(402.8 KiB, 1,719 DLs)

s.153A does not authorize de novo assessment. Non-pending assessments do not abate. Additions must be confined to search material

S. 153A provides that where a search is initiated u/s 132 the AO shall “assess or reassess the total income of six assessment years immediately preceding the assessment year” relevant to the previous year in which the search is conducted or requisition is made. The 1st Proviso states that the AO shall “assess or reassess the total income in respect of each assessment year falling within such six assessment years” while the 2nd Proviso states that the assessment or reassessment relating to the said six assessment years “pending” on the date of initiation of the search under section 132 shall “abate“. In the assessee’s case, search action was initiated and assessments under s. 153A were framed for six assessment years making various additions. The assessee claimed that the additions were not tenable as regular returns had been filed where the particulars relating to the additions had been disclosed and the same had been accepted u/s 143 (1) and also that no material had been found during the search to justify the additions. The revenue claimed that the effect of the Provisos to s. 153A was that all assessments abate and there had to be a de novo assessment in which the AO was not confined to the material found during the search. HELD rejecting the claim of the Revenue:

(i) S. 153A does not authorize the making of a de novo assessment. While under the 1st Proviso, the AO is empowered to frame assessment for six years, under the 2nd Proviso, only the assessments which are pending on the date of initiation of search abate. The effect is that completed assessments do not abate. There can be two assessments for the same assessment year. Assessments which are not pending before the AO on the date of search but are pending before an appellate authority will survive.

(ii) An assessment can be said to be “pending” only if the AO is statutorily required to do something further. If a s. 143 (2) notice has been issued, the assessment is pending. However, the assessment in respect of a return processed u/s 143 (1) is not “pending” because the AO is not required to do anything further about such a return.

(iii) The power given by the 1st Proviso to “assess” income for six assessment years has to be confined to the undisclosed income unearthed during search and cannot include items which are disclosed in the original assessment proceedings.

(iv) On facts, as the returns had been processed u/s 143 (1), the assessments were not “pending” and as no material was found during the search, the additions could not be sustained.

(155.6 KiB, 1,209 DLs)

Reopening u/s 147 not valid if there is no finding regarding failure to disclose material facts

In AY 2002-2003, the assessee claimed deduction u/s 80-IB (10) of Rs. 3.85 crs which was allowed by the AO vide s. 143 (3) order. The assessment was reopened u/s 147 after the expiry of four years from the end of the assessment year on the ground that the claim for deduction u/s 80IB (10) included ineligible items of other income such ‘society deposit’, ‘stilt parking’ and sundry credit balances and that income had thereby escaped assessment. The assessee filed a writ petition to challenge the s. 148 notice. HELD upholding the challenge:

(i) Under the proviso to s. 147, an assessment made u/s 143 (3) can be reopened after the expiry of 4 years from the end of the assessment year only if there is a failure on the part of the assessee to disclose fully and truly all material facts necessary for the assessment;

(ii) On facts, the assessee had furnished details of the claim u/s 80IB (10) including the break up of the other income. Even the recorded reasons showed that the inference that the income has escaped assessment was based on the disclosure made by the assessee itself. Further, there was no finding in the recorded reasons that that there was a failure to disclose necessary facts;

(iii) Accordingly, the condition precedent to a valid exercise of the power to reopen the assessment was absent. An exceptional power has been conferred upon the Revenue to reopen an assessment after a lapse of four years and the conditions prescribed by the statute for the exercise of such a power must be strictly fulfilled and in their absence, the exercise of power would not be sustainable in law.

(43.1 KiB, 793 DLs)

Twisting and texturising POY is “manufacture”. Department must examine process. Opinion of expert must be considered

The assessee was engaged in twisting and texturising POY and the question arose whether this amounted to ‘manufacture’ for purposes of s. 80IA. The assessee provided an opinion from Mumbai University which stated that the activity was ‘manufacture’ and the same was not controverted by the revenue. HELD deciding in favour of the assessee:

(i) Though the Court has repeatedly asked the department to examine the process applicable to the product in question and not to go only by dictionary meanings, the recommendation is not being followed. Even when the assessee gives an opinion on a given process, the Department does not submit any counter opinion.

(ii) Applying the test laid down in Oracle Software India Ltd, as POY simplicitor is not fit for being used in the manufacture of a fabric and it becomes usable only after it undergoes the operation/process which is called as thermo mechanical process which converts POY into texturised yarn, the said process is “manufacture”.

(54.2 KiB, 904 DLs)

Copying software onto blank discs is “manufacture” for s. 80-IA

The assessee imported Master Media of software from Oracle Corporation which was duplicated on blank discs, packed and sold in the market. The question arose whether the activity of copying the discs amounted to manufacture or processing of goods for purposes of s. 80IA. HELD, deciding in favour of the assessee:

(i) In interpreting the expression “manufacture or processing of goods”, one has to move with the times and bear in mind that technological advancement in computer science makes knowledge as of today obsolete tomorrow. Therefore where the issue arises for determination, the Department should study the actual process undertaken by the assessee to decide whether there is manufacture or processing.

(ii) The term “manufacture” implies a change, but, every change is not a manufacture, despite the fact that every change in an article is the result of a treatment of labour and manipulation. However, this test of manufacture needs to be seen in the context of the process adopted by the assessee for duplication of software. If an operation/ process renders a commodity or article fit for use for which it is otherwise not fit, the operation/ process falls within the meaning of the word “manufacture”. Applying this test, as the assessee has undertaken an operation which renders a blank CD fit for use for which it was otherwise not fit, the duplicating process constitutes ‘manufacture’ u/s 80IA(12)(b).

(iii) The argument of the revenue that since the software on the Master Media and the software on the pre-recorded media is the same, there is no manufacture because the end product is not different from the original product is over-simplified and does not take into account the ground realities of business in modern times. In Tata Consultancy Services v. State of AP 271 ITR 401 (SC) it was held that a software programme put in media for transferring or marketing is “goods”. When one buys a software programme, one buys not the original but a copy. Accordingly, to say that the contents of the original and the copy are the same is not correct.

(22.8 KiB, 2,636 DLs)

AO deemed to have applied his mind if facts are on record and reopening u/s 147 on change of opinion is not permissible even within 4 years

In CIT vs. Kelvinator of India Ltd. 256 ITR 1 the Full Bench of the Delhi High Court was considering a case of reopening u/s 147 within 4 years from the end of the assessment year. The Court held that when a regular order of assessment is passed in terms of section 143 (3) of the Act, a presumption can be raised that such an order has been passed on application of mind. It was held that if it be held that an order which has been passed purportedly without application of mind would itself confer jurisdiction upon the Assessing Officer to reopen the proceeding without anything further, the same would amount to giving premium to an authority exercising quasi-judicial function to take benefit of its own wrong. It was held that section 147 of the Act does not postulate conferment of power upon the Assessing Officer to initiate reassessment proceedings upon a mere change of opinion. On appeal by the department to the Supreme Court, HELD dismissing the appeal:

Though the power to reopen under the amended s. 147 is much wider, one needs to give a schematic interpretation to the words “reason to believe” failing which s. 147 would give arbitrary powers to the AO to re-open assessments on the basis of “mere change of opinion”, which cannot be per se reason to re-open. One must also keep in mind the conceptual difference between power to review and power to re-assess. The AO has no power to review; he has the power to re-assess. But re-assessment has to be based on fulfillment of certain pre-condition and if the concept of “change of opinion” is removed, as contended on behalf of the Department, then, in the garb of re-opening the assessment, review would take place. One must treat the concept of “change of opinion” as an in-built test to check abuse of power by the AO. Hence, after 1.4.1989, the AO has power to re-open, provided there is “tangible material” to come to the conclusion that there is escapement of income from assessment. Reasons must have a live link with the formation of the belief. This is supported by Circular No.549 dated 31.10.1989 which clarified that the words “reason to believe” did not mean a change of opinion.

(202.6 KiB, 838 DLs)

Right to set-off loss is a “vested right” which is available despite amendment in year of set-off

In AY 2002-03, the assessee suffered a long-term capital loss. U/s 74(1) as it then stood, such loss could be carried forward and set off against all capital gains including short-term capital gains. S. 74 was amended in AY 2003-04 to provide that long-term capital loss could only be set-off against long-term capital gains and not against short-term-capital gain. When the assessee claimed a set-off in AY 2004-05 the question arose whether the amended law should apply or the un-amended law. HELD deciding in favour of the assessee:

(i) In Govinddas 103 ITR 123 (SC) it was held that unless the terms of a statute expressly so provide or necessarily require it, retrospective operation should not be given to a statute so as to take away or impair an existing right or create a new obligation or impose a new liability otherwise than as regards matter of procedure. If the enactment is ambiguous in language, which is fairly capable of either interpretation, it ought to be considered as prospective only.

(ii) Applying this principle, the amended s. 74 is applicable to computation of loss under the head “Capital Gains” for AY 2003-04 and onwards. As regards loss of earlier years, the law as it then stood gave a vested right of set off the loss against all capital gains. There is nothing in the amendment which withdraws the said vested right. Consequently, the loss can be set off against short-term capital gains despite the amendment.

(133.8 KiB, 2,926 DLs)

Shares activity treated as investment in earlier years cannot be treated as business in subsequent years if facts are the same

The assessee was engaged in two different activities of sale and purchase of shares. The first set of transactions involved investment in shares in which the assessee took delivery of the shares. The second set of transactions involved dealing in shares for business purposes. The assessee was accordingly an investor as well as a dealer. The income from investment activity was offered as capital gains while the income from dealing activity was offered as business income. This position was accepted by the AO in the earlier years. In AY 2005-06, the AO took a different view and held that even the shares held on investment account had to be assessed as business income. The Tribunal allowed the assessee’s appeal (see 122 TTJ (Mum) 87). On appeal by the Revenue, HELD dismissing the appeal:

(a) The Tribunal has correctly applied the principle of law in accepting the position that it is open to an assessee to maintain two separate portfolios, one relating to investment in shares and another relating to business activities involving dealing in shares. Delivery based transactions were rightly treated as being in the nature of investment transactions giving rise to capital gains.

(b) The Tribunal correctly accepted the position that though the principle of res judicata is not attracted, there ought to be uniformity in treatment and consistency when the facts and circumstances are identical. The Tribunal has noted that the assessee has followed a consistent practice in regard to the nature of the activities, the manner of keeping records and the presentation of shares as investment at the end of the year in all the years and there is no justification for a different view being taken by the AO.

(c) The Tribunal applied the correct principle in holding that while entries in the books of account alone are not conclusive in determining the nature of income, it does have a bearing.

(59.9 KiB, 735 DLs)

State Govt. PSUs do not need COD approval

The assessee is a State Govt. undertaking. Its appeal was dismissed by the Tribunal on the ground that the approval of the Committee on Disputes (“COD”) had not been obtained. In a writ petition filed by the assessee, the Additional Solicitor General appearing for the revenue stated that it was not the contention of the revenue that COD approval was required for appeals before the Tribunal in Income-tax matters. It was pointed out that though in ONGC vs. CIDCO 2007 (7) SCC 39, the Supreme Court had directed the formation of a Committee to sort out differences between the Central Government and State Government entities, and a Committee would be constituted by the UOI to look into disputes on a case to case, this was not necessary in income-tax matters. Accordingly, the order of the Tribunal was set-aside for a decision on the merits.

(264.0 KiB, 4,456 DLs)

Provisions for NPA as per RBI Norms by NBFCs is not deductible

The assessee, a NBFC, made a ‘Provision for NPA’ in terms of the RBI Directions 1998. It claimed a deduction for the said provision u/s 36 (1)(vii) on the ground that as it was debited to the P&L Account and reduced the profits, it was a ‘write off’. In the alternative, it was claimed that there was a diminution in the value of its assets for which a deduction u/s 37 as a trading loss was eligible. It was also claimed that the RBI Directions overrode the I. T. Act. The Tribunal allowed the claim but the High Court rejected it. On appeal, HELD dismissing the claim:

(i) The RBI Directions issued u/s 45JA of the RBI Act provide that anticipated losses must be taken into account but expected income need not be taken note of. This is for ensuring that NBFCs state true and correct profits without projecting inflated profits. These are prudential norms or disclosure norms but have nothing to do with the computation or taxability of the provisions for NPA under the IT Act. Further though the RBI Directions deviate from the accounting practice as provided in the Companies Act, they do not override the provisions of the IT Act. The RBI Directions 1998 and the IT Act operate in different fields.

(ii) The “Provision for NPA” made in terms of the RBI Directions does not constitute expense for purposes of s. 36(1)(vii). The said Provision is for presentation purposes and in that sense it is notional.

(iii) The argument that a provision for NPA under commercial accounting is not “income” hence on the basis of “Real Income Theory” it cannot be added back has no merit. Though profits have to be computed on commercial principles and on real income basis, this is subject to the provisions of the Act. A provision for NPA is only a notional expense. Further, under the Expl to s. 36(1)(vii) a provision for doubtful debt is not allowable. For the same reason, deduction can also not be claimed u/s 37 (1).

(iv) The argument of the NBFCs that the non-grant of benefits u/ss 36 (1)(viia) & 43D to NBFCs and confining such benefits to banks, SFCs, HFCs violates Articles 14 & 19 of the Constitution has no merit. As regards Art 14, the business operations of NBFCs and banks are quite different and they satisfy the test of “rational and intelligible differentia” having nexus with the object sought to be achieved. As regards Art 19 (1), keeping in mind the important role assigned to banks in the economy and the fact that NBFCs are vulnerable to economic and financial uncertainties, the restriction placed on NBFC by not giving them the benefit of deduction satisfies the principle of “reasonable justification”. Further, laws relating to economic activities should be viewed with greater latitude than other laws.

(69.4 KiB, 930 DLs)

Right to subscribe for shares arises only when offer is made by the company

The assessee held shares in Jindal Iron and Steel Co. Pursuant to a rights issue of partly convertible debentures announced by Jindal, the assessee received an offer to subscribe to 1875 PCDs on Rights Basis. The assessee renounced his right to subscribe to PCDs and received a consideration of Rs. 56,250/- for the renunciation. Against the said sale consideration, the assessee claimed on the basis of Dhun Dadabhoy Kapadia 63 ITR 651 that he had suffered a diminution in the value of the original 1500 equity shares being the difference between the cum-right price per share and the ex- rights price per share aggregating Rs. 3,00,000. The difference of Rs. 2,43,750 was claimed as a short-term capital loss. The lower authorities held that as the shares were held long-term, the said loss was also long-term. On appeal by the assessee, HELD allowing the appeal:

(i) The right to subscribe for additional offer of shares/debentures on Rights basis, on the strength of existing shareholding in the Company, comes into existence when the Company decides to come out with the Rights Offer. Prior to that, such right, though embedded in the original shareholding, remains inchoate. The same crystallizes only when the Rights Offer is announced by the Company. Therefore, in order to determine the nature of the gains/loss on renunciation of right to subscribe for additional shares/debentures, the crucial date is the date on which such right to subscribe for additional shares/debentures comes into existence and the date of transfer [renunciation] of such right. The said right to subscribe for additional shares/debentures is a distinct, independent and separate right, capable of being transferred independently of the existing shareholding, on the strength of which such Rights are offered.

(ii) For the purposes of s. 48 an important principle that must be borne in mind is that chargeability and computation go hand in hand. Computation is an integral part of chargeability under the Act. Accordingly, the right to subscribe for additional offer of shares/debentures comes into existence only when the Company decides to come out with the Rights Offer and it is only when that event takes place, that diminution in the value of the original shares held by the assessee takes place. One has to give weightage to the diminution in the value of the original shares which takes place when the Company decides to come out with the Rights Offer as held in Dhun Dadabhoy Kapadia 63 ITR 651 (SC).