Taxaholic’s The Week That Was – 2

This week, the author suggests that a Anna Hazare style crusader is needed to explain to the CBDT the irrationality of its stand that the monetary limits for filing appeals will apply only to fresh appeals and not to pending appeals. Also, on the issue whether software income is assesable as “royalty”, the CBDT should abandon its ostrich-like stance and take a firm stand one way or the other like its Australian counterpart says the author

Legislature Proposes; Judiciary Disposes

Old timers will recollect the excitement that the judgement of the Tribunal in Pranav Constructions 61 TTJ (Mum) 145 had created. The Tribunal had done the unthinkabale. It held that the hafta or protection money paid by the assessee to local politicians and goons could be claimed as “business expenditure” on the footing that without such payments, business could not be conducted. Till then, unsavoury issues like hafta were meant to be confined to a fiction writer’s imagination without official cognizance.

The judgement obviously upset somebody high up in the department because in the very next Budget a retrospective amendment “for the removal of doubts” was inserted in the form of Explanation to s. 37(1) to provide that a payment for a purpose which is an offence or which is prohibited by law was not incurred for business purposes. In the Memorandum as well in the Explanatory Circular it was made clear that “The amendment will result in disallowance of the claim made by certain tax payers of payments on account of protection money, extortion, hafta, bribes, etc. as business expenditure“. The amendment was made effective from the date of commencement of the Act, 1.4.1962 to ensure that all traces of Pranav Construction was removed.

Well, Pranav Construction may not be dead after all. The Madhya Pradesh High Court has in CIT vs. M/s Khemchand Motilal Jain held that what one has to ask is not whether an offence was committed but whether the payment is in itself an offence or prohibited by law. Kidnapping is an offence, said the Court, u/s 364A of the IPC, but the payment of ransom is not an offence nor is it prohibited by law. So, the payment of ransom was an allowable deduction, uninhibited by Explanation 1 to s. 37(1).

Applying this logic, while extortion is an offence, paying the extortion money is not. So, why is Pranav Construction not still good law?

The Perils of the AAR

While litigation is rightly said to be a game of chance, the AAR plays its part by being an unpredictable body. Unlike other judicial bodies which are bound to some extent to follow their own judgements, the AAR is under no such compulsion and can merrily take one view in the case of one applicant and an opposite one in the case of another applicant without any fear of being hauled up for inconsistency. Add to that the fact that the rulings of the AAR are final and binding on the applicant and the AAR becomes a body to be wary of.

The assessee learnt this the hard way In Re Cairn U.K. Holdings Ltd on the question whether the benefit of s. 112 applies to non-residents. Faced with an adverse ruling of the Tribunal in BASF AG 293 ITR (AT) 1 and a favourable ruling of the AAR in Timken 294 ITR 513 (AAR), the assessee put in an application hoping that the AAR would follow its own ruling and the assessee could sneak out with a favourable ruling.

To the assessee’s dismay, the AAR did the opposite. It dissented from its own judgement and followed the judgement of the Tribunal. By laborious reasoning, the assessee was held not entitled to the benefit of s. 112.

‘Royal’ty treatment!

The raging controversy over whether income from software is assessable as “royalty” or as good ol’ business income continued unabated. While the Delhi Bench of the Tribunal took the view in Gracemac Corp 42 SOT 550 (Del) that the income was assessable as “royalty“, the Bombay Bench took the view in TII Team Telecom International that the income was assessable as “business profits“. Why the classification of the receipt is a big deal is because if it is assessable as business income and the assessee does not have a PE in India, no part of the receipt is assessable to tax in India.

At the heart of the dispute is whether the software can be said to be a “copyright” or a mere “copyrighted article“. The proponents of the “copyrighted article” theory cite the judgement of the Supreme Court in TCS vs. AP 271 ITR 401 where it was held that the sale of software CDs is a “sale” exigible to sales-tax by taking the value of the software into account. The detractors of the theory ask how a judgement in the context of sales-tax can apply to the definition of “royalty” in income-tax law.

The only way to speedily solve the imbroglio is for the CBDT to do what its Australian counterpart did – issue a series of comprehensive instructions on the subject. Of course, this is just wishful thinking. It has been years, nay decades, since the CBDT assumed a leadership position in any matter. The CBDT prefers to be an ostrich and bury its head in the stand, leaving the Courts to sort out the brawling parties.

Monetary Limits

The CBDT’s stance on fixing monetary limits for filing appeals reflects the thinking of a body which which wants to show itself to be progressive but is still stuck in a time-warp. If monetary limits are imposed on the filing of fresh appeals, should they not logically apply to pending appeals? After all the thinking is that for matters with low tax effect, it is not worth the department’s while to incur costs on court fees, counsel fees etc to pursue the appeal. Also, small assessees must have the satisfaction that there is an end to the litigation. This logic applies to pending appeals as much as they apply to fresh appeals.

This was the logic which impelled the Bombay High Court to take the view in CIT v. Pithwa Engg. Works 276 ITR 519 (Bom) that the monetary limits imposed by the CBDT will apply to pending appeals as well. In a sagacious ruling, the Court held as follows:

“This Court can very well take judicial notice of the fact that by passage of time money value has gone down, the cost of litigation expenses has gone up, the assesses on the file of the Departments have been increased consequently, the burden on the Department has also increased to a tremendous extent. The corridors of the superior courts are chocked with huge pendency of cases. In this view of the matter, the Board has rightly taken a decision not to file references if the tax effect less than Rs. 2 lakhs. The same policy for old matters need to be adopted by the Department. In our view, the Board’s circular dated March 27, 2000 is very much applicable even to the old references which are still undecided. The Department is not justified in proceeding with the old references wherein the tax impact is minimal. Thus, there is no justification to proceed with decades old references having negligible tax effect“

This view has been accepted by the Madhya Pradesh High Court in Ashok Kumar Manibhai Patel and Co 317 ITR 386 and the Delhi High Court in Delhi Race Club.

The Board should have graciously accepted this view-point and directed that a refund of court fees should be taken by withdrawing pending appeals. This itself would have led to an inflow of several crores of rupees given that each appeal costs Rs. 10,000 in court fees and there are literally hundreds of low-tax-effect appeals pending. Instead, in its letter dated 2.9.2011, it has persisted in taking the indefensible stand that its latest Circular dated 9.2.2011 should not apply to pending appeals. And, by a sleight of hand, the CBDT has suggested that the Supreme Court ruling in CIT vs. Surya Herbal supports its stand.

It is really high time that some Anna Hazare type of crusader drills some sense into the heads of the mandarins!

CA Vellalapatti Swaminathan Iyer
Hyderabad