(474.9 KiB, 442 DLs)

Despite s. 271(1B), s. 271 (1)(c) penalty is not valid if AO’s satisfaction not recorded at stage of initiation

In Ram Commercial Enterprises 246 ITR 568 (Del) {affirmed in Rampur Engineering 309 ITR 143 (Del) (FB)}, the Delhi High Court held that if the AO did not record his satisfaction that the assessee had concealed particulars of his income before completion of the assessment proceedings, the initiation of penalty proceedings was bad in law and the order imposing penalty was invalid. To supersede this law, sub-sec (1B) was inserted in s. 271 by the Finance Act, 2008 with retrospective effect from 1.4.1998 to provide that if the assessment order contained a direction for initiation of penalty proceedings under 271 (1) (c) it would be deemed to constitute satisfaction of the AO. S. 271 (1B) was challenged as being constitutionally invalid on various grounds. HELD upholding the validity of s. 271 (1B) on its own reading of the provision that:

(1) There is no cogent reason why retrospectivity to s. 271 (1B) is w.e.f. 01.04.1989. However, this cut off date does not create invidious discrimination and violate Art. 14 vis-à-vis those whose case is to be considered on the basis of law obtaining prior to 01.04.1989 because if an assessee has fallen foul of the law on penalty he cannot be heard to say that rigours of law ought not to apply to him because another person similarly placed is not exposed to such a rigour. There is no equality in illegality.

(2) Ram Commercial (and other judgements) do not lay down that reasons have to be recorded. The emphasis is on recording of satisfaction and that the prima facie satisfaction reached by the AO must be reflected and/or apparent from the assessment order itself.

(3) This law is not changed by s. 271 (1B). The Revenue cannot urge that prior to s. 271 (1B), “satisfaction” both at the initiation stage and the imposition stage was required but after s. 271 (1B) it is required only at the stage of imposition and not at the stage of initiation.

(4) S. 271 (1B) merely provides that an order initiating penalty cannot be declared bad in law only because it states that penalty proceedings are initiated. However, it must still be discernible from the record that the Assessing Officer has arrived at prima facie satisfaction for initiating penalty proceedings.

(5) The Revenue’s submission that prima facie satisfaction of the AO need not be reflected at the stage of initiation is not acceptable. The presence of prima facie satisfaction for initiation of penalty proceedings was and remains a jurisdictional fact which cannot be wished away even post amendment. If an interpretation such as the one proposed by the Revenue is accepted then s. 271 (1B) will fall foul of Article 14 of the Constitution as it will then be impregnated with the vice of arbitrariness. The AO would then be in a position to pick a case for initiation of penalty merely because there is an addition or disallowance without arriving at a prima facie satisfaction with respect to infraction of s. 271 (1)(c).

(157.2 KiB, 302 DLs)

Retracted Confessions can be acted upon

Pursuant to a search under FERA, the premises of the appellant were searched on 11.4.1989. Foreign currency was recovered though no incriminating material was found. In his statement recorded on the same day, the appellant confessed to indulging in various foreign exchange transactions. One Mr. Narendra Mirani also confessed that the foreign exchange seized from him during the search was purchased by him from the appellant and the rates of purchase were given. The appellant was arrested on 12.4.1989 and on 14.4.1989 he filed an application before the Magistrate and retracted the confessional statement on the ground that it was false and obtained under duress. Narendra Mirani also retracted his confession. It was argued that as, except the retracted confessional statement of the appellant and Narendra Mirani, there was no material to establish the charges against the Appellant, the conviction was illegal. On appeal, HELD, dismissing the appeal:

(1) The effect of Vinod Solanki vs. UOI (233) ELT 157 (S.C.) is that in criminal or quasi criminal proceedings, a person accused of commission of offence under FERA has not to prove to the hilt that confession has been obtained from him by inducement or threat by the person in authority. However, when confession had been retracted, the Court must bear in mind the attending circumstances and other relevant factors to come to conclusion whether the confession was voluntary and was not obtained by any inducement, threat or force. At the same time, mere retraction of the confession may not be sufficient to make confessional statement irrelevant for the purpose of quasi criminal proceedings and the Court is obligated to take into consideration the pros and cons of confession and retraction made by the accused.

(2) The effect of K.I. Pavunny vs. AC (90) ELT 241 (S.C.) is that if a confessional statement is retracted, the Court is required to examine whether it was obtained by threat, duress or promise and also whether the confession is truthful. If it is found to be voluntary and truthful inculpatory portion of the retracted confession can be acted and even conviction can be based upon the same. However, prudence and practice require that in case of retracted confession Court should seek assurance by way of corroboration from other evidence adduced. A general corroboration is sufficient.

(3) On facts, the appellant took more than two days to retract the statement even after production before the Magistrate. There is no plausible explanation retraction was not done at first available opportunity. Further, foreign exchange was recovered and when asked to explain the same, confessional statements were made by the appellant and Narendra Mirani. The confessions accordingly stand corroborated by the foreign exchange. In these circumstances, the confessional statements cannot be said to be made under force, duress, coercion or because of inducement from any person in authority. Accordingly, they can be acted upon despite retraction.

(152.0 KiB, 273 DLs)

Sale & Lease back transactions are not a “sham”

The assessee, a State Electricity Board, sold energy saving devices on which 100% depreciation was permitted and took the same assets on lease and claimed a deduction for the lease rent. The claim was disallowed by the AO & CIT (A) on the ground that the transactions were a “sham” though this was reversed by the Tribunal. On appeal by the department, HELD, dismissing the appeal:

(i) The fact that the machinery was an integral part of the boilers and continued with the assessee even after the sale is irrelevant because the assessee received the sale consideration and paid the lease rental. The mere reduction of tax liability is not conclusive of an arrangement being a “sham” or a “device”.

(2) The principle that an assessee is entitled to arrange his affairs to reduce tax liability, without violating the law has been approved by the Supreme Court in A. Raman 67 ITR 11 and Azadi Bachao Andolan 263 ITR 706 and the contrary observations in McDowell 154 ITR 148 are not the ratio of that judgement.

(3) The words “device” or “sham” cannot be used to defeat the effect of a legal situation.

(235.8 KiB, 667 DLs)

Replacement expenditure is neither “current repairs” nor “revenue”

The assessee incurred expenditure on replacement of machinery in a textile mill and claimed the same as revenue expenditure on the ground that it was merely for replacement of spare parts in the spinning mill system and did not give rise to a new asset. In the books, the expenditure was capitalized. The CIT (A), ITAT and High Court decided in favour of the assessee. However, on appeal by the revenue, HELD, reversing all the lower authorities:

(i) Each machine in a textile mill is a separate and independent item though it is a part of the integrated process of manufacture of yarn and is integrally connected to the other machines in the mill for production of the final product. The machine cannot be treated as a mere part of an entire composite machinery of the spinning mill.

(ii) To constitute “current repairs” u/s 31 the expenditure must be incurred to ‘preserve and maintain’ an already existing asset and not to bring a new asset into existence or to obtain a new advantage. For determination of ‘current repairs’ the question whether the expenditure is revenue or capital is not the proper test. However, as the machine was an independent entity, its’ replacement brought into existence a new asset and was not current repairs.

(iii) The expenditure was also not “revenue” u/s 37 (1) as the replacement brought into existence a new asset and also gave rise to an enduring benefit.

(iv) Though accounting practices may not be the best guide in determining the nature of expenditure, the fact that the assessee treated the expenditure as an addition to the existing assets shows that the claim for deduction under the Act was made merely to diminish the tax burden and not under the belief that it was actually revenue expenditure.

(494.3 KiB, 439 DLs)

Even “foreseeable losses” are allowable as deduction

The assessee was engaged in the business of executing works contracts and was following the mercantile system of accounting and the “percentage completion method”. It claimed a deduction for “foreseeable losses” on incomplete projects which was disallowed by the AO and CIT (A) on the basis that it was merely an anticipated loss based on an estimate. It was also held that as a major part of the work was not completed, the losses could not be properly anticipated. On appeal by the assessee, HELD, allowing the appeal:

(i) Para 13.1 of Accounting Standard 7 (AS-7) mandates that a foreseeable loss on the entire contract should be provided for in the financial statements irrespective of the amount of work done and the method of accounting followed;

(ii) The fact that AS-7 has not been notified by the Central Government as an accounting standard for purposes of s. 145 (2) is not relevant;

(iii) In principle, anticipated losses on incomplete projects are allowable as a deduction subject to their being calculated as per AS-7.

(189.7 KiB, 514 DLs)

Transfer Fees recd by Co-op Hsg Soc from incoming & outgoing members upto limits is exempt on the ground of mutuality

In Walkeshwar Triveni Co-op Hsg Society 88 ITD 159 (Mum) (SB), the Special Bench held that while transfer fees received from the transferor member was exempt from tax on the ground of mutuality, transfer fees received from the transferee member was not exempt from tax on the ground that at the time of payment, he was not a member of the society. In deciding cross appeals, HELD, partly reversing the judgement that:

(i) A Co-op housing society is a mutual association and satisfies all the tests of mutuality. There is no commerciality involved in it because its only activities are maintenance of its property and the subscription and or contributions received from its members can only be extended for this purpose. Further, the participants and contributors are identifiable and belong to the same class. The fact that only some members out of those who contributed may participate in the surplus is irrelevant as long as the class is identifiable.

(ii) Even transfer fees received from transferee members is exempt on the ground of mutuality because the fee can be appropriated only if the transferee is admitted to membership. If the transferee is not admitted, the moneys will have to be refunded.

(iii) However, if an amount is received more than what is chargeable under the Bye-laws or Government directions, the society is bound to repay the same and if it retains the same it will be in the nature of profit-making and that amount will be chargeable to tax.

(161.5 KiB, 511 DLs)

UOI vs. Dharmendra Textile 306 ITR 277 (SC) on 271 (1) (c) penalty distinguished

The assessee claimed set off of capital loss against profits of business, which was disallowed and penalty proceedings u/s 271 (1) (c) for ‘furnishing inaccurate particulars’ was imposed. The CIT (A) and ITAT deleted the penalty by holding that set off was wrongly claimed on account of counsel’s negligence and penalty was not leviable. The department argued before the High Court that even if the set-off of capital loss against business profits was by negligence or mistake, the fact remains that the particulars of income furnished were not correct and willful concealment not being an essential requirement for levy of penalty u/s 271(1)( c) as held by the Supreme Court in UOI vs. Dharmendra Textile Processors 306 ITR 277, penalty could not be deleted. HELD, rejecting the plea:

The judgment in Dharmendra Textile cannot be read as laying down that in every case where particulars of income are inaccurate, penalty must follow. What has been laid down is that qualitative difference between criminal liability u/s 276C and penalty u/s 271(1) ( c) had to be kept in mind and approach adopted to the trial of a criminal case need not be adopted while considering the levy of penalty. Even so, the concept of penalty has not undergone change by virtue of the said judgment. Penalty is imposed only when there is some element of deliberate default and not a mere mistake. In view of the finding that the furnishing of inaccurate particulars was simply a mistake and not a deliberate attempt to evade tax, penalty was not leviable.

(29.4 KiB, 453 DLs)

Reference to larger Bench against Daga Capital rejected but appeals blocked

The assessee contended that the judgement of the ITAT Mumbai Special Bench in Daga Capital 26 SOT 603 where the view was taken that s. 14A (2) and (3) inserted by the Finance Act 2006 w.e.f 1-4-2007 and Rule 8-D inserted by the Income Tax (5th Amendment) rules 2008 w.e.f. 24-3-2008 were retrospective and applied w.e.f 1.4.1962 was wrong and the matter was required to be reconsidered by a 5 Member Bench on the following grounds:

(i) Rule 8D results in an onerous liability which takes it beyond the pale of being a mere procedural / clarificatory or declaratory provision. It results in a fresh liability imposed upon the assessee. It creates a departure from settled principles and goes far beyond the object and scope of section 14A (1) of the Act. Accordingly, Rule 8D cannot be interpreted as being retrospective in operation.

(2) The intention of s. 14A was to disallow expenditure that relates to earning of exempt income and not to disallow some astronomical expenditure determined as per artificial Rules. The disallowance mandated by Rule 8D many a times far exceeds the income and in effect there will be an enhancement of income if Rule 8-D is interpreted in the manner done by the Special Bench.

(3) On facts, the disallowance as per Rule 8-D on a dividend income of Rs. 1.81 crore works out to Rs. 6.12 crores. Other examples are provided to show that the disallowance of alleged expenditure will exceed the exempt income.

However, HELD rejecting the application that:

(i) Although at the time of hearing, the initial impression was to write a reference to the President for constituting a larger Bench the fact that an appeal has been filed in the Bombay and Delhi High Courts against Daga Capital means that (as per the decision of the President in Star India) a reference to a larger bench cannot be made.

(ii) However, the appeals should be blocked for 6 months or till the disposal of appeal by the Bombay High Court in Daga Capital whichever is earlier.

See Also:

 

(i) New Rule 8D – A lesson in tight rope walking? By CA Anant Pai

 

(ii) DCIT vs. Citizen Hotels (ITAT Mumbai) and ACIT vs. Indexport Ltd (ITAT Mumbai) (S. 14A & Daga Capital cannot put assessee in worse position)

 

(iii) Harsha Bhogle 114 TTJ 266 (Mum): Reference to Special Bench is not permitted when appeal is pending before the High Court.

 

(126.5 KiB, 251 DLs)

(iv) Click the button for the Bombay High Court’s order admitting Daga Capital’s appeal.

(138.2 KiB, 342 DLs)

U/s 260A, High Court has no power to condone delay

S. 260A permits the filing of an appeal to the High Court within 120 days. In CIT vs. Velingkar Brothers 289 ITR 382 (Bom) (FB), The Full Bench held that the Court had power to condone delay u/s 260A. However, in Hongo India 236 E.L.T. 417 and Chaudharana Steels 238 E.L.T. 705, the Supreme Court held in the context of sections 35H & 35G of the Excise Act, that in the absence of specific powers, the High Court has no power to condone delay. On the question whether the said judgement of the Supreme Court would apply to s. 260A as well, HELD:

S. 35 G of the Excise Act is pari materia with s. 260 A of the I. T. Act. S. 260 A (7) as well as s. 35 G (9) of the Excise Act provide that the provisions of the Code of Civil Procedure, 1908 relating to appeals to the High Court shall as far as may be, apply to the appeals filed under the respective provisions. No such provision is to be found in Section 35 H of the Excise Act. Therefore, the argument advanced by the Counsel for the revenue that s. 35 G and s. 35 H of the Excise Act are materially different cannot be said to be wholly without substance. However, once the Apex Court has held that the High Court has no power to condone delay in filing Appeal under s. 35 G of the Excise Act, we have no option but to hold that this Court has no power to condone delay under s. 260 A because s. 260 A is pari materia with s. 35 G of the Excise Act. As the appeals were delayed, they had to be dismissed.

(208.1 KiB, 381 DLs)

Balancing charge is not chargeable to tax

The assessee purchased bottles and crates costing less than Rs. 5,000/- and was allowed 100% depreciation thereon u/s 32 (1) (ii). When the bottles and crates got worn out, they were sold by the assessee. The question arose whether the said sale proceeds were assessable to tax. Prior to AY 1988-89, the sale proceeds would have been assessable as a “balancing charge” u/s 41 (2). After the deletion of s. 41 (2), the department claimed that depreciation constituted “expenditure” and that the sale proceeds represented a “recoupment of that expenditure” which was chargeable as business profits u/s 41 (1). HELD, rejecting the stand of the department that:

(i) Prior to 1.4.1988, Ss. 41(1) and 41(2) both existed on the statute book. S. 41(1) deals with recoupment of trading liability while s. 41(2) deems balancing charge to be business income. Both operate in different spheres. If the argument of the department that balancing charge should be read as falling within the scope of s. 41(1) is accepted then it was not necessary for Parliament to enact S. 41(2) in the first instance. Section 41(1) alone would have sufficed.

(ii) The necessity to enact s. 41(2) in addition to s. 41(1) arose from the fact that, in its very nature, depreciation is neither a loss, nor expenditure, nor a trading liability, referred to in s. 41(1). Depreciation recovered on sale of a capital asset was includible in the total income as balancing charge only under s. 41(2). That concept was foreign to the scheme of s. 41(1).

(iii) Even after the introduction of the concept of “block of assets” w.e.f. 1.4.1988, the proviso to s. 32(1) (ii) continued till 1.4.1995. After that date, even purchases below Rs. 5,000 came within “block of assets”. Accordingly, assets purchased prior to 31.3.1995 do not form part of the block of assets and profits on sale of such assets are not taxable as a balancing charge either u/s. 41(1) or u/s 50.