Direct Tax

Shimla HC Decodes Scope of Sec 43-B, IT Act, 1961

by

In a recent judgment, the Shimla High Court had to adjudicate on the conditions prescribed in Section 43-B, IT Act, 1961 for an assessee to claim deductions. The issue related to Section 43-B(f) which envisages deductions to an employer for payments made to employees on encashment of cash leaves.

Facts 

For the Assessment Year 2002-03, the assessee inter alia claimed expenses of Rs 45,00,000/-, a sum it paid to LIC on contribution to Credit Leave Encashment Trust. The Assessing Officer disallowed the claim of such expense and added it to the income of the assessee. The assessee was unsuccessful in appeal before the ITAT. The dates are relevant to understand the issue at hand: 

The fund was established on 29.10.2002 and contribution of Rs 45,00,000/- to LIC was made on the same date.

Provision for contribution of Rs 45,00,000/- was not made by the assessee after closure of financial year 2001-02, i.e. on 31.03.2002. 

The assessee was not following the mercantile system of accounting during the financial year 2001-02. 

The liability of payment of Rs 45,00,000/- did not accrue nor was it paid during the financial year 2001-02.    

Summary of arguments adopted by the assessee and the Revenue is as follows: the assessee argued that the payment of Rs 45,00,000/- was part of the entire past liability of Rs 1.80 crores assessed by the insurer. The liability was not a contingent liability. And since the liability was met before due date of submission of returns, i.e., 31.10.2002, it was a permissible deduction under Proviso to Section 43-B(f), IT Act, 1961. Revenue, on the other hand, contended that the amount was not deductible under the IT Act, 1961 and even if it was, since it was not ascertained during the relevant financial year could not be a permissible deduction under Proviso to Section 43-B, IT Act, 1961. 

Section 43-B, IT Act, 1961 

Section 43-B, IT Act, 1961 allows for certain deductions to an assessee only on actual payment. Section 43-B(f) states ‘any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee;’ and the Proviso states: 

Provided that nothing contained in this section [[except the provisions of clause(h)]] shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return.

Shimla HC Answers Two Questions 

The first question that the Shimla High Court decided to answer was whether the contribution made by a corporate employer to a fund for payment of leave encashment to its employees was entitled to deduction. The High Court disagreed with the ITAT and held that it is not accurate to state that such a fund has not been statutorily recognized. The inclusion of Section 43-B(f), as per the High Court, proved otherwise. The High Court cited Exide Industries case to rightly conclude that amount of contribution made by an assessee towards a fund for payment of leave encashment to its employees was a deductible expense. 

The second question then was: did the assessee meet requirements of Section 43-B and its Proviso? The High Court answered in the negative. The High Court noted that Proviso allows only allows an assessee to claim a deduction if the sum payable as an employer in lieu of any leave was incurred by the assessee according to the regular method of accounting employed by him and the sum was actually paid in the previous accounting year. The second condition is not a correct interpretation of the Proviso, as it clearly states the payment can be made after the accounting year but before due date of filing returns. 

Nonetheless, the Shimla High Court denied the assessee’s claim for deduction on the ground that the liability of Rs 45,00,000/- had already been incurred as a past liability. The assessee’s assertion that the amount was part of a past liability of Rs 1.80 crores determined by the insurer, the High Court noted had not been substantiated. And since the finding of fact is not controverted the High Court denied assessee’s claim for deduction. 

Conclusion 

The insight this case offers us is that the payment towards a fund for encashment of leave is a permissible deduction under Section 43-B, IT Act, 1961. The payment can be made after the end of accounting year but before the due date to successfully claim deduction. But, the payment must be for satisfaction of a past liability incurred during the previous accounting year and the accounting method adopted by an assessee must reflect the liability. The observation that Section 43-B alongwith Proviso also requires payment before the end of accounting year does not align with a plain reading of the provision and does not hold on scrutiny.     

Issuance of Shares under Amalgamation Scheme is Not Transfer of Property: ITAT

by

The Rajkot Bench of ITAT recently ruled that issuance of shares under a scheme of amalgamation does not amount to transfer of capital assets under IT Act, 1961. The Assessing Officer had applied Sec 56(2)(vii)(c)(ii) of the IT Act, 1961 to assert that a skewed swap ratio was applied for transfer and valuation of shares, but the ITAT held in favor of the assessee. 

Facts 

The assessee was a public limited company. It filed its revised returns on 07.05.2015 declaring total income of Rs 4,74,48,046/- and book profit of Rs 5,20,68,396/- and it was selected for scrutiny. The Assessing Officer noted that the assessee company had amalgamated with three private limited companies with itself. The latter were owned by relatives of promoters of the assessee company.  During amalgamation, the assessee issued shares to shareholders of all three companies as per the scheme of amalgamation. 

The Assessing Officer took the view that a skewed swap ratio was chosen in the process of amalgamation and the assessee company transferred its shares to the beneficiaries at a discount. And the transfer of capital to such beneficiaries attracted Sec 56(2)(vii)(c)(ii) of the IT Act, 1961. Thus, the Assessing Officer held that the excess value of Rs 18,74,73,500/- transferred to the beneficiary, related parties should be added to the income of assessee. 

CIT(Appeals) on appeal filed by the assessee deleted the addition made by the Assessing Officer. And it was against the order of CIT (Appeals) that the Revenue approached the ITAT.  

Revenue’s Stand 

Revenue made two arguments and the latter appears rather strange. The first argument was that the share of assessee company was valued at Rs 1.82 per share while the amalgamated companies had a share price of Rs 10.65 per share. The Revenue argued that the difference of Rs 8.83 between two prices was passed over or given to the individual shareholder by adopting a colourable device and defeating the purpose of Sec 56(2)(vii)(c)(ii) of the IT Act, 1961. 

Revenue in its second argument conceded that the issuance or allotment of shares under a scheme of amalgamation does not amount to transfer of capital asset under Sec 47 of the IT Act, 1961. And no capital gains would be taxable in the hands of assessee. However, ‘the real income should be taxable in the hands of the assessee company.’ (para 11) 

What is real income in this case? And how did the Revenue suppose it was taxable if the transaction was not a taxable as per the applicable charging provisions of the IT Act, 1961? Even if one concedes that some benefit had occurred, in the absence of an express charging provision to tax such a benefit the entire case collapses. And yet the Revenue thought it was a fit case to file an appeal despite the CIT (Appeals) making an order that the no income had accrued under IT Act, 1961.    

Decision 

ITAT relied on multiple precedents to underline its three reasons for holding in favor of the assessee: 

First, ITAT held that the assessee company receives shares of the amalgamated company upon a statutorily valid and approved procedure of amalgamation under Companies Act, 1956. And once the share is issued at the court approved price, ‘then no one has the right to raise questions regarding one received more or less in value of shares.’ (para 14) ITAT added: 

… the new share is allotted as per the Amalgamation scheme under the supervision of the High Court after hearing of all stakeholders including the Government. The Scheme of amalgamation under which an exchanger ratio of shares is approved by the high court, and it is conclusive. So, question of skewed swap ratio or issuing shares at discounted rate does not arise.’ (para 20) 

Second, ITAT held that under Section 2(1B) read with Section 47 of the IT Act, 1961 transfer of shares during an amalgamation or even a fresh allotment of shares does not amount to transfer of a capital asset. And once there is no transfer of property, on merely receiving shares in lieu of shares previously held, Sec 56(2)(vii)(c)(ii) of the IT Act, 1961 cannot be applied. 

Finally, ITAT noted that Sec 56(2)(vii)(c)(ii) of the IT Act, 1961 does not apply to public limited companies but only to individuals and HUFs. 

ITAT’s decision in the impugned case is well-reasoned and decides the issue appropriately even if the decision in this case was straightforward. The case though is another instance of what I can term as unnecessary litigation by the Revenue Department. The ITAT’s decision correctly aligned with the CIT (Appeals) decision and the Revenue needn’t have appealed against the latter order pretending that the assessee had adopted a colorable device. The law and facts were straightforward to not require dedication of such extensive resources to this case.     

Section 71(3A), IT Act, 1961 is Constitutional: Delhi HC

by

In a recent judgment, the Delhi High Court held that Section 71(3A), IT Act, 1961 was constitutional and did not violate Art 14 and/or Art 19(1)(g) of the Constitution. The High Court’s primary reasoning was that the introduction of sub-section (3A) to Section 71 did not take away a vested right of the assessee but only introduced a new condition for an assessee to set off the loss. 

Section 71, IT Act, 1961

Section 71(1), IT Act, 1961 allows an assessee to set off loss under one head of income against income under another head of income, subject to certain conditions. To the said conditions, Finance Act, 2017 added another condition by introducing a new sub-section (3A) which states that: 

Notwithstanding anything contained in sub-section (1) or sub-section (2), where in respect of any assessment year, the net result of the computation under the head “Income from house property” is a loss and the assessee has income assessable under any other head of income, the assessee shall not be entitled set off such loss, to the extent the amount of the loss exceeds two lakh rupees, against income under the other head. (emphasis added)

The condition of claiming a set off of loss, not beyond two lakh rupees was challenged by the assessee before the Delhi High Court. 

Assessee’s Challenge 

The asssesee made the following main arguments in its attempt to assail the constitutional validity of Section 71(3A), IT Act, 1961: first, that that prior to the amendment assessee had an unhindered right to claim set of loss and promissory estoppel should be applied against the State since introduction of Section 71(3A) amounted to breach of a promise; second, the assessee claimed that the impugned sub-section created unreasonable restrictions on taxpayer rights and was violative of Art 14 and Art 19(1)(g) of the Constitution. 

The State’s arguments, in short, were that the Section 71(3A) was not a revenue harvesting measure but an anti-abuse provision. In the absence of an upper limit, high income taxpayers were paying huge amount as interest payments and setting off the same against incomes from other heads. 

High Court’s Analysis 

The Delhi High Court noted that as per the facts: when the assessee constructed his house in 2014, he was entitled to claim deductions – without an upper limit – on interest payments made for housing loan; but, from Assessment Year 2018-19, the deductions were limited to a maximum of Rs 2 lakhs. The introduction of the upper limit was challenged by the assessee as an unreasonable restriction on taxpayer rights. 

The Delhi High Court noted that assessee’s challenge to Section 71(3A) was founded on the impugned sub-section having a retroactive effect, i.e., applicability of a law/provision to a fact situation where assessee has vested rights. And a successful challenge to retrospectivity was only possible if a vested right of the assessee was disturbed by introduction of the impugned sub-section. The High Court noted that neither the previous nor the amended provision created an indefeasible right in the petitioner’s favor to set off the losses. (para 24) 

In the absence of a crystallised right, the Delhi High Court added, the assessee’s argument that impugned sub-section violates Article 14 does not hold water. The High Court’s reasoning was that the impugned sub-section does not take away the right of assessee to set off losses in toto, but only circumscribes it and imposes conditions. And further, a new class of taxpayers has not been created by the impugned provisions but only new conditions have been imposed on an existing class of taxpayers. Further, the State has provided a clear rationale for imposing the conditions, i.e., to prevent misuse of the provision by high-income taxpayers. Thus, the High Court concluded that the criteria of reasonable classification and intelligible differentia were met by the impugned sub-section and it was not violative of Article 14. The High Court added that the provision was not manifestly arbitrary either. Finally, the High Court also rejected the assessee’s challenge vis-à-vis Article 19(1)(g) and noted that the restriction was proportional and reasonable and not in violation of the assessee’s right to do business. 

Conclusion 

The assessee’s case that a vested right has been taken away by a retroactive amendment to Section 71 did not have much traction to begin with. The legislature has the discretion to limit the tax benefits, in this case, the deductions were restricted to a certain amount to prevent certain high-income taxpayers from misusing the provision. While the introduction of said limit also affected taxpayers such as the assessee in this case, it was still not a right of the assessee to claim such a deduction. The mere fact that the assessee could claim the deduction without any limit from 2014 until 2018, was not enough for it to claim a vested right for such deductions. And the Delhi High Court correctly dismissed the claim of violation of Article 14 and Art 19(1)(g) of the Constitution.     

Taxation of Perquisites: SC Rules on Constitutionality

by

Challenge 

In a recent judgment, the Supreme Court ruled on constitutionality of Section 17(2)(viii), IT Act, 1961 and Rule 3(7)(i), IT Rules, 1962 which include concession loans under perquisites and provided for their valuation respectively.  

Section 17(2) defines perquisites to include various perks under different clauses. Section 17(2)(viii) is a residuary clause which empowers the executive to include other perks and uses the phrase: ‘as may be prescribed’. Rule 3, IT Rules, 1962 prescribes the additional amenities and benefits that are taxable as perquisites. Rule 3(7)(i) provides that interest-free/concessional loans provided by a bank to its employees are taxable as fringe benefits or amenities if the interest charged on such loans is less than the Prime Lending Rate charged by the State Bank of India. 

Both the provisions – Section 17(2)(viii), IT Act, 1961 and Rule 3(7)(i), IT Rules, 1962 – were challenged on the ground of excessive and unguided delegation of essential legislative function to the Central Board of Direct Taxes (‘CBDT’). Rule 3(7)(i) was also challenged for being arbitrary as it made the Prime lending Rate charged by the SBI as the benchmark lending rate. 

SC Decides: Not Unconstitutional

Supreme Court examined the scope of Section 17 and noted that while the various clauses had included different kinds of perquisites in its scope, clause (viii) as a residuary clause had deliberately left it to the rule making authority to tax ‘any other fringe benefit or amenity’ by promulgating a rule. And it was in exercise of this power that Rule 3(7)(i) of IT Rules, 1962 was enacted. The effect of the Rule was two-fold: first, interest-free/concession loans were included in the definition of perquisite; second, the valuation rule suggested that the value of loan was to be calculated as per the Prime Lending Rate charged by the State Bank of India. 

The Supreme Court elaborated on the meaning of the term perquisite and noted that it should be assigned the meaning as in common parlance. It also cited a few judicial decisions and held that perquisite can be understood to mean a privilege or gain related to employment. And based on this understanding a concessional/interest-free loan will certainly qualify as a perquisite. (para 19) 

The other questions were whether Section 17(2)(viii) read with Rule 3(7)(i) led to delegation of essential legislative function. Relying on Birla, Cotton, Spinning and Weaving Mills case, the Supreme Court noted that essential delegated legislative function means the determination of legislative policy. And that as per relevant judicial precedents, allowing executive freedom to determine whom to tax and finalizing tax rates was not delegation of essential legislative function. In the impugned case, the Supreme Court observed that the legislative policy was encoded in Section 17, and the rule making power was not boundless. The rule making body under Section 17(2)(viii) was bound to include only a perquisite within the ambit of taxation. And it was in pursuance of the policy provided in the main legislation, that Rule 3(7)(i) makes an interest-free/concession loan taxable. 

Supreme Court cited a bunch of judicial precedents where Courts have held that a delegated legislation is not unconstitutional if the essential legislative function is not delegated. And it concluded:

We are of the opinion that the enactment of subordinate legislation for levying tax on interest free/concessional loans as a fringe benefit is within the rule- making power under Section 17(2)(viii) of the Act. Section 17(2)(viii) itself, and the enactment of Rule 3(7)(i) is not a case of excessive delegation and falls within the parameters of permissible delegation. Section 17(2) clearly delineates the legislative policy and lays down standards for the rule-making authority. (para 31) 

The Supreme Court was right in stating that the essential legislative function was not delegated by Section 17(2)(viii) as perquisite was defined, and the phrase ‘as may be prescribed’ was to be interpreted in the context of the preceding clauses and was not unregulated for the executive to include any benefits within the meaning of perquisite. And an interest-free loan/concession loan was certainly a perquisite as per common understanding of the term.  

Rule 3(7)(i), IT Rules, 1962: Not Arbitrary 

The final question that the Supreme Court had to decide was whether Rule 3(7)(i), IT Rules, 1962 was arbitrary because it used the Prime Lending Rate by State Bank of India as the benchmark in comparison to the rate of interest charged by other banks. (paras 32-34) While the Supreme Court did not articulate the argument of petitioner’s in full, it seems the petitioner wanted the interest rates of their banks to be the benchmark instead of the interest rate of one bank of which many may not be employees. The Supreme Court decided this question in favor of the State and held that using the SBI interest rate as benchmark was neither arbitrary nor unequal exercise of power. The Supreme Court’s conclusion rested on two reasons: first, that benchmarking all concession/interest-free loans ensured consistency in application and provided certainty on the amount to be taxed. And tax efficiency was promoted through certainty and simplicity; second, that in matters of taxation law the legislature deserves a wider latitude since taxation law deal with complex and contingent issues. 

Both the above reasons are not beyond reproach, but the latter certainly has acquired a cult-like status in cases involving challenges to constitutionality of provisions of a tax statute. The assumption that tax laws are complex is a half-truth as taxation laws do try to address multi-faceted problems, but not every tax provision is ‘complex’ for it to warrant a hands-off approach by the judiciary. Also, I would suggest that ‘complexity’ is a feature of most laws in today’s complex regulatory and economic law environment. Thus, there is a danger of courts not scrutinizing taxation laws/provisions adequately before dismissing challenges to their constitutionality. Perhaps the doctrine of wide leeway to legislature in matters of tax law needs a small course correction and a rescrutiny of its rationale. 

Not Providing Opportunity of Being Heard Vitiates Order Imposing Penalty: Raj HC

by

In a recent decision, the Rajasthan High Court held that the petitioner’s representation – filed under Section 270AA, IT Act, 1961 – for waiving the penalty imposed under Section 270A, IT Act, 1961 was wrongly rejected without providing an opportunity of being heard. And since the impugned orders did not specifically state which sub-clause of Section 270A(9) of IT Act, 1961 are attracted in the case, the orders are quashed and set aside. It is pertinent to briefly mention the provisions in question here: under Section 270A an assessee may have to pay penalty for misreporting or under-reporting an income, but under Section 270AA, the assessee can file an application for waiver of or immunity from penalty. However, as per Proviso to Section 270AA(4) an order rejecting the application of immunity cannot be passed without providing the assessee an opportunity of being heard.  

Facts 

For the Assessment Year 2018-19, the petitioner filed its original return of income on 30.11.2018 and the revised return on 29.03.2019. The petitioner’s case was listed for scrutiny and an exhaustive list of issues were communicated by various notices to which the petitioner replied. During the scrutiny proceedings, the petitioner realized that it had made a provision for ‘doubtful GST ITC’ of Rs 16,30,91,496/- and had mistakenly claimed it as an expense. The said amount was suo motu surrendered by the petitioner and was added to the total income. The said amount was added to the petitioner’s total income via an assessment order but the said order also imposed a penalty on the petitioner under Section 270A for misreporting income. 

The petitioner’s application under Section 270AA against the penalty order was rejected by the Deputy Commissioner. The petitioner’s revision application under Section 264 challenging the rejection was also rejected. The petitioner’s case was that no opportunity of being heard was provided to it which was in non-compliance of Section 270AA and neither did the order specify as to how it misreported the income. 

Against the said rejections, the petitioner approached the Rajasthan High Court via a writ petition. 

Arguments 

The petitioner argued that it had filed an application against imposition of penalty under Section 270AA and the Proviso to Section 270AA(4) clearly states that an order rejecting the petitioner’s application cannot be passed without providing it an opportunity of being heard. The petitioner further assailed the Deputy Commissioner’s order on the ground that it was a one-line non-speaking order. And also that the order of revisional authority instead of correcting the flaws in the Deputy Commissioner’s order stated that the petitioner’s order fell within the ambit of Section 270A(9) clause (a) or (c). While clause (a) mentions misrepresentation of facts, clause (c) mentions claims of expenditure not substantiated by evidence. The petitioner argued that it was never specified in either of the orders how its case was covered by either of the two clauses since it voluntarily offered the amount for taxation by revising its income. 

The Income Tax Department argued that the case was a clear case of misrepresentation and suppression of income since the petitioner had merged doubtful ITC for GST with its expense account. And that the revisional authority had correctly and specifically pointed that the petitioner’s case was covered by clause (a) and (c) of Section 270(9) of the IT Act, 1961. Thus, there was no need or ground for Court’s interference with the orders of the Deputy Commissioner and the revisional authority. 

Decision Favors Assessee 

The Rajasthan High Court accepted the petitioner’s arguments and decided that the orders of the income tax authorities should be quashed and were liable to be set aside. The High Court’s conclusion was based on three major reasons: 

First, the High Court observed that it was undisputed that the amount in question had been offered by the petitioner for taxation voluntarily and was not discovered by the Income Tax Department during the scrutiny proceedings. 

Second, the High Court noted that under Section 270AA(3) an assessing authority can grant an assessee immunity from penalty sought to be imposed under Section 270A, but the Proviso to Section 270AA(4) makes it clear that an order rejecting the assessee’s application for immunity cannot be passed without providing an opportunity of being heard. And while in the impugned case the petitioner had sought personal hearing, no opportunity of being heard was provided. 

Third, the High Court noted that the order of the Deputy Commissioner was a non-speaking order, it had mechanically reiterated the provision of Section 270AA(3), and neither had it specifically stated under which sub-clause of Section 270AA(9) was the case covered. The High Court was particularly harsh about the order of the revisional authority and noted that: 

The revisional authority apparently did not consider the fact that the petitioner was not afforded opportunity of hearing in violation of provisions of proviso to Section 270AA (4) and that the order impugned before it was wholly non-speaking and attempted to justify imposition of penalty under Section 270A (9) (a) and (c). The very fact that the indications were made that the matter fall within (a) and (c), necessarily means that even the revisional authority was not sure whether it was a case of misrepresentation or suppression of facts or claim of expense, not substantiated by any evidence. (para 20) 

Since the orders were in violation of the provisions in question, were vague and the income tax authorities did not provide an opportunity of being heard to the petitioner, they were set aside and quashed by the High Court with the directions that the petitioner be provided immunity under Section 270AA. 

Conclusion 

The Rajasthan High Court’s decision duly appreciated the facts in question and interpreted the relevant provisions prudently. The degree of specificity expected from the income tax authorities was also clearly articulated. While the Income Tax Department argued that identification of two sub-clauses, either of which could cover the case was a specific identification of the provision in question, the High Court rightly interpreted the same to be vague.    

Delhi HC Disallows Disclosure of PM Cares Fund Documents Under RTI Act, 2005

by

The Delhi High Court in a recent judgment allowed the Income Tax Department’s appeal against the Central Information Commission’s (‘CIC’) order directing the respondent be provided copies of all documents submitted by PM Cares Fund to obtain exemption under Section 80G of the IT Act, 1961. The Delhi High Court’s main reason was that the IT Act, 1961 was a special legislation vis-à-vis the RTI Act, 2005 and provisions of former would prevail in matters relating to disclosure of information of an assessee. The High Court concluded that information relating to an assessee can only be disclosed by the authorities prescribed under Section 138 of IT Act, 1961 and CIC does not have jurisdiction to direct furnishing of information of an assessee. 

Brief Facts 

PM Cares Fund is a charitable fund which was established to provide relief to the public during COVID-19 and other similar emergencies. The Income Tax Department had granted exemption to PM Cares Fund under Section 80G of the IT Act, 1961 on 27.03.2020. The respondent wanted to know the exact procedure followed by the Income Tax Department in granting a swift approval to the PM Cares Fund and whether any rules or procedure were bypassed by the Income Tax Department in granting the approval. On 27.04.2022, the CIC via its order had directed that the respondent be provided copies of all the documents submitted by PM Cares Fund in its exemption application and copies of file notings approving the application. The Income Tax Department approached the Delhi High Court challenging the CIC’s order. 

The Income Tax Department’s primary contentions were that information of an assessee relating to income tax can only be sought under Section 138, IT Act, 1961 and not RTI Act, 2005. And that information sought by the respondent is exempt under Section 8(1)(j) of RTI Act, 2005, i.e., it is personal information, and further that CIC could not have directed disclosure of information without providing an opportunity of hearing to PM Cares Fund. (para 2-5)

The respondent, on the other hand, argued that the non-obstante clause in Section 22, RTI Act, 2005 ensures that it will have an over-riding effect over other statutes for the time being in force. Further that if there are two methods for obtaining information, there was no bar in seeking information under either of the methods. The respondent also argued that the bar of Section 8(1)(j) would not apply as the information sought is not personal information but there is an overriding public interest in disclosing the information. (para 6)    

Reasoning and Decision     

The Delhi High Court’s primary reasoning related to the ‘inconsistency’ between the IT Act, 1961 and RTI Act, 2005 due to non-obstante clauses contained in both the statutes. It is apposite to cite Section 138 in entirety to analyse the the Delhi High Court’s reasoning.

138. (1)(a) The Board or any other income-tax authority specified by it by a general or special order in this behalf may furnish or cause to be furnished to—

  (i) any officer, authority or body performing any functions under any law relating to the imposition of any tax, duty or cess, or to dealings in foreign exchange as defined in clause (n) of section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999); or

 (ii) such officer, authority or body performing functions under any other law as the Central Government may, if in its opinion it is necessary so to do in the public interest, specify by notification in the Official Gazette in this behalf,

any such information received or obtained by any income-tax authority in the performance of his functions under this Act, as may, in the opinion of the Board or other income-tax authority, be necessary for the purpose of enabling the officer, authority or body to perform his or its functions under that law.

(b) Where a person makes an application to the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner in the prescribed form48 for any information relating to any assessee received or obtained by any income-tax authority in the performance of his functions under this Act, the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner may, if he is satisfied that it is in the public interest so to do, furnish or cause to be furnished the information asked for and his decision in this behalf shall be final and shall not be called in question in any court of law.

(2) Notwithstanding anything contained in sub-section (1) or any other law for the time being in force, the Central Government may, having regard to the practices and usages customary or any other relevant factors, by order notified in the Official Gazette, direct that no information or document shall be furnished or produced by a public servant in respect of such matters relating to such class of assessees or except to such authorities as may be specified in the order. (emphasis added)

The non-obstante clause of RTI Act, 2005, contained in Section 22, states as follows: 

The provisions of this Act shall have effect notwithstanding anything inconsistent therewith contained in the Official Secrets Act, 1923 (19 of 1923), and any other law for the time being in force or in any instrument having effect by virtue of any law other than this Act. (emphasis added)

In my view, the Delhi High Court’s framing of the issue – non-obstante clauses in IT Act, 1961 and RTI Act, 2005 are inconsistent and seemingly in conflict with each other – is erroneous. The non-obstante clause of Section 138(2), IT Act, 1961 overrides only Section 138(1) while Section 22, RTI Act, 2005 overrides every other law for the time being in force. Section 138(2) empowers the Central Government, by an order notified in the Official Gazette, to circumscribe or prevent powers of officers to disclose information under Section 138(1). Section 138(2) cannot be read so say that IT Act, 1961 will override all other laws in matters relating to disclosure of information relating to an assessee. In fact, it is Section 22 of RTI Act, 2005 which states that it will override all other statutes. While both provisions use non-obstante clauses, their scope and effect is different and there is no direct conflict of the manner suggested by the High Court.   

By framing the issue as that of ‘conflict’ of two non-obstante clauses, the Delhi High Court then had to necessarily answer as to which Act would prevail. The High Court was of the opinion that IT Act, 1961 is a special legislation governing all provisions and laws relating to income tax and super tax in the country. While RTI Act, 2005 is a general legislation to enable citizens to exercise and enable their right to information. The High Court did not give too much importance to the dictum that latter legislation prevails over the earlier legislation. The High Court opined that the date on which statutes come into force cannot be the sole deciding factor in determining the application and overriding effect of a legislation, and that in its opinion it is more important that the special legislation, i.e., IT Act, 1961 should prevail over the general legislation, i.e., RTI Act, 2005. Which factors need to be accorded more importance is of course is the discretion of the judges. In this case, the High Court was of the view that the dictum of special legislation should prevail general legislation is of primary importance; the question though arises is: is it a straightforward answer that IT Act, 1961 is a special legislation and RTI Act, 2005 a general legislation? 

The Delhi High Court cited some precedents to this effect which have held that whether a statute is a general or special statute depends on the principal subject-matter and particular perspective. And a legislation can be a general legislation for one subject matter and a special legislation for others. For example – and as cited by the High Court in its judgment – in LIC v DJ Bahadur case, Supreme Court had observed that in matters of nationalisation of LIC the LIC Act is the principal legislation while in matters of employer-employee dispute, the Industrial Disputes Act, 1948 is the principal legislation. Applying this dictum, the High Court made a defensible conclusion that in matters relating to disclosure of information of assessees relating to income tax, IT Act, 1961 is the principal legislation while RTI Act, 2005 is the general legislation.

Finally, the Delhi High Court made another observation that, in my view, is not an accurate reading of Section 138. After noting that Section 138, IT Act, 1961 provides a special procedure for disclosure of information, the High Court observed: 

Applying the said analogy to the facts of the present case, Section 138(1)(b) of the IT Act which specifically states that information relating to an assessee can only be supplied subject to the satisfaction of Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner, as the case may be, would prevail over Section 22 of the RTI Act. (emphasis added) (para 18) 

The inaccuracy of the Delhi High Court’s observation is in supplying the word ‘only’ to Section 138. It is trite that in tax jurisprudence, that provisions of a tax statute are to be construed strictly. And strict interpretation of provisions of a tax statute requires that a provision be read as is, without adding or subtracting any words from it. The Delhi High Court in adding the word ‘only’ to Section 138 (1)(b) departed from the doctrine of strict interpretation of tax statutes and for no good reason. The observation that a special legislation – IT Act, 1961 –  prevails over the general legislation – RTI Act, 2005 – cannot form basis of the conclusion that information can ‘only’ be provided under the special statute. A bare reading of Section 138 does not support the High Court’s interpretation.  

Conclusion 

The Delhi High Court’s observations in the impugned case are on shaky grounds. The only defensible part of the judgment is that a special statute prevails over a general statute, but as I argue that issue only arises because the High Court erred in framing the headline issue as that of conflict of non-obstante clauses, when the non-obstante clauses in question have differing scopes and do not necessarily clash. The result is that PM Cares Fund continues to enjoy a certain level of opaqueness that is, in my view, not in public interest. And for the meanwhile, Delhi High Court’s deficient reasoning has provided the opaqueness a convenient legal cover.

Fee Attributable to Transmission of Non-Live Feed Not Royalty: Delhi HC

by

The Delhi High Court in a recent decision[1] held that the fee attributable to ‘non-live’ feed cannot be categorized as royalty under Section 9(1)(vi) of the IT Act, 1961. The High Court relied on the observations in Delhi Race Club case to support its conclusions. 

Facts 

The assessee entered into a tripartite agreement – titled as the ‘Novation Agreement’ – with ESS Singapore and Star India Private Limited by way of which various existing agreements regulating distribution of channels, ads, etc. came to be novated. For the Assessment Year 2015-16, the assessee offered an amount of Rs 65,44,67,199/- as royalty income subject to tax under Section 9(1)(vi) of the IT Act, 1961. The Assessing Officer questioned the assessee as to why out of total income of Rs 1181.63 crores only Rs 65,44,67,199/- was offered for taxation as royalty. The assessee replied that only the income attributable to ‘non-live’ feed was taxable as royalty while the income attributable to ‘live’ feed would not fall within the ambit of royalty as contemplated under Section 9(1)(vi). 

The ITAT noted that in the agreement, under the head of ‘consideration’ the parties acknowledge and agree that 95% of the commercial fee is attributable to live feed and 5% to the non-live feed. The ITAT concluded that the fee from non-live feed would not be covered within the ambit of royalty. The ITAT’s view was assailed by the Revenue before the Delhi High Court. 

Arguments and Decision 

The arguments were straightforward with the Revenue contending that the fee from ‘non-live feed’ was covered within the scope of royalty under Explanation 2 of Section 9(1)(vi) of the IT Act, 1961.  The assessee contended otherwise, primarily relying on, Delhi Race Club case ratio. 

The Delhi High Court cited the ratio of Delhi Race Club case where it was held that live telecast/broadcast is not a work under Section 2(y) of the Copyright Act and thus a live telecast/broadcast would have no copyright. The Delhi High Court in the Delhi Race Club case held that copyright and broadcast reproduction rights are two separate rights and the two rights though akin are nevertheless separate and distinct. Expressing its concurrence with the ratio of Delhi Race Club case, the Delhi High Court in the impugned case observed that: 

In light of the unequivocal conclusions as expressed by the Division Bench in Delhi Race Club and with which we concur, we find that once the Court came to the conclusion that a live telecast would not fall within the ambit of the expression „work‟, it would be wholly erroneous to hold that the income derived by the assessee in respect of „live feed‟ would fall within clause (v) of Explanation 2 to S.9(1)(vi) of the Act. (para 10)

The Delhi High Court in the impugned case was correct and prudently followed the well-reasoned ratio of Delhi Race Club case. The Revenue in an attempt to bring fee from ‘live’ feed within the ambit of royatly, in the impugned case, also sought to place assessee’s income under Explanation 6 to Section 9(1)(vi) which states as follows: 

            … the expression “process” includes and shall be deemed to have always included transmission by satellite (including uplinking, amplification, conversion or down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret;

The Delhi High Court correctly rejected the Revenue’s argument noting that Explanation hinges on transmission being via satellite while in the impugned case the transmission happened via SIPL. 

Conclusion 

The Delhi High Court made additional observations on the relationship of international tax law and domestic law and how the former overrides the later. (paras 15-17) From the judgment and the arguments reproduced in the judgment, the context and relevance of international tax law is not entirely clear. Most likely, the High Court was trying to underline that the definition of royalty under the IT Act, 1961 can be amended by the legislature, but if the definition of royalty in the applicable Double Taxation Avoidance Agreement is more beneficial to the assessee it would apply. Or that the definition in an international agreement cannot be negated via domestic actions alone. Nonetheless, the relevance of the High Court’s observations on international tax law are not immediately apparent.   

[1] The Commissioner of Income Tax, International Taxation v Fox Network Group Singapore PTE Ltd TS-28-HC-2024DEL

Section 194N of IT Act, 1961 is Constitutional: Madras HC

by

The Madras High Court recently[1] upheld constitutionality of Section 194N of the IT Act, 1961. Section 194N inserted via Finance Act, 2019 was argued by the petitioners to be unconstitutional on the grounds of it being illegal, arbitrary, and violative of their fundamental rights under Article 14 and 19(1)(g) of the Constitution. Section 194N imposes an obligation on the banks including co-operative societies carrying on banking – when paying any sum exceeding one crore rupees, increased to three crores in 2023 – to withhold a tax of 2% of the amount. The petitioner’s main argument that the amount withdrawn by co-operative societies was not income was rejected by the Madras High Court. 

Facts and Arguments 

The petitioner, a licensed bank, maintained accounts of co-operative societies. All the account holders were registered under the Tamil Nadu Co-operative Societies Act, 1963. When loans were sought by members of the societies, petitioner used to grant a loan via banking channels to the members. If a member did not have a bank account, the petitioner used to transfer the money to current account of the society for onward disbursement to the farmers. The societies would withdraw the cash and disburse it to the farmers. The petitioner stated that it was used a conduit between the State on one hand and societies on the other to transfer various kinds of cash support to farmers including crop loans and other gifts. 

The main argument of the petitioner was that the withdrawal of money by the co-operative society was intended to be forwarded to the farmers. And that the money did not constitute income of the society. And neither was the money income in the hands of recipients since they were gifts or monetary assistance provided by the State. When the petitioner was issued a showcause notice for non-compliance with Section 194N, it replied that the provision is arbitrary and withdrawal of cash cannot be regulated in a manner proposed under Section 194N. The petitioner argued that the tax withholding provisions under Chapter XVIIB were intended to be applicable only to receipts which constituted income in the hands of the recipient. The petitioner assailed the provision as being unreasonable and that its stated aim of promoting digital payments was immaterial in determining the reasonableness of the provision. 

Curiously, the petitioner also argued that a new charge was created via Section 194N and equated Section 194N to a charging provision, questioned its placement under the Chapter XVIIB of the IT Act, 1961 and termed it ‘eccentric’. (para 19)

The State, on the other hand, emphasised the objective of the provision, i.e., to promote digital payments. The State underlined its aim of creating an economy that was robust and cashless, as far as possible. And that the cash withdrawals in the co-operative banks were fraught with irregularities that led to a large portion of income escaping the tax net. (paras 31-36)      

Decision  

The Madras High Court did not engage with the petitioner’s main argument in a straightforward manner. It instead cited precedents to observe that the use of the word ‘sum’ instead of ‘income’ in Section 194N does not advance the petitioner’s case that the rigours of the provision would only apply if receipt constitutes taxable income in the hands of the recipient. The High Court referred to various provisions relating to withholding tax in Chapter XVII and the varied terminology used in them such as sum, amount, income and noted that the used of the terminology is not conclusive to establish if tax needs to be deducted at source. In fact, the High Court placed greater emphasis on the intent and objective and noted that the intent of the provision is equally crucial to interpret the terms used in the provision. (paras 39-51)     

Next, the Madras High Court relied on some relevant precedents to negate petitioner’s argument that Section 194N was a charging provision. The High Court held that the impugned provision was clearly a machinery provision. The High Court further observed that the objective of preventing cash withdrawals from escaping tax net and promoting a digital economy were intended to be achieved through Section 194N and the legality of the provision cannot be argued to be fatal based on its placement under the IT Act, 1961. 

Further, the Madras High Court relied on facts to reject the petitioner’s other argument, i.e., cash withdrawal was not income for the society. The High Court observed that there is nothing on record to show the entirety of the amount is further disbursed to the recipients of State’s cash assistance and other income support schemes. The High Court noted that one of petitioner’s argument was that the gifts were not taxable in the hands of the intended beneficiaries, and thus there was no need to deduct tax at source. But the High Court observed, the bank was not aware of the purpose at the time of withdrawal and that in many instances the withdrawal amount was more than the intended gift amounts for the beneficiaries.  

Another provision, that the High Court referred to was Section 197, IT Act, 1961 which allows a payee to obtain a nil certificate on the ground that the receipt is not amenable to tax. Section 197 did not include situations incorporated in Section 194N, meaning that the petitioner could not the option provided to other payees under Section 197. (paras 73-75) While the petitioner did not have the remedy under Section 197, it could invoke Section 194N itself wherein the Central Government in consultation with RBI is empowered to issue a Notification enlisting the recipients to whom rigour of Section 194N would not apply. The High Court noted that since such a Notification has already been issued in favor of certain recipients, the proper remedy for the petitioner is to approach the Central Govt seeking an exemption rather than make a claim that the receipts in the form of cash withdrawals from banks are not taxable. The High Court was indirectly hinting that the petitioner did not make a wise decision to not comply with its statutory obligations provided in Section 194N. (paras 77-78)   

Decision 

The impugned decision stands on defensible if not impeccable reasoning. The High Court sufficiently emphasised the intent for introduction of Section 194N and noted that machinery provisions can be introduced to meet social objectives such as expansion of tax base and introduce transparency in the fiscal economy. The High Court referred to legislative intent to highlight that machinery provisions while not charging provisions can mandate deduction of tax on withdrawal of money even if the money is not income in the hands of the recipient. But, the High Court was unable to provide a clear and articulate reasoning as to why legislative intent should override every other consideration while interpreting a statutory provision. 

[1] The Income Tax Officer, Tiruchirappalli v M/s. The Thanjavur District Central Co-operative Bank Ltd TS-821-HC-2023MAD.  

Employment Includes Self-Employment: ITAT Interprets Section 6, IT Act, 1961

by

ITAT, Mumbai recently[1] interpreted the term ‘employment’ used in Explanation 1(a), Section 6, IT Act, 1961 and held that the term includes within its remit self-employment such as business or profession. ITAT relied on CBDT’s Circular and the Kerala High Court’s decision on a similar issue which also held that the term employment includes self-employment.  

Facts 

In the impugned case, assessee filed his return on 28.01.2020 and claimed his status as ‘non-resident’ for the assessment year and did not offer his global income for taxation. The Assessing Officer (‘AO’) observed that the assessee had left for Mauritius as an investor on a business visa and not for the purpose of employment and could not avail the benefit of Explanation 1(a). 

Section 6(1) inter alia states that an individual is resident in India if he is in India for 365 days in the four years preceding the relevant previous year and is in India for a period or periods amounting to 60 days in the previous year. Explanation 1(a) to Section 6(1) states that an individual being a citizen of India, who leaves India in any previous year ‘for the purpose of employment outside India’, 60 days shall be read as 182 days. In simple terms, the Explanation alters the residence condition of 365+60 days to 365+182 days for an Indian citizen who leaves India for purpose of employment. A person who leaves abroad for purpose of employment has can spend more time in India before being considered a resident.  

In the impugned case, the AO was arguing that the assessee’s case was covered within the general rule of 365+60 days since he did not leave for employment outside India but as an investor on a business visa. While the asssessee argued that his case was covered by the 365+182 days condition since he left for Mauritius as a consultant to a company. Since the assessee had spent 176 days in India, determining the applicable condition was crucial to answering the residential status of the assessee. The ITAT had to determine if an assessee leaves India not for employment, but self-employment, can it be granted the benefit of the relaxed condition of 365+182 days. 

Decision 

ITAT primarily relied on the CBDT Circular and the Kerala High Court’s decision to conclude that the term employment cannot be given technical meaning and employment would include going aboard for any avocation including self-employment such as business or profession. The qualifier is that the term employment did not include visits abroad for tourism purposes or medical treatment or the like. ITAT and the Kerala High Court’s decision align closely with CBDT’s explanation as to why the relaxation in the residency test was introduced. As per CBDT’s Circular the residency test was modified to avoid hardship to Indian citizens who were employed or ‘engaged in other avocations outside India’. (para 7.3) It is apparent that relaxation in the residency test introduced via Explanation 1(a) was not limited to only employed persons but also any Indian citizen carrying out any avocation outside India. 

Conclusion 

ITAT Mumbai’s decision in the impugned case is the correct interpretation of the law and arrives at a fair conclusion ensuring parity between people who leave India for the purposes of employment and people who leave India for business purposes. Hopefully, the AO in the impugned case and other similar cases will adhere to this interpretation of the law and scrutinize assessments accordingly.     

[1] Asst Commissioner of Income Tax v Shri Nishant Kanodia TS-11-ITAT-2024 Mum.

Issuance of Share Capital Not Taxable: Delhi High Court cites Precedents

by

The Delhi High Court recently pronounced a decision[1] wherein it adhered to the ratio of Vodafone and Nestlecases that investment by a foreign company via shares in its Indian subsidiary company is not income of the latter and not taxable under IT Act, 1961. The High Court relied on the Press Release by the Union of India indicating its approval of the former case and set aside the notices and subsequent orders issued in the impugned case under Section 148, IT Act, 1961. 

Facts 

The Delhi High Court was deciding a bunch of appeals together, and briefly elaborated on facts of one of the cases. The High Court elaborated that the petitioner was foreign company, resident in Italy, and subscribed to shares of its Indian subsidiary company. The petitioner subscribed to 15,00,000 shares at a face value of Rs 10 each and made a foreign remittance of Rs 1,50,00,000. The petitioner stated that since it did not earn any income from any source in India, it did not file any income tax returns in India. The Income Tax Department issued notices under Section 148(b) and passed orders under Section 148(d) of the IT Act, 1961 alleging that income had escaped the assessment. The petitioners challenged the said notice and orders and all the consequent actions taken therein. The petitioners assailed the allegations of money laundering and round tripping arguing that the notices did not mention the name of the company whose shares were bought and the Income Tax Department was merely trying to verify the transaction in question and was unable to substantiate any of its allegations.  

The Income Tax Department justified its actions by referring to risk management strategy. Explanation 1 of Section 148 states that the information with the Assessing Officer which suggests that income chargeable to tax has escaped assessment means any information flagged in accordance with the risk management strategy formulated by CBDT. The petitioners challenged the constitutional validity of the Explanation as well.  

Decision 

The Delhi High Court primarily relied on Vodafone and Nestle decisions to agree with the petitioners that the transactions in questions were capital account transactions that were incapable of generating any income. And in the absence of income, IT Act, 1961 cannot be invoked. To recall briefly, the Vodafone case involved issuance of shares by an Indian subsidiary company to its foreign holding company. The Assessing Officer disagreed on the valuation and opined that the shares should have been valued on the higher side. The difference between the share price arrived at by the companies and the higher price arrived by the AO was treated as ‘income foregone’ by the Indian subsidiary company. Accordingly, transfer pricing adjustment was made to tax the income foregone as a loan granted by the subsidiary company to its holding company. The Bombay High Court decided that the transaction could not be taxed under IT Act, 1961 reasoning that Chapter X of IT Act, 1961 – encompassing transfer pricing provisions – was incorporated to prevent underreporting of profits and overreporting of losses – and not to levy tax on capital receipts when there was no express provision to levy tax on such capital receipts. 

The Delhi High Court in the impugned case expressed complete concurrence with the Bombay High Court and cited the subsequent acceptance of the Bombay High Court’s decision by the Union of India. In the impugned case, the High Court accordingly set aside the notice and orders issued under Section 148, IT Act, 1961. 

Conclusion 

The Delhi High Court’s decision is, apart from the Nestle case, another instance where the Bombay High Court’s approach in the Vodafone case has received approval and rightly so. The High Court correctly cited the relevant precedents to arrive at its conclusion. Finally, though the petitioners challenged the constitutional validity of Explanation 1 to Section 148, the High Court left the question open. The issue may rear its head in another instance where the concerned Court may find it appropriate to pronounce a decision on the same.     

[1] Ms/ Angeltantoni Test Technologies SRL v Assistant Commissioner of Income Tax, Circle Intl Tax TS-804-HC-2023-DEL

LinkedIn