IT Act 1961

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

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

Introduction  

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

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

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

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

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

Section 187C, Companies Act, 1956

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

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

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

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

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

Narrow Understanding of Beneficial Ownership? 

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

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

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

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.    

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. 

Leg History of Sec 90(4) & 90(5), IT Act, 1961

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The infographic below is a snapshot of the legislative history of Section 90(4) and 90(5) of IT Act, 1961. It provides a summary view of the Income Tax Department’s attempt to include a stringent condition for a non-resident assessee to claim DTAA benefits. The condition, simply stated, was that a TRC issued by a contracting state is a necessary but not a sufficient condition to claim DTAA benefits. It was supposed to allow the Indian income tax authorities to go behind the TRC issued by another state.

The importance and relevance of the legislative history of the aforesaid provisions can be better understood by reading this and this in the wake of Delhi High Court’s decision involving tax benefits under the India-Singapore DTAA. An appeal against the decision is pending before the Supreme Court at the time of publishing this infographic.

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

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

Facts 

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

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

Arguments and Decision 

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

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

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

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

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

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

Conclusion 

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

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

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

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

Facts and Arguments 

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

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

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

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

Decision  

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

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

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

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

Decision 

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

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

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

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

Facts 

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

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

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

Decision 

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

Conclusion 

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

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

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