(314.1 KiB, 1,189 DLs)

Receipts with no nexus to exports have to be excluded for s. 80HHC deduction

Explanation (baa) to s. 80HHC defines the term “profits of the business” to mean business profits as reduced by 90% of .. “receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature“. The Tribunal took the view, on the basis of Bangalore Clothing 260 ITR 371 (Bom) that receipts towards recovery of freight, insurance, packing receipts, sales tax set off/refund and service income were “operational income” and not liable to be excluded under Expl (baa) to s. 80HHC. On appeal by the Revenue, HELD reversing the Tribunal:

(i) The ratio of Ravindranathan Nair 295 ITR 228 (SC) is that Explanation (baa) to s. 80HHC required receipts constituting independent income having no nexus with exports to be reduced from business profits under clause (baa) so as to avoid distortion in the computation of export profits;

(ii) In Bangalore Clothing Co 260 ITR 371 (Bom) it was held that If an item of income is closely linked with business operations and constitutes “operational income”, it cannot be excluded under Explanation (baa) to s. 80HHC. This proposition is inconsistent with the law in Ravindranathan Nair and is no longer good law. The submission that Bangalore Clothing was impliedly approved in Baby Marine Exports 290 ITR 323 (SC) is not acceptable because that judgement turned on the fact that the export house premium was an integral part of the consideration for the sale realized by the assessee, a supporting manufacturer.

(170.5 KiB, 1,477 DLs)

To compute the PE ‘duration test’ under Art. 5 (2) of the DTAA, different project sites can be aggregated only if the test of interconnection and interrelationship is satisfied

Article 5(2)(i) of the India-Mauritius DTAA defines “permanent establishment” to include “a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or supervisory activity continues for a period of more than nine months“. The assessee, a Mauritius company, executed three contracts in India. While the period of each contract was less than 183 days, cumulatively they exceeded that period. The question arose whether in determining whether the assessee had a PE in India, the period of all contracts could be aggregated. HELD:

(i) Though there is a PE under Article 5(1) (“fixed place of business”), a ‘construction, installation or project site’ cannot fall under this if the period specified in Article 5(2)(i) is not satisfied. Article 5(2)(i) is a test of ‘permanence’ for purposes of Article 5(1) and both are required to be read together;

(ii) For computing the threshold time limit under Article 5(2)(i), the activities of a foreign enterprise on a particular site or a particular project etc have to be seen and not on all the activities in a tax jurisdiction as whole. Each building site, construction project, assembly project or supervisory activities in connection therewith has to be viewed on a standalone basis. This is on the assumption that the different business activities are not so inextricably interconnected that they are required to be viewed as a coherent whole;

(iii) In certain DTAAs (e.g. India-Australia), the relevant PE clauses specifically require application of the aggregation principle on all sites, projects or activities for computation of threshold duration test. However, even such aggregation requires exclusion of double counting of days when more than one site or project exists on a day, or when work is carried out at two or more different places on a day. However, when aggregation is not specifically provided for in the relevant PE definition clause, it is not open to infer the application of the aggregation principle;

(iv) The principle that the duration test applies to each individual site or project is subject to two exceptions. The first is where the assessee has artificially split the contract so as to avoid the duration test. However, the onus to show that the contracts have been split to avoid the duration test is on the revenue and has to be supported with reasons and not by vague and generalized allegations. The second is when the activities are so inextricably interconnected or interdependent that these are required to be viewed as a coherent whole. In applying this test, it is not relevant whether the activities are carried out for the same principal or different principals. What is relevant is the nature of activities, their interconnection and interrelationship and whether these activities are required to be essentially regarded as a coherent whole in conjunction with each other;

(v) On facts, as there was no finding that the three contracts were inextricably interconnected, interdependent or could only be seen only as a coherent whole in conjunction with each other, the duration of the projects could not be aggregated for the purposes of ascertaining whether or not there was a PE.

(49.9 KiB, 1,697 DLs)

For s. 36(1)(vii) Bad Debt, write off of individual debtor’s a/c is not necessary

The assessee made a provision for bad debts by debiting the P & L A/c and crediting the Provision for Bad debts A/c. Thereafter, the provision account was debited and the loans and advances a/c was credited. The AO denied the claim for bad debts u/s 36(1)(vii) on the ground that the individual account of the debtor had not been written off. The CIT (A) and Tribunal allowed the assessee’s claim though the High Court reversed it. On appeal by the assessee, HELD reversing the High Court:

(i) Pursuant to the Explanation inserted w.r.e.f. 1.4.1989 a mere provision for bad debt is not entitled to deduction u/s 36(1)(vii). However, in the present case, besides debiting the P&L A/c and creating a provision for bad debts, the assessee had also obliterated the said provision by reducing the corresponding amount from the debtors account in the Balance Sheet. Consequently, the figure in the loans and advances in the Balance Sheet was shown net of the provision for bad debts;

(ii) The AO’s insistence that the individual account of the debtor should be written off was not acceptable because (a) it was based on a mere apprehension that the assessee might claim deduction twice over and it was open to the AO to check whether the assessee was claiming double deduction, (b) if the individual accounts were closed, the Debtor could in the recovery suits rely on the Bank statement and contend that no amount is due and payable to the assessee and (c) the AO was empowered by s. 41(4) to tax the recovery.

(133.0 KiB, 901 DLs)

ITAT should dispose off stay granted appeals within s. 254(2A) period

S. 254 (2A) empowers the Tribunal to grant stay of recovery of demand for a period not exceeding 365 days. The 3rd Proviso to s. 254(2A) inserted by the Finance Act 2008 provides that if there is a delay in disposing of the appeal within the said period, the order of stay shall stand vacated even if the delay in disposing of the appeal is not attributable to the assessee. The assessee’s appeal was adjourned by the Tribunal from time to time for no fault of the assessee and in view of the fact that an identical issue was pending before a Special Bench of the Tribunal. The Tribunal initially granted stay but on the expiry of 365 days dismissed the stay application on the ground that it had no power to extend stay in view of the said 3rd Proviso to s. 254 (2A). The assessee filed a Writ Petition to challenge the constitutional validity of the said 3rd proviso to s. 254(2A). HELD:

(i) The 3rd Proviso to s. 254 (2A) is a stringent provision as a result of which even if the delay in disposing of the appeal is not attributable to the assessee, the stay has to stand vacated in any event upon the lapse of a period of 365 days. Having regard to the nature of the provision which has been enacted by Parliament, the Tribunal is under a bounden duty and obligation to ensure that the appeal is disposed off, so as to not result in prejudice to the assessee, particularly in a situation where no fault can be found with the conduct of the assessee. The fact that an issue was pending before the Special Bench was not a reason for the Tribunal not to dispose of the appeal, particularly since the consequence of the inability of the Tribunal to do so would result in the vacating of the order of stay. It is unfortunate that the Tribunal simply adjourned the appeal merely on the ground of the pendency of an identical issue before the Special Bench. The state of affairs which has come to pass could well have been avoided by the appeal being taken up for final disposal.

(ii) The Tribunal was directed to dispose of the pending appeal within four months. The department’s statement that no coercive steps for enforcing the demand would be taken was recorded. The question of constitutional validity of the 3rd proviso to s. 254(2A) was left open.

(3.0 MiB, 2,086 DLs)

S. 195 (1) TDS obligation does not arise if the payment is not chargeable to tax. Samsung Electronics not followed

The assessee made a remittance to IMAX Canada towards technology transfer fee without deduction of tax at source. The AO took the view that the consideration was “fees for technical services” u/s 9 (1)(vii) and that tax ought to have been deducted at source as per Transmission Corporation 239 ITR 587 (SC). He accordingly held the assessee to be an “assessee-in-default” u/s 201 though the CIT(A) reversed the same. On appeal by the revenue, the question as to whether a person responsible for making payment to a non-resident was liable to deduct tax at source u/s 195 (1) if he did not apply to the AO u/s 195 (2) for permission to remit without deduction at source was referred to the Special Bench. HELD by the Special Bench:

(i) The effect of the judgements of the Supreme Court in Transmission Corporation and Eli Lilly 312 ITR 225 is that s. 195 (1) applies only if the payment made to the non-resident is chargeable to tax. If the payer has a bona fide belief that no part of the payment has income character, s. 195 (1) will not apply and it is not necessary to apply to the AO u/s 195 (2). This interpretation is supported by the Circulars of the CBDT setting out the alternative procedure for TDS;

(ii) As regards Samsung Electronics 320 ITR 209 (Kar) (which held that s. 195 / 201 liability cannot be avoided on ground of non-taxability of recipient), a judgement of a non-jurisdictional High Court need not be followed where there are conflicting High Court judgements or where the judgement is rendered per incuriam (Kanel Oil 121 ITD 596 (Ahd)) or where the correct legal position was not brought to the notice of the High Court (Lalsons Enterprises 89 ITD 25 (Del) (SB). Apart from the judicial conflict, the alternative TDS procedure as per the CBDT Circulars was not brought to the attention of the High Court. Consequently, the judgement of the Special Bench in Mahindra & Mahindra 313 ITR 263 (AT)(Mum) (which held that s. 195 (1) did not apply if the payment was not chargeable to tax) has to be followed in preference to that of Samsung Electronics;

(iii) As regards the merits, though the question framed is general and there is no specific direction in the order of reference, the Special Bench, the entire appeal is open before the Special Bench and it is not confined to the question framed (NTPC 24 ITD 1 (SB) followed);

(iv) On merits, as the services rendered by the payee were auxiliary to the sale of equipment, the consideration was not chargeable to tax in India.

(173.9 KiB, 1,663 DLs)

Tax planning is valid. As McDowell (5 judges) has been explained in Azadi Bachao (2 judges), the latter is binding

The assessee purchased US-64 Units of the UTI in May 1990 for Rs. 3.75 crs, received dividend thereon of Rs. 45 lakhs and sold the units in July 1990 for Rs. 3.25 crs. The assessee claimed that deduction u/s 80M was available on the dividend and that a short-term capital loss of Rs. 51.61 lakhs on purchase and sale of units was allowable. The AO, CIT (A) and Tribunal took the view that the loss was not allowable by relying on McDowell vs. CTO 154 ITR 148 (SC) on the ground that though the transactions were genuine, they were not bana fide as there was motive of tax planning. On appeal by the assessee, HELD allowing the appeal:

(i) In Azadi Bachao Andolan 263 ITR 706 (SC) it was held that once the transaction is genuine merely because it has been entered into with a motive to avoid tax, it would not become a colourable devise and earn any disqualification. It was held that an act, which is otherwise valid in law, cannot be treated as non est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interest as per the perception of the revenue. The aforesaid view looks to be the correct view. Applying the principles of Azadi Bachao Andolan, as the transaction of purchase of units has been held to be genuine by the Tribunal and the basic object of purchasing the units was to earn dividends, which are tax free u/s 80-M and to sell the units by suffering losses, it cannot be concluded by any stretch of imagination that the assessee used any colourable devise, particularly when Parliament has incorporated s. 94 (7) w.e.f. 1.4.2002 to recognize and regulate the purchase and sale of units and the dividends/income received from such units. (Wallfort Share & Stock Brokers 310 ITR 421 (Bom) followed);

(ii) The argument of the revenue based on McDowell & Co cannot be accepted because the judgment rendered therein by Justice Chinnappa Reddy has been explained in detail by the later judgment in Azadi Bachao Andolan. It is well settled that if a smaller Bench of the Supreme Court has later on explained its earlier larger Bench then the later judgment is binding on the High Court. (Precedents referred to). Accordingly, the view expressed in Azadi Bachao Andolan has to be accepted as binding and it cannot be said that the principle of law laid down by the House of Lords in Duke of Westminster as applied in Azadi Bachao Andolan is no longer applicable. Moreover, no such principles having been laid down in the majority judgment in McDowell & Co.

(212.6 KiB, 1,370 DLs)

Tests laid down to determine when contract manufacturing will amount to a contract of sale for S. 194C TDS

The assessee entered into an agreement with a third party for the manufacture of certain pharmaceutical products under which it provided the formulations and specifications and the manufacturer affixed the trademark of the assessee on the articles produced. The raw materials were purchased by the manufacturer and property in the goods passed to the assessee only on delivery. The agreement was on a principal to principal basis. The AO took the view that the contract was a contract of ‘work’ and tax was deductible at source u/s 194C though the Tribunal upheld the contention of the assessee that the contract involved a sale and did not represent a ‘contract for work’ u/s 194C. On appeal by the Revenue, HELD dismissing the appeal:

(i) A contract for sale has to be distinguished from a contract of work. If a contract involves the sale of movable property as movable property, it would constitute a contract for sale. On the other hand, if the contract primarily involves carrying on of work involving labour and service and the use of materials is incidental to the execution of the work, the contract would constitute a contract of work and labour;

(ii) The argument of the Revenue that the restrictions imposed on the manufacturer to (a) utilise the formula provided by the assessee, (b) affix the trade-mark of the assessee, (c) manufacture as per specifications provided by the assessee and (iii) deal exclusively with the assessee show that the contract is not one of sale is not acceptable because this has not been the understanding of the law at any point of time even by the CBDT and judicial precedents;

(iii) Though a product is manufactured to the specifications of a customer, the agreement would constitute a contract for sale, if (i) the property in the article passes to the customer upon delivery and (ii) the material that was required was not sourced from the customer / purchaser, but was independently obtained by the manufacturer from a third party;

(iv) This position is now statutorily recognized in Expl. (e) to s. 194C inserted by the FA 2009 to provide that the expression ‘work’ shall not include manufacture or supply of a product according to the requirement or specification of a customer by using material which is purchased from a person other than such customer;

(v) On facts, as (i) the agreement was on a principal to principal basis, (ii) the manufacturer had his own establishment where the product was manufactured, (iii) the materials required in the manufacture of the article or thing was obtained by the manufacturer from a person other than the assessee and (iv) the property in the articles passes only upon the delivery of the product manufactured, the contract was one of “sale” and there was no obligation to deduct tax u/s 194C. The fact that the assessee imposed restrictions on the manufacturer as to quality of the goods, user of trade marks etc are merely matters of business expediency.

(188.3 KiB, 1,095 DLs)

For Expl (baa) to s. 80HHC, netting of income from expenditure is not allowed

The assessee claimed deduction u/s 80HHC on profits which included interest income of Rs. 3.25 crores. Under Explanation (baa) to s. 80HHC, 90% of the said interest income has to be reduced from the profits. The assessee claimed that the interest expenditure incurred by it having a nexus with the said interest income had to be netted off and only the balance, if any, could be subjected to the 90% reduction. The assessee proved that there was a nexus between the income and the expenditure. The claim was rejected by the AO though it was accepted by the CIT (A) and the Tribunal relying on Lalsons Enterprises 89 ITD 25 (Del) (SB). On appeal by the Revenue, HELD reversing the Tribunal:

(i) Explanation (baa) to s. 80HHC requires that ninety per cent of receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature have to be reduced from the profits. The reason why items like brokerage etc have to be excluded is because they do not possess any nexus with export turnover and their inclusion in profits would result in a distortion of the figure of export profits. However, as some expenditure might have been incurred in earning these incomes, an adhoc deduction of ten per cent from such income is allowed;

(ii) Once Parliament has legislated both in regard to the nature of the exclusion and the extent of the exclusion, it would not be open to the Court to order otherwise by rewriting the legislative provision. The task of interpretation is to find out the true intent of a legislative provision and it is clearly not open to the Court to legislate by substituting a formula or provision other than what has been legislated by Parliament. It is not open to say that something more than the 10% statutorily provided should also be allowed. In Shri Ram Honda Power Equip 289 ITR 475 the Delhi High Court has not adequately emphasized the entire rationale for confining the deduction only to the extent of ninety per cent of the excludible receipts and it cannot be followed;

(iii) As regards the judgement of the Special Bench in Lalsons Enterprises “We are affirmatively of the view that … the Tribunal … has transgressed the limitations on the exercise of judicial power and …. has in effect legislated by providing a deduction on the ground of expenses other than in the terms which have been allowed by Parliament. That is impermissible”.