For Expl (baa) to s. 80HHC, netting of income from expenditure is allowed

The AO & CIT(A) computed s. 80HHC deduction by deducting 90% of the gross interest received from the profits of business. However, the Tribunal, relying on Lalsons Enterprises 89 ITD 25 (Del) (SB) & Shri Ram Honda Power Equip 289 ITR 475 (Del), held that only the net interest could be deducted (subject to nexus between the expenditure and income being proved). On appeal by the department, the High Court (CIT vs. Asian Star Co Ltd 326 ITR 56 (Bom)) reversed the Tribunal and held that the gross receipts had to be excluded. On appeal by the assessee, HELD reversing the High Court:

Under Clause (1) of Explanation (baa) to s. 80HHC, 90% of any receipts by way of brokerage, commission, etc “included in any such profits” have to be deducted from the profits & gains of business. The expression “included any such profits” means such receipts by way of brokerage, commission, etc included in the profits & gains. Therefore, if any quantum of receipts by way of brokerage, commission, etc is allowed as expenses u/s 30 to 44D and is not included in the profits of business, 90% of such quantum of receipts cannot be reduced under clause (1) of Explanation (baa) to s. 80HHC. In other words, only 90% of the net amount of any receipt of the nature mentioned in clause (1) which is actually included in the profits of the assessee is to be deducted from the profits of the assessee for determining “profits of the business”. The High Court wrongly relied on CIT vs. K. Ravindranathan Nair 295 ITR 228 (SC) & circular dated 19.12.1991 explaining the clauses of the Finance Bill, 1991 (Principle in Distributors (Baroda) 155 ITR 120 (SC) followed; Shri Ram Honda Power Equip 289 ITR 475 (Del) approved)

s. 80HHC/ 28(iiid): DEPB sale proceeds is not “profits”

The assessee sold the Duty Entitlement Pass Book (“DEPB”) which had accrued on export of its products. 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 revenue, the High Court (CIT vs. Kalpataru Colours and Chemicals 328 ITR 421 (Bom)) reversed the Tribunal and held that the sale proceeds could not be bifurcated into “profits” and “face value” and the entire sale proceeds was “profits” for s. 80HHC r.w.s. 28(iiid). On appeal by the assessee, HELD reversing the High Court:

DEPB is “cash assistance” receivable against exports under the scheme of the Government. While the face value of the DEPB falls under clause (iiib) of s. 28, the difference between the sale value and the face value of the DEPB (the “profit”) will fall under clause (iiid) of s. 28. The High Court was not right in taking the view that the entire sale proceeds of the DEPB realized on transfer of the DEPB and not just the difference between the sale value and the face value of the DEPB represent profit on transfer of the DEPB. DEPB represents part of the cost incurred by a person for manufacture of the export product and hence even where the DEPB is not utilized by the exporter but is transferred to another person, the DEPB continues to remain as a cost to the exporter. When DEPB is transferred, the entire sum received on such transfer does not become his profits. It is only the amount that he receives in excess of the DEPB which represents his profits on transfer of the DEPB.

For s. 115JA/JB s. 80HHC deduction to be computed as per P&L Profits & not normal provisions

In computing “book profits” u/s 155JA & 115JB, the assessee claimed that the deduction admissible thereunder u/s 80HHC had to be computed on the basis of the “book profits” and not on the basis of the income computed under the normal provisions of the Act. This claim was upheld by the Tribunal by relying on the judgement of the Special Bench in DCIT vs. Syncome Formulations 106 ITD 193. On appeal by the Revenue, the High Court (233 CTR 443 (Bom)) reversed the Tribunal. On appeal by the assessee, HELD reversing the High Court:

In view of this Court’s Order in the case of CIT vs. Bhari Information Technology Systems upholding the judgment of the Special Bench of Tribunal in DCIT vs. Syncome Formulations (I) Ltd 106 ITD 193, the impugned judgment of the High Court is set aside and the judgments of the ITAT in these cases stand affirmed.

Transfer of shares of foreign company by non-resident to non-resident does not attract Indian tax even if object is to acquire Indian assets held by the foreign company

A Cayman Island company called CGP Investments held 52% of the share capital of Hutchison Essar Ltd, an Indian company engaged in the mobile telecom business in India. The shares of CGP Investments were in turn held by another Cayman Island company called Hutchison Telecommunications. The assessee, a Dutch company, acquired from the second Cayman Islands company, the shares in CGP Investments for a total consideration of US $ 11.08 billion. The AO issued a show-cause notice u/s 201 in which he took the view that as the ultimate asset acquired by the assessee were shares in an Indian company, the assessee ought to have deducted tax at source u/s 195 while making payment to the vendor. This notice was challenged by a Writ Petition but was dismissed by the Bombay High Court. In appeal, the Supreme Court remanded the matter to the AO to first pass a preliminary order of jurisdiction which the AO did. This order was challenged by the assessee by a Writ Petition which was dismissed by the High Court (329 ITR 126 (Bom). On appeal by the assessee, HELD allowing the appeal:

(By the Court)

(i) The department’s argument that there is a conflict between Azadi Bachao Andolan 263 ITR 706 (SC) & McDowell 154 ITR 148 (SC) and that Azadi Bachao is not good law is not acceptable. While tax evasion through the use of colourable devices and by resorting to dubious methods and subterfuges is not permissible, it cannot be said that all tax planning is impermissible;

(ii) In the taxation of a Holding Structure the burden at the threshold is on the Revenue to establish abuse in the sense of tax avoidance in the creation and/or use of such structure(s). The Revenue may invoke the “substance over form” principle or “piercing the corporate veil” test only after it is able to establish that the transaction is a sham or tax avoidant (e.g. structures used for circular trading or round tripping or to pay bribes) or if the Holding Structure entity has no commercial or business substance and has been interposed only to avoid tax. A strategic foreign direct investment coming to India should be seen in a holistic manner and keeping in mind certain factors like the period of business operations in India etc. On facts, the Hutchison structure was in place since 1994 and could not be said to be created as a sham or tax avoidant. The holding companies were not a “fly by night” operator or short time investor;

(iii) The Revenue’s argument that u/s 9(1)(i) it can “look through” the transfer of shares of a foreign company holding shares in an Indian company and treat the transfer of shares of the foreign company as equivalent to the transfer of the shares of the Indian company on the premise that s. 9(1)(i) covers direct and indirect transfers of capital assets is not acceptable. S. 9(1)(i) (unlike the DTC Bill, 2010) does not use the word “indirect transfer”;

(iv) The argument that CGP, the intervened entity, had no business or commercial purpose and that its situs was not in the Cayman Islands but in India (where the assets were) is also not acceptable. The situs of the shares of a company is where the registered office is;

(v) The High Court’s finding that, applying the “nature and character of the transaction” test, the transfer of the CGP share was not adequate in itself to achieve the object of consummating the transaction between HTIL and VIH and that there was a transfer of other “rights and entitlements” which were “capital assets” is not correct because the transaction was one of “share sale” and not an “asset sale”. It had to be viewed from a commercial and realistic perspective. As it was not a case of sale of assets on itemized basis, the entire structure, as it existed, ought to have been looked at holistically. A transfer of shares lock, stock and barrel cannot be broken up into separate individual components, assets or rights such as right to vote, right to participate in company meetings, management rights, controlling rights, control premium, brand licences and so on as shares constitute a bundle of rights. The sum of US$ 11.08 bn was paid for the “entire package” and it was not permissible to split the payment and consider a part of it towards individual items (Mugneeram Bangur 57 ITR 299 (SC) followed);

Per Radhakrishnan, J (concurring):

(i) On the conflict between McDowell & Azadi, It is a cornerstone of law that a tax payer is enabled to arrange his affairs so as to reduce the liability of tax and the fact that the motive for a transaction is to avoid tax does not invalidate it unless a particular enactment so provides. However, for the arrangement to be effective, it is essential that the transaction has some economic or commercial substance;

(ii) On facts, CGP’s interposition in the corporate structure and its disposition, by way of transfer, for exit, was for a commercial or business purpose and not with the ulterior motive for evading tax. It cannot be considered to be an artificially interposed device and the principle of “fiscal nullity” will not apply. For the principle of “fiscal nullity” to apply, there should be a pre-ordained series of transactions and there should be steps inserted that have no commercial purpose. In that case, the inserted steps can be disregarded for fiscal purpose and one can look at the end result. However, the sale of the CGP shares was a genuine business transaction, not a fraudulent or dubious method to avoid capital gains tax. The situs of the shares was in the Cayman Islands;

(iii) The argument that s. 9(1) should be given a purposive interpretation so as to cover even indirect transfers is not acceptable. On the transfer of shares of a foreign company to a non-resident off-shore, there is no transfer of shares of the Indian company, though held by the foreign company and it cannot be contended that the transfer of shares of the foreign holding company, results in an extinguishment of the foreign company control of the Indian company and it also does not constitute an extinguishment and transfer of an asset situate in India. Transfer of the foreign holding company’s share off-shore, cannot result in an extinguishment of the holding company right of control of the Indian company nor can it be stated that the same constitutes extinguishment and transfer of an asset/ management and control of property situated in India;

(iv) S. 195 applies only if payments are made from a resident to another non-resident and not between two non-residents situated outside India. The transaction was between two non-resident entities through a contract executed outside India, consideration passed outside India and the transaction had no nexus with the underlying assets in India. In order to establish a nexus, the legal nature of the transaction has to be examined and not the indirect transfer of rights and entitlements in India.

In absence of “legal right” to bind principal, Dependent Agent is not “PE”

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, the Court of Appeal held that for Article 5(5) of the DTAA, the question whether the agent has the authority to conclude contracts on behalf of the enterprise had 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. On further appeal, HELD reversing the Court of Appeal:

Article 5(5) of the DTAA provides that “when a person, not an independent status to whom paragraph 6 applies, acting on behalf of an enterprise and has and habitually exercises in a Contracting State authority to conclude contracts on behalf of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State for any activities which that person undertakes for the enterprise.” There is no dispute that Dell AS is not an independent agent. The expressions “on behalf” and “have authority to conclude contracts on behalf of” in Article 5(5) mean that the contracts must be legally binding. These expressions must be given their normal meaning as per the Vienna Convention. This is also supported by the Commentary on the OECD Model Convention on which the DTAA is based. A similar view has been taken by the Conseil d’Etat of France in Zimmer (included with the Appeal Court’s order). As the language of the Article is clear, it is not possible to adopt the “functional approach” proposed by the Revenue. Consequently, Dell Products does not have permanent establishment in Norway.

High Court to decide whether sales-tax subsidy is a capital receipt

The assessee received sales-tax incentive for setting up a new industrial undertaking in Patalganga. The assessee claimed that the said subsidy was a capital receipt. The Special Bench (DCIT vs. Reliance Industries Ltd 88 ITD 273) upheld the assessee’s claim. On appeal by the department (for a subsequent year), the Bombay High Court held (order enclosed) that as a finding had been recorded by the Special Bench that the object of the subsidy was to encourage the setting up of industries in the backward area by generating employment therein, the subsidy was, applying the “purposive test” in Ponni Sugars and Chemicals Ltd 306 ITR 392 (SC), a capital receipt and held that a substantial question of law did not arise. The department filed an appeal to challenge the judgement of the High Court. HELD allowing the appeal:

Having heard learned counsel on both sides, we are of the view that the High Court ought not to have dismissed the appeals without considering the following questions, which, according to us, did arise for consideration. They are formulated as under … (C) Whether on the facts and circumstances of the case and in law the Hon’ble Tribunal was right in holding that sales tax incentive is a Capital Receipt?” Accordingly, the civil appeals are allowed, impugned orders are set aside and the cases are remitted to the High Court to decide the questions, formulated above, in accordance with law.”

Govt’s decision not to appoint ITAT Members till amendment providing for 2 years’ appointment upheld

Out of 23 vacancies in the post of Judicial Member (JM) & Accountant Member (AM), the Selection Board recommended 18 candidates in the main select list and 4 candidates in the wait list. Out of the 18 selected candidates, 2 were not cleared by Vigilance. On 26.04.2006, the 16 were approved by the Appointments Committee of the Union Cabinet for a period of 2 years. The Law Ministry was directed to first amend the ITAT (Recruitment and Conditions of Service) Rules, 1963, so as to provide for appointment of the members of the ITAT for a period of two years. As the selection list was not given effect to pending the amendment in the Rules, the Revenue Bar Association filed a Writ Petition in the Madras High Court for a mandamus to give effect to the selection list which was allowed. This was challenged by the UOI in the Supreme Court but the SLP was dismissed with the direction that all formalities to give effect to the Selection List should be completed. The Appointments Committee thereafter approved the names of all the 16 selected candidates and appointed them till the date of retirement on attaining the age of 62 years. On 31.08.2007, the Appointments Committee also decided that the appointment of members of the ITAT in future will be taken up only after the recruitment rules of ITAT are amended. In 2008, the candidates who were in the “wait list” filed applications in the Central Administrative Tribunal for directions for their appointment which was opposed by the UOI on the ground that the Appointments Committee had decided that no further appointment of members in the ITAT would be made until the ITAT Recruitment Rules were amended. The CAT allowed the applications and directed that the wait-listed candidates be considered for filling up the advertised vacancies existing in the posts of JM & AM. The UOI challenged the order of CAT in the Delhi High Court contending that the vacancies in the post of JM & AM can be filled up only after the recruitment rules were amended as decided by the Appointments Committee. The High Court dismissed the challenge on the ground that the recruitment rules had already been amended by insertion of Rule 4(a) and there was nothing in the amendment which disqualified the wait-listed candidates from being appointed as members of the ITAT. It was also held that the selection having been conducted by a high-power Selection Board presided over by a sitting Judge of the Supreme Court deserved to be given due weightage and consideration. It was also held that the only way of reducing the backlog was to fill up the vacancies at the earliest and by not doing so, the UOI was prolonging the agony of a large number of assesses apart from depriving itself of its legitimate dues which depends upon the verdict of the ITAT. On appeal by the UOI, HELD reversing the CAT & High Court:

Under Rule 4, a person on the select panel has no vested right to be appointed to the post for which he has been selected, but he has a right to be considered for appointment. The candidates in the wait-list, not having been approved by the Appointments Committee, were not persons selected for appointment pursuant to the decision that further appointments would be made only after the amendment of the Rules. As the Central Government is both the rule making authority as well as the appointing authority of any member of the ITAT, if it has taken a decision to undertake appointments in future after amendment of the rules, it is difficult for the Court to hold that the reason given by the Government for not making any further appointments because of the proposed amendments to the rules is not a justifiable or proper reason and that the decision of the Government in not approving the wait list of candidates recommended by the Selection Board is not proper. The High Court’s reliance of Rule 4(a) was wrong because this had been inserted on 26.04.2004 and was not in the mind of the Appointments Committee when it took the decision on 26.04.2006 and 31.08.2007 to make further appointments only after the Rules were amended. As the immediate need for filling up the vacancies has been met by the appointment of the 16 Members, the Court cannot compel the Government to make the appointments from the wait-listed candidates by a writ of mandamus.

For s. 115JA/JB s. 80HHC deduction to be computed as per P&L Profits & not normal provisions

The assessee had a loss as per the normal computation though it had a profit as per the P&L A/c. In computing the book profits u/s 115JA, the assessee claimed deduction u/s 80HHE. The AO rejected the claim on the basis that as the assessee had no income under the regular provisions of the Act, it was not eligible for s. 80HHE deduction in computing the s. 115JA book profits. This was upheld by the CIT (A) though the Tribunal gave relief by following the judgement of the Special Bench of the Tribunal in DCIT vs. Syncome Formulations 106 ITD 193. This was upheld by the High Court. On appeal by the department, HELD dismissing the appeal:

In DCIT vs. Syncome Formulations 106 ITD 193 the Special Bench held in the context of s. 80HHC that the deduction is to be worked out not on the basis of regular income tax profits but it has to be worked out on the basis of the adjusted book profits in a case where s. 115JA is applicable. In the said judgment, the dichotomy between regular income tax profits and adjusted book profits u/s 115JA was clearly brought out and it was rightly held that in s. 115JA relief has to be computed u/s 80HHC(3)/(3A). It was held that once the law itself declares that the adjusted book profit is amenable for further deductions on specified grounds, in a case where s. 80HHC (80HHE in the present case) is operational, it becomes clear that computation for the deduction under those sections needs to be worked out on the basis of the adjusted book profit. Accordingly, the deduction claimed by the assessee u/s 80HHC & 80HHE has to be worked out on the basis of adjusted book profit u/s 115JA and not on the basis of the profits computed under regular provisions of law applicable to computation of profits and gains of business. We agree with the view taken by the Special Bench of the Tribunal.

CBDT’s low tax effect circular not applicable to matters having “cascading effect”

The High Court, relying on CBDT’s Instruction No. 3/2011 dated 9-2-2011, dismissed the department’s appeal as not maintainable on the ground that the tax effect was less than Rs. 10 lakhs. The department filed a SLP in the Supreme Court. HELD allowing the Petition:

Liberty is given to the Department to move the High Court pointing out that the Circular dated 9th February, 2011, should not be applied ipso facto, particularly, when the matter has a cascading effect. There are cases under the Income – Tax Act, 1961, in which a common principle may be involved in subsequent group of matters or large number of matters. In our view, in such cases if attention of the High Court is drawn, the High Court will not apply the Circular ipso facto. For that purpose, liberty is granted to the Department to move the High Court in two weeks.

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”.