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Case Laws Update

  1. AUTHORITY FOR ADVANCE RULINGS

  1. Person leaving India for employment – whether Non Resident under Explanation (a) to sec. 6(1) of the Income-tax Act, 1961

British Gas India P. Ltd., In re [2006] 285 ITR 218 (AAR): 155 TAXMAN 326 (AAR)

A careful reading of Explanation (a) to sec. 6(1) of the Act, would show that the requirement of the Explanation is not leaving India for employment but it is leaving India for purposes of employment outside India. Therefore, for the purpose of the Explanation an individual need not be an unemployed person who leaves for India for employment outside India.

Facts

  1. The applicant, a private company in India, was part of the BG group, a leading international energy company having expertise across the spectrum of the natural gas chain.
     

  2. G, who had commenced employment with the applicant company in February/March 2002, was deputed to BG in the UK to work there for two years with effect from July 1, 2005. During the financial year 2005-06 G worked in India only for 88 days.
     

  3. On these facts the applicant sought the ruling of the Authority on the question whether G would be a non-resident.

Ruling

  1. That since the stay of G in India was for less than 182 days (as he was in India only for 88 days) he became a non-resident in the light of Explanation (a) to section 6(1) of the Income-tax Act, 1961.
     

  2. It was not correct to say that since he was already in employment and was leaving India he could not be said to leave India for employment. The requirement of Explanation (a) was not leaving India for employment but leaving India for the purpose of employment outside India. For the purpose of the Explanation the individual need not be an unemployed person who leaves India for employment outside India. The fact that G was already an employee at the time of leaving India was neither material nor relevant.

  1. TDS u/s 195 from – Payments to Non-Resident for purchase of computer software

Headstart Business Solutions P. Ltd., In re [2006] 285 ITR 530 (AAR): 204 CTR (AAR) 519: 155 TAXMAN 639 (AAR)

Expression "any other sum chargeable under the provisions of this Act" in s. 195(1) contemplates not only amounts, the whole of which are taxable, but also amounts of mixed composition, a part of which only might be taxable as well as other disbursements which are of the nature of gross revenue receipts and are yet chargeable under the provisions of the Act and therefore, applicant-company was required to deduct tax while making payment for purchase of software from the non-resident company.

Facts

  1. The applicant, a resident Indian company, entered into a contract with a non-resident company for supplying packaged business software solution. The product was delivered in physical form through a compact disc accompanied by a software licence key which was delivered electronically through e-mail over the internet. The software licence key always bore the name of the client to whom the software was to be delivered.
     

  2. The applicant applied to the Authority for a ruling on the question whether the applicant was bound to withhold taxes while making payment for the software purchased from the non-resident company. On the facts stated the Authority ruled:

Ruling

  1. That the questions whether there was no royalty income or whether the non-resident company had no permanent establishment in India were beyond the scope of consideration of the application.
     

  2. That the only point to be considered was whether payment of the sum to the non-resident company was chargeable to tax under that Act. The sum might or might not be income or there might be income hidden or otherwise embedded therein. Under section 195(1) there existed a legal obligation on the part of the applicant (Indian company) to withhold taxes while making payment for the software purchased from the non-resident company.

Cases followed

  1. Transmission Corporation of A P Ltd. vs. CIT [1999] 239 ITR 587 (SC)
     

  2. P C Ray and Co. (India) P. Ltd. vs. A C Mukherjee, ITO [1959] 36 ITR 365 (Cal)

  1. Tribunal

  1. Disallowance of Administrative Services Fees u/s 40(a)(i) [prior to its amendment by the Finance Act, 2003 w.e.f. 1-4-2004] – Applicability of Article 26 of India –USA DTAA r/w Article 12(4) of the DTAA and section 90(2) of the I.T. Act

Herbalife International India (P.) Ltd. vs. ACIT, [2006] 101 ITD 450 (Delhi) Assessment Year 2001-02

Assessee claimed deduction of administrative expenses paid to ‘H’, its parent company of USA. The said payment also included fee for the period 1-1-2000 to 31-3-2000, since RBI granted permission in respect of same only on 30-6-2000. The A.O. disallowed the claim by invoking section 40(a)(i) on ground that services rendered by ‘H’ were ‘technical services’ as per provisions of section 9(1)(vii) and assessee had failed to deduct tax at source. The A.O. disallowed fees related to period 1-1-2000 to 31-3-2000 on the ground that it was related to previous assessment year. Since payment in question by assessee to ‘H’ attracted provisions of Indo-US DTAA and Article 26(3) of Indo-US DTAA neutralizes rigour of provisions of section 40(a)(i), the A.O. could not seek to invoke provisions of section 40(a)(i) to disallow the claim of assessee for deduction even on assumption that sum in question was chargeable to tax in India. Further, since Reserve Bank of India granted approval for remittance for fee related to period 1-1-2000 to 31-3-2000 by assessee to ‘H’ only by its letter dated 30-6-2000, the claim of assessee that expenses accrued as a liability to it only during previous year, was to be allowed and action of revenue authorities holding that it was prior period expenses could not be sustained.

  1. The assessee-company was incorporated in India by its American parent company ‘H’ with the approval of the Ministry of Industry for carrying on the business of trading and marketing of herbal products after manufacturing the same in India on contract basis.
     

  2. It entered into an Administrative Service Agreement (ASA) dated 10-11-1999 with ‘H’. Under the said ASA, ‘H’ agreed to render various services including data processing, accounting, financial and planning services in respect of its herbal products in lieu of some administrative fee payable by the assessee.
     

  3. The expenses incurred by ‘H’ in USA for providing such services were not only for providing services to the assessee but also to its various other subsidiaries across the world by maintaining its centralized staff and other resources and the cost so incurred was apportioned and claimed from the assessee on a scientific basis, as administrative fees.
     

  4. The assessee claimed an expenditure equivalent to Rs. 5.83 crores towards the administrative fee paid to ‘H’ during the year in question, which included the fee for the period 1-1-2000 to 31-3-2000 since the RBI granted its permission in respect of the said remittance only on 30-6-2000.
     

  5. The A.O., however, held that the services rendered by ‘H’ fell within the definition of ‘fees for technical services’ as per provisions of section 9(1)(vii) and since there was a failure to deduct tax at source, he disallowed assessee’s claim thereof by invoking the provisions of section 40(a)(i).
     

  6. As regards the fees related to period from 1-1-2000 to 31-3-2000, the A.O. held that said amount related to previous assessment year and, therefore, could not be claimed in relevant assessment year.

  7. On appeal, the Commissioner (Appeals) confirmed the impugned order.

Decisions

On Second Appeal, the Tribunal held in favour of the assessee, as follows:

  1. Article 26 of India-US DTAA deals with ‘non-discrimination’. Article 26(1) says that nationals of one contracting State shall not be subjected in the other contracting State to any taxation or any requirement connected therewith which is much more onerous, than it is on the nationals of that other contracting State. Article 26(2) provides against discrimination in the context of a permanent establishment in the other contracting State. Article 26(3) is a general clause providing for indirect discrimination against a non-resident.
     

  2. The provisions of section 40(a)(i), as it stood prior to its amendment by the Finance Act, 2003 with effect from
    1-4-2004, applied to payments by an assessee outside India to a non-resident only. After 1-4-2004, the provisions apply equally to both resident and non-resident. In the instant appeal, the provisions of section 40(a)(i) as it existed prior to 1-4-2004 alone were applicable. Admittedly in the instant case, the exceptions set out in Article 26(3) were not attracted. Therefore, the payment made by the assessee to ‘H’ was of the nature contemplated by Article 26(3).
     

  3. The payment in question by assessee to ‘H’ attracted the provisions of the Indo-US DTAA. The payment in question, if at all, would be taxable in the hands of ‘H’ in India only if it was a payment for included services within the meaning of Article 12(4) of the said DTAA and not taxable in India otherwise. The sum in question could not be taxed as business income, since ‘H’ admittedly did not have a permanent establishment in India. If the income was considered as having accrued or arisen to ‘H’ in India, yet it could be taxed in India only if it was fees for included services. Even if the payment was considered as ‘fees for technical services’ within the meaning of the Act, yet it could not be taxed because ‘fees for technical services’ and ‘fees for included services’ under India-US DTAA had different meaning and they were not one and the same. If the revenue wanted to tax the payment by assessee to ‘H’ in the hands of ‘H’ in India, it had to bring its case within the ambit of Article 12(4) of the DTAA, i.e., fees for included services. The payment in question would, therefore, have to be judged in the context of the DTAA as to whether it was taxable in India or not.
     

  4. The provisions of section 40(a)(i), as it existed prior to its amendment by Finance Act, 2003 with effect from
    1-4-2004, provided for disallowance of payment made to a non-resident only where tax is not deducted at source on such payment at source. A similar payment to a resident does not result in disallowance in the event of non-deduction of tax at source. Thus, a resident left with a choice of dealing with a resident or a non-resident in business, would opt to deal with a resident rather than a non-resident owing to the provisions of section 40(a)(i). To that extent, the non-resident is discriminated. Article 26(3) of Indo-US DTAA seeks to provide against such discrimination and says that deduction should be allowed on the same condition as if the payment is made to a resident. Thus, this clause in DTAA neutralizes the rigour of the provisions of section 40(a)(i). By virtue of the provisions of section 90(2), the law, which is beneficial to the assessee to whom the DTAA applies, should be followed. Therefore, in view of Article 26(3) of Indo-US DTAA, the A.O. could not seek to invoke the provisions of section 40(a)(i) to disallow the claim of the assessee for deduction even on the assumption that the sum in question was chargeable to tax in India.
     

  5. It was not in dispute that as per the provisions of the FERA, 1973, the payment by the assessee to ‘H’ could not be made by the assessee without obtaining the approval of the Reserve Bank of India. It was also not in dispute that the RBI granted approval for the remittances by the assessee to ‘H’ only by its letter dated 30-6-2000. Considering the law laid down in the judicial pronouncements relied upon by the assessee, the claim of the assessee that the expenses for the period 1-1-2000 to 31-3-2000 accrued as a liability to the assessee only during the previous year was to be allowed and the action of the revenue authorities holding that it was a prior period expenses could not be sustained. The expenditure claimed for that period was, therefore, directed to be allowed as a deduction.
     

  6. As regards the question as to whether the revenue authorities were justified in disallowing the claim of the assessee for deduction in respect of fees paid to ‘H’ for the period relating to 1-1-2001 to 31-3-2001, there was no dispute that RBI permission was not required on or after 1-6-2000 consequent to the repeal of FERA, 1973 and introduction of FEMA, 1999. Under FEMA, 1999, the payment in question by the assessee to ‘H’ would fall in the category of current account transaction and, therefore, it did not call for any permission from Reserve Bank of India and the authorised dealers were permitted for making remittances in connection with current account transactions. In view of the same, the payment for that period did not require the permission under any other law. Though the assessee did not receive any bill for that period from ‘H’, it had made an estimate of the amount payable to ‘H’ for that period on the basis of the bill that it had received from ‘H’ for the period from 1-1-2000 to 31-12-2000. That was a reasonable basis on which the assessee could claim a liability as having accrued. The liability of the assessee, in the instant case, had, therefore, to be held as accrued and arisen during the previous year relevant to assessment year 2001-02 and, therefore, the claim made by the assessee for deduction deserved to be accepted. The A.O. was directed to allow the same.

Cases referred

Therefore, the claim of the assessee for deduction of the entire administrative fee paid to ‘H’ should be allowed as a deduction. The Assessing Officer was directed to allow the deduction accordingly.

  1. Nonsuch Tea Estates Ltd. vs. CIT [1975] 98 ITR 189 (SC),
     

  2. CIT vs. John Flower India Ltd. [1999] 239 ITR 312/105 Taxman 447 (Bom.)
     

  3. CIT vs. Kirloskar Tractors Ltd. [1998] 231 ITR 849 (Bom),
     

  4. Associated Cement Co. Ltd. vs. Commissioner of Custom 2001 (128) ELT 21 (SC),
     

  5. Bharat Earth Movers vs. CIT [2000] 245 ITR 428 (SC)

[Authors’ Note: The Tribunal also dealt with the assessee’s other claims for other deductions viz., expenditure incurred for improvement carried out in leased premises, loss incurred on account of foreign exchange fluctuations and the claim for deduction on account of obsolete and damaged inventory. The same are not discussed here].

  1. Allowability of income–tax paid on behalf of expatriate employees in respect of remuneration and perquisites received overseas–Section 37(1) of the Income–tax Act, 1961

Marubeni India (P.) Ltd. vs. JCIT, [2006] 101 ITD 437 (Delhi) Assessment Years 1997-98 and 1998-99

Assessee-company, a 100 per cent subsidiary company of a Japanese company, took over certain employees of Japanese company on deputation basis. Those employees also continued to be employees of Japanese company and received salaries and perquisites from Japanese company outside India. Assessee claimed to have paid those employees by way of incentives, taxes which they had to pay in India in respect of salary and perquisites received by them from Japanese company and claimed deduction for the same. Since there was no written agreement with those employees or other document to show that assessee was liable under terms of employment to pay the aforesaid sums and moreover, a letter written by the assessee to Joint Commissioner of Income-tax showed that amounts were paid not under contract with employees but in order to settle some controversy arising out of non-deduction of tax under section 192 in respect of salaries paid by Japanese company to expatriate employees outside India, the assessee’s claim that employees were paid under contractual liability could not be accepted. The Tribunal held that amounts in question paid by assessee as incentives would not be allowed as a deduction.

  1. The assessee-company was a 100% subsidiary of a Japanese company.
     

  2. It took over certain employees of the Japanese company on deputation basis. Those employees also continued to be employees of the Japanese company and the salaries and perquisites, which those employees were receiving from the Japanese company, were continued to be received by them outside India.
     

  3. For their services to the assessee, they were paid a comparatively small amount of salary and perquisites in India.
     

  4. The assessee claimed to have paid to aforesaid employees by way of incentives, the taxes which they had to pay in India in respect of the salary and perquisites received by them from Japanese company outside India and same was claimed as deduction.
     

  5. The Assessing Officer held that the amounts could not be allowed as a deduction as there was no ascertained liability and the assessee had failed to prove that it was liable under the terms of the employment to pay the aforesaid amount.
     

  6. The Commissioner (Appeals) dismissed the assessee’s appeal.

Decision

On Second Appeal, the Tribunal held in favour of the Revenue as follows:–

  1. As admitted by the assessee, there was no contract between the assessee and the employees in writing. However, the case was put forth on the footing that the arrangement was oral. If the arrangement was oral, then why the assessee or the employees chose to wait for more than two years before making the payment of the taxes. Even from the inception, the employees were employed also by the Japanese company on substantial salaries and perquisites which were paid to them outside India. Their services were merely seconded to the assessee and compared to the salaries which they were receiving from the Japanese company, what the assessee was paying them, was very little. The taxes payable on the salary paid by the Japanese company would, therefore, amount to a substantial amount which the employees would not like to delay. Further, if the employees were so important to the assessee because of their expertise in international trading, it stood to reason and probabilities that the assessee would employ them under clear terms and conditions reduced to writing. It was not clear whether even the salary paid by the assessee-company to the expatriates was only under oral arrangement or whether there was a contract in writing. Considering the fact that Tribunal was dealing with people involved in business and professionals who came from Japan all the way to India, it was difficult to believe that the entire arrangement was not formalized or reduced into writing and was merely oral. The inference was that there was no such arrangement either in writing or oral. The assessee merely agreed to pay the salary to the employees when their services were seconded by the Japanese company. If there was no contractual liability, then the amounts could not be claimed as a deduction for the years under appeal. It was also difficult to imagine that the assessee-company, well advised in its income tax matters, would not have claimed the liability as a deduction in the returns for the years filed originally since the amounts were quite substantial.
     

  2. What seemed to have happened, as pointed out by the Commissioner (Appeals) in rather strong terms, was that the assessee was compelled to pay the taxes in respect of the salaries of the employees received by them outside India from the Japanese company, which the Japanese company ought to have deducted and paid to the Indian Government under section 192. Since it failed to do so and since it was a non-resident company, and since the assessee was its 100 per cent subsidiary, there was pressure brought upon the assessee-company to settle the matter with the Income-tax Department by paying the tax component referable to the salaries paid to the employees by the Japanese company outside India. This was borne out by the letter dated 21-12-1998 written by the assessee-company to the Joint Commissioner. The letter showed that the amounts were paid not under any contract with the employees, but in order to settle some controversy arising out of non-deduction of tax under section 192 in respect of the salaries paid by the Japanese company to the expatriate employees outside India. It seemed that the amount, that was to be deducted and paid by the Japanese company as taxes on the salaries, was paid by the assessee-company under an arrangement or settlement with the income-tax authorities. It was not possible to accept the assessee’s claim that they were paid under a contractual liability. It appeared that there was no liability at all in the first place.
     

  3. The assessee had referred to the letter written by the assessee to the Assessing Officer giving justification for the late claiming of the incentives paid to the expatriate employees in the form of taxes. The letter vaguely referred to the eligibility of the employees for incentives for working in India and went on to say that there was no clear idea as to whether the incentive was to be paid to them or not and if it was to be paid, what would be the amount. This letter was actually a give-out. If there was no clear idea at all as to whether the assessee was liable to pay the incentive, it really meant that there was no ascertained liability at all. The statement that the employees were eligible for ‘some bonus and incentive for working in India’ in the letter was quite ambiguous and non-committal. Nothing could be inferred therefrom in favour of the assessee.
     

  4. The Tribunal next examined the question whether the amounts could be allowed on grounds of commercial expediency. A sum of money expended not out of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on grounds of commercial expediency and in order to indirectly facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purpose of the company’s business. The argument based on the principle of commercial expediency did not, however, accord with the facts of the case. As already seen that there was no contractual liability undertaken by the assessee at the time when the services of the employees were seconded to it by the Japanese company, to pay the tax in question as incentive to them and as part of their salary payable by the assessee-company. If such a liability had been undertaken, it was not necessary for the assessee to put forth its claim on the principle of commercial expediency at all. The company could not say that there was a contract – oral arrangement – with the employees to pay the taxes and, at the same time, contend that the taxes were paid not under any oral arrangement but voluntarily on ground of commercial expediency and indirectly to facilitate the carrying on of the business. The argument based on the principle of commercial expediency was available to the assessee only in the year of payment; i.e., the assessment year 1999-2000. It was only in that year that the amount was actually paid without any pre-existing liability and, therefore, this argument was open to the assessee to be raised only in that year.
     

  5. For the aforesaid reasons, it was not possible to allow the amount of taxes paid by the assessee as incentive, as a deduction in the assessment years
    1997-98 and 1998-99.

Cases referred

  1. Indian Aluminium Co. Ltd. vs. CIT [1971] 79 ITR 514 (SC),
     

  2. CIT vs. Tej Quebecor Printing Ltd. [2006] 281 ITR 170,
     

  3. CIT vs. Chandulal Keshavlal & Co. [1960] 38 ITR 601 (SC),

[Authors’ Note: The Tribunal also dealt with the assessee’s claim for deduction of employer’s contribution to provident fund and the employee’s contribution to provident fund, which the A.O. disallowed/ added u/s.43B and u/s. 2(24)(x), respectively. The same are not discussed here].

  1. Non resident company – Signing of the appeal by an authorised representative – Non-filing of the power of attorney with the appeal – Dismissal of the appeal by the CIT(A) – Section 249 of I.T. Act r/w Rule 45 of the I.T. Rules

Cartier Shipping Co. Ltd. vs. JCIT, [2006] 8 SOT 781 (Mum.) Assessment Years 1994-95, 1995-96, and 1998-99

Appeal in a case where company is not resident in India shall be signed by a duly authorised person and Power of Attorney is required to be annexed along with memorandum of appeal to prove that appeal was filed by a duly authorized person and in case Power of Attorney is not annexed along with return of income or an appeal, it would be very difficult for authority concerned to determine whether it was signed by a duly authorised person. Where the assessee had not filed Power of Attorney along with appeal, the Commissioner (Appeals) was justified in dismissing that appeal on ground that Form No. 35; i.e., Memorandum of Appeal, was not signed by the authorised person.

Facts

  1. The assessee was a foreign company, which was required to get the appeal signed by the authorised signatory.
     

  2. The assessee did not file copy of Power of Attorney along with appeal memo in Form No. 35.
     

  3. The Commissioner (Appeals) dismissed the appeal filed by the assessee on the ground that Form No. 35; i.e., memorandum of appeal was not signed by an authorized person.

Decision

On Second Appeal, the Tribunal held as follows:

  1. According to Rule 45(2), an appeal to the Commissioner (Appeals) shall be made in Form No. 35 and the grounds of appeal and the form of verification appended thereto relating to an assessee shall be signed and verified by the person who is authorized to sign the return of income under section 140.
     

  2. ii) As per section 140, a return may be signed and verified by a person who holds a valid Power of Attorney from such company where the assessee company is not resident in India and such Power of Attorney shall be attached to the return.
     

  3. Since the appeal to the Commissioner (Appeals) is to be signed by a person in a manner in which return of income is signed and filed, the appeal in a case where the company is not resident in India shall be signed by a duly authorized person and the Power of Attorney is required to be annexed along with the memorandum of appeal to prove that the appeal was filed by a duly authorized person.
     

  4. The object of filing of the Power of Attorney along with the return of income or an appeal is only to appraise with the facts to the authority concerned, before whom it is filed, that signatory of the appeal or the return of income is a duly authorized person. In case Power of Attorney is not annexed along with the return of income or an appeal it would be very difficult for the authority concerned to determine whether it was signed by a duly authorized person or not.
     

  5. Since the assessee had not filed the Power of Attorney along with the appeal before the Commissioner (Appeals), the Commissioner (Appeals) had all reason to believe that appeal was not signed by authorized signatory.
     

  6. vi) Since assessee could not place any evidence on record to prove that person who was authorised signatory to sign the appeal before the Commissioner (Appeals), there was no justification in remanding the matter back to the Commissioner (Appeals) for adjudication of appeal on merit as prayed by the assessee.

  7. vii) No doubt, a right of appeal conferred by the assessee is to be liberally construed and where the appeal lies to some authorities, the authorities should not be so hyper technical in rejecting the appeal. But, the appeal must be filed in accordance with the law. If it is required to be signed by a duly authorized signatory, it must be signed by the said person. Hence, an appeal cannot be allowed to proceed even though it is not signed by authorized signatory as defined in section 140(c). Since the instant appeal was not signed by a duly authorized signatory, the Commissioner (Appeals) was justified is dismissing the same.

Cases referred

  1. Patel & Co. vs. CIT [1986] 161 ITR 568/24 Taxman 203 (Guj.)
     

  2. CIT vs. Ashoka Engineering Co. [1992] 194 ITR 645/63 Taxman 510 (SC) &
     

  3. CIT vs. Bengal Card Board Industries & Printers (P.) Ltd. [1989] 176 ITR 193/[1990] 49 Taxman 60 (Cal.)

  1. Addition to Income u/s 92 of the Income–tax Act (prior to its substitution by the Finance Act, 2001 w.e.f. 1-4-2002) – Conditions precedent

DCIT vs. Rohm & Hass (India) (P.) Ltd. [2006] 8 SOT 803 (Mum) Assessment Years 1997-98 and 1998-99

In order to invoke provisions of section 92, it must be satisfied that course of business between resident and non-resident company is so arranged that business transacted between them produces to resident either no profit or less than ordinary profits, which might be expected to arise in that business, and then only Assessing Officer can determine amount of profits, which may reasonably be deemed to have been derived therefrom and include such amount in total income of the resident.

Assessee-company which was a wholly owned subsidiary of a non-resident company had been receiving commission income from the parent company. The A.O. rejected the assessee’s claim for loss on ground that loss suffered by assessee was due to lower commission agreed to between the assessee and the non-resident company. The A.O. made an addition by invoking provisions of section 92. Merely because there was loss, it could not be said that commission in business was so arranged that it produced no profit or less than ordinary profit particularly, when another company having no close connection with non-resident company was working at the same rate of commission Therefore, the A.O. was not justified in invoking provisions of section 92.

Facts

  1. The assessee-company was a wholly owned subsidiary of a non-resident company. The assessee-company was receiving commission income @10% from that company and had declared certain loss.
     

  2. The A.O. came to a finding that the loss suffered by the assessee was due to lower commission agreed to between the assessee and the non-resident company and by invoking the provisions of section 92 assessed the income of the assessee on the basis of 20% of the commission income in both the years.
     

  3. On appeal, the Commissioner (Appeals) held that the Assessing Officer was not justified in invoking the provisions of section 92 and, accordingly, decided the issue in favour of the assessee.

Decision

On Second Appeal, the Tribunal held in favour of the assessee as follows:

  1. In order to invoke section 92, this condition must be satisfied that the course of business between a resident and a non-resident company is so arranged that the business transacted between them produces to the resident either no profits or less than the ordinary profits, which might be expected to arise in that business and then only the A.O. can determine the amount of profits, which may reasonably be deemed to have been derived therefrom and include such amount in the total income of the resident.

  2. In the instant case, it was an admitted position that the assessee was dealing only with non-resident company and was having close connection with that non-resident company because the assessee was a wholly owned subsidiary of that non-resident company. But still this fact had to be established that the business between the resident assessee-company and non-resident company was so arranged that the business transacted between them produced to the resident either no profit or less than the ordinary profit.

  3. The assessee-company had brought on record the agreement of the non-resident company with another Indian company; i.e., ‘M’ and as per this agreement effective from 1-1-1992, commission was payable at 5% of the net sales price and the assessee-company was also receiving 5% commission from this non-resident company from beginning, which had been increased to 10% from 1-1-1997 and this would show that there was no such arrangement between the assessee-company and the non-resident company resulting into no profit or less than the ordinary profit to the resident assessee-company.

  4. Admittedly, expenses of the assessee-company were higher than the income, resulting into loss in both the years but the A.O. could not point out any abnormal expense, which could call for any disallowance and merely because there was loss, it could not be said that the business was so arranged that it produced no profit or less than the ordinary profit particularly when another company; i.e., ‘M’ having no close connection with the non-resident company was working at the same rate of commission, i.e., @5% and the assessee-company had got the said commission increased to 10% from
    1-1-1997.

Hence, the order of the Commissioner (Appeals) was justified.

  1. Foreign Institutional investor (FII) claiming set off of Long-term Capital Loss first against Short-term Capital Gains u/s 70 of I.T. Act [before amendment by the Finance Act, 2002 w.e.f. A.Y. 2003-04], and paying Long-term Capital Gains Tax at the concessional rate – Held – It is permissible

JCIT vs. Montgomery Emerging Markets Fund [2006] 100 ITD 217 (MUM) (SB) Assessment Years 1995-96 and 1996-97

In view of provisions of law contained in section 70 which existed for period from assessment years 1988-89 to 2002-03, a loss arising from one source can be set off against income from any other source under the same head of income and, therefore, for the relevant assessment years, setting-off of short-term capital gains against long-term capital losses is permissible.

CBDT Circular No. 495, dated 22-9-1987 and CBDT Circular No. 36, dated 7-7-1955

Facts

  1. For the assessment year 1995-96, the assessee, while computing its income, set off both short-term capital loss as well as long-term capital loss against the income from short-term capital gains for getting benefit of concessional rate of tax on entire amount of long-term capital gains.
     

  2. The Assessing Officer rejected the method adopted by the assessee and held that long-term capital loss should first be set off against the long-term capital gains and if there was a remainder of long-term capital loss, that would be set off against the short-term capital gains.
     

  3. On appeal, the Commissioner (Appeals) held that as per the amendment to section 70 brought in by the Finance Act, 1987 (No. 2 of 1987), there was no distinction between short-term and long term capital gains in the matter of set off and carry forward of losses and, therefore, computation submitted by the assessee was in accordance with law.
     

  4. On revenue’s appeal to the Tribunal, it was argued on behalf of the assessee that the order of the Commissioner (Appeals) relating to set off of losses was in accordance with the law applicable for the relevant assessment years 1995-96 and 1996-97. But the revenue relied up on an order of the Tribunal passed in the case of Ravindra K. Mariwala vs. Joint CIT [2003] 86 ITD 35 (Mum.), where it was held that the long-term capital loss is to be adjusted against the long-term capital gain.
     

  5. The assessee further invited the attention of the Tribunal to the latest amendments brought to sections 70 to 74 with effect from assessment year 1992-93 and further clarification issued by the CBDT in its Circular No. 495, dated 22-9-l987 [1987] 168 ITR 87 (St.). It also contended that the decision arrived at by the Tribunal in the case of Ravindra K. Mariwala was not correct view. On hearing both sides, the Regular Bench referred the issue to Special Bench.

Decision

The Special Bench of the Tribunal held in favour of the assessee, as follows:

  1. Section 70 deals with the law relating to set-off of loss from one source of income against another source of income under the same head of income. The heading given to the section is self-explanatory and provides for specific law relating to intra-head adjustment of income and loss. This is for the purpose of arriving at the net outcome of income or loss under particular head of income.
     

  2. The law relating to inter-head set off is provided in section 71. The heading given to section 71 is again a clear statement for set off of loss under one head against income from another head.
     

  3. The relevant section 70 upto the assessment year 1987-88 placed restrictions on long-term capital loss in setting off against other sources of income falling under the head ‘Capital gains’. It is clear that the law relating to set off under a particular head of income provided in section 70 isolated the long-term capital loss from the benefit of setting off against other sources except against long-term capital gains. This position existed up to the assessment year 1987-88.
     

  4. Thereafter, the Finance Act, 1987 brought an amendment in section 70 with effect from 1-4-1988. The amendment removed the isolation in respect of the set off of long-term capital loss and made the law simple. It provided that save as otherwise provided in the Act, where the net result for any assessment year in respect of any source falling under any head of income is a loss, the assessee shall be entitled to have the amount of such loss set off against his income from any other source under the same head. The fetter against long-term capital loss was, thus, dispensed with.

  5. It is very clear from the CBDT’s Explanatory Note in Circular No. 495, dated 22-9-1987 that by the amendment brought in by the Finance Act, 1987, the law provided in section 70 for set off of loss from one source against income from any other source under the same head of income was made simpler resulting in a uniform treatment of capital loss whether short-term or long-term. This position prevailed for the period from assessment years 1988-89 to 2002-03.
     

  6. The position was again amended by the Finance Act, 2002 with effect from
    1-4-2003 where the earlier restriction against the set off of long-term capital loss has been again reinstated. The law for the assessment year 2003-04 onwards, in fact assumed the same colour which it had in the past, up to the assessment year 1987-88.
     

  7. As far as these appeals were concerned, the relevant assessment years were 1995-96 and 1996-97. Therefore, the law applicable to the instant case was the law which was modified by the amendment brought in by the Finance Act, 1987 and existed for the interregnum period from assessment years 1988-89 to 2002-03.

  8. The law is very simple and straight in its declaration. Section 70 deals with set off of loss under the same head of income. In other words, it deals with intra-head set off of loss. The question of inter-head set off pointed out by the Assessing Officer is dealt in by the provisions of law contained in section 71. Therefore, the distinction drawn by the assessing authority between inter-head and intra-head set off in the context of section 70 did not arise at all. In the amended provisions of law contained in section 70, the option is given to an assessee to set off any loss arising from any source falling under any head of income against his income from any other source under the same head. The most important issue to be considered is ‘what is source of income’? Long-term capital gains as well as short-term capital gains and the losses also are considered for taxation under a common head "capital gains". The law states that under a particular head, there could be a number of sources of income out of which assessee may incur loss in respect of some source and assessee may earn income from other source. There can be a bundle of sources under a particular head of income. Out of that particular head of income, the assessee is free to set off loss against income from another source. There is no distinction between short-term capital asset or long-term capital asset as far as the head of income ‘cCapital gains’ is concerned.
     

  9. Every spring of income is a different source of income for an assessee and for that matter, the transfer of one property may be one source of income different from the transfer of another property which would be again another source of income.
     

  10. Therefore, it is very apparent that source of income does not mean head of income. The Assessing Officer had proceeded on a hypothesis as if the source of income is the head of income itself. This is not a proper construction of law provided in section 70. Short-term capital gains/loss as well as long-term capital gains/loss both are computed under the head ‘Capital gains’ for the aggregation of income culminating into total income which is taxable under the Income-tax Act. What is taxed by the Income-tax Act is not different sources of income independently, but income from different sources clubbed under respective heads and finally aggregated into the total income. The classification of income under different heads for computing the total income does not interfere with the independent character of different sources of income available to an assessee. Both, short-term capital gains/loss and long-term capital gains/loss are different sources of income, falling under the same head ‘Capital gains’. Even under short-term capital gains, different transactions will be different sources of income resulting in short-term capital gains/loss. Likewise, different transactions of long-term capital assets will be different sources of income for an assessee to arrive at long-term capital gains/loss. This is reflected in the scheme of computation of capital gains provided in section 48 where gains or loss is computed on the basis of individual asset and transaction and not on the basis of class of assets. Therefore, every transaction of a property is a different source of income for the assessee. Head of income is not the source of income. Source of income is having a direct nexus with the stream or fountain out of which the income springs to the assessee. Head of income is provided for clubbing purpose of those like minded incomes derived from different sources for the purpose of aggregation and allowable deductions.
     

  11. Therefore, there is no basis in grouping short-term capital assets as a separate source of income and long-term capital assets as a separate source of income. Not only short-term and long-term assets are different sources of income, but even the different short-term assets and different long-term assets involved in the respective transactions are again different sources of income. When section 70 provides that a loss falling under a source of income can be set off against income from any other source under the same head, it means that the long-term capital loss being a separate source can be set off against short-term capital gains, which is another separate source of income. Within the provisions of law contained in section 70, there is no further identification of sources of income against which alone loss of a particular source can be set off. What is mentioned in the law is only source of income. As far as the head of income ‘Capital gains’ is concerned, the sources could be transfer of short-term capital asset as well as transfer of long-term capital assets and transfer of different assets will be different sources of income. There is no further identification or qualification with respect to any source so that the law would presume any sort of restriction on set off of loss arising from one source against income arising from any other source. Therefore, the contention of the assessee that irrespective of the identity of the source of income, it is possible for the assessee to set off the loss of a particular source against income from another source, both falling under the same head of income was tenable in law. Accordingly, the computation made by the assessee by setting off the long-term capital loss against short-term capital gains and in that way saving the differential tax benefit available to long-term capital gains was supported by law.
     

  12. This position is highlighted by the CBDT Circular No. 8 of 2002 dated 28-7-2002 issued as Explanatory notes on provisions relating to direct taxes brought in by the Finance Act, 2002. The circular stated that the existing provision contained in section 70 provides that where the net result for any assessment year in respect of any source falling under any head of income is a loss, the assessee shall be entitled to have the amount of such loss set off against his income from another source under the same head. Further, section 74 of the Income-tax Act provides that loss under the head "Capital gains" can be carried forward and set off against capital gains in the following eight assessment years. The legislature found that this position has created an anomaly inasmuch as assessee can get the benefit of concessional rate of tax in respect of long-term capital gains coupled with the freedom to choose the mode of set off of capital loss. Therefore, the amendment has been brought in and the circular stated that since long-term capital gains are subjected to lower incidence of tax, the Finance Act, 2002 has rectified the anomaly by amending section 70 to provide that while losses from transfer of short-term capital assets can be set off against any capital gains, whether short-term or long term, losses arising from transfer of long-term capital assets will be allowed to be set off only against long-term capital gains.
     

  13. The above explanation provided in the CBDT circular is a speaking testimony to the arguments of the assessee that there is no hitch in the law existed for the assessment years 1988-89 to 2002-03 in setting off long-term capital loss against short-term capital gain. When the statute provides such a freedom to the assessee, the Assessing Officer was not justified in making a further grouping of sources and to hold that long-term capital loss must be set off first against long-term capital gains. The Assessing Officer was in fact bringing out an order of priority of his own relating to the manner in which a loss has to be set off when the statute has not provided any such order of priority. The statute has not prescribed any order of precedence according to which the loss out of one source has to be set off against income from any other source. There is no provocation to visualize that the long-term capital loss must first be set off against long-term capital gains. That could only be an extreme case of logical argument. Such an argument could not find support from the provisions of law contained in section 70 as it stood for the relevant time.
     

  14. Therefore, in the facts and circumstances of the case, the assessee had its right to set off the long-term capital loss against short-term capital gains for the reason that every transaction relating to the assets brought under the common head of income ‘Capital gains’ is to be treated as separate source of income. Every transaction is, for that matter, a source of income with reference to transfer of that asset. Further, during the relevant period, statute has not placed any distinction between long-term asset and short-term asset or for that matter long-term capital gains and short-term capital gains. It is within the legitimate right of an assessee to choose the option which is more favourable to it so that it could avail the benefit of concessional rate of tax on the long-term capital gains.

  15. xv) Therefore, setting off of short-term capital gains against long-term capital loss was permissible to compute the amount for taxation under the head ‘Capital gains’. Therefore, the orders of the Commissioner (Appeals) were just and in accordance with law.

Cases Referred

  1. Ravindra K. Mariwala vs. Jt. CIT [2003] 86 ITD 35 (Mum.)
     

  2. Meghdoot Enterprises (P.) Ltd. vs. IAC [1992] 40 ITD 471 (Delhi)
     

  3. ITO vs. V.R. Nimbkar [1986] 19 ITD 714 (Bom.)
     

  4. Seth Shiv Prasad vs. CIT [1972] 84 ITR 15 (All.)
     

  5. CIT vs. Lady Kanchanbai [1962] 44 ITR 242 (MP.)
     

  6. CIT vs. Lady Kanchanbai [1970] 77 ITR 123 (SC)
     

  7. Fort Properties (P.) Ltd. vs. CIT [1994] 208 ITR 232/72 Taxman 415 (Bom.)
     

  8. CIT vs. Bosotto Bros. Ltd. [1940] 8 ITR 41 (Mad.)
     

  9. J.C. Thakkar vs. CIT [1955] 27 ITR 658 (Bom.) and
     

  10. CIT vs. Naga Hills Tea Co. Ltd. [1973] 89 ITR 236 (SC).
 

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