TAXATION OF EXPORT INCENTIVES ON CASH BASIS – YAHI HAI RIGHT CHOICE!

By Subash Agarwal, advocate

1.       INTRODUCTION

It is a well-known fact that various incentives are provided to the exporters to make it easier for them to compete in the international market where the players from the developed economies are better placed in terms of infrastructural facilities and lower cost.

          The benefits that the exporters are normally entitled to in regard to the payment of import/customs duty are as under –

(i)      Duty Entitlement Pass Book Benefit (DEPB)

(ii)     Duty Draw Back Benefit (DDB)

(iii)    Duty Exemption Entitlement Certificate (DEEC) also known as Advance License Scheme

(iv)    Duty Free Replenishment Certificate (DFRC)

Under the aforesaid schemes, an assessee is entitled to import entitlements on the basis of exports at zero or concessional rate. The said entitlements can be utilised either by way of actual import of raw material at  zero or concessional rate or the said entitlement can be sold in the open market at a premium and the profit is pocketed. In the case of advance licence scheme, the exporter is entitled to the benefit on the basis of future export commitments but on failure to honour the commitment, the exporter has to make good the benefit wrongly availed to the government.

2.       ENTITIES FOLLOWING MERCANTILE SYSTEM ARE ON THE   HORNS   OF DILEMMA   IN CERTAIN SITUATIONS

In certain situations, the assessees following mercantile system are sitting on the horns of dilemma as to how to account for such benefits particularly when the benefit is merely notional and may not materialise in the subsequent year. Common instances of such cases are-

a) Actual entitlement earned but no import of raw material is made.

b) Actual import of raw material is made at zero or concessional rate but no corresponding sale is made.

c) Actual entitlement earned in year one but same is sold at a profit in year two.

For the followers of mercantile system, department also insists that the benefit on the basis of entitlement be offered to tax in the year one even if actual sale is made subsequently. The problem is compounded when the assessee himself takes credit of the estimated benefit in its accounts on the insistence/advise  of the accountants/auditors.

3.    LEGAL POSITION- NOTIONAL/CONTINGENT PROFITS CANNOT BE TAXED EVEN IF CREDITED IN ACCOUNTS.

Some of the reported judgements from the high courts and the apex court on the issue are analysed hereunder-

a)   In the case of Indian Overseas Bank Ltd. vs. CIT 246 ITR 206 (Mad), it was held that even in the mercantile system of accounting, any contingent/estimated benefit cannot be brought to tax.         

b) In CIT v. Shoorji Vallabhdas and Co. [1962] 46 ITR 144, 148 (SC)  it has been  laid down as under :

"Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a hypothetical income, which does not materialise."

c)    The above principle is applicable irrespective of whether the accounts are maintained on cash system or under the mercantile system. If the accounts are maintained under the mercantile system what has to be seen is whether income can be said to have really accrued to the assessee-company.

In CIT v. Birla Gwalior (P.) Ltd. [1973] 89 ITR 266 where the assessee maintained its accounts on the mercantile system, hon’ble Apex court after referring to the decision in Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC), which was also a case where the accounts were maintained on the mercantile system, has held:

"Hence, it is clear that this court in Morvi Industries' case [1971] 82 ITR 835 did emphasise the fact that the real question for decision was whether the income had really accrued or not. It is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income."

d)   In Poona Electric Supply Co. Ltd. v. CIT [1965] 57 ITR 521, Supreme court held

"Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act."

e)    Above view was also reiterated in Godhra Electricity Co. Ltd. V. Commissioner Of Income-tax 225 ITR 746 (SC)

4.       SOME DIRECT CASE-LAWS ON THE ISSUE

Above mentioned principles have been adopted in regard to adjudication of the question of  year of taxation of export license benefits in the following cases-

(i)      Jamshri Rajitsinghji Spg. & Wvg. Mills Ltd. V. Inspecting Assistant Commissioner. 1992-(041)-ITD -0142 -TBOM

FACTS

During the previous year relevant to the assessment year under appeal, the appellant had exported certain quantities of goods manufactured by them against which they were entitled to import 36,674.705 kgs. of fibre. No portion of this quantity was actually imported during the year. In the accounts for the relevant year, the appellant company calculated that if 36,674.705 kgs. of fibre were imported, it would be entitled to exemption from customs duty otherwise chargeable amounting to Rs. 31,75,231. This amount was taken to the credit of profit & loss account by reducing the material consumption account and the corresponding debit was raised to the material import entitlement account which appeared on the assets side of the balance-sheet. In return of income, it was claimed that by making these entries the appellant had taken into account a notional profit which it actually had not earned and which was not exigible to tax. He claimed that the book profits should, therefore, be reduced by a sum of Rs. 31,75,231.

HELD

“What the appellant had accounted for in its books was a future duty benefit which it would get in respect of imports of fibre if and when such imports were to be effected. Then again, the materials imported against licences under the scheme were to be utilized for the manufacture of the resultant products specified in the Duty Exemption Entitlement Certificate and clause 30 of the Scheme provided that such materials shall not be loaned, sold or transferred, disposed of otherwise under any circumstances. In the present case, the appellant had acquired advance licences on two occasions in respect of two instances of exports referred to above on 29-10-1984 and 23-3-1985 and had applied for further licences in respect of cloth exported and yarn exported; but the benefit by way of Duty Exemption in respect of advances, which are received or due to be received by the assessee, had not accrued to the assessee because no imports had been effected. The contingency on which such benefit could be said to have accrued was the import of the fibres which the appellant could effect duty-free as a consequence of the exports effected by it under this scheme. The fact that in the accounts this was shown as a material import entitlement does not ipso facto clothe it with the nature of income. The considerations which weighted with the company in making such entries in the books to show a figure of book profits may be different and we are not aware under what circumstances this item came to be included in the books. Judging purely from the point of view of liability to income-tax, we are of the view that this item of duty exemption was neither income on accrual basis nor had it actually been received nor did it afford any tangible benefit to the appellant in the form of concession of duty in the year of account for the simple reason that the liability to pay duty did not exist during this year since no goods were imported. It can happen that even in cases where export is made, for some reason or the other, the appellant fails to obtain the advance licence or fails to effect imports in to accounting year. In such an eventuality, the benefit of duty exemption cannot be said to arise and there is, therefore, no question of taking credit for DEEC. The amount of Rs. 31,75,231 can at best be described as an estimated value of concession or saving in import duty that the appellant expected to earn at the time of importing raw material. Such concession or such benefit can only be accounted for in the year in which the imports are effected. It is not a benefit in praesenti but in futuro. No profit or reduction in liability has actually been earned by the appellant during this year. Such concession in duty or what is called duty exemption is anticipated but not actually realised. It can be realised only in subsequent years if and when the appellant effects imports. In our opinion, no income can be said to have accrued or arisen in respect of advance licences received in the current period on the goods exported because no income in real terms had accrued. The cases cited by the learned counsel, to which detailed reference has been made in the preceding paragraphs, would seem to support this view. We need refer to only one more case of the Madras High Court in the case of CIT v. Indian Overseas bank [1985] 151 ITR 446. In that case, the Bank dealing in foreign currencies on behalf of its customers had certain foreign exchange contracts entered into by it which were not settled on the close of the accounting period ended December 31, 1967. As the contracts were in different foreign currencies, the loss or profit arising on outstanding contracts was estimated based on the rate of exchange as on the closing day. In view of the devaluation of Sterling in November 1967, the loss arising on account of outstanding foreign exchange amounted to Rs. 9,20,125. The assessee-bank made provision for this in its accounts on the ground that this amount had to be provided for before ascertaining the profit. The ITO estimated the loss as purely anticipated and uncertained. The AAC reversed the order which was confirmed by the Tribunal. The Madras High Court, on these facts, held that only the actual loss incurred can be deducted but not any probable or possible loss. As there was no settlement of the outstanding contracts, the amount claimed could only be considered to be notional or anticipated loss and such notional or anticipated loss could not be allowed as a deduction. The same principle on a parity of reasoning would apply to the taxability of anticipated profit or concession in excise duty which the appellant expected to get in the event of import of raw material. Since such event had not taken place during the year of account, the benefit, if any, was inchoate, incapable of actual determination and had, in effect, not accrued during the year of account. We are, therefore, inclined to accept the stand of the appellant that this was not an income of the appellant during the year. All the principles laid down by the various judicial pronouncements, to which we have referred in the earlier paragraphs, have accepted the theory of real income and whatever has been stated in these judgments would seem to apply in a case of this type. No real income had accrued to the appellant by virtue of getting or expecting to get advance licences irrespective of the fact that such estimated benefit was accounted for in the books of the appellant. This fact, as we have pointed out earlier, is not determinative of the issue of the taxability of this amount. We would, therefore, hold that the amount of Rs. 31,75,231, being the value of material import entitlement receivable by the appellant, does not constitute the income of the appellant for the year under appeal since it had neither accrued nor arisen during the year of account. This ground of appeal is, therefore, allowed.”

(ii)   Joint Commissioner Of Income-tax Spl. Range V. Deva Singh     

     Sham Singh.2005-(095)-ITD -0235 -TASR

“In the present case, we are concerned with section 28(iiia) read with section 2(24)(va) which were inserted with retrospective effect from 1-4-1962. The effect of this insertion is that the "profit on sale of a licence granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947" became chargeable to tax under the head 'Profits and gains of business or profession' and the earlier controversy regarding such item being capital or revenue receipt was set to rest.

Considering the facts of the present case, we find that the assessee credited a sum of Rs. 62,85,884 to the profit and loss account being the consideration received/receivable for transfer of material import entitlements during the year and offered it for taxation. Apart from that a sum of Rs. 125.08 lakhs was also credited to the profit and loss account

-----------            ------    ----

Break-up of this amount has been appended at page 41 of the paper book which shows that Rs. 45.08 lakhs is the estimated value of material import entitlement in the shape of advance licence, whereas the other item, namely Rs. 80 lakhs is the amount of special import licence. At this stage, it would be appropriate to appreciate the concept of "Material import entitlements". In simple terms, it is an authorization to import goods at concessional custom duty or make duty-free import. Whereas the Special import licence is issued pursuant to the making of actual exports, the advance licence is issued in anticipation of export and is coupled with the export obligation. If the exporter fails in discharging its obligation of making the requisite exports, he becomes liable to reimburse the Government with the concession in duty availed by it through such advance licence. By virtue of holding the Import Entitlement (Special Import Licence or Advance Licence), an exporter becomes entitled to make imports itself. Alternatively, he can also sell Import Entitlement in the market and earn a profit therefrom. In the instant case, the assessee valued the profit from advance licence at Rs. 45.08 lakhs and the profit from sale of Special Import Licence at Rs. 80 lakhs and did not offer it for taxation. Besides these two figures, the actual amount realised by way of sale of import entitlements at Rs. 62.85 lakhs was duly credited to the profit and loss account and shown as taxable. The question for our consideration is to decide as to whether the sum of Rs. 125.08 lakhs is taxable or not which represents the notional value of the estimated benefit that the assessee may get in future. As noted above, there can be two ways of exploiting Import entitlements. The first, being the case where the exporter actually imports the goods at concessional rate of duty. In such circumstances, the imported goods becomes purchases and the question of profit can arise only when these are actually sold. To put in simple term, if the concessional purchase cost is Rs. 100 (Rs. 120 without import entitlements) and the goods are actually sold for Rs. 130. The event of accrual of income due to import entitlement can be said to take place when the sales are made which results into profit of Rs. 30. It can neither be at the threshold of acquiring the import entitlements nor at the time of making concessional or duty-free imports because the income does not accrue at the time of making purchases but when such goods are sold and income is realized after adjusting cost price against the sales consideration. The other situation may be where the imports are not directly made by the holder of Import Entitlement and the licences are actually transferred to the outside parties at premium. Our case falls in this category when the assessee acquired import licences in the year under consideration and sold them on premium in subsequent years, but the Assessing Officer proceeded to tax the estimated profit on the import entitlements in the hands of the assessee at the year end.

---   -----

The Legislature by inserting section 28(iiia) has settled the position by providing that profit on sale of a licence granted under Import (Control) Order would be charged to Income-tax. The expression "profit on sale" is employed in this sub-section in contradistinction to the cash assistance "received or receivable" as incorporated in section 28(iiib) and the duty of customs or excise "repaid or repayable" as contained in section 28(iiic). The intention is very clear that insofar as the import entitlements are concerned, the profit has to be recognised only when such licences are sold and the profit is, in fact, realised. Mere holding of licence as at the year end does not result into accrual of income. If the view of the department is accepted, it would amount to double taxation because not only the profit on acquisition of such import licences as is the case in hand, would be taxable but the actual profit realized on the sale of such licences would again become subject-matter of taxation in view of the specific provision contained in section 28(iiia). It is a matter of record that a sum of Rs. 62.85 lakhs, being the profit realized on sales of import entitlements in this year was voluntarily offered for taxation and as against the estimated income of Rs. 45.08 lakhs against Advance Licence recognized in accounts, only a sum of Rs. 6.64 lakhs was realized after the close of the year which was also declared for taxation in the succeeding years. In view of these facts, we hold that the income accrues at the time when the assessee transfers/surrenders import entitlements in favour of the outside party and not when such import entitlements are acquired or held by it. The order of the CIT(A) being in conformity with the statutory provisions, does not warrant any interference on this score. This ground is, therefore, not allowed.”

5.     Conclusion

                It is surprising that inspite of the settled law as explained above, the deparment is breathing down the assessee’s neck , still hauling the assessees over the coals on the issue leading to avoidable litigation.

DAMN THE TORPEDOES, MERILYN SHIPPING SURGES AHEAD FULL SPEED- Kolkata Tribunal now gives a detailed order considering A.P High Courts suspension order!!!

TRADING IN CURRENCY FUTURES – WHETHER SPECULATIVE?

By Subash Agarwal, Advocate

 “Whether the trading in Futures transactions in currencies is a business transaction and not a speculative transaction and losses incurred therein can be set-off with other business income?”

Before giving the answer, let us first analyse the relevant provisions of the Act and the applicable judgements of the Courts, if any and the said analysis is done hereunder-

1.           Futures transactions in currencies are no doubt business transactions because of the profit motive, regularity and volume involved. But it is imperative to see whether such transactions are “speculative” in nature since the losses in speculative transactions can be set-off only against “speculative” profits and against no other head of income.

2.           As per section 43(5), “Speculative transaction” means-

"a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips”.

3.           Though from the plain reading of the above definition of “speculative transaction”, the future transactions in currencies appear to be speculative in nature, but it is imperative to analyse the clause (d) of the proviso appended to section 43(5) which carves out exception to the above- stated rule.

Clause (d) states that an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 carried out in a recognised stock exchange shall not be deemed to be a speculative transaction;

Further, the meaning of the term “eligible transaction” has been explained in the “Explanation” appended to section 43(5). Since the transactions made in the recognized stock exchanges conforms to the criteria laid down for making the transactions eligible, it is not necessary to discuss the same.

4.                It is worthwhile to note that section 2(ac) of the Securities Contracts (Regulation) Act, 1956 defines “derivatives” as under-

“derivative" includes -

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices, of underlying securities;

From the above, it is clear that “Futures” and “Options” are part of derivative transactions. Since the value of such contracts varies with the price of the underlying security viz., shares, exchange rate / currency rate. In DCIT vs. Paterson Securities (P) Ltd. 127 ITD 386 (Chennai), it was held that a derivative is a financial instrument, the price of which has a strong correlation with an underlying commodity, currency, economic variable or financial instrument. The different types of derivatives are “future contracts and options”.

5.                    A confusion may arise as to whether “currency futures” is part of the term “derivative” as defined in section 2(ac) of SCRA, particularly when the term currency is not figuring therein. There are various reasons to come to the conclusion that “yes, it is!”. The reasons are-

(a)     The definition of “derivative” in section 2(ac) of SCRA is an inclusive definition, which means that any other item conforming to the given characteristics will also qualify to be a “derivative” transaction.

(b)    SEBI was constituted by the Government to protect the interests of the investors in securities and to promote the development of, and regulate the securities market (see Function of the SEBI as per section 11 of the SEBI Act, 1992).

But SEBI has also been regulating the currency derivatives as evident from the undernoted Press Release / Circular-

Ø  Press Release No. 297/2007 dated 14.11.2007.

SEBI approves new derivative products viz., Options & Futures in shares and Exchange traded currency Futures & Options.

Ø  SEBI / DNPD / Circular-38/ 2008 dated 06.08.2008

Guidelines issued for trading in Exchange Traded Currency Derivatives.

(c)    Earlier, the Central Government had notified vide Notification No. S.O. 1327 (E) dated 22.5.09, the MCX Stock Exchange Ltd., which provides India-wide electronic platform for trading in currency futures under the regulatory control of SEBI and RBI, as a recognized stock exchange for the purpose of section 43(5), clause (d). (Earlier notification dated 25.01.2006 was in respect of NSE / Bombay Stock Exchange, which dealt in ,inter alia, in derivatives relating to shares  and also currencies).

Then  after  United Stock Exchange of India (USE), the fourth pan India exchange, was launched for trading in financial instruments in India and received final approval from the market regulator SEBI to start currency futures trading, the Central Government has notified vide Notification No. 12/2011 dated 25.2.11 the said stock Exchange also as a recognized stock exchange for the purpose of section 43(5), clause (d)

It is worth noting that MCX Stock Exchange Ltd. (MCX-SX)  should not be mixed-up with the Multi Commodity Exchange of India Ltd., which is currently providing a platform for trading in commodities only. Commodity derivatives are so far outside the ambit of sec 43(5), clause (d).

Thus the intention of the government is also to consider currency as part of “Securities” for all practical and legal purposes.

               In view of the above discussion, it can be concluded that “Futures” transactions in currencies traded in the trading platform of the four recognized stock exchanges viz., National Stock Exchange , Bombay Stock Exchange , MCX Stock Exchange and United Stock Exchange of India  are business transactions and not speculative transactions and loss arising there from can be adjusted against any other business income including speculative income.

SOME RECENT DIRECT TAXES JUDGEMENTS: A COMPILATION (Part II)

 Subash Agarwal, Advocate

(A)    Supreme Court

1.       I.C.D.S. Ltd. vs. CIT 350 ITR 527 (SC)

Where assessee, engaged in business of hire purchase, leasing etc., having purchased vehicles from manufacturers, leased out those vehicles to customers, it was entitled to claim depreciation in respect of vehicles so leased out

Facts

Assessee was engaged in business of hire purchase, leasing and real estate etc. It purchased vehicles from manufacturers and thereupon leased out those vehicles to customers. Assessee's claim for depreciation on said vehicles was rejected on ground that it had merely financed purchase of these assets and was neither owner nor user of these assets.

Held

(i)                 It was apparent from records that assessee was exclusive owner of vehicles at all points of time and, in case of default committed by lessee, assessee was empowered to re-possess vehicle.

(ii)               Moreover, at conclusion of leased period, lessee was obliged to return vehicle to assessee

(iii)             It was also undisputed that assessee was a leasing company and income derived from leasing of vehicles had been assessed as its business income.

(iv)             Section 32 imposes a twin requirement of 'ownership' and 'usage for business' for a successful claim of depreciation.

(v)               As long as asset is utilized for purpose of business of assessee, requirement of section 32 will stand satisfied, notwithstanding non-usage of asset itself by assessee.

(vi)             Assessee satisfied both requirements of section 32, i.e., ownership and usage of vehicles for purpose of business, and, thus, its claim for depreciation was to be allowed.

2.       CIT vs. Monnet Industries Ltd. 350 ITR 304 (SC)

Interest paid on borrowed fund for mere extension of existing business, is allowable as deduction under section 36(1)(iii)

Assessee was having a ferroalloys manufacturing plant. It set up a sugar plant at a different place out of its borrowed fund. There was a unity of control and management in respect of ferroalloys plant as well as sugar plant and there was also intermingling of funds and dove-tailing of business. Since there was mere extension of existing business of ferro-alloys plant, interest paid on funds borrowed for purposes of setting up of sugar plant was allowable as deduction under section 36(1)(iii)

(B)     High Courts

1.       CIT vs. Kamal Wahal 351 ITR 4 (Del.)

In order to get exemption u/s. 54F new residential house need not to be purchased by the assessee in his/her own name or exclusively in his/her name

Held

For the purposes of Section 54F, the new residential house need not be purchased by the assessee in his own name nor is it necessary that it should be purchased exclusively in his name. It is moreover to be noted that the assessee in the present case has not purchased the new house in the name of a stranger or somebody who is unconnected with him. He has purchased it only in the name of his wife. There is also no dispute that the entire investment has come out of the sale proceeds and that there was no contribution from the assessee's wife.

Having regard to the rule of purposive construction and the object which Section 54F seeks to achieve and respectfully agreeing with the judgment of this Court, we answer the substantial question of law framed by us in the affirmative, in favour of the assessee and against the revenue.

2.       CIT vs. Amit Jain 351 ITR 74 (Del.)

No Penalty for showing share trading income under the Capital Gains instead of Business

The record reveals that the amount in question, which formed the basis for the assessing officer to levy penalty was in fact truthfully reported in the returns. In view of this circumstance, that the assessing officer chose to treat the income under some other head cannot characterize the particulars or reported in the return as inaccurate particulars or as suppression of facts. 

3.       Khanna And Annadhanam vs. CIT 351 ITR 110 (Del.)

Compensation to CA Firm for loss of referral work is a non-taxable capital receipt

The assessee, a firm of Chartered Accountants, was one of the “associate members” of Deloitte Haskins & Sells for 13 years pursuant to which it was entitled to practice in that name. Deloitte desired to merge all the associate members into one firm. As this was not acceptable to the assessee, it withdrew from the membership and received consideration of Rs. 1.15 crores from Deloitte. The said amount was credited to the partners’ capital accounts & claimed to be a non-taxable capital receipt by the assessee. The AO rejected the claim. The CIT (A) reversed the AO. The Tribunal reversed the CIT (A). On appeal by the assessee to the High Court HELD reversing the Tribunal:

(i) There is a distinction between the compensation received for injury to trading operations arising from breach of contract and compensation received as solatium for loss of office. The compensation received for loss of an asset of enduring value would be regarded as capital. If the receipt represents compensation for the loss of a source of income, it would be capital and it matters little that the assessee continues to be in receipt of income from its other similar operations (Kettlewell Bullen 53 ITR 261 (SC) & Oberoi Hotel 236 ITR 903 (SC) followed);

(ii) On facts, the compensation was for loss of a source of income, namely referred work from Deloitte because it is somewhat difficult to conceive of a professional firm of chartered accountants entering into such arrangements with international firms of CAs, as the assessee in the present case had done, with the same frequency and regularity with which companies carrying on business take agencies, simultaneously running the risk of such agencies being terminated with the strong possibility of fresh agencies being taken. In a firm of chartered accountants there could be separate sources of professional income such as tax work, audit work, certification work, opinion work as also referred work. Under the arrangement with DHS there was a regular inflow of referred work from DHS through the Calcutta firm in respect of clients based in Delhi and nearby areas. There is no evidence that the assessee had entered into similar arrangements with other international firms of chartered accountants. The arrangement with DHS was in vogue for a fairly long period of time -13 years- and had acquired a kind of permanency as a source of income. When that source was unexpectedly terminated, it amounted to the impairment of the profit-making structure or apparatus of the assessee. It is for that loss of the source of income that the compensation was calculated and paid to the assessee. The compensation was thus a substitute for the source and the Tribunal was wrong in treating the receipt as being revenue in nature.

4.     CIT vs. C.S. Srivatsan 30 taxmann.com 423 (Mad.)

Where company in which assessees were directors, paid franchise commission to franchiser, owned by HUF of directors, and such franchises met personal expenses of directors, same could not be brought to tax under section 2(24)(iv)

Facts

·                  The assessees were directors of the company 'CRS' which was engaged in the business of retail-selling of silk sarees and other textiles.

·                  'CRS' effected its sale through franchisees which were owned by different HUFs of the assessee. Said franchisees were paid commissions for the sale effected by them.

·                  The Assessing Officer treated the personal expenses of the assessees and their family members (Franchisee commission paid to different HUF) paid by the company as the income of the Directors, by invoking the provisions of section 2(24)( iv).

·                  The Tribunal held that the personal expenses met out of the company's money could not be treated as income in the hands of the assessees under section 2(24)(iv ) as the money had not been paid directly to them, but to the franchisees, which their HUF owned.

Held

The Tribunal has taken note of the following aspects and has given the specific findings:-

·        CRS paid franchise commission to various firms owned by HUF of Directors.

·        This has been done on the basis of agreement entered into which were in force.

·        The payment by CRS on the basis of franchise agreement to various persons cannot be treated as payment to Directors who have substantial interest in the company and section 2(24)(iv ) cannot be invoked.

·        If the receiver of franchise commission has met the personal expenses of the Director, it is not the responsibility of the company for such act of the receiver of franchise commission.

·        The findings rendered by the Tribunal do not warrant any interference, as it is supported by factual matrix and legal reasoning.

5.     CIT vs. Abhinav Kumar Mittal 30 taxmann.com 357 (Delhi)

Where reference made by Assessing Officer to DVO for valuation of properties of assessee was not in accordance with law and DVO's valuation was based on incomparable sales, addition made to income of assessee under section 69 on basis of DVO's valuation was wrong

Held

No material was found in the search and seizure operations, which would justify the Assessing Officer's action in referring the matter to the DVO for his opinion on valuation of the said properties. If that be the case, then the valuation arrived at by the DVO would be of no consequence. In any event, the Tribunal has also held that the DVO's valuation was based on incomparable sales, which is not permissible in law.

6.     R.N. Gupta Co. Ltd. vs. CIT 30 taxmann.com 424 (Punj. & Har.)

Scrap being by-product of manufacturing activity, there are no expenses which could be excluded from sale of scrap for computing deduction under section 80HHC

Facts

The assessee is engaged in manufacturing of goods for export. In the process of manufacturing, the scrap is generated, which is a bi-product of manufacturing activity. The Assessing Officer has not accepted the explanation of the assessee that no expenses are incurred for generation of scrap, and therefore, expenditure should be taken as nil for not accepted. The Assessing Officer has disallowed the deductions claimed by the assessee under Section 80 HHC of the Income Tax Act, 1961.

Held

The expenditure is incurred by the assessee not for generation of the scrap but for generation of the finished product. There is and cannot be any expenses which are incurred for generation of scrap. Scrap is bi-product of the manufacturing activity. Therefore, there are no expenses which could be excluded from the sale of scrap. Since the question of law stands answered by this Court in favour of assessee.

7.       Association of Corpn. & Apex Societies of Handlooms vs. ADIT 30 taxmann.com 22 (Delhi)

Form No. 10 could be furnished by assessee-trust for purposes of section 11(2), i.e., for accumulation of income, during reassessment proceedings

Facts

The Tribunal rejected the assessee's claim for accumulation of income on the ground that Form No. 10 had not been furnished along with the return but was filed during the course of reassessment proceedings

HELD

·        One has to keep in mind the fact that while reopening of an assessment cannot be asked for by the assessee on the ground that it had not furnished Form No. 10 during the original assessment proceedings, this does not mean that when the revenue reopens the assessment by invoking section 147, the assessee would be remediless and would be barred from furnishing Form No. 10 during those assessment proceedings.

·        Therefore, Form No. 10 could be furnished by the assessee-trust during the reassessment proceedings.

8.       Zafa Ahmad & Co. vs. CIT30 taxmann.com 267 (All.)

In course of proceedings under section 68, assessee could not be asked to prove source of source or origin of origin

Facts

The assessee was a partnership firm, in which 'K' and 'Z' were partners, who had deposited amounts in their capital accounts in the firm. During assessment proceedings, assessee was asked to explain the source of the deposits. It was explained that 'K' had received the amount from six persons and 'Z' from five persons by way of gift and all of them had filed their income-tax return and gift-tax returns. The Assessing Officer did not accept the assessee's plea and added the whole amount as unexplained deposit under section 68.

Held

·        It is not in dispute that the amounts have been deposited by the two partners in their capital account. The partners are income tax payees. They have explained the source as having received gift from various persons, who have also filed their Income-tax returns and have been assessed accordingly.

·        Merely because, the donors are weavers and they own only one loom would not make any difference. They have filed their Income-tax returns and have also filed the return under the Gift-tax Act. They have paid the gift-tax also. Assessment under the Gift-tax Act had also been made, though the assessments made were summary in nature.

·        The Tribunal had erred in holding that the amount deposited by the two partners is liable to be added under section 68 on the ground that the gifts received by the respective partners from the various persons could not be explained as the creditworthiness of the donors had not been established.

·        The Tribunal had wrongly drawn an adverse inference upon the fact that the donors had filed their Income-tax returns on a single day and, further, the return for the Gift-tax was filed well within the due date.

·        Thus, the assessee had explained the nature and source of the deposit and discharged its burden. The order of the Tribunal on this ground cannot be sustained and is liable to be set aside.

9.       CIT vs. Hindustan Equipment (P.) Ltd 30 taxmann.com 295 (MP)

Once net profit rate is applied to compute income, there is no scope of disallowance under section 40A(3)

Assessing Officer disallowed 20 per cent of purchase price alleged to be paid in cash. He also rejected books of account of assessee and estimated six per cent extra profit in respect of such purchases. Held, since profit was estimated by applying net profit rate, there was no scope for further disallowance under section 40A(3) in respect of such purchases.

10.     CIT vs. Avinash Jain 30 taxmann.com 133 (Delhi)

Where assessee engaged in purchase and sale of shares, maintained two separate portfolios i.e. an investment portfolio and a trading portfolio, income arising from sale of shares out of investment account was to be treated as 'capital gain' and not 'business income' of assessee

Assessee, engaged in sale and purchase of shares, maintained two separate portfolios; an investment portfolio and a trading portfolio. During relevant assessment year, assessee declared certain income arising from sale of shares under head 'capital gains'. A.O. treated income from sale of shares as 'business income. CIT(A) and Tribunal set aside assessment order holding that short-term capital gains and long-term capital gains were out of investment account and were not related to trading account of assessee. Hon’ble High Court upheld the order of the Tribunal.

11.     CIT vs. Elgin Mill Co. Ltd 29 taxmann.com 391 (All.)

Where assessee unilaterally wrote back amount of retirement gratuity in assessment year 1976-77 which was allowed as expenditure in assessment year 1972-73, same would not be treated as remission or cessation of liability so as to attract provisions of section 41(1)

FACTS

·        The assessee unilaterally wrote back the amount of retirement gratuity (i.e. Rs. 32, 99, 929) in assessment year 1976-77 which was allowed as expenditure in assessment year 1972-73.

·        The Assessing Officer made addition of said amount by invoking section 41(1).

·        On appeal, the Commissioner (Appeals) held that there was no cessation or remission of the liability and by writing back the amount, no benefit had been derived by the assessee. He, therefore, held that the addition by invoking the provisions of section 41(1) could not be sustained and, therefore, the addition of Rs. 32,99,929 was deleted.

·        On further appeal, the Tribunal confirmed order of CIT(A).

HELD

·        The provisions of section 41(1) would be applicable only where there has been a remission or cessation of trading liability and if such liability has been allowed as an expenditure in any of the assessment years. It is not in dispute that the amount of Rs. 32,39,929 towards gratuity has been allowed as trading liability during the assessment year 1972-73. The question is whether the said amount can be added back under section 41(1) on the ground that there liability has been by way of remission or cessation as an unilateral act of writing back in the books of account by the assessee. In the present case by an unilateral act of the assessee in writing back the amount of gratuity of Rs. 32,39,929 which was allowed as expenditure in the assessment year 1972-73 would not be treated as remission or cessation of the trading liability so as to attract the provisions of section 41(1). It may be mentioned here that from the Assessment year 1997-98 even unilateral act of writing off a trading liability attracts section 41(1) as Explanation (1) to section 41(1) has been inserted by the Finance (No.2) Act, 1996 with effect from 1-4-1997 which provides that the expression 'loss or expenditure or some benefit in respect of any such trading liability by way of remission or cessation thereof' shall include the remission or cessation of any liability by a unilateral act by the first mentioned person under clause (a ) of section 41(1) or by the successor in business under clause (b) of section 41(1) by way of writing off such liability in his accounts. Thus, this Explanation has been made effective from 1-4-1997 i.e., it shall be applicable from the Assessment year 1997-98 onwards and cannot be pressed into service for the Assessment year 1972-73.

·        In view of the foregoing discussion, the Commissioner (Appeals) and also the Tribunal had rightly held that the sum of Rs. 32,39,929 cannot be taxed during the assessment year in question by invoking the provisions of section 41(1).

12.     CIT vs. Sudeep Goenka 29 taxmann.com 402 (All.)

Penny stock: Where assessee proved sale transaction of shares by filing mass documentary evidence and payment of sale price was made through bank channel, sale transaction could not be disbelieved only because assessee could not give identity of purchasers

Facts

·        Assessee showed long term capital gains on sale of shares in his reply to notice under section 142(1).

·        The Assessing Officer treated the sale price of shares as income of the assessee from undisclosed sources, holding it a bogus transaction, as the shares were sold for more than 30 times of the purchase price.

·        On appeal, the Commissioner (Appeals) deleted the addition as the assessee had filed purchase bills of shares, letters of transfer, sale bills, accounts of brokers, purchase and sale chart, copy of quotations of Stock Exchange showing the rate of shares at relevant times and letters from broker confirming sale. On an independent inquiry, ICICI Bank informed that payment of sale price of shares was made through bank draft. Thus, documentary evidence proved that the transactions were actual and not fictitious accommodation entries.

·        On appeal, the Tribunal upheld the order of Commissioner (Appeals).

HELD

·        The Commissioner (Appeals) after considering entire evidence of record found that purchase and sale transactions were proved. He further, found that payment of the sale price was made to the assessee through bank channel and not in cash as such the transactions are actual transactions and not a fictitious accommodation entries.

·        The sale transactions cannot be disbelieved only for the reason that the assessee could not give the identity of the purchasers

(c)      Tribunal

1.       ACIT vs. Kiran Constructions 30 taxmann.com 235 (Hyd.)

Mere providing of machinery on hire without any manpower cannot be termed as carrying out of any work by plant and machinery owners and, thus, no tax is required to be deducted under section 194C

Held

·        For carrying out any work, as per provisions of section 194C, manpower is sine qua non and without manpower it cannot be said that work has been carried out.

·        Mere providing of machinery on hire without any manpower cannot be termed as carrying out of any work by plant and machinery owners and, thus, provisions of section 194C cannot be applied and as such no disallowance can be called for under section 40(a)(ia).

2.       Rainy Investments (P.) Ltd. vs. ACIT 30 taxmann.com 169 (Mum.)

Section 14A is not applicable in respect of share application money

Facts

·        The assessee-company was engaged in the business of investment in shares and securities. As the profit and loss account, filed along with, disclosed dividend income which had been claimed exempt by the assessee per its return, section 14A, read with rule 8D was attracted.

·        The Assessing Officer made disallowance accordingly and same was confirmed by the Commissioner (Appeals).

HELD

·        There is much force in the assessee's argument that 'share application money', to the extent it is actually so, so that it only represents amount/s paid by way of application for allotment of shares, the same cannot be regarded as an investment in shares, or an asset (or asset class) yielding tax-free income, and neither is it capable of yielding any tax-free income. The same would, therefore, have to be excluded in working out the disallowance under rule 8D.

·        Further it is clarified that the exclusion of 'share application money' is not in the least for the reason that it did not yield any tax-free income for the relevant year, but for the reason that it is incapable of any such income.

·        Accordingly, the Assessing Officer shall restrict the disallowance under section 14A to the amount so determined subject to verification of share application money.

3.     Thomas Muthoot vs. JCIT (TDS) 30 taxmann.com 354 (Coch.)

Since partners and firm are not two separate legal entities and exemption is available in respect of TDS liability on interest paid by firm to its partners, assessee-partner's belief that he had no TDS liability on interest paid by him to firm, is a 'reasonable cause' for non-imposition of penalty

Facts

The assessees were partners in a firm and paid interest on drawings to the firm, without deducting tax at source under section 194A.

The Joint Commissioner imposed penalty under section 271C for failure to deduct tax at source, which was confirmed by the Commissioner (Appeals).

HELD

The penalty under section 271C shall be levied if there is failure on the part of a person to deduct the whole or any part of the tax as required by or under the provisions of Chapter XVII-B.

The assessees have not deducted tax at source under section 194A on the interest on drawings paid by them to the partnership firm in which they are partners. There is no dispute with regard to the fact that the provisions of section 194A has provided exemption from deduction of tax at source only in respect of interest credited or paid by a partnership firm to its partners. The provisions of section 194A do not provide such kind of exemption to the interest paid by a partner to the partnership firm in which he is a partner.

The rigours of provisions of section 271C is softened by the provisions of section 273B, which provide that the penalty under that section shall not be imposable on the person, if he proves that there was reasonable cause for the said failure.

In the instant cases, the fact remains that the assessees, being individuals, had paid interest to the partnership firm, in which they were partners. In view of the legal position that the partners and firm are not two legal entities and further in view of the exemption provided in section 194A in respect of interest credited or paid by a partnership firm to its partners, the assessees were under the belief that they were not liable to deduct tax at source. Hence, the said view entertained by the assessees cannot be altogether be discounted with as untenable, since the issue that the TDS provisions shall not apply to the payment made by a partner to the partnership firm is a debatable one.

Considering the explanation furnished by the assessees, the belief entertained by the assessees that they were not liable to deduct tax at source on the interest paid by them to the partnership firm in which they are partners, can be considered as a 'reasonable cause' in view of the legal position existing between a partner and the partnership firm. The partners and partnership firm are not two different legal entities, though they are two different taxable entities. Further, it is stated that the partnership firm, which received interest from the assessees, duly included the same in its return of income filed before the department and the said partnership firm was not liable to pay any tax, since it declared loss. Hence, as observed in the case of Muthoot Financiers, no loss is caused to the revenue.

The explanation offered by the assessee fits in the category of 'reasonable cause' in terms of section 273B. Therefore, the Assessing Officer is directed to delete the penalty levied under section 271C