Analysis of six important judgements (Oct to Dec ’09)

Legal decisions form the daily diet of tax practitioners. And when these legal decisions transform in to ‘precedents’, they condition not only our minds while arguing tax matters, but also dictates terms to the judges to dispose the cases in accordance with the precedents. This is the ‘controlling influence’ or the ‘sovereignty’ that precedents exercise over judiciary. Precedents are welcome in the sense that they standardize judicial thinking and do away with randomness in the outcomes of matters decided. For example, two similar cases heard by two different judges are decided uniformly in accordance with a common precedent applicable to both.

The credit for developing a precedent should not go entirely to the judiciary. Behind the evolution of the precedent lies the hard work of the tax advocates, who support the judiciary as ‘officers of the court’ by providing innovative legal propositions to the judges to determine the cases. In short, whereas precedents appear to be handiwork of judges because the judges write the orders and sign them, in the same also lies the hidden acumen of the advocates who have argued the matter.

The distressing trend today is the steady decline in the contribution of this acumen from the tax practicing community. Maybe, one of the reasons is that we are moving away from the “Age of Hardwork” to the “Age of Ready Made”. For example, the food we ate on Sundays in childhoods, were the ones we cooked at our homes. This is in sharp contrast to the fact that we eat the same food today in a hotel. Likewise, if we compare the tax books we refer today with the same ones about thirty years ago; we will find a marked difference. The vintage ones carried reliable commentaries and analytical comments by learned authors like Shri. Nani Palkhiwala, the moment a controversial amendment was put on the tax statute. From this, one could make a reliable projection, as on that date, of what the Court would decide on that amendment in future. Mr. Palkhiwala was a visionary and his analytical comments in the law book had the capability to shape a future precedent. But today, tax reference books have been reduced to a mere ‘digests’ of cases rather than commentaries. We know how a controversial amendment will fare in law only when the Court decides and we have no preparedness beforehand.

The above should underline the value of academics in tax profession. Profession is not just earning money by citing readily available precedents. It should also include endeavors from tax professionals in developing legal canons, which can assist the judiciary to settle contentious issues in a just and equitable manner. Tax practitioners are not just accountable to their clients. The society looks upon them as watch dogs to monitor both the course and development of law.

With the above background in mind, I would invite the readers to this article “Analysis of six important judgements”. A simple effort has been made by the author to gather a few interesting judgments and draw the readership in to discussion of the same. In the process, if any legal acumen is activated per chance either in the readership or in me, the purpose of this article would be felt more than achieved.

1. TDS u\s 195:-

To begin with, let me take up a decision regarding liability to deduct tax at source. Responsibility to deduct tax at source is the undesirable curry that government forces down the throat of every assessee, just like we were made to drink cabbage soup in our childhoods. And even after dutifully discharging this ‘tax deduction at source business’, we can never sleep easily. We may always wake up in the midnight in cold seat with an uneasy feeling that probably we have still missed some thing and we may incur disallowance u\s 40{a}. TDS responsibility is always a sword handing over our heads.

The decision, which comes in my mind, is that of the Karnataka High Court in CIT vs. Samsung Electronics {ITA no. 2808 of 2005 dt. 24-9-2009 – courtesy www.itatonline.org}. Here, the High Court has opined that moment a payment is to be made to a non-resident; the payer is liable to deduct tax at source u\s 195, whether the sum is chargeable to tax or not under the Income Tax Act. If, the payer wants to escape from this tax deduction obligation, he has to approach the assessing officer by making an application u\s 195 [2] for non deduction or deduction at a lower rate. If, such an application is not made, it is no longer open to the payer to argue that the payment had not resulted in taxable income in the hands of the non resident and that therefore, there is no failure on part of the payer to deduct tax u\s 195 {1}. In coming to this conclusion, the High Court has believed that the Supreme Court, in its decision the case of Transmission Corporation of A.P vs. CIT, as reported in 239 ITR 587{SC} has delivered a dictum to such effect.

Readers may need to take a closer look at the decision of Supreme Court in Transmission Corporation case. In that decision, the sum paid to the non – resident was admittedly chargeable to tax in principle. The issue was whether tax is required to be deducted if the sum did not wholly represent ‘income’ and the income involved was only a part of this sum. In short, the income was embedded as a part of the gross sum paid to the non resident and the whole of sum did not represent ‘income’.

The Supreme Court observed as a first principle that ‘the scheme of section 195 and section 197 leaves no doubt that the expression ‘any sum chargeable to tax under the provisions of this Act’ would mean ‘sum’ on which income tax is leviable. In other words, the sum is chargeable to tax and would be assessed to tax under the Act’. However, if the sum is found chargeable to tax, there is no escape from the TDS obligation thereon on the ground that the whole of sum may not entirely represent income.

The decision, in my opinion, is an endorsement by the Supreme Court that only if the sum is chargeable to tax in principle, the question of deduction of tax u\s 195 should arise and not if the sum is not chargeable to tax in India or is exempt.

Readers may therefore examine the decision of the Karnataka High Court in Samsung Electronics from the above angle. Attention of the readers may also be drawn to the Special Bench decision of the Mumbai Tribunal in the case of Mahindra and Mahindra vs. DCIT as reported in 122 TTJ {Mum}{SB} 577, where the Special Bench has observed that tax has to be deducted u\s 195 [1] only if the sum is chargeable to tax in India. The Authority for Advance Ruling in IMT Labs {I} Pvt. Ltd. [2006] 287 ITR 450 {AAR} and Headstart Business Solutions {P} Ltd. [2006] 285 ITR 530 {AAR} have also taken the same view after considering the decision of the Supreme Court in Transmission Corporation. Though Advance Rulings do not constitute judicial precedents because AAR is not a part of judiciary, the reasoning provided in the rulings should interest the readers.

2. Disallowance u\s section 14A:-

The controversial section 14A [and also its equally illustrious offspring Rule 8D] never ceases to fascinate us. One thing should be admitted – that there is never a dull moment in the tax arena when either of them is around.

This time, it was the turn of the parent provision itself. The decision, I am now referring, is that of the Cochin Tribunal in the case of State Bank of Travancore vs. ACIT [2009] 318 ITR {AT} 171 {Cochin}. Here, the assessee bank had subscribed to tax free bonds for maintaining the required statutory ratio by banks. The Tribunal has held that the bank had subscribed to the bonds not for earning income but to comply with a statutory requirement and therefore, the expenditure incurred in connection with the bonds was not disallowable u\s 14A.

Our general understanding of the law is that an item of expenditure, in order to be allowed as a deduction in the computation of business income, should be incurred for the purposes of the business. However, if the expenditure is found ‘related’ to any income, which is not includible in the total income of the assessee, the same shall not be allowed as a deduction by virtue of the express bar in section 14A [1].

Therefore, in case the provisions of section 14A are involved, the expenditure has to be tested at two successive levels. Firstly, it must be shown to be incurred for the purposes of the business and after being so shown, it must secondly not be any expenditure ‘in relation’ to any income not includible in the total income. In short, if any expenditure is found ‘relatable’ to exempt income, it shall be disallowed u\s 14A [1] notwithstanding that it is actually incurred for the purposes of the business.

It is possible that some exempt income may result incidentally from the statutorily required investment and not by any volition of the assessee to earn this income. Yet, the moot point for considering any disallowance u\s 14A would be whether any expenditure incurred is ‘in relation’ to such income.

Readers may examine the Tribunal decision in light of the above propositions.

3. Passing of a ‘reasoned’ order: –

What lends grace and finesse to the Law is the principles of natural justice. These principles constitute the positive life force that transforms the static law in to dynamic justice. These are the principles by which a person subjected to an order is assured that justice has manifestly been done and not just appeared to be done. It is for this reason the Courts have progressively held that these principles have to be followed even if the same are not expressly cited in the provisions of the statute. The Income Tax Act is no exception to this rule. Lastly, the above discipline applies with equal force even to order passed by appellate authorities.

One such vital principle of natural justice is the requirement of passing a reasoned order. After all, it is only from these reasons that the party subjected to the order can know whether he has been adjudged properly or not. It also renders the order amenable to proper scrutiny and appraisal by higher authorities in further appellate proceedings.

It is quite possible that an appellate authority may fully concur with the findings of the lower authorities. But, he cannot dispose the appeal merely with a statement that he agrees with the findings of the lower authority. He is duty bound to state his own reasons expressly why he feels so. Absence of such reasons may render this appellate order deficient on the principles of natural justice. This is because it cannot be known from such an order whether the appellate authority has really applied his own mind or not.

Such a case came before the Bombay High Court in the case of Shivsagar Veg Restaurant vs. ACIT [2009] 317 ITR 433 {Bom} where the Tribunal had confirmed the order of a lower authority with just a statement that it agrees with the findings of the lower authority not assigning any reasons for this conclusion. The High Court held that the Tribunal being the final authority on facts, it was incumbent upon it to appreciate the evidence, consider the reasons of the authorities below and assign its own reasons in the order passed by it. The order of the Tribunal fell short in this regard and was thus set aside by the High Court.

4 Interpretation of statutes :-

Making law is the domain of the Legislature and the judiciary has no hand in the same. Its function is to interpret this law and administer it to a judicial end. In this process, if the purpose behind the legislation is also achieved, it can look back at its job as well done.

Even if the language in the law is found deficient, it is not permissible for the Courts to write in to the law or alter its language. Further, while interpreting a provision of the law, the Court cannot also subject the language to any violence.

Ordinarily, Courts are required to interpret the law literally from the language given in an enactment. But, the Courts are certainly entitled to look in to the object for which the provision was enacted and lend an interpretation by which the purpose behind the legislation is achieved. If a strict literal interpretation can lead to unintended consequences, the Court would be entitled to avoid such construction and lean towards a purposeful mode of interpretation alternatively as held by the Supreme Court in the case of CIT vs. Gotla J. H. [1985] 156 ITR 323 {SC}.

Such an instance came before the Supreme Court in the case of CIT vs. Alam Extrusions [2009] 319 ITR 306 {SC}. Here, the Court was concerned with the provisions of section 43 B [b] under which ‘any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of the employees’ would be allowed as a deduction, irrespective of the method of accounting followed by the assessee, in the year in which it is actually paid.

As per the first proviso inserted by Finance Act 1987 w.e.f. 1-4-88, if the concerned payment was made before the due date of filing the return u\s 139 [1], then the deduction was also permissible.

But, the second proviso introduced by Finance Act, 1989, w.e.f. 1-4-89 provided a stumbling block. Its effect was that if the above payment was not made before the due date under the respective enactments [like the Provident Fund Act], the same would not be allowed at all.

This second proviso was omitted by Finance Act 2003 w.e.f. 1-4-2004. The literal effect of this omission was that for the Assessment Years 1989-90 to 2003-04, provident fund payments made beyond the due dates prescribed in the Providend Fund Act would not be allowed, whereas from Assessment Years 2004-05, the same would be allowed. It is this strikingly illogical inequity that came to the notice of the Supreme Court in this decision.

The Supreme Court, at the outset, observed that the object of section 43 B was not to deny deduction absolutely but to allow the same on fulfillment of certain conditions. It further noted that the purpose of the omission of the second proviso by the Finance Act 2003 w.e.f 1-4-2004 was to remedy the unintended consequences that flowed from this proviso while it was in operation.[the unintended consequence being to deny the deduction absolutely for all times to come].The Court held that the amendment brought about by Finance Act 2003 was curative in nature and should apply retrospectively from 1-4-88 i.e. the date from which the first proviso was brought on the statute.

While this decision of the Supreme Court undoubtedly comes in as a welcome whiff of fresh air, one cannot also simultaneously help heaving a sigh of disappointment at the Legislature for not declaring Finance Act 2003 amendment as retrospective from 1-4-88 instead of 1-4-2004 in the first place itself. This would have saved this country a lot of unnecessary litigation, which has emanated from this short sightedness.

5. MAT liability u\s 115JA – whether interest u\s 234-A, 234-B and 234-C can be charged?

Sometimes, a slip between the cup and the lip may prove costly rendering even the tea gulped down the throat wasteful. Such can be the position in tax litigations, when a moot point, which is central to the issue in litigation, may innocuously be missed.

The issue, whether interest can be charged under sections 234-A, 234-B and 234-C in case of MAT liability on book profits, is one such see-saw courtroom battle presently in vogue. One branch of authorities led by the Bombay High Court decision in the case of Snowchem India Ltd. vs. CIT reported in 313 ITR 170 {Bom}, applying the Supreme Court decision in case of CIT vs. Kwality Biscuits Ltd. [2006] 284 ITR 434 {SC}, has held that such interest cannot be charged , the principle being that advance tax is payable within the financial year at which time book profits are not determinate as the accounts are finalized only after the year end. On the other side, other authorities, {the recent being a Third Member decision of the Ahmedabad Tribunal in the case of Kanel Oil [courtesy :- www.itatonline.org ]}have strongly differed with Bombay High Court decision. The principle point of difference made out was that the Supreme Court decision in the case of CIT vs. Kwality Biscuits Ltd. [2006] 284 ITR 434 {SC}was in context of the erstwhile provisions of section 115-J. The material difference between the provisions of section 115-J and section 115-JA is that the later section contains an additional sub-section [4] which provides that “save as otherwise provided in this section, all other provisions of this Act shall apply to every assessee, being a company, mentioned in this section”. This sub-section has been interpreted as meaning that even advance tax provisions in the Act would also apply and consequently, interest under section 234-A, 234-B and 234-C are leviable. Section 115-JA has been felt akin to section 115JB and not to section 115J.

Readers may carefully take note of the propositions I will be making. Section 4 of the Income Tax Act constitutes the charging section. Sub-section [1] of this section provides that “where any Central Act enacts that income tax shall be charged for any assessment year at any rate or rates, income tax at that rate or those rates shall be charged for that year in accordance with and subject to the provisions [including ……] in respect of the total income of the previous year of every person”. Sub-section [2] further provides where advance tax has to be paid, the same shall be payable under the provisions of the Income Tax Act.

Section 209 is the advance tax provision. Sub-section [1] [a] provides that the assessee should pay advance tax at ‘the rates in force’ for the financial year on the current income estimated.

The definition of the expression ‘rates in force’ is given in section 2 [37A]. For advance tax purposes, the same means the rates specified in the Finance Act.

The Finance Act, 1987, which introduced the provisions of section 115J, did not mention or refer to section 115J in its provisions specifying advance tax rates.

Section 115-JA was introduced by Finance [no. 2] Act of 1996 and even this Finance Act did not mention or refer to section 115JA in its provisions specifying advance tax rates. This fact has been well observed by the Cochin Tribunal in its decision in the case of Escapades Resorts Pvt. Ltd. vs. ACIT reported in 107 ITD 323 {Cochin}.

On the other hand, Finance Act 2000 which introduced section 115JB specifically mentions this section in its provisions specifying advance tax rates.

Is not possible that the Legislature intended advance tax to be charged only on book profits u\s 115JB and not on book profits under section u\s 115J and section 115JA? Can advance tax be charged on book profits u\s 115JA, when there is no provision in the Finance Act?

These aspects, which have not been considered by the legal authorities deciding on section 115JA, are left for consideration of the readers.

6. Rectification of mistake – section 154 – whether permissible in case of a change in opinion.

We know that an assessment cannot be re-opened u\s 147 by an Assessing Officer based on a mere change in opinion. In a decision that should raise curious eyebrows, the Supreme Court has held in the case of Mepco Industries Ltd. vs. CIT [2009] 319 ITR 208, 215 {SC}that rectification u\s 154 cannot be done in case of a change in opinion.

We are familiar with the general principles of law concerning rectification of mistakes. Firstly, the expression ‘mistake apparent from record’ should mean an obvious and patent mistake and not something which can be established by long drawn process on points on which there may be two opinions. A decision on debatable point or issue is not a mistake apparent from record. These are the principles laid by the Supreme Court in the case of T.S. Balaram, ITO vs. Volkart Bros. [1971] 82 ITR 50 {SC}.

A mistake on a point of law is rectifiable. A Supreme Court decision does not bring any new law in to existence, but only declares the law as it ‘existed’ at the time of its inception on the statute [M.A. Murthy vs. State of Karnataka [2003] 264 ITR 1 {SC}]. Based on this proposition, whereas some High Courts have ruled that an order can be rectified u\s 154 to bring it in conformity with a subsequent Supreme Court decision, others have disagreed on the ground that whether the issue is debatable or not should be seen as at the time of the order passed and a subsequent Supreme Court decision cannot obliterate the factum of the earlier controversy.

Now coming back to the decision of the Supreme Court in Mepco Industries Ltd., the Commissioner in his revision powers u\s 264 had initially allowed the assessee’s claim that subsidy received by it was a capital receipt and therefore not taxable in terms of the decision of the Supreme Court in case of CIT vs. P .J. Chemicals Ltd. [1994] 210 ITR 830 {SC}.

This order was later rectified by the Commissioner against the assessee relying on a subsequent Supreme Court decision in the case of Sahney Steel and Press Works vs. CIT [1997] 228 ITR 253 {SC}, where on particular facts of the case, the Court had ruled that subsidy received was a revenue receipt and taxable. [There was no conflict between both these two Supreme Court decisions and each one had ruled according to the nature of the subsidy involved in their cases].

The assessee’s challenge to this rectification came up before the Supreme Court. In its decision, the Supreme Court discussed various Supreme Court and High Court decisions on the scope of powers of rectification u\s 154. But, its ultimate decision against the rectification seems to be founded more particularly on a principal objection – that the rectification cannot be done on basis of a change in opinion. Readers may carefully analyze this decision.

7. At the time of concluding this article, the New Year has just set in. My wish is that this year 2010 should usher the best of times to the readers. With this fond wish, I will take leave.