Income of Indian branch computed on basis of commercial activities rendered by it to its foreign HO

For determining the total income of an Indian branch receipt arising on account of commercial services rendered by it to American head office to be considered

The Tribunal held as under:

1) Article 7(3) of the India-US DTAA is in two parts. The first part of the Article relates to the activity carried on by the branch office which is commercial in nature whereas the second part relates to the activities which are not commercial in nature and relates to specific services performed by the branch office;

2) The assessee contented that it was rendering services covered by second part and, hence, the income arising on account of such specific services couldn’t be considered for determining its total income;

3) The services performed by the branch office was on account of outsourcing of commercial activities by its head office and, therefore, income arising out of such services rendered would be taxable under article 7(3) of India-USA DTAA, whereas if some non-commercial activities were specifically assigned by the head office to its branch office, then income arising out of such activity would not be taxable;

4) The branch office was involved in the customer care and medical transcription services. Thus, it was very clear that the branch office was also rendering services of commercial nature which had been outsourced by the head office;

5) After going through the order of the CIT (A), it was quite obvious that the assessee was only carrying out the normal commercial activities of the head office, in USA, i.e., a part of medical transcription work and software development. The assessee hadn’t established the fact that the activities carried on by it were non-commercial and in the nature of specific services as per the instruction of the head office. There was no infirmity in the order of the CIT (A) in holding that the income earned by the assessee from the activities carried on by it was taxable in India - Wellinx Inc. v. ADIT (International taxation) [2013] 35 taxmann.com 420 (Hyderabad - Trib.)

Pre-payment charges for closure of housing loan are eligible for section 24 deduction

Prepayment charges for closure of loan account which was taken for acquisition of property are allowable under section 24(b)

In the instant case during the assessment, the AO disallowed the assessee's claim for deduction of prepayment charges on closure of housing loan. Further, the CIT (A) upheld the disallowance. Aggrieved assessee filed the instant appeal.

The Tribunal held in favour of assessee as under:

1) The definition of interest under section 2(28A) makes it clear that it has basically two components, firstly, the amount of interest for moneys borrowed and secondly, the amount paid by whatever name called in respect of the money borrowed or debt incurred;

2) The second category might also encompass any charges paid for not utilizing the credit facility. By incorporating the definition of 'interest' in section 24(b), the position that emerges is that not only the amount paid as interest but also any other amount paid, by whatever name, called, in relation to such debt incurred also qualifies for deduction;

3) By early repayment, the assessee managed to wipe out its interest liability in respect of the loan, which would have otherwise qualified for deduction under section 24(b) during the continuation of loan;

4) It was obvious that these prepayments had live and direct link with the obtaining of loan which was availed for acquisition of property. It was beyond comprehension as to how the amount paid as interest on the loan taken was allowable as deduction but the amount paid as prepayment charges of the very same loan was not deductible;

5) The payment of such 'prepayment charges' couldn’t be considered as de hors the loan obtained for acquisition or construction or repair, etc., of the property on which interest was deductible under section 24(b). Both, the direct interest and prepayment charges, were species of the term 'interest'. Therefore, the impugned order of CIT(A) was to be set aside and deduction claimed by the assessee was to be granted - Windermere Properties (P.) Ltd. v. Dy. CIT [2013] 34 taxmann.com 109 (Mumbai - Trib.)

Special audit can be directed without providing an opportunity of personal hearing to assessee

Proviso to section 142(2A) does not envisage any personal hearing to assessee before an order under sub-section (2A) can be passed

In the instant case the assessee-company was opposed to the proposal of special audit on the ground that there were no complexities in the accounts and contented that proviso to section 142 (2A) provides an opportunity of personal hearing to assessee.

The HC held as under:

1) The requirement of personal hearing is normally not seen as necessary concomitant to a reasonable opportunity of being heard. The same depends on the statutory provisions from which such right flows, the nature of the proceedings and the consequences likely to follow from such proceedings;

2) The proviso to section 142(2A) does not envisage any personal hearing before an order under sub-section (2A) can be passed. The said proviso only requires giving a reasonable opportunity of being heard to the assessee. Such reasonable opportunity ordinarily would not include right of personal hearing;

3) It was strongly argued by assessee that the very fact that the AO believed that the accounts were complex, it meant that the issues were complex and the personal hearing was required. This contention was misconceived. Complexity of accounts and complexity of the question whether accounts were complex or not were two totally different things;

4) Thus, a clear distinction had to be drawn between the two. Whether the accounts were complex so as to call for special audit was one aspect. Another aspect was whether the question to ascertain if the accounts were complex was itself a complex question. This would have a bearing on whether personal hearing was necessary. Thus, assessee’s contention of personal hearing was rejected;

5) Coming to the question of validity of the order on the premise of complexity and the requirement of interest of revenue, it was noticed that the assessee had been given previous notice under section 142(1) with respect to its accounts. For a long time the assessee did not comply with such notices;

6) The authorities had highlighted several aspects of the matter to indicate that the accounts were complex and that interest of revenue would be served if the special audit report was obtained. The various points on which the AO desired that the auditor should make a report itself would demonstrate that the accounts were complex;

7) The AO had sufficient material at his command to form an opinion that the accounts were complex and that it was in the interest of the revenue to get them audited by the special auditor. Thus, there was no merit in instant petition and the same was to be dismissed. - Neesa Leisure Ltd. v. Dy. CIT [2013] 35 taxmann.com 216 (Gujarat)

HC presumes existence of culpable mind in not filing return within time; confirms prosecution

Where assessee had not filed return of income timely, it could be prosecuted under section 276CC on presumption that there existed a culpable mental state as onus to prove that delay was not willful was on assessee and not on department

In the instant case, the assessee had filed the return of income on 1-5-1995 for assessment year 1994-95. The revenue's case was that inspite of several notices issued to assessee, she had filed the return of income beyond the statutory period. Therefore, delay in filing return was wilful and deliberate and, thus, she was liable to be prosecuted and punished under section 276CC. However, the trial Court and the Sessions Court discharged the assessee. The revenue then filed the petition seeking reversal of orders of both the Courts.

The High Court held as under:

1) It was not in dispute that the assessee had not filed the return for the assessment year 1994-95 within prescribed period and not even within the period within which the revenue had required her to do so. The assessee had not even responded to the communications sent by the revenue requiring her to file return of income or to show the proof of filing. So, the offence under Section 276CC stood committed by that time and for that offence, the department could file a criminal complaint against her after obtaining requisite sanction from the competent authority which it did obtain and complaint was filed in Court;

2) It was for the respondent to establish during the trial that her failure to file return was not willful. The Courts went wrong in going into the question as to whether the explanation offered by the assessee before the filing of the complaint in Court was rightly rejected or not;

3) Once the complaint stood filed, the trial Court was only required to examine whether cognizance was to be taken or not and if it was decided to take cognizance, thereafter, trail Court was required to examine whether in the pre-charge evidence the complainant had been able to show that the assessee had not filed her return for the relevant assessment year within the prescribed period, which fact in the present case was not even disputed by the assessee;

4) So, after raising the presumption under section 278E, the trial Court should have framed the charge against the assessee leaving it to her to show thereafter that there was no willful default on her part. Just because the assessee had applied for the compounding of the offence before the filing of the complaint against her in Court, and the same had not been decided before the filing of the complaint, it could not be said that the complaint was not maintainable;

5) The trial Court was not required to examine at the stage of charge as to why the department was not compounding the offence in the case of the respondent herein. If she was aggrieved by any action or inaction on the part of the authority for compounding, she would have had recourse to legal remedies instead of waiting for the prosecution to be launched by the department;

6) The revisional Court also did not go into the aforesaid aspects and simply affixed its seal of approval to the order of the trail Court and, therefore, its order also couldn’t be sustained. This petition, accordingly, was allowed. The impugned orders of the trial Court and the revisional Court were set aside – ACIT v. Nilofar Currimbhoy [2013] 35 taxmann.com 99 (Delhi)

Due date under sec. 36(1)(va) for payment of employee’s contribution to PF is same as contemplated under section 43B

Employee's contribution towards Provident Fund if paid before due date of filing return is allowable under section 36(1)(va) to employer-assessee
In the instant case the AO had disallowed the payment made by the assessee to the Provident Fund Authority on account of employee's contribution towards Provident Fund since there was delay in payment.  On appeal, the CIT (A) held that since the money had already been paid by the assessee and was no longer in the hands of assessee it could not be taken as income. Further, the Tribunal confirmed the decision of CIT (A). Aggrieved revenue filed the instant appeal.

The HC held in favour of assessee as under:

1) Any sum received by the assessee from his employees towards contributions to the Provident Fund is the income of the assessee, however, section 36(1)(va) allows deduction if contribution thus received is deposited on or before the due date;

2) The due date referred to in section 36(1)(va) is to be read in conjunction with section 43B(b) and a reading of the same would make it amply clear that the due date as mentioned in section 36(1)(va), is the due date as mentioned in section 43B(b), i.e., payment or contribution made to the Provident Fund Authority before the filing the return for the year in which the liability to pay has accrued;

3) The AO proceeded on the basis that 'due date', as mentioned in section 36(1)(va) was the due date fixed by the Provident Fund Authority, whereas he was required to take note of section 43B(b).  By not taking note of the provisions contained therein, he committed gross error, which had been rectified by the appellate authority and confirmed by the Tribunal. So, there was no scope of interference in the order of the Tribunal – CIT v. Kichha Sugar Co. Ltd [2013] 35 taxmann.com 54 (Uttarakhand)

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

Facts

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?

Held

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 taxmann.com 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 taxmann.com 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 taxmann.com 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 taxmann.com 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 taxmann.com 38 (Jaipur - Trib.)