(245.6 KiB, 451 DLs)

S. 147: Sanction of CIT instead of JCIT renders reopening invalid

The AO issued a notice u/s 148 to reopen an assessment. As a s. 143 (3) order had not been passed & 4 years had elapsed, the AO ought to have obtained the sanction of the Joint/Additional CIT u/s 151(2). Instead, he routed the file through the Additional CIT and obtained the sanction of the CIT. On appeal by the assessee, the Tribunal struck down the reopening on the ground that correct sanction had not been obtained. On appeal by the department, HELD upholding the Tribunal:

(i) S. 151(2) requires the sanction to be accorded by the Joint/Additional CIT. The AO sought the sanction of the CIT. Though the file was routed through the Addl. CIT, the latter only made an endorsement “CIT may kindly accord sanction”. This showed that the Addl. CIT did not apply his mind or gave any sanction. Instead, he requested the CIT to accord approval. This is not an irregularity curable u/s 292B;

(ii) The different authorities specified in s. 116 have to exercise their powers in accordance with law. If powers conferred on a particular authority are arrogated by other authority without mandate of law, it will create chaos in the administration of law and hierarchy of administration will mean nothing. Satisfaction of one authority cannot be substituted by the satisfaction of the other authority. If the statute requires a thing to be done in a certain manner it has to be done in that manner alone. Also, the designated authority should apply his independent mind to record his satisfaction and it should not be at the behest of a superior authority.

(240.0 KiB, 375 DLs)

AO’s self-determination of ALP without referring to TPO is “erroneous & prejudicial to interests of revenue”

The assessee entered into international transactions with its AEs, the value of which exceeded Rs. 5 crores. The AO passed an order u/s 143(3) in which he recorded the finding that he had examined the transactions and found them to be at arms’ length and no transfer pricing adjustment was required to be made. The CIT thereafter passed an order u/s 263 on the ground that in view of Instruction No. 3 of 2003 dated 20.5.2003, the AO ought to have referred the issue to the TPO instead of himself determining the arms’ length price of the transactions and that the assessment order was consequently “erroneous and prejudicial to the interests of the revenue”. On appeal, the Tribunal (114 TTJ (Del) 1) upheld the revision order. On further appeal by the assessee, HELD dismissing the appeal:

Though s. 92CA enables the AO to refer an international transaction to the TPO if he considers it “necessary or expedient” to do so, Instruction No. 3 dated 25.5.2003 makes it mandatory for the AO to make a reference to the TPO if the aggregate value of the international transaction exceeds Rs. 5 crores. This Circular, having been issued u/s 119, is binding on the AO. The AO ought to have referred the matter to the TPO having regard to the fact that Specialized Cell was created to deal with complicated and complex issues arising out of the transfer mechanism. The AO’s omission to follow the binding Circular amounted to making assessment without conducting proper inquiry and investigation and resulted in the order becoming “erroneous and prejudicial to the interest of the Revenue”. The observations in Sony India 288 ITR 52 (Del) (while upholding the constitutional validity of the aforesaid Circular) that the said Circular was a “Guideline” which did not take away the discretion of the AO was made in a different context.

(214.5 KiB, 749 DLs)

S. 37(1): Distinction between capital & revenue expenditure explained

The assessee incurred expenditure on removal of encroachments and claimed the same as a revenue deduction on the ground that the expenditure was incurred in the normal course of the business. The AO, CIT (A) & Tribunal rejected the claim on the basis that the assessee had acquired an advantage of an enduring nature. The High Court (for an earlier year, Airport Authority of India vs. CIT 303 ITR 433) upheld the view of the authorities that the expenditure was capital in nature. For the present year, the issue was referred to the Full Bench. HELD by the Full Bench reversing the lower authorities:

The question that has to be considered is whether the expenditure is incurred for initiating the business or for removing an obstruction to facilitate an existing business. Expenditure incurred for running the business or working it, with a view to produce profits is in the nature of revenue expenditure. The aim and object of the expenditure determines its character and not the source and manner of its payment. The fact that the expenditure is ‘once and for all’ is not conclusive. While expenditure for acquisition of a source of income would ordinarily be capital expenditure, expenditure which merely enables the profit making structure to work more efficiently would be in the nature of revenue expenditure. Expenditure incurred to fine tune trading operations to enable the management to run the business effectively, efficiently and profitably leaving the fixed assets untouched would be an expenditure of a revenue nature even though the advantage obtained may last for an indefinite period. On facts, the land belonged to the assessee and the amount paid for removal of encroachers was not for acquisition of new assets. The payment was made to facilitate its smooth functioning of the business i.e. in relation to carrying on the business in a profitable manner (Airport Authority of India 303 ITR 433 (Del) reversed; Bikaner Gypsum vs. CIT 187 ITR 39 (SC) followed)

(328.8 KiB, 522 DLs)

Amount paid for non-compete rights while acquiring business is capital expenditure

The assessee acquired the mailing business of Kilburn Office as a going concern on a slump sale basis pursuant to a Business Transfer Agreement. The consideration for the transfer was Rs. 18.92 crores which included Rs. 5.94 Crores by way of non-compete fee for a period of 5 years. In the accounts, the expenditure was treated as a capital payment though a deduction was claimed in the computation u/s 37(1). The AO disallowed the claim though the CIT (A) allowed it as deferred revenue expenditure. On appeal by the department, the Tribunal reversed the CIT (A) following Tecumesh India 132 TTJ 129 (Del) (SB) though it directed the AO to consider whether the payment was an “intangible asset” for purposes of depreciation. On appeal by the assessee, HELD dismissing the appeal:

In the books, the assessee treated the non-compete expenditure as capital in nature. Warding off competition in business even to a rival dealer will constitute capital expenditure. It is not necessary that the non-compete fee has to be paid to create monopoly rights. The non-compete agreement was to last for 5 years, which period is sufficient to give enduring benefit (Tecumesh India 132 TTJ 129 (Del) (SB) approved; Eicher Ltd 302 ITR 249 (Del) distinguished; Q whether depreciation is eligible left for determination by AO).

(562.3 KiB, 695 DLs)

S. 9: Profits from offshore supply of equipment & software not taxable in India

The assessee, a Swedish company, entered into contracts with ten cellular operators for the supply of hardware equipment and software. The contracts were signed in India. The supply of the equipment was on CIF basis and the assessee took responsibility thereof till the goods reached India. The equipment was not to be accepted by the customer till the acceptance test was completed (in India). The assessee claimed that the income arising from the said activity was not chargeable to tax in India. The AO & CIT (A) held that the assessee had a “business connection” in India u/s 9(1)(i) & a “permanent establishment” under Article 5 of the DTAA. It was also held that the income from supply of software was assessable as “royalty” u/s 9(1)(vi) & Article 13. On appeal, the Special Bench of the Tribunal (Motorola Inc 95 ITD 269 (Del)) held that as the equipment had been transferred by the assessee offshore, the profits therefrom were not chargeable to tax. It was also held that the profits from the supply of software was not assessable to tax as “royalty”. On appeal by the department to the High Court, HELD dismissing the appeal:

(i) The profits from the supply of equipment were not chargeable to tax in India because the property and risk in goods passed to the buyer outside India. The assessee had not performed installation service in India. The fact that the contracts were signed in India could not by itself create a tax liability. The nomenclature of a “turnkey project” or “works contract” was not relevant. The fact that the assessee took “overall responsibility” was also not material. Though the supply of equipment was subject to the “acceptance test” performed in India, this was not material because the contract made it clear that the “acceptance test” was not a material event for passing of the title and risk in the equipment supplied. If the system did not conform to the specifications, the only consequence was that the assessee had to cure the defect. The position might have been different if the buyer had the right to reject the equipment on the failure of the acceptance test carried out in India. Consequently, the assessee did not have a “business connection” in India. The question whether the assessee had a “Permanent Establishment” was not required to be gone into (Ishikawajma Harima 288 ITR 408 (SC), Skoda 172 ITR 358 (AP) & Mahavir Commercial 86 ITR 147 followed);

(ii) The argument that the software component of the supply should be assessed as “royalty” is not acceptable because the software was an integral part of the GSM mobile telephone system and was used by the cellular operator for providing cellular services to its customers. It was embedded in the equipment and could not be independently used. It merely facilitated the functioning of the equipment and was an integral part thereof. The fact that in the supply contract, the lump sum price was bifurcated is not material. There is a distinction between the acquisition of a “copyright right” and a “copyrighted article” (Tata Consultancy Services 271 ITR 401 (SC) Sundwiger EMFG 266 ITR 110 & Dassault Systems 229 CTR 125 (AAR) followed).

(33.5 KiB, 635 DLs)

S. 147: If AO disputes Audit objection, she cannot use that as “reason to believe”

The Revenue Audit raised an objection that the assessee had made remittances to foreign parties without deduction of TDS u/s 195 and that the expenditure ought to have been disallowed u/s 40(a)(i). In reply, the AO wrote back stating that as the amounts remitted to the foreign parties were not chargeable to tax in India, the assessee was under no obligation to deduct tax u/s 195 and that the expenditure was not disallowable u/s 40(a)(i). However, she still issued a notice u/s 147 and reopened the assessment to disallow the said expenditure. The assessee filed a Writ Petition to challenge the reopening. HELD allowing the Petition:

U/s 147, it is only the AO’s opinion with respect to the income escaping assessment which is relevant for the purpose of reopening an assessment. While it is true if the audit party brings certain aspects to the notice of the AO and thereupon, the AO forms his own belief, it may be a valid basis for reopening assessment, the mere opinion of the Audit Party cannot form the basis for the AO to reopen an assessment. On facts, the AO had categorically come to the conclusion that the objection of the audit party was not valid and that the assessee’s explanation with respect to non-requirement of collection of TDS was required to be accepted. Accordingly, the AO could have no “reason to believe” that income had escaped assessment and so the s. 148 notice was without jurisdiction (P. V. S. Beedies 237 ITR 13 (SC) & Indian & Eastern Newspaper 119 ITR 996 (SC) distinguished; Lucas TVS 249 ITR 306 (SC) followed).

(36.3 KiB, 494 DLs)

S. 147: AO cannot assess other “escaped income” if reason for issue of s. 148 notice dropped

The AO reopened the assessment u/s 148 on the ground that certain income had escaped assessment. However, in the reassessment order, the AO did not assess the income which was referred to in the reasons but instead assessed other income which had escaped assessment. The Tribunal quashed the reassessment order on the ground that if the AO did not assess the income for which he had reopened the assessment, he had no jurisdiction to assess other escaped income. The Department challenged the Tribunal’s order by relying on Explanation 3 to s. 147 & Sun Engineering 198 ITR 297 (SC). HELD dismissing the appeal:

If the AO does not assess the income in respect of which the s. 148 notice was issued, it means there was no ‘reason to believe’ that income had escaped assessment. If so, the AO has no jurisdiction to assess any other escaped income that comes to his notice during the reassessment proceedings. Though in Sun Engineering 198 ITR 297 (SC), it was held that the AO had jurisdiction to assess other income, it was not a case where the AO had not assessed the income in respect of which the s. 148 notice was issued. Explanation 3 to s. 147 also contemplates that the income in respect of which the s. 148 notice is issued is assessed (Jet Airways 331 ITR 236 (Bom) & Ranbaxy Lab 60 DTR 77 (Del) followed).

(26.5 KiB, 453 DLs)

S. 153A: Assessments pending in appeal do not abate

For AY 2002-03, an addition of Rs. 99 lakhs was made by the AO & confirmed by the CIT (A). During the pendency of the appeal before the Tribunal, a search under s. 132 was conducted and s. 153A proceedings were initiated. The Tribunal held that in view of the s. 153A notice, the assessments of the six preceding assessment years prior to the date of search abated and that assessments pending in appeal would stand merged in the fresh assessment to be made by the AO u/s 153A pursuant of the search. The AO was directed to reconsider the additions in the s. 153A assessment. On appeal by the department, HELD reversing the Tribunal:

The second proviso to s. 153A provides that “assessments relating to any assessment year falling within the period of six assessment years pending on the date of initiation of the search u/s 132 shall abate“. The words “pending on the date of initiation of search” has to be assigned simple and plain meaning. If the assessment is finalized, there are no “pending proceedings” to be abated. The pendency of an appeal does not mean that the assessment proceedings are pending. The word ‘abatement‘ refers to something, which is pending or alive and its suspension or termination. Proceedings which are complete are not liable for abatement (Circular No.7 of 2003 dated 5.9.2003 referred)

(188.1 KiB, 570 DLs)

S. 2(22)(e) does not apply to “non-gratuitous” advances to substantial shareholder

The assessee, a substantial shareholder in a closely held company, let out his flat to the company and also permitted it to place it on mortgage. In consideration, the company passed a resolution authorizing the assessee to obtain from the company an interest-free deposit up to Rs.50 lakhs. He also received an amount by way of “security deposit”. The AO assessed the said “advances/ deposits” as “deemed dividend” u/s 2(22)(e). The CIT (A) deleted the addition though the Tribunal upheld it. On appeal by the assessee, HELD reversing the Tribunal:

The phrase “by way of advance or loan” s. 2(22)(e) must be construed to mean those advances or loans which a shareholder enjoys simply on account of being a person who is the beneficial owner of shares. If such loan or advance is given to such share holder as a consequence of any further consideration received from the shareholder, then such advance or loan cannot be said to be “deemed dividend” u/s 2(22)(e). Thus, while gratuitous loan or advance given by a company to a substantial shareholder comes within the purview of s. 2(22)(e), a case where the loan or advance is given in return to an advantage conferred upon the company by the share holder does not. On facts, as the advance was in lieu of the company being permitted to mortgage the assessee’s falt, it was not “gratuitous” and so not assessable as “deemed dividend” (Creative Dyeing 318 ITR 476 (Del) & Nagindas Kapadia 177 ITR 393 (Bom) followed).

(206.3 KiB, 179 DLs)

RTI: Tribunal Member’s ACR Can Be Disclosed If In “Public Interest”

The Petitioner claimed that pursuant to complaints of corruption against Ms. Jyoti Balasundaram, Member, CESTAT, the President of the CESTAT had made adverse entries in the Annual Confidential Report (ACR) of Ms. Jyoti Balasundaram for the year 2000-01 and that the Ministry of Finance had opened a file for follow up action. However, as no proper action was not taken in the matter and the file was closed in favour of Ms. Jyoti Balasundaram, the Petitioner filed a RTI application seeking inspection and copies of the file. The application was rejected by the CPIO of CESTAT, the First Appellate Authority & the CIC on the ground that the ACR grades & file notings could not be disclosed to third parties. On a Writ Petition filed to challenge the non-disclosure, HELD:

The ACR & the Follow up file are an integral part of the ACR record of the officer. In Arvind Kejriwal vs. CPIO AIR 2010 Delhi 216 it was held that except in cases involving overriding public interest, the ACR record of an officer cannot be disclosed to any person other than the officer himself/herself. As the CIC has not examined whether larger public interest justifies the disclosure of the information sought by the Petitioner in this case, matter remanded with the direction the information should be disclosed if the CIC comes to a conclusion that larger public interest justifies the disclosure.