Improvements which enhance therapeutic efficacy of a medicine are patentable

No patents for improvements to existing medicines other than improvements in therapeutic efficacy in view of higher “patentability” threshold in section 3(d) of the Patents Act.

Novartis’ Patent application for cancer medicine rejected by SC as it was “copy and paste” of Zimmermann patent and mere change in form with no improvement in therapeutic efficacy, hence, hit by section 3(d) of the Patents Act.

In the instant case, the appellant (Novartis) filed the application for grant of patent for Imatinib Mesylate in beta crystalline form at the Chennai Patents Office. The Assistant Controller of Patents and Designs held that the patentability of the alleged invention was disallowed by section 3(d) of the Act. Appellant’s appeal was dismissed by the IPAB. Hence, the appellant filed present SLP to SC against IPAB‘s orders under article 136 of the Constitution.

Supreme Court held against appellant as under:

1) For grant of patent the subject must satisfy the twin tests of “invention” and “patentability”. Something may be an “invention” as the term is generally understood, yet it may not qualify as an “invention” for the purposes of the Act. Further, something may even qualify as an “invention” as defined under the Act, yet may be denied patent for larger considerations as may be stipulated in the Act;

2) After the amendment with effect from Jan 1, 2005, section 3(d) reads as under:

“Section 3. What are not inventions? The following are not inventions within the meaning of this Act,—(d) the mere discovery of a new form of a known substance which does not result in the enhancement of the known efficacy of that substance or the mere discovery of any new property or new use for a known substance or of the mere use of a known process, machine or apparatus unless such known process results in a new product or employs at least one new reactant.”

The aforementioned amendment to section 3(d) is one of the most crucial amendments that saw the Bill through the Parliament and, as noted, the amendment is primarily in respect of medicines and drugs and, to some extent, in respect of chemical substances used in agriculture.

3) There is no force in this submission that section 3(d) is a provision ex majore cautela. In course of the Parliamentary debates, the amendment to section 3(d) was the only provision cited by the Government to allay the fears of the opposition members concerning the abuses to which a product patent in medicines may be vulnerable to. We have, therefore, no doubt in that the amendment/addition made to section 3(d) is meant especially to deal with chemical substances, and more particularly with  pharmaceutical products.

4) The amended portion of section 3(d) clearly sets-up a second tier of qualifying standards for chemical substances/pharmaceutical products in order to leave the door open for true and genuine inventions but, at the same time, to check any attempt at repetitive patenting or extension of the patent term to spurious products. Section 3(d) represents “patentability”, a concept distinct and separate from “invention”.

If clause (d) is isolated from the rest of section 3, and the legislative history behind the incorporation of Chapter II in the Patents Act, 1970, is disregarded, then it is possible to see section 3(d) as an extension of the definition of “invention” and to link section 3(d) with clauses (j) and (ja) of section 2(1);

5) On reading clauses (j) and (ja) of section 2(1) with section 3(d) it would be clear that the Act sets different standards for qualifying as “inventions” in case of things belonging to different classes.  For medicines and drugs and other chemical substances, the Act sets the invention threshold even higher, by virtue of the amendments made to section 3(d) in the year 2005;

6) Imatinib Mesylate is a known substance from the Zimmermann patent itself. Not only is Imatinib Mesylate known as a substance of the Zimmermann patent, but its pharmacological properties are also known in the Zimmermann patent.  In the article published in the Cancer Research journal, the consequential finding is that Imatinib Mesylate does not qualify the test of “invention” as laid down in section 2(1)(j) and section 2(1)(ja) of the Patents Act, 1970;

7) The efficacy of Imatinib was equally known, as is evident from the Zimmermann patent itself. The subject product, that is, beta crystalline form of Imatinib Mesylate, is, thus, clearly a new form of a known substance, i.e., Imatinib Mesylate, of which the efficacy was well known. It, therefore, fully attracts section 3(d) and must be shown to satisfy the substantive provision and the Explanation appended to it.

8) Now, when all the pharmacological properties of beta crystalline form of Imatinib Mesylate are equally possessed by Imatinib in free base form or its salt, where is the question of the subject product having any enhanced efficacy over the known substance of which it is a new form?.

9) On the issue of section 3(d), there appears to be a major weakness in the case of the appellant. There is no clarity at all as to what is the substance immediately preceding the subject product - the beta crystalline form of Imatinib Mesylate? In course of the hearing, the counsel appearing for the appellant greatly stressed fact that in terms of invention, the beta crystalline form of Imatinib Mesylate is two stages removed from Imatinib in free base form. The same is said in the written notes of submissions filed on behalf of the appellant. But this position is not reflected in the subject application, in which all the references are only to Imatinib in free base form (or to the alpha crystalline form of Imatinib Mesylate in respect of flow properties, thermo-dynamic stability and lower hygroscopicity);.

10) What is “efficacy”? Efficacy means1 “the ability to produce a desired or intended result”. Hence, the test of efficacy in the context of section 3(d) would be different, depending upon the result the product under consideration is desired or intended to produce. In other words, the test of efficacy would depend upon the function, utility or the purpose of the product under consideration. Therefore, in the case of a medicine that claims to cure a disease, the test of efficacy can only be “therapeutic efficacy”. The question then arises, what would be the parameter of therapeutic efficacy and what are the advantages and benefits that may be taken into account for determining the enhancement of therapeutic efficacy?

11) With regard to the genesis of section 3(d), more particularly, the circumstances in which section 3(d) was amended to make it even more constrictive than before, we have no doubt in that the “therapeutic efficacy” of a medicine must be judged strictly and narrowly. Our inference that the test of enhanced efficacy in case of chemical substances, especially medicine, should receive a narrow and strict interpretation is based not only on external factors but also on sufficient internal evidences that lead to the same view. It may be noted that the text added to section 3(d) by the 2005 amendment lays down the condition of “enhancement of the known efficacy”;

12) Further, the Explanation requires the derivative to “differ significantly in properties with regard to efficacy”. What is evident, therefore, is that not all advantageous or beneficial properties are relevant, but only such properties that directly relate to efficacy, which in case of medicine is its therapeutic efficacy.

13) In case of chemicals, especially pharmaceuticals, if the product for which patent protection is claimed is a new form of a known substance with known efficacy, then the subject product must pass, in addition to clauses (j) and (ja) of section 2(1), the test of enhanced efficacy as provided for in section 3(d), read with its Explanation. Beta crystalline form of Imatinib Mesylate failed in both the tests of invention and patentability as provided under clauses (j), (ja) of section 2(1) and section 3(d), respectively, and, thus, the appeals filed by Novartis AG failed and were to be dismissed with costs - Novartis AG v. Union of India [2013] 32 taxmann.com 1 (SC)

Exp. on ‘clinical drug trial’ is deductible even if the impossible “incurred in-house” condition isn’t satisfied

Explanation to Section 35(2AB)(1) does not require that the expenses which are included in this explanation are essentially to be incurred inside an in-house research facility because it is not possible to incur these expenses for in-house research facility

In the instant case, the issue that arose for consideration of HC was as under:
"Whether the expenditure which was not incurred in an in-house research facility could be discarded for weighted deduction under sec. 35(2AB) of IT Act?”

Deliberating on the issue, the HC held in favour of assessee as under:

1) The Explanation to section 35(2AB)(1) provides that expenditure on scientific research in relation to drugs and pharmaceuticals shall include expenditure incurred on clinical drug trials, obtaining approval from any regulatory authority and filing an application for a patent under the Patents Act, 1970. The whole idea thus appears to be to give encouragement to scientific research. By its very nature, clinical trials may not always be possible to be conducted in closed laboratory or in similar in-house facility provided by the assessee and approved by the prescribed authority;

2) Before a pharmaceutical drug could be put in the market, the regulatory authorities would insist on strict tests and research on all possible aspects, such as possible reactions, effect of the drug and so on;

3) Extensive clinical trials, therefore, would be an intrinsic part of development of any such new pharmaceutical drug. It cannot be imagined that such clinical trial can be carried out only in the laboratory of the pharmaceutical company;

4) The activities of obtaining approval of the authority and filing of an application for patent necessarily have to be outside the in-house research facility. Thus, the restricted meaning suggested by the Revenue would completely make the explanation quite meaningless;

5) Segregation of the expenditure by prescribed authority into two parts, namely, those incurred within the in-house facility and outside, by itself would not be sufficient to deny the benefit to the assessee under section35(2AB) of the Act - Cadila Healthcare Ltd. v. CIT [2013] 31 taxmann.com 300 (Gujarat)

Related case:
Exp. on ‘drug trials’ can’t be disallowed even if it isn’t incurred in-house as trials can be carried outside labs only - Cadila Healthcare Ltd. v Addl CIT [2013] 29 taxmann.com 229 (Ahmadabad - Trib.)

Even retro amendment can't tax indirect transfer as it doesn't override tax treaties; HC follows Vodafone

Retro amendments made to overcome Vodafone's decision are fruitless exercises as the same do not contain a non-obstante clause to override treaty. Therefore, where a French company acting as an Investment vehicle transferred its interest in Indian concern to another French company, the transferor was not liable to any tax in India as per India-France DTAA

The facts of the case were as under:

a) L, Hyderabad was an Indian company and 80 per cent of its shares were held by French company S;

b) Company S was a JV between two French companies G and M. G and M sold their shares in S to another French company Sanofi;

c) G and M had applied for Advance Rulings to AAR regarding the taxability of capital gains in India arising out of sale of shares in S to Sanofi in terms of Article 14(5) of Indo-France DTAA;

d) AAR held that such deal was chargeable to tax in India. Hence, G and M filed separate writ petitions before the High Court challenging the ruling of AAR;

e) Sanofi was held as 'assessee in default' for non-deduction of TDS under section 195 from payment made to G and M. Hence, present writ petition was filed by Sanofi before the High Court.

The High court held in favour of assessee as under:

1) S is an independent corporate entity registered and resident in France and FDI in SBL is its commercial substance and purpose;

2) S was established as a Special Purpose Vehicle to facilitate FDI and to cushion potential investment risks of M and G on direct investment in L;

3) Uncontested assertion by petitioners that a higher rate of tax on capital gains (in comparison to what would have been chargeable in India) is payable in France and has been remitted to Revenue in France lends further support to the inference that S was not conceived, pursued and persisted with to serve as an Indian tax avoidant device;

4) Since Revenue failed to establish its case that genesis or continuance of S establishes it to be an entity of no commercial substance and/or that S was interposed only as a tax avoidant device, no case made out for piercing or lifting of the corporate veil;

5) Subsequent to the transaction in issue and currently as well, S continues in existence as a registered French resident corporate entity and as the legal and beneficial owner of L shares;

6) The transaction in issue clearly and exclusively is one of transfer of the entire shareholding in S by M/G in favour of Sanofi. Transfer of L shares in favour of S is neither the intent nor the effect of the transaction;

7) The Revenue's contentions that retrospective amendments by Finance Act,2012 would over-ride DTAA provisions deserves to be rejected for the following reasons:

a. The Finance Act, 2012 introduced GAAR provisions (sections 95 to 102) which override treaties in case of abuse of treaty provisions was proposed to be operationalized w.e.f 1-4-2014. Section 90(2A) inserted by Finance Act,2012 enables application of GAAR even if same is not beneficial to assessee;

b. In contra-distinction, retrospective amendments relied upon by Revenue-Explanation 2 to section 2(47) and Explanations 4 and 5 to section 9 are not fortified by a non-obstante clause to override tax treaties - Sanofi Pasteur Holding SA v. Department of Revenue, Ministry of Finance [2013] 30 taxmann.com 222 (Andhra Pradesh)

Royalty paid by an NR to other NR can't be taxed in India if it arises from patent exploited outside India

The royalty in respect of license granted by a non-resident to another non-resident for manufacturing of CDMA handsets cannot be taxed in India even if these handsets are sold to Indian parties. The source of royalty would be deemed as the place where patent is exploited, viz, where the manufacturing activity takes place, which is outside India.

In the instant case, the appellant was a company incorporated in the USA and was engaged in development and licensing of CDMA technology. The appellant granted license to 'use and sell CDMA technology' to the unrelated Original Equipment Manufacturers ('the OEMs'), who were non-resident and were located outside India, in consideration for royalty. The licenses granted by the appellant to the OEMs were used for manufacturing of handsets and network equipments, which, in turn were sold to various parties located outside India and in India. In respect of taxability of its income in India, the appellant contended that the royalty income earned by it from the OEMs of CDMA mobile handsets and network equipments sold in India was not taxable in India either under Section 9(1)(vi)(c) of the Act or under Article 12(7)(b) of the India-USA DTAA.

Deliberating on the issue, the Tribunal held in favour of assessee as under:

1) The license to manufacture products by using the patented intellectual property of the appellant had not been used in India as the products were manufactured outside India and when such products were sold to parties in India it couldn't be said that OEMs had done business in India;

2) Sale in India without any operations being carried out in India would amount to business with India and not business in India;

3) No patents of the appellant had been used for customization of handsets;

4) The role of appellant ended when it licensed its CDMA technology for manufacturing handsets and when it collected royalty from OEMs on these products;

5) There was no finding that the OEMs had carried on business in India or a part of the sale consideration was attributable to any sale or licensing of software carried out in India. When OEM's itself were not brought to tax, to hold that the appellant was taxable was not correct;

6) The source of royalty was the place where patent was exploited, viz, where the manufacturing activity took place, which was outside India. Hence, the Indian parties would not constitute source of income for the OEMs; and

7) The software was only used with the hardware and was not independent of the equipment or the chipset. Since no separate consideration was paid by Indian parties for licensing of the software and the consideration was paid only for the equipment which had numerous patented technologies, the sale couldn't be bifurcated or broken down into different components.

Thus, the royalty earned by the appellant couldn't be brought to tax in India under Section 9 of the Act or Article 12 of the India-USA DTAA - QUALCOMM INCORPORATED v. ADIT [2013] 30 taxmann.com 30 (Delhi - Trib.)   

Mere payment of advance tax isn’t sufficient to avoid additions for ‘undisclosed income’ if ROI isn’t filed by due date

On assessee's failure to file IT return by the due date under section 139, payment of advance tax per se cannot indicate his intention to disclose income so as to exclude the applicability of Chapter XIV-B provisions i.e. "Special Provisions for assessment of search cases"

In the instant case, the issue that came for consideration before the Supreme Court was as under:

“Whether payment of advance tax by an assessee would by itself tantamount to disclosure of income for the relevant assessment year and it couldn’t be treated as undisclosed income for the purpose of application of Chapter XIV-B of the Act”?

The Supreme Court held in favour of revenue as under:

1) Chapter XIV-B, find application only in the event of discovery of "undisclosed income" of an assessee. The legislature has defined "undisclosed income" without providing any definition of "disclosure" of income. The only way of disclosing income, on the part of an assessee, is through the filing of a return, as stipulated in the Act;

2) The legislature has clearly carved out two scenarios for income to be deemed as undisclosed: (i) where the income has clearly not been disclosed and (ii) where the income would not have been disclosed. If a situation is covered by any one of the two, income would be undisclosed in the eyes of the Act and hence, subject to the machinery provisions of Chapter XIVB;

3) If the search is conducted after the expiry of the due date for filing return (as in the instant case), payment of advance tax is irrelevant in construing the intention of the assessee to disclose income. Such a situation would find place within the first category carved out by section 158B of the Act i.e. where income has not been disclosed;

4) Payment of advance tax may be a relevant factor in construing intention to disclose income or filing return as long as the assessee continues to have the opportunity to file return of Income;

5) The disclosure of total income by the filing of a return under section 139 of the Act is mandatory even after the payment of advance tax by an assessee, since the "current income" which forms the basis of the advance tax is a mere estimation and not the final total income for the relevant assessment year liable to be assessed; and

6) On failure to file return of income by the due date under section 139 of the Act, payment of advance tax per se cannot indicate the intention of an assessee to disclose his income. As the assessee had not filed its return of income by the due date, the AO was correct in assuming that the assessee had not disclosed its total income and applied provisions of chapter XIV-B – ACIT v. A.R. Enterprises [2013] 29 taxmann.com 50 (SC)

Presumption as to validity of document wouldn’t discharge assessee’s onus to prove ‘source’ and ‘nature’ of receipt evidenced by document

In view of Sec. 292C, if any document is found during the search, such document shall be presumed to be depicting the true position. Even in that case, assessee would be under obligation to prove the ‘source’ and ‘nature’ of receipts to avoid the additions envisaged under provisions of Sec. 68, 69, etc.

In the instant case, the assessee-partnership firm was subject to survey action under section 133A of the Act. Incriminating documents were recovered from its premises. During assessment, the AO had made certain additions based on certain computer printouts. During appellate proceedings before ITAT, the assessee relied on Section 292C, which contains a statutory presumption as to truth of documents found during survey/search, and argued that addition made by AO under Sec. 69A was not justified as the document which was presumed to be true showed that the amount came from the partner and hence, it could not be treated as unexplained money under sections 68, 69A etc.

The Tribunal held in favour of revenue as under:

1) All that section 292C provides for a presumption as to the truth of any document found during search or the moneys recovered from assessee is belonging to the assessee;

2) The same does not contradict, rather compliments and supports the rule of evidence as enshrined in sections 68, 69, etc. The two, therefore, have to be read in conjunction and as complimentary, and not as disjunctive or de hors each other.

3) Sec. 68, 69A etc. casts an obligation on assessee to explain both the nature and source of the money, and not its source alone;

4) It was revealed during proceedings that the basic facts had been withheld by the assessee. Therefore, the deeming fiction of Section 69A validly applied by the Revenue in the facts and circumstances of the case as the assessee's explanation was silent as to the nature of receipts - Alliance Hotels v. ACIT [2012] 28 taxmann.com 277 (Mumbai - Trib.)

HC held regulatory function of a State Agency an economic activity and denied it registration; BIS's verdict contradicted

As the activity of the State Seed Certification Agency assists the sale of certified seeds and is "in relation to any trade, commerce or business", its activity cannot be held to be a "charitable purpose" in terms of section 2(15).

The petitioner-assessee was registered under the State Society Registration Act to carry on the functions of the certification agency under the Seeds Act, 1966 in the Andhra Pradesh State. The petitioner used to certify the Seeds which met the minimum seeds certification standards as per the Indian Minimum Seed Certification Standards, 1988. The petitioner collected a fee for providing certification as the process of certification involved technical and scientific evaluation of the seeds, although the fee collected by it was enough to enable it to sustain its activities and did not result in much profit to it. However, CCIT rejected the approval in his case for exemption under section 10(23C)(iv).

On appeal, the High Court held in favour of revenue as under:

1) The term "advancement of any other object of general public utility" used in Section 2(15) of the Act includes all objects to promote the welfare of the public, particularly when the object is to promote or protect the interest of a particular trade or industry;

2) The activity of the petitioner would fall within "advancement of any other object of general public utility" but in view of the fact that certification of seeds by the petitioner facilitated trade, commerce or business in the certified seeds by the client of the petitioner, the proviso to section 2(15) would come into operation; and

3) The petitioner's activity assisted the sale of certified seeds and was "in relation to any trade, commerce or business", therefore, its activity couldn’t be regarded as "charitable purpose".

In view of the above, the rejection by CCIT of the petitioner’s application for approval under section 10(23C)(iv) was upheld - Andhra Pradesh State Seed Certification Agency v. CCIT [2012] 28 taxmann.com 288 (Andhra Pradesh)

Editor’s Note – In a recent ruling of Bureau of Indian Standards vs. DGIT(E) [2012] 27 taxmann.com 127 (DELHI), the Delhi High Court held otherwise - that performing any regulatory function can’t be enfolded within the proviso to Section 2(15) to construe it as service ‘in relation to trade, commerce or business’ so as to exclude it from the scope of "charitable purpose". The ruling in Bureau of Indian Standards (Supra) has not been considered in the instant case.

HIGHLIGHTS - COMPANIES BILL, 2012

On 18th December, 2012 the Companies Bill, 2011 had been passed by the Lok Sabha. However, it was passed with certain modifications as recommended by the Parliamentary Standing Committee on Finance. Some of the amendments to the Companies Bill (as passed by the Lok Sabha) are as under:

1) Definition of 'key managerial personnel'(KMP) in clause 2(51) amended to include ‘Whole-time director' within its realm. Further, the pre-condition of CFO’s appointment by BOD to treat him as KMP was deleted;

2) As per amended clause 3, in case of One Person Company, nominee mentioned in Memorandum of Association would become member not only on subscriber's death but also in the case of subscriber's incapacity to contract due to insanity, etc.;

3) Words ‘of money’ omitted from Sec. 2(64) to cover bonus shares in paid-up share capital;

4) As per amended clause 2(40), the ‘statement of changes in equity’ should form an integral part of the financial statements of companies governed by Ind-AS;

5) Clause 23 amended to allow a private company to make rights and bonus issues;

6) Members are empowered to offer whole of their holdings of shares to public in offer for sale; earlier this was restricted to part shareholdings only;

7) In accordance with the Supreme Court's interpretation of section 67 of the Companies Act, 1956 in Sahara India Real Estate Corpn. Ltd. v. SEBI [2012] 115 SCL 478/25 taxmann.com 18, clause 42 was amended to define 'private placement' in order to curb public issues in the garb of private placement;

8) Time-limit for filing annual return in clause 92(4) relaxed from 30 days to 60 days from the date of AGM or due date of AGM, if the AGM wasn’t convened;

9) Corporate Social Responsibility spending has been made mandatory;

10) As per amended clause 139 appointment of auditors for five years needs to be ratified by members at every Annual General Meeting;

11) Clause 152(6) provides that not less than two-thirds of the total number of directors of a public company shall be liable to retire by
rotation and be appointed by the company in general meeting. The independent directors are being excluded from the "total number of directors" for computing the proportion, nonetheless they are appointed under this Act or any other law;

12) As per newly inserted clause 245(2), where members or depositors seek any other suitable action from or against an audit firm, the liability shall be of the firm as well as of each partner who was involved in making any improper or misleading statement of particulars in the audit report or who acted in a fraudulent, unlawful or wrongful manner;

13) Provisions relating to voluntary rotation of auditing partner (in case of audit firm) modified to provide that members may rotate the partner at such interval as may be resolved by members instead of every year.

Airport Authority isn’t a ‘municipality’; agriculture land in its limit but beyond municipal limit isn’t a cap. asset

As Hyderabad Airport Development Authority (“HADA”) can’t be treated as a ‘municipality’, agricultural land situated within its jurisdiction isn’t a ‘capital asset’ by virtue of exclusion u/s 2(14)(iii) and capital gains resulting from sale of such land aren’t taxable as capital gains

In the instant case, the moot question that arose before the Tribunal was whether HADA could be considered as municipality and agricultural land situated within its jurisdiction could be considered as capital asset under section 2(14)(iii)(a)/(b).

The Tribunal held as under:

1) It was  clear from section 2(14)(iii)(a)/(b) that the gain on sale of an agricultural land would be exigible to tax only when the land transferred was located within the jurisdiction of a municipality;

2) HADA was basically and essentially a creation of the Act of the State Legislature consisting of persons appointed by the State Government on salary basis. The Board Members were not elected by the people and there was no element of people’s choice being represented in any manner in the constitution of the Board. The Board functioned strictly under the supervision and control of the State Government and did not hold or possess a “local fund”. Being so, HADA couldn’t be called as a local authority;

3) HADA was only entrusted with the responsibility of preparing draft Master Plans and granting technical approval for any proposed construction or development in its jurisdiction. It didn’t have any power or ability to collect taxes nor was it responsible for provision of civic amenities which would be within the exclusive domain of the local authorities;

4) HADA, being a Development/Special Area Authority constituted under the said Act, couldn’t be either equated with a distinct municipality or considered as a complete substitute of a municipality or any other local authority;

5) HADA couldn’t be treated as a 'Municipality' and, as such, the agricultural lands situated within the jurisdiction of HADA wouldn’t constitute capital asset. Thus, gains consequential to sale of such land wouldn’t be chargeable to tax - Smt. T. Urmila v. ITO [2012] 28 taxmann.com 222 (Hyderabad - Trib.)

Retro amendments don’t automatically alter analogous DTAA provisions and can’t be read into DTAA provisions

If a particular term has been specifically defined in the treaty, the retrospective amendment to the definition of such term under the Act would have no bearing on the interpretation of such term in the context of the Convention.

In the instant case, the Mumbai Tribunal decides on the issue of applicability of retrospective amendments to the provisions of treaty as under:

1) Para 1 of Article 23 of India-Mauritius treaty provides that “the laws in force in either of the Contracting States shall continue to govern the taxation of income in the respective Contracting States except where provisions to the contrary are made in this Convention”;

2) When we read full text of Para 1 of Article 23, it becomes manifest that if there is some provision in the Treaty contrary to the domestic law, then it is the provision of the treaty which shall prevail;

3) If the retrospective amendment is in the realm of a provision of which no contrary provision is there in the Treaty, then such amendment will have effect even under the DTAA and vice versa;

4) If a particular term has been specifically defined in the Treaty, the amendment to the definition of such term under the Act would have no bearing on the interpretation of such term in the context of the Convention;

5) A country who is party to a Treaty cannot unilaterally alter its provisions. Any amendment to Treaty can be made bilaterally by means of deliberations between the two countries who signed it;

6) The term “royalty” has been defined in the DTAA as per Article 12(3) of Indo-US DTAA.  Such definition of the term “royalty” as per this Article is exhaustive. Pursuant to the insertion of Explanation (5) by the Finance Act, 2012, no amendment has been made in the DTAA to bring the definition of royalty at par with that provided under the Act. Subject matter of the Explanation is otherwise not a part of the definition of Royalty as per Article 12; and

7) Thus, the retrospective insertion of Explanation 5 to section 9(1)(vi) couldn’t be read in the DTAA - WNS North America Inc. v. ADIT [2012] 28 taxmann.com 173 (Mumbai - Trib.)

Huge profits and lack of govt. grants took away Sec. 10(23C) exemptions of an educational institute

The assessee was a registered society formed by Govt. of Madhya Pradesh for promotion and development of open school system in the State. It had claimed exemption under section 10(23C)(iiiab). During assessment proceedings, the AO opined that the assessee was systematically generating profits, thus, it couldn’t be regarding as existing for the benefit of public at large. Accordingly, the exemption was denied by AO for impugned assessment years. On appeal, the CIT(A) affirmed the stand of the AO.

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

1) Only the application of income as required under the Act and the predominant objects have to be kept in mind while granting or refusing exemption under section 10(23C);

2) Sec. 10(23C)(iiiab) speaks about any educational institution which is solely existing for educational purposes and not for profit and at the same time, which is wholly or substantially financed by the Government;

3) As per the data furnished, there was huge profit generated by the assessee which clearly established the profit motive of the assessee;

4) As regards the condition of wholly and substantially financed by the Govt., it was found that only in one year the Government had given some grant to assessee;

5) In respect to government grant, the word “wholly or substantially” used in the aforesaid section, means that, either it can be 100% or nearly to 100% but in any case may not be less than 75% because it has been used with the word wholly and not singularly; and

6) Moreover, the assessee’s case couldn’t be covered under Section 10(23C)(iiiad) as it was found that the surplus generated by the assessee was in crores which indicated that a huge abnormal profit had been earned by the assessee.

In view of the above, it was held that there was no infirmity in the conclusion drawn by the lower authorities to deny section 10(23C) exemption - m.p. rajya open school v. dcit [2012] 28 taxmann.com 29

Even dishonour of cheque due to ‘signature mismatch’ would be violation of sec. 138: SC

In the instant case, the following issues came up for consideration before Supreme Court:

1) Whether section 138 of the Negotiable Instrument Act covers dishonour of cheques other than due to insufficiency of funds?

2) Whether section 138 covers dishonour of cheques on the ground that “signatures do not match with specimen signatures on records of bank”?

The Supreme Court held as under:

a) The expression “amount of money …………. is insufficient” appearing in Section138 of the Act is a genus. Dishonour for reasons such “as account closed”, “payment stopped”, “referred to the drawer” are only species of that genus;

b) Just as dishonour on the ground that the account has been closed is a dishonour falling in the first contingency referred to in Section 138, so also dishonour on the ground that the “signatures do not match” or that the “image is not found”, which too implies that the specimen signatures do not match the signatures on the cheque would constitute a dishonour within the meaning of Section 138 of the Act;

c) If after issue of the cheque the drawer closes the account it must be presumed that the amount in the account was nil, hence, insufficient to meet the demand of the cheque;

d) A similar result can be brought about by the drawer changing his specimen signature given to the bank or in the case of a company changing the mandate of those authorized to sign the cheques on its behalf;

e) So long as the change is brought about with a view to prevent the cheque from being honoured the dishonour would become an offence under Section 138 subject to other conditions prescribed being satisfied.

Thus, it held that the dishonour due to signature mismatch would be covered by Sec. 138 of the Negotiable Instrument Act, and, thus, the trial Court could now proceed with the trial of the complaints filed by the appellants expeditiously - Laxmi Dyechem v. State of Gujarat [2012] 28 taxmann.com 1 (SC)

Subject matter to initiate winding-up proceedings isn't subordinate to pending arbitration on such matter

In the instant case, the petitioner-creditor was a NBFC. It granted credit facilities to a company. The agreement was backed up by the personal guarantees executed by two directors of the company.  The loan was partly secured by the company by pledging of a fixed deposit held in the name of the company in a bank. Cheques issued for repayment in three trenches were dishonored. In view of the huge unpaid dues, the petitioner filed winding up petition contending that the company was unable to pay its debts. Simultaneously, the petitioner invoked the arbitration clause contained in the agreement and applied to the Bombay High Court under section 9 of the Arbitration Act, 1996. The company contended that Court should exercise its discretion in not admitting the petition and should direct the petition to be stayed over till the arbitral reference between the parties would be concluded.

Deliberating on the issue, the High Court held as under:

1) The scope of an arbitral reference is altogether different from the scope of a creditor's winding up petition even though the claim in both actions may be founded on the same cause;

2) The initiation of an arbitral reference in respect of a claim, which is made the subject-matter of a creditor's winding up petition as well, will not operate as a bar on the winding-up proceedings;

3) Creditor's arbitration petition on a claim, and his simultaneous winding-up petition on the same claim could never been regarded as parallel proceedings;

4) The institution of a suit or an arbitral reference, in such a situation, makes no difference since the arbitral reference has to be initiated in place of a suit if the matrix contract on which the money is claimed is governed by an arbitration agreement.

In view of the above findings, it held that initiation of an arbitral reference in respect of a claim which is made subject-matter of a creditor's winding up petition would not operate as a bar on winding up proceedings - Maheshwary Ispat Ltd., In re [2012] 28 taxmann.com 4 (Calcutta)

Performing regulatory function by BIS isn’t a business activity even if it earned profit from such functions

The BIS (“the assessee”), a statutory body, was established under the Bureau of Indian Standards Act, 1986 ("the BIS Act"). The exemption granted to assessee under section 10(23C)(iv) was withdrawn by DIT(E) on the contention that the nature of activities carried on by the assessee was hit by proviso to section 2(15), as the activities carried on by assessee were in the nature of business. The DIT(E) further noted that the assessee had earned substantial amount of income. The assessee, thus, filed instant writ against the order of DIT(E).

The High Court held in favour of assessee as under:

1) Assessee is a statutory body established under the BIS Act and brought into existence "for the harmonious development of the activities of standardization, marking and quality certification of goods". This has been its primary and pre-dominant object, and the profit/revenue earned on discharging its functions is purely incidental;

2) The assessee performs sovereign and regulatory function, in its capacity of an instrumentality of the state. Therefore, it could not be said that it was carrying on an activity of trade, commerce or business;

3) "Rendering any service in relation to trade, commerce or business" couldn’t cover within its fold the regulatory and sovereign authorities, set up to act as agencies of the State in public duties;

4) The primary object for setting up such regulatory bodies is to ensure general public utility. Further, it couldn’t be said that the public utility activity of evolving, prescribing and enforcing standards, "involves" the carrying on of trade or commercial activity.

Therefore, the impugned order of DIT was quashed by High Court - Bureau of Indian Standards v. DGIT(E) [2012] 27 taxmann.com 127 (Delhi)

Unabsorbed depreciation of earlier years brings down tax burden on long-term Capital-gains

In the instant case, the assessee’s claim to set off brought forward unabsorbed depreciation against current year's long-term capital gain was rejected by the AO on the basis of following reasoning:

a) Set-off of current year's business loss against the income under the other heads of income does not include unabsorbed depreciation as it was not a part of business loss;

b) Section 32(2) restricts the allowable depreciation of the current year only to the extent of profits and gains of business; and

c) The other reason for rejecting assessee's claim was that the Act treats business loss separately from the depreciation because business loss can be carried forward only for 8 assessment years whereas depreciation can be carried forward for unlimited period.

The AO completed the assessment after disallowing the claim of the assessee for set off of brought forward depreciation. On appeal, the CIT(A) upheld the order of the AO.

On appeal, the Tribunal held in favour as under:

1) As per provisions of sec.32(2), if the current year's depreciation cannot be set off owing to the profits or gains chargeable being less than the allowance, then the allowance or the part of the allowance to which effect has not been given shall be added to the amount of allowance for depreciation for the following previous year. This means that brought forward depreciation merges with the current year's depreciation because of the legal fiction created by provisions of Sec. 32(2) of the Act;

2) However, this fiction has been subjected to the provisions of sections 72(2) and 73(3). Bare reading of sec. 72 suggest that in case of set off of business loss vis-à-vis depreciation, the first preference shall be given to the business loss as per the provisions of section 72(1) for the simple reason that the business loss can be carried forward only up to 8 assessment years whereas the depreciation can be carried over up to unlimited period; and

3) As has been discussed hereinabove, the brought forward unabsorbed depreciation is treated as current years' depreciation because of the legal fiction, therefore, the treatment given to the current year's depreciation is equally applicable to brought forward depreciation and  the same is also allowed to be set off from the long-term capital gains - Suresh Industries (P.) Ltd. v. ACIT [2012] 27 taxmann.com 203 (Mumbai - Trib.)