Bombay High Court

When A Princess Worried About Tax on Alimony

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All things in life have a tax angle, including alimony payments. In this article I elaborate on tax treatment of alimony payments under the Income Tax Act, 1961 (‘IT Act, 1961’). Upfront, these are the three takeaways from this article: 

first, a lump sum payment of alimony amount is not taxable in the hands of recipient, since it is a capital receipt.

second, the monthly payment of alimony amount is taxable in the hands of recipient, since it is an income from a particular source. 

third, the payer receives no tax deductions for alimony payments, even if the payments are made under a decree of court. 

The law on all three above aspects was laid down by the Bombay High Court in Princess Maheshwari of Pratapgarh v Commissioner of Income Tax. This case is the focus of my article below. 

Decree of Nullity Sprouts Tax Questions  

(i) Decree of Nullity of Marriage 

In September 1963, Princess Maheshwari Devi of Pratapgarh obtained a decree of nullity of her marriage with Maharaja of Kotah. The Bombay City Civil Court (‘civil court’) pronounced the decree of nullity under Section 25, Hindu Marriage Act, 1955. As part of the proceedings, the Princess had claimed monthly alimony and a gross sum as permanent alimony from the Maharaja. The Civil Court ordered the Maharaja to pay the Princess an amount of Rs 25,000 as permanent lump sum alimony and a sum of Rs 750 per month as monthly alimony. The Maharaja was obligated to pay the latter until her remarriage, if and when, it took place.    

(ii) Two Tax Questions 

I will spare you details of assessment years and focus on the broader issue: the Princess claimed tax exemption on the lump sum alimony amount as well as the monthly alimony amounts. Her claims were rejected by the Income Tax Office and Appellate Tribunal, and against the said decisions she appealed to the Bombay High Court.

The High Court had to answer two questions: 

First, whether the monthly alimony of Rs 750 was income in hands of the Princess and liable to tax? 

Second, whether the lump sum alimony of Rs 25,000 was income in hands of the Princess and liable to tax? 

The framing of questions is crucial, from an income tax viewpoint. A receipt of money is only taxable if it constitutes ‘income’ as defined under the Income Tax Act, 1961 (‘IT Act, 1961’). Else the receipt falls outside the ambit of IT Act, 1961 though given the current and expansive definition of income, rarely if ever is a receipt of money not subjected to income tax. 

Monthly Alimony is Taxable in Hands of Princess  

The Bombay High Court answered the first question in favor of the Income Tax Department and held that the monthly alimony payment to the Princess constituted her income and was taxable in her hands. The arguments from both sides were as follows.  

(i) Arguments 

The advocate for the Princess rested her case for tax exemption of the monthly alimony on various grounds. Some of them were: 

First, alimony is merely an extension of husband’s obligation to maintain his wife and Section 25, Hindu Marriage Act merely enlarges that obligation. The advocate was implying that the husband is obligated to maintain his wife, whether they continue to remain married or not.  

Second, the alimony payment to the Princess did not emerge from a definite or particular source and in fact, the payment would cease on her remarriage. 

Third, monthly alimony is a personal payment from her ex-husband and not a consideration for any services performed – past or future. 

The counsel for the State though argued that the decree of Civil Court had created a legal right in favor of the Princess. The right to receive a monthly alimony amount had a definite source, i.e., the decree of court, and should be taxed as income in hands of the Princess.   

(ii) High Court Applies the Law

The Bombay High Court scanned through the previous cases to state judicial understanding o the term ‘income’. For example, one notable case, the Privy Council had observed that income is something that is ‘coming in’ with some sort of regularity from a definite source. The High Court after scanning various other precedents, succinctly stated the judicial definition of income as: 

a periodical return for labour/skill that a person receives with some regularity, and from a definite source. But an income excludes a ‘windfall’ gain. 

The above definition would squarely cover a monthly alimony payment. The only point then in the Princess’s favor was her claim that the monthly alimony was not a result of application of any labour or skill on her part. But the High Court rejected this point and held that even voluntary payments can constitute income in hands of recipient if they come with regularity from a definite source. The High Court though further pointed out that the monthly alimony was paid to the Princess because of the civil court decree which was obtained by her by expending effort and labour. And the civil court decree is the source of her right to claim monthly alimony as minus the decree she would have no right to alimony. The High Court concluded: 

Although it is true that it could never be said that the assessee entered into the marriage with any view to get alimony, on the other hand, it cannot be deneid that the assessee consciously obtained the decree and obtaining the decree did involve some effort on the part of the assessee. The monthly alimony being a regular and periodical return from a definite source, being the decree, must be held to be “income” within the meaning of the said term in the said Act.

The monthly alimony amount was something the Princess would receive regularly because of the decree, because of her efforts to obtain to same from the civil court and thus it would constitute her income under IT Act, 1961 and be subjected to income tax. 

Lump Sum Amount Received as Alimony: Exempt from Tax  

As regards the taxability of lump sum amount of Rs 25,000 received as alimony, the Bombay High Court decided that it amounted to a capital receipt and was not taxable as income in the hands of the Princess. The High Court observed: 

It is not as if the payment of Rs. 25,000 can be looked upon as a commutation of any future monthly or annual payments because there was no pre-existing right in the assessee to obtain any monthly payment at all. Nor is there anything in the decree to indicate that Rs. 25,000 were paid in commutation of any right to any periodic payment. In these circumstances, in our view, the receipt of that amount must be looked upon as a capital receipt.

Capital receipt, in income tax law, is only taxable if there is an express charging provision in income tax law to that effect. Else, not. Only revenue receipt is charged to income tax by default. Thus, the above distinction of revenue and capital receipts was in favor of the Princess. Also, because the High Court took the view that the lump sum payment did not ‘commute’ any monthly or periodical payments that the Princess would have received since she had no pre-existing right to receive the monthly alimony payment. To be clear, the lump sum alimony amount could be taxable if it ‘commutes a part of the future alimony’. However, the High Court said there was nothing in the civil court decree that indicated that the lump sum amount commuted her monthly payments. At the same time, the High Court did acknowledge that ‘beyond doubt that had the amount of Rs. 25,000 not been awarded in a lump sum under the decree to the assessee, a larger monthly sum would have been awarded to her on account of alimony.’ Thus, leaving a window ajar to tax lumpsum alimony amounts in future cases.     

No Tax Deductions for Alimony Payments

The unfairness of IT Act, 1961 is that it does not allow deduction for alimony payments. Typically, husbands pay alimonies to their ex-wives. Presuming that the alimony payment is from a portion of husband’s already taxed income, such payment should ideally qualify for a deduction. It can be viewed as an expense. If not the entire amount, a deduction with an upper cap can be provided. And for monthly alimony payments anyways the wife is liable to pay income tax, so providing the husband income tax deduction on such payments may not be too harmful from a revenue perspective. Currently, the husband pays income tax on his income, pays a portion of such income as monthly alimony to his ex-wife, and the ex-wife is liable to income tax for the monthly alimony as it constitutes her income. A bountiful for the revenue, unless the spouses are smart and rich enough to agree only to a one-time alimony amount, circumventing the uneven tax consequences of IT Act, 1961.   

In fact, the Bombay High Court described the above position of law as ‘unfortunate’. It heeded the legislature to pay attention to this aspect and noted: 

It is clearly desirable that a suitable amendment should be considered to see that in cases where the payments of alimony are made by a husband from his income and are such that they cannot be claimed as deductions from the income of the husband, in the assessment of his income, they should not be taxed in the hands of the wife. That, however, is not for the courts but for the Legislature to consider.

The Bombay High Court made the above observations in 1982. Since the IT Act, 1961 has been amended several times to include various capital receipts within the realm of taxability. But not lump sum alimony payments categorized as capital receipts have not been made taxable. Neither have deductions on alimony payments been included. Our lawmakers seem busy ‘simplifying’ the income tax law, rather than introducing substantive and meaningful policy changes that acknowledge new social realities. 

Conclusion 

Neither the Income Tax Act, 1961 and unfortunately nor does the Income Tax Bill, 2025 provide a clear answer about taxability of alimony payments. Tax lawyers typically advice their clients based on above discussed judgment of the Bombay High Court. Any legislative clarity on this front seems a bit distant for now.    

Regardless, I would like to conclude with a normative question: 

Who SHOULD pay the tax on alimony payments? 

Depending on your gender biases, views on divorce, necessity of alimony payments, your perception of divorce settlements as fair or otherwise, your answers would vary. Typically, women receive alimony payments from their ex-husbands. And people who have strong and inflexible opinions that women use family laws as ‘get rich quick’ route are likely to argue that women should foot the tax bill on both kinds of alimony payments: made via lump sum amounts and/or on monthly basis. 

A tax law view would be to ask who benefits from the alimony payment? And who bears the burden? The latter should receive a deduction on the payment and the former should shoulder the tax liability. Irrespective of gender. I’m willing to go a step further and suggest that even if the alimony payment is not made because of a court order, but voluntarily as part of a valid contract, the above principles should apply. Taxability of alimony payments should not depend on whether court ordered it, or parties themselves agreed to it. IT Act, 1961 provides deductions to all kinds of voluntary contributions including to political parties, it is imperative that same principles apply to personal relationships if it ends with mutual consent – actual or perceived. We should stop hiding behind the argument that alimony payment is a personal obligation and thus does not qualify for deduction. Unless one entertains the far-fetched belief that providing such a deduction may further catalyze divorces.         

Finally, and just as a matter of abundant caution I would like to add that transfer of various assets – jewelry, house, etc. – between two spouses can and do happen when they are still legally married and sometimes after the marriage has legally ended. The transfers of such assets attract different tax liabilities and warrant a separate discussion.  

Intersection of Trusts, DTAAs, and IT Act, 1961: Profile of ADIA Case

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Abu Dhabi Investment Authority (‘ADIA’) is currently embroiled in a tax dispute in India that involves questions about its eligibility to claim tax benefit under India-UAE DTAA, recognition of foreign trusts in India, and interpretation of provisions of IT Act, 1961 on taxability of revocable trusts and their representative assessees. The Bombay High Court, in October 2021, held that ADIA was entitled to avail the tax exemption under India-UAE DTAA despite ADIA making the investments and earning income through a trust registered in Jersey. The High Court held that AAR’s ruling – against which an appeal was filed before the High Court – that ADIA was not entitled to tax exemption was erroneous. An appeal against the High Court’s decision is currently pending before the Supreme Court. I rely on the High Court’s judgment to highlight some of the novel questions that arise in the case.   

Facts 

The case involves Green Maiden A 2013 Trust (‘trust’) settled in Jersey. ADIA was both the settlor and sole beneficiary of the trust while Equity Trust (Jersey) Ltd. was the trustee. Under its Deed of Settlement, the trust was a revocable trust and ADIA in its capacity as a settlor contributed two hundred million dollars in the trust. ADIA’s reasons for settling the trust and using it for investment in India were that UAE did not offer a legal framework for settling trusts or incorporating a sole shareholder subsidiary company. Also, ADIA preferred making illiquid investments through separate legal entities which ensured it does not have to directly deal with portfolio companies. The trust through which ADIA made investments was registered with SEBI under the relevant Foreign Institutional Investor and Foreign Portfolio Investor regulations.     

ADIA’s case was that since the capital contribution made to the trust were revocable, any income earned by trust on investments made in India should be treated as income of ADIA itself. Under Article 24, India-UAE DTAA, any income earned by Government of one of the Contracting States is exempt from tax, and in case of UAE, Government includes ADIA. If the income of trust was treated as income ADIA, the income would be eligible for exemption under the said provision. The Revenue resisted such interpretation by arguing that the income was of the trust registered in Jersey and India-UAE DTAA could not be invoked, but the Bombay High Court rejected the Revenue’s assertion.     

Relevant Statutory Provisions 

Before I dig deeper into the issues and arguments, it is important to highlight the relevant provisions of IT Act, 1961:

Section 61, IT Act, 1961 states that all income arising to any person by virtue of a revocable transfer of assets shall be chargeable to income tax as the income tax of a transferor and shall be included in his total income. Section 63, IT Act, 1961 states that a transfer shall inter alia be revocable if it in any way gives transferor a right to reassume power directly or indirectly over whole or any part of the income directly or indirectly. And Section 63(b) specifically states that transfer shall include a trust. Finally, Section 161(1)(iv), IT Act, 1961 states that a “representative assessee” means in respect of income which a trustee appointed under a trust declared by a duly executed instrument in writing whether testamentary or otherwise, receives or is entitled to receive on behalf, or for the benefit, of any person, such trustee, or trustees. 

Arguments on Income and DTAA 

ADIA’s argument was that as per the Deed of Settlement, ADIA has the right to terminate the trust before end of its term, ADIA can re-assume power over entire income arising from investments in portfolio companies as well as principal amount in portfolio companies meaning that all capital contributions made or to be made by ADIA were revocable transfers under Section 63, IT Act, 1961. Thus, in view of Section 61, all income from investments made by trusts shall be chargeable as part of total income of the transferor/settlor, i.e., ADIA.

ADIA made an alternative argument and argued that even presuming Section 61 was inapplicable, under Section 161(1)(iv) the trustee, i.e., Equity Trust (Jersey) Ltd. can only be taxed ‘in the like manner to the same extent’ as the beneficiary. Thus, the income assessed in the hands of the trustee ‘will take colour’ of that of ADIA’s income and will be eligible for exemption under Art 24, India-UAE DTAA. (para 14) The argument that the tax liability of the representative assessee is co-extensive with that of the assessee is on firm footing especially if one reads Section 166 whereunder the Income Tax Department is not barred from directly proceeding against the assessee. For example, it can proceed either against the trustee or beneficiary of a trust for recovery of tax. Either way, ADIA added, it is the beneficial interest in trust that that is taxable in the hands of the trustee and not the corpus of the trust. And more importantly, as per ADIA, any income for which the representative assessee/trustee is liable is income of the beneficiary.  

The Revenue’s arguments were that: first, there is no DTAA between India and Jersey, thus the trust which was settled in Jersey was taxable as a non-resident under IT Act, 1961; second, Indian Trusts Act, 1882 will not be applicable to foreign trusts though it conceded that there is nothing in the IT Act, 1961 which suggests that Sections 60-63, 161, 166 will not be applicable to foreign trusts; lastly, that ADIA would have been eligible for tax exemption under Art 24, India-UAE DTAA if it had invested in India directly.     

The High Court decided in favor of ADIA by interpreting the relevant provisions of IT Act, 1961 strictly. I elaborate on the High Court’s observations below.        

Recognition and Validity of Trusts 

There were two major aspects regarding trusts that were discussed in the case: first, as per ADIA, Sections 61-63, 160, 161, and 166 do not expressly state that they are not applicable to foreign trusts; second, was whether the settlor of a trust can also be its beneficiary.

The Bombay High Court approached the first issue in a straightforward fashion and noted that there is nothing in Sections 61 and 63 that restricts their applicability to foreign trusts and the argument that India has not ratified the Hague Convention on the Law Applicable to Trust and their Recognition does not resolve the issue one way or the other. (para 26) The High Court relied on H.M.M. Virkamjit Singh Gondal case to note that even foreign trusts are recognized under the IT Act, 1961. As regards the second issue, the High Court relied on Bhavna Nalinkant Nanavati case to note that the only restriction on trusts is that the settlor cannot be the trustee and sole beneficiary of a trust, while in the impugned case the settlor – ADIA – was only a beneficiary and not trustee which is permissible. 

Once the applicability of IT Act, 1961 to foreign trusts was established, and correctly so, the High Court’s other conclusions relying on other relevant judicial precedents were inevitable and resolved the issues satisfactorily.      

Merit(s) of High Court’s Decision  

The Bombay High Court’s decision is laudable for evaluating the factual matrix appropriately and applying the relevant law. Since the decision is currently under appeal and pending before the Supreme Court, any comment on the outcome of the case is mere speculation for a distant observer. Nonetheless, a perusal of the Bombay High Court’s decision reveals certain merits in its reasoning and conclusion. 

Most notable aspect of the Bombay High Court’s decision is its engagement with the intent of Sections 60-64, IT Act, 1961, colloquially referred to as ‘clubbing provisions’. AAR, as per the High Court, had noted that the intent of clubbing provisions is to ensure that a taxpayer does not circumvent tax payments by ensuring that it does not receive income from a property but still retains control over that property. The High Court observed that AAR’s observation that if ADIA had invested directly in India, it would have been exempt from tax does not appreciate why ADIA had not directly invested in India. The reason, the High Court noted, as been explained in detail by ADIA, was commercial expediency. Again, this is a correct understanding and optimum application of the relevant provisions to the commercial transactions. Clubbing provisions have an anti-tax evasion intent and are intended to prevent use of devices such as trust for tax evasion. But, if an entity is entering into commercial transactions which makes it difficult to obtain a tax benefit, then the commercial reasons for such transactions should be understood. However, acknowledging commercial reasons and commercial expediency is a tricky territory and needs to be navigated appropriately. The combination of facts in the impugned case justified High Court’s conclusion, but commercial expediency cannot always be treated as sacrosanct to determine eligibility for tax benefits and may not be a prudent approach in all factual scenarios.  

Further, it is indeed novel that the Income Tax Department was emphasizing on the formal nature of transaction while the taxpayer was trying to underline the substance of it. The former was arguing that since the investment was made by a trust from Jersey, ADIA cannot claim tax exemption under India-UAE DTAA while ADIA was trying to emphasise that since it was the settlor of a revocable trust and its beneficiary, the income of Jersey trust was effectively ADIA’s income. Typically, one witnesses the Income Tax Department trying to invoke substance of a transaction to justify taxation or recharacterize the transaction. The roles seemed to have reversed in the impugned case.  

Finally, the case also reflects the intricate nature of trusts and how determining their taxability is sometimes more peculiar than that of other forms such as corporates. The revocable/irrevocable nature of trusts, their discretionary nature, foreign trusts, representative assessees all add layers that make their taxability an intricate affair, as in the impugned case. 

Including Capital Gains within Scope of Income: A Short Note from Tax History

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Provisions to tax capital gains in India’s income tax law were first included in 1947. The Act XII(22) of 1947, amended Income Tax Act, 1922 (‘IT Act, 1922’) – predecessor to India’s current income tax statute, IT Act, 1961 – and expanded the definition of income to include capital gains. The expansion of definition of income was subject of a judicial challenge where the Bombay High Court and thereafter the Supreme Court concluded that the term income can encompass capital gains, though Justice Chagla – then at the Bombay High Court – had a different opinion. The different reasonings offer us a small glimpse of the understanding of the term income seven decades ago, and wider interpretive challenges at the interface of constitutional law and tax law that continue until today. 

Amendment of 1947 

The Act XII (22) of 1947 introduced certain amendments to the IT Act, 1922 to bring capital gains within the net of income tax. A new definition of capital asset was inserted under Section 2(42A) where it was defined as property of any kind held by an assessee whether connected with his business, profession, or vocation. Section 6 was amended to include an additional head of capital gain, and definition of income was expanded include any capital gain chargeable under Section 12B. In turn, Section 12B stated that capital gains shall be payable by an assessee under the head capital gains in respect of any profits or gains arising from sale, transfer or exchange of a capital asset effectuated after 31.03.1946. The Bombay High Court correctly noted that the amendments aimed to levy tax on capital gains earned through sale, transfer or exchange and not on the entire value of the underlying capital asset. Levying tax on the realised gains continues to be the commonly accepted and widely adopted definition of capital gains tax.   

Challenge on Grounds of Legislative Competence

The legislative competence to enact the amendment was the subject of a judicial challenge before the Bombay High Court and thereafter the Supreme Court. The Bombay High Court noted that the central question before it was whether the Union was competent to enact the amendment in view of the provisions of Government of India Act, 1935. The High Court noted the relevant legislative entries in List I of the Seventh Schedule that required interpretation were:

Entry 54, List I stated: ‘Taxes on income other than agricultural income.’ 

Entry 55, List II stated: ‘Taxes on the capital value of the assets, exclusive of agricultural land, of individuals and companies; taxes on the capital of companies.’ 

The Bombay High Court, through Justice Chagla and Justice Tendulkar pronounced an interesting judgment wherein both the judges upheld the vires of the amendment but reasoned differently. Justice Chagla, in his opinion, emphasised on the distinction between income and capital and opined that he need not be guided by the reasonable or common interpretation of the term ‘income’, but instead it is important that he relies on legislative practice. He referred to the relevant cases British cases and concluded that ‘capital accretion could never have been looked upon as income by an English lawyer’ and it was not correct to give a connotation to the word income that was foreign to legislative practice. Justice Chagla concluded that taxes on income could not include taxes on capital accretion. 

Justice Tendulkar though opined that relying on legislative practice was only appropriate when the term in question was ambiguous. Also, that income has been held to not include capital accretion only in the context of taxation laws and the cases do not restrict the scope of the term income outside taxation laws. This distinction may seem specious, because in the impugned case, the scope of the term income was also in reference to a tax statute, i.e., IT Act, 1922, even if indirectly. At the same time, it is true that the immediate query was whether income can include capital gains under the legislative entry – Entry 54, List I. Justice Tendulkar accordingly observed that merely because the term income is interpreted narrowly for purposes of income tax law, does not mean it acquires a similar meaning outside taxation law. The term income as used in Entry 54, List I could be interpreted differently as compared to the term income as used in a tax statute. Justice Tendulkar further reasoned that words should be given their natural meaning and concluded that the term income under Entry 54, List I was wide enough to include capital gains AS contemplated under Section 12B, IT Act, 1922. 

While both judges of the Bombay High Court adopted different reasoning in their opinions, both concluded that the provisions inserted in IT Act, 1922 were intra vires the Government of India Act, 1935. The difference was that Justice Chagla’s view was that the amendment was covered by Entry 55, List I while Justice Tendulkar was of the view that Entry 54, List I was wide enough to include the amendment relating to capital gains within its ambit. Justice Tendulkar’s reasoning though left one question unanswered: if capital gains could be included in Entry 54, List I, was Entry 55, List I redundant? The latter specifically included taxation on capital value of assets in its ambit. One could argue though that Entry 55, List I only included taxation on capital value of assets and did not contemplate taxation on capital gains. This interplay of both the legislative entries was not addressed adequately by Justice Tendulkar.     

Supreme Court Interprets Income Liberally  

In appeal against the Bombay High Court’s judgment, the Supreme Court expressed its agreement with the view adopted by Justice Tendulkar. The Supreme Court made two crucial observations: first, in citing legislative practice, the Bombay High Court observed that legislative practice deducted by citing the judicial decisions only revealed interpretation of the term income in the context of tax statutes and it does not necessarily narrow the natural and grammatical meaning of the term income; second, the Supreme Court observed that the words used in a legislative entry should be construed liberally and in their widest amplitude. Thus, the Supreme Court concluded that the impugned amendment was intra vires Entry 54, List I and it was unnecessary to state if the amendment was within the scope of Entry 55. Supreme Court’s judgment which aligned with Justice Tendulkar also suffered from similar limitation of not adequately addressing the interplay of both the entries: Entry 54, List I and Entry 55, List I.    

Capital Gains = Income 

One takeaway from the High Court and Supreme Court decisions is that income wasn’t intuitively understood to comprise capital gains, until as recent as 1947. Taxation on capital gains is such an integral part of our contemporary income tax laws that the notion of capital gains not being included in the scope of income may seem otherworldly to contemporary tax lawyers. Yet the process of expansion of income to include within its scope capital gains wasn’t a straightforward process as evident in the case discussed above. In fact, the only debates since 1947 have been about rationalizing capital gains provisions and not their place in income tax laws per se. While jurisprudence has grown on the distinction between revenue and capital receipts, and arguments that the latter are not taxable unless there is an express charging provision to that effect; the wider place of capital gains under income tax law is never under challenge per se. At least not directly.     

Another aspect that is worth pointing in some detail is the interpretive tools that judges used to determine the meaning of the term income and capital gains. Legislative practice, reasonable interpretation of the term, as well as the notion of liberal interpretation of legislative entries all interlocked to determine the fate of India’s first attempt to include capital gains in the universe of income tax laws. The judges also observed that to hold that the term income has been crystallised would act against any attempt to further enlarge the definition of income, and would imply that no further amendments to the definition of income are possible. Though I doubt that the intent of arguing that income excludes capital gains was to imply that the definition of income is permanent. The argument that capital gains cannot form part of income was based on the understanding of income as a regular or recurring source of monetary benefit while capital gains was understood as a rare or at least a non-regular means of benefitting monetarily and thereby outside the ambit of income.  

Portuguese Civil Code, Income Tax, and Companies Act: Understanding Beneficial Ownership 

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The Bombay High Court, in a recent judgment, had to unravel the interplay of Portuguese Civil Code, IT Act, 1961, and the Companies Act, 1956 – among other issues – to ascertain the tax liability of assessees. While the case involved other issues, I will focus on the beneficial ownership aspect and how the assessees understood it and the High Courts’ response to the same.   

Introduction  

The appellant in the case, along with his two brothers each held around 30-33% of shares in private limited companies which were engaged in the business of construction and hospitality. All the three brothers were married to their spouses in terms of the Portuguese Civil Code (‘Code’) as applicable to the State of Goa. Under the Code, in the absence of any ante nuptial agreement between the spouses, each of them had 50% right to their common estate. The IT Act, 1961 acknowledges the applicability of the Code and to that extent, under Section 5A provides that: 

            Where the husband and wife are governed by the system of community of property (known under the Portuguese Civil Code of 1860 as “Communiao Dos Bens”) in force in the State of Goa and in the Union Territories of Dadra and Nagar Haveli and Daman and Diu, the income of the husband and of the wife under any head of income shall not be assessed as that of such community of property (whether treated as an association of persons or a body of individuals), but such income of the husband and of the wife under each head of income (other than the head “Salaries”) shall be apportioned equally between the husband and the wife and the income so apportioned shall be included separately in the total income of the husband and of the wife respectively, and the remaining provisions of this Act shall apply accordingly.    

For the Assessment Year 2011-12, the appellant filed the return on income on 29.09.2011 under Section 139(1) of the IT Act, 1961, comprising of income under various heads. The return was processed on 27.09.2012. A search was conducted on 30.01.2012 in the premises of one of the companies in which the appellant was a registered shareholder and subsequently was issued a notice requiring filing of their revised returns for the Assessment Years from 2006-07 including those of 2011-12. The appellant replied that the returns filed on 29.09.2011 be treated as the returns in response to the notice. The appellant also submitted detailed explanations and documents. The Assessing Officer rejected explanations of the appellant and added income under Section 2(22)(e) of the IT Act, 1961 and held that the payments made to the appellant in various transactions through the companies was deemed dividend. Similar additions were also made to the incomes of wives of all the three brothers. 

After a series of contrary decisions at the Assessing Officer and Commissioner level, the ITAT held that the amounts were correctly added to the income of appellant against which the latter approached the Bombay High Court. On the issue of beneficial ownership, the question before the High Court was: the appellant who holds 33% of the shares in company can by virtue of being governed by the Code said to be holding only 16.5% shares with his wife being the beneficial owner of the other half? Why was the extent of shareholding – 33% or 16.5% – important? This is because under Section 2(22)(e) of the IT Act, 1961, for a loan or advance made by a private company, to be considered as a deemed dividend, it is important that such payment is made to a person holding a substantial interest, subject to fulfilment of other conditions. And under Section 2(32) of the IT Act, 1961 a ‘person who has a substantial interest in the company’ in relation to a company, means a person who is the beneficial owner of the shares, not being shares entitled to a fixed rate of dividend whether or without a right to participate in profits, carrying not less than 20% of the voting power.  Section 2(22)(e) read with Section 2(32) of the IT Act, 1961 meant that for the purposes of appellant, if his shareholding in the company was adjudged to be 16.5% and not 33%, the deemed dividend provision would not apply to it.       

The appellant’s argument thus was: Under the Code, in a contract of marriage, the ownership and possession of common assets vests in both the spouses during the subsistence of marriage. Where the husband is 33% registered holder of the shares in a company, his wife is the beneficial owner of half (16.5%) of the shares in company. The argument ran into the hurdle of Section 187C, Companies Act, 1956.  

Section 187C, Companies Act, 1956

Section 187C (1), Companies Act, 1956 provides that any person whose name is entered in the register of members of a company but does not hold beneficial interest in the shares shall make a declaration to the company specifying name and particulars of the person who holds the beneficial interest. Sub-section (2) further provides that a person who holds beneficial interest in a share or shares of a company shall make a declaration the company specifying the nature of interest.   

Relying on the mandate of Section 187C(1) and (2), the Revenue argued that under Section 187C of the Companies Act, 1956 the appellant was under an obligation make declaration to the company about who holds beneficial ownership of shares but having failed to do so, now cannot take advantage of the Code to claim beneficial ownership. Further, the Revenue argued that the Code which provides for communion of assets between spouses is not applicable to shares of companies since only the person whose name is in the Register of Shareholders of the company has the voting rights based on shares held by him and that voting right cannot be divided between the two spouses.  

The appellant though contested the Revenue’s argument and stated that Section 187C of Companies Act, 1956 only applied where beneficial shareholding was created through contract and not by virtue of the operation of law, in this case, the Code. The appellant’s view, as per the High Court, would imply that two class of shareholders could be created – those bound by Section 187C, while those exempt from Section 187C since they were governed by the Code. But was this distinct and separate class of shareholders recognized under the Companies Act, 1956? The High Court answered in the negative. 

Examining the relevant provisions of Companies Act, 1956 the High Court correctly concluded that only a person who agrees to Memorandum of Articles of a company, or a person who holds equity capital in the company, and whose name is entered as beneficial owner of shares can claim to be a member of the company. And only a member of the company shall hold voting rights in the company in proportion to the capital owned. No third person can claim to be a member or hold voting rights. The High Court’s conclusion was that Companies Act, 1956 was a complete code in itself and it ‘does not does not envisage a situation where by virtue of a personal law applicable to a shareholder of a company, the spouse of such shareholder could claim voting rights in a poll to pass resolutions or, for that matter, claim a privity of contract to bind herself to the Memorandum of a Company and the Articles of Association of such company.’ (para 57) 

The High Court’s conclusion did not disrupt the position under the Code in that each spouse is entitled to 50% of the assets. However, the High Court was clear in its opinion that the Code not per se or automatically disrupt internal scheme of the Companies Act, 1956.  

Narrow Understanding of Beneficial Ownership? 

The concept of beneficial ownership is acknowledged under all the above-mentioned relevant provisions of the IT Act, 1961 and the Companies Act, 1956. The question is if the concept needs to be understood and interpreted as per the objectives of the provision and statute in question, and whether there is parity in the concepts of both the statutes? The Bombay High Court’s opinion was that the terms ‘beneficial owner of shares’, ‘shareholder’, ‘member’ used in Section 2(22)(e) of IT Act, 1961 only meant registered shareholder or registered beneficial owner whose name is in the register of shareholders. To this extent, it was correct in stating that there was an equivalence in the concepts under both the statutes – IT Act, 1961 and Companies Act, 1956.

However, was the High Court’s opinion, that the wife is not a beneficial owner of shares unless her name is registered a narrow understanding of the concept of beneficial ownership and does it dilute one of the core ideas contained in the Code. Prima facie, yes. But, as the High Court justified, personal law cannot create a relationship between the wife and other members of the company. Such a relation must be and can only be created under the Companies Act or there needs to be an express provision acknowledging the overriding effect of the personal law. The accommodation to the Code is provided in Section 5A of the IT Act, 1961, but a similar and comparable provision is absent in the Companies Act, 1956. In such a scenario, while the concept of beneficial ownership seems to be narrowly interpreted by the Bombay High Court, it shows fidelity to the provisions that governed the concept and issue at hand.

Further, it is worth thinking if the wife was registered as a beneficial owner of 16.5% of shares, if and how the outcome would have differed? The outcome, in my view, would have been in favour of the appellant, but not because of operation of the Code but because of proof of compliance with the Companies Act which would have created evidence of beneficial ownership. Again, the concept of beneficial ownership is acknowledged, but only if the prescribed formalities under the Companies Act are followed. This to be seems a reasonable and defensible approach towards the interplay of the Code and Companies Act.     

Appellate Authority Ignored CBIC’s Circular: Bombay HC

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In a recent decision[1] the Bombay High Court expressed surprise that the appellate authority ignored CBIC’s Circular while ordering the assessee to pay back the Input Tax Credit (‘ITC’) refund granted to it along with interest. The High Court set aside the order by appellate authority.  

Facts 

The assessee had filed an application on 29.08.2018 seeking refund of ITC under Section 54(3), CGST Act, 2017 on export of goods made under a Letter of Undertaking. The assessee was granted a 90% refund of ITC via the first order and via a subsequent order, after scrutiny, the entire amount claimed as refund was granted. The Department, however, challenged the order granting refund to the assessee before the Commissioner/appellate authority claiming that the assessee must pay back the entire refund amount along with the interest. The Commissioner passed an order in favor of the Department which was assailed by the asssessee before the Bombay High Court. The primary ground of the assessee’s challenge was the legality of the Commissioner’s order.    

Two Circulars 

The legality or sustainability of the Commissioner’s order rested on CBIC’s Circular issued on 18.11.2019 (‘Circular of 2019’). The Department argued that the assessee was not allowed to make a simultaneous claim for refund that related to different financial years. And that in the impugned case, the assessee had claimed credit for the period from 1.04.2018 to July 2019 and financial year 2017-18. 

The assesee, on the other hand, argued that the refund was in conformity with Rule 89(4), CGST Rules, 2017 which provide a detailed formula for computing the refund for the assessee. Further, the assessee argued that the Commissioner’s view was not in accordance with the CBIC’s Circular dated 31.03.2020 (‘Circular of 2020’) which clarified and negated some of the refund related conditions mentioned in the Circular of 2019. 

The Commissioner was correct in interpreting the Circular of 2019. Paragraph 8 of Circular of 2019 stated that while an applicant file a refund for a tax period or by clubbing different tax periods, the refund claim cannot spread across different financial years.  The Commissioner was remiss in not noting that the Circular of 2020 had categorically modified the Circular of 2019 and removed the condition that a refund cannot be spread across more than one financial year. (para 2.5) Paragraph 2.4 of Circular of 2020 stated that: 

On perusal of the provisions under sub-section (3) of section 16 of the Integrated Goods and Services Tax Act, 2017 and sub-section (3) of section 54 of the CGST Act, there appears no bar in claiming refund by clubbing different months across successive Financial Years. (emphasis added) 

The rationale for modification was motivated by the underlying legal principle that a Circular cannot introduce a more stringent condition than imposed by the statutory provision. Circular of 2020 was also prompted by the Delhi High Court’s decision wherein it termed the condition imposed Paragraph 8 of the Circular of 2019 as arbitrary and stayed the condition which prevented an assessee from claiming refunds that spread across more than one financial year. The High Court had ordered opening of portal to allow the exporters to claim refunds that were tied to more than one financial year.   

Decision 

A persual of Rule 89(4) along with the Circular of 2020 clarifies the legal position amply, and the Bombay High Court correctly noted that the assessee was entitled to claim the ITC credit available for the prior financial years too. The High Court stated that it was a matter of wonder as to how the Commissioner could arrive at a decision contrary to both the Rule and the Circular of 2020 to deny the refund to the assessee. And that either the Commissioner had overlooked or not addressed the matter because it did not record a finding on the issue, which was impermissible. (para 11) Accordingly, the High Court concluded that the order of the Commissioner could not be sustained and was liable to be set aside. 

Conclusion 

The impugned decision is an instance of the Department challenging a legally sound order of one of its own officers, and the appellate authority, in this case the Commissioner, adopting a view that was contrary to the CBIC’s Circular. Either the Circular of 2019 was cherrypicked because it favored the Department or there was a genuine oversight by the Commissioner in not referring to the Circular of 2020, which had diluted the Circular of 2019. Either way, through the impugned case, the GST Department does not give the impression of a sound tax administration that is taking decisions as per the applicable law.  

[1] M/s Sine Automation and Integration Pvt Ltd v Union of India TS-697-HCBOM-2023-GST. 

Bombay High Court Adopts ‘Purposive Interpretation’: Permits Rectification of GSTR-1

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In a recent decision[1], the Bombay High Court permitted the petitioner to rectify their GSTR-1 despite even though statutory deadline for rectification of such return had expired. The High Court cited the relevant provisions – Sections 37, 38, and 39 of CGST Act, 2017 – and stated that they need to be interpreted purposively and the law cannot be interpreted to mean that there is no room for correcting inadvertent errors in returns. 

Facts 

The petitioner, Star Engineers (I) Pvt Ltd, designed, manufactured, and supplied wide range of electronic components for industrial purposes. The petitioner was a regular supplier of the components to Bajaj Auto Limited and during the Financial Year 2021-22 supplied various components to third party vendors on ‘Bill-to-Ship-to-Model’ on instructions of Bajaj Auto Limited. The aforesaid Model allows a supplier to ship the goods to one entity, while issue the bill in favor of another entity. In this case, the petitioner was supplying goods to third party vendors and invoices were issued in the name of Bajaj Auto Limited. However, while filing GSTR-1 for the period July 2021, November 2021, and January 2022, the petitioner inadvertently mentioned GSTIN of the third-party vendors instead of Bajaj Auto Limited.

The above error in filing GSTR-1 meant that the supplies made by the petitioner for the said period were not reflected in GSTR-2B of Bajaj Auto Limited but in the GSTR-2B of the third-party vendors. Accordingly, Bajaj Auto Limited was unable to claim ITC for the said supplies. To compensate itself for the same, Bajaj Auto Limited reduced the payment amount to the petitioner equivalent to the GST stating its inability to claim ITC to that extent. 

In September 2023, the petitioner approached the Deputy Commissioner of Sales Tax requesting that it be allowed to rectify the error in GSTR-1 for the supplies made during the Financial Year 2021-22 as it was causing prejudice to the petitioner. However, the Deputy Commissioner rejected the request on the ground that while rectification of the error would not cause any loss the Government exchequer, it was past the due date prescribed under the statute. Against, the said decision the petitioner approached the Bombay High Court. 

Purposive Interpretation of Sections 37, 38, and 39 of CGST Act, 2017 

The Bombay High Court noted the relevant provisions of the CGST Act, 2017 which mandate the filing of returns and prescribe the outer time limit for rectification of errors that may creep into such returns at the time of filing. 

Section 37(1) requires all registered persons to furnish electronically all details of their outward supplies and the said information will be communicated to the recipient of such supplies. This provision has translated into the registered person filing GSTR-1 stating their outward supplies and the recipient receiving an auto-drafted ITC statement based on the information disclosed in GSTR-1. Section 37(3) allows for rectification or omission in the returns, but the Proviso states that no rectification shall be allowed after 30 November following the end of financial year to which the returns pertain.  Section 38 states that the details of outward supplies provided under Section 37 shall be communicated to the recipient. Section 39(1) also contains a similar obligation regarding both the input and output supplies and ITC paid or payable. While Section 39(9) allows rectification of errors and omissions. Proviso to Section 39(9) prescribes a similar outer time limit as Proviso to Section 37(3). 

The Bombay High Court perusing the above provisions observed that they ‘need to be purposively interpreted.’ (para 12) What did purposive interpretation mean in this context? The High Court elaborated that Section 37(3) cannot be interpreted to mean that the assessee cannot be allowed to rectify errors in returns and reflect an accurate record. Not allowing rectification of errors would lead to preservation of inaccurate records consisting of errors, which the High Court observed would not be in consonance with the purpose of GST. The High Court stated that the proviso cannot be allowed defeat the intent of provision especially if rectification of the error would not lead to loss of revenue. 

The Bombay High Court also reasoned that GST regime had inaugurated a regime where returns are completely online. It stated that there are a wide variety of traders in India and many may have limited resources and expertise as a result of which inadvertent errors may creep into the returns and the keeping the same in mind, assessees should be allowed to rectify errors in their returns and the provisions of law ‘should be alive’ to such considerations. (para 20)

Similar Judicial Precedents 

The Bombay High Court in allowing the petitioner to their rectify GSTR-1 beyond the due date followed a slew of precedents – M/s Sun Dye Chem v Assistant Commissioner (ST) & Ors[2], Pentacle Plant Machineries Pvt Ltd v Office of GST Council & Ors[3], Shiva Jyoti Constructions v Chairperson, CBEC & Ors[4], Mahalaxmi Infra Contract Ltd v GST Council & Ors[5] – where various High Courts have awarded a similar relief to the assessees. The High Court did cite the precedents in support of its reasoning and conclusion. In these precedents none of the High Courts expressly invoked purposive interpretation, but instead the relief was provided based on facts and Court’s satisfaction that errors of assesses in their returns were bona fide. Further, the common thread in all the cases is that the High Courts were convinced that the rectification of the returns would not lead to loss to the Government exchequer. The latter issue weighed with the High Court in the impugned case as well.    

Conclusion 

The Bombay High Court’s decision in the impugned case invoked the bona error of the petitioner, the fact that no illegality involved, and that the rectification of GSTR-1 would cause no loss to the exchequer. It was not a simple case of purposive interpretation wherein the High Court went beyond the statutory provisions to allow the petitioner to rectify returns even after expiry of the statutory deadline. In the absence of even one of the three factors mentioned above, the High Court’s decision could have been different. Finally, it is important to underline here that reliefs such as in the impugned case are ordinarily and perhaps can only be granted by Courts. Officers allowing rectification of returns after expiry of statutory deadlines is a possibility that is hard to foresee. 

[1] Star Engineers (I) Pvt Ltd v Union of India 2023:BHC – AS: 37549-DB. 

[2] 2020 TIOL 1858 HC MAD GST. 

[3] 2021-TIOL-604-HC-MAD-GST. 

[4] MANU/OR/0522/2023. 

[5] MANU/JH/1003/2022. 

Bombay High Court Decides a ‘Peculiar Case’: Orders Refund of Tax Paid Under Protest

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The Bombay High Court recently adjudicated a case[1] it termed as ‘peculiar’ and ordered that the Revenue Department should refund the tax paid by petitioner under protest. The High Court invoked the doctrine of unjust enrichment and precedents on taxes paid under a mistake of law to support its conclusion. 

Facts 

The facts of the case are straightforward: the petitioner, The Hongkong and Shanghai Banking Corporation, filed a writ petition regarding an amount of Rs 56,19,84,075/- it deposited with the Revenue Department. The petitioner claimed that the payment was without any authority in law and not a tax payable by the petitioner. The Revenue Department undertook audit of petitioner’s books and accounts from March 2007 to April 2012 and raised certain objections on non-payment of service tax by the petitioner for ‘interchange income’. As a fallout of the objections, despite no showcause notice being issued by the Revenue Department or a demand being raised, the petitioner deposited Rs 56,19,84,075/- as tax under protest. The petitioner’s letter that accompanied the deposit clearly stated that the payment of tax was ‘under protest’ and as a matter of good faith to co-operate with the Revenue Department. The petitioner was categorical in its assertion that it was not liable to pay service on the interchange income and payment of tax was only to buy peace with the Revenue Department. 

After the deposit of the said amount, the Revenue Department never took any steps to ascertain the tax liability of the petitioner as no showcause notice was issued to the petitioner as regards its interchange income regarding which objections were raised during the audit. Since the Revenue Department never took any steps for ascertaining the tax liability of the petitioner, the petitioner filed an application for a refund of the amount citing lack of action by the Revenue Department and arguing that the payment was made under protest and should not be considered as payment of tax regarding interchange income. 

The petitioner argued that the retention of the said amount by the Revenue Department would amount to violation of Article 14 of the Constitution as well as Article 265 of the Constitution, the latter forming the crux of its case. 

The Revenue Department’s reason for rejecting the application for refund was that the matter regarding levy of service tax on interchange fee had been referred to a Supreme Court bench and admissibility of refund can only be considered after the bench pronounces its final verdict. The Supreme Court in Citibank N.A. case[2]had delivered a split verdict on taxability of interchange fee and the matter had been referred to a larger bench which had yet to pronounce its verdict. Citing the pendency of the matter before a larger bench of the Supreme Court, the Revenue Department denied a refund. 

Bombay High Court Decides 

The Bombay High Court ordered a refund of the tax paid under protest by the petitioner. As per the High Court, for the Revenue Department to satisfy requirements of Article 265 of the Constitution, i.e., ‘No tax shall be levied or collected except by authority of law’, it needs to demonstrate that it has power to withhold/appropriate the amount towards tax. However, i was not the case as in the impugned case the amounts were received by the Revenue Department by fortuitous circumstance wherein the petitioner voluntarily deposited the amount. 

The Bombay High Court reasoned that since the payment of tax by the petitioner was under protest, it did not preclude the Revenue Department from taking steps to realise the tax and in the absence of such steps such as issuance of showcause notice, the payments made by the petitioner retained the character of tax under protest and not tax collected under authority of law under Article 265 of the Constitution. (paras 25-27) In the absence of any provisions under Finance Act, 1994 – under which service on interchange income was supposedly due – which authorized the Revenue Department to retain the said amounts, the High Court held that retaining such amounts violated Article 265 of the Constitution. The High Court cited relevant precedents to reiterate that even if the amounts were paid under a mistake of law, the petitioner was allowed to claim refunds. And it further underlined that the refusal to refund the tax paid under protest would amount to unjust enrichment on behalf of the Revenue Department.  

What about the pending case before the Supreme Court? The Bombay High Court held that it was not relevant to the issue of refund more so because no show cause notice was issued for the period in question. (para 30) Also, the High Court endorsed petitioner’s argument that even if a recovery is initiated against the petitioner, it is not the case that the Revenue Department will not be in a position to recover the dues given that the petitioner is a reputed bank with large scale operations in the country. 

The Department’s stubborn refusal to refund the amount paid in the impugned case was curious, if not surprising. The reason that a case on taxability of interchange income is pending before the Supreme Court was flimsy to begin with. Even if the Supreme Court in the pending case eventually decides in favor of the Revenue Department, there was nothing to stop it from recovering the said tax dues from the petitioner as the High Court rightly pointed out. And if the Revenue Department was convinced of the taxability, why was no showcause notice issued in the first place after auditing the petitioner’s books? I guess we will never know the answer to this.    

Conclusion 

The Bombay High Court’s conclusion rested on three important points: first, that the amount paid by the petitioner was not under any law, but under protest and lack of action by the Revenue Department ensured that the payment retained the character of tax under protest; second, that retention of tax under protest would amount to violation of Article 265 of the Constitution since a tax can only be collected under a authority of law and any tax paid under protest or a mistake of law is liable to be refunded; third, the High Court also alluded to the doctrine of unjust enrichment and held that if the Revenue Department does not refund the tax paid under protest it would amount to unjust enrichment, a concept that loosely ties in with the mandate of Article 265, but is articulated separately by Courts.             

[1] The Hongkong and Shanghai Banking Corporation v Union of India 2023:BHC-OS:13826-DB. 

[2] Commissioner of GST and Central Excise v M/s Citibank N.A. Civil Appeal No. 8228 of 2019 dated 09.12.2021. 

Bombay High Court Upholds Amendment to Definition of Income under IT Act, 1961 

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In a significant decision[1], the Bombay High Court upheld the amendment made to definition of income in Income Tax Act, 1961 (IT Act, 1961) via which all forms of subsidy granted by the Central or State Government, in cash or kind, are now considered income and taxable under the IT Act, 1961. The petitioner’s core challenge to the amendment was that it removed the distinction between revenue and capital subsidy while latter had been held by Courts to be non-taxable. The Bombay High Court did not engage with several arguments of the petitioners that traversed issues of legislative competence and fundamentals of income tax jurisprudence, but instead reasoned that the challenge was because of petitioner’s reduced profits and therefore was unwarranted. 

Facts 

Petitioner was a biotechnology company and had a manufacturing plant in Hadapsar, Pune. It was eligible for concessions on electricity duty and VAT/GST/ subsidy under the State of Maharashtra’s ‘Package Scheme of Incentives, 2013’ which came into effect from 1 April 2013. Petitioner was entitled to the subsidies from 1 January 2015 to 31 March 2045, having fulfilled the eligibility conditions prescribed under the Scheme. 

The Finance Act, 2015 amended the definition of income under Section 2(24), IT Act, 1961 wherein clause (xviii) was added. The clause stated: 

            assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee; 

other than, –

  • The subsidy or grant or reimbursement  which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43; or 
  • The subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government, as the case may be;  

Clearly, any incentives in the form of subsidies or otherwise provided to companies or assessees in general were included in the definition of income and made exigible to tax. The significance of this amendment can be appreciated through a brief understanding of the history of income tax under which revenue receipts are by default taxable, but capital receipts are taxable only if there is an express provision to that effect. Income tax laws have evolved in the past few decades in such a manner that a large variety of capital receipts have been expressly made taxable and the distinction between revenue and capital receipts though still in existence, has been blurred to a large extent. The above cited clause is another step towards rendering the distinction between revenue and capital receipts otiose. 

The petitioner’s case was built on this distinction which has been upheld by Indian Courts in numerous decisions.[2] The petitioner’s arguments also raised important issues of legislative competence and arguments that alluded to fiscal federalism, which unfortunately went unaddressed by the Bombay High Court. Some of the petitioner’s arguments were: the amendment does not create any distinction between capital and revenue subsidy though only the latter is taxable under Sections 4 and 5 of IT Act, 1961; that IT Act, 1961 levies tax only on ‘real’ income and the definition of income cannot be extended to include every kind of subsidy especially when it is received on capital account; the subsidy given by a State Government is by forsaking its own revenues and taxing the same in the hands of the petitioner amounts indirect tax on revenue of the State in violation of Article 289; the amendment was also challenged as violative of Article 14 for being arbitrary and discriminatory as well as Article 19(1)(g) of the Constitution for causing unreasonable hardship on the petitioner as it had made a huge investment in a backward region on the promise of subsidy and now the Union may take away 30-40% of the subsidy via income tax. 

The petitioner’s cited a bevy of cases to underline the fact that the distinction between subsidy received on revenue and capital account has been acknowledged by Courts and only the former has been held to be taxable and not the latter. The Revenue, on the other hand, invoked the argument that Courts should be deferential in matters of economic law as it involves complex decision-making impinging on economic and fiscal policy of the country. Accordingly, it argued that the legislature has wide leeway in drafting provisions on taxation of income and can choose to levy tax on certain persons and Article 14 cannot be invoked against tax laws casually. Similarly, reduction of profits of the petitioner, the Revenue argued, cannot be a ground to invoke violation of Article 19(1)(g).  

Bombay High Court Focuses on Reduced Profits 

The spectrum of issues highlighted by the petitioner were ultimately futile, as the Bombay High Court upheld the amendment by relying on and focusing on one strand, i.e., Article 19(1)(g) and reduction of profits of the petitioner. The High Court did cite the relevant judicial precedents that distinguished capital and revenue receipts and the ‘purpose test’ enunciated by the Supreme Court in various cases, but only for ornamental reasons. (para 17-21) The High Court used the well-entrenched doctrine in Indian jurisprudence that in matters of economic laws – by extension tax laws – the legislature has a wide latitude. It cited the relevant precedents on this point as well to underline its agreement with the approach that courts cannot intervene unless there is manifest arbitrariness and violation of Article 14 or if the restrictions were unreasonable thereby contravening Article 19(1)(g) of the Constitution. (paras 24-25) 

The latter particularly was conclusive in influencing the Bombay High Court’s conclusion that the amendment to definition of income was constitutional. The High Court noted that the petitioner’s argument about withdrawal of fiscal incentives tends to conflate the issue with fiscal immunity. And that the profits as well as incentives are subject to fluctuation and the amendment reflects a recalibration of fiscal advantages in tune with the broader economic policy considerations. And that diminution or even drastic reduction in profits cannot amount to violation of Article 19(1)(g) of the Constitution. (para 31) The High Court concluded that: 

The policy of tax in its effectuation, might, of course, bring in some hardship in some individual cases. That is, inevitable. Every cause, it is said, has its martyrs. Mere excessiveness of a tax or even the circumstances that its imposition might tend towards the diminution of the earnings or profits of petitioner, per se and cannot constitute violation of constitutional rights. If in the process a few individuals suffer severe hardship that cannot be helped, for individual interests must yield to the larger interests of the community or the country as indeed every noble cause claims its martyr. (para 38) 

The doctrine of deference in matters of economic law proved decisive in the Bombay High Court finally upholding the amendment to the definition of income. While the merits of this doctrine are beyond the scope of this post, it is crucial to mention that the sacrosanct status accorded to this doctrine is preventing Courts from engaging in a fundamental analysis of the violation of Fundamental Rights and other well established doctrines in taxation law in this case the well founded distinction between revenue and capital receipts and the promise of IT Act, 1961 to only tax ‘real’ income. The High Court was especially remiss in interlinking the two aspects, i.e., if subsidy on capital account did not constitute ‘real’ income, then is it still within legislative competence to levy tax on such subsidy?    

Conclusion 

The Bombay High Court’s decision falls short primarily on not engaging with the various arguments put forth by the petitioners. In my view, there is considerable merit in determining the scope of income and whether IT Act, 1961 can be amended by the Union to include any form and kind of receipt as income. Historically, capital receipts have not been taxed under IT Act, 1961 but there is no express bar in including such receipts within the fold of income. However, the related concern in this case was that a portion of subsidy benefits extended by the State Government, would end up being paid as taxes to the Union. Apart from a constitutional question, this issue also raises the point of efficacy of such subsidies and grants provided by the State Government. It is unlikely that any Court will read a limitation on the Union’s legislative power on that ground, but it is worth examining from the perspective of efficacy of policies providing tax exemptions. Finally, it is worth noting that though the distinction between revenue and capital receipts has been significantly blurred via numerous provisions expressly taxing the latter, the question of whether it amounts to ‘real’ income as opposed to hypothetical income has not been answered conclusively in this context. Courts have opined that mere accounting entries cannot be relied on to state that the assessee has received income, ‘real’ income that can be taxed. A similar analysis in the context of revenue and capital receipts is amiss, as it is possible to suggest that not every capital receipt amounts to a ‘real’ income taxable under the IT Act, 1961.   

[1] Serum Institute of India Pvt Ltd v Union of India TS-723-HC-2023-BOM. 

[2] See, for example, CIT v Chapalkar Brothers 400 ITR 279 (SC); CIT v Shree Balaji Alloys 7 ITR-OL 50 (SC). 

Tea is an Agricultural Produce: Bombay High Court Rules

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In a recent decision[1], the Bombay High Court ruled that tea qualifies as an agricultural produce warehousing services in relation to it are exempt from GST as specified in Notification No. 12 of 2017. The writ was filed by the petitioner against rulings of advance and appellate advance ruling authorities which held that tea which underwent process of blending/mixing ceased to be an agricultural produce. The High Court also made a pertinent observation about the scope of a CBIC Circular and whether it can dilute a statutory Notification. 

Facts 

The petitioner was licensed for carrying the warehouse business under the Bombay Warehouses Act, 1959. The petitioner had let one if its warehouse to M/s Unilever India Export Ltd (‘Unilever’). Unilever would procure tea at public auctions and directly from manufacturers and would undertake blending and packing of the tea at the petitioner’s warehouse. The petitioner was of the view that tea was an agricultural produce under Clause 2(d) of the Notification No. 12 of 2017 and thus warehousing services provided to such a product were exempt form GST as specified under Serial No. 54(e) of the said Notification. 

The relevant portions of the Notification No. 12 of 2017 state that: 

Clause 2(d):

“agricultural produce” means any produce out of cultivation of plants and rearing of all life forms of animals, except the rearing of horses, for food, fibre, fuel, raw material or other similar products, on which either no further processing is done or such processing is done as is usually done by a cultivator or producer which does not alter its essential characteristics but makes it marketable for primary market;” 

And, Serial No. 54(e) of the Notification No. 12 of 2017 exempts from GST the loading, unloading, packing, storage or warehousing of agricultural produce. 

Reading both the provisions together suggests that warehousing services related to agricultural produce were exempt from GST. The petitioner’s primary contention was that manufacturing and packaging of tea undertaken by Unilever did not alter the essential characteristics of tea and were undertaken to make it fit for human consumption and marketable. It was further argued that every agricultural product undergoes some treatment to make it fit for human consumption, save it from perishing and to make it fit for transportation. The ‘minimal’ processes undertaken by Unilever, as per the petitioner, did not change the nature of tea and it retained the character of an agricultural produce. The Revenue, on the other hand, argued that the kind of processes undertaken by Unilever required plant and machinery and cannot be categorized as minimal processes undertaken to make tea fit for primary market. And that tea ceased to an agricultural produce after undergoing the processes undertaken by Unilever.  

High Court Relies on Supreme Court Decision

The Bombay High Court, in determining the nature of processes undertaken by Unilever and their effect on tea relied cited D.S. Bist and Sons case [2] (which was relied on heavily by the petitioners) where it was held that tea leaf that underwent the process of withering, roasting, crushing and fermentation continued to be an agricultural produce since the process was to ensure that the flavor and color of tea leaves was brought out, but tea still retained its essential characteristics. The High Court held that the facts and observations in D.S. Bist and Sons case should have persuaded the advance ruling authorities and appellate advance ruling authorities to have come to a similar conclusion. (para 26) As per the High Court tea, an agricultural produce, retained its essential characteristics even after the processes undertaken on it by Unilever. The High Court observed: 

In so far as the impugned orders are concerned, on a perusal of the orders passed by the AAR the emphasis appears to be more on the issue that the process by which the tea leaves are dried which results in emergence of a manufactured product, and therefore, tea ceases to be an agricultural produce. In our opinion, such reasoning would in fact go contrary to the decisions of the Supreme Court as noted above for the reason that the essential characteristic of the tea being an ‘agricultural produce’ would not stand extinguish by mere processing and packing in whatever form. (para 31)

Circular Cannot Go Beyond Statutory Notification 

Another issue that the Bombay High Court addressed in its judgment was the interplay and effect of a Circular on the contents of a statutory Notification. The Revenue contended that their stance that tea that underwent the processes of fermentation, etc. was not an agricultural produce was in accordance with a CBIC Circular issued on 15 November 2017. The High Court, however held that a Circular cannot whittle down or scuttle an Exemption Notification. (para 29) What was the basis of High Court’s opinion? As per the High Court the Exemption Notification No. 12 of 2017 was issued in exercise of power under Section 11, CGST, Act, 2017 wherein the Government can grant exemption from tax on satisfaction in public interest and on recommendations of the GST Council. Thus, the clarification issued in Circular dated 15 November 2017 cannot amend a statutory Notification so as to take tea as an agricultural produce from the ambit of exemption. There is a precedent[3] to this effect, but the underlying premise of the High Court’s opinion is interesting in the context of GST. The Circulars issued by CBIC, admittedly in exercise of its administrative powers, often issue clarifications or state its interpretations of various clauses contained in a statutory Notification, i.e., a Notification issued in exercise of powers under a statutory provision. The High Court’s opinion on the scope of such Circulars will be tested in future as well to determine if a Circular is merely ‘interpreting’ a Notification and issuing a ‘clarification’ or does the Circular go beyond what the Notification states. In the impugned case, the Bombay High Court correctly held it to be the latter. However, it will be a tricky exercise and results are likely to be determined by facts of each case, but the High Court has opened doors for an examination of the scope of what a Circular can state in the context of GST. 

Conclusion The High Court’s observations in the impugned case are welcome and provide clarity on two crucial issues: the scope of the term agricultural produce and the scope of a Circular in terms of what kind of clarifications and interpretive clarities it can provide. Both these facets are likely to occupy judicial attention in the future as well and the dust is far from settled. However, we have a welcome decision that can become a reference point for future disputes. 

[1] Nutan Warehousing Company Pvt Ltd v The Commissioner, Central Tax, Pune – II, 2023: BHC-AS: 37052: DB. 

[2] Commissioner of Sales Tax, Lucknow v D.S. Bist and Sons, Nainital (1979) 4 SCC 741. 

[3] Sandur Micro. Circuits, Ltd v Commissioner of Central Excise, Belgaum (2008) 14 SCC 336. 

Bombay High Court Orders Refund of TDS: Opines on Illegal Tax

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In a recent judgment[1], the Bombay High Court ordered the Revenue Department to return the tax deposited by the assessee and opined that retaining tax that was not owed by the assessee in the first place would be in contravention of Article 265 of the Constitution.  

Facts 

The petitioner, an Indian company entered a Foreign Technical Collaboration with a US company. Petitioner agreed to pay US company US $ 16,231,000 net of any Indian income tax meaning that if any withholding tax was required to be deducted it would be paid by the petitioner while the US company would be paid the gross amount. The petitioner sought a no objection certificate from the Revenue Department without withholding any tax. The petitioner’s argument was that the services are rendered by the US company outside India, the income embedded in the amount accrues and arises to the US company outside India and is not taxable in India. However, the Revenue Department only issued a no objection certificate provided a 30% withholding tax was deducted. The petitioner paid the said witholding tax under protest and it was the refund of the withholding tax amount that was the subject of the impugned judgment. The petitioner’s case, succinctly put, was that the since the amount paid to US company was held to be non-taxable in India the Revenue Department was obliged to refund the withholding tax. 

The Revenue Department rejected the petitioner’s claim for refund on the ground that the tax was paid on behalf of the US company. 

Petitioner’s Argument 

Petitioner’s argument was that the Revenue Department was incorrect in taking the view that the witholding tax was deposited by it on behalf of the US company. The petitioner argued that the tax was paid by it on from its own pocket over and above the consideration agreed between it and the US company. And the US company has agreed to the same and has issued a no objection certificate that the refund be issued to the petitioner. 

The edifice of petitioner’s argument though was that once the Court had held that the income earned by the US company was not taxable in India, the tax deducted at source by it was not in accordance with the law and the amount so deducted must be paid back to it. 

The Revenue, on the other hand, made several arguments of varying persuasion but was not able to substantiate them convincingly. The Revenue, for example, suggested that the Court’s order that the income earned by US company was not taxable in India could not be used by the petitioner and the refund could be claimed only by the US company. The Revenue also suggested that the US company had claimed credit of witholding tax against tax liabilities. However, the Bombay High Court did not agree to any of the Revenue’s arguments. 

Bombay High Court Decides 

The Bombay High Court cited the order wherein it was held that the US company did not owe any tax in India on the income and concluded that: 

Technically, even though the amount deposited by Petitioner would be called as ‘tax deductible at source’, what Petitioner paid was ‘an ad hoc amount not technically a TDS amount’. Moreover, since it is also confirmed by this Court that the amount paid to DAVY was not chargeable to tax in India, Respondents’ insistence on Petitioner paying that amount was not in accordance with law and the amount so paid over must be refunded to Petitioner. (para 17) 

 The Bombay High Court relied on a few additional aspects: CBDT Circular No. 7 0f 2007 dated 23.10.2007 which stated that where no income has accrued to the non-resident or where income has accrued but no tax is due, then in such cases the amount deposited with the government cannot be said to be ‘tax’. The High Court also cited a line of relevant precedents which have established that the Revenue authorities can only collect tax per law and any tax collected illegally or not due from the taxpayer needs to be refunded else would in contravention of Article 265 of the Constitution. 

Conclusion 

The refund of tax paid out of caution and which is held to be not due from the assessee should not, ideally speaking, be a painful and long drawn process. In the impugned case, the petitioner as part of business transaction paid the tax on behalf of the US company but had to engage a lengthy process to claim refund of a tax which should have been paid much earlier. Single judgment such as in the impugned case lacks the ability to ensure course correction by the Revenue Department, but we live in hope.       

[1] Grasim Industries Ltd., v Assistant Commissioner of Income Tax, Mumbai 2023: BHC-OS:9537-DB. 

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