(19.4 KiB, 128 DLs)

Reopening beyond 4 years on basis of Supreme Court’s judgement not justified if assessee has not failed to disclose material facts

The AO passed an order u/s 143(3) r.w.s 147 in which he allowed deduction u/s 80HHC though the assessee had suffered a loss in the export business by setting off the said loss against the export incentive. After the expiry of four years from the end of the assessment year, the assessment was reopened u/s 147 on the ground that pursuant to the judgement of the Supreme Court (probably Ipca Laboratories vs. CIT 266 ITR 521) s. 80HHC deduction could be allowed only if there were positive profits from export operations and the assessee had been wrongly allowed deduction u/s 80HHC. The Tribunal struck down the reopening. On appeal by the department, HELD dismissing the appeal:

The assessee had claimed deduction u/s 80HHC after a full disclosure of the material facts. As four years had elapsed from the end of the assessment year, the assessment could not be reopened in the absence of failure to disclose the material facts. The judgment of the Supreme Court is an expression of opinion on the interpretation of statute. Merely because a judgment has been rendered, the same cannot be a ground for reopening the assessment u/s 147 as it amounts to a change of opinion. Austin Engineering 312 ITR 70 (Guj) followed)

(245.7 KiB, 355 DLs)

S. 50C is only a measure of tax & is constitutionally valid

The assessee was the owner of land & building. It entered into a development agreement for the development & sale of the land. The consideration receivable by the assessee was Rs. 4.85 crores. For stamp duty purposes, the agreement was valued by the authorities at Rs. 15.50 crores and the duty on the same was paid by the developer. As the stamp duty valuation adversely affected the assessee for purposes of s. 50C (which provides that the value adopted by the stamp valuation authority shall be deemed to be the full value of the consideration received or accruing as a result of the transfer), the assessee filed a writ petition challenging the constitutional validity of s. 50C. HELD dismissing the Petition:

(i) There is a distinction between the subject matter of a tax and the standard by which the amount of tax is measured. The subject matter of tax is capital gains and the manner in which it should be computed is provided by s. 50C. S. 50C is only a measure of tax and not the subject matter of tax. The valuation rule of the Stamp Act is for the purpose of computation of income. It is only a standard of measure for imposing tax. (Principle laid down in A. Sanyasi Rao 219 ITR 330 (SC) followed);

(ii) S. 50C was introduced with a view to prevent evasion of tax and under-valuation of the transaction and must be read in that context. The classification made by s. 50C is in respect of an identifiable group of assessees and is not arbitrary, unreasonable or discriminatory. (K. R. Palanisamy v/s UOI 306 ITR 61 (Mad) followed)

(435.0 KiB, 1,427 DLs)

Rule 8D r.w. S. 14A (2) is not arbitrary or unreasonable but can be applied only if assessee’s method not satisfactory. Rule 8D is not retrospective and applies from AY 2008-09. For earlier years, disallowance has to be worked out on “reasonable basis” u/s 14A (1)

In AY 2002-03, the assessee claimed that no disallowance u/s 14A in respect of the tax-free dividend earned by it could be made as it had not incurred any expenditure to earn the dividend. The AO rejected the claim and made a disallowance u/s 14A. This was deleted by the CIT (A). On appeal by the department, the Tribunal followed the judgement of the Special Bench in Daga Capital 117 ITD 169 (Mum) (where it had been held that s. 14A(2) & (3) & Rule 8D are procedural in nature and have retrospective effect) and remanded the matter to the AO for re-computing the disallowance. The assessee challenged the decision of the Tribunal. HELD:

(1) The argument that dividend on shares / units is not tax-free in view of the dividend-distribution tax paid by the payer u/s 115-O is not acceptable because such tax is not paid on behalf of the shareholder but is paid in respect of the payer’s own liability;

(2) S. 14A supersedes the principle of law that in the case of a composite business expenditure incurred towards tax-free income could not be disallowed and incorporates an implicit theory of apportionment of expenditure between taxable and non-taxable income. Once a proximate cause for disallowance is established – which is the relationship of the expenditure with income which does not form part of the total income – a disallowance u/s 14A has to be effected;

(3) The argument that a literal interpretation of s. 14A leads to absurd consequences is not acceptable. S 14A is founded on a valid rationale that the basic principle of taxation is to tax net income i.e gross income minus expenditure;

(4) The argument that the method in Rule 8D r.w.s 14A (2) for determining expenditure relating to the tax-free income is arbitrary and violative of Article 14 is not acceptable because there is an adequate safeguard before Rule 8D can be invoked. The AO cannot ipso facto apply Rule 8D but can do so only where he records satisfaction on an objective basis that the assessee is unable to establish the correctness of its claim. Also a uniform method prescribed to resolve disputes between assessees and the department cannot be said to be arbitrary or oppressive. There is a rationale in Rule 8D and its method is “fair & reasonable”. It cannot be said that there is “madness” in the method of Rule 8D so as to render it unconstitutional;

(5) Rule 8D, inserted w.e.f 24.3.2008 cannot be regarded as retrospective because it enacts an artificial method of estimating expenditure relatable to tax-free income. It applies w.e.f AY 2008-09;

(6) For the AYs where Rule 8D does not apply, the AO will have to determine the quantum of disallowable expenditure by a reasonable method having regard to all facts and circumstances;

(7) On facts, though in the earlier years, the Tribunal had held that the tax-free investments had been made out of the assessee’s own funds, this did not mean that there was no expenditure incurred to earn tax-free income. Even though Rule 8D did not apply to AY 02-03, the AO had to consider whether disallowance could be made u/s 14A (1). Also, the principle of consistency would not apply as s. 14A had introduced a material change in the law.

(24.4 KiB, 535 DLs)

S. 14A applies where shares are held as investment and the only benefit derived is dividend. S. 36(1)(iii) deduction allowable if shares held as stock-in-trade

The assessee borrowed funds to acquire controlling interest shares in a company with which she claimed to have business dealings. The interest on the borrowings was claimed as a deduction u/s 36(1)(iii). The AO rejected the claim on the ground that the only benefit derived from the investment in shares was dividend and that the interest had to be disallowed u/s 14A. This was confirmed by the CIT (A). The Tribunal held that the deduction of interest was allowable u/s 36(1)(iii) in principle though a portion of the interest paid had to be regarded as attributable to the dividend and was disallowable u/s 14A. On appeal by the Revenue, HELD reversing the order of the Tribunal:

(i) The only benefit derived by the assessee from the investment in shares was the dividend income and no other benefit was derived from the company for the business carried on by it. As dividend is exempt u/s 10(33), the disallowance u/s 14A would apply. The Tribunal was not correct in estimating the s. 14A disallowance to a lesser figure than the interest paid on the borrowing when the whole of the borrowed funds were utilized by the assessee for purchase of shares;

(ii) Deduction of interest u/s 36(1)(iii) on borrowed funds utilized for the acquisition of shares is admissible only if shares are held as stock in trade and the assessee is engaged in trading in shares. So far as acquisition of shares in the form of investment is concerned and where the only benefit derived is dividend income which is not assessable under the Act, disallowance u/s 14A is squarely attracted.

(234.9 KiB, 360 DLs)

S. 147 reopening for rectifying s. 154 mistakes is invalid

The AO issued a notice u/s 148 to reopen the assessment within 4 years from the end of the assessment year. There were four recorded reasons and one of them was that the AO had committed a computational error in the assessment order by deducting the wrong figure instead of the right figure. The assessee filed a Writ Petition to challenge the reopening inter alia on the ground that as the mistake could be rectified u/s 154, the reopening was bad. HELD upholding the challenge:

(i) While Explanation 2 to s. 147 deems income to have escaped assessment if excessive deduction is allowed, the reopening of an assessment u/s 147 has serious ramifications because the AO is empowered to reassess income even in respect of issues not set out in the notice. Therefore, if the power to rectify an order u/s 154(1) is adequate to meet a mistake or error in the order of assessment, the AO must take recourse to that power as opposed to the wider power to reopen the assessment. If the error can be rectified u/s 154, it would be arbitrary for the AO to reopen the entire assessment u/s 147. Further, the error in the order was not attributable to a fault or omission on the part of the assessee and the assessee cannot be penalized for a fault of the AO;

(ii) When one or more modes of assessment or remedies are available to the taxing Authority, the Authority must adopt that remedy which causes least prejudice to the assessee.

(36.5 KiB, 373 DLs)

Reopening beyond 4 years on basis of retrospective amendment not justified if assessee has not failed to disclose material facts

In respect of AY 2003-04, the assessee claimed deduction u/s 80IA (4) which was partly allowed by the AO vide assessment order passed u/s 143(3). Subsequently, a retrospective amendment was made to s. 80IA by the Finance (No. 2) Act, 2009 w.e.f 1.4.2000 to provide that s. 80IA deduction would not be admissible to an assessee who carries on business which is in the nature of works contract. After the expiry of 4 years from the end of the assessment year, the AO reopened the assessment u/s 147 to deny the deduction u/s 80IA in view of the retrospective amendment. The assessee challenged the reopening by a Writ Petition. The department argued that the by virtue of the retrospective amendment, it had to be deemed that the assessee had submitted untrue facts at the relevant time and that s. 147 was attracted. HELD allowing the Petition:

Under the first proviso to s. 147 where an assessment has been made u/s 143(3), the assessment cannot be reopened after expiry of four years from the end of the relevant assessment year unless if income has escaped assessment by reason of failure on the part of the assessee to disclose fully and truly all material facts necessary for his assessment. In the present case, there was no failure on the part of the assessee to make a full and true disclosure of the material facts. The argument that in view of the retrospective amendment of section 80IB, it is deemed that the petitioner has failed to disclose the correct facts is not acceptable. The question whether there is a failure to disclose all material facts is a matter of fact and there can be no deemed failure as contended by the department. Consequently, in the absence of any failure on the part of the assessee to make a full & true disclosure of material facts, the initiation of proceedings u/s 147 was vitiated and could not be sustained.

(47.8 KiB, 573 DLs)

Failure to follow High Court’s order is contempt of court

The AO passed an assessment order in which he declined to follow the judgement of the Bombay High Court in CST vs. Pee Vee Textiles 26 VST 281 on the ground that the said judgement “is not accepted by the Sales Tax Department and legal proceeding is initiated against the said judgment”. On a Writ Petition filed by the assessee, the High Court has taken the view that as the said judgement in Pee Vee Textiles is not stayed, “the refusal to follow and implement the judgment of this Court by Mr.Dubey in our considered view prima facie amounts to contempt of this Court”. The Court directed issue of a show-cause notice to the AO as to why action under the Contempt of Courts Act should not be initiated against him.

(319.8 KiB, 748 DLs)

DEPB sale proceeds cannot be bifurcated into “profits” and “face value”. The entire amount is “profits” for s. 80HHC r.w.s. 28(iiid)

S. 28 (iiid) provides that “any profit on the transfer” of the DEPB shall be business profits. Under Explanation (baa) to s. 80HHC, 90% of “the sum referred to in s. 28(iiid)” has to be reduced from the business profits. Under the third Proviso to s. 80HHC (3), in the case of an assessee having an export turnover exceeding Rs. 10 crores, the profits referred to in s. 80HHC (3) can be increased by 90% of “the sum referred to in s. 28 (iiid)” only if two conditions are satisfied. If the said conditions are not satisfied, no relief on account of DEPB can be granted u/s 80HHC. In Topman Exports vs. ITO 318 ITR 87 (Mum)(SB)(AT) the Special Bench of the Tribunal held that “the sum referred to in s. 28(iiid)” meant only the “profits” on transfer of the DEPB and not the entire sale proceeds. The Tribunal held that the amount received on account of DEPB had to be bifurcated into the “face value” of the DEPB and the “profit” and that while the “face value” was assessable u/s 28(iiib), the “profit” was assessable u/s 28(iiid). The consequence was that only the “profit” suffered the rigors of the third Proviso to s. 80HHC (3) and not the “face value“. On appeal by the Department, HELD reversing the Special Bench:

The argument that s. 28(iiid) covers only the “profit” (difference between sale consideration and face value of the DEPB credit) and that the “face value” is assessable u/s 28(iiib) is not correct. The entire amount received on transfer of the DEPB credit is “profits” and falls under s. 28(iiid). There was no basis or justification for the Tribunal to hold that the face value of the DEPB credit can be reduced from the sale consideration. It is not permissible to bifurcate the proceeds of the DEPB into “face value” and “excess of face value”. The approach of the Tribunal is misconceived and unsustainable. As the assessee had an export turnover exceeding Rs.10 crores and did not fulfill the conditions set out in the third proviso to s. 80HHC (3), it was not entitled to a deduction u/s 80HHC on the amount received on transfer of DEPB.

(590.0 KiB, 578 DLs)

Transfer Pricing Law for user of foreign trademarks & advertisement expenditure laid down

The assessee manufactured cars using the brand name “Maruti”. It entered into an agreement with Suzuki, Japan, pursuant to which it began manufacturing cars using the brand name “Suzuki”. The TPO issued a show-cause notice in which he alleged that the substitution of the brand name “Maruti” for the name “Suzuki” meant that the assessee had sold the “Maruti” brand to Suzuki. On that basis, he determined the “arms length” sale proceeds at Rs. 4,420 crores. The assessee filed a writ in which the TPO was allowed to pass an order subject to the outcome of the Petition. In the order, the TPO abandoned the theory of “sale” to Suzuki but instead held (without giving the assessee a show-cause notice in this behalf) that as the assessee was using the trademark “Maruti-Suzuki”, the “Suzuki” trademark had “piggybacked” on the “Maruti” trademark without payment of any compensation by Suzuki to the assessee. He alleged that “Maruti” was a “super-brand” while “Suzuki” was a “weak-brand”. He held that the assessee was not liable to pay Suzuki for the trademark “Suzuki” but instead Suzuki was liable to pay the assessee for “piggybacking” on the trademark “Maruti”. He also held that the advertisement expenses incurred by the assessee had gone to benefit Suzuki. He accordingly directed that an adjustment of Rs. 206 crores be made in the hands of the assessee. HELD remanding the matter to the TPO:

(i) While the onus is on the assessee to satisfy the AO/TPO that the arm‘s length price computed by it is in consonance with s.92, the AO/TPO can reject the price computed by the assessee only if he finds that the data used by the assessee is unreliable, incorrect or inappropriate or he finds evidence, which discredits the data used and/or the methodology applied by the assessee;

(ii) The TPO/AO is obliged to give the assessee an opportunity to produce evidence in support of the arm‘s length price and before making adjustments, he is obliged to convey to the assessee the grounds on which the adjustment is proposed to be made and give the assessee an opportunity to controvert the grounds on which the adjustment is proposed;

(iii) Re user of trademark by the domestic entity on discretionary / mandatory basis: If a domestic Associate Enterprise uses a foreign trademark, no payment to the foreign entity on account of such user is necessary in case the user of the trademark is discretionary. However, the “income” arising from such transaction is required to be determined at arm‘s length price;

(iv) 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. Even where payment is made by the foreign entity, the arm‘s length price in respect of the international transaction needs to be determined taking into consideration all the rights obtained and obligations incurred by the parties under the international transaction including the value of marketing intangibles obtained by the foreign entity on account of compulsory use of its trademark by the domestic entity. Suitable adjustments in this regards will have to be made considering the individual profiles of these entities and other facts and circumstances justifying such adjustments.

(v) Re advertisement expenditure incurred for the trademark: The expenditure incurred by a domestic Associate Enterprise on advertising of its products using a foreign trademark does not require any payment or compensation by the owner of the foreign trademark/logo to the domestic entity on account of use of the foreign trademark/logo in the advertising undertaken by it, so long as the expenses incurred by the domestic entity do not exceed the expenses which a similarly situated and comparable independent domestic entity would have incurred.

(vi) If the expenses incurred by the domestic Associate Enterprise are more than what a comparable independent domestic entity would have incurred, the foreign entity needs to suitably compensate the domestic entity in respect of the advantage obtained by it in the form of brand building and increased awareness of its brand in the domestic market. The said “arms length price” should be determined by taking into consideration all the rights obtained and obligations incurred by the two entities, including the advantage obtained by the foreign entity.

(vii) In determining whether the advertisement expenses incurred by the domestic Associate Enterprise on advertising the brand trademark/logo of the foreign entity are more than what an independent domestic entity would have incurred, the TPO has to identify appropriate comparables and make suitable adjustments considering the individual profiles of these entities and other facts and circumstances justifying such adjustments.

(143.1 KiB, 386 DLs)

S. 10(23C)(vi): Surplus does not mean trust ceases to be “solely for educational purposes and not for profit”

The assessee-trust was a public charitable trust engaged in education of women. In the earlier years, the assessee was granted exemption u/ss 11, 10(22) & 10(23C)(vi). The assessee’s application for renewal of exemption u/s 10(23C)(vi) was rejected on the ground that (i) the objects permitted the non-educational object of constructing an ashram and (ii) the assessee had earned a surplus of over 12% from its activities and so was not existing “solely for educational purposes and not for profit”. On a Writ Petition filed by the assessee, HELD allowing the Petition:

(i) The fact that the assessee has varied objects does not mean that it ceases to be solely engaged in educational purposes when the facts show that the assessee has not carried out any other object;

(ii) The fact that a surplus incidentally arises from the activities of the assessee does not disentitle an assessee of the benefit of s. 10(23C). The third proviso to s. 10(23C) which permits accumulation of surplus up to limits shows that the generation of surplus is per se not a disabling factor. The effect of Aditanar Educational Institution 224 ITR 310 (SC) is that the decisive or acid test is whether the object is to make a profit. In evaluating or appraising the issue, one should bear in mind the distinction between the corpus, the objects and the powers of the concerned entity;

(iii) The judgement in Queens’ Educational Society 319 ITR 160 (Utt) that “the law is well settled that if the profit is proved by an educational society then that will be the income to the Society as the surplus amount remains in the account books of the society” is distinguishable on facts. The Court is not correct in holding as a principle of law that the benefit of the exemption can be denied on the ground that the assessee has only pursued its main object of providing education and not pursued the other objects for which the Trust was constituted because were the assessee to pursue other objects, it would clearly run afoul of s. 10(23C)(vi) and cease to exist solely for educational purposes. Pinegrove International Charitable Trust followed.