S. 14A: Onus is on AO to show expenditure is incurred to earn tax-free income

For AY 2006-07, the assessee earned dividend of Rs. 17 lakhs and LTCG of Rs. 12 crores. The assessee claimed that it had incurred no expense to earn the tax-free income and so no s. 14A disallowance was permissible. However, the AO disallowed Rs. 2 crores under Rule 8D towards interest and admin expenditure. The CIT (A) accepted that no interest was incurred and deleted that disallowance. He also reduced the admin expenditure disallowance. On appeal to the Tribunal, HELD:

(i) The contention of the Revenue that some expenditure, directly or indirectly, is always incurred for earning tax-free income cannot be accepted. The burden is on the AO to establish the nexus of the expenditure incurred with the earning of exempt income before making any disallowance u/s 14A (Hero Cycles 323 ITR 518 (P&H), Jindal Photo followed)

(ii) As regards interest, the AO has to show the nexus between the borrowed funds and the tax free investments. If that is not done, disallowance of interest is not permissible (K. Raheja Corporation (Bom) followed)

(iii) As regards admin expenses, s. 14A disallowance cannot be made on an ad-hoc basis. It is the department’s responsibility to bring material on record to show that expenditure was incurred for earning the exempt income. If this is not done, disallowance is not permissible (Wimco Seedlings followed)

Despite “Last Chance” appeal should be adjourned if there is sufficient cause

The department’s appeal was adjourned at the assessee’s request to 9.02.2010 and it was made clear that it would be the “last opportunity”. The assessee’s counsel filed an application for adjournment on 8.02.2010 on the ground that he was going to Mumbai for some urgent work. On 9.2.2010, no one appeared for the assessee and so the Tribunal rejected the adjournment application and allowed the department’s appeal. On appeal by the assessee to the High Court HELD:

Ordinarily, it is not incumbent on the Tribunal to adjourn the case when a last opportunity had already been granted to the assessee. However, there may be number of circumstances where adjournment becomes necessary in the interest of justice. If Counsel for assessee had to go for some urgent work to Mumbai and an application for adjournment was moved in advance, then in the interest of justice, a short adjournment should have been granted. If number of opportunities had already been afforded to the Counsel for assessee, then adjournment could have been granted, on payment of cost. The Tribunal has not assigned any reason as to whether reason mentioned in the application for adjournment, constituted sufficient cause for adjournment or not. Even if a last opportunity is granted and case is fixed for hearing and sufficient cause is shown on the date fixed for hearing, then the case can be adjourned and it should be adjourned, in the interest of justice. Accordingly, the Tribunal committed an illegality in rejecting the application for adjournment and in deciding the appeal exparte. Appeal remitted to the Tribunal for decision on merits on payment of costs of Rs.21,000 by the assessee.

Under Article 7 of the DTAA, foreign PE profits may be taxed in India

The assessee, an Indian PSU company, earned Rs. 10.68 crores from foreign projects in Oman etc. The assessee claimed that it had a “permanent establishment” (PE) in those countries and that in accordance with the DTAA, only the source country was entitled to tax the profits and India was not authorized to tax the foreign PE profits. HELD by the Tribunal rejecting the plea:

Article 7 of the DTAA provides that the profits of an enterprise of a Contracting State shall be taxable only in that state of residence unless the enterprise carries on business in other contracting state through a PE situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise “may be taxed” in the other Contracting State but only so much of them as is attributable directly or indirectly to the PE. While the first part gives exclusive taxation right to the State of residency, the second part gives taxation right to the state of residency as well as to the State where the PE is situated. The phrase “may be taxed” shows that the State of source has the non-exclusive right to tax while the State of residence continues to have the inherent right to tax. This interpretation is supported by the OECD Commentary on the Model Convention. P.V.A.L. Kulandagan Chettiar 267 ITR 654 (SC) turned on different facts and does not lay down the proposition that the profits of a foreign PE cannot be taxed in the State of residence of the assessee.

Foreign income-tax is deductible u/s 37(1). Bar in s. 40(a)(ii) does not apply to foreign taxes

The assessee paid Rs.42.57 lakhs in Belgium as income-tax and claimed that as deduction u/s 37(1). The AO rejected the claim by relying on s, 40(a)(ii) which provides that any sum paid on account of tax levied on profits or gains of business shall not be allowable as a deduction, though the CIT (A) allowed the claim on the ground that the bar in s. 40(a)(ii) did not apply to foreign taxes. On appeal by the department, HELD dismissing the appeal:

The term “tax” is defined in s. 2(43) to mean income-tax chargeable under the provisions of this Act. S. 37(1) allows a deduction of all taxes and rates. Taxes levied in foreign countries whether on profits or gains or otherwise are deductible u/s 37(1) not hit by s. 40(a)(ii). It is also not application of income. The same view has been taken by ITAT Mumbai in South East Asia Shipping Co & Tata Sons Ltd and the department’s Reference Applications u/s 256(1) & 256(2) were rejected and the issue has reached finality.

S. 54EC: If investment within 6 months of transfer is impossible, then relief available if investment made within 6 months of receipt of consideration

The assessee entered into a development agreement on 12.7.2005 in which the consideration was fixed at Rs 2.50 crores. A correction deed was entered into on 2.7.2007 in which the sale consideration was increased to Rs. 4.90 crores. The assessee invested Rs. 50 lakhs in s. 54EC bonds on 3.8.2007 and 27.10.2007. The AO held that the date of transfer was 12.7.2005 and as the s. 54EC investments had been made beyond a period of 6 months from the date of transfer, the exemption was not available. The assessee claimed that as it was impossible for him to invest within 6 months from the date of transfer, the period of 6 months had to be reckoned from the date of receipt of consideration. HELD by the Tribunal:

Though s. 54EC requires the investment to be made within 6 months of the date of transfer, a technical interpretation cannot be adopted but it has to be interpreted having regard to the purpose and spirit of the section. In Circular No 791 dated 2.6.2000 the CBDT held in the context of capital gains arising u/s 45(2), that though the transfer arises in the year of conversion of a capital asset into stock-in-trade, the period of 6 months for investment u/s 54E has to be reckoned from the date of sale of the stock-in-trade. The CBDT appreciated the impossibility of the assessee being able to invest the amount in specified assets within six months from the date of transfer. This interpretation of the CBDT supports the assessee’s claim that where the consideration is received much after the date of transfer and it is not possible to invest the same within 6 months of the date of transfer, the period of 6 months must be reckoned from the date of receipt of consideration.

TPO has no power to question business purpose of transaction

The assessee made payment of Rs. 31.34 crores to its associated enterprise for “Second Line Support” services. The TPO & DRP held that the assessee had not benefited from the expenditure and that it was not “necessary to be incurred” and that its ALP was Nil. On appeal by the assessee HELD:

There is no force in the Revenue’s claim that the assessee was not required to make any payment to its AE for resolving warranty claims. The assessee has the right to enter into an arrangement according to which its business interests are protected. It is the prerogative of the assessee to decide the business expediency. Rule 10B(1)(a) does not authorize disallowance of any expendtture on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in view of the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. However, the reasonableness of an expenditure has not been excluded from determination and the TPO has to determine the ALP of the transaction (CIT vs. EKL Appliances Ltd & Dresser Rand followed).

Objective tests to classify shares gains as STCG vs. biz profits laid down

The assessee offered gains from sale and purchase of securities as “capital gains”. The AO assessed it as business profits on the ground that in the earlier years, it was offered as such. The CIT (A) & Tribunal accepted the assessee’s plea on the ground that the securities were shown as “investments” in the accounts and in the earlier years, the STCG was offered as business profits as there was no difference in the tax rate. On appeal by the department, HELD reversing the Tribunal:

There was a dispute whether in the earlier years, the gains were offered as business profits or as capital gains and the Tribunal had not given a clear finding. The Tribunal ought to examine the issue holistically keeping in mind the parameters/tests laid down in CIT vs. Rewashanker A. Kothari 283 ITR 338 (Guj) and CBDT’s Circular No.4/2007 dated 15th June 2007 on when income from transactions in securities should be treated as “business profits” and when as “capital gains”:

 

(a) Whether the initial acquisition of the subject-matter of transaction was with the intention of dealing in the item or with a view to finding an investment?;

 

(b) Why and how and for what purpose the sale was effected subsequently?;

 

(c) How the assessee dealt with the subject-matter of transaction during the time the asset was with the assessee. Has it been treated as stock-in-trade or as an investment in the balance sheet?

 

(d) How the assessee returned the income from such activities and how the department dealt with the same in the preceding and succeeding assessments?;

 

(e) Whether the deed of partnership or memorandum of association, if the assessee is a firm or a company, authorises such an activity?

 

(f) Most importantly, what is the volume, frequency, continuity and regularity of transactions of purchase and sale of the goods concerned?

To “make available” technical knowledge, mere provision of service is not enough; the payer must be enabled to perform the service himself

The assessee, engaged in prospecting and mining for diamonds entered into an agreement with a Netherlands company for conducting air borne survey and providing high resolution geophysical data. The AO held that the consideration was chargeable to tax as “fees for technical services” under Article 12 of the India-Netherlands DTAA and held the assessee liable u/s 195 & 201 for failure to deduct TDS. This was reversed by the CIT (A) & Tribunal on the ground that though the Dutch company had performed services using technical knowledge and expertise, such technical experience etc had not been “made available” to the assessee. On appeal by the department to the High Court, HELD dismissing the appeal:

Article 12(5) of the DTAA defines “fees for technical services” to mean payments in consideration for the rendering of any technical or consultancy services “which make available technical knowledge, experience, etc or consist of the development and transfer of a technical pIan or technical design. To be said to “make available”, the service should be aimed at and result in transmitting technical knowledge etc so that the payer of the service could derive an enduring benefit and utilize the knowledge or know-how on his own in future without the aid of the service provider. In other words, to fit into terminology “making available”, the technical knowledge, skills” etc must remain with the person receiving the service even after the particular contract comes to an end. It is not enough that the services offered are the product of intense technological effort and a lot of technical knowledge and experience of the service provider has gone into it. The technical knowledge or skills of the provider should be imparted to and absorbed by the receiver so that the receiver can deploy similar technology or techniques in the future without depending upon the provider. On facts, while the Dutch company performed the surveys using substantial technical skills, it has not made available the technical expertise in respect of such collection or processing of data to the assessees, which the assessee can apply independently and without assistance and undertake such survey independently. Consequently, the consideration is not assessable as “fees for technical services” (AAR Rulings in Perfetti Van Melle Holding, Shell India & Areva T&D distinguished)

Despite concealment, no s. 271(1)(c) penalty if s. 115JB book profits assessed

For AY 2001-02, the assessee filed a ROI declaring loss of Rs.43.47 crores under the normal provisions of the Act and book profits of Rs.3.86 crores u/s 115JB. The AO assessed a loss at Rs.36.95 crores as per normal provisions and book profits at Rs.4.01 crores. As there was a reduction in the loss under the normal provisions owing to various additions and disallownaces, the AO levied penalty u/s 271(1)(c) in accordance with with Explanation 4 & Gold Coin 304 ITR 308 (SC). Before the High Court, the assessee argued that even if there was a concealment u/s 271(1)(c) with respect to the normal assessment, the same was not relevant because the assessee’s income was assessed u/s 115JB. The High Court accepted the plea and held that as the s. 115JB “book profits” were by a legal fiction deemed to be the “total income”, the furnishing of wrong particulars had no effect on “the amount of tax sought to be evaded” as defined in Explanation 4 to s. 271(1)(c). On appeal by the department to the Supreme Court, HELD:

Delay condoned. The special leave petition is dismissed.

S. 194C default does not result in s. 40(a)(ia) disallowance if TDS paid before ROI due date

For AY 2008-09, the assessee made payments to contractors from April 2007 to February 2008. However, the TDS thereon was deducted (belated) in March 2008 and paid before the due date for filing the ROI. The AO disallowed the payments u/s 40(a)(ia) though the CIT (A), relying on Bapusaheb Nanasaheb Dhumal, allowed the claim on the ground that as the TDS was (belatedly) deducted in March 2008, it could be paid before the due date for filing the ROI. On appeal by the department, HELD dismissing the appeal:

(i) Though u/s 194C, tax had to be deducted at the time of payment or credit, the assessee deducted TDS only in March. While the assessee has to face consequences for its failure to deduct TDS in time, no disallowance u/s 40(a)(ia) can be made because clause (A) of the proviso to s. 40(a)(ia) provides that if the tax is deducted during the last month of previous year and paid on or before the due date of filing the ROI, no disallowance shall be made (Bapusaheb Nanasaheb Dhumal 40 SOT 361 (Mum) followed);

(ii) S. 40(a)(ia) was amended by the FA 2010 w.e.f. 1.4.2010 to provide that no disallowance shall be made if the TDS (for whichever month) is paid before the due date of filing the ROI. While in Bharti Shipyard Ltd 132 ITD 53 (Mum) (SB), it was held that the amendment is not retrospective, a contrary view has been taken by the Calcutta High Court in CIT v. Virgin Creations. Considering the precedent in the judicial hierarchy, the judgement of the non-jurisdictional High Court prevails over a judgement of the Special Bench (Kanel Oil & Export 121 ITD 596 (Ahd) (TM) followed)