(162.7 KiB, 2,437 DLs)

No s. 40(a)(ia) disallowance for short-deduction TDS default

The assessee paid Rs. 3.37 crores as “machine hire charges” on which it deducted TDS u/s 194C at 1%. The AO held that the payment was “rent” and TDS ought to have been deducted at 10% u/s 194-I. He disallowed the expenditure u/s 40(a)(ia). This was reversed by the CIT (A). On appeal by the department, HELD dismissing the appeal:

S. 40(a)(ia) provides for a disallowance if amounts towards rent etc have been paid without deducting tax at source. It does not apply to a case of short-deduction of tax at source. As the assessee had deducted u/s 194C, it was not a case of “non-deduction” of TDS. If there is a shortfall due to difference of opinion as to which TDS provision would apply, the assessee may be treated as a defaulter u/s 201 but no disallowance can be made u/s 40(a)(ia). (Chandabhoy & Jassobhoy (ITAT Mumbai) followed – included in file)

(149.5 KiB, 902 DLs)

Transfer Pricing: No s. 271G Penalty for failure to respond to “omnibus” notice

Though no transfer pricing adjustment was made, the AO levied penalty u/s 271G of Rs. 22 lakhs (2% of the value of international transactions) on the ground that the assessee had not furnished the documents prescribed under Rule 10D r.w.s. 92D(3). This was deleted by the CIT (A). On appeal by the department, HELD dismissing the appeal:

S. 271G authorizes the levy of penalty if the information/ documents prescribed by s. 92D (3) are not furnished. Rule 10D prescribes a voluminous list of information and documents required to be maintained and it is only in rare cases that all clauses would be attracted. Some of the documents may not be necessary in case of some assessees. Before issuing a notice u/s 92D(3), the AO has to apply his mind to what information and documents are relevant and necessary for determining ALP. A notice u/s 92D(3) is not routine and cannot be casually issued but requires application of mind to consider the material on record and what further information on specific points is required. The notice cannot be vague or call for un-prescribed information. On facts, the TPO issued a notice calling for “information and documents maintained as prescribed u/s 92D r.w. Rule 10D” without specifying any particular information under any clause of Rule 10D. The notice was “omnibus”, issued in a casual manner, without examining records nor nature or details of international transactions and showed total lack of application of mind as to what information was required in this case. Even in the penalty order, the exact nature of default was not brought out.

(332.6 KiB, 1,253 DLs)

No S. 271(1)(c) Penalty Without AO’s Finding on “Inaccurate Particulars”

The AO imposed s. 271(1)(c) on the ground that the assessee had filed “inaccurate particulars” by wrongly (i) claiming deduction for contribution to a ‘staff welfare fund’ despite the bar in s. 40A(9) and the qualification of the auditors and (ii) claiming depreciation on vehicles at 25% though the prescribed rate was 20%. The assessee argued that despite s. 40A(9), the payment to the fund was allowable as “business expenditure” and that the higher depreciation was claimed on the basis that the vehicles were “plant & machinery” despite the lower rate prescribed for vehicles in the Rules. The CIT (A) & Tribunal deleted the penalty. On appeal by the department, HELD dismissing the appeal:

There is no finding by the AO that the assessee furnished inaccurate particulars and that its explanation was not bonafide. Accordingly, the imposition of penalty u/s 271(1)(c) was a “complete non-starter”. A mere erroneous claim made by an assessee, though under a bonafide belief that, it was a claim which was maintainable in law cannot lead to an imposition of penalty. The claim for deduction was made in a bona fide manner and the information with respect to the claims was provided in the return and documents appended thereto. Accordingly, there is no furnishing of “inaccurate particulars”. Making of an incorrect claim for expenditure does not constitute furnishing of inaccurate particulars of income (Reliance Petroproducts 322 ITR 158 (SC) followed)

(38.0 KiB, 2,585 DLs)

No S. 14A disallowance in absence of nexus between investment in tax-free securities & borrowed funds. S. 14A disallowance cannot exceed exempt income

In AY 2007-08, the assessee received dividend of Rs. 4 lakhs in respect of investment in shares made in earlier years. No investments were made during the year. It was claimed that the investment in the earlier years was made out of reserves & surplus and that there was no expenditure incurred during the year to earn the dividend. The AO held that as in the earlier years, the assessee had borrowed funds, s. 14A applied. He applied the rate of interest paid on the borrowings and disallowed Rs. 12.73 lakhs. This was deleted by the CIT (A). On appeal by the department, HELD dismissing the appeal:

(i) If there is no nexus between borrowed funds and investments made in purchase of shares, disallowance u/s 14A is not warranted (Winsome Textiles 319 ITR 204 (P&H) & Hero Cycles 323 ITR 518 followed);

(ii) As the total dividend income received was Rs.4 lakhs, a disallowance of Rs.12 lakhs by invoking s.14A is not warranted.

(55.8 KiB, 2,516 DLs)

AO cannot apply Rule 8D without showing how assessee’s method is incorrect

For AY 2008-09, the AO made a disallowance of Rs. 31 lakhs u/s 14A by applying Rule 8D without recording any satisfaction as to how the assessee’s calculation of s. 14A disallowance was incorrect. In appeal, the CIT (A) upheld the applicability of Rule 8D though he reduced the disallowance to Rs. 19 Lakhs. The department filed an appeal while the assessee filed a C.O. HELD by the Tribunal:

It is a pre-requisite that before invoking Rule 8D, the AO must record his satisfaction on how the assessee’s calculation is incorrect. The AO cannot apply Rule 8D without pointing out any inaccuracy in the method of apportionment or allocation of expenses. Further, the onus is on the AO to show that expenditure has been incurred by the assessee for earning tax-free income. Without discharging the onus, the AO is not entitled to make an ad hoc disallowance. A clear finding of incurring of expenditure is necessary. No disallowance can be made on the basis of presumptions (law laid down in assessee’s own case for AY 2007-08 reiterated)

(129.0 KiB, 1,274 DLs)

Despite high volume & short holding period, shares gain is STCG

The assessee, a marine consultant, offered income by way of LTCG, STCG, speculative profit & profit from futures trading. The AO held that as the volume of transactions was high (222), the period of holding of the STCG shares was short (2 -5 Months) & there was speculation & F&O profit, the LTCG & STCG was assessable as business profit. On appeal, the CIT and Tribunal upheld the assessee’s claim on the basis that (a) As the LTCG shares were held for several years, the assessee acted as investor, (b) the STCG shares were assessable as such because (i) there was no intra-day trading, (ii) most of the shares were held for a period of 2 to 5 months, (iii) In the preceding AY, the AO did not assess the STCG as business income and on the principles of consistency, a different view cannot be taken on the same facts, (iv) the assessee has no borrowings and (v) merely because there was a speculative business does not mean that even delivery based transactions of shares should be assessed under the head business. On appeal by the department, HELD dismissing the appeal:

The Tribunal recorded the finding that in a number of cases the assessee had held the LTCG shares for more than 10 years and that the purchase and sale of shares within a period of one year had been offered as STCG. In the preceding AY, the AO accepted this. As per Gopal Purohit 228 ITR 582 (Bom) (SLP dismissed) it is open to an assessee to trade in the shares and also to invest in shares. When shares are held as investment, the income arising on sale of those shares is assessable as LTCG/STCG. Accordingly, the decision of the Tribunal in holding that the income arising on sale of shares held as investment were liable to be assessed as LTCG/STCG cannot be faulted.

(157.5 KiB, 1,068 DLs)

S. 275(1)(a) Penalty limitation period not curbed by Proviso

S. 275(1) (a) provides that no order imposing penalty shall be passed after the expiry of six months from the end of the month in which the quantum order of the CIT (A) or Tribunal is received by the CIT. The Proviso to s. 275(1)(a),as inserted by the FA 2003, provides that if the CIT (A) passes the order on the quantum appeal on or after 1.6.2003, the order imposing penalty has to be passed before the expiry of one year from the end of the financial year in which the order of the CIT (A) is received by the CIT. The Tribunal held that the effect of the Proviso was that one could only have regard to the order of the CIT (A) for determining limitation. The fact that an appeal was pending before the Tribunal was irrelevant. It accordingly held that the penalty order having been passed after 1 year of receipt of the CIT (A)’s order was barred by limitation. On appeal by the department, HELD reversing the Tribunal:

The period of six months provided for imposition of penalty u/s 275(1)(a) starts running after the successive appeals from an assessment order have been finally decided by the CIT(A) or the ITAT. The proviso to s. 275(1)(a) extends the period for imposing penalty from six months to one year of the receipt of the CIT (A)’s order after 1.6.2003. The proviso carves out an exception from the main section inasmuch as in cases where no appeal is filed before the ITAT the AO must impose penalty within a period of one year of the date of receipt of the CIT (A)’s order. To read the provision as suggested by the assessee would obliterate the main provision itself. A proviso is merely a subsidiary to the main section and must be construed harmoniously with the main provision. The proviso to s. 275(1)(a) does not nullify the availability to the AO of the period of limitation of six months from the end of the month when the order of the ITAT is received (Rayala Corporation 288 ITR 452 (Mad) followed).

(315.4 KiB, 1,155 DLs)

License fee for Software, even if “copyrighted article”, taxable as “royalty”

The applicant was the developer of software. It granted a non-exclusive and non-transferable license to an Indian company to use the software without any sub-licensing rights. The licensee was not allowed to modify the software programme and could make copies only for its own use. The applicant filed an application for advance ruling in which it claimed, relying on Dassault Systems 322 ITR 125 (AAR) and Tata Consultancy Services 271 ITR 401 (SC), that the transaction involved the use/ right to use of a “copyrighted article” but not the “copyright” itself and so the license fees were not assessable to tax as “royalty” u/s 9(1)(vi) of the Act & Article 12 of the India-Sri Lanka DTAA. HELD rejecting the applicant’s plea:

S. 9(1)(vi) & Article 12 define the term “royalty” to include any payment for the use of, or the right to use, a “copyright” of scientific work. Software programmes are a “copyright” and are protected under the Copyright Act, 1957. As the software programme is a “copyright”, any payment received for transferring the right to use it is “royalty” as defined in the Act. The argument that there is a distinction between a “copyright” and a “copyrighted article” is not acceptable because there is no such distinction made either in the Income-tax Act or the Copyright Act. The use of software involves the use of the copyright; the software cannot be divorced from the copyright itself. Accordingly, even a fee for the use of a “copyrighted article” is assessable as “royalty”. (Microsoft/Gracemac 42 SOT 550 (Del) followed; Dassault Systems 322 ITR 125 (AAR) not followed; Tata Consultancy 271 ITR 401 (SC) distinguished)

(78.8 KiB, 947 DLs)

Dependent Agent Permanent Establishment: Tests to determine Agent’s right to bind, & dependence on, principal

The assessee, a company registered in the Netherlands but resident in Ireland for tax purposes appointed Dell AS, a Norwegian company, as its “commissionaire” for sales to customers in Norway. Dell AS entered into agreements in its own name and its acts (under the commission agreement and Commission Act) did not bind the principal. The assessee claimed that it was not taxable in Norway in respect of the products sold through Dell AS on the ground that Dell AS was not its “Dependent Agent Permanent Establishment” (DAPE) under Article 5(5) of the Norway-Ireland DTAA on the ground that (a) the agent had no authority to enter into contracts “in the name of the assessee” and legally bind the assessee and (b) the agent was not a “dependent” agent. However, the income-tax department took the view that Dell AS constituted a PE under Article 5(5) of the DTAA and that 60 percent of Dell Products’ net profit on sales in Norway was attributable to the PE. This was confirmed by the Oslo District Court. On appeal by the assessee to the Court of Appeal, HELD dismissing the appeal:

(i) Under Article 5(5) of the DTAA, an agent is considered a permanent establishment for the principal if two conditions are fulfilled (i) the agent must be “dependent” on the principal and (ii) the agent must have the right to conclude contracts “in the name of” the principal. The question whether the agent has the authority to conclude contracts on behalf of the enterprise has to be considered, not from a literal sense whether the contracts are “in the name of the enterprise”, but from a functional sense whether the agent “in reality” binds the principal. The objective of Article 5 (5) is to protect the principle of source taxation, i.e. that the tax shall be due to the country where the revenue was created. This principle would be disregarded if only the commission relationship was considered despite the financial and legal attachment between the agent and the principal being strong. To ask if Dell AS “in reality” binds Dell Products is in accordance with the functional interpretation of Article 5 (5). The “substance” must prevail over the form. The fact that a commissionaire under the Commissionaire Act and the commission agreement does not bind the principal through his sales is not enough to rule out that a permanent establishment does not exist (Vienna Convention, OECD Model Convention Commentary, Commentaries by Klaus Vogel & Arvid Skaar considered, decision of the French SAT in Zimmer that as the commissionaire did not bind the principal, it was not a PE despite dependence on the principal not followed);

(ii) On facts, Dell Products was “in reality” bound by the contracts concluded by Dell AS because (a) all sales were made under the trademark “Dell”; (b) the sales were made on standard / approved conditions laid down by Dell Products; (c) in practice, all of the agent’s agreements were honoured by the principal and (d) there were no instances where the agent’s sales have not been accepted by the principal;

(iii) The question whether the agent is “dependent” on the principal has to be decided on the application of various tests such as the degree of instruction and control. On facts, Dell AS was “dependent” on Dell Products because (a) Dell AS was only allowed to sell permitted products on conditions of prices and guarantees determined by Dell Products, (b) there was an overlap of board members in the two companies and a board member of Dell Products was the general manager of Dell AS, (c) due to the integrated accounting system of the Dell companies Dell Products had full insight to the finances of Dell AS, (d) under the commission agreement, Dell Products had access to Dell AS’ premises, (e) Dell AS sold goods as a commissionaire only on behalf of Dell Products though it had the theoretical right to sell for others; (f) all business of Dell AS was done under the trademark Dell, its letterheads, agreements and advertisements had the logo “Dell”. Dell AS was thus “branded” identically as the rest of the Dell Group, but without owning the brand. All these facts made Dell AS fully dependent on the principal. Without the commission agreement, Dell AS may as well close down its operations. The fact that the agent acted independently in matters of staff hire, purchase and lease of assets and premises, etc was irrelevant because the “big picture” showed Dell AS to be dependent on Dell Products;

(iv) The determination of profits “attributable” to the PE has to be done as if the agent was “independent” of the principal. On the methods to be used, Article 7(2) of the DTAA provides for the “direct method” of allocating all costs and revenue between the HO and the PE while Article 7(4) provides for the “indirect method” of allocating only the net profits using keys such as sales, revenues, expenses, number of employees, capital structure or a combination of these factors. In Norway, the “indirect method” is in practice. This is practical because the accounts do not permit individual items of income and expenditure to be identified for allocation purposes and also because it gives a result which is in accordance with the arm’s length principle. While under Article 7(2), a two-step procedure has to be adopted by first determining a commercial remuneration for Dell AS and then a commercial profit for other functions performed by the PE, under Article 7(4) it is sufficient that the result to a reasonable degree corresponds to the arm’s length principle and requires that the PE should be allocated revenues in accordance with its functions, risk and assets used. On facts, the value creation occurred through sales made by Dell AS and it was “the major value driver”. Dell Products’ functions and contribution to the value creation was limited compared to the activity of Dell AS. Consequently, allocating 60% of Dell Products’ profits from sales in Norway to the PE was reasonable (over & above the assessment of commission in the agent’s hands).

(325.8 KiB, 2,168 DLs)

Loss on pro-rata reduction of share capital is “Notional”. In absence of consideration, capital gains provisions do not apply

The assessee invested Rs.24.84 crores in equity shares of Times Guarantee Ltd. Pursuant to a scheme of reduction u/s 100 of the Companies Act, the face value of Times Guarantee shares was first reduced to Rs. 5 from Rs. 10 and thereafter two equity shares of Rs.5 each were consolidated into one equity share of Rs.10. The result was that the assessee’s investment was reduced to Rs.12.42 crores. The assessee, relying on Kartikeya Sarabhai 228 ITR 163 (SC) & G. Narsimhan 236 ITR 327 (SC), claimed that the reduction in face value was a “transfer” and that it had suffered a long-term capital loss of Rs.22.21 crores after indexation. The AO disallowed the claim on the ground that (i) there was no “transfer” and (ii) there was no “consideration” and the machinery provisions of s. 48 cannot apply. The issue was referred to the Special Bench. HELD by the majority (R. S. Syal, AM, dissenting):

(i) First the face value of each share was reduced from Rs. 10 to Rs. 5 and then two shares of Rs. 5 each were consolidated into one share of Rs. 10 each. If the argument is that earlier shares were replaced or substituted by new shares, then there is no “transfer” but it is merely a case of substitution of one kind of share with another kind of share (Rasiklal Maneklal (HUF) 177 ITR 198 (SC) followed);

(ii) Assuming that a reduction of shares in the manner done by the assessee amounts to a “transfer”, s. 45 is not attracted because there is no “consideration” received by the assessee for the transfer. Unless and until a particular transaction leads to “computation” of capital gains or loss as contemplated by s. 45 & 48, it cannot attract capital gain tax. On facts, the assessee had not received any consideration for reduction of share capital. While the number of shares held by the assessee has reduced to 50%, nothing had moved from the side of the company to the assessee (B. C. Srinivasa Setty 128 ITR 294 (SC) & Bombay Burmah 147 TR 570 followed)

(iii) Further, by the reduction, the assessee’s rights had not been extinguished because it continued to hold the same percentage in the holding of Times Guarentee as it did before the reduction. There was no change in the intrinsic value of his shares and even his rights vis-à-vis other shareholders as well as vis-à-vis company remained the same. The concept of capital gains has to be understood as in the commercial world and there was no loss that can be said to have actually accrued to the shareholder as a result of reduction in the share capital. Also, there would be no change even in the cost of acquisition of shares by virtue of s. 55(v).

Per R. S. Syal, AM, dissenting:

(iv) On the point of “transfer”, a reduction of share capital u/s 100 of the Companies Act can take place either by paying excess capital to the shareholders or by cancelling lost capital. While the first method amounts to a “transfer” as held in Anarkali Sarabhai 224 ITR 422 (SC), the other method (adopted by the assessee) results in an “extinguishment of rights” in the shares which is also a “transfer” as held in Grace Collis 2481TR 323 (SC). Consequently, a reduction of capital by cancellation of shares results in a “transfer”;

(v) On the point that a capital loss cannot be computed if there is no consideration, while it is true that the failure of the computation provisions results in a failure of the charging provisions as held in B. C. Srinivasa Setty, there is a distinction between a case where the computation provision is incapable of ascertainment and a case where it is ascertained as zero or Nil. In the present case, the consideration received by the assessee was Nil. It was not a case where the consideration was incapable of ascertainment (observations in Mohanbhai Pamabhai 91 ITR 393 (Guj) treated as obiter dicta. Bombay Burma Trading Corp 147 Taxation 570 (Bom) not followed as being only a case of rejection of a s. 256(2) application);

(vi) On the point that there is no “loss”, the argument that as with the reduction of capital, there is a corresponding increase in the net worth per share and the assessee’s interest in TGL remains unaffected on an overall basis is not acceptable because after the reduction, the assessee is left with lesser number of shares. The fact that the book value has increased has no effect. An increase or decrease in the market value of shares is of no consequence if the shares are held as investment (principles laid down in Dalmia Investment Co & Dhun Dadabhoy Kapadia 63 ITR 651 (SC) held not applicable on the ground that Dalmia was in the context of shares held as stock-in-trade and both were under the 1922 Act);

(vii) the apprehension that the assessee would derive a double advantage by claiming the loss now and the entire cost at the time of sale is unfounded because (a) the assessee’s books shows the investments at the reduced amount and (b) u/s 55(2)(iv)(v), the cost of acquisition of the remaining consolidated shares will be the reduced amount.