(299.0 KiB, 958 DLs)

S. 158BD order void if referring AO’s “satisfaction” not recorded

On 30.8.2000, search u/s 132 was carried out on the premises of Manoj Aggarwal pursuant to which a block assessment u/s 158BC was made on 29.8.2002. On 15.7.2003, Manoj Aggarwal’s AO sent a letter to the assessee’s AO that the assessee had given bogus accommodation entries. On 22.3.2004, a notice u/s 158B was sent to the assessee and thereafter an assessment order was passed. This was upheld by the CIT(A). However, the Tribunal set aside the assessment on the ground that (i) Though the assessee’s AO had recorded satisfaction, Manoj Aggarwal’s AO had not recorded satisfaction that undisclosed income belongs to any person other than the searched person, (ii) though Manoj Aggarwal’s AO had written a letter to the assesse’s AO, it was after the assessment order was passed and he had become “funtus officio“, (iii) the notice u/s 158B was issued after beyond reasonable time (19 months). The department filed an appeal only on the question whether recording of satisfaction by the searched party’s AO was mandatory. HELD dismissing the appeal:

(i) In Manish Maheshwari vs. ACIT 289 ITR 341 (SC) it was held that recording of satisfaction by the AO of the searched person that any undisclosed income belongs to any person, other than the person searched, was a condition precedent and it is only thereafter that the AO of the third person can proceed against his assessee u/s 158BC;

(ii) The word “satisfaction” has not been defined in the Act. By its very nature “satisfaction” must precede the sending of papers/documents by the searched person’s AO to the third person’s AO. Mere use or mention of the word “satisfaction” in the order/note will not meet the requirement of concept of satisfaction as used in s. 158BD. The satisfaction has to be in writing and can be gathered from the assessment order, if it is so mentioned/recorded, or from any other order, note or record maintained by the AO of the person searched. The AO must reach a clear conclusion that good ground exists for the AO of the third person to initiate proceedings as material before him shows or would establish “undisclosed income” of a third person. There must be rational and tangible nexus between the material found in search and the satisfaction;

(iii) On facts (without going into the issue of whether the AO was “functus officio“), the assessment order passed in the case of Manoj Aggarwal does not show any “satisfaction” that any undisclosed income belongs to the assessee. Though Manoj Aggarwal’s AO wrote a letter to the assessee’s AO informing him that the assessee was providing bogus accommodation book entries and the the quantum of transactions was given as per Annexures, the Annexures were missing from the file. No evidence and material was brought on record to show that the assessee had received cash for the entries. So, the onus on the AO that there was valid satisfaction was not discharged.

(538.8 KiB, 2,483 DLs)

S. 153C assessment sans “speaking” & “incriminating” documents void

Search & seizure action u/s 132 was carried out in the case of Shri M.N. Navale, the President of the assessee Educational Society, in the course of which certain documents pertaining to the assessee were found. Based on the documents, the AO issued a notice u/s 153C and made an assessment on the assessee. The assessee challenged the s. 153C proceedings on the ground that the mere finding of documents in the premises of the searched person was not sufficient if the documents were not “incriminating”. HELD upholding the challenge:

Though s. 153C confers jurisdiction if the AO is “satisfied” that “documents” seized belong to a person other than the person referred to in s. 153A so as to be able to assess that other person, the document must have prima facie incriminating information. The document seized must not only be a ‘speaking one’ but also be prima facie ‘incriminating one’ for attracting s.153C. If the impugned documents merely contain the notings of entries which are already recorded in the books of account or subjected to scrutiny of the AO in the past in regular assessment u/s 143(3) of the Act, such document cannot be said to be containing the incriminating information so as to confer jurisdiction u/s 153C.

(105.3 KiB, 1,963 DLs)

No s. 271(1)(c) penalty for failure to disallow u/s 14A

For AY 2005-06 the assessee had investments in shares of Rs. 37 crores on which it earned tax-free dividend. The assessee also had borrowings of Rs. 33 crores on which it paid interest of Rs. 1.10 crores. However, no disallowance u/s 14A was made. The AO computed the disallowance at Rs. 95 lakhs and levied penalty under Explanation 1 to 271(1)(c) on the ground that there was no satisfactory explanation for not attributing expenses to tax-free income. This was deleted by the CIT (A). On appeal by the department, HELD dismissing the appeal:

Though the computation of s. 14A disallowance was not made, the figures of dividend and interest were stated in the P&L A/c. Even the tax auditors did not state that s. 14A disallowance should be made. As there is no allegation by the AO that there was collusion between the auditor and the assessee to ignore s. 14A, it cannot be said that the explanation was not bona fide. Further, as Rule 8D was not enacted at the time, segregation of expenditure relatable to tax-free income would be disputable and lead to bona fide difference in opinion. So, penalty u/s 271(1)(c) cannot be levied.

(106.9 KiB, 1,604 DLs)

Despite borrowing, shares gain can be STCG & not business profits

The assessee offered income from Futures and Options, speculative business, short-term capital gains (STCG) and LTCG from transactions in shares. The AO held that the STCG was assessable as “business income” on the ground that (i) the assessee was carrying on business in F&O and speculative transactions, (ii) a majority of the transactions were settled in a short span of 30 days, (iii) more than 30% of the profit is from transactions where the purchase and sales took place within the period of one month, (iv) the frequency of transactions was huge, (v) the assessee had borrowed funds for purchase of shares and claimed the interest as a deduction which was almost 30% of the STCG and (vi) the assessee had the infrastructure to trade. The CIT (A) confirmed the AO (though for the next AY he took the reverse view). On appeal by the assessee, HELD allowing the appeal:

(i) The question whether the surplus on the sale of shares is to be assessed as capital gains (short term or long term) or as business income has to be decided according to the cumulative effect of several facts and circumstances such as (a) the intention of the assessee, (b) the nature of the commodity sold, (c) whether the assessee has used his own funds or borrowed funds, (d) the treatment given to the asset in the books of account, (e) the consistent stand taken by the revenue authorities in respect of the sale proceeds of the asset in the earlier years, (f) the frequency and volume of the transactions, (g) the period of holding the shares and (h) whether the assessee took or gave delivery of the shares;

(ii) On facts, the gains had to be treated as STCG because:

(a) the assessee has shown the shares as investment in the Balance Sheet;

 

(b) In the earlier years and subsequent year, the AO has accepted u/s 143(3) the STCG and LTCG offered by the assessee;

 

(c) The shares offered as LTCG were held for long periods of time;

 

(d) the fact that the assessee is also carrying on substantial F&O transactions as speculation business is not relevant because as per CBDT circular accepted in Gopal Purohit 34 DTR 52 (Bom), a person can have two portfolios, one for investment and the other as stock-in-trade;

 

(e) The fact that the assessee borrowed for the purpose of buying shares is not conclusive that the assessee intended to do business in shares and not merely invest in them if the interest is capitalized as cost of the shares & not claimed as a revenue expenditure (Shanmugam 120 ITD 469 (Pune) followed). The fact of borrowing cannot be held against the assessee if there are other predominating factors in favour. Also as the assessee has own funds, it can be presumed that the shares were bought out of those funds.

(211.6 KiB, 1,248 DLs)

Despite detection in survey, No s. 271(1)(c) penalty if income offered in ROI

A survey was conducted pursuant to which certain discrepancies were found and the assessee surrendered Rs. 88.14 lakhs. In the ROI due for the financial year of survey, the assessee offered the said sum as income. The AO levied penalty u/s 271(1)(c) on the ground that the offer of income was pursuant to detection in the survey and not voluntary. The CIT(A) & Tribunal deleted the penalty. On appeal by the department to the High Court, HELD dismissing the appeal:

Though it is possible that but for detection in the survey, the assessee might not have offered the income, penalty u/s 271(1)(c) can only be levied if “in the course of proceedings” the AO is satisfied that there is “concealment” or “furnishing of inaccurate particulars“. The words “in the course of proceedings” mean the assessment proceedings because there is no question of the satisfaction of the AO in survey proceedings. Further, the question whether there is “concealment” or “inaccurate particulars” has to be determined with reference to the return of income. As the assessee had offered the detected income in the return, there was neither concealment nor the furnishing of inaccurate particulars.

(390.3 KiB, 3,604 DLs)

Transfer Pricing principles on use of multi-year data, adjustment to operating profits & +/- 5% adjustment

The assessee adopted the TNMM and claimed that (i) as its operations were for a part of the year, an adjustment to the margins on account of ‘capacity utilisation’ should be made, (ii) the pre-operative expenditure should be excluded, (iii) multi-year data should be used to determine comparables, (iv) if only one comparable is left, the entire exercise should be carried out afresh and (v) even if there was only one comparable, the +/- 5% adjustment should be made. The AO & DRP rejected the claim. On appeal to the Tribunal, HELD:

(i) The rejection of comparables on the ground of non-availability of current year’s financial data is proper because under Rule 10B(4), only the current year’s financial data is relevant for determination of ALP except where it is shown that the data of the earlier two years reveals facts which could have an influence on the determination of the transfer price;

(ii) A selected comparable should be functionally comparable. A company which is majorly dealing in other segments cannot be accepted as functionally comparable;

(iii) The argument of the assessee that if there is only one comparable, the ALP cannot be determined and a fresh search of comparables should be conducted is not acceptable. There is no principle of law that if only one comparable remains, the entire exercise would fail;

(iv) The argument that expenses incurred prior to the commencement of manufacturing activity hence should be excluded from operating expenses under Rule 10B(1)(e)(i) is not acceptable because operational expenses is that which is incurred to earn that income. Expenses with nexus with revenue have to be considered as operational expenses and cannot be excluded only on the ground that the date of occurrence of the revenue is later and expenses have been incurred prior to that;

(v) The assessee’s argument that the margins have to be recomputed after claiming adjustment of capacity utilization is not acceptable. Under the TNMM, the net profit margin actually realized has to be considered and there is no room for any assumption for taking the profit margin. It is not permissible to deviate from the book results on the ground of capacity utilization. Under Rule 10B(3)(ii), there cannot be any deviation in the net profit shown in the books of account and the adjustment, if any, can be made to the same to eliminate the material affects to such differences to the extent of these adjustments are reasonably accurate. As no credible and accurate information with regard to capacity utilization was furnished, adjustment was not allowable;

(vi) The Proviso to s. 92C which gives the assessee the option to adjust the ALP by +/- 5% is applicable only where more than one price is determined by the most appropriate method. In a case where only one price is determined by the most appropriate method, the benefit of +/- 5% is not available to the assessee.

(72.8 KiB, 657 DLs)

If Not ‘Bad Debt’, ‘Business Loss’ claim sans specific ground invalid

The assessee claimed advances of Rs. 10.85 lakhs as a “bad debt” u/s 36(1)(vii). The AO & CIT (A) rejected the claim on the ground that as the debt had not been accounted as income, the conditions of s. 36(2) were not satisfied and the claim was not allowable. The alternate claim as a “business loss” was also rejected by the CIT (A). Before the Tribunal, the assessee raised a ground only on “bad debt” (and not “business loss”). At the hearing, it conceded the claim for “bad debt” and pressed for the claim for “business loss”. HELD dismissing the appeal:

The claim regarding “business loss” cannot be entertained because, though the CIT (A) has dealt with the issue, there is no specific ground. The claim is also not maintainable under Rule 27 since that applies only to a Respondent in the appeal.

(193.8 KiB, 2,136 DLs)

Granting development rights for demolition & reconstruction of building results in “transfer of land & building”

The assessee, being owner of land and building, entered into an agreement with the developer pursuant to which the developer demolished the building and constructed a new building. The FSI on the land was retained by the assessee. The additional FSI required for construction was brought in by the developer. The assessee received Rs. 2.18 crores from the developer for permitting the development which was offered to tax as capital gains. The AO & CIT (A) held that as the stamp duty value of the property was Rs. 3.82 crores that had to be taken as the consideration u/s 50C. On appeal to the Tribunal, the assessee claimed that the transaction was not subject to capital gains at all on the ground that (i) the grant of development rights was not a “transfer” (ii) there was no “cost of acquisition” of the development rights. It was also argued that s. 50C did not apply to development rights: HELD dismissing the appeal:

(i) The assessee’s argument that in the grant of development rights, there is no transfer of land or FSI (since the developer brought additional FSI) is not acceptable because (i) the assessee itself argued before the AO (to contest the AO’s proposal to tax the gains as business income) that there was a “transfer” of a capital asset and (ii) there was demolition of an existing building and it was not merely a case of construction of additional floor/modifications on the existing structure. Consequently, there was a transfer of “land & building” in favour of the developer;

(ii) The assessee’s argument (relying on New Shailaja Co-op Hsg Soc) that there is no “cost of acquisition” is also not acceptable because while in that case the assessee had become entitled to additional FSI owing to the DC Regulations for which there was no cost, the present was one of “transfer of existing land and building” which was demolished by the builder for fresh construction and the documents were registered (Jethalal D Mehta 2 SOT 422 (Mum), Lotia Court Coop Hsg Soc 118 TTJ 199 (Mum), New Shailaja Coop Hsg Soc, Om Shanti Coop Soc etc not followed);

(iii) The argument on s. 50C is also not applicable because it is a case of “transfer of land and building” to the developer.

(235.1 KiB, 1,434 DLs)

No “Equipment-Use” Royalty If Payer has no control over equipment

The assessee, a UK bank carrying on business in India, entered into an agreement with Sema Group, Singapore, for the provision of data processing support to the assessee for its business in India. Sema had a Data Centre at Singapore which it agreed to make available for “exclusive use” by the assessee for a specified period. Broadly, the service rendered was that the raw data relating to branch transactions of the assessee was transmitted to Sema’s mainframe computer in Singapore for processing. The raw data was processed by Sema’s staff as per the requirements of the assessee using the application software owned by the assessee. The processed data, i.e., the output data was transmitted electronically to the assessee in India using the software provided by the assessee, which was not designed by Sema. The AO & CIT (A) held the payments made by the assessee to Sema to be “royalty” u/s 9(1)(vi) & Article 12 of the DTAA on the ground that (i) the provision of the computer facility to process the data was consideration for use of a “process” and (ii) the consideration was for “the use or right to use, any industrial, commercial or scientific equipment”. On appeal by the assessee to the Tribunal, HELD allowing the appeal:

(i) The argument of the revenue that the ‘data processing’ by Sema is consideration for “use of a process” is not correct. The activity of transmitting raw data to Sema, processing of the data by Sema using software belonging to the assessee and the transmission of the proceessed data to the assessee did not, at any stage, involve the “use of any process” by the assessee so as to constitute “royalty” under Article 12(3)(a). The consideration received by Sema was for using the computer hardware which does not involve use or right to use a process;

(ii) The argument of the revenue that the consideration paid was for the “use of equipment” is also not correct because in order to constitute user of equipment, the customer should actually have domain or control over the equipment, or in other words, the equipment should be at its disposal. The customer should be in a position to use the equipment in its business activities. If a customer is given the mere access to some infrastructural facilities of the service provider and where the service provider has all the control, disposition and possession of such infrastructure and also the service provider operates such infrastructure on its own, then the customer cannot be said to have been assigned a right to use the equipment in the form of the infrastructure. In that case, the transaction partakes of the character of provision of services or facilities by the owner of the infrastructure in favour of the customer, as against giving the infrastructure to the customer itself for being used in the manner desired by the customer;

(iii) On facts, though the Data Centre was made available for the assessee’s “exclusive use”, the assessee had no right to access the computer hardware except for transmitting raw data for further processing. The assessee had no control over the computer hardware or physical access to it. The assessee could not come face to face with the equipment, operate it or control its functions in any manner. The assessee had no possessory rights in relation to the computer mainframe. The assessee merely took advantage of a facility of use of sophisticated equipment installed and provided by another. Accordingly, the payment was not royalty under Article 12(3)(b) of the DTAA.

(511.5 KiB, 1,517 DLs)

S. 2(22)(e) “deemed dividend” not assessable if recipient not shareholder

The assessee, a company, received advances of Rs. 6.32 crores by way of book entry from Jacksons Generators Pvt. Ltd, a closely held company. The shareholders having substantial interest in the assessee company were also having 10% of the voting power in Jacksons Generators. The AO & CIT(A) held that as the shareholders who held substantial interest in Jacksons Generators also also had substantial interest in the assessee company, for purposes of s. 2(22)(e), the amount received by the assessee from Jacksons constituted “advances and loans” and was assessable as deemed dividend. On appeal, the Tribunal, relying on Bhaumik Colour 313 ITR 146 (Mum) (SB), deleted the addition on the ground that though the amount received by the assessee by way of book entry was “deemed dividend” u/s 2(22)(e), it was not assessable in the hands of assessee company as it was not a shareholder of Jacksons Generators. On appeal by the department to the High Court, HELD dismissing the appeal:

(i) U/s 2(22)(e), any payment by a closely-held company by way of advance or loan to a concern in which a substantial shareholder is a member holding a substantial interest is deemed to be “dividend” on the presumption that the loans or advances would ultimately be made available to the shareholders of the company giving the loan or advance.
The legal fiction in s. 2(22)(e) enlarges the definition of dividend but does not extend to, or broaden the concept of, a “shareholder”.As the assessee was not a shareholder of the paying company, the “dividend” was not assessable in its hands (Bhaumik 313 ITR 146 (Mum) (SB), approved in Universal Medicare 324 ITR 363 (Bom) & Hotel Hilltop 313 ITR 116 (Raj) followed);

(ii) As the conditions stipulated in s. 2(22)(e) treating the loan and advance as deemed dividend are established in these cases, it is open to the Revenue to take corrective measure by treating this dividend income at the hands of the shareholders and tax them accordingly as otherwise it amounts to escapement of income at the hands of those shareholders.