(198.6 KiB, 1,521 DLs)

CIT-DR’s “false & frivolous” submissions constitute “criminal contempt” & justify recovery of costs from salary

In the department’s appeal, the assessee raised a preliminary objection that the notice u/s 143(2) was not issued within the prescribed period of 12 months. The AO accepted that the s. 143(2) notice had not been issued in time. Accordingly, the Tribunal, relying on Hotel Blue Moon 321 ITR 362 (SC), dismissed the department’s appeal without going into the merits of the appeal. Thereafter, the CIT-DR addressed two letters to the Hon’ble Members in which it was alleged that the (i) permitting the assessee to argue first in the department’s appeal was against “norms in appellate proceedings“, (ii) the Bench had “passed the order in undue hurry” without waiting for the department’s written submissions to be filed and (iii) the order was “ex parte”. It was also alleged that the letter was sent by post as the Bench clerk had refused to accept the letter. The letters were treated as a MA by the Tribunal and heard. Thereafter, the CIT-DR filed a letter of apology clarifying that it was not his intention to “hurt the sentiments” of the Members though he did not appear personally before the Bench. HELD dealing meticulously with each assertion made by the CIT-DR and terming them as “frivolous and untrue“:

“We are of the view that the conduct of the learned CIT(A) in addressing correspondence to the Hon’ble Members in respect of an appeal which has been heard and under consideration for passing orders is improper. It is an attempt to interfere with the due course of any judicial proceeding and tends to interfere with or obstructs or tends to obstruct the administration of justice and as such would be “Criminal contempt” within the meaning of the Contempt of Courts Act, 1971. The allegations made in the letters dated 23.3.2010 and 24.3.2010 are serious enough to warrant an action seeking protection of the Hon’ble High Court in exercise of its powers to punish for contempt of the sub-ordinate Courts and Tribunals. In our opinion, there cannot be a fitter case for imposition of exemplary costs on the learned Departmental Representative, who in our view, is responsible for such a M.A. and for wasting the time of the Tribunal by raising frivolous arguments and making blatantly false submissions. The cost should have to be recovered from the salary of the delinquent employee, who is responsible for such actions and entry made in his service record on the adverse comments made against the D.R. by the Tribunal. We however refrain from doing so in the hope that such indiscretion would not be repeated in future and also in view of the letter of apology filed by the D.R.”

(188.6 KiB, 943 DLs)

While kidnapping is an offense, paying ransom is not; Bar in Explanation 1 to s. 37(1) not attracted

The assessee, engaged in manufacture and sale of bidis, sent its whole-time director to a forest area for purchase of tendu leaves. There, the director was kidnapped by dacoits and the assessee paid ransom of Rs. 5.50 lakhs to secure his release. The AO disallowed the claim for deduction of the said amount u/s 37(1) though the CIT (A) and Tribunal upheld the claim on the ground of commercial expediency. Before the High Court, the department relied on the Explanation to s. 37(1) and argued that expenditure incurred for any purpose which is an offence or which is prohibited by law is not allowable as a deduction. HELD dismissing the appeal:

The Explanation of s. 37(1) provides that expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business. It has to be seen whether the expenditure is incurred for any purpose which is an offence or prohibited by law. While kidnapping for ransom is an offence u/s 364 A of the IPC, the payment of ransom to secure the release of a kidnapped person is not an offense. The payment of ransom is not prohibited by law. Accordingly, the Explanation of to s. 37 (1) is not applicable and the ransom is deductible as business expenditure.

(166.5 KiB, 969 DLs)

Fee for “user of name” and “accreditation” not taxable as “royalty”

The assessee, engaged in manufacture of tooth paste etc paid Rs 11,71,826 as “accreditation panel fees” to British Dental Health Foundation UK without deduction of tax at source. The AO disallowed the sum u/s 40(a)(i) on the ground that the sum was taxable as “royalty” and tax had not been deducted at source u/s 195(1). The CIT(A) deleted the disallowance. Before the Tribunal, the department argued that since the assessee derived valuable advantage from the accreditation by BDHF and use the same as a marketing tool, the amount constituted “royalty”. HELD dismissing the appeal:

(i) The obligation to deduct tax u/s 195(1) arises only if the payment is chargeable to tax in the hands of non-resident recipient. If the recipient of the income is not chargeable to tax, the vicarious liability on the payer is ineffectual. As the AO had not established how the recipient was liable to pay tax, he was in error in disallowing u/s 40(a)(i) (GE India Technology Center 327 ITR 456 (SC) followed;

(ii) On merits, though the accreditation fees permitted the assessee the use of name of British Dental Health Foundation, it did not constitute “royalty” under Article 13 of the India-UK DTAA because it did not allow the accredited product to use, or have a right to use, a trademark, nor any information concerning industrial, commercial or scientific experience so as to fall within the definition of the term. The purpose of the accreditation by a reputed body was to give certain comfort level to the end users of the product and to constitute the USP of the product. The term “royalty” cannot be construed as per its normal connotations in business parlance but has to be construed as per the definition in Article 13. The amount constituted “business profits” and as the recipient did not have a PE in India, it was not taxable in India.

(94.3 KiB, 954 DLs)

Software License income is assessable as “Royalty”

International Business Machines Corporation & IBM World Trade Corporation (IBM), both US companies, entered into a “Software License Agreement” with IBM Australia, an Australian company, under which they granted the latter “the non-exclusive rights (i) to license and distribute copies of IBM Programs for their ultimate use by customers, (ii) to use such IBM Programs in revenue producing activities, (iii) to use such IBM Programs internally, (iv) to make or have made copies for the purposes described above, for distribution to affiliated companies etc“. In consideration, IBM Australia agreed to pay IBM a fee of 40% of the revenue billed for each copy of an IBM programme distributed to a third party. IBM Australia initially withheld tax on the payments on the basis that it constituted “royalty” under Article 12(4) of the Australia-USA DTAA though it later sought a refund on the basis that the whole payment was not royalty which was rejected by the Department. IBM filed an application for a declaration that the whole of the amounts received was not assessable as “royalty“. HELD dismissing the application:

(i) Under Article 12(4) of the Treaty, “royalty” is defined to mean “consideration for…the right to use any copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right” (Article 12(4)(a)(i)) or “…. the supply of technical … or commercial knowledge or information” or for “the supply of any assistance of an ancillary and subsidiary nature” to enable the application of the rights referred to in Article 12(4)(a)(i) or the knowledge/information referred to in Article 12(4)(b)(i) (Article 12(4)(b)(ii));

(ii) On facts, the argument that the SLA is in essence a distributorship agreement for the marketing of IBM computer programs and that the IP licenses granted to IBMA is only to enable it to carry on the function of a distributor is not acceptable. The SLA is not a distribution agreement which confers distribution rights independently of the grant of IP rights. There is no reference in the SLA to the payments being for the exercise of general distributorship rights. Rather, the payments are described as being for the acquisition of the stated IP rights. The detail of the SLA concerns the definition of IP and IP rights. There is no such detail with respect to distribution rights. The rights/content granted by the SLA are, in each case, rights/content of a kind contemplated by Article 12(4) and so the whole of the consideration is assessable as “royalty”.

(167.0 KiB, 941 DLs)

No penalty under Expl 7 to s. 271(1)(c) for dispute regarding ALP method

The assessee adopted the TNMM to determine the ALP in respect of the broking transactions entered into with its affiliates. The AO & TPO held that the assessee ought to have adopted the CUP method and made an adjustment of Rs. 1.10 crores. This was accepted by the assessee. The AO levied penalty under Explanation 1 to s. 271(1)(c) on the ground that the assessee had filed inaccurate particulars of income. This was deleted by the CIT (A). On appeal by the department to the Tribunal, HELD dismissing the appeal:

Explanation 1 to s. 271(1)(c) does not apply to transfer pricing adjustments. Penalty for transfer pricing adjustments is governed by Explanation 7 to s. 271(1)(c). Under Explanation 7 to s. 271(1)(c), the onus on the assessee is only to show that the ALP was computed by the assessee in accordance with the scheme of s. 92 C in “good faith” and with “due diligence”. The assessee adopted the TNMM and no fault was found with the computation of ALP as per that method. Instead, the method was rejected on the ground that CUP method was applicable. It is a contentious issue whether any priority in the methods of determining ALPs exists. So, when TNMM is rejected, without any specific reasons for inapplicability of the TNMM and simply on the ground that a direct method is more appropriate to the fact situation, it is not a fit case for imposition of penalty. The expression ‘good faith’ used alongwith ‘due diligence’, which refers to ‘proper care, means that not only must the action of the assessee be in good faith, i.e. honestly, but also with proper care. An act done with due diligence would mean an act done with as much as care as a prudent person would take in such circumstances. As long as no dishonesty is found in the conduct of the assessee and as long as he has done what a reasonable man would have done in his circumstances, to ensure that the ALP was determined in accordance with the scheme of s. 92 C, deeming fiction under Explanation 7 cannot be invoked.

(247.5 KiB, 1,563 DLs)

Income from license of software not assessable as “royalty”. Gracemac not followed; Motorola still good law

The assessee, an Israeli company, entered into an agreement with Reliance Infocomm for supply and licence of software for RIL’s wireless network in India. The assessee received Rs. 3 crores which it claimed to be “business profits” and not taxable for want of a permanent establishment (PE) in India. The AO took the view that the said sum was assessable as “royalty”. This was reversed by the CIT (A) following Motorola Inc 96 TTJ 1 (Del) (SB). In appeal before the Tribunal, the department argued that in view of Gracemac Corp 42 SOT 550 (Del), the use of software was assessable as “royalty”. HELD dismissing the appeal:

(i) Under Article 12 (3) of the India-Israel DTAA, royalty is defined inter alia to mean payments for the “use of” a “copyright” or a “process”. There is a distinction between “use of copyright” and “use of a copyrighted article”. In order to constitute “use of a copyright”, the transferee must enjoy four rights viz: (i) the right to make copies of the software for distribution to the public, (ii) The right to prepare derivative computer programmes based upon the copyrighted programme, (iii) the right to make a public performance of the computer programme and (iv) The right to publicly display the computer programme. If these rights are not enjoyed, there is no “use of a copyright”. The consideration is also not for “use of a process” because what the customer is paying for is not for the “process” but for the “results” achieved by use of the software. It will be a “hyper technical approach totally divorced from ground business realities” to hold that the use of software is use of a “process”. (Motorola Inc 96 TTJ 1 (Del) (SB) and Asia Sat 332 ITR 340 (Del) followed. Gracemac Corp 42 SOT 550 (Del) not followed);

(ii) It is well settled that a DTAA prevails over the Act where it is more favourable to the assessee. The view taken in Gracemac, relying on Gramophone Co AIR 1984 SC 667, that the Act overrides the treaty provisions where there is irreconcilable conflict is not acceptable because (a) it is obiter dicta, (b) contrary to Azadi Bachao Andolan 263 ITR 706 (SC) and (c) Gramophone Co not applicable to I. T. Act as it dealt with law in which specific enabling clause for treaty override did not exist. (Ram Jethmalani vs UOI also considered).

(1.1 MiB, 812 DLs)

If AO has allowed s. 10A deduction, DRP cannot withdraw it

The assessee claimed deduction of Rs. 32.18 crores u/s 10A. The AO passed a draft assessment order u/s 144C in which he allowed s. 10A deduction though he reduced the quantum by Rs. 44.49 lakhs. When the assessee filed objections before the Dispute Resolution Panel (“DRP”), it took the view that the assessee was not at all entitled to s. 10A deduction as it was engaged in “research & development”. On the alternative plea that the assessee was engaged in providing “engineering design services”, the DRP directed the AO to examine the claim on merits. The assessee filed a Writ Petition claiming that the directions given by the DRP was beyond jurisdiction. This was dismissed by the single judge. On appeal by the assessee, HELD allowing the appeal:

(i) As the AO had accepted that the assessee was eligible for s. 10A deduction and had only proposed a variation on the quantum, the DRP had no jurisdiction to hold that the assessee was not at all eligible for s. 10A deduction;

(ii) The DRP’s direction that the AO should decide the alternate claim of the assessee having regard to the material is also without jurisdiction. If such orders and directions are permitted to be allowed, it would defeat the object of the alternate dispute resolution.

(166.8 KiB, 1,771 DLs)

No s. 14A disallowance of interest on borrowed funds if AO does not show nexus between borrowed funds & tax-free investment

In AY 2000-01 the assessee had investments in shares & mutual funds of Rs. 20 crores on which it earned tax-free dividend of Rs. 13.35 lakhs. The assessee also had borrowed funds on which it claimed deduction of interest of Rs. 8.70 crores. The AO disallowed interest of Rs.2.79 crores on the ground that it was relatable to earning tax-free dividend. The Tribunal deleted the disallowance on the ground that the investments had been made out of the assessee’s own funds and not out of the borrowed funds. The department filed an appeal before the High Court. HELD dismissing the appeal:

Counsel for the Revenue could not point as to how interest on borrowed funds to the extent of Rs.2.79 crores was attributable to earning dividend income which are exempt u/s 10(33) of the Act. Therefore, in the absence of any material or basis to hold that the interest expenditure directly or indirectly was attributable for earning the dividend income, the decision of the Tribunal in deleting the disallowance of interest made u/s 14A cannot be faulted.

(188.4 KiB, 916 DLs)

Even issues “sub-judice” before High Court can be heard by Tribunal

The assessee transferred its power transmission business by a slump sale for a consideration of Rs.143 crores and offered that amount as capital gains u/s 50B. The AO took the view that as the net worth of the business was a negative figure of Rs.157.19 crores representing the liabilities, the said amount had to be added to the consideration. Before the Tribunal, the assessee relied on Zuari Industries vs. ACIT 105 ITD 569 (Mum) and Paperbase Co vs. CIT 19 SOT 163 (Del) and claimed that the negative net worth had to be treated as zero. As the Bench had reservations on the correctness of the said judgements, the matter was, at the request of the assessee, referred to the Special Bench. Before the Special Bench, the assessee pointed out that as the Bombay High Court had admitted the appeal in the case of Zuari Industries Ltd, the reference made to the Special Bench be withdrawn. The assessee relied on the orders in Tivoli Investments & Harsha Bhogle 114 TTJ (Mum) 266 where it was held that if a matter is sub-judice before the High Court, the Tribunal cannot consider the issue. HELD rejecting the contention of the assessee:

The objection to the Special Bench hearing the issue only on the ground that the High Court has admitted the appeal is not acceptable for two reasons. Firstly, the mere fact that a superior authority is seized of an issue identical to the one before the lower authority does not create any impediment on the powers of the lower authority in disposing off the matters involving such issue as per prevailing law. If the suggestion is accepted, there would be chaos and the entire working of the Tribunal will come to standstill. Secondly, the Special Bench was constituted at the assessee’s request because it then wanted an “escape route” from a potential adverse view. The assessee cannot now argue that the Special Bench be deconstituted. Such “vacillating stand” cannot be approved.

(199.6 KiB, 1,096 DLs)

Off-shore supplies not taxable despite composite contract & PE’s role in clearance

The assessee, a Korean company, entered into three contracts with Delhi Transco Ltd for (i) offshore supply contract on CIF basis, (ii) onshore supply contract and (iii) onshore service contract. The applicant claimed that the income arising from the offshore supply contract was not taxable in India. The revenue claimed that the profits from the off-shore supply was taxable in India on the basis that (a) though the supply contract was awarded separately, any breach under one contract was deemed breach of the other contracts, (b) the award of separate contracts did not dilute the responsibility of the applicant for successful completion of the facility as per specifications, (c) the three contracts were composite contracts and one could not exist without the other, (d) the offshore supplies were on CIF basis and the contracts for offshore supply and onshore contracts were signed on the same date, (e) the insurance requirement of the offshore supplies contract require that the applicant will take out and maintain insurance of cargo, installation, worker compensation, etc, (f) the case is not a case of a sale simpliciter but is for full package involving onshore services. It could not have made a difference had the contract been one instead of three divisible contracts. HELD rejecting the contentions of the department:

(i) The clauses in the offshore supply contract agreement regarding the transfer of ownership, the payment mechanism in the form of letter of credit which ensures the credit of the amount in foreign currency to the applicant’s foreign bank account on receipt of shipment advice and insurance clause establish that the transaction of sale and the title took place outside Indian Territory. The ownership and property in goods passed outside India. The transit risk borne by the applicant till the goods reach the site in India is not necessarily inconsistent with the sale of goods taking place outside India. The parties may decide between them as to when the title of the goods should pass. As the consideration for the sale portion is separately specified, it can well be separated from the whole. (Ishikwajima Harima 288 ITR 410 (SC) & Hyosung Corporation 314 ITR 343 (AAR) followed; Ansaldo Energia SPA 310 ITR 237 (Mad) distinguished);

(ii) Nothing in law prevents parties to enter into a contract which provides for sale of material for a specified consideration although they were meant to be utilized in the fabrication and installation of a complete plant;

(iii) Though the assessee had a PE in India, that came into existence for the purpose of carrying out the contract for onshore supplies and services etc and had no role to play in offshore supplies. Even if the PE was involved in carrying on some incidental activities such as clearance from the port and transportation, it cannot be said that the PE is in connection with the offshore supplies.