the other hand, a consultant and architect to develop the planis a wider term and it includes all expenses and to handle general office work. It hired 2incurred after company formation but prior to office staff and 1 accountant to process thecommercial production. salary, payment to contractors, payment forPre-operative expenses are those which are purchase of construction material and to takeconnected with actions that are required for care of all accounting and statutory work.start-up of operations. Pre-operative expenditure As per para 9 of “AS-10: Accounting for fixedcan, therefore, be capitalized by apportionment/ assets”, administration and other generalallocation to assets which are the subject matter overhead expenses are usually excluded fromof operation. the cost of fixed assets because they do not3.1 Accounting treatment of pre-operative relate to a specific fixed asset. However, inexpenses some circumstances, such expenses as are specifically attributable to construction of a3.1.1 Pre-operative expenses of capital nature project or to the acquisition of a fixed assetare to be capitalized with the cost of fixed or bringing it to its working condition, mayassets in relation to which they have been be included as part of the cost of the constructionincurred. Further, there are few revenue expenses project or as a part of the cost of the fixedwhich are directly attributable to the asset asset.under construction, i.e., salary of engineersand technicians engaged in installation of plant. Therefore, the entire cost of consultant andThese expenses are also apportioned to the architect shall be allocated to cost of fixedasset under construction and capitalized with assets, whereas, salary of accountant can becost of such asset at the time of commissioning. allocated on some reasonable basis. Salary of office staff shall be debited to profit and lossThe cost directly attributable to acquisition or account only because it has no nexus, directconstruction of an asset can be following: or indirect, with construction of power plant. (a) Site-preparation; 3.2 Tax treatment of pre-operative expenses - (b) Initial delivery and handling costs; It is a well established principle that all expenses, as envisaged in section 30 to section 37, are (c) Installation costs, i.e., construction of special allowed as deduction if they are incurred during foundation for plant; the course of carrying on the business and are (d) Professional fees, i.e., architect and engi- directly and intimately connected with the neers fees. business.Such expenses are allocated to the acquired or The expression ‘for the purpose of the business’constructed asset and forms part of actual cost as used in section 37(1) refers to a businessof acquisition of asset. that is being carried on by the assessee. Thus, any expenditure incurred before the setting3.1.2 Now a question arises what treatment up of a business cannot be deducted. However,shall be given to the general and administrative such expenditure can be treated differently,cost incurred during the course of construction say, it can be capitalized with actual cost ofof asset or before actual commencement of capital asset or it can form part of work-in-business. The nature of general and progress, etc.administrative expenses can be understood withthe following example. 3.2.1 Capitalization with actual cost of fixed asset - All pre-operative or pre-production expenditure,634 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 34
  • 35. which has direct or indirect nexus with the u In the case of CIT v. Bharat Agrico Co.acquisition or creation of fixed asset, have to [1999] 102 Taxman 296 (Pat.), the assesseebe capitalized. capitalised along with cost of machinery, pre-operative expenses which included in-Where any capital asset, say a crane is used terest paid to partners prior to start ofin construction of a building, the depreciation business. The High Court held that theon such crane shall be regarded as pre-operative payment of interest to the partners hadexpenditure and will form part of actual cost no nexus, direct or indirect, with the settingof building constructed. up of the business; hence, it could not beA reference can be made to the decision of the added to actual cost of machinery forSupreme Court of India in case of Challapalli capitalisation.Sugars Ltd. v. CIT [1975] 98 ITR 167. In this u In the case of Kapur Sons & Co. v. CITcase the Supreme Court held that the expression [1985] 23 Taxman 66 (Delhi), the Court“actual cost” of an asset should include all had held that certain expenses such asexpenditure necessary to bring such an asset rent and taxes cannot be capitalised tointo existence and to put it in working condition. the cost of building (cinema hall), as suchThe Court held that the expression “actual expenses are not paid in connection withcost” should be construed in the sense which construction of such building. In this caseno man of commerce would misunderstand. the Court referred to the nature ofFor this purpose, it would be necessary to expenses, being ground rent and tax paidascertain the connotation of this expression in to Municipal Corporation, for the inclu-accordance with the normal rules of accountancy sion of these expenses incurred in theprevailing in the commerce and industry. construction of the cinema hall. The CourtThere should be nexus between expenditure incurred held that there has to be some nexus betweenwith setting up of business expenses and actual cost. u In the case of Gujarat Ambuja Cements Ltd. 3.2.2 Allowable as revenue expenditure if there is v. Asstt. CIT [2005] 4 SOT 59 (Mum. - an extension of business - Any expenditure, to ITAT), the assessee started commercial pro- be regarded as pre-operative expenditure, should duction since October 1986. Prior to this, be incurred before commencement of business. assessee charged depreciation on some However, where there is an extension of an fixed assets, which were put to use before established business, any expenditure incurred start of commercial production. Assessee before commencement of extended business capitalized pre-operative expenses including shall be an allowable expenditure, provided depreciation on such assets in accordance there is complete interlacing of funds, unity with accounting practices of ICAI. The of control, common management, common Tribunal held that assessee was entitled administration, etc., pervading two lines of to depreciation as per rules on capitalized activity. value of pre-operative expenses including depreciation charged on assets used in 3.2.2A In the case of Dy. CIT v. Modern Syntex pre-operative period. (India) Ltd. [2005] 3 SOT 27, the Jaipur Tribunal held that in case of expansion of existing business, In case, the expenditure incurred has no expenditure incurred for such purpose was to nexus, whether direct or indirect, with be considered as revenue expenditure and the setting up of a business or the instal- therefore, was allowable as business expenditure. lation of the machinery, it can neither be allowed as deduction nor it can be capi- 3.2.2B To establish that new business line is talized with actual cost of capital asset. an extension of an established business, the December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 35 635
  • 36. DIRECT TAX LAWSenterprise should prove that there is an interlacing operative expenditure incurred by assessee onand inter-dependence between businesses carried said project was revenue expenditure.on by the enterprise. Interlacing and inter- 3.2.3 Setting up of business v. Actual commencementdependence is primarily judged on following of business - From the above discussion, it iscriteria 3: established that all expenses incurred before (a) Unity of control; commencement of business is not allowed as deduction. Now the question arises at this (b) A common management; juncture, whether all expenses incurred before (c) A common business organization; actual commencement of business, but incurred after business is ready to be commenced, are (d) A common administration; disallowed. The answer is ‘No’. (e) A common fund; and This question is considered by the Delhi High (f) A common place of business. Court in the case of GNS Stock Holdings (P.)In the case of Kalyani Steels Ltd. v. Dy. CIT Ltd. v. Dy. CIT [2011] 12 taxmann.com 376/[1997] 62 ITD 233, the Pune Tribunal held that 46 SOT 510. The High Court held that:management, funds, place of business of new (a) The actual commencement of the busi-undertaking and of established undertaking ness may have some interval from thewas common. Thus, interest expenses incurred date when the business was set up, butin connection with new undertaking and claimed in order to hold that the business is setas pre-operative expenses could be allowed as up, it is to be seen as to whether it wasdeduction. ready to commence though actual com-In Jay Engineering Works Ltd. v. CIT [2008] 166 mencement might not have been takenTaxman 115 (Delhi), the assessee-company was place.manufacturing fans and sewing machines at (b) It is only after the date of setting up ofvarious units. It undertook a Fuel Injection the business that the previous year of theEquipment Project in Hyderabad. Assessee newly set up business would commence,claimed that pre-operative expenses incurred and the expenses incurred prior to thein relation to said project like testing charges, date of setting up of business could notinterest charges, bank commission, foreign be taken into account for the purposes oftravelling, etc., were in nature of revenue nature. determining the profits of a newly set upThe Assessing Officer rejected assessee’s claim business.holding that said pre-operative expenditurewas in nature of expenses incurred in connection (c) The assessee is entitled to admissible busi- ness expenses from the day when thewith setting up of a new line of business and,therefore, said expenditure was capital assessee’s business could be said to have been set up from the day when the businessexpenditure. was ready to commence and not from theThe Delhi High Court held that new venture date of actual commencement of thewas managed from common funds; control business.over two units was in hands of same managementand administration; and there was necessaryunity of control leading to an inter-connection, CONCLUSIONinter-dependence and inter-lacing of two 4. Any preliminary or pre-incorporation expensesventures. It could be said that Fuel Injection shall be amortised in profit and loss accountEquipment Project was only an extension of upfront or alternatively it can be written offexisting business of assessee. Therefore, pre- against security premium.636 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 36
  • 37. However, for the computation of income-tax, or construction of a new asset. If expenses aresuch expenditure shall be allowed as deduction not attributable to acquisition of a fixed assetin 5 equal instalments subject to conditions or setting-up of a new business, it will bespecified in Section 35D, namely: charged to profit & loss account. u the expenditure is mentioned specifically For income-tax purpose, pre-operative expenses in section 35D(2); shall form part of actual cost of asset, if it has direct or indirect nexus with acquisition of u the expenditure is incurred before com- capital asset. mencement of business; or Pre-operative expenditure, unless they form u the expenditure is incurred after com- part of cost of capital asset, will be a sunk cost mencement of business, in connection with and not allowed as deduction if there is no the extension of an undertaking or in con- nexus between expenses and acquisition of nection with setting up a new unit. asset.Pre-operative expenses shall form part of actual The entire discussion can be assimilated throughcost of an asset in accordance with “Accounting following chart. A revenue expenditure incurredStandard-10: Fixed assets”, if such expenses by a company at different levels shall be treatedare directly or indirectly attributable to acquisition as under: ••• 1. CIT v. Hindustan Insecticides Ltd. [2001] 116 Taxman 406 (Delhi) 2. Medreich Ltd. v. Dy. CIT [2011] 15 taxmann.com 371 (Bang. - Trib.) 3. B.R. Ltd. v. V.P. Gupta, CIT [1978] 113 ITR 647 (SC) December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 37 637
  • 38. DIRECT TAX LAWSDIRECT TAX LAWS 1. Whether proportionate disallowance can be made under section 40(a)(ia) due to the less deduction of TDS? One interesting and beneficial judgment has recently been given by the Tribunal in the case of Dy. CIT v. S.K. Tekriwal [2011] 15 taxmann.com TDS 289 (Kol. - Trib.) which shall undoubtedly help in setting aside the objections of the revenue and the consequent proportionate disallowance of expenses by applying the provisions of section 40(a)(ia). It shall cover the case of less deduction Issues of TDS due to the difference of opinion about provisions applicable. The Tribunal has held that as section 40(a)(ia) does not cover the case of lower deduction of tax at source but is only applicable where there is no deduction at all and where tax is not paid after deduction by the assessee and, hence, has concluded that where there is a deduction of tax by the assessee, though at a lower rate due to the difference of the opinion about the provisions applicable, yet the related expense cannot be disallowed by the revenue. 2. Whether an assessee can be treated as an assessee-in-default under section 201 unconditionally for less deduction of TDS? In the above cited case law it has been held that an assessee can be declared as an assessee- in-default under the provisions of section 201 where there is less deduction of TDS. This question calls for deciding the fact whether the provisions of section 40(a)(ia) should be treated at par with the provisions of section 201, as far as the shorter deduction of TDS is concerned, meaning thereby that when both GAURAV PAHUJA CA sections, i.e., sections 40(a)(ia) and 201 intend to strengthen the recovery of tax deducted at source then what is the reason of giving relief under the provisions of the former when there is less deduction of TDS but no relief under the provisions of the later in the same circumstances, i.e., for less deduction. Although638 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 38
  • 39. the decision of the Tribunal in the above said which comes under the purview of sectioncase is in accordance with the provisions of 194J. However, the term “other personnel” assection 40(a)(ia), as it does not cover the case used here is in relation to the managerial,of less deduction, yet, at the same time, the technical or consultancy services, thus, it mustdecision given by the Hon’ble Supreme Court not be correlated with some other kind ofin the case of Hindustan Coca Cola Beverage (P.) personnel CIT v. McDowell & Co. Ltd. [2009]Ltd. v. CIT [2007] 163 Taxman 355, seems to 314 ITR 167/180 Taxman 514 (SC). Also, inhave been ignored altogether, which provided order to bring consideration received forthat where the deductee, recipient of income, rendering a service under “fee for technicalhas already paid the taxes on amount received services” it is necessary that some technicalfrom the deductor, the department once again know-how must be provided by a humancannot recover tax from the deductor on the element.same income by treating the deductor to be In view of the above, where no technical know-an assessee-in-default for shortfall in amount how is provided but only a standard serviceof tax deducted at source. Thus, it would not is provided to the customers, e.g., for thebe appropriate to say unconditionally that an movement of the containers, it cannot be treatedassessee can be treated as an assessee-in-default as the rendering of a technical service bringingwhen there is less deduction of TDS by an it under the purview of section 194J and theassessee and the same can be done only when same should come under the provisions ofthe recipient didn’t pay the taxes due on the section 194C. Similar view is taken by theamount received from the deductor, subject to ITAT, Mumbai Bench ‘B’ in the case of Asstt.other relevant provisions of the Act. CIT v. Merchant Shipping Services (P.) Ltd. [2011] 129 ITD 109/9 taxmann.com 17.3. Whether payment of consideration bya shipping agent to another person for 4. Whether section 194C is applicablethe shifting of the cargo of its only when there is a sub-contractorcustomers through various types of directly employed for the execution of acranes owned by such another person contract or it would be applicable evenshould be subject to tax deduction under when the execution of a contract is donesection 194C or 194J? through a sister concern?No doubt, the shifting of the cargo involves The said controversy arose due to the use ofthe use of heavy cranes and the use of knowledge the expression “any person responsible forand the skills of the persons engaged in handing paying any sum to any resident” in sectionthe containers while they are in the process 194C. According to the simple reading of theof loading and unloading but should such section, TDS is applicable even when paymentknowledge and skills be treated as the technical is made to a sister concern by an assessee.knowledge resulting into providing a technical However, the basic intention of the sectionservice becomes a moot question in determining should also be given its due importance beforethe applicability of section 194C or 194J. a conclusion is drawn. Although the sectionFurther, the recipient shall always prefer lower seeks to bring any such sum under tax netdeduction and, thus, would like to follow the which is paid by an assessee for carrying outprovisions of section 194C. Moreover, the use any work by another person for the assessee,of the expression “other personnel” in the yet its intention cannot be to charge a sum ofExplanation (2) to section 9(1)(vii), intends to money which is paid by an assessee to anotherwiden the scope of the “fee for technical services” establishment which is its sister concern and December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 39 639
  • 40. DIRECT TAX LAWSthis kind of routing is done just for the sake of the term “profits in lieu of salary” becomesof simplifying a transaction or for the purpose significant here. In addition, the manner andof smooth execution of the contract. Doing so the way of collection and distribution of tipsshall be equivalent to a situation where tax to the employees has to be considered, e.g., theis paid for transferring the money from one tips are paid by the customers on their ownpocket of a person to his another pocket. Further, once they are pleased with the service renderedthis controversy is answered by the first appellate to them or the tip is charged compulsorilyauthority’s Bangalore Bench, in the case of from them by way of a service charge and isSands Advertising Communications (P.) Ltd. v. included in the bills raised by the hotels, whichDy. CIT (TDS) [2010] 37 SOT 179 in favour of on collection comes under the books of accountthe assessee. of the hotels first and then is paid to employees. As far as the importance of existence of a relationship of employer and employee is5. Whether TDS is to be deducted under concerned, it shall be there, irrespective of thesection 192 by the hotel employers at way of collection and disbursement of tips, asthe time when they pass on the tips the employee is getting the tips in addition tocollected by them to their employees by the salary for the services rendered by him totreating them as a part of salary of such his employer.employees or these should be treated as The Hon’ble Delhi High Court in the case ofan income from other sources in the CIT v. ITC Ltd. [2011] 199 Taxman 412/11 taxmann.com 84, held that the receipt of tipshands of recipients? by the employees is chargeable under the headSection 192 which provides for the TDS deduction “Salaries” and, thus, is liable for TDS deductionon the payment of salary by a person is under section 192 of the Act as section 17reproduced below: widens the scope of section 15 of the Act. Further, in the said case it is mentioned that ‘any person responsible for paying any the tips were collected from the customers by income chargeable under the head “salaries” way of service charges and were to be paid shall, at the time of payment, deduct to the assessee necessarily and without any income-tax on the amount payable at the option to the customers, thus, such payment average rate of income-tax computed on was not gratuitous or voluntary contribution the basis of the rates in force for the by the customers. Also, when such tips were financial year in which the payment is collected by the assessee it was routed through made, on the estimated income of the its books of account and when it was finally assessee under this head for that financial disbursed among the employees of the assessee, year.’ it made the deduction of TDS mandatory underThus, in order to bring a payment under the section 192 of the Act. Thus, it is implied thatpurview of the above said section, it is mandatory where an employer does not collect the tipsthat it should be chargeable under the head by way of a service charge through its inclusion“salaries”. Further, the terms “salary”, in the bills issued to its customers and the“perquisite” and “profits in lieu of salary” are employees collect the tips from the customersdefined under section 17 of the Income-tax directly, which is gratuitously paid by theAct, 1961. Apparently the tips collected by the customers without any compulsion, the samehotel employers and given by them to their cannot be brought to tax deduction under sectionemployees does not come under the purview 192 and shall probably escape assessment.of “salary” or “perquisite”. However, the scope •••640 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 40
  • 41. DIRECT TAX LAWS LANDMARK RULINGS An Overview of Latest Judgments on Direct Tax Laws| Unabsorbed book losses for the purpose and set off of losses and, hence, bothof MAT shall not be computed in accordance systems should not be mixed, lest it wouldwith section 70 to section 79 give misleading results;In Susi Sea Foods (P) Ltd. v. Asstt. CIT [2011] 3. Sections 70 to 79 provide for set off or15 taxmann.com 232 (Visakhapatnam - Trib.), carry forward and set-off of losses underfor the purpose of the MAT provision, the the Act only; manner of set-off or modali-assessee bifurcated its accumulated loss shown ties of carry forward and set-off of lossin its books of account into business loss and to be followed for book purposes is nowheredepreciation. As depreciation was less than prescribed in the Act; thus, section 115JA(4)business loss, it deducted same from the net cannot have application for said purpose;profit. The Assessing Officer, however, deducted andbusiness loss of the earlier years from profits 4. Loss incurred in a year cannot beearned in the subsequent period and computed ignored, i.e., it is not possible to omit pastthe business loss at nil. Accordingly, the losses from books of account under doubleaccumulated losses appearing in its books of entry system of accounting.account were held to be unabsorbed depreciation. [Section 115JA, read with sections 70 and 79, ofFurther, applying provisions of the Income- the Income-tax Act, 1961 - Minimum alternatetax Act in respect of carry forward of business tax - Assessment year 2000-01]loss, it also ignored losses of more than 8years. }The Tribunal remanded the matter - The Tribunal | Expenses on improvements made in theremitted back the matter to the Assessing Officerwith following observations: newly purchased house shall not form part of the cost of acquisition 1. Principles prescribed in sections 70 to 79 are not applicable for computing accumu- In Smt. S. Sudha v. Asstt. CIT [2011] 15 lated losses shown in books of account taxmann.com 212/48 SOT 335 (Chennai - Trib.), following accounting principles; the assessee purchased a residential apartment and claimed deduction under section 54F which 2. There is drastic variation between income- included the price as per sale deed, stamp tax provisions and accountancy principles charges, registration charges, advocate’s, fees, in respect of manner of carry forward brokerage, tiles laying, white-washing, electrical rewiring and wood work. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 41 641
  • 42. DIRECT TAX LAWSThe Tribunal partly held in favour of assessee - account; if there is only some shortfall inIt held that expenses relating to laying of tiles, deduction of tax due to any difference of opinionwhite-washing, electrical re-wiring and wood as to taxability of any item or nature of paymentswork were incurred by the assessee after falling under various TDS provisions, assesseepurchasing the property, which could not be can be deemed to be an assessee-in-defaulttreated as part of the acquisition cost. The under section 201 but no disallowance can beamount spent by the assessee to improve the made by invoking provisions of section 40(a)(ia).habitability might have been an essential [Section 40(a)(ia), read with sections 194-I andexpenditure, but it couldn’t form part of the 194C, of the Income-tax Act, 1961 - Businesscost of acquisition. disallowance - Interest, etc., payable to a residentHowever, regarding the expenses incurred in without deduction of tax at source - Assessmentrelation to advocate’s fees and brokerage, the year 2007-08]Tribunal held that legal scrutiny of title deeds }and documents is very essential in purchasingimmovable properties. Therefore, the exclusion | Expenditure on installation of accountingof brokerage and advocate’s fees from the cost software is a revenue expenditureof acquisition of the new property was notjustified. In CIT v. Asahi India Safety Glass Ltd. [2011] 15 taxmann.com 382 (Delhi), assessee was in[Section 54F of the Income-tax Act, 1961 - Capital business of manufacturing safety glass used ingains - Exemption of, in case of investment in automobiles. It entered into an agreement withresidential house - Assessment year 2008-09]  ‘A’ for installation of a software application } for assistance in areas of financial accounting, inventory and purchase. As software application| No disallowance under section 40(a)(ia) supplied by ‘A’ worked on Oracle application,if there is a shortfall in deduction of tax at ‘A’ required assessee to enter into a licencesource, however, assessee shall be deemed agreement with Oracle also. In respect ofto be an assessee-in-default aforesaid transactions, assessee incurred certain expenditure and claimed deduction thereof asIn Dy. CIT v. S.K. Tekriwal [2011] 15 a revenue expenditure. Assessing Officertaxmann.com 289 (Kolkata - Trib.), assessee disallowed deduction holding that expenditurewas engaged in the business of construction. incurred had brought about an enduring benefitThe Assessing Officer noticed that the assessee to assessee. On appeal, Commissioner (Appeals)had debited certain payments in the profit and as well as Tribunal allowed deduction of aforesaidloss account under the head ‘Machine hire expenses holding that said expenses werecharges’ and tax at the rate of 1% was deducted recurring in nature, expended either to upgradefrom such payments. The Assessing Officer system or to run the system.concluded that the payments were made forhiring of machines, and that the provisions of The High Court held in favour of assessee -section 194-I were applicable and so, tax should It held that expenditure incurred to enablehave been deducted at the rate of 10%. The management to run its business effectively,Assessing Officer then made proportionate efficiently and profitably, leaving fixed assetsdisallowance under the provisions of section untouched, would be an expenditure in nature40(a)(ia). of a revenue expenditure, even though advantage may last for an indefinite period. Extent ofThe Tribunal held in favour of assessee - It expenditure cannot be a decisive factor inheld that section 40(a)(ia) refers only to a duty determining the nature of expenditure. Therefore,to deduct tax and to pay it to Government’s the expenditure incurred by the assessee on642 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 42
  • 43. account of software and professional expenses consideration of surrendering his tenancy rights,was a revenue expenditure. the assessee was given certain premises by the developer who had developed the property in[Section 37(1) of the Income-tax Act, 1961 - Business which the assessee had the tenancy rights inexpenditure - Allowability of - Assessment years question. This property was sold by the assessee1997-98 and 1998-99] in the year 1995. The assessee’s submission } was that since this property was acquired without any cost of acquisition, income arising on the| Exemption under section 54F could not sale thereof could not give rise to any taxablebe restricted to 50% merely because property capital gains. The Assessing Officer rejectedwas purchased jointly in names of assessee his claim. On appeal, the Commissioner (Appeals)and his wife was of the view that market value of tenancy right, i.e., the date on which the assessee wasIn CIT v. Ravinder Kumar Arora [2011] 15 given free premises by the developer, was thetaxmann.com 307 (Delhi), assessee had shown cost of his acquisition in respect of the assetcertain long-term capital gain on sale of a plot sold.of land and claimed exemption under section54F on account of purchase of new residential The Tribunal held in favour of revenue - Itproperty. Assessing Officer allowed only 50% held that the market value of tenancy right atof exemption claimed on ground that residential the time when it was surrendered, was to behouse was purchased jointly in names of assessee regarded as cost of acquisition of premisesand his wife. On appeal, Tribunal allowed and, thus, when said premises was sold,assessee’s claim in full by recording finding subsequently, income arising from its sale wasof fact that whole of purchase consideration to be brought to tax as capital gains.was paid by assessee and property was purchased Further, the Tribunal held that there is anby assessee in joint name with his wife for important distinction between an asset not having‘shagun’ purpose and because of fact that assessee cost of acquisition and an asset cost of acquisitionwas physically handicapped. of which cannot be determined. The formerThe High Court held in favour of assessee - could lead to taxable capital gains and the saleIt held that section 54F mandates that house of latter one cannot lead to taxable capitalshould be purchased by assessee; it does not gains.stipulate that house should be purchased in [Section 48 of the Income-tax Act, 1961 - Capitalname of assessee only. Therefore, the Tribunal gains - Computation of - Assessment year 1996-was justified in allowing exemption under section 97]54F for total consideration paid by assessee. }[Section 54F of the Income-tax Act, 1961 - Capitalgains - Exemption of, in case of investment in | Exemption under section 54F shall beresidential house] available on purchase of two floors forming } part of single residential unit In Asstt. CIT v. Sudha Gurtoo [2011] 15| FMV of tenancy right shall be the cost of taxmann.com 231 (Delhi - Trib.), the assesseeacquisition for computation of capital gain sold two commercial properties/capital assetson surrender of tenancy rights and claimed deduction under section 54F onIn Balmukund P. Acharya v. ITO [2011] 15 ground of purchase of two residential units,taxmann.com 244 (Mumbai - Trib.), the assessee being ground floor and first floor in a Groupwas in possession of a rented premises. In Housing Complex. The Assessing Officer disallowed same on ground that deduction December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 43 643
  • 44. DIRECT TAX LAWSwas not allowable, as two distinct properties a deduction was only a contingent liabilitywere purchased. and provision made for liability which might have arisen in the future and (ii) as the assesseeThe Tribunal held in favour of assessee - It was following mercantile system of accounting,held that deduction under section 54F shall be no deduction could be allowed in respect ofallowed because what the assessee had in her a liability which had definitely not arisen andpossession was one single unit comprising of that deduction could be made in respect of antwo floors of one and the same double storeyed ascertained and enforceable liability which couldresidential house having common staircase, be enforced on or before the end of the relevantkitchen, etc. previous year. Thus, he held that claim of[Section 54 of the Income-tax Act, 1961 - Capital deduction was not admissible and it was,gains - Exemption of, in case of investment in accordingly, declined. On appeal, theresidential house - Assessment year 2005-06] Commissioner (Appeals) upheld the Assessing } Officer’s order. The Tribunal held in favour of assessee - It| Provision for expected losses recognized held that deduction on account of interest ratein accordance with AS-7 is an allowable swap valuation was to be allowed. In thisexpenditure regard, the Tribunal provided the following reasonings:In Dredging International N.V. v. Asstt. DIT[2011] 15 taxmann.com 198 (Mumbai - Trib.), (a) the real issue in this appeal is not thethe assessee claimed deduction in respect of deductibility but only timing of theprovision for future losses, which the Assessing deduction;Officer rejected in the draft assessment order. (b) the accounting principle of prudence, whichThe Tribunal held in favour of assessee - The has been relied upon by the assessee, isTribunal held that provision for foreseeable now binding in view of section 145(2),losses made in accordance with guidelines of read with Notification No. 9949;AS-7 and duly debited in audited accounts of (c) just because anticipated profits are notcompany is an allowable expenditure. assessed to tax, it would not follow, as[Section 37(1) of the Income-tax Act, 1961 - Business a corollary thereto, that anticipated lossesexpenditure - Allowability of - Assessment year cannot be allowed as deduction in com-2006-07]  putation of business income; } The Tribunal relied on the order passed by the Special Bench in the case of Dy. CIT (IT) v.| Losses on account of valuation of interest Bank of Bahrain & Kuwait [2010] 41 SOT 290rate swaps are allowable deductions (Mum.). [Section 28(i), read with section 145, of the Income-In ABN Amro Securities India (P.) Ltd. v. tax Act, 1961 - Business loss/deductions - AllowableITO [2011] 15 taxmann.com 177/133 ITD 343 as - Assessment year 2003-04] (Mumbai - Trib.), the assessee was engagedin the business of dealing in the Government }Securities, bonds, debentures and providingservices of arranging for and underwriting | Commercial use of residential units byissue of debentures and bonds, etc. The assessee purchaser would not disentitle the developerhad claimed a deduction for loss on interest to benefit of section 80-IB(10)rate swap valuations. The Assessing Officer In Smt. Manju Gupta v. Asstt. CIT [2011] 15concluded that : (i) what had been claimed as taxmann.com 287 (Mumbai - Trib.), assessee-644 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 44
  • 45. company was engaged in business of construction that amount received without any considerationof housing project. The housing project completed was taxable under section 56. However, theby assessee consisted of 19 shops and 32 Assessing Officer recognized that partition ofresidential flats. Assessing Officer noted that HUF had taken place on 31-5-2005. On appealsaid residential flats were sold to a company CIT(A) upheld the order of the Assessing Officer.which rented said flats for non-residential The Tribunal held in favour of assessee - Itpurposes. Assessing Officer found that built- held that the money received by the assesseeup area of shops and residential flats used for in her capacity as coparcener and towards hernon-residential purposes, as a whole, exceeded share of the properties of the HUF, on partitionstipulated limit of 2000 sq. ft., and, therefore, of HUF, could not be said to be sum of moneyfound that assessee had violated condition or property received without consideration.prescribed in section 80-IB(10)(d). On that ground, The right, title and interest of the coparcenerclaim of assessee under section 80-IB(10) was in the assets of the HUF would itself be adenied by Assessing Officer. consideration. Therefore, the sum received byThe Tribunal held in favour of assessee - It the assessee towards her share as coparcenerheld that flats were constructed as residential of the HUF from the HUF on partition of theunits as was evident from approved plan and HUF could not be brought to tax as incomecompletion certificate and any subsequent use and the addition made by the Assessing Officerby an end-user for non-residential purposes in this regard was directed to be deleted.could not change nature of residential units [Section 171 of the Income-tax Act, 1961 - Hinduto commercial establishments. Therefore, undivided family - Assessment after partition -deduction under section 80-IB(10) could not Assessment year 2006-07]be denied on that ground. }Insofar as shops were concerned, it was a factthat area covered by shops was less than 10% | Consideration received for live broadcastingof total built-up area and in view of decision cannot be considered as royaltyof the Special Bench of Tribunal in BrahmaAssociates v. Jt. CIT [2009 ] 30 SOT 155/119 In Asstt. DIT v. Neo Sports Broadcast (P.)ITD 255 (Pune) claim of assessee under section Ltd. [2011] 15 taxmann.com 175 (Mumbai -80-IB(10) could not be rejected. Trib.), the assessee entered into an agreement with Nimbus, a commercial agent of Bangladesh[Section 80-IB of the Income- tax Act, 1961 - Cricket Board (‘BCB’), for receiving signal andDeductions - Profits and gains from industrial broadcasting cricket matches that were to beundertakings other than infrastructure development played in Bangladesh. The assessee contendedundertakings - Assessment year 2008-09] that the payment to be made on account of } recorded matches was in the nature of royalty but that towards live matches was not covered| Sum received by coparcener on partition within the definition of royalty and, hence,of HUF cannot be brought to tax not taxable. The Deputy Director noticed that the matches were to be broadcast in the IndianIn Smt. Sudha V. Iyer v. ITO [2011] 15 Territory and the income by way of advertisementtaxmann.com 234 (Mumbai - Trib.), the assessee revenue and subscription revenue was to bereceived certain sum on account of partition received by the assessee. It was observed thatof HUF. The Assessing Officer was of view without the receipt of signal, no income wouldthat order for partition was passed on 14-10- accrue to the assessee on this account. He,2008 and not in the relevant current assessment therefore, held that there was a businessyear (i.e., assessment year 2006-07). He held connection between Nimbus and receipts in December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 45 645
  • 46. DIRECT TAX LAWSIndia and, accordingly, the payment under area was given on lease to persons who wereconsideration was in nature of royalty for transfer running shops, cinema halls, eateries, etc., inof any copyright. the mall. Under agreements entered into by and between the assessee and the lessees, theThe Tribunal held in favour of assessee - It assessee was collecting business conductingheld that any consideration received for live fees and business facility charges which werebroadcasting cannot be considered as royalty all offered to tax under head ‘Income fromfor transfer of a copyright so as to fall within house property’. In addition to above charges,domain of the Explanation 2 to section 9(1)(vi) the assessee had also been collecting maintenanceand, therefore, there is no requirement of charges from the lessees as also from the personsdeduction of tax under section 195. Following to whom premises were sold, towards promotionprinciples were laid by the Tribunal in this and upkeep of the mall and such amount wasjudgment: offered to tax under head ‘Income from business’. (a) In order to constitute a business connec- The Assessing Officer held that upkeep of the tion of a non-resident in India, it is necessary mall and promotional charges also originated that some sort of business activity must from property itself and, therefore, were to be be done by non-resident in taxable terri- taxed as ‘Income from house property’. On tory of India; appeal, the Commissioner(Appeals) allowed (b) When a non-resident allows any resident claim of the assessee by holding that agreement in rest of upkeep of mall was basically an to commercially exploit its asset for a consideration, it would not amount to independent contract to ensure a well-maintained, modern, secured and quality premises and to business connection in terms of section 9(1)(i); have a top class support system to maximize footfalls in the mall. The Tribunal upheld the (c) A ‘copyright’ can be created only after order of the Commissioner(Appeals). ‘work’ has been performed for first time; and The High Court held in favour of the assessee - It held that the Tribunal was justified in holding (d) There is no copyright in live events and that maintenance charges received were towards depicting same cannot infringe upon any maintenance and promotion of the common copyright. area and amounts received towards maintenance[Sections 9 of the Income-tax Act, 1961, read with charges were business receipts liable to besection 2(y) of the Copyright Act, 1957 - Income assessed under head ‘Income from business’.- Deemed to accrue or arise in India - Assessment [Section 28(i) of the Income-tax Act, 1961 - Businessyear 2008-09] income - Chargeable as - Assessment years 2004- } 05 to 2006-07]  }| Receipt of maintenance charges for abuilding given on rent shall be taxable as | Project completion method is an acceptablebusiness income method for computation of business incomeIn CIT v. Runwal Developers (P.) Ltd. [2011] in case of a real estate company15 taxmann.com 196/203 Taxman 3 (Bombay) In Asstt. CIT v. Skylark Build [2011] 15(Mag.), the assessee was in business of building taxmann.com 213/48 SOT 306 (Mumbai - Trib.),and developing residential and commercial the assessee started a project with constructioncomplexes and was also running a mall. It had of a transit building on land provided by theconstructed an area, part of which was sold Municipal Corporation of Greater Mumbaito various persons. Major portion of the remaining (MCGM) to shift slum dwellers. Under the646 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 46
  • 47. scheme formulated by MCGM, the assessee | No penalty under section 271(1)(c) couldhad been offered TDR in lieu of handing over be levied merely because assessee’s claimpossession of constructed transit buildings. The to set off the losses is deniedassessee had constructed nine transit buildings,seven of which had been handed over to MCGM. In Rubber Udyog Vikas (P.) Ltd. v. Asstt. CITIt had received TDR in two instalments and [2011] 15 taxmann.com 303 (Delhi - Trib.),both were sold in the respective years in which assessee claimed set off of brought forwardthey were received. The amount received business loss against capital gains earned duringtherefrom was set off against work-in-progress. year. Assessing Officer denied the same as itThe Assessing Officer rejected the method is not permissible under section 71/72 andfollowed by the assessee and assessed the income levied penalty under section 271(1)(c).from sale of TDRs during the year of receipt The Tribunal held in favour of assessee - Itas an independent item of income. held that since assessee had disclosed allOn appeal, the Commissioner(Appeals) observed particulars along with return of income, nothat the assessee was following project completion penalty could be levied under section 271(1)(c)method and the sale proceeds could be taxed merely on ground of denial of assessee’s claimonly in the year of completion. for set off of business loss against other heads of income.The Tribunal remanded the matter - The Tribunalremanded back the matter to the Assessing [Section 271(1)(c) of the Income-tax Act, 1961 -Officer with the following observations:  Penalty - For concealment of income - Assessment year 1994-95] (a) Since assessee had been following project completion method which was an accepted } method of accounting in construction business and was also recommended as | Liaison office of non-resident assessee per AS-7, income from project had to be in India cannot be considered as its PE in computed in year of completion; India (b) Since Assessing Officer had not given any In Dy. DIT v. M. Fabricant & Sons Inc. [2011] finding regarding year of completion of 15 taxmann.com 358 (Mumbai - Trib.), the project, that aspect required verification; liaison office of non-resident assessee in India was carrying out activities of selection of goods (c) In case on verification it was found that and negotiation of price as part of purchasing project was completed in any assessment process as per instructions of assessee. The year, Assessing Officer would compute Assessing officer held that the liaison office income from project after taking into account shall be regarded as its permanent establishment. entire expenditure and receipts from beginning of year including TDRs; The Tribunal held in favour of assessee - It held that liaison office could not be considered (d) However, in case project was not found as a permanent establishment of assessee in complete, Assessing Officer would set off India and, therefore, profit attributed to liaison TDR receipts against work-in-progress and office could not be held to have accrued or no income would be assessed on account arisen in India. of TDR receipts separately. [Section 9 of the Income-tax Act, 1961 - Income[Section 5 of the Income-tax Act, 1961 - Income - - Deemed to accrue or arise in India]Accrual of - Assessment years 2006-07 and2007-08] } } December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 47 647
  • 48. DIRECT TAX LAWS| Gross interest received on refund of tax as a whole it was clear that word ‘minorities’is taxable and not the interest remaining in the trust deed was with reference to ‘religiousafter deduction of the interest on late payment minorities’ only and further, the assessee’s own argument that people of different religiousof TDS denominations would stand to be covered byIn Dy. CIT v. Sandvik Asia Ltd. [2011] 15 term ‘minorities’, i.e., those residing in Tellicherrytaxmann.com 381 (Pune - Trib.), assessee earned Municipality and its suburbs (to which objectsinterest income on income-tax refund. It also of the trust extend), itself abundantly clarifiedpaid interest on late payment of tax. Assessee that import and purport of said word wasclaimed that interest paid by it was to be set with reference to religious minorities. Further,off against interest received and only net interest to extent word ‘minorities’ occurring in deedwas liable to tax. Assessing Officer rejected its was liable to be construed as referable to ‘religiousclaim. minorities’, section 13(1)(b) would standThe Tribunal held in favour of revenue - It automatically attracted. Therefore, denial ofheld that assessee was assessable in respect of registration under section 12A to the assesseegross interest received from department and by the Commissioner was justified, and hisnot merely on net interest remaining after set order was, accordingly, to be upheld.off of interest paid to department. Therefore, [Section 13, read with section 12A, of Income-taxAssessing Officer had rightly set aside assessee’s Act, 1961 - Charitable or religious trust - Denialclaim. of exemption - Assessment year 2008-09][Section 4 of the Income-tax Act, 1961 - Income - }Chargeable as - Assessment year 1992-93] | Shareholder for the purpose of section } 2(22)(e), refers to both a registered shareholder| Denial of registration to a charitable religious and a beneficial shareholdertrust because it is established for the benefit In Dy. CIT v. Madhusudan Investment &of a religious community Trading Co. (P.) Ltd. [2011] 15 taxmann.comIn Tellicherry Minority Welfare Trust v. CIT 252 (Kolkata - Trib.), the assessee-company[2011] 15 taxmann.com 185/48 SOT 313 (Cochin leased out its property to ‘M Ltd.’ for 22 years.- Trib.), the assessee-trust, formed for charitable In pursuance of a settlement of a dispute, aand religious purpose, applied for registration security deposit of ` 3.80 crores was paid byunder section 12A. Beneficiaries of the Trust ‘M Ltd.’ to the assessee to be refunded at thewere financing poor minorities and other end of the lease period. According to thebackward classes. On examination of the Assessing Officer the security deposit was nothingassessee’s objects, the Commissioner observed but an advance and, thus, was deemed dividendthat the assessee-trust was established for benefit under section 2(22)(e), as two of the beneficialof a particular religious community or caste shareholders of the ‘M Ltd.’ were alsoand, thus, was hit by section 13(1)(b). He, shareholders and were substantially interestedaccordingly, rejected the assessee’s application. in the assessee-company. The assessee submittedThe assessee contended that the Commissioner that it neither held any shares in ‘M Ltd.’ norhad misconstrued the word ‘minority’ to mean had any beneficial interest in the said company,a religious minority or with reference to a and that deemed dividend in terms of sectionreligious community. 2(22)(e) can be assessed only in hands of a person who is a shareholder of the lender-The Tribunal held in favour of the revenue - company and not in the hands of a personIt held that from reading of the Trust deed other than a shareholder.648 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 48
  • 49. The Tribunal held in favour of assessee - It asset as defined in section 2(14). Therefore,held that no deemed dividend shall arise in consideration received by assessee would bethe hands of the assessee-company. In this taxed under the head ‘Capital gains’.regard, the Tribunal held as following: [Section 2(14), read with section 45, of the Income- (a) Deemed dividend can be assessed only in tax Act, 1961 - Capital gains - Capital asset - hands of a person who is a shareholder Assessment year 2003-04] of lender-company and not in hands of } a person other than a shareholder; (b) Expression ‘shareholder being a person | Mere writing off the bad debts from the who is beneficial owner of shares’ re- books is sufficient for allowability of claim ferred to in first limb of section 2(22)(e) under section 36(1)(vii) refers to both, registered shareholder and In CIT v. Sirpur Paper Mills. Ltd. [2011] 15 beneficial shareholder; taxmann.com 373 (Andhra Pradesh), assessee (c) Therefore, if a person is a registered filed its return wherein certain amount was shareholder but not a beneficial share- claimed as bad debts. In support of that claim, holder then provision of section 2(22)(e) assessee submitted that it had issued computer will not apply. Similarly, if a person is generated reminders to customers in a standard a beneficial shareholder but not a regis- proforma. Assessing Officer accepted a part of tered shareholder, then also provision of assessee’s claim. Tribunal, however, allowed section 2(22)(e) will not apply. assessee’s claim in full.[Section 2(22) of the Income-tax Act, 1961 - Deemed The High Court held in favour of assessee -dividend - Assessment year 2003-04]  It held that when an assessee writes off a debt } or a part thereof as irrecoverable in accounts for previous year, same can be allowed as| Consideration received on letting one’s deduction under section 36(1)(vii) and no furthername is taxable as a capital gain proof is necessary.In Asstt. CIT v. S.P. Sambandam [2011] 15 [Section 36(1)(vii) of the Income-tax Act, 1961 -taxmann.com 388 (Chennai - Trib.), assessee Bad debts - Assessment year 1996-97]was one of the promoters of company and was }in active management till lately. On being relievedfrom the company, assessee sought to withdraw | Reopening of an assessment is possibleusage of his name for which company offered even if original assessment had not beenhim ` 1.35 crores as consideration for use of completedassessee’s name in future. Assessee acceptedoffer of company and received said sum. In Nishant Exports v. CIT [2011] 15 taxmann.comAssessing Officer taxed said receipt as income 217 (Kerala), the assessee claimed deductionfrom other sources. of profit on exports profit under section 80HHC which was allowed in an intimation issued byThe Tribunal held in favour of assessee - It the Assessing Officer under section 143(1). Itheld that word ‘S’ had commercial importance was, however, found that the assessee had notin local market and was, thus, a brand name satisfied conditions prescribed under amendedassociated with business of company which provisions of section 80HHC - Consequently,had been transferred from assessee to company. the Assessing Officer invoked section 147 andBrand name is always treated as a capital December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 49 649
  • 50. DIRECT TAX LAWSrevised assessment, withdrawing partial relief | Securing an order shall mean that assesseegranted under section 80HHC to the assessee. has commenced its businessThe High Court held in favour of the revenue - In Dy. CIT v. Hazira Gas (P.) Ltd. [2011] 15It held that only condition for reopening of taxmann.com 336 (Ahd. - Trib.), the assessee-an assessment is that the Assessing Officer company was incorporated with object of carryingshould have a reasonable belief that income on business of buying, selling, supplying,chargeable to tax has escaped assessment, though marketing, distributing and importing of naturalregular assessment has not been completed. gas. In order to achieve aforesaid objectives,Thus, the Assessing Officer is entitled to reopen it had entered into several agreements andand bring to tax escaped income. Memorandum of Understandings for sale and[Section 147, read with section 143, of the Income- purchase of gases. Expenditure incurred ontax Act, 1961 - Income escaping assessment - those agreements, etc., was claimed as deductionGeneral - Assessment year 2000-01]  under section 37(1). Assessing Officer opined that all expenses incurred by assessee were in } nature of pre-operative expenses that were to be capitalized.| Where no aircraft is purchased by airlinecompany, business cannot be deemed to The Tribunal held in favour of assessee - Ithave commenced held that it was noted from details of Memorandums of Understanding that assesseeIn Kingfisher Training & Aviation Services had entered into agreements of sale of gasesLtd. v. Asstt. CIT [2011] 15 taxmann.com 325 with other companies in assessment year in(Bangalore - Trib.), the assessee-company was question or before. In view of fact that assesseeengaged in operation of air-transportation and had started securing orders for sale of gases,other air services. During relevant assessment it could be concluded that it had commencedyear, assessee incurred various expenses relating its business and, thus, expenditure in questionto pre-operation activities. Assessee filed its was to be allowed as deduction.return wherein it claimed set off of said expensesagainst interest income earned from bank [Section 37(1) of the Income-tax Act, 1961 - Businessdeposits. Revenue authorities rejected assessee’s expenditure - Allowability of - Assessment yearclaim holding that expenditure in question 2003-04]could not be allowed to be set off as it related }to pre-operation period. | Depreciation on toll road shall be allowedThe Tribunal held in favour of revenue - Itheld that in view of fact that not even a single to developer until its ownership is transferredaircraft was purchased by assessee-company to State Governmenttill end of previous year, it was to be concluded In Gujarat Road & Infrastructure Co. Ltd. v.that assessee had not set-up its business by CIT [2011] 15 taxmann.com 387 (Ahd. - Trib.),end of impugned previous year. Therefore, assessee was engaged in business of setting-authorities below were justified in rejecting up of infrastructure facility by way of constructionassessee’s claim. of road as per policy of Government of India.[Section 37(1) of the Income-tax Act, 1961 - Business It entered into an agreement with Governmentexpenditure - Allowability of - Assessment year of Gujarat to build, own, operate and transfer2005-06] (BOOT) a toll road. Assessee built that road and started to collect toll charges from vehicles } passing through that road. It claimed depreciation650 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 50
  • 51. on toll road. The Commissioner disallowed its valid justification for challenging reassessmentclaim on the ground of ownership of toll bridge proceedings on that ground. In this regard,(i.e., the capital asset) which was not with the the High Court relied on the judgment in theassessee. case of CIT v. Panchvati Motors (P.) Ltd. [2011] 12 taxmann.com 111 (Punj. & Har.) whereinThe Tribunal held in favour of assessee - It it was held that where an assessee appears inheld that depreciation on toll road shall be any proceedings or cooperates in any enquiryallowed to the assessee. In this regard, following relating to assessment or reassessmentreasonings were given by the Tribunal: proceedings, it shall be presumed that the“(a) Toll road was an integral part of the business assessee has been validly served with a notice activity of the assessee and without which and it shall not be open to the assessee to the assessee could not carry on its busi- object that notice was not served upon him or ness activity; was not served same in time or was served upon him in an improper manner; an exception (b) The road constructed by the assessee formed the most important source of its revenue to aforesaid presumption has been made in a case where such an objection has been raised and the basic objective was to construct the toll road under the BOOT scheme; before completion of the assessment or reassessment.  and [Section 272BB read with section 148 of the Income- (c) Thus, the assessee had fulfilled the basic criteria for claiming depreciation, i.e., tax Act, 1961 - Notice deemed to be valid in certain circumstances - Assessment year 2000-01]  existence of a capital asset, ownership of such asset and most important that the } assets were put to use for its business purpose.” | Compensation received for allowing access[Section 32, read with section 263, of the Income- to private land is not a rent, but a capitaltax Act, 1961 - Depreciation - Allowance/rate of receipt- Assessment year 2003-04] In Dy. CIT v. T. Kannan [2011] 15 taxmann.com } 268 (Chennai - Trib.), pursuant to a Court decree, the assessee received certain amount| Assessee cooperating in assessment or from a company for providing that companyreassessment proceedings, shall be presumed easement right to a private road situated onto have been validly served with a notice his land. He treated said receipt as a capital receipt and credited same to land account.In Om Sons International v. CIT [2011] 15 The Assessing Officer, however, treated saidtaxmann.com 184 (Punj. & Har.), Assessing amount as rent received for using the landOfficer initiated reassessment proceedings against under the head ‘Income from other sources’.the assessee under sections 147 and 148. After The Tribunal held in favour of assessee - Itcompletion of the reassessment proceedings,the assessee challenged validity of proceedings held that there being no relationship of a landlord and tenant between the parties, amount receivedunder section 148 and consequential order passedunder section 143(3) in absence of a proper by the assessee could not be treated as rent.service of notice. Thus, said receipt was only a capital receipt and could not be taxed under the Act.The High Court held in favour of the revenue -It held that in the objection raised by the [Section 4 of the Income-tax Act, 1961 - Income - Chargeable as - Assessment year 2007-08]assessee in instant case it did not give any } December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 51 651
  • 52. DIRECT TAX LAWS| Amount paid for service rendered outside In Ramesh D. Tainwala v. ITO [2011] 15India, to a foreign company which does not taxmann.com 181/48 SOT 324 (Mumbai - Trib.),have any branch or business place in India the assessee was one of the promoters of ‘TP’ Ltd. and together with other promoters helddoes not fall within purview of TDS substantial shares in the company. By anIn Asstt. CIT v. Leaap International (P.) Ltd. agreement ‘I’ Ltd. (acquirer) agreed to purchase[2011] 15 taxmann.com 251 (Chennai - Trib.), shareholding of the assessee along with otherthe assessee-company was engaged in the promoters of ‘TP’ Ltd. Acquirer, with a viewbusiness of foreign forwarding and custom to ensure that promoters after sale of shareshouse clearing. It had made payment to foreign did not indulge in competing in the business,companies towards freight charges for moving entered into a non-compete agreement wherebythe goods and for transportation clearing/ the assessee was paid ` 2 crores. The Assessingforwarding at the foreign ports and the Officer held that receipt-in-question was a feeremittances was for services rendered outside received for not carrying out any activity inIndia. The Assessing Officer disallowed the relation to any business and, therefore, wasexpenditure in terms of section 40(a)(i) on chargeable to tax under section 28(va). Theaccount of non-deduction of TDS under section assessee contended that sum received in cash195. The assessee submitted that services were on account of transfer of right to carry on anyrendered outside India and the companies, to business, would be chargeable under headwhom payments were made, did not have any ‘Capital gains’ in view of proviso to item (i)branches in India and, therefore, the payments of section 28(va)(a). were not liable for deduction of tax under The Tribunal held in favour of the revenue -section 195. The Commissioner (Appeals) deleted It held that since the assessee was not carryingthe disallowance. on any business on his own but was a promoterThe Tribunal held in favour of assessee - The and director of the company whose sharesTribunal held that once it is found that the were purchased by the acquirer, in such apayments have been made to foreign companies situation there was no question of transfer offor services rendered outside India and that a right to carry on the business and, therefore,such foreign companies do not have any branch payments on account of non-compete fees couldor business place in India, then the income of not be brought to tax under section 45. Therefore,such foreign companies would, obviously, not payments received as non-compete fee wouldbe taxable in India.Then as per the provisions be chargeable to tax under section 28(va)(a)of section 195 as the sum is not chargeable and not under head of ‘Capital gains’.under the provisions of this Act the said section Further, following principles are laid down incannot have an application. This view finds this judgment:support from the decision of the Apex Courtin the case of G.E. India Technology Cen. (P.) (a) If a receipt is considered as payment ofLtd. v. CIT [2010] 327 ITR 456/193 Taxman compensation with source remaining in-234. tact, it would be a revenue receipt falling under section 28(va)(a);[Section 195 of the Income-tax Act, 1961 - Deductionof tax at source - Payment to non-resident - (b) If receipt is a payment for sterilization ofAssessment year 2005-06]  source of income, then it would be a capital } receipt, nevertheless falling within ambit of section 45, subject to condition that| Receipt of non-compete fees with source there results a transfer of capital asset and machinery for computation of theremaining intact, shall be taxable under capital gain under section 48.section 28(va)(a)652 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 52
  • 53. [Section 28(va) of the Income-tax Act, 1961 - - Trib.), the assessee-trust was formed to runBusiness income - Non-compete fees - Assessment educational institutions. It applied for registrationyear 2007-08] under section 12AA. DIT(E) rejected said } application on ground that probable fees to be collected from students was having a component| Income from job work of other manufacturer for future expansion of institutions and same component was in nature of profit and, thus,of eligible products shall be entitled for objects of trust also included a profit motive.deduction under section 80-IA The Tribunal held in favour of revenue - ItIn CIT v. Ambuja Ginning Pressing & Oil held that since object of assessee-trust was toCo. (P.) Ltd. [2011] 15 taxmann.com 273 establish a number of educational institutions(Gujarat), the assessee-company was engaged in a brand name and to run those institutionsin the business of ginning and pressing of on commercial lines, it could not be regardedcotton, etc. The Assessing Officer held that the a charitable activity. Therefore, DIT(Exemption)receipt from the job work by the assessee (net was justified in rejecting assessee’s applicationof expenses) were not eligible for deduction seeking registration under section 12AAunder section 80-IA. On appeal, theCommissioner(Appeals) and the Tribunal allowed [Section 12AA of the Income-tax Act, 1961 -the deduction claimed under section 80-IA in Charitable or religious trust - Registration procedure]respect of job work receipts. }The High Court held in favour of assessee -It held that the job work done by the assessee | Payment to sub-contractors shall be subjecton account of others could not be said was to TDS under Section 194C, even if it is notnot a manufacturing activity carried out by debited to profit and loss accountthe assessee. Consequently, it could not be In A.K. Patel & Co. (Construction) (P.) Ltd.said that the income derived therefrom was v. Dy. CIT [2011] 15 taxmann.com 380 (Ahd.not income derived from the industrial - Trib.), the revenue made disallowance underundertaking. Whether the assessee carries on section 40(a)(ia) in respect of payments madethe manufacturing activity on its own behalf by assessee-company to sub-contractors for notor on behalf of others on a job work basis, the depositing TDS on due dates. Assessee submittedincome derived therefrom, is income from the as follows:industrial undertaking and, therefore, wouldbe entitled to deduction under section 80-IA. (a) its income under contract was commis- sion income and, hence, no deduction under[Section 80-IA of the Income-tax Act, 1961 - section 194C was required;Deductions - Profits and gains from infrastructureundertakings]  (b) it had not debited amount paid to sub- contractor as an expense in profit and } loss account; and| Where object of trust was to establish a (c) it deducted gross value of sub-contractnumber of educational institutions in a brand from its gross income from contract andname and to run these on commercial lines, had shown commission income separatelyit is not a charitable activity in profit and loss account.In Rajah Sir Annamalai Chettiar Foundation The Tribunal held in favour of revenue - Itv. DIT [2011] 15 taxmann.com 313 (Chennai held that mere entry in books of account of assessee is not conclusive and it could not be December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 53 653
  • 54. DIRECT TAX LAWSaccepted that assessee had not debited amount | There is no bar, in law, to send a noticeof payments made to sub-contractor in its under section 148 after return is filed by anP&L account. Therefore, payment made to sub- assesseecontracts shall be disallowed under Section40(a)(ia). In P. Dayananda Pai v. Asstt. CIT [2011] 15 taxmann.com 249 (Karnataka), as the assessee[Section 194C, read with section 40(a)(ia), of the did not file his return for the relevant assessmentIncome-tax Act, 1961 - Deduction of tax at source - year by stipulated date, i.e., 30-10-1991, thePayment to Contractors/Sub-contractors - Assessment Assessing Officer issued him a notice underyears 2005-06 to 2007-08] section 148 on 14-12-1992. However, prior to } service of said notice, the assessee filed his return of income. On consideration of the said| Living allowance provided to employees return, the Assessing Officer observed thatdeputed in USA shall be exempt from tax there was escapement of income, then accordingly, he issued another notice underIn ITO v. Saptarshi Ghosh [2011] 15 section 148 on 24-11-1994. In response, thetaxmann.com 328 (Kolkata - Trib.), the assessees assessee filed a revised return on 20-10-1995.were employees of an Indian company and The assessee contended that second notice datedwere deployed on deputation in the USA for 24-11-1994 was invalid, in law, as said noticerendering services as employees of said company. was issued during pendency of the first noticeDuring deputation, they continued to receive and no reasons were recorded before issuancesalary and benefits in India. An additional of notice.amount of living allowance were paid forpurposes of additional routine expenses in the The High Court held in favour of the revenue -USA. It was clear that place of posting did not It held that:change to USA and employees were sent there (a) Notice dated 24-11-1994 was, in fact, notwith reference to specific projects and projects a ‘second notice’ under section 148 dur-could change at instance of employer. Employees ing pendency of an earlier or first noticewere to report back to employer and serve under section 148 inasmuch as purpose ofemployer after acquiring skills from US projects. sending the notice dated 14-12-1992 hadSalary structure of employees remained same. been fulfilled when return was filed evenDuring period of deputation, an employee would prior to the service of said notice. There-continue to receive his salary and benefits in fore, notice dated 24-11-1994 was validlyIndia and additional amounts were paid only issued after considering the return filedfor purposes of additional routine expenses in by the assessee;the USA. (b) Since reasons recorded prior to the issu-The Tribunal held in favour of assessee - It ance of notice on 24-11-1994 on basis ofheld that assessee-employees were to be treated return filed by the assessee were suffi-on tour and, therefore, living allowance paid cient to establish nexus with material onto them was eligible for deduction under section record and formation of his opinion that10(14). there had been escapement of income of[Section 10(14) of the Income-tax Act, 1961, read the assessee from assessment in particu-with rule 2BB of the Income-tax Rules,1962 - lar year, assumption of jurisdiction by theSpecial allowance - Assessment year 2006-07] Assessing Officer by recording said rea- sons and issuance of said notice dated } 24-11-1994 was in accordance with law; and654 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 54
  • 55. (c) There is no bar, in law, to send a notice [Section 28(i), read with section 56, of the Income- under section 148 after return is filed by tax Act, 1961 - Business income - Chargeable as the assessee. Such a notice can be issued - Assessment years 2004-05 and 2005-06] by the Assessing Officer after perusal of } the return filed by the assessee, after a return is filed but no assessment has been | Taxing authority must not look into business made and the assessee is found to have matters from its own viewpoint but that of understated his income or claimed exces- sive loss or deduction in return.   a prudent businessman In CIT v. Rockman Cycle Industries (P.) Ltd.[Section 148 of the Income-tax Act, 1961 - Income [2011] 15 taxmann.com 306 (Punj. & Har.)(FB),escaping assessment - Issue of notice for - Assessment assessee borrowed money from its sister concernyear 1991-92] carrying interest at rate of 18% per annum and } purchased preference shares from another sister concern which carried dividend at rate of 4%.| Where entire business is transferred Assessing Officer held that there was noincluding resources to carry out such business, justification to borrow funds at rate of 18%commission received in consideration of interest for making investment in shares, whichsame shall be business income would give a dividend of 4% only. Having regard to fact that borrowing was made fromIn Dy. CIT v. FX Info Technologies (P.) Ltd. its sister concern and investment was also in[2011] 15 taxmann.com 296 (Delhi - Trib.), another sister concern, claim for deduction ofassessee was carrying on business of distribution interest was disallowed by Assessing Officer.of products of ‘A’ Ltd. In view of heavy losses,assessee-company decided to transfer distribution The High Court remanded the matter - It heldarrangement to one ‘S’. As per terms of that Assessing Officers or appellate authoritiesagreement, assessee had agreed to transfer its and even Courts can determine true legal relationdealer network to ‘S’ with list of its clients, resulting from a transaction between differentcustomers, benefit of all contracts, engagements concerns and if some device has been used byand orders in connection with business of ‘A’s’ assessee to conceal true nature of transaction,products. Further, assessee had provided services it is duty of taxing authority to unravel thatof its skilled employees to ‘S’ who had vast device and determine its true character. However,experience and knowledge in said line of business legal effect of transaction cannot be displacedand in consideration assessee received income by probing into ‘substance of transaction’ ;in form of commission from ‘S’ which was taxing authority must not look at businessoffered to tax as ‘business income’. Assessing matter from its own viewpoint but that of aOfficer, however, treated said income as ‘Income prudent businessman.from other sources’. On appeal, Commissioner [Section 37(1) of the Income-tax Act, 1961 - Business(Appeals) allowed assessee’s claim. expenditure - Allowability of - Assessment yearThe Tribunal held in favour of assessee - It 1987-88]held that aforesaid services were rendered by }assessee while carrying on business in anorganized way. Thus, on facts, Commissioner | Payment for hiring of cranes on time(Appeals) had rightly concluded that commission basis shall not be covered for deduction ofincome earned by assessee was taxable as tax under section 194C‘business income’. In Asstt. CIT v. Sanjay Kumar [2011] 15 taxmann.com 230 (Delhi - Trib.), the assessee December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 55 655
  • 56. DIRECT TAX LAWShad paid a sum for hiring cranes on time as its collecting agent in India with respect tobasis. As per the arrangement, the payment advertising charges from the Indian advertisershad to be made on a daily basis notwithstanding for advertisements placed on TV channels. SIPLwhether the crane was actually used or not. was entitled to a commission of 15% on theAccording to the Assessing Officer such payments receipts from Indian advertisers. The Assessingwere in the nature of payments made to Officer held that the assessee was a conduitcontractors, hence, were liable for deduction for its holding company, i.e., STAR Ltd. He,of tax at source under the provisions of section therefore, held that income from sales revenue194C. On appeal, Commissioner(Appeals) of advertisements did not belong to the assesseereversed the order of the Assessing Officer. and could not be assessed in the assessee’s name. On appeal, the CIT(A) confirmed theThe Tribunal held in favour of assessee - It order of the Assessing Officer.upheld the order of the Commissioner(Appeals)on following reasonings: The Tribunal held in favour of assessee - It held that in terms of the CBDT Circular No. (a) The CBDT has opined, in Circular No. 23 where a non-resident’s sale to the Indian 681 dated March 8, 1994, inter alia, that customers are secured through an agent, the the provisions of section 194C would not assessment in India of the income arising from apply in relation to payments made for the said transactions will be restricted to amount hiring or renting of equipments, etc.; of profit which is attributable to the agent’s (b) Payments made to the crane owners were services. The advertisement revenue, in the not at all relating to the work/output instant case, had been generated through a made by the cranes and it was with reference commission agent, i.e., SIPL and income in to the period of the lease; case of SIPL had already been taxed. Therefore, (c) The running cost was to be borne by the taxability in respect of such sales could not extend beyond that income. The Tribunal further assessee. Therefore, such payments could not be said to be made for the ‘work observed that the assessee-company was formed contract’ as covered by section 194C. not only for procuring advertisement business from India but also from other countries and,[Section 194C, read with section 40(a)(ia), of the therefore, it was not driven by Indian-taxIncome-tax Act, 1961 - Deduction of tax at source considerations alone. The Tribunal, accordingly,- Contractors/sub-contractors, payments to - upheld the assessment of income in case of theAssessment year 2006-07] assessee. } [Section 9 of the Income-tax Act, 1961, read with India-Netherlands DTAA - Income - Deemed to| Where foreign-subsidiary got exclusive accrue or arise in India - Assessment year 2000-rights for sale of advertising time slots in 01]India on various TV channels, it could not }be treated as a conduit of its parent company.In International Global Networks BV v. Asstt. | Creation of assessee-society on splittingDIT [2011] 15 taxmann.com 197/48 SOT 127 up of its parent society could not be treated(Mumbai - Trib.)(URO), the assessee, a company as inheritance under section 78(2)incorporated in Netherlands and subsidiary of In Ballabgarh Co-op. Milk Producers UnionSTAR Ltd., was granted exclusive rights for Ltd. v. ITO [2011] 15 taxmann.com 331 (Delhisale of advertising time slots in India on various - Trib.), the assessee-co-operative society wasTV Channels. The assessee had appointed SIPL engaged in supply of milk and manufacture656 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 56
  • 57. of milk products. It was created by bifurcation all communications relating to this agreementof an old society. During relevant assessment would pass. Terms of agreement further providedyear, assessee filed its return claiming set off that assessee would provide all details of agreedof brought forward loss from parent society endorsements to reinsurers by e-mail and wouldagainst its current income. Revenue authorities act as a claim administrator and submit claimrejected assessee’s claim. advices to relevant market systems. For services rendered, assessee along with other reinsuranceThe Tribunal held in favour of revenue - It brokers acting as an intermediary in reinsuranceheld that in terms of section 78(2), where a process for ‘N’ Ltd. would be entitled to 10%person carrying on business or profession has brokerage. The Assessing Officer opined thatbeen succeeded in such capacity by another services provided by assessee were consultancyperson otherwise than by inheritance, said services in nature and payments received byanother person will not have a right to carry it would fall within definition of ‘fees forforward unabsorbed business loss of first person technical services’ as defined under theand set off same against its income in a Explanation 2 to section 9(1)(vii) as well as videsubsequent year. In instant case, creation of Article 13(4) of the Indo-U.K. Tax Treaty.assessee-society on splitting- up of parent societycould not be treated as inheritance and, therefore, The Tribunal held in favour of assessee - Itprovisions of section 78(2) were not applicable. held that mere provision of technical servicesIn view of above, the Tribunal held that is not enough to attract Article 13(4)(c) of theauthorities were justified in rejecting assessee’s Indo-UK Treaty as it additionally requires thatclaim. service provider should also make his technical knowledge, experience, skill, know-how, etc.,[Section 78 of the Income-tax Act, 1961 - Losses known to recipient of service so as to equip- Carry forward and set off of, in case of change him to independently perform technical functionsin constitution of firm or on succession - Assessment in future, without help of service provider.years 2004-05 and 2005-06] Payments made to it would be regarded as } ‘fees for technical services’ only if twin test of rendering services and making technical| Intermediary services suggesting various knowledge available at same time is satisfied.options for finalization of reinsurer shall Since services rendered by assessee did notnot be regarded as technical services for involve technical expertise, nor assessee madetaxability under Article 13 of India-UK DTAA available any technical know-how, skill, etc.,In Guy Carpenter & Co. Ltd. v. Addl. DIT and was merely acting as an intermediary in[2011] 15 taxmann.com 285 (Delhi - Trib.), the process of finalization of reinsurer suggestingassessee-company, incorporated in London, various options to Indian insurance companyoperated as a recognized insurance broker and for their consideration and acceptance, it couldit was licensed for carrying out intermediate not be said that payment received by assesseeinsurance business by the Financial Services from insurance company in India, was fees forAuthority (FSA) of the United Kingdom. It technical services. Therefore, it could not beentered into an agreement with ‘N’ Ltd. in brought to tax in India.India to reinsure on an excess loss basis, [Section 9 of the Income-tax Act, 1961, read withcatastrophic risk arising from its primary Article 13 of Indo-U.K. DTAA - Income - Deemedinsurance cover in conjunction with ‘J’, ‘M’, to accrue or arise in India [Royalties and fees for‘A’ and ‘G’ Ltd. Terms of agreement specified technical services] - Assessment year 2006-07]that assessee in conjunction with ‘J’ Ltd. wouldbe recognized as an intermediary, through whom } December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 57 657
  • 58. DIRECT TAX LAWS| Consideration paid for perpetual licence of all claims and disputes between parties.of patent and copyright is taxable as royalty Satyam agreed to pay to the applicant an amount of $ 70 million for extinguishment of all rightsIn Upaid Systems Ltd., In re [2011] 15 and obligations between parties, for severingtaxmann.com 126/203 Taxman 28 (AAR), the their business relationship arising out of priorapplicant, a British company, is engaged in agreements towards compensation for deficiencybusiness of providing and enabling electronic in its patent noted by the applicant, for grantpayment services via mobile and fixed telecom of perpetual worldwide royalty-free licenceline and other telecom service networks. Over by the applicant on all its patents to Satyam,years, applicant has been conceiving of designing subject to Satyam not having a right to assignand developing software technology relating licence. Satyam deposited said amount in escrowto payment processing platforms and services. account and sought to deduct tax from amountsIn year 1966, a new framework for an advanced to be paid to the applicant. Applicant resistedintelligent processing platform was conceived. that claim and has sought advance ruling onIn order to exploit that invention commercially, its tax liability in India in respect of the aforesaidappropriate software had to be designed and amount. developed.  AAR held partly in favour of applicant - TheAfter developing an appropriate design, applicant Authority has partly held in favour of theoutsourced development of software to an Indian applicant and segregated the total compensationcompany ‘Satyam’ which developed the software of $ 70 million into following components:and thereafter, an assignment agreement effectivefrom 1-1-1998 was executed between parties (a) Since as per settlement deed Satyam hadwhereunder Satyam, after receiving good and been granted perpetual licence over a patentvaluable consideration, assigned to applicant and copyright of applicant, a part ofin perpetuity all worldwide rights, title and compensation paid by Satyam to appli-interest in the software and intellectual property cant ought to be attributed to licence ofrights and copyright over software developed. right to use patented software and anyPatent authority in Britain granted ‘Patent 947’ improvement to be made on it which willto applicant in respect of the said software. be taxable in terms of section 9(1)(vi);Applicant, subsequently, discovered certain facts (b) Other than part of compensation attrib-which led it to believe that some of the signatures utable to royalty, balance cannot be con-in inventors’ assignment, purportedly signed sidered to be income accruing or arisingby employees of Satyam, were not genuine in India to applicant;but were forged ones due to which value ofits entire patent portfolio had been impaired. (c) The interest earned by applicant on de-Applicant filed complaint against Satyam in posits in Escrow account is taxable inDistrict Court of Texas. However, thereafter hands of applicant.concerned parties entered into a settlement [Section 9 of the Income-tax Act, 1961 - Incomeagreement which provided for parties to sever - Deemed to accrue or arise in India]all ties with each other forever and for settlement }658 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 58
  • 59. ACCOUNTS & AUDIT INTRODUCTION 1. Fair value accounting is an integral aspect of International Financial Reporting Standards (IFRS). In good times, everyone likes fair value accounting, however, in bad times there is a cataclysmic outpouring. With the plan to converge DOLPHY D’SOUZA to IFRS by India, the debate on fair value CA accounting has exacerbated. Some argue that fair value accounting is procyclical and caused the financial crisis a few years ago. However, subsequent research done by SEC indicates Fair value that financial institutions collapsed because of credit losses on doubtful mortgages, caused by sub-prime lending, and not due to fair value accounting.accounting - Those criticizing fair value accounting do not seem to provide any credible alternatives. If we take a step back to historical cost accounting, wherein financial assets have been stated at Integral to outdated values and, hence, are not relevant or reliable from the point of view of the providers of capital. Is there any better way of accounting for derivatives, other than using fair value IFRS accounting? For example, in the case of long- term foreign exchange forward contracts there may not be an active market. For such contracts, entities obtain MTM quotes from banks. In practice, significant differences have been observed between quotes from various banks. Though fair value in this case is judgmental within a range, yet it is a much better alternative than not accounting for the derivative or accounting at historical price. Almost six years ago an exercise was conducted by a global accounting firm to determine employee stock option charge. By making changes to the input variables, all within the allowable parameters of IFRS, option expense December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 59 659
  • 60. ACCOUNTS & AUDIT(based on fair value) as a percentage of reported a company is allowed to choose either the costincome was found to vary by as much as 40% option or fair value option for accountingto 155%. However, since then the IASB has purposes. The apprehension of using fair valueissued IFRS 13 Fair Value Measurement, and accounting for investment properties is drivenvaluation practices have become steadier. With by tax considerations. However, one may notethe passage of time subjectivity and valuation that IFRS financial statements are driven towardsspread has reduced substantially. the needs of the investors and not of any regulator. Therefore, the income-tax authorities should ensure that IFRS is tax neutral.KINDS OF ASSETS AND LIABILITIESLIABLE TO FAIR VALUE ACCOUNTING Being an emerging economy, without deep markets in many areas, India may have to face2. The next question is what kind of assets specific challenges. Many of the challenges inand liabilities lend themselves better to fair determining fair valuation applicable to emergingvalue accounting. Whilst many non-financial economies may also apply to any other developedassets under IFRS are accounted for at historical economies. However, lack of expertise andcost, biological assets are accounted for at fair experience in emerging economies may amplifyvalue. Unfortunately many biological assets the problem. Additional education might beare simply not subject to reliable estimates of needed on how to make estimates and judgmentsfair value. Take for instance, a colt which is and the disclosure of fair value in the financialkept as a potential breeding stock and grows statements.into a fine stallion. The stallion starts winningrace events and is also used in the Bollywoodfilms. The stallion earns substantial amount PROBLEM AREAS IN CASE OFfor its owner from breeding and other services. EMERGING ECONOMIESThe stallion gets older and his utility decreases. 4. Many emerging economies do not have aEventually the stallion dies of old age and the deep and active market for long-term maturities,carcass is used as pet food. At each stage in and in the case of corporate bond there maythe life of the horse, the fair values would not be an active market at all. Valuation ofchange significantly, but estimating the fair such bonds would be difficult as there wouldvalues could be extremely subjective and difficult. be no market, and estimating discounted rateIn many ways, the stallion reminds one of for longer-term maturities could be challenging.fixed assets. Changes in fair value of fixed A country may have only one risk premiumassets are not recognized in the income that covers all maturities but not broken upstatements; then why should the treatment be for specific duration or for industrial sector ordifferent in the case of biological non-financial specific location (risk may vary based on specificassets? location within the country (e.g., South India as compared to East India) - this can compoundTHE INDIAN SCENARIO the problem.3. In India the debate on fair value has confused Any valuation that involves tax and foreignus because of lack of understanding of IFRS. exchange as a variable will add anotherFor example, a common misunderstanding is dimension of complication in the case of emergingthat all assets and liabilities are stated at fair economies. This is because tax rates andvalue. However, the truth is that under IFRS regulations are not stable and change quitemany non-financial assets such as fixed assets frequently. Also, experience indicates that foreignor intangible assets are stated at cost less exchange reference rates announced by thedepreciation. In the case of investment properties, Central Bank or a regulatory body may be660 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 60
  • 61. significantly different from the market. In the FIMMDA periodically. However, under IFRScase of foreign exchange forward contract, there this approximation may not work, as it is clearmay not be an active market beyond one year. that the different States have different riskSignificant differences have been observed in profiles, which impacts their valuation.the MTM quotes from various banks on long- Under IFRS a company may have to fair valueterm forward contracts. its foreign currency convertible bond listed onIf one has to value a corporate bond that is a foreign securities exchange. However, in manynot actively traded, the discount rate would instances at the reporting period there may bebe the base rate plus credit spread based on no trade, as it may not be actively traded. Thiscredit rating. There are various rates used for could lend itself to potential abuse as insignificantdiscounting, such as the zero coupon interest trades at the reporting date may inaccuratelyrate, yield to maturity (YTM) rate, Mumbai determine the fair value of the bonds. TheInterbank Offer Rate (MIBOR), Fixed Income appropriate thing to do in such situations isMoney Market and Derivative Association to make an adjustment to the quoted price(FIMMDA) rate, etc. FIMMDA issues credit based on a detailed analysis so as to measurerating based credit spread on a monthly basis. the bond at its fair value.Reuters issues credit spread on a daily basis It is also common in an emerging economybut only for AAA rated instruments. The that an entity is required to estimate fair valuereliability of the valuation of the bond would on an unquoted instrument, without the benefitdepend upon: (a) the reliability of the base of detailed cash flow forecasts, managementrate used, (b) the availability and reliability of budgets or robust multiples. An entity maythe credit rating for the instrument, (c) the own an insignificant amount, say 10% of anotherreliability of the credit spread. If a company entity and, therefore, may not be legally entitleduses a particular curve to discount a corporate to obtain that information from the investee.bond (say YTM curve) which is different from In many cases, local benchmark companies orthe acceptable practice in the market (say their financial information may simply not beFIMMDA), then the value would differ from available on which to base the valuation. RBIthe way the market determines it. requires unquoted equity instruments to beSimilar issues would also arise in the case of valued at break-up value from the company’svaluation of Government bonds. Many of them latest available balance sheet, and in its absence,may be very illiquid, particularly the State at ` 1 per company. Such valuations wouldGovernment bonds. Quotes from different brokers not be acceptable under IFRS. IAS 39 allowsoften differ significantly. Also it is difficult to cost option in limited circumstances (whenknow if the brokers are acting as principals fair value cannot be determined reliably), thoughor agents and whether the broker will fulfil its replacement, IFRS 9 does not permit it. Inthe deal at the committed price. Valuing them either standard, valuing a company at ` 1in the absence of a market may yield different would not be acceptable.results as risk premium for State Governments When estimating fair value in an emergingmay not be available and would certainly not economy, modelling a non-financial variablebe the same as that of the Central Government. could be extremely difficult. For example, underAs per RBI’s requirements, State Government IFRS, acquisition accounting requires fairsecurities are valued by applying the YTM valuation of contingent liabilities of the acquiree.method by marking it up by 25 basis point, If the contingent liabilities were with regardabove the yields of the Central Government to tax, in many developed economies there issecurities of equivalent maturity put out by a settlement system and past experience onPrimary Dealers Association of India (PDAI)/ which an estimate can be based. However, in December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 61 661
  • 62. ACCOUNTS & AUDITemerging economies the litigations tend to be to provide the same results if different valuersvery long drawn ones and uncertain, eventually were valuing it. This is because it is not aresulting in a full liability or no liability at all. science but an art and no guidance orThe tax authorities that influence the variable methodology can ever make it a science. Further,may change their behaviour rapidly, thereby recent additional guidance from the IASBmaking the historical behaviour an inaccurate contained in IFRS 13 will certainly be helpfulbasis on which to predict future behaviour. in bringing about clarity and consistency on how these issues are handled and in collapsingSometimes market dynamics work in a very the range within which the fair value shouldcomplicated manner in emerging economies. fall. Issuance of further practical guidance thatIt may be difficult to determine the principal specifically deals with fair valuation issues inor most advantageous market due to regulatory the emerging economies will also reduce theor political circumstances. For example, a resistance in these economies towards faircommodity market may have been cornered valuation.by a few selected players; though in legalterms all market participants can trade in themarket, yet in actual terms it may be restrictive. FAIR VALUE MEASUREMENT UNDERWhether such a market should be considered IFRS-13in determining the fair value, if the marketparticipant is not entirely clear whether it will 5. Under IFRS guidance on how to measurebe allowed entry and trade without any fair value was limited and resided in multiplerestriction? Such questions would be more standards that sometimes presented conflictingcommon in emerging economies. Many of these concepts. With the issuance of IFRS 13 Fairquestions have been addressed to in IFRS 13. Value Measurement and a similar standard, FAS 157 under US GAAP, a uniform guidanceHighest and best use is a concept that underscores has been created that will reduce complexityfair valuation. As people are supposed to act in applying the fair value principles and improverationally, a fair value measurement considers consistency across the world.a market participant’s ability to generateeconomic benefit by using the asset in its highest “Fair value” often means different things toand best use. However, highest and best use different people. In the context of IFRS it meansis subject to the restrictions of what is physically, the price that would be received to sell anlegally and financially feasible. This could be asset or paid to transfer a liability in an orderlya difficult area, particularly in emerging transaction between market participants at theeconomies in the absence of clear laws or the measurement date (i.e., an exit price). Fairmanner in which they are implemented. For value is not an entity-specific measurement,example, a builder that owns a piece of land rather it is focused on market participantmay not be clear whether he will be allowed assumptions for a particular asset or liability.to construct 10 floors or 20 floors and whether For example, an entity may have fair valuethe property development is restricted by laws land on the assumption that it would buildin terms of its usage, for example, only for a residential complex. However, if marketresidential or commercial purposes, etc.? This participants believe that the highest and bestcould make the valuation of the land a difficult use is to build a commercial complex, adoptingtask. IFRS 13 could result in a higher fair value than previously determined.The above are some of the main issues thatemerging economies may face more prominently A fair value measurement assumes that thethan developed economies. In any system or transaction to sell the asset or transfer themethodology, fair valuation cannot be expected liability takes place either in the principal market662 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 62
  • 63. or in the most advantageous market. For example, replacement cost, which differs from the costif an entity previously measured the fair value incurred). Management must use valuationof an agricultural produce based on its local techniques that are appropriate in themarket, but there is a deeper and more liquid circumstances and for which sufficient data ismarket for the same agricultural produce (for available. In some cases, this will result inwhich transportation costs are not prohibitive), more than one technique being used (for example,the latter market would be deemed as the using both an income and a market approachprincipal market and would be used to determine to value a business). While measuring fairfair value. value, an entity is required to maximize the use of relevant observable inputs and minimizeIFRS 13 includes a fair value hierarchy which the use of unobservable inputs. When multipleprioritizes the inputs in a fair value measurement. valuation techniques are appropriate,Level 1 applies to assets and liabilities that are management evaluates the results and selectsquoted in an active market; the quoted prices the point within any indicated range that isare used for valuation. In Level 2, inputs (other most representative of fair value.than quoted prices included within Level 1)that are observable for the asset or liability, 5.2 Fair value measurement in an inactiveeither directly or indirectly are used. Examples market - When markets become inactive andare: interest rates and yield curves observable market activities significantly decline, theat commonly quoted intervals, implied volatilities objective of fair value measurement (an exitand credit spreads. In Level 3, unobservable price in an orderly transaction which is notinputs for the asset or liability are used. Example a distress sale) does not change. However, anis, projected cash flows used to value a business entity may determine that a quoted price doesin an entity that is not publicly listed. not represent fair value because the transactions are not orderly. In such cases, appropriate5.1 Three different valuation techniques under adjustments would be made to the quotedIFRS 13 - IFRS 13 describes following three price to reflect the asset or liability at fairdifferent valuation techniques that may be used value.to measure fair value (which would be classifiedwithin the hierarchy, based on the inputs usedin the valuation technique): (1) Market approach: CONCLUDING REMARKSuses prices and other relevant information from 6. Fair value accounting does not create goodmarket transactions involving identical or similar or bad news, rather it is an impartial messengerassets or liabilities; (2) Income approach: converts and is the most relevant yardstick from anfuture amounts (e.g., cash flows or incomes user’s (investor’s) perspective. However, IASBand expenses) to a single current (discounted) should also focus on providing specific guidanceamount and (3) Cost approach: reflects the amount on the fair value challenges that emergingrequired currently to replace the service capacity economies such as India would have to face.of an asset (frequently referred to as current ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 63 663
  • 64. ACCOUNTS & AUDITACCOUNTS & AUDIT Issues in CARO reporting in Audit SRINIVASAN ANAND G. report of companies CA T he Central Government has notified Revised Schedule VI and Companies (Cost Accounting Records) Rules, 2011 during the year 2011. This article examines the impact of the Revised Schedule VI and Companies (Cost Accounting Records) Rules, 2011 on reporting under CARO, 2003.BACKDROP notification by the Central Government of Revised Schedule VI and the Companies (Cost Accounting1. Section 227(4A) of the Companies Act, 1956 Records) Rules, 2011-both applicable from(“the Act”) empowers the Central Government financial year 2011-12. This article discussesto direct that, by general or special order, the the impact of Revised Schedule VI and theauditor’s report of such class or description Companies (Cost Accounting Records) Rules,of the companies as specified in the order 2011 on the reporting obligations of auditorsshall also include a statement of such matters of companies under CARO, 2003.as specified in the order. In other words, auditor’sreport (except in cases of banking companies,insurance companies, section 25 companies and APPLICABILITY OF CARO, 2003-private limited companies satisfying specified EXEMPTION TO PRIVATE LIMITEDconditions) shall include a statement on matters COMPANIESspecified by the Companies (Auditor’s Report)Order, 2003 (CARO, 2003) issued under section 2. CARO, 2003 is not applicable to the audit227(4A) of the Act. The year 2011 has seen the report of a private limited company which satisfies all the following three conditions:—664 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 64
  • 65. (a) Paid-up capital + reserves of the com- and loss account cannot be reduced from the pany does not exceed ` 50 lakhs at any paid up capital and revaluation reserve. Thus, point of time during the financial year. the total of paid-up capital and reserves, in this case, will be: (b) Company does not have loan outstanding exceeding ` 25 lakhs from any bank or financial institution at any point of time Paid–up capital ` 30 lacs during the financial year. Revaluation Reserves ` 10 lacs (c) Company’s turnover does not exceed ` 5 Capital Reserve ` 11 lacs crores at any point of time during the financial year. Aggregate of paid-up capital and ` 51 lacs reservesThe Revised Schedule VI (effective from financialyear 2011-12) seems to impact the applicabilityor otherwise of condition (a) i.e. whether the Since the aggregate of paid-up capital andaggregate of paid-up capital and reserves of reserves exceeds ` 50 lacs, CARO, 2003 shallthe private limited company exceeds the limit apply to the private ltd. company in question.of ` 50 lakhs. Suppose a Private Limited reportsthe following position as on 31st March, 2012: Situation under Revised Schedule VI ICAI’s views are that debit balance in profit ` and loss account should be reduced only from Paid up capital 30 lacs the figure of revenue reserves (and not from the paid up capital and revaluation reserve (in Revaluation reserve 10 lacs cases where there are no revenue reserves) Capital reserve 11 lacs were rendered in the context of the Old Schedule VI. The Old Schedule VI required deduction P&L A/c [Dr. Balance] 22 lacs of debited balance of P&L account from uncommitted reserves only. The Revised ScheduleIs CARO, 2003 applicable in this case? VI provides that the debit balance of P&L account shall be shown as a negative figureSituation under Old Schedule VI under the head ‘Surplus’ and the balance of Reserves and Surplus after adjusting negativeAccording to para 1(2)(iv) of CARO, 2003, if balance of surplus even if the resulting figurethe paid capital plus reserves of a private is in the negative. Thus, it seems that in viewlimited company exceeds ` 50 lacs at any time of the Revised Schedule VI, the sum of paid-during the year under audit, CARO, 2003 will up capital and reserves will be ` 29 Lakhs [i.e.apply to it. According to the Statement on ` 30 lakhs (paid-up capital) plus negative figureCARO, 2003 issued by ICAI, all reserves- capital of Reserves and Surplus (` 1 Lakh)]. This seemsas well as revenue should be considered in to be a better view as the requirement of thereckoning the limit of ` 50 lakhs. Credit balance Revised Schedule VI seems to be to take anin profit and loss account should also be overall view of the “Reserves” and “Surplus”considered a reserve for this purpose. Debit taken together rather than looking at each ofbalance in profit and loss account, if any, should them separately. Thus, it seems that CARO,be reduced from the figure of revenue reserves. 2003 shall not apply in the instant case as paidIf there are no revenue reserves, as in the up capital plus reserves is less than `50 lakhs.present case, the debit balance in the profit ICAI’s clarification on the subject is desirable. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 65 665
  • 66. ACCOUNTS & AUDITAUDITOR’S COMMENTS PURSUANT TO comment, he should clearly mention the factPARA 4(vii ) OF CARO, 2003 REGARDING that he has made only a general review of cost records and that he has not made any detailedINTERNAL AUDIT SYSTEM audit of cost records. If the records have not3. As per para 4(vii) of CARO, 2003, the auditor been written up or are prima facie incomplete,has to report whether the company has an the auditor should make a suitable commentinternal audit system commensurate with its in his audit report under para 4(viii) of CARO,size and nature of its business in respect of 2003. He should also qualify in his main auditthe following companies: report his affirmation under section 227(3)(b) as to whether proper bodies of account as(A) Listed Companies. required by law have been maintained so far (B) Unlisted Companies which satisfy one of as it appears from an examination of these the following two conditions: books. This is because cost records are books of account under section 209(1)(d). (a) Company’s paid-up capital and re- serves as at the commencement of the financial year concerned exceeds ` 50 Cost Accounting Records Rules, 2011 lakhs; or The Central Government, pursuant to the power (b) Company whose average annual turn- conferred on it by section 209(1)(d) of the Act over for three consecutive immedi- issued product-specific Cost Accounting Record ately preceding financial years ex- Rules from time to time covering 44 products/ ceeds ` 5 crores. activities. The Central Government broughtAs ICAI’s Statement on CARO, 2003 clarifies each product/activity within the ambit of sectionthat the aggregate of paid-up capital and reserves 209(1)(d) by notifying product-specific Costwill be calculated in the same manner as for Accounting Record Rules. Maintenance of costthe purposes of exemption of private limited records prescribed these rules was mandatorycompanies from CARO, 2003, the same issues for the 44 products and activities covered byrelating to dealing with accumulated loss when these rules. Cost records maintenance wascompany has no revenue reserves explained compulsory for the companies producing onein para 2.0 above will arise in case of Para or more of these 44 products with exemptions4(vii) also. for SSI units. If a company is producing two products - one falling in the list of these 44 products covered by Cost Accounting RecordsAUDITOR’S COMMENTS PURSUANT TO Rules and other not falling in the list of 44PARA 4(viii) OF CARO, 2003 REGARDING products, then cost records are mandatory forMAINTENANCE OF COST RECORDS the former product and not for the latter. The Ministry of Corporate Affairs notified the4. In terms of Para 4(viii) of CARO, 2003, Companies (Cost Accounting Records) Rules,where maintenance of cost records has been 2011 on June 3, 2011. These Rules introducedprescribed by the Central Government under a common set of record rules for industriesclause (d) of sub-section (1) of section 209 of other than 8 regulated industries specified inthe Act, Auditor to report whether such accounts the Rules, in place of industry specific rulesand records have been made and maintained. in vogue earlier. The 8 regulated industriesThe auditor need to make only a general review which continue to be governed by activity/of the cost records to ensure that prescribed product-specific rules are as under:cost records have been maintained. In his666 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 66
  • 67. 1. The Cost Accounting Records (Bulk Drugs) the sale or supply of all products or Rules, 1974 services during the financial year. It includes any turnover from job work 2. The Cost Accounting Records (Electricity or loan license operations but does Industry) Rules, 2001 not include any non-operational 3. The Cost Accounting Records (Fertiliz- income]; or ers) Rules, 1993 (c) the company’s equity or debt secu- 4. The Cost Accounting Records (Formula- rities are listed or are in the process tions) Rules, 1988 of listing on any stock exchange, whether in India or outside India. 5. The Cost Accounting Records (Industrial Alcohol) Rules, 1997 The terms “production activity”, “processing 6. The Cost Accounting Records (Petroleum activity”, “manufacturing activity”, or “mining activity” are defined in the 2011 Records Rules. Industry) Rules, 2002 The term “Processing” has been defined as 7. The Cost Accounting Records (Sugar) Rules, under: 1997 “Processing Activity” includes any act, 8. The Cost Accounting Records (Telecom- process, procedure, function, operation, munications) Rules, 2002. technique, treatment or method employedThe Rules require every company to which the in relation to—rules apply, including all units and branches (i) altering the condition or propertiesthereof, to keep cost records in respect of each of inputs for their use, consumption,of its products and activities on regular basis. sale, transport, delivery or disposal;Rule 3(1) of the 2011 Records Rules provides orthat these rules shall apply to every company, (ii) accessioning, arranging, describing,including a foreign company as defined undersection 591 of the Act, which satisfies the or storing products; orfollowing conditions: (iii) developing, fixing, and washing exposed photographic or cine- (I) The company is engaged in the produc- tion, processing, manufacturing, or min- matographic film or paper to pro- duce either a negative image or a ing activities; and positive image; or(II) At least one of the following three con- ditions is satisfied: (iv) printing, publishing, finishing, per- foration, trimming, cutting, or pack- (a) the aggregate value of net worth as aging; or on the last date of the immediately preceding financial year exceeds ` 5 (v) pumping oil, gas, water, sewage or any other product; or crores; or (vi) transforming or transmitting, distrib- (b) the aggregate value of the turnover made by the company from sale or uting power or electricity; or supply of all products or activities (vii) harbouring, berthing, docking, elevat- during the immediately preceding ing, lading, stripping, stuffing, tow- financial year exceeds ` 20 crores of ing, handling, or warehousing prod- rupees [“Turnover” means gross ucts; or turnover made by the company from December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 67 667
  • 68. ACCOUNTS & AUDIT (viii) preserving or storing any product in (iii) creation of value or wealth by pro- cold storage; or ducing goods or services.’ (ix) constructing, reconstructing, recon- The 2011 Records Rules define “product” as ditioning, repairing, servicing, refit- under: ting, finishing or demolishing of ‘“Product” means any tangible or intangible buildings or structures; or goods, material, substance, article, idea, (x) farming, feeding, rearing, treating, know-how, method, information, object, nursing, caring, and stocking of liv- service, etc. that is the result of human, ing organisms; or mechanical, industrial, chemical, or natural act, process, procedure, function, operation, (xi) telecasting, broadcasting, telecom- technique, or treatment and is intended municating voice, text, picture, in- for use, consumption, sale, transport, store, formation, data or knowledge through delivery or disposal.’ any mode or medium; or The 44 Products Cost Accounting Record Rules (xii) obtaining, compiling, recording, main- notified by the Central Government are basically taining, transmitting, holding or using manufacturing sector-oriented. Maintenance of the information or data or knowl- cost records is a necessity for service sector edge; or enterprises also. With this in view, the 2011 (xiii) executing instructions in memory to Records Rules define “production activity” to perform some transformation and/ inter alia cover “transformation of tangible inputs or computation on the data in the (raw materials, semi-finished goods, or sub- computer’s memory.” assemblies) and intangible inputs (ideas,A look at the above definition suggests that information, know-how) into goods or services”companies in farming sector, construction sector, and “creation of value or wealth by producing goods or services”. Thus, the 2011 Recordsdata processing sector, publishing industry,have all been brought within the ambit of cost Rules have extended the requirements to maintain cost records under section 209(1)(d) to companiesrecords maintenance obligations under section209(1)(d) of the Act. engaged the services sector also. However, the 2011 Records Rules shall not apply to a bankingThe 2011 Record Rules define the expression company or insurance company as such a“Production Activity” as under: company is “a company which is a body ‘“Production Activity” includes any act, corporate governed by any special Act”. process, or method employed in relation Requirements of the 2011 Records Rules - Cost to - records to be maintained as per CASs and (i) transformation of tangible inputs (raw GACAP issued by ICWAI - The cost records materials, semi-finished goods, or sub- are to be maintained in accordance with the assemblies) and intangible inputs generally accepted cost accounting principles (ideas, information, know-how) into and cost accounting standards issued by the goods or services; or Institute of Cost and Works Accountants of India (ICWAI) to the extent these are found (ii) manufacturing or processing or mining to be relevant and applicable. The variations, or growing a product for use, con- if any, are to be clearly indicated and explained. sumption, sale, transport, delivery or disposal; or Requirement of compliance report from Cost Accountant - Rule 5 of the 2011 Record Rules668 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 68
  • 69. provides that every company to which these for forming his opinion on maintenance ofrules apply shall submit a compliance report, cost accounts and cost records for the purposesin respect of each of its financial year commencing of para 4(viii) of CARO, 2003 as the last dateon or after the 1st day of April, 2011, duly for holding Annual General Meeting is also 6certified by a “cost accountant”, along with months from the end of the financial year (i.e.the Annexure to the Central Government, in 30th September) and statutory auditor’s reportthe prescribed form (i.e. Form B). “Form B” has to be ready at least a couple of monthsmeans the form of the compliance report and before the AGM so that the annual reportincludes Annexure to the compliance report. containing audited accounts and statutoryAccording to Rule 2(c) of the 2011 Record auditor’s report can be printed and sent 21Rules, “cost accountant” means a cost accountant clear days before the AGM. However, the openingas defined in clause (b) of sub-section (1) of paragraph of Compliance Report in Form Bsection 2 of the Cost and Works Accountants reads as under :Act, 1959 (i.e. a member of the ICWAI) and “I/We ...................................... being inwho is either a permanent employee of the permanent employment of the company/company or holds a valid certificate of practice in practice, and having been appointedunder sub-section (1) of section 6 and who is as cost accountant under Rule 5 of thedeemed to be in practice under sub-section (2) Companies (Cost Accounting Records)of section 2 of that Act and includes a firm Rules, 2011 of ...................................... (mentionof cost accountants. name of the company) having its registeredIn view of the requirements of mandatory office at ………………………….. (mentioncompliance reporting by cost accountants, it registered office address of the company)would be only fair for the Central Government (hereinafter referred to as the company),to unburden the statutory auditors from have examined the books of accountrequirements of para 4(viii) of CARO, 2003 prescribed under clause (d) of sub-sectionand their obligations under section 227(3)(b) (1) of section 209 of the said Act, andregarding maintenance of proper books of account other relevant records for the period/yearinsofar as cost records are concerned. The Central ...................................... (mention the financialGovernment should delete Para 4(viii) of CARO, year) and certify as under:”2003 by Notification and clarify that the obligation This may be contrasted with the opening paraof statutory auditor under section 227(3)(b) of cost audit report in Form II to the Costregarding maintenance of proper books of account Audit Report Rules, 2011 which reads as under:insofar as cost records are concerned extendsonly to the 8 regulated industries listed above. “I/We, ...................................... having been appointed as Cost Auditor(s) under sectionIssue of timely availability of compliance report 233B of the Companies Act, 1956 (1 ofto statutory auditor - Rule 6 of the 2011 Record 1956) of ...................................... (mentionRules provides that every company to which name of the company) having its registeredthe 2011 Record Rules apply shall submit the office at ...................................... (mentioncompliance report to the Central Government registered office address of the company)within 180 days from the close of the company’s (hereinafter referred to as the company),financial year to which the compliance report have audited the books of accountrelates. Since, there is a time-line of 180 days prescribed under clause (d) of sub-sectionfrom the end of the financial year within which (1) of section 209 of the said Act, andthe report has to be obtained and submitted. other relevant records in respect of theThis means the compliance report may not .................................... (mentions name/snecessarily be available to the statutory auditor of product group/s) for the period/year December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 69 669
  • 70. ACCOUNTS & AUDIT ...................................... (mention the financial in a cost audit. Thus, it would appear that the year) maintained by the company and report, “cost accountant” would “examine” cost records, in addition to my/our observations and Detailed unit-wise and product/activity-wise suggestions in para 2.” cost statements and schedules thereto to see whether these are maintained and whetherItem 3 of Form B requires the “cost accountant” they comply with cost accounting standardsto state whether “Detailed unit-wise and issued by ICWAI. He would not be requiredproduct/activity-wise cost statements and to apply audit procedures like examiningschedules thereto in respect of the product documentary evidence supporting the entriesgroups/activities are/are not kept in the in books of account. In view of this, it appearscompany.” The corresponding requirement in that it may be possible for the company tocost audit report in Item (vii) of the opening make arrangement with its Cost Accountantpara of cost audit report in Form II reads as to obtain the compliance report say in Aprilunder: itself. It would be better if the statutory auditor “Detailed unit-wise and product/activity- arranges with his company-client before hand wise cost statements and schedules thereto to have this compliance report in time so that in respect of the product groups/activities it will be useful for him to form and base his under reference of the company duly opinion for the purposes of para 4(viii) of the audited and certified by me/us are/are CARO. not kept in the company.” Issue of reliance on compliance report toThe words “duly audited and certified by me/us statutory auditor - A question arises whetherare/are not kept in the company” in cost audit question arises whether, in case of companiesreport are absent in Item 3 of Form B. covered under Companies (Cost AccountingThus, a comparison of Form B and Form II Records) Rules, 2011, reliance can be placed by the statutory auditor on the compliancesuggests that the compliance report involves“examination of cost records” but not an “audit report for the purposes of para 4(viii) of CARO,of cost records”. This is understandable as 2003? If the “cost accountant” issuing compliance report is practicing cost accountant, then therescope of compliance report is “in respect ofthe product groups/activities” while in case ought not to be any problem for the statutory auditor in relying on Form B compliance report.of cost audit report it is “in respect of theproduct groups/activities under reference of He can rely on the same provided he himself does not discover any shortcomings in thethe company”. Thus, the “cost accountant”has to cover cost records for all product groups/ work done by the “cost accountant” during the course of his audit. In such a case, he mayactivities while cost auditor has to cover onlycost records of the product groups/activities preface his remarks as under:under reference of the company. Since the “Based on the Compliance Report dated“cost accountant” in compliance report has to …...…… issued by the cost accountantcover a much larger area than cost auditor in M/s.......….. in Form B to the Companiescost audit report, it is only to be expected that (Cost Accounting Records) Rules, 2011the examination of cost records be less intensive and based on such test checks as consideredthan that of the cost auditor. Further, it is necessary, in my/our opinion, cost accountsdesirable that this compliance report should and cost records have been made andbe available to the cost auditor for the purposes maintained by the company. We haveof cost audit. This would mean that cost not, however, made a detailed examinationaccountant’s examination of cost records for of the records with a view to determinecompliance report has to be less intensive than whether they are accurate or complete.”670 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 70
  • 71. However, if the “cost accountant” issuing and reserves for exemption of private limitedcompliance report is a permanent employee of company from CARO, 2003 and applicabilitythe company then question of independence of the comment on internal audit system underof the “cost accountant” arises. It would be para 4(vii) of CARO, 2003 to unlisted companiesbetter for ICAI to clarify whether the statutory and (ii) Comment on cost records maintenanceauditor can rely on Form B in such a case. under para 4(vii) of CARO, 2003. There is a need for ICAI’s guidance on these issues by revising the Statement on CARO, 2003. TheCONCLUSION MCA should consider dropping Para 4(viii) of5. The Notification of Revised Schedule VI CARO, 2003 and clarify that the obligation ofand Companies (Cost Accounting Records) Rules, statutory auditor under section 227(3)(b)2011 during the year 2011 (which is drawing regarding maintenance of proper books of accountto a close) will impact audit reporting under insofar as cost records are concerned extendsCARO, 2003 on issues such as (i) calculation only to the 8 industries which are still governedof the limit of aggregate of paid-up capital by product-specific cost accounting records rules. ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 71 671
  • 72. ACCOUNTS & AUDITACCOUNTS & AUDIT INTRODUCTION AS-11 and AS-16 – 1. AS-11 in the context of “The Effects of changes in Foreign Exchange rates” is mandatory Dusting the dilemma for all the enterprises for the accounting periods commencing on or after April 1, 2004. The for treatment of entities may be covered under AS-11 under two circumstances, i.e., either when an entity has transactions in foreign currency or when exchange rate it has foreign operations. For the purpose of making financials as per IGAAP, the financials differences on need to be prepared in the Indian currency. As a result of it, the transactions of the entity borrowing cost during need to be stated in INR and financial statements of the foreign operations need to be translated to INR. AS-16 “Borrowing Costs” deals with construction period the capitalization of the interest and other costs incurred by the entity in connection with the borrowing of funds for a qualifying asset. It often happens that enterprises borrow in foreign currency at a lower rate of interest to fund the expansion of the projects. In that situation, when the enterprises pay the interest cost, should it be treated as a “Borrowing cost” as per AS 16, or as an exchange difference as per AS 11 or both? THE ISSUE & THE DILEMMA 2. An issue came before the EAC (Expert Advisory Committee) regarding the combined application of the AS-11 and AS-16. The case relates to a company in its expansion phase for its project requirements. The company funded its requirement under External Commercial Borrowing route (ECB) from a bank in the USA, in Dollars. As at the year - end, there VARUN KUMAR was reduction in reinstatement of liability as CA a result of reduction in exchange rate of US Dollar. The gain on the reinstatement of liability in “Foreign Currency Loan Account” was credited by the company to Profit & Loss account as “Other Income”. The same amount was debited to Profit & Loss account as “Expenditure transfer672 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 72
  • 73. to capital account” and, thus, crediting the 3.4 It can be said that the costs which will be“Capital Work in Progress” leading to abatement/ covered under Paragraph 4(e) of AS-16 will bedecapitalization, because the project was in capitalized as borrowing costs. The amount ofthe construction stage. interest on the foreign currency borrowing not covered by Paragraph 4(e) AS-16 will beAn opinion was sought from the EAC on whether accounted as per AS-11.exchange rate variations on the foreign currencyloan taken/foreign currency liability incurred 3.5 Paragraph 4(e) of the AS-16 “Borrowingfor the project, during the period of construction Costs” clearly mentions that borrowing costshould be capitalized or abated/decapitalized, may include only that part of exchange difference,as the case may be, as an incidental expenditure which can be considered as an “adjustment toduring construction? interest costs”.The above issue arose as a result of theimplications of AS-11 and AS-16. The dilemma DEFINITION OF “ADJUSTMENT TOwas whether in the above situations, the exchange INTEREST COSTS”difference during the construction period shouldbe treated as a “Borrowing cost” as per AS- 4. Generally, entities borrow funds in foreign16, or as an exchange difference as per AS- currency at a lower interest rate as compared11 or both? to borrowing locally. In such a scenario, the exchange difference on the principal amountSOLUTION of foreign currency borrowings, to the extent3. The solution was the combined application of, the difference between interest on localof paragraph 4(a), 4(e) of AS-16 and paragraph currency borrowing and interest on foreign6 of AS-11. currency borrowing, is regarded as an adjustment to the interest costs. In layman terms, the3.1 Paragraph 4(a) of the AS-16 “Borrowing difference between the interest on local currencyCosts” states that: borrowing and the interest on foreign currency “Borrowing costs may include: interest borrowing (to the extent of exchange difference and commitment charges on bank on the amount of principal of the foreign borrowings and other short-term and long- currency borrowings) will be covered under term borrowings; paragraph 4(e) of AS-16 and is actually “adjustment to interest costs”3.2 Paragraph 4(e) of the AS-16 “BorrowingCosts” states that: ROLE OF ACCOUNTING STANDARD “Borrowing costs may include: exchange differences arising from foreign currency INTERPRETATION (ASI) 10 borrowings to the extent that they are 5. Suppose the entity has borrowed locally regarded as an adjustment to interest instead of foreign currency borrowing. Consider costs.” the rate of interest on local currency borrowing3.3 Paragraph 6 of AS-11 “The Effects of changes as the one at which the entity could havein Foreign Exchange rates” states that: borrowed funds in India. In the given situation, Paragraph 4(e) of AS-16 comes into play and “This Statement does not deal with the exchange differences arising from foreign exchange differences arising from foreign currency borrowings, to the extent they are currency borrowings to the extent that regarded as an adjustment to interest costs, they are regarded as an adjustment to are capitalized. interest costs (see paragraph 4(e) of AS- 16, Borrowing Costs)”. Further, if there is foreign exchange gain instead of loss then the same should be reduced from December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 73 673
  • 74. ACCOUNTS & AUDITthe cost of the asset to the extent the exchange 6.1.1 Applications of Paragraph 4(e) of AS 16 andloss has been capitalized as per provisions of Paragraph 6 of AS-11 for computation of borrowingthe paragraph 4(e) of AS-16. Any excess exchange cost -gain should be treated as an income for the Step 1 Interest on Foreign Currency Loan foryear in which it arises. the F.Y. 2009-10 – INR 2,40,000, i.e., [USD 1,00,000 × INR 48 per USD × 5%]6. ILLUSTRATIONS Step 2 Increase in liability for repayment of6.1 Illustration 1 - PHP Ltd. (Indian company) loan – INR 3,00,000, i.e., [USD 1,00,000 × INRengaged in the power generation required funds 3 (INR 48 – INR 45)]for expansion. The company opted for borrowing Step 3 Interest, if the loan had been borrowedin US Dollars from a bank in the USA under locally – INR 4,95,000, i.e., [USD 1,00,000 ×the External Commercial Borrowing route. Loan INR 45 per USD × 11%]was obtained of USD 1,00,000 on April 1, 2009.The interest rate was 5% p.a. and payable Step 4 Difference between interest on Localannually. The exchange rates on April 1, 2009 Currency Borrowing and Foreign Currency Loanand March 31, 2010 were INR 45 and INR 48 – INR 2,55,000, i.e., [INR 4,95,000 - ` 2,40,000]per USD respectively. Had the company not 6.1.2 The above date can be representedborrowed in foreign currency, it could have diagrammatically as follows -borrowed locally at an interest rate of 11% p.a.6.1.3 Point to ponder - If the difference between Note 1 : In illustration 1, the difference betweenthe interest on local currency borrowing and the interest on local currency borrowing andthe interest on foreign currency borrowing is the interest on foreign currency borrowing (INRequal to or more than the exchange rate difference 2,55,000) is less than the exchange rate differencearising on restatement of principal amount of on the amount of principal of the foreign currencythe foreign currency borrowings, the entire borrowing (INR 3,00,000). Hence, only INRamount of exchange difference is covered under 2,55,000 can be capitalized in the given caseparagraph 4(e) of AS-16. under paragraph 4(e) of AS-16.674 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 74
  • 75. 6.2 Illustration 2 - Suppose in Illustration 1 Step 2 Increase in liability for repayment ofabove, the company could have borrowed locally loan – INR 3,00,000, i.e., [USD 1,00,000 × INRat an interest rate of 13% instead of at 11%. 3 (INR 48 – INR 45)]6.2.1 Application of Paragraph 4(e) of AS 16 and Step 3 Interest if the loan had been borrowedParagraph 6 of AS 11 for computation of borrowing locally – INR 5,85,000, i.e., [USD 1,00,000 ×cost - INR 45 per USD × 13%]Step 1 Interest on Foreign Currency Loan for Step 4 Difference between interest on Localthe F.Y. 2009-10 – INR 2,40,000, i.e., [USD Currency Borrowing and Foreign Currency Loan1,00,000 × INR 48 per USD × 5%] – INR 3,45,000, i.e., [INR 5,85,000 – INR 2,40,000] 6.2.2 The above data can be represented diagrammatically as follows -Note 2 : In illustration 2, the amount of principal Step 2 Decrease in Liability for repayment offoreign currency borrowings (INR 3,00,000) is loan – (INR 5,00,000), i.e., [USD 1,00,000 × INRless than the difference between the interest 5 (INR 40 – INR 45)]on local currency borrowing and the interest Step 3 Interest if the loan had been borrowedon foreign currency borrowing (INR 3,45,000). locally – INR 4,95,000, i.e., [USD 1,00,000 ×Hence, INR 3,00,000 can be capitalized fully, INR 45 per USD × 11%]in the given case under paragraph 4(e) ofAS-16. Step 4 Difference between interest on Local Currency Borrowing and Foreign Currency Loan6.3 Illustration 3 - In continuation to illustration – INR 2,95,000, i.e., [INR 4,95,000 – INR 2,00,000]1, suppose the exchange rate as at March 31,2011 is ` 40 per USD. 6.3.1 The above data can be represented diagrammatically as follows -Step 1 Interest on Foreign Currency Loan forthe F.Y. 2010-11 – INR 2,00,000, i.e., [USD1,00,000 × INR 40 per USD × 5%] December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 75 675
  • 76. ACCOUNTS & AUDITNote 3 : Now there is foreign exchange gain only to the extent the amount of exchangeof INR 5 Lakhs on the foreign currency difference on foreign currency principal amountborrowings. Out of it only INR 3 Lakhs can does not exceed the difference between interestbe reduced from the cost of asset – Capital on local currency borrowings and interest onWork in Progress (CWIP) because till date foreign currency borrowings. This is consideredexchange loss of INR 3 Lakhs only has been as borrowing cost to be dealt with under AS-16capitalized under the provisions of paragraph (Refer to diagram 1 in illustration 1). The4(e) of AS-16. The balance of INR 2 Lakhs remaining exchange difference, if any, is(INR 5 Lakhs - INR 3 Lakhs), will be treated accounted for under AS-11 (Refer to diagramas an income for the year and credited to 1 in illustration 1). If there is the foreignProfit & Loss account. exchange gain arising on the foreign currency borrowings, the same should be reduced from the cost of the fixed asset to the extent theCONCLUSION exchange loss has been capitalized as per the7. It can be concluded that the exchange difference provisions of paragraph 4(e) of AS-16 (Referarising on the foreign currency borrowings to illustration 3). Further, if there still remainsduring the construction period should be some exchange gain even after aforementionedbifurcated into “interest portion” (Accounted reduction from the cost of fixed asset, then theas per AS-16) and exchange gain/loss (Accounted same should be treated as an income for theas per AS-11). The foreign exchange loss on year in which it arises (Refer to illustration 3).the foreign currency loan can be capitalized •••676 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 76
  • 77. ACCOUNTS & AUDIT Accounts & Audit in Brief A Fortnightly Analysis of Changes in Accounts & Audit Accounts and audit, like all fields today, register new developments frequently. Here is a synoptic view of such changes which one cannot afford to miss. RAJESH GOSAIN CANATIONAL UPDATES Accounts Exposure Draft - Limited Revision to AS 10, Accounting for Fixed Assets The Institute of Chartered Accountants of India (“ICAI”) has issued an Exposure Draft of ‘Limited Revision to Accounting Standard (“AS”) 10, Accounting for Fixed Assets’. The changes are proposed primarily to: (i) improve accounting for fixed assets during their construction period; (ii) incorporate consequential amendments to AS 29, Provisions, Contingent Liabilities and Contingent Assets, regarding the provision made for costs of dismantling/removing December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 77 677
  • 78. ACCOUNTS & AUDIT the items and site restoration; the related obligation of an entity during a particular period for purposes other than to produce inventories during that period; (iii) improve accounting for spares with a view to bring it in line with the improvements being made in International Accounting Standard (“IAS”) 16, Property, Plant and Equipment at the suggestion made by the ICAI to the International Accounting Standards Board (“IASB”); and (iv) bring consistency between this standard and other AS. As a consequence to the change in the accounting for spares, the Guidance Note on Accounting for Machinery Spares (Re: AS 2 and AS 10) would stand withdrawn from the date when AS 10 revision comes into effect. (Comments to be sent to ICAI by December 20, 2011) Source: ICAI website (24 th November, 2011) Link: http://220.227.161.86/24956announ14787.pdf Exposure Draft - Guidance Note on Recognition of Revenue by Real Estate Developers The objective of this Guidance Note is to recommend the accounting treatment by sellers or developers dealing in ‘Real Estate’. Real estate transactions covered by the following AS are outside the scope of this Guidance Note: u AS 10, Accounting for Fixed Assets; u AS 12, Accounting for Government Grants; u AS 19, Leases; and u AS 26, Intangible Assets This Guidance Note covers all forms of transactions in real estate. For example: (a) Sale of plots of land without any development; (b) Sale of plots of land with development in the form of common facilities like laying of roads, drainage lines and water pipelines, etc.; (c) Development and sale of residential and commercial units, row houses, independent houses, with or without an undivided share in land; (d) Acquisition, utilization and transfer of development rights; (e) Redevelopment of existing buildings and structures; (f) Joint development agreements for any of the above activities. This Guidance Note primarily prescribes the application of Percentage of Completion Method as per AS 7, Construction Contracts, in respect of real estate activities, having the same economic substance as construction type contracts. In respect of transactions of real estate which are in substance similar to delivery of goods, AS 9, Revenue Recognition is applicable. This Guidance Note would be applicable to all real estate transactions commenced or entered into on or after April 1, 2012. An early application is permitted, provided this is applied to all transactions which commenced or were entered into on or after the date of application. This Guidance Note on its becoming effective would supersede the Guidance Note on ‘Recognition of Revenue by Real Estate Developers’ issued by the ICAI in 2006. (Comments to be received by December 13, 2011) Source: ICAI Website (14th November, 2011) Link: http://220.227.161.86/24887announ14694.pdf678 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 78
  • 79. Guidance Note on ‘CAS 6 - Material Cost’ Material cost is one of the major elements of cost, while deriving cost of production. Therefore, the Institute of Cost and Works Accountant (“ICWAI”) has released Guidance Note on Cost Accounting Standard 6, Material Cost (CAS-6), with a view to standardize the treatment of material cost. This Standard sets out the principles of proper allocation and determination of material cost. More importantly, this is one of the first Standards, framed under the revised framework in line with the international practice in this regard. The Standard provides the detailed discussion about the following: u Types of the materials This part enlists the various types of materials covered under CAS-6; being raw materials, process materials, additives, manufactured/bought out components, sub- assemblies, accessories, semi-finished goods, consumable stores, spares and other indirect materials. u The definitions used in the Standard This part defines the meaning of certain terms, e.g., material cost, imputed cost, standard cost, abnormal cost, administrative cost, direct and indirect material cost, etc. u Principles of measurement of material cost This part discusses the principle of valuation of receipt of materials (imported or indigenous), finance cost incurred in acquisition of material, valuation of self manufactured material, etc. u Assignment of material cost Assignment of material cost involves establishing a suitable procedure to identify and record the resources consumed. This part lays down the principles in this regard. u Presentation This part prescribes how the direct and indirect materials are to be classified and disclosed in the cost statements. u Disclosures This part describes how information needs to be disclosed in the cost statements dealing with determination of material cost. u Annexures exhibiting the practical examples Source: ICWAI Website Link: http://www.casbicwai.org/casb/docs/Guide_note_cas6.pdfAudit FAQs - on Companies (Cost Accounting Records) Rules, 2011 and Companies (Cost Audit Report) Rules, 2011 Third part of Frequently Asked Questions (“FAQs”) is issued to clarify practical aspects on the Companies (Cost Accounting Records) Rules, 2011 and the Companies (Cost Audit Report) Rules, 2011. These include: u Exemption from these Rules; u Authentication of compliance report by the cost auditor; u Practical queries in respect of turn key contracts; December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 79 679
  • 80. ACCOUNTS & AUDIT u Applicability of the Cost Accounting Rules in case of a retail company engaged in the telecommunication sector; u Applicability of the Cost Audit Rules in case of electricity companies; u Applicability in case of other types of companies; u Price determination in case the product is sold to a related party; u Use of digital signature. Source: ICWAI Website Link: http://www.icwai.org/icwainew/docs/FAQ/3-FAQ-CARR-CAR.pdf Cost Accounting Records and Cost Audit - Clarification regarding applicability and compliance requirements Certain applicability and compliance requirements in respect of the Companies (Cost Accounting Records) Rules, 2011 and the Companies (Cost Audit Report) Rules, 2011 are further clarified through this circular. These include: u Filing of compliance report; u Period for maintenance of the cost records; u Defining the term “turnover”; u Filing the cost audit reports; u Appointment of cost auditor, etc. Source: ICWAI Website Link: http://members.icwai.org/members/docs/mca/CostAuditLetter.pdf Cost Accounting Records and Cost Audit - Clarification about coverage of certain sectors This circular enlists the types of the entities covered or exempted from the Cost Accounting Record Rules and certain Cost Audit Orders. Among others, exempted category in respect of Cost Accounting Record Rules mainly include wholesale and retail trading activities, banking, financial, leasing, insurance, education, healthcare, business and professional consultancy, IT & IT enabled services, companies engaged in job work operations, companies engaged in mining activities (till the time of commencement of commercial operations). Certain Cost Audit orders would not be applicable to certain class of companies, e.g., generation of electricity for captive consumption, hundred per cent EOU, etc. Source: ICWAI Website Link: http://members.icwai.org/members/docs/mca/CostAccountingRecord.pdf Others Extension of last date of filing Financial Statements in XBRL mode MCA has extended the due date for filling of financial statements in XBRL mode for the companies covered under Phase-I (excluding exempted companies), having balance sheet date for the financial year 2010-11 on or after 31 March, 2011, without any additional fees.   The date has been extended from 30 November, 2011 to 31 December, 2011 or 60 days of their due date of filling, whichever is later. Source: ICAI Website (30th November, 2011)Link: http://220.227.161.86/25019announ14831.pdf680 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 80
  • 81. Council Guidelines for conversion of CA firms into LLPs ICAI has issued Detailed Guidelines for conversion of CA firms into LLPs. This is a welcome move for all the chartered accountants in practice, willing to extend their size and practice. This is because the limit of 20 partners would no longer be applicable as the LLP is a body corporate, having no upper ceiling as to partners. These Guidelines provide detailed procedure for conversion of CA firms into LLPs and formation of new LLPs by chartered accountants in practice. These have come into force w.e.f. 4th November, 2011. Source: ICAI Website (4th November, 2011) Link: http://220.227.161.86/24889announ14695.pdf Rules and Procedures for obtaining opinion from Expert Advisory Committee In the present fast changing and competitive era, the business organisations often enter into complex business transactions, whereas accounting practices and norms are not yet settled, which require authoritative guidance. The Expert Advisory Committee (“EAC”) of the ICAI is formed to provide such authoritative guidance in the form of opinions on such matters raised by the members of the ICAI. The opinion on these matters can be obtained from the EAC on payment of charges of ` 25,000/10,000 (` 50,000/20,000 proposed) as per its Advisory Service Rules (available on the ICAI’s Website or the ICAI head office, New Delhi). These are then available in the form of Compendium of Opinions for the benefit of the members. So far 28 volumes have been issued. Source: ICAI Website (2nd November, 2011) Link: http://icai.org/new_post.html?post_id=7835&c_id=219 Guidance Note on Non-Financial Disclosure - Latest Publication ICSI for bringing the clarity on disclosure of certain items which are non-financial in nature has issued a Guidance Note on Non-Financial Disclosures as its latest publication.  Source: ICSI WebsiteLink: http://www.icsi.edu/WebModules/Publications/Images/GNNFD.JPGINTERNATIONAL UPDATES IAS/IFRS IASB and FASB have published revised proposal for revenue recognition The International Accounting Standards Board (“IASB”) and the Financial Accounting Standards Board (“FASB”) have issued a revised draft standard to improve and converge the financial reporting requirements of the International Financial Reporting Standards (“IFRSs”) and the US General Accepted Accounting Principles (“GAAP”) for revenue (and some related costs) from contracts with customers. The proposed Standard would improve IFRSs and US GAAP by: u providing a more robust framework for addressing to revenue recognition issues; u removing inconsistencies from existing requirements; December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 81 681
  • 82. ACCOUNTS & AUDIT u improving comparability across companies, industries and capital markets; u providing more useful information to users of financial statements through improved disclosure requirements; and u simplifying the preparation of financial statements by streamlining the volume of accounting guidance. (Comments to be provided by 13th March, 2012 through ‘Comment on a Proposal’ section of www.ifrs.org or on www.fasb.org.) Source: IASB Website (14th November, 2011)Link: http://www.ifrs.org/Alerts/PressRelease/rev+rec+reexpose+14+Nov+ 2011.htm Comments invited on two drafts - Q&A for IFRS for SMEs The SME Implementation Group (SMEIG) has published two draft Questions & Answers (“Q&As”) on the IFRS for Small and Medium sized Entities (“SMEs”). The topics covered are: u Whether an entity can choose to apply the recognition and measurement provisions of IFRS 9, Financial Instruments: Classification and Measurement; u Whether the recycling of cumulative exchange differences on disposal of a subsidiary is prohibited. These drafts have been issued by the International Accounting Standards Board (“IASB”) after issue of the IFRS for SMEs in 2009, with the intent to undertake a post-implementation review of the standard on its application by a broad range of entities. (Comments to be sent by till 31st January, 2012 on http://www.ifrs.org/IFRS+for+SMEs/ Draft.htm) Source: IASB Website (21st November, 2011)Link: http://www.ifrs.org/Alerts/SME/CommentsQAsSMEs.htm 2011 French translation of International Financial Reporting Standards (“IFRS”) 2011 version of the French translated IFRS is now available. This translated version of IFRS can be accessed online by eIFRS/Comprehensive subscribers in the secure eIFRS subscriber area after logging in with their username and password and then navigating to the ‘Latest Additions’ section. Source: IASB Website (16th November, 2011)Link: http://www.ifrs.org/Alerts/Publication/French+IFRSs+Nov+2011.htm OTHERS Guide to Using International Standards on Auditing in the Audits of Small and Medium Sized Entities, Third Edition The Small and Medium Practices (“SMP”) Committee of the International Federation of Accountants (“IFAC”) has released the third edition of its Guide to Using International Standards on Auditing in the Audits of SME (“ISA Guide”). This ISA682 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 82
  • 83. Guide is a comprehensive implementation guide and is issued for helpingpractitioners to understand and efficiently apply the clarified International Standardson Auditing (“ISAs”) while auditing SMEs. The first edition was issued in 2007. u Volume 1 covers the basic concepts of a risk-based audit in conformity with the ISAs. u Volume 2 contains practical guidance on performing SME audits, including two illustrative case studies—one of an SME audit and another of a micro- entity audit.Source: IFAC Website (9th November, 2011)Link: http://www.ifac.org/publications-resources/guide-using-interna-tional-standards-auditing-audits-small-and-medium-sized-en ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 83 683
  • 84. ACCOUNTS & AUDITACCOUNTS & AUDIT Carbon credits : INTRODUCTION 1. The term ‘Carbon credit’ has been coined in response to the concerns of global warming A new and climate change. One of the major reasons for global warming is the failure of ozone layer to protect the earth’s atmosphere from dimension to ultra-violet rays. This failure is because of industrial pollution and some substance being emitted in the atmosphere by virtue of human the accounting activities. This global warming causes many changes in the climatic conditions that will make our earth unfit for living. Such disturbances and taxation are causing unusual changes like frequent storms, floods, earthquakes, droughts, crop failures, scanty rainfall, rising sea levels disappearing of islands and coastal areas and many other methods irreparable damages. In 1997 world submit in relation to global warming held in Kyoto, Japan evolved the concept of carbon credit to mitigate emission of greenhouse gases which cause negative climatic changes. Carbon credit is a tool being used for reducing emission of pollutants in the atmosphere by giving it a monetary value. GLOBAL LEGISLATION ON CARBON CREDITS 2. The Kyoto Protocol is an international agreement arising from the United Nations Framework Convention on climate change, 1992 (UNFCCC). The UNFCCC is the umbrella under which countries are trying to devise mechanisms and protocols to combat carbon credit. The main objective of UNFCCC is to reduce the impact DR. SUSHMA BAREJA of greenhouse gases in the atmosphere. There Associate Professor are six major greenhouse gases Carbon dioxide, Dayal Singh College (E) Methane, Nitrous Oxide, Hydrofluoro-carbons, University of Delhi Perfluoro-carbons and Sulphur hexafluoride. These gases are indexed by their Global Warming Potential (GWP) so that they can be expressed in carbon dioxide units.684 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 84
  • 85. WHAT ARE CARBON CREDITS? THE CONCEPT OF CARBON TRADING3. Each carbon credit represents one tonne of 4. A carbon market functions much like anycarbon dioxide either removed from the other financial market in which carbon sharesatmosphere or saved from being emitted. Carbon (sometimes called pollution credits) representingcredits are issued as Certified Emission Reduction the right to emit greenhouse gases are bought(CERs) by the UNFCCC. The CERs are certificates and sold. The market works in conjunction within fungible form which can be traded in any a cap on allowable emission. Polluters that areof the following emission markets: below the cap can sell the ‘excess’ emission rights as credits or shares to others who are u European Union Emission Trading Systems above the limit. For trading purpose, one credit (EUETS) - Multi Country Trading Scheme. is considered equivalent to one tonne of CO2. u Chicago Climate Exchange (CCX) - North A simple example will clarify it. ABC Ltd. America. emits 40 units of greenhouse gases in the u European Climate Exchange (ECX) - Eu- environment out of 60 units allotted to it, i.e., rope. it has 20 units of emission as credit outstanding u Nord Pool - Norway, Denmark, Sweden balance in its pollution A/c XYZ Ltd. emits 60 units instead of 40 units allotted to it, i.e., and Finland. it has a debit balance of 20 units in its pollution u Powernext, a Paris based company oper- A/c. Now ABC Ltd. will transfer its 20 excess ating a European energy exchange, owned units to XYZ Ltd. so that both the companies by NYSE Euro next. pollution A/c is matched. This transfer of 20 u Multi Commodity Exchange (MCX) - India. units will be for a monetary consideration and, hence, it is referred to as carbon trading. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 85 685
  • 86. ACCOUNTS & AUDITIn order to facilitate reaching emission limits, thrown open by the Kyoto Protocol. By hostingthree flexible mechanisms were agreed upon CDM projects, India has a lot to gain fromin the Marrakesh Accords in 2001. They are:- Carbon credit, as is clear from the following: 1. Clean Development Mechanism (CDM) - u It will gain in terms of advanced techno- It was created to give a cost effective logical improvements and related foreign option to developed countries to achieve investments. their emission reduction targets. It is a u It will contribute to the underlying theme way out for Annex 1 countries (USA, UK, of greenhouse gas reduction by adopting Japan, New Zealand, Canada, Australia, alternative sources of energy. Germany, France, etc.) to earn such cre- dits by investing and funding climate u Indian companies can make profits by friendly projects and technologies in the selling the CERs to the developed coun- developing countries (Non-Annex 1 - India, tries to meet their emission targets. Sri Lanka, China, Afghanistan, Pakistan, India being a developing country has no emission etc., thus helping control emissions. targets to be followed. However, it can enter into CDM projects. Companies investing in 2. Joint Implementation Projects (JIP) - Ba- sically these are same as CDM’s but with Windmill, Bio-gas and Bio-diesel are the ones that will generate carbon credits for selling to Annex - 1 countries investing in climate friendly technology in Annex-1 countries, the developed nations. The Delhi Metro Rail rather than other developing countries. Corpn. has become the first rail project in the world to earn carbon credits because of using 3. Emission Trading (ET) or Carbon Trading regenerative breaking system in its rolling stock. (discussed earlier). This system reduces 30 per cent electricity consumption. DMRC can now claim 4,00,000A FEW ACTIVITIES ELIGIBLE CERs for 10 years beginning from December 2007 when the project was registered with theFOR CARBON CREDITS UNFCCC. It translates into 1.2 crore per year5. Some of the activities that are eligible for for 10 years.availing of carbon credits include— In this new regime, India could emerge as one 1. Afforestation and reforestation projects. of the largest beneficiaries accounting for 25 per cent of the total world carbon trade, as 2. Agri-biomass based energy projects. per a recent World Bank report. India’s carbon 3. Energy generation by controlled combus- market is growing faster then IT, BPO bio- tion. technology industries. 4. Household level biogas plants treating or- ganic farmyard kitchen and bio-wastes. ACCOUNTING FOR AND TAXATION 5. Solar energy, etc. OF CARBON CREDITS A NEW DIMENSION ADDEDBRIGHT INDIAN SCENARIO 7. Generation of revenue by taking up structural CDM projects would give a new dimension to6. India has emerged as the world leader in Accounting and Taxation. As the concept ofreduction of greenhouse gases by adopting CDMS carbon trading is new, even at internationalover the past few years. The Indian companies level, various aspects and jurisprudence arehave successfully encashed the opportunities yet to evolve. The Council of The Institute of686 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 86
  • 87. Chartered Accountants of India has approved CONCLUSIONof the accounting guidance note on carboncredit effective from July 1, 2009. As per the 8. The pious purpose behind the carbon creditguidance note, the self-generated carbon credits is to reward the efforts of those who are doingare “intangible assets” and they need to be business in an environment-friendly way. Intreated as “inventory” in the balance sheet till view of this, the steps taken under Kyoto Protocolthey are sold. As per AS-2, CERs should be are laudable. On one hand, such measures aremeasured at cost or net realizable value, helping in reducing carbon emission, therebywhichever is lower. making the world a better and safe place to live in and on the other hand, such measuresRegarding tax treatment of CERs, no directive are bridging the gap between the developedhas been issued by the Income-tax Department. and developing countries as Annex - 1 nationsSince most of the CDM projects are covered have to purchase CER from the non-Annex -in infrastructure sectors like power plants, 1 nations.renewable energy projects, etc., such projectsenjoy tax holiday benefits under section 80- The need of the hour is that the internationalIA of the Income-tax Act. Similarly, Indirect bodies, Indian Government, ICAI and otherTax legislations do not provide for any specific professional bodies must come out withguidelines on the treatment of CERs for tax guidelines, standards, legislations and rulespurposes. CERs may be considered as goods and regulations on carbon credits to sustainfor VAT purposes and be treated similar to developments and reduce the emission of theelectricity - which is either excluded from purview pollutants in the atmosphere.of VAT or included in the “Schedule” of goodsexempted from VAT in order to promote CDM •••projects in India. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 87 687
  • 88. CORPORATE LAWSSERVICE TAX Conversion of Chartered Accountant (“CA”) Firms into Limited Liability Partnerships (“LLP”) T he Institute of Chartered Accountants of India (“ICAI”) vide its Guidelines No.1-CA (7)/03/2011, dated 4th November, 2011 (“the Guidelines”) has formalized the procedure for conversion of CA firms into LLPs and formation of new LLPs by the members in practice. The limited liability partnership is not a new concept; however after a long wait, ways for members in practice have now been opened to venture into a new type of entity. This would help the firms enlarging its size, business and opportunities on one hand; however reducing the liability of the members of the firm on the other hand. SARIKA GOSAIN This article explains the procedure for transforming CA CA firms into LLPs.BACKGROUND converting/constituting CA firms into LLPs has now been allowed.1. The Institute of Chartered Accountants ofIndia (‘ICAI’) vide its Guidelines No.1-CA (7)/ Literally, LLP is a hybrid form of a business03/2011, dated 4th November, 2011 (“the enterprise, combing the benefits and privilegesGuidelines”) has formalized the procedure for of a partnership firm and a company. LLP isconversion of CA firms into LLPs and formation a body corporate like any other company withof new LLPs by the members in practice, subject a separate legal entity; however limiting theto the provisions of the LLP Act, 2008 (“LLP liability of the partners to the extent of theirAct”) and Rules and Regulations framed there- respective contributions and commitments, withunder (“Rules & Regulations”). These guidelines simpler entry or exit of partners. Therefore,would be effective from 4th November, 2011. LLP is an entity, easier to form and close with lesser regulatory compliances.Though, LLP Act came into force w.e.f. 1stApril, 2009; however, the much awaited move688 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 88
  • 89. TRANSFORMING CA FIRMS INTO LLPs- (A) Conversion of existing CA firms into LLPs -THE PROCEDURE (i) Provisions to be followed - Provi- sions of Chapter-X of the LLP Act2. The said guidelines hereby are laid down and Second Schedule thereto are re-in respect of: quired to be followed for converting u Conversion of existing CA firms into LLPs an existing CA firm into LLP. u Constitution of separate LLPs Chapter X of the LLP Act: Conversion to limited liability partnership - a synopsis u Chapter X of the LLP Act sets out the procedure for conversion of different entities, including firms into LLP. u The Registrar of LLP (“the Registrar”) on satisfactory compliance with the relevant provisions of LLP Act, Rules and Regulations, issues a certificate of registration. u LLP shall, within fifteen days of the date of registration, inform the concerned Registrar of Firms, about the conversion. u Upon such conversion, the LLP and the partners thereof shall be bound by the relevant provisions of the LLP Act, Rules and Regulations. u From the date of registration- (a) the LLP shall be formed; (b) all assets and liabilities relating to the firm shall vest in the LLP without further act or deed; (c) the firm shall be deemed to be dissolved and removed from the records of the Registrar of Firms. SECOND SCHEDULE TO THE LLP ACT : Conversion from firm into limited liability partnership - a synopsis u In addition to the Chapter X, the Second Schedule to the LLP Act sets out the specific procedure for conversion of firm into LLP, interpreting and explaining certain terms and eligibility. u Statements to be filed to the Registrar- – A statement by all of its partners and fee, as prescribed. – Incorporation document and other prescribed documents. u Any conviction, ruling, order or judgment of any authority in favour of or against the firm may be enforced by or against the LLP. u Every agreement and contracts before the conversion shall be continued in the name of LLP. u Every partner of a firm shall continue to be personally liable (jointly and severally with the LLP) for the liabilities and obligations of the firm, incurred prior to the conversion. u The LLP shall for a period of 12 months commencing not later than fourteen days after registration, mention the following on every official correspondence: – A statement that it is converted into LLP; and – The name and registration number, if applicable, of the firm from which it was converted. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 89 689
  • 90. CORPORATESERVICE TAXLAWS (ii) Proposed name-approval - The suf- approved by ICAI, e.g. ‘ABC & fix1 of the proposed name of LLP as Co. LLP’ or ‘ABC & Associates ‘Chartered Accountant’ or ‘Chartered LLP’. Accountants’ shall be allowed by the (c) No additional privileges - The newly Registrar subject to ICAI’s approval. converted CA LLPs can perform (iii) Resemblance of names-with non-CA only the professional services4 entity - On resemblance of the pro- allowed under the Chartered Ac- posed name of LLP of CA firm with countants Act, 1949 and shall any other non-CA entity, the word be subject to the same regula- ‘Chartered Accountant’ or ‘Chartered tions, as if they were in part- Accountants’ may be included in the nership firm. No additional privi- proposed name of LLP of CA firms, leges which are not allowed to subject to following the procedure the CA firms will be provided as mentioned above. on mere conversion into LLP. (iv) Registration procedure-with ICAI - (d) Inter-se seniority-converted firms - On receiving the name registration Inter-se seniority among the firms from the Registrar, the requisite forms2, shall be given to LLPs as per containing all the details of the existing policy of ICAI. In case proposed LLP and the copy of name of merger of two LLPs, same registration shall be submitted3 to rules as applicable to firms ICAI, for registering LLP with ICAI. merging shall apply. (v) Names reserved - Once the names of (e) Inter-se seniority-non-converted a CA firm are registered with the firms - The non-converted firms ICAI, these shall remain reserved for shall also remain on the same the partners as one of the options for position of seniority in relation LLP names, subject to the provisions to converted CA LLPs. of LLP Act, Rules & Regulations. (vii) Conversion of proprietary firm into (vi) Seniority and other criteria - With LLP - These guidelines shall also be regard to registration of LLP with equally applicable while converting ICAI, following guidelines relating proprietary firms into LLPs. The to seniority and other criteria shall conversion of proprietary firm shall be followed: be by way of incorporation of new LLPs. (a) Similar/Identical names - In re- spect of proposed LLP, where (viii) Registration number - After conver- two similar/identical/nearly sion, the LLP’s registration number similar firm names (having same (with minimum 6 numbers) with ICAI partners or not) have been reg- shall remain the same Firm Registra- istered by ICAI, only one such tion Number (FRN) allotted to the firm’s name shall be approved firm before the conversion by ICAI and remaining firms registered with the Regional Code like ‘W’ for with ICAI (either desiring to Western, ‘E’ for Eastern etc. e.g. FRN convert into LLP or not) will W 1 2 3 4 5 6, FRN E 2 0 0 0 0 0 require to change the firm’s name. etc. (b) Suffix - Other than the suffix (ix) Name regulations - The existing regu- “LLP”, no other suffix shall be lations with regard to name allot-690 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 90
  • 91. ment to CA firms shall remain un- (i) The other such firms shall changed. stand dissolved. (x) Merger/conversion of the firms - In (ii) Seniority shall be decided case of merger of a firm and conver- as per applicable rules of sion with LLP and vice versa, senior- ICAI. ity may be provided to the surviving (iii) The Board of Directors of entity as per policy prescribed by all the Companies who have ICAI.* appointed all the erstwhile (xi) Existing Provisions - The provisions firms as auditors, may take of CA Act, CA Regulations, 1988 and a declaration from the said Code of Ethics, issued by ICAI shall LLP with all the partners remain applicable to all partners of of all the erstwhile firms the converted CA firms into LLP, on record and the appoint- jointly and severally. ment of auditors of all the erstwhile firms made un- (xii) Clarifications required from MCA - der the Companies Act, The following Guidelines are subject 1956, shall be deemed to to the clarification from Ministry of be in the name of the said Corporate Affairs (“MCA”): LLP. (a) Conversion of one firm into LLP - (B) Constitution of separate LLPs - When a CA firm has been appointed by a company as their (i) Provisions to be followed - Mem- statutory auditor under the Com- bers in practice desiring to consti- panies Act, 1956 and the said tute separate LLPs are required to firm with the same partners is follow the provisions of the LLP Act, converted/formed into LLP, then Rules & Regulations. the same FRN will continue. The (ii) Proposed name-Approval - The suf- Board of Directors of the com- fix6 of the proposed name of LLP as pany may take on record the ‘Chartered Accountant’ or ‘Chartered conversion/formation of the CA Accountants’ shall be allowed by the firms into LLP and the new LLP Registrar subject to ICAI’s approval. shall be deemed to be an au- ditor of the said company for (iii) Registration procedure-with ICAI - the same financial year5. On receiving the name registration from the Registrar, the requisite forms7, (b) Conversion of more than one firm containing all the details of the pro- into LLP - Wherever more than posed LLP and the copy of name one CA firms with all the part- registration shall be submitted8 to ners desire to convert/form only ICAI, for registering LLP with ICAI. one LLP, then for the LLP so converted/formed, the name and (iv) Seniority and other criteria - With FRN may be selected out of only respect to registration of LLP with one such firms for the purpose ICAI, following guidelines relating of registration with ICAI and: to seniority and other criteria shall be followed:* The rules of determining seniority may be extracted from the following link: http://220.227.161.86/ 14525rules_of_network_merger_demerger.pdf December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 91 691
  • 92. CORPORATESERVICE TAXLAWS (a) Inter-se seniority - Inter-se se- be applicable to all partners of LLP niority among the firms shall jointly and severally. be given to LLP as per existing (ix) Dispute Resolution - Any dispute in policy of ICAI. In case of merger respect of these guidelines shall be of two LLPs, same rules as referred to the committee of the ICAI. applicable to firms merging shall apply. (x) Clarification sought - Any clarifica- tion regarding the approval and reg- (b) Suffix - Other than the suffix istration of proposed LLP with the “LLP”, no other suffix shall be ICAI, requests are to be sent at: approved by ICAI, e.g. ‘ABC & Co. LLP’ or ‘ABC & Associates The Secretary, The Institute of Char- LLP’. tered Accountants of India* (c) No additional privileges - The newly constituted CA LLPs can only 3. OTHER RELATED PROVISIONS perform the professional services9 3.1 LLP of CA’s can have more than 20 partners - allowed under the CA Act and Under section 3(1) of the LLP Act, LLP is a shall be subject to the same corporate body and a legal entity separate regulations, as if they were in from its partners. Indian Partnership Act, 1932 partnership firm. No additional shall not be applicable to LLPs and there shall privileges which are not allowed be no upper limit on the number of partners to the CA firms will be pro- in an LLP unlike an ordinary partnership firm vided on mere formation of LLP. where the maximum number of partners is 20. (v) Constitution of proprietary firm as Presently, CA firms are restricted to a maximum LLP - These guidelines shall be equally of 20 partners, being covered under the applicable while constituting a pro- Partnership Act, 1932. After allowing the CA prietary firm as LLP. firms to convert/ form LLPs (being a body (vi) Registration number - The LLP’s reg- corporate), there would be no such restriction istration number (with minimum 6 any more. In other words, the LLP of CA’s can numbers) with ICAI shall be like the have more than 20 partners. This way, CA Firm Registration Number (FRN) firms would be in a much strengthened position allotted to the firms by ICAI with to compete with global audit houses, as these the Regional Code like ‘W’ for Western, will be bigger in size, having more branches ‘E’ for Eastern etc. e.g. FRN W 1 in different cities, thereby capable of serving 2 3 4 5 6, FRN E 2 0 0 0 0 0 etc. a larger chunk of clientele. (vii) Name regulations - The existing regu- 3.2 LLP v. Multi-Disciplinary Firms - Once lations with regard to name allot- the suitable amendments are approved in the ment to CA firms shall remain un- legislations governing regulators like the ICAI, changed. the Institute of Company Secretaries of India (ICSI) and the Institute of Cost and Works (viii) Existing Provisions - The provisions Accountants of India (ICWAI), the concept of of CA Act, CA Regulations, 1988 and Multi-Disciplinary Firms (“MDF”) or Multi- Code of Ethics issued by ICAI shall * P.B No: 7100, “ICAI Bhavan”, Indraprastha Marg, New Delhi – 110002 The original guidelines of ICAI can be downloaded from the following link: http://220.227.161.86/24889announ14695.pdf692 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 92
  • 93. Disciplinary LLPs would become operative. were enacted, only one form of partnershipThen CAs would be in a position to partner existed in India, namely, Partnerships underwith company secretaries, cost accountants, Indian Partnership Act, 1932. Subsequently,lawyers and other professionals, as specified LLP Act was enacted, which is applicable w.e.f.by ICAI to act as “one-stop” shop for the 1st April, 2009.clients to avail various professional services Though LLPs are bodies corporate under sectionunder one umbrella. 3(1) of the LLP Act; however, now MCA has3.3 LLP of CA’s not to be treated as body clarified that LLPs would also be construedcorporate for the limited purpose of section as partnerships for the purpose of these three226(3)(a) of the Companies Act, 1956 - The Acts. This would mean that LLP of CA’s wouldMCA, after receiving representation from the be considered as members in practice and henceICAI, clarified that for the limited purposes can do the statutory audits and attestationof section 226(3)(a) of the Companies Act, 1956, work now.LLP of CAs will not be treated as body corporate. This is done by interpreting the wordsThis is because as per the said section, a body ‘partnership’ wherever occurring in the CAcorporate is disqualified from appointment as Act, the Cost and Works Accountants Act,auditor by a company. Since LLP is a body 1959 and the Company Secretaries Act, 1980.corporate as per section 3(1) of the LLP Act, It is clarified that the word ‘partnership’ shallwithout this exemption, LLP of CAs would be construed to include LLP’s where all thehave become disqualified for appointment as other partners are natural persons (individuals).auditor. The word ‘partner’ shall also be construedSource:http://mca.gov.in/Ministry/pdf/Circular_ accordingly. It is also clarified that this30A-2011_26may2011.pdf interpretation shall apply only to these three Acts and not to any other enactment where3.4 LLP of CA’s allowed to become Statutory the word ‘partnership’ occurs.Auditors - Currently, section 2 of the respectiveActs governing the three professional Institutes Source: http://mca.gov.in/Ministry/latestnews/(ICAI, ICSI and ICWAI) defines members who Circular_04Apr2011.pdfare deemed to be in practice. When these Acts ••• 1. As per Rule 18(2)(xvi) of LLP Rules, 2009 2. Form No. 117 and Form No. 18 3. As per regulation 190 of the Chartered Accountants Regulations, 1988 4. As per Section 2(2) of the Chartered Accountants Act, 1949 5. As per section 58(4) of the LLP Act, 2008 6. As per Rule 18(2)(xvi) of LLP Rules, 2009 7. Form No. 117 and Form No. 18 8. As per regulation 190 of the Chartered Accountants Regulations, 1988 9. As per Section 2(2) of the Chartered Accountants Act, 1949 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 93 693
  • 94. SERVICE TAXSERVICE TAX Some Controversies V.S. DATEY in Service Tax T here is no dearth of controversies in service tax. The definitions are vague and capable of wide meaning. Adding fuel to fire, the revenue minded officers try to rope in various transactions under service tax net. Sometime, service provider is in dictating position and charges service tax, as he does not want to take risk. Sometimes, service receiver is in dictating position and he refuses to pay service tax charged by the service provider. Poor assessee is caught between the fire. Some recent controversial issues in service tax are discussed in this article.SOFTWARE - GOODS OR SERVICE ‘goods’. All these products find place in CentralOR BOTH Excise Tariff as well as Customs Tariff. Packaged software - ‘Packaged software or1. Service tax has created many weird creatures canned software’ means a software developed– like ‘Ardha Nari Nateshwar’ (half man half to meet the needs of variety of users, andwoman demi-God). One such creature is ‘IT which is intended for sale or capable of beingsoftware’. The ‘creature’ is such that it is both sold, off the shelf [Notification No. 6/2006-CEcompletely goods and completely service at dated 1-3-2006, Notification No. 14/2011-CEone and the same time. Hamlet had said ‘To dated 1-3-2011 – parallel Notification No. 25/be or not to be, that is the question’. Indian 2011-Cus., dated 1-3-2011]assessees are saying ‘Software is goods or service(or both), that is the question’. Thus, it should be capable of being sold ‘off the shelf’.It is well settled through judicial pronouncementsthat both tailor made software and packaged Sometimes, the license to use packaged softwaresoftware are ‘goods’. Even paper license is is for limited period (usually one year). The694 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 94
  • 95. license is renewed on payment of renewal fee case of imported software) is paid on basis ofby giving password. Thus, ‘packaged software MRP valuation by the manufacturer, duplicator‘is not sold. In such cases, issue is whether or the person holding the copyright to suchservice tax applies or excise duty/sales tax software, service tax will not be payable onapplies. such packaged or canned software – Notification No. 53/2010-ST, dated 21-12-2010 – confirmedDefinition of ‘packaged software’ includes in MF(DR) Circular No. 15/2011-Cus., dated‘capable of being sold off the shelf’. Thus, by 18-3-2011.renewal of license, a software ‘capable of beingsold off the shelf’ is sold. Paper license of software and PUK cards - Documents of title conveying the right to useIt is true that in Infotech Software Dealers Assn. Information Technology Software (popularlyv. UOI [2010] 29 STT 132 (Mad.), it was observed termed as paper license of software) falls underthat when software is sold through medium 4907 00 30 of Customs Tariff with duty rateof internet in form of downloadable, it does of 12.5%. However, it is exempt vide Sr. No.not fit in ambit of ‘IT software of any media’ 157 of Notification No. 21/2002-Cus., datedand then when only password is given and 1-3-2002. It is also covered under Central Excisenot CD, it does not satisfy requirement of Tariff under same heading i.e. 4907 00 30 andbeing goods. However, it seems the aforesaid excise duty rate is Nil. Thus, on paper licence,definition of ‘packaged software’ was not noticed. basic customs duty or CVD is not applicable,Further, it is well settled that law is not static if imported without accompanying software –and technological advances can be considered confirmed in MF(DR) Circular No. 15/2011-in interpreting a provision. Thus, downloading Cus., dated 18-3-2011.of software can be considered as ‘sale of goods’as technology enables such transaction. PUK (Personal Unlocking Key) cards of paper board or plastic are in the form of scratchExcise duty on packaged software - In case of cards. These are not documents of title topackaged or canned software falling under software, but they contain printed mattertariff item 8523 80 20, excise duty is payable containing numbers, which when entered, enableon MRP valuation basis w.e.f. 21-12-2010. The the importer to access right to use such software,abatement available is 15% of MRP, i.e. excise which he has downloaded from internet. PUKduty (and corresponding CVD in case of imported card is a printed matter falling under headingpackaged or canned software) is payable on 4911 as ‘other printed matter’. Thus, on PUK‘value’ which will be 85% of MRP printed on cards, basic customs duty or CVD is notthe packaged or canned software. applicable, if imported without accompanyingIf appropriate excise duty (in case of software software – confirmed in MF(DR) Circular No.manufactured in India) or customs duty in 15/2011-Cus., dated 18-3-2011.Summary of taxability of Information Technology SoftwareI have tried to summarise the position as follows, though I agree that disputes are possible. Category of Excise Duty (In case Customs Duty (in Service Tax Vat/CST software of manufacture in India) case of imports) Packaged Yes No basic customs duty software with but CVD is payable No Yes MRP December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 95 695
  • 96. SERVICE TAX Category of Excise Duty (In case Customs Duty (in Service Tax Vat/CST software of manufacture in India) case of imports) Packaged Duty on cost of media No basic customs duty Service tax on Yes software where but CVD is payable transfer of right to MRP not use software required Tailor made No No Yes Yes software Paper license No No Yes Yes of software and PUK cardsSERVICE TAX ON BAD DEBTS Delays in getting payments from customer, particularly Government and PSU, is another2. The change of service tax payment liability serious matter, where service provider paysfrom ‘receipt’ basis to ‘accrual’ basis has created the tax but does not get money from customerserious problem regarding cases where service for quite some time.receiver does not pay the bill amount or makedeductions from the bill while making payment Some assessees are trying to get over the problemto service provider. by issuing ‘Demand Note’, ‘Demand Advise’ or ‘Proforma Invoice’ or some such names.Service provider can refund the payment received However, really this is not going to solve theto service receiver, or issue credit note in problem since issue of invoice within 14 daysfollowing situations – (a) if service is not provided of completion of service is mandatory. If suchpartly or fully or (b) amount of invoice is re- invoice is not issued, ‘date of completion ofnegotiated due to deficient provision of service service becomes the ‘point of taxation’ for purposeor any terms contained in the contract. After of payment of service tax. Wherever possible,such refund or credit note, assessee can take assessee can take support of followingself credit of excess service tax paid by him departmental clarification.when he had issued the invoice/Bill/Challan[Rule 6(3) amended w.e.f. 1-4-2011]. When the service is deemed to be completed - Invoice is required to be issued within 14 daysSuch adjustment is not permissible for bad debts. from date of completion of service. The invoiceThus, in case of bad debt (which is not covered needs to indicate value of service. Thus, evenin (a) or (b) above, service tax is payable on if physical part of providing the service isbad debts also. The position is similar to Central completed, invoice cannot be issued unlessExcise, State Vat and CST, where excise duty auxiliary part like measurement, quality testingor sales tax is payable even when the customer is completed. Thus, service can be treated asdoes not pay. completed only when these activities are also completed. However, such activities do notHowever, in services, proportion of bad debts include flimsy or irrelevant grounds for delayis much higher than that in case of sale of in issuance of invoice. This interpretation appliesgoods. This is particularly so in some sectors in determination of the date of completion oflike construction, consultancy etc. Often service provision of service in case of ‘continuousprovider raises bill of higher amount, keeping supply of service’ also - MF(DR) Circular No.scope for negotiations. 144/13/2011-ST, dated 18-7-2011.696 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 96
  • 97. CAN DATE OF INVOICE BE Is the ‘late fee’ mandatory? – Though the‘POINT OF TAXATION’? word used is ‘fee’, it is really nothing but penalty. ‘Fee’ is for service provided.3. In many cases, date of invoice is practically In Jindal Stainless Ltd. v. State of Haryana [2006]‘point of taxation’. Thus, practically, date of 152 Taxman 561 (SC), it has been held thatinvoice is the ‘taxable event’. Really, service regulatory fees can be only compensatory inprovided or to be provided is the ‘taxable nature.event’ for purpose of levy of service tax. Issueor non-issue of invoice is only a procedural Fees cannot be equated to taxes. There mustpart. That by itself cannot be taken as a taxable be a broad co-relationship with the fees collectedevent. In my view, this provision in the rule and administration of the service - Secretary,can be challenged as beyond the provisions of Government of Madras v. Zenith Lamp & Electricalthe Act. Ltd. AIR 1973 SC 724 – same view in Jindal Stainless Ltd.’s case (supra) Vijayalakshmi Rice Mills v. CTO [2006] 147 STC 609 (SC).LATE FEE FOR RETURNS PRIOR TO31-3-2011 : ` 2,000 OR ` 20,000 Thus, it can be argued that the ‘fee’ is penalty and, hence, cannot be imposed without passing4. Rule 7C as amended w.e.f. 8-4-2011 provides an adjudication order. It can be reduced orfor ‘late fee’ upto ` 20,000 for delayed filing waived for sufficient reasons.of return. The ‘late fee’ was ` 2,000 upto8-4-2011. One issue is what about returns for What about returns pertaining to period uptothe period upto 30th September, 2010, filed September, 2010 filed after 8-4-2011 - It isafter 8-4-2011? Another issue is whether the possible that assessee had not filed returns‘late fee’ is mandatory or discretionary. pertaining to period upto September, 2010 and may file it after 8-4-2011.The late fee payable is as follows – (a) DelayUpto 15 days – ` 500 (b) Beyond 15 days and As per article 20(1) of the Constitution, noupto 30 days – ` 1,000 (c) Delay beyond 30 person shall be convicted of any offence exceptdays – ` 1,000 plus ` 100 per day of delay for violation of law in force at the time ofbeyond 30 days, from 31st day onwards - rule commission of the act charged as an offence.7C inserted w.e.f. 12-5-2007. This ` 100 per Thus, penalty can be imposed only on basisday continues till limit of ` 20,000 is reached. of law prevailing on date of offence and notThis limit will be reached after total delay of on any subsequent amendment in law.220 days. Penalty is imposable on basis of law operatingOnce the payment is made for submitting delayed on the date on which the wrongful act isreturn, any penalty proceedings in respect of committed. Any subsequent change in law cannotsuch delayed submission of return shall be be applied to past offences - P.V. Mohammaddeemed to be concluded. Barmay Sons v. Director of Enforcement 1992 (61) ELT 337 (SC).Waiver or reduction of penalty for non-filingof return, if service tax payable is Nil - Return Hence, it can be argued that offence wasis required to be filed even if no service tax committed prior to 8-4-2011 and penaltyis payable. However, if gross amount of service applicable that time i.e. when return shouldtax payable is Nil, Central Excise Officer can have been filed, will apply [Counter argumentreduce or waive penalty, in a case where return is that non-filing of return is a continuouswas not filed, and sufficient cause is shown offence and continues till return is filed. Hence,[proviso to rule 7C of Service Tax Rules inserted if return is filed after 8-4-2011, late fee asw.e.f. 1-3-2008]. applicable on that day will apply]. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 97 697
  • 98. SERVICE TAXIMPORT AND EXPORT OF SERVICE India (or in India), department refuses to consider it as export of service, even where payment5. Though rules relating to import and export is received in foreign exchange.of service are quite clear, wherever any paymentis made to foreign party in foreign exchange, Following chart indicates the provisions relatingdepartment treats it as ‘Import of Service’. On to import and export of some important service.the other hand, if service is provided fromProvisions of import and export relating to some important services Nature of Service Category When import When Export Commission Agent (Business 3(iii) Commission Agent Commission Agent in India Auxiliary Service) outside India providing providing service to Principal service to Principal in outside India and payment India received in convertible foreign exchange Banking Services 3(iii) Bank or Financial Bank or Financial Institution Institution outside India in India providing service to providing service to customer who is receiving the customer who is receiving service outside India and the service in India payment received in conver- tible foreign exchange Management consultancy, 3(iii) Service provider outside Service provider in India Technical consultancy, Technical India providing service to providing service to customer Testing and Analysis Service, IT customer who is receiving who is receiving the service Software, Legal consultancy (other the service in India outside India and payment than relating to immovable received in convertible foreign property), Manpower recruitment exchange and supply, Sponsorship Service, Advertising, transport of goods by air or rail or road, telecom- munication services Practising CA/CWA/CS 3(iii) Does not arise, as a Service provider in India foreign entity cannot get providing service to customer Certificate of Practice who is receiving the service (COP) in India. outside India and payment received in convertible foreign exchange Advertisement other than 3(iii) Advertisement published Advertisement published in advertisement in print media outside India in relation India for foreign entity and to business in India payment received in conver- tible foreign exchange Air transport of goods 3(iii) Goods imported by air. Goods exported outside India, Service tax is payable on service receiver is outside freight in excess of 20% India and payment is received FOB (since customs duty in foreign exchange is payable on air freight upto 20% of FOB value)698 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 98
  • 99. Nature of Service Category When import When Export Business Exhibition, Commercial 3(ii) Service at least partly Service at least partly Training and Coaching, performed in India by performed outside India by Maintenance and Repair, service provider located Indian service provider and Photography, CHA service, outside India payment received in conver- Technical inspection and tible foreign exchange certification Construction Service, Works 3(i) Service provider outside Indian service provider Contract Service, Architect India providing service in providing service in respect of services, Legal consultancy respect of immovable immovable property outside relating to immovable property, property within India India and payment received in Hotels convertible foreign exchangeCONFUSION CREATED BY DECISION IN MO, Singapore on basis of expenses incurredCASE OF MICROSOFT by assessee plus 10% for product support and consulting services and plus 15% in case of6. Controversy and confusion has been created marketing of Microsoft products. Payment wasby Tribunal’s decision in Microsoft Corpn. (I) obviously in freely convertible foreign currency.(P.) Ltd. v. CST [2009] 22 STT 201 (New Delhi Assessee claimed that the service is ‘export of- CESTAT). In this case, the assessee was service’ and exempt. Commissioner, in effect,providing marketing support service in India held that the services are used in India and,to its holding company in USA and subsidiary hence, are not ‘export of service’. This viewin Singapore. The service was provided to was more or less upheld by Tribunal. Therecustomers of the holding company in USA are some other issues in this case, which areand subsidiary in Singapore. A prima facie view not relevant for our discussions.was held that this is not export of service, andassessee was asked to make pre-deposit of ‘ Basic issue - The basic issue for consideration70 crores out of demand of ‘ 125 crores of tax is whether service of Microsoft India is ‘usedplus ‘ 125 crores as penalty – writ petition outside India’. Who is the user of service providedagainst the order has been dismissed – Microsoft by Microsoft, India? The customers in IndiaCorpn. India (P.) Ltd. v. CST [2009] 23 STT 400 received products from Microsoft, Singapore(Delhi). and not from Microsoft, India. Thus, their privity of contract was with Microsoft, Singapore. IndianIn this case, Microsoft Operation P Ltd., Singapore customers did not make any payment to(MO, Singapore) entered into ‘Market Deve- Microsoft, India. Payment for services was madelopment Agreement’ with Microsoft Corporation by Microsoft, Singapore to Microsoft, India in(India) P Ltd. (assessee - Microsoft India for foreign exchange based on cost plus markup.short). Both are subsidiaries of MicrosoftCorporation, USA. Microsoft Singapore will Service is used outside India - User of servicessupply Microsoft products to customers in India. of assessee (Microsoft, India) can be onlyMicrosoft India is required to provide product Microsoft, Singapore and not any customer ofsupport services and consulting services for Microsoft, Singapore situated in India. Thus,Microsoft products. Microsoft India is also service is ‘used outside India’ as the userrequired to market Microsoft products supplied (Microsoft, Singapore) is situated outside Indiaby MO, Singapore. and he got benefit from the service outside India.For various services provided by assessee(Microsoft India), payment will be made by December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 99 699
  • 100. SERVICE TAXConclusion - In my view, service is provided INTEREST IF TAX DUES PAID AFTERby Microsoft India to Microsoft, Singapore. 1-4-2011The user and beneficiary of service providedby Microsoft India is Microsoft, Singapore who 8. Interest rate has been increased to 18%is situated outside India and does not have from 13% w.e.f. 1-4-2011. Is the interest payableany office in India. Thus, the service is used when amount due prior to 31-3-3011 is paidoutside India. It should qualify as ‘export of after 1-4-2011?service’, more particularly because in reverse Interest is payable at rates as applicable fromdirection, it is treated as ‘import of service’ time to time (and not at the rate applicableand is treated as taxable in India. Unfortunately, on first day of default) – M J Exports (P.) Ltd.sympathy factor is working against them and v. UOI 2006 (202) ELT 583 (Bom.) Commr. ofhence we have to see what would be ultimate Cus. (I) v. Consolidated Solvents & Chem. Corpn.outcome. 2009 (243) ELT 625 (Trib. - Mum.).Further development - The issue was taken up Thus, in my view, suppose tax payment wasfor final hearing by Tribunal. As per reports, due on 5-10-2010, assessee should calculatethere was difference of opinion and hence interest for the period 6-10-2010 to 31-3-2011matter has gone to third member. @ 13% and for the period 1-4-2011 to 15-5- 2011 @ 18%.SERVICE TAX PROVISIONS DO NOTHAVE EXTRA TERRITORIAL JURISDICTION PROVIDING FREE FLATS TO7. Section 64(1) of Finance Act, 1994 states LAND OWNERthat provisions of Chapter V of the Finance 9. Often, in case of an agreement between theAct, 1994 (which contain provisions relating land owner and developer, the landowner givesto service tax) extend to whole of India except his land against some upfront payment andJ&K. Thus, the Act does not have any extra- a share in constructed area. The issue is whetherterritorial jurisdiction. service tax is payable, and if yes, then whatHowever, department tries to levy service tax would be the point of taxation.even where the service is provided outside In my view, the land owner is paying for flatsIndia, just because service provider is an Indian in kind (i.e. land) and hence should be subjectentity. to service tax (though I agree there are differentIn fact, some exemption notifications have been views on this issue). As regards point of taxation,issued on the assumption that such services actually it should be when land is conveyedcan be taxed in India! to the builder. However, there is a view that the developer is not providing any service to land owner and no service tax is payable (I do not agree with this view). •••700 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 100
  • 101. SERVICE TAX The Ongoing Battle on Validity of Levy of Service Tax on Renting of Immovable Property for Commercial/Business use T his article explains the legal battle going on between the department and the affected assessees pursuant to the introduction of renting of immovable property for commercial or business use as a taxable service in the year 2007. V. PATTABHIRAMANINTRODUCTION OF THE LEVY was added to this provision to clarify that the expression ‘for use in the course or furtherance1. Renting of immovable property for use in of business or commerce’ includes use ofthe course or furtherance of business or commerce immovable property as factories, office buildings,was roped into the service tax net with effect warehouses, theatres, exhibition halls andfrom 1-6-2007. At that time, section 65(90a) of multiple-use buildings. Another Explanation wasthe Finance Act, 1994 (‘the Act’) defined the inserted with effect from 16-5-2008 to declareterm ‘renting of immovable property’ as ‘includes that ‘renting of immovable property’ includesrenting, letting, leasing, licensing or other similar allowing or permitting the use of space in anarrangements of immovable property for use immovable property irrespective of the transferin the course or furtherance of business or of possession or control of the said immovablecommerce’. The provision however excluded property. These provisions remain unamended(i) renting of immovable property by a religious till date. Section 65(105)(zzzz) of the Act, insertedbody or to a religious body, and (ii) renting with effect from 1-6-2007, defined the taxableof immovable property to an educational body, service as ‘any service’ provided or to be providedimparting skill or knowledge or lessons on to any person, by any other person, in relationany subject or field, other than a commercial to renting of immovable property for use intraining or coaching centre. An Explanation the course or furtherance of business or December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 101 701
  • 102. SERVICE TAXcommerce’. The introduction of this levy met DEPARTMENT RETALIATES WITH Awith stiff resistance from the affected parties RETROSPECTIVE AMENDMENT(especially, retailer trade) in the initial stageitself. 3. The Finance Act, 2010 totally substituted section 65(105)(zzzz) in order to make it explicit that the activity of ‘renting’ is by itself a ‘taxableASSESSEE WINS THE FIRST ROUND IN service’. The amended definition read as ‘serviceDELHI HIGH COURT provided or to be provided to any person, by any other person, by renting of immovable property,2. The validity of the levy was first challengedin the Delhi High Court in Home Solutions or any other service in relation to such renting, for use in the course of or for furtherance ofRetails India Ltd v. Union of India [2009] 20 STT129. The High Court first observed that service business or commerce’ (emphasis supplied).tax being a tax on value addition provided by In effect, the activity of renting was released from the clutches of the phrase ‘in relation to’,a service provider, if there was no value addition,then there would be no ‘service’. With the so as to make it clear that ‘renting’ was a taxable service by itself. The amendment wasaforesaid observation in mind, the High Courtanalysed the provisions of section 65(105)(zzzz) given retrospective effect from the date of introduction of the levy, viz., 1-6-2007. Validatingof the Act, with particular emphasis on theexpression ‘in relation to’ used therein, and provisions covering the period 1-6-2007 to 8-5-2010 (the date on which the Finance Act,came to the conclusion that, insofar as rentingof immovable property for use in the course 2010 received the assent of the President) were also simultaneously enacted. The departmentor furtherance of business or commerce wasconcerned, any value addition could not be justified this amendment by clarifying that thediscerned. The High Court therefore held that amendment was necessitated by taking into consideration the precarious situation in whichsection 65(105)(zzzz) did not in terms entailthat the renting of immovable property for use the landlords had been placed in the wake of the Delhi High Court judgment, due to non-in the course or furtherance of business orcommerce would by itself constitute a taxable reimbursement of service tax element by the tenants, and also in order to clarify the legislativeservice and be exigible to tax under the Act.The assessee thus won the first round, but intent and also to bring in certainty in tax liability.Revenue filed a Special Leave Petition in theSupreme Court, which was admitted by theSupreme Court. This petition is still pending ASSESSEE LOSES THE SECOND ROUNDdisposal in the Supreme Court, but the Supreme IN THE DELHI HIGH COURTCourt did not pass any orders staying theoperation of the High Court judgment. It is 4. The same assessee who was the winner ininteresting to note that the Delhi High Court the first round again challenged the amendedcited reference to the definition of ‘renting of provisions in the case of Home Solutions Retailsimmovable property’ in section 65(90a) of the (India) Ltd. v. Union of India [2011] 33 STT 95/Act (which included ‘renting’ in the definition), 13 taxmann.com 188 (Delhi). The petitionerbut did not discuss this provision, but instead challenged the validity of the amendment ondecided the issue purely on the definition of the following grounds:taxable service in section 65(105)(zzzz) of the (i) The levy in the present case clearly re-Act. lated to lands and buildings, and hence, the power to legislate vested exclusively702 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 102
  • 103. in the State legislature by virtue of Entry purpose. The value of the building gets 49 of List II of the Seventh Schedule to accentuated because of the scarcity of lands the Constitution of India; and buildings, goodwill, accessibility and similar ancillary advantages which con- (ii) The impugned activity did not entail any stitute value addition. value addition so as to be treated as a ‘taxable service’ as held in their own case u When premises is taken for commercial earlier; purposes, it is basically to subserve the cause of facilitating commerce or busi-(iii) The retrospective effect given to the amend- ness and promoting the same. Therefore, ment and the consequent validating pro- there can be no trace of doubt that an visions were bad in law. element of value addition is involved, andThis time, the case was heard by a three-Judge once there is value addition, there is elementBench, and the Bench analysed the issues of service.exhaustively, and held eventually as follows: u The imposition of service tax under sec- “(a) Section 65(105)(zzzz) and section 66 tion 65(105)(zzzz) read with section 66 is of the Act, as amended by the Fi- not a tax on land and buildings which is nance Act, 2010, are intra vires, the under Entry 49 of List II of Seventh Schedule Constitution of India. to the Constitution of India, what is being taxed is the activity, and the activity denotes (b) The decision rendered in the first Home Solutions Retail India case does the letting or leasing with a purpose, and not lay down the law correctly as we that purpose is fundamentally for com- mercial or business purpose and its fur- have held that there is value addi- tion when the premises is let out for therance. Once there is value addition and the element of service is involved, in use in the course of or furtherance of business or commerce, and is conceptual essentiality, service tax gets attracted and impost gets out of the purview accordingly overruled. of Entry 49 of List II, and falls under the (c) The challenge to the amendment giving residual entry i.e., Entry 97 of List I. it retrospective effect is unsustain- u It is well settled in law that it is open to able and accordingly, the same stands repelled and the retrospective amend- the legislature to pass a legislation retro- spectively and remove the base on which ment is declared as constitutionally valid”. (para 74) a judgment is delivered. In Vijay Mills Co. Ltd. v. State of Gujarat [1993] 1 SCC 345,The significant observations of the High Court the Supreme Court held that ‘it is openon which the above conclusions are based, are for the legislature to change the very basisas follows: of the provisions retrospectively and to u When a particular building or premises validate the actions on the changed ba- has the ‘effect potentiality’ to be let out sis’. In State of Himachal Pradesh v. Narain on rent for commercial or business pur- Singh [2009] 13 SCC 165, the Supreme poses, an element of service is involved Court held that ‘it would be permissible in the immovable property and that for the legislature to remove defect in tantamounts to value addition which would earlier legislation and the defect can be come within the component of service removed both retrospectively and prospec- tax. An element of service arises because tively by legislative action and the pre- a person who intends to avail the prop- vious action can be validated’. erty on rent wishes to use it for a specific December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 103 703
  • 104. SERVICE TAXFOUR OTHER HIGH COURTS UPHOLD or commerce. Such renting of immovableCONSTITUTIONAL VALIDITY OF THE LEVY property is an activity which amounts to rendition of service in the course or fur-5. The constitutional validity of the levy in the therance of business or commerce.instant case was also challenged before four u Though renting of any property ipso factoother High Courts recently, as detailed below: would not amount to service for the purpose (a) Cinemax India Ltd. v. Union of India [2011] of service charge, if renting of immovable 32 STT 359/12 taxmann.com 492 (Guj.) property is made in the course of or (‘the Gujarat High Court case’) furtherance of business or commerce, value (b) Utkal Builders Ltd. v. Union of India [2011] addition is made by the service provider 32 STT 398/12 taxmann.com 390 (Orissa) in favour of the service recipient. Such (‘the Orissa High Court case’) activity undertaken by the service pro- vider for value addition in the course of (c) Shub Timb Steels Ltd. v. Union of India furtherance of business or commerce, i.e., [2010] 29 STT 479/8 taxmann.com 117 to carry on activity of business or com- (Punj. & Har.) (‘the Punj. & Har. High merce of the service recipient, amounts to Court case’) rendition of service and will fall within (d) Retailers Association of India (Rai) v. Union the meaning of definition of ‘service tax’. of India [2011] 32 STT 443/437 (Bom.) u The use of the word ‘furtherance’ means (‘the Bombay High Court case’). that, if a service provider is renting theThe issues before these High Courts are the property in the course or furtherance ofsame as those that were before the Delhi High business or commerce, it will amount toCourt in the Home Solutions Retails (India) Ltd. an activity in favour of the service recipi-case (supra), explained in para (4). All the four ent for helping forward business, promo-High Courts have upheld the constitutional tion of business, advancement of businessvalidity of the levy in accordance with the and progress of business. It automaticallyamended provisions, as well as the retrospectivity generates value addition and comes withingiven to the amended provisions. Important the meaning of ‘service tax’ as defined inobservations from these judgments are given section 65(105)(zzzz).below, courtwise : u Accordingly, the provisions of section5.1 Gujarat High Court Case : 65(105)(zzzz) as amended with retrospec- tive effect from 1-6-2007 are upheld. The u The petitioners have argued that renting provisions will be attracted only if the of immovable property is a transaction by immovable property is rented for the use which right in or in relation to immov- in the course or furtherance of business able property is transferred for a certain or commerce. The provisions will not be period and it is not an activity involving attracted in cases of vacant land/build- performance, skill, expertise or knowledge, ings mentioned in Explanation 1 to that and that the amount received by the lessor/ provision. licensor is consideration for transfer of right in or in relation to immovable prop- 5.2 The Orissa High Court Case : erty. Such analogy cannot be applied in u The entire focus of the Delhi High Court the case of renting of immovable prop- in the first Home Solutions Retails (India) erty by a service provider to a service Ltd. case (supra) seems to be on section recipient who hires the property for use 65(105)(zzzz), and the impact, scope and in the course or furtherance of business ambit of section 65(90a) which defines704 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 104
  • 105. ‘renting of immovable property’ has not of transfer of right in immovable prop- been discussed. It is well settled principle erty does not involve value addition, the of law that, if a judgment proceeds with- provision cannot be held to be void in the out taking note of or ignoring relevant absence of encroachment on List II. provision of law, the said judgment can- u It is well settled that competent legisla- not be held to have correctly decided the ture can always clarify or validate a law issue. retrospectively. It cannot be held to be u The nature of transactions made by the harsh or arbitrary. Object of validating petitioner with its tenant clearly amounts law is to rectify the defect in phraseology to renting of immovable property for the or lacuna and to effectuate and to carry purpose of business or commerce, and is out the object for which earlier law was therefore clearly covered by section 65(90a) enacted. Therefore, there was no ground itself, and service tax is clearly leviable to set aside giving retrospective to the thereon. amendment from 1-6-2007, on which date the levy was initially introduced. u Amendment to section 65(105)(zzzz) is clearly clarificatory in nature and Parliament 5.4 The Bombay High Court Case : certainly possesses the necessary legisla- u The essential nature and character of levy tive competence to declare the amend- is that it constitutes the levy of tax on ment to be retrospective in operation. taxable services. The charge of tax is not5.3 The Punj. & Har. High Court Case : on lands and buildings as a unit nor is the tax on land and buildings. To be a u It could not be said that service tax on tax on land and buildings under Entry 49 service of renting of property is exclu- of List II, the tax must be directly on land sively covered by Entry 49, List II, since and buildings. That is not the true char- the said Entry relates to tax on land and acter of an impost on taxable services. building, and not to any activity relating thereto. u The renting of immovable property, in legislative wisdom of Parliament, involved u It cannot be held that renting of property a conferment of service and it is in that does not involve any service as service legislative exercise that Parliament pro- can only be in relation to property and ceeded to levy service tax. The true nature not by renting property. Renting of prop- and character of levy in the present case erty for commercial purposes is certainly is a levy under the residuary power which a service and has value for the service has been conferred upon Parliament in receiver. List I. u The aspect of service element in renting u The levy of a tax on taxable service pro- transaction is certainly an independent vided or to be provided to any person by aspect covered under Entry 92C, read with any other person, by the renting of im- Entry 97, of List I. In any case, subject- movable property, is based on a consid- matter of impugned levy being outside ered determination by Parliament that such the scope of Entry 49 of List II, power of transactions do in fact involve an element Union legislature is undoubted. of service. The fact that the service pro- u Question whether levy will be harsh, being vided may not, to the petitioners, accord in addition to income-tax and property with what is commonly regarded as a tax, is not a matter for the instant Court service would not militate against the once there is legislative competence for validity of the legislation, as could be the levy. Even if it is held that transaction noted from the Supreme Court judgment December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 105 705
  • 106. SERVICE TAX in the case of Tamil Nadu Kalyana Mandapam u More significantly, even if the Court were Assn. v. Union of India [2006] 4 STT 308. to proceed on the basis suggested by the The validity of the legislation does not petitioners that no element of service is depend on determination of fact by the involved, that would not make the leg- Court that a service is provided in the islation beyond the legislative competence transaction which is brought to tax. of Parliament. So long as the legislation does not trench upon a field which has (In the aforesaid judgment of the Supreme been reserved to the State Legislatures, Court, the Supreme Court had inter alia the only conclusion that can be drawn is observed that ‘a levy of service tax on a that the law must be treated as valid and particular kind of service could not be within the purview of the field set apart struck down on the ground that it does for Parliament. not conform to a common understanding of the word “service” so long as it does u The amendment was brought in order to not transgress any specific restriction cure the deficiency which was found upon contained in the Constitution’.) interpretation by the Delhi High Court. The object of giving retrospective effect u A legislative hypothesis contained in par- to the amendment is to expressly bring liamentary legislation cannot be questioned the legislative provision in conformity with on the ground that the assumption of fact the original parliamentary intent. The is in error, Parliament is entitled to make .Supreme Court held in Bakhtawar Trust assessments of fact on the basis of which v. M.D. Narayan [2003] 5 SCC 298 that it it legislates. Indeed, such assessments of is open to the legislature to alter the law fact are intrinsic to the very nature of the retrospectively provided the alteration is legislative exercise and the Court which made in such a manner that it would be exercises the power of judicial review no more possible for the Court to arrive particularly in fiscal matters would not at the same verdict. The purpose and object be justified in re-examining the wisdom of validating legislation is to ensure a or the correctness of such an exercise by fundamental change of circumstances upon Parliament. The legislature in fiscal mat- which the earlier judgment was founded. ters is entitled to a high degree of latitude This may be done by enacting retrospec- in designing legislation and in formulat- tively a valid and legal taxing provision ing methodologies for the recoveries of and then by fiction making the tax al- fiscal extraction. Such an exercise cannot ready collected stand under the enacted ordinarily be questioned as being beyond law. The amendment in the present case the powers of the enacting legislature. passes muster on that test. u The legislative basis that has been adopted by Parliament in subjecting taxable ser- vices involved in the renting of immov- ISSUE GOES TO THE SUPREME COURT able property to the charge of service tax 6. The fact that five different High Courts cannot be questioned. The assumption by have, in different but concurring voices, upheld a legislative body that an element of service the constitutional validity of the levy, as well is involved in renting of immovable prop- as its retrospective application, should, in the erty is certainly not an assumption which normal course, have led to the wishful belief can be regarded as being so manifestly that the litigative battle has come to an end. absurd or perverse as to lead to an in- However, the reality is that the belief has been ference that Parliament has treated as a belied. The Retailers Association of India have service an item which in no rational sense filed a Special Leave Petition in the Supreme could be regarded as involving service.706 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 106
  • 107. Court against the Bombay High Court judgment, or before 30-9-2011. The Supreme Court haveand the Supreme Court has taken the petition also clarified that ‘there is no stay on imposition‘on board’ on 18-9-2011 and had also recorded of service tax under sub-clause (zzzz) of clausethat ‘the appeals will be heard on the SLP (105) of section 65 read with section 66 of thePaper Books’ and that ‘additional documents, Finance Act, 1994 (as amended), insofar as theif any, may be filed by the parties’. The Supreme future liability towards service tax with effectCourt have also granted a stay on the taking from 1-10-2011 is concerned’. The scene nowup of any coercive steps against the petitioners shifts to the Apex Court for the ‘final battle’.for recovery of arrears of service tax due on ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 107 707
  • 108. SERVICE TAXSERVICE TAX Hindu marriage is a religious ceremony besides being T.N. PANDEY Ex.-Chairman, CBDT a social function T he Delhi High Court in a recent decision in the case of All India Tent Dealers Welfare Organization v. Union of India [2011] 33 STT 211/14 taxmann.com 16 has held that erection of pandals/shamianas for the Hindu marriages is covered by the term ‘social function’ as given in the Explanation to section 65(77a) of the Finance Act, 1994 and, hence, persons providing such services would be liable to pay service tax at the prescribed rate. In this article the author has examined the relevant provisions in the service tax legislation and the recent decision of the High Court and has opined that a Hindu marriage, despite being deemed as a social function, does not lose its characteristics as a religious ceremony covered by the circular dated 17-9-2004 issued by the CBEC which is binding on the field officers and, hence, service providers & such services should not be made liable to pay service tax.INTRODUCTION BACKGROUND OF THE ISSUE1. The above mentioned subject is being examined 2. The occasion to consider the problem arosein later discussions with reference to the in the context of an interpretation of sectionprovisions of the Finance Act, 1994 concerning 65(77a) concerning liability to pay service taxtaxation of services in the light of Delhi High by pandal and shamiana contractors (serviceCourt’s ruling in the case of All India Tent providers) where the issue was whether suchDealers Welfare Organization v. Union of India services in the context of marriages were liable[2011] 33 STT 211/14 taxmann.com 16. to payment of service tax on the ground that marriage is a social function.708 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 108
  • 109. LEGAL PROVISIONS3. For considering the said issue,it is necessary to give an accountof the legal provisions that arerelevant in the context of querybeing examined. (a) Historical background - Initially, the pandal or shamiana contractor’s ser- vices were brought within the ambit of service tax net by the Finance Act, 1997, w.e.f. 1-8-1997. However, the Government vide Notifica- tion No. 49/98, dated 2-6- 1998 exempted the taxable service pro- vided to a client, by a pandal and shamiana shamiana in any manner and also contractor from whole of the service tax. includes the services, if any rendered The provisions relating to levy of service as a caterer.” tax on a pandal and shamiana contractor were also omitted from the Finance Act, (b1) According to the Explanation to section 1994. Thus, the levy of service tax on 65(105), the taxable service shall also include pandal or shamiana services remained any such service provided or to be pro- effective only for the period between 1- vided by any unincorporated association 8-1997 to 1-6-1998. However, the levy of or body or persons to its members for a service tax on a pandal and shamiana consideration. contractor has been revived by the Fi- The key ingredients of the definition of a pandal nance (No. 2) Act, 2004, with effect from or shamiana are as follows: 1-9-2004. Thus, period during which the service tax on pandal and shamiana con- (i) There must be service in relation to a tractor is leviable is as under: pandal or shamiana; u From 1-8-1997 to 1-6-1998; and (ii) Such service may be provided in any manner; u From 10-9-2004 and onwards. (iii) Such service must be provided by a pandal (b) Taxable services - Service tax is charge- or shamiana contractor; able on taxable services specified under clause (105) of section 65 of the Act. In (iv) Pandal and shamiana contractor’s service respect of pandal and shamiana contractor’s also includes the services, if any, ren- service, sub-clause (zzw) of clause (105) dered as a caterer; of section 65 of the Act, defines a taxable (v) Such service is provided to any person. service as under: “‘taxable service’ means any service OTHER DEFINITIONS provided or to be provided [to any person] by a pandal or shamiana 4. Clause (77a) of section 65 of the Act, defines contractor in relation to a pandal or “pandal or shamiana” as under: December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 109 709
  • 110. SERVICE TAX “‘pandal or shamiana’ means a place fixture, lights and lighting fittings, floor specially prepared or arranged for coverings and other articles for use, at a organizing an official, social or business place which is not a pandal or shamiana function.” as defined in sub-section (77a) will not bring the supplier within the definition of[Explanation - For the purpose of this clause, a pandal or shamiana contractor and in“social function” includes marriage.] the result such service will not be clas-The following are the key ingredients of the sifiable under clause (zzw) as a taxabledefinition: service - Vide Kartar Singh Kochar, In re u It must be a place. [2005] 2 STT 277 (AAR - New Delhi). u Which is specially prepared or arranged (iii) There is exemption of 30% to pandal or shamiana contractors also providing ca- for organizing specific function. tering subject to certain conditions. u Such function must be an official, social (including marriage w.e.f. 1-6-2007) or business function. DELHI HIGH COURT’S DECISION4.1 By virtue of amendment made by the Finance 6. In All India Tent Dealers Welfare OrganizationAct, 2007, services provided in relation to pandal (supra), a writ petition was filed before theor shamiana used for organizing “marriage” Delhi High Court wherein the petitionerwould also be chargeable to service tax w.e.f. contended that erection of a pandal/shamiana1-6-2007. for marriage is in furtherance of religious ceremonies, rites and rituals, especially for4.2 Clause (77b) of section 65 of the Act, defines Hindu marriages which are to be performed‘pandal or shamiana contractor’ as under: for the religious function. Thus, the Hindu“pandal or shamiana contractor” means a person marriage should not be considered as a socialengaged in providing any service, either directly function for the purpose of service tax. Therefore,or indirectly, in connection with the preparation, the revenue was to be restrained from levyingarrangement, erection or decoration of a pandal and/or collecting any service tax on erectionor shamiana and includes the supply of furniture, of pandal or shamiana for a Hindu marriage.fixtures, lights and lighting fittings, floor coverage The High Court has decided that if the entireand other articles for use therein. provision is properly understood, it is clearly discernible that the Hindu marriage is not(This definition is not relevant in the present treated or regarded a social function per se. Ifcontext) the dictionary clause is appositely appreciated, there can be no trace of doubt that only when5. EXEMPTION FROM TAX a ‘pandal or shamiana’ is used for marriage, it earns the status of ‘social function’ because (i) Service provided for pure religious cere- the service component is involved. It is worth monies or congregation - Pandal or shamiana noting, that the statute itself postulates that service provided for pure religious cere- marriage is to be regarded as a social function monies or congregation, for example, for and full effect has to be given to the same. worship of Gods/Goddesses, are not li- That apart, the prerequisite is the use of ‘pandal able to service tax - Vide Circular No. 80/ or shamiana’ and, therefore, the contention 10/2004-CX(ST), dated 17-9-2004. raised that Hindu marriage is not a contract (ii) Mere supply of furniture, fixtures, lights but a scared institution and, hence, no service and lighting fittings, floor coverings and tax is imposable treating it as a social function other articles - Mere supply of furniture, has to be repelled.710 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 110
  • 111. 6.1 The writ petition was, thus, dismissed on make her a partner of his family tree. Muriheadthe ground that there was no merit in the ‘Historical Introduction to the Private Law ofpetition. Rome’ pp. 23, 24.ANALYSIS OF THE DECISION HINDU MARRIAGES ARE7. The provisions of the Act and the decision RELIGIOUSLY PERFORMEDof the High Court raise an important issue 8. Marriage is one of the necessary SAMSKARASwhether a Hindu marriage can be deemed as or religious rites for all the Hindus, whatevera ‘social function’ as mentioned in the Act and the caste, who do not desire to adopt the lifeas decided by the High Court on the basis of of a perpetual Brahmachari or of a Sanyasi.the Explanation to section 65(77a) of the Act Of course, there has never been any doubt as(supra) even if it is a religious ceremony, which to its being a necessary SAMSKARA for ais eligible for exemption as per the Circular Hindu woman of any caste.dated 17-9-2004 (supra 5(i))? 8.1 Marriage is a religious function - Thus,7.1 Marriage is a civil and religious contract - Hindu marriages are sacraments and, hence,Speaking generally the conception is that these are, prima facie, covered by the exemptionmarriage is a union of a man and a woman provided by the Circular [vide para 5(i) supra].as husband and wife. According to section 112 Circular speaks of ‘pure religious ceremonies’.of the Indian Evidence Act, 1872, and section This implies that there should be no camouflaging2(a) of the Indian Majority Act, 1875, marriage of any kind of sacramental religious marriagesis a ceremony by which two persons are made – not mere disguise of religious activity buthusband and wife through a series of ceremonies the activity, in fact, and in form should be ofunder the Hindu Law/Hindu Marriage Act. a religious nature according to the Hindu rites.Even according to Western thinking as mentioned Religion implies faith and devotion - thingsby Tomlin (quoted in ‘Advanced Law Lexicon’ to which a person is devoted/committed.(3rd edition) by P. Ramanatha Aiyer at page Religious means pious/devout, conscientious,2915) marriage is a civil and religious contract etc. The Hindu system of marriage describedwhereby a man is joined and united to a woman earlier in essence implies such characteristicsfor the purposes of a civilized society. of religion and, hence, can certainly be considered7.2 Marriage is a religious duty - A duty a as religious function - not social function andman owes to his ancestors and to himself - covered by the aforesaid circular.In India, from the Vedic age, the ceremony of 8.2 In Hindu marriages there is no violationmarriage has been considered as a pious activity of the principle of equality - In giving a particularreligiously performed as per the laid down treatment (exemption) for service providersrules/standards by sages. With the early Romans, for pandals and shamianas for the Hinduas with the Hindus and the Greeks, marriage marriages, there would be no violation of thewas a religious duty- a duty a man owed alike principle of equality enshrined in the Constitutionto his ancestors and himself. Believing that the of India. This aspect has been considered inhappiness of the dead in another world depended many decisions of the Courts. For example, inon their proper burial and on the periodical Chennamma v. Dyana Setty AIR 1953 Mys. 136,renewal by their descendants of prayers and it has been decided that section 23 of thefeasts and offerings for the repose of their Mysore Hindu Law Women’s Rights Act X ofsouls, it was incumbent upon him above all 1933 does not violate Article 15 of the Constitutionthings to perpetuate his race and his family on the ground that it applies only to personscult. In taking to himself a wife, he was about who follow the Mitakshara School of the Hinduto separate her, from her father’s house and December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 111 711
  • 112. SERVICE TAXlaw and not other Hindu or to Muslims, FUTURE SCENARIOChristians or Parsees. 11. It may be that such a situation may not8.3 Separate treatment for the Hindus in the arise after the passing of the new Goods andAct - Separate treatment for the Hindus under Services Tax law. The draft of the negative listtax laws has been accepted under the Income- circulated by the Government (proposed to betax Act, 1961 where ‘Hindu undivided family implemented from 1-4-2012, which date may(HUF)’ has been recognized as a separate taxable not be adhered to as per the present indications)entity with some provisions of the Act applying shows that there will only be a single entryonly to HUFs. under the religious category – religious services provided by any person - making a shift fromAPPLICABILITY OF DEEMING ASPECT religious institutions to religious purpose.9. The Explanation to section 67(77a) (supra)provides that a marriage is to be deemed as CONCLUDING REMARKa social function. Deeming implies treating a 12. Despite the Explanation to section 65(77a)thing something which it is not there or negatively of the Finance Act, 1994 providing that forby deeming something not to be something levy of service tax for Pandal or Shamianawhich it is not. But by such deeming, the services, marriage would be deemed to be aessential characteristics of the deemed thing social function, the providers of such servicescannot be said to have been lost or destroyed should not be liable to service tax for makingfor marriage ceremony, even if it is deemed these available for the Hindu marriages; theto be a social function for the purposes of same being religious ceremonies will be coveredsection 65(77a) of the Act and will not cease by Circular No. 80/10/2004-CX/ST, datedto be a religious function and, hence, it would 17-9-2004 which is binding on the field officers.be entitled to exemption provided by the circular Thus, the High Court’s order needs recon-referred to earlier. sideration/review. •••712 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 112
  • 113. SERVICE TAX Service Tax Penalty & Reasonable Cause P enalties have always been any assessee’s nightmare. Penal sections exist in every law to ensure proper compliance of the law by the subjects. The service tax law is also no different. Thus, while the Act provides for penal provisions, there are inbuilt reliefs for a genuine taxpayer where non-compliance is based on a bona fide belief or understanding. All sections imposing penalty on the assessee provides for the event of failure on part of assessee and penalties thereof. However, section 80 is the saviour to a genuine assessee as it provides deletion of penalty in case of a ‘reasonable cause’. The author in GAURAV GUPTA this article has discussed various case-laws on the concept CA of reasonable cause as envisaged in section 80.INTRODUCTION Accordingly, while the Finance Act, 1994 (“Act”) provides for penalties, it also provides for1. Penalties have always been any assessee’s deletion thereof on production of a reasonablenightmare. Even a genuine taxpayer feels cause by the assessee for non-compliance ofaggrieved not of the tax being demanded from the corresponding provision. We shall first takehim, but penalty being imposed on him. Penalties a glimpse of penalties levied under the Act.are demanded by revenue even on a matterwhich is disputed all across and on issueswhich are not clear to a taxpayer. The law PENALTIES UNDER THE ACTimposes penalties to ensure that all taxpayers 2. The Act along with Service Tax Rules, 1994pay their taxes and demand compliance from (“Rules”) provides for the imposition of penaltiesits subject. However, an automatic imposition in the cases of defaults by assessees which areof penalty is neither desirable nor equitable. provided as follows: December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 113 713
  • 114. SERVICE TAXSection Default PenaltySection 70(1) read Delay in filing of return from • If delay is less than or upto 15 days fromwith Rule 7(C) of the date prescribed for submis- the prescribed date, ` 500;Rules sion of such return • beyond 15 days but not later than 30 days, ` 1000; and • beyond 30 days, ` 1000 plus ` 100 for every day from the 31st day till the date of furnishing the said return • However maximum penalty under this section cannot exceed ` 20,000Section 76 Failure to pay Service Tax • ` 100 for every day during which such failure continues, or, at the rate of 1% of such tax, per month, whichever is higher. • However, penalty under this section shall not exceed 50% of the service tax payable.Section 77(1) Failure on the part of assessee • ` 10,000 or ` 200 for every day during to: which such failure continues, whichever is • pay service tax, or higher • take registration or • take registration in accordance with the provisions of section 69 • furnish information called by an officer • produce documents called for by a Central Excise Officer • appear before the Central Excise Officer Failure on the part of assessee Upto ` 10,000 to: • keep, maintain or retain books of account and other documents as required • pay tax electronically, through internet banking • issue proper invoiceSection 78 Under payment of service tax • Equal to the amount of service tax found in or obtaining improper refund default by an assessee by reason of: • However, where true and complete details of • fraud; the transactions are available, penalty shall • collusion; be reduced to 50% of the amount of service • wilful mis-statement; tax found in default • suppression of facts; • Where service tax in default and the interest • contravention of any of the thereon is paid within 30 days from the date provisions of the Act with of communication of order determining such the intent to evade payment service tax, penalty shall be reduced to 50% of service tax of the amount of service tax found in default • In case of an assessee whose value of taxable services does not exceed ` 60 lakh during any of the years covered by the notice or preceding financial year, period of 30 days shall be extended upto 90 days.714 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 114
  • 115. ARE PENALTIES IMPOSABLE BY Mens rea–Required for impositionDEFAULT? of penalty?3. As per the above table, there are penalties It has been observed by various courts thatfor the various mistakes made by the assessee no penalty would be imposable when there isprescribed under law. The important question no mala fide intent to evade payment of tax.is as to whether imposition of penalties should The understanding is based on various judgments.be automatic on defiance of a provision? The Penalty cannot be imposed as a matter of courseanswered may be found in the landmark decision and in a routine manner without establishingof Hindustan Steel Ltd. v. State of Orissa 1978 with cogent and reliable evidence that proves(2) ELT J 159 (SC), wherein the Supreme Court beyond reasonable doubt the existence ofheld as under: “culpable mental state”. The above statement “The discretion to impose penalty must draws support from number of decisions, some be exercised judicially. Penalty will of which are as under: ordinarily be imposed in case the party u Anantharam Veerasinghaiah & Co. v. CIT acts deliberately in defiance of law......, [1980] 123 ITR 457 (SC); but not in cases where there is technical or venial breach of the provisions of the u CIT v. Khoday Eswara & Sons [1972] 83 ITR Act or where the breach flows from bona 369 (SC); fide belief that the offender is not liable u CIT v. Anwar Ali [1970] 76 ITR 696 (SC); under the Act. An order imposing penalty for failure to carry out a statutory obligation u Cement Marketing Co. of India v. Assistant is the result of quasi judicial proceeding. Commissioner of Sales Tax 1980 (6) ELT 295 Penalty will not be ordinarily imposed (SC) unless the party either acted deliberately u EID Pary (I) Ltd. v. Asstt. Commissioner of in defiance of law or was guilty of conduct Commercial Taxes AIR 2000 (SC) 551 contumacious or dishonest or acted in conscious disregard of its obligations. u Tribunal’s decision in the case of Smitha Penalty will not be imposed merely because Shetty v. CCE [2007] 9 STT 55 (Bang. – it is lawful to do so. Even if a minimum CESTAT) was approved by the Apex Court penalty is prescribed, the authority will in the case of CCE v. Sunitha Shetty [2006] be justified in refusing to impose penalty, 4 STT 360/2004 (174) ELT 313 wherein it when there is a technical or venial breach was held that in absence of any mens rea of the Act or where the breach follows penalty should not be levied. from a bona fide belief that the offender However, today, this space would be incomplete is not liable to act in the manner prescribed without mention of another landmark judgment by the statute.” delivered by the Supreme Court in the caseThese observations of the Supreme Court have of Union of India v. Dharmendra Textile Processorsbeen reaffirmed and reiterated by the Supreme [2008] 174 Taxman 57/2008 (231) ELT 3 (SC).Court in the case of Akbar Badruddin Jiwani v. The judgment has become a absolute relianceCollector of Customs 1990 (47) ELT 161. for revenue authorities as it had made certain striking observations in relation to penalties,Further, there are inbuilt conditions in every viz:penal section which are required to be satisfiedbefore penalty is imposed. Of all conditions, u No discretion available on quantum ofcourts have held that for imposition of a penalty, penalty under section 11AC of Centralmens rea is a must. Excise Act, 1944 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 115 715
  • 116. SERVICE TAX u Mens rea not an essential ingredient there - and explanation is bona fide. In situation under for attracting civil liability as is the (a), penalty was always leviable. In situation case of prosecution under section 276C. (c), penalty was never leviable. In situation (b), penalty would not have been leviable u The adjudicating authority does not have since the onus of establishing mens rea even a discretion to levy duty less than could not have been discharged by the what is legally and statutorily leviable. AO. However, pursuant to DharmendraThus, from a plain reading of the decision one Textile penalty in such a case will bemay infer that the decision has obviated the leviable since it is not necessary for theimposition of penalty in all cases without any AO to establish mens rea. That is the arearequirement of mens rea. However, the same in which legal position has changed.”would be too harsh interpretation for a genuine Thus, it was observed by the Tribunal thattaxpayer. Supreme Court has distinguished penal provisions in civil suits are not automatic.Dharamendra Textile Processors (supra) in otherdecisions. In the matter of Union of India v. Intent to evade tax is an important determinantRajasthan Spinning Mills 2009 (238) ELT 3 (SC), of mens rea. Accordingly, in cases where therethe Apex Court held that the decision in is no loss to the exchequer, penalty was deletedDharmendra Textile must be understood to mean by courts holding absence of mens rea. In thisthat though the application of section 11AC regard, reliance is placed on the decision renderedwould depend upon the existence or otherwise in the case of Ispat Industries Limited v. CCEof the conditions expressly stated in the section, 2007 (119) ECC 435 (CESTAT - Mum.), whereinonce the section is applicable in a case the the Tribunal allowed the appeal barring it byconcerned authority would have no discretion limitation on the following observation:in quantifying the amount and penalty must “the entire exercise is revenue neutral asbe imposed equal to the duty determined under if duty had been paid, it would havesub-section (2) of section 11A. In other words, been available as credit to the other unitthe penalty section cannot be read in a manner and therefore, there could not have beento mean that in all cases where addition is any intention to evade payment of duty.”confirmed, penalty shall also mechanically belevied. The most appropriate interpretation of Furthermore, it is now a well-settled legaldecision in Dharmendra Textile Processors (supra) position that if a party has bona fide belief incan be found in the decision of Kanbay Software a legal position, penal provisions will not apply.India (P.) Ltd. v. Dy. CIT [2009] 31 SOT 153 Reliance is placed on the judgment of the(Pune) (ITAT Pune), wherein Tribunal has held Apex court in the matter of Padmini Productsas under: v. CCE 1989 (43) ELT 195. The Apex Court held as under: “There can be three distinct mutually exclusive situations in case of an addition “If there was scope for such a belief or to income: (a) Where the addition is on opinion, then failure either to take out a account of contumacious conduct of licence or to pay duty on that belief, the assessee and mens rea is established; when there was no contrary evidence that (b) Where it can neither be established the producer or the manufacturer knew that the addition is on account of that these were excisable or required to contumacious conduct of the assessee nor be licensed, would not attract the penal is it established that the assessee’s conduct provisions of section 11A of the Act….. and explanation is bona fide; (c) Where it further there were no materials from which is established that the assessee’s conduct it could be inferred or established that716 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 116
  • 117. the duty of excise had not been levied 4.1 Section 80 is an overriding section - From or paid or short-levied or short-paid or the reading of the section, it is appropriately erroneously refunded by reason of fraud, clear that the section has overriding effect collusion or any wilful misstatement or over: suppression of facts, or contravention of u Section 76, any of the provisions of the Act or of the rules made thereunder.” u Section 77, andThus, while mens rea is an inbuilt condition u first proviso to section 78.in every penal provision, still a finer reading Thus, there are still provisions which are outsidemay defy the benefit to assessee on technical the ambit of section 80 for providing relief togrounds as is seen in the case of Dharamendra the assessee. Accordingly, sections not mentionedTextiles. Accordingly, the Act has provided an in section 80 may not find relief from theexplicit section which provides relief to a genuine imposition of penalty. The understanding findstaxpayer in certain conditions. We shall now support from the decision in the case of R.B.discuss provision of section 80. Bahutule v. CCE [2007] 8 STT 286 (Mum. – CESTAT)/2004 (166) ELT 233 (Trib. - Mum.),SECTION 80 - THE PARAMOUNT wherein, it was held that the adjudicating authorities do not have a discretion for not4. Further to the above safeguard, to save a imposing penalty for not applying for registrationgenuine taxpayer from the wrath of the penalties, for service tax purposes. Section 80 does notsection 80 has been provided in the Act, which allow any such discretion to the adjudicatingreads as follows: authorities. They have discretion not to impose “SECTION 80. Penalty not to be imposed any penalty for delay in paying service tax in certain cases - Notwithstanding anything and delay in furnishing returns but they have contained in the provisions of section 76, no such discretion for not imposing or reducing section 77 or first proviso to sub-section penalty for failure to apply for registration. (1) of section 78, no penalty shall be Further, it is pertinent to highlight here that imposable on the assessee for any failure with invocation of extended period levy of referred to in the said provisions if the penalty is not automatic. The understanding assessee proves that there was reasonable draws support from the decision of High Court cause for the said failure.” in the case of CST v. Atria Convergence Tech.Thus, the section reads as under: (P.) Ltd. [2010] 27 STT 343 (Kar.). u Notwithstanding anything contained in Here, treatment of section 78 by section 80 the provisions of section 76, section 77 or requires special mention. Earlier section 78 first proviso to sub-section (1) of section was completely within the purview of section 78, 80, however, with a specific amendment vide Finance Bill, 2011, the applicability of section u No penalty shall be imposable on the 80 was restricted to the first proviso to section assessee for any failure referred to in the 78. Now, as per the amended section, power said provisions if the assessee proves that to waive penalty is available only in cases there was reasonable cause for the said where the information is captured properly in failure. the specified records. This requires aThe requisites of the section are discussed in reconsideration from the law makers as failuredetail as under: because of a reasonable cause requires relief, December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 117 717
  • 118. SERVICE TAXwhether or not the information was available. 2010], wherein it was observed that on a conjointThat’s what we know as the law of natural reading of section 76 and section 80, it is notjustice. In Ashwani & Associates v. CCE [1994 possible to envisage a discretion as being vested- 2006] STT 54 (New Delhi - CESTAT) (Trib.), in the authority to levy penalty below theit was observed that it is mandatory on the prescribed limit.part of revenue to follow the principles of The above decision draws reliance from thenatural justice i.e. audi alteram partem rule meaning decision of High Court in the matter of CCE&Cthat other party should be heard, before imposing v. Port Officer [Tax Appeal No. 1367 of 2009,any penalty and provide an opportunity to dated 8-7-2010]. Similar observations have beenassessee to prove that there was a reasonable made in the following cases:cause. Thus, it shall require the jury to consideras to whether the evolved law be allowed to u CCE v. Riya Travels & Tours (I) (P.) Ltd.be restricted by the technical. [2009] 22 STT 386 (Mum. - CESTAT)(TM).4.2 Penalty cannot be reduced - Another u CST v. Lark Chemicals [Central Excise Appealimportant inference from the reading of section No. 241 of 2006, dated 30-8-2007]80 is that the section provides for deletion of Thus, while section 80 can save an assesseepenalty but not reduction of penalty lower from imposition of penalty but cannot be reliedthan the minimum provided under the sections. upon for relief from penalty below the minimumThe understanding stands confirmed in penalty prescribed under the Act.Dharmendra Textile Processors (supra). In caseof CCE v. S.J. Mehta & Company (24) STR 383 4.3 Application of section 80 on different sections(Trib. - Ahd.), an important observation of cannot be different - Another importantHon’ble High Court has been relied upon, observation on section 80 by Tribunal requireswhich is reproduced from the ruling hereunder: mention here. In the case of Anil Kumar Yadav v. CCE [Final Order Nos. 67-68 of 2011, dated “This Court in the Tax Appeal No. 1367 20-1-2011], the following observation was made of 2009 has taken the view that on a by (CESTAT - Mad.) Tribunal: conjoint reading of sections 76 and 80 of the Act, it is not possible to envisage a “The said section 80 does not authorize discretion as being vested in the authority the adjudicating authority to waive the to levy a penalty below the minimum penalties under some of the listed sections prescribed limit. If the authority imposing and to impose penalty under some of the penalty is not entitled to levy below them. The only condition provided under the minimum prescribed, the appellate section 80 is that if the assessee proves authority and the Tribunal cannot read that there was a reasonable cause for the provision so as being vested with failure on his part for attracting penalties such powers, namely, to reduce the penalty under the sections listed thereunder, no below the minimum prescribed. This Court penalty shall be imposable.” has, therefore, answered the question Thus, if a reasonable cause has been upheld accordingly in the negative and the said for evoking section 80, no penalty can be imposed tax appeal was disposed of.” under all sections covered by section 80.The understanding has also been confirmed in 4.4 Existence of a reasonable cause is a must -the decision of CCE&C v. V.M. Constructions What is a ‘reasonable cause’? The phrase[Tax Appeal No. 828 of 2010, dated 25-11- ‘reasonable cause’ is wide enough to cover all718 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 118
  • 119. possible reasons which an assessee may have neutrality, involving no intention toto face which would have abstained him from evade tax.”complying with the provisions. The reasons (ii) Bona fide belief - An assessee not payingare beyond all ink to compile, so we discuss taxes on his bona fide belief that such taxhere few instances as upheld by courts as is not applicable on him is a good causebeing reasonable and deleting penalties: for non-imposition of penalty as has been (i) Absence of intention to evade taxes - held in various decisions. In the case of Absence of mens rea is but obvious the Shobha Digital Lab. 2011 (24) STR 430 (Trib. most important pleading in establishing - Delhi), the Tribunal deleted the penalty the reasonable cause as in absence of intent on the ground that in case of presence of to evade taxes, there remains no merit for a bona fide doubt on the part of the as- the taxpayer for non-compliance of a statute. sessee, penalty was deleted under section In the case of CST v. Vinayaka Travels 80. The court observed: [C.E.A. No. 59 of 2010, Misc. Civil Appeal “There being different views of High No. 21505 of 2010, dated 27-1-2010], High Courts expressing conflicting opi- Court observed as under: nion on the point of dispute are “Therefore, in the facts of the case, sufficient for any person to entertain it cannot be said that they intended a bona fide belief. In the circumstances, to evade duty and there was any mis-statement or suppression of facts, mala fide motive or intention in not if any, cannot be said to be wilful.” paying the tax within the time pres- Support may further be drawn from cribed. Therefore, the authorities in Jaiprakash Industries Ltd. v. CCE 2002 (146) exercise of their discretion under ELT 481 (SC) and Padmini Products section 80 of the Act, which is con- (supra). Similar decision has been taken ferred on them, held that the cause in the case of ETA Engineering Ltd. v. CCE shown is a reasonable cause and [2007] 8 STT 61 (New Delhi – CESTAT)/ waived the penalty, which is purely [2006 (3) STR 429 (Trib. - LB)] and K. a question of fact.” Prabhakar Reddy v. CCE [2011 (24) STR Revenue neutrality has also been accepted 330 (Trib. - Bang.)] as a reasonable cause and in absence of (iii) Service tax paid before show-cause notice intent to evade taxes, relief has been granted and liability not disputed - Payment of under section 80. Reliance in this regard taxes before issuance of show-cause no- may be placed upon CCE v. Chillies Ex- tice is also an important determinant of port House Ltd. [Final Order No. 318 of assessee’s intention. The same has also 2011, dated 15-2-2011] served as one of the reasonable causes for “However in the facts and circum- invocation of section 80. In the case of stances of the present case, the sub- CST v. Vijaya Bank [Final Order Nos. 81- mission of ld. advocate that it was 82 of 2011, dated 24-1-2011], the Tribunal a fit case for invoking the provisions held that if that be so, their coming for- of section 80 deserves to be taken ward and depositing the entire amount of note of. It is not in dispute that if service tax along with interest would get the respondent had paid the service covered by the provisions of section 73(3), tax during the disputed period, they which mandates the Revenue Officers, not would have been eligible for the to issue any show-cause notice. We find refund. This is a case of revenue- that the provisions of section 80 can be December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 119 719
  • 120. SERVICE TAX invoked in this case, there being reason- CONCLUSION able cause for non-imposition of penalty on the assessee. 5. Penal sections exist in every law to ensure proper compliance of the law by the subjects. Thus, the intention of a bona fide taxpayer The service tax law is also no different. Thus, has been taken cognizance of by the Court while the Act provides for penal provisions, for deleting the penalty. It can be inferred there are inbuilt reliefs for a genuine taxpayer that this plea can save a bona fide taxpayer where non-compliance is based on a bona fide from penalty as being made aware about belief or understanding. Section 80 has been applicable tax. However, a dishonest tax- time and again used by judicial and quasi judicial payer who intentionally evaded tax may bodies to provide relief to the assessees. Thus, not find favour from judiciary even on the section is an indispensable part of the Act payment of tax before issuance of show- and protects a genuine taxpayer, as penal cause notice. provisions punish an intentional defaulter. The above were some of the decided rea- sonable causes as held by different courts. ••• The list is not exhaustive and a genuine taxpayer needs no precedents.720 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 120
  • 121. INVESTMENT PLANNING Recent changes in PPF & Small Saving Schemes w.e.f. 1-12-2011 T his article examines the recent changes notified by Central Government in small savings schemes with effect from 1-12-2011BACKDROP w.e.f. 1-12-2011 which are discussed in the following paras. The summary of changes in1. The Central Government has notified various interest rates across all schemes is as under:changes including increase in interest rates Instrument  Current Rate (%) Increased Rate Remarks w.e.f. 1-2-2011 (%) Savings Deposit 3.5 4.0 Increased rates applicable to existing accounts also PPF 8.00 (tax-free) 8.6 (tax-free) —do— 1 year Time Deposit 6.25 7.7 Increased rates applicable only to new accounts opened on or after 1-12-2011 2 year Time Deposit 6.50 7.8 —do— 3 year Time Deposit 7.25 8.0 —do— 5 year Time Deposit 7.50 8.3 —do— December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 121 721
  • 122. INVESTMENTSERVICE TAX PLANNING Instrument  Current Rate (%) Increased Rate Remarks w.e.f. 1-2-2011 (%) 5 year Recurring 7.50 8.0 —do— Deposit 5 year MIS 8.00 (6 year MIS) 8.2 —do— 5% bonus on No bonus on maturity maturity 5 year NSC 8.00 (6 year 8.4 —do— NSC) DISCONTINUANCE OF KISAN VIKAS vide Notification F.No. 1-13/2011-NS-II launchedPATRA (KVP) new 10-year NSCs w.e.f. 1-12-2011 carrying interest rate of 8.7% p.a. compounded half-2. The Central Government has vide Notification yearly. Non-Resident Indians not eligible toF.No. 1/10/2011-NS-II], dated 25-11-2011 notified invest in this. This can be purchased inthat the sale of Kisan Vikas Patras shall be denominations of ` 100/` 500/` 1,000/` 5,000/discontinued with effect from the close of business ` 10,000. The interest is not tax-free. Onlyon Wednesday, the 30th November, 2011. thing is that TDS is not liable to be deducted from interest payment. Rule 24 clearly providesNEW 10-YEAR NSC (IX-ISSUE) that interest on these new 10-year NSCs shall be liable to tax under the Income-tax Act, 1961LAUNCHED W.E.F. 1-12-2011 on the basis of annual accrual specified in3. The Central Government has vide the National Rule 15 as under:Savings Certificates (IX-issue) Rules, 2011 notified The year for which interest accrues Amount of interest accruing on certificate of ` 100 denomination First Year 8.89 Second Year 9.68 Third Year 10.54 Fourth Year 11.48 Fifth Year 12.50 Sixth Year 13.61 Seventh Year 14.82 Eight Year 16.13 Ninth Year 17.576 Tenth Year 19.13722 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 122
  • 123. The amount of interest accruing on a certificate It would be interesting to compare this 10-of any other denomination shall be proportionate year NSC with NSC (VIII-issue). The salientto the amount specified above in the Table. features of comparison are as under: Points of comparison 10-year NSC (NSC IX issue) NSC (VIII issue)-5 year NSC Tenure 10 years 5 years Rate of interest 8.7% p.a. 8.4% p.a. (on NSCs issued on or after 1-12-2011) Whether investment in the No. This certificate has not yet Yes-as this has been notified under instrument qualifies for been notified under section 80C. section 80C Deduction under section 80C Investment in this certificate will of the Income-Tax Act, 1961? qualify for deduction only if and when notified under that section Whether accrued interest will No. Yes. Since rules provide that accrued be considered reinvestment interest shall be deemed to be qualifying for section 80C reinvestment deduction? Taxability of interest Fully taxable Fully taxable. However, interest qualifies for deduction under section 80C Effective rate of return for 7.83% 10.34% (after considering deduction taxpayer in 10% tax bracket in respect of interest and principal under section 80C). Effective rate of return for 6.96% 13.125% (after considering deduction taxpayer in 20% tax bracket in respect of interest and principal under section 80C) Effective rate of return for 6.09% 17.14% (after considering deduction taxpayer in 30% tax bracket in respect of interest and principal under section 80C)PUBLIC PROVIDENT FUND- contributions has been increased from ` 70,000AMENDMENTS TO THE PPF SCHEME to ` 1,00,000 vide the Public Provident Fund (Amendment) Scheme, 2011. The increase in4. The interest rate on PPF has been increased limits takes effect from 1-12-2011. Investmentfrom 8% p.a. to is 8.6% p.a. vide Notification in PPF qualifies for deduction under sectionF.No.1/9/2011-NS. (II), dated 25-11-2011 This 80C. Interest on PPF is tax-free under sectionhigher interest rate of 8.6% p.a. applies to 10(15) of the Act. It would be misleading toexisting balances as well as new contributions. compare the proposed 8.6% p.a. with interestThe annual ceiling on investment under Public offered by some PSBs on their fixed depositsProvident Fund (PPF) Scheme the subscriptions which is as much as 9.5% p.a. The returnsmade to the fund on or after the 1-12-2011. offered by banks on term deposits are fullyand the balances at the credit of the subscriber taxable while the 8.6% p.a. is tax-free.as on 1-12-2011. The ceiling on annual December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 123 723
  • 124. INVESTMENTSERVICE TAX PLANNINGThe effective tax-adjusted returns on PPF after considering tax benefits for taxpayers in varioustax brackets is as under: Tax Bracket Effective return on PPF (present) Effective return on PPF (w.e.f. 1-12-2011) 10% 9.88% p.a. 10.62% p.a. 20% 12.5% p.a. 13.43% p.a. 30% 16.33% p.a. 17.55% p.a. Non-taxpayer 8% p.a. 8.6% p.a.However, with the above good news also comes Presently, a bonus of 5% is paid on maturitysome not so good news. Interest on loans obtained which will not be payable on new ac-from PPF has been increased to 2% p.a. from counts opened on or after 1-12-2011existing 1% p.a w.e.f. 1-12-2011. Further, the u The maturity period for Monthly IncomeCentral Government has vide Notification F.No. Scheme (MIS) will be reduced from 6 years1/12/2011-NS-II], dated 25-11-2011 discontinued to 5 years.commission to agents under Standardized AgencySystem (SAS) on PPF collections w.e.f. 1-12- Thus, the increase of 0.2% p.a. for 5 years2011. This would mean that subscribers will works out to 1% p.a. over 5 years. This is morenot be able to avail the convenience of operating than offset by loss of 5% bonus. There are noPPF account through agents. tax concessions on MIS either by way of section 80C benefits or by way of tax-free interest under section 10(15) of the Income-Tax Act.MONTHLY INCOME SCHEME (MIS) With banks offering much higher rates of interest5. The Central Government has vide Notification than this on their FDs (some nationalized banksF.No. 1/11/2011-NS-II notified the following offer as high as 9.5% for 10-year deposits)changes to the Post Office Monthly Income coupled with loans against FDs and easyAccount Scheme (popularly known as MIS) premature encashment, it is doubtful whetherw.e.f. 1-12-2011 this new MIS scheme will fire the imagination of masses. u Rate of interest increased from 8% p.a. to 8.2% p.a. in respect of deposits made on or after 1-12-2011. In other words, there INCREASE IN INTEREST RATES ON POST is no rate increase for existing accounts. OFFICE TIME DEPOSITS u No bonus shall be paid on deposits made 6. The rates of interest of Post Office Time in accounts opened on or after 1-12-2011. Deposits have been increased as under vide Notification dated 25-11-2011 Deposit Current Rate (%) Revised increased rate w.e.f. 1-12-2011 (%) 1 year Time Deposit 6.25 7.7 2 year Time Deposit 6.50 7.8 3 year Time Deposit 7.25 8.0 5 year Time Deposit 7.50 8.3724 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 124
  • 125. Liquidity of Post Office Time Deposit (POTD) - These deposits particularly the one with 51, 2, 3 & 5 years - will be improved by allowing years tenure are comparable to NSCs and tax-premature withdrawal at a rate of interest 1% saver deposits with banks of 5-year durations.less than the time deposits of comparable These deposits, NSCs and the tax-saver termmaturity. For premature withdrawals between deposits with banks enjoy section 80C deduction6-12 months of investment, Post Office Savings subject to limit of ` 1,00,000. The differencesAccount (POSA) rate of interest will be paid. between Post-office Time Deposits (after proposed changes), NSCs and tax-saver term deposits with banks is as under: Post Office Time Deposits Tax-saver Term Deposits 5-year NSCs (NSC-VIII issue) with banks Term of the deposit Different tenures-1 year/ 5–year tenure only, 5–year fixed term 2 years/3 years/5 years neither shorter nor longer Premature encash- premature withdrawal No such facility. Cannot Premature withdrawal ment/liquidity at a rate of interest 1% even be pledged for permissible after 3 years in less than the time loans or given as certain exceptional circums- deposits of comparable security tances. maturity will be allowed. For premature with- drawals between 6-12 months of investment, Post Office Savings Account (POSA) rate of interest will be paid. Taxability of interest Fully taxable Fully taxable Fully taxable Whether interest No. No. Yes. accrued annually deemed to be reinvested and eligible for section 80C deduction? Sovereign Guarantee Yes. No. Yes. for repayment5 YEAR RECURRING DEPOSIT These schemes enjoy no tax benefits. Interest is fully taxable. Amount invested does not7. Vide Notification F.No. 1/7/2011 dated qualify for section 80C deduction. The increased25-11-2011, the rate of interest on 5–year recurring rate of 8% does not compare favourably atdeposit has been increased from 7.5% to 8% present to high rates of 9.5% p.a. offered byp.a. at a recurring deposit of ` 10 per month some public sector banks. The rates offered bywhich gave ` 728.90 on maturity will now PSBs are fixed and not liable to change in lineyield ` 738.62 on maturity. This amendment with changes in g-sec rates. So, if there is aapplies to new RDs opened on or after 1-12- perception that g-sec rates are not going to2011. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 125 725
  • 126. INVESTMENTSERVICE TAX PLANNINGincrease drastically over a five year period, it The RBI has deregulated interest rates on savingsmay make sense to open RDs with PSBs instead. bank accounts in banks. The interest on savings bank account in banks is not tax-free but fullyIn fact, the RD and MIS of Post Office formed taxable. When comparing rates of POSB andtogether a powerful accumulation combo-pack bank accounts, one should compare the rateswhere a person opens RDs, then deposits the offered by banks with the effective rate of pre-maturity amount into MIS and then again tax return on POSB and not with 4.0% whichreinvests the monthly payouts into RD which is tax-free rate.on maturity would again be invested into aMIS. But the removal of the 5% maturity bonus Further, the banks offer internet banking andon MIS and the comparatively lower rates of ATM withdrawals convenience which Post Officeinterest offered by RD and MIS as compared never offers.to banks would mean that investors wouldnow chose Bank RDs and Fixed Deposits for CONCLUSIONaccumulation. Further, banks offer facility foropening RDs and FDs through net banking 9. Only Public Provident Fund has becomewhich is not the case with Post Office. more attractive avenue for investment than before. In all other cases, it would seem bank deposits have become more desirable avenuesPOST OFFICE SAVINGS ACCOUNT for investments.8. The rate of return is proposed to be increasedfrom 3.5% to 4.0% p.a.. The revised rate of •••interest of 4.0% p.a. is tax-free under section10(15) of the Income-tax Act, 1961 and thustranslates into pre-tax rate of returns as underfor various tax-brackets. Tax bracket Pre-tax rate of return 10% 4.44% 20% 5.0% 30% 5.71% Non-taxpayer 4.0%726 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 126
  • 127. STOCK MARKET How STREET SMART INDIAN PROMOTERS 1. It is a known fact in our country that someshareholders of the Indian promoters are street smart in manipulating their accounts. Since the “Satyam saga” the above notion has gained such importance as never before. Manipulation of are cheated accounts and fudging up of books are common malpractices resorted to by the greedy entre- preneurs for personal vested interests. In a raging bull market revenue and profits are by some overstated to get a higher multiple of their stock price whereas in a dull market siphoning of funds through unethical means makes the day for them. It would be prudent to note that promoters large cap companies are smart enough to camouflage the figures. For a commoner its a Herculean task to find flaws in them. As far the mid and smallcap universe are concerned a close eye on them can reveal a lot of fuss. Without much ado here are a few notable examples of how manipulations have done it in the past or how they are still going on. WAYS OF MANIPULATIONS 2. Raising Fake Bills : Consider that you are the CEO of a listed company-you approach one of the coolest and helpful buddies of yours who happens to own an establishment. You ask him for the bill and you pay against the same by means of a cheque. Instead of getting the goods in lieu of the cheque you request for the money back and you pay a meagre commission to your buddy; the bill gets generated but the material never comes to the godown ARUN K. MUKHERJEE of the company and you pocket large bucks. Investment consultant This is a common practice indulged in by a number of listed corporates. Obviously, this reckless behaviour would result in losses for such companies. Stock price, thus, crashes and results falter but the entrepreneur makes a killing out of it. December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 127 727
  • 128. STOCK MARKETSERVICE TAXSIPHONING OF FUNDS from the truth. A lot of listed companies operate in collusion with several private concerns in3. Some quarters back a pharma company the name of their cohorts or in the name ofcalled farzi biggyan (name changed) sold its their relatives, trusted employee’s name, etc.,assets to a biotech company for a cash con- There are proprietary and partnership firmssideration of 60 odd crores. If the circumstances owned by the promoter in some other ‘benami’were not conducive to do business why on names. The listed company sells inventory toearth would a company not sell itself totally private firms that are owned by the promotersinstead of only its assets? Not a single penny at decimal profit margins. Those private firms,was paid as a dividend. Debts were not written in turn, make a killing by selling the same tooff or reduced. Company never expanded or the distributor or to the wholesaler at a fatwent in for a new venture and no bids were 12-15% margin. This is how the promoters getinvited. It got sold to the one which approached richer through dubious means whereas thejust casually without any credentials. Nobody innocent retail investors hoping to make someknows where the money went. As a result of money get stuck up, as the company neverthis initiative the company became like a shell delivers much to them.company and shareholders got big time cheated.The company is trading at below par in thebourses with negligible volumes. CREATING FAKE JVs 6. A lot of bogus companies go in for a JVMAKING GRANDIOSE ANNOUNCEMENTS and within a period of 5-6 years and pull off from them citing differences between the JV4. Imagine some listed company with not even partners. The investment gets written off after8 crores average quarterly turnover claiming a while. The money invested in the JV is nevera robust book position of over 1000 crores. It recovered. Creating a JV is a smart manner tomakes grandiose announcements and brags siphon off big sums of money. If asked aboutabout the company in the print media etc., the investment in it, the smart promoter wouldetc., to bag fake orders or sign fake MoU’s vow of having filed a lawsuit which incidentallywith desolate/out of reach countries. In such would never materialize. The promoter, withcases the Indian listed entity requests the foreign his canny ways would take back the moneyparty to sign the fake deal for the sake of in cash. So, “bat khatam paisa hazam”. Thisgetting its bank loan sanctioned. It pays the is one of the most popular tricks played byorder supplier a fat sum and convinces him the promoters. Well known establishments areto send a fax/signed MoU documents. Since adept at resorting to such means but since thisthe foreign company has nothing to loose and can never be proved, the practice is gettingis not accountable to the Indian laws it readily epidemic in nature with other ethical promotersobliges and the fake deal is made. The investors getting sucked in it.get fooled by being lured to buy the shares,promoter takes the advantage of the rise instock price by exiting and makes a killing TAKING GULLIBLE INVESTORS FOR Aagain. RIDE 7. Often the promoters work hand in gloveACTING IN COLLUSION AND IN BENAMI with the operators. The usual route is to showNAMES cooked up profits, loaned shares to operators and unloading of the promoter’s holding.5. There’s a myth among most of the retail Promoters usually collude with market operatorsinvestors that mills and textile companies hardly who flaunt about their right connections withmake much money. Nothing could be farther foreign and Indian institutional investors as728 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 128
  • 129. clients. The promoter also helps the operators are puppets of the promoters. They do analysisby coming out with fake announcements like on the instructions of the promoters.having bagged a huge order or a JV or an There are several other ways through whichacquisition which can bring a turn around in the money gets siphoned of by the promoterthe fortunes of the company. The hype takes causing disappoint to the investors who werethe stocks higher and eventually both the parties expecting to make some profit in stock markets.rake the mullah by dumping the simple gullible Unfortunately there’s nothing much one caninvestors. As the bubble bursts, investors are do about it. These unscrupulous promotersleft with worthless stocks and the entire money have deep pockets and right connections whichis gone. In the stock markets it is an open helps them in the time of need.secret that a lot of renowned/reputed analysts A couple of small cap stock ideas to enrich your lives folks : MID CAP MASTERPIECE - A STOCK TIP - 1Scripscan : WPIL Ltd. dollar multinational pump making company. They have agreed to manufacture pumps forBSE Code : 532054 SUPER CRITICAL THERMAL POWER PLANT’sCmp : 202 in INDIA which currently no one makes. India doesn’t have the right technology to makeMarketcap : 170crs those pumps. CLyde has also committed toRisk category : Low outsource its major orders to the Indian facility.Returns expected : 40% CAGR for next 5 years. They have also agreed to have technology transfer to manufacture pumps for Nuclear Power plantsStory : WPIL Limited is engaged in the design, in INDIA. WPIL recently acquired UK-baseddevelopment, manufacture, marketing, ‘Mathers Foundry’ which is in the business ofinstallation and servicing of pumps. The making steel castings used in equipments forcompany’s products include vertical turbine the oil and gas sectors, nuclear, paper, chemicalpumps, vertical mixed flow and axial flow and power generation companies. Mathers ispumps, submersible pumps, horizontal the sole manufacturer of castings in the ZERONcentrifugal pumps and iron castings. Its products range of Super Duplex alloys. ZERON is aare used in water supply, barge pump stations, super duplex stainless steel that resists allirrigation, thermal power plants, fire fighting, forms of corrosive actions in seawater service.sea water treatment, mining and in offshore WPIL’s thrust in the area of waste waterareas, nuclear power plants and river water treatment,mining and power plant relatedpumping applications. So it is a pump making pumping systems has got a major boost fromcompany which was earlier known as this acquisition. Both the developments shouldWorthington Pumps India Ltd. A few years catapult the company in the top major league.back the company which was with the BN The company’s fundamentals have alreadyKhaithan group was taken over by Mr. Prakash improved and bear testimony to the fact theAgarwal of Hindusthan Udyog Limited. The business is on right track. A glance throughopen offer was at Rs. 60.They hold nearly 75% the insider trading statistics given by the BSEstake in it. The main reason why people like shows that management is aggressively buyingthis company is because they have a JV with the shares from the open market. Check outCLYDE WATER PUMPS UK, a multi-billion the link given below of BSE to have a feel of December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 129 729
  • 130. STOCK MARKETSERVICE TAXthe confidence the management is having right 07 to ` 220 crores in FY 2011. Net profit marginnow (http://www.bseindia.com/Insidetrade_ has grown from ` 1.48 crores to ` 15.73 crores.ScripWise.asp?scripcd=505872).The promoters NPM which was as low as 2.30% way backknow most of the vital facts about their company. in FY07 short up to 7.17% in FY11.This yearThe increase in promoter’s holdings is a clear the company is expecting a 60% growth insignal of the present value of the company. their revenues to around 350 crores and NPThus promoters hiking stake in WPIL indicates of around 25 crores giving it an EPS of aroundthe confidence and sends a positive signal to 31.For a growing company with an amazingthe stakeholders. What is commendable about business model in place even if one assignsthe company is that, though there’s been a 10 PE the target price comes to ` 310. Theabsolutely no equity dilution for the past 11 company should keep on delivering at minimumyears, yet WPIL achieved 5 year top-line CARG of 40% CAGR growth per year for the nextof 27.6% and bottom-line CARG of 60.4%.Total 5 years. A gem of a buy at present levels. Justrevenues have grown from ` 65 crores in FY go for it! MID CAP MASTERPIECE - A STOCK TIP - 2Scripscan : KDDL Ltd. Cartier, Tag Heuer, Gucci, MontBlanc and so on. Having the experience of more than 20BSE Code : 532054 years in the international watch business, KDDLCmp : 133.50 Ltd. has promoted ETHOS Swiss Watch Studios as India’s first premium watch store carryingMarketcap : 95 crs a wide range of superb timepieces from theRisk category : Low best known manufacturers of the world. KDDLReturns expected : 50% CAGR for next 5 years. has carved a niche for itself with a unique business model in place. In view of the growingStory : KDDL Ltd. was established in the year spending propensity of the expanding HNI1983 with installation of a watch dial factory population, ETHOS is accelerating its storein technical collaboration with Leschot SA of rollout plan to cater to the fast growing demand.Switzerland. It has been recognized as the Already having 25 stores across the country,premium manufacturer of high quality watch the company has additionally signed-up fordials having state-of-the-art factories in different 20 new stores in the current financial year.industrial cities of India such as Parwanoo The management aims at adding 10-15 stores(Himachal Pradesh), Derabassi (Punjab) and every year over the next few years and byBangalore (Karnataka). KDDL has an annual 2015 ETHOS’s store portfolio should touchproduction capacity of 12 million dials across over 100 stores-far exceeding those of its4 production facilities. With a market share of competitors. One of the major costs involvedaround 70 %, it is the largest supplier to the in building a strong brand is the marketingIndian watch manufacturers like Titan, Timex expense. The company is leveraging the powerand HMT and Swiss watch group like Swatch. of social networking platforms like FacebookKDDL runs the retail chain, ETHOS, established that are fast emerging as innovative marketingin 2003 which has grown to be India’s largest mediums for building-up a strong customerretailer of Swiss watches offering a large variety base. The social group, under the name ofof exclusive brands, such as Omega, Rado, Ethos Swiss Watch Studios, is home to more730 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 130
  • 131. than 4,000 watch lovers where the company segment in the last decade (CAGR of 35%).is continuing to build strong bond with its With the rapid growth in the Indian populationcommunity. The company fervently believes and increased spending on luxury productsthat the members will increase to 20,000 by like watches, its retail subsidiary is all set toend of the next financial year. It further plans capture a lion’s share in the luxury watchto enhance its presence by creating communities retailing market. The fact that its retail subsidiaryacross other social media platforms. The was able to grow at 40% even during theincreasing cost of production in China due to recessionary period of 2008-10 shows its truehigher wages coupled with a stronger currency potential and prospects. Given the uniqueaugurs well for the manufacturing division. opportunity available to it backed up by aEven marginal shifts in outsourcing of watch qualified and experienced management, thecomponents by the Swiss watch manufacturers company has the right potential to become afrom China to India would present a huge 1,000 crore, market cap company in the nextopportunity to KDDL. On the retailing side, 5-6 years (it present market cap being 95 crores).there is no reason to believe why the Indian In short, its a low-risk high-return kind ofmarket cannot replicate the phenomenal growth investment with a high margin of safety.witnessed in Chinese luxury watch retailing ••• December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 131 731
  • 132. SERVICE TAX732 December 1 to 15, 2011 Taxmann’s Corporate Professionals Today Vol. 22 n 132
  • 133. RNI NO. : DELENG/2006/18023 D. NO. DL (C) - 05/1149/10-12LICENSED TO POST WITHOUT PRE-PAYMENT NO. U(C)-02/2010-12

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