Analysis_of_Six_Important_Decisions_July_to_Nov_2010[1]

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Analysis of Six Important Decisions Apr - Nov 10 http://www.itatonline.org1

Analysis Of Six Important Decisions July to November 2010

By CA Anant N. Pai.

It is true that the law is attired in the language used in the statute. But, it would be

sheer folly to assume that this law is bound or self contained in the language only. Law, in

its natural state, has a dimension that extends beyond the language used in the statutory

provisions. It has capabilities to overflow in to the realm of the unwritten law i.e. the

principles of law and its interpretations. Whereas the language used in a statutory

provision constitutes the express law, the legal principles constitute the implied law.

The logical end point of every law should be delivery of justice. It is here that the

implied law operates as the unseen force supplementing the express law towards this

objective. Ultimately, it is the manner in which the law is administered in a State that

determines how progressive its society is.

In this article, popularly reported decisions have been avoided as they have been

amply covered in articles written by other authors. A few decisions have been handpicked

by the author where the judiciary has endeavored to read the law beyond the language it is

couched and interpret the same on the basis of the implied law, it felt, was sighted within.

The readers are advised to form their own opinions on the same.

1. Indo-UK DTAA When Treaty benefits available ?- Fiscal Domicile Meaning :-

The Mumbai Tribunals decision in the case of Linklaters LLP vs. ITO as

reported in [2010] 40 SOT 51 {Mum} has thrown up an interesting legal proposition.

The assessee, in this case was an UK based law firm, which did not have an officein India. It rendered services in India through its partners and employees who visited India

for this purpose. The Tribunal found that its income from these services were taxable in

India by virtue of section 9 [1] of the Income Tax Act, 1961. The next consequential issue

to be decided was whether the assessee firm could an avail the benefits of the provisions of

the Indo-UK DTAA. This is because if the benefits of the DTAA were available to it and it

is also found that it had no permanent establishment or fixed base in India through which

these services were rendered, then its income from services would not be taxable in India

[Article 7, paragraph 1 Business Profits]

Now, the benefits of the DTAA are available only to a person who is resident

in either of the Contracting States.{emphasis supplied in bold underline}. Under the tax

regime prevailing in UK, a partnership firm is treated as a transparent entity and ignored

for purposes of taxation. The partners of the firm are taxed instead. This is in contrast to

the situation in India, where a partnership firm is taxed as the fiscal entity.

The Tribunal found that a partnership firm is recognized as a person in paragraph

2 of Article 3 {General definition} of the DTAA. But, in order to avail of the benefits of

the DTAA, a further condition was required to be satisfied and i.e. this partnership firm

must be shown to be resident in UK. Under the provisions of paragraph 1 of Article 4


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{Fiscal Domicile }of the DTAA, the term resident of a Contracting State means any

person who, under the law of that State, is liable to taxation by reason of his domicile,

residence, place of management or other criterion of a similar nature. In short, unless the

partnership firm is shown to be liable to taxation in UK on the basis of its location, itcannot access the DTTA in India as a resident. And the difficulty here is that in UK, the

assessee partnership firm is not taxed, but its partners are subjected to taxation.

The Tribunal noted that the head note of the Article 4 is Fiscal Domicile.

Drawing inspiration from this, it held that as long as all the partners of the assessee firm

are liable to taxation in UK as residents, the assessee firm can be treated as a resident in

terms of the DTAA in India. In short, what the Tribunal proposed is that the test of

residence must be satisfied by qualifying to be fiscal domiciled and if the all the

partners were assessable to tax in UK as residents, it amounts to, in substance, to the same

thing as the firm being fiscally domiciled person in UK.

In my opinion, the real test of efficacy of this decision will be in situation in whichincome of a partnership firm is doubly taxed both in India and UK and the issue of grant

of tax credit is involved. The problem is often vexed due to the mismatch in the legal

perceptions in these countries about whether a partnership firm is a fiscal entity or not.

Whereas in India, the firm is subjected to tax, in UK the partners are taxed and not the

firm. Tax credit is given in the State of residence only when the same entity is taxed on the

same income in both the States- which phenomenon may not be perceived in the

circumstances because in one State, the firm is taxed and in the other, its partners.

Suppose, by way of example, an enterprise of an Indian partnership firm

carries on business in UK through a permanent establishment {PE}. The partnership

firm will, in the first place, be taxed in India on its business profits on the basis of its

residence. UK will also subject its profits attributable to the PE to tax, but in hands ofthe partners of the firm. The issue for consideration of the readers is whether, on the

basis of the Mumbai Tribunals interpretation of the expression fiscal

domicile[Article 4- Indo UK DTAA} in its decision in the case of Linklaters

discussed above, the tax regime in India will grant tax credit to the partnership firm

for the taxes paid by its partners in UK ? This, in my opinion, will be the acid test

set out for the Linklaters decision in the coming future.

2. Accrual of income must be factual and not merely contractual The decision of the Delhi High Court in the case ofCIT vs. Vasisth Chay Vypari in

ITA nos. 552/2005 and others dated 29-11-2010 {courtesy www.itatonline.org] presents

an opportunity for dynamic thinking.

The assessee, a NBFC, advanced Inter Corporate Deposits (ICD) to Shaw Wallace.

As the interest was not received by the assessee for more than six months in view of the

adverse financial position of the borrower, the assessee treated the ICD as a Non

Performing Asset (NPA) in terms of the directions of the RBI and did not account for the

interest. However, the AO held that as the assessee was following the mercantile system of

accounting, the interest had accrued even if it was not actually realized. This was

confirmed by the CIT (A) though reversed by the Tribunal.


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On appeal by the department, the High Court held dismissing the appeal in the

following manner:-

[i] U/s 45Q of the RBI Act read with the NBFCs Prudential Norms (Reserve Bank)Directions 1998, it was mandatory on the part of the assessee not to recognize the interest

on the ICD as it had become a NPA.

[ii]The assessee was bound to compute income having regard to the recognized

accounting principles set out in Accounting Standard AS-9. AS-9 provides that if there are

uncertainties as to recognition of revenue, the revenue should not be recognized.

[iii] Accordingly, the argument of the revenue that the interest on the NPA can be

said to have accrued despite it being a NPA is not acceptable.

{Here, the decision of the Supreme Court in Southern Technologies vs. JCIT 320

ITR 577 (SC) relied by the Revenue was distinguished by the High Court on the ground

that there the interest was admittedly accrued, but its realization was doubtful for which a

provisions was made in the accounts and whereas in the instant case before it, the interest

income was not booked in the accounts by the assessee because its very realization was

questionable at inception itself}.

Readers may examine whether the issue before the Delhi High Court could have also

been approached from another example.

The law, as on date, is fairly well settled to the effect that income can be said to have

accrued to an assessee if he acquires the right to receive it [CIT vs. Shri Goverdhan Ltd

{1968} 69 ITR 675 {SC}]. The income should become a debt in favour of the assessee

[E.D. Sasson and Co. Ltd. {1954} 26 ITR 27 {SC}]. In short, if a right to receive the

income has contractually vested in a person, then the income is accrued to him for taxpurposes.

At the same time, it may be noted that the above principle of accrual of income is

intricately linked to the principle of real income. The decision of the Supreme Court in

the case ofState Bank of Travancore vs. CIT {1986} 158 ITR 102 {SC} is testimony to

this proposition. The Apex Court has held that whether an accrual has taken place or not

must, in appropriate cases, be judged on the principles of real income theory. If, in the

reality of a situation, the very accrual of income is prevented, then no tax can be levied on

the income. On the other hand, if after the income has accrued, it is subsequently found to

be non realizable, then the accrual having already occasioned cannot be defeated due to

any subsequent non realization of the income.

By analogy, if you have a contractual right to draw water from a well and the well is

dried at the time of your proposed drawing, is not your right to draw this water illusory ?

In summary, if the uncertainty of realization of income precedes its accrual,

then the event of its accrual is defeated at the roots itself. It is this principle, which I

propose that the readers may apply in the context of the Delhi High Court case of

Vasisth Chay Vyapar discussed above. From the facts of the case, it appears that the


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was with respect to the income assessable under the normal provisions and not regarding

the book profits u\s 115JB returned as the total income and later assessed.

4. Dismissal of a SLP by Supreme Court consequential effectsThe order of the Supreme Court in the case of CIT vs. CIT vs. GlaxoSmithKiline{Asia} SLP {Civil} {No (s) 18121 /2007 dated 26-10-2010 - {Courtesy:-

www.itatonline.org} should be understood as a dismissal of a SLP and not a dismissal of

an appeal. The consequential effect of lack of any precedent in this order can then be

appreciated.

The Supreme Court had dismissed the SLP filed by the Income Tax Department as

under:-

The assessee did not have any employee other than a company secretary and all

administrative services relating to marketing, finance, HR etc were provided by GlaxoSmith Kline Consumer Healthcare Ltd (GSKCH) pursuant to an agreement under which

the assessee agreed to reimburse the costs incurred by GSKCH for providing the various

services plus 5%. The costs towards services provided to the assessee were allocated on

the basis suggested by a firm of CAs. The AO disallowed a part of the charges reimbursed

on the ground that they were excessive and not for business purposes which was upheld by

the CIT (A). However, the Tribunal deleted the disallowance on the ground that there was

provision to disallow expenditure on the ground that it was excessive or unreasonable

unless the case of the assessee fell within the scope of s. 40A (2). It was held that as it was

not the case of the Department that s. 40A (2) was attracted, the disallowance could not be

made (see 290 ITR 35 (Del) for facts). The department challenged the deletion. HELD

dismissing the SLP:

(i) The Authorities below have recorded a concurrent finding that the said two

Companies are not related Companies under s. 40A (2). As far as this SLP is concerned,

no interference is called for as the entire exercise is a revenue neutral exercise. Hence,

the SLP stands dismissed. For other years, the authorities must examine whether there is

any loss of revenue. If the Authorities find that the exercise is arevenue neutralexercise,

then the matter may be decided accordingly;

(ii) The larger issue is whether Transfer Pricing Regulations should be limited to

cross-border transactions or whether the Transfer Pricing Regulations be extended to

domestic transactions. In domestic transactions, the under-invoicing of sales and over-

invoicing of expenses ordinarily will be revenue neutral in nature, except in two

circumstances having tax arbitrage such as where one of the related entities is (i) loss

making or (ii) liable to pay tax at a lower rate and the profits are shifted to such entity;

(iii) Complications arise in cases where the fair market value is required to be

assigned to transactions between related parties u/s 40A(2). The CBDT should examine

whether Transfer Pricing Regulations can be applied to domestic transactions between

related parties u/s 40A(2) by making amendments to the Act. The AO can be empowered

to make adjustments to the income declared by the assessee having regard to the fair


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market value of the transactions between the related parties and can apply any of the

generally accepted methods of determination of arms length price, including the methods

provided under Transfer Pricing Regulations. The law can also be amended to make it

compulsory for the taxpayer to maintain Books of Accounts and other documents on thelines prescribed in Rule 10D and obtain an audit report from his CA that proper

documents are maintained;

(iv) Though the Court normally does not make recommendations or suggestions, in

order to reduce litigation occurring in complicated matters, the question of extending

Transfer Pricing regulations to domestic transactions require expeditious consideration

by the Ministry of Finance and the CBDT may also consider issuing appropriate

instructions in that regard.

A dismissal of a SLP merely means that the Supreme Court is not inclined to admit

the SLP as an appeal and hear it. It means that the Supreme Court does not consider the

matter fit for exercise of its jurisdiction under Article 131 of the Constitution. It does notamount to affirmation of the decision of the High Court. This is more particularly so when

it does not comment on the correctness of the decision of the High Court. It is only when

the SLP is allowed that it is converted in to an appeal. When the order is passed in appeal

by the Supreme Court, the decision of the High Court merges in to it and what subsists

operatively thereafter is only the order of the Supreme Court as the final word. If such an

order passed in appeal by the Supreme Court involves an answer by it on a question of

law, the answer amount to a law declared by it and therefore a binding precedent on the

lower courts and authorities. This is my perception of the law regarding SLPs which I want

to share with the readers.

The order of the Supreme Court dismissing the Departments SLP in theGlaxoSmithKline {Asia} may therefore be viewed by the readers from the above angle. It

should not be read as a decision which says the provisions of section 40A [2] are not to be

applied if the transaction between related parties is revenue neutral. In fact, it is quite

possible that the issue of application of the provision of section 40A [2] may not even be

involved before the Supreme Court. While the order of the Supreme Court recaptures the

facts of the case and gives its decision declining the SLP, as to what was the question to be

answered by the Supreme Court does not find mention in the order. But, from the facts

cited in the order, the issue could have been more probably, whether a disallowance can be

made of the expenditure on grounds of excessiveness when the payer and payee are not

related as per the provisions of section 40A [2] and when the Department had never

invoked the provisions of section 40A [2] in the first place. This order should also not be

construed as the Supreme Court saying that if an expenditure transaction is tax neutralbetween the parties, no disallowance can be made for excessiveness. I also clarify that it is

also not my case that such a disallowance is permissible in absence of a provision

authorizing it. According to me, the Supreme Court meant that since the SLP is filed by

the Revenue, the Court is not considering it fit for exercise of jurisdiction under Article

131 as no effective prejudice is caused to the Department because the issue is revenue

neutral. {There is no monetary loss to the Department from a revenue neutral transaction

and issue is therefore not significant enough for the Supreme Court to intervene}


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Since this order is being widely reported, I thought I should share my views with the

Readers.

5. Levy of interest How much mandatory?As a general rule, levy of penal interest u\s 234-A, u\s234-B and u\s 234-C foralleged delay in depositing taxes has held to be mandatory by the Supreme Court in the

case of CIT vs. Anjum M.H. Ghaswala [2001] 252 ITR 1 {SC}. Unless there is no

express power granted by the statute to waive the same, the taxing authority would not

have any discretion in the matter of levy of the same.

At the same, time, when the assessee is visited with the interest liability either

because of impossibility in depositing the tax [where the liability to pay the tax has arisen

because of a retrospective amendment} or due to the fault of the Department only, judicial

authorities have intervened to redeem the assessee in this situation.

In the case ofJSW Steel Ltd vs. ACIT [2010] 5 ITR {Trib} 31{Bangalore}, the

assessee was found liable in assessment for interest u\s 234-B on book profits assessed as

the total income u/s 115JB of the Income Tax Act. It was the assessees case that this

liability had arisen because of a provision brought subsequently with retrospective effect

that deferred tax has to be added back in computation of the book profits. The Tribunal

found that it was impossible for the assessee to have paid the advance tax when at the due

dates for paying the advance tax, this provision was not on the statute book. It accordingly

deleted the interest levied.

In another case, the Delhi High Court in the case ofCIT vs. Mesco Airlines Ltd

[2010] 327 ITR 554 {Del} has ruled that the assessee should not be burdened with interest

u\s 158BFA [1] for delayed filing of the block assessment return for the period of delayoccasioned by the time taken by the Department to supply copies of documents seized by

the Department, which documents were necessary for compiling the income to be returned.

Taking a cue from the above decisions, two legal principles come to my mind.

Firstly, the law does not compel any one to perform the impossible (lex non ogit ad

impossibilia). Secondly, no person should be allowed to take advantage of ones own

default [and that too at the cost of the other and even when the defaulter is an authority

himself]. It is time that these principles should be read in to the law by our tax courts in

cases where charging of penal interest is otherwise mandatory, where the assessee is not at

fault.

With these remarks, I shall take leave of the readers.

Disclaimer: The contents of this document are solely for informational purpose. It does not constitute professional advice or a formal recommendation. While due care has been taken in preparing this document, the existence of mistakes and omissions herein is not ruledout. Neither the author nor itatonline.org and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon. No part of this document should bedistributed or copied (except for personal, non-commercial use) without express written permission of itatonline.org.

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Analysis_of_Six_Important_Decisions_July_to_Nov_2010[1]