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i48th Residential Refresher Course8th-11th January, 2015 at Udaipur

FOREWORD

Dear Participant,

We are pleased to welcome you to this 48th Residential Refresher Course (RRC) of the Bombay Chartered Accountants’ Society being held from 8th January 2015 to 11th January 2015 at this beautiful venue near the City of Lakes-Udaipur. We also have great pleasure in placing in your hand the Paper Book containing the papers for this Residential Refresher Course contributed by our learned paper writers.

One of the flagship activities of the BCAS, the popularity of the RRC continues to be intact over the years. The unique features of the RRC have remained same. What makes this special is the voluntary contribution by the paper writers, the speakers and the various co-ordinators. The active involvement of the group leaders and other participants at the group discussion along with other proceedings at the RRC ensures an excellent standard of discussion on topics covered at the RRC.

The structure of the RRC where subjects are first discussed in small groups and then presented by the paper writer at the general assembly is well-established and has been popular. Group leading creates future leaders and provides an opportunity to master the subject. This year we will be deliberating on topics on current and emerging issues in our core areas of tax and company law besides a paper on the management perspective of mergers and acquisition.

The feedback of the paper writers in the past has been that they too have benefited from deliberations and discussions with the delegates.

The residential nature of the RRC builds camaraderie amongst delegates from various places especially when we have a sizable number of participants from outside Mumbai participating in the RRC.

We are sure you will all return home enriched and rejuvenated.

Nitin P. Shingala Rajesh S. Shah President Chairman BCAS Seminar Committee

ii 48th Residential Refresher Course8th-11th January, 2015 at Udaipur

Programme Schedule

Thursday 8th January, 2015

4.15 p.m. to 5.45 p.m. CA Sunil Gabhawalla’s Paper - Group Discussion

6.00 p.m. to 6.15 p.m. Inauguration

6.15 p.m. to 7.00 p.m. Speech by Chief Guest

7.15 p.m. to 8.30 p.m. Presentation Paper by CA Khushroo Panthaky

Friday 9th January, 2015

8.30 a.m. to 10.00 a.m. CA Pradeep Kapasi’s Paper Group - Discussion

10.00 a.m. to 11.30 a.m. Reply to Paper by CA Sunil Gabhawalla

11.30 a.m. to 1.00 p.m. Reply to Paper by CA Pradeep Kapasi

Saturday 10th January, 2015

8.30 a.m. to 10.00 a.m. CA Milin Mehta’s Paper - Group Discussion

10.00 a.m. to 11.30 a.m. Presentation Paper by CA Bhagirat Merchant

11.30 a.m. to 1.00 p.m. Reply to Paper by CA Milin Mehta

Sunday 11th January, 2015

9.00 a.m. to 12.15 p.m. Brain Trust Meeting

Trustees - Advocate Mr. Saurabh Soparkar and CA Rajan Vora

12.15 p.m. to 12.45 p.m. Concluding Session

iii48th Residential Refresher Course8th-11th January, 2015 at Udaipur

Contents

Sr. No.

Papers for Group Discussion Paper Writers Page No.

1 Taxation of Some Entity Related Issues (Private Trusts, HUF, AOP, Firm, Succession, Company)

CA Pradip Kapasi 1

2 Concept of deemed income and deemed gains under section 56(2)(vii), (viia) and (viib), section 69 & Gain under section 43CA & section 50C etc.

CA Milin Mehta 33

3 Issues in CENVAT Credit and Reverse Charge Mechanism under Service Tax

CA Sunil Gabhawalla 63

Paper for Presentation

4 Companies Act, 2013 – Provisions related to Accounts, Audit & Auditors – Issues and Implementation Challenges

CA Khusroo Panthaky 71

5 Strategic Intent of Mergers and Acquisitions CA Bhagirath Merchant 87

Brain Trust

6 Income Tax – Critical Issues (including International Taxation) Trustees:

Adv. Saurabh Soparkar

CA Rajan Vora

93

iv 48th Residential Refresher Course8th-11th January, 2015 at Udaipur

Taxation of some entity related issues (Private Trusts, HUF, AOP, Firm, Succession, Company)

148th Residential Refresher Course8th-11th January, 2015 at Udaipur

Taxation of Some Entity Related Issues (Private Trusts, HUF, AOP, Firm,

Succession, Company)

PRADIP KAPASI Chartered Accountant


2 48th Residential Refresher Course8th-11th January, 2015 at Udaipur

• Practising Chartered Accountant• A Law Graduate from GLC• Co-author of books

– Taxation and Accounting of shares & securities– Fringe Benefits Tax– Search, Seizure and Survey”– Stamp Duty– “Search & Seizure – Block Assessment Special Income-tax Assessment Procedure” – Taxation of Firms and partners, AOP/BOI and JV-FAQs– Digest of Case laws– International Taxation – Some Important Aspects – Wills and Successions – Hindu Undivided Family – Law and Taxation

• Past President of BCAS. • Past President of The Chamber of Tax Consultants• Lecturer at Jamnalal Bajaj Institute of Management Studies on the subject ‘Taxation’ for Masters

Degree in Management Studies. (1989-2001)• Visiting Professor at IIM – Indore on the subject “Corporate Taxation” for Masters Degree in

Management Studies.• Addressed various Lecture Meetings and presented papers on the subject of Direct Tax Laws,

Stamp Duty and Allied Laws.• Regular contributor of Articles in magazines of professional interest and the newspapers• Co-author of monthly feature ‘Controversies’ in BCA Journal. • Past Editor of ‘BCA Referencer-cum-Diary’.• Past Assistant Editor of ‘Income Tax Review’. • Member of various sub-committees of BCAS and CTC. • Editorial Board member of AIFTP Journal.• Editorial Board member of The Chamber’s Journal.

Group Leaders of Paper on Taxation of some entity related issues by CA Pradip Kapasi

CA Chintan J. ShahCA Meghna SarangCA Pankaj Agarwal

CA Phalgune K. EnukondlaCA Sidhartha B. KaraniCA Vinod kumar Jain

CA Pradip Kapasi




CA Pradip Kapasi

INDEX

INTRODUCTION ................................................................................................................................................4

I PRIVATE TRUSTS ....................................................................................................................................4

A. Specific and Discretionary Trusts ..................................................................................................5

B. A Trust through Will .....................................................................................................................10

C. Minor Beneficiary Trust ................................................................................................................11

D. Creditors’ Trust .............................................................................................................................12

E. Foreign Trust .................................................................................................................................12

F. Pets’ Trust .....................................................................................................................................13

G. Business Trust ..............................................................................................................................13

H. Securitisation Trust .......................................................................................................................16

II HINDU UNDIVIDED FAMILY (HUF) .......................................................................................................17

A. Status of a daughter.....................................................................................................................17

B. Character of property received on inheritance ...........................................................................19

C. Status of HUF post deemed partition u/s 6 or S. 30 of The Hindu Succession Act, 1956 ....20

D. Subsequent marriage of the recipient .........................................................................................20

III AOP and BOI .........................................................................................................................................21

A. Scheme of taxation of an AOP and BOI ....................................................................................21

B. Status of an AOP .........................................................................................................................22

C. Status of Body of Individuals .....................................................................................................23

D. Taxation at Maximum Marginal Rate (MMR) ...............................................................................24

E. Losses ...........................................................................................................................................25

F. Option to assess ..........................................................................................................................26

G. Minimum Alternate Tax (MAT)......................................................................................................26

H. Share of a member ......................................................................................................................26

IV FIRM ......................................................................................................................................................27

V SUCCESSION.........................................................................................................................................27

A. Income of a discontinued profession .........................................................................................27

B. Income of a discontinued business ............................................................................................28

VI COMPANY ..............................................................................................................................................29

VII LOSSES AND RESIDENTIAL STATUS ..................................................................................................30

Acknowledgements .........................................................................................................................................31



INTRODUCTIONThe object of the paper is primarily to refresh the knowledge on a subject, that is otherwise complex and at times, very complex and also to capture the judicial developments (India Advantage Fund, Shri Vikramsinghji of Gondal, Bharti Overseas Trading Co.), the recent legislative developments (Hindu Succession Act, Securitisation Trust, Business Trust and One Person Company) and also the bureaucratic developments (Cir. No. 13/2014 dated 28-7-2014).

The paper attempts to identify the unresolved issues in respect of each of the topics discussed herein and present the same for discussion and consideration of the participants. It is natural that good number of issues are identified for discussion in a subject as vast and diverse, that is addressed in this paper. While the participants may study and discuss all such issues, the group leaders may, amongst themselves identify the limited number of issues for the interaction at the general assembly.

It is said that the rash or the inexperienced will attempt things which a wise person would be reluctant to undertake. These words, best explain one’s attempt to write a paper on a subject that has the widest possible spectrum – ‘Fools rush in where the angels fear to tread’.

The vehicle of a trust is and has always been considered to be one of the best tools of the inheritance planning which helps ensuring the judicious distribution of income and wealth by securing the income and the wealth for the persons in whose welfare the author is interested in. Similarly, a joint family ownership ensures the substantial benefits arising out of the unity of control and management, besides assuring significant wealth creation. It also ensures, to an extent, perpetual succession without much hassle. These benefits continue to canvas a valid case for the utility of such vehicles and mediums, which is independent of the tax advantages.

I PRIVATE TRUSTS A Private Trust is constituted under The Indian Trusts Act, 1882, a statute that has codified the law

relating to the private trusts in India. The scope of this Act extends to the whole of India excluding the State of Jammu and Kashmir and the Andaman and Nicobar Islands. A ‘trust’, under the Act, is an obligation annexed to the ownership of a property, arising out of a confidence reposed or declared by the owner of the property and accepted by a trustee for the benefit of another. A trust is constituted on settlement of a property by the ‘author’ of a trust who is the person who reposes or declares the confidence in the ‘trustees’, who are the persons who accept the confidence and manage and administer, the trust property, as per the wishes of the author, recorded in the Instrument of Trust, for the benefit of the ‘beneficiaries’, who are the persons for whose benefit the property is settled by the author and the confidence of the author is accepted by the trustees.

A trust represents a fiduciary obligation, voluntarily undertaken, by the trustees, for the benefit of persons other than the trustees. A trust deed usually records an agreement between the author and the trustees and not with the beneficiaries, though they have the right to ensure that the trust property is applied only for the purpose of trust.

Settlement of a property in trust is an essential feature of a trust, the title whereof is required to be conveyed and vested in the trustees. The trustees have to keep the property separate and utilise the same for the specific purposes and objects of the trust. They have the power to manage and dispose of the property as per the terms of the settlement subject to their obligation to maintain and render accounts thereof. Trustees are neither the agents of the author nor of the beneficiaries. Unless otherwise provided, a beneficiary cannot appoint or revoke the trustees. A trust can be settled for the benefit of an unborn person provided the interest of such a person is preceded to by a living person and is not in violation of the rule against perpetuity. A settlement comes to an end as per the terms of the trust.

There is no country in the world where fiduciary relations exhibit themselves so extensively and in such varied forms as in India. The possession of a dominion over a property coupled with the obligations to use the property for the benefit of persons other than the possessor is quite familiar to Indians.



A trust is based not on a consideration but on confidence that promotes the cause of a selfless service without expectation of any benefit to the service provider who does not have any beneficial enjoyment of the property but for an outsider, he is clothed with such rights and is enabled to personate the beneficiary in dealing with the world. – Salmond

Under the Constitution of India, the subject ‘Trust and Trustees’ is in the concurrent list and as a consequence thereof, the Centre and the States have the powers to legislate in the matters of a trust. A trust is a Private Trust when it is settled for the benefit of a few specific persons in contrast to the one for the general public. The primary purpose of a trust is to protect the interest of the beneficiaries who otherwise are found to be unable to so protect. A trustee is under a legal obligation to use the property, settled in trust, for the benefit and welfare of the beneficiaries.

As per S.6 of the Indian Trust Act, 1882, a trust is created when the author of the trust conveys his intention to create a trust and defines the trust property, the objects of the trust and the beneficiary. The persons necessary for a valid creation of a trust are the settlor or the author and the trustees and the beneficiaries. The requisites or the certainties of the trust are; the words used should be imperative; the subject matter of the trust should be certain and the object and purpose of the trust should be clear.

There are no special provisions in the Income-tax Act for;

• bringing to charge an income of a private trust, or

• computation of its income, as also

• determination of its residential status.

Any transfer of income to a trust without the transfer of assets shall continue to be taxable in the hands of the transferor of such income. Further, the income arising in respect of asset under a revocable transfer shall also be continued to be taxed in the hands of the transferor. So, however, such income will not be so taxed but will be taxed in the hands of the transferee where the transfer is by way of a trust which is not revocable during the lifetime of the beneficiary provided the transferor derives no benefit from such income. Sections 60 to 63 of the Act.

Like in other cases, most of the provisions of the Act, including the provisions of S. 4 to S. 6, apply to the income of a private trust. The Act however contains special provisions in Ss. 160 to 167 and s. 238 of the Act; for

• assessment of the income of a trust by providing for taxation of a representative assessee,

• the rate at which the income of the trust is to be taxed, and

• the manner of recovery of such tax.

A. Specific and Discretionary Trusts The Income-tax Act, 1961 for the purposes of rate of taxation, makes a distinction between a

determinate (‘specific’) trust and an indeterminate (‘discretionary’) trust. A distinction is also made between a trust created under a Will and otherwise as also between an ‘oral trust’ and a ‘written trust’. Subject to certain exceptions, the profits and gains of business carried on by a trust, specific or discretionary, and the income of a discretionary trust, from whatever sources, is taxed at the maximum marginal rate (‘MMR’).

A trustee is a representative assessee within the meaning of the term u/s 160(1) and is deemed to be an assessee for the purposes of the Act, vide S.160(2) of the Act. S.161(1) provides that the tax on income of the trust shall be levied upon and recovered from a trustee in the ‘like manner and to the same extent’ as it would be leviable upon and recoverable from the person represented by him. The concept of the ‘like manner and to the same extent’ shall have application limited to computation of



total income of the beneficiaries of a specific trust, where the beneficiaries are known and their shares are determinate.

The application of the principle has three consequences; determination of status, quantum of income and taxes. The status of even a discretionary trust will be an individual for tax purposes. S.A.E. Head Office Monthly Paid Employees Welfare Trust, 271 ITR 159 (Delhi). However, the benefit of the threshold limit exemption shall not be available and the entire income will be taxed at the MMR, Piarelal Sakseria Family Trust, 136 ITR 583 (MP). The benefit of threshold exemption from tax available otherwise to a beneficiary of a specific trust shall be available while assessing the income in the hands of a trustee.

Subject to the above, the scheme of taxation governing the liability of the representative assessee i.e. a trustee in the matters of filing return of income, payment of taxes, assessment and recovery of taxes, by and large, remain the same.

A trustee, as regards the income of the trust, is subjected to the same duties, responsibilities and liabilities, as that of the beneficiaries, as if the income were income received by or accruing to or in his favour. He is liable to assessment in his own name in respect of such income, subject to the application of the rule of ‘like manner and to the same extent’. The assessment made on the trustee is deemed to have been made upon him in his representative capacity only. The liability of a trustee is confined to the income which is accrued in his hands or is received by him and does not extend to the other income of the beneficiary for which he alone will be assessable and be taxed. There may be a common assessment order that involves multiple assessments qua each beneficiary. It is possible that different trustees may be assessed for different sources of income. The rule is subject to exceptions contained in S.161(1A), 164 and 166, cases where income is assessable at MMR or at the rate applicable to an AOP.

Since the liability of the trustee is co-extensive with that of the beneficiary, in the assessment on the trustee, all such exemptions, deductions and abatements should be given as if the beneficiary is assessed directly. The AO must allow set off of the capital loss, which had arisen, in the hands of the trust. The interposition of the trustee does not affect, generally speaking, the incidence of tax on the beneficiary. If the beneficiary has made advance payment of tax and the assessment is subsequently made on the trustees, credit must be given to the trustees for the tax so paid in advance by the beneficiary. The trustee should be entitled to claim a refund where the total income of the beneficiary justifies such a claim.

Where the beneficiary is not liable to tax at all in respect of certain income, there would be no liability to tax on the trustee in respect of that income.

The principle underlying the assessment of income, in the hands of a trustee is to secure, for the State, its share of taxation in the simple and effective manner by taxing an income in the hands of a person, at the earliest point of time, who is entitled to receive it.

‘Trust’ is not specifically included in the definition of a person u/s. 2(31) of the Act leading to a question that often arises for consideration is whether the income of a Trust, when assessable in the hands of the trustees, is so assessable in the status of an ‘individual’ or that of an ‘AOP or BOI’, more so when there are more than one trustees. A similar issue also arises for determining the residential status of a trustee of a Trust.

For ascertaining the status in which an income of the trust is to be assessed, what is really relevant is the true status of the beneficiary as the tax is to be levied to the same extent as is leviable upon a beneficiary. A mere fact that there are more than one trustees shall not make the trust assessable as an AOP. The status of a trustee is determined from the status of the beneficiaries. If the beneficiary is an individual then the status of the trustee would be also be of an individual. This will be so even where there is more than one beneficiary provided all of them are individuals. The income will be taxed at the individual rates of taxes applicable to the total income of each beneficiary. It is only in exceptional



circumstances that the beneficiaries will be taxed as an AOP as constituting a unit of assessment. The assessment on the trustee however is in his representative capacity and is separate and distinct from his personal assessment.

The Supreme Court in Nizam’s Family Trust, held that the words ‘in like manner and to the same extent’ have three consequences. First, there would have to be as many assessments on the trustee as there are beneficiaries with determinate and known shares, though, for the sake of convenience, there may be only one assessment order specifying separately the tax dues in respect of the income of each beneficiary. Secondly, the assessment of the trustee would have to be made in the same status as that of the beneficiary whose interest is sought to be taxed in the hands of the trustee. Thirdly, the amount of tax payable by the trustee would be the same as that payable by each beneficiary in respect of his beneficial interest if he were assessed directly.

The application of the principle of ‘like manner, to the same extent’, enshrined in S. 161, should be carried to its logical conclusion by allowing, in computation and assessment of total income, all those deductions and exemptions otherwise allowable under the Act, to the beneficiaries in assessment of his income in the hands of the trustees who is a representative assessee under the Act. The questions that arise in such cases about the liability of a person who is required to comply with conditions attracted to such a claim are;

• Should the investment for a valid claim, u/ss. 54 to 54H, be made in the name of the trustees and out of the funds of the Trust?

• Is the difficulty of investment more pronounced in a case where the claimant is a Discretionary Trust, in which case it is not possible to reinvest the gains in the name of the beneficiary?

The Income-tax Act does not use the term ‘Discretionary Trust’. Instead, in a roundabout manner, S. 164(1) provides that, an income of a Trust shall be charged at the MMR, where:

the income or any part thereof, is not specifically receivable on behalf of, or for the benefit of any one person, or

the individual shares of the persons on whose behalf or for whose benefit such income or such part thereof is receivable are indeterminate or unknown.

Accordingly, a Trust that suffers from any one or both of the conditions listed above is taxed at the MMR. Such a Trust is usually recognised as a Discretionary Trust.

Clause (i) of the Explanation 1 to S. 164, provides that the income shall be deemed to be not specifically receivable on behalf of or for the benefit of any one person (unknown) unless;

the person for whose benefit such income is receivable is expressly stated in the instrument of trust and,

is identifiable as such on the date of instrument or deed.

Clause (ii) of the Explanation 1 to S. 164, provides that the individual shares of the beneficiaries of income shall be deemed to be indeterminate or unknown unless;

the shares are expressly stated in the instrument of trust, and

are ascertainable as such on the date of instrument or deed.

For attraction of tax at the MMR, violation of any of the conditions is sufficient. A Trust Deed accordingly should ensure the following to ensure that it is not taxed at the MMR;

the beneficiaries are expressly stated,

they are identifiable as on the date of the deed,



their shares are expressed in the deed, and

such shares are ascertainable on the date of the deed.

S. 164(1) provides for four exceptions to the rule that income of a discretionary trust will be charged at the MMR. These exceptions are;

where none of the beneficiaries:

a) has income chargeable under the Act exceeding the maximum amount not chargeable to tax, or

b) is a beneficiary under any other trust.

the income is receivable under a Trust;

a) declared by Will and

b) such Trust is the only Trust so declared.

the income is receivable under a Trust created before 1-3-1970 for the benefit of the relatives of the settlor.

the income is receivable by the trustees of a ‘Labour Welfare Trust’ exclusively for the benefit of certain employees.

The 2nd proviso to S. 164(1) exempts even a business discretionary trust from being taxed at the MMR in a case where profits and gains of such a trust are receivable;

under a Trust declared by Will,

exclusively for the benefit of a relative,

dependent on him,

for support and maintenance, and

such Trust is the only Trust so declared.

A property can be settled in Trust under the Indian Trust Act as also under the Transfer of Property Act for the benefit of a would be daughter-in-law or a son-in-law or an unborn child or any such person. It is for consideration whether such a trust, during the intervening period, will be treated as a Discretionary Trust and whether income of such a Trust will be taxed at the MMR, M.K. Kannan Marriage Benefit Trust and Others, 240 ITR 785 (Mad.), P. Bhandari, 147 ITR 500 (Mad.), M.K. Chandrakanth, 225 ITR 101 (Mad.) and Brig. Kapil Mohan, 252 ITR 830 (Delhi), Sadani Family Trust, 1 ITD 223, T. Senthil Kumaran, 39 TTJ 177 (Mad.) and M.K. Jhavar, 23 TTJ 48 (Cal.). However, please see, Atreya Trust, 55 Taxman 489 (Cal.)

An Alternative Investment Fund has the objective of investing the funds collected from investors, the unit holders, from time to time. It receives income by way of dividend, interest and capital gains and distributes such income to the unit holders. Such a Trust, only on compliance of conditions of S. 10(23D) or S.10(23FB) is eligible for exemption of its income. Difficulties arise in cases where the Trust is not so exemption compliant. Such a Trust, by its business model, has a fluctuating body of investors where identity and shares remain ‘unknown’ and ‘indeterminate’ at the time of its constitution. This situation poses difficulties in taxation of its income. The CBDT has issued a Circular dated 28-7-2014 bearing No. 13/2014 advising the AO to treat such Alternative Investment Funds as discretionary and tax their income at the MMR. The participants are requested to consider;

• Whether the stand of the CBDT is rational? India Advantage Fund, 50 taxmann.com 350, H.E.H. Nizam’s Family Trust, 224 ITR 473 (AAR) and Raptakos Brett & Co. (P) Ltd., 177 ITR 202 (Bom.).



A Trust Deed authorising the trustees to change the shares of the beneficiaries may be exposed to the risk of being treated as discretionary by the authorities. Mirje Family Trust, 18 ITD 25 (Pune), Suniteeraje A. Apte Family Trust, 14 TTJ 499 (Bom.). It may be possible for the trustees to convert a discretionary trust to a specific one, where authorised by the deed, Hiren Kiren Jagruti Hina Trust, 8 ITD 106 (Ahd.).

A Trust, though discretionary, may not be held to be so and may not be taxed at the MMR in cases where it is settled for the benefit of a sole beneficiary, Pallavi S. Mayor, 127 ITR 701 (Guj.). The tests of whether the shares of the beneficiaries are determinate or not or whether the beneficiaries are known or not are to be applied to the income of the trust and not to the corpus. Thus, a trust cannot be held to be a discretionary trust simply because the corpus beneficiaries are not identified or their shares therein are undefined, Rai Saheb Seth Chunilal Modi Family Trust, 149 ITR 724 (MP). What must be seen is whether the beneficiaries and their shares were known or determinable from the trust deed when the income was received by the representative assessee i.e. at the end of each accounting year, when the net income becomes calculable. It does not appear necessary that the beneficiaries should be named in the trust deed. It is enough if at the end of each accounting year it can be ascertained having regard to the terms of the trust deed who the beneficiaries in that accounting year were, Shree Ram Mills Ltd., 162 ITR 471 (Bom.).

Option to assess: S. 166 confers an option on the AO to assess the income in the hands of the beneficiary directly. An Assessing Officer is vested with an option to tax either a trustee or the beneficiary. So however, an option once exercised, the income will not be taxed again in the hands of the other person Clagget, 171 ITR 409 (S.C.). Income once taxed in the hands of the trustees cannot be included in the income of the beneficiary even for rate purposes. Gargiben, 130 ITR 439 (Guj). The combined effect of sections 166 and 167 is explained by the Supreme Court in Bibhuti’s Case 51 ITR 88 by clarifying that the Income-tax Department has two options:

To assess the representative assessee or the person beneficially entitled to the income, and

Having assessed either, of the two, to recover the tax from the property held by him or by the other.

Once a person is assessed in respect of any income of the trust, he shall not be again assessed in respect of the same income under any other provisions of the Act. There is however, no specific clarification for confirming that the income, once taxed in the hands of the trustees, will not again be taxed in the hands of the beneficiaries. S. 166 permits, perhaps as an alternative, the direct assessment of the income in the hands of the beneficiary and/ or recovery of the tax payable by him, however again it’s not clarified that an income once taxed in the hands of a beneficiary will not be taxed in the hands of the trustees.

An option once exercised shall be final and will prevent an AO from taxing the income for the subsequent years in the hands of trustees. No. 45/78/66- IT(5) dated 24-2-1967. The other income of the Trust in respect of which beneficiaries are known and their shares are determinate will be taxed at the regular rates, only. The AO is entitled, vide s. 167, to recover the taxes from the beneficiary as also from the trustee even where the assessment is made directly on the beneficiary.

The issue that requires consideration is;

• Whether an income of a discretionary trust can be taxed in the hands of the beneficiary directly by the AO u/s 166? Jyotendrasinhji, 201 ITR 611 (SC). Such an assessment is not barred under the law in respect of income actually received by him. Moti Trust, 236 ITR 37 (SC), Kamlini Khatau, 201 ITR 109 (SC). But also see, Alpana Kirloskar, 150 ITD 311 (Delhi).

Rate of Tax: S. 161(1A) and S. 164 provide for taxing income of the trust at the MMR in the circumstances specified therein or at the higher rates that inter alia includes the case of a trust where income of one of the beneficiaries is taxable or has an income that is taxable at the higher rate.



The tax recoverable from a trustee would be at the rate applicable to the income of a trust and share therein and not at the rate applicable to the total income of the beneficiary which may include income chargeable in the hands of other trustees as also the income of the beneficiary from other sources. Easter Scales, 115 ITR 323 (Cal.),

The issues that require consideration are;

• Whether the share in income of a beneficiary from a trust is to be included or not while determining whether income of the beneficiary is taxable or not? Kindly see, P. N. Bajaj, 262 ITR 593 (Mad.). Should such an ‘income’ be the gross total income, or the total income or the chargeable income?

• Whether the income of a discretionary trust be taxed at the MMR where it is taxed in the hands of the beneficiary, directly? R. Sreevidya, 84 ITD 222 (Cochin).

The CBDT, vide Cir. No. 320 dated 11-1-1982, has clarified that income of Welfare Trusts, Societies etc. will not be taxed at the MMR but will be taxed at the rates applicable to an AOP, Raptakos Brett & Co. (P) Ltd., 177 ITR 202 (Bom.). The Board has also clarified that income of a discretionary trust will be taxed at the ordinary rates and not at MMR in cases where the case of the trust is covered by First proviso to S. 164(3).

A trust settled for the benefit of a deity cannot be taxed at the MMR but will be taxed at the rates applicable to an AOP. Shri Hanuman Mandir Trust, 84 ITD 83 (Pune).

Recovery of tax: A trustee by virtue of s. 162 is entitled to recover the taxes paid by him from the beneficiary of the trust or he is entitled to retain an amount equal to the taxes paid out of any monies in his possession. He is also entitled to secure a warrant from the Assessing Officer for retaining such amounts.

Trust in Trust: A Trust, whether discretionary or otherwise, can be a beneficiary in another Trust. Such a Trust cannot be treated as a discretionary trust and the income of such a Trust will not be taxed at the MMR simply for the reason that one of its beneficiaries is a discretionary trust, Ramesh K. Shah Trust, 88 ITD 477 (Ahd.), Atman Trust and Bharat Trust, 31 ITD 315 (Ahd.) and 51 TTJ 305 (Ahd.)

Corpus Income: Where a beneficiary is not entitled to the corpus and the income from the corpus, the income thereof will not be taxed in his hands but may be taxed in the hands of the beneficiary entitled thereto. J. B. Wadia, 48 ITR 135 (Bom.) and Gosar Family Trust, 30 TTJ 183 (Ahd.)

Income from House Property: S. 26 contains a provision for taxing the income under the head income from house property in the hands of an owner or a deemed owner of the property. The specific provision of S. 26 shall override the provisions of S. 161, Karelal Kundanlal Trust, 148 ITR 412 (MP)

B. A Trust through Will Any income of a Trust consisting of Profits and Gains of business is liable to be taxed at the MMR,

irrespective of the fact that the Trust is a Specific Trust, as per the provisions of S. 161(1A) of the Act. No relief of exempting income up to a threshold limit is provided in such a case and the income of every rupee is liable to be taxed at the MMR. The other income of such a Trust is however taxable at the regular rates. The beneficiaries of the Trust are not liable to tax in respect of the profits and gains of business, so taxed in the hands of the Trust.

An exception to the above rule has been carved out, by the Proviso to S. 161(1A), whereunder the profits and gains of the Trust are not charged at the MMR in a case where such income is receivable under a Trust;

a) declared by a Will,



b) exclusively for the,

c) benefit of any relative,

d) dependent on the person making the will,

e) for support and maintenance, and

f) such a Trust is the only Trust so declared by him.

S. 164(1), like s. 161(1A), provides for taxing any income of a Discretionary Trust at the MMR. Clause (ii) of the Proviso to the said section saves an income of such a Trust from being taxed at the MMR in a case where the relevant income is receivable under a Trust

a) declared by any person by a Will, and

b) such a Trust is the only Trust so declared by him.

Any profits and gains of such a Trust, however is saved from being taxed at the MMR only if the conditions specified in the 2nd Proviso to the said section, which conditions are the same as those prescribed in the Proviso to S. 161(1A), are fulfilled. The combined reading of these provisions indicate that an income of even a Discretionary Trust is liable to be taxed only at the ordinary rates where the Trust is created under the Will and satisfies the conditions laid down in the two Provisos. Even profits and gains of business of such a Trust are saved from MMR provided six conditions are satisfied, while other incomes are so saved on satisfaction of two out of the six conditions.

In the context of the above discussion, the eligibility or otherwise of a Trust for being taxed at the ordinary rates, be examined under the following facts in respect of the Profits and Gains of Business;

• A person has settled the only trust under a Will for the benefit of more than one relative where one of the relatives has independent income by way of interest and the other relative has a source of income that has arisen subsequent to the execution of the Will.

• The deceased has also settled a Charitable Trust under a Will besides the above referred Private Trust.

• The relatives happen to be the parents of the deceased who are residing with the brother of the deceased and their needs are partly met by such brother.

• The sister of the deceased also has, in her Will, settled a Trust for the benefit of her mother.

C. Minor Beneficiary Trust A Trust created for the benefit of a Minor will be taxed, ordinarily, on the general principles of taxation of

a Trust discussed therein. The income, when found to be taxed in the hands of a minor, will be clubbed in the hands of parents. The tax treatment of a Minor’s Trust, however will be different when the Trust is settled with the condition of accumulation of income during the period of minority. The courts in such a case have held that the income of the Trust, accumulated, cannot be taxed in the hands of the minor and therefore cannot be clubbed with the income of the parents. The income/ wealth of the minor, from sources other than the Trust, will be taxed as per the regular provisions of the law, and may be clubbed where the law provides for clubbing.

For the same reasons, the accumulated wealth cannot be taxed in the hands of the minor and not be clubbed in the hands of the parents.

The issues that are required to be considered are;

• Whether the income or wealth, during the intervening period, can be taxed in the hands of the Trustees?



• If yes, at what rates of taxation?

• Will the answer be different in case of a sole beneficiary Trust?

D. Creditors’ Trust The income from property settled in a trust, for the benefit of creditors, may not be taxable in the hands

of the settlor. The objective of the settlement in such cases is to ensure the fair and equitable distribution of the property and income thereof amongst the creditors of the settlor who has not been able to repay his debts in full, Dutt’s Trust, 10 ITR 477 (Cal.) and Smt. Ved Wati Munjal, 38 ITD 11 (Chd.).

In such a case, the issues that require consideration are;

• Whether the capital gains arising on transfer, by the trustees, of the property settled in trust is liable to be taxed in the hands of the settlor or in the hands of the trustees or the creditors?

• Whether the income from the trust property, in the intervening period will be liable to tax in the hands of the settlor or in the hands of the trustees or the creditors? If yes, at the MMR or the ordinary rates?

E. Foreign Trust For the purposes of our discussion, a ‘Foreign Trust’ is a Trust settled outside India, by a non-resident,

for the benefit of the resident beneficiaries, wherein the trustees are non-residents or residents, appointed under an instrument in writing, in accordance with the laws of the country in which it is constituted. Such a Trust can either be a determinate (specific) Trust or an indeterminate (discretionary) Trust. It may hold investments in and outside India. The income accruing or received on such investments is distributed as per the deed of trust.

The taxation of the income of this Trust in India is largely governed by the general rules of taxation applicable to a domestic Trust. The income of this Trust is taxed in the hands of the trustees, in the status of the beneficiaries and the residential status of the trustees is derived from that of the beneficiaries. The income in case of a specific Trust will be taxed in the like manner and to the same extent of the beneficiaries, where taxed in the hands of the trustees. The Assessing Officer shall have an option to assess the trustees or the beneficiaries of the Trust and the option once exercised shall be binding on the Assessing Officer. The income of a discretionary Trust is taxed in the hands of the trustees at the MMR.

The primary liability for taxation of the income of the Trust is governed by provisions of S.4 to S.6 of the Income Tax Act. Accordingly, the income of the Trust, irrespective of the residential status of the trustees or beneficiaries, is liable to tax in India where such income has accrued or has arisen or is deemed to have accrued or have arisen in India or is received or is deemed to have been received in India. The income when taxable in India is computed as per the provisions of the Income Tax Act, 1961 which however is subject to application of the DTAA.

In a case where none of the beneficiaries are resident or are resident but not ordinarily resident, the income of the trust accruing or arising or being received outside India is not taxable in India. In a case where the beneficiaries or the trustees are resident and ordinarily resident under the Act, the global income of the Trust is taxable in India.

If income from investments is received abroad for a beneficiary who is non-resident in India, the trustee would not be chargeable in respect of that income merely by reason of the trustees who are residents in India. As the beneficiary is chargeable on such income, so will be the trustees. Conversely, if the beneficiary is a resident in India and is in receipt of income from a foreign trust, held by foreign trustees, such foreign income would be chargeable in India, and directly in the hands of the beneficiary or in the hands of a foreign trustee in the status of a resident in India.



A foreign income of an overseas Discretionary Trust can therefore not be subjected to Income Tax in India unless;

• the trustees are residents under the Income-tax Act, 1961; or

• the beneficiaries are residents under the Act and the income has been distributed to any or all of them. In this case, the possibility of claiming credit for the overseas taxes paid by the trust has to be explored; or

• such a Trust is a sole beneficiary Trust and the beneficiary is a resident under the Act.

The taxation of the wealth of the trust is also governed by the above-mentioned principles.

A return of income, where required by S.139(1), is required to be filed keeping in mind the 1st and the 4th provisos of S.139 (1) of the Act.

F. Pets’ Trust Settling an amount in Trust, for the benefit of the animals in general, may qualify for being treated as

a ‘charitable purpose’ u/s 2(15) and the income of such a Trust may be exempted from taxation on compliance with the conditions set out in sections 11 to 13 of the Act. This tax shelter may, however, not be available to a Trust that is set up specifically for the benefit of one or a few household pets for which the settlor has immense love and affection and has a desire to provide for their welfare during his lifetime and thereafter by settling an appropriate amount in Trust. The pets are the beneficiaries of such a Trust and their interest is being taken care of by the individuals who are appointed as the trustees of such a Trust.

The possibility of constituting such a Trust and its taxation, are the areas that, have remained to be explored and therefore requires consideration. Large sums are known to have been settled in countries, overseas, for the benefit of the specific pets, carrying specific directions for the trustees.

The questions that require consideration in respect to a Trust for the benefit of pets are;

• Whether such a settlement for the pets is possible within the framework of the Constitution of India and do the laws in existence permit the formation of such a Trust?

• Whether the provisions of S. 160 to S. 167 or any other provisions of the Income-tax Act, 1961 apply to such a Trust?

• Whether the beneficiary pet is a ‘person’ within the meaning of the said term u/s 2(31) of the Act and is liable to file the return of income and pay tax thereon?

• Can a pet own wealth and earn income in India?

The additional question is, can we all work for recognition of a Pet Trust under the laws of this country and make it possible?

G. Business Trust With the publication of the SEBI notification dated 26th September, 2014 an attempt has been made to

fulfil the long awaited dream of a common man to participate in the progress of the real estate sector, a sector which was hitherto open to a limited few on account of the huge capital requirement, statutory hurdles, non-transparent dealings, issues of management, imperfect markets, difficult exit routes and the incidence of taxation. The new vehicles of REITS and INVITS enable a retail investor with a capital as low as ` 2,00,000/- to share the progress. It also infuses the much needed capital in the otherwise perennially starved finance market for the real estate business. The listing of the units ensures an easy liquidity for the investors.



The medium of the Business Trust (REITS and INVITS) provide an investment opportunity to the investors while facilitating an exit for the sponsors which enables a retail investor to participate in the Real Estate and Infrastructure segment of the economy which hitherto was largely inaccessible to him on account of the sheer size of the investment, required to be made in acquiring even a single piece of the Real Estate. Simultaneously, it will bring in the much desired transparency and discipline in the Real Estate sector on account of the stringent regulations prescribed from the Governance of the REITS.

For an effective implementation of the REITS, it is necessary that the parallel amendments are carried out in the SCRA, for including the units of a REIT in the definition of a ‘security’ and in FEMA to enable the inflow of foreign investments, particularly by excluding such units from the definition of the “Real Estate Business”.

The units of REIT are compulsorily required to be listed on a Recognised Stock Exchange. Following the world model, the investment is likely to be principally in the completed assets which are ready for being rented and are capable of generating revenue from rents. The new scheme is not likely to make any difference in the taxation of the income arising on the structured investments in under construction real estate, monitored and administered by certain private finance companies.

It is preferable that a complete pass-through status is conferred on the Business Trusts under the tax laws, on the lines provided for the mutual funds, venture capital funds and the securitisation trusts.

The key players in the game of Real Estate Investment Trusts (REITs) are:

• Special Purpose Vehicle which holds the real estate.

• Sponsors who are the promoters of the SPV.

• Trust, who gathers funds from the unit holders and lenders and is controlled, monitored, managed and assisted by the trustees, managers and principal valuers.

• Unit holders who invest their capital in the units of the Trust.

Different and separate tax regimes are provided for each of them:

Special Purpose Vehicle; Its income continues to be taxed as per the regular provisions of the Act including that of the MAT. The distribution of income by way of dividend, even to a Business Trust, is subject to DDT. The payments to the Business Trust, wherever applicable, are liable to TDS. No special provision for taxation of the SPV are made in the Act on introduction of the concept of the Business Trust.

Sponsors; The transfer of shares by the Sponsor, held in the Special Purpose Vehicle, to the Business Trust, in exchange of the units of the Business Trust are not treated as ‘transfer’ at the relevant time and does not attract the capital gain tax, in view of the provisions of S. 47(xvii) of the Act. No parallel amendment in S. 2(47) has been carried out to provide that such an exchange, by a Sponsor is not a ‘transfer’. The gains, if captured in the books at the relevant time, may be exposed to MAT where the Sponsor is a company.

Special provisions are made for computation of capital gains, in the hands of the Sponsors, on a subsequent transfer of the units of the Business Trust, vide S. 2(42A) and S. 49(2AC) of the Act, whereunder the period of holding of the units relates back to the date of acquisition of shares of the SPV that were exchanged for units, and the cost of acquisition of shares is taken as the cost of acquisition of such units. The indexation shall accordingly be for the period commencing from the year of acquisition of the shares. The gains, if any, so computed, is liable to tax in the hands of the Sponsor at the regular rates, under the ordinary provisions of the capital gains taxation so however, such gains are not eligible for any exemption u/s 10(38) by virtue of the 2nd proviso to the said section. The income received from the Business Trust is taxed or exempted, in the hands of the Sponsor, on



the same lines as that of any other unit holder of the Business Trust. The expenditure incurred by the Sponsor may be eligible for deduction as per the regular provisions of the Act. The income from units, in the hands of the company Sponsor, is subjected to MAT where applicable and if distributed amongst the share holders is liable to DDT.

Business Trust; The main sources of income of the Business Trust are dividend and interest income from SPV, rental income from lessees, capital gains on transfer of the shares of SPV and other income. In turn, it incurs expenditure on administration, interest and taxes.

The dividend income received by the Business Trust from SPV is exempted in its hands u/s 10(34) of the Act.

The interest income received by it from SPV is exempted in its hands u/s 10(23FC) of the Act.

Capital gains of the Business Trust are liable to tax in its hands subject to the provisions of S. 111A and S. 112 of the Act.

The rental income and any other income of the Business Trust are charged in the hands of the Business Trust at the MMR. No parallel amendments are made for such taxation at MMR in S.161 or S.164 of the Act.

The income of the Business Trust is not liable to any MAT, it being a Trust registered under the Indian Trust Act.

Any distribution of income by the Business Trust, amongst the unit holders, is not liable to any DDT, unlike the distribution of income by the Securitization Trust.

Unit Holders; A unit holder, like any typical holder of units of a mutual fund, receives an income on distribution of income by the Business Trust, besides capital gains on transfer of units. S. 115UA(1) provides that the income received by the unit holder, on distribution by the Business Trust, is of the same nature and in the same proportion as it had been received by, or accrued to, the Business Trust. Accordingly, such income in the hands of the unit holder, is classified into two parts; interest income and non-interest income.

The interest component of the income received from the Business Trust on distribution is taxed, in the hands of the unit holder, under the head Business Income or Other Sources, as the case may be.

Other component of the income, received from the Business Trust on distribution, is not taxed in the hands of the unit holder by virtue of S. 10(23FD) of the Act.

The expenditure incurred by the unit holder is allowed as a deduction where it is wholly and exclusively incurred for earning interest income.

The capital gains on transfer of units of the Business Trust is subjected to concessional tax as per S. 111A, where STCG, and is exempted where LTCG u/s 10(38) of the Act.

The unit holder is liable to MAT in respect of interest component of its income if it happens to be a Company.

The major concerns or the issues surrounding the scheme of taxation of the ‘Business Trust’ are as under:

1. Unlike in case of a Mutual Fund or a Securitisation Trust, a complete pass- through status is not provided for a Business Trust, rather, it is restricted to the case of an interest income only.

2. A specific provision is made for taxation of income at the maximum marginal rate. No such provisions have been made for taxation of income of a Mutual Fund or a Securitisation Trust or a Venture Capital Fund at MMR.



3. The scheme of taxation should have been incorporated in S.160 to S.166. Instead, the scheme has been introduced without making necessary amendments in the said provisions.

4. The rental income of the SPV suffers taxation in the hands of SPV and is also made liable to DDT when distributed as dividend to the Business Trust. Thus, there is an additional burden of DDT. This burden can be avoided where the SPV transfers the real estate asset to the Business Trust and the Business Trust in turn lets it out for rent. This course however involves incidences of the transaction costs, besides the capital gains tax or business income tax, in the hands of SPV on transfer of asset.

5. The gains arising on transfer of shares of SPV, in exchange of units of the Business Trust, if captured in the books of the promoters, is liable to MAT.

6. The capital gains, arising on transfer of units by the sponsor, is liable to taxation which dampens the desire of the sponsor to exchange the shares for units. A sponsor, to that extent, is otherwise also in a disadvantageous position when compared to a unit holder inasmuch as capital gains of an unit holder is eligible for the benefit of exemption u/s 10(38) by the 2nd proviso to that section.

7. The expenses incurred for earning income in the hands of the Business Trust or the sponsors or the unit holders may not be eligible for deduction if such expenses are held to have been incurred for earning an exempt income.

8. It is difficult to apportion the expenses, for example interest, where part of the income is taxable.

9. Interest income is not taxable in the hands of the recipient Business Trust and hence the interest expenditure incurred on borrowing by the Business Trust is not allowable as deduction.

10. The wordings of S. 115UA(1), namely ‘Notwithstanding anything contained in any other provisions of the Act, any income distributed by a business trust to its unit holders shall be deemed to be of the same nature and in same proportion in the hands of the unit holder as it had been received by, or accrued to the business trust‘ are difficult to comprehend. Do they indicate that the gross amount of interest will be taxable in the hands of the unit holder i.e. gross of tax as also gross of expenditure of the Business Trust and also of the unit holder?

11. In computing the period of indexation on transfer of units by a sponsor, a difficulty may arise on account of period of holding of the erstwhile shares.

H. Securitisation Trust A Securitisation Trust is the one that is defined as such under the SCRA and the SEBI Regulations and

is regulated thereunder. The taxation of such a trust is governed by the provisions of Chapter XII- EA read with S.10(23DA) of the Act.

Any income of such a trust, from the activity of securitisation, is not taxable as per the provisions of S.10(23DA) of the Act. The activity of securitisation is the one which is carried out as per the ‘Guidelines on Securitisation of Standard Assets’ issued by the RBI or the one that is specified under the SEBI Regulations and the SCRA.

The Securitisation Trust however is liable to pay an additional tax, as per S.115TA on the amount of income distributed by it to its individual or HUF investor at the rate of 25% on income so distributed and at the rate of 30% when such income is distributed to any other person. However, no additional tax is so payable where the income of the investor is not chargeable to tax under the Act. Such additional tax is increased by the surcharge and the education cess and the secondary education cess. The liability to pay additional tax arises only where the income of the Securitization Trust is distributed.

The income received by an investor by way of distributed income, from a Securitisation Trust, is exempted from taxation u/s 10(35A) provided such income has suffered the additional tax u/s 115TA



in the hands of the Securitisation Trust. Such amount, however, is liable to MAT as per clause (ii) of Explanation 1 to S.115JB of the Act. Any further distribution of income, by an investor company, is however liable to DDT u/s 115O of the Act.

In the scheme of taxation of a ‘Securitisation Trust’, the following issues remain unaddressed;

• The exemption from taxation for the Securitisation Trust does not extend the income generated from activities not related to securitisation. Such income is taxed as per the regular provisions of the Income Tax Act.

• No deduction under the Act, vide S.115TA(4), is allowed to the Securitisation Trust in respect of the income that is charged to additional tax. However, an expenditure incurred on the activity of securitisation is allowed to be deducted in the hands of the Trust.

• There are no special provisions for exempting capital gains in the hands of the investor on transfer of a capital asset being investment in the Securitisation Trust.

• Any loss arising in the hands of the investor is not allowed to be set-off and/or carried forward.

• Any expenditure incurred by an investor in relation to earning the income from the Securitisation Trust is not allowed as deduction as per S.14A of the Act.

• The exemption for the investor is provided for with effect from A.Y. 2014-15. The liability to additional tax on Securitisation Trust is effective for distribution of income on or after 1-6-2013. Thus, in the hands of the investor, an exemption is possible even in respect of income that has been distributed during the period 1-4-2013 to 31-5-2013.

II HINDU UNDIVIDED FAMILY (HUF)

A. Status of a daughter A daughter and a wife of a member co-parcener, under the classical Hindu Law, are the members

of an HUF and they have a right of maintenance, though they are not the co-parceners and cannot demand a partition of the HUF nor can they demand a share in the assets of the HUF. So, however on partition, the family is obliged to set apart assets for their maintenance. A daughter, on marriage, ceases to be a member of her father’s HUF and becomes a member of her husband’s HUF with the right of maintenance. A Class I female relative of a male Hindu, however has a right to receive a share in the property of HUF through him where he may be her husband or father or a son as per S.6 of the Hindu Succession Act, 1956.

Far reaching and sweeping changes have been made in the Hindu Succession Act, 1956 by the Hindu Succession (Amendment) Act, 2005. One of such radical changes is effected by the substitution of S.6 of the Hindu Succession Act with effect from 9th September, 2005, which change, without abolishing the joint family or the family property has rewritten the law hitherto prevailing, in respect of a daughter’s right in a Mitakshara co-parcenary.

The above noted position vis-a vis the females, under the classical Hindu Law, is materially changed by the amendments in the Hindu Succession Act,1956 made effective on pan-Indian basis from 2005. Andhra Pradesh (1985), Tamil Nadu (1989), Karnataka (1994) and Maharashtra (1994) had introduced similar amendments qua their respective states, earlier to 2005, all of which now stand repealed by virtue of the amendment of 2005.

The amendments have the effect of vesting a daughter of a coparcener, in a joint Hindu family governed by Mitakshara law, with all the rights of a co-parcener, by birth, in the same manner as that of a son. She is vested with the same rights and liabilities in the coparcenery property of an HUF as that of a son and with that, all the incidences thereof. She also has the additional right of disposition of her share



in the HUF under a Will, a right which otherwise is enjoyed by a male in the family u/s 30 of the Act. But, at the same time, she is better off than her brother, because she is capable of disposing of entire property (her share) by Will, while her brother would have to share it along with his sons as joint family property.

In other words, all the prerogatives and uniqueness of a son’s position in the family is available to a daughter as well.

The amending provision is a beneficial legislation which, among other things, is also directed towards eradicating social evils such as dowry and dowry deaths. It also achieves the constitutional mandate of equality between sexes. With the amendment, the difference between a daughter and a son of the Mitakshara Hindu family is removed and the daughter is conferred the coparcenery rights in the joint family property by birth in the same manner and to the same extent as the son. She is, therefore, now entitled to claim partition and her share in the family property and can also dispose of her share through Will to a person of her choice.

The implications of the amendment are wide. Since a daughter is placed on an equal footing with that of a son, she is now invested with all the rights and liabilities including the right to demand a partition.

The new law marks a watershed in revolutionalising the Hindu law as codified under Hindu Succession Act recognizing for the first time equal right of Hindu women in matters of succession.

As long as there is no partition, she continues to be a member of the joint family, even after marriage and continues to enjoy the same coparcenery rights as a male member, in father’s family. The amendments in the four states satisfied only a small section of women who were unmarried on the dates of amendment. It was in this context that more rational amendments giving the daughter the same right as that of the son in joint family property without any qualification, were felt necessary on the basis of a detailed report from the Law Commission, that recommended the enlargement of the rights of daughters under an all India enactment that led to the Hindu Succession (Amendment) Act, 2005.

The main incidences of a coparcenary property are;

• Unity of possession and community of interest in HUF’s property. All coparceners share a joint possession and title even the HUF property.

• Devolution by survivorship and not by succession subject to the provisions of S.6 and S.30 of the Hindu Succession Act, 1956.

• Doctrine of survivorship to apply to an HUF property.

• Acquisition of a coparcenary interest on birth of a son and on amendment of a daughter, as well.

• No coparcener can dispose of the property of the HUF neither he has any specific share in the said property. He or she however has a limited right of disposition of his or her interest in the HUF property by virtue of S.30 or S.6(3) of the Hindu Succession Act, 1956. In contrast, a separate property, possessed by a member of the family, belongs exclusively to him and has a full right of disposition unobstructed by the other members of the family and also by the sons and grandsons.

The legislature fell short of taking an important step towards ultimate women empowerment by making a wife of a coparcener herself a coparcener as has been done in a daughter’s case.It is rather odd, that while a daughter can demand partition, specifically recognised in Hindu Succession (Amendment) Act, 2005 a wife of a coparcener does not have such right.

Another significant amendment, that has been carried out, vests a daughter coparcener to will away her coparcenary interest in the property of HUF vide S.6(2) of the Hindu Succession Act, 1956 with



effect from 9th September, 2005. With this, a daughter has been bestowed with the right similar to that vested in a male Hindu u/s 30 namely to will away her share in interest of an HUF property. Yet another amendment effects, vide S. 6(3), a deemed partition of the HUF property on death of a male Hindu to the extent of his interest in Mitakshara coparcenary.

The amendment raises certain important questions which are as under:

• With the daughter being recognized as a coparcener, whether all doubts concerning the status of HUF under the Income Tax Act are resolved in cases where the family consists of a father and a daughter or only of two daughters?

• Can an HUF seeking to be assessed as an HUF plead that there are more than one co-parceners consisting of the son and the daughter’s daughter or her granddaughter or the great granddaughter?

• Can an HUF comprising of two female coparceners only claim the taxable status of HUF?

• Whether an HUF who has been denied a separate taxable status for A.Y. 2003-04 for want of more than one coparceners, claim in appeal that on amendment, the daughter has joined the coparcenery and therefore the taxable status should be conferred on it? Can it make such a claim beginning with A.Y. 2006-07?

• A daughter on marriage becomes a member of her husband’s family. Can she, post amendment, claim that like husband, she also has a family consisting of herself, her husband and her children and claim separate taxable status for her HUF qua the property received on partition of her father’s HUF? Can she claim the status of karta of her HUF?

• Whether the coparcenery interest of a daughter, like in the case of a son, travels three degrees downwards to her descendants? If yes, is it qua her female descendants or male descendants or both? The amendment to S.6 of the Hindu Succession Act confers specific co-parcenary rights on daughter and not on daughter’s daughter or son or her daughter or son or his son or his daughter. In the circumstances, is it possible to hold that a granddaughter/son or the great granddaughter/son become co-parceners by virtue of their birth or it will be correct to hold that the fiction created by the amendment is limited to the daughter’s rights and cannot be extended beyond her qua her father’s HUF?

• Whether the coparcenery right of a daughter shall terminate on her death? If yes, will her legal heirs have a claim in the property of the HUF through her?

B. Character of property received on inheritance Under the classical Hindu law, a property received on inheritance by a son, from his father, is

characterised as an ancestral property and as a consequence, his sons, grandsons and great grandsons acquire an interest in the said property. Such a property is recognised as an HUF property with the coparcenary interest of the sons, etc that cannot be disposed off by the father. The income of such a property belongs to the HUF. This position, about the character of an inherited property, was apparently changed with the legislation of the Hindu Succession Act, 1956. S.8 of the said Act provides that the property of a male Hindu, dying intestate shall devolve according to the provisions of the Act on his specified legal heirs, by succession and not by survivorship. S.30 of the said Act provides that a Hindu may dispose of, by Will or other testamentary disposition, any property which is capable of being so disposed of by him. The said S.30 also permits the disposition by a Hindu under a Will, of his/her interest in a coparcenary property. The sum and substance of this legislation is that the character of a property received on inheritance, is a property with absolute right of disposition in the hands of the recipient and as a consequence, the income thereof be taxable in his hands, only. It is in the advent of this legislation, that a raging debate had generated about the true character of an



inherited property in the hands of the son. ‘Did such a property cease to be an ancestral property, in the hands of the son? And the son therefore had an absolute right of disposition of such property?’, are the questions that were being debated for a long period. It seems that the issue is partly settled by the decision of the Supreme Court in the case of Chandersen, 161 ITR 370, which has the effect of putting to rest the controversy created by the conflicting decisions of the High Courts. The Apex Court held that the property of a Hindu dying intestate, after the legislation of the Hindu Succession Act, 1956, devolved on his heirs in accordance with the provisions of the Act and the son inherited the property in his individual capacity and not as representing his HUF.

• It is required to be considered whether this decision has rested the controversy. Whether the controversy continues at least in respect of;

a) the share of property received on deemed partition of an HUF as per S.6 and S.30 of the Hindu Succession Act, 1956, by a son, and

b) the ancestral property received on succession from father by a son.

C. Status of HUF post deemed partition u/s 6 or S. 30 of The Hindu Succession Act, 1956 The interest of a deceased male Hindu, in the coparcenary property, devolved by testamentary or

intestate succession on the female relative of Class I or a male relative claiming through her, in accordance with the preamended S.6 of the Hindu Succession Act. Post amendment, effective from 9th September, 2005, such interest, in all cases shall so devolve by such succession on his legal heirs including on his daughter and the children of a pre-deceased daughter. Likewise S.30 of the Act continues to presume the share of a Hindu in the HUF property to be an asset capable of being disposed of by him by a Will under a testamentary succession to a person of choice. Similar rights are given to a daughter coparcener, under the amended s.6(2), to dispose of her interest in a HUF property by a Will.

A deemed partition of the HUF in these cases is assumed wherein, the interest of the deceased coparcener is deemed to be the share in the HUF’s property, that would have been allotted to him or her if a partition of the property had taken place immediately before his or her death. The share of HUF property, so acquired by the recipient, is considered to be held by him or her as a full owner with an absolute right of disposition thereof and not as a limited owner. The interest which such a legatee inherits is neither by survivorship nor by inheritance but devolves under a statute whereunder he/she is substituted in place of the deceased male, while the interest received u/s 6(3) is by succession.

In view of the statutory position, the questions that arise for consideration are;

• Whether an HUF comes to an end, on death of a coparcener, on application of the deeming fiction?

• Whether the income pertaining to the fictionally partitioned property be taxed in the hands of the relative or the legatee for the period commencing with the death of the male Hindu?

Till such time her share is actually given to the heir or an actual partition takes place, he/she continues to be a member of the family and the income relating to his/her share shall continue to be taxed in the hands of an HUF till an actual partition takes place.

D. Subsequent marriage of the recipient An unmarried male Hindu in receipt of a property, on partition of the HUF, cannot constitute an HUF in

the absence of a family and shall hold the property in his individual capacity. The income from such a property is taxed in the hands of the recipient in the status of an individual. However, on marriage, he will constitute a family consisting of himself and his wife, and the property received on partition in the past shall now be held as the HUF property and the income thereof shall be taxable as the income of



the HUF, Prem Kumar, 121 ITR 347 (Allahabad). This view of the Allahabad High Court was dissented in the case of Vishnu Kumar Bhaiya, 142 ITR 357 by the Madhya Pradesh High Court. The view of the Allahabad High Court is confirmed by the Bombay High Court in the case of Dr. Prakash B. Sultane, 280 ITR 593 wherein it was held that the income from the property received on partition of an HUF became the income from property of the recipient’s HUF on his marriage.

The nature of the property received on partition of an HUF retains the character of the ancestral property in the hands of the recipient. This position should remain unchanged even where the recipient happens to be unmarried and without his own family. Such a property cannot be regarded as his separate property though he has an absolute right of disposition till such time he marries and constitutes a family.

Whether this controversy shall be taken as rested in favour of recontinued treatment of income in the hands of the HUF on marriage or is the principle that ‘once an individual property, always an individual property unless blended with the joint property’ shall rule the roost.

III AOP AND BOI

A. Scheme of taxation of an AOP and BOI S. 2(31) of the Act specifically includes an AOP and a BOI in the definition of a ‘person’. An AOP and

a BOI are treated as ‘residents’ for the purposes of the Act, vide s.6(2) or (4), in every case except where the control and management of the affairs, during the year, are situated wholly outside India. S. 40(ba) regulates the disallowance of certain payments made by an AOP or a BOI to its members. S. 67A provides for the method of computing a member’s share in the income of an AOP or a BOI. S. 86 r.w.s. 110 provides that:

income tax shall not be payable by a member in respect of his share in the income of an AOP or a BOI .Such a share of a member however, shall form part of his total income but such inclusion shall be limited for the purposes of determining the rate of taxation as per s.110 of the Act.

such a share shall not be included in the total income of a member, even for the rate purposes, where the income of the AOP or a BOI is chargeable to tax at the maximum marginal rate (MMR) or at a higher rate.

where an income of an AOP or a BOI is not chargeable to tax, in its hands at the ordinary rates or at the MMR, then the share of a member in such an income shall be chargeable to tax as part of his total income and be charged to tax.

Section 167B provides for taxing the total income of an AOP or a BOI at the MMR in cases where:

the individual shares of the members are indeterminate or unknown, or

the total income of any member exceeds the amount not chargeable to tax .

In circumstances where income of any of the members is taxed at a rate higher than the MMR, the income of the AOP or the BOI will be charged to tax at such a higher rate. The shares are deemed to be indeterminate or unknown if they are so on the date of the formation of the AOP or the BOI or any time thereafter. Section 155(2) contains a provision for rectification, of the completed assessment of a member, to give effect to the assessment of an AOP or BOI.

An Explanation is inserted in s. 2(31) by the Finance Act, 2002 to provide that an AOP or a BOI, shall be deemed to be a “person” whether or not it was formed with the object of deriving income, profit or gain.

No special provisions are found in the Act for treatment of the losses of an AOP or a BOI or for share of a member in such losses. Special provisions are made in s. 5A of the Act for treatment of



the income of a husband and wife governed by a special system prevailing in Goa and some Union territories.

B. Status of an AOP An AOP is not defined under the Income-tax Act. The principles that emerge through the various

decisions including, from the decision in the case of Indira Balakrishnan, 39 ITR 546 (SC), for supplying a meaning to an AOP, are summarised as under:

There must be two or more members,

The members need not be individuals,

A minor can be a member through a guardian,

They should join in a common purpose or action,

The action should be to produce income, subject to amendment,

It should involve a common management,

The members should share profits and losses,

There must be an agency relationship, and

It should not be governed by the Indian Partnership Act, 1932

Accordingly, coming together, voluntarily, of two or more persons in a unity of purpose with the object of carrying on an activity for producing profits and gains( subject to the amendment contained in Explanation to s. 2(31), and sharing the same, with the common management may constitute an AOP, provided it is not a partnership.

Whether two or more persons, coming together, constituted an AOP or not has always been an enigmatic question. There is a very thin line dividing an AOP from a non-AOP. Few of the cases that decided the issue could have been decided on a mere toss of coin. This enigma is duly highlighted by the decisions in the cases of Van OORD ACZ.BV, IN RE 248 ITR 399 (AAR), Geo Consultants, 304 ITR 283 (AAR) and Linde AG, ITR (AAR), delivered by the same forum, with diametrically conflicting views, within a short span of time. The conflict is accentuated by the insertion of the Explanation w.e.f. 1-4-2002 completely eliminating the need to have an income as the object. Almost every joint venture or enterprise or a common or joint activity is now made vulnerable to uncertainties and litigation. The risks, tax and civil, involved at times is huge. The uncertainty can make or mar a project and addressing this is a serious challenge.

The stand of the Revenue has generally been to tax the income of a joint enterprise in the hands of the AOP. Serious difficulties arise in assessment of total income, recovery and refund of taxes where the members have offered the income in their individual hands on the understanding that they have not constituted an AOP and that the income is taxable in their respective hands. On the other hand, the Revenue assesses the income, so offered, in the hands of the AOP. The incidental fall out of the Revenue’s treatment is the denial of the benefit of the DTAA to the non-resident member of the Joint Venture leading to indirect taxation of its income from the venture in India, in the status of an AOP. Domestically such issues routinely arise in projects of development of real estate that involves joining of hands by a land owner and the developer inter alia inviting an issue of the characterization of income in addition to the usual issues. The insertion of the Explanation has accelerated the Revenue’s case for a collective assessment in the status of an AOP. Such an inference, on introduction of the Explanation, that income is assessable in the status of an AOP, can now be easily drawn causing serious difficulties for strategic alliance otherwise acting at an arm’s length.



In the circumstances, the participants are requested to define the essentials for constituting an AOP and advice how to avoid being taxed as an AOP. Addressing the following questions may be helpful:

• Is business or an enterprise essential?

• Is joining together on own volition essential?

• Is common management essential?

• Is profit motive essential?

• Is sharing of profit essential?

• Is an agreement to share losses essential?

The CBR vide Circular No. 30 of 1941 had clarified that the transactions in the nature of temporary partnership be taxed in the hands of each person carrying on the Joint Venture. The Delhi High Court in the case of B. N. Gupta, 193 ITR 482, following the above circular has confirmed the above position. Also see Srimati Sadhana Nayyar, 13 TTJ 409 (Bom).

There is no cut and dried formula to decide what is an AOP. Each case might have to be decided on the particular facts and the background of the case, the fact best expressed in the words of the Supreme Court in the famous case of Indira Balkrishna, “ .... there is, however, no formula of universal application as to what facts, how many of them and of what nature are necessary to come to a conclusion that there is an association of persons within the meaning of the charging section: it must depend on the particular facts and circumstances of each case as to whether the conclusion can be drawn or not.”

C. Status of Body of Individuals A BOI, like an AOP, is not defined under the Act. It however is a unit of assessment for the purpose

of taxation. As the name suggests, it comprises of individuals, i.e human beings only. However the Supreme Court in the case of Meera & Co 224 ITR 635 (SC) held that the income be assessed in the status of a BOI even in a case where one of the persons constituting BOI was not an individual but a company.

The term BOI is held to be wider than the AOP. It may not require voluntary getting together of persons and a common design may not be insisted upon. The potential or capacity to hold properties and to earn income jointly may however be essential for constituting a BOI and so would be the sharing of risk and unity of interest. With the introduction of the Explanation in Section 2(31), the case of the revenue for taxing an income in the status of a BOI, if not an AOP, has become stronger.

Section 5A of the Act provides that an income of the husband and of the wife, other than an income under the head ’salaries’, shall not be assessed as that of ‘Community of Property’ (whether as an AOP or as a BOI) but shall be apportioned between the husband and wife equally and assessed accordingly. A ‘Community of Property’ is a system in force in the state of Goa and in the Union Territories of Dadra & Nagar Haveli and Daman & Diu known as “Communiao Dos Bens” under the Portuguese Civil Code of 1860.

The questions that arise for consideration in context of BOI are;

• Whether an income of a BOI be charged at MMR? If yes, please narrate the circumstances in which it can be so taxed?

• Whether a share in the income of a member of a BOI is to be included in his hands for rate purposes?



• Whether the share of a member in the income of the BOI is includible in the total income of the member for rate purposes or otherwise?

D. Taxation at Maximum Marginal Rate (MMR) An income of an AOP or BOI, as noted above, is taxable at the MMR, as per s.167B of the

Act, where the individual shares of the members, in the whole or any part of the income, are indeterminable or unknown. Where, on the date of formation of an AOP or BOI or anytime thereafter, the shares of the members are unknown or indeterminate, then in such cases, the shares should be deemed to be so indeterminate or unknown for attracting the MMR of tax. In a case where the income of any of the members is otherwise taxable at the rate higher than the MMR, then in such a case, the total income of the AOP or the BOI shall be taxed at such higher rate.

No specific provisions are made, for the benefit of concessional rate of taxation, in respect of that part of the total income of the AOP or BOI which is otherwise eligible for concessional rate of tax, for example capital gains. Unlike s.164, s.167B brings to tax the entire total income at the MMR even where shares are determinate or known in respect of the other part of the income only.

There is also an ambiguity in respect of ascertaining whether a member is chargeable to tax at a higher rate than MMR. Should such ascertainment be with reference to the income of such a member for the year or generally? A member, for example, may not have any other income or may have loss for the year under consideration. The incidental issue is, should the share from AOP be included for determining whether the income is chargeable to tax at a higher rate or not? The difficulties arise in cases where the only source of income of the members is that of the share in AOP or BOI.

The concerns are also raised about applicability of s.167B in cases where none of the members are entitled to a share during the life of an AOP or BOI, like in cases, of a club.

The wealth of an AOP or BOI, may be liable to Wealth Tax, and in cases where the shares of the members are indeterminate or unknown, the wealth may be liable to tax at the higher rate.

In the background of the above discussion, the participants may consider the following issues;

• Whether the income of the AOP or BOI, under the head ‘Capital Gains’, be eligible for the concessional rate of taxation, otherwise available u/s. 111A and S.112 of the Act? Whether the provisions of S.167B apply only to such income which is otherwise taxable at the regular rates?

• Whether only a part of the income or the whole of the income of an AOP or BOI be taxed at the MMR in a case where, the share of the members in respect of the one part is determinate and known, while they are not specified for the other part?

• Whether for ascertaining the rate or tax at which the income of a member is taxable, the income of the year alone is to be considered or the position generally to be considered? Should such income include the share in AOP for the year or not?

• Is wealth of an AOP or BOI taxable in cases where the shares of the members are indeterminate or unknown? If yes, at what rate of tax?

• Whether the income when taxed in the hands of the members, instead of an AOP, will be taxed at the MMR?

• Is S.167B applicable to a case where none of the members have any share in income of the AOP?



E. Losses There are no specific provisions, like S. 67(4), 75, 76 and 77 (now deleted) and S. 78, to provide for

the treatment of losses of an AOP. The issues that regularly arise about the treatment of such losses are;

• Whether such losses are to be distributed amongst the members of the AOP and are to be adjusted against their respective income?

• Whether such losses when not distributed or where remained to be absorbed in the hands of the AOP are to be carried forward by the AOP or by the members?

• Whether the losses, so unabsorbed, will have to be reduced on account of retirement of any of the members of the AOP?

The complexity of the questions is more pronounced considering the fact that the new scheme of taxation of AOP provide for four different methods of taxing an income of the AOP. Even under the old scheme of taxation, prevailing up to assessment year 1988-89, there was a steep divergence of the judicial opinion on the subject. Under the 1922 Act, the Assessing Officer had an option to tax an AOP on its income or to directly tax the member of such an AOP in respect of his share income. However under the 1961 Act such an option does not appear to be available with the Assessing Officer. This position, under the Act of 1961 is confirmed by the Supreme Court vide its decision, found to be debatable by a few, in the case of CIT v. Ch. Atchaiah, 218 ITR 239.

S. 167B r.w.s. 86(v) specifically provides for manner of taxation of income of an AOP, which provisions require strict adherence. These provisions clearly in an unambiguous manner lay down as to how and in whose hands an income of an AOP is to be taxed and at what rate such income is to be taxed. They also provide when such income is to be taxed in the hands of the members and thereafter indicate whether such taxation in the hands of the member is for rate purposes or for regular taxation. In view of this it appears that neither the assessing officer nor the assessee is left with any option regarding the hands in which the income of an AOP is to be taxed. The uncertainty however continues to prevail in cases of the treatment of losses of an AOP. In the circumstances, it is for consideration, in the context of losses;

• Whether the said scheme providing for taxation of income of an AOP will also apply with equal force to the taxation and treatment of losses?

• Are the losses of an AOP to be carried in the hands of an AOP or that such losses are to be carried forward by the members constituting an AOP?

• Can a member of an AOP, relying on the 2nd proviso to S.86, claim a right to set-off his share in losses of an AOP against his income? Can the AO rely on the 1st proviso to deny such a claim?

• Will retirement of a member holding, 50% share in profit and loss of AOP, alter the quantum of the brought forward assessed losses of the AOP post retirement in the hands of an AOP?

Reliance may also be placed on CBDT’s Circular No. 551 dated 23-1-1990 wherein in the Board vide paras 11.1 to 11.10 have explained in detail, the new scheme of taxation of an AOP and its members and the implications of the proviso to S.86.

The treatment of losses of an AOP, in four different cases, may be as follows:

The losses are to be carried forward by the AOP alone where shares of the members are indeterminate or unknown,

The losses are to be carried forward by the AOP alone where any of the members has a taxable income and the income of the AOP is taxed at the MMR or at higher rates.



The losses are to be set-off and adjusted in the hands of the members by virtue of the second proviso to S. 86 where the income of the AOP is below the taxable limit. The members alone will carry forward the unabsorbed losses. This view is however not free from doubt.

The losses of the AOP, covered by main s. 86 (where the income is taxed at normal rates in the hands of the AOP and is included in the hands of members for rate purposes only), are to be set-off in the hands of the AOP only on the basis of the decision of the Supreme Court in Atchaiah’s case.

F. Option to assess Under the 1922 Act, the Assessing Officer had an option to assess the income of the AOP in the

hands of the AOP or its members. No such specific provision has been made for conferring an option to assess such income in either hands. In the circumstances, it is therefore appropriate to hold, under the 1961 Act, that the income of the AOP be taxed in the hands of the AOP, alone unless specifically provided for in the Act. This position in law has been confirmed by the Supreme Court in the case of Ch. R. Atchaiah, 218 ITR 239. In any case, the income of the AOP where taxed in the hands of the members, shall not be subjected to the MMR of tax u/s 167B of the Act.

An Assessing officer under the Act of 1922, had an option to tax the income of an AOP is the hands of the AOP or its members, as was beneficial for the revenue. This option had not been retained in Act of 1961 as has been explained by the Supreme Court in the case of Ch. Atchiah R., 218 ITR 239. An income of an AOP is taxable in the hands of the AOP alone.

G. Minimum Alternate Tax (MAT) S.115JB brings to tax the book profit of a company in specified circumstances. A deduction is provided

in computing the book profit of a company for an income that is not taxable in view of Chapter III of the Act. The said Chapter III does not specifically exclude the share of a member of an AOP or a BOI from the total income of the member, unlike specific exclusions provided for the member of an HUF and the partner of a firm. The participants, under the circumstances, may consider;

• Whether share of a member company in the profits of the AOP or a BOI is eligible for being excluded from ‘book profit’ or that such a share is subjected to MAT?

• Whether the share in the income of an AOP is liable to MAT u/s. 115JB in the hands of a member where income of AOP is taxed at a) MMR b) Ordinary rates c) Not taxed being within the threshold limit?

H. Share of a member S. 67A provides for the method of computation of a member’s share in income/loss of an AOP. It is this

share, so computed, is the one on which no tax is payable by the assessee, in view of S. 86 of the Act. Such a share forms part a of the total income of the member for the limited purpose of ascertaining the rate at which tax is otherwise payable by the member on his total income, excluding his share in the income of an AOP. In short, it is includible for rate purposes only. No share however is includible, in total income for rate purposes or for taxation, where income of an AOP is chargeable to tax at the MMR. In contrast, the share is chargeable to tax where no income tax is chargeable on the total income of an AOP. A few questions that arise for consideration on a combined reading of S. 67A and S. 88 are:

• Whether interest, salary, bonus, commission or remuneration received by a member, from an AOP, is taxable in his hands or not?

• Whether provisions of S. 86 are applicable to a case of an AOP which has incurred loss for a year?



• If no, whether share of losses of a member can be set-off against the other income of a member in his hands?

• If no, can share of such losses of a member be adjusted in computing his total income for rate purposes?

• Whether a member is required to pay tax on his share of income in an AOP in a case where no tax was chargeable on the total income of an AOP on account of deductions under Chapter VI-A or Chapter III of the Act?

IV FIRM Firm and deemed dividend

S. 2(22)(e) provides for treating any payment by way of a loan or an advance, by a closely held company to;

• a shareholder being the beneficial owner of shares, or

• any concern in which such shareholder is a member or a partner

to be a deemed dividend to the extent to which the company possesses accumulated profits.

There is a judicial consensus that, the deemed dividend should be taxed in the hands of the shareholder and not in the hands of the concern which is the recipient of an advance or a loan. There is also a consensus that, the shareholder in question should not only be a beneficial holder but should be a registered holder as well.

In the above background, a question that often arises for consideration is, as to whether the deemed dividend be taxable in the hands of the partnership firm or the partners in the cases;

• Where the loan is received by the firm and the investment in shares is made by the firm and the shares are held in the names of the partners, or

• Where the loan is received by the firm and the investment is made by the shareholders and the shares are held in their names.

The Delhi High Court, in the case of National Travel Services, 347 ITR 305 has carved out an exception to the above referred judicial consensus by holding that the deemed dividend in the first case, should be taxed in the hands of the firm even where it is not a registered shareholder. The same High Court has once again, in the case of Bharti Overseas Trading Co., 349 ITR 52, in the context of the second case, held that the deemed dividend should be taxed in the hands of the firm which was neither a registered holder nor a beneficial holder of shares. The ratio of these is required to be examined.

V SUCCESSION

A. Income of a discontinued profession Any sum received after the discontinuance of a profession is deemed to be the income of the recipient,

of the year of receipt, provided the discontinuance was on account of the a) cessation of the profession or b) the retirement or the death of the person as per S. 176(4) of the Act. The charge of taxation is attracted, under this provision, only where the sum received was otherwise includible in the total income of the person, had it been received before such discontinuance.

It is usual to come across cases of receipts, of outstanding professional fees post cessation, retirement or death, which fees in the past have not been brought to tax in the hands of the professional. In many a cases, such fees are realised by the executors of the estate of the deceased professional and are passed on to his legal heirs.



Bringing to tax such receipts, in the year of receipt, in the hands of the recipient has been a challenge for the Revenue Department. The issues that arise usually are:

• Whether such receipts, post discontinuance, are taxable? If yes, under which head of income? If yes, in whose hands;

o Legal Representative u/s. 159, or

o Executor u/s 168, or

o Legal heir who receives the fees?

• Is method of accounting, followed by the professional, relevant for the purposes of applying S. 176(4)?

• Will a deduction be allowed for expenses, incurred post discontinuance, from such fees?

• Will provisions of S. 176(4) apply in a case where the profession is not discontinued but is succeeded to by another person?

• Will credit for TDS be allowed in the hands of the recipient?

B. Income of a discontinued business Any sum received after discontinuance of a business is deemed to be the income of the recipient,

of the year of receipt, provided the sum received was otherwise includible in the total income of the person, had it been received before such discontinuance as per S. 176(3A) of the Act.

It is usual to come across cases of outstanding business dues, post discontinuance of business, which in the past have not been brought to tax. It is also common that the business of the assessee has been taken over by another person and the outstanding dues thereof are realized by the successor. In many a cases, such dues are realized by the erstwhile partners.

An assessee following the mercantile system of accounting is liable to tax in respect of such dues in the year of accrual, only, in which case the income is taxable during the continuance of business itself in the hands of the assessee himself. S. 176 does not bring to tax an income of the assessee of the pre-discontinuance period. In short, it does not shift the year of taxation from one year to another year. In such a case of accrual during continuance of business, the provisions of S. 176(3A) has no role to play and should not be pressed for the purposes of bringing to tax an untaxed income which had remained to be taxed on account of a lapse on the part of the Revenue Department. It is only such income that had not accrued during the continuance of the business that can be subjected to provisions of S. 176(3A) on realisation, post discontinuance. Importantly, such income is not made taxable on its accrual but it is brought to tax only on its receipts as the method of accounting ceases to have relevance for taxation u/s 176(3A) of the Act. The usual cases of this nature are the cases where the right to receive is in dispute during the continuance of business and is settled after discontinuance.

S. 170 provides for taxing the successor, in respect of the income of the previous year, after the date of succession. The objective of this provision is to ensure that the successor is taxed in respect of the income of the business, for post succession period only and the income up to the date of succession is charged to tax in the hands of the predecessor alone. In the circumstances, S. 170 shall not help in bringing to tax the income pertaining to the business transactions of the predecessor whether accrued or not, in the hands of the successor, unless it is shown that the income has accrued to the successor. A right to receive such income by the successor does not make such income liable to tax in his hands under the provisions of S. 170. In any case S. 170 is not a charging section and has a limited role that is restricted to defining the period from which the income of the business is taxable in his hands subject to the important fact that the business during that period is carried on by him and the income



pertaining thereto has accrued in his hands. S. 170 does not convert an income of a predecessor into an income of the successor.

S. 189 provides for the continued liability for the assessment of the total income and the amount of tax, etc. of the firm post discontinuation of its business or its dissolution. This provision once again does not create a charge on the income of the firm and limited in its application which is restricted to ensuring the deemed continuity of the firm for the purposes of assessment and recovery of taxes. This provision cannot help in bringing to tax an income that has accrued or is received after the dissolution of the firm. S. 159 contains similar provisions that are made applicable post death of an individual to provide for continuation of the proceedings in the hands of a legal representative.

Bringing to tax such receipts, in the year of receipt, in the hands of the recipient, has been a challenge for the Revenue Department. The issues that arise usually are;

• Whether such receipts, post discontinuance, taxable? If yes, under which head of income? If yes, in whose hands;

a) Erstwhile partners, or

b) Successors of business, or

c) Person who receives the sum, or

d) Legal representative or the Executor or the Legal heir in case of a proprietary concern.

• Is method of accounting, followed by the erstwhile businessman, relevant for the purpose of applying s. 176(3A)?

• Will a deduction be allowed for expenses, incurred post discontinuance, from such sum?

• Will provisions of s. 176(3A) apply in a case where the business is not discontinued but is succeeded to by another person?

VI COMPANY One person company

The Companies Act, 2013 enables the formation of a company with a single shareholder, known as One Person Company (OPC). S. 2(6) of the Companies Act, 2013 defines an OPC as One Person Company means a company which has only one person as a member. The OPC, on registration under the Companies Act, is characterised as a company with all the trappings of a company. It is recognised as a private company under the Companies Act. OPC is incorporated as a private company and should have a natural person, who is an Indian citizen and resident of India as its member. Ministry of Corporate Affairs, vide its G.S.R. notification No. 250(E) dated 31-3-2014, has notified the rules that enables the formation of an OPC.

An OPC is capable of owning, holding properties and investments in its own name and can conduct business with limited liability. It can be converted into a private company and can be liquidated, as well. The shares of such an OPC can be transferred and on death of the shareholder, can be transmitted.

An OPC offers spectacular possibilities for the sole proprietor to enjoy the benefit of limited liability and allows and confers the benefits of a legal entity distinct from its shareholders and opens a possibility for enjoying a respectability attached to a corporate status while encouraging the incorporatisation of micro business and service entities. OPC holds a bright future for the small entrepreneur with low risk taking capacity. It enables them to showcase their capacities with greater flare and confidence.

A person cannot incorporate more than one OPC or cannot be a nominee in more than one OPC. An OPC will cease to be a company in a case where its average annual turnover, in three immediately



preceding consecutive years exceeds ` 2 crore or where its paid up capital exceeds ` 50 lacs. An existing private company otherwise satisfying the criteria of an OPC is allowed to convert itself into an OPC. It is required to maintain the regular books of account and get the same audited and obtain the audit report and file the annual return.

There are no special provisions for taxing an OPC under the Income tax Act. S. 2(31) includes a ‘company’ while defining a ‘person’. A ‘company’, u/s 2(17) inter alia includes any ‘Indian company’ and an ‘Indian company’ vide S. 2(26), inter alia includes a company formed and registered under the Companies Act, 1956, now 2013.

Accordingly, it is appropriate to hold that an OPC is a ‘company’ for the purposes of the Income tax Act. As a consequence, that each rupee of the income will be taxed at the flat rate of 30% and will be further subjected to Surcharge and Education Cess and in the alternative will be subjected to MAT. The dividend distributed by an OPC will be subjected to DDT. The income on transfer of shares, by the sole shareholder, will be subjected to Capital Gains Tax. Importantly, the capital gains an transfer of capital asset from the sole proprietary concern to the OPC will be exempt from tax subject to compliance of conditions contained in s. 47(xiv) of the Act.

The issues that may be addressed in the context of an OPC are;

• Whether an assessee can claim that such an OPC should be taxed in the status of an individual? In the alternative, can an AO pierce the veil of the company to treat the income of the company as that of an individual?

• Will the capital gains arising an conversion of an OPC into a private company or vice versa, exempt from tax?

VII LOSSES AND RESIDENTIAL STATUS The losses of an assessee, for an assessment year, are eligible for set-off against the income from

the same or any other sources, of that year, as per the provisions of S. 70 and S. 71 of the Act. Such losses, when remaining to be absorbed, are allowed to be carried forward for being set-off against the income of subsequent years, subject to certain conditions, as per the provisions of S. 71B to S. 74A read with S.75 and 78 to 80 of the Act. These provisions do not make a distinction based on the residential status of a person, neither do they distinguish a domestic loss from an overseas loss.

With the liberalisation of the FEMA and the sizeable increase in the Indo-Global business, it is common to come across cases where;

A person, resident under the Act, has Indian income and foreign losses or vice versa.

A person, non-resident under the Act, has Indian income and foreign losses or vice versa.

There is change in the residential status of the person between the years in which loss was first incurred and the year in which such loss is ready for set-off against the income of that year.

It is true, as noted above, that the Act does not distinguish a loss from a domestic source from that of a foreign source and therefore, does not provide for any express and specific prohibition for an inter se set-off. This licence however is subject to the fundamental understanding, which is inherent to the scheme of taxation, that a set-off is permissible only of losses from such sources, the income whereof is liable to taxation in India.

On a touchstone test of the above referred fundamental principle, the following understandings emerge;

The losses of a resident, wherever incurred, are eligible for set-off against other income wherever earned, as per the provisions of the Act and are allowed to be carried forward to the subsequent year for being set-off against income of that year. This understanding of law shall remain



unaffected by the provisions of the tax laws of the foreign country and of the DTAA. In any case, none of the DTAA provides for treatment of the losses.

It is for consideration whether an assessee can opt for not setting off the foreign income, on which foreign tax is paid, against the Indian losses.

It is also for consideration whether an Assessing Officer can deny the right of the set-off of the foreign losses against the Indian income, on the ground that such losses are allowed to be carried forward in the country of loss for being set off against the foreign income of the subsequent year.

An offshoot of this situation is a case where the foreign losses otherwise carried forward under the Act are set-off against the foreign income in that country and the assessee also claims a set-off against Indian income in the same year where the Assessing Officer refuses the second one on the ground that the set-off is being claimed twice.

The foreign income of a non-resident is not subjected to Indian taxation and therefore, the foreign losses, if any, of such a person are not allowed to be set-off against his Indian income. On the same understanding, these losses from the Indian sources shall not be deemed to have been set-off against the foreign income and such losses shall remain intact for being carried forward for set-off against Indian income of the subsequent year. This finding requires to be confirmed.

It is for consideration whether this understanding vis-à-vis a non-resident shall change in a case where the non-resident invokes application of the DTAA in respect of his Indian income. It is in the interest of the non-resident that he avoids application of DTAA till such time he is out of the Indian losses and hence such losses are set-off in his hands.

The understandings derived under the above-mentioned principles may take a curious turn, in a case where the assessee undergoes a change in the residential status between the year in which the loss was incurred and the year in which the set-off is desired. For instance;

• A resident with unabsorbed foreign losses turns into a non-resident leading to a situation wherein his foreign income is no more taxable in India. Can he continue to set-off such foreign losses against the Indian income after the change of status? The right to set-off Indian losses, however will remain intact in any case.

• A non-resident with foreign losses turns into a resident leading to a situation whereunder he claims the right to set-off the unabsorbed foreign losses against the foreign as well as Indian income on the ground that he is now liable to tax in India on his foreign income.

ACKNOWLEDGEMENTS‘Pursuit of knowledge is the noblest endeavour’- I sincerely thank the Bombay Chartered Accountants Society for giving me a golden opportunity to express my views on complex and challenging topics and gain greater insight on the subject in the process. I wish all the participants good luck to achieve greater heights in this noble profession.



NOTES

Concept of Deemed Income and Deemed Gains ...


Concept of Deemed Income and Deemed Gains u/s. 56(2)(vii), 56(2)

(viia), 56(2)(viib), Section 69 and Section 43CA/50C, etc.

MILIN MEHTA Chartered Accountant



Mr. Milin Mehta, is a Chartered Accountant and a senior partner K. C. Mehta & Co., Chartered Accountants (Baroda, Mumbai and Ahmedabad), for about 3 decades. He is a fellow member of the Institute of Chartered Accountants of India. He is also a Law Graduate and has obtained a Master’s Degree in Commerce. After becoming Chartered Accountant at a very young age of 21 years, he involved himself in the professional practice and also various social and professional activities. With bright academic record, he has secured rank in the merit list in the examination of the Institute of Chartered Accountants of India and also secured Gold Medal in the M. Com. Examination of the M. S. University of Baroda.In the professional practice he is mainly engaged in the area of providing consultancy to various corporate and non-corporate bodies in the area of strategy, taxation (domestic and international) and Mergers, Acquisitions, Joint Ventures, etc. He has been strategic advisor to several industrial groups.Mr. Mehta has also been invited as special invitee to the Committee of the Institute of Chartered Accountants for making representation before the Central Board of Direct Taxes / Standing Committee of the Parliament on formation of new Direct Taxes Code. Mr. Mehta was also a member of the Committee set up by the Central Board of Direct Taxes for framing “Tax Accounting Standards” which are renamed as “Income-tax Computation and Disclosure Standards”.He has held the position of Treasurer and Vice Chairman of the Western India Regional Council of the Institute of Chartered Accountants of India covering Gujarat, Maharashtra and Goa.He has contributed a large number of papers in various seminars and conferences organised by professional organisations all throughout the country and has also contributed articles in reputed Professional Journals and Magazines. Mr. Milin Mehta has been invited very often to take lectures in educational seminars for the senior tax officials.He has also co-authored a book on “Minimum Alternate Tax” published by the Bombay Chartered Accountants’ Society.He is also active in social service and is Past President of the Baroda Lions Club Education Trust, which manages Baroda High Schools in the city of Baroda. He is a Government Nominated member of the Senate and elected member of Syndicate of the prestigious M. S. University of Baroda.Mr. Mehta works in several reputed listed, unlisted and private companies as independent / professional / non-executive Director.

CA Milin Mehta

Group Leaders of Paper on Concept of Deemed Income by CA Milin Mehta

CA Bhavin R. Shah

CA Bipin D. Karani

CA Chetan Dhabalia

CA Manoj Chandaliya

CA Neelesh Vithlani

CA Nimesh K. Chothani



Concept of Deemed Income and Deemed Gains u/s. 56(2)(vii), 56(2)(viia), 56(2)(viib), Section 69 and Section 43CA/50C, etc.

CA Milin Mehta

PREAMBLEIt is after a considerable time that I have set down to write a paper and that too, which is suitable for Group Discussion. I am sure that in this time of presentations and talks, the art of writing a paper, group discussions (and not on online forums) is getting diminished. I realised it when I started actually writing the paper. I have no option but to live with the said limitation, the only problem is that even the participants may have to live with it. Be as it may, the organisers may be conveniently blamed, though I would certainly consider them to be courageous enough to invite me.

I should thank the organisers for having given me this opportunity to present the paper. But for this opportunity, I would not have read the Foreword written by Shri B. A. Palkhivala to the 10th Edition of “Kanga and Palkhivala’s – The Law and Practice of Income Tax”. So humbling, so true, worth taking some extracts from it:

“The power to tax involves the power to destroy”, warned Chief Justice John Marshall. To which, a century later, the reply of Justice Holms was, “The power to tax is not the power to destroy while this Court sits”. …..

….

….

When my brother, then hardly two years at the Bar, began to write this book, he kept in mind the following basic principles:

1. Tax laws, like all other laws, to be respected, must be made respectable,

2. Laws, to be respectable, must be fair and intelligible, stampe and simple; easy to administer and easy obey.

3. Revenues rise with tax cuts; when income-tax is scaled up, income is scaled down.

4. If there is widespread tax evasion, it may be more meaningful to search for the cause in the tax system than in the taxpayer.

5. Enlightened administration is as essential as enlightened enactment, and it can be good recompense for a bad law.”

How true these words are even today. What Mr. N. A. Palkhivala, thought in 1949 is very relevant even today i.e. more than 65 years later. All the amendments introduced are primarily for curbing the widespread tax evasion and mindless tax avoidance. The question arises (in terms of Para 4 above, whether the search of the Government is in right direction or they need to look at the tax system.

Words of Justice Holmes quoted above from his decision in the case of Panhandle Oil Co. v. Mississippi ex rel. Knox, 277 U.S. 233 (1928), remind us that the power to tax is not an absolute power and it has to pass through the judicial tests. I am sure that the taxes sought to be imposed by the provisions of section 50 C / 43 CA of the Income Tax Act, 1961 (ITA) discussed in this paper, would be examined by the Courts for its constitutional validity.

These are the thoughts I wish to start this paper with and would want the participants to ponder.



PART I – DEEMING FICTION

1.0 DEEMING FICTION1.1 In Ex parte Walton : In re Levy 17 ChD 7461 it was observed that “When a statute enacts that

something shall be deemed to have been done, which in fact and truth was not done, the court is entitled and bound to ascertain for what purposes and between what persons the statutory fiction is to be resorted to and full effect must be given to the statutory fiction and it should be carried to its logical conclusion.”

1.2 On the concept of Deeming Fiction, the decision of the Chandigarh Bench in Subhash Chand v. Asstt. CIT [2012] 49 SOT 732, succinctly summarises the observations of various judicial opinions as under:

“By catena of decisions, three rules are fairly well settled for interpreting a provision creating a legal fiction. They are as under:

(i) The court is to ascertain the purpose for which the fiction has been created, and after ascertaining this, the court is to assume all those facts and consequences which are incidental or inevitable corollaries to giving effect to the fiction.

(ii) The legal fiction cannot be interpreted in a manner that extends the effect of fiction beyond the purpose for which it is created or beyond the language of the section by which it is created. Neither can one allow himself to be so carried way by a legal fiction as to ignore the words of the very section which creates it or its context or setting in the statute which contains that section nor can one lose sight of the purpose for which the fiction is created.

(iii) Outside the bounds of the legal fiction the difference between the reality and the fiction may still persist in the provisions of the same Act which creates the fiction and the difference may be ascertained by reference to the subject and context of those provisions.”

1.3 It is in this context that we need to interpret all the provisions which are within the scope of this paper. All the provisions create a legal fiction and therefore operate in the limited bounds of the fiction so created and purpose for which it was created. Any attempt to expand the scope of the provision or applying the same in the circumstances other than the circumstances in which it is meant to be applied, would be unjustified and untenable in law.

1.4 The interesting situations arise when we have more than one deeming fictions apply to the same transaction. Take a case of introduction of a land to a partnership by a partner as part of his capital contribution below the stamp duty value of such land. There are several situations of similar types and therefore, the transactions remain in the zone of uncertainties for long. The only good thing about these controversies is that it provides sufficient material for a paper to be written and group discussions to be held.

1.5 Earlier Avtaar’s of Deeming Fiction of Income vis-à-vis fair value taxation It is not in long history (4th September, 1981) that the Hon’ble Supreme Court watered down the

provisions of section 52 of the ITA, which sought to compute the capital gains on transfer of a property with reference to the market value, when the apparent consideration was less than the fair market value. While interpreting the said provision of law the Supreme Court in the case of K. P. Verghese v. ITO 131 ITR 597 (on page 616) observed as under:

“It does not create any fictional receipt. It does not deem as receipt something which is not in fact received. It merely provides a statutory best judgment assessment of the consideration actually received by the assessee and brings to tax capital gains on the footing that the fair market value

1.Quoted in Pandurang Vinayak Chaphalkar AIR 1953 SC 244



of the capital asset represents the actual consideration received by the assessee as against the consideration untruly declared or disclosed by him. This approach in construction of sub-section (2) falls in line with the scheme of the provisions relating to tax on capital gains. It may be noted that section 52 is not a charging section but is a computation section. It has to be read along with section 48 which provides the mode of computation and under which the starting point of computation is “the full value of the consideration received or accruing”. What in fact never accrued or was never received cannot be computed as capital gains under section 48. Therefore sub-section (2) cannot be construed as bringing within the computation of capital gains an amount which, by no stretch of imagination, can be said to have accrued to the assessee or been received by him and it must be confined to cases where the actual consideration received for the transfer is under-stated and since in such cases it is very difficult, if not impossible, to determine and prove the exact quantum of the suppressed consideration, sub-section (2) provides the statutory measure for determining the consideration actually received by the assessee and permits the Revenue to take the fair market value of the capital asset as the full value of the consideration received in respect of the transfer.

1.6 Purport of the decision in the case of K. P. Verghese was that substitution of any value other than the transaction value can be done only if there is an evidence available to show that the transaction has actually taken place at a value higher than the transaction value and in such a scenario, deeming fiction can be used for ascertaining taxability of such transaction. It was accordingly held that merely because there is a differerence of more than 15% in the fair market value of an asset transferred and the consideration stated in the document transferring the said asset, the tax cannot be imposed based on the fair market value.

1.7 As you would observe that the said decisoin of K. P. Verghese had heavily relied upon the marginal notes, circulars of the CBDT, speech of the Finance Minister while introducing the provisions and applicability of Gift Tax Act to the same transaction. However, the question remains is that whether the cardinal principle enunciated in the decision of K. P. Verghese (underlined in the above passage) that what never accrued or never received cannot be computed as capital gains, is still independently applicable.

The Participants may ponder as to whether the ratio of the decision of K. P. Verghese can still be applied to sections 50 C/43 CA of the ITA. The participant may keep in mind the following:

• The support of marginal notes, circulars, speech, etc. is not available for interpreting section 50C/43 CA

• Presumption of the fair value U/s. 50 C / 43 CA has been made rebuttable and mechanism is provided for challenging the valuation either under the respective stamp laws or before the valuation officer under the ITA.

• Objective criteria of taking the Stamp Duty Valuation is considered as the value to be substituted.

SCOPE OF THE PAPERScope of the present paper is to deal with the following provisions:

I. Section 50C

II. Section 43CA

III. Section 56(2)(vii)

IV. Section 56(2)(viia)

V. Section 56(2)(viib)

VI. Section 69/69B/69C (referred to



PART II - SECTION 50 C

2.1 Use of black money in the transactions of land and building (real estate) cannot be denied. Successive attempts in this regard have given only partial success. More attempts are made by introducing first Section 50C and recently Section 43CA of the Act, dealing exclusively with respect to the transactions in land or building or both. Basic principle of both the sections are same, being the stamp duty value of the transactions involving transfer of land or building or both will be the minimum value for computing capital gains (section 50C) or profits and gains of business or profession (section 43CA), unless successfully challenged before either the stamp duty valuation authorities or valuation officer under the Act.

2.2 I do not propose to go into the basics of section 50C, as the learned participants would have certainly gone through scores of papers and material explaining the basic provisions. It would be worthwhile to only discuss various controversial issues which have cropped up over the period concerning the applicability of Section 50C.

2.3 Concept of Land or building or both Section 50C apply only to the transfer of a capital asset being (a) land, (b) building, or (c) both

land and building. The section therefore does not apply to any other transactions. Therefore, two cardinal conditions are to be satisfied: (1) There has to be a transfer; and (2) The transfer has to be of land, building or both. If either of the condition is not satisfied, the provisions of section 50C may not apply. If the Asset does not qualify to be a capital asset U/s. 2 (14), either on account of it being an exempt asset or on it being stock in trade, then the question of applicability of section 50C does not arise. Accordingly, an agricultural land, not being a land situated outside the specified area, will be covered by Section 50C. It may be kept in mind that any agricultural land, wherever situated, if held as stock-in-trade, will be covered by section 43CA.

2.4 An immovable property is a bundle of rights. There are cases where there is a transfer of the whole bundle or where only a part of the bundle is transferred. Lease Hold Right is the rightful separation of ownership and possession. Before the lease, the owner had the right to enjoy the possession of the land but by the lease he excludes himself during its currency from that right. Similarly a lessee is enjoying the possession of the land, but does not have ownership rights over the land.

2.5 Since section 50C applies only to transfer of land or building or both, whether it would also apply to transactions involving transfer of any interest in land, etc. In this scenario, the question arises whether in case of the following transactions whether section 50C/43CA, as the case may be shall apply:

2.5.1 Transfer of Development Rights When the development rights are transferred it enables the acquirer of the development rights

to develop the property, but the ownership rights over the land continues to remain with the owner. Therefore, it is certainly not a transfer of land. Therefore, at the stage of execution of the development agreement, it is a case of transfer of interest in the land and not transfer of land. Section 2(47) of the ITA dealing with the definition of “transfer” in relation to the “capital asset” it provides as under:

(v) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882) ; or

(vi) any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or



any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property

Definition of transfer [either Clause (v) or Clause (vi)], read with the decision in the case of Chaturbhuj Dwarkadas Kapadia 260 ITR 491 (Bom), postulate that entering into the development agreement shall amount to transfer of the land and capital gains shall accrue.

Can it be said that when there is a development agreement executed with respect to a land, it would amount to transfer of the land and accordingly, the provisions of section 50C will also be applicable to such transaction.

Would the position be same for applying section 43CA in a case where the land is held or is converted as stock in trade and is therefore not treated as “capital asset”?

Attention is invited to the order of the ITAT in the case of Chiranjeev Lal Khanna [2011] 132 ITD 474 (Mum), wherein it was held that provisions of section 50C is applicable to cases of development agreements. Can this decision be distinguished on the ground that the said decision was given due to several admissions made by the Assessee on facts and the Tribunal got swayed by the fact that it involved demolition of existing building and new construction was to be made by the developer?

Also see the decision in the case of Arif Akhtar Hussain 140 TTJ 413

It may be interesting to note that when the transferor had complete rights in respect of land, but transferred only part thereof (i.e. development rights), it was held to be transfer of land for section 50C. However, when the transferor had only partial rights in respect of the land (like leasehold rights), and if these rights were transferred it was held that it would not be covered by section 50C. Refer to Atul G. Puranik 132 ITD 499 (Mum). Attention is also invited to the decision of Lucknow Bench in the case of Hari Om Gupta in ITA No. 222/LKW/2013, wherein it was held that transfer of lease hold rights would be covered by Section 50C.

2.5.2 Ownership of land Peculiar situation arise when a person joins an agreement as a confirming party and not as owner

of the land. In these cases, a person has entered into an agreement to sale with the owner of the land and has made either full or substantially the whole of the consideration to the owner and has therefore right to get the conveyance executed in his own favour. At the time of execution of the deed of conveyance, the original owner conveys the property and the person holding the rights under the agreement to sell joins as the confirming party. If the value at which the transaction takes place is lower than the stamp duty valuation on the date of execution of the deed of conveyance, question of applicability of section 50C arises. In this situation, the Confirming Party does not assign land, but merely assigns his right to get the deed of conveyance executed. Therefore it would not amount to transfer of land. Land is conveyed by the Owner of the Land. The transaction does take place at a value which is lower than the stamp duty valuation. The following issues arise for consideration:

2.5.3 Whether the difference can be taxed in the hands of the owner of the land on the ground that he is conveying the land and the value at which the land is conveyed is lower than the stamp duty value? One view is that since the agreement determining the price was executed by him earlier the stamp duty value should be considered as of that date. However, the counter argument will be that though the agreement between the owner and the confirming party was executed which determined the consideration, but there was no agreement between the owner and the ultimate purchaser. Therefore, the owner may not be able to take benefit of the same (even if theoretically it is said that the said benefit is available even in section 50C).



2.5.4 In my view this is a case of actually two transactions. One between the owner and the confirming party. Second being between the confirming party and the ultimate purchaser. Both transactions will be taxed separately. The owner will be taxed considering the stamp duty valuation on the date on which the original agreement was executed. The Confirming Party concerned is not covered by the provisions of section 50C as he is not transferring the land and therefore the concept of stamp duty valuation does not apply to him. Attention is invited to the decision in the case of ITO v. Smt. Sushma Gupta [2011] 44 SOT 568 (Delhi), wherein a contrary view is taken. Since this decision does not deal with the fine issue of difference between “land” and “right in respect of land” but rather deals with the issue of execution of documents through power of attorney. Therefore, this decision may not be possibly come in the way of arguing the matter otherwise.

2.5.5 Sale of FSI / TDR There are transactions in the nature of sale of unutilised FSI on a piece of land. Similarly, sale

of transferable development rights (TDR) is also very prevalent in a city like Mumbai. Interpreting the provisions of Section 3(26) of the General Clauses Act, 1897, Bombay High Court in Chheda Housing Development Corporation 2007 (3) MLJ 402 held that FSI and TDR are benefits arising out of land, are immovable property. However, the same are not land. The term immovable property is much wider than land / building / both and therefore it was held that any transfer of FSI or TDR is not covered by the provisions of section 50C of the Act Refer to Shri Prem Rattan Gupta ITA 5803/ Mum / 2009.

2.6 Relevant date for applying Stamp Duty Valuation There are times when there is a gap between the date on which the agreement fixing the

consideration for transfer of land/building is executed and the date on which the documents conveying the property is actually executed. The stamp duty value on the date on which the original agreement is executed could be lower than the stamp duty value on the date on which the transaction is executed. To cover the difficulties arising on account of the same, Section 43CA provides that when the date on which an agreement fixing the consideration is executed, duly supported by payment otherwise than in cash either on or before execution of such an agreement, then for applying section 43CA, the stamp duty valuation as on the date of the said agreement is to be considered.

2.6.1 While such an exception is carved out in section 43CA, there is no such exception carved out for Section 50C. There is no logical reason why such an exception is not carved out for section 50C.

Is it possible to argue that the said exception may also be read into section 50C and accordingly, if there is a prior agreement, duly supported by payment otherwise than in cash on or before such agreement, then the date of such agreement shall be the relevant date for stamp duty value?

Once again it would be worthwhile to refer to the observations of the Hon’ble Supreme Court in the case of K. P. Verghese 131 ITR 597:

There are many situations where the construction suggested on behalf of the Revenue would lead to a wholly unreasonable result which could never have been intended by the legislature. Take, for example, a case where A agrees to sell his property for a certain price and before the sale is completed pursuant to the agreement and it is quite well- known that sometimes the competition of the sale may take place even a couple of years after the date of the agreement-the market price shoots up with the result that the market price prevailing on the date of the sale exceeds the agreed price at which the property is sold by more than 15% of such agreed price. This is not at all an uncommon case in an economy of rising prices and in fact we would find in a large number of cases where the sale is completed more than a year or two after the date of the agreement that the market price prevailing on the date of the sale is very much more than the price at which



the property is sold under the agreement. Can it be contended with any degree of fairness and justice that in such cases, where there is clearly no under-statement of consideration in respect of the transfer and the transaction is perfectly honest and bonafide and, in fact, in fulfilment of a contractual obligation, the assessee who has sold the property should be liable to pay tax on capital gains which have not accrued or arisen to him. It would indeed be most harsh and inequitable to tax the assessee on income which has neither arisen to him nor is received by him, merely because he has carried out the contractual obligation under taken by him. It is difficult to conceive of any rational reason why the legislature should have thought it fit to impose liability to tax on an assessee who is bound by law to carry out his contractual obligation to sell the property at the agreed price and honestly carries out such contractual obligation. It would indeed be strange if obedience to the law should attract the levy of tax on income which has neither arisen to the assessee nor has been received by him.

2.7 Underlying assets being land or building There is an increasing trend where, a company is formed exclusively for holding

immovable property in the form of land / building. The transfer of ownership of such properties used to take place merely by transfer of shares of the said company and change of directors. The value of the property would be captured while valuing the shares of the company. The question which arises is whether the said transfer will amount to transfer of land and therefore, if the value captured in the shares of the company is less than the stamp duty valuation, whether section 50C can be invoked in this case.

2.7.1 Similar matter came up before the Mumbai Tribunal in the case of Irfan Abdul Kader Fazlani & Others in ITA 8831/Mum/2011. In this case, the Assessee sold shares of the Company which owned flats / buildings. If stamp duty value of the flats and buildings were to be considered, the shares ought to have been transferred at a significantly higher value than the value at which these shares were actually transferred. Department argued that this is a fit case of lifting the corporate veil and the transfer of shares should be valued by applying Section 50C for the underlying flats and building. The ITAT held that the same is not permissible. While holding such, the ITAT observed that in the facts and circumstances of that case, it is not a fit case for lifting the corporate veil. Decision of the Supreme Court in the case of Vodafone 341 ITR 1 (SC) was relied upon. The grounds on which the contention of the department was rejected was that the company was formed several years ago, the asset was purchased several years after the company was formed and the said asset was also held for several years. Therefore, it was not possible to say that the entire transaction was actually a colourable device.

The question however, arises, that in a case where a company is specifically formed for holding the land/building. The company has no asset other than such land / building. The shares of such company are sold at a value which is significantly lower than the stamp duty value of underlying asset. Whether in such a scenario, provisions of section 50C can be applied?

Attention is invited to the provisions of section 2(47)(vi) which provide that transfer includes “any transaction of becoming a member of a company which has the effect of transferring, or enabling the enjoyment of, any immovable property”. Attention is also invited to the decision of the Mumbai Tribunal in the case of Chiranjeev Lal Khanna 132 ITD 474, wherein relying on the provisions of section 2(47)(v), the ITAT held that transfer of development rights is transfer of the land and accordingly, section 50C will be applicable.

2.8 Slump sale In case of sale of a business/undertaking as a slump sale, may include, land/building/both.

While the whole of the business is sold by way of an umbrella agreement, there are subsidiary



agreements executed for transfer of specific asset to suit the requirements of law applicable to transfer of such assets. If such transaction involve transfer of immovable property, it would require execution of separate deed of conveyance. Generally, in the deed of conveyance, it is specifically mentioned that the value mentioned in the deed is only for stamp duty purposes. The question arises as to whether it is possible for the AO to apply Section 50C in respect of the land / building transferred as part of the business sold as going concern.

Section 2(42C) define “slump sale” as under:

“slump sale” means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.

Explanation 1.— For the purposes of this clause, “undertaking” shall have the meaning assigned to it in Explanation 1 to clause (19AA).

Explanation 2.— For the removal of doubts, it is hereby declared that the determination of the value of an asset or liability for the sole purpose of payment of stamp duty, registration fees or other similar taxes or fees shall not be regarded as assignment of values to individual assets or liabilities;

2.8.1 Section 50B deal with computation of capital gains in case of slump sale. Like section 50, focus of Section 50B is to fasten the cost of acquisition and not the full value of consideration received. For the purpose of determining the full value of consideration received or accrued as a result of transfer will be determined by applying general provisions of capital gains computation. In this scenario, whether it is possible for the tax department to consider that there is no bar in section 50B to substitute the full value of consideration received or accrued by the stamp duty value of the land / building included in the transaction?

2.8.2 It may be worthwhile to note that a transaction will be eligible to apply the provisions of section 50B only if there is an existence of an “undertaking” as defined u/s. 2 (19AA), Explanation 1. Explanation 1, provides that “undertaking” shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity. Accordingly, the term “undertaking” does include individual assets unless it constitutes a business activity.

2.8.3 It may be observed that undertaking is defined to be an asset in itself, separate from the underlying assets constituting the undertaking. Accordingly, when there is a sale of an undertaking on a slump sale basis, the consideration is received as a result of transfer of undertaking as a whole and not on account of individual parts constituting it. Further, it is also not possible, nor is it permitted under law, to assign values to individual assets comprised in the undertaking. Even prior to introduction of Section 50B, it was held in number of judgements that “undertaking” if sold as a “slump sale” would itself constitute a capital asset U/s. 2 (14) distinct and separate from its constituents and it would incorrect to tax the transaction by dissecting into its components. However, it is essential that the slump sale transaction should fall within the definition of “undertaking” so as to constitute a business activity.

2.9 Reference to the DVO As has been mentioned in the paper earlier, the stamp duty valuation adopted by the stamp

duty authorities is not the final word for applying section 50C. The section provides that if the Assessee objects to adoption of the stamp duty value for computing his capital gains, then the AO is required to make a reference to the DVO and the value arrived by the DVO or the stamp

2 West Coast Electric Supply Corporation Ltd. [1977] 107 ITR 483 (Mad), Electric Control Gear Manufacturing Co. [1997] 227 ITR 278 (SC), Artex Manufacturing Co. [1997] 227 ITR 260 (SC), Premier Automobiles Ltd. 264 ITR 193 (Bom).



duty value, whichever is lower, will be considered as the full value of consideration received or accruing as a result of transfer. Section 50C(2) requires the Assessee to claim before the AO that the stamp duty value exceeds the fair market value of the property on the date of transfer. Further, it also mandates that the stamp duty value adopted by the stamp duty authorities is not disputed in any appeal, revision or no reference is made before any authority, court or the High Court.

2.10 Disputing valuation under the Stamp Act vs. DVO The provision is so drafted that the remedy of disputing the stamp duty valuation under the

respective stamp laws and valuation by the DVO are two mutually exclusive alternatives. Accordingly, if the stamp duty value is disputed under the respective stamp laws, then the Assessee does not have an option to require the AO to make a reference to the DVO. It is possible to contend on the part of the department that if the Purchaser disputes the valuation under the stamp laws (as he is generally liable to pay the stamp duty), then also the seller is prohibited from reference to the DVO. In this connection it is necessary to keep in mind the following:

• If the Assessee does not object before the AO in terms of Section 50C(2) contending that the stamp duty value exceeds the fair market value, the AO is not obliged to make a reference to the DVO and will be entitled to complete the assessment taking the stamp duty valuation. Refer Ambattur Clothing Co. Ltd. [2010] 326 ITR 248 (Mad), Sanjaybhai Z. Patel [2011] 48 SOT 231 (Ahd)

• Once the Assessee objects to the stamp duty valuation in terms of Section 50C(2), AO does not have an option but to make reference to the DVO. The usage of the words “the Assessing Officer may refer the valuation of the capital asset” does not give an option to the AO. The word “may” be interpreted as “shall”. Ajmal Fragrances and Fashions Pvt. Ltd. 34 SOT 57 (Mum), Manjula Singhal [2011] 46 SOT 149 (Jodh). There are several other decisions in this regard. It may be mentioned that the AO is not entitled to make qualitative assessment of the objections raised by the Assessee and then take a view whether reference to the DVO is justified or not.

• Once the DVO gives his valuation, the AO cannot disregard the value given by the DVO. In terms of Section 50 C (3), if the value by the DVO is less than the stamp duty value, then the value given by the DVO has to be considered. The AO has no power to disregard the said valuation. Bharti Jayesh Sanghani [2011] 128 ITD 345 (Mum).

• If the Purchaser has objected to the stamp duty valuation before the stamp authorities or by way of reference, appeal, etc. it does not still debar the seller to object to the said valuation before the AO and thus requiring the AO to make reference to the DVO. B. N. Properties Holdings Pvt. Ltd. [2010] 6 ITR (Trib) 1 (Chennai).

2.11 Deeming Fiction U/s. 45 (3) v. 50 C Section 45(3), has its history going down to the decision in the case of Sunil Siddharthbhai [1985]

156 ITR 509 (SC), wherein it was held that when a partner contributes an asset to the firm, it does amount to transfer, but the amount credited to his capital account due to such contribution of asset, does not constitute consideration received or accruing as a result of transfer. Therefore the charge of capital gain failed. Subsequently, w.e.f. 1-4-1988, Section 45 (3) was introduced to provide that the amount recorded in the books of account will be deemed to be as full value of consideration received or accruing as a result of trasfer of the capital asset on such introduction. At times we may have a conflict of deeming fictions and it would be necessary to resolve the conflict between the two.



Consider a case of a partner of the firm / LLP introducing a capital asset being land / building to the firm / LLP as its capital contribution. As agreed between the Partners a certain sum is recorded in the books of Account of the firm. By virtue of section 45 (3), the said value so recorded in the books will be deemed to be full value of consideration received. If such value is less than the stamp duty value of the land / building so introduced, then does the AO have a right to substitute the said value for computing capital gains in the hands of the partner.

Attention is invited to the Ruling of the AAR in case of Canoro Resources Ltd. 180 Taxman 220 it was held that provisions of determination of ALP under the transfer pricing provisions shall have precedence over the deeming fiction of section 45 (3) and accordingly, if a partner has introduced capital asset in an international transaction to a partnership firm at a value less than the ALP of such transaction then the AO has right to substitute ALP, despite deeming fiction of section 45 (3).

Mumbai Special Bench in the case of United Marine Agencies [2011] TIOL 266 (Mum)(SB) held that provisions of section 50 applicable in case of depreciable assets do not debar the application of section 50C and accordingly, if a building which is a depreciable asset is transferred at a value which is less than the stamp duty value, then the department has a right to substitute the stamp duty value.

2.12 Impact on the purchaser – Cost of acquisition If provisions of section 50C are successfully applied, the seller of the property pays tax on

the sum which is higher than the actual consideration received by him as per the documents. However, when it comes to the purchaser, his purchase price does not get affected and it continues to remain the same. There was therefore a hue and cry about there being double taxation. If the purchaser is purchasing the land / building as capital asset, he will be hit by the provisions of section 56(2)(vii) and therefore he will be liable to pay tax on the differential value. Therefore, on the same amount, the seller, as well as the purchaser will pay the tax. Similarly, when the purchaser is purchasing the asset as stock-in-trade, provisions of section 56(2)(vii) is not applicable. However, cost of acquisition of the stock in trade remains the same as is stated in the documents, though the seller has paid tax on the higher sum. Therefore, when the purchaser further sells this asset (as it is his business), he will have to pay tax on the differential amount (including the differential on which the seller had paid the tax due to application of section 50C or 43CA.

2.12.1 Therefore, whether the purchaser is acquiring the asset as capital asset or stock in trade, there is double taxation. However, if we look at things logically and consider the object of introducing these provisions, there is actually no double taxation and each person is taxed on the amount on which he ought to be taxed. Unstated consideration in case of transactions which are below the stamp duty value is that actual transaction has actually taken place at least at the stamp duty value and difference between the document value and stamp duty value is not accounted for. If that presumption is true then:

(A) The seller is taxed for the consideration which he received including the unstated consideration; and

(B) The purchaser is taxed (u/s. 56(2)(vii)) if purchased as capital asset and by not allowing deduction of differential, if purchased as stock-in-trade), because he has not paid the tax on the source from which the differential sum is paid.

2.13 Impact on the purchaser – Sections 69/69B/69C As mentioned earlier, if the purchaser has purchased the land / building as capital asset, there

is no need to invoke the provisions of section 69B, as the difference between the stamp duty value and the document value is treated as income of the purchaser under the deeming fiction of



section 56(2)(vii). It is therefore academic to consider the application of Section 69B, etc. in this situation.

2.13.1 However, when the assessee has purchased the asset as stock-in-trade, the question arises whether the AO can apply provisions of section 69B/69C by treating it as amount of investment not fully disclosed in the books of account or as unexplained expenditure. There are large number of decisions which have held that section 50C has application only in the case of the seller and it has no application at all on the purchaser and therefore, it would be incorrect to apply section 50C for making addition in the hands of the purchaser.

2.13.2 Further, if the provisions of section 69B/69C is seen and compared with the language used in section 69, the reason why the addition cannot be made sharply comes out. Section 69 provided that when the assessee has made investment which are not recorded in the books of accounts, then the value of such investment is deemed to be the income. As against this, section 69B uses a more restrictive language. The language used is as under:

“Where in any financial year the assessee has made investment or is found to be owner… and the AO finds that the amount expended on making such investments …. exceeds the amount recorded in this behalf in the books of account….”

Section 69B does not provide for presumption but requires AO to have a positive finding that the amount expended exceeds the amount recorded. Therefore, the onus is on the department to prove that the amount exceeds the amount recorded. Mere reliance on section 50C to presume that the amount expended is more than the amount recorded is not permitted. Similar language is used even in Section 69C.

[Refer to the decision of Gujarat High Court in the case of Sarjan Realities Ltd 40 taxman.com 398 (Guj), wherein it is held that section 50C has no application in the case of the purchaser]

PART III – SECTION 43 CA3.1 As discussed earlier, provisions of section 50C applied only in case where the asset is held by the

transferor as capital asset. Accordingly, the provisions of section 50C did not affect or control the transactions where the land / building / both were held as stock in trade. It was therefore not very uncommon that the asset otherwise held as capital asset, was first converted into stock in trade and thereafter it was sold. In this situation, the rigours of the section 50C could be avoided.

3.2 To plug the said loophole and to bring the real estate transactions entered into by the persons in real estate business, section 43CA is introduced w.e.f. 1.4.2014.

Section 43CA - Summarised

• Applies in case of computing profits and gains of business or profession

• In case of transfer of land or building or both;

• Not being a capital asset

• If consideration received or accruing as a result of the transfer is less than the value adopted, assessed or assessable by any authority of a State Government for stamp duty purposes in respect of such transfer

• Then the value adopted, assessed or assessable for stamp duty purposes shall be deemed to be the full value of consideration received or accruing as a result of such transfer



• Provisions of Section 50C(2) and 50C(3) dealing with the challenge to the said valuation applies

• In case where the date of agreement fixing the consideration for transfer and the date of registration of transfer is different, then stamp duty value assessable on the date of agreement to be considered, provided where the consideration or part thereof is paid, otherwise than in cash, on or before the date of such Agreement. [Note : This exception is not applicable in case where provisions of section 50 C are applicable.]

3.3 Cases of percentage of completion method Assessees who are engaged in the business of development of the real estate project, are

required to compute their income following the guidance note issued by the Institute of Chartered Accountants of India. Simply put, the Guidance Note provides that when a binding contract with a customer in respect to a unit in a real estate development project is entered into, the revenue in respect thereof is to be measured in terms of percentage of completion method as provided for in Accounting Standard 7.

3.4 If the initial booking is done by the developer from the customer at a price which is lower than the stamp duty value, then how would the percentage of completion contract method be applied. In my opinion, the profits and gains of business or profession on a year to year basis shall be computed based on the actual transaction value. If there is a difference between the transaction value and the stamp duty value, then the said difference should be offered to tax in the year in which the actual deed of conveyance takes place. The reasoning for the same is as under:

• So far as the profits / AS – 7 is to be applied is with reference to the revenues and costs as per the books of account and there is no space for any presumptions.

• Section 43 CA comes into place only where there is a difference in the value at the time of transfer of the land / building / both. The expanded definition of transfer U/s. 2 (47) is applicable only where the asset is held as “capital asset”. Since admittedly the transaction to which section 43 CA apply is stock-in-trade, the said expanded definition does not apply. Therefore the taxable event U/s. 43 CA is only when the property is actually conveyed and not before that.

• It is not correct to presume that on the date on which the deed of conveyance will be executed the stamp duty value will be different than the value at which the said land / building was conveyed by the developer.

3.5 What is meant by Agreement As is seen earlier, that the relevant date for applying the stamp duty value is the date on which the

assessee has entered into an agreement fixing the value of consideration. Most of the developers do not enter into a formal agreement to sale, but they merely give only the booking letter at the time when the first payment is made by the customer. It is only after significant money is deposited by the customer, the developer would enter into a formal agreement. The question that arises is what is the relevant date i.e. the date on which the booking letter is given or the date on which formal agreement is executed.

3.5.1 If the booking letter does not fix the value of the consideration it will certainly not be considered as agreement for the purpose of applying Section 43CA(3) of the Act. The question that arises is that if booking letter does fix the value of the consideration and is signed by both the Parties, whether it would constitute an agreement.

3.5.2 Section 2(e) of the Indian Contract Act, 1872 define Agreement to be “every promise and every set of promises that forms the consideration for each other is an agreement.” Whereas a contract may



be defined as an agreement between two or more parties that is intended to be legally binding. With this difference between agreement and contract, it may be stated that even where the booking letter, though not binding, but clearly show the agreement between the Parties, it can be safely concluded that it would qualify to be an agreement and therefore the benefit of Section 43CA(3) (subject to the condition of payment being made) will be available.

3.6 Payment of consideration, otherwise than by cash As mentioned above, reference date for the stamp duty valuation will be the date of a agreement

executed prior to execution of the deed of conveyance, provided on or before the date of such agreement, consideration or part thereof has been received by any mode other than cash. The term “other than cash” is very wide and can cover all types of transactions including book entries.

Please examine whether any of the following cases will be cases where it can be considered that consideration has been received otherwise than in cash:

(1) The intending purchaser had a sum of money receivable from the seller. The purchaser issues a letter to the seller that part of the money receivable may be treated as advance towards purchase of an asset.

(2) The intending purchaser had a business associate (or theoretically a third party) who had a sum receivable from the seller. The parties exchange letters or a tripartite agreement is executed for considering part of the receivable of the associate as advance by the intending purchaser for purchase of an asset.

(3) The intending purchaser borrows by book entry from the developer and requests the developer to transfer the loan as an advance towards purchase of the asset.

The reason why I want the participants to ponder over these questions is just to drive home the point that whether such absurdity is permitted under law and whether such an interpretation is permissible?

PART IV - SECTION 56(2)(vii)

4.1 Section 56(2)(vii) is the third version of the proposed tax on the donee based gift tax on the individual and HUF recipient of gift, christened as Income Tax.

• Section 56(2)(v) was introduced by Finance (No. 2) Act, 2004 w.e.f. 1.4.2005 and applied with respect to any sum of money received on or after 1st September, 2004 but before 1st April, 2006. This applied only to gifts in cash and did not cover gifts in kind.

• Section 56(2)(vi) was introduced covering gifts from 1st April, 2006 to 30th September, 2009. This also covered only gifts in cash and excluded gifts in kind.

• Section 56(2)(vii), made applicable in respect of gifts received on or after 1st October, 2009 brought within the tax ambit the gifts in kind. At the time of introduction of this provision, receipt of immovable property without consideration were only included. However, with effect from 1.4.2014, receipt of immovable property for a consideration lower than the stamp duty valuation is also covered.

Fundamental issue which requires consideration by all the participants is that unlike the original Gift Tax Act, section 56 (2)(vii) uses the words “consideration”. As you would recall, while defining the term Gift Us. 2 (xii), gift meant transfer without consideration in money or money’s worth.



Section 2(d), The Indian Contract Act, 1872 defines consideration as “When, at the desire of the promisor, the promisee or any other person has done or abstained from doing or promises to do or abstain from doing something, such act or abstinence or promise is called a consideration for the promise.”

4.2 Individual and HUF Section 56(2)(vii) applies only in case of receipt by individual or HUF. It excludes any other form

of assessee. The ITA Section 2 (31) define the person to be

(i) An individual

(ii) A Hindu Undivided family

(iii) A company

(iv) A firm

(v) An association of persons or a body of individuals, whether incorporated or not,

(vi) A local authority, and

(vii) Every artificial juridical person, not falling within any of the preceding sub-clauses.

4.2.1 For limited purposes of receipt of shares of a company not being a company in which public are substantially interested (unlisted companies), section 56 (2)(viia) also covers the firms and unlisted companies.

4.2.2 Therefore, any receipt of any sum of money or property (other than shares of an unlisted company) either without consideration or without adequate consideration by any person other than an individual or HUF is not chargeable to tax in the hands of recipient. Further, shares of an unlisted company received by any person other than individual, HUF, firm and unlisted companies, is not chargeable to tax U/s. 56(2)(vii)/(viia).

4.2.3 In case of a trust which is created for the benefit of a set of family members, where individual shares of the beneficiaries are unknown at the time of creation of the trust, it would be treated as discretionary trust and will be assessed at the “maximum marginal rate” and in the status of an Association of Persons (AOP). If such a trust receives any sum of money or property, then it would not be chargeable to tax U/s. 57 (2) (vii) / (viia).

The Participant may debate on the tax liability at each of the events below:

• Mr. X is a business-man and he has 2 children.

• He sets up a trust for the benefit of his 2 children. Complete discretion is given to the trustees for deciding the share of the individual beneficiaries

• This trust receives shares of an unlisted company as a gift from a person who is not a relative of either Mr. X or his children

• 2 years after setting up of the Trust, the Trustees pass an irrevocable resolution determining the share of both the children as equal share



• After such shares are determined, the trust receives further shares from a non-relative.

• On the date of distribution (say 7 years after formation of the trust), the trustees distribute assets of the trust, including the shares held by it to the two children equally.

The question that arises is:

• Whether receipt of shares by the Trust will attract any tax in the hands of the trust or beneficiaries?

• At the time when the trustees pass an irrevocale resolution determining the share of the beneficiaries, whether it can be deemed that the beneficiaries received the shares and would the same attract tax in the hands of the beneficiaries?

• Whether the shares received by the trust after share of the beneficiaries become specific, would attract any tax, as at that time each beneficiary had specific interest in the shares?

• At the time of distribution of asset from the trust, whether there would be any tax in the hands of the Beneficiaries as they receive the shares without consideration. Is it possible for the beneficiaries to contend that the distribution does not result into any receipt without consideration by them, as they already had undivided interest in the said asset by virtue of their 50% share in the assets of the trust and accordingly, mere distribution does not attract any tax.

It may be worthwhile to make reference to the decisions which were rendered in the context of the family partition. In case of Girja Bai v. Sadashiv Dhundiraj [1916] 43 IA 151 (PC), it was observed as under”

“Partition does not give him (a coparcener) a title or create a title in him; it only enables him to obtain what is his own in a definite and specific form for tpurposes of disposition independent of the wishes of his former co-sharers.”. Similar views were expressed in Atrabanessa Bibi v. Safatulla Mia (1916) 43 Cal 509. In case of Indoji Jethaji v. Kothapalli [1919] 54 IC 146 it was held that partition effects a change in the mode of enjoyment of property but is not an act of conveying property from one living person to another.

4.3 Properties Covered and its valuation Section 56(2)(vii) covers some of money (cash) and some specified properties. Therefore, any

receipt of property other than the property as enumerated in the definition of property is outside the purview of the taxation u/s. 56(2)(vii). Further, each of the property has its own rules of valuation under the Act and Rules. Further, the provisions apply only in case where the property received is a “capital asset”. The status of the property, being a capital asset is to be seen from the stand point of the receiver of the property. Therefore, a person holding a property as stock in trade or capital asset, transfers it to the assessee who intends to hold this property as capital asset (and not as stock-in-trade) then only the provisions of section 57(2)(vii) gets attracted. Therefore, to illustrate this point, jewellery received by a person doing business in jewellery, for the purpose of his business, does not have to pass through the test of section 57(2)(vii). Similarly an art dealer receiving a painting is not required to get the said painting evaluated if he is acquiring the said painting as stock-in-trade. The law also does not provide or prohibit conversion of the asset so received as stock-in-trade from converting it into capital asset later on.



The provisions are summarised below for ready reference:

Nature of Property Definition Valuation Principles

Immovable property Only includes land, building or both

Stamp Duty Valuation as defined in Section 50C

Shares and securities Undefined Rule 11UA

Quoted Shares & Securities – as per the stock exchange

Unquoted equity Shares – Book Value (specific computation provided)

Unquoted shares or securities other than equity shares – open market price

Jewellery As per the Explanation to Section 2(14) (ii) – Capital Asset

If purchased from registered dealer then invoice value, If received by other mode then registered valuer

A r c h a e o l o g i c a l collections, drawings, paintings, sculptures or any work of art (artistic work)

Not defined If purchased from registered dealer then invoice value

If received by other mode then registered valuer

4.3.1 It may therefore be mentioned that there would not be any income imputed in the following cases, by virtue of the provisions of section 56(2)(vii) read with the rules determining the fair market value of the said properties:

• Any property purchased as stock-in-trade;

• Any property purchased at any price which does not fall within the above items of property;

• Purchase of land or building or both at a value which is not less than the stamp duty value;

• Purchase of quoted share or security by way of transaction carried out through recognised stock exchange at the transaction value recorded in the said stock exchange;

• Purchase of quoted share or security outside the recognised stock exchange at a price which is not lower than the last traded price. If the more than one traded price available on the date of transaction then the lowest of such traded price to be considered. If the traded price is not available on the transaction date, then lowest traded price on the date immediately preceding the transaction date on which the traded price available to be considered.

• In case of unquoted equity shares if purchased at a price not lower than the book value computed in the manner provided for in Rule 11UA(1)(c)(b). Note that this book value is not exactly the same as normally the book value of the shares is to be computed.

• In case where the jewellery or artistic work is purchased from a registered dealer (meaning the person registered under the Cental Sales Tax, GST or State VAT laws), at the price at which the invoice thereof is prepared by such registered dealer.



4.4 Immovable Property In case where an individual or HUF receives immovable property being land or building or both,

without consideration, the stamp duty value of which exceeds ` 50,000 or for a consideration which is less than the stamp duty value of such property by an amount exceeding ` 50,000, then either the value of the said property or the difference referred to above, as the case may be, shall be chargeable to income tax under the head “Income from other sources”.

4.4.1 The method of determination of the stamp duty valuation is same as the method provided for in section 50C(2) and 50C(3). Attention is invited to the fact that, Section 56(2)(vii) does not give benefit to the Assessee in case where the assessee has purchased the property under a prior agreement determining the consideration payable, as provided for in Section 43CA. Where a developer has entered into an Agreement with a customer on a date (x) and then it takes two years for him to complete the project and the final deed of conveyance is executed by the developer in favour of the customer on a later date (y), then the stamp duty valuation for the developer for applying section 43CA will be date (x), whereas for the same transaction, the date for stamp duty valuation for the customer for applying section 56(2)(vii) shall be date (y). If valuation is different on these two dates, then both will be assessed to tax with reference to different values.

4.4.2 As has been stated while discussing the provisions of section 50C, it is possible to contend that the benefit of prior date as reference date for stamp duty valuation shall also be available to similar cases for section 56(2)(vii).

4.4.3 It must be borne in mind that if there is a transaction of land or building or both which takes place below the stamp duty valuation, then the purchaser as well as seller will now be liable to pay tax on the difference, unless the purchaser is purchasing the said asset as stock in trade.

4.5 Shares and Securities For the purpose of section 56 (2) (vii), the term share and securities is not defined. Recourse

therefor will have to be made to the definition of the terms under the provisions of the Securities and Contracts (Regulation) Act, 1956.

“(h) “Securities” include-

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

(ia) derivative;

(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;

(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

(id) units or any other such instrument issued to the investors under any mutual fund scheme;

(ii) Government securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interests in securities;”



4.5.1 Rules of Valuation of Shares and Securities are given in Rule 11UA of the Income Tax Rules, 1962. The Rules divide the valuation of Shares and Securities in the following three categories:

Quoted Shares and Securities

Unquoted Equity Shares

Unquoted securities other than Equity Shares

4.5.2 Quoted Shares and Securities4.5.2.1 What are Quoted Shares/Securities?

Quoted shares and securities are defined to be the shares and securities quoted on any RSE with regularity from time to time, where the quotations of such shares and securities are based on current transaction made in the ordinary course of business.

It may be seen that the definition is qualitative assessment and not objective assessment as provided for in SEBI Regulations like “frequently traded shares”. The language used here is same as the language of Rule 2(9) of Schedule III of the Wealth Tax Act, 1957 (WTA). Therefore, merely because a quote is available in the market may not be the ground for considering the shares or securities as quoted shares or securities. The line of decisions available for interpretation of the very terms under the WTA will be very relevant here. W.e.f. 1st April, 1993, the said provisions dealing with the valuation of shares and securities were moved to the Gift Tax Act (GTA) and GTA is made in operational w.e.f. 1st October, 1998. It may be kept in mind that therefore, there has not been any judicial testing of the said terms in context of circumstances in last several years and general economic environment, corporate regulations, framework of financial transactions and operations of the stock exchanges have undergone significant changes. Therefore, while applying these decisions, it would be very appropriate to test the ratio of these decisions in terms of current situation. For ready reference, attention is invited to the following decisions, which were rendered with reference to the WTA:

• Smt. Nirmala Birla [1976] 105 ITR 483 (Cal)(FB)

• Nirajkumar Bajaj [1992] 196 ITR 381 (Bom)

• Mahadeo Jalan [1972] 86 ITR 621 (SC)

• Short v. Tresury Commissioners [1947] 2 All ER 298

• Govindlal Bangur [1980] 123 ITR 216 (Cal) [on the issue of – ordinary course of business used in the valuation]

• Purshottam Das Bangur [1984] 148 ITR 651 (Cal)

• G. V. Kasturiswami Naidu [1973] 92 ITR 145 (Mad) [Reference to “Harshad Mehta Scam”]

I must point out that when you refer to these decisions, you may realise that how much is the contextual difference in the situation today and the times when these decisions were rendered. In my view therefore it would be the best to adopt the criteria considered by SEBI for treating a share or security as “frequently traded” under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.

4.5.2.2 Rules of Valuation of Quoted Shares

The Rule 11UA (c) (a) gives the rules of valuation of quoted shares and securities. The Rule provides that in case of quoted shares and securities, received by the assessee by way of transaction carried out through a recognised stock exchange (RSE), then the fair market value of such shares and securities shall be the transaction value as recorded in the said RSE.



It further provides that if the quoted shares and securities are received otherwise than through purchase in a RSE, then the fair market value of such shares and securities will be the lowest price of such share and securities quoted on any of the RSE on the valuation date. If the shares and securities are not quoted on the valuation date, then the lowest price quoted on any of the RSE on a date immediately preceding the valuation date.

X Corporation, is listed on NYSE. It has a WOS in India and business of subsidiary (and therefore its valuation also) comprises of 30 % valuation of X Corporation. The shares of X Corporation are quoted significantly lower than its book value. Mr. WB purchases the shares at the quoted price on the NYSE. Since Mr. WB is a well known person, the information trickles down to Indian Tax Authorities and a smart officer issues a notice to Mr. WB for taxing the said transaction on the following grounds:

• Substantial value of the shares of X Corporation is derived from assets (subsidiary’s share in this case) located in India. Therefore, by virtue of amended section 9(1)(i), Explanation 5, the shares securities of X Corporation is situated in India.

• Since the transaction of purchase of shares gives rise to income “in consequence of” or “by reason of” asset situated in India, by virtue of Section 9 (1)(i) read with Explanation 4, the income, computed U/s. 56(2)(vii) shall be deemed to accrue or arise in India.

• The shares of X Corporation are not listed on a Recognised Stock Exchange as defined in Section 2(f) of Securities Contracts (Regulation) Act, 1956, as section 2(f) applies only to SEs which are recognised by the Central Government i.e. Indian Stock Exchanges

• In view of the same, the shares will have to be valued based on the book value of the said Shares.

• Since the shares are acquired by a person at a value which is less than the book value, though at the market price, can attract tax in India.

Participants may ponder. Because of amendments to Section 9, there are several implications may arise and affect transactions in foreign companies, which are unintended like mergers of two foreign companies may attract tax in India, though intention is to grant exemptions. Consequential amendments are not carried out in other provisions for considering the situations likely to arise due to amendment to section 9.

4.5.3 Unquoted Equity Shares Equity shares other than quoted equity shares are required to be valued for the purpose of section

56 (2)(vii) as per its book value, duly considering the paid up value of the respective shares applying the below mentioned formula:

Fair Market Value of unquoted equity Shares = (A-L) X (PV) (PE)

Where,

A = Book value of assets shown in the balance sheet (as reduced by tax paid / deducted net of refund claimed and amount shown as asset that does not represent the value of any asset (like DRE, etc.)

L = Book value of liabilities shown in balance sheet (excluding the paid up capital in respect of equity shares, proposed dividends, reserves and surplus, provision for taxation in excess of MAT, provision for liabilities other than ascertained liabilities, contingent liabilities other than arrears of dividend payable in respect of cumulative preference shares.

PE = Total amount of the paid up equity as shown in the balance sheet

PV = The paid up value of such equity shares



4.5.3.1 In the above context the following should be kept in mind:

(1) For the purpose of section 56(2)(vii), the balance sheet means audited balance sheet upto the date on which the shares are acquired. There is no option available to refer to the earlier audited balance sheet (like available for valuation of shares for Section 56(2)(viib), if no balance sheet is made upto the valuation date.

(2) Revaluation reserves are not to be excluded in computation. Therefore, if the assets of the Company are revalued, then the said revaluation reserves will increase the book value of equity shares.

(3) There is no need to see or alter the book value, even where evidence is available that the market value of the assets of the company are significantly higher. Therefore, if there is a holding company, then it is not necessary to first ascertain the book value of the subsidiary and then the holding company.

4.5.4 Unquoted Shares and Securities other than Equity Shares Rule 11UA(1)(c)(c) provides that fair market value of the unquoted Shares and Securities other

than equity shares shall be estimated to be the price it would fetch if sold in the open market on the valuation date as determined by a report from a merchant banker or a Chartered Accountant, other than the auditor.

4.5.4.1 There has been unnecessary usage of the words like “other than equity shares of a company not listed in any RSE”. Therefore, it can be said that no guidance is available in respect of unquoted equity shares of a company which is listed on the RSE. Unquoted Equity Shares (i.e. in case of infrequently traded equity shares) of a listed company will not be covered by Para (b) or Para (c) of Rule 11UA(1)(c).

4.5.5 Typical issues for consideration with respect to Shares and Securities4.5.5.1 ESOP: In case where a company allots shares to the employees under the employee stock option

plans or issues Sweat Equity Shares (collectively referred to as ESOP for convenience), the same are covered by Section 17(2)(vi). While the taxable event of the ESOP and Section 57(2)(vii) is the same, i.e. the date on which the Shares are alllotted / transferred, the date of valuation is different in both the cases. In case of ESOPs, the relevant date for valuation is the date on which the employee exercises the Option. Therefore, there is bound to be difference in the dates of valuation in both the cases. Principles of valuation is different in case of Section 57(2)(vii) and Section 17(2)(vi). While Section 57(2)(vii) uses the concept of objective evaluation of quoted price / book value based on quoted / unquoted shares, Section 17(2)(vi) read with Rule 3(8) provide for quoted price/ merchant banker determined price based on listed / unlisted shares. As has been explained that all quoted shares will be listed shares but all listed shares need not be quoted shares.

The Participants may ponder on the following situations with specific reference to the ESOPs

• When the price determined in accordance with Section 17(2)(vi) is lower than Section 56(2)(vii) price, whether upto 17(2)(vi) price, tax will be levied u/s. 17(2)(vi), as salaries and on the balance the tax will be levied u/s. 56(2)(vii)?

• When the price determined in accordance with Section 17(2)(vi) is higher than Section 56 (2)(vii) price, could there be a case of double taxation as there is no provision for substitution of value determined in one for computing the income of the other?



4.5.5.2 Rights: The question that arises for consideration is that whether the provisions of section 56 (2)(vii) is attracted when there is a right issue in terms of Section 81 of the Companies Act, 1956 (or Section 62 of the Companies Act, 2013). To take an instance of an unlised company, whether there would be any tax liability on the shareholders, if the rights issue by an unlised company is done at below book value of these shares determined in accordance with Rule 11 UA.

The matter came up before the Mumbai Tribunal in the case of Sudhir Menon HUF TS-146-ITAT-2014(Mum) / [2014] 45 taxmann.com 176. The ITAT relying on various judgements and definition of income U/s. 2 (24) held as under:

(1) Allotment of fresh shares in a company will be covered by the provisions of section 56 (2) (vii) per se. It would be incorrect to read that for attracting section 56 (2)(vii), there has to be transfer from an owner of a share to another person.

(2) To the extent the shares subscribed to are right shares, i.e., allotted pro-rata on the basis of the existing share-holding (as on a cut-off date), the provision, though per se applicable, does not operate adversely. A disproportionate allotment, which cannot, therefore, strictly be regarded as right shares, though could be allotted under a rights issue, would however invite the rigours of the provision, i.e., to that extent. Accordingly, bonus issues will be out of rigours of Section 56 (2)(vii).

(3) Since in this case, the Assessee got shares which were less than the proportionate shares, there was no income. [Note : There could be different scenario in cases of persons who subscribed for either more shares or were allotted more than proportionate shares.]

While there is no difficulty in accepting the logic of the decision in case where the allotment of shares are done on a pure rights basis or bonus shares, especially when the reliance is placed rightly on the decisions like K. P. Verghese.

This provision may have interesting implications in cases of mergers and acquisitions, where the share capital can be restructured immediately prior to such corporate actions.

4.6 Jewellery, artistic work, billion While Explanation to Section 56(2)(vii) provide that the fair market value of the property, other than

an immovable property, means the value determined in accordance with the method as may be prescribed, there is no Rule prescribed for valuation of Bullion.

4.6.1 With respect to the Jewellery and Artistic Work, it provides that if the said Jewellery or artistic work is acquired from a registered dealer then the invoice value shall be considered to be the fair market value. In case where the jewellery or artistic work is not acquired from a registered dealer then the Assessee may obtain a report of valuation from a registered valuer in respect of the price it would fetch if sold in the open market on the valuation date.

4.6.2 Considering the definition, it may be advisable, to obtain report of the valuation in the following cases:

• Acquisition of jewellery / artistic work from outside India. As the persons selling the same, including auction houses, jewellery shops or regular shops would not be registered under the Central Sales Tax / GST / State VAT Laws, will not qualify to be registered dealer and therefore invoice value will not be considered to be the fair market value.

• Acquisition of artistic work from the artist himself / herself. Generally the artists are not registered as dealers. This can certainly cause difficulties as assessment of value of artistic work could be not only very subjective but an expensive affair.



4.7 No relief for restructuring u/s. 56 (2)(vii) Section 56(2)(viia) provides that in case of shares which are received on restructuring of the

business referred to in section 47, it would not attract the rigours of section 56(2)(viia). There is no such exception provided in Section 56(2)(vii) and therefore rigours of section 56(2)(vii) is not avoided in some of the restructuring exercises.

4.8 Exempted transfers Nothing contained in section 56(2)(vii) apply to the receipt of any sum of money or property :

(a) from any relative; or

(b) on the occasion of the marriage of the individual; or

(c) under a will or by way of inheritance; or

(d) in contemplation of death of the payer or donor, as the case may be; or

(e) from any local authority as defined in the Explanation to clause (20) of section 10; or

(f) from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in clause (23C) of section 10; or

(g) from any trust or institution registered under section 12AA.

4.8.1 The following issues arise on account of the exemption so provided :

(a) A gift received by a person from his relative is not within the rigours of Section 57(2)(vii). The term relative is defined. While all other terms of the said definition does not pose any difficulty, the question arises on interpretation of item No. (D), which refer to brother or sister of either of the parents of the individual. Therefore, for a person his uncles and aunties are included and therefore Gifts received from uncle and aunt is not covered by Section 56 (2)(vii). However, the question that arises is that whether gift received by uncle / aunt from his/ her nephew or niece is covered or not. Is it possible to say that A is a relative of B, but B is not a relative of A and accordingly, when uncle is a relative of nephew, whether it can be said that the nephew is not a relative of the uncle.

In today’s time, it is not very uncommon, where the nieces and nephews also take care of their old age uncle and aunt and in such a scenario, if there is a gift from the nephews and nieces to the uncle, will it have the rigours of taxation?

(b) The term Relative has been amended w.e.f. 1.10.2009, so as to include in case of HUF, any member thereof. Therefore any gift received by the HUF from its members will be exempted from tax.

(c) The exception also covers the cases of property received in contemplation of death of the payer. As held in the case of Abdul Karim Mohd [1991] 191 ITR 317 (SC), it was held that the term “gifts in contemplation of death” as used under the Gift Tax Act, 1958 has the same meaning as in section 191 of the Indian Succession Act, 1925. The requirement of the said section for a gift to qualify as gifts in contemplation of death u/s. 191 and accordingly under Section 56(2)(vii) are as under:

(i) the gift must be of movable property;

(ii) it must be made in contemplation of death;

(iii) the donor must bill and he expects to die shortly because of the illness;



(iv) possession of the property should be delivered to the donee; and

(v) the gift does not effect if the donor recovers from the illness or the donee predeceases the donor.

In the case of Shri Shreyans J. Shah [2005] 95 TTJ 896 (Mum.), it was held that transfer of property by a person before becoming a Sanyasi, cannot be considered to be gift in contemplation of death. Though Hindu Law recognizes that taking Sanyas amounts to “civil death”, the requirement here is of physical death.

(d) Clauses (e), (f) and (g), of the exception exclude contribution received by an individual / HUF from a local authority, an institution referred to in Section 10(23C) or from an institution registered u/s. 12AA. However, it does not cover any international charity, which may be registered outside India and may not be registered in India. Therefore, if any such funds are received of a purely charitable nature by an individual / HUF resident in India, will become taxable in India.

(e) Clause (b) exempt any sum of money or property received at the time of marriage of the individual. It must be kept in mind that only the individual getting married is exempted and not any other relative of such individual. Therefore if father / mother of the bride / groom receives any sum of money or property (certainly not very uncommon in India), then the said sum of money will attract provisions of section 56(2)(vii) and if the said gift exceed in aggregate a sum of ` 50,000 (again not very uncommon in India), then the whole of the sum so received could attract tax.

4.9 Impact on the Cost of Acquisition Section 49(4) provides that at the time of computing the capital gains of an asset, the value of

which has been subject to income tax u/s. 56(2)(vii)/(viia), then the cost of acquisition of such propriety shall be deemed to be the value which has been taken into account for the section 56 (2)(vii)/(viia).

4.9.1 It may be pointed out that when an asset is acquired by an assessee for use in its business (building acquired for business) and such asset is subjected to income tax u/s. 56(2)(vii), then the assessee will not be entitled to depreciation on the value which has been taken into account for section 56(2)(vii), as provisions of Section 43(1), defining “actual cost” does not recognise such eventuality.

4.9.2 As has been mentioned earlier, that if the assets are acquired as stock in trade (like shares or securities), then there is no question of implication of Section 56(2)(vii) and therefore the question of substitution of cost of acquisition does not arise.

PART V – SECTION 56(2)(viia)

5.1 For curbing the menace of widespread conversion of unaccounted money into accounted money by transaction of purchase and sale of shares of unlisted company, Finance Act, 2010 inserted w.e.f. 1st June, 2010 provisions of Section 56(2)(viia).

5.2 Salient features of the provisions introduced can be summarised below:

• It applies only in case where the recipient is either a firm or a company, not being a company in which public are substantially interested (“closely held company”)



• It applies only when such firm / closely held company receives shares of another company which is also a closely held company.

• It applies in cases where the shares are acquired without consideration or for less than adequate consideration. The reference value is the book value computed in the manner provided for in Section 56(2)(vii)

• Threshold of ` 50,000 applies and therefore if the shares are received without consideration then the value of the shares should be more than ` 50,000 and if the shares are received on inadequate consideration then the difference should be more than ` 50,000.

• It is important to note that even where the shares are received as “stock-in-trade”, the provisions shall apply. This is a major distinction between provisions of section 56(2)(vii) and Section 56(2)(viia). Section 56(2)(vii) does not apply if the individual or HUF receive the shares and are held by such individual or HUF as stock in trade. However, in case where the shares are received and held as stock in trade by a company or firm, then it cannot escape the rigours of Section 56(2)(viia).

5.3 The proviso to section 56(2)(viia) provides that the provisions shall not apply in the following cases:

(i) Transfer of shares of Indian Company in a scheme of amalgamation of a foreign company with another foreign company, subject to conditions U/s. 47 (via). However, this does not cover cases of transfer of shares of the foreign holding company of an Indian Company under a scheme of amalgamation of two foreign companies. By virtue of section 9, Explanation 5, shares of foreign holding company shall be deemed to be situated in India.

(ii) Transfer of shares of Indian Company in a scheme of demerger of a foreign company to another foreign company, subject to conditions U/s. 47 (vic). However, this does not cover cases of transfer of shares of the foreign holding company of an Indian Company under a scheme of demerger of two foreign companies. By virtue of section 9, Explanation 5, shares of foreign holding company shall be deemed to be situated in India.

(iii) In case of restructing of a co-operative bank, as provided for in Clause 47 (vicb)

(iv) Any transfer or issue of shares under a scheme of demerger to the shareholder of the demergeed company as provided for U/s. 47 (vid). Kindly note that this exemption is available only if the demerger is within the definition of demerger as defined u/s. 2 (19AA) of the Act.

(v) Any transfer by a shareholder of shares held in amalgamating company pursuant to a scheme of amalgamation as provided for U/s. 47 (vii).

5.4 It may be mentioned that the discussion with respect to Rights Issue / Bonus issue in connection with Section 57 (vii) shall also apply in case where the shares are held by a firm or an closely held company. Accordingly no further discussions on the same is being done here.

PART VI – SECTION 56(2)(viib)

6.1 In the recent times, several instances have come to light where issuance of shares at a very high premium has been used as a means for channellising of unaccounted money into mainstream activities. This was also used for taking illegal gratification. To check usage of this type of method, by Finance Act, 2012, Section 56(2)(viib) was introduced with effect from 1.4.2013, which accordingly affect issuance of shares by a company after 1.4.2012.



6.2 Salient features of the provisions are mentioned herein:

• The provisions apply

– when the shares are issued by an unlisted company; Issuance of shares by a listed company is excluded from rigours;

– when shares are issued to a resident; Accordingly, issuance of shares to a non-resident is excluded

• Unlike Section 56(2)(vii) and 56(2)(viia), the tax is levied if the shares are issued at a value which is higher than the fair market value and tax is payable by the company which issues shares and not by the recipient of the shares.

• The provisions do not apply where the shares are issued by a venture capital undertaking to a venture capital company or venture capital fund (as defined in Explantion to Section 10 (23FB). The Central Government has a power to notify a class of person or persons issuance of shares to whom will not attract the rigours of Section 56 (2) (viib).

• The fair market value to be determined for applying these provisions is highest of the following three methods:

– Book Value (computation similar to the computation discussed in the context of Section 56(2)(vii) – [Refer to Rule 11UA(2)(a)]

– Fair market value determined by a merchant banker or a chartered accountant using Discounted Free Cash Flow Method [Refer to Rule 11 UA (2) (b)]; or

– On the market value of tangible and intangible assets of the company including goodwill, know-how, patents, copyrights, etc. [Refer to Clause (a) (ii) of Explanation to Section 56(2)(viib)]. This requires to be substantiated by the Company to the satisfaction of the AO.

6.3 In view of the above provision therefore, if a company issues shares at a premium which is higher than the premium which is worked out based on highest of the value as per the three alternate methods suggested above, then the difference will be deemed to be income of the issuing company.

6.4 The following aspects need to be considered and kept in mind:

A. The provisions apply at the time when the consideration is received for issuance of shares. Therefore, even at the stage prior to allotment of shares, the amount will become taxable. Thefore if a company issues shares in a year and receives share application money against the issuance of shares, but has not allotted shares before end of the previous year, then also the amount will become chargeable to tax in the year in which the shares are issued.

B. The provisions of Section 56(2)(viib) do not make distinction between the Equity Shares and Preference Shares. Accordingly, if preference shares are to be issued, it is not certain as to how any of the above methods will apply. Further, no guidance is provided when convertible preference shares are allotted. The provisions do not cover cases when the Company issues convertible debentures. When the debentures are issued at that time since debentures are not shares, the provisions of Section 56(2)(viib) do not apply. At the time when the debentures are converted, then at that time there is a contractual obligation to issue / allot the shares on conversion of the debentures. How can the book value or market value on that date alter the contractual position.



CONCLUSIONWhenever deeming fictions are created under the tax statute, the assessee feels cheated, if the provisions enlarge the scope of taxation or enlarge the compliance burden or enhance the obligations in any manner. The question that arises in our mind is why such an injustice is being done. Do we deserve to have these provisions? I felt disgusted at times when I read these provisions, especially the provisions limiting the right of a company to issue shares at a premium.

However, it is also philosophical to ask a question that has the conduct of all of us as a society, tax professionals, businessmen, etc. compelled the legislature to impose these obligations. French Philosopher Joseph de Maistre wrote in 1811 “Toute nation a le gouvernement qu’elle mérite” [Translation – “Every Nation has the Government it deserves”or “Every Nation has the Government it is fit for”] In the same spirit, can we say “A nation gets the laws that it deserves.”. Blatant misuse of the provisions have contributed significantly in making the laws complex. Intelligent minds should have protested such blatant misuse. The misfortune is that the most intelligent minds have actually acted in devising schemes for misuse of the provisions.

Before I part with the paper, I wish to invite members to deliberate in their souls that should the role of the profession and professional body be larger than what we presently perform to be true “partners in nation building”.

Hope all of you have a meaningful deliberation in the conference and provide me with solutions to the problems that I face, which have been conveniently placed as posers in the paper.



NOTES

Issues in Reverse Charge Mechanism & CENVAT Credit Rules



SUNIL GABHAWALLA Chartered Accountant



Sunil Gabhawalla is a chartered accountant in practice with 3rd rank at the All-India Level. He is also a cost accountant. He has an excellent academic record with ranks throughout the career.

Sunil practices in the entire field of taxation with a specialisation in Indirect Taxes. He is one of the leading consultants for service tax & VAT related matters.

He is a visiting faculty at Narsee Monjee Institute of Management Studies, the Indo-German Chamber of Commerce & the National Academy of Customs, Excise & Narcotics.

He has authored books on topics relating to service tax, NRI Taxation & computers. His comprehensive treatise on service tax published by the Bharat Law House runs in its 17th edition.

He has delivered numerous talks on topics of professional interest at various forums including industry/trade associations. He has also written articles in various professional and business journals.

Sunil is Hon. Jt. Secretary of the Bombay Chartered Accountants’ Society and a member of the Study Group constituted by Maharashtra Government & the ICAI for implementing GST.

CA Sunil Gabhawalla

Group Leaders of Paper on Issues in CENVAT Credit by CA Sunil G. Gabhawalla

CA Ganesh Prabhu Balkrishnan

CA Manju L. Navandar

CA Saurabh P. Shah

CA Viren Mathia

CA Manmohan Sharma



A. ISSUES IN REVERSE CHARGE MECHANISM

1. Directors XYZ Limited is a listed company in the business of real estate development. It has appointed 4

directors, A, B, C and D. Mr. A is a whole time director on employment with the company. Mr. B, is a registered architect, who not only provides architectural services to XYZ Limited, but also to other clients. He draws his remuneration as a consultant from XYZ Limited. C & D are independent directors. For Financial Year 2013-14, the company has made the following payments to its directors:

Salary & Allowances to Mr. A 2500,000.00

Joining incentive paid to Mr. A prior to his joining as an employee 500,000.00

Professional fees paid to Mr. B who is a registered architect (Mr. B has also received an aggregate amount of ` 600,000.00 from other clients)

1000,000.00

Rent for letting out of office by Mr. B to the company 300,0000.00

Sitting fees paid to Mr. C 100,000.00

Sitting fees paid to Mr. D (it may be noted that Mr. D is ordinarily resident in USA) 100,000.00

In all the above cases, discuss the liability of XYZ Limited to discharge service tax under RCM and the liability of the respective directors to register and pay service tax at their end. Some indicative pointers for discussions (not exhaustive) are as under:

1. Can it be said that a director provides a service to the company by attending a board meeting?

2. What is the scope of the exclusion clause pertaining to employments under Section 65B(44)? Can it cover payments in the nature of joining bonus?

3. What is the scope of the reverse charge mechanism provided vide Entry 5A of Notification 30/2012-ST dated 20.6.2012? Does it cover services rendered only in the capacity as a director or does it also cover other services rendered by the director? Comparison may also be made between Entries 5 and 5A of the said Notification.

2. Legal Consultancy Services MNO & Co. is a partnership firm of advocates engaged in providing various legal consultancy

services to its clients. One of its partners, Mr. M appeared before the Delhi HC on behalf of its following clients and charged fees as under:

Name of the Client Advocate Fees Travel Expenses Recovered

Total Bill Hotel facility provided by client

ABC Private Limited 500,000.00 75,000.00 575,000.00 50,000.00

Mr. Z 150,000.00 45,000.00 195,000.00 15,000.00


CA Sunil Gabhawalla



In the above cases, examine the position of MNO & Co. as well as its clients so far as discharge of service tax liability is concerned. Some indicative pointers for discussions (not exhaustive) are as under:

1. What is the value on which the service tax needs to be discharged by ABC Private Limited? Is Section 67 of the Act wide enough to cover reimbursement of expenses? In what situations is Rule 5 of the Service Tax (Determination of Value) Rules, 2006 triggered?

2. Whether the hotel facility directly provided by the client can be considered as non-monetary consideration and therefore a part of the value of taxable service as well?

3. What is meant by ‘business entity’? In what circumstances can Mr. Z be considered as business entity?

3. Sponsorship OPQ Private Limited is engaged in the business of e-commerce. It has sponsored an event

conducted by the Retailers Association of India and has paid them sponsorship fees of INR 1,500,000.00. Further, they have also sponsored the live telecast of the Indian Premier League wherein the logo of the company and its products is displayed as a flash along with the live broadcast of cricket match. For the same, they have paid fees of INR 2,000,000.00 for sponsoring the advertisement break on Star Sports Channel.

In both the above cases, examine the liability of OPQ Private Limited to discharge service tax under RCM and the liability of the respective service providers to pay service tax at their end. Also consider the impact of CENVAT Credit availability in both the cases for both the parties. Some indicative pointers for discussions (not exhaustive) are as under:

1. What is the scope of ‘sponsorship service’? Is a ground event an essential element of ‘sponsorship service’? Would the essential nature of sale of time slots override the nature of ‘sponsorship service’ in the case of television sponsors?

2. What happens if the two parties to the contract dispute about the applicability of reverse charge?

3. Whether the service recipient can pay the service tax from accumulated CENVAT Credit?

4. Whether the service recipient can claim the CENVAT Credit of the service tax paid by him? If yes, when and is there any outer time limit for the same

5. The definition of “output service” and “exempted service” may be examined under the CENVAT Credit Rules, 2004 to determine the eligibility of CENVAT Credit at service provider’s end.

4. Manpower Supply Service Jack & Co., a partnership firm is engaged in the business of providing house-keeping services to its

various clients. The amounts are charged based on the number of people deputed at the customers’ site. For Financial Year 2013-14, Jack & Co. has provided the following services to its customers:

STV Private Limited 600,000.00

MNO & Co. (partnership firm) 130,000.00

ABC Co-op. Hsg. Society Limited 110,000.00

HAL LLP 40,000.00



In all the above cases, examine the liability of Jack & Co. to discharge service tax and the liability of the respective service recipients to discharge service tax under RCM at their end. Would your answers change if the nature of services rendered were “security services”? Also examine the eligibility of basic exemption limit under Notification 33/2012-ST both the Jack & Co. and to its’ customers.

B. ISSUES IN CENVAT CREDIT

5. Input Services Evergreen is setting up a plant at Gujarat for the purposes of manufacturing tyres, which is liable for

payment of central excise duty. For the said purpose, it has obtained the services of a construction contractor who has charged service tax for the services of construction of the factory building provided by him. Evergreen has also appointed an architect for supervising the project and has paid the architect professional fees including service tax. Examine the possibility of Evergreen claiming CENVAT Credit of the service tax so paid.

Evergreen also has an existing operational plant located at Pune. It recently underwent an Excise Audit and the following objections on claim of CENVAT Credit were pointed out by the Audit Team:

1. Service Tax paid to the factory canteen contractor

2. Service Tax paid to the vendor for transportation of employees from the staff quarters to the factory and back. The vendor is registered under service tax under the category of “Tour Operator” Services, which was obtained by him after receiving a show cause notice from the Department.

3. Service Tax paid on hiring of cars when the employees are on outstation tours

4. Service Tax paid on hiring of radio taxies for local conveyances

5. Service Tax paid on Group Medi-claim Policy and Professional Indemnity Insurance Policies for Directors

Examine whether the deficiencies pointed out by the Audit Team are correct?

6. Documentation & Miscellaneous MITHYAM Limited has undergone a lot of turmoil in the recent past. One of the turmoils pertains to

the detailed investigation carried out by service tax officials about the CENVAT Credits claimed by it from time to time. Based on the investigation, the officials have raised the following preliminary objections:

a) MITHYAM has wrongly availed CENVAT Credit in regard to Mobile Phones, in regard to which, Tax paid Invoices are in the name of Executives of MITHYAM with their residential addresses

b) MITHYAM has wrongly availed CENVAT Credit in regard to Service tax paid to the landlord on the recovery of Electricity Charges along with Rent Paid, for which in view of the service tax officials, no Service tax is payable under law

c) MITHYAM has wrongly availed CENVAT Credit regard to payments made to various Services Suppliers, which upon a Cross check has revealed that, the said Services Suppliers have in turn not deposited Service tax collected from MITHYAM to the Govt. Treasury

d) MITHYAM has wrongly availed CENVAT Credit in regard payments to various Services Suppliers to whom about 500 cheques have been issued on 31st March of the year but the said cheques have been presented to the Bank by the said Suppliers only after a time lag of 5 months. This practice is being followed by MITHYAM every year with a clear intent to claim set off against



Service tax payable to Govt. without any effective payment being made to the Input Service Suppliers

e) MITHYAM has wrongly claimed CENVAT Credit in regard to Service tax on Commission paid to Business Intermediaries, due to business exigencies for procuring large contracts. The business intermediary has confessed before the Income Tax Authorities that the transaction was one of accommodation and no service was actually rendered. The proof of payment of service tax by the said intermediary is however available on record

f) MITHYAM claimed credit of service tax charged by the vendors at the time of purchase of software. The said software is not installed at MITHYAM’s locations but is sold to customers and service tax collected on the sale of such software. The Department is of the view that since the service is not used by MITHYAM, credit is not available.

g) In view of the amendment in the provisions of Rule 4(7), MITHYAM is not eligible for the following credits claimed by it:

Description Date of Invoice Date of Payment Date of Claim of Credit

Services received from a consultant, the value being disputed

1-1-2014 valued at ` 500,000

1-11-2014 finally settled at ` 300,000

1-11-2014 only on final settlement

Services received from security agencies, where the payment terms are 8 months credit

1-10-2014 1-10-2015 1-10-2015

h) MITHYAM had also claimed CENVAT Credit of unpaid vendors on 31-8-2014 with a corresponding reversal on the same date, in order to reclaim the credit at the time of actual payment. However, the original ST-3 Return did not disclose these details. MITHYAM filed a revised ST-3 Return to reflect the credit as well as the reversal. The Department is contesting the same as an afterthought.

7. Negative List and CENVAT Credit FUNINMALL is a restaurant and gaming outlet. It is providing a taxable service of renting the lawn

area for parties, alongwith providing gaming services in the package. It also independently and mainly provides access to the gaming services to other retail customers.

While providing gaming services is excluded from service tax under the negative list, FUNINMALL chooses to artificially bundle the above two services (of renting of lawn and gaming services) and pay Service Tax on the entire value. By doing so, it wants to claim the Cenvat Credit of the Countervailing duty paid on Capital Goods and other fixed assets not specifically listed in the capital goods definition (as inputs) installed for the Gaming Purposes by treating them as used for both taxable as well as exempted services.

Whether the stand taken is proper? Participants may examine the provisions of Section 66B, Section 66D, Section 66F of the Finance Act, 1994 and Rule 2(e), Rule 2(l) and Rule 6 of the CENVAT Credit Rules, 2004.



NOTES

Audit of Companies – The shift under the Companies Act, 2013


Audit of Companies The shift under the Companies Act, 2013

KHUSHROO PANTHAKY Chartered Accountant



Khushroo B. Panthaky is a Fellow Chartered Accountant with 30 years of professional experience in Accounting, Auditing and Business Advisory Services within the profession. He is currently a Senior Partner with Walker, Chandiok & Co., a renowned Accounting and Consulting Firm. Khushroo also heads the Banking & Financial Services Industry Vertical (BFSI) of the firm.

Khushroo has extensive experience, both locally and internationally, in auditing and advising large corporations and multinationals. He has a detailed understanding and knowledge of local and international Accounting Standards and International Auditing Standards, Corporate Governance Codes, Internal Control and Risk Management practices. He had also been involved in the past in Technical Interpretations and Consultations. He also has adequate experience in leading Financial Due Diligence engagements, in India and abroad.

Over the past 15 years Khushroo has extensively specialised in BFSI, particularly in the Insurance Industry and has audited very large companies in India and overseas. He is currently the Engagement Partner for statutory audits in varied industry segments such as banking, insurance, broking, FMCG, manufacturing, engineering, logistics, IT/ITES, media, film exhibition, brewery, vinery, education, REIT and hotel management. During Khushroo’s tenure with a large accounting firm in India in the past, he was deputed to New York for around 3 years, where he was one of the Senior Managers leading audit engagements of multinational Insurance Companies such as Prudential Insurance Company of America and American International Group (AIG).

Khushroo has also completed a diploma in Insurance from Darden Business School in Virginia. He graduated from Sydenham College of Commerce and is also a Bachelor at General Law. He is an eminent speaker in many Workshops, Seminars and Conferences, locally and internationally, and has presented technical papers in India, Singapore, Hong Kong, United Kingdom and USA on varied subjects and themes.

Khushroo is a visiting faculty at the National Insurance Academy in Pune and is invited by other Management Institutes in India to address on varied subjects. He is very active with The Institute of Chartered Accountants of India (ICAI) and has contributed to its Central and Regional Committees relating to Insurance and Risk Management, Internal Audit, Corporate Governance, Auditing & Assurance Standards Board, Accounting Standards Board etc. Khushroo was a member of the Editorial Board of Diploma in Insurance and Risk Management (DIRM) and also a Technical Reviewer at the Financial Reporting Review Board (FRRB) of ICAI. From the Harvard Business School, Khushroo has completed an advanced programme on Managing and Transforming Professional Services Firm.

Khushroo is a Free Mason from the Grande Lodge of Scotland and an active Lion in Lions Club International, besides being the Treasurer of Indian Tourism Council and a Trustee in some of the community Trusts.

CA Khushroo Panthaky



BACKGROUNDThe Companies Act, 2013 (the “Act”), was introduced with the key objectives of improving governance in Corporate India, strengthening auditor regulation, enhancing Investor protection measures, etc. and more importantly to make the Act more contemporary. There have been significant developments in the economic environment in India and overseas including increased size and complexity of companies over the last 56 years or so, which further warranted this shift. The fine print of this Act has been/will be defined by Rules. The Act has been simplified to a great extent considering the reduction in sections from over 650+ in the erstwhile Companies Act, 1956 to around 470 in the new Act. However, there are around 300 references in the new Act, where it mentions of rules, bringing back complexity to a great extent The Act aims at enhancing transparency, enhancing protection measures for investor community and minority share holders, having stringent Corporate Governance measures, stronger regulation of auditors, having business friendly corporate regulations, bringing in e-governance measures and improving accountability in India’s corporate sector. The Act has also introduced the concept of Corporate Social Responsibility initiatives for the first time.

The Act has laid down specific and onerous obligations on the company and its auditors with stringent penalties, including imprisonment for non-compliance with the relevant provisions for appointment of auditors.

APPOINTMENT OF AUDITORSSection 139 of the Act provides that every company shall, at its annual general meeting, appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the conclusion of sixth annual general meeting. However, such an appointment will have to be ratified by the members at every annual general meeting. Explanation to Rule 3(7) of Companies (Audit and Auditors) Rules, 2014, provides that if the appointment is not ratified by the members of the company, the Board of Directors shall appoint another individual or firm as its auditor or auditors after following the procedure laid down in this behalf under the Act.

In accordance with Rule 3(6) of Companies (Audit and Auditors) Rules, 2014, where the Board had disagreed with the recommendations of the Audit Committee for appointment of an individual or a firm as auditor and the Audit Committee, after considering the reasons given by the Board, decides not to reconsider its original recommendation, the Board shall record reasons for its disagreement with the committee and send its own recommendation for consideration of the members in the annual general meeting.

Section 139 also provides that before such appointment is made, the written consent of the auditor to such appointment and a certificate from the individual auditor or the firm, that the appointment, if made, shall be in accordance with the prescribed conditions be obtained.

Audit of Companies

The shift under the Companies Act, 2013CA Khushroo Panthaky



Rule 4 of Companies (Audit and Auditors) Rules, 2014 requires the auditor to submit a certificate that:

a) He or the firm (it), as the case may be, is eligible for appointment and is not disqualified for appointment under the Act, the Chartered Accountants Act, 1949 and the rules or regulations made thereunder;

b) the proposed appointment is as per the term provided under the Act;

c) the proposed appointment is within the limits laid down by or under the authority of the Act;

d) the list of proceedings against the auditor or audit firm or any partner of the audit firm pending with respect to professional matters of conduct, as disclosed in the certificate, is true and correct

The certificate provided by the Auditor shall also indicate whether the auditor also satisfies the criteria provided in Section 141 of the Act. (enumerated in subsequent paragraphs)

The company shall inform the auditor concerned of his or its appointment, and also file a notice of such appointment with the Registrar in Form ADT-1, within fifteen days of the meeting in which the auditor is appointed/re-appointed.

TENOR OF APPOINTMENTSection 139 (2) provides that an individual shall not be appointed or re-appointed as auditor for more than one term of five consecutive years and an audit firm for more than two terms of five consecutive years in the following class of companies (excluding one person company and small companies):

a) listed companies;

b) all unlisted public companies having paid-up share capital of rupees ten crore or more;

c) all private limited companies having paid-up share capital of rupees twenty crore or more;

d) all companies having public borrowings from financial institutions, banks or public deposits of rupees fifty crore or more.

Rule 6 of Companies (Audit and Auditors) Rules, 2014 specifies that the period for which the individual or the firm has held office as auditor prior to the commencement of the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive years, as the case may be. Companies have a period of three years from the date of commencement of this Act to comply with the provisions of this sub-section. Nothing contained in this sub-section shall prejudice the right of the company to remove an auditor or the right of the auditor to resign from such office of the company.

After completion of term by the auditor, he or it shall not be eligible for re-appointment as auditor in the same company for five years. Further, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years. Also, the incoming auditor or audit firm shall not be eligible, if such auditor or audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms. “Same network” includes the firms operating or functioning, hitherto or in future, under the same brand name, trade name or common control.

Section 139(3) provides that members of a company may resolve that in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members.

In the case of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments (collectively referred as “Government undertakings”, the Comptroller and Auditor-General of India shall, in respect of a financial year, appoint



an auditor duly qualified to be appointed as an auditor of companies under this Act, within a period of one hundred and eighty days from the commencement of the financial year, who shall hold office till the conclusion of the annual general meeting.

The first auditor of a company, other than a Government company, shall be appointed by the Board of Directors within thirty days from the date of registration of the company and in the case of failure of the Board to appoint such auditor, it shall inform the members of the company, who shall within ninety days at an extraordinary general meeting appoint such auditor and such auditor shall hold office till the conclusion of the first annual general meeting. In the case of Government undertakings, the first auditor shall be appointed by the Comptroller and Auditor-General of India within sixty days from the date of registration of the company and in case the Comptroller and Auditor-General of India does not appoint such auditor within the said period, the Board of Directors of the company shall appoint such auditor within the next thirty days; and in the case of failure of the Board to appoint such auditor within the next thirty days, it shall inform the members of the company who shall appoint such auditor within sixty days at an extraordinary general meeting, who shall hold office till the conclusion of the first annual general meeting.

Any casual vacancy in the office of an auditor shall:

a) in the case of a company other than a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within thirty days, but if such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the Board and he shall hold office till the conclusion of the next annual general meeting;

b) in the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Comptroller and Auditor-General of India within thirty days. However, in case the Comptroller and Auditor-General of India is unable to fill the vacancy within the said period, the Board of Directors shall fill the vacancy within next thirty days.

RE-APPOINTMENTA retiring auditor may be re-appointed at an annual general meeting, if:

a) he is not disqualified for re-appointment;

b) he has not given the company a notice in writing of his unwillingness to be re-appointed; and

c) a special resolution has not been passed at that meeting appointing some other auditor or providing expressly that he shall not be re-appointed.

Where at any annual general meeting, no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of the company.

REMOVAL/RESIGNATION OF AUDITORSThe auditor appointed under Section 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the Central Government in that behalf. In accordance with Rule 7 of Companies (Audit and Auditors) Rules, 2014, an application should be made to the Central Government in Form ADT-2 with fees as provided for this purpose under the Companies (Registration Offices and Fees) Rules, 2014. The application shall be made to the Central Government within thirty days of the resolution passed by the Board. The company shall hold the general meeting within sixty days of receipt of approval of the Central Government for passing the special resolution. The auditor concerned shall be given a reasonable opportunity of being heard.



Special notice shall be required for a resolution at an annual general meeting appointing as auditor, a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed, except where the retiring auditor has completed a consecutive tenure of five years or, as the case may be, ten years. The company shall send the notice to the retiring auditor. Any representation made by the retiring auditor shall be sent by the company to its members. If the same could not be sent for any reason, it shall be read out at the meeting and also filed with the Registrar.

The auditor who has resigned from the company shall file within a period of thirty days from the date of resignation, a statement in Form ADT-3 with the company and the Registrar, and in the case of Government undertakings, the auditor shall also file such statement with the Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant with regard to his resignation.

If the auditor does not comply with these provisions, he or it shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees.

The Tribunal, either suo motu or on an application made to it by the Central Government or by any person concerned, if satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, may, by order, direct the company to change its auditors. If the application is made by the Central Government and the Tribunal is satisfied that any change of auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place. Also, such an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section, shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order. In the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers. In case of criminal liability of any audit firm, the liability other than fine, shall devolve only on the concerned partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud.

ELIGIBILITY CRITERIA FOR BEING APPOINTED AS AUDITORSIn accordance with Section 141, a person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant. However, a firm whereof majority of partners practising in India are qualified for appointment, as aforesaid, may be appointed by its firm name to be auditor of a company. Where a firm, including a limited liability partnership, is appointed as an auditor of a company, only the partners who are chartered accountants shall be authorised to act and sign on behalf of the firm.

The following persons shall not be eligible for appointment as an auditor of a company:

a) a body corporate, other than a limited liability partnership, registered under the Limited Liability Partnership Act, 2008;

b) an officer or employee of the company;

c) a person who is a partner, or who is in the employment, of an officer or employee of the company;

d) a person who, or his relative or partner:

is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. A relative may, however, hold security or interest in the company of face value not exceeding one lakh rupees In the event of acquiring any security or interest by a relative, above the threshold prescribed, the corrective action to maintain the limits as specified above shall be taken by the auditor within sixty days of such acquisition or interest; or



is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of five lakh rupees; or

has given a guarantee or provided any security in connection with the indebtedness of any third person to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, for one lakh rupees.

e) a person or a firm who, whether directly or indirectly, has business relationship with the company, or its subsidiary, or its holding or associate company or subsidiary of such holding company or associate company. The term “business relationship” shall be construed as any transaction entered into for a commercial purpose, except:

commercial transactions which are in the nature of professional services permitted to be rendered by an auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and the rules or the regulations made under those Acts;

commercial transactions, which are in the ordinary course of business of the company, at arm’s length price like sale of products or services to the auditor, as customer, in the ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other similar businesses;

f) a person whose relative is a director or is in the employment of the company as a director or key managerial personnel;

g) a person who is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies;

h) a person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction;

i) any person whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialised services as provided in section 144 (covered below in a separate paragraph).

Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned above after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

REMUNERATION OF AUDITORSThe remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as may be determined therein. The Board may fix remuneration of the first auditor appointed by it. The remuneration shall, in addition to the fee payable to an auditor, include the expenses, if any, incurred by the auditor in connection with the audit of the company and any facility extended to him but does not include any remuneration paid to him for any other service rendered by him at the request of the company.

POWERS AND DUTIES OF AUDITORSSection 143 lays downs the powers and duties of auditors. Every auditor of a company shall have a right of access at all times to the books of account and vouchers of the company, whether kept at the registered office of the company or at any other place and shall be entitled to require from the officers of the company, such information and explanation as he may consider necessary for the performance of his duties as auditor, and amongst other matters inquire into the following matters, namely:



a) whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members;

b) whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company;

c) where the company not being an investment company or a banking company; whether so much of the assets of the company as consists of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company;

d) whether loans and advances made by the company have been shown as deposits;

e) whether personal expenses have been charged to revenue account;

f) where it is stated in the books and documents of the company that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading:

The auditor of a company which is a holding company shall also have the right of access to the records of all its subsidiaries in so far as it relates to the consolidation of its financial statements with that of its subsidiaries.

The auditor shall make a report to the members of the company on the accounts examined by him and on every financial statement which are required by or under this Act to be laid before the company in general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made thereunder and to the best of his information and knowledge, state that the said accounts and financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.

The auditor’s report shall also state:

a) whether he has sought and obtained all the information and explanations, which to the best of his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements;

b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him;

c) whether the report on the accounts of any branch office of the company, audited by a person other than the company’s auditor, has been sent to him and the manner in which he has dealt with it in preparing his report;

d) whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns;

e) whether, in his opinion, the financial statements comply with the accounting standards;

f) the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company;

g) whether any director is disqualified from being appointed as a director under sub-section (2) of section 164;



h) any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith;

i) whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls;

j) such other matters as may be prescribed.

Rule 11 of Companies (Audit and Auditors) Rules, 2014, specifies that the auditor’s report shall also include their views and comments on the following matters, namely:

a) whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statements;

b) whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long-term contracts including derivative contracts;

c) whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company.

Where any of the matters required to be included in the audit report under this section is answered in the negative or with a qualification, the report shall state the reasons therefor.

In the case of a Government company, the Comptroller and Auditor-General of India shall direct such auditor, the manner in which the accounts of the Government company are required to be audited and thereupon the auditor so appointed shall submit a copy of the audit report to the Comptroller and Auditor-General of India which, among other things, include the directions, if any, issued by the Comptroller and Auditor-General of India, the action taken thereon and its impact on the accounts and financial statements of the company.

The Comptroller and Auditor-General of India shall within sixty days from the date of receipt of the audit report have a right to:

a) conduct a supplementary audit of the financial statements of the company by such person or persons as he may authorise in this behalf; and for the purposes of such audit, require information or additional information to be furnished to any person or persons, so authorised, on such matters, by such person or persons, and in such form, as the Comptroller and Auditor-General of India may direct; and

b) comment upon or supplement such audit report:

Any comments given by the Comptroller and Auditor-General of India upon, or supplement to, the audit report shall be sent by the company to every person entitled to copies of audited financial statements and also be placed before the annual general meeting of the company at the same time and in the same manner as the audit report.

The Comptroller and Auditor-General of India may, in case of Government undertakings, if he considers necessary, by an order, cause test audit to be conducted of the accounts of such Government undertakings and the provisions of Section 19A of the Comptroller and Auditor-General’s (Duties, Powers and Conditions of Service) Act, 1971, shall apply to the report of such test audit.

Where a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company (herein referred to as the “company’s auditor”) under this Act or by any other person qualified for appointment as an auditor of the company under this Act and appointed as such under section 139, or where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.



The branch auditor shall prepare a report on the accounts of the branch examined by him and send it to the auditor of the company who shall deal with it in his report in such manner as he considers necessary.

In accordance with Rule 12 of Companies (Audit and Auditors) Rules, 2014, the duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor, if any, shall be similar to the duties and powers of the company’s auditor as enumerated earlier. The branch auditor shall submit his report to the company’s auditor. The provisions regarding reporting of fraud by the auditor shall also extend to such branch auditor to the extent it relates to the concerned branch.

Every auditor shall comply with the auditing standards. The Central Government may prescribe the standards of auditing or any addendum thereto, as recommended by the Institute of Chartered Accountants of India in consultation with and after examination of the recommendations made by the National Financial Reporting Authority. Until any such auditing standards are notified, any standard or standards of auditing specified by the Institute of Chartered Accountants of India shall be deemed to be the auditing standards.

The Central Government may, in consultation with the National Financial Reporting Authority, by general or special order, direct, in respect of such class or description of companies, as may be specified in the order, that the auditor’s report shall also include a Statement on such matters as may be specified therein.

REPORTING ON FRAUD BY AUDITORSIf an auditor of a company, in the course of the performance of his duties as auditor, has sufficient reason to believe that an offence involving fraud is being or has been committed against the company, by officers or employees of the company, he shall immediately report the matter to the Central Government, but not later than sixty days of his knowledge and after following the procedure indicated hereinbelow:

a) auditor shall forward his report to the Board or the Audit Committee, as the case may be, immediately after he comes to know of the fraud, seeking their reply or observations within forty-five days;

b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee, along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within fifteen days of receipt of such reply or observations;

c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of forty-five days, he shall forward his report to the Central Government, along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he failed to receive any reply or observations within the stipulated time.

The report shall be sent to the Secretary, Ministry of Corporate Affairs, in a sealed cover by Registered Post with Acknowledgement Due or by Speed Post, followed by an e-mail in confirmation of the same. The report shall be on the letter-head of the auditor, containing postal address, e-mail address and contact number and be signed by the auditor with his seal and shall indicate his Membership Number. The report shall be in the form of a statement as specified in Form ADT-4. Also, there would be no contravention of any provisions, if such reporting on fraud is done in good faith.

The provisions of this section shall mutatis mutandis apply to the cost accountant in practice conducting cost audit under Section 148; or the Company Secretary in practice conducting secretarial audit under Section 204.

If any auditor, cost accountant or company secretary in practice does not comply with the provisions relating to reporting of fraud, he shall be punishable with fine which shall not be less than one lakh rupees but which may extend to twenty-five lakh rupees.



RESTRICTION ON SERVICES TO BE PROVIDED BY AUDITORSSection 144 of the Act provides that an auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

a) accounting and book keeping services;

b) internal audit;

c) design and implementation of any financial information system;

d) actuarial services;

e) investment advisory services;

f) investment banking services;

g) rendering of outsourced financial services;

h) management services; and

i) any other kind of services as may be prescribed:

An auditor or audit firm who or which has been performing any non-audit services on or before the commencement of this Act shall comply with the provisions of this section before the closure of the first financial year after the date of such commencement.

The term “directly or indirectly” shall include rendering of services by the auditor,

in case of auditor being an individual, either himself or through his relative or any other person connected or associated with such individual or through any other entity, whatsoever, in which such individual has significant influence or control, or whose name or trade mark or brand is used by such individual;

in case of auditor being a firm, either itself or through any of its partners or through its parent, subsidiary or associate entity or through any other entity, whatsoever, in which the firm or any partner of the firm has significant influence or control, or whose name or trade mark or brand is used by the firm or any of its partners.

AUDITOR TO ATTEND GENERAL MEETINGSIn accordance with Section 146, all notices of, and other communications relating to, any general meeting shall be forwarded to the auditor of the company, and the auditor shall, unless otherwise exempted by the company, attend either by himself or through his authorised representative, who shall also be qualified to be an auditor, any general meeting and shall have right to be heard at such meeting on any part of the business which concerns him as the auditor.

PENAL PROVISIONS FOR CONTRAVENTIONIf any of the provisions of Sections 139 to 146 (both inclusive) is contravened, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees, or with both.

If an auditor of a company contravenes any of the provisions of Section 139, Section 143, Section 144 or Section 145, the auditor shall be punishable with fine which shall not be less than twenty-five thousand



rupees but which may extend to five lakh rupees. If an auditor has contravened such provisions knowingly or wilfully with the intention to deceive the company or its share holders or creditors or tax authorities, he shall be punishable with imprisonment for a term which may extend to one year and with fine which shall not be less than one lakh rupees but which may extend to twenty-five lakh rupees.

Where an auditor has been convicted as above, he shall be liable to:

a) refund the remuneration received by him to the company; and

b) pay for damages to the company, statutory bodies or authorities or to any other person for loss arising out of incorrect or misleading statements of particulars made in his audit report.

The Central Government shall, by notification, specify any statutory body or authority or an officer for ensuring prompt payment of damages to the company or specified persons and such body, authority or officer shall after payment of damages to such company or persons file a report with the Central Government in respect of settling such damages in such manner as may be specified in the said notification.

Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to or by, the company or its directors or officers, the liability, whether civil or criminal as provided in this Act or in any other law for the time being in force, for such act shall be of the partner or partners concerned of the audit firm and of the firm jointly and severally.

PROVISIONS RELATED TO COST AUDITIn accordance with the provisions of Section 148, the Central Government may, by order, in respect of such class of companies engaged in the production of such goods or providing such services as may be prescribed, direct that particulars relating to the utilisation of material or labour or other items of cost as may be prescribed shall also be included in the books of account kept by that class of companies. The Central Government shall, before issuing such order in respect of any class of companies regulated under a special Act, consult the regulatory body constituted or established under such special Act.

If the Central Government is of the opinion, that it is necessary to do so, it may, by order, direct that the audit of cost records of class of companies, which are covered under paragraph above and which have a net worth of such amount as may be prescribed or a turnover of such amount as may be prescribed, shall be conducted in the manner specified in the order. The audit shall be conducted by a Cost Accountant in practice who shall be appointed by the Board, based on recommendation of the Audit Committee, where applicable, on such remuneration which shall be ratified by share holders subsequently.

However, no person appointed under Section 139 as an auditor of the company shall be appointed for conducting the audit of cost records. Further, the auditor conducting the cost audit shall comply with the cost auditing standards. “Cost auditing standards” mean such standards as are issued by the Institute of Cost and Works Accountants of India, constituted under the Cost and Works Accountants Act, 1959, with the approval of the Central Government.

An audit conducted under this section shall be in addition to the statutory audit conducted under section 143. The qualifications, disqualifications, rights, duties and obligations applicable to statutory auditors shall, so far as may be applicable, apply to a cost auditor appointed under Section 148 and it shall be the duty of the company to give all assistance and facilities to the cost auditor appointed under this section for auditing the cost records of the company. The report on the audit of cost records shall be submitted by the cost accountant in practice to the Board of Directors of the company within a period of one hundred and eighty days from the closure of the financial year to which the report relates and the Board of Directors shall consider and examine such report, particularly any reservation or qualification contained therein.



A company shall within thirty days from the date of receipt of a copy of the cost audit report, furnish the Central Government with such report along with full information and explanation on every reservation or qualification contained therein. If, after considering the cost audit report referred to under this section and the information and explanation furnished by the company, the Central Government is of the opinion that any further information or explanation is necessary, it may call for such further information and explanation and the company shall furnish the same within such time as may be specified by the Government.

If any default is made in complying with the provisions of this section, the company and every officer of the company who is in default shall be punishable in the manner as provided in Section 147 in relation thereto and the cost auditor of the company who is in default shall be punishable in the manner as provided in Section 147 in relation to statutory auditors of the company.

Rule 3 of Companies (Cost Records and Audit) Rules, 2014 specifies the class of companies including Foreign Companies which shall be required to include cost records in their books of account. Rule 4 of Companies (Cost Records and Audit) Rules, 2014 specifies the class of companies which shall be required to get its cost records audited in accordance with these rules. In all instances where a cost audit is applicable, the cost auditor shall be appointed within one hundred and eighty days of commencement of every financial year. The company shall inform the cost auditor concerned of his or its appointment as such and file a notice of such appointment with the Central Government within a period of thirty days of the Board meeting in which such appointment is made or within a period of one hundred and eighty days of the commencement of the financial year, whichever is earlier, through electronic mode, in Form CRA-2, along with the fee as specified in Companies (Registration Offices and Fees) Rules, 2014.

Rule 7 of Companies (Cost Records and Audit) Rules, 2014 specifies that the requirement for cost audit shall not be applicable to a Company:

whose revenue from exports, in foreign exchange, exceeds seventy five per cent of its total revenue or

which is operating from a Special Economic Zone.

PROVISIONS RELATED TO INTERNAL AUDITIn accordance with Section 138 of the Act read with Rule 13 of The Companies (Accounts) Rules, 2014, the following class of companies shall be required to appoint an internal auditor or a firm of internal auditors, namely:

a) every listed company;

b) every unlisted public company having

paid-up share capital of fifty crore rupees or more during the preceding financial year; or

turnover of two hundred crore rupees or more during the preceding financial year; or

outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year; or

outstanding deposits of twenty five crore rupees or more at any point of time during the preceding financial year; and

c) every private company having

turnover of two hundred crore rupees or more during the preceding financial year; or

outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year



The internal auditor shall either be a chartered accountant or a cost accountant or such other professional as may be decided by the Board. Further, the internal auditor may or may not be an employee of the company. The Central Government may, by rules, prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board. The Audit Committee of the company or the Board shall, in consultation with the Internal Auditor, formulate the scope, functioning, periodicity and methodology for conducting the internal audit.

An existing company covered under any of the above criteria shall comply with the requirements of section 138 read with Rule 13 of the Companies (Accounts) Rules, 2014 within six months of commencement of such section.

PROVISIONS RELATED TO SECRETARIAL AUDITIn accordance with Section 204 of the Act read with Rule 9 of The Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, the following prescribed class of companies shall annex to their Board’s report as specified in Section 134, a secretarial audit report, given by a company secretary in practice, in Form No. MR.3:

a) listed company

b) every public company having paid-up share capital of fifty crore rupees or more; or

c) every public company having a turnover of two hundred fifty crore rupees or more.

It shall be the duty of the company to give all assistance and facilities to the Company Secretary in practice, for auditing the secretarial and related records of the company.

The Board of Directors, in their report made in terms of Section 134, shall explain in full any qualification or observation or other remarks made by the Company Secretary in practice in his report.

If a company or any officer of the company or the Company Secretary in practice, contravenes the provisions of this section, the company, every officer of the company or the Company Secretary in practice, who is in default, shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.



NOTES


Strategic Intent of Mergers & Acquisitions

BHAGIRAT MERCHANT Chartered Accountant

1. Name : Bhagirat B Merchant2. Date Of Birth : 19th May, 1946.3. Educational : B. Com., F.C.A., MBA Qualification (PGDBM in U.S. Money & Capital Markets-New York Institute of Finance, New York.)4. Started his career with India’s First Private Sector Merchant Banking Company viz., H.L. Financial

Consultants & Management Services Pvt. Ltd. (FICOM) and handled many assignment of Loan Syndication, Public Issues & Fixed Deposit Depts., mobilisation of NRI investments from eastern and West European countries for reputed and big corporations/companies and managed over 140 IPO’s.- Became member of the Stock Exchange, Mumbai as one of the First professionals to be

admitted as a member of a recognized stock exchange in India . - Was elected as “President” of The Stock Exchange, Mumbai w.e.f. 1st April, 1994 for the year

1994-95. Implemented the computerization of trading activities through the BSE Online Trading (BOLT)

in January 1995 and also prepared the blue print the new concept called “Dematerialisation”. - Actively pursuing ‘Teaching is Reaching’ concept through series of lectures on “Indian

Scriptures and Management Principles, “Ethics and Business” and Regularly invited to discourses on “Adhyatma” (Bhagawad Gita and Ancient Indian Scriptures).

- Was appointed on the Board of Tarragon Capital Advisors (India) Pvt. Ltd., a newly SEBI registered investment banking company as the Chairman w.e.f. 1st October, 2010.

5. DIRECTORSHIPS of various companies and Venture Capital Funds. 6. OTHER ACTIVITIES :

a) Faculty attachment with The Training Institute of BSE on various subjects such as NRI guidelines for investment & FEMA, Merchant Banking, Project Finance and Feasibility Studies, Fundamental Analysis, Depositories – Paperless Trading, International Finance GDR, ADR, Euro issues, ECB guidelines etc. Portfolio Management, Mutual Funds and FIIS, Mergers and Acquisitions. Venture Capital and Private Equity Finance. Capital Market Management Programmes, Corporate Governance.

b) Visiting/Guest Faculty at various Management Institutes c) Participated in various seminars, conferences & refresher courses organised by: Professional Bodies, Chambers of Commerce, Management Institutes/Training Colleges in

India and abroad, Stock Exchanges/Investors Association all over India: Commerce/Economic College, Universities Other Organisations/Institutions

d) Gave talk on various subjects relating to Merchant Banking & Leasing, Capital Market, Investments.

7. AWARDS : • Received “Samajshri” award for 1995 from Indian Council of Management Executives for

meritorious services rendered towards Investors Protection during 1994-95.• Special felicitations by the Bruhad Mumbai Gujarati Samaj in the year 1994-95

8. ACHIEVEMENT : • First Indian Share & Stock Broker to deliver a keynote address at the International Conferences

“Sub-continent Investment Forum-covering India, Pakistan, Srilanka & Bangladesh” - organised by Euromoney at London in June, 1994.

• First Indian Share & Stock Broker to have been invited by World Bank to talk on the “Changing Face of Indian Capital Markets” in August, 1994 at Washington D.C.U

CA Bhagirat Merchant



“Merger” is the consolidation of two firms that creates a new entity in the eyes of law. The French have a good word for it : “Fusion” – conveying the emergence of a new structure out of two old ones.

An acquisition on the other hand is simply a purchase. The distinction is important to lawyers, accountants and tax specialists but less so in terms of its economic impact. Business people use the terms interchangeably. The acronym “M & A” stands for it all.

GROWTH : ORGANIC OR INORGANICOne of the most fundamental motives for mergers and acquisitions is growth. Companies seeking to expand are faced with a choice between internal (organic) growth and growth through mergers and acquisitions (inorganic).

Organic growth comes from improving a company’s performance from within and is so important for most chief executive officers. These executives know that the expectation of superior organic growth is the most important driver of enterprise value in the capital markets. It is also a less expensive way to grow because a company typically pays a premium to acquire another company. A combination of factors can make organic growth hard to attain and they are:–

A) if a company has a window of opportunity to gain additional market share that will remain available for a limited period of time, then slow organic growth may not suffice. This process entails longer time for implementation of expansion projects and it is possible that a competitor may respond quickly and take away market share. Thus the advantage a company had dissipates over time or be whittled away by the actions of rivals. The only solution may be to acquire another company that has the necessary infrastructure – efficient manufacturing facilities, distribution networks, quality management and other resources;

B) company could find itself in saturated, price competitive markets – pressured by customers who themselves are squeezed – and are forced to compete for incremental share of market with competitors who follow similar strategies; and

C) disappointing organic growth can stem from organisational impediments – such as short-term incentives that subvert long term objectives – risk averse cultures and inferior research & development / innovation capabilities.

However, globalisation has changed the dynamics of corporate growth mainly on account of rapid advancements in science and technology which comes out with disruptive technologies at shorter intervals. This has made most corporate chiefs to think differently and innovatively to redefine growth parameters. Prior to the globalisation, India economically was in dire straits and was forced to renegotiate debt covenants with the IMF and that made us develop new focus of economic liberalisation. This led to an opening up of the Indian economy and widespread fear that the domestic economy would be wiped out by more cost competitive imports. Indian companies realised that they had no choice but to become more efficient if they didn’t want to be overrun by multinational competitors. Indian companies started

Strategic Intent of Mergers & AcquisitionsCA Bhagirat Merchant



rethinking every aspect of its business: products, technology, sourcing, market segmentation, plant location etc. along with basic strategies, business priorities and management techniques. Progressive and forward looking Indian companies set a goal to manufacture products at the most competitive prices and of global quality as rapidly as possible. Thus we saw an explosion of companies becoming ISO 9000 certified and introducing management practices, including automation aimed at increasing quality, productivity and efficiency. This made Indian companies to scout around globally for targeting companies for takeover and future growth. Some of the prominent Industrial Houses which have attained exemplary growth and have created value through the inorganic business models are :–

A) Aditya Vikram Birla Group : 24 buy-outs in 15 years (1998 onwards)

B) Tatas : 51 deals in 8 years starting from 2000 onwards

C) Mahindra & Mahindra group : 50 deals worth US $ 5 billion in 10 years – 2002/3 onwards

D) House of Godrej : 2010 onwards

The importance of developing a corporate strategy for inorganic growthRegulatory change, technological change, uncertainty in financial markets, creation of economies of scale and the significant engine of this dynamism – business leadership – propel the dynamics of corporate transformation. Success of achieving and attaining this transformation depends on managing in the face of these uncertainties. The core of this inorganic growth is the development of a value creating and executable M & A strategy at a justifiable price.

Many companies face significant problems in the evolution of their business models. For example : typewriters, cameras, adding machines – manufacture of these products represented a strong and attractive business. However, with the development of newer technologies these products became obsolete practically overnight and the companies manufacturing them were forced to react. We live in a world of high risks, contradictions and limited resources – both financial and material. Companies need to fine tune their management practices on a continuous and consistent basis and those who have not read the writings on the wall, have destroyed the share holders wealth.

Most successful companies create an acquisition strategy that includes the following components:–

1. Promoters bring their family values to the Board where these are discussed, defined and documented as “Corporate Vision” which enables the company to develop the business models and the long term strategic planning to attain the organic/internal growth that is envisaged. Once the targeted internal growth is attained, the company then decides to develop M & A strategies along with its overall growth strategy. In India Aditya Birla Group uses M & A strategy to build and reinforce leadership positions in its core businesses to expand internationally, as well as access new capabilities ranging from technology to talent through its M & A strategy linked to the Group’s overarching growth strategy.

2. Building a team of experienced executives for M & A. Mr. V S Parthasarathy, M & A Chief of Mahindra & Mahindra Group says that he believes in 1/3rd philosophy. He says that when you build a team for an M & A, split it into three. The first team should do the transaction and walk away, the second should be there for the first 100-day integration and then move on. The last team is involved in the business. He also says that his M & A team typically has two kinds of people – the process manager who knows the nuts and bolts of the deal and the business manager who knows the nuts and bolts of the business. The two teams work in tandem on every deal.

3. Learning from the M & A deals done by the company. Every completed deal needs to be put through a very detailed analysis in order to learn about how good the company was or not at developing and defining its strategies : identifying target company for takeover, efficacy of its due diligence exercise



and its integration process. Such introspection enables the company to institutionalise M & A policy, process and people to ensure discipline, focus, and commitment.

4. Companies who have consistently yielded the best returns tend to be frequent acquirers and careful learners from their experiences. This is the main reason why serial acquirers are more successful than one-off acquirers. The willingness of the management of the company to analyse its own performance and commitment to make changes for improvement is very critical component of M & A game.

5. The successful companies do not deviate from their core competencies as they leverage their accumulated experience in their own industry to grow inorganically either vertically or horizontally.

6. Value creation is a continuous and consistent process which successful companies know thoroughly well and they never lose their sight after the deal is over. On the contrary, they continue to put their business plan about the growth in top line, sales, margins, cash flows, cost reduction measures and consequent increment in the bottom line always in front of them. The intensive research of the target company that the acquiring company has done before the deal is consummated, was in the form of its new business and revenue models that can deliver value. This approach prescribes to have a good strategic concept of the deal grounded in industry fundamentals. Post-deal management is made much easier if a clear vision is defined as part of the acquisition process. Furthermore, this vision should be developed into an operating manual. The constant review of this operating directives be followed up with rapid and intense implementation to ensure major strategic and operational changes in the first 6 months because within this period the acquirer has the traction to make changes. After this initial period the newness wears out and change becomes more difficult. This management style will help create value for all stakeholders. We don’t have to run the acquired company on earnings per share and next year’s accounting figures only. What one has to remember is, that the cash flows are more important statements. The company has to maximise cash flows which only maximises share holder value and hence one need to manage the real thing and not accounting as is normally misunderstood.

The above is a narrative of acquisition strategy and management, though, volumes have been written on this topic and scores of management consultants are in the business of providing necessary assistance.



NOTES

Income Tax – Critical Issues (including International Taxation)


Brain Trust Income Tax – Critical Issues

(including International Taxation)

SAURABH SOPARKAR Advocate

RAJAN VORA Chartered Accountant



Rajan Vora heads Ernst & Young India’s Direct Tax Litigation practice and is presently based in Mumbai, India. He has extensive experience in representing tax litigation matters before the Income Tax Appellate Tribunal and Authority for Advance Rulings. His experience includes more than 35 years in litigation and corporate tax advisory services including Transfer Pricing and International Tax issues.

He was co-opted for various special committees by Institute of Chartered Accountants of India. He was the President of Bombay Chartered Accountants’ Society in 1990-91. He has authored several publications of Professional organisations like that of Institute of Chartered Accountants of India, Bombay Chartered Accountants’ Society and Chamber of Tax Consultants, etc. He is a member of Taxation Committee of Bombay Chartered Accountants’ Society and Indian Merchants’ Chamber.

He has presented papers and has been regular panel speaker at Seminars and Symposiums in India and abroad.

Mr. Saurabh Natwarlal Soparkar, is B.Com., LLB, A.C.A., Senior AdvocateDetails of educational qualifications(a) Passed S.S.C. Examination from Gujarat S.S.C. Exam. Board in March 1973 obtaining 6th rank in the State of Gujarat.(b) Passed B.Com. Examination from the Gujarat University in April 1977. secured 1st rank among the students of ‘Accountancy & Auditing’.(c) (i) Passed LLB (Gen.) Exam. from the Gujarat University in April 1979 with 1st class and obtained two gold medals for the highest marks in the paper of ‘Hindu Law and Mohammedan Law’. (ii) Passed LLB (Spl.) Exam. from the Gujarat University in April 1980 with 1st class.(d) (i) Passed the intermediate Exam. of the Institute of the Chartered Accountants of India in November 1978. Secured 3rd rank in India and 1st

in the State of Gujarat. (ii) Passed the final Exam. of the Institute of the Chartered Accountants of India in November 1980. Secured 3rd rank in India and 1st in the State of Gujarat. Awarded prizes for the highest marks in the paper of ‘Company Law’Experience(A) Practising as an advocate before the Gujarat High Court and the Income Tax Appellate Tribunal,

Ahmedabad since June 1981. Fields of interest : Tax Laws, Company Law and Commercial Laws. Designated as a Senior Advocate by the Gujarat High Court.

(B) Had been standing counsel for the Income Tax department for a period of three years (1986-89) for the State of Gujarat.

(C) Contributed papers at various residential seminars held at different places for:1. I.C.A.I., New Delhi, BCAS and CTC, Bombay2. Ahmedabad, Baroda, Rajkot, Surat, Pune, Agra, Lucknow, Raipur, Kanpur, Bengaluru, Chennai,

Raipur, Kanpur, Nagpur and various other branches of the I.C.A.I. & I.C.S.I.3. Income Tax Bar Associations and the Tax Advocates Associations.4. All India Federation of Tax Practitioners

(D) Visiting Professor at I.I.M., Ahmedabad on the subject of ‘Corporate Tax Planning’ for about 22 years.(E) Member: Board of Governors

1. CEPT University, 2. Ahmedabad University, 3. Ahmedabad Education Society(F) Past President of Income Tax Appellate Tribunal Bar Association

CA Rajan Vora

Adv. Saurabh Soparkar



1. The assessee an individual filed his TDS return as required u/s 200(3) for the quarter ending September, 2012 on 30th June, 2013. He was required to file his TDS return by 15th October, 2012. Thus the return was delayed by 258 days. The assessee received a notice of demand asking him to pay sum of ` 51,600/- calculated @ ` 200/- per day u/s 234E of the Act. Assessee being aggrieved by such demand notice seeks your advice to file an application u/s 264 of the Income Tax Act since he was sick during such time and that he could not attend his normal business during the said period. Please advice as to whether his action would be entertained by the Commissioner if not what is the remedy available to him. The AO is pressing for demand and threaten the assessee of taking coercive action? Whether the assessee can deny the liability u/s 234E and file appeal before the First Appellate Authority?. (SS)

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2. An Individual occupied rented shop in a building which was used for the purposes of his business. The owner of the building enters into an agreement with the developer for redevelopment of the said building on 1st June, 2014. Consequence to the same, the Developer enters into an agreement with the assessee and agrees to give him two adjacent residential flats in the new building. Will assessee be liable to capital gain tax? If yes whether the assessee would be able to claim deduction u/s 54F since he receives residential flats against his shop? If the builder gives possession of the new flats after three years, what would be the tax consequence? Whether the assessee is entitled to claim deduction u/s 54F in respect of both the units even after the amendment in the Act effective from A.Y. 2015-16 where it is provided that the assessee would be entitled to claim the benefit u/s 54F for one residential house only as against a residential house provided earlier? (SS)

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Brain Trust — Income Tax – Critical Issues (including International Taxation)

Adv. Saurabh Soparkar, CA. Rajan Vora



3. TDS u/s 195 - Grossing up u/s 195A read with Section 206AA: If any income is payable to a Non-Resident on ‘Net of Tax’ basis, the Resident payer is required

to compute the amount of TDS in accordance with section 195A. If the Non-Resident payee does not have a PAN in India, section 206AA gets attracted. If the Non-Resident payee is eligible to access a DTAA with India, the issue arises as to how the ‘grossing up’ is to be done. In other words, is the grossing up u/s 195A to be worked out with reference to the TDS rate specified in the applicable DTAA, or the TDS rate of 20% as specified in Section 206AA? (SS)

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4. Mr. Sarosh Gujral, a proprietor of Gujral Tuition Classes following cash system of accounting, receives during the period from 1st October, 2012 to 31st December, 2012 full fees for next academic financial year i.e. financial year 2013-14. Would the Assessing Officer be correct in holding that since the amounts have been actually received, they are to be taxed in A.Y 2013-14, i.e. in the year of receipt, more so as he is following cash system of accounting for taxation? The assessee’s contention is that the amounts received are mere advances and he would offer the said amounts as income in the next financial year when he actually conducts classes in respect of such fees received. Is his contention right?

He has made payment on 28-3-2013 for his air ticket to Bangaluru, the travelling to take place in May 2013. He has also acquired a car on lease for which lease rentals are paid in advance for three years before the year end. He wants to claim these amounts as deduction in the year of payment, i.e. A.Y 2013-14.

Please advise. (RV)..............................................................................................................................................................................

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5. The assessee filed the return of income of 29th October, 2007, the return was processed u/s 143(1) of the Act. Later on 24th December, 2009, the Assessing Officer made a reference, under section 92CA(3), to the Transfer Pricing Officer for determination of arm’s length price of the international transactions entered into by the assessee with its associated enterprises. According to order passed by the TPO the income of the assessee required an upward revision of ` 2 crores. Based on such order of the TPO, the Assessing Officer proceeded to reopen the assessment, recording the reasons as follows:

“As per form 3CB, the international transactions entered into by the assessee with the associated enterprises were of ` 50 Crores and to ascertain as to whether the international



transactions with the AEs were at arm’s length, reference was made under section 92 CA(3) of the Act to TPO and that vide order dated 15-10-2010. The TPO found that the international transactions of the assessee with its associated enterprises were not at arm’s length and an adjustment of ` 2 crores was directed to be made to the income of the assessee. As per the order u/s 92CA(3) of the Act, the income of the assessee has to be enhanced by ` 2 crores.

Considering the above fact of the case, as the assessee has not valued its international transactions with associate enterprises at arm’s length, resulting under assessment of income by an amount of ` 2 crores should have been added to the income.”

The assessee objects to this initiation of reassessment proceedings as also adjustment made as per TPO’s order Pl. advice. (Considering the fact that the adjustment ordered by the TPO are based on the facts of the case and that, the assessee himself appeared before the TPO from time to time and did not contest or, objected to the notice issued by the TPO to compute the arm’s length price). (RV)

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6. Taxability of Reimbursement of Salary / Remuneration of an Expatriate/ Seconded Employee:

The issue of taxability of reimbursement of salary/ remuneration of an expatriate employee on secondment/deputation by a parent company or an associate enterprise has become controversial due to divergent judicial pronouncements. The tax department is taxing the same as FTS in the hands of the parent company/associated enterprise though there is no mark up and appropriate tax is deducted from the salary of the expatriate employee.

What is the correct view? How should such an arrangement be structured to avoid controversy? (RV)

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7. The assessee filed return of income declaring income of ` 75 lakhs under the normal provisions of the Act and ` 90 lakhs as per section 115JB. The Assessing Officer while completing the assessment under section 143(3) computed book profits for the purpose of minimum alternate tax under section 115JB and accordingly levied the interest under sections 234B and 234C. The assessee paid the tax on the income assessed by the Assessing Officer however challenges the levy of interest under sections 234B and 234C stating that at the relevant point of time there were various decisions including the decision of the Hon’ble



Supreme Court in the case of CIT v. Kwality Biscuits Ltd. [2006] 284 ITR 434, wherein it has been held that no interest under sections 234B and 234C is leviable once the income-tax is determined under section 115JB. However, the Commissioner of Income Tax (Appeals) did not accept the contention of the assessee and held that in view of the later decision of the Hon’ble Supreme Court in the case of Jt. CIT v. Rolta India Ltd. [2011] 330 ITR 470 levy of interest under sections 234B and 234C is mandatory and consequential and hence confirmed the same. The assessee seek your advice on the stand taken before ITAT. (SS)

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8. The assessee company was in the business of generation of electricity. Pursuant to an agreement with one M/s General Electricals the assessee company was allowed to transmit electricity generated by it on exclusive basis from the power lines owned by the said General Electricals. During the course of assessment proceedings for the A.Y. 2009-10 the AO observed that the assessee company had not deducted tax u/s 194-I of the Act from the payment made to General Electricals and therefore he disallowed the expenditure incurred on transmission of electricity charges paid to General Electricals u/s 40(a)(ia) of the Act. According to the AO Explanation (i) to section 194-I defines rent as any payment, by whatever name called, under any lease, sub-lease, or tenancy or any other agreement or arrangement for the use of land, building, plant, machinery or equipment, etc. The assessee seeks your advice on the action of the AO.

It is pointed out by the assessee that the said General Electricals had already filed its return of income for the year under consideration and that it has also paid taxes due on such returned income which include the income received from the assessee and therefore according to the assessee amendment made in section 40(a)(ia) by way of second proviso to section 40(a)(ia) should be applied in its case and that no disallowance should have been made. Whether the amendment made by Finance Act, 2012 by way of insertion of second proviso to section 40(a)(ia) is of retrospective nature or not?

In view of conflicting decisions, please advice. (SS)..............................................................................................................................................................................

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9. Section 90(2) vs Section 206AA If a Non-Resident payee is eligible to access a treaty but does not have a PAN in India, does

tax have to be deducted as per the rates specified in various articles of the applicable DTAA,



or in accordance with provisions of Section 206AA? In other words, does Section 90(2) override Section 206AA, or does Section 206AA override the provisions of Section 90? (SS)

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10. The assessee Mr. Raja received the notice u/s 148 on 31-12-2011 for the A.Y. 2008-09. In response to which Mr. Raja vide letter dated 12 January, 2008 submitted that the return originally filed on 30th September, 2008 should be treated as return in response to the notice issued u/s. 148. Thereafter the assessment was completed u/s. 143(3) of the Act making certain addition. However during the course of assessment proceedings though the assessee had participated in such assessment proceedings he had objected the same on the ground that he had not received notice u/s. 143(2) of the Act and therefore assessment proceedings were bad in law. However during the course of appellate proceedings it was stated by the AO that original notice was issued on the assessee on 10th July, 2012 which was returned back and therefore an inspector was sent to the address of the assessee who had affixed the notice on 22-7-2012 since the assessee’s flat was locked. Thus according to the AO since the assessee had already participated in assessment proceedings he could not raise such issue in appellate proceedings and that its case was covered by provisions of section 292BB of the Act. The assessee wants to challenge assessment on both the grounds that merely co-operating in the assessment proceedings would not disentitle him the right to object such assessment since he had already objected to such assessment and also on the ground that notice by affixture was bad in law. Please advice. (RV)

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11. The AO has made addition by invoking the provisions of section 14A of the Act, in the following cases

• The assessee had not debited any expenses against such exempt income stating that the same were not incurred for the purpose of earning such income.

• Despite the assessee having no income exempt from tax, earned during the year under consideration.

• The assessee had not incurred any expenditure during the year under consideration and the AO makes the addition on notional basis by invoking rule 8D.



• The assessee was dealing in shares and had not received any dividend during the year and had offered income from dealing in shares as income from business and profession. Would it make any difference if the assessee receives ` 1 as dividend? (RV)

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12. Exclusions u/s. 9(1)(vii)(b) from scope of taxable FTS

Section 9(1)(vii)(b) provides that fees for technical services payable by a resident are not deemed to accrue or arise in India if they are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or ………………”

What is the true import of the underlined words?

Poser 1

An Indian manufacturer of machinery sells a machine in Mexico. It engages a local engineering company to install, commission and maintain the machine in Mexico. Would the fees paid to the local Mexican engineering company for installation and commissioning of the machine be taxable in India?

Poser 2

The parent company of an Indian subsidiary supplies an advanced machine to its customer in Pakistan. As per the arrangement, the Indian subsidiary is required to install, commission and maintain the machine in Pakistan. The Indian subsidiary obtains the services of its Chinese counterpart and avails of the services of Chinese technicians to carry out the work in Pakistan. Would the fees paid by the Indian company to the Chinese company for installation and commissioning of the machine in Pakistan be taxable in India? (RV)

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13. The assessee was an owner of the property for more than ten years which was given on rent. The assessee has all along offered the income by way of rent as business income. However he had not claimed any depreciation on the said property all along nor was the same allowed by the AO. During the year under consideration the assessee sold the said property and income therefrom has been offered to tax as long term capital gains. The AO treated such income on sale of property as short terms capital gains invoking the provisions of section 50 of the Act



(since according to the AO the property was business asset and that depreciation there on was allowable though not claimed.)

The assessee claims that the income from rent was wrongly assessed/offered as business income. According to the assessee the AO should have correctly assessed such income as Income from House Property as against Business Income wrongly offered by the assessee. In this regard the assessee wants to rely on the Circular 14 of 1955 dated 11-4-1955)

According to the AO though the section 50 refers to capital assets in respect of which depreciation “has been allowed “ under the Act, should be interpreted as “allowable” under the Act. And that even if the depreciation is not claimed or allowed, the income on sale of depreciable asset would be covered within the ambit of section 50 of the Act (the AO takes cue from the provision of section 43(6) which defines WDV where the intent of the legislature clearly depicted by using the words “depreciation actually allowed”.

The assessee wants to challenge such addition, please advice. (SS) ..............................................................................................................................................................................

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14. Interpretation of MFN Clause in Protocol to India-France DTAA

Payment for management services is taxable as Fees for Technical Services (FTS) under the India-France tax treaty. Treaty does not have any clause on “make available”. Protocol to the tax treaty provides for Most Favoured Nation (MFN) clause. Most Favoured Nation (MFN) clause provided in Article 7 of the Protocol to the tax treaty is given below.

In respect of Articles 11 (Dividends), 12 (Interest) and 13 (Royalties, fees for technical services and payments for the use of equipment), if under any Convention, Agreement or Protocol signed after 1st Sept., 1989, between India and a third State which is a member of the OECD, India limits its taxation at source on dividends, interest, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate of scope provided for in this Convention on the said items of income, the same rate or scope as provided for in that Convention, Agreement or Protocol on the said items income shall also apply under this Convention, with effect from the date on which the present Convention or the relevant Indian Convention, Agreement or Protocol enters into force, whichever enters into force later.

Article 7 of the Protocol given above contains restrictions on both – the rate and scope. Can “make available” clause be read into treaty in view of MFN status given in the protocol? (SS)

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15. Taxability of Offshore and Onshore Supply and services under a Composite Contract:

Please explain the following issues on taxability of offshore and onshore supply and services.

a) Can composite contract for installation and commissioning of a project in India be dissected for the purpose of taxability of the contract? If yes, explain the basis and manner of apportioning the income earned on offshore supply and onshore supply and services?

b) If certain services linked with the manufacture and fabrication of the material and equipment to be supplied overseas form an integral part of the composite contract, will such services be taxable in India?

c) Will the answer be different if the foreign company has permanent establishment in India?

d) Three entities form a consortium and undertakes composite contract. Each entity agrees to perform specific few tasks out of the various tasks given under the composite contract. Will it be taxed as Association of Person or will each entity be taxed for the profits earned by each of them independently? (SS)

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16. The assessment of the assessee was reopened by the AO for the assessment year 2009-10 on the ground that he had received an information from the DDIT, that the assessee had purchased goods from the parties whose names were appearing in the list of suspicious dealers who were only issuing accommodation bills without actually supplying any material. During the assessment proceedings the appellant had challenged the reopening of the assessment stating that the AO was not having any material to come to a satisfaction that the income had escaped the assessment. According to the assessee, the AO had not applied his mind on the subject matter since he did not have any material before him.

During the assessment proceedings the assessee had produced goods received note, gate pass, invoice of the vendor, stock records showing purchase and utilisation of such material in manufacturing/sales thereof. The assessee also produced bank statement evidencing the fact that the payments were made by the assessee by account payee cheques. However according to the AO the records produced by the assessee were self serving records and that merely because payment is made by account payee cheque would not prove the claim to be genuine. Further according to the AO the assessee had not produced those parties and therefore according to him the assessee had failed to discharge onus lied on him.

Further according to the assessee the AO has not given any material on which he has relied on, such as statement of the vendor/affidavit that he has issued only accommodation bills or any other material which the assessee could rebut. Thus assessee wants to challenge the order on following grounds please advice.

• The onus of producing party lied on the AO and not of the assessee since reopening was made on the basis of such statement and information received by the AO.



• According to the assessee if the purchases are treated as bogus then in that case sales should also be treated as bogus and accordingly the income reduced to the extent of GP margin offered by the assessee.

• The assessee challenges the reopening of the assessment u/s. 147 since according to him the AO had not applied his mind.

• The assessee also challenges the order of the AO on the ground that the AO had violated the principles of natural justice by not providing material asked for. Please advise (RV)

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17. Mr. Shyam was residing in old building of the Co-operative Society. The Co-operative Society has decided to re-develop the said building and accordingly approached the Developers. The Developers has agreed to demolish the building and give a new flat having larger area to each member.

Accordingly, Mr. Shyam surrendered the flat on 1st January, 2010 and was allotted a new flat of larger area in the building to be constructed. The building was constructed and a possession of new flat was given to Mr. Shyam on 31st December, 2011. Mr. Shyam has following questions:-

a) Whether surrendering of flat would amount to a sale of premises and whether Capital Gain would arise or not? If yes, what will be the value of surrender Flat ? Whether can he state that the amount is invested in new flat and accordingly the benefit of Section 54 is available?

b) He wants to sell the flat immediately on getting possession of the new flat. Whether the transaction of selling a new flat would be treated as a Long Term Capital Gain or Short Term Capital Gain? In such a situation, what will be the cost of new flat received in lieu of surrender of old flat?

c) Any other tax implications in the above matter? (RV)..............................................................................................................................................................................

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18. Domestic Transfer Pricing Provisions

Aggregate of specified domestic transactions (SDT) should exceed ` 5 crores to be considered a SDT. If the assessee has entered into following transactions, will provisions of SDT apply?



Situation-1

Nature of transaction Book value (`)

Expenditure to related party specified u/s. 40A(2)(b) 2 crores

Goods transferred from 80-IA unit to other unit 1 crore

Sale of goods to associated enterprise 2.5 crores

Situation-2


Expenditure to related party specified u/s. 40A(2)(b) 2 crores

Goods transferred from 80-IA unit to other unit 1 crore

Sale of goods to associated enterprise from 80-IA unit 1.5 crores

If the ALP of goods sold to associated enterprise is 2.5 crores, will the answer be different?

Situation-3


Expenditure to related party specified u/s. 40A(2)(b) 1 crore

Purchase of fixed asset from the related party specified u/s. 40A(2)(b) 1 crore

Sale of fixed asset to the associated enterprise from 80-IA unit 1 crore

Sale of goods to associated enterprise from 80-IA unit 2.5 crores

Will expenditure on fixed asset eligible for 100% deduction u/s. 35(2AB) or 35 be considered for limit of ` 5 crores? (RV)

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19. Mr. Rajaram booked a flat on 1st January, 2010 for ` 55 lakhs and paid initial payment of ` 2 Lakhs by cheque. Subsequently, Mr. Rajaram made certain payments as per the progress of the construction work. Mr. Rajaram wants to enter into an agreement and register the same. However, he was told that the Stamp Duty Valuation of the said flat as on today is ` 1 Crore. He has no alternative but to pay the Stamp Duty at the prevailing rate. He would like to know whether the transaction, now, entered into for ` 55 lakhs will have any tax considering on account of introduction of Section 43CA of the Act and any other tax implications either to himself or to the builders. Please advise (SS)

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20. Mr. Purohit booked a flat on 1st April, 2010 and was issued a letter of allotment by the Builders for ` 60 lakhs. He went on paying the installments as per the progress of the work. He finally entered into an agreement with the Builders on 1st April, 2012. Building is now ready for occupation. He would like to sale the said flat for a consideration of ` 100 lakhs. He is in a dilemma as to whether he should take the possession of the flat and sell the flat or he should sell the flat before taking possession of the flat, in order to treat Capital Gain on sale of the flat as Long Term Capital Gain. Please advise Mr. Purohit in the matter. (SS)

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21. Fixed Place PE:

Foreign company provides services to an Indian enterprise through its employees/personnel who stays at hotel rooms. Will foreign company constitute fixed place PE in India? Will income of foreign company arising from supervision, direction and control over operations from contract executed in India be taxable in India? (SS)

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22. The assessee is a Charitable Trust registered under Section 12AA of the Act and is fulfilling of the conditions of Sections 11 & 12. During the year under consideration, the said trust sold House Property for a sum of ` 80 lakhs, however the valuation of the said property as per the Stamp Duty Authority was ` 100 lakhs. The Trust had invested the said money in Other Capital Assets. Whether the provisions of Section 50C will be applicable in the above case? Please advise. (RV)

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23. Will interest free loan given to an associated/related enterprise be considered for the purpose of DTP? (RV)

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24. A tax holiday undertaking has incurred loss during the year and has transactions covered u/s. 80-IA(10). Will domestic transfer pricing provisions apply? (RV)

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25. A Third Party Assurance (TPA) Company is giving cashless services to the insured person for and on behalf of an Insurance Co. The job of the TPA is to give the cashless services to the persons who have insured under “Mediclaim” policies issued by the Insurance Company.

In the case of TPA, the question has arisen in the A.Y. 2010-11 as to whether TPA is required to deduct tax on payments made to various hospitals for giving the medical services to the Insured persons and whose payment has been directly made by TPA company.

Assuming that though no services have been received by the TPA, but still it is required to deduct TDS but has not deducted TDS on the same. The AO has added the amounts paid by the TPA Co. to the various hospitals as no TDS was deducted, which was required. The TPA has argued as under:-

a) It was not required to deduct TDS since no services have been utilised by the TPA.

b) No expenditure has been debited to Profit & Loss Account and no expenses have been claimed in the return of income and hence the provisions of S.40(a)(ia) are not applicable to the facts of the case. According to TPA, it is only a felicitator and the expenditure was paid for and on behalf of the insurance company and TPA has no say in the final determination of the claim. It has received full amounts from the Insurance Company without any add on the payments to the hospitals. For providing the services to the insurance company, it receives separately certain fixed amount from the Insurance Co.

c) Even otherwise, the second proviso to section 40(a)(ia) would be applicable, though same has been introduced by Finance Act, 2012 but is of retrospective nature.

d) Lastly, it argued that the provisions of S.40(a)(ia) is applicable only to the amounts “payable” as on the last date of the year and not to the payments already made before the year end as envisaged in S.40(a)(ia).



Please advise the TPA Co. as to whether line of arguments stated above are correct or not ? (SS)

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26. Indian Subsidiary of a Foreign Company

Under what circumstances and conditions can an Indian Subsidiary be said to constitute a PE of its parent company in India? What precautions should be taken while structuring the business arrangement between the parent and subsidiary companies? (SS)

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27. The assessee is a Charitable Trust and fulfilled all the conditions in respect of the Charitable Trust. However during the year, it has spent ` 26 lakhs on Other General Public Utility as envisaged u/s.2(15) of the Income-tax Act.

The Commissioner of Income Tax (Exem) has withdraw the registration granted u/s.12AA on the ground that the appellant is carrying on business activities.

According to the Trust, the registration granted u/s.12AA cannot be withdrawn since the condition as stated in S.2(15) of the Act is to be looked into every year. It is possible that in the next year, the trust may not utilise the money for General Public Utility and in such event, the income earned by the trust will be exempt.

Please advise in the matter (RV)..............................................................................................................................................................................

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28. a) Will remuneration to non-resident director be covered under the provisions of DTP or will it be treated as an international transaction?

b) How will the remuneration paid to a partner or a director be benchmarked?

c) Will provisions of DTP apply if both the units are entitled for tax holiday of 100%? (RV)..............................................................................................................................................................................

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29. Recovery of outstanding demand

a) The assessee has sought the stay of demand before the Commissioner of Income Tax (A) in respect of which appeal is pending before him.

The appellant requested the CIT(A) to keep the demand in abeyance till the disposal of appeal, however, the CIT(A) is of the view that only the Commissioner of Income Tax has power to grant the stay. Can CIT(A) grant the stay for recovery of amount?

b) The Company was granted the Stay of Recovery of Outstanding Demand by the ITAT. However, in spite of specific direction by the ITAT, the AO obtained a consent letter from the assessee and recovered part of the amount. Does the AO has power to recover the amount / adjustment of refund, even with the consent of the company, though there was a stay of demand by the ITAT? (SS)

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30. Mr “A” filed the return declaring an Income of ` 5 lakhs. The assessment was taken under scrutiny. On receipt of the notice, Mr A realised that by mistake he has not considered one bank account and in which there was a income of ` 3 lakhs which remained to be offered in the return of income. Immediately on realizing the mistake he voluntarily disclosed the income and requested the Assessing Officer not to levy the penalty u/s.271(1)(c) of the Act.

Can income declared voluntarily be treated as a concealment of income or not, considering the recent judgment of Supreme Court in the case of Mak Data P Ltd. v CIT 358 ITR 593 ? What is the position in such type of cases were income has been declared to buy peace or to avoid litigation vis-a-vis penalty u/s.271(1)(c) of the Act. (SS)

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