(119.2 KiB, 2,551 DLs)

HUF is a “relative” for gifts exemption u/s 56(2)(v), (vi) & (vii)

The assessee received a gift of Rs.60 lakhs from his HUF. The AO & CIT(A) held that as HUF was not covered by the definition of “relative”, the gift was chargeable to tax u/s 56(2)(v). The alternate submission that gift was exempt u/s 10(2) was rejected on the basis that s. 10(2) applied only to amounts received “out of income of the estate” on partial or total partition of the HUF. On appeal by the assessee, HELD allowing the appeal:

(i) S. 56(2)(v) exempts gifts from a “relative”. Though the definition of the term “relative” does not specifically include a Hindu Undivided Family, a ‘HUF” constitutes all persons lineally descended from a common ancestor and includes their mothers, wives or widows and unmarried daughters. As all these persons fall in the definition of “relative”, an HUF is ‘a group of relatives’. As a gift from a “relative” is exempt, a gift from a ‘group of relatives’ is also exempt since the singular will include the plural;

(ii) The gift was also exempt u/s 10(2) because the two conditions required to be satisfied for relief viz (1) that the assessee is a member of the HUF and (2) that he receives the sum out of the income of such HUF (may be of an earlier Year) were satisfied.

(187.7 KiB, 996 DLs)

Despite “Wrong Claim”, s. 147 reopening invalid if failure to disclose not alleged

The AO reopened the assessment after the end of 4 years from the assessment year on the ground that the assessee had “wrongly claimed deduction u/s 80IA” and that “long term capital gains had been wrongly set-off”. There was no allegation in the recorded reasons that there was any failure on the part of the assessee to disclose fully and truly all material facts necessary for the assessment. The assessee filed a Writ Petition to challenge the reopening. HELD quashing the s. 148 notice:

There is a well known difference between a wrong claim made by an assessee after disclosing all the true and material facts and a wrong claim made by the assessee by withholding the material facts. It is only in the latter case that the AO is entitled to proceed u/s 147. The power conferred by s. 147 does not provide a fresh opportunity to the AO to correct an incorrect assessment made earlier unless the mistake in the assessment so made is the result of a failure of the assessee to fully and truly disclose all material facts necessary for assessment. Further, it is necessary for the AO to first state that there is a failure to disclose fully and truly all material facts. If he does not record such a failure he would not be entitled to proceed u/s 147. (Hindustan Lever 268 ITR 332 (Bom) followed).

(328.2 KiB, 1,610 DLs)

Transfer Pricing: Despite FAR matching, Loss Co to be excluded

The assessee was engaged in providing franchise support services to Pizza Hut, Kentucky Fried Chicken and Taco Bell franchisees and received royalty. From the list of comparables provided by the assessee (after excluding persistent loss-making companies), the TPO rejected some other loss-making companies & determined the ALP applying the TNMM and made an adjustment of Rs. 2.28 crores. This was upheld by the DRP. Before the Tribunal, the assessee relied on Sony India 114 ITD 448 (Del) & Quark System 38 SOT 307 (SB) and claimed that loss was a normal incident of business and merely because a company is showing loss, it does not cease to be a comparable. HELD dismissing the appeal:

Merely because a company is showing losses, it does not lose its status of comparable if the other criteria depict its status as a comparable because the declaration of loss is an incident of business which is at par with profit. However, while the assessee considered these companies on the basis of their FAR Analysis i.e. (function performed, assets employed and risk assumed), the TPO held that FAR of a company indicated the avowed objective of the company and the tools that it sought to employ to achieve that objective but it was the financial result which decided whether that company has been successfully in achieving the objective or not. The TPO held that if the assessee’s contention based on FAR analysis only is accepted then the process of choosing comparable will not proceed beyond the matching of FAR. All types of other tests i.e. data base screening, quality and quantitative screening or use of diagnostic with ratios will be rendered meaningless and unnecessary. Further, while the assessee itself applied a filter of persistent operative losses and companies on that basis, what was the basis for inclusion of the loss making companies? The loss making companies had not been excluded simplicitor on the ground that they are declaring loss but the TPO had pointed out that their comparablity has been taken into consideration by the assessee on the basis of FAR analysis and “other aspects” have not been considered. TPO had looked into “other aspects” also

(178.1 KiB, 1,241 DLs)

For “Equipment Royalty” u/s 9(1)(vi), control of equipment by payer essential

The assessee, an Indian company, remitted Rs. 34 lakhs to Yahoo Holdings (Hong Kong) Ltd, a Hong Kong company, for placing banner advertisements on the web portal of Yahoo Hong Kong. The AO & CIT (A) took the view that the payment was “for the use or right to use any industrial, commercial or scientific equipment” (i.e. the server) and had the character of “royalty” under clause (iva) of Expl 2 to s. 9(1)(vi). On appeal by the assessee, HELD allowing the appeal:

(i) The word “use” in relation to equipment occurring in clause (iva) of Expl to s. 9(1)(vi) is not to be understood in the broad sense of availing of the benefit of an equipment. The context and collocation of the two expressions “use” and “right to use” followed by the word “equipment” indicate that there must be some positive act of utilization, application or employment of equipment for the desired purpose. If an advantage was taken from sophisticated equipment installed and provided by another, it could not be said that the recipient/customer “used” the equipment as such. The customer merely made use of the facility, though he did not himself use the equipment. What is contemplated by the word “use” in clause (iva) of Expl 2 to s. 9(1)(vi) is the customer came face to face with the equipment, operated it or controlled its functions in some manner. But if it did nothing to or with the equipment and did not exercise any possessory rights in relation thereto, it only made use of the facility created by the service provider who was the owner of the entire network and related equipment and there was no scope to invoke clause (iva) in such a case because the element of service predominated (ISRO Satellite 307 ITR 59 (AAR), Dell International 305 ITR 37 (AAR) & Asia Satellite 332 ITR 340 (Del) followed; Frontline Soft 12 DTR 131 (Hyd) held not good law);

(ii) On facts, the banner advertisement hosting services did not involve use or right to use by the assessee any industrial, commercial or scientific equipment and no such use was actually granted by Yahoo (Hong Kong) Ltd to the assessee. Uploading and display of banner advertisement on its portal was entirely the responsibility of Yahoo (Hong Kong) and the assessee was only required to provide the banner Ad to Yahoo (Hong Kong) for uploading the same on its portal. The assessee had no right to access the portal of Yahoo (Hong Kong) and there was nothing to show any positive act of utilization or employment of the portal of Yahoo (Hong Kong) by the assessee.

(266.3 KiB, 1,588 DLs)

S. 36(1)(ii) bars tax avoidance scheme of paying commission instead of dividend

The assessee paid commission of Rs. 1.20 crores to its three employee directors who also held the entire share capital. The AO & CIT (A) rejected u/s 36(1)(ii) the claim for deduction of the commission on the ground that it was in the nature of “dividend”. On appeal by the assessee to the Tribunal, the matter was referred to the Special bench. HELD by the Special bench dismissing the appeal:

(i) The argument that s. 36(1)(ii) is applicable only to employees who are not shareholders is not acceptable because payment of dividend to shareholders is not compulsory. S. 36(1)(ii) applies to all employees including shareholder employees though the disallowability is restricted to partners and shareholders because it is only in those cases that payment can be said to be in lieu of profit or dividend;

(ii) The argument that as no dividend was “payable”, s. 36(1)(ii) does not apply is not acceptable because the word “payable” does not mean that dividend should be statutorily or legally payable. Since payment of dividend is discretionary and not compulsory, any such construction will lead to absurd results. The word “payable” means that dividend would have been declared by any reasonable management on the facts and circumstances of the case considering the profitability and other relevant factors and become payable to shareholders. If a reasonable conclusion can be drawn that the dividend ought to have been paid and that instead of paying dividend, commission was paid, s. 36(1)(ii) would be attracted;

(iii) On facts, there is no evidence to show that the directors had rendered any extra services for payment of huge commission in addition to services rendered as an employee for which salary was paid. Further, though the turnover and the profit was exceptionally high as compared to the earlier years, this was because of the stock market boom. The assessee being a share broker gets commission on sale/purchase of shares by investors/traders and its income is assured irrespective of whether the investor/ trader loses or gains in the transaction. The steady rise in performance was due to improved market conditions and not because of any extra service rendered by the directors. Also, no dividend was declared even though any reasonable management would have declared at least about 20% dividend in the years when there were substantial profits;

(iv) The device adopted by the assessee was obviously with the intention to avoid payment of full taxes. There is obvious tax avoidance. S. 36(1)(ii) is intended to prevent escape from taxation by describing the payment as bonus or commission when in fact it should have reached the shareholders as profit or dividend (Loyal Motor 14 ITR 647 (Bom) referred)

(13.6 KiB, 1,167 DLs)

Long Delay due to procedural reasons in filing Dept appeals cannot be condoned

The department filed a SLP challenging the order of the Bombay High Court declining to condone delay of 656 days in filing the appeal. The delay was explained as having been caused by “several facts such as non traceability of case records, procedural formalities involved in the Department and the papers are to be processed through different officers in rank for their comments, approval etc. and then the preparation of the draft of appeal memo, paper book and the administrative difficulties such as shortage of staff“. HELD dismissing the SLP:

In our opinion, the said explanation does not make out a sufficient cause for condonation of delay in filing the appeal before the High Court. In that view of the matter, we do not find any ground to interfere with the impugned judgment. The Special Leave Petition is dismissed on the ground of delay as well as on merits.

(7.5 KiB, 2,177 DLs)

Tests to determine whether shares gains assessable as STCG or business profits

The Supreme Court vide order dated 15.11.2010 dismissed the Department’s Special Leave Petition against the judgment of the Bombay High Court in CIT vs. Gopal Purohit 228 CTR 582 (Bom) where it was held that:

(a) it was open to an assessee to maintain two separate portfolios, one relating to investment and another relating to business of dealing in shares,

 

(b) that a finding of fact had been arrived at by the Tribunal as regards the two distinct types of transactions namely, those by way of investment and those for the purposes of business,

 

(c) that there should be uniformity in treatment and consistency when facts and circumstances are identical particularly in the case of the assessee and

 

(d) that entries in books of account alone are not conclusive in determining the nature of income though they have a bearing.

(318.6 KiB, 1,392 DLs)

Software embedded in off-shore supply may be taxable even if supply not taxable

The assessee, a USA company, entered into two separate contracts with AAI, one for supply of equipment and the other for rendering installation and training services. The AO & CIT(A) held (i) that the two contracts were an “indivisible works contract“, (ii) that as the supply involved embedded software, the income had to be bifurcated between “supply of equipment” and “royalty” in the ratio of 30:70, (iii) that the equipment-supply profits had accrued on completion of contract and not at the time of transfer of title, (iv) that 50% of the equipment-supply profits was attributable to the assessee’s PE in India and this was taxable at the global profit rate of 13.4%. On appeal to the Tribunal, HELD:

(i) The two contracts constitute one agreement because (a) the essential purpose of both contracts was to set up the ATS, (b) the contract for supply of equipment and software would have been of no consequence without installation and performance services, (c) the dates of payment for the supply contract were connected with the service contract and (d) it was difficult to segregate the contract from installation/service contract (Ishikawajima-Harima 288 ITR 408 (SC) referred);

(ii) The PE came into existence on clearance of the goods in India because after transfer of title outside India, the possession was handed over to the assessee for safe custody, installation etc. This required storage space and supervision which cannot be said to be preliminary or auxiliary activities in nature as the equipments were required to be installed;

(iii) The bifurcation of revenue into supply of equipment and software in the ratio of 30:70 had to be upheld because (a) though the software was embedded in the equipment and supplied as one package for one price, it was permissible to segregate the composite consideration into different components and (b) the assessee had not shown the segregation done by the customs authorities for imposing duty on the equipment and software (Rotem Company 279 ITR 165 (AAR) & Motorola 95 ITD 269 (SB) referred);

(iv) In a turnkey contract, in which the assessee is under obligation to supply the equipment and the software and also install them, the profit is taxable on completion of each milestone and not at the time of handing over the functioning system to the contracting party. The department’s argument that in a works contract, mere supply of equipment and software is of no consequence till installation and so profits should be taxed at that stage is not correct because even if “turnkey”, the taxable events in the execution of a contract may arise in several stages in several years if the obligations under the contract are distinct ones. The supply profits are consequently not taxable as it accrued on supply outside India;

(v) On facts, as the supply of equipment and software constituted a milestone in the contract, the income therefrom arose in the year of shipment which was in an earlier year. It did not accrue or arise in the present year. As the PE came into existence when the equipment was handed over to it by the AAI, the profits from installation contract and services was taxable.

(331.8 KiB, 1,245 DLs)

Transfer Pricing: Loss/High-Profit cos need not per se be excluded

The Tribunal had to consider the following transfer pricing issues: (i) Whether if two distinct services are rendered to the AE and mark-up is received for one and not for the other, the aggregate position can be considered for determining ALP, (ii) whether multi-year data can be considered, (iii) whether if loss making comparables are rejected, high profit making comparables should also be rejected? HELD by the Tribunal:

(i) The assessee rendered three services to its AE and while it received a mark-up for “application of technical development services” and “promoting the licensing of technology”, it did not receive any mark-up for “application research”. The argument that the three activities should be aggregated to determine the ALP is not acceptable because the entire benefit of the “application research” was retained by the AE and not shared with the assessee and so there was no justification for not compensating the assessee;

(ii) Under Rule-10B(4), only the data relating to the financial year can be taken and as an exception, the data of two years prior to the financial year may be taken but only if such data reveals facts which could have influenced the determination of transfer pricing. If the assessee wants to consider previous year’s data, the burden is on it to demonstrate that the previous year’s data contained certain facts which would influence the determination of transfer pricing. In the absence of that, there is no scope for considering data other than that of the current year;

(iii) While in principle, it is correct that if loss making units are excluded, abnormal profit making units should also be excluded, on facts, the TPO had rightly rejected the loss making companies as not being comparable. In principle, neither loss making units nor high profit making units can be eliminated from the comparables unless, there are specific reasons for eliminating the same which is other than the general reason that a comparable has incurred loss or has made abnormal profits.

(70.4 KiB, 971 DLs)

Registration as Public Trust not necessary for s. 12A “Charity” registration

The assessee, a company registered under s. 25 of the Companies Act applied for registration as a “charitable institution u/s 12A of the I. T. Act. The Director (Exemptions), relying on Bhraman Madhav Murthi Mandal vs Joint Charity Commissioner 43 Comp Cas 361 (Bom), rejected the application on the ground that registration with the Charity Commissioner was a condition precedent for registration u/s 12A and that registration could not be granted for failure to produce the Charity Commissioner’s certificate. On appeal by the assessee, HELD allowing the appeal:

In Bhraman Madhav Murthi Mandal vs Joint Charity Commissioner, the Court dealt with the issue whether a company holding property for public religious and charitable purposes is required to be registered under the Public Trust Act. This does not mean that registration as a public trust is a condition precedent for grant of registration u/s 12A. There is no requirement in the Income-tax Act that the institution constituted for advancement of charity, must be registered as a trust under the Public Trusts Act (Agriculture Produce and Market Committee 291 ITR 419 (Bom) & Disha India Micro Credit (Del) followed)