(120.6 KiB, 637 DLs)

S. 72: Gains arising from “business assets” not eligible for set-off against B/fd business loss

The assessee sold land & building used for business purposes. Though the gain was offered as capital gains, the assessee claimed, relying on Cocanada Radhaswami Bank Ltd 57 ITR 306 (SC) and other judgements, that as the assets were “business assets”, the gains there from were eligible for set-off against the brought forward business loss u/s 72. The issue was referred to a Special Bench. HELD by the Special Bench against the assessee:

S. 72 (1) allows brought forward business loss to be set-off against the “profits & gains of any business or profession” of the subsequent year. The expression “profits & gains of business” means income earned out of business carried on by the assessee and not just income connected in some way to the business or profession carried on by the assessee. The land & building were fixed & capital assets used by the assessee for its business purposes. The gains arising there from were assessable as capital gains and were not eligible for set-off against the brought forward business loss u/s 72 (Express Newspapers 53 ITR 250 (SC) followed; Cocanada Radhaswami Bank 55 ITR 17(SC) distinguished; Steelcon Industries reversed)

(148.3 KiB, 457 DLs)

Onus on AO to show foreign co has a PE in India. Under India-France DTAA, even dependent agent is not PE in absence of finding that transactions are not at ALP

The assessee, a French company, engaged in the operation of ships in international traffic, claimed that it did not have a PE in India and that no part of its income was chargeable to tax in India. The AO & DRP held that as the assessee had an agent in India which concluded contracts, obtained clearances and did the other work, there was a PE in India under Articles 5(5) & 5(6) of the DTAA. On appeal by the assessee, HELD allowing the appeal:

(i) In order to constitute a PE under Article 5(1) & 5(2), three criteria are required to be satisfied viz; physical criterion (existence), functionality criterion (carrying out of business through that place of physical location) & subjective criterion (right to use that place). There must exist a physical “location”, the enterprise must have the “right” to use that place and the enterprise must “carry on” business through that place. An “agency” PE will not satisfy this condition because the enterprise will not have the “right” to use the place of the agent. Under Article 5(6) of the India-French DTAA (which is at variance with the UN & OECD Model Conventions), even a wholly dependent agent is to be treated as an independent agent unless if it is shown that the transactions between him and the enterprise are not at arms’ length. The Department’s argument that as the AO had not examined whether the transactions were done in arm’s length conditions, the matter should be restored to him is not acceptable because the onus was on the Revenue to demonstrate that the assessee had a PE. The onus is greater where the very foundation of DAPE rested on the negative finding that the transactions between the agent and the enterprise were not made under at arms length conditions. A negative finding about transactions with the dependent agent not being at ALP is sine qua non for existence of a DAPE under the India-France DTAA. The AO could not be granted a fresh inning for making roving and fishing enquiries whether the transactions were at arm’s length conditions or not (Airlines Rotables 44 SOT 368 followed);

(ii) (Observed, on a conceptual note, taking note of revenue’s plea but without deciding) If as a result of a DAPE, no additional profits, other than the agent’s remuneration in the source country – which is taxable in the source state anyway de hors the existence of PE, become taxable in the source state, the very approach to the DAPE profit attribution seems incongruous. Further, before accepting the DAPE profit neutrality theory, as per Morgan Stanley 292 ITR 416 (SC), the arm’s length remuneration paid to the PE must take into account ‘all the risks of the foreign enterprise as assumed by the PE’. In an agency PE situation, a DAPE assumes the entrepreneurship risk in respect of which the agent can never be compensated because even as DAPE inherently assumes the entrepreneurship risk, an agent cannot assume that entrepreneurship risk. To this extent, there may be a subtle line of demarcation between a dependent agent and a dependent agency PE. The tax neutrality theory, on account of existence of DAPE, may not be wholly unqualified at least on a conceptual note.

(81.3 KiB, 665 DLs)

Long-term & short-term gains from PMS transactions taxable as business profits

The assessee offered LTCG & STCG on sale of shares which had arisen through a Portfolio Management Scheme of Kotak and Reliance. The investments were shown under the head “investments” in the accounts and were made out of surplus funds. Delivery of the shares was taken. The AO & CIT (A) held that as the transactions by the PMS manager were frequent and the holding period was short, the LTCG & STCG were assessable as business profits. On appeal by the assessee, HELD dismissing the appeal:

In a Portfolio Management Scheme, the choice of securities and its period of holding is left to the portfolio manager and the assessee has no control. Only the portfolio manager can deal with the Demat account of the assessee. While, at the time of depositing the amount, the assessee will make entry in his books of account as investment in PMS, he is not aware of the transactions in the shares being entered into by the portfolio manager on his behalf as his agent. Since the assessee comes to know about the purchase and sale of shares under PMS after the expiry of the quarter, the accounting treatment in the books of the assessee in respect of shares purchased/sold by the portfolio manager under PMS cannot be entered in the books of the assessee. It is at the end of the year the shares available in the DEMAT account can be entered. Therefore, at the time of deposit of amount, the intention of the assessee was to maximize the profit. As the purchase and sale of shares under PMS is not in the control of the assessee at all, it cannot be said that the assessee had invested money under PMS with intention to hold shares as investment. The portfolio manager carried out trading in shares on behalf of his clients to maximize the profits. Therefore, it cannot be said that shares were held by the assessee as investment. The fact that the transactions were frequent and its volume was high indicated that the portfolio manager had done trading on behalf of the assessee. The fact that the shares remaining at the end of the year were shown under the head ‘investment’ makes no difference. Even the LTCG is assessable as business profits and s. 10(38) exemption is not available. The fact that the AO took a contrary view in the preceding year is irrelevant. There is no difference between similar transactions carried out by an individual in shares and the transactions carried out by portfolio manager. There is, however, a difference between investment in a mutual fund and PMS.

(265.5 KiB, 671 DLs)

Transfer Pricing: Important Principles on scope, data & comparability set out

In a transfer pricing matter, the Tribunal had to consider the following issues (i) whether transfer pricing adjustments have to be restricted to AE transactions only, (ii) whether a turnover filter can be applied and only companies with turnover within the range can be considered for comparison; (iii) whether the TPO is entitled to collect information u/s 133(6) for determining the ALP or he is confined to data available in public domain on the specified date, (iv) Whether the +/-5% adjustment is a “standard deduction”, (v) whether an adjustment to the ALP can be made for “low capacity utilization”? HELD by the Tribunal:

(i) Under Chapter X, only international transactions between AEs are required to be computed having regard to the ALP. Accordingly, the transfer pricing adjustments have to be restricted to the AE transactions by adopting the operating revenue and operating costs of only those transactions (Starlite 133 TTJ 425 (Mum) followed);

(ii) Though the Act & Rules does not provide for a turnover filter, there has to be an upper and lower limit because size does matter in business. A big company is in a position to bargain the price and attract more customers. It also has a broad base of skilled employees who are able to give better output. A small company may not have these benefits and the turnover would come down reducing profit margin. When are loss making companies are excluded from comparables, super-profit making companies should also be excluded. A reasonable classification of companies on the basis of net sales or turnover has to be made (Sony India 114 ITD 448 (Del), Indo American Jewellery 41 SOT 1 (Mum) & Philips Software 26 SOT 226 followed);

(iii) While Rule 10D(4) requires that the information should be “contemporaneous” and exist latest by the “specified date”, there is no “cut-off date” upto which only the information available in public domain can be considered by the TPO. Even data that becomes available in the public domain after the specified date can be considered. If the TPO collects information u/s 133(6), he is not required to inform the assessee about the process used by him nor is he required to furnish the entire information to the assessee. However, the assessee must be given proper hearing if any information is proposed to be used against it;

(iv) The +/-5% adjustment is a “standard deduction” and not merely the range within which if the ALP falls that the ALP of the assessee is required to be accepted (Philips Software 26 SOT 226, Development Consultants 23 SOT 455 followed)

(v) All comparables have to be compared on similar standards and the assessee cannot be put in a disadvantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure.

(134.5 KiB, 755 DLs)

S. 194H TDS: Tests to determine “Principal-Agent” Relationship Explained

The assessee entered into agreements with hospitals etc (“collection centres“) in accordance with which the centres collected samples from patients seeking laboratory tests and forwarded it to the assessee. The centres raised a bill on the patient, retained their “discount” and paid the balance to the assessee. The assessee claimed that it had rendered “professional services” & that the centres had rightly deducted TDS u/s 194J. The AO held that in collecting the sample and forwarding it to the assessee, the centres acted as an “agent” of the assessee and that the “discount” retained by it was “commission” and that the assessee ought to have deducted TDS u/s 194H. He consequently disallowed the “discount” u/s 40(a)(i) in the hands of the assessee. This was upheld by the CIT (A). On appeal by the assessee, HELD reversing the AO & CIT(A):

(i) To fall within s. 194-H, the payment must be by a “person acting on behalf of another person“. The element of “agency” has necessarily to be there. If the dealings between the parties is not on a “principal to agent” basis, s. 194-H does not get attracted;

(ii) On facts, the relationship between the assessee and the Centres was not on a “principal & agent” basis because (a) under the agreement, the Centres availed the professional services of the assessee to test the samples and were under no obligation to always forward these samples to the assessee; (b) The Centres issued its own bill to the patient, collected the fees and issued the receipt, (c) the assessee raised its invoice on the Centres after giving a “discount” over the standard price list; (d) the rates charged by the Centres from its customers were not decided by the assessee, (e) there was no privity of contract between the assessee & the patient, (f) the amounts collected by the Centres was not on behalf of the assessee. Consequently, the relationship between the assessee and the Centres was on principal to principal basis and s. 194H did not apply (Ahmedabad Stamp Vendor Association 257 ITR 202 (Guj), Bhopal Sugar Industries AIR 1977 (SC) 1275, Singapore Airlines 319 ITR 29 (Del), Qantas Airways 332 ITR 25 (Bom) considered);

(iii) Further, the obligation of TDS u/s 194 H arises only at the time of “payment” or “credit”. As the assessee had not paid or credited any amount to the account of the Centres, s. 194H had no application. The assessee had only credited the net amount received from the Centres as its income.

(133.9 KiB, 466 DLs)

Transfer Pricing: CUP method will determine ALP of interest-free loan

The assessee advanced Rs. 7.39 crores to its AE on interest-free terms. For transfer pricing purposes, It claimed that no external comparable uncontrolled price was available for benchmarking the transaction and so the Transactional Net Margin Method (TNMM) was applicable to determine the arm’s length basis of the loan. Applying TNMM, the assessee claimed that the notional interest was factored in the software development income and no separate addition could be made. This was rejected by the TPO & CIT (A) on the ground that the giving of interest-free loans to the AE was an entirely separate transaction not in conjunction with the activity of software development and hence merited a separate analysis. On appeal by the assessee, HELD by the Tribunal:

The assessee was required to comply with the transfer pricing provisions of s. 92 to 92F with respect to the transaction of interest-free loan to its subsidiary. The CUP method is the most appropriate method in order to ascertain the ALP of such international transaction by taking into account prices at which similar transactions with other unrelated parties have been entered into. For that purpose, an assessment of the credit quality of the borrower and estimation of a credit rating, evaluation of the terms of the loan e.g period of loan, amount, currency, interest rate basis, and additional inputs such as convertibility and finally estimation of arm’s length terms for the loan based upon the key comparability factors and internal and/or external comparable transactions are relevant. None of these inputs have anything to do with the costs; they only refer to prevailing prices in similar unrelated transactions instead of adopting the prices at which the transactions have been actually entered in such cases, the hypothetical arms length prices, at which these associated enterprises, but for their relationship, would have entered into the same transaction, are taken into account. Whether the funds are advanced out of interest bearing funds or interest free advances or are commercially expedient for the assessee or not, is wholly irrelevant in this context. As the transaction is of lending money, in foreign currency, to its foreign subsidiary, the comparable transaction should also be of foreign currency lending by unrelated parties (Perot Systems 130 TTJ 685 (Del) followed).

(1.6 MiB, 518 DLs)

S. 132: Cash seized in search has to be adjusted against “Advance Tax”

Pursuant to a search u/s 132, cash was seized from the assessee and third parties and assessed as the assessee’s income. Though the assessee requested that the said seized cash be treated as payment of “advance tax”, the AO ignored the same and levied interest u/s 234A, 234B & 234C on the basis that advance tax had not been paid. On appeal, the CIT (A) relied on Central Provinces Manganese 160 ITR 961 (SC) and held that the ground was not maintainable. It was also held that cash seized from third parties could not be treated as the assessee’s payment of advance tax. On appeal by the assessee, HELD allowing the appeal:

(i) S. 246 permits an appeal to be filed when the assessee “denies his liability to be assessed”. The levy of interest u/s 234A to 234C is a part of the process of assessment. The expression “denies his liability to be assessed” does not mean a total denial of liability. Even a partial denial of the assessment i.e. of the liability to pay interest is covered and the appeal is maintainable (C. P Manganese 160 ITR 961 (SC) explained, Kanpur Coal Syndicate 53 ITR 225 (SC) & JK Synthetics 119 CTR 222 (SC) followed);

(ii) On merits, s. 132B (1) provides that the assets seized u/s 132 may be adjusted against the amount of any “existing liability” and the liability determined on completion of the assessment. The expression “existing liability” cannot be ascribed a restricted meaning. The liability to pay advance tax is an “existing liability” and so the cash seized ought to have been adjusted against that liability. The cash seized from third parties, having been assessed in the assessee’s hands, retains the same character as cash seized from the assessee (Sudhakar Shetty 10 DTR (Mum) 173 followed).

(542.7 KiB, 728 DLs)

S. 194-I TDS: To be “Rent”, payee must have “control” over asset

The assessee, a SEB, entered into an agreement with NTPC for purchase of power and another with Power Grid Corporation for transmission of the power from NTPC’s ‘bus bars’ to the delivery point. The AO & CIT (A) took the view that the transmission charges paid by the assessee to Power Grid was “rent for use of plant” and tax ought to have been deducted u/s 194-I. The argument that as the payee had been assessed, no recovery could be made from the payer was also rejected. The assessee was held liable for failure to deduct TDS. On appeal by the assessee, HELD allowing the appeal:

(i) S. 194-I defines “rent” to include any payment, by whatever name called, under any lease, agreement or arrangement “for the use of” any machinery or plant. For a payment to be construed as “rent”, it is a condition precedent that the payer should have some control over the asset. There is a distinction between ‘the use of an asset’ and the ‘benefit derived from an asset’. In a transaction of hire/ leasing, the possession of the goods and its effective control is given to the customer and the customer has the freedom and choice of how to use the asset. On the other hand, if the customer entrusts to the assessee the work of achieving a certain desired result and that involves the use of goods belonging to the owner, the control of the asset remains with the owner and there is no “use” by the customer (Asia Satellite 332 ITR 340 (Del) followed, Japan Airlines 325 ITR 298 (Del) & Krishna Oberoi 257 ITR 105 (AP) distinguished;

(ii) On facts, the transmission lines were under the possession & control of Power Grid. The assessee was merely enabled to use the services of transmission of electricity and not the use of transmission wires per se. The assessee was not involved in the in the actual operations of the transmission lines. The transmission wires were also used by other customers of Power Grid. Consequently, the payments were not “rent” u/s 194-I;

(iii) Under the Explanation to s. 191, a person can be treated as an assessee in default u/s 201(1) only when, apart from the lapse in deduction of tax at source, the recipient of income has failed to pay such tax directly. S. 201(1) imposes vicarious (and not penal) liability on the payer to make good the shortfall in tax collection. If the tax liability is discharged by the recipient of income, the vicarious liability cannot be invoked.

(208.4 KiB, 738 DLs)

S. 194-I: Distinction between “hire of vehicles” & “transportation contract”

The assessee paid “hire charges” for hiring helicopter & aircraft services and deducted TDS at 2% u/s 194C. The AO & CIT (A) held that the assessee ought to have deducted TDS at 22.44% u/s 194-I on the ground that “vehicles” were “plant and machinery” and the assessee had “hired” the vehicles and not merely taken services for carrying passengers or goods. The assessee was held liable to pay the deficit u/s 201. On appeal by the assessee, HELD allowing the appeal:

The department’s argument that the assessee has hired helicopter/air craft/vehicle is not correct because these were not hired on a periodic basis or on day-to-day basis. Instead, the transport services provided by the transporters were availed of. The assessee paid charges on the basis of flying hours, cost of landing charges and refuelling charges, etc. The crew, fuel, maintenance operation licences, etc. were all under the control of the service providers and not under the control of the assessee. If the assessee does not enjoy control over the vehicles and if the running and maintenance expenditure is borne by the transport service providers, the contract is not one for the “hiring” but is merely for availing transportation services. Payment for transportation services is not covered by s. 194-I (Accenture Services 44 SOT 290 (Mum), Tata AIG 43 SOT 215 (Mum) and Ahmedabad Urban Development Authority followed).

(167.7 KiB, 482 DLs)

S. 263: AO’s acceptance of Jurisdictional High Court view may be “erroneous & prejudicial” to interests of Revenue

The AO passed an assessment order on 24.3.2006 in which he allowed deduction u/s 80HHF without setting off the brought forward losses. The CIT passed a revision order u/s 263 on 19.10.2007 in which he claimed that the loss had to be set-off in terms of the judgement dated 11.3.2004 of the Supreme Court in IPCA Laboratories 266 ITR 521. The assessee claimed that the action of the AO was in line with the judgement dated 24.7.2000 of the Bombay High Court in Shirke Construction 246 ITR 429 which held the field till it was overruled on 17.5.2007 (291 ITR 380 (SC)). It was pointed out that even after the SC ruling in IPCA, there were Tribunal judgements (Infocon International 2 SOT 444) which had followed Shirke Construction and held that s. 80HHF deduction was available without set-off of the losses. It was argued that (i) the law prevailing on the date of the assessment order had to be seen as per G. M. Stainless Steel 263 ITR 255 (SC) and in any event (ii) there were two views possible and the AO’s view could not be termed erroneous as per Malabar Industrial 243 ITR 83 (SC). HELD by the Tribunal upholding the revision:

(i) For the purpose of examining validity of revision proceedings, the legal position prevailing at the time the revision powers are exercised by the CIT has to be seen and not the position prevailing at the time the assessment order was passed. In G.M. Stainless Steel 263 ITR 255 (SC) the law at the date of assessment and the date of revision was the same though it was made clear that the law at the date of revision had to be seen (Max India Ltd 295 ITR 282 (SC) followed);

(ii) The argument that the AO’s view was a “possible view” and therefore revision is not permissible as per Malabar Industrial Co is not acceptable because the AO’s view should not only be “possible view” but also a view which is not “unsustainable in law”. A view contrary to the law laid down by the Supreme Court is unsustainable in law even though it may have been a “possible view” at the stage of passing the assessment order;

(iii) The argument that the AO was bound to follow the jurisdictional High Court’s order in Shirke Construction 246 ITR 429 till it was overruled is not acceptable because the AO, being part of the revenue machinery, should follow judicial decisions as long as he can do so without sacrificing the legitimate interests of the revenue. If the AO does not raise demands on issues which have been decided in favour of the assessee by the jurisdictional High Court, even though the department is in appeal against the same, the interests of the revenue will be prejudiced and remain unprotected. While the AO is bound by the higher judicial authorities and has to loyally execute the directions contained in those orders, he is not prevented from taking the same stand, as he took in those assessments though he cannot collect the demand.