(207.0 KiB, 1,055 DLs)

S. 80-I deduction allowable without setting off loss of other units

The assessee had two units, namely, a steering unit and an axle unit, both of which were eligible u/s 80-I. While one unit was making profits, the other was incurring losses. The AO and CIT (A) took the view that deduction u/s 80-I on the profits of one unit could be allowed only after setting off the losses of the other unit. On appeal, the Tribunal allowed the claim of the assessee on the ground that the two units were independent of each other and that u/s 80-I (6), the profit making unit had to be considered to be independent of the other. Before the High Court, the department claimed that the issue was covered in their favour by Synco Industries 299 ITR 444 (SC) where it had been held that the losses had to be set off before claiming deduction u/s 80-I. HELD dismissing the appeal and deciding in favour of the assessee:

(i) The effect of s. 80-I (6) is that the deduction has to be computed as if the industrial undertaking were the only source of income of the assessee. Each industrial undertaking is to be treated separately and independently. It is only those industrial undertakings which have a profit or gain which have to be considered for computing the deduction. The loss making industrial undertaking would not come into the picture at all. The loss of one such industrial undertaking cannot be set off against the profit of another such industrial undertaking to arrive at a computation of the quantum of deduction that is to be allowed to the assessee u/s 80-I (1);

(ii) In Synco Industries 299 ITR 444 (SC), the Supreme Court did not hold that while computing the deduction u/s 80-I(6), the loss of one eligible industrial undertaking is to be set off against the profit of another eligible industrial undertaking. All that the Supreme Court said was that in computing the gross total income of the assessee, the same has to be determined after adjusting the losses and that, if the gross total income of the assessee so determined turns out to be “Nil”, then the assessee would not be entitled to deduction under Chapter VI-A. In fact, the Supreme Court clearly held that while computing the quantum of deduction u/s 80-I (6), the AO has to treat the profits derived from an industrial undertaking as the only source of income of the assessee in order to arrive at a deduction under Chapter VI-A and that the loss sustained in one of the units is not to be taken into account.

(129.3 KiB, 1,610 DLs)

Even if there is no assessment u/s 143 (3), reopening u/s 147 is bad if there are no proper “reasons to believe”. AO cannot go beyond the recorded reasons

The assessee was a partner in a firm. Upon retirement, he received an amount of Rs. 50 lakhs in addition to the balance lying to his credit in the books of the firm in full and final settlement of his dues. The assessee filed a return in which the said amount was not offered to tax on the ground that it was a capital receipt. No assessment order was passed. The AO issued a notice for reopening u/s 148 on the ground that as in the assessment of the firm the amount paid by it to the assessee had been allowed as a revenue deduction, the amount received by the assessee had to be assessed as income. Reliance was also placed on ss. 28 (iv) & (v). The assessee filed a Writ Petition to challenge the reopening. HELD allowing the Petition:

(i) The basic postulate which underlines s. 147 is the formation of the belief by the AO that income chargeable to tax has escaped assessment. The AO must have reason to believe that such is the case before he proceeds to issue a notice u/s 147. The reasons which are recorded by the AO for reopening an assessment are the only reasons which can be considered when the formation of the belief is impugned. The recording of reasons distinguishes an objective from a subjective exercise of power. The requirement of recording reasons is a check against arbitrary exercise of power. The validity of the reopening has to be decided on the basis of the reasons recorded and on those reasons alone. The reasons recorded while reopening the assessment cannot be allowed to grow with age and ingenuity, by devising new grounds in replies and affidavits not envisaged when the reasons for reopening an assessment were recorded;

(ii) The only reason recorded by the AO was that as the firm had been held eligible to claim a deduction of the amount paid to the assessee, the amount received by the assessee was chargeable to tax. However, this is unsustainable because the law is well settled that what the partner gets upon dissolution or retirement is the realization of a pre-existing right or interest which is not assessable to tax. Mohanbhai Pamabhai 165 ITR 166 (SC) followed. Even u/s 45 (4) (which applies only where there is a distribution of assets on dissolution or otherwise), the gains are taxable in the hands of the firm and not in the hands of the partner. The amount received by the assessee is also not chargeable u/s 28 (iv) {value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of profession} and 28 (v) {any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm}. A payment made to a partner on dissolution does not fall u/s 28 (v);

(iii) Though in Rajesh Jhaveri 291 ITR 500 (SC) the Supreme Court held that the passing of an Intimation u/s 143 (1) does not amount to an “assessment” and in the absence of an assessment, there was no question of a “change of opinion”, the Court also held that there must be “reason to believe” i.e. “cause or justification” that income had escaped assessment. There must be relevant material on which a reasonable person could have formed a requisite belief even though the material need conclusively prove the escapement;

(iv) Though Explanation (2) (b) to s. 147 creates a deeming fiction of income having escaped assessment in cases where an assessment has not been made, the act of taking notice cannot be at the arbitrary whim or caprice of the AO but must be based on a reasonable foundation. Though the sufficiency of the evidence or material is not open to scrutiny by the Court, the existence of the belief is the sine qua non for a valid exercise of power;

(v) On facts, it was impossible for any prudent person to form a reasonable belief that the income had escaped assessment. Consequently, the s. 148 notice was quashed.

(44.2 KiB, 3,348 DLs)

Bad debts need not be proven to be irrecoverable u/s 36(1)(vii). It is sufficient if they are written off

The Supreme Court had to consider whether after the amendment to s. 36 (1) (vii) w.e.f. 1.4.1989, an assessee had to establish, as a matter of fact, that the debt advanced by the assessee had, in fact, become irrecoverable or whether writing off the debt as irrecoverable in the accounts was sufficient. HELD deciding in favour of the assessee:

(i) The position in law is well-settled. After 1.4.1989, it is not necessary for the assessee to establish that the debt, in fact, has become irrecoverable. It is enough if the bad debt is written off as irrecoverable in the accounts of the assessee. When a bad debt occurs, the bad debt account is debited and the customer’s account is credited, thus, closing the account of the customer. In the case of companies, the provision is deducted from Sundry Debtors.

(ii) As the AO has not examined whether the debt has, in fact, been written off in accounts of the assessee. the matter is remitted to the AO for de novo consideration of the above-mentioned aspect only and that too only to the extent of the write off.

(158.0 KiB, 1,529 DLs)

Non-exempt capital loss cannot be set off against exempt capital gains

S. 10 (38) inserted w.e.f. 1.10.2004 provides that long-term capital gains (LTCG) on which security transaction tax (STT) is paid shall not be included in total income. The assessee earned long term capital gain (LTCG) of Rs. 33,01,57,200 on sale of shares after 1.10.2004 in respect of which STT was paid. The LTCG was exempt u/s 10 (38). In the period prior to 1.10.2004, the assessee suffered a long term capital loss of Rs. 9,23,55,945 on redemption of units. The assessee claimed that the said long term capital losses were not liable to be set off against the exempt capital gains. The AO & CIT (A) took the view that in computing income under the head “capital gains”, the said loss had to be set off against the capital gains. On appeal by the assessee, HELD deciding in favour of the assessee:

(i) Under the scheme of the Act, income which does not form part of the total income as per Chapter-III does not enter the computation of total income at all. (N.M. Raiji 17 ITR 180 (Bom) followed where it was held that exempt share income of a partner could not be taken into account even for rate purposes);

(ii) S. 70 (3) which provides that long-term capital gains shall be set off against long-term capital loss does not apply because the exempt capital gains do not enter the computation of total income at all and the question of aggregating them under Chapter VI and setting them off u/s 70 (3) does not arise. Consequently, the right of carry forward the loss u/s 74(1) is unaffected;

(iii) S. 10(38) was inserted with the object to grant exemption to LTCG as tax has already been levied on a different footing (STT). The revenue’s contention that long term capital loss should be adjusted against exempt LTCG will be contrary to the intention, object and purpose of enacting s. 10 (38). Further, the revenue’s view will result in absurdity if the facts are reversed because then LTCG earned before 1.10.2004 (which is taxable) will be eligible for set off against (exempt) long term capital loss suffered after 1.10.2004. This will result in a loss from an exempt source being set off against taxable gain which is contrary to law.

(iv) Consequently the long term capital loss is not liable to be set off against exempt income long term capital gains.

(53.6 KiB, 1,015 DLs)

Issue whether MAT companies can provide depreciation as per Income-tax Rules while computing s. 115J book profits referred to Larger Bench

The assessee, a private limited company, provided for depreciation in its Profit & loss account by adopting the rates specified in the Income-tax Rules and computed its “book profits” u/s 115J on that basis. The AO recomputed the book profits by adopting the depreciation rates as per Schedule XIV to the Companies Act as those were lower than the income-tax rates. The CIT (A) & Tribunal upheld the stand of the assessee on the ground that Schedule XIV was not applicable to a private limited company though the High Court took the view that s. 205 of the Companies Act stood incorporated into s. 115J and consequently depreciation had to be provided at the rates specified in Schedule XIV and not in terms of the Income-tax Rules. On appeal by the assessee, HELD doubting its own judgement in Malayala Manorama 300 ITR 251:

(i) The law laid down in Malayala Manorama 300 ITR 251 {that (i) Schedule VI does not create any obligation to provide for any depreciation much less for depreciation at Schedule XIV rates, (ii) As per the Company Law Board Circular the rates in Schedule XIV are the minimum rates and a company can provide for higher rates and (iii) Schedule XIV itself contemplates that depreciation can be provided at rates different from the Schedule rates} needs re-consideration because s. 115J by a deeming fiction legislatively only incorporates provisions of Parts II and III of Schedule VI of the Companies Act and not sections 205, 350 or 355. Once a company, whether private or public, falls within the ambit of it being a MAT company, s. 115J applies and is required to prepare its Profit & loss account only in terms of Parts II and III of Schedule VI. By the Companies (Amendment) Act, 1988, the linkage between depreciation as per Rule 5 and the Companies Act have been expressly de-linked and the rates are also different.

(ii) If the judgement in Malayala Manorama is to be accepted, the very purpose of enacting s. 115J would stand defeated particularly when the said section does not make any distinction between public and private limited companies.

(iii) Accordingly, the matter needs re-consideration by a larger Bench of the Court.

(59.7 KiB, 1,254 DLs)

Interest on surplus funds is “other income” and not eligible for dedn u/s 80P

The assessee, a co-op credit society, was engaged in providing credit facilities to its members and also marketing the agricultural produce of its members. The assessee had surplus funds which it invested in short-term deposits with banks and govt securities. The question arose whether the said interest earned on the said deposits was “business profits” and eligible for deduction u/s 80P(2)(a)(i). The assessee argued that its activity of providing credit facilities to its members was an “eligible activity” u/s 80P(2)(a)(i) and that as the investments were made as per statutory requirement, the benefit was allowable from the gross total income. HELD deciding against the assessee:

(i) S. 80P(2)(a)(i) allows a deduction in the case of a co-op society engaged in carrying on the business of providing credit facilities to its members of the whole of the amount of profits and gains of business attributable to such activity. The words “profits and gains of business” means “business profits” and not “Income from other sources”;

(ii)The interest on surplus invested in short-term deposits, not being attributable to the business of providing credit facilities to the members or marketing of agricultural produce of the members, is assessable as “other income” and not as “business profits”;

(iii) The words “the whole of the amount of profits and gains of business” attributable to one of the activities specified in s. 80P (2)(a) mean that the source of income is relevant and that the income must be “operational income”.

(3.0 MiB, 1,428 DLs)

S. 10A deduction allowable without set off of losses of non-eligible units

In respect of AY 2003-04, the assessee had an unit in Chennai which was engaged in software development and whose profits were eligible for deduction u/s 10A. The assessee had another unit in Delhi which was engaged in trading and had suffered a loss. The assessee claimed that it was eligible for a deduction u/s 10A on the whole of the profits of the Chennai unit without it being reduced by the losses of the Delhi unit. The AO and CIT (A) rejected the claim on the ground that after the amendment of s. 10A w.e.f. 1.4.2001, a deduction is allowed from the “total income” and consequently the losses have to be taken into account. On a reference to the Special Bench, HELD deciding in favour of the assessee:

(i) S. 10A allows a deduction of the “profits and gains derived by the undertaking from the export of computer software” “from the total income of the assessee”. The effect is that the deduction has to be made at the stage of computing the income under head “Profits & gains” and not at the stage of computing the gross total income;

(ii) S. 80AB is confined to deductions granted under Chapter VI-A. As s. 10A does not fall in Ch. VI-A, s. 80AB has no application;

(iii) S. 10A grants a deduction to the “profits of the undertaking” and not to the “profits of the assessee”. There is a well known distinction between the “undertaking” and the “assessee” as also noted by the CBDT in Circular F. No. 15/563 dated 13.12.1963. The deduction u/s 10A attaches to the undertaking and not to the assessee;

(iv) Consequently, the losses of a non-eligible unit cannot be set off against the profits of an eligible unit and are eligible to be set-off against other income or to be carried forward. The position of a losses of an eligible unit may be on a different footing.

(99.7 KiB, 1,518 DLs)

Foreign Co not liable to tax in India if Indian agent is paid on arms’ length basis

The assessee, a UK company, operated the “BBC World News Channel”. It appointed its subsidiary in India (BBC India) to solicit orders for the sale of advertising airtime on the Channel and to pass on such orders to the assessee for acceptance and confirmation. The payment from the Indian advertisers in foreign currency was to be received directly by the assessee while the consideration in Indian rupees would be received by BBC India and remitted to the assessee. BBC India was entitled to receive 15% marketing commission of the advertisement revenues. The assessee claimed that as the revenue was ‘business profits’ and there was no permanent establishment in India, the income was not taxable in India under the India-UK DTAA. The AO took the view that BBC India was a ‘business connection’ under s. 9 (1)(i) as well as a ‘permanent establishment’ under Article 5 of the DTAA and that 20% of the total advertisement revenue was attributable to India. This was upheld by the CIT(A) who estimated the profits of the assessee at 10% of the total advertisement revenue allocable to India on the basis of CBDT Circular No. 742 dated 2.5.96. On appeal by the assessee, HELD deciding in favour of the assessee (without going into the issue of whether there was a business connection or PE) that:

(i) In the transfer pricing proceedings for subsequent years, the department had accepted that the commission of 15% paid to BBC India was fair and at arms’ length. It was found that the rate of commission in the assessee’s trade was fairly uniform and almost everyone was charging the same rate of commission;

(ii) In Circular No. 23 of 1969 dated 23rd July 1969 the CBDT has held that if a non resident’s sales to Indian customers are secured through the services of an agent in India, the assessment in India of the income arising out of the transaction will be limited to the amount of profit which is attributable to the agent’s services provided that non-resident’s business activities in India are wholly channeled through its agent, the contracts to sell are made outside India and sales are made on a principle-to-principle basis. It has been held that in the assessment of the amount of profits, a deduction will be given for the expenses incurred, including the agent’s commission. Accordingly, if the agent’s commission fully represents the value of the profit attributable to his service, nothing further can be assessed in the hands of the non-resident;

(iii) This principle that if a transaction is at arms length and the associated enterprise, which also constitutes a permanent establishment, is remunerated on arm’s length basis, taking into account all the risks–taking functions, then nothing further would be left to attribute to the permanent establishment has been accepted in Morgan Stanley 292 ITR 416 (SC), SET Satellite (Singapore) 307 ITR 205 (Bom) and Galileo International 114 TTJ 289 (Del) {approved 224 CTR 251(Del)};

(iv) The consequence is that even if the assessee had a business connection or permanent establishment in India, it could not be assessed to tax in India.

(110.3 KiB, 2,761 DLs)

Even employees’ contribution to PF paid before due date of filing ROI is allowable u/s 43B

S. 2 (24) (x) provides that amounts received by an assessee from employees towards PF contributions etc shall be “income”. S. 36 (1) (va) provides that if such sums are contributed to the employees account in the relevant fund on or before the due date specified in the PF etc legislation, the assessee shall be entitled to a deduction. The second Proviso to s. 43B (b) provided that any sum paid by the assessee as an employer by way of contribution to any provident etc fund shall be allowed as a deduction only if paid on or before the due date specified in 36(1)(va). After the omission of the second Proviso w.e.f 1.4.2004, the deduction is allowable under the first Proviso if the payment is made on or before the due date for furnishing the return of income. The High Court had to consider whether the benefit of s. 43B can be extended to employees’ contribution as well which are paid after the due date under the PF law but before the due date for filing the return. HELD deciding in favour of the assessee:

(i) Though the revenue has argued that a distinction is to be made between “employers’ contribution” and “employees’ contribution” and that employees’ contribution being in the nature of trust money in the hands of the assessee cannot be allowed as a deduction if not paid on or before the due date specified in the PF etc law, the scheme of the Act is that employees’ contribution is treated as income u/s 2 (24) (x) on receipt by the assessee and allowed as a deduction u/s 36 (1) (va) on making deposit with the concerned authorities. S. 43B (b) stipulates that such deduction would be permissible only on actual payment;

(ii) The question as to when actual payment should be made is answered by Vinay Cements 213 CTR 268 where the deletion of the second Proviso to s. 43B w.e.f 1.4.2004 was held applicable to earlier years as well. As the deletion of the 2nd Proviso is retrospective, the case has to be governed by the first Proviso. Dharmendra Sharma 297 ITR 320 (Del) & P.M. Electronics 313 ITR 161 (Delhi) followed;

(iii) If the employees’ contribution is not deposited by the due date prescribed under the relevant Acts and is deposited late, the employer not only pays interest on delayed payment but can incur penalties also, for which specific provisions are made in the Provident Fund Act as well as the ESI Act. Therefore, the Act permits the employer to make the deposit with some delays, subject to the aforesaid consequences. Insofar as the Income-tax Act is concerned, the assessee can get the benefit if the actual payment is made before the return is filed, as per the principle laid down in Vinay Cement.

(77.7 KiB, 1,560 DLs)

Issue of s. 143 (2) notice is mandatory for block assessment proceedings. Disclosed items cannot be assessed in block assessment. Circulars are binding on the revenue.

Chapter XIV-B provides that where a search u/s 132 is conducted, the AO shall determine the undisclosed income for the block period. S. 158 BC(b) provides that in making the block assessment the provisions of s. 143 (2) shall “so far as may be, apply”. The Supreme Court had to consider whether a block assessment order passed without service of notice on the assessee u/s 143(2) within the prescribed period of time was valid. HELD, deciding in favour of the assessee:

(i) While notice u/s 143 (2) is not necessary if the AO accepts the return as filed, the notice within the prescribed time is mandatory if the AO proposes to make an assessment u/s 158BC r.w.s143 (3). Omission to issue notice u/s 143(2) is not a procedural irregularity and the same is not curable and, the requirement of notice u/s 143(2) cannot be dispensed with. If the intention of the legislature was to exclude the provisions of s. 143 (2), the legislature would have indicated that.

(ii) In Circular No.717 dated 14.8.1995 the CBDT has directed that the AO “shall proceed to determine the undisclosed income of the block period and the provisions of s. 142, sub-s (2) and (3) of s. 143 and s. 144 shall apply accordingly”. This circular clarifies the requirement of law in respect of service of notice u/s 143 (2). The circular is binding on the department though not on the Court.

(iii) A search is the sine qua non for a block assessment under Ch. XIV-B. A block assessment is in addition to regular assessments proceedings and not in substitution thereof. The scope and ambit of a block assessment is limited to materials unearthed during search and can only be done on the basis of evidence found as a result of search or requisition.