Monday, July 22, 2013

AAR can only determine tax liability of an applicant and not any of its affiliates or AOP

It would be impermissible for the authority (‘AAR’) to determine tax liability of person other than the applicant


The applicant, a foreign company, formed a consortium with an Indian company to execute a project (i.e., ‘contract’) in India. The contract was awarded to the consortium. Under the contract, the applicant was responsible for offshore supplies, offshore services and the Indian company was responsible for onshore supplies, construction and erection. The applicant approached the AAR to determine the taxability of income receivable from offshore supplies made to Indian company. The AAR ruled that the applicant’s income from offshore supplies would not be taxable in India in view of the Supreme Court’s decision in Ishikawajima. Revenue filed an application for rectification of apparent mistake as the contract was awarded to consortium (AOP) and not to applicant, thus, ruling of AAR that applicant was not liable to be taxed was inconsistent with the finding that AOP was the assessing unit. The AAR allowed the rectification application of revenue and posted the application for main hearing as to whether AOP could be liable to be taxed in respect of offshore supplies?


Section 245N of the Act doesn't permit AAR to rule on tax liability of a person other than the applicant. The AAR couldn’t give a ruling that the applicant was not liable to be taxed and somebody else would be liable to be taxed.  The proposed question framed by AAR for determination could only relate to applicant's tax liability. It would be impermissible for AAR to determine tax liability of person other than the applicant (i.e., AOP) - CTCI Overseas Corporation Ltd., In re [2013] 35 391 (AAR - New Delhi)

Sum paid for property likely to come into existence and payment for brand building isn’t royalty

If a property was likely to come into existence because of certain payment, the same couldn’t be deemed as 'royalty' because it lacked the condition of 'use or right to use'. Even if payment was made for creation of the brand and not for the use of such brand, the same couldn’t be characterized as 'royalty'

In the instant case the assessee, a foreign company (Marriot), entered into a franchise agreement with a franchisee-hotel in India (‘AHL’) to establish and operate MRHS International Hotel. The franchisee desired certain sales, marketing, publicity and promotion services to be performed outside India in support of the operation of the hotel. It agreed to perform such services.  AHL agreed to pay 1.5% of its gross revenue to the assessee for 'International Marketing Activities'. During assessment the AO brought this amount to tax as "royalty" under Article 12(4) of India-Netherlands DTAA (‘treaty’).  Further, the CIT(A) allowed the assessee’s appeal holding the amounts to be reimbursements. Aggrieved revenue filed the instant appeal.

The Tribunal held as under:

1) As per Article 12(4) of the treaty, in order to cover any payment within the purview of "royalty", it was imperative that the payment must be for a consideration for use or right to use any copyright of the literary artistic work, etc., or any patent, trademark, etc. (i.e., ‘defined property');

2) Payment could be made as a consideration for the use or right to use of the defined property only when such property was in existence at the time of use. If a property didn’t exist or was likely to come into existence because of the payment made, the same couldn’t qualify as 'royalty' because it lacked the condition of 'use or right to use';

3) The term 'royalty' as per Article 12(4) of treaty contemplates a consideration for the use of or right to use of the defined property already in existence and the payment was agreed to  be made for its use or right to use. If the payment made was of such a nature which helped in the creation of the defined property, that couldn’t regarded as royalty;

4) Even if payment made by AHL towards the international marketing activities led to the brand building, it would still be a payment for the creation of the brand and not for the use of such brand, which could  be characterized as 'royalty';

5) Thus, the impugned consideration couldn’t be deemed as 'royalty' under Article 12 of treaty. The actual expenses to be incurred by the assessee might have been more or less than the said fixed rate of consideration. In such a situation, there was every possibility of the assessee having some mark up on the costs incurred by it on advertisement. No material had been placed on record to demonstrate that the actual expenses incurred by the assessee were equal to the amount received.  Thus, the CIT(A) was not justified in deleting the addition by holding that it represented 'reimbursement of expenses'. Matter remanded to AO to decide whether amounts taxable as Business Profits under Article 7 of treaty – Dy. DIT v. Marriott International Licensing Company BV [2013] 35 400 (Mumbai - Trib.)

Certificate of registration as Income Tax Practitioner is mandatory for representation before revenue authority

Mere possession of educational qualification without undergoing departmental examination is not sufficient to have any right to practice as Income Tax Practitioner. Representative can’t appear before revenue authorities without any certificate of registration as Income Tax Practitioner (‘ITP’)

1) Mr. Y (representative of assessee) was not advocate registered with the State Bar Council. Therefore, he should not have claimed that since he was retired departmental Officer, therefore, without any certificate of registration as ITP he could appear before the Income-tax Authorities and the Tribunal;

2) He had also admitted that though he was practicing in Gwalior, but he was not registered with the CIT, Gwalior. His claim was totally wrong and his conduct was liable to be impeached. Section 288(2)(v) & (vi) provides the meaning of ‘authorized representative’ who have passed any accountancy examination recognized by the Board or any person who has acquired such educational qualifications prescribed by the Board in this behalf;

3) Mere possession of educational qualification without undergoing departmental examination by the Board isn’t sufficient to have any right to practice as ITP. According to Rule 53, 54 and 55 of the IT Rules, the Chief CIT or the CIT shall have to maintain prescribed form to register ITP to whom certificate is issued;

4) The person, who claims to be registered as ITP shall have to file proper application supported by documents to prove his accountancy examination recognized and educational qualifications achieved by him as per Rules;

5) The above provisions of the IT Act and IT Rules clearly prove that Mr. Y is not ITP as provided in the Income-tax Act and Rules. Therefore, without any certificate of registration in his favour under the above provisions, he couldn’t practice before the IT authorities and the Tribunal - SAMAGRA VIKAS MAHILA SAMITI V. CIT [2013] 35 390 (Agra - Trib.).)

Discount on shares offered under ESOP held as ‘expenditure’ and part of employees’ cost

Discount on shares offered under ESOP is construed, both by the employees and company, as nothing but a part of package of remuneration.  It is deductible on straight line amortization basis over vesting period of the options.

In the instant case the moot question that arose before the ITAT was whether the Employee Stock Option compensation expense, was an allowable deduction in the computation of income under the head “Profits and gains of business or profession”?

The Tribunal allowed deduction on such discount and held as under:

1) When a company undertakes to issue shares to its employees at a discounted premium on a future date, the primary object of this exercise is not to raise share capital but to earn profit by securing the consistent and concentrated efforts of its dedicated employees during the vesting period;

2) Such discounted premium is construed, both by the employees and company, as nothing but a part of package of remuneration. In other words, such discounted premium on shares is a substitute of direct incentive in cash for availing of the services of the employees;

3) The discount on premium under ESOP was simply one of the modes of compensating the employees for their services and was a part of their remuneration. The sole object of issuing shares to employees at a discounted premium was to compensate them for the continuity of their services to the company;

4) Such discount couldn’t be described either as a short capital receipt or a capital expenditure. It was nothing but the employees cost incurred by the company. The substance of this transaction was to disburse compensation to the employees for their services, for which the form of issuing shares at a discounted premium was adopted;

5) By undertaking to issue shares at discounted premium, the company does not pay anything to its employees but incurs an obligation of issuing shares at a discounted rate on a future date in lieu of their services, which is nothing but an expenditure under section 37(1) of the Act;

6) A liability was definitely incurred by the assessee and was deductible, notwithstanding the fact that its quantification might take place in a later year. The discount in relation to options vesting during the year couldn’t be held as a contingent liability;

7) Liability to pay the discounted premium was incurred during the vesting period and the amount of such deduction was as per the terms of the ESOP scheme by considering the period and percentage of vesting during such period. Deduction of the discounted premium was to be allowed during the years of vesting on a straight line basis;

8) The amount of discount claimed as deduction during the vesting period is required to be reversed in relation to the unvested or lapsed options at the appropriate time. However, an adjustment to the income is called for at the time of exercise of option by the amount of difference in the amount of discount calculated with reference the market price at the time of grant of option and the market price at the time of exercise of option - Biocon Ltd. v. Dy.CIT [2013] 35 335 (Bangalore - Trib.) (SB)

Percentage Completion Method isn’t mandatory for real estate developers, they can follow either Percentage Completion Method or completed contract method

It is not mandatory for all real estate developers to workout their profits by following percentage of completion method as prescribed by ICAI under AS-7

In the instant case the assessee was engaged in the business of developing and selling real estate projects. It filed nil return of income for both the assessment years 2008-09 and 2009-10, by adopting Project Completion Method. During assessment, the AO rejected the assessee's accounts on the ground that it hadn’t followed AS-7 for recognition of revenue as per which income was to be deduced on the basis of Percentage Completion Method. The AO, accordingly, computed the profit on percentage completion method and completed the assessment. Further, CIT(A) upheld the action of  action of AO.

On appeal, the Tribunal held in favour of assessee as under:

1) The assessee maintained complete books of account, which were duly audited by qualified Chartered Accountants. It had also maintained its account on mercantile basis by regularly applying Project Completion Method. The assessee had been consistently followed the same method. The auditors had reported no change in method of accounting adopted by the assessee;

2) The real estate developers are not pure contractors but are sellers of flats or goods. It is not mandatory for all real estate developers to follow Percentage Completion Method as per AS-7 prescribed by ICAI. The AS-7 recognizes the position that in the case of construction contracts the assessee could follow either the Project Completion Method or Percentage Completion Method.;

3) The Apex Court in the case of CIT v. Hyundai Heavy Industries Co. Ltd., [2007] 161 Taxman 191 (SC) also took the similar view and held that both the methods of accounting ( i.e., Project Completion Method and Completed Contract method) were recognized methods of accounting. The assessee was at liberty to choose any of the above methods and if any one of the method of accounting was consistently followed by the assessee, the AO couldn’t change such method of accounting;

4) The completed contract method followed by the assessee, in the instant case, therefore, could not be faulted with by the revenue authorities and on that basis it was not correct to say that the accounts of assessee did not present correct and complete picture of its profits;

5) Therefore, there was no justification in rejection of accounts by application of provisions of section 145(3) and changing the method from project completion to percentage completion method by the AO, which was upheld by the CIT(A). Therefore, the order of the Commissioner (Appeals) was to be set aside - Krish Infrastructure (P.) Ltd. v. ACIT [2013] 35 38 (Jaipur - Trib.)