(155.6 KiB, 1,842 DLs)

No PE under DTAA if three criteria are not fulfilled

The assessee, a UK company, entered into an agreement with Jet Airways under which it agreed to provide Jet Airways with two segments of services, first, to carry out repairs and overhauling of aircraft components outside India and, second, to provide spares and components in the period the components were being repaired. To ensure that the spares and replacement components were readily available, the assessee maintained a stock of the components at the operating base of the airline in India. Though the stock was under the direct control of the assessee, it was in the possession of the airline as a bailee. The AO took the view that as the stock was kept in India with Jet Airways, Jet Airways constituted an “agent” and a “permanent establishment” in India under Article 5(4)(b) of the India-UK DTAA and that 10% of the receipts was liable to tax in India. This was upheld by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) In order for a PE to come into existence under Article 5(1) (“the basic rule”), three criteria have to be satisfied viz. (a) the physical criterion (existence of physical location) (b) subjective criterion (right to use that place) and (c) functional criterion (carrying on business through that place). It is only when the three conditions are satisfied that a PE under the basic rule can be said to have come into existence. The onus is on the Revenue to show that the assessee has a PE;

(ii) On facts, though the stock was stored at specific locations in India, such locations were not at the disposal of the assessee and the assessee could not carry out its business from that place. There was consequently no PE under Article 5(1). Further, even if there was a PE, the consideration relatable to the repairs done outside India was not taxable as it was not “attributable” to the PE. The existence of a PE does not justify taxation of all profits as one cannot infer the force of attraction principle. As regards the consideration for the right to use the components, the business element thereof is over when the component is handed over to the airline. There is no “carrying on of business” from that location. Consequently, there is no PE under article 5(1);

(iii) The argument of the Revenue that there is a “Dependent Agent PE” under Article 5(4)(b) is also not correct. The rationale of a Dependent Agent PE is that the foreign enterprise carries on business through a dependent agent, who is integrated into the principal’s business to a substantial extent. However, on facts, as Jet Airways was neither the dependent agent of the assessee and nor was the assessee carrying on business through Jet Airways, there was no PE under Article 5(4)(b);

(iv) When a PE exists, even such a consideration, which may otherwise be taxable in the source country under Article 13, is taxable on net basis under Article 7. Therefore, merely because an amount is not taxable under Article 7 in the source country, it is not end of the road so far taxability for that item in the source country is concerned. As evident from a plain reading of the consideration clause in the agreement between the parties, consideration for use of replacement components is distinct and separate and the same can perhaps be neatly segregated from the overall receipts. In this view of the matter, non taxability under Article 7 will still mean that application of Article 13 is to be considered and adjudicated upon. As the authorities had not examined whether the consideration for use of the replacement components was “for the use of industrial, commercial or scientific equipment” and taxable as “royalty” under Article 13(3)(b), the matter was remanded for that purpose.

(157.5 KiB, 3,669 DLs)

Fees for Technical Services, even if rendered outside India, are taxable

The assessee, an Indian company, entered into an agreement with a Chinese company for bauxite testing services in its laboratories (outside India) and for preparation of test reports. The assessee filed an application u/s 195(1) in which it argued that as the services were rendered outside India and the recipient did not have a permanent establishment in India, the payments were not chargeable to tax under the India-China DTAA and no tax was required to be withheld at source. The AO took the view that the payments constituted “fees for technical services” u/s 9(1)(vii) and Article 12 of the DTAA and tax was required to be withheld at 10%. This was upheld by the CIT (A). The assessee appealed to the Tribunal. HELD dismissing the appeal:

(i) As regards taxability u/s 9(1)(vii), in Ishikawajima-Harima Heavy Industries 288 ITR 408 and Clifford Chance 318 ITR 237 (Bom) it was held that “fees for technical services” were not chargeable to tax in India if two conditions were not satisfied viz. that the services were (a) rendered in India and (b) were utilized in India. However, these judgements are no longer good law in view of the retrospective amendment to the Explanation to s. 9(1)(vii) by the Finance Act, 2010. The effect of the amendment is that “fees for technical services” are chargeable to tax in India even if rendered outside India. Except in a situation in which a territorial method of taxation is followed, which is usually also a lowest common factor in taxation policies of tax heavens, source rule is an integral part of the taxation system. It is thus fallacious to proceed on the basis that territorial nexus to a tax jurisdiction being sine qua non to taxability in that jurisdiction is a normal international practice in all tax systems. (The concepts of “territorial nexus” and “source rule” discussed);

(ii) As regards taxability under the DTAA, Article 12(4) defines “fees for technical services” as “the provision of services of .. technical .. nature by a resident of a Contracting State in the other Contracting State“. Article 12(6) provides that such technical services shall be deemed to arise in a Contracting State when the payer is a resident of that State;

(iii) The argument that in using the words “in the Contracting State“, Article 12(4) incorporates the “place of performance test” and negates the “source rule” and that services rendered offshore are not taxable is not acceptable for two reasons. Firstly, because the expression “provision for services” is wider than the term “provision for rendering of services” and covers services rendered in the one State but used in the other State. Secondly, because the interpretation will render Article 12(6) redundant. A literal interpretation to a tax treaty which renders a treaty provision unworkable should be avoided. (Principles of treaty interpretation reiterated);

(iv) Consequently, the payment was chargeable to tax under s. 9(1)(vii) as well under Art. 12 of the DTAA and tax had to be withheld at source u/s 195.

(126.2 KiB, 2,382 DLs)

S. 50C does not apply to “rights” in land & building like tenancy rights

The assessee, a tenant in a flat, sold tenancy rights for Rs. 30 lakhs and offered long-term capital gains on the basis that the said sum was the consideration. The AO took the view that as the market value adopted the Sub-Registrar was Rs. 33,11,200, the said market value had to be adopted as the consideration u/s 50C. This was confirmed by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) S. 50C is a deeming provision and incorporates a legal fiction that if the consideration received on transfer of land or building is less than the stamp duty value, the said stamp duty value shall be deemed to be the full value of consideration for purposes of computing capital gains;

(ii) It is trite law that a legal fiction cannot extend beyond the purpose for which it is enacted. As long as there is no ambiguity in the statutory language, resort to any interpretative process to unfold the legislative intent is impermissible. The statute has to be interpreted on the basis of the language used. No words can be added and only the language used can be considered so to ascertain the proper meaning and intent of the legislation. (Law on interpretation discussed in detail);

(iii) S. 50C does not apply to all capital assets but only to “land or building”. A tenancy right is not “land or building” (It is “rights” in building). Consequently, s. 50C has no application and the capital gains have to be computed on the basis of the actual consideration and not the stamp duty value.

(110.7 KiB, 1,268 DLs)

Timeshare membership fee is taxable only over the term of contract

The assessee, a time-share company having resorts at tourist places granted membership for a period of 33/25 years on payment of certain amount. During the currency of the membership, the member had the right to holiday for one week in a year at the place of his choice from amongst the resorts of the assessee. The membership fee was received either in lump sum or in installments to the prospective member. In addition to the membership fee, the member was liable to pay maintenance charges or subscription fees irrespective of whether he made use of the resort or not. If the resort was utilized, additional payment towards utilities like electricity, water, etc was payable. Though the assessee was following the mercantile system of accounting and treated the membership fee as revenue receipt, only 40% of the amount received was offered for taxation in the year of receipt. The balance was equally spread over the period of membership of 25 or 33 years on the ground that it was relatable to the services to be offered to the members. The AO took the view that as per the accrual system of accounting, the entire receipt had to be assessed as income in the year of receipt. The CIT (A) upheld the stand of the assessee. On appeal by the department, the matter was referred to the Special Bench. HELD by the Special Bench:

(i) In E.D. Sassoon & Co. Ltd. v. CIT 26 ITR 27, the Supreme Court held that two conditions are necessary for income to have “accrued to” or “earned by” an assessee viz. (i) the assessee has contributed to its accruing or arising by rendering services or otherwise, and (ii) a debt has come into existence and he must have acquired a right to receive the payment. In the present case, though a debt is created in favour of the assessee immediately on execution of the agreement, it cannot be said that the assessee has fully contributed to its accruing by rendering services because the assessee has a continuing obligation to provide accommodation to the members for one week every year till the currency of the membership. Till the assessee fulfils its promise, income has not accrued to it;

(ii) The argument of the assessee that the balance amount of membership fees has to be spread over the tenure of membership on the ground that heavy expenditure for the upkeep and maintenance of the resorts has to be incurred is not acceptable because separate charges are collected for maintenance and use of utilities and therefore the matching concept cannot be pressed into service with regard to the membership fee. The principles laid down in Calcutta Co. Ltd 37 ITR 1 (SC) and Rotork Controls India 314 ITR 62 are not applicable because though there is a liability, it is difficult not only to quantify but also to reasonably estimate it on a scientific basis. If the assessee had chosen to provide for the liability every year to comply with the matching concept, it would have been wholly unscientific and arbitrary;

(iii) Recognizing the entire receipt as income in the year of receipt can lead to distortion. Following the principles laid down in Madras Industrial Investment Corporation 225 ITR 802 (SC), where it was held that allowing the entire expenditure in one year might give a distorted picture of the profits of a particular year, recognizing the entire receipt in one year can also lead to distortion;

(iv) Consequently, the entire amount of timeshare membership fee receivable by the assessee up front at the time of enrollment of a member is not chargeable to tax in the initial year on account of contractual obligation that is fastened to the receipt to provide services in future over the term of contract.

(148.4 KiB, 2,717 DLs)

Tests laid down to determine whether income from shares is “business” income or “capital gains”

The assessee, a director and shareholder in a company engaged in share trading, returned income of Rs. 78,89,499 earned by her on transfer of shares as a “short-term capital gain”. The AO took the view that as there were voluminous transactions, the assessee was engaged in share trading and the income was assessable as “business income”. This was upheld by the CIT (A). On appeal, HELD dismissing the appeal:

(i) The legal principles are well settled viz. that:

(a) Whether a transaction of sale and purchase of shares is a trading or investment transaction is a mixed question of law and facts,

 

(b) It is possible for an assessee to be both an investor as well as dealer in shares,

 

(c) Whether a particular holding is by way of investment or of stock-in-trade is a matter within the knowledge of the assessee and it is for the assessee to produce evidence from the records as to whether he maintained any distinction between shares held as investment and those held as stock-in-trade,

 

(d) The treatment in the books by an assessee is not conclusive and if the volume, frequency and regularity at which transactions are carried out indicate systematic and organized activity with profit motive then it becomes business profit not capital gain,

 

(e) Purchase with intention to resale can constitute capital gains or business profit depending on circumstances like quantity of purchase and nature of activity,

 

(f) No single fact has any decisive significance and the question must be answered depending on the collective effect of all relevant material brought on record.

(ii) These principles have to be applied to the following facts:

(a) The assessee entered into transaction of purchases and sale of shares of about 32 companies totalling Rs.1,87,83,440 which were sold for Rs.2,69,71,368. Though most transactions were effected by actual delivery, the holding period was less than 6 months. Most of the gain was earned in shares held for a period for short periods;

 

(b) In the earlier years the assessee has nil or small long term capital gain which indicates that holding investments for a longer period is not the main intention except few scrips which are carried over without any transactions year after year. Accordingly to the extent of investment activity in shares one can see that the assessee has invested in some 5 to 6 companies scrips which have been carried over from year to year in which there are no frequent or large number of transactions and these investments in shares can be considered as assessee’s proper “investments”;

 

(c) Purchase and sale of shares in short period indicates that the assessee purchased the shares with a motive to earn profit in short period;

 

(d) The assessee undertook daily transactions without delivery in a few select scrips;

 

(e) The assessee borrowed funds to purchase shares;

 

(f) The dividend received was meager;

 

(g) The assessee’s group companies were involved in share trading.

(iii) These facts indicate that the intention of the assessee was to gain profits by dealing in short term period only. Consequently, the income from sale of shares was assessable as “income from business” and not “short-term capital gains”;

(iii) The decision in Gopal Purohit 122 TTJ 97 (affirmed in 228 CTR 582 (Bom)) is distinguishable because there the assessee had consistently been investing in shares and the ratio of sales to investment was very less and the LTCG was more than the STCG. Similarly Janak S. Rangwalla 11 SOT 627 (Mum) is also distinguishable on facts.

(67.9 KiB, 1,969 DLs)

Tests laid down to determine whether income from shares is “business” income or “capital gains”

The assessee, engaged in management consultancy, offered profits of Rs. 1.03 crores earned by it on sale of shares as long-term and short-term “capital gains” depending on the period of holding. The AO took the view that as the assessee was regularly dealing in shares throughout the year, the assessee was engaged in the “business” of trading in shares and that the profits were assessable as “business income“. This was confirmed by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) Though there is no fixed formula to determine whether the activity of purchasing and selling shares can be treated as a trading activity or as investment activity, certain guiding principles have been laid down in CBDT’s Circular No. 4/2007 dated 15.6.2007 as well as in Gopal Purohit 122 TTJ 87 (Mum) (affirmed in 228 CTR 582 (Bom)), Saranath Infrastructure 120 TTJ 216 (Luck) and other judgements. These principles of law have to be applied to the following facts:

(a) As per the books of account, the assessee has treated the entire investment in shares as an “investment” and not as “stock-in-trade”;

 

(b) The assessee is not a share broker nor he is having a registration with any Stock Exchange;

 

(c) Almost 83% of the capital gain is from shares that were held for a long period of time;

 

(d) There were no derivative transactions by the assessee;

 

(e) There were no transactions without delivery;

 

(f) The assessee used his own surplus funds for investing in shares and not borrowed any money;

 

(g) In the preceding years, the assessee consistently declared the gain/profit on the sale of the shares as ‘Capital Gains’ and the same has been accepted by the A.O. Though the rule of res judicata is not applicable to income-tax proceedings, in the absence of change in facts, there should be consistency in the approach of the Revenue;

 

(h) The assessee received substantial dividend on the investments.

(ii) The intention of the assessee cannot be read from his mind but it reflects in his conduct and the way he treats the transactions. Considering the totality of the facts, the transactions of sale and purchase of shares cannot be treated to be trading in shares nor as an adventure in the nature of the trade but is assessable as ‘capital gain’.

(17.2 KiB, 976 DLs)

Supreme Court doubts law requiring PSUs to obtain COD approval; directs review

In ONGC vs. CCE 104 CTR (SC) 31, the Supreme Court directed the Central Government to set up a ‘Committee on Disputes’ to monitor disputes between the Government and Public Sector Enterprises and give clearance for litigation. It was held the no litigation could be proceeded with in the absence of COD approval. This was followed in ONGC vs. CIDCO (2007) 7 SCC 39 and it was held that even disputes between PSUs and State Governments would require COD approval. HELD doubting the correctness of this law and referring the matter to a larger bench for reconsideration:

“In our experience, the working of the COD has failed. Numerous difficulties are experienced by the COD which are expressed in the letter of the Cabinet Secretary, dated 9th March, 2010. Apart from the said letter, we find in numerous matters concerning public sector companies that different views are expressed by COD which results not only in delay in filing of matters but also results into further litigation.

 

In the circumstances, we find merit in the submission advanced before us by learned Attorney General that time has come to revisit the orders passed by the three Judge Bench of this Court in the case of Oil & Natural Gas Commission vs. Collector of Central Excise (supra)”.

(88.1 KiB, 1,297 DLs)

S. 43(5): Derivatives are speculative transactions if not for bona fide hedging

In respect of AY 2005-06, the assessee, a dealer in shares, entered into transaction of purchases of Nifty Futures, which being a derivative instrument, was settled by payment of differences and not actual delivery of shares. The assessee argued that the transactions were hedging transactions meant to minimize the loss due to fluctuation of price of shares held as stock-in-trade and could not be regarded as speculative transactions u/s 43(5) so as to disallow the loss from being set off against other income. The AO took the view that a derivatives transaction could be regarded as a hedging transaction u/s 43(5)(b) only to the extent of the inventory of shares held by the assessee and that the excess would be regarded as a speculative transaction. As, on the date the Nifty Futures were purchased, the inventory of shares held by the assessee was less that the value of the Futures, the loss was treated as a speculation loss. The CIT (A) allowed the appeal on the ground that the s. 43(5)(d) inserted by FA 2005 w.e.f. 1.4.2006 (which provides that derivatives are not speculation transactions) was clarificatory). On appeal by the Revenue, HELD reversing the CIT (A):

(i) In Shree Capital Services 121 ITD 498 (Kol) it has been held by the Special Bench that the amendment to s. 43(5)(d) is neither clarificatory nor retrospective in operation. Consequently, derivatives can be considered non-speculative u/s 43(5)(b) only to the extent they are for hedging purposes;

(ii) The argument of the assessee that to constitute a hedging transaction u/s 43(5)(b), a transaction need not be in the same shares held by the assessee as inventory or that the value of hedging transactions should be equal to or less than the value of inventory held by the assessee is not acceptable. Circular No. 23D dated 12-9-1960 makes it clear that bona fide hedging transactions shall not be regarded as speculative provided that the hedging transactions are up to the amount of his holdings and confined to shares in his holding. The value and volume of hedging transactions should be in equal proportion and the hedging transaction should be in respect of the same scripts held by the assessee;

(iii) If the arguments of the assessee are accepted, it will lead to a situation where all speculative transactions will be claimed as hedging transactions and the purpose behind s. 73 of not permitting set off of speculative loss against business income will become redundant. The fact that in Nifty futures and index futures there cannot be any identification of shares does not change the position in law till the insertion of s. 43(5)(d);

(iv) As the AO has gone by the overall value of inventory without individual script wise tally (though required to be done), the plea of the assessee that the loss in purchase of Nifty Futures should not be considered as speculative to the extent of the value of inventory held by the Assessee on a particular day is acceptable.

(377.3 KiB, 936 DLs)

Parliament is competent to constitute Tribunals for special Acts. However, the failure to ensure independence of judiciary and separation of judicial and executive power renders the Company Law Tribunal unconstitutional. Suggestions given on how to remedy the defects

The Companies (Second Amendment) Act 2002 provides for the constitution of the National Company Law Tribunal (‘NCLT’) and National Company Law Appellate Tribunal (‘NCLAT’) to take-over the functions which are being performed by the CLB, BIFR, AAIFR and the High Court. The constitutional validity of the said amendment was challenged before the Madras High Court. The High Court upheld the creation of the NCLT and the vesting the powers thereto as being constitutional though it took the view that certain provisions were violative of the basic constitutional scheme of (i) separation of judicial power from the Executive and Legislative power and (ii) independence of judiciary enabling impartial exercise of judicial power. In an appeal to the Supreme Court, the UOI accepted to rectify some of the defects pointed out by the High Court though it challenged the other findings. HELD by the Supreme Court:

(i) The fundamental right to equality before law under Article 14 of the Constitution includes a right to have the person’s rights adjudicated by a forum which exercises judicial power in an impartial and independent manner. When access to courts to enforce such rights is sought to be abridged etc by directing him to approach an alternative forum, such legislative act is open to challenge if it violates the right to adjudication by an independent forum;

(ii) Parliament has the legislative competence to make a law providing for constitution of Tribunals to deal with disputes and matters arising out of special enactments like the Companies Act by taking away the jurisdiction vested in the High Courts. However, this power is subject to constitutional limitations and cannot encroach upon the independence of the judiciary and must keep in view the principles of Rule of Law and separation of powers. If Tribunals are to be vested with judicial power hitherto vested in or exercised by courts, such Tribunals should possess the independence, security and capacity associated with courts;

(iii) The eligibility criteria and qualifications for being appointed as members can be examined by the superior courts in exercise of the power of judicial review. If the qualifications and eligibility criteria provided for selection of members is not proper and adequate to enable them to discharge judicial functions and inspire confidence and conducive for the proper functioning of the Tribunal, it will result in invalidation of the constitution of the Tribunal;

(iv) A Tribunal packed with members who are drawn from the civil services and who continue to be employees of different Ministries or Government Departments by maintaining lien over their respective posts, amounts to transferring judicial functions to the executive which would go against the doctrine of separation of power and independence of judiciary;

(v) When a Tribunal is substituted in place of the High Court it is essential that the standards applied for appointing such members should be as nearly as possible as applicable to High Court Judges. Only persons with a judicial background and eligible for appointment as High Court Judges, can be considered for appointment of Judicial Members;

(vi) On facts, the qualifications in s. 10FD for appointment as a member are so dilute as to suggest that the qualifications prescribed are tailor made to provide sinecure for a large number of officers to serve up to 65 years in Tribunals exercising judicial functions. The Tribunals cannot become providers of sinecure to members of civil services, by appointing them as Technical Members;

(vii) There is also the dilution of independence. If any member of the Tribunal is permitted to retain his lien over his post with the parent cadre or ministry or department in the civil service for his entire period of service as member of the Tribunal, he would continue to think, act and function as a member of the civil services. A litigant may legitimately think that such a member will not be independent and impartial. The independence of members discharging judicial functions in a Tribunal cannot be diluted;

(viii) If the members are selected as per s. 10FD, there is every likelihood of most of the members, including the ‘Judicial Members’ not having any judicial experience or company law experience and such members being required to deal with and decide complex issues of fact and law;

(ix) There is also lack of security of tenure with regard to the short term of three years, the provision for routine suspension pending enquiry and the lack of any kind of immunity which requires to be remedied;

(x) Several other defects in Parts 1B and 1C of the Act pointed out which render them unconstitutional and invalid. Suggestions given as how to make them operational.

(146.9 KiB, 1,225 DLs)

S. 271(1)(c) Penalty: Supreme Court chides High Court for “casual” order. Guidelines laid down as to how judgements should be written. Correctness of Gold Coin 304 ITR 308 (SC) reiterated

The assessee filed a Nil return after claiming depreciation. The AO disallowed depreciation but still assessed the total income at Rs. Nil. Penalty u/s 271(1)(c) was levied on the disallowance which was deleted by the Tribunal on the ground that as the returned income and the assessed income was Nil, penalty could not be levied. The department filed an appeal before the High Court which was dismissed on the basis that no penalty u/s 271(1)(c) could be levied where the returned and assessed income were Nil. On further appeal by the Revenue, HELD allowing the same:

(i) The High Court has dealt with the appeal in a most casual manner. The order is not only cryptic but does not even remotely deal with the arguments projected by the Revenue before it. It is unfortunate that the guidelines issued by the Supreme Court from time to time as to how judgments/orders are to be written are not being adhered to. It is true that brevity is an art but brevity without clarity is likely to enter into the realm of absurdity, which is impermissible. This is reflected in the impugned order. Detailed guidelines laid down as to how judgements should be written;

(ii) On merits, in view of CIT vs. Gold Coin Health 304 ITR 308 (SC) (which overruled Virtual Soft Systems 289 ITR 83 SC), penalty u/s 271(1)(c) is leviable even if the assessment is at a loss;

(iii) At first glance, it appeared that Gold Coin Health required reconsideration by a larger Bench in view of CIT vs. Elphinstone Spinning and Weaving Mills Co 40 ITR 142 (which was followed in Virtual Soft) but it is not so because of distinguishing features between Gold Coin and Elphinstone Spinning;

(iv) In order to enable the Court to refer any case to a larger Bench for reconsideration, it is necessary to point out that particular provision of law having a bearing over the issue involved was not taken note of or there is an error apparent on its face or that a particular earlier decision was not noticed, which has a direct bearing or has taken a contrary view. This is not the case herein and so a reference to a larger Bench is not necessary.