Analysis of four important judgements (April to June’10)

The fortunes of tax litigations can be akin to the outcomes of a war. Though elements of luck cannot be totally ruled out, the role of stratagems in shaping its outcomes can never be undermined. If a case is well pleaded or the law is ‘finely’ applied by the court – even an elephant can pass through the eye of a needle and whereas if it is not, even an ant may not so pass. An analysis of decisions can provide us valuable insights and critical inputs about the role stratagems have played in leading tax disputes to its logical ends.

In selection of important decisions for this article by the author, the criteria of ‘importance’ are the decisions in which law has been ‘finely’ applied. Further, discussion of recent important decisions on dividend stripping, 80-HHC issues, MAT etc., though widely affecting, have been avoided in this article as the same are, by now, easily accessible in popular tax journals and websites and any further discussions here would be wasteful duplication.

A decision may not be of the Supreme Court or of the High Court, but that of the Tribunal. But, if the decision is exemplary in its approach to the law or demonstrates an innovative application of the law, the same has been chosen to be analyzed in this article.

1. Re-assessment:- Objection to jurisdiction taken for the first time in second round of litigation – Permissible.

The first decision, I would like to take up for discussion with the readers, is that of the Ahmedabad Tribunal in the case of Shrimant F. P. Gaekwad {Decd}vs. Asst. CWT as reported in [2010] 3 ITR {Trib} 476 {Ahd}.

The facts of the case are that in the course of appeals against the original re-assessment proceedings u\s 17[1] of the Wealth Tax Act, 1957 for Assessment Years 1972-73 to 1979-80, the assessee had not assailed the re-assessments on the ground that the same lacked jurisdiction. The Tribunal had set aside the re-assessments and remitted the matters back to the file of the Assessing Officer with some direction for their consideration on merits.

The fresh re-assessment orders made by the Assessing Officer went in to a second round of litigation before the Tribunal. Here, the assessee challenged for the first time the re-assessments on the ground that the same lacked jurisdiction. The assessee alleged that the re-assessment notices could be issued only if there was a failure on his part to disclose fully and truly material facts necessary for his assessments, which condition is sine quo non for the Assessing Officer to assume jurisdiction to make a re-assessment u\s 17 [1] and that in his case, there was no such failure. The re-assessment notices had been thus issued without assuming such jurisdiction and this is being so, the re-assessments were null and void in law.

The Department’s Representative argued that that the assessee had never raised this issue of jurisdiction before the lower authorities or before the Tribunal in the first stage. He contended that the assessee had given up the contention regarding the validity of the re-assessment notices in the original proceedings and the matter had become final when the Tribunal had passed its order. In these circumstances, he urged that, such a plea cannot be taken for the first time now in the second round of litigation. In short, as per the Department’s Representative, what remained to be now considered by the Tribunal were only the re-assessments on its merits.

The Tribunal held that the assessee is entitled to raise the question of validity of the re-assessment notices for the first time even in the second round of litigation. In coming to this conclusion, the Tribunal has followed the decision of its jurisdiction High Court in the case of P.V. Doshi vs. CIT [1978] 113 ITR 22 {Guj}.

The decision of the Gujarat High court in P.V. Doshi’s case provides interesting aspects of law. In this case too, the validity of the proceedings initiated u\s 147 of the Income Tax Act was challenged for the first time in the second round of litigations.

The Gujarat High Court here noted that the conditions precedent for initiating reassessment proceedings had been introduced by the Legislature by way of safeguards in public interest so that the finally concluded proceedings should not be lightly re-opened with consequent hardship to the assessee and also necessary waste of public time and money in such proceedings. These conditions have therefore be treated as being mandatory. There can never be a waiver of a mandatory provision for the simple reason that in such cases jurisdiction could not be conferred on the authority by mere consent, but on the conditions precedent for exercise of jurisdiction being fulfilled. If jurisdiction cannot be conferred by consent, there would be no question of waiver, acquiescence or estoppels or the bar of res judicata being attracted because the order in such case would lack inherent jurisdiction and would be a void order or a nullity. If an original order is without jurisdiction, it would be a nullity confirmed in further appeal. The appellate order of the Tribunal thereon would also be a nullity and the Tribunal cannot confer any jurisdiction on the Income Tax Officer by making a remand order.

It was thus held that a jurisdictional provision which was mandatory and enacted in public interest could never be waived and the want of jurisdiction was discovered by the Appellate Assistant Commissioner, there was no question of waiver by the assessee. No question of finality of the remand order of the Tribunal would arise because the mandatory conditions for founding jurisdiction for initiating re-assessment proceedings had been fulfilled, The order of re-assessment was held to be not valid.

It is following the ratio laid down in the Gujarat High Court decision, that the Ahmedabad Tribunal held in the aforesaid case of Shrimant F. P. Gaekwad {Decd.} vs. Asst. CWT [2010] 3 ITR {Trib} 476 {Ahmd} that the assessee was justified in raising the question of validity of the re-assessment notices u\s 17 [1] of the Wealth Tax Act for the first time in the second round of litigation.

The decision of the Ahmedabad Tribunal is, in my view, very well founded. Jurisdiction is the power granted by the statute on an authority to decide a particular case. This jurisdiction is a creature of the statute. It can neither be self assumed by the authority or derived by a consensus with the party being heard. It cannot be conferred on the authority by acquiescence of the party to the case. If the statute confers jurisdiction on any authority only on fulfillment of certain fundamental pre-conditions, it is only on fulfillment of these conditions that the authority acquires jurisdiction. The fulfillment of such conditions are mandatory and if found wanting, any exercise by the authority on basis of purported jurisdiction would be invalid in law. An order passed by an authority without jurisdiction is null and void. Such an order is as good as an order not passed at all. Even though such an order is a nullity, it can still hold ground unless it is impeached by the affected party in further appeal and struck down. In such a decision, the appellate authority is required to hold that this order as void.

There is a however a difference between an order passed without jurisdiction and an order passed by an authority with improper exercise of jurisdiction. Whereas in the former case, the jurisdiction is totally lacking at source, in the latter case, the jurisdiction is properly assumed, but improperly exercised. An order passed without jurisdiction is a nullity and not curable. On the other hand, an order involving only an improper exercise is only procedurally defective and is not a nullity. A higher authority can set aside this order with a direction that the order may be redone with proper exercise of jurisdiction.

Therefore, an order which is defective on jurisdiction should be first tested as to whether the defect is so fundamental that jurisdiction could not have been assumed at all. If so found, then such an order would be null and void in law. On the other hand, if the authority is found to have satisfied all the mandatory pre-condition for assuming jurisdiction, any defect in procedural exercise of the jurisdiction is curable and would not render the order a nullity.

Where the re-assessment provisions provide that the notice for re-assessment can be issued only if the income [or the wealth] of the assessee has escaped assessment on account of failure of the assessee to disclose facts materials for the assessment, such a pre-condition is fundamental to the assumption of jurisdiction by the authority proposing to re-assess. Absence of such a condition cannot invoke re-assessment provisions.

It may also be noted that an issue of jurisdiction is a question of law and the accepted rule in pleading is that a question of law can be raised at any time. Even if the issue is not raised in original proceedings, there is no bar in law in raising the same in further proceedings.

When an order lack jurisdiction at its roots, all proceedings that emanate from such order become nullity. This is because the only legal effect that can from a null order is nullity and nothing else.

If the principles of jurisdiction are seen in the above context,, the decision of the Ahmedabad Tribunal in Shrimant F. P. Gaikwad’s case should appear most satisfying.

2. Re-assessment u/s 147 vs. Rectification u/s 154 –

While the subject of jurisdiction of an Assessing Officer to re-assess u\s 147 is fresh in our minds, it would be timely to also refer to the decision of the Bombay High Court in the case of Hindustan Unilever Ltd. Vs. Dy. CIT [2010] 5 taxman.com 18 {Bom} / 38 DTR 91 {Bom}.

This is an instance where the watchful watchdog caught a wolf in a sheep’s clothing from damagingly sneaking in to the flock. Here, the Bombay High Court has decisively held that it would be entirely arbitrary for the Assessing Officer to re-open the entire assessment u\s 147 to rectify an error which can be rectified u\s 154. Such arbitrary exercise, the High Court observed, was certainly not a consequence which the Parliament contemplated.

In this case, one of grounds on which the assessment is sought to be reopened u\s 147 was a computational error in the assessment order.. For Assessment Year 2004-05, the assessee had returned a business income of Rs.1,826.43 crores. The loss of Rs.10.84 crores arising out of the Plantation division and attributable to the business activity was deducted from the business income so as to result in a profit of Rs.1815.59 crores from business operations. The Assessing Officer while passing his order of assessment dated 27th December 2006 adopted the business income of Rs.1815.59 crores which was in terms of the computation made by the assessee. While making deductions from the business income, the Assessing officer deducted an amount of Rs.10.84 crores as a loss arising from the Plantation division. This was a plain computational error on the part of the Assessing Officer because the figure of Rs.1815.59 crores disclosed as business income by the assessee in the computation of income was after the adjustment of the loss from the Plantation division of Rs.10.84 crores. The Assessing Officer, therefore, plainly made a computational error in once again deducting an amount of Rs. 10.84 which had already been accounted for in the computation of business income at Rs.1815.59 crores.

The High Court held as under :-

“We find that there is merit in the submission which has been urged on behalf of the assessee. Section 154 empowers the Income tax Authorities, including an Assessing Officer, to amend any order passed by them with a view to rectify any mistake apparent from the record. The limitation for the exercise of the power is under subsection (7) of Section 154, four years from the end of the financial year in which the order sought to be amended was passed. There can be no dispute about the position that the computational error that has been made by the Assessing Officer in the present case is capable of being rectified under Section 154(1). The Assessing Officer is within the period of limitation prescribed by subsection (7) of Section 154. Moreover, the computational error cannot be attributed to any act or omission on the part of the assessee, as the assessee in the course of its statement of computation of total income had clearly disclosed that the business profits were arrived at after adjusting the losses sustained by the Plantation division (attributable to the business activity) from the business income.

Explanation (2) to Section 147 provides a deeming fiction, for the purposes of the Section, of cases where income chargeable to tax would be regarded as having escaped assessment. Clause (c) of Explanation (2) incorporates a situation where an assessment has been made, but income chargeable to tax has been under assessed; or assessed at too low a rate; or where such income has been made the subject of excessive relief under the Act. Where the power to rectify an order of assessment under Section 154(1) is adequate to meet a mistake or error in the order of assessment, the Assessing Officer must take recourse to that power as opposed to the wider power to reopen the assessment. The assessee cannot be penalized for a fault of the Assessing officer. We must emphasize that we are not dealing with a case where the error in the order of assessment is attributable to a lapse or omission on the part of the assessee. The provisions of the statute lay down overlapping remedies which are available to the Revenue but the exercise of these remedies must be commensurate with the purpose that is sought to be achieved by the legislature. The reopening of an assessment under Section 147 has serious ramifications. Explanation (3) to Section 147 provides that for the purposes of assessment or reassessment, the Assessing Officer may assess or reassess the income in respect of any issue which has escaped assessment and where such issue comes to his notice subsequently in the course of the proceedings under the Section, notwithstanding that the reasons for such issue have not been included in the reasons recorded under subsection (2) of Section 148. In other words, once an assessment is validly reopened in exercise of powers conferred by Section 147, the Assessing Officer is empowered to reassess the income in respect of any other issue which comes to his notice in the course of the proceedings, though such reasons have not been set out in the notice under Section 148. [emphasis supplied in underline]. There is, therefore, merit in the submission that is urged on behalf of the assessee that before recourse can be taken to the wider power to reopen the assessment on the ground that there is a computation error, as in the present case, the Assessing Officer ought to have rectified the mistake by adopting the remedy available under Section 154 of the Act. All statutory powers have to be exercised reasonably. Where a statute confers an area of discretion, the exercise of that discretion is structured by the requirement that discretionary powers must be exercised reasonably. Indian Law is governed by the prescriptions of a written constitution. Fairness and fair treatment are norms which emanate from the guarantee of equality and non discrimination under Article 14. Constitutional norms, including non discriminatory application of law, must guide the interpretation of statutes. Statutory enactments must be read to be in conformity with constitutional norms. The exercise of powers vested by a statute must equally be consistent with constitutional norms. The remedies which the law provides are tailored to be proportional to the situation which the remedy resolves. Where the statute provides for several remedies, the choice of the remedy must be appropriate to the underlying basis and object of the conferment of the remedy. A simple computational error can be resolved by rectifying an order of assessment under Section 154(1). It would be entirely arbitrary for the Assessing Officer to reopen the entire assessment under Section 147 to rectify an error or mistake which can be rectified under Section 154. An arbitrary exercise of power is certainly not a consequence which Parliament contemplates.

In this case the Revenue has an efficacious remedy open to it in the form of a rectification under Section 154 for correcting the computational error and that consequently recourse to the provisions of Section 147 was not warranted.”.

The above decision of the Bombay High Court is self speaking and does not require explanatory elaborations. Suffice it would be say that where an authority has been vested under a statute with discretionary powers to remedy a deficiency, the extent of force to be applied by the authority should be commensurate with the situation and not an excessive abuse of power. It should not result in to a case where the remedy is worse than the malady intended to be cured.

3. Mere supply of man power –whether PE results ?

The decision of the Mumbai Tribunal in the case of DDIT vs. Tekmark Global Solutions, LLC as reported in [2010] 38 SOT 7 [Mum} presents an interesting reading as what does not constitute a permanent establishment.

The assessee here is tax resident of USA. It provided technical services to one, Lucent Technologies Hindustan Pvt. Ltd. In India. During the year under consideration [financial year 2002-03], it deputed certain personnel to Lucent on a hire out basis. The personnel were to work under the control and supervision of Lucent. Tekmark was entitled to receive re-imbursement of the salaries of its personnel from Lucent. The assessee Tekmark had neither control nor supervision of these personnel and the personnel’s deputation was entirely at the will of Lucent, who could terminate any personnel’s deputation if found not suitable.

The Assessing Officer held that these personnel constituted in India a permanent establishment of the assessee under Article 5 [2][l] of the Indo-US DTAA qua the technical services rendered directly by the assessee to Lucient [which he considered as business profits under Article 7] and subjected the business income to tax.

In appeal, the Tribunal held that the presence of the assessee’s deputed personnel in India did not result in permanent establishment in India. According to the Tribunal, the services rendered by the personnel were independent of and not under the control of the assessee. Their work was therefore independent of the technical services rendered by the assessee to Lucient in India. Further, even if a permanent establishment was assumed, there was no business profits attributable to the same as what was received by the assessee in respect of the personnel was only re-imbursement of salary costs.

This short and concise decision of the Tribunal is in my view correct exposition of the law for the reasons given below.

As per Article 7 [1] {Business Profits] of the Indo-US DTTA, profits of an enterprise of an US resident cannot be taxed in India unless the business of the enterprise is carried through a permanent establishment in India. The expression ‘permanent establishment’ should be understood as an extension of an enterprise’s business presence in to another State.

The definition of ‘permanent establishment’ is found in Article 5 of the Treaty. Article 5 [1] provides for the general rule that permanent establishment means a fixed place of business through which the business of an enterprise in wholly or partly carried on. Article 5 [2] enumerates several types of fixed places of business which would be considered as ‘permanent establishments’ in terms of the Treaty. No such fixed places of business were admittedly existent in the case before the Mumbai Tribunal being discussed here.

Article 5 [2][l] is important for our discussion. As per Article 5 [2][l], the definition of Permanent Establishment includes any ‘furnishing of services,’ other than included services as defined in Article 12 [royalties and fees for included services] within a Contracting State by an enterprise ‘through employees or other personnel’ [emphasis supplied in underline] for specified period therein.

The readers may here note that there is a significant difference between a mere supply of manpower and supply of services through the manpower. In the former case, the delivery of the manpower is the service provided. In the latter case, there is no delivery of the manpower, but delivery of the service through the manpower. In the former case, the manpower is the end product supplied; whereas in the latter case, the manpower is only the intermediary through which services are rendered. In case manpower is merely supplied and the same has to work under the control and supervision of the client, it can be rightly said that no services are rendered by the manpower provider through the manpower. In fact, whatever services are supplied by the manpower to the clients are their own independent services and nothing to do with the manpower provider.

Applying this logic, we find that in the instant case before the Tribunal, there was only supply of manpower by the assessee to Lucient and no furnishing of services through its manpower. The services of the deputed manpower were entirely under the control and supervision of Lucient. If seen from the above angle, one should be inclined to agree with the Tribunal’s finding that there was no permanent establishment resultant in India qua the assessee in terms of Article 5 [2][l] of the DTAA.

In the instant case before the Tribunal, the personnel were deputed by the assessee without profit on ‘cost reimbursement’ basis. According to me, even if the personnel were deputed at a profit to the assessee, the business profit resulting on supply of the manpower could not have been taxed in India as there is no permanent establishment involved.

Readers are urged to ponder over the above discussion.

4. Interest received on delayed payment of sale price – entitled to deduction u/s 80-IB.

In respect of incentive deductions relating to profits derived from new industrial undertakings, Courts have been generally reluctant to allow deduction in respect of interest incomes received by the undertakings. This is because interest received is not looked upon as a component of the profits derived from the manufacturing activity of the undertaking.

At the same time, it cannot be said, as an absolute rule, that interest income can never be a part of the manufacturing profits entitled to the incentive deduction. The decision of the Bombay High Court in the case of CIT vs. Vidyut Corporation as reported in [2010] 324 ITR 221 {Bom} is one of the exceptional cases, where such interest income has been allowed to be treated as part of the profits derived by a new industrial undertaking for purposes of deduction u\s 80-IB.

Here, the assessee in manufacturing business was a claimant of deduction u\s 80-IB. The assessee normally sold its manufactured products on immediate payment basis. If, payment was not immediate, a promissory note was drawn by the purchaser for the amount of discounting charges mutually agreed. The promissory note was discounted by the assessee with its bankers and the bank deducted its discounting charges. The assessee was reimbursed by the purchaser by payment of interest. The issue before the Bombay High Court was whether such interest receipts could be regarded as derived from the industrial undertaking for the purpose of deduction u\s 80-IB.

The High Court answered in affirmative and in favour of the assessee. The High Court observed that the price realized by the assessee from the sale of manufactured goods constitutes a component of the profits derived from the industrial undertaking eligible for deduction u\s 80-IB,. The interest received on delayed payment of the sale price is nothing but a component of the sale price as paid in a delayed manner. The interest so received partakes the character of sale price and is therefore eligible to be considered as a part of the profits derived from the eligible business of the industrial undertaking.

This decision should prove to be useful to claimants of incentive deductions relating to profits derived from eligible businesses. If a sale price is negotiated with a pre- condition of charging interest for credit extended, then the assessee may successfully press their claim for the interest component as an additional sale price charged based on this decision. After all in commercial practice, differential prices are known to charged based on credit terms allowed. This should mean that merely because the value charge is styled as ‘interest’, it should not affect its character as a sale price.