(135.1 KiB, 2,280 DLs)

Large volume of purchase & sale of shares does not per se mean activity is business

The assessee, a broker in the BSE, disclosed short-term capital gains and long-term capital gains on sale of shares. The AO accepted the LTCG as such though he held that the STCG was assessable as “business profits” on the ground that the assessee was a stock broker & there was large volume and frequency (more than 300) transactions. On appeal, the CIT (A) reversed the AO. On appeal by the department to the Tribunal, HELD dismissing the appeal:

(i) It is no more res integra that a person can be both “Investor” as well as “Trader” in shares. (Draft Instruction No. 2005, Instruction No. 1827 dated 31.8.1989 & Circular No. 4/2007 dated 15.6.2007 referred). The assessee has to maintain the distinction between shares held as stock and those held as investments in its records;

(ii) While volume of transactions is an important indicator of the intention of the assessee whether to deal in shares as trading asset or to hold the shares as investor, it is certainly not the sole criterion. The AO’s conclusion that since sale and purchase had been determined by the volatility in the market, the same is against the basic feature of investor is not based on sound rational reasoning. A prudent investor always keeps a watch on the market trends and, therefore, is not barred under law from liquidating his investments in shares. The law itself has recognized this fact by taxing these transactions under the head “Short Term Capital Gains”. If the AO’s reasoning is accepted, then it would be against the legislative intent itself;

(iii) The fact that the assessee did not borrow funds for investment in shares is an important aspect which cannot be lost sight off while deciding the true intention of the assessee;

(iv) The fact that the AO accepted the assessee’s claim in earlier years that it was an investor is material because though the principles of res judicata do not strictly apply to income tax proceedings it is well settled law that the principles of consistency should not be ignored. Uniformity in treatment and consistency under the same facts and circumstances is one of the fundamentals of the judicial principles which cannot be brushed aside without proper reason;

(v) The fact that the AO accepted the offering of LTCG also showed that the assessee’s status as investor was accepted by him;

(vi) Some part of the STCG had arisen out the earlier investment which had been accepted as being on investment account. As the modus operandi of the assessee remained the same in regard to other shares purchased during the year, the assessee’s claim could not be negated only on the basis of frequency of the transaction (Gopal Purohit 228 CTR 582 (Bom), Sadhana Nabera 41 DTR 393 & Jayshree Pradip Shah considered).

(229.8 KiB, 1,270 DLs)

Foreign income-taxes not eligible for deduction u/s 37(1). Despite bar in DTAA, credit for State taxes to be given u/s 91 in addition to Federal taxes

In respect of AY 2000-01, the assessee earned profits on export of software which was eligible for deduction u/s 80HHE. The assessee paid foreign income-taxes of Rs. 60 crores on the said profits in respect of which the assessee claimed tax credit u/ss 90 & 91. The assessee also claimed that it was eligible for a deduction u/s 37(1) in respect of the said foreign income-taxes. While the AO allowed tax credit, he denied deduction u/s 37(1) on the ground that the said payment of foreign taxes was an “application of income” and that it was hit by s. 40(a)(ii). On appeal, the CIT (A) upheld the claim of the assessee by following the orders of the Tribunal in the assessee’s own case & where a department’s reference u/s 256(2) had been rejected the Bombay High Court. In appeal before the Tribunal the department argued that the earlier decisions of the Tribunal should not be followed as they were against the basic scheme of the Act and also that they were no longer good law in view of Explanation 1 to s. 40(a)(ii) inserted by FA 2006 w.e.f. 1.4.2006. HELD upholding the plea of the department:

(i) While there are four basic methods in which relief in the home jurisdiction can be given for taxes paid in a foreign jurisdiction, ss. 90& 91 adopt the system of granting credit for the foreign taxes against the Indian taxes payable in respect of the income (Tax Law Design and Drafting referred);

(ii) The argument that the bar of deduction in s. 40(a)(ii) is not applicable to foreign taxes is no longer acceptable in view of Lubrizol vs CIT 187 ITR 25 (Bom) (being rendered after the lead order of the Tribunal) where it was held that foreign tax payments is an “appropriation of income” and that the words “any tax” in s. 40(a)(ii) covered foreign taxes. Further, this position is clarified by Explanation 1 to s. 40(a)(i) inserted by FA 2006. Accordingly, the earlier judgements of the Tribunal cannot be followed despite the fact that the department’s reference u/s 256(2) was rejected by the High Court;

(iii) The claim of the assessee that it is entitled to tax credit u/ss 90 & 91 in respect of the foreign taxes as well as a deduction u/s 37(1) is not justified and results in a double unintended benefit. On facts, while the assessee paid US Federal Income-tax @ 35% of Rs 35 crores and claimed deduction u/s 37(1) which resulted in tax advantage of Rs 13 crores being 38.5% of this amount, it also claimed tax credit of Rs 35 crores against its Indian income-tax liability despite the fact that the profits were not taxed in India owing to deduction u/s 80HHE. The result is that for a payment of US taxes of Rs 35.01 crores, the assessee claimed tax relief of Rs 48.49 crores in India. Even if tax credit was denied in cases where s. 80HHE was eligible (as done by the CIT (A)), the assessee would still get an effective advantage of 38.5% if it was granted a deduction u/s 37(1). This results in incongruity;

(iv) The argument that if deduction u/s 37(1) is not granted, credit for foreign taxes should be granted u/s 90 even in respect of income eligible for deduction u/s 80HHE is not acceptable because this would be contrary to the language of the DTAA and result in an assessee getting refund of US taxes if he had no tax liability in India. (Green Emirate Shipping 100 ITD 203 distinguished & Digital Equipments 94 ITD 340 followed);

(v) The argument that ss. 90 & 91 are confined to USA Federal taxes and not to USA State taxes and that therefore the bar in s. 40(a)(ii) does not apply to USA State taxes is not acceptable because any payment of income-tax is an application of income as held in Inder Singh Gill 47 ITR 284. Further, the scheme of ss. 90 & 91 does not discriminate between Federal taxes and State taxes and though the India-USA DTAA confines the credit only to Federal taxes, the assessee will be entitled to relief u/s 91 in respect of both taxes as that will be more beneficial to the assessee vis-à-vis tax credit under DTAA. Consequently, the bar against deduction in s. 40(a)(ii) will apply to USA State taxes as well though the assessee will be entitled to credit in respect of USA State taxes.

(73.8 KiB, 2,301 DLs)

Though foreign artistes are chargeable to tax in India, their agents are not in the absence of a PE

The assessee, an event organizer, entered into an agreement with “Colin Davie Artiste Services”, a UK company, under which the latter agreed to procure renowned foreign entertainers like “Diana King” & “Shaggy” for performances in India. The assessee agreed to pay a fee to the entertainers as well to Colin Davie & to reimburse expenses incurred. In respect of the fees paid to the entertainers, the assessee accepted that the same was chargeable to tax in India under Article 18 of the India-UK DTAA and deducted tax at source u/s 195. However, in respect of the fees paid to Colin Davie and amounts paid towards reimbursement of expenses, the assessee argued that the same were not liable to tax in India. The AO took the view that as the payment to Colin Davie was high, it was actually meant for payment to the entertainers. He also held that the nature of services agreed to be rendered by Colin Davie were such that it could not be performed without having a presence in India. On appeal, the CIT (A) accepted the stand of the assessee. On appeal by the department, HELD dismissing the appeal:

(i) The contention of the AO that the entire consideration including the fee to be paid to Colin Daive is in fact fees payable to the artiste for performance in India is not substantiated. On the other hand, it is well known that internationally reputed performers are not easily approachable and to discuss with them about performing in India, time schedule, structure of the show/concert, venues, itinerary, fees etc requires good business negotiation and persuasive skill apart from accessibility. The artists/performers are quite unapproachable and emotional and are known for their varied and sometimes unpredictable behavior. Accordingly, agents, who act as a link and who have acumen and skills to negotiate with such artists/performers are required to be engaged and paid fees;

(ii) As Colin Davie was not a performer, his income was not covered under Article 18 of the DTAA but was covered by Article 7 and as the services were rendered outside India and there was no PE, the same was not assessable to tax in India. Even under the Act, by virtue of Carborandum Co 108 ITR 335 (SC), Circular No. 17 of 1953 dated 17.7.1953 & Circular No.786 dated 7.2.2000, commission paid to agents for services rendered outside India is not chargeable to tax in India and there is no obligation to deduct tax u/s 195;

(iii) As regards payment made towards reimbursement of expenses, the law is well settled by virtue of Krupp UDHE Gmbh 38 DTR (Bom) 251 & Siemens AG 220 CTR (Bom) 425 that the same is not chargeable to tax and there was no obligation to deduct tax at source.

(78.5 KiB, 1,224 DLs)

Though assessee shown as “owner” of demat shares in depository’s books, if he shows to be mere “pledgee”, there is no “benefit” u/s 2(24)(iv)

The assessee, Chairman & Managing Director of Reliance Industries Ltd, was appointed Managing Director of Reliance Communication and Infrastructure Ltd (RCIL) w.e.f. 11.3.04. On 13.3.04 RCIL decided to take an interest-free loan of Rs. 50 crores from the assessee and offered by way of security 50 crore equity shares of Reliance Infocom Ltd (RIC). Each share of RIC had a market value of Rs.53.71 per share and the 50 crore shares received by the assessee were worth Rs.2685 crores. The said RIC shares were dematerialized and transferred to the assessee’s demat account. Within a few weeks, RCIL repaid the loan and the assessee transferred the shares of RIC to RCIL. The AO took the view that there was a necessity for the assessee to acquire the 50 crore shares of RIC because of a struggle to have control and management of RIC and that the transaction was wrongly shown as a loan and pledge. He also held that as the assessee was recognized as beneficial owner by the Depository, the result was that there was a transfer of ownership in shares by way of sale and that the assessee was to be considered as owner for all purposes. As the assessee was a director, it was held that the difference between the market value of shares (Rs. 2,685 crores) and the amount paid by the assessee (Rs. 50 crores) was a “benefit” assessable u/s 2(24) (iv). On appeal, the CIT (A) reversed the AO on the ground that the transaction was a “pledge” and not a “sale”. On appeal by the department, HELD dismissing the appeal:

(i) Prior to the concept of dematerialisation, a valid pledge of shares could be created by delivery of the shares to the pawnee either physically or constructively. With respect to demateriaized shares, though s.12 of the DP Act provides for the manner of creating a pledge, this is not the only method. Dematerialized shares continue to be “goods” and the law laid down in the Companies Act and the Sale of Goods Act for deciding whether a sale of shares has taken place or not will continue to govern;

(ii) Though a person is shown as the beneficial owner in the register of a depository participant, this is not conclusive and he can show that he is not the beneficial owner of shares but only holds the shares as a pawnee and as security for repayment of debts due by the real beneficial owner;

(iii) On facts, the assessee had shown that he held the shares not as beneficial owner but as Pawnee as security for repayment of debts. The allegations made by the AO that the assessee needed to own the shares to overcome the power struggle were vague and unsubstantiated. As a pawnee/pledgee, the assessee does not have absolute rights over the shares. He could sell the security in a manner contemplated by law. In case the proceeds were greater than the amount due to him, he had to pay the surplus to the pawnor. Consequently, there was no “benefit” assessable u/s 2(24)(iv).

(13.5 KiB, 1,395 DLs)

High Court’s judgement on transfer pricing in cases not leading to “erosion of tax revenue” nullified

In Coca Cola India Inc vs. ACIT 309 ITR 194 the P&H High Court upheld the constitutional validity of Chapter X & laid down far-reaching principles on the applicability of transfer pricing provisions to cases where the non-resident was also assessed in India and there was supposedly no cross-border transaction or erosion of tax revenue. On appeal by the assessee, HELD disposing off the SLP:

“The issue in this special leave petition concerns the application of the principle of Transfer Pricing. In the case of assessee herein, Notice was issued under Section 148 of the Act for some of the Assessment Years. On the question of jurisdiction, a writ petition was filed by the assessee, which has been disposed of by the High Court in the writ jurisdiction. However, on going through the papers, we find that foundational facts are required to be established which could not have been done by way of writ petition. For the afore-stated reasons, we are of the view that the assessee should be relegated to adopt proceedings, which are pending, as of date, before various Authorities under the Act … We, accordingly, direct these Authorities to expeditiously hear and dispose of pending proceedings as early as possible. If the petitioner-assessee herein is aggrieved by the orders passed by any of these Authorities, it will have to exhaust the statutory remedy provided under the Act. We make it clear that each of the Authorities will decide the matter uninfluenced by any of the observations made in the impugned judgement.”

(12.4 KiB, 1,246 DLs)

High Court’s judgement on transfer pricing of trademarks & brands licensing nullified

In Maruti Suzuki vs. ACIT 328 ITR 210 (Del), the Delhi High Court whilst remanding the matter to the TPO for fresh consideration inter alia held that if a domestic Associate Enterprise is mandatorily required to use the foreign trademark on its products, the foreign entity should make payment to the domestic entity on account of the benefit the foreign entity derives in the form of marketing intangibles from such mandatory use of the trademark. Certain other far-reaching principles on transfer pricing of trademarks & brands were set out. On appeal by the assessee, HELD disposing off the Appeal:

“In this case, the High Court has remitted the matter to the Transfer Pricing Officer with liberty to issue fresh show-cause notice. The High Court has further directed the TPO to decide the matter in accordance with law. Further, on going through the impugned judgement of the High Court dated 1st July, 2010, we find that the High Court has not merely set aside the original show-cause notice but it has made certain observations on the merits of the case and has given directions to the TPO, which virtually concludes the matter. In the circumstances, on that limited issue, we hereby direct the TPO, who, in the meantime, has already issued a show-cause notice on 16th September, 2010, to proceed with the matter in accordance with law uninfluenced by the observations/directions given by the High Court in the impugned judgement dated 1st July, 2010.”

(164.8 KiB, 1,366 DLs)

Non-examination of issue by AO does not per se make assmt order prejudicial to interests of revenue for s. 263 revision

The assessee, a statutory body established under the Chartered Accountants Act 1949 for regulating the profession of Chartered Accountants, obtained exemption u/s 10(23C)(iv) pursuant to a notification issued by the CBDT. The notification provided that the exemption would not apply to profits and gains of business unless the business was incidental to the attainment of the objectives of the assessee and separate books of accounts were maintained. The AO accepted the assessee’s claim for exemption and completed the assessment. The DIT (E) exercised revisional powers u/s 263 and took the view that the assessment order was erroneous & prejudicial to the interests of the revenue on the ground that (i) the activity of running coaching classes was not provided for in the CA Act and so the income from coaching class was “business” income and not eligible for s. 10(23C)(iv) exemption and (ii) expenditure incurred overseas for traveling, membership fee of foreign professional bodies etc meant that the application of income was outside India which was not permitted by s. 10(23C)(iv). It was noted that the AO had not applied his mind to the issues and so the assessment order was set aside with direction to make a fresh assessment. On appeal by the assessee, HELD quashing the s. 263 order:

(i) The argument of the revenue on the basis of Gee Vee Enterprises 99 ITR 375 (Del) that non-making of inquiry by the AO is sufficient to justify action u/s 263 is not acceptable in view of the later decision in Vikas Polymers (Del) where it was held that the fact that the AO has not applied his mind to the issue may mean that the order is erroneous but it does not necessarily mean that the order is also prejudicial to the interests of the revenue. The CIT should apply his mind to the information provided by the assessee in the course of the revisional proceedings and record a finding instead of simply remanding the matter to the AO for examination;

(ii) On merits, the objection of the DIT that the CA Act does not contemplate running of coaching classes is wrong. The major activity of the assessee revolves around chartered accountancy education and training and nominal fees are charged for this purpose. The discharge of a statutory function does not amount to a commercial or business activity. Further, the assessee is exempt not only u/s 10(23C)(iv) but also u/s 11 as an educational institute;

(ii) The objection that overseas expenses could not have been incurred without permission of the CBDT as required by s. 11(1)(c) is not sustainable because there is no such requirement u/s 10(23C)(iv). Further, the mere fact that expenditure has been incurred on foreign travel does not mean that the assessee has incurred expenses for purposes which are not for India. Instead, the assessee has to maintain status and standard of professional qualification of chartered accountancy and observe developments taking place in the world.

(475.4 KiB, 3,260 DLs)

If NPV of future sales-tax liability is paid, there is no “remission” for s. 41(1)

The assessee availed of the sales-tax deferral schemes of 1983 & 1988 offered by the Maharashtra State Govt under which the sales-tax collected by the assessee could be paid after 12 years. The total sales-tax collected by the assessee was Rs. 7,52,01,378 which was deemed to have been paid and deduction was allowed u/s 43B. In 2002, the State issued a circular permitting premature repayment of the deferred sales-tax liability at its Net Present Value (NPV). The NPV of the deferred sales-tax liability was computed at Rs. 3,37,13,393, which the assessee paid and was discharged of the liability to pay Rs. 7,52,01,378. The difference between the deferred sales-tax and its NPV amounting to Rs. 4,14,87,795 was treated by the assessee as a capital receipt. The AO took the view that as a deduction for the sales-tax liability had been allowed u/s 43B, the “remission” from that liability was taxable u/s 41(1). This was upheld by the CIT (A). On appeal by the assessee, the issue was referred to the Special Bench in view of conflicting judgements. HELD by the Special Bench deciding in favour of the assessee:

(i) For s. 41(1) to apply, two conditions have to be satisfied. First, the assessee should have obtained an allowance or deduction in respect of any loss, expenditure or trading liability and second, the assessee should have subsequently (i) obtained any amount in respect of such loss or expenditure or (ii) obtained any benefit in respect of such trading liability by way of remission or cessation thereof;

(ii) The first requirement of s. 41(1) that the assessee should have obtained an allowance or deduction in respect of loss, expenditure or trading liability is not satisfied because all that CBDT Circular No. 496 dated 25.9.1987 provides is that “…the statutory liability shall be treated to have been discharged for the purposes of s. 43 B”. Accordingly, the benefit of deduction was allowed for the purpose of s. 43 B only and not under any other provisions of the Act. The AO applied the aforesaid Board Circular while giving the benefit of deduction u/s. 43B. Circulars are binding on the department;

(iii) The second requirement of s. 41(1) is also not satisfied because in paying the NPV, the assessee has paid the equivalent of the Future Value of the sum. As the sum of Rs. 3,37,13,393 is the NPV of the future sum of Rs.7,52,01,378 and its payment discharges the full liability, there is no remission or cessation of liability by the State Govt. It is a simple case of collecting the amount at net present value which is due later on (principles of s. 63 of the Contract Act applied);

(iv) The fact that the assessee has not obtained the modified Eligibility Certificate or that it used the expression ‘remission’ of loan liability in its books are irrelevant because the making or absence of an entry cannot determine rights and liabilities of parties.

(624.3 KiB, 1,809 DLs)

In absence of “thin capitalization rules”, interest paid to shareholders for loans cannot be disallowed despite capital-structure tax-planning

The assessee, a Belgium company, was set up to execute a project in India and had a PE in India. The assessee’s share capital of Rs. 38 lakhs was owned by two foreign companies (shareholders) in the ratio of 60:40. The said two shareholders also advanced loans to the assessee aggregating Rs. 94.10 crores in the same ratio in which they held shares in the assessee i.e. 60:40. The assessee’s debt-equity ratio was 248:1. The assessee paid interest of Rs. 5.73 crores on the loans obtained from its shareholders and claimed that as a deduction. The AO disallowed the claim on the ground that (i) though the moneys were borrowed from the shareholders, in view of the abnormal debt-equity ratio, they were to be treated as capital / loan taken from the Head Office and (ii) that as the RBI approval did not permit the PE to borrow, the loan was in contravention of law. This was upheld by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) Under Article 7 (1) & 7(3)(b) of the India-Belgium DTAA, the profits of the assessee as are attributable to the PE are chargeable to tax in India. In determining such profits, all expenses are allowable subject to limitations specified in the DTAA and the Indian laws. The only limitation is that notional interest paid by a branch to its HO is not allowable. This limitation does not apply as the assessee borrowed from an outside party, i.e. its shareholders;

(ii) The argument of the revenue that the abnormal debt-equity ratio attracts the “Thin Capitalization Rule” and that the “debt” should be characterized as “equity” for purposes of considering whether interest is deductible is not acceptable. Several countries have detailed “thin capitalization rules” (e.g. Belgium). However, there are no such rules in India though the DTC 2010 has proposed this vide s. 123(1)(f). In the absence of specific “thin capitalization” rules, it is not open to the revenue to characterize debt as equity and disallow the interest (principles in Azadi Bachao Andolan 263 ITR 706 (SC) followed). The domestic law limitation of Art 7(3) refers to the Source Country & not the Residence Country;

(iii) Imposing the “thin capitalization rules” on the assessee when domestic companies are not subject to such rules will violate the “non-discrimination” provision in Art. 24(5);

(iv) The argument that the finance structure should be treated as a “colourable device” and disregarded is not acceptable because there is no anti-abuse provision in the DTAA and in the absence of specific language (such as the proposed s. 129(9) of DTC 2010), the DTAA cannot be over-ridden by the Act;

(v) The Expl to s. 37 has no application to interest allowable u/s 36(1)(iii).

(17.6 KiB, 1,781 DLs)

Q of S. 40A (2) not examined as exercise is “revenue-neutral”. Transfer Pricing Provisions should be extended to domestic transactions to “reduce litigation”

The assessee did not have any employee other than a company secretary and all administrative services relating to marketing, finance, HR etc were provided by Glaxo Smith Kline Consumer Healthcare Ltd (“GSKCH”) pursuant to an agreement under which the assessee agreed to reimburse the costs incurred by GSKCH for providing the various services plus 5%. The costs towards services provided to the assessee were allocated on the basis suggested by a firm of CAs. The AO disallowed a part of the charges reimbursed on the ground that they were excessive and not for business purposes which was upheld by the CIT (A). However, the Tribunal deleted the disallowance on the ground that there was provision to disallow expenditure on the ground that it was excessive or unreasonable unless the case of the assessee fell within the scope of s. 40A (2). It was held that as it was not the case of the Department that s. 40A (2) was attracted, the disallowance could not be made (see 290 ITR 35 (Del) for facts). The department challenged the deletion. HELD dismissing the SLP:

(i) The Authorities below have recorded a concurrent finding that the said two Companies are not related Companies under s. 40A (2). As far as this SLP is concerned, no interference is called for as the entire exercise is a revenue neutral exercise. Hence, the SLP stands dismissed. For other years, the authorities must examine whether there is any loss of revenue. If the Authorities find that the exercise is a revenue neutral exercise, then the matter may be decided accordingly;

(ii) The larger issue is whether Transfer Pricing Regulations should be limited to cross-border transactions or whether the Transfer Pricing Regulations be extended to domestic transactions. In domestic transactions, the under-invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature, except in two circumstances having tax arbitrage such as where one of the related entities is (i) loss making or (ii) liable to pay tax at a lower rate and the profits are shifted to such entity;

(iii) Complications arise in cases where the fair market value is required to be assigned to transactions between related parties u/s 40A(2). The CBDT should examine whether Transfer Pricing Regulations can be applied to domestic transactions between related parties u/s 40A(2) by making amendments to the Act. The AO can be empowered to make adjustments to the income declared by the assessee having regard to the fair market value of the transactions between the related parties and can apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under Transfer Pricing Regulations. The law can also be amended to make it compulsory for the taxpayer to maintain Books of Accounts and other documents on the lines prescribed in Rule 10D and obtain an audit report from his CA that proper documents are maintained;

(iv) Though the Court normally does not make recommendations or suggestions, in order to reduce litigation occurring in complicated matters, the question of extending Transfer Pricing regulations to domestic transactions require expeditious consideration by the Ministry of Finance and the CBDT may also consider issuing appropriate instructions in that regard.