Post-Supply Discounts Cannot be Included in Transaction Value: Madras HC

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The Madras High Court recently observed that post-supply discounts offered by a supplier to the recipient cannot be included in the transaction value/value of supply for levying GST. The High Court distinguished between subsidy offered by a third party and a discount and noted that a discount by itself cannot qualify as subsidy.  

Introduction to Taxability of Discounts under GST  

Before discussing the case, I think it is important to provide contest of the type of discounts envisaged under CGST Act, 2017 and their manner of inclusion and exclusion from the value of supply. 

Section 15, CGST Act, 2017 contains stipulations as to which amounts can or cannot be included in the value of a taxable supply, where both the recipient and supplier are not related, and price paid or payable is the sole consideration for supply. Section 15(3)(a) states that discounts offered at the time of or before a supply shall not be included in the value of supply in such discount has been duly recorded in the invoice in respect of such supply. Section 15(3)(b), which was in focus in the impugned case, states that a discount after a supply has been effected shall not be part of value of supply if: (i) such discount is established in terms of agreement entered into at or before the time of such supply and specifically linked to relevant invoices; (ii) ITC as is attributable to the discount on the basis of the document issued by the supplier has been reversed by the recipient of the supply. 

Typically, discounts offered before or at the time of supply are excluded from the value at the time of generation of invoice itself. While discounts offered after the supply cannot, due to their nature be reflected in the invoice per se, but the value can be reduced by filing credit notes thereafter and linking it to the supply in question. It is the latter kind of discount that was the Madras High Court’s focus in the impugned case.  

Facts and Arguments  

The facts of the impugned case were not clearly stated by the Madras High Court in its judgment, but from what one can gather it seems: the petitioner challenged the inclusion of volume discount in the value of supply and the Revenue Department’s stance that the discount was a ‘private’ subsidy. Under Section 15(2)(e) subsidies directly linked to the price are included in the value of supply except subsidies provided by the Central and State Governments. The petitioner’s case was that it paid GST on the transaction value in the invoice which includes the volume discount, and the Revenue Department cannot add the volume discount over and above the invoice amount as it would to double taxation on the same amount. The petitioner contended a manufacturer would incentivize the distributors to sell mobile phones on a discount and such discount cannot be construed as a subsidy under Section 15(2)(e). 

The Revenue Department seems to have added the discount value to the invoice by claiming that the discount is a subsidy by a third party and amounts to consideration under Section 2(31)(b), CGST Act, 2017. The Revenue Department’s order under challenge before the High Court also mentioned that the after-supply discount must be as per the terms agreed and based on certain parameters and workable criteria. And a discount cannot be offered at the complete discretion of the supplier. The Madras High Court held that the order was unsustainable in law and liable to be quashed. 

Madras High Court Decides 

The Madras High Court made three observations that were vital to the dispute and are our understanding of when post-supply discounts can or cannot be included in the value of supply: 

First, the High Court observed that Section 15(2)(e) of CGST Act, 2017 will only come into play when a part of the consideration payable for the supply is subsidized by third party other than the Central Government or the State Government. While this is a straightforward interpretation of the impugned provision, it is a necessary clarification for frequently some basic and obvious things need to be made clear to the Revenue Department. (para 45)

Second, the High Court observed that a subsidy will be embedded in the transaction value only if it disguised as a discount. However, a discount by itself will not qualify as a subsidy. (para 48) A discount will only be part of the transaction value if it is on account of a subsidy offered by a third party. The High Court was trying to distinguish the discount offered by a supplier on their own account and a discount offered due to contribution by a third party; the latter being a ‘private’ subsidy that was liable to be included in the value of supply and the former being a discount that as per Section 15(3)(a) and/or Section 15(3)(b), whichever is applicable, not being part of the value of supply. While this an important distinction, it still leaves open the question of how a discount is to identified and distinguished from a ‘private’ subsidy. We do know that a discount does not by itself become a subsidy, but we don’t know when they transform into a subsidy. 

Third, the High Court stated the discount can only impact the transaction value of the supplier and its recipient. And there is no scope for confusing the further supply made by the recipient and the sale it effected to its customers and the discount it offered. (paras 51-52) 

As I stated above, the High Court did not narrate the facts clearly, so it is difficult to understand some of its observations especially the third observation listed above. But, after reading the judgment, it does seem that in this case this is what transpired: 

A supplied goods to B, which included the price of volume discounts and GST was calculated by including the value of volume discounts. When B further supplied those goods to C on a discounted value, the Revenue Department included the discount value offered by B in the transaction value of supply made from A to B contending that the discount offered by B to C was a subsidy provided by A to B. This not only caused the possibility of double taxation of the discount, but also inter-relating two different supplies and not treating them independent of each other. The value of supply from A to B was calculated in reference to the value of supply from B to C and the High Court frowned on the same. 

Conclusion 

The Madras High Court’s judgment is succinct on its findings on law and almost equally precise on the facts, though the latter lack clarity which is an impediment to completely understanding its approach to the underlying dispute. Despite the hiccups in comprehension, the High Court’s findings on law are welcome and clarify an important aspect on the GST implications of discounts and their impact on the value of supply.             

Supply of Vouchers and GST: Three Decisions and a Defensible Conclusion

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This article focuses on the issue raised by M/s Kalyan Jewellers Limited (‘Kalyan Jewellers’) as regards the pre-paid instruments (‘PPI’)/vouchers issued by them to their customers. The claim of Kalyan Jewellers before the Advance Authority (‘AAR’), Appellate body for Advance Rulings (‘AAAR’), and thereafter before the Madras High Court was that the PPIs/vouchers issued by them were actionable claims. And due to the exemption of actionable claims under Schedule III of the CGST Act, 2017, the supply of PPIs was not subject to GST. Section 2(1) of CGST Act, 2017 defines actionable claims to have the same meaning as assigned to them under Section 3 of Transfer of Property Act, 1882 which inter alia defines it as a claim to any debt other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property. And Schedule III of CGST Act, 2017 – as it existed then – stated that actionable claims, other than lottery, betting and gambling shall neither be treated as supply of goods nor supply of services. AAR, AAAR, and the Madras High Court all three adopted varied perspectives on the issue, and I examine all three below.     

AAR and AAAR Adopt Different Perspectives 

PPIs issued by Kalyan Jewellers directly or through third party vendors could be redeemed at any store of Kalyan Jewellers across India. PPIs were purchased by customers by paying a value of money specified on the PPI, and on payment the value was loaded on the PPI. And the customers could redeem the PPI against purchase of any jewellery in any of the outlets of Kalyan Jewellers. Kalyan Jewellers’ claim was that GST was only attracted when customers redeemed their PPIs, since the goods were sold at the time of redemption of PPIs and not at the time of supply of PPIs.

AAR observed that if the customer loses the PPI or is unable to produce it before expiry it cannot be used to purchase any goods. Based on the limited use of PPI, AAR concluded that PPI was not an actionable claim but only an instrument accepted as consideration/part consideration while purchasing goods from a specific supplier whose identity was established in the PPI. AAR held that PPIs constitute vouchers as defined under Section 2(118) of CGST Act, 2017 which states as follows: 

“voucher” means an instrument where there is an obligation to accept it as consideration or part consideration for a supply of goods or services or both and where the goods or services or both to be supplied or the identities of their potential suppliers are either indicated on the instrument itself or in related documentation, including the terms and conditions of use of such instrument; 

Relying on the above definition, the fact that PPI belongs to the customer who purchases it and is allowed to redeem it, AAR concluded that PPIs issued by Kalyan Jewellers are neither money nor actionable claims. And since other ingredients of a supply were fulfilled, the issuance of PPIs constituted as a supply.

The remaining question was that of time of supply, i.e., should GST be payable at the time of issuance of vouchers or at the time of their redemption by the customers? Time of supply where vouchers are involved is mentioned in Section 12(4), CGST Act, 2017 where it is stated that the time of supply shall be the date of issue of voucher, if the supply is identifiable at that point; or the date of redemption of voucher in all other cases. And since PPIs were redeemable against any jewellery, the time of supply in this case was held to be at the time of redemption of PPIs.     

Kalyan Jewellers filed an appeal before AAAR on the ground that PPIs only had a redeemable value but no inherent value capable of being marketable for the purpose of levy of GST. Kalyan Jewellers repeated its argument that PPIs are not actionable claims or goods and if their supply is subject to GST it would amount to double taxation since GST would also be paid at the time of supply of jewellery. AAAR adopted an interesting to determine the issue. AAAR held that PPI in question was neither a good nor a service, but it was not necessary to arrive at a determination if it was an actionable claim. 

AAAR categorized the PPI as a voucher, like AAR’s approach, but added its own observations. AAAR held that voucher is just means of an advance payment of consideration and per se it is neither a good nor a service. (para 7.9) It clarified that there was no issue of double taxation for if GST was levied at the time of issuance of PPI no GST would be payable at the time of its redemption. And whether supply of PPIs is taxable at the time of their supply or their redemption would be determined by the fact if the underlying supply is identifiable at that point. AAAR concluded that since the PPIs mentioned that they can be redeemed against gold jewellery at a known rate of tax, they were taxable at the time of their supply. (para 7.11) And since the PPI was neither a good or a service, it was classifiable as per the goods or services supplied on its redemption.      

It is interesting to note that Kalyan Jewellers was insistent that their PPIs be classified as actionable claims and not be subject to GST at the time of their supply but only at the time of their redemption. AAR and AAAR pretty much sidestepped the issue of actionable claim. Both the AAR and AAAR made one common observation, and in my view correctly so, that PPIs satisfied the definition of voucher and were means of consideration, treating the issue of whether PPIs were actionable claims as incidental and almost unnecessary. 

Madras High Court Goes a Step Ahead 

One would assume that AAAR’s succinct and accurate identification of PPI as vouchers would end the matter of taxability of PPIs issued by Kalyan Jewellers; but, that was not to be. Kalyan Jewellers appealed AAAR’s appealed before the Madras High Court and made similar arguments and claims it made before AAR and AAAR, i.e., PPIs issued by it were actionable claims and were subject to GST only at the time of their redemption and not at the time of their issuance. (paras 12-13) 

Madras High Court went a step further than both AAR and AAAR to interpret the definition of voucher, actionable claims and debt in significant detail and referred to the relevant provisions of Transfer of Property Act, 1882, General Clauses Act, 1897 and the Educational Guide issued under Finance Act, 1994. The High Court concluded that the PPIs issued by Kalyan Jewellers were a debt instrument as they acknowledged debt and could be redeemed on a future date towards sale consideration on purchase of any merchandise from the Kalyan Jewellers outlet. And if Kalyan Jewellers refused to redeem the value of PPI, the customer would have a right to enforce. 

Another factor that influenced the Madras High Court’s conclusion that PPI was an actionable claim was its attention to the fact that while the PPIs issued by Kalyan Jewellers mentioned that the customers would not be entitled to refund if PPIs expire before redemption, the said condition was not in accordance with RBI’s Master Directions on PPIs. The High Court clarified that even if the PPI expires before the customer claims refund, the customer would be entitled to claim refund. Accordingly, the High Court clarified that:

The “Gift Voucher/Card” is a debit card. It is like a frozen cash received in advance and thaws on its presentation at the retail outlet for being set off against the amount payable by a customer for purchase of merchandise sold by the petitioner or the amount specified therein is to be returned to the customer as per RBI’s Master Direction where a customer fails to utilize it within the period of its validity. (para 72)  

While the Madras High Court held that the PPI was an actionable claim, it also partially endorsed the AAAR’s approach that there was no need to determine if the voucher was an actionable claim to conclude that it was neither a good nor a service. As per the High Court it was sufficient to state that since PPIs were actionable claims, they were ‘as such’ not liable to taxation themselves, but only the underlying transactions were taxable. Here again, the implication of PPIs being not liable to GST as such is not clear, since PPIs are anyways liable to tax only in reference to the supply of goods or services that they facilitate. So while the High Court did finally endorse PPIs as actionable claims, it did not, and as per me, will not materially affect their taxability.    

Finally, the High Court’s conclusion was correct as it clarified that the PPI/voucher being the means of consideration could not be subject to GST, but only the goods or services purchased via it were taxable. Of course, presuming the other prescribed ingredients of supply were satisfied. (paras 79-80) As regards the time of supply, the High Court’s opinion was similar to that AAR and AAAR and there was no substantial change i.e., if goods were identifiable at the time of supply of vouchers that would constitute as time of supply else time of supply would be the date of redemption of vouchers. 

Is the Dust Settled on GST Implications of Vouchers? 

Has the Madras High Court’s opinion finally settled the dust on PPIs and their status as actionable claims under GST? I doubt it. The High Court in its decision cited the Karnataka High Court’s decision in M/s Premier Sales Promotion Pvt Ltd, where the latter made two observations that are slightly at odds with the impugned decision. The Karnataka High Court observed that PPIs do not have any inherent value of their own but are instruments of consideration and would fall under the definition of money under CGST Act, 2017. And money has been specifically excluded from the definition of both goods and services. (para 16) Second, the Karnataka High Court held that the issuance of PPIs was akin to a pre-deposit and their issuance did not amount to supply. (para 22) The Madras High Court cited the latter observations of the Karnataka High Court. (para 96) But, the Madras High Court never indicated if it agreed or disagreed with the Karnataka High Court’s approach. And, the difference in opinion of both the High Courts raises the question if PPIs are better classified as money or actionable claims?  

One way to understand this issue is by viewing vouchers as a sub-category of money. Vouchers serve the purpose of consideration or part consideration for goods or services while money, in its traditional form, also performs the same function. PPIs are also typically instruments or forms of consideration. And since PPIs also typically contain identities of suppliers, they tend to satisfy all ingredients of a voucher as in the impudnged case and are better understood as such. While the current divergence between the two High Courts on the actual character of PPIs, did not create any immediate implications in both cases, since both money and actionable claims are outside the purview of GST per se. The divergent interpretations of both the High Courts may present hurdles going forward and will require some reconciliation. 

Conclusion 

On balance, the Madras High Court’s decision is well-reasoned and, in my view, correctly identifies the status of PPIs. The High Court could have, like the AAAR chosen to not adjudicate on the issue of whether PPIs constitute an actionable claim, since the point of their taxability could have been decided only by a reference to the definition of vouchers. However, it scrutinized the key phrases and referred to various legislations and arrived at a justifiable conclusion creating a solid anchor for jurisprudence on the issue of GST implications of PPIs. 

NAA is Constitutional, Individual Orders Can be Challenged on Merits: Delhi HC

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Introduction 

This post focuses on the Delhi High Court’s recent judgment upholding the constitutionality of NAA, a statutory body established under Section 171, CGST Act, 2017. I’ve examined the working of NAA in detail here and here, where I’ve highlighted the problematic aspects of NAA’s various orders. In this post, I will summarize the petitioner’s arguments and the State’s response. At the outset, it is important to highlight that NAA’s functions and powers have been transferred to Competition Commission of India w.e.f. 01.12.2022. While the petitions challenging the constitutionality of NAA have been pending before the Delhi High Court for a while now, a decision on the constitutionality of NAA after it has passed hundreds of orders and has practically ceased to function is also an instance of how tax justice for taxpayers is elusive and littered with delays, even under a ‘transformative’ and ‘game changing’ legislation such as GST.  

The Delhi High Court, in upholding the constitutionality of NAA, has not broken any new ground. In fact, it has blunted various persuasive arguments of the petitioner’s by choosing to adopt a pedantic and literal interpretive approach that saves the face of NAA and paves path for almost unfettered delegated legislation in tax legislations. The High Court has used similar vocabulary as NAA deployed in its orders to defend its constitutionality. The High Court has floundered in engaging with the true import and scope of petitioner’s arguments and instead has provided them the concession of challenging the NAA’s individual orders on merits which is at best a half-baked solution to a constitutional challenge. 

The centrepiece of the petitioner’s case was that Section 171, CGST Act, 2017 and Rules 122, 124, 126, 127, 129, 133, 134 of CGST Rules, 2017. The notices and orders of NAA imposing penalties on taxpayers were also challenged, but the constitutional validity of the aforesaid provisions was the main subject of the impugned decision. And the constitutionality of the provisions and the related arguments also are the focus of this post.  

Section 171(1), CGST Act, 2017 states that any reduction in rate of tax on any supply of goods or services or the benefit of input tax credit shall be passed on to the recipient by way of commensurate reduction in prices. Section 171(2) empowers the Central Government, on recommendations of the GST Council, to constitute an authority or empower an existing authority to examine if the mandate of sub-section (1) is being followed by the registered taxpayers. It was in exercise of its powers under Section 171(2) that the Central Government constituted NAA.        

The relevant Rules under challenge inter alia provided that NAA shall consist of one Chairperson and four technical members, it shall have the power to determine the procedure and methodology to determine if the mandate of Section 171(1) is being adhered to, amongst other relevant details about initiation and conduct of proceedings by NAA. 

Arguments 

The petitioner’s arguments traversed a wide array of issues. The challenge to Section 171 involved arguments that Section 171 prescribed a financial extraction akin to a tax which cannot be levied via subordinate legislation; Section 171 suffered from the vice of excessive delegation as it delegates essential legislative functions to the Government and contains no legislative or policy guidance as to how NAA is to exercise its powers; and further while Section 171 delegates to the Government the power to determine the powers of NAA, the Government via Rule 126 has further delegated to the NAA the power to determine the methodology and procedure to adjudicate on violation of Section 171. The petitioners also contended that the term ‘commensurate’ has not been defined under Section 171 and meaning of profiteering hinges on the phrase ‘commensurate reduction in prices’ resulting in a circular reasoning in the provision. Section 171 was accordingly challenged as being violative of Article 14 and 19(1)(g). 

The other leg of challenges involved the opaque and uncertain methodology adopted by NAA in determining the violation of Section 171. And that in the absence of any legislative guidance, NAA acted arbitrarily demanding taxpayers reduce prices without disclosing specifics of its methodology. The petitioner highlighted the methodology adopted by NAA in profiteering complaints involving real estate companies to underline the arbitrariness in NAA’s approach. The petitioner also compared India’s anti-profiteering mechanism with that of Malaysia and Australia to underline their argument that the anti-profiteering mechanism in India was a price control mechanism interfering with their right to determine prices of goods and services.  

Petitioners further highlighted that there was no time prescribed for taxpayers to reduce prices, there was no judicial member in NAA even though it performed a quasi-judicial function, taxpayers did not have a statutory right to appeal against NAA’s orders. And that NAA did not allow any other method to pass on benefits of reduced taxes except via reduction in prices. For example, altering the sizes of products to pass on benefits of reduced taxes to customers had been rejected by NAA except in one case. 

The State justified the legal framework of NAA as constitutional. The arguments were, to a large extent, comparable to the rhetoric that NAA deployed in its orders in justifying its constitutionality. Some of the arguments that the State adopted were: Section 171 was enacted in pursuance of the Directive Principles of State Policy under Articles 38, 38(b), and 38(c) which inter alia mention economic justice and prevention of concentration of resources in a few hands. Section 171 was within the legislative competence of the Union under Article 246A of the Constitution. The State interpreted Section 171(1) differently from that of the petitioners and argued that it provided amply policy direction. It was argued that Section 171(1) clearly states that ‘any reduction’ in tax rates must be passed to recipients by ‘commensurate reduction in prices.’ And that only minutiae had been left for delegated legislation. The State defended NAA’s powers to determine the procedure and methodology stating that it clearly flows from Section 171 and this not a case of excessive delegation.

The State also challenged petitioner’s argument that only reduction of prices cannot be the sole method via which the taxpayers can adhere to the mandate of Section 171. The State argued that taxpayers should be allowed to ‘only’ reduce price in compliance of Section 171 and NAA is justified in interpreting the provision which is least prone to tax avoidance as allowing other methods may involve manipulation by taxpayers. 

The State argued that Section 171 did not provide for a price control mechanism as argued by petitioners and it only influenced the indirect price component and did not restrict the freedom of suppliers to determine the price. And that NAA was only indulging in fact finding exercise and absence of a judicial member was not fatal to its orders. Neither can absence of a time for which taxpayers are to maintain reduced prices can be the basis of challenging the constitutionality of NAA. 

I’ve tried to summarise the important arguments raised by both sides; but, in my view, the core challenge was of excessive delegation. Section 171 does not provide legislative and policy guidance to NAA and Rule 126 questionably allows NAA to determine its own procedure and methodology, a methodology which the State argued it ‘may’ determine but was not obligated to determine. The issues of excessive delegation and opaqueness/arbitrariness in the NAA’s functioning were the overarching themes in the arguments. And State defended the constitutionality of Section 171 by interpreting it in a manner as if it was the most precise and comprehensive statutory provision. 

Delhi High Court Upholds NAA’s Constitutionality 

The Delhi High Court gave multiple reasons for upholding the constitutionality of NAA. The High Court dutifully cited the principles that presumption of constitutionality guides adjudication of constitutionality of a provision and that in matters of economic laws the legislature has a wide latitude, both principles duly entrenched in Indian jurisprudence via a long line of judicial precedents. Further, the High Court observed that GST heralded a new indirect tax regime in India to reduce the cascading effect of multiple indirect taxes. On these broad and abstract principles there is little to find fault with the High Court’s approach. It is the specifics that make this judgment deficient in reasoning. I highlight some of the deficiencies below.  

To begin with, one of petitioner’s argument was that the key phrases used in Section 171 ‘commensurate’ and ‘profiteering’ are defined in reference to each other, a case of circular reasoning. The High Court invoked the State’s reference to Directive Principles of State Policy, the objective of GST to reduce cascading effect of taxes, and the dictionary meaning of ‘commensurate’ to conclude: 

Section 171 of the Act, 2017 mandates that whatever is saved in tax must be reduced in price. Section 171 of the Act, 2017 incorporates the principle of unjust enrichment. Accordingly, it has a flavor of consumer welfare regulatory measure, as it seeks to achieve the primary objective behind the Goods and Services Tax regime i.e. to overcome the cascading effect of indirect taxes and to reduce the tax burden on the final consumer. (para 100)

Again, what the Delhi High Court says here is correct, but it does not address the petitioner’s simple argument that in absence of precise phrases or clear definitions the provision suffers from arbitrariness as it allows NAA complete discretion to interpret and implement the provision. Also, the constitutionality of a provision cannot be defended by reference to its intended objectives. The fact that Section 171 was enacted in reference to Directive Principles of State Policy or for consumer protection is irrelevant to the argument that it suffers from arbitrariness. The High Court places undue emphasis on the intent of the provision to adjudicate its constitutionality and sidestepped the core issue of the provision lacking sufficient policy guidance.  

The second questionable aspect of the judgment was in the Delhi High Court’s conclusion that Section 171 contains a clear legislative policy and does not delegate essential legislative functions. And the High Court added that not only does Section 171 prescribe a clear legislative policy it also contains all the navigational tools, checks and balances to guide the authority tasked with its workability. Section 171 creates a substantive obligation on taxpayers to not profiteer, but the authority to implement the mandate, NAA, has under the relevant rules been given the power to determine its own procedure, determine the scope of complaints and investigation, determine the methodology to determine profiteering – without being under an obligation to determine it or disclose it – which cannot be reasonably traced to the statutory provision. And a statutory right to appeal against NAA’s order is absent. In such a scenario, the High Court’s interpretation that Section 171 contains sufficient policy guidance, imbibes Section 171 with more substance than it contains. 

Further, Section 171(3) states that the authority, i.e., NAA shall exercise such  powers and discharge such functions as may be prescribed. And under Rule 126, the Central Government empowers NAA to determine the methodology and procedure for determining if the taxpayers are passing on benefits of reduced taxes to consumers. It is indeed difficult to not see that the delegated legislation function assigned to the Central Government was further passed to NAA leading to a situation where NAA framed Rules to determine its own powers and determine the methodology to determine profiteering. In my view, this is a clear case of impermissible delegated legislation where an authority has been entrusted to self-determine scope of its own powers circumscribed by a thinly worded statutory provision. Also, it is worth pointing out that the Methodology that NAA prescribed in exercise of its powers was not a methodology that reliably informed the taxpayers of how the reduced prices are to be calculated and unreasonably suggested that increased costs of compliance for taxpayers are immaterial to determine compliance with Section 171. The Delhi High Court’s observations on this issue are: 

Moreover, as per Rule 126 NAA ‘may determine’ the methodology and not ‘prescribe’ it. The substantive provision i.e. Section 171 of the Act, 2017 itself provides sufficient guidance to NAA to determine the methodology on a case by case basis depending upon peculiar facts of each case and the nature of the industry and its peculiarities. Consequently, so long as the methodology determined by NAA is fair and reasonable, the petitioners cannot raise the objection that the specifics of the methodology adopted are not prescribed. (para 126) 

What is the difference between ‘determining’ and ‘prescribing’? NAA, in its orders has observed that it is not obligated to prescribe a methodology since different fact situations require different approaches. And it is only supposed to determine the methodology as per the facts, an approach which the Delhi High Court endorses in the above paragraph. But, is it justifiable to rely on the said interpretation to conclude that the methodology need not be revealed to the taxpayers?

The above observations of the Delhi High Court where it almost completely agreed with the State’s arguments and in fact NAA’s own defence of its own constitutionality, pretty much sealed the case for the petitioners. The High Court though concluded that all other arguments of the petitioners’ also did not have a persuasive value. For example, the High Court observed NAA’s investigations could be validly extended beyond the scope of original complaint (para 159), time limit to complete investigations were only directory and not mandatory despite use of the word ‘shall’, (para 158 )and that NAA was a fact-finding body and absence of judicial members was not fatal to its constitutionality. (para 146) The last finding collapses on an examination of NAA’s function and High Court’s own interpretation of Section 171 as a provision that creates a substantive obligation on taxpayers. (para 100) Clearly, in implementing Section 171, NAA is adjudicating on rights and obligations of consumers and taxpayers and yet NAA’s functions were interpreted to be confined to mere fact-finding exercise. While the actual fact-finding was undertaken by the investigative arm of the NAA, i.e., DGAP. And if a body like NAA has powers to impose penalties and cancel registrations, do they not impact taxpayer obligations? How is it defensible to accord it a status of mere fact-finding body performing functions of expert determination? 

Finally, while the State and the Delhi High Court were correct in stating that absence of a right of appeal is not fatal to the constitutionality of a body, it needs to be stated that the absence of such a right should have made the High Court more cautious that there are enough checks and balances to protect taxpayer rights at the NAA level. Instead, by upholding the arguments that investigation by DGAP can traverse beyond the subject matter of complaint, the time limit to complete investigation is directory in nature and otherwise misreading the mandate and nature of NAA, the Delhi High Court has granted a wide leeway to the State in matters of anti-profiteering in particular and generally in drafting tax legislations with unfettered delegated legislative powers to the executive.

Conclusion 

I’ve argued previously that NAA adopted self-serving interpretation of Section 171, relied on opaque and arbitrary methodology to adjudicate complaints of profiteering and that its manner of creation was tinged with unconstitutionality. The Delhi High Court has concluded otherwise, though as I’ve highlighted above, its reasoning and interpretive approaches are not beyond reproach. The concession that the petitioners have received from the Delhi High Court is that NAA adopted a flawed methodology in adjudicating complaints of profiteering in real estate projects. The High Court observed that NAA relied on the difference between ratio of ITC and turnover in pre and post-GST periods, but there is no direct co-relation between ITC and turnover. And that varying expenses and nature of construction activity should have been considered by NAA. But, the impact of these observations will only be revealed when specific orders of NAA are challenged on merits. (para 129) Since a bulk of NAA’s orders related to the real estate sector, this is not insignificant, but still does not detract from the High Court’s flawed approach in engaging with the arguments on constitutionality of NAA.            

NCLT Cannot Declare an Assessment Order as Void: Kerala HC

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The Kerala High Court in a recent judgment used strong words against an order of NCLT, Kochi Bench for declaring an assessment order passed under KVAT Act as void ab initio. The High Court observed that NCLT did not have the power to declare an assessment as void ab initio and quashed its order. I describe the case below and state whether there was a need for Kerala High Court to use harsh words against NCLT. 

Before I describe the case, it is important to reiterate, for context, that Section 14, IBC, 2016 imposes a moratorium on initiation of any coercive legal action against the corporate debtor. Section 14(1)(a) empowers the adjudicating authority to declare a moratorium for prohibiting the institution of suits or continuation of suits against the corporate debtor including any judgment, decree, or order in any court of law. While Section 33(5), IBC, 2016 states that where a liquidation order has been passed, no suit or other legal proceeding shall be initiated by or against the corporate debtor except with prior approval of the adjudicating authority.   

Facts 

The petitioner, Deputy Commissioner (Works Contract) approached the Kerala High Court impugning an order of NCLT, Kochi passed on 26.10.2022 under Section 33(5), IBC, 2016. 

The company, the corporate debtor, against whom an assessment order was passed was under the liquidation process under IBC, 2016 and was admitted into the Corporate Insolvency Resolution Process (‘CIRP’) on 25.10.2019. The CIRP effected public announcement on 03.11.2019 and a moratorium was declared under Section 14, IBC, 2016 which was to be effective on 02.12.2021, the day on which liquidation order was passed.

For the year 2015-16, the GST Department found certain discrepancies relating to VAT payments by the corporate debtor. For the year 2015-16, the corporate debtor was issued a notice under Section 25, KVAT. The assessment against the corporate debtor was completed via order dated 25.02.2021 and total VAT liability was determined as 11,76,35,626.70/- On a Form-C dated 04.01.2022 the Department claimed the said tax amount before the resolution professional appointed for the corporate debtor under IBC, 2016. 

Against the Form-C application, the corporate debtor filed an application before NCLT, Kochi under Section 33(5), IBC, 2016 seeking permission to prefer an appeal against the order of assessment dated 25.02.2021. 

While the petitioner had filed an application seeking permission to file an appeal against the order of assessment, NCLT, Kochi declared the assessment order as void ab initio. NCLT stated that the assessment order had been passed in violation of the prohibition contained in Section 14(1)(a), IBC, 2016 and directed that the tax claim be considered independently without considering the assessment order passed on 25.02.2021. Against the NCLT’s order, the State approached the Kerala High Court.  

Kerala High Court Expounds on the Law 

The issue before the Kerala High Court was: whether the NCLT is empowered to declare an assessment order as void ab initio under Section 33(5) of IBC? The straightforward answer is no, and the High Court arrived at the same conclusion, but not before it had a few harsh words to say about NCLT, Kochi. 

The law on the interface of tax claims and IBC has been expounded by various judgments, with the Courts on various occasions clarifying the overriding effect of IBC over all other legislations including tax laws. The Kerala High Court relied on two judgments, VM Deshpande case and the Sundaresh Bhatt case. The latter case was decided in the context of interplay of IBC, 2016 and Customs Act where the Supreme Court had clarified that the custom authorities can only determine the tax, interest, fine or any penalties that are due but cannot enforce their claims during the period of moratorium. This was the ratio of VM Deshpande case too, though decided in the pre-IBC period. 

The Kerala High Court relied on the above two precedents to enunciate that the law was that the tax authorities have the limited power to determine the quantum of tax and make assessments, but not enforce its demands. Accordingly, it rightly held that: 

Thus, after declaring the moratorium, there is an embargo on enforcing the demand, but there is no embargo under Section 14, read with Section 33(5) of the IBC, for determining the quantum of tax and other levies, if any, against the Corporate Debtor. (para 5.3) 

Applying the said dictums to the impugned case meant that during the moratorium the VAT assessments could have been finalized against the corporate debtor, but the said tax assessments could not be enforced. And in enforcing the said tax demands, there was a violation of Section 14, IBC, 2016. In seeking permission of NCLT to appeal against the enforcement of the tax demands, the corporate debtor was trying to enforce the law as laid down by Supreme Court in previous decisions. The NCLT went a few steps ahead and declared the tax assessment as void ab initio and non-est in law. A power that it certainly does not possess under any of the relevant provisions of IBC, 2016. NCLT should have merely provided the corporate debtor a permission to appeal, while not commenting on the assessment order per se. The Kerala High Court correctly quashed NCLT’s order and in doing so termed it as preposterous, untenable, and showing a lack of basic understanding of law. (para 6)

Conclusion 

The Kerala High Court correctly interpreted and applied the relevant precedents to the facts of the case. Equally, it was right in terming the NCLT’s order as untenable in law. The High Court in striking down the NCLT’s order also commented on the quality of persons in NCLT and their competence. I’m sure there are more suitable and appropriate channels to address the quality of personnel in NCLT instead of commenting on their legal aptitude in a judgment. I do not agree with NCLT striking down the assessment order and NCLT should have approached the issue in a more considered manner, but the Kerala High Court’s comments on NCLT personnel in the judgment could have been avoided as well.         

Religious Vows and Income Tax Obligations: Harmony to Clash 

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The Supreme Court is currently seized of a matter which, at its core, involves determining to what extent do the religious beliefs of a person exempt them from withholding tax obligations under the IT Act, 1961. In this article, I will focus on the issues involved and refer to the relevant judgments of the Madras High Court – Single Judge Bench and Division Bench, as well as the judgment of a Single Judge Bench of the Kerala High Court, currently under appeal before a Division Bench. The judgments reveal differing opinions and unravel layers of the central dilemma – should interpretation of tax law accommodate personal religious beliefs, or should tax law be indifferent to religious beliefs, irrespective of the hardship it may cause.    

Background 

The controversy involved nuns, sisters, priests, or fathers who provided their services as teachers in schools. The schools were provided grant-in-aid by the State Government under its grant-in-aid scheme. Christian religious institutions/religious congregations (‘societies’) which controlled the schools and represented the cause of the teachers before the High Court(s) contended that the teachers were bound by Canon law as they taken vows of poverty to the Christ. As a result of their vows, the teachers had suffered a civil death, were incapable of owning property and thus their salaries belonged to the society in question. The teachers were obligated to ‘make over’ their salaries to the societies and did not possess any title over them. And it was the society which accounted for the money in its tax returns and not the teachers. In view of the above, the petitioners contended that the salaries of teachers cannot be subjected to deduction of tax at source as stipulated under IT Act, 1961.  

Before I summarise the arguments adopted by the parties, it is vital to understand the successive Circulars and Instructions issued by CBDT on the issue. I’ve summarised the content of each Circular in a chronological fashion.  

Circular No.5 of 1940, issued on 02.01.1940: Medical fees, examination fees or any other kind of fees received by the missionaries are taxable in the hands of the missionaries themselves, even though they are required by terms of their contracts to make over the fees to the societies. The Circular stated that not only does the accrual happen in favor of the missionaries but there is an actual receipt by them. 

Circular No.1 of 1944, issued on 24.01.1944: Cited the principle of diversion of income and noted that the fees received by missionaries is not their income and clarified that where a missionary employee collects fees in payment of bills due to the institution, the amount collected will income of the institution and not of the employee. No income tax will be collected on fees received by missionaries for services rendered by them which as per their conditions of service they are required to make over to the society. 

Circular F. No. 200/88/75-II (AI), issued on 05.12.1977: Referred to the Circular of 1944 and reiterated that since the fees received by the missionaries is to be made over to the congregation there is an overriding title to the fees which would entitle the missionaries exemption from payment of income tax. 

CBDT Letter, F. No. 385/10/2015-IT (B), issued on 26.02.2016: Observed that the Circular of 1944, which was reiterated in 1977, was only applicable on amounts received as fees as payment of bills due to the institutions and does not cover salaries and pensions. And while Circular of 1977 mentions the word ‘salary’, the operative portion only dealt with fees. 

CBDT Letter, F. No. 385/10/2015-IT (B), issued on 07.04.2016: Reiterated the position in previous letter and noted that salary and pension earned by member of congregation in lieu of services rendered by them in their individual capacity are taxable in the hands of members even if same are made over to the congregation. No exemption from TDS is envisaged under the Circulars and Instructions of the Board. 

The shift in stance on TDS obligations, from 1944 to 2016, is evident from a summary of the above Circulars. The shift though was not caused by any substantive change in the underlying law but facts. From 2015 onwards, the teachers were to be paid salaries in their individual accounts via ECS, while previously the grant-in-aid from the State Government was credited as a lumpsum amount to the account of the societies itself. Prior to 2015, no withholding tax was deducted, primarily because that was the interpretation of the 1977 Circular. However, in 2015, before crediting the salaries to individual accounts of teachers, the Pay and Accounts Officer addressed a communication to the Principal Commissioner of Income Tax (Chennai) as to whether tax is to be deducted from salaries of teachers and received a reply in the affirmative, which the societies alleged was contrary to the Circulars issued until then. Nonetheless, it triggered a chain of events which culminated into CBDT Instructions of 2016 which also affirmed that tax should be deducted and thereafter societies filed writ petitions before the Madras and the Kerala High Court challenging the orders of deduction of tax. 

Diversion of Income vis-a-vis Application of Income 

The Revenue’s stance that religious beliefs do not exempt from withholding tax obligations highlighted the apolitical character of IT Act, 1961. And the Division Bench of the Madras High Court agreed with this argument and premised its interpretation of provisions relating to withholding tax partly on that assumption. (paras 29-30) In my view though, the Revenue’s case hinges on the core issue that the salary of teachers which they are bound to make over to the societies is an application of the teacher’s income and not a diversion of income. The petitioners contended otherwise: that the societies had an overriding title on the teacher’s salaries due to their vow of poverty and making over the salaries amounts to diversion of income and not application of income. 

Application of income, under direct tax law, means a person applies the income or spends it on an avenue of his choosing ‘after’ its receipt. This could mean donation of the entire income to another person, transferring a part or entirety of the income to a dependent based on a previous promise or otherwise parting with the income after receiving it. In such cases, since the income is received by the person and is accrued in their favor, it is taxable in the person’s hands. The subsequent application of income for charitable or other purposes is immaterial to chargeability of income in the hands of the person who receives the income in the first place.  

Diversion of income, fully expressed as ‘diversion of income by an overriding title at source’, implies that the person has diverted their income, by a contractual arrangement or otherwise, to another person and never receives the income. It is important that not only does the person not receive the income, but more crucially the accrual does not happen in favor of the person who diverts their income. Diversion of income can happen in various ways. If a person, as part of an employment or professional contract, dedicates a portion of his income to a charity whereby a charity has a right to receive such money every month, it can be said that the person has diverted that portion of their income and created a charge in favor of the charity. The portion of money earmarked for charity neither accrues in the person’s favor nor does it receive that income. The diversion needs to happen at the source of income to create an overriding title in favor of the other person. But, if the contractual terms are such that the entire income accrues in favor of the person and thereafter a portion of income is diverted towards charity, it will not amount to diversion of income but application of income. 

Courts in India have tried to demarcate the two concepts through various decisions. And while an articulation of the concepts is coherent, their application to various fact situations remains a challenge. Courts have, for example, observed that diversion of income happens where third person becomes entitled to receive the amount before an assessee can lay claim to receive it as its income, but no diversion of income happens when it is passed to a third person after receipt of income even if it may be passed in discharge of an obligation. These broad dictums while understandable need to be applied to situations that are rarely straightforward such as the current case involving nuns and fathers who have taken a vow of poverty.     

Have Teachers Diverted Their Income?  

Based on the above summary exposition of application and diversion of income, it is apposite to examine if the teachers who have taken a vow of poverty diverted their income or were they recipients of income which they applied in favor the societies. From a Canon law perspective since the teachers had suffered a civil death and were no longer capable of owning property, the case is that of diversion of income. And the teachers should not be taxable. And as the petitioners argued, the teachers were merely conduits, and the income was that of the societies. But such an approach tends to completely discount or at least dilutes relevance of the provisions under IT Act, 1961. 

The Division Bench of Madras High Court and the Single Judge Bench judgment of the Kerala High Court disagreed with the above line of argument and gave the IT Act, 1961 more primacy. Both the Courts in their respective judgements observed that the societies did not have a legal right to receive the salaries as they accrued to individual teachers. While the precepts of canon law might require the teachers to part with their salaries, it was held that the said obligation was in the realm of personal law and did not entitle the societies to receive salaries from the State Government. It can be said that from the State Government and Revenue’s standpoint, only teachers were entitled to receive the salaries, but from the standpoint of societies teachers were mere conduits to receive the money and the right to receive the money was of societies. The latter view, of course, is based primarily if not entirely on personal law.  

The single judge bench of the Madras High Court – against which a writ appeal was decided by the Division Bench of the Madras High Court – however, said the above conclusion did not give ‘due regard to personal law’ and the Revenue Department cannot ignore the personal law of the teachers. And by applying the test of distinction between diversion and application of income enunciated by Courts in previous decisions, Single Judge of the Madras High Court held that the correct conclusion is that the teachers only receive the salary on behalf of their societies as they do not partake in any part of their income. And no tax should be deducted at the time of disbursal of their salaries.      

The question then is to what extent, if at all, should income tax accommodate the religious beliefs of the teachers? If the religious belief is to be accommodated, the teachers would have to be considered as fictitious persons – and also in accordance with the long-standing practice of the Income Tax Department as per its pre-2016 Circulars – and only societies would be considered recipients of income via a deeming fiction. This would save the teachers – who do not receive any benefits of portion of their income in reality – from income tax obligations of filing returns and claiming refunds, etc. If the societies are accounting in their income tax returns, it should not be a problem as it has not been since 1944. 

What is the case for not accommodating the religious beliefs? One, there is no express provision in IT Act, 1961 that exempts people from withholding tax obligations on the ground of their religious beliefs. At the same time, I would suggest that accrual, which is one crucial basis to determine chargeability of income, may be a more pertinent lens to view this issue. For example, if the salary accrues to the teachers – due to their services provided on basis of their qualifications, as argued by the Income Tax Department – then it can be said that IT Act, 1961 and its withholding tax obligations applies to them, and the teachers are merely applying their income by making it over to the societies under their personal vows. In the alternative, if the accrual happens in favor of societies, then it is a clear case of diversion of income. But can personal religious vows transfer titles in property? Doubtful. Though if the societies can argue – and I’m not sure they have – that the teachers are bound to transfer salaries to them not just because of their personal vows but also under their contractual obligations with the school/societies, there may be room to suggest that diversion of income happens under contractual terms as well, creating an escape from withholding tax obligations. 

Story of CBDT Circulars 

Apart from the above, a sister issue is that of the validity, content, and scope of Circulars. The Income Tax Department has contended before the Courts that the Circulars that were issued under the IT Act, 1922 and do not represent the legal position under IT Act, 1961. Further, it has been argued the Circulars issued before 2016, only clarify the legal position as regards the fees received by teachers in a fiduciary capacity and not the salaries and pensions. For example, while the Circular of 1977 mentions salaries, the operative part of the Circular only refers to fees. The Division Bench of Madras High Court has opined that the Circulars suffer from vagueness, do not refer to the contemporary position such as the requirement of crediting salaries of teachers in their individual bank accounts such via ECS. Further, the Madras High Court in the same judgment has held that the Circulars can only act as a guide to interpretation and are not binding on Courts. And more importantly, the CBDT does not have the power to grant exemptions when the statutory provisions do not permit such exemptions.  

The Single Judge Bench of the Madras High Court opined that the Principal Commissioner of Chennai could not have issued directions to deduct tax by ignoring the previous valid Circulars. But, the Revenue has a persuasive argument in stating that pre-2016 Circulars only refer to fees and not salaries and pensions. The Single Judge of the Madras High Court questioned the validity of 2016 Instructions on the ground it covered the same subject matter as the previous Circulars. While the Division Bench held that the pre-2016 Circulars did not apply to salaries, but only fees. This, again, is a matter of interpretation. A perusal of the Circulars does suggest that the pre-2016 Circulars clarify tax obligations on fee and refer to salaries incidentally. Even if fee is interpreted to encompass salaries, the more crucial fact in my view is that the manner of crediting salaries has changed. Post-2015, teachers are supposed to be paid salaries via ECS in their individual accounts undeniably making them recipients of the income. This fact was not considered in pre-2015 Circulars necessitating issuance of new directions in 2016. Change in facts can change the interpretation of law. I doubt there is much grouse in that argument.  

Conclusion

I think the ‘correct’ answer in this case depends on various parameters and what is accorded due importance. The Single Judge of the Madras High Court invoked Fundamental Rights relating to religion under Article 25 and 26 to support his conclusion in favor of the teachers, while the Division Bench dismissed their relevance to the issue. Similarly, as highlighted above, if personal law is given primary consideration, then the conclusion favors the teachers, while if a strict interpretation of the withholding tax provisions is followed then as the Division Bench of the Madras High Court observed, there is no exemption based on personal religious beliefs. In my view, a deeper look into accrual and by extension diversion and application of income may provide us an insight as to how to satisfactorily resolve this issue. The Single Judge of Kerala High Court, for example, based its conclusion by reasoning that the salary accrued to the teachers who provided service in their individual capacity and not to the societies. The right to receive income is that of the teachers who entrust their salaries to the societies under a personal vow. (para 16) And, this is a fair conclusion and understanding of the arrangement. In fact, this is what the first Circular of 1940 also infers, but in the context of fees. Last, it is worthwhile to underline that the validity of Circulars and Instructions and the interpretation placed on them may ultimately prove to be crucial in determining the fate of this case.       

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

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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.    

Whose Money is it? Madras HC Says Deposit of Cash Amounts to Payment of GST

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The Madras High Court, in a recent decision, observed that the money in Electronic Cash Ledger (‘ECL’) of the taxpayer belongs to the exchequer since the money was deposited in the name of the exchequer in the form of GST. The High Court held that it cannot be said that the Government can only utilize the money in the ECL only when the taxpayer files the monthly return, i.e., GSTR-3B. The High Court reasoned that the taxpayer cannot keep the money in ECL forever and deprive the exchequer the right to utilize the amount deposited in the Government’s account on the pretext of non-filing of GSTR-3B. The High Court’s decision is at variance with the Jharkhand High Court’s decision where it was held that mere deposit of amount in the ECL does not amount to payment of tax to the exchequer and a taxpayer discharges tax liability only on filing of GSTR-3B. 

Facts 

On the date of introduction of GST, i.e., 01.07.2017, the petitioner had Rs 33 crores (rounded off) in balance as CENVAT credit which could not be transitioned to GST regime due to technical difficulties faced by the petitioner in filing TRAN-1. Since the credit was not transitioned and reflected as ITC, the petitioner could not file GSTR-3B for July 2017 within the due date. The inability to file GSTR-3B for July 2017 disentitled the petitioner from filing GSTR-3B for August to December 2017 due to the bar under Section 39(10). Accordingly, the petitioner discharged the GST liability for the period of July 2017 to December 2017 by depositing amounts in the Electronic Cash Ledger and Electronic Credit Ledger under appropriate heads of CGST, SGST, IGST into the government account. Once the petitioner was able to file TRAN-1, the GST portal allowed it to file GSTR-3B for July 2017 to December 2017 which it did on 24.01.2018. 

The petitioner was served with a recovery notice on 16.05.2023 demanding payment of interest of Rs 24 crores (rounded off) for belated filing of returns for the period of July 2017 to December 2017. The petitioner’s representation against the recovery was rejected by the Department and the validity of recovery proceedings formed the subject of the writ petition before the Madras High Court. 

The issue, simply put, was whether the petitioner was liable to pay interest on the amount it regularly – and before due date – deposited in the ECL, but in respect of which GSTR-3B was filed belatedly. 

Arguments 

The petitioner’s argument was that the deposit of cash in ECL is tantamount to deposit of money with the Government since that deposit is made into the Government’s treasury account maintained with the RBI. The petitioner relied on Section 49(1) and Explanation (a) to Section 49 of the CGST Act, 2017. Section 49(1) states that: 

Every deposit made towards tax, interest, penalty, fee or any other amount by a person by internet banking or by using credit or debit cards or National Electronic Fund Transfer or Real Time Gross Settlement or by such other mode and subject to such conditions and restrictions as may be prescribed, shall be credited to the electronic cash ledger of such person to be maintained in such manner as may be prescribed. 

And Explanation (a) to Section 49 states that ‘the date of credit to the account of the Government in the authorized bank shall be deemed to be the date of deposit in the electronic cash ledger.’ 

Based on the above two provisions, the petitioner argued that once money is deposited in ECL, it cannot be withdrawn by the taxpayer at their sweet will since it is money deposited in the Government account maintained with RBI. And a refund from ECL can only happen under Section 54 and, at the same time, if the Department wishes to recover any amount from a taxpayer they can do it via a journal entry for appropriation of amount against the pending tax demand. The petitioner added that merely because debit of ECL is a mere journal entry does not take away from the fact that tax is paid to the Government at the time of remittance under Section 49(1). And since they had deposited amount in ECL on time which amounts to payment of tax, there was no case to levy an interest on them under Section 50, CGST Act, 2017. 

The Department, on the other hand, argued that ‘cash’ which is paid vide a challan is a deposit into the petitioner’s own ECL and is not tax paid to the Government unless the said amount is debited by filing GSTR-3B returns. The Department relied on Section 49(3) which states that the amount available in ECL can be used towards making any payment towards tax, fee or interest and that tax under different heads, i.e., CGST, SGST, IGST is paid only on filing GSTR-3B and debiting the amount from ECL. It is only when GSTR-3B is filed that the tax liability is discharged. 

As is evident, the fulcrum of arguments was whether deposit of cash in the Govt’s account and subsequent credit in ECL amounts to payment of tax or whether debit from ECL at the time of filing of GSTR-3B amounts to payment of tax.  

Madras High Court Favored the Petitioner 

The Madras High Court favored the petitioner by interpreting Section 39, Section 49, and Explanation (a) to Section 49 and to support its interpretation the High Court also relied on the challan used to deposit cash and the format of GSTR-3B. 

Section 39(1) states that:

Every registered person, other than an Input Service Distributor or a non-resident taxable person or a person paying tax under the provisions of section 10 or section 51 or section 52 shall, for every calendar month or part thereof, furnish, in such form and manner as may be prescribed, a return, electronically, of inward and outward supplies of goods or services or both, input tax credit availed, tax payable, tax paid and such other particulars, in such form and manner, and within such time, as may be prescribed, on or before the twentieth day of the month succeeding such calendar month or part thereof. 

The Madras High Court emphasised on the phrase ‘tax paid’ and noted that Section 39 makes it clear that in GSTR-3B the detail of tax paid has to be furnished which is paid via GST PMT-06 challan. And since the challan mentions RBI as the beneficiary bank, any amount deposited vide the challan goes to RBI under the name of GST where the Government maintains an account. The High Court then examined the columns and details provided in GSTR-3B which contain a column of tax paid in cash. And thereby concluded that it was necessary that tax should have been paid via GST PMT-06 ‘prior’ to filing of GSTR-3B since there is a column in GSTR-3B which requires furnishing the details of tax paid in cash. 

The Madras High Court then cited Section 39(7) which states as follows:

Every registered person, who is required to furnish a return under sub-section (1) or sub-section (2) or sub-section (3) or sub-section (5), shall pay to the Government the tax due as per such return not later than the last date on which he is required to furnish such return.” 

The Madras High Court’s interpretation was novel and vital to the case. As per the High Court, Section 39(7) requires that the tax be paid before the due date of filing monthly return – GSTR-3B – and that filing of the monthly return is not important, but that tax should be paid before the due date of filing of monthly return. (paras 24-26) The High Court thus decoupled the payment of tax with filing of GSTR-3B and derived this conclusion from the manner in which Section 39(7) is phrased. 

The Madras High Court subsequently interpreted Section 49(1) and Explanation (a) to mean that the date on which account of the Government is credited is deemed to be the date of deposit in the ECL. The High Court noted that this implies that at the first step the Government’s account is credited and then the taxpayers’ ECL. And that latter was merely a journal entry or an accounting entry.   

The Madras High Court’s combined reading of Section 39(1), 39(7), 49(1) and Explanation (a) led it to the conclusion that the payment of tax must be made before the filing of GSTR-3B and the payment is made in the Government’s authorized account maintained with RBI. This inevitably led the High Court to the conclusion that GST is paid when money is deposited in the Government’s account and not when GSTR-3B is filed. The High Court further reinforced its interpretation by reasoning that if one were to hold that the Government cannot utilize GST collection until the taxpayer files GSTR-3B then the taxpayer can retain the amount in ECL forever by delaying filing of returns. Thus, the High Court reasoned that the moment money is deposited by generating the challan GST PMT-06, it is the money of the exchequer. The amount deposited is GST collected by a taxpayer on behalf of the Government and the Government’s right to utilize it cannot be postponed until the taxpayer files GSTR-3B. (paras 35-41)     

Jharkhand High Court Favored the Department 

On a similar issue, the Jharkhand High Court in M/s RSB Transmissions case, referred to the same provisions, but interpreted them differently to conclude that tax is paid at the time of filing of GSTR-3B and not when cash is deposited in ECL. The Jharkhand High Court referred to the deposit of money vide a challan, Explanation (a) to Section 49 and noted that the deposit of cash was a deposit in the ECL of the taxpayer and did not amount to discharge of tax liability. While, as per the Madras High Court, the money deposited vide a challan is deposited into the Government’s account maintained in RBI and thereafter shown in ECL via a journal entry. 

The Jharkhand High Court also differed in its interpretation of Section 39(7) by observing that no tax can be paid before filing of GSTR-3B. The Jharkhand High Court noted that it is only on filing of GSTR-3B that the ECL is debited towards payment of tax, interest or penalty. The High Court emphasised on the term ‘deposit’ used in Section 49(1) and 49(3) which states that the amount available in ECL ‘may be’ used for payment towards any tax, interest, interest, penalty or fees. The Jharkhand High Court viewed the ECL as an ‘e-wallet’ where the taxpayer can deposit cash anytime by generating the requisite challans. And refund of the said cash can be obtained under the procedure prescribed under the Act. (para 15)   

Importance of Proviso to Section 50 

Section 50(1) and the Proviso also received differing interpretations from the Madras High Court and the Jharkhand High Court primarily because the way the former interpreted Section 39(7). 

Section 50(1) states that: 

Every person who is liable to pay tax in accordance with the provisions of this Act or the rules made thereunder, but fails to pay the tax or any part thereof to the Government within the period prescribed, shall for the period for which the tax or any part thereof remains unpaid, pay, on his own, interest at such rate, not exceeding eighteen per cent., as may be notified by the Government on the recommendations of the Council. (emphasis added)  

The Madras High Court interpreted the term prescribed period in reference to Section 39(7) cited above and held that Section 39(7) provides that tax should be paid before due date of filing monthly return, i.e., GSTR-3B. And, the said tax, as the Madras High Court had noted is deposited vide a challan. This fact becomes crucial in interpreting the Proviso to Section 50(1) which states: 

Provided that the interest on tax payable in respect of supplies made during a tax period and declared in the return for the said period furnished after the due date in accordance with the provisions of section 39, except where such return is furnished after commencement of any proceedings under section 73 or section 74 in respect of the said period, shall be levied on that portion of the tax that is paid by debiting the electronic cash ledger.  (emphasis added)

The Jharkhand High Court had relied on the latter part of Proviso to conclude that tax is actually paid when the ECL is debited. The Jharkhand High Court had observed: 

This again goes to show that only on filing of GSTR-3B return, the debit of the tax dues is made from Electronic Cash Ledger and any amount lying in deposit in the Electronic Cash Ledger prior to that date does not amount to discharge of tax liability. A combined reading of Section 39 (7), 49 (1) and Section 50(1) read with its proviso and Rule 61(2) also confirms this position. (para 15)

The Madras High Court expressed its disagreement with the above interpretation and noted that Section 50(1) read with Section 39(7) provides for payment of tax via cash and its Proviso cannot be interpreted to mean that tax is paid only on debit of ECL. The Madras High Court noted that the Jharkhand High Court’s interpretation of the Proviso is contrary to Section 50(1) which is not permissible since a Proviso does not travel beyond the main provision, only carves out an exception to it. (paras 55 and 58)

The Jharkhand High Court’s interpretation of Proviso to Section 50 flowed from its interpretation of Section 39(7) and since the Madras High Court interpreted Section 39(7) differently, its interpretation of Proviso to Section 50 differed accordingly. Though, the latter seems more aligned with the bare text of the provisions. 

Conclusion

The Madras High Court’s conclusion was premised on its understanding that deposit of cash vide challan is a deposit in the Government’s account which it can utilize immediately. The Madras High Court viewed GSTR-3B as the ‘ultimate proof’ for discharge of tax liability of the taxpayer, a return that quantifies and formalizes the tax payment made earlier. (para 38) The Jharkhand High Court viewed the deposit vide challan as a deposit in the e-wallet of the taxpayer. (para 15) The Jharkhand High Court did not pay attention to the first few words of Explanation (a) to Section 49(1) which state ‘the date of credit to the account of the Government …’. The import of these words, in my view, is that the cash is deposited in the account of the Government and by the deeming fiction the date of deposit is treated to be the date of deposit in ECL of the taxpayer. The cash deposit happens in the Government’s account which is merely reflected in the ECL later. And via a journal entry caused by GSTR-3B, the remainder amount, if any, is shown in ECL which can be refunded to the taxpayer. The Jharkhand High Court was also remiss in not paying adequate attention to the phrase ‘tax paid’ used in Section 39(1) and which the Madras High Court corrected, to some extent.   What then is the purpose of GSTR-3B? In my view, the Madras High Court is correct in observing that tax liability is quantified on filing of GSTR-3B even though the tax is deposited before the filing of GSTR-3B. This is because, as the petitioners argued before the Madras High Court, a taxpayer cannot simply withdraw money from ECL unless the prescribed procedure is followed. And a proper officer would not ordinarily allow withdrawal from ECL if there is outstanding tax liability. The cash so deposited, is de facto in the Government’s control. To conclude, it suffices to say that the Jharkhand High Court erred in stating that tax cannot be paid before filing of GSTR-3B while the Madras High Court has accorded less than deserved importance to GSTR-3B, though it does not detract from the fact that the latter’s view reflects a more accurate reading of the law. 

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

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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.

Tax Residency Certificate and Stakes in the Blackstone Case – II

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In the first part of this Article, I detailed Delhi High Court’s decision in the Blackstone case. This part focuses on the immediate and larger issues that are likely to be considered by the Supreme Court in its decision on the appeal against the Delhi High Court’s decision. The central issue in the appeal is likely to be the eligibility for tax benefits under a DTAA, and as one witnessed in the Azadi Bachao case, any legal opinion on the issue will navigate both domestic and international tax law.     

Interpretation of DTAAs

To begin with, DTAAs, a legislative instrument agreed to and signed by two contracting states, needs to be interpreted to decipher the agreement between the two sovereign states. The Delhi High Court had to contend with two issues relating to DTAA: whether Article 13 incorporated the concept of beneficial ownership and the conditions imposed by the LOB clause. With regards to the former, the High Court compared Article 13, as it stood at the relevant time, with other provisions of the DTAA, i.e., Articles 10, 11, and 12 which provide for taxation of dividends, interest, and royalties respectively. The High Court correctly pointed out that in India-Singapore DTAA the concept of beneficial ownership attracted taxation only qua Articles 10,11, and 12 which expressly provided for it and beneficial ownership cannot be read into Article 13 in the absence of any mention of the same in the latter. (para 61)    

The Delhi High Court was also unequivocal in its conclusion that the LOB clause included in Article 24A of the India-Singapore DTAA provides for an objective and not a subjective test. As per the LOB clause, only companies that are not shell companies can claim benefits of the India-Singapore DTAA and to establish if a company is not a shell company there is an expenditure test. The High Court observed that the audited financial statement of Blackstone Singapore and independent chartered accountant certificate established that the expenditure of the company is above the prescribed limit. The High Court rejected the Income Tax Department’s view that Blackstone Singapore was a shell company by observing that all expenditure incurred by it in Singapore, direct and indirect, will be considered an operational expense. The Income Tax Department’s attempt to bifurcate expenses into operational and other expenses was rejected. (para 70) 

In interpreting both Article 13 and LOB clause in Article 24A of the India-Singapore DTAA, the Delhi High Court adopted a good faith interpretation of the treaty. One could also suggest that a strict interpretation was adopted. Either way, it is the acceptable and welcome interpretive approach as it avoids reading into the DTAA phrases and expressions that are not expressly included in its text. Particularly, notable are the Delhi High Court’s observations that LOB clause incorporates an objective test. If the expenditure threshold is met and the expenses are verified, the Income Tax Department cannot form a subjective opinion that the expenses are not operational expenses.   

The interpretation of both the above provisions is likely to be tested before the Supreme Court. Though the Delhi High Court’s opinion stands on firm footing, it is difficult to ascertain how the Supreme Court will approach the same issues. 

Validity of TRCs and Relevance of Azadi Bachao Ratio 

From a domestic tax law perspective, an issue that needs determination is the mandate and requirements of Sections 90(4) and 90(5). As I’ve mentioned in the first part of this article, Section 90(4) states than an assessee, who is not a resident of India, is not entitled to claim any tax relief under DTAA unless it obtains a TRC from the country of residence. And Section 90(5) states that an assessee referred to in sub-section (4) shall provide such other documents and information, as may be prescribed. Both the sub-sections, in no manner, state that TRC is a necessary but not a sufficient condition to claim DTAA benefits. This interpretation is not only borne out by the bare text of the provisions, but also their legislative history. The Delhi High Court, like the Punjab and Haryana High Court, arrived at a correct conclusion that the legislative history of these provisions does not support the Income Tax Department’s argument that it can go behind the TRC issued by a contracting state.   

Further, the appeal will necessarily involve engagement with the Supreme Court’s ratio in Azadi Bachao case. The Azadi Bachao case settled various issues, the relevant portion of the ratio for the purpose of our discussion here are: under Section 119, IT Act, 1961, CBDT possesses the power to issue a Circular stating that TRC issued by Mauritius would be a sufficient evidence of the assessee’s residence status. While the Circular was issued in the context of India-Mauritius DTAA, there is no legal reason why a similar approach would be invalid in the context of India-Singapore DTAA. Especially, as the Delhi High Court noted, the Press Release of the Ministry of Finance issued in 2013 also adopted a similar position. And the Press Release described the general legal position and not in context of India-Mauritius DTAA.   

Nonetheless, the arguments about the scope and mandate of CBDT have reared their head often and will perhaps do so in the future. And the impugned appeal provides an opportunity to raise the issue about CBDT’s powers again. But we do need an understanding beyond the simple dictum that CBDT’s Circulars are binding on the Income Tax Department. If and to what extent do the assessing officers possesses the mandate to scrutinize returns and question the TRC still does not have a straightforward answer. Does CBDT Circular and Azadi Bachao case foreclose any possibility of an assessing officer questioning the TRC? The Supreme Court, in Azadi Bachao case, was categorical in its conclusion that the Circular No. 789 issued by CBDT – mandating acceptance of TRC issued by Mauritius – in reference to India-Mauritius DTAA was within the parameters of CBDT’s powers under Section 119, IT Act, 1961. And the said Circular did not crib, cabin or confine the powers of the assessing officers but only formulated ‘broad guidelines’ to be applied in assessment of assessees covered under the India-Mauritius DTAA.    

Both the above aspects in respect of domestic tax law, specifically IT Act, 1961 will likely be argued and examined in the impugned appeal. The nature and extent of their influence will only be known in due time. 

Way Forward 

Prima facie, there is little to suggest that the Delhi High Court’s view deviates from the accepted interpretation of the Azadi Bachao case and the guiding principles of tax treaty interpretation. Neither is the Delhi High Court’s understanding of legislative history of Section 90(4) and 90(5) incorrect. The Supreme Court can and may have other views. Irrespective of the outcome, the arguments advanced by both parties, the reasoning and approach of the Supreme Court and the outcome of the case will impact Indian tax jurisprudence in multiple ways.  

Tax Residency Certificate and Stakes in Blackstone Case – I

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In BlackStone case framed the following as the main issue for consideration: whether the Income Tax Department can go behind the tax residency certificate (‘TRC’) issued by another jurisdiction and issue a re-assessment notice under Section 147, IT Act, 1961 to determine the residence status, treaty eligibility and legal ownership. In this article, I will focus only on the issue of TRC. In the first part of this article, I provide a detailed explanation of the case and in the second part I highlight the stakes involved in the case given that the Supreme Court has decided to hear an appeal against the Delhi High Court’s judgment.  

Facts 

Blackstone Capital Partners (Singapore) VI FDI Three Pte. Ltd (‘Blackstone Singapore’) acquired equity shares of Agile Electric Sub Assembly Private Limited, a company incorporated in India in two tranches on 16.08.2013 and 31.10.2013. In the Assessment Year 2016-17, Blackstone Singapore sold all the equity shares. In its return of the income, Blackstone Singapore claimed that the capital gains earned by it on sale of shares were not taxable in India as per Article 13(4) of the India-Singapore DTAA.  The import of Article 13(4) was that capital gains earned by a resident of India or Singapore were taxable only in its resident state. Since Blackstone Singapore possessed a TRC issued by Singapore, it claimed tax exemption in India on its capital gains under the India-Singapore DTAA. On 08.10.2016, Blackstone Singapore’s return was processed with no demand by the Indian Income Tax Department. 

On 31.03.2021 a notice was issued to Blackstone Singapore under Section 148, IT Act, 1961 (reassessment notice). On 28.04.2021 Blackstone Singapore filed its return and requested reasons for re-opening the assessment. Eight months later, on 02.12.2021 Blackstone Singapore was provided reasons for re-opening the case. The primary reason, as per the Income Tax Department, was that Blackstone Singapore was part of US-based management group and it appeared that the source of funds and management of affairs of Blackstone Singapore was from US. And there was an apprehension that Blackstone Singapore was not the beneficial owner of the transaction. The Income Tax Department was claiming that beneficial owner of the shares was Blackstone US, with Blackstone Singapore being a conduit/shell company incorporated to avail tax benefits under the India-Singapore DTAA.  

Blackstone Claims Tax Exemption 

Blackstone Singapore’s case for tax exemption of capital gains was predicated on the following: 

First, Blackstone claimed that it was entitled to claim tax exemption under Article 13(4) of the India-Singapore DTAA. Article 13(4) of the India-Singapore DTAA originally stated that the gains derived by resident of a Contracting State from the alienation of any property other than those mentioned in paragraphs 1,2 and 3 of this Article shall be taxable only in that State. In simple terms it meant that capital gains of a resident of Singapore or India were taxable only in its resident state. Since Blackstone possessed a valid TRC from Singapore, it was as per Article 13(4), not liable to pay tax in India, but in the country of its residence. 

Second, Blackstone relied on the chequered history of the India-Mauritius DTAA. In reference to the India-Mauritius DTAA, CBDT had issued a Circular No. 789 on 13.04.2000 stating if a TRC was issued by the Mauritian authorities, it would constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the DTAA accordingly. And the validity of the said Circular was upheld by the Supreme Court in the Azadi Bachao case and its ratio subsequently approved in the Vodafone case. Analogously, Blackstone Singapore claimed that TRC issued by Singapore should be sufficient to qualify for tax benefits under the India-Singapore DTAA.  

Third, Blackstone cited a Press Release issued by the Ministry of Finance on 01.03.2013 regarding TRC. The Press Release categorically stated that the TRC produced by a resident of a contracting state will be accepted by the Indian Income Tax Department for the purpose that he is a resident of that contracting state and that the income tax authorities in India will not go behind that certificate to question the resident status. The income tax authorities had no option but to accept the validity of TRC issued by Singapore.         

Fourth, Blackstone, to rebut allegations that it was not the beneficial owner or was a shell company in Singapore, argued that it fulfilled the requirements incorporated in the India-Singapore DTAA. Article 3 of the Third Protocol of India-Singapore DTAA added Article 24A in the DTAA w.e.f 01.04.2017. Article 24A contains a detailed LOB clause and as per one of its conditions the resident of one of the Contracting States is prevented from claiming the benefits of DTAA if its annual expenditure on operations in that State was less than Rs 50,00,000 in the immediately preceding period of 24 months from the date the gains arise. In the expenditure was below the prescribed, it was presumed that the company was shell/conduit company. Blackstone Singapore argued that since its expenditure for running the Singapore company was above the prescribed threshold it cannot be considered a shell company and denied treaty benefits. 

Income Tax Department Defends its Interpretation of the Treaty  

First, the Income Tax Department claimed that the management and funding of Blackstone Singapore was in US and not Singapore. And that the ultimate holding company was in US, and Blackstone Singapore entity was used as a conduit since the India-US DTAA did not provide capital gains exemption. The filings of Blackstone Group before SEC, US were used to underline the control of Blackstone, US over Blackstone, Singapore. Further, the Income Tax Department argued that Blackstone, Singapore had a paid-up capital of US $1 and it was hard to believe that it had independently decided to acquire assets worth US $53 million and in two years made profits of US $55 million. 

Second, the Income Tax Department argued that Blackstone Singapore does not meet the LOB test since the expenditure mentioned in the LOB clause is ‘operations expenditure’ and not just an ‘accounting entry’. The Income Tax Department argued that a major part of Blackstone’s expenses were merely management expenses paid to a group company which were nothing more than an accounting entry and did not constitute real expenses.  

Third, the Income Tax Department argued that as per Section 90(4) of the IT Act, 1961, TRC was a ‘necessary’ but not a ‘sufficient’ condition to claim DTAA benefits. And that a TRC is only binding when a court or authority makes an inquiry into it and makes an independent decision. Though a plain reading of Section 90(4) does not support this interpretation.  

Fourth, an extension of the third argument, it was argued that the Press Release of 2013, Supreme Court’s decision in Azadi Bachao case and the CBDT Circulars that were considered in Azadi Bachao case were issued in the context of India-Mauritius DTAA and were not applicable to India-Singapore DTAA. Further, it was contended that Azadi Bachao case did not circumscribe the jurisdiction of an assessing officer in individual cases. And that CBDT Circulars only provide ‘general’ instructions and cannot interfere with quasi-judicial powers of the assessing officers.        

Delhi High Court Favors Blackstone 

On the issue of TRC, the findings of the Delhi High Court were categorically in favor of Blackstone Singapore. The High Court observed that: 

… the entire attempt of the respondent in seeking to question the TRC is wholly contrary to the Government of India’s repeated assurances to foreign investors by way of CBDT Circulars as well as press releases and legislative amendments and decisions of the Courts … (para 71)

The Delhi High Court noted that the actions of the Income Tax Department in questioning the TRCs were contrary to Azadi Bachao, Vodafone cases and other cases. 

On the issue of whether Section 90(4) provides that TRC is a necessary or a sufficient condition to claim DTAA benefits, the Delhi High Court relied on legislative history of Section 90(5) instead of the bare text of Section 90(5). To begin with, Section 90(4) is worded in negative terms and does not use either the word ‘sufficient’ or ‘necessary’. Section 90(4) states that:

            An assessee, not being a resident, to whom an agreement referred to in sub-section (1) applies, shall not be entitled to claim any relief under such agreement unless a certificate of his being a resident in any country outside India or specified territory outside India, as the case may be, is obtained by him from the Government of that country or specified territory. 

Clearly, mere reliance on the bare text of Section 90(4) does not throw sufficient light on whether the TRC constitutes a sufficient evidence of residence in a contracting state. The Delhi High Court referred to Finance Bill, 2013 which proposed to introduce Section 90(5). The proposed draft text of Section 90(5) as contained in Finance Bill, 2013 was: 

The certificate of being a resident in a country outside India or specified territory outside India, as the case may be, referred to in sub-section (4), shall be necessary but not a sufficient condition for claiming any relief under the agreement referred to therein.” 

However, immediately after introduction of the Finance Bill, 2013, the Ministry of Finance issued a clarification via a Press Release clearly stating that a TRC issued by a contracting state would constitute as sufficient evidence of its residence, and the Delhi High Court clarified that the clarification was not Mauritius specific. Since the proposed Section 90(5) was not implemented by the Finance Act, 2013, the Delhi High Court refused to accept the Income Tax Department’s argument that TRC is a necessary but not a sufficient condition to claim DTAA benefits. The High Court also relied on similar reasoning and conclusion arrived at by the Punjab & Haryana High Court in the Serco Bpo Pvt Ltd case.  

Accordingly, the Delhi High Court concluded that:

Consequently, the TRC is statutorily the only evidence required to be eligible for the benefit under the DTAA and the respondent’s attempt to question and go behind the TRC is wholly contrary to the Government of India’s consistent policy and repeated assurances to Foreign Investors. In fact, the IRAS has granted the petitioner the TRC after a detailed analysis of the documents, and the Indian Revenue authorities cannot disregard the same as doing the same would be contrary to international law. (para 91) 

Aftermath

The Income Tax Department, unsurprisingly appealed against the Delhi High Court’s decision and the Supreme Court, also unsurprisingly, has stayed the decision. The Supreme Court will, in all likelihood, have a final say on the matter; though in India, the Revenue Department wishes to be final authority on all tax matters. Nonetheless, there are important legal and policy questions that are stake in this case. Based on my understanding, I detail and highlight the stakes involved in the second part of this article. 

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