(125.7 KiB, 493 DLs)

No S. 14A/ Rule 8D disallowance without showing how assessee is wrong

In AY 2009-10, the assessee earned tax-free dividend of Rs. 32 lakhs on investments that had been made in earlier years. The assessee claimed that as he had not incurred any expenditure to earn the dividend income, no disallowance u/s 14A was permissible. The AO rejected the claim and made a disallowance by applying Rule 8D. The CIT(A) deleted the disallowance on the ground that the AO had mechanically applied Rule 8D to compute the disallowance. On appeal by the department to the Tribunal, HELD dismissing the appeal:

The AO has not brought on record anything which proves that there is any expenditure incurred towards earning of dividend income. The AO has not examined the accounts of the assessee and there is no satisfaction recorded by the AO about the correctness of the claim of the assessee and without the same he invoked Rule 8D. While rejecting the claim of the assessee with regard to expenditure or no expenditure, as the case may be, in relation to exempted income, the AO has to indicate cogent reasons for the same. The AO has not considered the claim of the assessee and straight away embarked upon computing disallowance under Rule 8D of the Rules on presuming the average value of investment at ½% of the total value. This is not permissible (J. K. Investors (Bombay) followed)

(79.1 KiB, 439 DLs)

S. 153A: After expiry of s. 143(2) time limit, s. 143(1) assessment is final & addition u/s 153A can be made only if incriminating material is found in search

For AY 2005-06, the AO passed an intimation u/s 143(1) accepting the return as filed. Subsequently, there was a search u/s 132. The AO noticed that an amount of Rs. 93 lakhs received by the assessee as a loan in earlier years had been treated as a gift and credited to the capital account. He passed an assessment order u/s 153A in which he held that the said amount was assessable as a cash credit u/s 68. The CIT(A) partly confirmed the addition. Before the Tribunal, the assessee argued that as no incriminating material was found during the search, the addition could not be made u/s 153A. HELD by the Tribunal upholding the plea:

In All Cargo Global Logistics 137 ITD 287 (Mum)(SB), the Special Bench held that in a case where the assessment has abated the AO can make additions in the assessment, even if no incriminating material has been found. However, in a case where the assessment has not abated, an assessment u/s 153A can be made only on the basis of incriminating material (i.e. books of account & other documents found in the course of search but not produced in the course of original assessment and undisclosed income or property disclosed during the course of search). On facts, as the assessment was completed u/s 143(1) and the time limit for issue of s. 143(2) notice had expired on the date of search, there was no assessment pending and there was no question of abatement. Therefore, the addition could be made only on the basis of incriminating material found during search. As the addition u/s 153A was made on the information/material available in the return of income (i.e. the information regarding the gift was available in the return of income as capital account had been credited by the assessee by the amount of gift) and not on the basis of any incriminating material found during the search, the AO had no jurisdiction to make the addition u/s 153A.

(143.4 KiB, 580 DLs)

S. 40(a)(ia) TDS: Special Bench verdict in Merilyn Shipping is not good law

The assessee incurred expenditure on which TDS ought to have been deducted but was not. The AO disallowed the expenditure u/s 40(a)(ia). On appeal, the Tribunal relied on Merilyn Shipping & Transports 146 TTJ 1 (Viz) (SB) and held that the disallowance u/s 40(a)(ia) could be made only for the expenditure that is “payable” as of 31st March and not for the amounts that have already been “paid” during the year. On appeal by the department to the High Court, HELD reversing the Special Bench:

The key words in s. 40(a)(ia) are “on which tax is deductible at source under Chapter XVII –B” and this makes it clear that it applies to all expenses. Nothing turns on the fact that the legislature used the word ‘payable’ and not ‘paid or credited’. Unless any amount is payable, it can neither be paid nor credited. If an amount has neither been paid nor credited, there can be no occasion for claiming any deduction. The Special Bench was wrong in making a comparison between the draft Bill and the enacted law to determine the intention of the Legislature. A comparison is permissible only between the pre-amendment and post amendment law to ascertain the mischief sought to be remedied or the object sought to be achieved by the amendment. The fact that the impact of s. 40(a)(ia) is harsh is no ground to read the same in a manner which was not intended by the legislature. The law was deliberately made harsh to secure compliance of the provisions requiring deductions of tax at source. It is not the case of an inadvertent error. For the same reason, the second proviso sought to become effective from 1st April, 2013 cannot be held to have already become operative prior to the appointed date. Consequently, the majority view in Merilyn Shipping & Transports is not acceptable.

(237.6 KiB, 356 DLs)

Removal of ITAT President appointed on “officiating” basis is proper & legal

Shri. G. E. Veerabhadrappa, the senior-most Vice President of the Tribunal, was vide order dated 13.10.2011 appointed President of the Tribunal in an “officiating capacity till the post was filled up on regular basis“. Vide notification dated 5.5.2012 the said order was modified to read “in an officiating capacity up to 31.8.2012 or further orders“. On 31.8.2012, Shri. H. L. Karwa was appointed the President in place of Shri. G. E. Veerabhadrappa. Shri. Veerabhadrappa was thereafter transferred on 7.11.2012 to Calcutta. Shri. Veerabhadrappa filed a Petition claiming that (i) the curtailment of the period of appointment till 31.8.2012 was unjustified, (ii) his removal from the post of President was actuated by “malice and personal vendetta” of the Law Secretary owing to his refusal to cancel the transfers of Shri. Hari Om Maratha and Smt. Diva Singh and (ii) the appointment of Shri. H. L. Karwa (the junior-most Vice President) as President was irregular as found by the Appointments Committee of the Cabinet. The Law Ministry opposed the Petition on the ground that there were complaints regarding integrity and that the decision was taken at the highest level after “due consideration”. HELD by the CAT dismissing the Petition:

(i) The order appointing the Applicant as President made it clear that the appointment was “in an officiating capacity and until further orders“. The appointment order did not confer any invincible right on the Applicant to continue in office. Also, the order dated 5.5.2012 restricting the Applicant’s tenure as President till 31.8.2012 was challenged by him several months later. Even though there may not be delay and laches, it can be said that the conduct was one of acquiescence and did not entitle him to relief;

(ii) As regards the allegation that the removal was motivated by “malice and personal vendetta“, the exchange of correspondence between the President and the Law Ministry regarding the transfers of the Members took place after the passing of the order dated 5.5.2012 curtailing the tenure of the Applicant till 31.8.2012. There is some merit in the contention of the Respondents that the Applicant is trying to create a “smoke screen” by unnecessarily dragging the names of the Law Secretaries and making personal allegations;

(iii) The allegation that the appointment of Shri. H. L. Karwa as Officiating President was improper as a selection process was not resorted to is also not correct. The Government is entitled to appoint the President in an officiating capacity so as to ensure that no vacuum is left in the Institution. The opinion expressed by the Appointments Committee of the Cabinet is totally misconceived. It is immaterial whether the person appointed as officiating President is junior or not and there is no question of supersession. It is, however, desirable that the appointment to the post of President be made at the earliest on a regular basis rather than on an ad-hoc/ officiating basis.

(221.0 KiB, 1,408 DLs)

Taxation of foreign professional firms & concept of “force of attraction” under India-UK DTAA explained. Linklaters LLP 40 SOT 51 (Mum) held to be not good law

The assessee, a U.K. partnership firm of Solicitors, provided legal consultancy services in connection with different projects in India and claimed that the taxability of the income arising there from had to be processed under Article 15 (“independent professional services“) of the India-UK DTAA. The AO rejected the claim regarding applicability of Article 15 and held that as the assessee had a PE in India as per Article 5 and as the services had been rendered in India, the entire income was chargeable to tax in India under Article 7. In AY 1996-97, the Tribunal (82 ITD 106 (Mum)) accepted the claim of the assessee that if the aggregate period of stay of the employees/ partners did not exceed 90 days, the income was not taxable under Article 15 of the DTAA and if it exceeded that period, only the Indian activity was taxable u/s 9(i). The said verdict was affirmed by the Bombay High Court in 176 Taxman 485. Later, another Bench in Linklaters LLP vs. ITO 40 SOT 51 (Mum) held that as the aforesaid verdicts of the Tribunal & High Court in Clifford Chance turned on the basis that fees for technical services rendered outside India were not chargeable to tax u/s 9(1)(vii) and that they were not good law in view of the retrospective amendment to s. 9(1) by the Finance Act, 2010 w.e.f. 1.6.1976 which provided that “fees for technical services” would be taxable in India even if they were rendered outside India. In Linklaters LLP it was also held that the expression “directly or indirectly attributable” in Article 7(1) triggered the “force of attraction” rule and that the entire earnings relatable to the projects in India would be chargeable to tax in India. As there was doubt as to the correctness of the view in Linklaters, the Special Bench was constituted to consider two issues (i) whether the verdict of the High Court in Clifford Chance was good law after the retrospective amendment to s. 9 & (ii) whether the expression “directly or indirectly attributable to the PE” in Article 7(1) meant that the consideration attributable to the services rendered in the State of residence is taxable in the source State. HELD by the Special Bench:

(i) The view taken by the Tribunal and the High Court in Clifford Chance was that if Article 15 of the India-UK Treaty is not applicable because the stay of the partner exceeded 90 days, then the taxability of the income would be determined by s. 9(1)(i) of the Act. It was held that for determination of income u/s 9(1)(i), the territorial nexus doctrine plays an important part and if the income arises out of operations in more than one jurisdiction, it would not be correct to contend that the entire income accrues or arises in each of the jurisdictions. The High Court applied the law laid down by the Supreme Court in the context of s. 9(1)(i) that if all the operations are not carried out in the taxable territories, the profits and gains of business deemed to accrue in India through and from business connection in India shall be only such profits and gains as are reasonably attributable to the operations carried out in the taxable territories. Accordingly, the view expressed in Linklaters LLP that the judgment of the Bombay High Court is based on the premise of s. 9(1)(vii) and that the said premise no longer holds good in view of the retrospective amendment is not correct. The law laid down by the High Court continues to be good law;

(ii) As regards the rule of “force of attraction“, Article 7(1) provides that the profits of the UK enterprise “directly or indirectly attributable to the PE” may be assessed in India. The connotation of what is “directly attributable to the PE” is set out in Article 7(2) while the connotation of what is “indirectly attributable to the PE” is set out in Article 7(3). When the connotation of “profits indirectly attributable” to the PE is defined specifically in Article 7(3), one cannot refer to Article 7(1) of the UN Model Convention which is materially different from Article 7(1) & 7(3) of the India-UK DTAA. The reliance placed in Linklater on the UN Model Convention to come to the conclusion that the connotation of “profits indirectly attributable to PE” in Article 7(1) incorporates the “force of attraction” rule thereby bringing an enterprise having a PE in another country within the fiscal jurisdiction of that another country to such a degree that such another country can properly tax all profits that the enterprise derives from that country – whether the transactions are routed and performed through their PE or not – is clearly misplaced and not acceptable.

(270.1 KiB, 847 DLs)

Law on what constitutes a PE and how to attribute profits to a PE explained

The Tribunal had to consider the following legal issues: (i) whether the assessee could be said to have a PE in terms of Article 5(1) and 5(2) of the DTAA? (ii) what is the correct method to allocate profits to the PE?, (iii) whether fees for software is assessable as royalty after the retrospective amendment to s. 9(1)(vi) and (iv) whether the payment for link charges is taxable as ‘equipment royalty’? HELD by the Tribunal:

(i) The assessee’s argument that it does not have a PE under Article 5(1) cannot be accepted because its employees frequently visited the premises of CIS to provide supervision, direction and control over the operations of CIS and such employees had a fixed place of business at their disposal. CIS was practically the projection of assessee’s business in India and carried out its business under the control and guidance of the assessee and without assuming any significant risk in relation to such functions. Besides the assessee has also provided certain hardware and software assets on free of cost basis to CIS. However, it does not constitute a dependent agent PE in terms of Article 5(4) and 5(5) of the DTAA;

(ii) The correct approach to arrive at the profits attributable to the PE should. be as under: (i) compute the Global operating Income percentage of the customer care business as per annual report/10K of the company, (ii) this percentage should be applied to the end-customer revenue with regard to contracts/projects where services were procured from CIS. The amount arrived at is the Operating Income from Indian operations, (iii) the operating income from India operations is to be reduced by the profit before tax of CIS. This residual is now attributable between US and India, (iv) the profit attributable to the PE should be estimated on residual profits as determined under Step 3 above;

(iii) As regards the taxability of software license fees, he retrospective amendment to s. 9(1)(vi) by the Finance Act, 2012 widens the scope of the term “royalty” but does not impact the provisions of the DTAA in any manner. Consequently, the purchase of software falls within the category of copyrighted article and not towards acquisition of any copyright in the software and hence the consideration is not assessable as Royalty. Even otherwise, as the payment is in the nature of reimbursement of expenses, it is not taxable in the hands of the assessee (B4U International Holding & Nokia Networks OY followed);

(iv) As regards the payment of link charges as equipment royalty, there is no transfer of the right to use, either to the assessee or to CIS. The assessee has merely procured a service and provided the same to CIS, no part of equipment was leased out to CIS. Even otherwise, the payment is in the nature of reimbursement of expenses and accordingly not taxable in the hands of the assessee.

(122.7 KiB, 357 DLs)

Transfer Pricing: All related transactions cannot be considered for PLI determination

The assessee’s parent company, Digital Microwave Corporation USA, supplied equipment to Indian customers for which the assessee received commission. The said equipment was covered by warranty and the service relating thereto was provided by the assessee. The assessee also undertook installation of the said equipment and provided annual maintenance. The assessee claimed that while the receipt of commission and the provision of warranty service were “international transactions” with the AE and subject to transfer pricing regulations, the installation & maintenance service was an independent transaction and could not be considered while computing the PLI for determining the ALP. The TPO rejected the claim and held that in computing the profit level indicator of the international transactions involving warranty services and commission income, the operating revenue and operating costs of the installation/commissioning and maintenance services had to be taken. The CIT(A) & Tribunal upheld the assessee’s claim. On appeal by the department to the High Court, HELD dismissing the appeal:

The department’s argument that the installation, commissioning & maintenance services were intricately connected with the international transactions of warranty support services and commission income and that their operating cost and operating revenue had to be considered while computing the profit level indicator is not acceptable because the installation/ commissioning and maintenance agreements were independent agreements unconnected with the transactions of warranty support services and commission income. This is shown by the fact that while the equipment was supplied to 40 customers by the AE, only three of them availed of the installation services from the assessee. Also, a corroborative circumstance for construing the transactions of installation/commissioning and maintenance as domestic transactions was that the TPO had made no adjustment in respect of these transactions. The transactions pertaining to the installation/commissioning and maintenance services were also not deemed international transactions u/s 92B(2) because none of the conditions stipulated therein of a prior agreement existing between the customers of the assessee and the AE have been established as a fact. Moreover, there is no finding that the terms of the transaction of installation/commissioning as well as maintenance had been determined in substance between the customers and the assessee by the AE. In the absence of such finding, it cannot be deemed that the transaction of installation/commissioning as well as provision of maintenance services by the assessee to its domestic customers in India were international transactions falling within s. 92B(2).

(76.4 KiB, 305 DLs)

Writ to restrain ITAT Members from discharging statutory functions not maintainable

The Petitioner, a Chartered Accountant practicing before the Amritsar Bench of the Tribunal, filed a Writ Petition alleging that he was facing a lot of harassment at the hands of the Judicial Member (Shri. H. S. Sidhu) and the Accountant Member (Shri. B. P. Jain) of the Amritsar Bench. He alleged that the said Members were totally prejudiced against him as he had made a complaint against the Judicial Member to the Tribunal and also because he had not been able to meet the “expectations” and “illegal demands” of the said Members. It was also alleged that the Bench was delaying the matters of the Petitioner or passing unreasoned orders or by totally ignoring him. A Writ of Mandamus was sought for restraining the said Judicial and Accountant Members of the Amritsar Bench from discharging their functions. HELD by the High Court dismissing the Petition:

It appears that the writ petition is to settle scores which the Petitioner might have raised during the course of his conduct as representative of the assessees. The Petitioner has asserted that he is not able to meet the expectations and illegal demands raised by the Members but there are no details as to when and how the demands were raised. Not only the writ petition is bereft of any material particulars but also the Petitioner has no right to claim mandamus for restraining an authority constituted under the Act from discharging the functions entrusted to it by the Statute. The present writ petition is gross abuse of process of law and, therefore, it is dismissed.

(218.9 KiB, 713 DLs)

S. 40(a)(ia) TDS: Special Bench verdict in Merilyn Shipping is not good law

The assessee, engaged in the business of transport contractor and commission agent, incurred expenditure of Rs. 8.74 crores on payment to contractors where no TDS was deducted. The AO & CIT(A) held that the expenditure had to be disallowed u/s 40(a)(ia). On appeal, the Tribunal, relying on Merilyn Shipping & Transports 146 TTJ 1 (Viz) (SB) held that as the said amount had already been paid and was not “payable” as of 31st March, the disallowance u/s 40(a)(ia) could not be made. On appeal by the department to the High Court, HELD reversing the Tribunal:

In Merilyn Shipping 146 TTJ 1 (Viz) (SB) the majority held that as the Finance Bill proposed the words “amount credited or paid” and as the Finance Act used the words “amounts payable“, s. 40(a)(ia) could only apply to amounts that are outstanding as of 31st March and not to amounts already paid during the year. This view is not correct for two reasons. Firstly, a strict reading of s. 40(a)(ia) shows that all that it requires is that there should be an amount payable of the nature described, which is such on which tax is deductible at source but such tax has not been deducted or if deducted not paid before the due date. The provision nowhere requires that the amount which is payable must remain so payable throughout during the year. If the assessee’s interpretation is accepted, it would lead to a situation where the assessee who though was required to deduct the tax at source but no such deduction was made or more flagrantly deduction though made is not paid to the Government, would escape the consequence only because the amount was already paid over before the end of the year in contrast to another assessee who would otherwise be in similar situation but in whose case the amount remained payable till the end of the year. There is no logic why the legislature would have desired to bring about such irreconcilable and diverse consequences. Secondly, the principle of deliberate or conscious omission is applied mainly when an existing provision is amended and a change is brought about. The Special Bench was wrong in comparing the language used in the draft bill to that used in the final enactment to assign a particular meaning to s. 40(a)(ia). Accordingly, Merilyn Shipping does not lay down correct law. The correct law is that s. 40(a)(ia) covers not only to the amounts which are payable as on 31th March of a particular year but also which are payable at any time during the year.

(92.7 KiB, 642 DLs)

S. 43(5): Loss on foreign currency forward contracts by a manufacturer/ exporter is a “hedging loss” and not a “speculation loss”

The assessee, an exporter, entered into forward contracts with Banks to hedge against any loss arising out of fluctuation in foreign currency. The forward contract provided that the assessee would buy some quantity of dollars at a particular rate to cover export bill payment. The contract gave delivery option dates and the assessee had the option to cancel the contract and pay the loss to the Bank. The assessee suffered a loss of Rs. 15 lakhs on such cancellation. The AO & CIT(A) held that the loss constituted a “speculation loss” u/s 43(5) and could not be allowed as a deduction. On appeal, the Tribunal upheld the assessee’s claim. On appeal by the department, HELD dismissing the appeal:

Though the assessee is not a dealer in foreign exchange, it entered into forward contracts with banks for the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts. The transactions in foreign exchanges were incidental to the assessee’s regular course of business and the loss was thus not a speculative loss u/s 43(5) but was incidental to the assessee’s business and allowable as such. The fact that there may have been no direct co-relation between the exchange document and the precise export contract cannot be seen in isolation if there are in fact several separate contracts with the bankers (Soorajmull Nagarmull 129 ITR 169 (Cal) & Badridas Gauridu 261 ITR 256 (Bom) followed; M. G. Brothers 154 ITR 695 (AP) distinguished)