(143.4 KiB, 493 DLs)

S. 40(a)(ia) TDS: Special Bench verdict in Merilyn Shipping is not good law

The assessee incurred expenditure on which TDS ought to have been deducted but was not. The AO disallowed the expenditure u/s 40(a)(ia). On appeal, the Tribunal relied on Merilyn Shipping & Transports 146 TTJ 1 (Viz) (SB) and held that the disallowance u/s 40(a)(ia) could be made only for the expenditure that is “payable” as of 31st March and not for the amounts that have already been “paid” during the year. On appeal by the department to the High Court, HELD reversing the Special Bench:

The key words in s. 40(a)(ia) are “on which tax is deductible at source under Chapter XVII –B” and this makes it clear that it applies to all expenses. Nothing turns on the fact that the legislature used the word ‘payable’ and not ‘paid or credited’. Unless any amount is payable, it can neither be paid nor credited. If an amount has neither been paid nor credited, there can be no occasion for claiming any deduction. The Special Bench was wrong in making a comparison between the draft Bill and the enacted law to determine the intention of the Legislature. A comparison is permissible only between the pre-amendment and post amendment law to ascertain the mischief sought to be remedied or the object sought to be achieved by the amendment. The fact that the impact of s. 40(a)(ia) is harsh is no ground to read the same in a manner which was not intended by the legislature. The law was deliberately made harsh to secure compliance of the provisions requiring deductions of tax at source. It is not the case of an inadvertent error. For the same reason, the second proviso sought to become effective from 1st April, 2013 cannot be held to have already become operative prior to the appointed date. Consequently, the majority view in Merilyn Shipping & Transports is not acceptable.

(122.7 KiB, 338 DLs)

Transfer Pricing: All related transactions cannot be considered for PLI determination

The assessee’s parent company, Digital Microwave Corporation USA, supplied equipment to Indian customers for which the assessee received commission. The said equipment was covered by warranty and the service relating thereto was provided by the assessee. The assessee also undertook installation of the said equipment and provided annual maintenance. The assessee claimed that while the receipt of commission and the provision of warranty service were “international transactions” with the AE and subject to transfer pricing regulations, the installation & maintenance service was an independent transaction and could not be considered while computing the PLI for determining the ALP. The TPO rejected the claim and held that in computing the profit level indicator of the international transactions involving warranty services and commission income, the operating revenue and operating costs of the installation/commissioning and maintenance services had to be taken. The CIT(A) & Tribunal upheld the assessee’s claim. On appeal by the department to the High Court, HELD dismissing the appeal:

The department’s argument that the installation, commissioning & maintenance services were intricately connected with the international transactions of warranty support services and commission income and that their operating cost and operating revenue had to be considered while computing the profit level indicator is not acceptable because the installation/ commissioning and maintenance agreements were independent agreements unconnected with the transactions of warranty support services and commission income. This is shown by the fact that while the equipment was supplied to 40 customers by the AE, only three of them availed of the installation services from the assessee. Also, a corroborative circumstance for construing the transactions of installation/commissioning and maintenance as domestic transactions was that the TPO had made no adjustment in respect of these transactions. The transactions pertaining to the installation/commissioning and maintenance services were also not deemed international transactions u/s 92B(2) because none of the conditions stipulated therein of a prior agreement existing between the customers of the assessee and the AE have been established as a fact. Moreover, there is no finding that the terms of the transaction of installation/commissioning as well as maintenance had been determined in substance between the customers and the assessee by the AE. In the absence of such finding, it cannot be deemed that the transaction of installation/commissioning as well as provision of maintenance services by the assessee to its domestic customers in India were international transactions falling within s. 92B(2).

(76.4 KiB, 298 DLs)

Writ to restrain ITAT Members from discharging statutory functions not maintainable

The Petitioner, a Chartered Accountant practicing before the Amritsar Bench of the Tribunal, filed a Writ Petition alleging that he was facing a lot of harassment at the hands of the Judicial Member (Shri. H. S. Sidhu) and the Accountant Member (Shri. B. P. Jain) of the Amritsar Bench. He alleged that the said Members were totally prejudiced against him as he had made a complaint against the Judicial Member to the Tribunal and also because he had not been able to meet the “expectations” and “illegal demands” of the said Members. It was also alleged that the Bench was delaying the matters of the Petitioner or passing unreasoned orders or by totally ignoring him. A Writ of Mandamus was sought for restraining the said Judicial and Accountant Members of the Amritsar Bench from discharging their functions. HELD by the High Court dismissing the Petition:

It appears that the writ petition is to settle scores which the Petitioner might have raised during the course of his conduct as representative of the assessees. The Petitioner has asserted that he is not able to meet the expectations and illegal demands raised by the Members but there are no details as to when and how the demands were raised. Not only the writ petition is bereft of any material particulars but also the Petitioner has no right to claim mandamus for restraining an authority constituted under the Act from discharging the functions entrusted to it by the Statute. The present writ petition is gross abuse of process of law and, therefore, it is dismissed.

(218.9 KiB, 677 DLs)

S. 40(a)(ia) TDS: Special Bench verdict in Merilyn Shipping is not good law

The assessee, engaged in the business of transport contractor and commission agent, incurred expenditure of Rs. 8.74 crores on payment to contractors where no TDS was deducted. The AO & CIT(A) held that the expenditure had to be disallowed u/s 40(a)(ia). On appeal, the Tribunal, relying on Merilyn Shipping & Transports 146 TTJ 1 (Viz) (SB) held that as the said amount had already been paid and was not “payable” as of 31st March, the disallowance u/s 40(a)(ia) could not be made. On appeal by the department to the High Court, HELD reversing the Tribunal:

In Merilyn Shipping 146 TTJ 1 (Viz) (SB) the majority held that as the Finance Bill proposed the words “amount credited or paid” and as the Finance Act used the words “amounts payable“, s. 40(a)(ia) could only apply to amounts that are outstanding as of 31st March and not to amounts already paid during the year. This view is not correct for two reasons. Firstly, a strict reading of s. 40(a)(ia) shows that all that it requires is that there should be an amount payable of the nature described, which is such on which tax is deductible at source but such tax has not been deducted or if deducted not paid before the due date. The provision nowhere requires that the amount which is payable must remain so payable throughout during the year. If the assessee’s interpretation is accepted, it would lead to a situation where the assessee who though was required to deduct the tax at source but no such deduction was made or more flagrantly deduction though made is not paid to the Government, would escape the consequence only because the amount was already paid over before the end of the year in contrast to another assessee who would otherwise be in similar situation but in whose case the amount remained payable till the end of the year. There is no logic why the legislature would have desired to bring about such irreconcilable and diverse consequences. Secondly, the principle of deliberate or conscious omission is applied mainly when an existing provision is amended and a change is brought about. The Special Bench was wrong in comparing the language used in the draft bill to that used in the final enactment to assign a particular meaning to s. 40(a)(ia). Accordingly, Merilyn Shipping does not lay down correct law. The correct law is that s. 40(a)(ia) covers not only to the amounts which are payable as on 31th March of a particular year but also which are payable at any time during the year.

(92.7 KiB, 613 DLs)

S. 43(5): Loss on foreign currency forward contracts by a manufacturer/ exporter is a “hedging loss” and not a “speculation loss”

The assessee, an exporter, entered into forward contracts with Banks to hedge against any loss arising out of fluctuation in foreign currency. The forward contract provided that the assessee would buy some quantity of dollars at a particular rate to cover export bill payment. The contract gave delivery option dates and the assessee had the option to cancel the contract and pay the loss to the Bank. The assessee suffered a loss of Rs. 15 lakhs on such cancellation. The AO & CIT(A) held that the loss constituted a “speculation loss” u/s 43(5) and could not be allowed as a deduction. On appeal, the Tribunal upheld the assessee’s claim. On appeal by the department, HELD dismissing the appeal:

Though the assessee is not a dealer in foreign exchange, it entered into forward contracts with banks for the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts. The transactions in foreign exchanges were incidental to the assessee’s regular course of business and the loss was thus not a speculative loss u/s 43(5) but was incidental to the assessee’s business and allowable as such. The fact that there may have been no direct co-relation between the exchange document and the precise export contract cannot be seen in isolation if there are in fact several separate contracts with the bankers (Soorajmull Nagarmull 129 ITR 169 (Cal) & Badridas Gauridu 261 ITR 256 (Bom) followed; M. G. Brothers 154 ITR 695 (AP) distinguished)

(253.4 KiB, 354 DLs)

Transfer Pricing: In computing ALP, interest & abnormal costs to be excluded

The assessee rendered marketing support services to its foreign AE for which it earned a commission. The assessee claimed that in determining the ALP, the interest earned by it on short-term deposits arose from a core treasury function and had to be included in the operating profit and the expenses incurred by it on closure of business were ‘abnormal’ and had to be excluded from the operating profit. The TPO, CIT(A) and Tribunal (144 TTJ 474) rejected the assessee’s contention. On appeal by the assessee to the High Court, HELD:

(i) The question whether a particular activity of the assessee such as the interest generating activity should be taken into consideration in the determination of the ALP is a question which needs to be decided considering the nature of the business of the assessee and its’ “business model”. The Tribunal rightly held that as the earning of interest income was only the result of investment of surplus funds and was not a primary income-generating activity, the interest income had to be excluded from the “operating profit” for purposes of determination of ALP;

(ii) It is not possible to lay down a formula that would be applicable universally to determine whether a particular expenditure or cost incurred by the assessee is a normal or abnormal item of expense in cases relating to transfer pricing. If the assessee is compensated for its service on the basis of cost plus 10%, the question may arise as to whether the compensation paid for closure of the Indian units can be considered to be normal or abnormal cost, because the compensation would directly depend or vary according to the quantum of the costs. But if the assessee is being compensated by a fee or commission which has no connection with the costs incurred, such costs would be treated as abnormal. On facts, as the assessee was being compensated by way of a commission of fees by the AE and not on cost plus basis, the compensation paid in connection with the closure of the Indian units represents abnormal costs which have to be excluded for determining the ALP.

(67.3 KiB, 372 DLs)

Fact that payment is used for ‘illegal’ purpose does not attract Expl to s. 37(1)

The assessee exported tea to Iraq under the ‘Oil for Food Program’, as sanctioned by the United Nations. It paid commission of Rs 1.28 crores to one Alia Transportation, a Jordanian company. The Volcker Committee, which was set up to expose the ‘Oil for Food scam’ found that this company was a front company for the Iraqi regime, meant to receive illegal kickbacks, and did not render any services. The AO, acting on the report, held that the commission paid by the assessee was “illegal” and not allowable under the Explanation to s. 37(1). This was reversed by the CIT (A). On appeal by the department, the Tribunal (72 DTR 425) upheld the stand of the assessee on the ground that even if the amounts paid to Alia were actually kickbacks to Iraqi regime, that fact per se would not attract Explanation to s. 37(1). It was pointed out that while the transactions between Alia and the Iraqi regime may be contrary to the UN sanctions, the transactions between the assessee and Alia were not hit by the UN sanctions and that there was no specific violation of law by the assessee. It was emphasized that what the recipient of the payment does is not important because the assessee has no control over the matter. The onus of demonstrating that the assessee was aware that the payments were intended for kickbacks is on the AO which has not been discharged. It was held that the “purpose” of the expenditure has to be seen and if the payment is for bonafide business purposes, the fact that they end up being used as illegal kickbacks, will not attract Explanation to s. 37(1). On appeal by the department to the High Court, HELD dismissing the appeal:

The department could not satisfy us as to why were the findings recorded by the CIT(A) and the Tribunal are incorrect either on fact or in law. There is, as such, no reason why the appeal should be entertained. The appeal is, therefore, dismissed.

(96.3 KiB, 534 DLs)

S. 147: Reopening invalid if reasons silent on quantum of escaped tax

In AY 2000-2001 the assessee sold a plot of land after converting leasehold land into freehold. The capital gains arrived at was offered as LTCG and the same was accepted by the AO. After the expiry of 4 years, the AO issued a notice u/s 148 for reopening the assessment on the ground that as the property was sold within three years of conversion into freehold, the gains were assessable as STCG. The approval of the Joint/ Addl. CIT was obtained. However, in the recorded reasons, it was not stated whether the amount of income escaping assessment exceeded Rs. 1 lakh. The assessee challenged the reopening on the ground that as the recorded reasons did not state that the income escaping assessment is Rs. 1 lakh or more, the reopening was invalid. HELD by the High Court upholding the plea:

S. 149 (1) (b) provides that no notice u/s 148 shall be issued after the expiry of 4 years from the end of the relevant AY unless the income chargeable to tax which has escaped assessment amounts to Rs. 1 lakh or more. Under the proviso to s. 151 (1), no notice u/s 148 can be issued after the expiry of four years from the end of the relevant AY unless the CCIT/ CIT is satisfied on the reasons recorded by the AO that it is a fit case for issue of such notice. Accordingly, it is imperative that the AO should state in the recorded reasons that the escaped income is likely to be Rs.1 Lakh or more so that the sanctioning authority is aware that it has exercised power of extended period of limitation u/s 149 (1) (b) and applies its mind accordingly. A sanction given without being aware of this fact is not valid. On facts, as there is nothing in the recorded reasons to suggest that the income chargeable to tax which has escaped the assessment is Rs. one lakh or more, the reopening is not valid.

(171.6 KiB, 536 DLs)

Transfer Pricing: If more than one price is determined by the most appropriate method, the ALP has to be the arithmetical mean of such prices

The assessee was engaged in providing “software development support services” by which it developed software upon the instructions of its parent associated enterprise (IKOS Systems Inc). The entire software developed by the assessee was used by the parent AE captively for integrating the same with other software components developed by it. The assessee adopted the TNMM and claimed that its transactions were at ALP. The TPO rejected the assessee’s comparables on general grounds and selected his own comparables and used figures for a subsequent year. He determined the ALP at a much higher figure and made an adjustment. On appeal by the assessee, the Tribunal (109 ITD 101) held that the criteria adopted by the TPO for searching comparables was not correct. It held that the TPO was wrong in selecting his own comparables without first rejecting the assessee’s comparables. It also held that where one of the prices determined by the most appropriate method is less than the price as indicated by the assessee, that may be selected and there would be no need to adopt the process of taking the arithmetical mean of all the prices arrived at through the employment of the most appropriate method. On appeal by the department to the High Court, HELD:

The Tribunal was wrong in holding that if one profit level indicator of a comparable, out of a set of comparables, is lower than the profit level indicator of the taxpayer, then the transaction reported by the taxpayer is at an arm’s length price and there is no need to take the arithmetical mean. The proviso to s. 92C(2) is explicit that where more than one price is determined by most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices. The Tribunal was also wrong in the finding that unless and until the comparables drawn by the taxpayer were rejected, a fresh search by the TPO could not be conducted because s. 92C (3) which stipulates four situations where under the AO/ TPO may proceed to determine the ALP in relation to an international transaction. If any one of those four conditions is satisfied, it would be open to the AO/ TPO to proceed to determine the ALP price. Also, the question of applying OECD guidelines does not arise at all because there are specific provisions of Rule 10B (2) & (3) and the first proviso to s. 92C(2) which apply. The Tribunal was also not right in reducing the list of comparables to merely four. Having held that the comparables given by the assessee were to be accepted and those searched by the TPO were to be rejected, the only option then left to the Tribunal was to derive the arithmetical mean of the profit level indicators of the comparables which were accepted by it. It erred in selecting only one profit level indicator out of a set of profit level indicators. However, on facts this make no difference because even if the arithmetical mean of the comparables as accepted by the Tribunal are taken into account, the profit level indicator would be less than 6.99 % which is the profit level indicator of the assessee.

(133.1 KiB, 493 DLs)

Non-grant of refunds: Strictures passed against Dept for harassing honest taxpayers

A search was conducted at the premises of the assessee during which cash of Rs. 25 lakhs was seized. The assessee succeeded in the block assessments and the said amount of Rs. 25 lakhs became refundable to the assessee. However, the said amount was not refunded to the assessee on the ground that there were demands outstanding against a third party who was also named in the search warrant. The assessee claimed that he had no relation with the third party and the fact that there were demands outstanding there did not mean that the assessee’s refund could be blocked. The department refused to pass an order on the assessee’s application for refund. HELD by the High Court allowing the plea:

It is but evident that the department has failed to discharge its legal obligation in not refunding the seized amount. The argument of the department that unless a direction is issued, a speaking order shall not be passed on the application for refund of the amount due to him is not appreciated. It shows that the officers of the Income-tax Department are shirking their responsibilities. Speedy and affordable justice is the requirement of the day. But it cannot be achieved until the executive including tax-man discharge their duties faithfully honestly within the four corners of law. The revenue official failed to take any decision right or wrong on the refund application filed by the assessee and passed on the buck on the Court. Time has come for the heads of the departments to keep a strict vigil on such shirkers and to fix their responsibility. While it is no doubt true that collection of revenue is a serious matter for the State -and the bounden duty of the authorities functioning under the Act is to implement the provisions of the Act, there should be safety and assurance to an honest tax-payer. An honest tax-payer should not be subjected to unnecessary harassment and an action not warranted in law, which can be of very serious consequence to the tax-payer if is allowed to remain without correction, such harassment and browbeating of an honest tax-payer will otherwise drive even such honest tax-payers to become cynical and lead to a situation where taxpayers will get a feeling that paying taxes honestly is not a worthwhile exercise; that the tax authorities are a menace to the society rather than simply being representatives of the State for enforcing the tax provisions. The department shall pay costs of Rs. 15,000 to the assessee (Sandik Asia 280 ITR 643 (SC), Gujrat Flouro Chemicals 348 ITR 319 & Raghavendra Sherrigar (2005) 1425 STC 153) followed)