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Case Law Update

Tarunkumar Singhal Sunil Lala
Chartered Accountant Advocate


 

  1. Tribunal decisions:

  1. Tax on long-term capital gains on sale of shares — Benefit of section 112(1) is restricted to those cases where long-term capital gain is to be computed under second proviso to section 48. Proviso to section 112(1) did not apply and, therefore, long-term capital gain computed under first proviso to section 48 was rightly taxed @ 20% and not 10%.

Non Resident Company — Section 112, read with section 48, of the Income-tax Act, 1961.

Basf Aktiengesellschaft vs. Dy D.I.T. [Assessment Year 2001-02] [2007] 12 Sot 451 (Mum)

Facts

  1. The assessee, a non-resident, purchased certain shares of an Indian company in foreign currency. During the previous year, the assessee sold the said shares and declared the gain arising on the sale of shares as the long-term capital gain computed as per the provisions of the first proviso to section 48.

  2. The assessee claimed that the long-term capital gain was to be taxed @ 10% in view of the proviso to section 112(1).

  3. The Assessing Officer held that the proviso to section 112(1) would be applicable to those cases which were covered by the second proviso to section 48 and, consequently, the same could not be applied to the instant case. He further held that as per the provisions of section 112(1), the rate of tax on long-term capital gain in the instant case would be 20%.

  4. On appeal, the Commissioner (Appeals) upheld the impugned order.

Decision on Second Appeal, the Tribunal held in favour of the Department as follows:

  1. In section 112(1), the proviso has been placed by the Legislature at the end, i.e., after clauses (a) to (d) of section 112(1). According to literal construction, the proviso would be applicable to all the clauses. Therefore, the A.O. was not correct in holding that clause (c) of section 112(1) was out of the scope of the proviso to section 112(1). The stand of the A.O. was that clause (c) of section 112(1) would become infructuous if it was included in the scope of the proviso. The said stand of the A.O. could not be accepted because long-term capital gain in respect of assets other than shares and debentures sold by non-resident would be covered by the provisions of second proviso to section 48 and, consequently, in such cases, the proviso to section 112(1) would be applicable. Therefore, the proviso to section 112(1) would apply to all the clauses contained in sub-section (1) of section 112.

  2. Then the question was as to whether clause (c) of section 112(1) would apply to all non-residents or only to certain category of non-residents. Section 112 provides the rate of tax on long-term capital gains @ 20% in cases of various categories of assessees including non-residents. On a plain reading of clause (c), it appears that it applies to all non-residents (not being a company) and a foreign company. According to literal construction, clause (c) would apply to all non-residents; except provided otherwise by the Legislature expressly or impliedly. Section 112(1) as originally enacted, effective from the assessment year 1993-94, did not apply to non-residents but section 115AB was already on statute book effective from the assessment year 1992-93, which provided rate of tax of 10 per cent on long-term capital gain in respect of units purchased in foreign currency by an overseas financial organisation. Subsequently, section 115AD was also brought on statute book effective from the assessment year 1993-94, which provided 10 per cent rate of tax on long-term capital gain in respect of securities other than units purchased by foreign institutional investors. Other non-residents were taxable at higher rate vis-a-vis long-term capital gain. Subsequently, clause (c) as existing today, was inserted by the Finance Act, 1994 (effective from the assessment year 1995-96) in order to provide uniform rate of tax on long-term capital gains accruing to other non-residents. Therefore, by implication, section 112(1)(c) applied to non-residents other than the non-residents specified under sections 115AB and 115AD. Thus, the case of the assessee would fall within the ambit of section 112(1)(c). Thus, effective from the assessment year
    1995-96, the rate of tax on long-term capital gain accruing to such non-residents was 20%.

  3. The proviso to section 112(1) was inserted by the Finance Act, 1999, effective from the assessment year 2000-01. Therefore, for the assessment years 1995-96 to 1999-2000, the rate of tax on long-term capital gain accruing to non-residents (except non-residents falling under sections 115AB and 115AD) was 20% irrespective of the fact whether the case of the assessee fell within the scope of first proviso or second proviso to section 48. Till then, there was no dispute regarding rate of tax. However, the dispute regarding rate of tax had arisen between the assessee and the revenue after insertion of the proviso to section 112(1). The contention of the assessee was that the proviso would also apply to non-residents falling under the scope of the first proviso to section 48; while the stand of the revenue was that the proviso was exclusively applicable to those cases which fell within the ambit of the second proviso to section 48.

  4. A perusal of the two provisos to section 48 shows that computation of capital gain is bifurcated into two parts. The first proviso covers those cases where the capital asset being the shares in or debentures of an Indian company are acquired by a non-resident by utilizing the foreign currency. In such cases, the cost of acquisition, expenditure incurred wholly and exclusively in connection with transfer of such shares as well as the sale consideration is required to be converted in the same foreign currency which was utilised for acquiring such shares/debentures so as to compute the capital gain in foreign currency. The capital gain so computed is then reconverted into Indian currency for the purpose of computing tax thereon. This method is applicable to short-term as well as long-term capital asset, asset being shares in or debentures of an Indian company. Other assets are not covered under this proviso. On the other hand, second proviso to section 48 provides the method of computing long-term capital gains in respect of any long-term capital assets acquired by any assessee irrespective of his status except the long-term capital gain arising to non-resident from the transfer of long-term capital asset specified in the first proviso to section 48. According to this method, the cost of acquisition and the cost of improvement mentioned in section 48(ii) shall be substituted by ‘the indexed cost of acquisition’ and ‘the indexed cost of improvement’ which shall be deducted from the sale consideration for computing the long-term capital gain.

  5. Thus, the Legislature has provided two different categories for computing the long-term capital gain. The intention of the Legislature appears to be that no gain be taxed to the extent it relates to general inflation of price in the market. That is why, the Legislature has related ‘the indexed cost of acquisition’ and ‘the indexed cost of improvement’ to the ‘cost inflation index’ which is defined in clause (v) of the Explanation to section 48. Application of this method is restricted to the cases falling within the scope of the second proviso to section 48. A different method has been provided to the cases falling within the scope of first proviso to section 48 considering the rapid devaluation of Indian currency. Foreign investors represented that capital gain be computed in accordance with the increase in the value of asset in terms of foreign currency. Accepting such representations of non-residents, the Legislature has provided different methods for computing capital gain in the first proviso to section 48. The Legislature has also used the word ‘shall’ in the first and second proviso to section 48 vis-a-vis the computation of capital gain. On the other hand, the case of non-resident falling within the ambit of the first proviso has been specifically excluded from the computation of long-term capital gain in the second proviso. Thus, neither the assessee nor the Assessing Officer has any option in this matter. Therefore, the case of the assessee would fall within the ambit of the first proviso to section 48. Therefore, the proviso to section 112 could not be applied to the instant case.

  6. Section 115AD provides 10% of tax on long-term capital gain arising/accruing to foreign institutional investors vis-a-vis securities falling under section 115-O, but sub-section (3) of section 115AD specifically provides that both the provisos to section 48 would not apply in computing the long-term capital gain. Similarly, section 115AB provides 10% rate of tax on long-term capital gain arising/accruing to overseas financial organization vis-a-vis the units purchased in foreign currency, but sub-section (2) of this section specifically provides that the second proviso to section 48 would not apply for computing such capital gain. The first proviso to section 48 is not applicable to units purchased in foreign currency and, therefore, the Legislature has not mentioned about the first proviso to section 48 in sub-section (2) of section 115AB. So, the Legislature has provided concessional rate of 10 per cent on gross amount of long-term capital gain, i.e., computed without claiming any deduction/benefit provided in the first and second provisos to section 48.

  7. It is in this context that the Legislature thought that the assessee falling under the second proviso to section 48 should not be put to disadvantageous position as compared to the assessee falling under sections 115AB and 115AD. The Legislature has provided only the marginal relief under section 112(1) proviso in those cases where rate of 20 per cent on net long-term capital gain is more than 10% rate of tax on gross amount of capital gain. The assessee had conveniently ignored the provisions of sub-section (2) of section 115AB and sub-section (3) of section 115AD while advancing the arguments.

  8. Further, the Legislature was well aware of the first and second provisos to section 48. The Legislature has used the words ‘second proviso to section 48’ in sub-section (2) of section 115AB and the words ‘first and second provisos to section 48’ in sub-section (3) of section 115AD. Therefore, if the Legislature had intended to give benefit of marginal relief of tax to all non-residents, it could have easily used the words ‘first and second provisos of section 48’ in the proviso to section 112(1). So, there is a deliberate attempt of the Legislature to restrict the benefit of section 112(1) to those cases where the long-term capital gain is to be computed under the second proviso to section 48.

  9. Therefore, the proviso to section 112(1) did not apply to the instant case and, consequently, the long-term capital gain computed under the first proviso to section 48 was rightly taxed at the rate of 20 per cent.

Case referred to

  1. CWT vs. Meattles (P.) Ltd. [1985] 156 ITR 569/[1984] 19 Taxman 116 (Delhi)

  1. TDS from payment of Guarantee Fee to Non Resident Cricket Bodies – Whether liable to tax in India – Matter remanded back to A.O. – Section 194 E

ITO vs. Board for Cricket Control in India [Assessment Years 1993-94, 1995-96 to 1997-98 and 1999-2000]

Facts

  1. During the previous years, the assessee paid certain amount as guarantee fee to cricket bodies of different countries with which India had entered into tax treaties and did not deduct tax at source from the said payments.

  2. The A.O. held that the assessee should have deducted tax at source under section 194E from payments of guarantee fee and, accordingly, passed order against the assessee under section 201(1)/201(1A).

  3. The A.O. rejected the preliminary objection of the assessee that the proceedings under section 201(1)/201(1A) were conducted after the lapse of reasonable time. He also rejected the argument of the assessee that the payments of guarantee fee were not in the nature of income. The Assessing Officer further discussed the taxability of payments of guarantee fee in the hands of the relevant overseas cricket bodies in the light of provisions of the applicable tax treaties, and held that the income earned by the aforesaid cricket bodies by way of guarantee fee paid by the assessee to them was taxable in India.

  4. The A.O. further considered the clarification letter dated 17-5-1996 issued by the CBDT to the effect, so far as the payments to cricketing bodies of the countries, with which India has entered into tax treaties are concerned, that no tax withholding liability arises as no part of income of such bodies is taxable in India and held that it was an internal correspondence between the CBDT and the Director of Income-tax (Exemption) and the assessee could not claim any benefits or concessions from such internal correspondence between income-tax functionaries.

  5. On appeal, the Commissioner (Appeals) held that it could not be said that the letter dated 17-5-1996 by the CBDT was only an internal correspondence and that it was an instruction of the CBDT issued in response to a detailed representation made by the assessee. The Commissioner (Appeals) also referred to the judgment of the Supreme Court in the case of UCO Bank vs. CIT [1999] 237 ITR 889/104 Taxman 547 and held these instructions to be binding on the A.O.

  6. The Commissioner (Appeals), therefore, cancelled the order passed under section 201(1)/201(1A) for non-deduction of tax at source from payments of guarantee fee made by the assessee to cricket bodies of various countries.

Decision

On appeal by the department, the Tribunal held as under:

  1. As far as the assessee’s reliance on the CBDT’s letter dated 19-5-1996 was concerned, a co-ordinate Bench of the Calcutta Tribunal in the case of Pilcom vs. ITO [2001] 77 ITD 218 had already held that the said letter does not have any sanctity under section 119 and, therefore, it does not have any binding force on the Assessing Officer. The reasoning adopted by the Commissioner (Appeals) in giving the impugned relief was, therefore, to be rejected.

  2. The assessee had objected that the impugned order was time-barred, since the order was passed after the expiry of four years from the end of the relevant financial year. There was no substance in this either, since the filing of tax deduction returns itself was inordinately delayed. The A.O. could not have examined proper discharge of withholding obligations unless he had an opportunity to examine the tax deduction at source in returns. The delay was on the part of the assessee. A lapse by the assessee could not be used for the assessee’s advantage. The question of reasonable time is to be examined in the light of the facts of each case. In the instant case, the order under section 201(1)/201(1A) was passed within reasonable time.

  3. The question for consideration was as to whether on merits of the case, the guarantee fee received by the overseas cricket boards was taxable in India. This was relevant because the tax withholding liability is essentially a vicarious liability and unless the principal liability to pay tax in India exists, vicarious liability under section 195 cannot be invoked at all.

  4. The guarantee fee paid by the assessee was to the cricket bodies of the countries with which India had entered into tax treaties. It is settled legal position that in view of the provisions of section 90(2), the provisions of the tax treaty prevail over that of the domestic law unless the domestic law is more beneficial to the assessee. Therefore, in case it was concluded that the payment in question was not taxable in terms of the provisions of the applicable tax treaty, there was no need to address to the scope of provisions of the domestic law.

  5. In the instant case, the elementary exercise about the nature of payments of guarantee fee had not been conducted by any of the lower authorities. A taxability simply on the basis of intendment of the Legislature was to be disapproved and the Board clarification having the binding force of section 119 had been specifically disapproved by a co-ordinate Bench of the Tribunal in the case of Pilcom (supra). The exercise conducted by the lower authorities was, thus, not sufficient to decide the matter one way or the other.

  6. Hence, the matter was to be remitted to the file of the Assessing Officer for examining the nature of payments and, after ascertaining the true character or payments, decide whether or not (a) these payments were of income nature under the provisions of the Act and, if it was found to be of income nature (b) whether or not under the respective tax treaties, India had a right to tax the same.

Cases referred to

  1. UCO Bank vs. CIT [1999] 237 ITR 889/104 Taxman 547 (SC)

  2. Pilcom vs. ITO [2001] 77 ITD 218 (Cal.) and

  3. Board of Control for Cricket in India vs. DIT (Exemption) [2005] 96 ITD

  1. Whether limitations under domestic tax laws are to be taken into account for purposes of computing profits of a PE under Article 7(3) of India-UAE Tax Treaty - Held, yes

Whether just because Indian PEs of foreign banking companies are taxed at a rate higher than rate at which Indian co-operative societies carrying out same business activity are taxed, provisions of Article 24(2) of India-UAE Tax Treaty dealing with non-discrimination in taxation of PE, cannot be invoked — Held, yes – Articles 7(3), 25(1) and 24 (2) of India – UAE DTAA

Mashreqbank PSC vs. Dy DIT [Assessment Year 1996-97]

Facts

  1. The assessee, a non-resident banking company incorporated in the United Arab Emirates (UAE), was carrying on business in India through its permanent establishment (PE) and was assessable to tax in India in respect of the profits attributable to the PE.

  2. For the relevant assessment year, the A.O. had disallowed some of the expenses claimed by the assessee under sections 37(2A), 37(3) and 43B and also made certain addition to the income of the assessee under sections 36(1)(va) and 40A(3).

  3. On appeal, the assessee contended that in view of the provisions of Article 7(3) of India-UAE Tax Treaty all expenses attributable to business carried on in India by the assessee were allowable as deduction, without restricting the allowance of such expenses under various provisions of the Act. The Commissioner (Appeals) held that the profits attributable to the PE of the assessee in terms of Article 7(3) would have to be determined in accordance with the domestic laws of India and all restrictions on allowance of various business expenses, as contained in the Act, would, accordingly, apply.

Decision

On assessee’s appeal, the Tribunal held as under:—

  1. Article 25(1) of the India-UAE Tax Treaty specifically provides that the laws in force in either of the contracting State will continue to govern the taxation of income in respective contracting State except where express provisions to the contrary are made in the agreement. In view of this specific provision being a part of the India-UAE Tax Treaty, it could not be said that by virtue of Article 7(3) which provides that ‘in determining the profits of a permanent establishment, there shall be allowed as deduction expenses which are incurred for the purposes of the business of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere’, the provisions of Income-tax Act would not apply with regard to deductibility of expenses. In this view of the matter and further following the decision of the co-ordinate bench of the instant Tribunal in the case of Dy. CIT vs. Mitsubishi Heavy Industries Ltd. [1999] 102 Taxman 301 (Delhi)(Mag.) it was to be held that the provisions of domestic tax laws in India as also in the UAE would continue to apply except to the extent specific contrary provisions are set out in the India UAE Tax Treaty. The assessee would, thus, derive no advantage from the provisions of Article 7(3) so far as freedom from artificial disallowances under section 40A(3), section 40A(12), section 37(2A) and section 43B were concerned. As there is no specific contrary provision in the treaty, these and similar other restrictions on deductibility of expenses under the Indian Income-tax Act continue to be applicable, in computation of profits attributable to the Indian PEs of the UAE tax residents.
  2. The Canadian Federal Court in the case of Utah Menes vs. Queen 92 DTC 6194, [1992] 1 CTC 306 had an occasion to deal with the question whether a tax treaty, when providing that ‘in determining the profits of a PE, there shall be allowed as deduction, expenses which are incurred for the purposes of the PE, including executive and general administrative expenses so incurred, whether in the State in which the PE is situated or elsewhere enable the deduction of items not permitted by domestic law, so that non-residents are better off than residents. Even without the aid of a provision similar to one which exists in Article 25(1), the Court answered this question in negative and decided the issue against the tax-payer.
  3. One of the basic principles governing the interpretation of tax treaties is that a tax treaty must be interpreted in good faith. Article 31(1) of the Vienna Convention governing the interpretation of tax treaties also lays down that, ‘a treaty shall be interpreted in good faith, in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its objects and purpose’. It is, therefore, important that undue emphasis should not, in any event, be given to a legalistic and literal approach in interpreting a tax treaty; the effort should always be made to harmonise the interpretation of the words of the treaty with its object and purpose. Therefore, it is not possible to proceed on the basis that a discrimination in favour of the non-resident tax-payer by the host country, without any specific provision to that effect, can be inferred. It is only elementary that a tax treaty is required to be read as a whole and, when the India-UAE Tax Treaty is read as a whole, the scheme of non-discrimination is clearly discernible from the scheme of things. It would, therefore, be quite inappropriate to read the provisions of the treaty in such a manner so as to result in discrimination against residents of one of the Contracting States; there cannot be any justification for exception to this underlying object of the treaty by reading the provisions of tax treaty in such a manner as to permit discrimination against residents of the PE host country. When a treaty explicitly seeks to ensure that there is no discrimination by the host country against a non-resident, who is resident of the other Contracting State, it is really incongruous to interpret the treaty in such a manner that host country has to discriminate against its own residents vis-a-vis the residents of the other Contracting State. Such an interpretation will not only be contrary to the provisions of the Vienna Convention but also contrary to the law laid down by the Hon’ble Supreme Court of India, which, in turn, has concurred with the Canadian Federal Court on the principles governing tax treaties. Further,the assessee claimed that its income was chargeable to tax @ 46%. The A.O. charged to tax the assessee’s income @ 55%, the rate applicable to the foreign companies. On appeal, the Commissioner (Appeals) upheld the impugned order.
  4. Therefore, the limitations under the domestic tax laws are to be taken into account for the purpose of computing profits of a PE under Article 7(3). The plea of the assessee was incompatible with overall scheme of the tax treaties, particularly India-UAE Tax Treaty. Accordingly, the conclusion arrived at by the Commissioner (Appeals) was to be upheld. On Second Appeal, the assessee contended that in view of Article 26 of the tax treaty, i.e., non-discrimination clause, read with section 90(2), the business income is chargeable to tax @ 46% as is applicable to domestic companies.

  5. The provisions of a tax treaty override domestic tax laws in India, by virtue of specific provision to that effect in the Income-tax Act. Therefore, this superior position of the tax treaties vis-a-vis domestic law is subject to the conditions so laid down in the enabling provision set out under section 90. Now, this enabling provision itself clarifies that differential tax rate between a domestic company vis-a-vis foreign company shall not be construed as discrimination against the foreign companies.

  6. To that extent, therefore, overriding effect of the tax treaty provisions is nullified, and the provisions of article 26(2) of the India-UAE Tax Treaty, have to be construed in the light of this limitation. Article 26(2) provides that, ‘the taxation of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably be levied in that other State than the taxation levied on enterprise of that other carrying on the same activities in same circumstances or under similar conditions’. Therefore, the basic mandate of Article 26(2) is that a permanent establishment, in one state, of a non-resident enterprise must not be taxed any less favourably than the enterprise of that State. However, for the purpose of this comparison, it is not possible to ignore the form of ownership. Comparison can only be made with comparables. Under Article 3(1)(g), the expression ‘enterprises of a Contracting State’ has been defined ‘as an enterprise carried on by the resident of that Contracting State’. On the basis of definition of ‘resident’ under
    Article 4(1) and of ‘person’ under Article 3(1)(e), the expression ‘resident’ refers to ‘any individual, a company, and any other entity which is treated as a taxable unit under the taxation laws in force in the respective Contracting States, who, under the laws of that State, is liable to tax therein by the reason of his domicile, residence, place of management, place of incorporation or any other criterion of similar nature’. The form of ownership, therefore, becomes relevant.

  7. An enterprise cannot be considered in isolation with the person (i.e., individual, company or co-operative society, etc.) which carries it on. Further, a PE has no distinct form of ownership; the ownership characteristics of a PE have to be the same as that of the enterprise of which it is a PE. Therefore, in case PE belongs to a banking company formed in UAE, and taxable units of that banking company is ‘company’, such PE can only be compared with a domestic enterprise in India which is assessed as ‘company’ and carries on the same business. In the instant case, the assessee was admittedly a company incorporated in the UAE, and, therefore, for the purposes of Article 26(2), PE of the assessee could only be compared with a domestic company carrying on the same activities in the same circumstances or similar conditions.

  8. Therefore, just because Indian PEs of foreign banking companies are taxed at a rate higher than the rate at which Indian co-operative societies carrying out the same business activity are taxed, the provisions of Article 24(2) dealing with non-discrimination in taxation of the PE, cannot be invoked. Therefore, the impugned order was to be upheld.

  9. The assessee, a non-resident banking company incorporated in UAE, was carrying on business in India through its permanent establishment. The Assistant Commissioner disallowed a deduction to interest levied under section 12B by an order for interest tax assessment. The Commissioner (Appeals) confirmed the order of Assistant Commissioner on the ground that section 18 provides for deduction in respect of only ‘interest tax payable’, and since interest levy for deferment of advance interest tax payable is not a part of ‘interest tax payable’, deduction in respect of the same cannot be allowed.

  10. Section 18 cannot be viewed as a disabling clause; all it provides is that ‘notwithstanding anything contained in the Income-tax Act’, deduction in respect of interest tax if payable is to be allowed in computation of income of the credit institution assessable in respect of the same. It does not, therefore, restrict the scope of deduction otherwise allowable to the assessee. Quite to the contrary, section 18 enables the deduction in respect of interest tax even if any restrictions are imposed by the Income-tax Act, in respect of deductions of the same. When interest tax itself is allowed as a deduction, and interest levied under section 12B is admittedly a compensatory levy for delay in advance payment of interest tax, there cannot be any good reasons to decline deduction to interest levied under section 12B.

Cases referred to

  1. ITO vs. Degremont International [1985] 11 ITD 564 (Jp.),

  2. Banque Indosuez [IT Appeal Nos. 2089 to 2091 (Bom.) of 1991],

  3. Banque National de Paris [IT Appeal Nos. 1341 (Bom.) of 1987 and 1380 (Bom.) of 1989],

  4. Dy. CIT vs. Mitsubishi Heavy Industries Ltd. [1999] 102 Taxman 301 (Delhi) (Mag.),

  5. ABN Amro Bank NV vs. Asstt. DIT [2005] 97 ITD 89 (Kol.) (SB),

  6. Siemens Aktiengesellshaft vs. ITO [1987] 22 ITD 87 (Bom.) (SB) ,

  7. Utah Mines vs. The Queen 92 DTC 6194,

  8. Dy. CIT vs. Boston Consulting Group Pte. Ltd. [2005] 94 ITD 31 (Mum.)

  9. Union of India vs. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 (SC),

  10. N. Gladden vs. Her Majesty the Queen 85 DTC 5188 (FC),

  11. United Kingdon Revenue’s International Tax Handbook (IH 859) and

  12. Chohung Bank vs. Dy. Director of Income-tax [2006] 102 ITD 45/6 SOT 144 (Mum.)

 

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