Direct Tax Law Digest: Lockdown Edition

This article contains the major judgments rendered by courts across the country on interesting issues of direct taxation during the period of the COVID-19 lockdown, from April to June.

The judgments presented herein are updated section wise and issue wise in a concise manner. The author hopes that the same is useful for practitioners of tax laws.

Note: This digest is restricted only to the judgments rendered till June 27 and also doesn’t include any interim orders passed by the courts.

Section 4 – Charge of Income

a) Doctrine of mutuality in case of a commercial concern and arrangement

The Supreme Court in the case of Yum! Restaurants Marketing Private Limited v. CIT, dated April 24, held that if the realization of money by the taxpayer from both members as well as non-members was in the course of the same activity and is tainted with commerciality, then the test of mutuality is not met. Where the participants did not have the right to participate in surplus or were not entitled to get back the unspent portion of their respective contributions, then this was also held to be against the concept of mutuality. In such cases, the income earned inter-se was held to be chargeable to income tax.

Section 9 – Income deemed to accrue or arise in India

a) Whether activities carried out by liaison office (LO) are preparatory and auxiliary and hence the LO doesn’t constitute a permanent establishment under India – UAE DTAA?

The Supreme Court in the case of UOI v. UAE Exchange Centre, dated April 24, held that activity carried on by the LO in India (downloading particulars of remittances through electronic media, - printing cheques/drafts drawn on banks in India) did not contribute to earning of profits, directly or indirectly, by the assessee in UAE, as they were only supportive of the main transaction carried. Thus, the fixed place of business of the non-resident assessee in the form of LO would not qualify within the definition of PE in terms of Articles 5(1) and 5(2) of the DTAA.

b) Whether guarantee payment made to non-resident sports associations in connection with the 1996 World Cup Cricket tournament hosted in India, was subject to withholding tax?

The Supreme Court in the case of PILCOM v. CIT, dated April 29, held that Associations had participated in the World Cup Cricket tournament, where cricket teams of these Associations had played various matches in India. Though termed as guarantee money, the payments were intricately connected with the event. The source of income was from playing matches in India and the payments made to the Associations accrued and arose or deemed to have accrued or arisen in India. The expression 'in relation to' in Section 115BBA emphasised the connection between the game or sport played in India. Special provisions of withholding tax obligation under Section 194E of the ITA was not affected by the DTAA. The benefit of the DTAA could be pleaded by the deductee and if the case was made out, the amount would be refunded with interest.

Section 32 – Depreciation

a) Whether ATM can be considered as computer and charged higher rate of depreciation?

The Karnataka High Court in the case of CIT v. NCR Corporation Pvt. Ltd., dated June 16, held that so long as functions of computers are performed with other functions and other functions are dependent on the functions of the computer, ATMs are to be treated as computers and are entitled to higher rate of depreciation.

Section 40 – Amounts not deductible as expenses

a) Treatment of surcharge on sales tax and turnover tax

The Kerala High Court in the case of Kerala State Beverages (Manufacturing and Marketing) Corporation Limited v. ACIT, dated April 30, while interpreting Section 40(a)(iib) has held that surcharge on sales tax is introduced only as an increase in the tax payable and it cannot by equated with a 'fee or charge'. Section 40(a)(iib) is clear in its terms that it will take in only 'fee or charges' enumerated therein and any levy of surcharge on sales/turnover tax is clearly deductible.

Section 43B – Certain deductions to be allowed only on actual payment

a) Constitutionality of disallowance of provision of leave encashment without actual payment by the employer under Section 43B(f)

The Supreme Court in the case of UOI v. Exide Industries, dated April 24, while upholding the constitutional validity of Section 43B(f), has held that Section 43B strictly targets to ensure that the deduction is claimed on a particular expense as specified when actually paid. The mischief that the employer claiming the tax deduction of such a payment at a point of time and may end up not paying the amount to the employee at all is sought to be remedied by insertion of clause (f). Section 43B does not provide for deductions pertaining to statutory liabilities only.

Section 45 – Capital Gains

a) Whether the income arising on sale of shares held as capital asset after conversion from stock in trade as business income and not as capital gains?

The Karnataka High Court in the case of M/S Kemfin Services Pvt Ltd v. ACIT, dated June 11, has held that prior to introduction of Finance Bill, 2018 by which provisions of the Act have been amended to provide for taxability of in cases where stock in trade is converted into capital asset, there was no provision to tax the same. In the absence of any provision in the Act, the transaction in question could not have been subjected to tax. Prior to amendment of the Act, which came into force with effect from April 1, 2019, the income arising on sale of shares held as capital asset after their conversion from stock in trade was treated as capital gains.

Section 54F – Capital gain on transfer of certain capital assets not to be charged in case of investment in residential house.

a) The eligibility under Section 54F is that the assessee shouldn’t have more than one residential unit. What constitutes a residential unit? Whether two apartments in the same building can be stated to be one residential unit?

The Karnataka High Court in the case of Navin Jolly v. ITO, dated June 18, has held that held that expression 'residence' implies some sought of permanency and cannot be equated to the expression 'temporary stay' as a lodger. Further, the usage of the property has to be considered for determining whether the property in question is a residential property or a commercial property. Even if the property in question is residential, if it is used for commercial purposes, it cannot be stated to be a residential unit for the purposes of section 54F. If the assessee owns two apartments in same building, it has to be treated as one residential unit.

Section 68 – addition of unexplained cash credit

a) Whether unexplained cash credits in the accounts of partnership firm have to be added to the income of the firm or the partners who contributed the amount?

The Allahabad High Court in the case of M/s Kesharwani Sheetalaya v. CIT, dated April 24, has held that since this was the first year of the business of the assessee firm, it could not have any income at the time of its formation. If the department was not satisfied with the financial capability of the partner, the amounts could have been added at the hands of partner who contributed the capital and not at the hands of firm.

b) Deletion of addition under Section 68 because of acceptance of claim under penalty proceedings

The Supreme Court in the case of Basir Ahmed Sisodiya v. ITO, dated April 24, has held that since in the penalty proceedings, the assessee has offered explanation and caused to produce affidavits and record statements of the concerned unregistered dealers and establish their credentials, which credentials have also been accepted by the CIT(A) with clear finding of fact that there was no concealment of income or furnishing of any inaccurate particulars, the addition made under section 68 for bogus entries ought to be deleted.

c) Whether the whole amount has to be added or only the commission income

The Bombay High Court in the case of PCIT v. Alag Securities Pvt Ltd., dated June 12, has held that in case of an assessee engaged in providing ‘accommodation entries’, the entire deposits cannot be assessed as unexplained cash credits. Only the commission earned in providing the accommodation entries can be assessed as income.

Section 80-O – Deduction in respect of royalties, etc., from certain foreign enterprises for services rendered from India

a) How to interpret beneficial provisions under tax laws?

The Supreme Court in the case of Ramnath & Co v. CIT, dated June 5, has held that at and until the stage of finding out eligibility to claim deduction, the ambit and scope of the provision for the purpose of beneficial provision’s applicability cannot be expanded or widened and remains subject to strict interpretation. But, once eligibility is decided in favour of the person claiming such deduction, it could be construed liberally in regard to other requirements, which may be formal or directory in nature.

Section 92C – Computation of arm’s length price (Transfer Pricing)

a) Whether Transactional Net Margin Method does not require functional similarity between tested party and comparables?

Can comparable be excluded only on the ground that it is operating on supernormal profits?

The Delhi High Court in the case of PCIT v. Open Solutions Software Services, dated May 18, has held that only those comparables which are functionally similar to the assessee (tested party) and operate in a similar business environment as that of the assessee should be used for benchmarking to arrive at an accurate calculation of arm's length price. If the comparable and the assessee are functionally similar, then the comparable cannot be excluded only on the ground that it is operating on supernormal profits. It is not correct to state that Transactional Net Margin Method does not require functional similarity between the tested party and the comparable.

Section 147/148 – Reopening of assessement

a) Notice must disclose the reasons and grounds of the specific provisions. Subsequent information can form tangible material to re-assess income.

The Supreme Court in the case of New Delhi Television Limited v. DCIT, dated April 3, held that subsequent information which comes to the notice of the AO during the proceedings for the subsequent assessment years can definitely form tangible material to invoke powers vested with the AO under Section 147 of the Act. Further, if the revenue is to rely upon the second proviso and wanted to urge that the limitation of 16 years would apply, then in the notice or at least in the reasons in support of the notice, the assessee should have been put to notice that the revenue relies upon the second proviso. The assessee could not be taken by surprise at the stage of rejection of its objections.

b) Denial of deduction u/s 80 IB only on a change of opinion based on a report under section 131 when the AO itself had deliberated the issue of deduction while finalising the assessement.

The Madras High Court in the case of International Flavours and Fragrances India Private Limited v. DCIT, dated May 19, held that since the activity undertaken by the assessee amounted to manufacture or not, was deliberated upon before the respective assessment orders were passed, a change of opinion based on report of CIT under Section 131 cannot amount to failure on the part of an assessee to truly and fully disclose information/documents required for the purpose of completing the assessments.

c) Whether assessment can be reopened under Section 147, on the basis of audit objection pointing out factual omissions in the original assessment order?

The Madras High Court in the case of PCIT v. SKI Retail Capital Ltd., dated May 7, held that the non-application of mind on the part of the Assessing Officer to apply his mind independently for the purpose of reopening of assessment is writ large for the reason that the very same official in response to the audit objection had taken into consideration all the materials placed and requested for dropping of the audit objection and therefore, passing of second order of assessment by him amounts to change of opinion on the very same set of facts.

d) Whether acceptance or non-rejection of explanation tendered by assessee during assessment proceedings amounts to forming an opinion?

The Supreme Court in the case of ACIT v. Marico Ltd., dated June 1, held that non-rejection of the explanation in the Assessment Order would amount to the Assessing Officer accepting the view of the assessee, thus taking a view/forming an opinion. Therefore, in these circumstances, the reasons in support of the notice reopening such assessment proceed on a mere change of opinion and therefore would be completely without jurisdiction.

Section 220(6) – Stay on recovery of demand by AO during pendency of appeal before CIT(A)

a) Minimum pre-deposit as a condition for stay on recovery of demand

The Delhi High Court in the case of Jindal ITF Ltd. v. UOI, dated April 8, in a case involving tax demand on account of bogus sales and addition under Section 68 has held that the assessee has not been able to discharge the onus of proof under Section 68 by proving the creditworthiness as well as genuineness of the transaction. Hence, a minimum pre-deposit of 20% of demand has to be made prior to stay of demand.

The Kerala High Court in the case of The Aranattukara Oriental Service Co-operative Bank v. CIT(A), dated May 25, has held that the assessing officer or the appellate authority while exercising the power of appeal or stay of the assessment proceedings are enjoined obligation to give regard and respect to the directions of the High Court. It would not be necessary that the payment of 20% can be dispensed with only if there is an order of the high court.

Section 241A – Withholding of refund in certain cases

a) Conditions to be fulfilled before refund can be withheld

The Supreme Court in the case of Vodafone Idea Ltd. v. ACIT, dated April 29, has held that in respect of assessment year commencing on or after the April 1, 2017, a different regime has been contemplated by the Parliament. Section 241-A of the Act requires a separate recording of satisfaction on part of the Assessing Officer that having regard to the fact that a notice has been issued under sub-section(2) of Section 143, the grant of refund is likely to adversely affect the revenue; where after, with the previous approval of the Principal Commissioner or Commissioner and for reasons to be recorded in writing, the refund can be withheld.

Section 271 – Penalty in case where assessee has concealed the particulars of his income or furnished inaccurate particulars of such income

a) Can penalty proceeding survive when notice for penalty was in printed format but the inapplicable portion therein was not struck off?

The Bombay High Court in the case of Ventura Textiles Ltd v. CIT, dated June 12, has held that if the assessment order and the show cause notice, both issued on the same date, are read in conjunction, a view can reasonably be taken that notwithstanding the defective notice, assessee was fully aware of the reason as to why the Assessing Officer sought to impose penalty. Hence, the penalty proceedings cannot be quashed.

Section 276B – Prosecution for failure to deposit tax deducted at source

a) Initiation of prosecution even after delayed payments. Prosecution can be sustained even without determination of liability.

The Karnataka High Court in the case of Onara Hospitality Pvt. Ltd. v. ACIT, dated April, held that even if payment is made after delay and not during the statutory period, there is default and appropriate action can be taken under the Act. Further, the alternative argument canvassed by the learned counsel for the petitioners that without determining the penalty, the respondent was not entitled to resort to criminal prosecution of the petitioners under Section 276B of the Act, also cannot be accepted for the reason that the petitioners/accused have not disputed their liability.

The author is a dually qualified professional. He is a graduate of Campus Law Centre, Faculty of Law, University of Delhi and a Fellow Chartered Accountant. He currently practices law in the courts of Delhi. He can be reached at mail@deepakjoshi.in . He tweets at @ideepakjoshi