IT Act 1961

Possession, Ownership and Valuable Articles: Supreme Court Opines on Section 69A, IT Act, 1961

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On 16 May 2023, a Division Bench of the Supreme Court in M/s DN Singh case[1] delivered a well-reasoned judgment clarifying the scope of Section 69A, IT Act, 1961. The case required the Supreme Court to determine if a person in unlawful possession of bitumen can be equated to an owner and obligated to pay tax for its monetary value under Section 69A. The judgment is elegantly structured and helps us understand the intent and meaning of Section 69A.  

Introduction

The brief facts are as follows: assessee was a carriage contractor for bitumen which was loaded from oil companies to be delivered to various divisions of the Road Construction Department of the Government of Bihar. A scam was reported in the media that transporters were not delivering the requisite quantity of bitumen to the Road Construction Department and were misappropriating it after loading from oil companies. Taking note of the scam, Assessing Officer of the assessee took note of the difference in quantity between the bitumen lifted by the assessee and delivered by it and added the value of missing bitumen to the assessee’s income under Section 69A, IT Act, 1961.   

There were two assessment years in question: in the assessment year 1995-96, an addition was made in a sum of Rs.2,01,14,659 towards short delivery of bitumen while in the assessment year 1996-97 there was an addition in a sum of Rs.1,04,71,720. 

The assessee resisted addition of the amounts on two counts, i.e., bitumen was not a valuable article which was a pre-condition for invoking Section 69A and that the assessee was only a carrier but not owner of the bitumen in question and that Section 69A can only be invoked against owners of the valuable articles. Section 69A, IT Act, 1961 states as follows: 

Where in any financial year the assessee is found to be the owner of any money, bullion, jewellery or other valuable article and such money, bullion, jewellery or valuable article is not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewellery or other valuable article, or the explanation offered by him is not, in the opinion of the 4 Assessing] Officer, satisfactory, the money and the value of the bullion, jewellery or other valuable article may be deemed to be the income of the assessee for such financial year. (emphasis added)

In this post, I will focus on the Supreme Court’s approach towards interpretation of the two terms – owner and other valuable article – used in Section 69A to examine how it understood the scope and intent of the above-cited provision.  

Supreme Court Clarifies the Scope and Intent of Section 69A

The first question was whether the transporter would qualify as an owner of goods which the Supreme Court answered in the negative. The Supreme Court referred to the law relating to bailment and noted that entrustment of goods to the transporter would amount to bailment. The bailee/transporter is necessarily entrusted with the possession of goods for the purpose of delivery as per the directions and wishes of the consignee. Consequently, the Supreme Court held that: 

During the subsistence of the contract of carriage of goods, the bailee would not become the owner of the goods. In the case of an entrustment to the carrier otherwise than under a contract of sale of goods also, the possession of the carrier would not convert it into the owner of the goods. (para 39)

The Supreme Court cited a series of cases which examined the definition of owner in the context of income from house property to emphasise two elements: first, that the definition of ownership needs to be interpreted as per the context e.g., in the case of taxation of an owner from income from house property courts have held that the emphasis was on receipt of income. And an owner must be someone who exercises the right of an owner not on behalf of the owner but in his own right. Second, the Supreme Court emphasised the owner possesses a bundle of rights with respect to a property, e.g., power of possession, right to alienate, right of bequeath and right of enjoyment. (paras 57-58) Applying the above understanding and elements of ownership to the case, the Supreme Court observed that the transporter cannot be considered as owner of bitumen. The Supreme Court reasoned that a transporter by short delivering the bitumen breached the terms of contract and committed an act that was punishable under penal laws. Accordingly: 

Recognising any right with the carrier in law would involve negation of the right of the actual owner which if the property in the goods under the contract has passed on to the consignee is the consignee and if not the consignor. This Court has already found that the appellant is bereft of any of the rights or powers associated with ownership of property. The only aspect was the alleged possession of the goods which is clearly wrongful when it continued with the appellant contrary to the terms of the contract and the law. (para 61)

The Supreme Court found that the assessee was not in possession of bitumen in his own right, did not possess the power of alienation, could not claim any right over bitumen as an owner and the title of assessee was only a shade better than that of the thief. And thereby the Supreme Court refused to accept that the assessee was the owner of bitumen. 

Second question that the Supreme Court had to address was if bitumen constituted a valuable article under Section 69A. It referred to the principle of ejusdem generis and Noscitur a Sociis, and observed that to apply the aforestated principle to interpret a provision there must exist a genus which must not be exhausted by the categories enumerated in the catalogue. The Supreme Court underscored the scope of ‘other valuable article’ by using certain examples. It referred to the fact that watches, coconuts, cameras can or cannot constitute a valuable article depending on the facts of the case, but placed primary emphasis on the price of the goods in question. According to the Supreme Court, the intent was to ascertain if the goods were worth a great deal of money or a great price. Thereby, citing the price of bitumen as Rs 5/kg, it concluded that:

But if to treat it as ‘valuable article’, it requires ownership in large quantity, in the sense that by multiplying the value in large quantity, a ‘good price’ or ‘great deal of money’ is arrived at then it would not be valuable article. Thus, this Court would conclude that ‘bitumen’ as such cannot be treated as a ‘valuable article’. (para 79) 

The Supreme Court adopted the right approach in analysing the scope and intent of Section 69A. It examined in detail the position of a transporter as a bailee, the rights of a bailee vis-à-vis owner and how the former cannot be equated to an owner in the impugned case. More importantly, the Supreme Court never lost sight of the intent of Section 69A when interpreting the terms owner and other valuable article, ensuring that its interpretation of both terms was in the proper context and furthered the objective that the provision seeks to achieve. 

Notes on Concurring Opinion 

In his concurring opinion, Justice Hrishikesh Roy examined the term other valuable article in detail and made three important observations: 

First, that he observed that if one focuses on the words money, bullion and jewellery that precede other valuable article, it is justified to include only high value goods. And that if sundry articles of nominal value are included or if one emphasises on total high value of goods without looking at their low per unit price, it would defy the logic of legislature. (para 10) 

Second, he stated that the provision was unambiguous and needs to be interpreted strictly – a well-established dictum in tax law interpretation. Thus, other valuable article cannot be interpreted to mean ‘any article of value’ but means an item ‘worth great deal of money’. He reasoned that other valuable article has to be a high-priced article that was purchased to avoid income tax liability and not every article of any value. (para 15)  

Third, he correctly observed that high value and less bulky items that aided assesses in evading their income tax liabilities were intended to be brought within the scope of Section 69A and were the reason for 1964 Amendment to introduction of the impugned provision. (para 17) 

Justice Roy, in his concurring opinion, was able to successfully highlight the intent, scope and meaning of Section 69A. The concurring opinion is worth reading for its precision and its adds considerable value to the case and helps us understand the history, scope and meaning of Section 69A clearly.  

Conclusion 

The Supreme Court through its judgment has articulated the scope of Section 69A sufficiently clearly. Equally, the judgment also adequately refers to the intent of the provision, i.e., to bring within the income tax net assets that an assessee may purchase or otherwise own and hides from the income tax authorities. Any article can be of value, the question was whether the article in question was worth enough money to enable a person to escape income tax liability. And more appropriately, the Supreme Court observed that it is not important to ascertain the total value of the goods, but need is to look at per unit value of goods else the objective of Section 69A would not be served.   

[1] M/s D.N. Singh v Commissioner of Income Tax, Central, Patna & Anr 2023 LiveLaw (SC) 451. 

Winnings from Online Games: CBDT Clarifies Contours of Section 194BA, IT Act, 1961

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Finance Act, 2023 inter alia introduced changes to withholding tax obligations for winnings from lottery, crossword puzzles and horse races under Sections 194B and 194BB, IT Act, 1961. Finance Act, 2023 also introduced a new provision, i.e., Section 194BA, IT Act, 1961 to deduct taxes on winnings from online games apart from introducing a new charging provision, i.e., Section 115BBJ for such winnings. The Central Board of Direct Taxes (‘CBDT’), on 22 May 2023 issued a Circular[1] containing Guidelines for implementation of Section 194BA. This post is an attempt to examine the above mentioned changes and highlight how winnings from online games are being categorized separately under the IT Act, 1961.   

Changes Introduced by the Finance Act, 2023 

Prior to Finance Act, 2023, Section 194B, IT Act, 1961 provided that the person responsible for paying to any person any income by way of winnings from any lottery or crossword puzzle or card game and other games of any sort in an amount exceeding ten thousand rupees shall at the time of payment thereof, deduct income tax at the rates in force. Section 194BB imposed a similar obligation on the person responsible for making a payment of any income by way of winnings from any horse race or from wagering or betting in any horse race.  

The Finance Act, 2023 amended both the above provisions to clarify that the deduction of tax under the aforesaid provisions shall be on the amount or aggregate of amounts exceeding ten thousand rupees during the financial year. The State claimed that the deductors under Section 194B and Section 194BB were splitting winnings into various transactions below Rs 10,000 – presumably to avoid withholding tax obligations under Section 194B and Section 194BB – which was contrary to legislative intent and the amendments were an attempt to plug this loophole. 

Equally, Section 194B was amended to include ‘gambling or betting of any form or nature whatsoever’ but exclude online games from its purview. A new provision, i.e., Section 194BA was introduced to govern deduction of taxes on winnings from online games and which provides that taxes shall be deducted on net winnings in the user account at the end of the financial year. Simultaneously, a separate charging provision for winnings from online games was introduced, i.e., Section 115BBJ, IT Act, 1961 while winnings from other games continued be charged under Section 115BB. 

The cumulative effect of the above changes introduced by the Finance Act, 2023 is that withholding tax obligations and tax liabilities of winnings from online games have their own specific provisions – Section 194BA and Section 115BBJ, IT Act, 1961 – and will not be governed by generic provisions relating to winnings from games.     

Clarifications Issued Via the CBDT Circular  

On 22 May 2023, Central Board of Direct Taxes (‘CBDT’) issued guidelines in exercise of its powers under the newly inserted Section 194BA, IT Act, 1961. Simultaneously, Rule 133 was added to the Income Tax Rules, 1962 which prescribed a relatively straightforward formula to calculate net winnings under Section 115BBJ, IT Act, 1961. 

The CBDT Guidelines are meant to clarify certain aspects of the deductor’s obligations under Section 194BA. For example, the Guidelines state that a user account shall mean every account of the user, by whatever name called, which is registered with the online gaming intermediary. Further, that where a user has multiple user accounts on different platforms of a single deductor then each user account shall be considered on an aggregate except where such aggregation is not possible due to technological reasons. There are a few other clarifications; however, in my view, to understand the contours of the Section 194BA, IT Act, 1961 four aspects of the Guidelines are vital:

First, any bonus, winnings, incentives provided to players would be considered as part of net winnings and liable to deducted under Section 194BA. Except when such bonus is credited in the user account only for playing and cannot be used for any purpose then it will not be considered as part of net winnings. Further, if the latter is recharacterized and allowed to be withdrawn then they shall be treated as taxable deposit at the time of their characterization. Determining the time of characterization may not prove to be straightforward. Will it be the date the winner is informed or the date the winner can withdraw the bonus?   

Second, Section 194BA(2) provides where winnings are partly in kind and partly in cash, but the cash component is not sufficient to meet the withholding liability, then payer responsible for paying shall ensure that the tax has been paid in respect of the net winnings. The Guidelines add that the net winnings shall be released only after the deductee has provided proof of payment of tax. But then it curiously adds that the deductor to avoid difficulty may deduct the tax under Section 194BA and pay to the Government. But, if cash component is not sufficient to deduct the tax, how will the tax deduction take place? 

Third, an issue that is likely to be confusing under this provision is when winnings are in kind. While their valuation will be as per their fair market value, a concept that has been long recognized by the IT Act, 1961. But, where money in user account is used to buy something in kind then it will be considered as ‘net winnings in cash’ and deductor is required to deduct tax at source. Guidelines are not entirely clear on how deductor/payer will compute withholding tax liability in this scenario.      

Fourth, the Guidelines clarify that Section 194BA does not apply to insignificant amounts, i.e., where the net winnings in the amount withdrawn do not exceed Rs 100 a month. But tax needs to be deducted when net winnings cross Rs 100 in the same month or subsequent month. And the deductor ‘undertakes responsibility of paying the difference’ if the balance in the user account is not sufficient at the time of deduction. The minimum threshold of Rs 100 in net winnings is thus not a simple exemption but requires the deductor to be careful when and how to deduct tax, else the deductor becomes liable for the amount that escapes tax. 

The Guidelines offer clarity on a few other aspects and seem comprehensive and well-drafted to provide sufficient information to deductors – in this case online game intermediaries – about their tax withholding liabilities under the new provision. 

There are only two major areas of concern regarding Section 194BA read with its Guidelines: first, that the threshold limit is too low implying that the withholding liability of deductors is likely to be triggered for a large no. of transactions on their platforms significantly adding to their tax compliance burden; second, in case of winnings involving cash and kind, the withholding tax obligations of the deductor are not straightforward and may cause confusion.       

Conclusion  

It is obvious that via the Finance Act, 2023 an attempt has been made to create a distinct tax regime for winnings from online games under the IT Act, 1961. Prima facie, there is nothing qualitatively different about the nature of winnings from offline games vis-à-vis online games. Further, the tax obligations/tax rates also for winnings from online vis-à-vis offline games do not differ to require standalone provisions for online games. However, the State seems to think differently. As explained: 

There is a need to bring in specific provisions regarding TDS and taxability of online games due to its different nature, being easily accessible vide the Internet and computer resources with a variety of playing options and payment options. (Explanatory Memorandum to Finance Bill, 2023, page 27) (emphasis added)

Currently, we do not know the fully import of the phrase ‘different nature’. While the variety of payment options, recent popularity of online games played may have motivated the State to create a separate set of tax provisions for their winnings. It remains to be seen if the justification for a different set of provisions is borne out once these provisions are implemented.   

[1] https://incometaxindia.gov.in/pages/communications/index.aspx (Accessed on 23.05.2023). 

Supreme Court Interprets Section 153A, IT Act, 1961 Correctly & Provides ‘Remedy’ to the Revenue  

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Introduction 

On 24 April 2023, a Division Bench of the Supreme Court in Abhisar Buildwell case[1] interpreted the scope of Section 153A, IT Act, 1961. The specific question before the Supreme Court was: whether the jurisdiction of Assessing Officer to make assessment in respect of completed/unabated assessment is confined only to incriminating material found during a search or requisition under Sections 132 and 132A? The Supreme Court – relying on the Delhi High Court’s judgment – narrowly interpreted the Assessing Officer’s jurisdiction and answered the above question in the affirmative. The Supreme Court held that the Assessing Officer could not make additions to the completed assessment based on other material on record if no incriminating material was found during the search or requisition.     

Arguments About the Scope of Section 153A

To begin with, it is important to understand the elements of Section 153A, IT Act, 1961 which required consideration by the Supreme Court.  

Section 153A(1) states that in case of a person where a search is initiated under Section 132 or books of account, other documents or any assets are requisitioned under Section 132A, the Assessing Officer shall issue a notice to the person requiring him to furnish a return for the six assessment years immediately preceding the preceding year in which the search is conducted or requisition is made. And the Assessing Officer shall assess or reassess the total income in respect of each assessment year falling within such six assessment years. 

The Second Proviso, is worth citing in full: 

Provided further that assessment or reassessment, if any, relating to any assessment year falling within the period of six assessment years and for the relevant assessment year or years referred to in this sub-section pending on the date of initiation of the search under section 132 or making of requisition under section 132A, as the case may be, shall abate :   (emphasis added)

The Second Proviso cited above mentions that only the pending assessments or reassessments on the date of initiation of search or requisition shall stand abated. 

The State contended that even if no incriminating material is found during the search or requisition then additions to completed assessments could also be made by the Assessing Officer in respect of other material on record. The primary basis of the State’s argument was that the mandate of the Assessing Officer under Section 153A is with respect to ‘total income’ read with Section 4, IT Act, 1961, i.e., the charging provision under the statute which provides for assessment of total income. And if the Assessing Officer is allowed to only assess ‘partial income’ it would not be in accordance with the IT Act, 1961. Accordingly, the State argued that the Assessing Officer is authorized to make additions to completed assessments based on other material even if no new material was found during the search or requisition.  

The assessees, on the other hand, argued for a contextual interpretation of the term ‘income’ and Section 153A, IT Act, 1961. The assesses argued that the purpose of Section 153A is to discover information through search or requisition which could not ordinarily discovered. And, if no incriminating material is found after such search or requisition there is no justification for opening completed assessments by using other material on record. The assessees also had the strength of various High Court judgments which had taken a similar view.        

Delhi High Court’s Interpretation Approved by the Supreme Court

Various High Courts had expressed differing opinions on the issue before the Supreme Court. One such judgment which was the subject of appeal was the Delhi High Court’s judgment in Kabul Chawla case.[2] The Delhi High Court through a well-reasoned judgment in Kabul Chawla case, had laid down the scope of Section 153A in clear terms. The High Court had observed that once search under Section 132 takes place, a notice is mandatorily issued to the person requiring him to file returns for six assessment years preceding the previous year. And the Assessing Officer has the power to assess or reassess the total income for each of the said six years in separate assessment orders for six years. It added that while Section 153A does not expressly state that additions to assessment should be strictly based on evidence found during search, it does not mean that assessment ‘can be arbitrary or made without any relevance or nexus with the seized material. Obviously an assessment has to be made under this Section only on the basis of seized material.’ (para 37) The Delhi High Court had clarified that in the absence of any incriminating material, the abated/completed assessment can be reiterated and the abated assessment or reassessment can be made under Section 153A. 

The Delhi High Court had made it amply clear that completed assessments could be interfered by the Assessing Officer under Section 153A only on the basis of incriminating material found during search or requisition and not by relying on material already disclosed or known in the course of original assessment. 

The Supreme Court expressed ‘complete agreement’ with the observations of the Delhi High Court. (para 8) In doing so, the Supreme Court added its own reasons:  

First, it adopted a purposive interpretation of Section 153A to observe that the very purpose of search and seizure – which triggers Section 153A – is detection of undisclosed income through extraordinary powers. Thus, the foundation for search assessments under Section 153A is incriminating material discovered during such search or seizure.  

Second, it again referred to legislative intent behind the Second Proviso and observed that only pending assessments/reassessments for the six assessment years abate on initiation of search or requisition. Also referred to Section 153A(2) which states that if any proceeding or any order of assessment or reassessment under Section 153A(1) is annulled in appeal or any legal proceeding, then the assessment or reassessment which abated under the Second Proviso shall revive. Referring to the afore-stated provisions, it observed ‘the intention does not seem to be to re-open the completed/unabated assessments, unless any incriminating material is found with respect to concerned assessment year falling within last six years preceding the search.’ (para 11)  

Third, it stated that if the Revenue Department’s argument that completed assessments can be re-opened even if no incriminating material is found during the search or seizure, is accepted it would lead to two assessments order which was impermissible under the law and would make the Second Proviso redundant. This observation is pertinent because Section 153A replaced the previous provision Section 158BA to do away with the concept of parallel assessments for undisclosed income. And, under Section 153A the undisclosed income is taxed at the same rate as the rest of income, as opposed to the previous regime where undisclosed income was tax at a higher rate thereby necessitating two assessments. And IT Act, 1961 no longer recognises the concept of parallel assessments.     

‘Remedy’ to the Revenue 

The Delhi High Court’s interpretation of Section 153A, IT Act, 1961 was supported by adequate and articulate reasoning and the Supreme Court’s decision to that extent was also well-reasoned. The Supreme Court, however, made another observation that ‘the Revenue cannot be left with no remedy.’ (para 11) The Supreme Court added that even in case of block assessments under Section 153A where no incriminating material is found during a search, ‘the power of the Revenue to have the reassessment under section 147/148 of the Act has to be saved ..’. (para 11) Subject to the fulfilment of the conditions under Sections 147/148, the Supreme Court expressly saved the Revenue Department’s power to re-open assessments. The need to save the powers under Section 147/148 was not necessary and provide a ‘remedy’ to the Revenue seems like a balancing act on the part of the Supreme Court. And not the least, the concept of not providing a remedy to Revenue when its interpretation of the impugned provision was not upheld has no jurisprudential basis.   

Anyhow the implications of the Supreme Court’s these observations are unclear, the Revenue Department filed a Miscellaneous Application, which inter alia sough clarification of the Supreme Court’s judgment vis-à-vis Section 150, IT Act, 1961 which deals with limitation period for assessments/reassessments. At the time of writing, the Supreme Court has directed the Revenue Department to file a review petition. The review will lead to another set of arguments because of the Supreme Court’s unnecessary ‘remedy’. 

[1] Principal CIT v Abhisar Buildwell P. Ltd 2023 SCC OnLine SC 481. 

[2] CIT, Central-III v Kabul Chawla (2015) 61 taxmann.com 412 (Delhi).  

Machinery Provisions Brook No Vested Rights: Supreme Court Holds that Amendment to Section 153C, IT Act, 1961 is Retrospective

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On 6 April 2023, a Division Bench of the Supreme Court in Vikram Bhatia case[1], held that the amendment to Section 153C, IT Act, 1961 was retrospective in nature and would be applicable to searches conducted even before the date of amendment, i.e., 1.06.2015. The Supreme Court’s decision is another example of its deferential approach to the State in tax matters. The impugned case also highlights that the Revenue Department is not hesitant to argue that an amendment is retrospective on the pretext that the pre-amendment provision was interpreted contrary to legislative intent. An argument that the Supreme Court and other Courts have not scrutinized with necessary rigor.  

Background to Amendment of Section 153C, IT Act, 1961 

The relevant portion of Section 153C, as it stood before its amendment vide the Finance Act, 2015, provided that where the assessing officer is satisfied that any money, bullion, jewellery or other valuable article or thing or books of account or documents seized or requisitioned belongs or belong to a person other a person against whom search is conducted, then such books of account or assets shall be handed over to the assessing officer having jurisdiction over the other person. And the other person may be issued notice and their income reassessed under Section 153-A, IT Act, 1961.   

The Delhi High Court in Pepsico India case[2] held that the words ‘belongs or belong to’ should not be confused with ‘relates to or refers to’. In this case, the Delhi High Court noted that if  the purchaser’s premises are searched and a registered sale deed is seized, it cannot be said that it ‘belongs to’ to the vendor just because his name is mentioned in the document. (para 16) The Delhi High Court’s interpretation meant that the assessing officer could only initiate proceedings against a third party if the incriminating material found during search proceedings ‘belonged to’ the third party and not merely ‘related to’ the third party. The Revenue Department’s stance was that the Delhi High Court’s interpretation did not align with the intent of the provision. Though the Revenue Department’s disagreement with the Delhi High Court’s ruling could also stem from the fact that its interpretation set a high threshold for the assessing officer to invoke Section 153C against a third party. 

To overcome the effect of the Delhi High Court’s judgment, Finance Act, 2015 amended Section 153C, and Section 153C(1)(b) now states that where the assessing officer is satisfied that any books of account or documents, seized or requisitioned, pertains or pertain to, or any information contained therein, relates to, person other than against whom search is conducted, then such books of account or assets shall be handed over to the assessing officer having jurisdiction having jurisdiction over the other person. And the other person may be issued notice and their income reassessed under Section 153-A, IT Act, 1961.   

The scope of Section 153C was clearly widened, the threshold to proceed against a third party was lowered with the phrase ‘belongs to’ being replaced with ‘relates to’. The expression ‘belongs to’ though continued to qualify money, bullion, jewellery or other valuable article or thing mentioned in Section 153C(1)(a).  

Interpretation of Amended Section 153C, IT Act, 1961      

The Supreme Court heard appeals from common judgment[3] of the Gujarat High Court pronounced in April 2019. The Gujarat High Court observed that though Section 153C was a machinery provision, but by virtue of its amendment new class of assessees were brought within the scope of the provision and it affected their substantive rights and resultantly Section 153C could not be interpreted to be a mere procedural/machinery provision. Further, the Gujarat High Court reasoned that the amended provision was much wider in scope as compared to its predecessor. The Gujarat High Court concluded that amendment to Section 153C shall not be given a retrospective effect, and no notices could be issued post-amendment of Section 153C for searches conducted before its amendment, i.e., 1.06.2015. Against this decision of the Gujarat High Court, the Supreme Court heard appeals filed by the Revenue Department.    

The precise question before the Supreme Court was whether amendment to Section 153C, IT Act, 1961 was retrospective? And whether Section 153C, IT Act, 1961 would be applicable to searches conducted before 1.06.2015, i.e., the date before amendment. The Supreme Court answered in the affirmative. There are several limitations in the Supreme Court’s approach, let me highlight a few below. 

First, the Supreme Court accepted the State’s argument that the amendment to Section 153C, IT Act, 1961 was ‘a case of substitution of the words by way of amendment’. (para 10.1) The Supreme Court cited numerous precedents to the effect without really explaining the basis on which it was deciphering that the amendment in question was a ‘substitution’ amendment. In fact, the Supreme Court adopted a broad brush approach and neglected to observe that even post-amendment Section 153C(1)(a) retains the phrase ‘belongs to’. Section 153C(1), after amendment vide the Finance Act, 2015 states that: 

Nothwithstanding anything contained in section 139, section 147, section 148, section 149, section 151 and section 153, where the Assessing Office is satisfied that,-

  • any money, bullion, jewellery or other valuable article or thing, seized or requistioned, belongs to; or 
  • any books of account or documents, seized or requistioned, pertains or pertain to, or any information contained therein, relates to,   

a person other than the person referred to in section 153A, … (emphasis added) 

Clearly, both phrases ‘belong to’ and ‘relates to’ have been retained in Section 153C. And the afore cited portion of Section 153C provides reasonable basis to argue that the Finance Act, 2015 did not effectuate a ‘substitution amendment’ of Section 153C. The amendment only lowers the threshold to initiate the proceedings against the third person for certain kinds of documents and does not fully substitute the pre-amended provision.    

Second, the Supreme Court reasoned that Section 153C, IT Act, 1961 was a machinery provision and it must be construed to give effect to the purpose and object of the statute. (para 10.6) The Supreme Court then cited a host of decisions to support its stance that machinery provisions must be construed liberally. However, the decisions cited by the Supreme Court such as Calcutta Knitwears case[4], hold that machinery provisions should be interpreted liberally to give meaning to the charging provision. The judicial precedents on this issue do not state that machinery provisions should be interpreted liberally per se. Neither do any of the precedents cited by the Supreme Court state that legislative intent needs to be placed at the highest pedestal without weighing it against other factors such as taxpayer rights. 

Third, the Supreme Court rejected the assessee’s contention that Section 153C, IT Act, 1961 should not be interpreted to have retrospective effect since it affected the substantive rights of the third party. The Supreme Court rejected the argument on the ground that the pre-amended Section 153C was also applicable to the third party. While the Supreme Court is right, its statement does not sufficiently appreciate that the threshold to proceed against the third party after amendment to Section 153C was lowered directly affecting the rights of such party. Instead, it stressed that there was legislative intent to proceed against the third party before and after the amendment without delving into the details. Equally, the Supreme Court dismissed the argument that there is presumption against retrospectivity of a statute. The Supreme Court examined the jurisprudence on presumption against/for retrospectivity superficially. At no place in the judgment is there an examination as to why and how the amendment to Section 153C is ‘declaratory’ and why presumption against its retrospectivity is inapplicable.            

Fourth, which overlays with the second point, is that the Supreme Court laid considerable emphasis on legislative intent. Despite immense emphasis on legislative intent, the Supreme Court did not examine as to why one sub-clause of Section 153C continued to retain ‘belongs to’ after the amendment. And, neither did it refer to any source that helps us understand the original legislative intent or the intent behind amendment to Section 153C. In the absence of such references, legislative intent is a malleable phrase in the hands of any adjudicating authority, and it was used as such in the impugned case.  

Fifth, the Supreme Court stated that the Delhi High Court construed the term ‘belongs’ unduly narrowly and restrictively, but never clarified the precise objection to the High Court’s interpretive approach. Strict interpretation of tax statutes is the default approach of Courts, and deviations from it need to be justified not adherence to it. The Delhi High Court was clear in its judgment that a tax statute must be interpreted strictly and in case of doubt or dispute must be interpreted in favor of the assessee. (para 7) And the Delhi High Court adopted such an approach in construing Section 153C, IT Act, 1961. The Supreme Court never truly explained how adopting such an approach by the Delhi High was an unjust or restrictive interpretation. 

Sixth, the Supreme Court took made an interesting point when it referred to First Proviso to Section 153C. The said Proviso contains a deeming fiction where in case of a third person, the reference to the date of initiation of the search under Section 132 shall be construed as reference to the date of receiving of books of account or documents or assets seized or requisitioned by the assessing officer having jurisdiction over such person. The deeming fiction in the First Proviso moves the date of initiation of search to the date the assessing officer of the third person receives the documents. In the impugned case, while the search took place before 1.06.2015, the assessing officer of the third party received the documents on 25.04.2017 and issued notice to the third party on 04.05.2018. Thus, as per the deeming fiction, the search against the third party was initiated after 1.06.2015. Given these set of facts, it was not unreasonable to suggest that the applicable provision should have been the amended Section 153C. The Supreme Court’s used the First Proviso to support its conclusion (para 10.3) But the Supreme Court did not delve into the implication of the First Proviso adequately vis-à-vis its repeated emphasis on legislative intent. The Supreme Court observed that not allowing the Revenue Department to proceed against the third party ‘solely on the ground that the search was conducted prior to the amendment’ would frustrate the object and purpose of the amendment. In arriving at this conclusion, the Supreme Court did not satisfactorily examine how the deeming fiction in the First Proviso to Section 153C makes the actual date of initiation of search irrelevant for the third person.   

Conclusion 

The Supreme Court granting the State leeway in tax (and economic) laws is a well-entrenched doctrine in Indian tax jurisprudence. In this case, the Supreme Court used the doctrine impliedly to stamp its approval to an amendment to IT Act, 1961, stating that the amendment was retrospective in effect, without articulating its reasoning in a cogent and defensible manner. While the deeming fiction in the First Proviso to Section 153C lends some support to the Supreme Court’s conclusion, there was need for more robust reasoning to interpret the amendment to be retrospective in nature. The amendment of Section 153C has an appreciable impact on the substantive rights of the third parties. This factor alone was sufficient for the Supreme Court’s conclusion to be based on impeccable reasoning, but we only saw a glimpse of it in the judgment. 

[1] Income Tax Officer v Vikram Sujit Kumar Bhatia 2023 SCC OnLine SC 370. 

[2] Pepsico India Holdings Private Limited v ACIT 2014 SCC OnLine Del 4155. 

[3] Supreme Court, in its judgment, did not specifically state the name of parties and the exact decision. Though one of the Gujarat High Court’s decision decided in 2019 is Anikumar Gopikishan Aggarwal v CIT [2019] 106 taxmann.com 137 (Guj). In this case, the Gujarat High Court decided that amendment to Section 153C, IT Act, 1961 was prospective in nature.  

[4] Commissioner of Income Tax, III v Calcutta Knitwears, Ludhiana (2014) 6 SCC 444. 

Supreme Court Opines on Residence Rule under IT Act, 1961: Traverses Familiar Path

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In a judgment[1] delivered on 10 April 2023, a Division Bench of the Supreme Court opined on the residency principle of companies under Section 6(3)(ii) of IT Act, 1961. While there were a few other issues involved in the case, in this post I will focus on Supreme Court’s treatment of the residency principle of companies and how it missed an opportunity to advance the jurisprudence on this issue. Instead, it merely reproduced the ratio of previous judgments without adding any substantive value. 

Before proceeding, it is important to state that Section 6(3)(ii), IT Act, 1961 was amended in 2017. Pre-amendment, Section 6(3)(ii) stated that a company is said to be resident in India if the control and management of its affairs is situated wholly in India. Post-2017, Section 6(3)(ii) states that a company is said to be resident in India in any previous year if its place of effective management, in that year, is in India. The pre-amendment clause was applicable in the impugned case. The State though argued that to cull the meaning of pre-2017 clause it is important to consider the post-2017 clause, but this argument wasn’t expressly endorsed by the Supreme Court. (para 4.5) 

Facts and Issues 

Assessees in the impugned case were companies registered in Sikkim under the Registration of Companies (Sikkim) Act, 1961. Their business was to act as commercial agents for sale of cardamom and other agricultural products. The case of assessees was that they were residents of Sikkim and conducted their business in Sikkim and were thus governed by Sikkim State Income Tax Manual, 1948 and not IT Act, 1961. The reason the two income tax statutes were in question was because of historical reasons. Sikkim became part of India in April 1975, but all Indian laws were not immediately made applicable to Sikkim. Thus, residents of Sikkim continued to be governed by the Sikkim State Income Tax Manual, 1948. This was until Finance Act, 1989 proposed to make IT Act, 1961 applicable to Sikkim commencing from 1 April 1990. Thus, for the period prior to 1 April 1990, the assessees were foreign companies under IT Act, 1961 and could be considered as Indian residents only if control and management of their affairs was situated wholly in India. The State’s entire case was that the companies satisfied the latter criteria under Section 6(3)(ii), IT Act, 1961.   

The State contended that the assessees were not residents of Sikkim based on the documents obtained from their Delhi-based accountants in a search operation. The accountants were found in possession of book of accounts, signed blank cheques, cheque books, letter heads, rubber seals, and other income documents of the assessees. The State further alleged that the accountants were appointing Directors of the companies and thus the control and management of the assessees was completely from Delhi. 

The issue before the Supreme Court – and one that I focus on in this post – was: should the assessees be considered as residents of Sikkim due to reason of their incorporation in Sikkim or should they be considered as residents of India since they were (allegedly) completely managed and controlled from Delhi?   

Summary of Jurisprudence 

The Supreme Court dutifully cited the precedents that have elaborated on the test to determine the residence of a company not incorporated in India or to determine the control and management of HUF. The leading case on the issue is that of VVRNM Subbaya Chettiar[2], where in determining the residence of HUF under the Income Tax Act, 1922 the Supreme Court opined that ‘control and management’ signifies that the controlling and directive power or the ‘head and brain’ is functioning at a particular place with a certain degree of permanence. And since control and management of a company remains in the hand of a person or group of persons the question to be asked is wherefrom such person or group of persons control the company. Mere activity of a company at a particular place did not create its residence at that place. This test, in short referred to as the ‘substance over form’ test has been endorsed in subsequent decisions as well. For example, in Erin Estate[3] case the Supreme Court observed that the test was a mixed question of law and fact and clarified that what was necessary to show was from where the de facto control and management was exercised in the management of the firm and not the place from where the theoretical or de jure control was exercised. Similarly, in Narottam and Pereira Ltd[4]  the Bombay High Court observed that the authority which controls and manages the employees and servants is the central authority, and the place from where such central authority functions is the residence of the company.     

Expressing its agreement with the above line of jurisprudence, the Supreme Court stated that in the impugned case the Assessing Officer and Commissioner of Income Tax (Appeals) rightly concluded that the control and management of the assessees was with their accountants in Delhi and thus residence was in India. And that the conclusion is aligned with the findings of fact and material on record.  

No Substantial Addition to the Jurisprudence  

Given the set of facts detailed in the judgment, the Supreme Court’s decision seems justifiable. However, it also feels like a missed opportunity as the Supreme Court never really went beyond what was stated in the precedents. The facts offered an opportunity to examine – in some depth – how and if certain situations prove or lend support to the assertion that an assessee is controlled from a place other than its place of incorporation. Was the fact of an accountant possessing all relevant materials and documents of a company sufficient for an irrefutable conclusion that the accountant controlled the company? Or was the additional fact of an accountant appointing and controlling the Directors of a company an equal or more decisive factor? Further, inability to prove that assessees received all their payments in Sikkim and that their rates of commission were astronomical/unrealistic were relied on by the Supreme Court to arrive at its conclusion. But we are left unaware as to which fact was decisive or was it the combination of facts that tilted the case against the assessees. 

One crucial aspect that the Supreme Court did not address clearly was the burden of proof in such cases. It is important to note that the two cases that the Supreme Court cited approvingly, i.e., VVRANM Subbaya Chettiar and Erin Estate cases made their observations in the context of Section 4-A(b), IT Act, 1992 (the predecessor of Section 6(2), IT Act, 1961) where the burden of proof is on assessee to show that the HUF is not a resident of India. And in Erin Estate case it was clearly stated that the onus to rebut the initial presumption is on the assessee. (para 6) While under Section 6(3)(ii), IT Act, 1961, the applicable provision in the impugned case, the initial burden is on the State to show that a company incorporated outside India is wholly managed from India.    

In the impugned case, the petitioners argued that the State had not discharged its onus that the control and management of the company was wholly situated in India. (para 3.14) The Delhi High Court’s judgment which was under appeal had mentioned that once all the materials and documents of the company were discovered in possession of the accountants, the burden was on the assessee to prove that the residence of company was not in India. (para 6.3) Since the Supreme Court did not find any error in the Delhi High Court’s findings on this issue, it stands to reason that the High Court’s view was upheld. Is discovery of important documents of a company from a place other than the place of incorporation/registered office sufficient to shift the burden of proof to assessees? We do not have clear answers.    

The result is that the Supreme Court’s judgment apart from reiterating the substance over form test, added no significant jurisprudential value to the residence test under Section 6(3)(ii) of the IT Act, 1961.    

[1] Mansarovar Commercial Pvt Ltd v Commissioner of Income Tax, Delhi 2023 LiveLaw (SC) 291. 

[2] V.V.R.N.M. Subbayya v CIT, Madras AIR 1951 SC 101. 

[3] Erin Estate v CIT AIR 1958 SC 779. 

[4] Narottam and Pereira Ltd v CIT, Bombay City 1953 23 ITR 454 Bom. 

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