Introduction

04-Jan-16

Indirect Tax
VAT
Service tax
Sales tax
Excise duty - paid on production - the impact falls on the producers - the incidence may be on the consumers

Direct Tax
Wealth tax
Income tax

Incident and Impact

In direct tax - the incident and impact fall on the same person/position
In indirect tax - the impact and the incidence may fall on different persons/positions

Impact - first instance of imposing the tax - the impact falls on the first person/position that the tax is imposed
on - in certain taxes, the impact may be shifted
Incidence - final resting place of taxes - after shifting, the final incidence of the taxes

"All taxes are theft"

Taxes - necessary evil - perhaps taking the money earned by someone is theft - why should the govt. appropriate
certain percentage of your income/money - taxes are a mechanism of redistribution of wealth (brings about
equity) - taxes are also used to provision public goods

Taxes
• Redistribution of wealth
• Public goods
• Regulate

Public Revenue
• Taxes
• Borrowing
○ Within the country (internally)
○ Externally
• Aids/Grants
• PSUs

Public Expenditure
Health care
Education
Defense
Construction of public services - roads, railways, bridges, etc.

Taxes - contribute to public revenue - which is presumably spent on public expenditure - therefore, no quid pro
quo in taxes
There is no quantification of how much of the public services you are using as against another person - whether
or not you might be paying a high quantum of taxes

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or not you might be paying a high quantum of taxes

'cess' - in its nature is also a tax - the difference is that the amount collected has to be used for a specific
purpose - whatever revenue is collected has to be used for the purpose which it was collected - a cess is imposed
to cater to a specifically dedicated goal
E.g. Swachh Bharat Cess, Education Cess, etc.

29th December - SC judgement - upholding the cancellation of licensing by the State of Kerala - Kerala had
stopped issuing licenses for trade of liquor to hotels which were not 4 or 5 star - thereby Kerala had
monopolized the trade of liquor

Akbari Act, 1077

Taxes on liquor, cigarettes, etc. - very high - these goods usually contribute largely to the public revenue
'Sin goods' - highly taxed - but the reality is that consumption is not largely affected by high taxes - therefore, a
question arises about how effective taxes are in regulating behaviour people

GST (Goods and Services Tax) - subsuming a multitude of tax heads under the GST

Service tax and VAT - the bill amount is split up into two portions and the taxes are imposed on different
portions - therefore there is no double taxation here
Service charge - restaurants are not supposed to impose any service charge - not imposed by the govt. but the
restaurant owner - it is the tip that the customer should pay voluntarily

Seventh Schedule - Union List and State List have areas which can be taxed - Concurrent List does not include
areas which can be taxed because we wanted to avoid double taxation
The Constitution does not say that you cannot double tax - but it should be avoided

E.g. when we buy a duster - we pay excise duty to the Centre - we pay VAT to the State - the GST envisages a
system where we avoid double taxation where it currently exists

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Normative Underpinnings of Tax

05-Jan-16

All taxes are theft

Taxes are the price we pay for civilized society (by Justice Oliver Holmes)

Taxes - imposition of taxes is the sovereign power of any State

Most taxes - non-voluntary in nature - what is the basis for the State to impose taxes?
Taxes - generally associated with a certain level of coerciveness

Libertarians — Locke, Nozick

• Minimal State control
• Free markets
• Autonomy to hold property
• Per se do not see any harm in private holding of property - when you mix your own labour to create
something - even if it was naturally available to everybody - you become entitled to hold the fruits of your
labour - you can exclude others from it
○ Why is there merit in such private holding? Why do we recognize such kind of entitlement?

If property is a fruit of your own labour - if you become entitled to hold that property - you have an incentive to
put in those efforts and generate wealth for yourself
Labour is seen as something worthy to be rewarded - you reward labour by recognizing the entitlement to the fruits
of that labour
Therefore, libertarians only allow the govt. to claim certain portion of your wealth only in a minimalistic manner -
the portion appropriated by the govt. has to be then utilized for ensuring that you are able to continue to hold your
property in a secure manner

Locke - you are entitled to continue to hold your private property provided - you do not spoil it - and you leave
enough in common for other
This ideology may have made sense in a barter economy - the moment you bring in money, spoilage and leaving
enough in common lose meaning
Banks - we deposit surplus money - will it be considered spoilage?

Sovereign Gold Bonds - prevents spoilage - instead of buying physical gold, people can invest in gold bonds - you
will get your money back after it matures - this prevents hoarding of gold

Robert Nozick - he says that even if there is economic inequality - such kind of inequality should not be allowed
only at the stage of original distribution - the inequality exists because of diff. efforts put in by diff. people - there
should only be interference (and redistribution of wealth) only when you have come into the possession of those
resources by illegitimate means

Otherwise, libertarians do not propound any kind of interference (taxes) in possession of wealth - because the
wealth is accumulated by putting in one's own efforts and labour - this is seen as meritorious
If there is inequality - it will motivate others to put in more efforts in acquiring wealth

If your country views taxes from a libertarian lens - then there will only be minimalistic taxes - which are enough
and sufficient to maintain order in the society

There is an alternative approach to the libertarian view - says that you cannot make any labour or wealth without
help of others - if others have also helped - then it is necessary to pay back the others for their effort - that is where
States seek an entry point into claiming share from your income - therefore, through taxes you apportion that much
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States seek an entry point into claiming share from your income - therefore, through taxes you apportion that much
amount back to the govt.
The fruits of your labour are not your efforts alone

Even if you are putting in enough labour to generate wealth - you might not be entering the system at the same
point - because of certain circumstances, historical or otherwise (say oppression, poverty, luck, etc.) - it may be
necessary to offset that disadvantage
Everyone does not have the same kind of opportunities - therefore, people may not start from the same footing -
this impacts the ability to accumulate wealth - therefore, the govt. needs to intervene

John Rawls - talks about justice and fairness - if you have not begun the race from the same starting point then you
need to somewhere address that question also
Rawls' veil of ignorance - if no one knew where they would land up in life - then everyone would agree on a
system which would be equitable to all - we would not take an approach which allows others to be left behind
(because I might land up in that situation) - we would agree to contribute something for the creation of minimalistic
services for everyone
This would lead to the creation of public goods and would also lead to wealth distribution

Utilitarians — Bentham
Focusing on enhancing the utility of taxes on society

Jeremy Bentham - diminishing marginal utility - the moment your wealth increases, the utility of your wealth
decreases - the govt. should impose taxes which amount to quantum of wealth where the utility of the wealth is
equal to the benefit created for the person which you have vested the wealth with
You tax at that rate in which you hurt the person being taxed equal to the benefit you create for the common
revenue

Musgraves

Progressive taxation - tax slabs

Regressive taxation - which are equal for everyone - e.g. indirect taxes are usually regressive in nature - say you pay
excise duty on a packet of biscuits and a poor person also pays the same amount of excise duty

Most societies will impose taxes in a manner which is a combination of all these theories - to a certain extent you
will allow for entitlement - you will make some minimalistic public goods and services - you will also tax in a
progressive manner where the rich contribute more

OECD Report - Base Erosion and Profit Shifting

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Tax

06-Jan-16

Three tier structure

• Central govt.
○ Income Tax (except tax on agricultural income)
○ Corporation Tax
○ Central Sales Tax (Entry 92B - inter-state sale - the revenue generated is retained by the state from
which the goods have originated)
○ Central Excise Tax
• State govt.
○ Excise duty on liquor for human consumption
○ Tax on agricultural income
○ Sales Tax (tax on intra-state sale of goods)
○ Stamp Duty (duty on transfer of property)
○ State Excise Duty (duty on manufacture of alcohol)
○ Land Revenue (levy on land used for agricultural/non-agricultural purposes)
○ Duty on Entertainment
○ Tax on Professions & Callings
• Local authorities
○ Tax on properties (on buildings, etc. - higher for commercial properties than for residential properties)
○ Octroi (tax on the entry of goods for use/consumption within areas of the Local Bodies)
○ Tax on Markets
○ Tax/User Charges for utilities like water, supply, drainage, etc.

Art. 265 of the Indian Constitution - generally, NO tax can be imposed without reference to a particular Entry in
the Lists of the Seventh Schedule

In 1994 - no Entry found in any List for imposition of Service Tax - Amendment made in List I to insert Entry
92C for Service Tax (not yet made effective)
For imposing tax - Art. 265, Art. 246 read with the particular Entry of the respective List
Service Tax - till date it is imposed under the Finance Act of every year (read with Entry 97 of the Union List) - it
started with 3 services on which tax was imposed - now there is a negative list and everything else is covered
under the ambit of Service Tax

Now with the GST on the table - there is no need to activate Entry 92C as the Lists will have to be revised if the
GST Bill comes to pass

Union List (Article 246(1) of the Constitution specifies that Parliament has exclusive powers to make laws with
respect of any of the matters enumerated in List I in the Seventh Schedule to Constitution)
State List (As per Article 246(3) State Government has exclusive powers to make laws with respect to matters
enumerated in List II)
Concurrent List (both Parliament and state Government can pass legislation)

Art. 248 - grants exclusive powers to the Parliament to make any law with respect of any matter not enumerated
in the Concurrent List or State List - such power includes the powers of making any law imposing a tax not
mentioned in either of those lists - residuary powers

The Indian Constitution is unique in the sense that it contains an exhaustive enumeration and division of
legislative powers of taxation between the Centre and the States
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legislative powers of taxation between the Centre and the States
A scrutiny of Lists I and II of the Seventh Schedule would show that there is no overlapping anywhere in the
taxing power, and the Constitution gives independent sources of taxation to the Union and the States

Union List
Entry 92B - consignment of goods during inter-state trade or commerce
Sale - sale and purchase - agreement to purchase the goods
Consignment Sale - where the goods are in transit - there is no guarantee that the goods will be sold - if they
are not sold then the batch of goods can be returned

Taxes on newspapers - excluded - as taxes on newspapers would impinge on the freedom of speech and
expression

Indian constitution - unitary bias - the Centre has more powers than states - not pure federalism - in-built unitary
bias - especially apparent in the fiscal federalism - the states depend on the Central govt. when they are in need of
money - we have modes of transfer by which the Central govt. will transfer certain amount to all states

Modes of Transfer
• Tax sharing
• Grants in aid
• Borrowings

The revenue generated by imposition of cess and surcharges are NOT transferred to the states - they do not form
part of the common divisible pool

Mechanisms of Transfer
• Finance Commission - the Finance Commission is a constitutional body entrusted with the responsibility of
recommending transfer of resources from the Centre to states to address both vertical and horizontal
imbalances - Art. 280 - Finance Commissions have used equity and efficiency as the two guiding principles
while recommending inter se shares of states in tax devolution - the principle of equity addresses the
problem of differences in revenue raising capacity and cost disabilities across states
○ Vertical imbalances - the diff. b/w the revenue generated by the Centre and the state - because more
revenue generating areas are under the purview of the Centre
○ Horizontal imbalances - all states cannot generate the same quantum of revenue - due to availability of
resources, natural calamities, geographical reasons, infrastructural development, etc.
• Planning Commission - the Planning Commission oversees grants meant for state development expenditures
as part of an overall assistance package composed of loans and grants - transfers as during the Planning
Commission time have now stopped - now the Planning Commission has been replaced by the NITI Aayog
which is merely a recommendatory body - it is a think tank and it does not control how the states proceed
with fiscal development
• Central Ministries - transfers for specific purposes - some of the specific purpose transfer schemes are
entirely funded by the Centre and other are shared cost programs - major programs on poverty alleviation,
family planning and education fall in this category
○ Centrally Sponsored Schemes
 Sarva Siksha Abhiyaan
 The protest against such Schemes from the states was that the Centre through these Schemes, is
interfering in the mandate of state authority and is impinging on the state's authority to plan the
development of the state - even though it is the state's constitutional mandate

We are a Federalist nation - but it is not a co-operative federalism - there are imbalances
BIMARU - Bihar, MP, Rajasthan, UP

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BIMARU - Bihar, MP, Rajasthan, UP

Criteria and Weights for Tax Devolution - determined by the Finance Commission
• Population
• Area
• Fiscal discipline - how efficiently the state officials are using the revenue generated

These transfers are unconditional transfers - the Central govt. cannot dictate how the state govt. should spend the
amount

Tax Sharing
Art. 268 to Art. 270

Criticism of the GST from the states - the claim was that their fiscal autonomy will be affected - but the Centre
has promised to compensate for any losses of revenue if at all - but only for 5 years

07-Jan-16

Grants
Art. 275 - these grants can be made on the recommendation of the finance commissions
The finance commission provides the criteria for allocation of resources - but if this is not enough - there
could be unconditional grants upon the recommendation of the finance commission
Art. 282 - discretionary grants - from the Centre to the states - but only at the discretion of the Centre - for public
purposes - could be for something not listed under any of the Lists
Planning Commission grants have usually been given under the Art. 282

Borrowings
Art. 292 and 293
State govt. can borrow from the Centre
State govt. can also raise funds from the markets - but if the state is indebted to the Centre - then the state
has to seek the permission of the Centre to raise funds from the markets

Fiscal performance - states had not been too alert w.r.t fiscal discipline - in 2003 there was a FRBM Act - Fiscal
Responsibility and Budget Management Act, 2003 - states have put in their own FRBM Acts - under this Act the
states were supposed to curb their financial deficits - the ideal suggested by the Acts is a maximum of 3% deficit -
it is never 3% but at least if you manage to curb or curtail the deficit to around these numbers, then you are safe
and not in danger of falling into a spiral of debt
Usually govt. chalk out their expenditures and then they find revenues to fulfill these expenditures
If there is not enough revenue for their expenditure - there is a deficit - if this deficit is too large, then it will
become a debt trap

When the state govt. are spending public money - they must keep track of what kind of expenditures are being
made - how efficient these expenditures are - they must make sure that they do not spend on projects which are
ultimately not beneficial to the state - fiscal discipline

Austerity measures - fiscal consolidation - the govt. is trying to take back many subsidies that were granted
earlier - the govt. contracts out jobs instead of creating 'permanent liabilities' - all these measures are guided by the
principle of austerity and fiscal discipline

14th finance commission - criteria/weightage

Population
Demographic change

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 Demographic change
Area
Fiscal discipline
Forest area

Earlier only 32% of the revenue was shared with the states - but the 14th finance commission has made it 42%

Constitutional challenge to the imposition of the wealth tax - taxing entries

In 2015 - the wealth tax has been abolished - 2% surcharge if your income is more than 1 crore - this
judgement is still relevant however w.r.t residuary powers and taxing entries

Income - inflow of cash - recurring in nature

Wealth - accumulation of resources, acquisition of properties, inherited wealth

Wealth tax - aggregation of your assets (capital value of assets) minus any liabilities - wealth tax is imposed on
the balance amount

Sudhir Chandra Nawan v. Wealth Tax Officer [1969] 1 SCR 110

In this case - the basis of imposition of wealth tax challenged - under which entry has it been imposed?
The way that wealth tax was imposed - it included the capital value of all assets - which included lands and
buildings - lands and buildings were under Entry 49 of List II
Wealth tax was allegedly imposed under Entry 86 of List I - taxes on capital value of assets except
agricultural land

To calculate the wealth - value of all assets - which includes jewellery, lands, buildings, property shares and
liabilities (which are subtracted)
The state govt. already levies taxes on lands and buildings existing within the boundaries of each state

The challenge was therefore, under what entry the wealth tax was levied - the Centre had to clarify this
question
The SC tried to venture into the nature of the wealth tax
When state govt. impose the taxes on lands and buildings - it is merely an individualized kind of tax - e.g. if
you have land in Rajasthan, the state govt. of Rajasthan can impose tax on that land
When the Centre imposes wealth tax - it aggregates the value of all the lands, buildings, assets that you own
across different state territories/jurisdictions - it also takes into account your liabilities
Therefore, the court said that the nature of the wealth tax under Entry 86, List I is very different from the
tax being imposed by states under Entry 49, List II

The court said that the Centre can impose wealth tax under Entry 86 or Entry 97 of List I - the court upheld
the imposition of the wealth tax

When taxing statutes are challenged - it is very difficult for them to be struck down - the courts usually defer to
the decision of the govt. - a large leniency is given to the parliament for imposing taxes

In the year 1969 - Centre passed an amendment - the value of agricultural land was also included into the
computation of wealth for imposition of wealth tax
This inclusion of agricultural land is being challenged by HS Dhillon case

UOI v. HS Dhillon

08-Jan-16

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Wealth Tax Act, 1957 - excluded agricultural lands
1969 Amendment - the Central govt. sought to tax the capital value of agricultural lands

This was challenged in UOI v. HS Dhillon

The HC upheld the petition - if this imposition is under Entry 86 of List I - this entry excludes agricultural
land - then the Centre is overstepping the area demarcated for it
The HC held in favour of the petitioners - the Central govt. could not impose tax on agricultural land - there
is some sort of constitutional lacunae here

SC - seven judge bench to clarify the validity of this amendment

 Whether this imposition falls under Entry 49 of List II or Entry 86 of List I?
 Whether this imposition falls under Entry 97 of List I?
 If it is under Entry 86 of List I - what effect does the exclusionary clause in the entry - whether the
exclusion amounts to positive prohibition on the Central govt.?

Entry 86 List I - excludes tax on capital value of agricultural lands - but this subject is not included in the List
II either - this subject has to be located in some entry to allow for imposition of taxes on that subject matter
If it is excluded from the Central power - but it is not included in the state power

The SC says that in Sudhir Chandra Nawn case - it had already been determined that the wealth tax is NOT
under Entry 49 of List II
From this point - the primary question is whether such imposition can be brought into effect through the
backdoor by exercise of the residuary power of the Centre (Entry 97) - despite the explicit exclusion in the
Entry 86 of List I

Arguments by Palkiwalla - whenever there is an exclusion of any subject matter from List I, there is an
inclusion of that matter in List II
E.g. Entry 82 of List I excludes income tax on agricultural land - included in Entry 46 of List II
E.g. Entry 87 of List I excludes estate duty on agricultural land - included in Entry 48 of List II
E.g. Entry 88 of List I excludes succession duties on agricultural land - included in Entry 47 of List II

Whilst in Entry 86 of List I - taxes on capital value on agricultural land has been excluded - there is no
corresponding entry in the state list which includes this subject matter - there is only Entry 49 of List II
which talks about taxes on lands and buildings - it does not speak of capital value of agricultural lands

The Respondents argued that since the subject of agriculture has been generally taken away from the Centre -
it should be presumed that the state has the power to tax this subject matter under Entry 49 of List II

The Union argues that since such a tax is not present in any other category - it should come under the
purview of the residuary powers of the Centre
Any subject matter which is not mentioned in List II and List II - it falls within the purview of Entry 97

The Respondents counter that once a subject matter is explicitly excluded in the List I (from the powers of
the Centre) - how can you then bring that subject matter within the Centre's power through the backdoor
entry of Entry 97 of List I

Does an express exclusion amount to a prohibition on its consideration under Entry 97 (residuary clause) of
List I?

The SC tries to see what might happen if this particular subject matter has been so excluded - Entry 97 has
to be read with Art. 248
Art. 248 says - parliament has the exclusive power to make any law w.r.t any matter not enumerated in
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 Art. 248 says - parliament has the exclusive power to make any law w.r.t any matter not enumerated in
the concurrent list or the state list
The SC says that if we accept the argument of the Respondents - then Art. 248 will have to be redrafted with
a proviso - which adds the proviso 'provided it is not explicitly excluded in any Entry of List I'
The majority decision therefore accepts the argument of the Union - Art. 248 does not make any mention of
specific exclusions

The majority decision of the SC says that if the residuary power has to be invoked - then look at whether the
subject matter finds any mention in the concurrent list or the state list - if not, then residuary clause can be
invoked

The SC said that Sudhir Chandra Nawan's case - we had proceeded on the assumption that the wealth tax
was imposed under Entry 86 or Entry 97 of List I - we had not determined conclusively which Entry the
wealth tax was imposed under

The minority judges opined - once the subject matter is excluded in one Entry of the List I - then the subject
matter cannot be brought under the residuary clause - because it would nullify the very purpose of the
exclusion itself
The minority judges also say that whenever agriculture as a subject matter is concerned - it has always been
given to the state's power
List II - Entry 14, 18, 28, 30, 45, 46, 47, 48, 49 deals with agriculture and agricultural land - directly or
indirectly - leaving powers related to the same to the states
Therefore, agricultural land again should have been excluded from the Centre's power

In Sudhir Chandra Nawan - the court said that nothing prevents the parliament from imposing a tax, the subject
matter of which falls within two or more entries - therefore a combined reading of Entry 86 and Entry 97 is
possible

11-Jan-16

Aspects Theory

Federation of Hotel Association of India v. UOI (1989) 3 SCC 634

Expenditure Tax Act, 1987 - imposed by the Central govt. - 10% of value - imposed on all such hotels where
one is provided with accommodation and the room charges are Rs. 400 and above
Charging section — any payments are being made with the provisioning of
Any accommodation
Food or drink by the hotel - whether at the hotel or outside
Any accommodation on hire or lease
Any other services at the hotel such as beauty parlour, health club, swimming pool or other such
services
The govt. proposed and put in place this tax to discourage such wasteful expenditure

The hotels are members of the Federation - challenged the vires of this tax - this tax is nothing but a tax on
luxury and the subject matter of luxury falls within the state power - the Federation contended that the
Centre is overstepping its powers by using the misnomer of 'expenditure tax'
Further the Federation contends that the classification made by the Centre has no intelligible criteria - Art. 14
violation and Art. 19(1)(g) violation

Palkiwalla arguing for the Petitioners - says that they are challenging the nature of the tax - when one talks
about expenditure tax - the economist understanding of an expenditure tax is a tax imposed on the totality of
the expenditure made by the consumer - it is akin to a consumption tax - expenditure tax would mean a tax
on all the expenditure/consumption made by the person during the entire year
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on all the expenditure/consumption made by the person during the entire year
By imposing taxes on consumption - you are trying to incentivize your population to save rather than
spend - there was a consumption tax which was experimentally imposed and given up in 1957 - this was
imposed on the totality of expenditure of a person
The given circumstances do not conform to this understanding of expenditure tax
But in the given circumstance - the tax is imposed at each step of expenditure

Therefore it is argued that this tax is a misnomer - it is actually falls within the state power
Entry 62 of List II - taxes on luxuries
Entry 54 of List II - sale or purchase of goods (here foods and drinks)

The Central govt. says that we are imposing this expenditure tax under Entry 97 of List I
The Attorney General on behalf of the govt. - used HS Dhillon case - if there is a challenge to the vires of
the imposition of a tax by the Centre - it is enough to enquire whether the subject matter falls within List II

The AG says that the measure adopted for the levy of the tax does not necessarily determine its essential
character
The govt. is trying to put across the point of the objective of the tax and how it is imposing the tax does not
determine the essential characteristics of the levy
The object on which the expenditure is laid out might be an item of luxury or it might not be - it might be
levied on the price of the good or it might not be - this measure does not determine the essential character of
the tax
What is being taxed is the expenditure aspect - which is susceptible to be recognized as a distinct subject
matter w.r.t. legislative competence - this falls within Entry 97 of the List I
It is very crucial to question whether the economist's conception of such a tax is conditioning the legislature's
power

Aspects Theory - the judgement refers to the aspects doctrine (pith and substance doctrine)
The govt. says that the law w.r.t a particular subject matter might incidentally affect another subject matter -
but that does not mean that it is the same thing as the law being made on the latter subject matter
There might be overlapping - the overlapping must be in law - the same transaction may involve two or
more taxable events in different aspects

Separate and concurring judgement of Ranganathan

The object of a tax on luxury is to impose a tax on the enjoyment of certain types of benefits, facilities or
advantages on which the legislature wishes to impose a curb - the idea is to encourage society to cater to the
needs of those who cannot afford them
The object of the expenditure tax is to discourage expenditure which the legislature considers lavish and
ostentatious
The object of the first would be discourage certain types of living and enjoyment, while the object of the
second would be to discourage expenditure through unproductive and undesirable channels

Palkiwalla argues that accepting such kind of imposition would lead to dire consequences - say the Centre
will tax the income aspect and then when the same income is used to purchase something then there will be
a levy of expenditure tax as well

The court decided in favour of the Centre - this kind of legislative competence falls within the Centre's
power - the aspect of expenditure can be distinguished and is distinct
The court also accepts the argument that the subject of the tax is different from the measure of the levy - the
measure of the levy does not determine the nature of the tax

The argument from the petitioners is also that the tax does not make any reasonable classification - the fancy
restaurants which do not provide accommodation have been left out of the tax - even though the clientele of
Taxation Page 11
 restaurants which do not provide accommodation have been left out of the tax - even though the clientele of
these restaurants is very similar in terms of wealth and luxuries with the clientele of the hotels which have
been taxed
The court decided that it is now very settled that though taxing statutes are not outside the purview of Art.
14 - however, having regard to the wide variety of diverse economic criteria that go into the formulation of
fiscal policy, legislature enjoys a wide latitude in the matter of selection of persons, subject matter, events,
etc. for taxation - the tests of the vice of discrimination in a taxing law are less rigorous - a legislature does
not have to tax everything in order to be able to tax something - thus, a wide discretion can be exercised in
selecting persons and objects and the statute is not open to attack on the mere ground that it takes some
persons or objects and not others

The argument about unreasonable restriction on the freedom of trade and commerce - the different kinds of
taxes amount to very high rates - such high amount of taxes virtually makes them go out of business - this
amounts to a violation of Art. 19(1)(g)
The court says that a taxing statute is not per se a restriction on the freedom under Art. 19(1)(g) - the policy
of a tax in its effectuation might of course bring in some hardship in some individual cases - every cause it is
said has its martyrs - therefore, the mere excessiveness of the tax towards the diminution of earnings or
profits of an individual does not per se constitute a violation of Art. 19(1)(g)

12-Jan-16

All India Federation of Tax Practitioners v. UOI [2007 SC]

The imposition of service tax was gradually expanded - when it was first imposed, it was imposed on 3
services - gradually
In 1998 - service tax became applicable on Chartered Accountants and Cost Accountants
Challenged
When you refer to Entry 60 of List II - taxes on profession, trade, callings and employments have been
assigned to the state govt.
The Centre is envisaging a tax on the services of these professions - the argument of the Federation is that
the practice of every profession always involves the rendering of some service by these professionals -
therefore, Entry 60 should be interpreted to include the rendering of the services by the respective
professionals
The Centre is arguing that the taxes imposed by the state under Entry 60 are all together different in their
aspects as compared to the tax being envisaged by the Centre
State is imposing taxes on the individual professional - tax attached to the status of the individual
professional - e.g. existing as a doctor - e.g. the moment you get the Bar certificate you become eligible
to pay tax as a professional (lawyer) irrespective of the fact that you have undertaking any activity
relating to your profession
Centre is imposing taxes on the activity of the professional - e.g. working as a doctor - e.g. when you get
clientele and you go to court, you become eligible to pay service tax

The argument of the Federation is that the term 'profession' should be broadly interpreted to include the
rendering of services

Under List I
Entry 1 to 81 — general entries
Entry 82 - 92 — taxing entries

State List II
Entry 1 to 44 — general entries
Entry 45 - 63 — taxing entries

E.g. In Entry 22 of List I - you find railways - Entry 89 of List I - you find terminal taxes on goods carried by
Taxation Page 12
 E.g. In Entry 22 of List I - you find railways - Entry 89 of List I - you find terminal taxes on goods carried by
railways
The general entries refer to particular subject-matters and the taxes on the particular subject-matters are
found in the taxing entries

The court says that you can read the general entries broadly but you cannot read the taxing entries broadly
The court upheld the legislation

Perhaps the Federation could have argued that the measure of the levy does not determine the nature of the tax -
Entry 60 talks about taxes on 'professions' and not about taxes on 'professionals'
Here there is an alternative argument that the term 'professions' has been broadly interpreted to make it
synonymous with 'professional' - and a 'profession' as opposed to a 'professional' is nothing but the practice
of that particular profession

Kunnathat Thathunni Moopil Nair v. State of Kerala 1961 AIR SC 552 (5 judge bench — 4:1)
The govt. of Kerala came up with the Travancore Cochin Land Tax Act 1955 - this tax was imposed on all
lands in the state of Kerala (of whatever description and held under whatever tenure) - were to be charged at
a uniform rate Rs. 2 per acre
There was no difference made acc. to the quality of the land, the productivity of the land or the ability of the
land to generate incomes, etc.
There was no procedure provided in the Act to address the concerns/disputes/problems of the people on
whom the levy was imposed
The argument is that this tax is confiscatory in nature - it violates Art. 14, Art. 19(1)(f) and Art. 31(1)
The power of the govt. under this Act are arbitrary in nature
The way the govt. went about this tax imposition was that in case of default, the govt. could auction off
these lands - if the auction does not generate enough income from the auction - the govt. would retain
the land for itself - no appeals, no compensation, no procedure for grievance redressal
This kind of levy is being purposively put in place to confiscate these lands - especially forest lands which do
not have much income generating capacity
The govt. says that we are not concerned with the quality or productivity of the land - this tax is on the
holding of the land
The majority of the court found this tax to be violative of the Art. 14 rights of the Appellants
The court says that such imposition is confiscatory in nature - the Act has no provision of compensation -
this Act cannot continue - this Act violates the rights of the Appellants under Art. 14, 19(1)(f) and 31(1)

There is one dissenting judgement - if the tax is on the holding of the land - then there is no need for
classification based on the quality/productivity of the land

Usually the courts defer to the fiscal wisdom of the legislature - taxes are not outside the purview of Art. 14 and
other FRs - but they are less rigorous

Swachch Bharat Cess - health and sanitation falls under List II (Entry 6 and 66) - if the Centre is imposing this
cess to clean the cities, what are municipalities doing?

Taxes - imposed on the subject matter of particular entries

Cess and fees - no such restriction

Taxation Page 13
Tutorial

11-Jan-16

Taxes - theft or necessary evil?

Article review - Project Topic

Low rates or high rates?

Efficiency (ability to pay - more equitable form of imposition) v/s Equality (cost-benefit approach)
Economists argue against the cost-benefit approach
But one of the reasons tax is imposed is redistribution of wealth - e.g. I pay tax but do not use govt. schools

Tax rates - discriminative (tax slabs - progressive taxation) or uniform amount (same quantum - this is different
from uniform rate of taxation - e.g. toll tax is a uniform tax)
Again the argument for progressive taxation boils down to redistribution of wealth
Classical notion - progressive taxation takes away the incentive to put in more efforts to earn more
Economists argue for uniform rate of taxation - if you earn more then even though the rate of interest is the
same - you end up paying more - but this does not take away incentive to work harder

Tax - difficult to administer or easy to administer

Western democracies - complex system of taxation - irrespective of the complexities and inefficiencies of the
system, it continues

Taxes - visible or hidden (invisible) - it is a characteristic of the mode of payment of taxes

Visible tax - e.g. income tax
Hidden tax - e.g. VAT - you think you are buying a expensive product but a portion of that is paid by the
company is being paid as tax - the tax is packaged as some other product (e.g. MRP)

Some taxes are partly visible and partly invisible

Tax - general fund or earmarked fund

Taxation Page 14
Taxes and Fees

13-Jan-16

Taxes Fees
A tax is a compulsory exaction of money by public A fee is generally defined to be a charge for a special
authority for public purposes enforceable by law and is service rendered to individuals by some governmental
NOT a payment for services rendered agencies
Tax is levied as part of a common burden A fee is levied for a special benefit or a privilege
License fees
Development fees for import
Toll fees/tax
Fees levied by private operators (PPP Agreements -
build, operate and transfer)
Processing fees
There is NO quid pro quo in taxes - payment of taxes is There is some rendition of services in return for the
a part of the common burden which falls on all of use fees paid - payment of fees does NOT form a part of
the common burden as in tax - there is an element of
service involved here - there is a dedicated fund
There is a quid pro quo

Difference b/w license fees and development fees

• By payment of license fees - there is a conferment of a special status on you - there is an element of regulation
which comes in
• Development fees - compensatory in nature

Fees - Regulatory in nature and Compensatory in nature

• When a fee is charged for rendering specific services, a certain element of quid pro quo must be there b/w the
services rendered and the fees charged so that the fee commensurate with the cost of rendition of services -
this kind of a fee will be considered to be compensatory in nature
• Fees can also be regulatory when the activities for which the license is given requires to be regulated or
controlled - a fee which is charged for regulating such activity would be classifiable as a fee

The essential characteristic of a fee is quid pro quo - therefore it is always commensurate with the services
rendered - a fee is charged for rendering special services or for rendering a special status

Foundational understanding of imposition of a fee - there has to be quid pro quo - the impost has to be more or
less commensurate or matched up with the services rendered
In regulatory fees - it may not be that the impost is commensurate (as there is no service being returned) - they are
devoid of quid pro quo - but it is essential that they are NOT excessive in nature - if it is excessive in nature, then
even if it is named as a fee, it is actually a tax

The payment of fees - may incidentally help the govt. in its revenue generation - but if it becomes a primary
revenue generating mechanism/tool, it is NOT a fee - it would be a tax

There might be fees which are regulatory as well as compensatory in nature

The regulatory fees may incidentally augment the revenue for the govt. - but augmenting the revenue should not be
the primary purpose
A regulatory fee cannot not be excessive so as to ensure regulation - the license-seeker may have to fulfill
other criteria before getting a license
Taxation Page 15
 other criteria before getting a license
E.g. driving license - you not only pay the fee but you also have to pass the test

Seventh Schedule
Under List I
Entry 1 to 81 — general entries
Entry 82 - 97 — taxing entries

State List II
Entry 1 to 44 — general entries
Entry 45 - 63 — taxing entries

Fees can be imposed on any matters pertaining to any of the general entries
Whereas a tax can be imposed only on subject matters in the taxation entries

If the govt. cannot find a taxing entry for a particular subject matter - then the govt. may impose a tax in the guise
of a fee under any of the general entries

Taxes - can also be regulatory in nature - to regulate sin goods (liquor, cigarettes, etc.)

Quid pro quo in fees - there need not be an exact arithmetic exactitude

Secunderabad Hyderabad Hotel Owners Association v. Hyderabad Municipal Corporation AIR 1999 SC
635
HMC imposed a certain license fees on those set of businesses and entities running hotels, coffee houses, tea
stalls, cafeteria, tiffin rooms - food and beverage places - you would need to apply for a license - there is a
license fee which would be calculated depending on the area of operation of the business
HMC also comprised visits from the officials of the municipality to ensure that there are certain conditions
met by the business places - health and hygienic requirements, cleanliness requirements, food should be
wholesome and healthy - only if you qualify, the license will be issued
After some time, HMC enhanced the license fees - in the year 1997 (from the rates applicable in 1991 - 1992)
The Association says that this enhancing of fees makes this an imposition of tax
By this enhancement of fees - there is no quid pro quo - therefore, this is now in the nature of a tax
If there is to be an enhancement of taxes - there has to be a publication of such intentions in the official
gazette and the local newspapers, address any concerns and only then enhance the tax
The argument from the HMC is that they remove the garbage from the roads, maintain hygiene and
sanitation, etc. and that is the fee being rendered for these establishments
The HMC is anyway obliged to remove garbage and maintain sanitation in the city premises

The HMC says that this enhancement which has happened is not in the nature of a tax but it is compensatory
in nature - the HMC produced its budget before the court - they could successfully depict that the amount
expended to maintain sanitation and removal of garbage is much more than the revenue collected from the
levy of the enhanced fees - there is more garbage being collected from these establishments and the court
found merit in the argument of the HMC and the enhancement of fees

The Association argued that this amount is being put in the common fund of the HMC and not in a specific
fund - but the court said that it is not of consequence if there is a specific fund - what is necessary is the
rendering of services - if the services have been rendered, it does not matter if the fees collected are kept in a
specific fund or not

18-Jan-16

Taxation Page 16
Kewal Krishnapuri v. State of Punjab (1979) 3 SCR 1217
The fees being charged were in excess - there was a surplus of revenue - they started donating to educational
institutes - therefore, the increase in the fees was in the colour of a tax

The concept of fees have expanded to a certain extent - the elements of fees began to be diluted one after the
other
• Rendition of services - quid pro quo
• Special benefit/privilege
• Dedicated fund

The creation of a dedicated fund is not a very essential requirement of a fee

As seen in the Secunderabad Hyderabad Hotel Owners Association case - the Municipal Corporation could
demonstrate that they were spending much more on these services than the revenue collected from the levy
of the fees
Therefore, the procedure of creating a dedicated fund is not very crucial in determining whether the impost is
a fee or not

The relationship of quid pro quo is presumed to be very direct - those who contribute/pay the fees get the benefit
The courts began to loosen up this relationship - if the service is rendered in a particular area or a particular
class and the payer of the fees is a member of that class, then there is quid pro quo - i.e. if you are part of a
whole and the whole is being served, then this relationship satisfies quid pro quo

Hingir Rampur Coal Co. Ltd. v. State of Orissa 1961 AIR 459
Imposition of a cess on miners of coal - according to a particular Act, there was a development fund - Orissa
Mining Areas Development Fund Act, 1952 - under this Act, a cess was levied on the mineral resources on
the pit's mouth - the state govt. will be using the funds to provide amenities in the identified areas
Challenged - this is nothing but an excise duty which is being levied by the Central govt.
Entry 84, List I and Entry 52, List I - mining and regulations and development
Coal Mines Labour Welfare Fund Act, 1947 - centrally created fund
The challenge is that the cess is basically in the nature of excise duty already being charged by the Union

When the legislature decides to render a specific service to any area or any class of persons, it is not open to
the said area or the said class of persons to plead that they do not want the service and should therefore be
exempted
In regard to fees, there is and must always be co-relation b/w the fees collected and the service intended to be
rendered

Cases may arise where under the guise of levying of fee, legislature may attempt to impose a tax - in such a
case of colourable exercise of legislative power, courts would have to scrutinize the scheme of the levy very
carefully and determine whether in fact there is a co-relation b/w the service and the levy

Whether or not a particular cess levied amounts to a fee or tax would always be a question of fact to be
determined in the circumstances of each case
In this case - the co-relation was b/w the area or the class of persons and the service rendered - this was
considered to be enough

The co-relation - may not be a direct co-relation - a mere casual relationship may be enough

The traditional view that there must be actual quid pro quo for a fee has undergone a sea change in subsequent
decisions - the concept of a fee is undergoing transformation and though there must be relation b/w the services
rendered and the levy, such relation need not be direct and a mere casual relation may be enough
What has to be seen is whether there is a broad and general co-relationship b/w the totality of the fee and the

Taxation Page 17
What has to be seen is whether there is a broad and general co-relationship b/w the totality of the fee and the
totality of expenses of services

Dilution of the element of quid pro quo and the degrees of co-relation & no requirement of dedicated fund - the
very concept of a fee is being diluted - a fee has now become closer to the concept of a tax
By judicial decisions, the concept of fee has been progressively expanded

Part XIII of the Constitution

Art. 301 - freedom of trade, commerce and intercourse - binding on Union and state legislature

Art. 302 - Parliament may impose restrictions on freedom of trade, commerce and intercourse if required in public
interest

Art. 303 — Parliament

(1) no discrimination/preferences b/w states - even in public interest
(2) exception to clause (1) is scarcity of goods

Art. 304 - state govt.

19-Jan-16

Art. 302 Art. 304

Parliament's power to impose restrictions under Art. The power of the State to impose restrictions is subject to
302 is not subject to the requirement of the requirement of reasonableness
reasonableness
For the exercise of the power under Art. 302 by the For the exercise of the power under Article 304(b) by the
Parliament no previous Presidential sanction is State Legislature previous Presidential sanction is required
required for such legislation
The power of Parliament under Article 302 is subject The State power contained in Article 304(b) is made
to the prohibition of preference and discrimination expressly free from the prohibition contained in Article
decreed by Article 303(1) unless there is exception 303(1) because the opening words of Article 304 contains
carved out under Article 303(2) i.e. scarcity a non-obstante clause both to Article 301 and Article 303.

Art. 19(1)(g) - appears to be more individualistic in its approach

Art. 301 - more broad outlook - it is trying to attain the ideal of unified market within the country - overall trade
and commerce per se
Strategically - perhaps they are invoked together as Art. 19(1)(g) has more reasonable restrictions enumerated
than the stringent restrictions envisaged by Part XIII
Art. 19(1)(g) - does not apply to non-citizens - and therefore Art. 301 is much broader in scope

Implications of Part XIII on Taxation

Does freedom of trade, commerce imply freedom from all taxes? — NO
If it does not, are taxes outside the purview of scrutiny of Part XIII? — NO
Both are extreme suggestions

The imposition of taxes - facilitates trade and commerce - infrastructure development - then it does not amount to
restriction on trade and commerce
You asses taxes on the grounds of reasonableness and non-discrimination

Atiabari Tea Co. Ltd. v. State of Assam 1961 AIR

Tea growers in Assam & West Bengal carried their tea to the market in Calcutta from where tea would be sold
for consumption in the country or exported - majorly, the tea was moving out, very little was consumed in
Taxation Page 18
 for consumption in the country or exported - majorly, the tea was moving out, very little was consumed in
Assam
Assam govt. passed The Assam Taxation Act, 1954 - when the tea passed through the roadways or waterways
within the state of Assam, a tax would be imposed on them - the purpose was to levy a tax on movement of
good in the territory of the state of Assam

Entry 56 List II

The challenge was that the Act violated the freedom of trade guaranteed by Art. 301 of the constitution - it
was passed without obtaining the previous sanction of the President required by Art. 304(b), therefore it was
ultra vires

The govt. took the position that taxing laws are outside the purview of scrutiny under Part XIII

The court held that taxes may amount to restrictions - taxing laws are within the purview of Art. XIII - and
that this Act was a direct and immediate restriction on trade and commerce
The SC held that the tax was bad - the goods were being taxed solely because they were being carried or
transported - thus, it directly affects the freedom of trade

Doctrine of 'direct and immediate' effect - taxes may and do amount to restrictions but only those taxes which
directly and immediately restrict trade that would fall within the purview of Art. 301

Therefore, whenever a law is challenged on the ground of violation of Article 301, two fold scrutiny to be followed
1) examine the pith and substance of the levy
2) see the effect and the operation of the impugned law on trade and commerce

The Automobile Transport (Rajasthan) Ltd. v. State of Rajasthan

State of Rajasthan levied taxes on motor vehicles used within the state in any public place or kept for use in
the state
The validity of the tax was challenged on the ground that it constituted a direct and immediate restriction on
the movement of trade and commerce with and within Rajasthan as the tax placed a pecuniary burden on
commercial activity and so was hit by Art. 301

For the first time the judiciary evolved the concept of "compensatory taxes" - if the taxes are compensatory in
nature, then it cannot be said that they impede the free flow of trade and commerce - they will be outside the
purview of Part XIII

Compensatory tax
Taxes are compensatory taxes - which instead of hindering trade - actually facilitate trade and commerce by
providing roads, maintaining roads, etc.
Compensatory taxes - do not violate Art. 301

The Automobile case said that the interpretation of Atiabari Tea Co. case was correct but subject to a clarification -
the clarification is with regard to the principle of compensatory tax

Working test to enquire whether the levy is a compensatory tax or not

• Direct and immediate doctrine - whether the trade is having the use of certain facilities for the better conduct
of its business
• Proportionality doctrine - paying not patently much more than what is required for providing the facilities

Bhagatram Rajiv Kumar v. Commissioner of Sales Tax MP (1994)

The concept of compensatory nature of tax has been widened and if there is substantial or even some link

Taxation Page 19
 The concept of compensatory nature of tax has been widened and if there is substantial or even some link
between the tax and the facilities extended to dealers directly or indirectly, the levy cannot be impugned as
invalid

Bihar Chamber of Commerce case

The court reiterated the position that "some connection" between the tax and the trading facilities extended
to dealers directly or indirectly is sufficient to characterize it as compensatory tax
The Court went further to hold that the State provides several facilities to the trade, such as, laying and
maintenance of roads, waterways, markets etc. and on this premise, it was held that the entry tax was
compensatory in nature

20-Jan-16

Prior 1995 Post 1995

Compensatory - if levy is more or less commensurate Compensatory - if the purpose of the imposition of the
with the cost of the service or facility tax is not merely to confer a special advantage on the
traders but to benefit the public in general including the
traders

Jindal Stainless Ltd. v. State of Haryana 2006

This case provided the SC an opportunity to clarify the position w.r.t compensatory tax
Raw material is purchased from outside the state (inter-state sale - CST will be imposed)
Finished products are sent to other states on consignment basis or stock transfer basis - no sales tax is paid on
the input of raw material - no tax is paid on the export of the goods to other states

Haryana Local Area Development Tax Act, 2000

Entry tax - brought into a "local area" of the state - imposed on motor vehicles for use or sale of all
goods for use or consumption therein
Entire state is divided into local areas
This tax is imposed on vehicles bringing goods into the state and also vehicles carrying goods from one
local area to another
Exemption - if you are paying sales tax to the state of Haryana - you are exempt from paying this tax

Challenge on two grounds

This Act is violative of Art. 301 and is not saved by Art. 304
This Act in fact seeks to levy sales tax on inter-state sales - which is outside the competence of the state
legislature

Section 22 initially stated that the tax collected and levied would be used for the development of local areas -
then it was amended and now it stated that the tax collected and levied would be used to facilitate the free
flow of trade and commerce

The argument was that the working test for compensatory tax - given by the Automobile case - direct and
immediate test - is the only test which can differentiate b/w a compensatory tax and a revenue generating tax
The test of 'some connection' would imply that there is no difference b/w a compensatory tax and a revenue
generating tax
Under Entry 52 - entry tax - if the levy is compensatory in nature - such levy will have to be confined to a
local area and trading facilities sought to be provided also should be confined to be such local area

The compensatory nature of a tax should be self-evident from the taxing law itself - it should not be
dependent on the manner in which the tax revenue is utilized in the course of time - if there is a challenge,

Taxation Page 20
 dependent on the manner in which the tax revenue is utilized in the course of time - if there is a challenge,
then the govt. cannot say that we will use the revenue for such and such matters

If there is any ambiguity - the burden will fall on the state to show that in essence the levy was imposed as a
recompense for the facilities/services provided by the state
Mere declaration that the levy is compensatory in nature is not enough - whether a tax is compensatory or not
cannot depend on the preamble of the statute imposing it

The state legislature has the competence under Entry 52 List II to enact the impugned law
This tax is compensatory in nature - because of Section 22 of the Act - therefore, it does not come within the
purview of Art. 301 and 304

Bottom line - the Automobile's working test survives - the 'some connection' test is no longer a valid working
test for compensatory taxes
○ Direct and immediate effect
○ Proportionality

Points of distinction
Tax Fee/Compensatory Tax
Levied as a part of common burden Levied on an individual as such
Basis is ability/capacity to pay Based on principle of equivalence
No identification of specific benefit, even if Quantifiable and measurable
identified not capable of direct measurement
A tax can be progressive or proportional Has to be proportional and not progressive
Based on concept of burden Based on concept of reimbursement/ recompense

Fee v/s Compensatory tax - compensatory tax is paid as a member of a class - fees is paid individually
The benefit of compensatory tax comes to you as a member of a class
The benefit of fees comes to you as an individual

Does this imply that the concept of fees has been restored to its classical understanding?

21-Jan-16

Taxes and Fees - both have elements of compulsions in them - both are imposed by public authority
Tax Fees
No quid pro quo Quid pro quo - sine qua non for any imposition to be a
fee
Common burden - proceeds are put in a common fund Individual burden - dedicated fund
Incidental benefit Special benefit or advantage
Revenue augmentation Compensatory fees - levy is commensurate with the
Regulatory taxes services rendered
Regulatory fees - may not have any quid pro quo - but it
will not be excessive in nature - not augment the
revenue, else it will become regulatory taxes

Part XIII - Art. 301 to 304

Taxation Page 21
Atiabari - taxes may amount to restrictions - but only those taxes which directly and immediately impede trade and
commerce amount to restrictions and hence are violative of Art. 301 to 304

Entry 52 - taxes on entry of goods for consumption, sale and use

Entry 56 - taxes on movement of goods
Entry 57 - taxes on motor vehicles
Entry 59 - tolls

Automobile - taxes may amount to these restrictions - but regulatory measures and compensatory taxes are not
within the purview of Part XIII (Art. 301 to 304)
Working test for compensatory tax
○ Direct and immediate effect - facilitating trade and commerce in a direct and immediate way
○ Proportionality - the levy should be more or less the same as the cost of service being rendered

The development of the jurisprudence of compensatory tax - in the Bhagatram case and the Bihar Chamber of
Commerce case - the 'some connection' test was propounded - this kind of interpretation militates against the
initial proposition of Automobile case

Jindal Stainless - the SC said that the 'some connection' test is not good law - therefore, the working test of
Automobile i.e. direct and immediate effect + proportionality survives
Difference b/w tax v/s compensatory taxes & fees
Difference b/w compensatory tax (individual as a member of a class) and fees (individual)

Jindal's test to determine if a tax will be valid or not?

• What is the scope of the operation of the law?
• Whether it has chosen an activity like movement of trade and commerce as a criteria of its operation?
○ If yes - if the activity chosen is movement of trade and commerce - what is the effect of operation of law
on the freedom guaranteed under Art. 301?
○ Is the effect to facilitate trade and commerce OR is it to impede and burden trade and commerce?
If the effect is to facilitate trade and commerce - then it is a compensatory tax
If the effect is to impede trade and commerce - then you will have to scrutinize it under Art. 301 to 304 -
i.e. look at whether there is a reasonable restriction and sanction of the President

When we study fees - there has been a sea change in the concept of fees - changes in the degrees of co-relation
• Initially - direct benefit to the individual who is the payer of the fees
• If you belong to the area or class receiving the services - this is sufficient benefit to the payer of the fees
• Casual benefit to the payer of the fees - direct or indirect
• Broad and generic co-relation b/w the payment of the contributors and the people to whom these services are
being rendered

According to the Jindal case - the concept of fees is the initial proposition

Vijayalakshmi Rice Mills v. Commercial Tax Officer [AIR 2006 SC 2897]

AP govt. had put in place a cess under AP Rural Development Act, 1996 - the cess is collected from the
dealers of rice and paddy
The dealers of rice and paddy are challenging this cess on the grounds that they already pay purchase tax to
the govt., they pay sales tax when they sell their goods - such a tax is akin to a sales tax which is outside the
purview of the state powers
The dealers of rice and paddy claim that they do not get any special advantage or benefit under this cess -
thus, this cess in the nature of a tax - and it is outside the powers of the state
The state govt. claimed that the cess was a fee - and was within the purview of the state list - under Entry 66 -
the service being provided is rural development
Taxation Page 22
 the service being provided is rural development

The question is about the nature of the cess - dealers say this is a tax - the state govt. says this is a fee

The court said that by Jindal decision, the sea change that has happened in the concept of fees has NOT
vanished - the Jindal decision cannot be interpreted to determine the nature of a fee
Jindal was not about fees - it was about Art. 301
The concept of fees is still hinged on the broad and generic co-relation

V Niranjan's article - freedom of trade and commerce

Taxation Page 23
Tutorial | Introduction

18-Jan-16

Fiscal federalism - Art. 246 - distribution of taxing power and allocation of revenue at different levels of the govt.

East India Company came to India - 1600s - later the control over India was handed over to the crown - the fiscal
policy was centralized
Lord Mayo - those matters which were of local relevance, they were to be transferred to the provincial govt. and
those matters of national relevance, they were to be transferred to the central govt.
Railways, ferries, etc. - central powers
Agriculture, etc. - state powers

GoI Act, 1919 - Montague Chelmsford Report - the budget allocation has to be in 2 parts
Federal budget
Provincial budget - no permission required from the Central govt.

GoI Act, 1935

The matters to be divided into Three Lists
Federal
Provincial
Concurrent
The Federal govt. is to be the authority for levying of taxes and appropriation
Provisions for Union giving grant and aid to provinces
Borrowing power of authorities

Debates of the Drafting Committee in 1946 - the grants provided to states would be on the basis of
recommendation of the Finance Commission
Central govt. to be the appropriate authority for levying taxes and appropriating revenue
The budget to be assigned on the basis of 'need' changing from time to time
Matters of local importance were to be placed in state list
Finance Commission to be set up for appropriating taxes

Union List - Entry 82 to 97

Entry 97 (residuary power)
State List - Entry 45 to 63

Art. 265 - tax has to be levied by the authority of law

Tax can be collected only on the basis of a valid law
What happens if taxes have been collected on the basis of an invalid law?

Direct tax - imposed directly on the income of a person - where the activity of the person is identifiable
Indirect tax - indirectly imposed - from where the amount has been paid cannot be traced - the root of the tax
cannot be traced

If the law is invalid - and it is a direct tax - the money can be returned - but what happens in case it is an indirect
tax?
Unjust enrichment - taking benefit from the obligation of others
The govt. will keep the money - the govt. will act as a trustee for the citizens of India - utilize that money for the
welfare of the public

Taxation Page 24
Taxes should be collected and appropriated under a valid law

Direct tax - the source is identifiable

Income tax - levied and collected on individual & different persons (natural and artificial persons)
Wealth tax - a 'certain' percentage to be paid as tax on accumulated wealth

Indirect tax - the source is not identifiable

Central Excise tax - tax on manufacturing activities
Custom Duties - whenever any import or export is done by any person in India or outside India
Central Sales tax - trade b/w two persons who are living in different states (inter-state sale or transaction)
Service tax - tax paid by the persons availing the services
VAT - tax for intra-state sale or purchase of goods

'Cornerstone' - fiscal federalism (Part III of federalism)

Taxation Page 25
Residential Status | Income Tax Act, 1961

22-Jan-16

Every sovereign authority has the inherent power to tax - taxes can be based on 2 principles

Residence principle - residence should not be confused with nationality/citizenship - you may be a citizen of
some other country, but for the purposes of Income Tax Act, you may qualify as a resident
If you are found to be the resident of a particular sovereign - that sovereign can tax your global income

Source principle - a sovereign authority can tax you if the source of your income is located within the territory of
the sovereign - if the resources of one particular nation-State have contributed in the earning of your income,
then you should pay taxes to that nation-State

If both principles are used in combination - then it would lead to a situation of double taxation

Income - divided into 5 broad heads - Sec 14

• Salary
• Income from house property
• Profit and gains from business/profession
• Capital gains
• Income from other sources

Set off
Gross Income
Deductions - say charitable donations, investment in certain bonds
Net Income - the income tax is calculated on the net income

Exemptions are different from deductions

Exemptions - when you are given exemptions, that amount never becomes part of your total income -
exemptions are taken care of internally when the income is calculated initially
Deductions - once the income has been calculated, then you have deductions on the gross income to come
to the net income amount

e.g. agricultural income is exempt from income tax

Income earned in a year is taxable in the next year [financial year i.e. 1st April to 31st March] - Sec 3
The year in which you earn the money is called the 'previous year'
The year in which you pay the tax is called the 'assessment year'

The financial year is usually 12 months - but at times it might also be less than 12 months
Say when you start earning in the middle of the financial year
Say you start a new business in the middle of the financial year

The principle of collecting taxes in the next year is not applicable in some situations —
• Income of a non-resident from shipping
• Income of persons leaving India either permanently or a long period of time
• Income of bodies formed for short duration
• Income of person trying to alienate his assets with a view to avoid payment of tax
• Income of discontinued business

Taxation Page 26
 • Income of discontinued business

In principle you pay taxes in the next financial year - but practically, the system works in a manner in which as
you earn, you pay taxes
The govt. may ask you to pay taxes based on predicted profits - if you have under-paid, you pay up - if you have
over-paid, you can ask for refund

Assessee - Sec 2(7)

Assessee means a person by whom, income tax or any other sum of money is payable under the Act
It includes every person in respect of whom any proceedings under the Act have been taken for the assessment of
his income or loss or any amount of refund
It also includes a person who is assessable in the income or loss of another person - say if you are the employee
of another person
It includes a person who is deemed to be an assessee - if you are required to deduct tax at the source, but you
have not, then you become an assessee in default
It also includes a person who is an assessee in default

The term 'person' as used in Sec 2(7) means many things - defined in Sec 2(31)
Sec 2(31) "person" includes —
(i) an individual,
(ii) a Hindu undivided family,
(iii) a company,
(iv) a firm,
(v) an association of persons or a body of individuals, whether incorporated or not,
(vi) a local authority, and
(vii) every artificial juridical person, not falling within any of the preceding sub-clauses.
Explanation.—For the purposes of this clause, an association of persons or a body of individuals or a local
authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body
or authority or juridical person was formed or established or incorporated with the object of deriving
income, profits or gains;

Body of individuals - will include only individuals (natural persons)

Association of persons - will include all categories of persons - natural persons and juristic persons - e.g.
consortium form of businesses

The Income Tax Act - the provisions are inclusive in nature - there may be new emerging categories which can be
included within the provisions of the Act - e.g. Sec 2(31)(vii) can be used to include deities, regulatory bodies such
as BCCI, etc.

Income is defined in Sec 2(24) - inclusive definition

A revenue receipt is taxable as income unless it is expressly exempt under the Act
A capital receipt is generally exempt from being tax unless it is expressly taxable under the Act - unless a
provision of the Act allows for such a tax, the govt. cannot tax it

Therefore, the Income Tax Act eyes the revenue receipts which are recurring every year

What is capital and revenue?

Capital - all your assets
Revenue - will be generated out of the assets - the capital assets enable you to generate your revenue
Say you have land and you generate revenue in the form of rent - here your land is your capital asset, your rent is
your revenue receipt - the rent is taxable unless there is some specific express exemption under the Act -if you sell
off the land, and generate some revenue out of the sale, you cannot tax this revenue unless there is some specific
Taxation Page 27
off the land, and generate some revenue out of the sale, you cannot tax this revenue unless there is some specific
express provision under the Act allowing taxation on such sale of capital assets

Revenue receipts and capital receipts - circulating capital and fixed capital
Fixed capital is what the owner turns into profits by keeping it in his possession
Circulating capital is what he makes profits of by parting with it and letting it change its master

It is presumed that assets which provide you with enduring benefits are capital receipts

Capital expenditure - when I buy a capital asset

Revenue expenditure - when you expend it on a regular basis - recurring expenditure

Determining the residential status

Sec 6 of the Act
Determination of residential status is very important for the purpose of tax incidence - if you are a resident, the
tax on you is high - if you are a non-resident, only certain incomes can be taxed

Residence of individual ---

Sec 6. For the purposes of this Act,—
(1) An individual is said to be resident in India in any previous year, if he —
(a) is in India in that year for a period or periods amounting in all to one hundred and eighty-two days
or more; or
(c) having within the four years preceding that year been in India for a period or periods amounting in
all to three hundred and sixty-five days or more, is in India for a period or periods amounting in all to
sixty days or more in that year.

An Indian citizen who leaves India during the previous year for the purposes of employment or leaves India as a
member of a crew of an Indian ship - 60 days in clause (c) will become 182 days

'purposes of employment' does not mean employee only - it will include pursuing a profession as well -
participating in a gainful activity

An Indian citizen or a person of Indian origin who comes on visit to India during the previous year - 60 days in
clause (c) will become 182 days
A person is said to be a 'person of Indian origin' if his parents or any of his grandparents (maternal or paternal)
were born in undivided India - 60 days in clause (c) will become 182 days

The way in which this '60 days in clause (c) will become 182 days' is interpreted is that clause (c) becomes
redundant and only clause (a) applies

If a person who is resident in India - the next level of enquiry is

• Resident and ordinarily resident
• Resident but not ordinarily resident
○ Sec 6(6) A person is said to be "not ordinarily resident" in India in any previous year if such person
is —
(a) an individual who has been a non-resident in India in nine out of the ten previous years
preceding that year, or has during the seven previous years preceding that year been in India for a
period of, or periods amounting in all to, seven hundred and twenty-nine days or less; or

Madhukar Dhavale v. Income Tax Officer

MD had left the territory of India - he was the master of a ship with Great Shipping Co. Ltd. - to determine
his residential status, he showed his passport

Taxation Page 28
 his residential status, he showed his passport
He had stayed outside India for 201 days in the previous year
The department enquired with his employer - the shipping company said that the service of MD on the ship
was only for 158 days
The Tribunal took the employer's decision - the exception applies when you are away from India as a
member of a crew of an Indian ship - it is not important whether you are physically away from India or not
but whether you are away from India for these specified purposes or not
Therefore according to the case, only if a member of the crew can prove that he actually 'worked' for 182
days or more, then he can qualify as a 'non-resident' - otherwise, he will be deemed to be a resident

Mayur comes to India for the first time on 1st September, 2015. During his stay in India up to 31st December
2015. He stays in Delhi till November 2015 and then stays in Chennai till his departure from India. Determine his
residential status.
122 days in India - not a resident

Madhur had never been outside of India till his employment in A&O on 1st August, 2015 and returns on 30th
Jan to attend the Alumni meet
184 days in India - resident

25-Jan-16

Determining the residential status of a Company and HUF

Sec 6 of Income Tax

A HUF is said to be resident in India in any previous year except where during that year, the control and
management of its affairs is wholly outside India

If it can be proved that the control and management of the affairs of the HUF were wholly carried out outside in
India - then only you are NOT a resident

The sub-classification of R&OR and R&NOR is only applicable to individuals and HUFs - but not on other
categories of persons (say firms, companies, etc.)
You identify the karta of the HUF - and you apply the test contemplated in Sec 6(6)(a) - i.e. 9 out of 10
previous years or during the seven previous years preceding that year been in India for a period of, or
periods amounting in all to, seven hundred and twenty-nine days or less

Subbaiyah Chettiyar v. CIT (1947) 15 ITR 502 Madras

Determining the residential status of an HUF - what constitutes control and management of affairs
There was a HUF - living in Ceylon - the karta and the HUF were domiciled there and their businesses were
spread out in Colombo, Burma, etc. - they had certain properties, shares, etc. situated in British India
During the year 1941-42 - the karta visited India on several occasions and had been spending time attending
litigations regarding the property
The HUF and the karta have also started some partnership businesses in India - the karta had been staying in
India to ensure the commencement of business of these partnerships
The tax dept. claimed that since the karta had been in India - it should be presumed that the control and
management of the HUF has also shifted to India with him
The karta could not produce any evidence or correspondence to prove that the businesses were carried out
wholly from Colombo
The court presumed that the control had shifted to India with him - the control and management was partly
in India and partly outside - the karta could not provide any evidence to rebut this presumption - therefore,
the HUF was considered to be a resident of India for that particular previous year

The moment you establish residence - there is competence to tax the global income throughout the year
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The moment you establish residence - there is competence to tax the global income throughout the year

The HUF is a whole unit and you determine the residential status of the unit - you are NOT determining the
residential status of the karta

Residential status of a company

Sec 6(3) A company is said to be resident in India in any previous year if —
(i) it is an Indian company
(ii) during that year, the control and management of its affairs is situated wholly in India

If the company can prove that the control and management of affairs is situated wholly in India

'place of effective management' - inserted by the Finance Act of 2015 - prospective application - effective from
April 1st, 2016
Therefore, the clause now reads …
Sec 6(3)(ii) its place of effective management, in that year, is in India.
Explanation.— For the purposes of this clause "place of effective management" means a place where key
management and commercial decisions that are necessary for the conduct of the business of an entity as a
whole, are in substance made.

Narotam & Parela Ltd. v. CIT (1953) 23 ITR 454

N&P is a subsidiary of Scindia Steam Navigation Ltd. and its business was related to stevedoring in Ceylon -
the Co. was registered in Bombay, reg. office in Bombay, meetings of Board of Directors was held in
Bombay, the shareholder meetings were held in Bombay
The statute applicable is the 1922 Income Tax Act - the registration of a company had no impact on
residential status of the company
The Board had appointed two managers to manage the business in Ceylon - the managers had the power of
attorney - based on this arrangement, the assessee (the Co.) claims that the control and management of their
affairs is not in India at all - the control and management of the business has been completely delegated to
the managers in Ceylon
The court says that you may carry out your business in whatever manner that you want and yet it is possible
that the control and management of the affairs of the business is situated in India
The court makes a distinction b/w carrying out a business and the control & management of the affairs of
the business - the latter is much broader in its concept than the former - the statute uses the latter phrase
The court said that if the Board of Directors sits in India, and takes decisions in India - the control and
management of the affairs of the business is in India - the head and the brain of the company is located in
India (in Bombay)
There is a distinction b/w the agents, employees, power of attorney and the Directors of the company
It is not the de jure control and management (the capability to manage has been delegated) but the de
facto control and management (the authority to manage lies with the Board of Directors) that has to be
looked at
If the Board of Directors is vigilant over the functioning of the managers in Ceylon - then the head and
brains of the company lies in India - and if this continues all year long, then you are a resident of India

Control and management signifies the controlling and directing power, the head and brain as it is sometimes
called, and implies the functioning of such power at a particular palace with some degree of permanence
Here the term 'wholly' in the statute would seem to recognize the possibility of the seat of power in India

Radha Rani Holdings Pvt. Ltd. v. Additional Director of Income Tax (2007) 110 TTJ Delhi 920
This assesse Co. was incorporated under the laws of Singapore - it is a foreign company
When the dept. looked at the composition of this company - 99 shares belonged to Mrs. Geeta Soni resident
in India - 1 share was with Mrs. Juliana Castle who was a resident of Singapore
The dept. found that this company did not have any employee in Singapore - the address from where this
Taxation Page 30
 The dept. found that this company did not have any employee in Singapore - the address from where this
company operates was in Delhi - this address was the HQ of the Mother-Son Group
Mrs. Geeta Soni was the relative of the chairperson of the Mother-Son Group
The income of the Singaporean Co. came from the Mother-Son Group and there were many investors
pouring in capital into the Co.
The dept. claimed that this was a way to route investment from India through Singapore
The Co. claimed that the management and control took place in Singapore - the meetings and policy
decisions took place outside India
The dept. called for the passport of the GS - on the alleged dates of Board Meetings, GS was travelling to
Bangkok - GS was residing in India for the major part of the previous year
The tribunal said that with the technology available, it is not necessary that people should be physically
present for Board Meetings - the tribunal said that this company is NOT a resident of India - the tribunal
said that if the meetings and minutes of the meetings are available, it is possible that the meeting took place
in Singapore

The tribunal could have said that even if control was partly in India - it was not wholly in India

The classical test of 'head and brain of the company' is effectively applicable only if the control and management
is centralized - if the control and management is diffused, then it is problematic to apply this kind of test

Explanation added to the amendment — for the purposes of this clause, place of effective management
means a place where key management and commercial decisions that are necessary for the conduct of
the business of an entity as a whole are in substance made

29-Jan-16

In Radha Rani case - this is rather a company, although incorporated outside India, its affairs, etc. are primarily
being controlled by this person who is a resident in India - which would mean that the seat of power or the head
and brain is located in India
The tribunal did not find merit in this argument - the tribunal held that the company was not a resident of India

Case in UK
Laerstate BV v. HMRC [2009] UKFTT 209 (TC)
Co. Laerstate incorporated in Netherlands - in UK, registration is a criteria to determine the residential
status - therefore, the Co. was not a resident of UK
Laerstate had made some investments in an Anglo-American company - and later, it had also disposed off its
income and its shares in that company

In the year 1992 - it made certain investments

1996 - it disinvested its interest in the Anglo-American Company

In UK - the test is 'central control and management'

The question was what should be the residential status of Laerstate

One director of Laerstate - Mr. Bock - he was allegedly controlling the decisions and policy making for
Laerstate - Mr. Bock was a resident of UK
If it can be proved that the central control and management lay with Mr. Bock, who is a resident of UK,
then the Company would also be a resident of UK

In India - a Company is resident of India if it is incorporated in India - or it is a resident of India if the

control and management is wholly inside India - i.e. if the control and management is partly outside India,
then it is considered to be a non-resident
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 then it is considered to be a non-resident

Similarly in UK - incorporation test + central control and management test

Laerstate said that the central control and management is determined by the place where the resolutions of
the company are being signed - one must refer to the relevant transactions, documentation and the place
where the resolutions of the co. are being passed - i.e. if the Board meetings are held in Netherlands and that
is the place where the resolutions are being passed and documents are being passed - then that is the place
where the central control and management of the company lies

HMRC argued that the resolutions, etc. are not of consequence - to determine the central control and
management - one has to look at who was controlling the decisions of the company
If it was Mr. Bock - then the place where Mr. Bock was situated while taking these decisions should be the
place where the central control and management lies
Therefore, the UK govt. would get the power to tax this company - as Mr. Bock was situated in UK and the
Co. would therefore be considered as a resident of UK

In UK - the key decisions of Laerstate were being made by Mr. Bock - he was a resident of UK - the Co.
which is otherwise incorporated in Netherlands, would also be a resident of UK

During 1992 to 1996 - for this particular time period - Mr. Bock was the Director - all the key decisions were
being taken by Mr. Bock - where to invest, how much to invest, when to withdraw investment, etc. - these
decisions were being made by Mr. Bock - after 1996, when the decision was taken as to the selling of the
shares owned by Laerstate, Mr. Bock had resigned as Director - the new Director, Mr. Tapman did not have
enough information to arrive to this decision - i.e. whether the company should invest or dispose of the
shares, etc. - therefore, even after resignation, Mr. Bock was taking the key decisions of the company

The court looked at the records of the company - and held that Mr. Bock was a resident of UK and Mr.
Bock was controlling the company - therefore, the company was a resident of UK as well and not a resident
of Netherlands

The new Director did not have enough information to apply his own mind and come to a decision
Mr. Bock was no longer a Director of the company - but the kind of control he had established was such
that he was still making key decisions w.r.t policy of the company - therefore, he had de facto control over
the company - the courts analyzed the evidence before it (though Mr. Bock was no longer part of the
company - the prior control estd. by Mr. Bock to bind the company and take key decisions w.r.t policy
matters of the company continued after his resignation - therefore, he had de facto control over the
management of the company)
Mr. Bock was a resident of UK at the time and therefore, Laerstate is also a resident of UK

De jure and de facto control - applied in the Subbaiya Chettiar case - what is relevant is the de facto control over
the company - it is NOT the de jure control which has consequence

These tests might be complicated to apply to real fact situations - this determination is more in the nature of
substance rather than form

Even in Radha Rani Holdings - the argument by the income tax dept. was that Mrs. Geeta Soni was the critical
person behind the making of the decisions for the Co. - she held 99 shares and the other indv. in Singapore only
held one share - the majority of her time was spent in India and therefore, the control and management of the
Co. should be considered to be in India - further, there were evidences to show that this Co. was a paper
company - the Q. is why the tribunal did not look at the whole picture i.e. the substance rather than the form -
the tribunal confined itself to the form of decision-making to arrive at a judgement

Taxation Page 32
Comparative picture - similar kinds of fact situation - the way you approach the problem leads to very different
results

The test of 'control and management' of the company - is used to prevent situations of tax evasion by
incorporating a company in some other jurisdiction - because if you are a resident of India, your global income
can be taxed
Therefore, the seat of power - the head and brain - will help to determine the residential status of the company

Residential status of Companies in India

1. Place of incorporation test [POI test]

2. Place of effective management test [POEM] - internationally recognized test - particularly in the context of
BTA (Bilateral Treaty Agreements), this test is applied to determine the residential status of a company

The 'control and management' test has been replaced by POEM

Sec 6(3) of the Income Tax Act - a company is resident in India if —

• Incorporated in India
• Place of effective management is in India
○ Explanation —
Place of effective management is a place where key management and commercial decisions which are
necessary for the conduct of the business entity which are made as a whole and in substance made

Guidelines on POEM - CBDT guidelines

7th guideline - the place of effective management of a company engaged in active business outside India will be
presumed to be outside India, if the majority of the meetings of the Board of Directors are held outside India

This guideline does not say when the Co. will be inside India - it tells when the POEM will be outside India
The crucial component here is the determination of 'active business'

5th guideline - a company shall be held to be engaged in active business outside India if the passive income is not
more than 50% of the total income and less than 50% of the total assets are located in India and less that 50% of
total employees are in India or resident of India and less that 50% of the total expenses constitute the payroll of
these employees

• Active income - those incomes which are generated by certain activities that the company is engaged in
• Passive income - interest incomes, royalty payments, capital gains - you are not proactively engaged in
earning the income

Therefore, if active business is outside India + majority of Board meetings are held outside India - then the
POEM is outside India

If you are not a company which is engaged in active business outside India —
8th guideline
○ Identification or ascertaining the actual person(s) who make key management and commercial decisions
for the conduct of the business
○ Identification of the place where these decisions are taken
 If the place is in India - then the POEM will be in India - then the company will be a resident of
India

Taxation Page 33
This determination of POEM - will be that of substance and NOT of form - it will be considered depending on
the facts and circumstances of each case - the data of the past 3 years of the company will be considered (not just
some particular instances)

There are further tests to help with the determination of the POEM
Location test
Head-office test
Video-conferencing test
Whether authority has been delegated or not

Location test —
The determination of POEM has to be on the basis of substance and not the form —
Guideline 8.2 (a) The location where a company’s board regularly meets and makes decisions may be the
company’s place of effective management provided, the Board
(i) retains and exercises its authority to govern the company; and
(ii) does, in substance, make the key management and commercial decisions necessary for the conduct
of the company’s business as a whole.
It is not the formal holding of Board meetings at any particular place - but the place where the actual decisions of
the company are taken

01-Feb-16

Residential Status of a Company

POEM

Prior 2015 Amendment Post 2015 Amendment

Company - incorporated in India - Indian Company - Company - incorporated in India - Indian Company -
resident of India - global income can be taxed resident of India - global income can be taxed
Company - incorporated outside India - control and Company - incorporated outside India - place of
management of its affairs - wholly inside India - effective management - resident of India - global
resident of India - global income can be taxed income can be taxed

Board of Directors - head and brains of the POEM - Explanation — For the purposes of this
Company - key managerial and commercial clause "place of effective management" means a place
decisions - the place where the Board of Directors where key management and commercial decisions that
took these decisions - constitutes the place of control are necessary for the conduct of the business of an
and management of its affairs entity as a whole, are in substance made

With technological advancements - this interpretation This interpretation allows us to move away from the
is stagnated earlier test which tied up to the physical place of the
Board of Directors

POEM - allows us to move away from the centralized mode of decision making (earlier notion that the Board and
shareholders were clustered together) - allows for a more dispersed mode of decision making where the Directors
can be on the move (where the Board and the shareholders can be spread across jurisdictions - many cross-border
transactions)

POEM - again we have to search for the 'place' of effective management - it merely allows for different places of

Taxation Page 34
POEM - again we have to search for the 'place' of effective management - it merely allows for different places of
management but there has to be one place which constitutes the effective management
But it allows for greater flexibility from the earlier test
We do not have a strict definition of key management and commercial decisions - you have to look at the
whole picture to determine the POEM - you have to look at the substance of the decision and not just the
form
Say if the decision is being taken by someone else actually and not the Board - then you will not be
constrained by the form i.e. by the fact that it was a Board Resolution but you will look at who actually
took the decision and that would constitute key management and commercial decision
You will ask - who in substance is making the decisions - say the Board does not have enough
information to make the decision and someone else is actually taking the decision - you will look at the
whole picture

There is no definition of "effective" in the phrase POEM - no uniformity or consensus as to what POEM
means
South Africa - the place of implementation can also be POEM
India - we do not look at the place of implementation to determine POEM

We have taken the concept of POEM from the OECD commentary - but the elaboration and the interpretation
of POEM is different

Residence-based principle of taxation

Source-based principle of taxation - you find some economic nexus of your territory with the income
Active incomes - earned by the tax-payer engaging into some significant activity
e.g. professional incomes, business incomes, employment incomes
Passive incomes - those incomes which the tax-payer has earned w/o engaging in any significant activity
e.g. royalty income, interest income

Income earned from immovable property - rental incomes or capital gains

The way in which these categories operate is that nation States have a greater claim to tax active incomes and very
little claim to tax passive incomes - lowest claim from passive incomes derived from intangibles (royalties)
Rental incomes and capital gains are classified as passive income - but they lie somewhere in b/w

CBDT guidelines

POEM
1. Company engaged in active business outside India
2. Company other than those engaged in active business outside India

1. Company engaged in active business outside India

Guideline 6 - The process of determination of POEM would be primarily based on the fact as to whether or not
the company is engaged in active business outside India.

Guideline 5 - (a) A company shall be said to be engaged in “active business outside India” if the passive income is
not more than 50% of its total income and, -
(i) less than 50% of its total assets are situated in India; and
(ii) less than 50% of total number of employees are situated in India or are resident in India; and
(iii) the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure

To qualify as a Company engaged in active business outside India - the following conditions have to be met —
Taxation Page 35
To qualify as a Company engaged in active business outside India - the following conditions have to be met —
• Company's passive income should not be more than 50% of its total income
• Company's assets situated in India should be less than 50% of its total assets
• Company's employees situated or resident in India should be less than 50% of its total employees
• Company's payroll expenditure incurred on such employees should be less than 50% of its total payroll
employees
All 4 conditions have to be satisfied to be a 'Company engaged in active business outside India'

Guideline 7 - in addition to being a Company engaged in active business outside India — IF the majority of the
meetings of the Board of Directors are held outside India — POEM will be presumed to be outside India

At this stage, you bring on all the tests like where is the actual authority, where the power was delegated

Guideline 7.1 - however, if on the basis of facts and circumstances it is established that the Board of Directors of
the company are standing aside and not exercising their powers of management and such powers are being
exercised by either the holding company or any other person(s) resident in India, then the place of effective
management shall be considered to be in India

2. Company other than those engaged in active business outside India

Identify the person(s) who actually make key managerial & commercial decisions
Determine the place where these decisions are made

Location test

Guideline 8
The place where these management decisions are taken would be more important than the place where such
decisions are implemented. For the purpose of determination of POEM it is the substance which would be
conclusive rather than the form.

Guideline 8.2
It may be mentioned that mere formal holding of board meetings at a place would by itself not be
conclusive for determination of POEM being located at that place. If the key decisions by the directors
are in fact being taken in a place other than the place where the formal meetings are held then such
other place would be relevant for POEM. As an example this may be the case where the board meetings
are held in a location distinct from the place where head office of the company is located or such location is
unconnected with the place where the predominant activity of the company is being carried out.

Delegated Authority test

Guideline 8.2
If a board has de facto delegated the authority to make the key management and commercial
decisions for the company to the senior management or any other person including a shareholder and does
nothing more than routinely ratifying the decisions that have been made, the company’s place of effective
management will ordinarily be the place where these senior managers or the other person make those
decisions.

Location of Head Office

Guideline 8.2(c)
If the company’s senior management and their support staff are based in a single location and that
location is held out to the public as the company’s principal place of business or headquarters then that

Taxation Page 36
 location is held out to the public as the company’s principal place of business or headquarters then that
location is the place where head office is located.

If the company is more decentralized (for example where various members of senior management may
operate, from time to time, at offices located in the various countries)then the company’s head office would
be the location where these senior managers,-
(i) are primarily or predominantly based; or
(ii) normally return to following travel to other locations; or
(ii) meet when formulating or deciding key strategies and policies for the company as a whole.

To accommodate technological advancements

Members of the senior management may operate from different locations on a more or less permanent basis
and the members may participate in various meetings via telephone or video conferencing rather than by
being physically present at meetings in a particular location. In such situation the head office would normally
be the location, if any, where the highest level of management (for example, the Managing Director
and Financial Director) and their direct support staff are located.

Completely decentralized company - location of head office test would not be relevant at all
In situations where the senior management is so decentralized that it is not possible to determine the
company’s head office with a reasonable degree of certainty, the location of a company’s head office
would not be of much relevance in determining that company’s place of effective management.

Secondary tests

Guideline 8.2(f)
If the above factors do not lead to clear identification of POEM then the following secondary factors can be
considered :-
(i) Place where main and substantial activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept.

Guideline 9 - negative categories which will not affect the POEM

POEM guidelines - first, we try to estd. some form of active economic nexus with the territory - then we go back
to the location test, delegated authority, etc.

Taxation Page 37
Section 5 & 9

01-Feb-16

INCOME

Sec 4 - charging section

Sec 5 - scope of total income

Sec 5 Scope of total income.
(1) Subject to the provisions of this Act, the total income of any previous year of a person who is a
resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such
person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or
(c) accrues or arises to him outside India during such year :
Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-
section (6) of section 6, the income which accrues or arises to him outside India shall not be so
included unless it is derived from a business controlled in or a profession set up in India.

(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a
non-resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such
person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year.

Explanation 1.—Income accruing or arising outside India shall not be deemed to be received in India
within the meaning of this section by reason only of the fact that it is taken into account in a balance
sheet prepared in India.

Explanation 2.—For the removal of doubts, it is hereby declared that income which has been included
in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued
or arisen to him shall not again be so included on the basis that it is received or deemed to be received
by him in India.

If you become a resident of India - IT Act can tax your global income

You 'receive' in India - means that you are present in India when you get the money

Remittances are NOT included in receiving income - e.g. your relatives giving you money from abroad
Remittances - if you have already received it somewhere - it is merely being transferred right now

You are 'deemed to receive' in India - a legal fiction - even if the income is not given in India - by virtue of
legal fiction it will be considered to be given in India - e.g. you are a resident in India, but you deposit your
income in a foreign account - it will be deemed to be received in India

Income 'accrues or arises' in India

Accrues - keeps accumulating periodically
Arises - one time lump sum sort of income - suddenly arising

Taxation Page 38
 Arises - one time lump sum sort of income - suddenly arising

Sec 9 - deals with 'deemed to accrue or arise' in India

Income 'accrues or arises outside India'

Receipts and accruals

Your receipt of income may be followed by an accrual
The general principle in Income Tax is "receipt or accrual, whichever is earlier" - the Income Tax dept.
will not wait for the receipt of income, the tax will be deducted on the accrual of income itself

Say law firm gives you a signing bonus - you have received the sum but it has not accrued to you yet - you
have received that amount in the anticipation that you will join the firm - the right to receive the income will
vest in you only when you actually join the firm
Say you have been working for 3 months without pay - the salary has accrued to you but you have not
received it

Receipt is when you actually receive the amount

Accrual is when the right to receive that amount becomes vested in you

Arrears - can be used as an example for receipt and accrual - if you have arrears of income (because the Pay
Commission revised the salaries), then the income accrues to you but the income is received by you only
when the govt. releases the funds

Not ordinarily resident in India - proviso in Sec 5

Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section
(6) of section 6, the income which accrues or arises to him outside India shall not be so included unless
it is derived from a business controlled in or a profession set up in India.

Non-resident
Sec 5 (2) Subject to the provisions of this Act, the total income of any previous year of a person who is
a non-resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such person ;
or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year.

03-Feb-16

Sec 9. Income deemed to accrue or arise in India.

(1) The following incomes shall be deemed to accrue or arise in India :—
(i) all income accruing or arising, whether directly or indirectly, through or from any business
connection in India, or through or from any property in India, or through or from any asset or source of
income in India, or through the transfer of a capital asset situate in India.

Irrespective of your residential status - these incomes are taxable

(ii) income which falls under the head "Salaries", if it is earned in India.
Explanation.—For the removal of doubts, it is hereby declared that the income of the nature referred to
in this clause payable for—
(a) service rendered in India; and

Taxation Page 39
 (a) service rendered in India; and
(b) the rest period or leave period which is preceded and succeeded by services rendered in India
and forms part of the service contract of employment,
shall be regarded as income earned in India;

(iii) income chargeable under the head "Salaries" payable by the Government to a citizen of India for service
outside India ;

(iv) a dividend paid by an Indian company outside India ;

(v) income by way of interest payable by—

(a) the Government ; or
(b) a person who is a resident, except where the interest is payable in respect of any debt incurred,
or moneys borrowed and used, for the purposes of a business or profession carried on by such
person outside India or for the purposes of making or earning any income from any source
outside India ; or
(c) a person who is a non-resident, where the interest is payable in respect of any debt incurred, or
moneys borrowed and used, for the purposes of a business or profession carried on by such person
in India;

Whenever interest income is paid by the govt. it is always taxable in your hands - irrespective of the
residential status
The interest income payable by a resident is taxable - except in certain circumstances
The interest income payable by a non-resident is taxable - only when the business or profession is carried
on in India

X is paying interest to Y
• Say X is a resident and Y is a resident - firm being set up in India - interest income will be taxable in
the hands of Y
• Say X is a resident and Y is a non-resident - firm being set up in India - interest income will be taxable
in the hands of Y
• Say X is a non-resident and Y is a resident - firm being set up outside India - interest will be taxable in
the hands of Y [Sec 5(c)] [here the income is not deemed to accrue in India - but it is income that
accrues outside India - Y being a resident, this income is taxable]
• Say X is a non-resident and Y is a non-resident - firm being set up outside India - interest will not be
taxable
• Say X is a resident and Y is a non-resident - firm being set up outside India - interest will not be
taxable

When you are a resident in India - your global income is taxable

This section talks about the payers of the interest - and NOT the recipient of the interest - you will have to
derive the end result from these provisions

Sec 5 and Sec 9 have to be read together

EXAMPLE — Profit on sale of plant in London - half is received in India - 1 lakh 46 thousand
• Resident & OR - 1,46,000 taxable
• Resident but NOR - half is taxable [proviso of Sec 5(c)]
• Non-resident - half is taxable
Taxation Page 40
 • Non-resident - half is taxable

EXAMPLE — Profit on sale of plant in Delhi - half is received in London - 1,00,000

• R & OR - full amount taxable
• R but NOR - full amount taxable
• NR - full amount taxable

EXAMPLE — salary from an Indian company received in London - one half is paid for rendition services
in India - amount is 60,000
• R & OR - full
• R but NOR - half
• NR - half
Earned in India - is defined as rendition of services

EXAMPLE — interest on UK development bond - entire amount is received in London - 40,000

• R & OR - full
• R but NOR - N/A
• NR - N/A

EXAMPLE — rental income from property in London - received in London

• R & OR - full
• R but NOR - N/A
• NR - N/A

Following Explanation shall be inserted after sub-clause (c) of clause (v) of sub-section (1) of
section 9 by the Finance Act, 2015, w.e.f. 1-4-2016 :
Explanation.—For the purposes of this clause,—
(a) it is hereby declared that in the case of a non-resident, being a person engaged in the business of banking, any interest
payable by the permanent establishment in India of such non-resident to the head office or any permanent establishment or
any other part of such non-resident outside India shall be deemed to accrue or arise in India and shall be chargeable to
tax in addition to any income attributable to the permanent establishment in India and the permanent establishment in
India shall be deemed to be a person separate and independent of the non-resident person of which it is a permanent
establishment and the provisions of the Act relating to computation of total income, determination of tax and collection
and recovery shall apply accordingly;
(b) "permanent establishment" shall have the meaning assigned to it in clause (iiia) of section 92F.

(vi) income by way of royalty payable by—

(a) the Government ; or
(b) a person who is a resident, except where the royalty is payable in respect of any right, property or
information used or services utilised for the purposes of a business or profession carried on by such
person outside India or for the purposes of making or earning any income from any source outside
India ; or
(c) a person who is a non-resident, where the royalty is payable in respect of any right, property or
information used or services utilised for the purposes of a business or profession carried on by such
person in India or for the purposes of making or earning any income from any source in India :

Provided that nothing contained in this clause shall apply in relation to so much of the income by way

Taxation Page 41
Provided that nothing contained in this clause shall apply in relation to so much of the income by way
of royalty as consists of lump sum consideration for the transfer outside India of, or the imparting of
information outside India in respect of, any data, documentation, drawing or specification relating to
any patent, invention, model, design, secret formula or process or trade mark or similar property, if
such income is payable in pursuance of an agreement made before the 1st day of April, 1976, and the
agreement is approved by the Central Government :

Provided further that nothing contained in this clause shall apply in relation to so much of the income
by way of royalty as consists of lump sum payment made by a person, who is a resident, for the
transfer of all or any rights (including the granting of a licence) in respect of computer software
supplied by a non-resident manufacturer along with a computer or computer-based equipment under
any scheme approved under the Policy on Computer Software Export, Software Development and
Training, 1986 of the Government of India.

Explanation 1.—For the purposes of the first proviso, an agreement made on or after the 1st day of
April, 1976, shall be deemed to have been made before that date if the agreement is made in
accordance with proposals approved by the Central Government before that date; so, however, that,
where the recipient of the income by way of royalty is a foreign company, the agreement shall not be
deemed to have been made before that date unless, before the expiry of the time allowed under sub-
section (1) or sub-section (2) of section 139 (whether fixed originally or on extension) for furnishing
the return of income for the assessment year commencing on the 1st day of April, 1977, or the
assessment year in respect of which such income first becomes chargeable to tax under this Act,
whichever assessment year is later, the company exercises an option by furnishing a declaration in
writing to the Assessing Officer (such option being final for that assessment year and for every
subsequent assessment year) that the agreement may be regarded as an agreement made before the 1st
day of April, 1976.

Explanation 2.—For the purposes of this clause, "royalty" means consideration (including any lump
sum consideration but excluding any consideration which would be the income of the recipient
chargeable under the head "Capital gains") for—
(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent,
invention, model, design, secret formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent,
invention, model, design, secret formula or process or trade mark or similar property ;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or
similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific
knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including
the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright,
literary, artistic or scientific work including films or video tapes for use in connection with
television or tapes for use in connection with radio broadcasting, but not including consideration
for the sale, distribution or exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to
(iv), (iva) and (v).

Explanation 3.—For the purposes of this clause, "computer software" means any computer programme
recorded on any disc, tape, perforated media or other information storage device and includes any such
programme or any customized electronic data.

Taxation Page 42
 programme or any customized electronic data.

Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in
respect of any right, property or information includes and has always included transfer of all or any
right for use or right to use a computer software (including granting of a licence) irrespective of the
medium through which such right is transferred.

Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always
included consideration in respect of any right, property or information, whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.

Explanation 6.—For the removal of doubts, it is hereby clarified that the expression "process" includes
and shall be deemed to have always included transmission by satellite (including up-linking,
amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar
technology, whether or not such process is secret;

(vii) income by way of fees for technical services payable by—

(a) the Government ; or
(b) a person who is a resident, except where the fees are payable in respect of services utilised in a
business or profession carried on by such person outside India or for the purposes of making or
earning any income from any source outside India ; or
(c) a person who is a non-resident, where the fees are payable in respect of services utilised in a
business or profession carried on by such person in India or for the purposes of making or earning any
income from any source in India :

Provided that nothing contained in this clause shall apply in relation to any income by way of fees for
technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and
approved by the Central Government.
Explanation 1.—For the purposes of the foregoing proviso, an agreement made on or after the 1st day
of April, 1976, shall be deemed to have been made before that date if the agreement is made in
accordance with proposals approved by the Central Government before that date.
Explanation 2.—For the purposes of this clause, "fees for technical services" means any consideration
(including any lump sum consideration) for the rendering of any managerial, technical or consultancy
services (including the provision of services of technical or other personnel) but does not include
consideration for any construction, assembly, mining or like project undertaken by the recipient or
consideration which would be income of the recipient chargeable under the head "Salaries".

(2) Notwithstanding anything contained in sub-section (1), any pension payable outside India to a person
residing permanently outside India shall not be deemed to accrue or arise in India, if the pension is payable
to a person referred to in article 314 of the Constitution or to a person who, having been appointed before
the 15th day of August, 1947, to be a Judge of the Federal Court or of a High Court within the meaning of
the Government of India Act, 1935, continues to serve on or after the commencement of the Constitution
as a Judge in India.
Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, income
of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of
sub-section (1) and shall be included in the total income of the non-resident, whether or not,—
(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.

Taxation Page 43
(ii) the non-resident has rendered services in India.

Taxation Page 44
Tutorial | Taxes and Fees

25-Jan-16

Fees
• Proximate quid pro quo - diluted to remote quid pro quo (reasonable co-relation b/w what you pay and
what you receive)
• Requirement of a ear-marked fund - diluted - in Southern Pharmaceuticals case
• Proportionality

Evolution of compensatory tax

Atiabari - direct and immediate effect test

Every tax would then be hit by Part XIII

Automobile - reiterated the direct and immediate effect - but carved out an exception - if the tax is
compensatory in nature, it would not be hit by Part XIII
• Specific services required by the traders, etc. which are provided by the State
• The levy should be proportional to the service being provided

Bhagatram
Bihar Chamber of Commerce
The link need not be direct or immediate or substantial - some connection test

International Tourist Corporation

Distinction b/w tax and fee became very blurry

Jindal Stainless
Compensatory tax
○ Specific services required by the traders, etc. which are provided by the State
○ These benefits must be quantifiable - any revenue accruing to the govt. should be incidental to the
impost - revenue generation should not be the primary objective

Tax - common burden imposed on everyone - the principle for imposing a tax is the ability to pay - specific
advantage is purely incidental
Compensatory tax/fee - individualistic in nature - the principle is of equivalence

Compensatory tax is closer to a fee than to a tax

Fee - imposed on an individual
Compensatory tax - imposed on an individual as a member of class

Compensatory tax - everyone pays - selection moot problem - the tax is paid by all - because they own a vehicle
and are using the roads - trucks taxed more, cars taxed less - because trucks cause more damage to the road
(proportionality satisfied)
Fee - you pay if you use the service

Fee - compensatory OR regulatory - proportionality has to be maintained - you cannot impose a tax in the garb
of a regulatory fee

Taxation Page 45
Tutorial | Residential Status

01-Feb-16

Income tax - financial year (FY) - from 1st April to 31st March
• Previous Year (PY)
• Assessment Year (AY)

Sec 2(31) of the Income Tax Act, 1961 - who constitute 'persons'
• Individual
• HUF
• Firm — 2 basic criteria - registered partnership deed + profit sharing
• Company
• Artificial or juristic person

Sec 6 - residential status [is NOT equal to citizenship]

Residential status of an individual

• Resident
○ Basic Conditions
 If he has stayed in India for 182 days or more in PY
 OR if he has stayed for 60 days or more in PY + he has stayed for 365 days out of immediately 4
PYs
○ Ordinary Resident - 2 additional conditions
 Stayed in India for 730 days out of preceding 7 PYs
 AND he has been a RESIDENT in 2 years out of 10 preceding PYs
○ Not Ordinary Resident

• Not resident

Taxation Page 46
Business Connection

04-Feb-16

The following incomes shall be deemed to accrue or arise in India :—

All income accruing or arising, whether directly or indirectly, through or from any business connection
in India,

Section 9(1) - Business Connection

• Continuity of business activity - stray or isolated events do not give rise to business connection
• There should be a real and intimate connection
• Achieved through or from some firm or person (agent, intermediary) acting on behalf of the non-resident

Then income deemed to accrue or arise in India and will be taxable

Economic nexus between taxable income and territory
Not to be confused with POEM etc. - which is a residence based taxation principle
Source-based taxation principle
Judicially evolved over time

CIT v. R D Aggarwal 56 ITR 20 (SC)

R D Aggarwal firm located in India - act as commission agents and importers for certain non-residents -
the way in which this company operated, they were canvasing for these non-residents all around the
country - if they got any order, they would forward it to these non-residents - if the contract is made and
is successful, they got commission
If deal is finally settled - profits would arise in the hands of non-residents

The issue was whether this sale being made by R D Aggarwal on behalf of the non-residents can be
considered as a business connection in India

The court arrived at the decision that none of the activities of non-resident companies can be assumed to
take place in India - not procuring raw materials in India or manufacturing - R D Aggarwal only procured
orders from Amritsar and forwarded it to the non-resident - though there is some commercial activity,
such kind of activity does not amount to business connection - a real & intimate connection has to be
established

1922 Act applied here - 'securing orders' was not part of the determination of business connection under
statute at that point

Section 9.
[Explanation 2.—For the removal of doubts, it is hereby declared that “business connection” shall include any
business activity carried out through a person who, acting on behalf of the non-resident,—
(a) has and habitually exercises in India, an authority to conclude contracts on behalf of the non-
resident, unless his activities are limited to the purchase of goods or merchandise for the nonresident; or
(b) has no such authority, but habitually maintains in India a stock of goods or merchandise from
which he regularly delivers goods or merchandise on behalf of the non-resident; or
(c) habitually secures orders in India, mainly or wholly for the nonresident or for that non-resident
and other non-residents controlling, controlled by, or subject to the same common control, as that non-
resident:
Taxation Page 47
 resident:

If contracts are concluded on behalf of the non-resident, business connection will be established
Business connection is formed —
• Has and habitually exercises in India an authority to conclude contracts
• Stock of goods and delivery of goods
• Habitually secures orders

Brokers, commission agents or other agents working independently - do not form a business connection
If such brokers, etc. are found to be working mainly or wholly for a non-resident entity, then independent
status will be questionable and the business connection can be established

If you are a broker or commission agent and you are working independently, then there will be no business
connection established
If you are merely providing support services to the company - and not concluding the contracts or
engaging with the client - that is not a business connection - this is an independent agency - your income
will be taxable in your hands - but non-resident won't have any business connection with you
Merely providing support services like call centers does not amount to a business connection - only back-
office support services - status of an independent agency - non-resident will have no business connection

Therefore call centers or any other service centers won't be considered agents - so no business connection will
be established
If in call center- delegated authority to conclude contracts, strike deal, negotiate prices etc., you will have a
positive business connection

R D Aggarwal is still considered as a landmark judgment - the whole concept of business connection is still
good law as given by R D Aggarwal

Barendra Prasad Ray. v. ITO AIR (1981) SC 1047

Firm of solicitors in Kolkata - litigation regarding infringement of patent w.r.t German Company - Indian
solicitors working for the company - German company also had advisors in UK - and former asked the
latter to collaborate with Indian solicitors - Germans also asked Indian company to work with the UK
solicitor and let the UK solicitor argue the case before the court - Indian company obliged - UK solicitor
came and argued the matter - received his payment
The law firm in Kolkata was shown a show cause notice for why it did not deduct tax from the UK
solicitor's earnings
Indian company said that they were not involved in this - they didn't pay any money to the UK solicitor -
they don't even know how much was paid
The SC held that there was a business connection between the UK lawyer and Indian company - you
facilitated the whole process - gave the documents and helped him - you permitted him to argue - you
have a professional connection with him - and tax was upheld
The term business is not restricted to trade and manufacture but includes professions, vocations and
callings
Though there was no continuity in the matter - a one off incident - still the court held that there was a
business connection

This case has been criticized for the fact that it held that there was a business connection even though there
was only a one off incident

So the major principles of business connection are:

Taxation Page 48
So the major principles of business connection are:
i) Continuity - it should not be a one off incident
ii) Real and intimate connection
iii) Common control between the entities

Even if there is a business connection, global income still can't be taxed - only income received or accrued in
India through a business connection

CIT v. Currimbhoy Ebrahim & Co.

08-Feb-16

Western Union Financial Services Inc. v. ADIT (2007) 104 ITD 34 Delhi
Discusses the 'business connection' - how it is to be construed
US Co. engaging in money transfers
A wants to transfer money to B - A approaches Western Union office in USA - some unique no. is
generated - person B will approach the Western Union office in India - the unique no. will be checked in
the database - and after ID checking, etc. - the money will be handed over to B
The Western Union appoints Indian agents to work on their behalf - e.g. Indian Postal Services, non-
financial companies, tour & travel operators, commercial banks - these agents have the board of WU and
their software database, etc.

Is business connection being established here?

As agents, they are not wholly and mainly dependent on Western Union
Without the remuneration that the agents get from Western Union - the agents would still have their
business
WU will generate profits in USA - it is incorporated in USA - foreign company which is a non-
resident in India
If we want to tax WU for its operations in India - we will have to estd. a business connection

The court said that the transaction which was started in the US - could not have been completed without
the Indian counterpart/agents - there is a real and intimate business connection
Relevance placed on RD Agarwal and Co.

In RD Agarwal - the 1922 Act applied - 'securing orders' was not part of the provision then - the court
visualized the transaction, there was some commercial activity involved, but the commercial activity did not
give rise to a business connection
The court held that the expression means something more than a business - it presupposes an element of
continuity between the business of the non-resident and the activity in the taxable territory - though a
stray or isolated transaction would not be taken - the connection may take several forms - it may include
carrying on a part of main business or activity incidental to the non-resident or it may merely be a relation
which facilitates or assists the carrying on of that business

The generic understanding is that it should not be a stray or isolated incident

Barendra Prasad Ray - has been criticized for considering even a stray incident to determine a business
connection

In the Western Union case - the business connection was successfully established - but there was no
Permanent Establishment and hence the company could not be taxed - because the agents were found to be
independent agents - therefore, the profits generated from India could not be taxed by the Indian tax dept.

Taxation Page 49
independent agents - therefore, the profits generated from India could not be taxed by the Indian tax dept.
In this case - the agents were integral to the business and NOT incidental to it

RD Agarwal - not good in law in present times

In present times - business connection + PE

Sec 9
• If the non-resident is merely engaging in procurement of goods from India which are then immediately
exported - then no business connection
• If the non-resident is engaged in the business of running a news agency or of publishing newspapers,
magazines or journals - activities which are confined to the collection of news and views in India for
transmission out of India - no business connection
• If the non-resident is confined to the shooting of any cinematograph film in India - no business
connection

Taxation Page 50
Heads of Income | Salary

08-Feb-16

Salary
Sec 15, 16, 17

Gross Salary
Income from salary
Income by way of allowance
Taxable value of perquisites
Deduction u/s Sec 16
Entertainment allowance
Professional tax

Net Income = Gross Salary minus Deductions

If the relation between the payer and the payee is not of an employer and employee - then it will come to some
other head

Income from salary will include salaries from present, past, future employer

When you sign bonus amounts - will that come under this head

Allowances - usually, allowed a certain specific amount every month - e.g. HRA (House Rent Allowance), travel
allowance, etc.
Perquisites - fringe benefits - say white goods in ONGC, house provided by ONGC (the value of the goods or
facilities, etc. - as according to the Income Tax Rules)

Bonuses, advances, arrears in salary - fall under the category of income from salary
Receipt or due (accrual), whichever is earlier

Usually salaried income is received annually - if you receive the amount earlier, then it will be taxable - if it
becomes due but you have not received, then also it will be taxable

09-Feb-16

Salary Income - Employer-Employee Relationship

Sec 14 of the Income Tax Act - 5 heads of income - mutually exclusive - any income under the Income Tax Act
must fall within one of the dedicated heads of income - and thereafter, the deductions or exclusions under that
head would apply for that particular income

When you categorize some income under one head and thereafter, you are unable to compute the income under
that head - then the dept. cannot put that income under any other head
There might be a diff. of opinion b/w the head preferred by the assesse and the head proposed by the dept.

When you file a return for income - the assessee puts the income under diff. heads
But if the dept. has any objection to the head preferred to the assessee - then there are procedures such as show
cause notice, etc.

Taxation Page 51
The payer and the payee must have a employer—employee relationship
How would you recognize the relationship of employer and employee?
• Hiring and firing
• Control over the work
○ Contract for service - agent-principal relationship - the principal does not have control over how the
agent fulfills his work - what to do is defined - no control over how to do it
○ Contract of service - master-servant relationship - the master controls what to do and how to do it as
well - the master control how the servant goes about his work
 e.g. associates - associating with the law firm - is it a contract of service or contract for service
 e.g. tenured professor

Lakshminarayan Ram & Sons v. The Govt. of India AIR 1954 SC 364
LRMS was registered as a company in Bombay on 1st March, 1920 - the Co. was estd. as a managing agency
for other companies
The Co. entered into a contract of agency with Mills Co. in April 1920 - to function as managing agents on
behalf of Mills Co. - LRMS was supposed to get some remuneration for this management work
A lot of powers were delegated to LRMS for managing the Mills Co. - they could hire and fire the
employees, etc.
The Hyderabad govt. put into place a tax - Hyderabad Excess Profits Tax Regulation - to tax business
profits - any entity generating excess profits were required to pay taxes
LRMS was called upon to pay these taxes - the Co. said that the remuneration that they received is not in the
nature of business profits but in the nature of salary income
The court had to determine the character of the remuneration being received by the Co. - whether it was
salary income or business profits

LRMS said that they are working as managing agents for Mills Co. alone - they are getting their entire
remuneration from Mills Co. - they do not have any other clients - therefore, the remuneration is in the
nature of a salary income
The court looked at the object clause of the company - it was provided that the Co. could act as agents for
govt., private parties - they could carry on trade or business in India and outside India - the court finds that
although the Co. is working only for Mills Co. - there is nothing in their own formation that prevents them
from working for others as well
Further, the contract b/w LRMS and Mills Co. provided for the continuation of agency for 30 years or till
the time LRMS decided to withdraw - therefore, Mills Co. had no power to hire and fire LRMS as its
employee - here the Mills Co. had no right to fire LRMS [in an employer-employee relationship - there is a
right of the employee to give notice and resign but also a corresponding right of the employer to fire the
employee if he or she is not performing his or her duties properly]

Therefore, the court held that even though the remuneration is flowing only from one particular client - that
would not change the character or nature of the remuneration - therefore, the remuneration was business
income/profits and NOT salary income

Powell's Law of Agency

• A master can generally tell his servant what to do and how to do it
• Generally a principal cannot tell his agent how to carry out his instructions
• A servant is under more complete control than an agent
• Generally, a servant has no authority to make contracts on behalf of his master
• Generally the purpose of employing an agent is to authorize him to make contracts on behalf of his
principal

Ram Prasad v. CIT (1972) 86 ITR 122

Taxation Page 52
Ram Prasad v. CIT (1972) 86 ITR 122
The 1922 Act applies here
A was the MD of a Co. - the terms of the contract - besides remuneration, he would receive certain
commission from the profits of the company
In a particular year - there was a loss - despite that, the MD was given a certain commission because he had
worked really hard - the Director said that he would not take this commission and he would give it back to
the company because the company had made a loss

The dept. said that though the amount was remitted back to the company - the money was due to the
Director - therefore, pay income tax on it
The Director said that this was his business income and NOT salary income - if the money is categorized as
the former, then no income tax - if latter, then he will have to pay income tax

Is the Director an employee of the company or an agent of the company

Based on the AoA - the court found that the AoA appointed a MD for a period of 20 years - it provided
that the MD will specifically work for this company and also do the work of an agent of the company

Under another Article - the Board of Directors were to exercise control over the MD in certain specific
instances
The MD shall work for the execution of the decisions by the Board of Directors
One of the clauses b/w the MD and the Company - provided that the assessee was at liberty to resign from
his office upon giving 3 months' notice and the Co. in general meeting could terminate his services before
the expiry of 20 years if the assessee was found to be acting otherwise than in the interest of the company or
was found to be not diligent in his duty

The court arrived at the conclusion that the nature of the MD's activity was that of an employer and
employee
If the agreement for appointment - provides for a termination clause - then it cannot be said that the person
is not an employee
The nature of employment should be determined by the Articles of Association or any agreement under
which the contractual relationship has been brought about

The higher the degree of control - the higher is the presumption that you are a servant and not an agent
There are variegated tests - it is not merely the hire & fire test

Remuneration by MPs, MLAs and Judges

Is it salary?

CIG v. Shiv Charan Mathur [Rajasthan HC] (2008) 306 ITR 126
The Rajasthan HC has held that MPs and MLAs are constitutional position holders - the remuneration that
they receive cannot be categorized as salary income - the income is categorized under income from other
sources

Justice Deoki Nandan Agarwal v. UOI (1999) 237 ITR 237

The judge asked the question that if the income (remuneration) is categorized as salary - who appoints
them?
There is nobody who is the employer
The SC decided that it is true that HC and SC judges have no employer but that does not mean that they do
not receive salaries - they are constitutional functionaries - but under Article 125 and 221 of the
constitution - the Articles themselves mention that the judges will receive a salary - therefore, the
remuneration received is classified as salary income
The Articles itself articulates that what the judges receive will be a salary

Taxation Page 53
 The Articles itself articulates that what the judges receive will be a salary

MPs and MLAs - the income is income under other sources

Judges - the income is salary income

Art. 106 also speaks of salary and allowances for the members of the Houses of Parliament - but fuck this shit :-P

10-Feb-16
S. 17 of Income Tax Act – definition of salary. It is an inclusive definition.

Annuity - particular sum of money granted annually to which you’ve subscribed. It is not coming from your
employer. You have privately subscribed to it. Hence, it goes under income from other sources. But if the
annuity is paid by your employer, it goes under salaries. When it is payable by your current employer, it is taxable
as salary. If it is received from a former employer, it is taxed as profits in lieu of salary which doesn’t really make
a difference. If under your agreement, you agree on a date for payment of annuity and on the date, your employer
doesn’t pay you and decides to pay you in the future at some time, then it will not be taxed unless the right to
receive becomes vested in you. Other forms of annuities that you have privately subscribed to could be things
like life assurance companies, etc.

Retrenchment compensation - When compensation is given to you, it is taxable in your hands. Sec 10(10B)
provides for exceptions where it is not fully taxable or some part is exempted.
The amount is calculated —
○ In accordance with Sec 25F(b) of the Industrial Disputes Act for compensation received by a workman
at the time of retrenchment or
○ As notified by the government or
○ The amount received
You will receive what you receive - but under the 3 heads whatever was the least that you could have got - to
that extent you will get exemption

Gratuity - It is a retirement benefit. The difference from a provident fund is that in a Provident fund, you have
contributed to that amount from your own salary and along with that your employer will make some contribution
as well. However, gratuity is given to you by your employer and the amount will vary based on the service that
you have put in. You may or may not receive a gratuity based on your employer’s policy. It is the gratitude shown
by the employer towards you. Aim is incentivize you to work more for the employers. Depending on whether
you are a government employee or a non-government employee it changes. Government means central and state
government. When gratuity is received by government employee, it becomes fully exempt. But for others, there
are two kinds; those covered by Payment of Gratuity Act, 1972 and those not covered. For both they could be
either fully or partly exempt.
If you are a non-government employee covered under the Act, then your amount of exemption is calculated
like this: Rs. 3,50,000 is the outer limit prescribed. Then you see gratuity actually received. Then you see 15
days salary last drawn for each year of service (basic salary + dearness allowance). The least out of these
three would be exempt and the balance amount would be taxed.

Leave salary - According to service rules, all employees are eligible for certain leaves. If you don’t avail of them,
they might lapse or according to service rules, you may accumulate them and then get them encashed. When you
have these kinds of encashments they are known as leave salary. If your leave has lapsed, you can’t get anything.
If they accumulate you can either encash them during service or upon retirement. If you are a government/non-
government employee for encashed during service, it is taxable. If you are a govt employee for encashed on
retirement, it is fully exempt. If you are a non govt. employee for encashed on retirement, it is either fully or
partially exempt.

Pension - You can have uncommuted or commuted pension. Uncommuted is the periodical kind. Then it is

Taxation Page 54
Pension - You can have uncommuted or commuted pension. Uncommuted is the periodical kind. Then it is
taxable regardless of whether you are a govt/non-govt employee just like periodical salaries are. Commuted
pension is a lump sum. If it is commuted pension, then government employees have it fully exempt. Non-
government employees are again divided into whether gratuity is received or not. If gratuity is received, then one-
third of pension is exempt. If gratuity is not received, one half of pension is exempt.

Allowances - Allowances are monthly payments of money which you receive in cash. Depending upon taxability,
there are certain allowances which are fully taxable, there are some which are partially exempt and there are some
which are fully exempt. You get a range of allowances. Dearness allowance is to set off inflationary pressures.
Anyone in employment will always get it. It is fully taxable. City compensatory allowances are when you’re posted
in metropolitans. It is to reimburse you for the high cost of living in these cities. It is fully taxable. Some
allowances are exempt depending upon the actual expenditure by the employee. The exemption amount is
calculated as the lower amount between the allowance amount or the amount utilized for the specific purpose for
which the allowance was given (if fully spent - then fully exempt)

Karamchari Union Agra v. UOI, 2000

There were government employees who challenged the imposition of taxes on CCA, HRA and DA. They
filed petitions in numerous high courts. They said when they received these allowances, it was as
reimbursements to offset the inflationary pressures on them which would not be their income. They are
provided with dearness allowances and city compensatory allowances so they can survive in the city in which
they are posted. They claim that their expenditures far outweigh their allowances. The employees argue that
they are not getting any surplus out of it and hence, these allowances should not be taxed. The SC tried to
look at the definition of the term salary. It included within its ambit basic pay, etc. It also included profits in
lieu of salary and various items were listed within. One of them was any sum received from your employer.
Profits in lieu of salary would be in the sense of some benefit or advantage being derived by the employee.
Since that is the applicable definition, the court said that since any sum received from your employer would
be considered profits in lieu of salary and hence, would be taxable under Sec 17. These profits need not be
surplus in your hands. The SC upheld the taxability of the allowances.

11-Feb-16
Housing Allowance - HRA is provided to you for accommodation. A fixed sum is given to you and the
exemption amount is different for cities like Delhi, Bombay, etc. where the exemption is higher as compared to
other ones. One must be living on a rented premises to claim this exemption. If you’re living in your own house,
then you will get it but it will be fully taxed.

Perquisites -They are facilities which are provided to you in kind by the employer. Unlike allowances which are
available to you in cash so the amount is readily available for tax, there is no readily available amount for
perquisites. You have to ascertain the value of the facility and the value becomes taxable. Some prominent
perquisites are when you’re given furnished accommodations by your employer, facilities like a car or servants. It
is considered that the cost to the employer becomes the perquisite taxable in the hands of the employee. This will
also include cases where facilities are provided to you at a concessional rate. The amount being paid by the
employer becomes the perquisite.

Provident fund (PF) - They are of different types. There is a statutory PF, recognized PF, unrecognized PF and
public PF.
• SPF is the one which is established under this Act known as PF Act of 1925. If the employer is in the nature
of govt organization or the govt itself.
• RPF is more prevalent in the private sector. It is known as Employees PF and Miscellaneous Provision Act
of 1952 covers it. Any establishment which employs 20 or more persons is said to be covered by this statute
and it has to be recognized by the IT department.
• UPF is a fund which is not recognized by the IT department. It does not fall within the requirements of the
Act. Employer may have floated his own scheme.

Taxation Page 55
 Act. Employer may have floated his own scheme.
• PPF is the most popular one. It does not require you to be an employee. You just have to approach the
nationalized banks and open a PPF account. The minimum amount you can deposit is 500 and the
maximum is 1 lakh. There is a 15 year lock in period.

In SPF, RPF and UPF - the employer deducts the employee's contribution to the PF - this is employee's
contribution to the fund under Sec 80C of the IT Act - this amount is exempt from your gross income and
tax is only levied on your net income
In SPF, RPF and UPF - the employer also contributes (NOT in PPF) - employer's contribution is not
taxed - but in RPF, if the employer contributes more than 12% of the salary then the balance is taxed

Difference between Gratuity and PF

Both Gratuity and PF are retirement benefits but there is difference in their composition, purpose and
contributors. Gratuity is received from an employer at the time of retirement or at the time of leaving the
job in a lump sum as a token of gratitude towards services rendered (usually pertains to longer years of
service). PF is a mandatory deduction every month from employee's salary and deposited to a dedicated PF
account and employer also makes some contribution.

ESOP - Employee Stock Option Plan - This was popular in IT firms where the attrition rate was high. So to
incentivize employees to stay with the firm, these would be offered to them.

SWEAT Equity - It is offered to you on account of the intellectual property that you are bringing to the firm. It
is meant to be offered to people who are of high caliber and have skills which help the company when the person
doesn’t have the capital to participate.

In ESOP we have different schemes available.

One is employee stock purchase plan (ESPP). A certain part of the employee's salary is set aside for the purchase
of stock and when the prices according to the market are lower and it may be beneficial, the designated person,
purchases it from you.
Then there is the Stock Appreciation Right (SAR) - no real equity but a notional equity which does not exist in
reality. Herein, the fair market value of the stock will be noted down and over a period of years you can keep
encashing it there being a difference - appreciation.

Now we’re looking at the taxability of ESOP. There is an announcement of a stock option plan for the
employees and the company will say that so many shares have been set aside for the scheme. There is a grant date
which is the date when the employer provides you with the grant for the option (there might be certain
conditions that need to be fulfilled by the employee for the grant). Then there is the actual date known as the
vesting date - the vesting date is 6 months later. The employer has the right to apply for the shares earlier
granted. There will be exercise of the option. This means that a right which has been vested in the employee is
now being put into practice. The employee actually asks for the shares in his name.
E.g. If the grant is given on 11th Feb, the vesting would take place over 6 months called the cooling period.
Then the exercising of option would take place. If, exercising is open for 5 years when you can approach the
company and apply for shares. Basically, you can limit the exercise period.
Once you exercise the option - the shares are allotted - the shares are locked in for a certain period - you
cannot transfer them to anyone during that period - if you resign or terminate the job - then the shares are
bought back by the company at the price that you bought the shares

CIT v. Infosys Technologies

Which is the specific date on which the perquisite is said to arise? The court said that on the date of exercise
of the option, the shares are allotted to you but they are still in the lock-in period and cannot be sold so they
cannot be taxed until they’ve actually been sold. You cannot consider that the perquisite has reached the
employee until then. You also cannot determine what the value of your shares will be in the future and

Taxation Page 56
 employee until then. You also cannot determine what the value of your shares will be in the future and
hence, the value would be uncertain. This judgment was overruled.

It is now the date of exercising the option. The taxable value will be the amount FMV (fair market value) minus
the exercised price for the option. The balance amount is perquisite. This was done by an amendment/circular
regarding Sec 17(2)(vi) – ESOPs.
Now the day on which you exercise the option is considered to be the date when the perquisite arose. Fair
Market Value (on the date you exercise the option) minus the Exercise of Option Price (pre-determined
price) = Taxable amount.

13-Feb-16
Sumit Bhattacharya v. ADIT
Sumit was the Chairman of P & G India. He got SARs which he was supposed to redeem within a period of
10 years. He received some amount in US dollars which converted to 4.5 crore rupees. This income was
alleged to be taxed as salary. The assessee stated that SAR is granted to him by P & G USA and not P & G
India, which is not his employer.
He argued that this is capital gain but you can’t compute the gain. [If you can’t compute it, you can’t tax it]
[Under capital gains, you tax some gain on capital (e.g. sale of land) - this is taxed under the ITA, if you sell
stocks the difference that you make is taxable. The technical understanding is that in order to have a capital
gain, there ought to be a cost of acquisition, only then would a gain over that amount to capital gain and
hence be taxable under the ITA].
Here he argued that when SARs were granted to him there is nothing coming out of the pocket of the
employee.
The court holds that when you look at the definition of the term employer, you have to use a wider
definition. Income, if a fruit of your employment would necessarily be income obtained from the employer.
The SARs had been granted for his work for the P & G group. The income since it is coming from the
parent of your employer would be considered your salary.

Two deductions under salary income: Under Section 16 there was entertainment allowance and professional tax
being paid to the govt. If you’re a non-governmental employee then you don’t get this exemption. These taxes
go to the state govt.

Taxation Page 57
 Cases | Mid Sem

Wealth Tax
1. Sudhir Chandra Nawan v. Wealth Tax Officer
Entry 49 List II
Entry 86 List I
Entry 97 List I

2. UOI v. HS Dhillon
Entry 49 List II
Entry 86 List I
Entry 97 List I

Aspects Theory
3. Federation of Hotel Association of India v. UOI
Entry 54 List II
Entry 62 List II
Entry 97 List I
Measure of the levy does not determine the nature of the levy

4. All India Federation of Tax Practitioners v. UOI

Entry 60 List II - tax on individual professional and tax on the activity of the professional

5. KTM Nair v. State of Kerala

Art. 14, 19(1)(f), 31C

Fee
6. Secunderabad Hyderabad Hotel Owners Association v. Hyderabad Municipal Corporation
Enhancement of fees - commensurate with the services rendered
No specific dedicated fund required

7. Kewal Krishnapuri v. State of Punjab

Excessive fees - surplus of revenue - donation to educational institutes

8. Hingir Rampur Coal Company v. State of Orissa

Entry 84 List I and Entry 52, List I - mining and regulations and development

Direct and Immediate Effect - Compensatory Tax

9. Atiabari Tea Company v. State of Assam
Entry 56 List II
Direct and immediate effect test

10. Automobile Transport Ltd. v. State of Rajasthan

Working test for compensatory tax

11. Bhagatram Rajiv v. Commissioner of Sales Tax

Some link/connection

Taxation Page 58
12. Bihar Chamber of Commerce case
Some connection

13. Jindal Stainless Ltd. v. State of Haryana

Entry 52 List II - entry tax
Upheld the Automoile working test - compensatory nature should be evident from the taxing
statute - it cannot depend on the manner or use of the revenue collected

14. Vijalakshmi Rice Mills v. Commercial Tax Officer

Concept of fee - still based on broad and general co-relation
Entry 66 List II

Residential Status
15. Madhukar Dhavale v. Income Tax Officer
Residential status - person going out of India as part of shipping crew - the determination is
based on the days spent working on the ship not merely the days spent outside India

16. Subbaiyah Chettiyar v. CIT

Residential status of HUF - family in Ceylon - karta in India

17. Narotam & Parela Ltd. v. CIT

Residential status of a company - 1922 IT Act - if the control and management is wholly situated
in India
Distinction b/w 'conducting a business' and 'control and management' - head and brain of the
company
Not de jure control (capability to manage) and management but the de facto control and
management (authority to manage)

18. Radha Rani Holdings Pvt. Ltd. v. Additional Director of Income Tax
Residential status of a company - company incorporated in Singapore - majority shareholder in
India - going to Bangkok during the board meeting
Technological advancement - meeting can happen from anywhere

19. Laerstate BV v. HMRC

UK case on residential status of a company - central control and management

Business Connection
20. CIT v. R D Aggarwal
Business Connection

21. Barendra Prasad Ray. v. ITO

Business Connection - UK solicitor - argued case in India - Indian firm
Criticized judgement - one off incident used to estd. a business connection

22. Western Union Financial Services Inc. v. ADIT

Business Connection - Western Union
Business connection - something more than just business - element of continuity - this
connection can be of various forms - it may include carrying on a part of main business or

Taxation Page 59
 connection can be of various forms - it may include carrying on a part of main business or
activity incidental to the non-resident or it may merely be a relation which facilitates or assists the
carrying on of that business

Salary
23. Lakshminarayan Ram Gopal & Sons v. GOI
Employer - employee relation

24. Ram Prasad v. CIT

Employer - employee relation - is a Director an employee or agent of the company?

25. CIG v. Shiv Charan Mathur [Rajasthan HC]

MLAs and MPs - remuneration is not salary - income from other sources

26. Justice Deoki Nandan Agarwal v. UOI

Judges income is termed as salary - because the constitutional articles use the term 'salary'

27. Karamchari Union Agra v. UOI

Taxes on allowances - allowances come under profits in lieu of salary

28. CIT v. Infosys Technologies

When do ESOP shares become taxable - on the day of vesting - overruled

29. Sumit Bhattacharya v. ADIT

Salary and SAR - if income is the fruit of your employment - then it is salary

Taxation Page 60
Heads of Income | House Property

13-Feb-16

Sec 22 to 27

Gross Annual Value

Less Municipal Taxes
Net Annual Value
Less Deductions under Sec 24

Under this head of income, you need to have three conditions

(1) House property is a property which should consist of any buildings or lands appurtenant thereto;
(2) the assessee should be the owner of the property;
(3) the property should not be used by the owner for the purposes of any business or profession carried
on by him, the profits of which are chargeable to income tax

House property does not mean a residential house property

This property won’t only cover residential premises but also buildings that are let out - this does not only
attach to the building but also the land appurtenant thereto
You must have a building
Income from just land which you rent out for marriages, it will not be a house property income
You need to have a building - say, you have a building that you are using for residential purposes but the
backyard has been rented out - the income from renting the backyard would be income from house
property

You are not taxing the income generated from the house property but taxing the inherent capacity of the
property to generate income

Say you have 3 houses, one house would be exempt as your self-occupied house - the other houses would be
deemed to have been let out and you would have to pay tax on this notional income
If you just have one house, then you don’t have to pay this

You can maximum get an exemption from one house, that too if you stay in it - if there are two floors and
you’ve let one floor out - the let out floor would be taxed
E.g. the first floor you’ve occupied and the ground floor is your office - the premises would not be taxed
as house property - that would be income from business

In certain situations, if the property is someone else’s name, you would be considered the owner
When the tax payer is an individual and he has transferred the property to a spouse, or to a minor child
without adequate consideration, you would still be considered owner of the property

Holder of an impartible estate is a deemed owner

A person who has acquired the property under Power of Attorney transaction you will be deemed to be the
owner of that property

15-Feb-16

Another deemed owner- a person who has acquired the rights in the building under Section 269UA(f)
This clause refers when building has been leased for a period of 12 years or more - the person who has so

Taxation Page 61
 This clause refers when building has been leased for a period of 12 years or more - the person who has so
taken the property on lease would be considered the deemed owner - thus the notional income would be
taxable

Whenever the property is held by the member of a cooperative company, housing society - by virtue of your
membership, you’re holding that property - that property might still be in the name of the company but you
would be considered as the deemed owner

There are certain other property incomes that are not chargeable to tax: exemptions provided under Section 10
One is income from a farm-house [Sec 10(1)], annual value of any one palace of an ex-ruler, property
income of a local authority of a political party, trade union, educational institution

What happens when you have a number of houses?

Section 23 says that you would be exempt from one property if you’ve occupied it
When you have more than one house, the provision says that exemption can be claimed when you’ve
specified that the particular house is self-occupied
Hence there is no requirement of you staying there
Thus the option is available for the assessee, and he can specify whichever house he pleases to be
exempted
This house can also be changed from year to year - this change is done, because interest paid is
deductible - hence you might have an incentive to change the house that you claim to be self-occupied -
you don’t have to be necessarily occupying that house to claim is at being self-occupied)

Calculation of annual value

The way at which you arrive at the Gross Annual Value (GAV) —
1. The first step is to calculate the reasonably expected rent - you will have to look into the municipal value
of that house property (MVL) - this assessment is made by the municipality to determine the rate of
property tax - there are different factors taken into account in this determination
You will have to collate the fair rent of that particular property - this is the rent that a similar property in
the same locality would fetch
In context of the GAV you have to calculate the reasonably expected rent
E.g. MVL= 6000; Fair Rent= 8000 - the higher of these two subjected to the standard rent is the
reasonably expected rent
Standard rent is the Rent Control Act rent - there is a legal limit to the extent which the landlord can
recover the rent - if this standard rent applies (i.e. there is a Rent Control Act in the state), the fair
rent or the MVL cannot exceed Standard Rent - here, if the standard rent is 7000, then although fair
rent is 8000, the reasonably expected rent would be 7000
2. When you’ve actually let out the property - in that case, you would have the rent received or receivable -
the higher of the two [the reasonably expected rent and the received or receivable rent] will be taxed
But if initially you had been promised a higher amount, but the tenant says fuck off and pays an
amount lower than the reasonably expected rent, then the unpaid amount would be considered
unrealised amount and then you would be taxed on the amount actually received, which in this case
is lower than the reasonably expected rent
3. If there are certain vacancy periods, where you wanted to rent the property but you don’t find any taker -
because of this the rent falls below the reasonably expected rent, then you would only be taxed on the
lower amount - this vacancy period might extend to the entire year

16-Feb-16

1 2 3 4 5
Municipal Value 35,000 40,000 50,000 55,000 60,000

Taxation Page 62
Municipal Value 35,000 40,000 50,000 55,000 60,000
FIV 37,000 50,000 45,000 60,000 70,000
Std. Rent N/A 55,000 60,000 72,000 50,000
Reasonable Rent 37,000 50,000 50,000 60,000 50,000
Actual Rent Received/Receivable 40,000 60,000 30,000 75,000 1,20,000
Unrealized Rent - - - 5,000 -
Rent lost due to vacancy - - - - 8 months
GAV 40,000 60,000 50,000 70,000 40,000

Self-occupied property - GAV will be NIL

If you cannot occupy the property - because you are carrying out your occupation in some other place - then
GAV of the house will also be NIL

Municipal taxes - can be claimed as deduction - but if the property is self-occupied, then this deduction cannot
be claimed
There should be some GAV amount
The municipal taxes should be actually being paid by the owner - if the payment of municipal taxes has
been shifted onto the tenant, then also this deduction will not be available

Sec 24 provides for deductions

• Standard deduction - 30% of the annual value
○ Where you have self-occupied property, you can claim one deduction only which is interest on
borrowed property - basically your overall amount would be negative since your GAV is nil - you
can set this off against another house property if you have one - if you don’t have another house
property, you look for another head to set it off another but you can’t set it off against salary
income - there are internal rules for this
○ If the house property is self-occupied for residential purposes - then the amount of deduction will
not exceed 30,000
• Interest on borrowed capital
○ Interest on borrowed capital can be claimed as a deduction where capital is borrowed for the
purposes of acquiring, constructing, repairing, renewing or reconstructing the (house) property
 If the capital has been borrowed on or after 1st April 1999 for construction or acquisition of
house property (self-occupied) and such construction or acquisition is completed within 3 years
from the end of financial year (when the capital is borrowed) and the person who is extending
the loan certifies that such interest is paid - if these conditions are met, then the amount of
deduction that can be claimed is up to 2,00,0000
□ It used to be 1.5 lakhs but now it has been raised to 2 lakhs
□ The person who is extending the loan needs to certify that such interest has been paid
□ If these conditions are all met, then the amount of deduction that you can claim can be up
to 2 lakhs

If your property is let out and hasn’t been kept for self-occupation, your limits on interest on borrowed capital
will not exist
Sec 24 of the Income Tax Act - talks about deduction - if the house property has actually been let out or
deemed to be let out, then no cap applies for deductions - because the statute only talks about when the cap
will apply but there is no mention of house property which has been let out or deemed to be let out -
therefore, we draw the inference that there is no cap for deductions on such house property (which has
actually been let out or deemed to be let out)

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actually been let out or deemed to be let out)

The house property head of income will come into existence only once the construction of the house is
complete
But if you have borrowed money for the construction - then you will pay interest to the bank
This amount will be included in the deductions - i.e. in the 2,00,000 amount - as interest during the pre-
construction period

This pre-construction period commences on the date of borrowing and ends on 31st March immediately prior
to the date of completion of construction or acquisition or the date of repayment of loan, whichever is earlier
(this does not make sense - look at the statute - it says construction or acquisition should be
completed within 3 years from the end of the financial year in which the capital was borrowed)

The amount being claimed is put into five different instalments and is available through the next five years as
an added deduction - the amount is deductible from the date when you start paying the GAV
The financial year from which you have completed your process and the property head emerges, you can claim
this amount as deduction for the next five years

The principle amount that you have borrowed is also deductible under Sec 80C from your overall income up
to 1.5 lakhs
Sec 80EE - allows deduction on the interest on capital borrowed - up to 1,00,000
At times this is seen as in conflict with Sec 24

17-Feb-16

Sec 80EE - introduced in the statute from April 1st 2014 - it provides another set of deductions - up to 1 lakh
Loan should have been sanctioned b/w 1st April 2013 to 31st March 2014
First time buyer of house property
The amount of loan borrowed should not be more than 25 lakh
The property value should be less than 40 lakh
Where a deduction under this section is allowed for any interest - deduction will not be allowed for such
interest under any other section - then what happens to Sec 24?

The Finance Minister - gave budget speech - he had promised that the deduction available under Sec 80EE
would be a deduction available over and above Sec 24
But the actual provision of Sec 80EE seems to conflict with this promise
The CAs and experts still advise that the deductions under Sec 80EE can be claimed after you have exhausted
Sec 24

The government wanted to give a boost to the real estate agency - therefore, this provision was added

Income from other sources - under Sec 56(2)(iii) - this section says where an assessee lets on hire machinery,
plant of furniture belonging to him and also buildings and the letting of the building is inseparable from the
letting of such machinery, plant or furniture - such income shall be categorized as income from other sources

• Income from house property - even when you are holding that property as stock in trade - say it is your
business to keep letting out your house property, that would not be income from business but income
from house property (as there is a dedicated head for it)
• Gain/profit from business
• Income from other sources

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 • Income from other sources

East India Housing and Land Development Trust v. CIT (1961) 42 ITR 49 SC
There is a private company and this company was registered in India - among the objects of the company
it was stated that one of its objects was to buy and develop landed properties and to promote and develop
markets
In accordance with its objects - the company constructed shops and stalls on the land - and they rented
out these shops and stalls to various tenants and occupants - the question was whether the income from
renting out shops and stalls is a business profit or income from house property
The court held that this was income from house property - the income derived by this company is derived
from the property and it falls under the specific head (1922 Act) - the character of the income is not
altered because it is received by a company formed with the objective of developing and setting up
markets
Whenever you have arrangements where the shops and stalls are being rented out, it is considered to be
exploitation of the property and hence, income from it is considered to be from house property not from
business/profession

CIT v. National Storage Private Ltd. AIR 1968 SC 70

Here the assessee company was promoted - the government had come out with rules relating with
cinematography - if you are a film distributor, the film reels had to be stored in a particular godowns
which have been constructed strictly in conformity with the specified requirements
Company purchased land in Mahim (Mumbai) - it developed certain vaults for the storage of reels - there
were automatic fireproof doors, etc. - these vaults were given on license - the distributor was the
licensee - the distributor could use the vaults only for the purpose of storing film reels and nothing else
Further, services such as rewinding, cleaning, etc. were provided along with storage services
Is this income of the company - income from house property or income from business?

The company is providing other services as well (in addition to storage facilities)
The SC said that in cases where the income is received not from the bare letting of the tenement or from
letting accompanied by incidental services but the subject hired out is a complex one and the income
obtained is not so much because of the bare letting of the tenement but because of the facilities and
services rendered, the operations involved in such letting of the property may be of the nature of business
operations
In cases where the letting is only incidental and the subservient to the main business of the assessee, the
income derived from the letting will not be house property income

Manohar Singh v. CIT (1965) 58 ITR 592 PH

An individual purchased a piece of land near Mathura road - built a house consisting of 33 suites of
rooms - apart from residential portion where he himself resided
The entire building was not let out neither was a block of rooms let out - individual rooms were let out
The rooms were of different sizes, had attached bathrooms, common dining room, lunches and dinners
were provided but the tenants were not bound to have meals there, the tenants on request could be
provided with curtains, beds, pillows, etc., the duration of stay could be a few days or months
The court said that this is in the nature of business income - the complexity of services being provided is
not of the nature of simple letting out

This may not hold true if you are one individual and you are letting out a room for a PG - if you have a PG
which makes you pay rent as well as gives you other facilities, the income from rental would be house property
and the income from facilities would be business income

The distinction that has to be made is whether the letting of the property and the services provided are

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The distinction that has to be made is whether the letting of the property and the services provided are
composite in nature such that they cannot be separated i.e. you cannot have one without the other - then it
would be income from other sources
If it can be segregated, then the income from letting the house property is income from house property (rental
income) and the income from rendering services would be business income

The question is the kind of letting and the facilities being provided - whether they are composite in nature to
the extent of being inseparable so you cannot have one but not the other, then it goes to income from other
sources - if your landlord is bifurcating these amounts between rent and facilities, there is no problem - but if it
is composite and so inseparable that you can’t use one without the other then it becomes income from other
sources

18-Feb-16

Sultan Brothers Pvt. Ltd. v. CIT (1964) 51 ITR 353 (SC)

The Appellate was a company - which was the owner of a certain building in Mumbai - lease - let out the
building which was fully equipped - to be run as a hotel
The lease agreement - comprised of 2 amounts - monthly allowance + hiring of furniture and fixtures
The question was whether this amount should be taxed as business income or is it rental income or is it
income from other sources
The 1922 Act applies
According to the assessee - they said the entire amount is the business income
The dept. said that there should be a part of the amount categorized as income from house property (as
there is a dedicated head for it) and the rest of it should be business income

In the East India Development and the National Storage case - it was agreed that even if you are letting
out furniture and fixtures - that in itself does not classify it as a business income

Whether a particular letting is business has to be decided in the circumstances of each case - we think that
each case has to be looked at from a businessman's point of view to find out whether the letting was the
doing of a business or the exploitation of his property by the owner
We do not further think that the thing can by its very nature be a commercial asset - a commercial asset is
only an asset used in a business and business may be carried on with practically all things

Placing relevance on these kinds of findings - the court says that the object of this company no doubt was
to acquire land building and turn the same into profit by construction, reconstruction, furnishing, selling
or leasing etc. - but that by itself would not render the lease as a business income - this is basically an
income coming from the lease - the lessee is making a commercial use of this asset
Therefore, it is not a business income

[if the letting is not a bare letting but is accompanied by complex services which are being rendered - then
the letting would constitute business income]

Now the next level of enquiry is whether this is income from house property or income from other
sources

If the machinery, plant or furniture (facilities) are subservient to the letting (which is the primary
intention) - then it is income from house property
If the letting is following the facilities - then it is income from other sources

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 The court however, gave another reading - you will never come across a case where the letting of the
building is subservient to the letting of the furniture and fixtures - according to the court, you have to
enquire whether the letting of the building and the facilities is inseparable or not

In order to decipher the inseparability of the letting of the building and the furniture —
○ Was it the intention in making the lease that separate leases (w.r.t building and furniture) should be
enjoyed together?
○ Was it the intention to make the letting of the two practically one letting?
○ Would one have been let alone and a lease of it accepted without the other?
If the first two questions are affirmative and the last is negative - the parties intended the letting to be
inseparable

The court held that in this case - the letting was inseparable

Karnani Properties v. CIT

The case pertains to some property in Park Street in Kolkata
The assessee company owned Karnani Mansion which constituted numerous residential flats, some
shops - which were let out to tenant on monthly basis
The company also provided further facilities - such as electricity, use of lift, supply of hot and cold water,
certain arrangements of watchmen, scavenging, etc.

The question was whether the income was business income or income from other sources
When the matter came up before the HC - the HC was of the view that part of the income would be
income from house property
The SC was of the view that when the head of income from house property was not under dispute - the
HC cannot suddenly classify the income as such

The SC went on to hold - the services rendered by the assessee to the tenants was the result of its
activities carried on continuously in an organized manner with a set purpose and with the view to earn
profits - those activities were business activities and income arising therefrom was business income

CIT v. Shambhu Investment Pvt. Ltd.

SIP was owner of the building at Raheja Chambers, Nariman Point in Mumbai - the premises were
furnished by the company - the premises were being let out to various organizations - with furniture,
fixtures, air conditioners, etc. as table space
The assessee also provided the occupiers with other services such as electricity, water and other facilities
Assessee says this is business income
The dept. says this is rental income

Assessee argues that the premises are not rented out - the table space is available to the various
organizations for fixed timings during the day - therefore, business income
The dept. argues - purpose of the lease was to allow enjoyment of furnished premises

The court says - what has to be seen is what was the primary object of the assessee while exploiting the
property - if it is found, applying such test, that the main intention is to exploit the immovable property
by way of complex commercial activities, in that event it must be held as business income
If it is found that the main intention is for letting out the property - then it is rental income

The court asks the 3 questions of Sultan Brothers, it also cites National Storage case

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 The court asks the 3 questions of Sultan Brothers, it also cites National Storage case

The cost of the property to the assessee was 5 lakh rupees - it was found that the assessee had already
recovered 4,25,000 by way of security free advance from the occupants - the entire cost of the property
let out to the occupiers was already recovered by way of interest free advance
The court sees this kind of circumstances - it cannot be said that the assessee is exploiting the premises
for commercial business activities - therefore, this is rental income

19-Feb-16

Pfh Mall v. ITO, 2008

This was a Kolkata tribunal decision
Company under consideration was engaged in the business of construction and management of shopping
malls, department stores and shopping malls across the country - income received was shown as business
income and in this, they showed some expense as business expenditure
Department said this is income from house property - the tribunal places relevance on the cases we’ve
already looked at and checks the nature of the agreement that the company gets into

The premises are largely lent by the owners to Pantaloons India for retail outlets and there were certain
conditionalities that the business centers on offer by the company would be kept open for a certain
number of hours every day - they also provided other services to the business that were being carried out
like watchmen, water, electricity, parking, etc.
As clauses of their agreements, it was agreed that those who were being lent these premises would not let
anyone else to stay overnight in the mall
The agreement also said the occupiers of the premises have waived their right of tenancy which means
they declared that they are merely occupiers and not tenants of the premises

All these agreement clauses were attempted to be understood by the company as showing proof of a
commercial activity being carried out in an organized basis
Based on Karnani Properties, the present assessee fulfils all those criteria - the commercial activity should
be organized, conducted continuously and with a view to earn profits, etc. - they are all fulfilled

They also invoked National Storage and Shambhu Investment - they try to say that it is exploitation of the
property as a commercial property and not as mere letting out

The conclusion which the court reaches is that the mere fact that income is attached to immoveable
property cannot be the sole criterion for assessment of the income as house property - it is necessary to
dig further to find out what is the primary object of the assessee while exploiting the property - if it is
found that the main intention is for simply letting out of property, the resultant income must be assessed
as house property income - if on the other hand, the main intention is found to be the exploitation of
immoveable property by way of commercial activity, then the resultant income must be held as business
income
They are equating the similarities in the activities undertaken by this mall with the activities undertaken
whilst running of a hotel - the tribunal says both malls and hotels constituted buildings or groups of
buildings provided for accommodation thereof and the predominant activity is commercial activity - the
income will be business income
The court observed that the assessee had given up its business of textiles and then started setting up
shops and malls - it had carried out formalities to achieve this

CIT v. Chennai Properties Ltd., 2015

It was considered that the income was that from business and not house property in a similar scenario

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 It was considered that the income was that from business and not house property in a similar scenario
Relevance was placed on Sultan Brothers, etc.

According to East India Housing, it has been considered that when you are barely letting out any property
and your only business is to keep letting out, it will not alter the character of the income and it will remain
income from house property because your intention is to exploit the property through letting out - this case
does not speak of intention the way later cases speak of it - this case had a simple situation of acquiring,
constructing and then leasing

National Storage says there may be a situation where the building is involved in income generation but it is
not bare letting - the subject matter that is hired out is a complex activity - it said that where letting is not
merely for the building and it is not bare letting and the subject is of a complex nature with other services, then
you cannot say it is house property income and it becomes business income - it says that at times we have to
question what was the primary intention of the parties - was the facility subservient to the letting of the
building - then it would be house property - but if the primary intention is to provide services then it would be
business income
Keeping this in mind, the court says letting out the storage vaults it is not primarily for the letting out the
building - the service is either equally or more important - hence, it is business income

Sultan Brothers looked at income from other sources also - plant and machinery were being let out with the
building or furniture was being let out with the building - the assessee along with its own property plus fixtures
is leasing it out to someone who will run it as a hotel
When you yourself are running a hotel and giving additional services, it will be business income - but when you
are leasing it out to someone else who will run it as a hotel, will it be business income?
No
When you are letting out fixtures along with the building, then relying on East India Housing it becomes a
coterminous letting
Business income is not a question here
We must ask if the letting is inseparable and if it is, then we place this income under income from other
sources

You don’t look at if building was primary or if fixtures were primary when you’re talking about income from
other sources - you only look at separability.

Karnani Properties looks at when it will be held to business income - it says if you have property upon which
activity is being taken in an organized manner, in a set basis with the view of making profits, then this is
income from business activity
How is the property being exploited as an assessee?
If the very nature of exploitation is by merely letting it out, then it is house property
If you are commercially exploiting it, then it becomes business income

You may have to invoke cases in combination to understand which kind of income you are dealing with
Courts seem to pick cases to rely on based on what fits with their opinion

Sultan Brothers and National Storage - why aren’t we applying the test from the latter in the former instead of
using the coterminous line of argument - apparently, in the former the income is coming from the lease in
question - in the latter, the income is coming from the services being provided - possibly we could argue that
in the former, the building and the fixtures are inseparable and hence, we use income from other sources but
in the latter, the service is being paid for not a lease of the building and hence, it is business income

Income from sub-letting would be income from other sources

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Income from sub-letting would be income from other sources

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Heads of Income | Capital Gains

29-Feb-16

Sec 45 - charging section

The gain which is being made from transfer of a capital asset - not the capital asset itself

Revenue receipts - recurring in nature

Capital receipts - fixed asset for the owner - the owner does not part with the asset on a regular basis - it
enables the owner to generate income

Sec 2(14) of the Income Tax Act - defines capital asset - broad inclusive definition
Any property held by the assessee will be considered to be a capital asset

Sec 2(14) "capital asset" means—

(a) property of any kind held by an assessee, whether or not connected with his business or
profession;
(b) any securities held by a Foreign Institutional Investor which has invested in such securities
in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992
(15 of 1992),
but does not include—
(i) any stock-in-trade other than the securities referred to in sub-clause (b), consumable stores or
raw materials held for the purposes of his business or profession ;
(ii) personal effects, that is to say, movable property (including wearing apparel and
furniture) held for personal use by the assessee or any member of his family dependent on
him, but excludes—
(a) jewellery;
(b) archaeological collections;
(c) drawings;
(d) paintings;
(e) sculptures; or
(f) any work of art.
Explanation 1.—For the purposes of this sub-clause, "jewellery" includes—
(a) ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one
or more of such precious metals, whether or not containing any precious or semi-precious stone, and
whether or not worked or sewn into any wearing apparel;
(b) precious or semi-precious stones, whether or not set in any furniture, utensil or other article or
worked or sewn into any wearing apparel.
Explanation 2.—For the purposes of this clause—
(a) the expression "Foreign Institutional Investor" shall have the meaning assigned to it in clause (a)
of the Explanation to section 115AD;
(b) the expression "securities" shall have the meaning assigned to it in clause (h) of section 2 of the
Securities Contracts (Regulation) Act, 1956 (42 of 1956);

Stock in trade -
If something is held as stock in trade - then it does not form a capital asset - but it goes under
business profits

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 business profits

Personal effects - movable property that is held for personal use by the assessee or any dependent member
of his family
But there are certain items that would not count as personal effects - i.e. they would actually be
included in the ambit of capital assets

In India - the problem is that we do not hold gold or silver jewellery as a capital asset - we sell off only
when we are in distress - but the income tax department categorizes all jewellery as capital asset

Anything that pertains to agriculture - exempted from capital assets

The Central govt. does not usually meddle with agricultural land - the State govt. usually has prerogative
over agricultural land

The Income Tax Act - is a Central Act - therefore, agricultural land is excluded from the purview of this
Act completely

Sec 2(47) - transfer defined - inclusive definition

Sec (47) "transfer", in relation to a capital asset, includes,—
(i) the sale, exchange or relinquishment of the asset ; or
(ii) the extinguishment of any rights therein ; or
(iii) the compulsory acquisition thereof under any law ; or
(iv) in a case where the asset is converted by the owner thereof into, or is treated by him as,
stock-in-trade of a business carried on by him, such conversion or treatment ; or
(iva) the maturity or redemption of a zero coupon bond; or
(v) any transaction involving the allowing of the possession of any immovable property to be
taken or retained in part performance of a contract of the nature referred to in section 53A
of the Transfer of Property Act, 1882 (4 of 1882) ; or
(vi) any transaction (whether by way of becoming a member of, or acquiring shares in, a co-
operative society, company or other association of persons or by way of any agreement or any
arrangement or in any other manner whatsoever) which has the effect of transferring, or
enabling the enjoyment of, any immovable property.
Explanation 1.—For the purposes of sub-clauses (v) and (vi), "immovable property" shall have the
same meaning as in clause (d) of section 269UA.

Explanation 2.—For the removal of doubts, it is hereby clarified that "transfer" includes and shall be
deemed to have always included disposing of or parting with an asset or any interest therein, or
creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or
conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or
outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as
being effected or dependent upon or flowing from the transfer of a share or shares of a company
registered or incorporated outside India;

Depending on the period of your holding —

Short term capital asset
Long term capital asset

Sec 2(42A) - provides for this bifurcation - short term capital asset is a capital asset which is held by the
assessee for not more than 36 months from the date of transfer
In certain assets - if you are holding it for 12 months or more - it becomes long term capital asset
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In certain assets - if you are holding it for 12 months or more - it becomes long term capital asset

Short term capital asset - short term capital gains

Long term capital asset - long term capital gains

Under Sec 10(38) - provides an exemption - long term capital gains of a particular kind - if you have paid
STT (Securities Transaction Tax) - then you will not pay any further income tax
If it is a share which you held only for 12 months - then the capital gains made on it - you would be liable
to pay tax on this short term capital gains

Calculation of income under capital gains - computation - Sec 48

• Short term capital gains

○ Full value of consideration
○ Less —
 Expenses incurred wholly & exclusively for such transfers
 Cost of Acquisition
 Cost of improvement
○ Exemption u/s 54
 Sec 54 - B D E EA EB F G H
• Long term capital gains
○ Full value of consideration
○ Less —
 Expenses incurred wholly & exclusively for such transfers
 Indexed cost of acquisition
 Indexed cost of improvement

What is indexation?
In long term capital assets - the cost of acquisition may be very less and when you are actually selling it off,
it might be that over the years, the cost of the property or land or capital has increased exponentially
The index allows to convert the actual acquisition of the property to a proportional current market
value
This index accounts for the inflationary pressures - otherwise the figures will be unrealistic

01-Mar-16

Sec 2(14) - gold monetization scheme of 2015 has been included by the Finance Bill of 2016

The purpose of these sections - tax the gains

Sec 48 - computation of capital gains

• Full value of consideration
• Less
○ Cost of acquisition
○ Cost of improvement
○ Expenses which are incurred wholly and exclusively w.r.t the transfer of this capital
• Surplus - range of exemptions provided under Sec 54, 54A, 54EE

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The capital asset is not being taxed - the gain on the capital asset is being taxed

If the computation fails (Sec 48) - the charging also fails (Sec 45) - if Sec 48 fails, then Sec 45 also fails

CIT v. BC Srinivasan Shetty AIR 1981 SC 972

The assessee concerned in this matter was a firm and it was engaged in the manufacture and sale of
agarbattis - the partnership was dissolved - there was also good will of the firm worth Rs. 1,50,000 - a
new partnership came into existence and it purchased all the assets of the older firm and started a new
business
The new firm took over all the assets along with the good will as well as all the liabilities of the
erstwhile firm
According to the IT department - since all the assets have been sold - you were paid for it - the capital
gains from goodwill is taxable
The erstwhile firm said that there is no cost of acquisition

The court said that a variety of elements goes into the making of good will and its composition varies
in different trades
It is affected by everything relating to the business, the personality, the reputation, the nature and
character of the business, its location, impact on contemporary market, introduction to old
customers, etc. - however, it is impossible to predicate the moment of its birth - goodwill tends to
show progressive increase - its value may fluctuate from one moment to another and therefore, there
is no cost of acquisition that can be inferred in the context of goodwill

Ratio - the court goes on to hold that each head of income has a charging provision which is
accompanied by a set of computing provisions - thus, the charging section and the computation
provisions constitute an integrated code - when there is a case to which the computation provisions
cannot apply at all - it is evident that such a case was not intended to fall within the charging section
This legislative pattern is discernable in the Act

Therefore, in this case the SC arrives at a conclusion that if you cannot compute the income - then
the charging section also fails

This proposition will apply to any income which is tried to be computed - if the computation fails,
the charging section also fails - then the legislature never intended such an income under the
particular head

Revenue receipts - presumed to be taxable unless specifically exempted

Capital receipts - presumed to be exempt unless specifically taxable

In the previous case - if the new firm sells the goodwill further - there is a cost of acquisition

The ratio of the case can be applied across all heads of income - because the proposition is that if the
computation provision fails, then the charging provision fails

CIT v. DP Sandu Bros., Chembur (P) Ltd. (2005) 193 STR SC 578
Tenancy rights - when you are in the possession of certain premises and you are paying an amount for
the premises, you have certain tenancy rights
When you surrender the tenancy rights - there might be a situation where the owner of the property
pays you certain amount - e.g. when there is a breach of contract
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 pays you certain amount - e.g. when there is a breach of contract
E.g. tenancy contract - duration mentioned - if the owner tries to terminate the contract earlier -
then there is a breach of contract - you can claim certain amounts
E.g. lease - prematurely cancelled - you can claim certain amounts

In such cases - is there any cost of acquisition for the surrender of tenancy rights
The amount that the erstwhile tenant receives is capital gain according to the department - you have
received the amount by surrendering your tenancy (capital asset)

The SC said that the cost of acquisition could not be ascertained - you do not acquire the tenancy
rights by paying some amount - the amount that you pay under the contract is the rent or the lease
amount which is consideration for occupying or possessing the premises - this amount can also not
be taken as income from other sources

After this case - there was an amendment - the department says that the cost of acquisition is NIL
Sri Krishna Dairy & Agriculture Farm V CIT, 1987
The owner of a dairy farm - he had cows and buffalos - gave birth to calves - the owner sold off these
calves before they attained 6 months of age - the dept. said that this is capital gain and therefore, there
should be taxable
The dept. said that this is short-term capital gains - because the owner had not crossed 12 months
Here - no cost of acquisition
CIT V Ramaswamy Mudaliar, 1992
An individual had purchased a horse (mare) - for horse-racing - the mare was never actually used for
racing - the owner sent the mare to the breeding farm - there were certain expenses incurred for its
maintenance and training and fodder - the mare gave birth to a filly - the filly also was trained and
maintained properly
The owner sold the mare and the filly - surplus generated - the dept. said pay tax on capital gains
The owner said that there is cost of acquisition for the mare but not for the filly
BUT there is a cost of acquisition of the filly - the cost paid to the breeding farm - therefore, this is taxable
as capital gains

02-Mar-16

Charging section - Sec 45

• Capital asset - Sec 2(14)
• Transferred - Sec 2(47)
• Surplus/gain - computed u/s 48
• Not exempt under Sec 54, 54A, 54AB

Sec 47 - those transactions which are not transfers

• Assets are distributed by the company to its shareholders at the time of liquidation - no capital gains
tax will be payable by the assessee
• Distribution of capital assets on total or partial partition of HUF
• Transfer of capital asset for scheme of amalgamation
• Transfer of capital asset to its 100% subsidiary

These kind of transactions are not considered to be transfers - because the economic ownership of that

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These kind of transactions are not considered to be transfers - because the economic ownership of that
asset continues to be the same even after the transaction
• In partition, you had an interest beforehand, it just gets identified after the partition
• Same goes in the case of amalgamation and subsidiary - because the asset still belongs to you

Subsequent to this, if you sell this asset then you will be liable to pay capital gains tax
Sec 55 - cost of acquisition of the previous owner (house property received from the HUF property) will
become the cost of acquisition for you
Transfer could be by way of gift, irrevocable trust - the cost of acquisition would be the cost of
acquisition of the previous owner
The period of holding of the previous of owner might be included in your period of holding as well -
depends on the statutory provision - depends on the kind of transaction

Vodafone case
The issue was when a non-resident company purchases the shares of another non-resident company
from another non-resident company - what status does the Indian Tax Dept. have to claim
jurisdiction over this transaction

Sec 5(2)(b)
For a non-resident —
When the income is received or deemed to be received in India
When the income is accruing or deemed to be accrued in India

Sec 9(1)(i) - income generated through or from

Business connection in India
Capital asset situated in India
Source in India

Hutchinson Telecom Information Ltd. - holding shares in HTI BV - holding shares in CGP Ltd. (in
Caymen Island) - holding shares in many intermediary Mauritian Companies - holding shares in
Hutch Essar Ltd. (which is a joint venture b/w Hutch and Essar Ltd.)

Hutch is a Hong Kong based company - has subsidiaries all over the world

Vodafone (Dutch Company) - entered into a contract with Hutch for control of CGP Ltd.
If Vodafone purchased CGP Ltd. - all the companies under the control of CGP Ltd. would now be
controlled by Vodafone
Instead of purchasing the shares of Hutch in HEL - Vodafone purchased CGP Ltd. - and therefore,
replaced Hutch in the Indian telecom market

Vodafone, CGP Ltd., HTIL are all non-resident companies

How is the IT Dept. claiming anything here?
Vodafone is indirectly entering the Indian telecom market - therefore, this transaction is taxable
in India

For capital gains - what you require is transfer of a capital asset situated in India
Here Vodafone is purchasing shares of CGP Ltd. - these shares are not situated in India

The Dept. said that it is the "controlling interest" in the shares of CGP Ltd. which were located in
India - this controlling interest was transferred - this controlling interest along with a whole bundle of
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 India - this controlling interest was transferred - this controlling interest along with a whole bundle of
rights that are associated with this controlling interest was transferred to Vodafone
Brand names prevailing in India
Other intangibles associated with the joint venture company

First round of Bombay HC - show cause notices - the court rules that the IT Dept. does have
jurisdiction
Second round of Bombay HC - the dept. did the assessment

The SC and the Bombay HC said that there might be extinguishment of rights of Hutch and
relinquishment of its interest in the Indian joint venture - but so far as the controlling interest is
concerned, it is NOT separate from the shareholding
The shareholding is a bundle of rights - if the shares are transferred - any rights and interests that
are transferred along with shares are incidental to the transfer of shares itself
Can the controlling interest be recognized as a separate asset other than your shareholding
itself - unlike 'good-will' which is an asset separate and independent of shares of the company

○ Tax planning - legitimate

○ Tax avoidance - depends on whether the agreement is agreeable or not - if agreeable, then it is
tax planning - if not agreeable, then tax evasion
○ Tax evasion - illegal

If there is nothing in the law which prevents Vodafone from purchasing CGP Ltd. - then the
transaction is legal and legitimate

There was an amendment in the statute - with retrospective effect - after the judgement by the court

03-Mar-16

Sec 2(14)
Explanation.—For the removal of doubts, it is hereby clarified that "property" includes and shall be
deemed to have always included any rights in or in relation to an Indian company, including rights of
management or control or any other rights whatsoever;

Very broadly categorized formulations which were inserted into the Act - separate recognition of the right
to management or control or any right whatsoever

Sec 2(47)
Explanation 2.—For the removal of doubts, it is hereby clarified that "transfer" includes and shall be
deemed to have always included disposing of or parting with an asset or any interest therein, or creating
any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally,
voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India)
or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or
dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated
outside India;

Retrospective effect of the explanation

Vodafone case - the holding was that 'controlling interest' is not a separate asset - there was no direct
transfer - at best it was an indirect transfer
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transfer - at best it was an indirect transfer

But after the amendment in Sec 2(14) and 2(47) - the Vodafone case comes into the ambit of the Indian
Income Tax Department
Separate identification of rights pertaining to 'controlling interest' as an asset + separate identification
of the method in which such transfer of controlling interest takes place (directly or indirectly,
absolutely or conditionally, etc.)

As such retrospective application of laws is usually not appreciated - in taxing statutes, there are many
explanations which are inserted by way of amendment - it is said that these amendments are not creating
any new liabilities which will have retrospective effect but these amendments are merely clarifying the
already existing liabilities
"for removal of any doubt…"

After the amendment - even if the judgement was in favour of Vodafone - Vodafone will still be liable to
pay the taxes
At the time of the transaction itself - there was this liability to pay taxes
After the amendment - there is a clarification which cements the fact that the liability existed at the
time of the transaction itself

The primary liability would be at the hands of Hutch (HTIL) - because they received the payment - the
argument of the Dept. was that Vodafone is an assessee in default - at the time of payment, they should
have deducted the tax

Joint Development Agreements (JDAs)

There may be a person who is a land owner - but does not have the requisite finances - the person may
approach some developer - they will enter into some agreement where the person will provide the land
and the developer will bring in the capital, the skill, etc. - for some consideration
The owner of the land may get profits out of the developed property
The owner of the land may get some portion of the built-up area of the property

Say I have land - I enter into a transaction with a developer - the developer will build apartments - as
consideration I will get one entire floor in the apartment
The developer and I will own the land jointly - anyone who buys the flats will also hold the land
jointly with us

If the purchaser of the flat does not own any share in the land itself - then at any time, the land-owner can
say that I will demolish the building, you take your flat and leave

To avoid paying tax on capital gains - the land-owner would not sell the land to the developer - the land-
owner would just sign a power-of-attorney in the name of the developer
This arrangement defers the payment of the tax on capital gains
The owner would have to pay the tax only when he officially sells the flats to the new purchaser or if
the land is developed as a mall, then the land-owner could defer the payment of tax for a very long
time

Sec 53A of TOPA - talks about part performance

In the Finance Act of 1988-89 — there was a change in the definition of transfer - Sec 2(47)(v) any
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In the Finance Act of 1988-89 — there was a change in the definition of transfer - Sec 2(47)(v) any
transaction involving the allowing of the possession of any immovable property to be taken or retained in
part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act,
1882 (4 of 1882)

The moment you put the developer in possession of the property - you became liable for payment of
capital gains tax

The question after this insertion was when the capital gains tax became payable - because the amount was
usually very heavy
Whether it is the date on which the developer is put into the possession of the land
OR is it is the date on which the consideration for putting the developer in such possession is paid by
the developer

'possession to develop' test

The problem here again is that the payment of this consideration could be very staggered - according to
the agreement entered into

Chaturbhuj Dwarkadas Kapadia v. CIT (2003) 260 ITR 491 Bombay

Kapadia had interest in some land - he entered into an agreement with Floreal Investment Ltd. - joint
development agreement
According to the clauses - at the first level a limited power of attorney was made in the favour of FIL
authorizing the company to deal in the property and seek permissions and clearances from various
authorities
Second level - after having sought the requisite permissions and clearances - there would be an
irrevocable license to enter the property - the company was then authorized to demolish the existing
building and start development of the land (if there are any tenants - their claims would have to be
settled, etc.)
Under the virtue of the agreement, the developer would start paying certain proportion of the overall
consideration as a rental amount to the owner of the land - only upon the last payment of the
installment of the rent, the sale deed would be executed

1996 - the company sought clearances

By the end of 1996 - almost the whole of the consideration amount (Rs. 1,86,00,000) was received
and only 10 lakhs remained to be paid
1999 - the payment of the last installment took place and only then the irrevocable license was given
and the sale deed was executed

The dispute here was not whether the property was transferred or not
The dispute was about what time the tax liability arises
The Dept. said that in 1996 - a major chunk of the payment was already made by the developer
company - therefore, the tax liability arises then
The owner said that only in 1999 - the irrevocable license was granted - unless he puts the
developer in possession of the land for the purpose of development - there is no real transfer -
therefore the liability should arise in 1999

Sec 53A
Part performance.—Where any person contracts to transfer for consideration any immoveable
property by writing signed by him or on his behalf from which the terms necessary to constitute the
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 property by writing signed by him or on his behalf from which the terms necessary to constitute the
transfer can be ascertained with reasonable certainty, and the transferee has, in part performance of
the contract, taken possession of the property or any part thereof, or the transferee, being already in
possession, continues in possession in part performance of the contract and has done some act in
furtherance of the contract, and the transferee has performed or is willing to perform his part of the
contract, then, notwithstanding that where there is an instrument of transfer, that the transfer has not
been completed in the manner prescribed therefor by the law for the time being in force, the
transferor or any person claiming under him shall be debarred from enforcing against the transferee
and persons claiming under him any right in respect of the property of which the transferee has taken
or continued in possession, other than a right expressly provided by the terms of the contract:
Provided that nothing in this section shall affect the rights of a transferee for consideration who has
no notice of the contract or of the part performance thereof.

[In order to attract Section 53A, the following conditions need to be fulfilled —
There should be a contract for consideration
It should be in writing
It should be signed by the transferor
It should pertain to transfer of immovable property
The transferee should have taken possession of the property
Lastly, the transferee should be ready and willing to perform his part of the contract]

Part performance - 'readiness and willingness to perform'

The dept. says that the moment a substantive portion of the consideration has been paid - the capital
gains tax becomes payable then
The owner says that before irrevocable license is granted - there is no transfer

The owner argued that the date on which possession is parted with by the transferor is the date which
should be taken into account for determining the relevant accounting year in which the liability
accrues
The Dept. argued that one has to go by the date on which the developer substantially performed the
contract - since substantial payments were made during the financial year ending March 31, 1996, and
since majority of permissions were obtained during that year, the liability to pay capital gains tax
accrued during that assessment year

The Bombay HC says - if the contract, read as a whole, indicates passing of or transferring of
complete control over the property in favour of the developer, then the date of the contract would be
relevant to decide the year of chargeability

In this matter - the court reads the contract - the court decided in favour of the assessee and against
the department
It is the year in which the irrevocable license was granted - that the capital gains tax became payable

If the test was 'substantive performance' - as argued by the department - then it would be a lot of
subjectivity as to what is substantive performance - there would be subjectivity in how the income tax
officers would determine the intention of the developer to perform the contract

There are cases in which after parting with the possession of the land - the developer does not do
anything - will you still make the capital gains tax payable at the hands of the assessee
Say the owner gets 50% of the consideration (and will get 50% later after the project is completed) -
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 Say the owner gets 50% of the consideration (and will get 50% later after the project is completed) -
the owner parts with the possession - the developer does not do anything at all

The court is certain other cases has drawn a line of distinction

Every time, the possession to develop test will NOT work - there are cases in which you will have to
show actual development
This is because the definition of transfer is linked to Sec 53A of TOPA - which is part performance -
which is dependent on 'readiness and willingness to perform' - therefore, you will have to show the
readiness and willingness in order to establish part performance and therefore establish transfer upon
which capital gains tax will become payable

04-Mar-16

Binjusaria Properties Pvt. Ltd. v. ACIT

The assessee concerned (pvt. company) had given its land for development purposes to a particular
developer - the agreement was formulated
The pvt. company would give the land to the developer - in giving the land for development
purposes - the developer would provide 2 different cheques worth Rs. 2 crores - after the
development, 38% of the developed portion (built-up area) would be transferred to the company
as an owner (main consideration) - the 2 cheques were refundable on transfer of this 38% of
built-up area
The 2 cheques were basically a form of security with the owner of the land (here the company)
If the company does not want to refund the amount - the amount could be adjusted against the
ultimate consideration i.e. the 38% of the built-up area

The company put the developer into the possession of the land - even after 45 months, there was no
actual development on the land - no actual activity despite a lapse of almost 45 months
The Dept. however said that the cheques received by the company is a consideration for parting with
the possession of the land - further the developer has constructed a compound wall and some activity
is going on

Under Sec 2(47)(v) says that parting with possession would amount to transfer if there is part
performance as under Sec 53A of TOPA
Under Sec 53A TOPA - there has to be willingness and the readiness to perform the contract - if that
is absent - then the receipt of the amount cannot be charged under capital gains tax

The argument of the assessee is that there is no willingness or readiness to perform the contract - the
developer is not going ahead with any plan of development - therefore, it is not a transfer merely
because the possession has been given to the developer - hence, the receipt of the amount (cheques)
cannot be taxed as capital gains

The simplistic understanding of 'possession to develop' is being challenged - the assessee has done his
part of the performance but there is no perception of performance on part of the developer
The tribunal here is applying the test of 'actual development' - there is no willingness on part of the
developer to perform his part of the contract - therefore, Sec 53A TOPA fails - hence, no transfer

If there is no willingness that can be inferred from the facts of the situation - it does not fall under the
definition of transfer and therefore it cannot be charged as capital gains
Further, the tribunal observes that the cheques (2 crores each) is not receipt of any consideration - it
Taxation Page 81
 Further, the tribunal observes that the cheques (2 crores each) is not receipt of any consideration - it
is receipt of refundable amount

CIT v. Sadiq Shaikh

The concerned individual had put the developer in possession of the land which he owned - the
development was carried out completely on behalf of the individual
The court held that there is no transfer at all - even if the possession has been given to the
developer - the larger control has been retained by the individual himself

1. Where possession is handed over to the developer under the Development Agreement along with
General Power of Attorney (GPA) - capital gains tax is chargeable in the year in which such transfer
takes place and the possession is so handed over to the developer
The fact that payment of consideration is deferred to a future date is irrelevant
E.g. Chaturbhuj Dwarkadas case
2. Where the possession is handed over to the developer under the Development Agreement and from
the facts, it can be inferred that the developer has not performed his part of the contract - it does not
satisfy Sec 53A of TOPA - and consequently does not amount to transfer
3. Where the agreement only permits the development to be carried out by the developers while the
entire control over the property is retained by the owner such as license to construct, occupancy
certificate, are given in the name of the owner - mere execution of the agreement would not amount
to transfer under Sec 2(47)(v)

Sale of Shares

When you have shares under consideration

Can shares be capital assets?
When you invest in shares and are receiving dividend on them - when you sell them - capital
gains
Can shares be stock in trade?
When you are a broker, habitually trading in shares - then they are stock in trade

Can there be a situation where the shares are investment and stock in trade?
There can be a situation where the assessee claims that these shares are capital investments - whereas
the dept. claims that these shares are stock in trade i.e. it is your business to trade in these shares and
therefore the profits obtained is business income

ACIT v. Nagindas P Sheth

The assessee was an HUF - declared income worth 45 lakhs - some capital gains, business income,
income from other sources
The assessing officer noticed that the portion shown as (short term) capital gains - the assessee HUF
had been purchasing and selling shares frequently
The dept. issued a show cause notice asking why this portion not be considered as business income?

The assessee had made 158 share transactions - the dept. said that depending on the regularity and the
frequency of the transaction - they drew the inference that this income is not income generated from
capital gains - but this income is generated from the trade of shares i.e. business income

The matter went to the Commissioner

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 The matter went to the Commissioner
It was conceded that an assessee can have both trading portfolio and investor portfolio
 The investment was made in unlisted shares
 The assessee HUF had shown these shares as investment and had taken it at a cost
 The assessee HUF did not have any administrative setup or dedicated office from which it
could be presumed that they were trading in these shares
 The source of acquisition of shares was out of the own funds of the assessee and the family
funds
 There was no instance where the assessee had squared off the transaction on the same day
w/o taking delivery of the shares

A trader (as opposed to an investor) will usually not wait for dividend
 An investor will usually factor in dividend income
 The assessee had transacted in the shares within 30 days

The Commissioner said that whatever is short-term assets - it should be taxed as business income -
and whatever is long-term assets - it should be taxed as capital gains

The Bombay HC observed that merely because there is short-term transaction - frequency of
transaction is not the ultimate determinant of the fact that you are trading in shares
The HUF is treating the shares as capital asset and not as stock in trade (in his own books of
account) - the assessee has not squared off any transaction without taking actual delivery of
shares (an investor insists on having the shares on hand - a trader might not insist on getting
delivery of shares on the same date) - the amount invested was coming from the family funds
The Bombay HC found in favour of the assessee

CIT v. Gopal Purohit

Management Structure & System Pvt. Ltd.

08-Mar-16

Management Structure and Systems Ltd. v. ITO

The assessee company X is incorporated to engage in a range of activities like management
consultancy, investment, equity research, etc. - they had invested in certain shares and securities - the
way in which their business was carried out, instead of engaging in the listed activities, the company
gained profits from selling and trading of shares - of its total income, it was found that the larger
portion of its income was coming through capital gains short term and long term - this income was
higher in proportion when compared to the management consultancy fees that they got

The assessee company classified this as capital gains - the authority said this is business income
because look at the activities that you are performing - trading in shares has become your business

The assessee claims defenses on its part

1) For every transaction we have never rounded off our transactions without taking delivery of
the shares
2) The quantum of long term capital gains is coming from one particular investment and this
was in Infosys - they were long term shareholders there which they sold off as a chunk - our
short term capital gains is nearly 19 lakhs and long term was 99 lakhs - the shares that we sold
was being held as capital asset and not stock in trade
Taxation Page 83
 was being held as capital asset and not stock in trade
3) In their accounts, they have shown these shares as investments or capital assets rather than
stock in trade

The assessing officer said that although in the initial days of business your main objective was
management consultancy, your business has undergone a change and these have become incidental to
your main activity of trading in shares - it doesn’t matter how the assessee shows it in their own
accounts but the authority will make the assessment based on the nature of the transaction

The matter reached the Mumbai tribunal - there is no fixed formula to determine whether the activity
of the assessee who is purchasing and selling shares can be treated as trading activity or investment
activity - the tribunal places relevance on a CBDT circular (CBDT Circular 4/2007)

First, whether a particular holding of shares is by way of investment or stock in trade is a matter within
the knowledge of the assessee
For companies, when it purchases and sells shares, it must be shown that it is a stock in trade
Existence of the power to purchase and sell the shares in its MoA is not decisive of the nature of the
transaction

The Circular, which is in turn referring to some other SC decisions, is conceding that whether it is stock in
trade or capital asset lies within the knowledge of a particular assessee - that being the case, you cannot
nullify the intention of the assessee or the treatment which the assessee gives in his own books of accounts

When it is a company and it is claimed that the shares are stock in trade - it must be demonstrated from
the way that the company maintains its books of accounts - and whether this power exists to purchase and
sell the shares in the MoA is not decisive of this kind of transaction
This means that you cannot place reliance only on the power to invest in shares or the limitation on
purchase and sale of shares which is prescribed in the MoA to determine the nature of the transaction
It has to be demonstrated by other parameters

Otherwise, the court says that if the assessee is within the knowledge of how he is treating these shares -
whether as stock in trade or as capital asset - you must accept what the assessee chooses to do

For a company - the MoA may provide the power to invest in shares either as investment or as stock in
trade - but the nature of the transaction is to be determined by the treatment in the books of accounts
(which is a more specific and relevant document) rather than the MoA (which is a more generic document
delineating the powers of the directors, the extent of those powers and how they are to be exercised, etc.)
Therefore, the specific documents should be preferred over the generic documents
You may refer to the MoA to determine what kind of powers are given to the directors - the MoA
might give you the nature of the holding also - by reading the MoA closely you may get an indication
as to the nature of the holding within the powers of the directors - but this document will not be
conclusive in nature - it will not be indicative of the nature of transaction

Second, the substantial nature of transaction, the magnitude of purchase and sale of shares, the period of
holding would furnish a good guide to determine the nature of transaction

Third, ordinarily purchase and sale of shares with motive of earning profit would result in the transaction
being a trade but where the object of investment in shares is to derive dividend income, the transaction
will yield capital gains

Taxation Page 84
The CBDT also concedes to the fact that the assessee may have 2 different portfolios, one investment
portfolio and one trading portfolio - in that case the assessee would be liable to tax under 2 diff. heads
(capital gains and business profits)

The AO under this Circular have also been advised that no single principle would be decisive and the total
effect of all the principles should be considered to determine the nature of transaction

Frequently Asked Questions (in the Circular)

1. What is the intention of the assessee at the time of purchase or sale of the shares?
2. Whether the assessee has borrowed money to purchase and pay any interest thereon?
3. What is the frequency of these purchases and disposal in that particular item?
4. Whether purchase and sale is for realizing profits or purchases are made for retention and
appreciation in its value?
5. How the value of the items have been taken in the balance sheet?
6. How the company (the assessee) is authorized in the MoA and the AoA?

What is the intention of the assessee at the time of purchase or sale of the shares?
We can decipher this intention from the record which the assessee furnishes - depending on the
treatment in their books of accounts
You have to draw your understanding from the MoA and the AoA as well - it will be relevant but it
will not be the ultimate source of determination

You have to rely on all these questions - depending on how long the company is holding on to these
shares, whether it is borrowing money for investment, whether it is allowing appreciation to take place - all
these will give an indication as to how the company is treating these shares i.e. the nature of the
transaction
Obviously it makes more sense to have these shares as long term capital gains as they will be exempt from
tax (u/s 10) - if you keep selling and purchasing these shares and you show it as business profits, then it
will be taxed at around 30%

Whether the assessee has borrowed money to purchase and pay any interest thereon?
Usually if you are an investor - then you will utilize your own money - more likely this is capital gain
If you are a trader - then you will be more open to borrowing money and paying interest thereon -
more likely this is stock in trade

What is the frequency of these purchases and disposal in that particular item?
How quickly you are turning out and turning in your sale and purchase of shares

Whether purchase and sale is for realizing profits or purchases are made for retention and
appreciation in its value?
If you wait for dividend to accumulate, the value to appreciate in time, etc. - then it indicates that you
are treating these shares as an investment and not as a stock in trade

It may be the case that the share value jumps up to a high value a short time after sale and even as an
investor, you might prefer to sell off the shares soon rather than retain them - because you realize that you
might not get these prices 6 months down the line
Again, the Circular says that you will not rely on any one single principle - all the principles combined will
give a proper indication as to the nature of the transaction

Taxation Page 85
How the value of the items have been taken in the balance sheet?
If the item under question, if they are valued at cost - then it is an indication that it is an investment -
because capital assets are taken at cost of acquisition
If the item under question, if they are valued at market value - then it is an indication that it is a stock
in trade - because the stock in trade undergo several changes in the books of account depending on
the market value

How the company (the assessee) is authorized in the MoA and the AoA?

Management Consultancy
The tribunal held that the company was holding the shares as its asset as an investment - therefore,
the entire amount in the books of accounts has to be taken in the form of capital gains and not as
business profits as was being claimed by the Dept.

Despite this Circular there have been many cases regarding the treatment of shares - therefore, the Dept.
has come out with another Circular recently

Circular No. 6 of 2016

By virtue of this circular, it has been given as an advice to the AO that when you are dealing with these
shares —
1. Where the assessee itself, irrespective of the period of holding, opts to treat them as stock in trade,
the income arising from the transfer of these shares will be treated as business income
2. In respect of listed shares and securities, which are held for long term, if the assessee desires to treat
the income arising from the transfer as capital gains, the same shall not be put into dispute by the AO
However, this stand once taken by the assessee in a particular assessment year shall remain applicable
in subsequent assessment years also and taxpayers will not be allowed to adopt different or contrary
stands in this regard in subsequent years
[There has to some consistency in the position adopted by the assessee - say if you have a common
pool of shares, then you cannot say that it is capital gains in one year and business profits in the next
year - this kind of contrary positions cannot be adopted]
3. In other cases, the nature of transaction shall continue to be decided in accordance with the circular

Long term capital gains from transfer of shares is totally exempt - but short term capital gains are taxable
Say you sold off some shares - you might want to claim that they are stock in trade and not investment -
because, although business profits are taxed at around 30%, you can claim a range of expenditures which is
not available under short term capital gains
If you have different business - then you can set off business profits against business losses
Therefore, you as an assessee might want to change your position with regard to the nature of the
transaction

The MoA and AoA of any company provides for various authorizations - if the MoA and AoA provides
authorization only for purchase of shares for investment purposes or only as stock in trade - further, if in
the Board meetings, the resolution provides authorization for purchase for investment or for stock in
trade - and the books of account shows records which differ from the authorization - there is a mismatch -
the assessee can then be taken to the tribunal
The MoA and the AoA as well as the Board resolutions (which approved the purchase of shares) provide
an indication as to the nature of transaction - but they are not conclusive in nature
These are the checks and balances within the system

Taxation Page 86
Non-compete fees

Fees paid to a member of the organization to prevent them from setting up competing business

Agreements in restraint of trade, non-compete agreements

These can be signed individually as a contract or it can be part of your employment contract itself - certain
consideration is paid for this agreement

These payments were considered as capital gains non-chargeable to tax - because there is no cost of
acquisition

In 2002, there was an amendment vide the Finance Act, 2002

Sec 28 talks about business income
Sec 28 (va) any sum, whether received or receivable, in cash or kind, under an agreement
for—
(a) not carrying out any activity in relation to any business; or
(b) not sharing any know-how, patent, copyright, trade-mark, license, franchise or any other
business or commercial right of similar nature or information or technique likely to assist in the
manufacture or processing of goods or provision for services:
Provided that sub-clause (a) shall not apply to—
(i) any sum, whether received or receivable, in cash or kind, on account of transfer of the right
to manufacture, produce or process any article or thing or right to carry on any business,
which is chargeable under the head “Capital gains” ;
(ii) any sum received as compensation, from the multilateral fund of the Montreal Protocol on
Substances that Deplete the Ozone layer under the United Nations Environment Programme, in
accordance with the terms of agreement entered into with the Government of India.

This provision causes a lot of controversy in the treatment of non-compete fees

08-Mar-16

Sec 55(2) For the purposes of sections 48 and 49, “cost of acquisition”,—
(a) in relation to a capital asset, being goodwill of a business or a trade mark or brand name associated
with a business or a right to manufacture, produce or process any article or thing or right to carry on
any business, tenancy rights, stage carriage permits or loom hours,—
(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner,
means the amount of the purchase price ; and
(ii) in any other case not being a case falling under sub-clauses (i) to (iv) of sub-section (1) of
section 49, shall be taken to be nil ;

The statute gives 2 diff. options to charge that particular income under diff. heads without actually telling
you what is it that makes it a capital gain and what is it that makes it a business profit

Non-compete fees
A simplistic understanding would be —
Sec 28(va) addresses this issue in a negative tone - it is a self-restraint imposed on yourself - this
would fall under business profits
The proviso makes a positive kind of assertion - positive transfer of the right to carry on business -
this would fall under capital gains
Taxation Page 87
 this would fall under capital gains

Theoretically it would mean that when you impose a restraint on yourself, it would go u/s 28 whereas
when there is a positive transfer of the right to carry on business, it would go u/s 55 i.e. capital gains

But the way in which the interpretation has culminated has led to a lot of confusion

DCIT v. Mediworld Publications Pvt. Ltd. [Delhi HC]

MPPL was a publication house catering to medical professionals - journals, magazines, other
publications and materials
There was a specific asset transfer agreement under which MPPL received certain consideration
towards the sale of specified assets
Under this agreement, the right to carry on health care journals and communications business for a
specified time period was vested in the purchaser

No particular amount was assigned to this kind of right

But under the whole agreement, intangible assets and specified assets were transferred (not the whole
business) - under the agreement, this right to carry on this specific journal was given away to the
purchaser for a specified time period

The Delhi HC held that this kind of transaction and the consideration received grossly falls under the
proviso (1) and therefore, this will not be business income - this will be capital gains - the cost of
acquisition would be nil and the capital gains would be calculated accordingly

Ramesh Tainwala v. CIT [Mumbai Tribunal]

There were certain industries, Tainwala Polycontainers Ltd. - they are plastic manufacturers - they
were engaged in plastic manufacturing and marketing activities
This company was purchased by another company Time Packaging Ltd.
The assessee and his brother were the promoter of the company and the shareholder of the
company - this was a closely held family run business entity
Under the purchase agreement, there was a clause which comprised of the non-compete clause
According to this clause, the sellers(Tainwala) irrevocably undertake and covenant that during the
commencement of the contract (relevant period was identified) directly or indirectly carry on or
engage or concern or interest in any business which is similar to or competes, either directly or
indirectly, for the manufacturing of all the prescribed items, the processes, etc. specified in the clause
This is a non-compete agreement

As desired by the sellers, there was a non-compete consideration of Rs. 4 crores which was to be paid
by the acquirer to Mr. Ramesh Tainwala and Mr. Rakesh Tainwala

When the amount was given to Mr. Ramesh - he did not offer this Rs. 2 crore for tax - later, he said
that this is not business profit, this is a capital asset and therefore, no tax was liable under the head of
business income
The AO said that this was business income and that it should be brought to tax - the AO said that
this Rs. 2 crore was received for not carrying out any activity in relation to any business and therefore
it is chargeable to tax under Sec 28(va)
The assessee said that first, this amount is not taxable - even if it is taxable, it is not a business profit,
it is a capital gain and the proviso should apply to him

The tribunal said that the claim made by the assessee cannot be accepted
Taxation Page 88
 The tribunal said that the claim made by the assessee cannot be accepted
The tribunal said that for the proviso to be applicable, there must be a transfer of a right to carry on
any business - the assessee in this case, is not carrying on any business of his own but he was a
promoter and director of the company whose shares were purchased by the acquirer
The non-compete clause under the share purchase agreement does not carry any transfer of any right
to carry on any business but merely provides that the assessee shall not carry on any activity in
relation to the business of the acquirer

The tribunal further said that Sec 45 is attracted when there is a transfer of capital asset - in the
present case, the agreement by which the assessee agrees to refrain from indulging in a business
competing with another is independent by itself - an agreement to refrain from carrying on competing
business does not fall within transfer under Sec 2(47)
The tribunal also observed that if the agreement to refrain from indulging in competition is part and
parcel of the agreement for transfer of a business and the transferor agrees not to indulge in
competition, then in that case, it can be said that the right to carry on similar business was transferred
along with the business

The tribunal says that we cannot accept the position of the assessee that this is a capital asset -
because you have entered into a negative restraint to not carry on any business - for the proviso to
apply, what you need is a transfer of a right to carry on any business - here, what has been transferred
to the acquirer under the share purchase agreement is the shares of the company - the assessee is the
promoter, and is not carrying on any business of his own (i.e. the assessee was only carrying on the
business of the company)
In this case, there is an agreement to refrain from trade which is independent from the overall
agreement - further, if the agreement to refrain from indulging in competition is part and parcel of
the agreement for the transfer of business and the transferor agrees not to indulge in the business,
then it can be said that the right to carry on business has been transferred along with the business

Here what was transferred was the shareholding of the company by the promoters and therefore,
there is no question of a transfer of a right to carry on business arises

Based on this, the Mumbai Tribunal says that the proviso does not apply - Sec 28(va) would apply to
this transaction

Hami Aspi Balsara v. ACIT

The company was a manufacturing company (cosmetics and hygiene products) - there were some
intangible assets involved (IP rights etc.) - there was certain acquirer for the sale and purchase of
shares
The shares of the promoters and other shareholders was to be sold - share purchase agreement was
entered into - they received some amount of consideration (which was the full consideration under
the agreement)
The agreement included a non-compete clause —
In consideration of purchase price received by the sellers under this agreement, the sellers agree
that for a period of 5 years from completion, the sellers shall not be engaged in any of the
restricted businesses in India
There was no separate amount assigned for the non-compete clause

The AO found that there was a restraint clause embedded in the overall agreement - but there is no
separate consideration earmarked for it - he artificially split up the consideration - 80% was assigned
towards non-compete fees
Taxation Page 89
 towards non-compete fees
The question again was whether this amount of non-compete fees should be considered as business
income or capital gains

The tribunal rejected the artificial bifurcation created by the AO - if nothing has been earmarked in
the agreement itself, the AO cannot be allowed to split up the amount
The tribunal says that Sec 28(va) would be attracted where the assessee was carrying on the business
and not where the assessee only had a right to carry on the business in the form of capital asset
Based on this, since the assessee on her own was not carrying on the business, but the company in
which she was the shareholder was carrying on the business, Sec 28(va) would not be applicable

The assessee is not carrying on the business - the company in which she is a shareholder is carrying
on the business - the assessee is carrying on the business only by virtue of the capital asset that she
holds in the form of shares of the company - since she is not carrying on any business and Sec 28(va)
is applicable only when the assessee was carrying on some business (which is now restrained),
therefore Sec 28(va) is not applicable in this case
The assessee, on her own was not carrying on business, but the company in which she was a
shareholder, was carrying on the business - on a reading of Sec 55(2)(a), it becomes evident that
where the capital asset is in the nature of the right to carry on business, then the same will come
within the ambit of capital gain tax - Sec 28(va) would be attracted where the assessee was carrying on
business, and not where the assessee only had the right to carry on business in the form of capital
asset

The above 2 judgements are reaching contradictory conclusions

In both cases, the tribunal is saying that the one who is in the receipt of the amount should actually be
vested with the right to carry out the business

In the Ramesh Tainwala case - the tribunal is saying that the assessee is not carrying on the business and
therefore, cannot transfer any right to carry on the business - therefore, the proviso cannot apply - Sec
28(va) will apply
In the Hami Aspi Balsara case - the tribunal is saying that the assessee is not carrying on the business and
therefore, cannot really have any sort of negative restraint on carrying on the business - therefore, Sec
28(va) cannot apply - the proviso will apply

Is Sec 28(va) supposed to cover all those members of the company who may have access to confidential
information relating to the company like the employees, the promoters, the founding members, etc. - who
may not have the right to carry on business of their own - but can still impose a restraint on carrying on
any competing business - because there is no transfer of right to carry on business that is being done here
Sec 28(va) does not talk about any right to carry on business being vested in the assessee under
consideration - only the proviso talks about the transfer of such a right

Savita Mandhana
Share purchase agreement - the Co. is a family run company - certain shareholders within the family
hold the controlling interest - the shares are being sold to the purchaser company and Rs. 570 per
share was received
The Dept. tried to spilt up the amount to amount going towards the share purchase and the amount
going towards the non-compete fee
The tribunal rejected this split - the exercise of the bifurcation of the amount is not allowed
The tribunal also held that the assessee is not actively engaged in business and the stand of the
assessee in treating the amount for sale of shares as capital gains is therefore upheld
Taxation Page 90
 assessee in treating the amount for sale of shares as capital gains is therefore upheld

The tribunal placed relevance on the Hami Aspi case

So far as the assessee is actively engaged in the business, it has been stated that income attributable to
non-compete fees is liable to tax as business income
Here, it is not in dispute that the assessee is not actively engaged in the business
The stand of the assessee that the entire consideration is taxable only as capital gains should be
upheld - i.e. Sec 28(va) does not apply - the proviso applies

09-Mar-16

In Ramesh Tainwala there was an earmarked amount and when the assessee tried to bring it under the
head of capital gain, the tribunal held that there has to be a transfer of the right to carry on a business.
Since you didn’t have any right, you couldn’t have transferred the right, hence the proviso wouldn’t apply
to you. In Hami Aspi, the assets were transferred to the acquirer, there was nothing earmarked towards
the non-compete fees. The tribunal says that the artificial bifurcation is not allowed. The tribunal said that
for 28(va) to apply the individual must be carrying on some business and not only where the assessee only
had the right to carry on a business. Since she wasn’t carrying on any business, it wouldn’t fall under the
section. You are using similar reasoning to arrive at different conclusions. In the Savita Mandhana case,
Hami Aspi was relied upon. An overall amount was received, the department tried to split it up. The
tribunal held that the split up is not permissible. Even as a shareholder, she was not actively involved in
the business, hence the entire consideration would be capital gain.

In Hami Aspi it seems like Section 28(va) is regarding carrying on the business and not merely when he
merely has the right to carry on the business. Effectively, this implies, that Section 28(va) would apply
when you are carrying on the business. In Savita Mandhana the court said that she merely had the right
to carry on the business but didn’t actually carry on the business. Hence Section 28(va) would not apply.
The court did not go into the proviso.

Sumeet Taneja v. ACIT

Taneja and Khurana were promoters and directors in a company. They agreed to sell their 45% shares
to another company. The shares of Rs. 10 purchased by the promoters were sold at the amount to Rs.
94. The agreement also had a non-compete clause. The agreement is not only for the shares but also
for the transfer of management control. The sellers were supposed to resign as directors. The sellers
had agreed not to engage in any competing call centre, BPO in North India. The sellers were also not
to take advantage of the trademarks or induce the employees of the company.
The assessee contended that this is a capital gain. They said that they were not carrying on the
business but the company was. They had invested in the company to earn dividend and not to trade
in them.
The tribunal said that the transaction was not mere transfer of capital asset but was the transfer of a
business. It is the assessee who was prevented from doing business. Further, it was the assessee who
had given up his right to carry on the business and profits arising from the said transaction which is
assessable under Sec 28(va). Shares were held by the assessee because of his association with the seller
company and were the mode of holding in the said company. The assessee was the managing director
and was engaged in carrying on the business on day to day basis. It is not a simple transfer of shares
but a transfer of business.

If you merely have the right to carry on the business, then it becomes capital income, but if you
actually carry on the business, then it becomes business income. The tribunal held that this is the
Taxation Page 91
 actually carry on the business, then it becomes business income. The tribunal held that this is the
transfer of the business.

In the meantime between this case going to the tribunal and the HC, amendments were made
following the Vodafone case. Explanation was added to Sec 2(14). The assessee before the HC
brings in this definition. It upheld the judgment of the tribunal. Court said that it is not innocent
transfer of shareholding under Sec 2(14) read with explanation but a transfer of business with an all
pervasive control being entrusted to the purchaser.

10-Mar-16

Exemptions Under Capital Gains

Sec 54
When capital gains arise from transfer of residential property
Must be individual or HUF
Should be residential house property
Should have been a long term capital asset
If surplus generated, can claim exemption, as long as the same is used to purchase new residential
property or construct another.
If purchase – purchase one year before or two years after the date of transfer.
If construction – within three years from date of transfer.

Exemption is:
Amount of capital gain generated in transfer or
Amount invested in constructing or purchasing property, whichever is less.

E.g. surplus generated from sale – 15 lakhs. Cost of construction – 20 lakh. Thus, the 15 lakh is
exempt. Or if cost of construction is 10 lakh, then exemption is 10 lakh and balance five lakh is liable
to capital tax.
If the new residential property is transferred within a period of three years from the date of
acquisition, or date of completion, as the case may be, the amount provided as exemption, will be
taxed. (This is in line with it being a long term capital thing so as to avoid tax evasion by people)

The statute allows for the amount to be used up to 2/3 years as the case may be. But the surplus will be
taxable in that assessment year. So the assesse deposits the money in a dedicated deposit scheme (generally
in PSBs), and when you use the money, you may from this account. And when the return is filed, proof
has to be filed that the property was sold, surplus was generated and the same was put into the deposit
scheme. If there is money left over, then the same is taxable (in tune with the lower amount being
exempted).

Sec 54B
Assessee is an individual and the capital gains arise from land that is used for agricultural purposes.
Conditions: (1) the person has to be an individual; (2) the assessee transfers agricultural land (could be
short term or long term); (3) the land was used by the assessee or his parents or the HUF for a period of 2
years immediately preceding the transfer. The exemption will be available if the assessee purchases another
land for agricultural purposes within a period of two years from the date of such transfer. The location of
the land is not relevant (could be rural or urban). The exemption would depend upon the surplus and the
amount spent on purchase - whichever is less would be exempt. The deposit scheme is available here also.
The restriction on transfer also applies; you can’t transfer the land within 3 years.
Taxation Page 92
The restriction on transfer also applies; you can’t transfer the land within 3 years.

Sec 54F
Exemption on capital gain on the transfer of long term capital asset other than house property and the
surplus is used to buy house property.
This exemption is available only if on the date of transfer of original asset, the assesse does not hold more
than one residential house property other than the new house.
Sec 54 had a specific exemption for the transfer of house property for the purchase of another house
property. The surplus must be used for the purchase of the new house or construction.

Sec 54EE
New Section inserted by this year’s budget. Exemption for proceeds from the transfer of a long term
capital asset when they are invested by the assessee in such specified funds as may be notified by the govt.
These would be start-up ventures, although notifications have not come yet. The exemption would be up
to 50 lakhs.

Sec 54 GB
If you invest in micro, small and medium enterprises you can claim exemption.

Taxation Page 93
Budget | Finance Bill 2016

01-Mar-16

Just some relevant take away from the Union Budget -

POEM proposed to be deferred by 1 year

Krishi Kalyan Cess 0.5%to be levied on all taxable services

Deduction under Section 80GG for individuals paying rent but not receiving HRA proposed to be
increased from Rs. 24,000 to Rs. 60,000.

Additional exemption of Rs. 50,000 for housing loans up to Rs. 35 lakh, provided cost of house is not
above Rs. 50 lakh

One time dispute resolution Scheme for cases already pending due to retro-amendment
—————————————————————————————————————————

PoEM - deferred by a year - will come into effect from 2017

Deduction under Sec 24 - interest on borrowed capital - construction was required to be completed within 3
years - now it has been extended to 5 years

Sec 25A, 25AA, 25B - realization of arrears of rent + realization of unrealized rent which is realized
subsequently - all these sections have been compiled into a consolidated Sec 25A

Sec 80EE - has been a change therein - for the first time buyers - you can get deduction of up to 50%
beginning on 1st April 2017 - loan sanctioned can be 35 lakhs and the value of the house property should
not be more than 50 lakhs

Sec 80EE - sub-section (4) - this conflict b/w Sec 80EE and Sec 24 has NOT been resolved

Sec 80GG - there is an enhancement in this limit - now it is Rs. 60,000 per annum - people staying in rental
premises, not owning any house property and not receiving any HRA from employer

Earlier - when there is an EPF - the entire amount received was tax free - but now 60% of that amount is
taxable and 40% of that amount is exempt

Dividend was exempt in the hands of the shareholders (company would deduct DDT) - NOW, company
will still deduct DDT + shareholders who receive dividend of more than 10 lakh rupees, the shareholder
will have to pay 10% tax

Kisaan Kalyan Cess - 0.5%

What happened to Schedule VII - agriculture has been taken away from the central list - but still this
kisaan kalyan cess has been levied

Taxation Page 94
Clubbing of Income

10-Mar-16

Sec 60 to 64

Sec 64 - where an individual is assessable with respect to the remuneration of the spouse.
Conditions: (1) the assessee is an individual, (2) has substantial interest in a concern, (3) spouse of the assessee
is employed in the abovementioned concern, (4) spouse is employed in the concern without any technological
or professional knowledge.

“Concern” includes business, professional, proprietary concern

Whatever is the remuneration in the hands of the spouse will then be included in the hands of the assessee.
Substantial interest is 20% or more equity interest in the concern (either individually or with relatives –
husband wife, brother sister or lineal ascendant descendants).

Why is this being done? To make sure there is no tax avoidance. The salary is presumably shared between the
spouses. Hence, even if the spouse’s income is below the taxable slab, the same is still included to be taxed.

What of a situation when both husband and wife have substantial interest in the company? The one whose
remuneration is higher, that is the person in whose hands the income of the other spouse will go for taxation.

Under Sec 64
Income from assets transferred to son’s wife.
Assessee to be individual
Has transferred an asset after 1973
Asset transferred to son’s wife
Transfer may be direct or indirect
Transferred otherwise than for adequate consideration
Asset maybe held by the transferee in the same form or different form
The relationship daughter in law and father in law of should subsist both during the transfer of asset and
accrual of income.

Herein, the income is taxable in the hands of the transferor.

If transferred for the benefit (direct or indirect, as in the case of a trust) of the spouse, not directly to spouse,
this also attracts clubbing provisions.

The main idea is that the taxability is shifted in the hands of someone else to avoid the tax on your head when
the income remains within you only.

14-Mar-16

Sec 60 to 64

Sec 64

CIT v. CM Kothari & LRs [AIR 1964 SC 331]

Mr. Kothari - along with his two sons - was running a partnership firm - they were stockbrokers
The firm was interested in buying a house property - in 1947, they entered into an agreement to purchase

Taxation Page 95
 The firm was interested in buying a house property - in 1947, they entered into an agreement to purchase
a house property in Chennai - for Rs. 90,000 - they paid an advance of Rs. 5,000 which was debited in the
name of the firm
Suddenly when the execution of the deed happened - the sale deed was executed in the name of the ladies
of the house and not in the name of Mr. Kothari and his sons - it was executed in the name of Mrs.
Kothari and her two daughters-in-law
The amount was paid by the firm - the ladies then paid cheques to the firm to offset that money - i.e. they
reimbursed the firm for the payment

The property was then rented out and the rental income started to arise
When the assessing officer enquired as to where the ladies got the money - Mr. Kothari had deposited
some amounts in the accounts of the daughters-in-law as a diwali gift - the son had deposited some
money in the account of the mother as a birthday gift

The dept. said that in the past, in no occasion the father-in-law gifts such amounts to daughters-in-law
The dept. further said that the birthday gift to the mother was deposited much later after her birthday -
the deposit coincided with the purchase of the property

The amount which was gifted was exactly the amount for the purchase of the property

The allegation was that this was a benami transaction - but the SC did not accept this argument
But this was a circular arrangement for tax evasion - the SC ruled that the rental income will be taxed in
the hands of Mr. Kothari and his sons

When an individual is assessable in respect of income of his minor child - Sec 64

Whenever there is any income which accrues or arises or is received in the hands of a minor - then this income
will be included in the hands of the total income of the parent whose income is greater

If a child has a disability - then this clubbing provision does not apply
If the income of the minor child is from manual work, or from work involving application of skill, specialized
knowledge, experience - it will not be clubbed in the hands of the parent

If the marriage b/w the parents does not subsist - then the income will be clubbed in the hands of the parent
which is maintaining the child

The income is NOT clubbed in the hands of the relatives maintaining the child - if the parents are dead or do
not have custody of the child

E.g. child artists - the income will not be clubbed - there will be a representative assessee who will file the
returns on the behalf of the child
E.g. shares taken in the name of the a child - there will be dividend income - which will be clubbed in the
income of the parent

Taxation Page 96
Set-off & Carry Forward of Losses

14-Mar-16

There may be situations when one is incurring a loss - there will not be losses in salary income - but under other
heads, there may be losses

The steps are —

1. Inter-source adjustment
2. Inter-head adjustment
3. Carry forward the losses

Inter-source adjustment
Sec 70 - as a general rule - if the net result for any assessment year w.r.t any source is a loss - the assessee is
entitled to have such loss set off against other income but under the same head

If there is a loss from one house property , you can set it off against income from some other house property
Say there is a profit of Rs. 1.5 lakh from house property A - there is a loss of Rs. 30,000 from house
property B - the latter can be set off against the former

If there is loss from non-speculation business - it can be set off against any speculation business or any non-
speculation business (i.e. any other business)
Trading in shares, etc. - where transactions are not settled completely but based on future events- day
trading, brokerage, etc.

If there is a short-term capital loss - it can be set off against any other capital gains

Loss in a speculation business can only be set off against profits from other speculation business
Long-term capital loss can only be set off against other long-term capital gains

If there is a loss from owing and maintaining race horses - then it can be set off only against profits from similar
businesses

If your losses cannot be absorbed after inter-source adjustment - then you will have to resort to inter-head
adjustment

Inter-head adjustment

Sec 71
Business loss can be set off against property income, capital gains or other incomes but not against salary
income
Loss under the head of house property can be set off against any other head of income
Losses under capital gains cannot be set off against any other head of income

Carry forward the losses

The statute allows you to carry forward losses for the next 8 years

If on receipt of arrears you move to some other tax slab - there is some relief provided under Sec 89

Taxation Page 97
Taxation Page 98
International Taxation | Permanent Establishment

15-Mar-16

International taxation deals with the rules applicable to cross border transactions between the countries in the
world
Taxes are not international
There in neither any separate global tax law that governs cross-border transactions nor any international tax
court or administrative body for the international tax issues

Each nation State is interested in taxing whatever income generation activities are present in their own territory

International taxation - misnomer - it operates by way of bilateral treaties b/w nation States

Residence jurisdiction and source jurisdiction - when these jurisdictions operate together there might be a
situation where one individual is doubly taxed
Residence jurisdiction arises because of the nexus between the country and the person earning the income
Source jurisdiction arises on account of the nexus between the country and the activities that generate
income
This source-based taxation often gives rise to the problem of double taxation, where the same income
could be taxed twice - in India, and also in the country of residence of the taxpayer

E.g. if there is Co. ABC Ltd. which is a resident of India - therefore, India will tax the income of the Co. based
on residence jurisdiction - ABC Ltd. has subsidiaries in Germany and UK - these countries will tax the income
of the Co. based on source principle - here, the same transaction is being taxed twice, once in the home country
and once in the host country - here the DTAA will come into play as to which nation should withdraw
jurisdiction

Double taxation means taxing the same income twice, once in the home country and again in host country
No rules of international law prohibit international double taxation. So it is for the countries in the international
arena to solve double taxation problems

Juridical Double Taxation Economic Double Taxation

DTAA addresses juridical double taxation DTAA does NOT usually address economic
double taxation
"The phenomenon of international juridical double "economic double taxation" is used to describe the
taxation can be generally defined as the imposition of situation that arises when the same economic
comparable taxes in two (or more) States on the same transaction or asset is taxed in two or more states
taxpayer in respect of the same subject matter and for during the same period, but to different taxpayers
identical periods"
Juridical double taxation takes place when the foreign Economic double taxation takes place if assets are
income of a resident person is subject to taxation based on attributed to different persons by the domestic law
the principle of residence and other states tax transactions of the states involved
or assets within its own territory based on the principle of This dichotomy occurs when the tax law of one
source state attributes the asset to its legal owner while
the tax law of the other state attributes it to the
person in possession or control

Economic Double Taxation - the laws do not have any commonality with respect to their approaches to the

Taxation Page 99
Economic Double Taxation - the laws do not have any commonality with respect to their approaches to the
levy - therefore, the DTAA does not apply in such situations

Methods of avoiding double taxation —

1. Unilateral relief
○ Sec 91 of the Income Tax Act
○ A resident in India who has paid income tax in any country with which India does not have a treaty
for the relief or avoidance of double taxation is entitled to credit against his Indian Income tax for an
amount equal to the Indian coverage rate or the foreign rate whichever is lower applied to the double
taxed income
2. Bilateral relief
○ Depends on treaty agreement b/w the two nations - there can be two ways to opt for this relief
 The two countries agree that income from various specified sources should either be taxed in
only one of them or each of the two should tax only a particular specified portion
□ This is akin to an exemption - each of the country computes taxable income after
subtracting the income which is taxable in the other country
 The taxpayer is given a credit for the taxes paid in the other country - here the taxpayer will pay
the tax for the entire income in one country - but he will be provided with a credit for whatever
taxes have been paid in the other country
□ Credit is akin to a deduction (and not an exemption)
3. Multilateral treaties
○ These are similar to bilateral treaties. It is achieved through agreement between many countries
○ E.g. European Economic Community
4. Non-tax treaties
○ These are not direct treaties of tax, but are treaties of friendship, cooperation, political ties, diplomacy
etc. but which consequently result in tax consequences
○ Generic treaties which may involve tax consequences - but usually the countries enter into dedicated
treaties which address particular phenomenon

What are DTAAs (Double Taxation Avoidance Treaties)?

• DTAAs - treaties b/w two or more States
• Tax treaties do not choose b/w applicable domestic and foreign law - instead, they recognize that each
contracting State applies its own law, and then limit the contracting States' application of that law
• The jurisdiction of a State to tax is not allocated by a DTAA - the jurisdiction is already established
• Treaty rules do not 'allocate' jurisdiction to tax to the contracting States - States have original jurisdiction to
tax and by concluding tax treaties they agree to restrict their substantive tax law reciprocally
• In situations in which an overlapping of substantive tax law is expected to occur, States which are parties
to tax treaties decide which of them shall be bound to withdraw its tax claim
• The limitation by a contracting state of its domestic tax law may consist of the waiver of its tax claim in
favour of the other state (exemption method) or of the grant of a credit against its tax for taxes paid in the
other state (credit method)
• A DTAA neither generates a tax claim that does not otherwise exist under domestic law nor expands the
scope or alters the character of an existing claim

In the Western Union case - there was no tax levied because there was no permanent establishment - this
requirement of permanent establishment comes from treaty obligations which bind USA and India

In order to claim the treaty benefit - what is of consequence is whether an individual is 'liable to pay tax' -
whether the individual is actually paying the tax or not is of no consequence

Three main purposes for a country to enter into a tax treaty are:

Taxation Page 100

Three main purposes for a country to enter into a tax treaty are:
• First, to limit, if not eliminate, international double taxation issues that arise when the legislation of two
countries govern a single taxable event (i.e., if both countries wish to tax one particular type of income, the
treaty normally limits the taxation rate that may be applied by the country where the income arises);
• Second, to prevent or reduce tax evasion by facilitating the exchange of information between the tax
authorities of signatory countries;
• Finally, to provide certainty of treatment for cross-border trade.

In order to claim treaty benefit, a person should be resident of one of the contracting states
• A person is a resident of a country if he is liable to tax in the country by virtue of
○ Domicile
○ Residence
○ Place of management
○ Any other criterion of a similar nature
• ‘Liable to tax’ vs ‘subject to tax’
• Tie breaker rule
○ In the case of an individual - closer personal and economic nexus determines residency
○ In any other case - the place of effective management determines residency

Residential status of an individual

• Permanent home of the individual
• Where there are permanent homes in both the States, where there is personal and economic relations or
closer center of virtual interest
• Where vital interest in both the countries are the same or cannot be determined, where there is a habitual
abode
• Where there is habitual abode in both the countries or in neither, the country of which he is a
national/citizen
• If he is a national of both the States or neither of them, the tie-breaker that is applicable is only by mutual
agreement

Issues pertaining to DTAAs

1. Concept of Residence - who is entitled to apply the treaty?
2. Taxable presence - what types of activities give rise to a "Permanent Establishment" where a resident of
one country becomes taxable in another?
3. Withholding on items of income - when the person making a payment has the obligation to deduct tax and
pay it on behalf of the recipient - you may become an assessee in default - e.g. Vodafone case
4. Relief from double taxation - how one country will help its taxpayer to avoid double taxation by providing
a tax credit or an exemption?

Double tax relief and double tax avoidance

Avoidance - when the assessee pays in one country only - avoidance of double taxation of income under
the tax laws of the two countries
Relief - when the assessee has already paid in both countries and then applies for relief (by way of credit or
refund) - granting of relief in respect of income on which income tax has been paid under the Indian tax
laws and also in the other country
The distinction between avoidance of double taxation and relief against double taxation is that in case of
avoidance of double taxation the assessee does not have to pay the tax first and then apply relief in the form of
refund, as he would be obliged to do under a provision for relief against double taxation

Tax Residence Certificates become very important for claiming relief

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Tax Residence Certificates become very important for claiming relief
One dispute is regarding whether TRC is important even for avoidance of double taxation

For research — Roy Rohatyi, Raja Ratnam - available in the library

Klaus Vogel - considered to be an authority on international taxation

16-Mar-16

Treaty override is a situation where the domestic legislation of a State overrules treaty provisions of either a
single treaty or all treaties hitherto having had effect in that State
Treaty overrides may arise on account of Court decision contrary to the common interpretation of the
contracting states
A contracting state may redefine a undefined treaty term under its domestic law which effectively overrides the
treaty

Constitutional provisions in each State decides the interaction of domestic legislation and international treaty
obligation

• Self-Executing Treaty - situations where the domestic law cannot override the treaty provisions
Constitution provides that the treaty is self-executing and becomes part of the domestic law without
any further enactment or special law
E.g. Argentina, France, Italy
Usually a tax treaty has superior status to prior or subsequent domestic legislation
Domestic legislation cannot override such treaty
• In some jurisdictions, the State has to ratify a treaty and make a law in its own jurisdiction - the treaty has a
higher status
Constitution requires a parliamentary act to incorporate or approve a given international agreement
It attributes a superior status to the provisions of an international agreement
E.g. Norway, Singapore, Germany
Priority is accorded to treaty law through express legal provisions or case law decisions
• In some jurisdictions, international agreements are at par with domestic legislation - if there is a conflict,
the one which is later in time prevails - subsequent changes in the domestic law would override the treaty
E.g. Brazil, Sri Lanka, US
In case of conflict, the one last in date prevails

In countries such as Australia, Canada, India, UK - international agreements have no special status and become
part of the domestic law by parliamentary statute
Treaty can be overridden by subsequent legislative action
Parliament can override a treaty by a subsequent amendment or repeal

There can be various positions that different jurisdictions apply —

Treaty is accorded superior position
Treaty is considered at par with the domestic law
India - does not vocalize as to whether the treaty is superior or the domestic legislation is superior

Sec 90
• If no tax liability imposed under the Act, no question of resorting to the agreement
• If a tax liability is imposed by the Act, the agreement can be resorted to negative or reduce it
• In case there is a difference between the provision of the Act and the agreement, the provision of the
agreement will prevail over the provision of this Act

Taxation Page 102

 agreement will prevail over the provision of this Act

Treaty Interpretation
A tax treaty is an agreement and not taxing statute
The principles adopted in the interpretation of statutory legislation are not applicable in interpretation of
treaties
A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the
context and in the light of its objects and purpose

A tax treaty is required to be interpreted as a whole which essentially implies that the provisions of the treaty are
required to be construed in harmony with each other
The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need
not be examined in precise grammatical sense or in literal sense - even departure from plain meaning of
language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty in such
a manner as to make it workable rather than redundant

Literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated
insofar as particular items under consideration are concerned - words are to be understood with reference to the
subject-matter

It is inevitable that interpreter of a tax treaty is likely to be required to cope with disorganized composition
instead of precision drafting - therefore the words employed in the treaty are to be given a general meaning -
general to lawyers and general to layman alike
When a tax treaty does not define a term employed in it and the context of the treaty so requires, it can be given
a meaning different from domestic law meaning thereof - the meaning of the undefined terms in a tax treaty
should be determined by reference to all the relevant information and all on the relevant context - there cannot,
however, be any residual presumption in favour of a domestic law meaning of a treaty term

16-Mar-16

Art.7 Business Profits + Art.5 Permanent Establishment - assigns taxability of the non-resident entity in India

Art. 7 The profits of an enterprise of a Contracting State shall be taxable only in that State unless the
enterprise carries on business in the other Contracting State through a permanent, establishment
situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in
the other State but only so much of them as is directly or indirectly attributable to that permanent
establishment.

C.I.T. v. Visakhapatnam Port Trust

The words ‘permanent establishment’ postulate the existence of substantial element of an enduring or
permanent nature of a foreign enterprise in another country which can be attributed to a fixed place of
business in that country - it should be such as that it would amount to a virtual projection of the foreign
enterprise of one country into the soil of another country

The primary use of the PE concept is to determine the right of a state to tax the profits of an enterprise of
another state
Types of PE
Basic rule PE
Construction/ Installation PE
Service PE
Agency PE

Taxation Page 103

 Agency PE

SLIDE 6 onwards - PE

Western Union Financial Services Inc. v. ADIT

The department tried to project that Western Union has several types of PE in India - fixed place PE,
agency PE, installation PE

The dept. claimed that the postal dept., commercial banks, etc. are required to install the software of WU
and also display the boards of WU - the dept. argued that this forms as a fixed place PE of WU in India

The tribunal says that WU does not have its own outlet in India
SLIDES
These agents and the premises of these agents belong to their own activity - these premises do not belong
to the activities of WU

Liaison Offices of WU - the RBI has mandated that such offices can only operate for the purposes of
communication and cannot engage in income generating activities

The dept. claimed that there was a particular software (Voyager) which was installed in the computer
systems of the agents - therefore, the dept. argued that this was an installation PE
The tribunal says that installation PE is for exploration or exploitation of natural resources - and hence, in
the current case, there is no installation PE

The dept. also argued that there was an agency PE - they claimed that thee agents were dependent agents
What are the conditions for determining a dependent agency PE?
In order to become an independent agent — SLIDES

Arm's length transaction - where the transaction is not taking place in a compromised manner - where
both parties get fair value

The tribunal further observes that if an agent is not independent, it does not automatically lead to the
inference that the agent is dependent - in order to establish that an agent is dependent, you have to prove
the dependency of the agent

17-Mar-16

DIT v. Morgan Stanley & Co. Inc. [2007 SC]

MS Co., USA - USA based financial advisory services company
MSAS India is a wholly owned subsidiary of MS Co., USA - MSAS provides back office support service to
its parent company - on an arm's length basis
In order to maintain the quality of the support services - MS Co. sent its personnel on short-term
stewardship to MSAS - some personnel were sent on deputation to MSAS and they stayed on for a long
duration (several months to several years)
The cost of the stewards was paid by MSAS to MS Co. - i.e. MSAS reimbursed the cost of the stewards to
its parent company which was MS Co.

The question here is whether this amounts to a PE of the USA company in India - if there is a subsidiary
here in India - does that subsidiary become a PE of the foreign company in India

Fixed Place of Business

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 Fixed Place of Business

Agency PE
The subsidiary company was not soliciting customers or concluding any contracts for the parent
company - it was merely providing back-support services

MNE (multi-national entity)

Service PE
The SC observed that there were two sets of employees being employed in MSAS on behalf of MS Co.

By sending stewards to the subsidiary company - MS Co. is merely trying to protect its own interests in the
competitive world by ensuring the quality and confidentiality of MSAS services - therefore, there is no
service PR established by sending stewards to the subsidiary company
The service provided should be something integral or essential - here the stewards are merely checking
quality of the services being provided

So far as the deputation staff was concerned - at times the subsidiary itself would request for certain
deputation - the deputation employees would participate in the management of the subsidiary, providing
recommendations and so on - the Indian subsidiary would reimburse the parent company for the same
The deputation staff are actively actually providing services to the subsidiary company itself - the parent
company holds control over these employees over the entire duration of their stay in India and the parent
company is being remunerated for these services
Therefore, a Service PE has been established in India

The test for a Service PE is when a company provides services in India and the services are furnished
through its employees - i.e. there should be some service provided in India by the foreign entity and this
service has to be provided by the employees of the foreign entity

There was an argument for transfer pricing here - but that was not established because the transaction took
place at arm's length

Whatever amount is being paid by way of reimbursements - that is the taxable amount
If you are an foreign Co. with activities in India - your base tax is 30% + cesses and surcharges
If you are a foreign Co. with a PE in India - your base tax is 40%

E-Funds Corporation v. DIT [Delhi HC 2014]

Assessing Officer - FAR Analysis - Functions, Assets, Risks - these are criteria to determine dependency or
independency of the agent
If the entity is an independent agent - then the functions of the agent would be independent and distinct,
the entity would contribute more assets and the risks assumed by the agent would be higher

HC Order
Business Connection

Subsidiary per se does not automatically form a PE

Fixed Place PE

Taxation Page 105

Taxation of Non-Resident Law Firms

28-Mar-16

Ishikawajima Harima Heavy Industries Ltd. v. DIT AIR 2007 SC 929

A Japanese company which had formed a consortium with 5 other companies (some Indian) - this
consortium had bid for a project of Petronet India Ltd. (Indian Co.) at Dahej, Gujarat - Petronet
wanted to carry out some installations in the high seas off the coast of Gujarat - and certain LNG
Petronet related tanks and pipelines
Some of these constructions were to be carried out in the high seas - some within the territory of India
The contract was to be given out on turnkey basis - if there is some work to be executed but you do not
want to get involved in that work, the entire work can be out sourced (designing, supply of materials,
construction, execution, etc.) - the entire work is done by the other party - you just have to turn the key
and the execution of the work starts

On shore activities to be performed - and other off shore activities as well

On shore activities involved certain supplies (tangible goods) as well as certain services
Off shore activities involved certain supplies (goods in tangible form) as well as certain services

The consortium (6 members) - had divided the entire project in different parts - the remuneration was
also divided according to the work that they did - the liability was joint and several
The Japanese company was responsible for certain on shore activities and certain off shore activities -
certain supplies and services
A part of this work was conducted within India - and some part was conducted in the high seas
(towards the country)
For its portion of the work - the Jap. Co. received part of the money in Indian currency and part of the
money in US dollars

When it came to deductibility of tax on these payments - TDS (tax deducted at source) provisions
might become applicable
Petronet approached the AAR (authority to get doubts regarding tax clarified - it is binding only on the
parties who approach the authority - does not create precedent for any other party)
The authority said that the entire amount is taxable in India
The Jap. Co. said that so far as on shore activities are concerned - the Co. was willing to pay tax - but as
far as the off shore activities are concerned, the Co. said that they should not be liable to pay tax

Petronet (Indian Co.) is releasing the money - the Jap. Co. (non-resident) is receiving the money

The Jap. Co. argues that for the operations in India, it is willing to pay tax - but for the off shore
activities (operations outside India), there should be no tax liability

Sec 9(1)(i) Explanation 1(a) in the case of a business of which all the operations are not carried out in
India, the income of the business deemed under this clause to accrue or arise in India shall be only such
part of the income as is reasonably attributable to the operations carried out in India;

Sec 9(1)(vii) income by way of fees for technical services payable by—
(b) a person who is a resident, except where the fees are payable in respect of services utilised in a
business or profession carried on by such person outside India or for the purposes of making or
earning any income from any source outside India; or

Taxation Page 106

earning any income from any source outside India; or

The argument by the Jap. Co. is that each member of the consortium has a different part of the project
which it will perform - whatever on shore activities are conducted, the Indian Income Tax Dept. has
the authority to tax on the basis of source based principle - whatever is off shore, the payment for that
portion of the work is not taxable
The Dept. is arguing that the contract is one whole - the entire contract has territorial nexus in India - if
any part of the project goes wrong, the entire project is going to be affected

The SC read Sec 9(1)(vii)(c) [did not read clause (b)]

Sec 9(1)(vii) income by way of fees for technical services payable by—
(c) a person who is a non-resident, where the fees are payable in respect of services utilised in a
business or profession carried on by such person in India or for the purposes of making or earning any
income from any source in India:

The Court says that this clause requires two conditions -

The services which are the source of the income that is sought to be taxed have to be utilized in
India as well as rendered in India
The court said that the services have been utilized but NOT rendered in India - the court however,
did not go on to distinguish what utilization and rendition is - the court did not clarify where the
term 'rendition' come from - the court did not justify as to why it looked at Sec 9(1)(vii)(c) either

The Dept. made the argument that it is a turnkey contract - the entire project will be impacted if any
portion of the contract goes wrong - because the contract is being entirely sourced from India,
therefore, the entire amount should be taxable in India rather than any piecemeal taxation
The nature of the contract is a divisible one - it is not one whole contract - merely because it is a
turnkey contract does not lead to the conclusion that the entire amount should be taxable in India

There was a PE of the Jap. Co. in India - this was never contested - the presence of PE was positively
determined - according to the court, it was essential that the PE should have contributed to the
generation of the income that is sought to be taxed

Japan -
India - DT...

Article 7 of the DTAA b/w Japan and India

Article 12(5)
The court says that there is a PE - even if you receive an FTS - you will go to Article 7 and not Article
14 - because Article 7 is applicable to enterprises (Article 14 is applicable to individuals)
The PE did not participate in the income generation from the off shore activities at all
The Dept. made the argument that the contract is a whole and cannot be considered in a piecemeal
fashion

The court said that even where there is a business connection and a PE - business connection and PE
are not the same
There is a requirement of utilization of services and the rendition of services
The SC concluded that the Jap. Co. will pay taxes only for its on shore activities

Taxation Page 107

Because of this judgement - there was an amendment in 2010
Sec 9(2) Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this
section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause
(vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident,
whether or not,—
(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.

Say you are working in a UK firm - no office or branch in India - you are providing some legal services for
some project being carried out in India - what is the taxability of the payment for these services?
FIND — relevant domestic provisions & the provisions of the DTAA

29-Mar-16

Technical services - does it include legal services?

Sec 9(1)(i) - business connection
Explanation 1(a)
Sec 9(1)(vii)(b) - resident FTS

Sec 9(1)(vii)(c) - for this provision to apply - you need both utilization and rendition of services

Clifford Chance v. DIT (2009) 111 Bom LR 428

Clifford Chance - UK based law firm - catering to certain power projects in India - the law firm had
kept a record of the no. of hours spent on these projects
There were certain intermittent periods when the employees and the staff of the law firm had come
down to India - the firm had kept a separate account of it
The firm had made separate billings w.r.t. to the services rendered in India and outside India
Indo-UK DTAA - Article 15
The firm raised the argument that Article 15 - this article requires fees for professional services can be
taxed in India if the services are performed in India and the assessee if present in India for more than
90 days

ARTICLE 15
INDEPENDENT PERSONAL SERVICES
1. Income derived by an individual, whether in his own capacity or as a member of a partnership,
who is a resident of a Contracting State in respect of professional services or other independent
activities of a similar character may be taxed in that State. Such income may also be taxed in the other
Contracting State if such services are performed in that other State and if :
(a) he is present in that other State for a period or periods aggregating to 90 days in the relevant
fiscal year ; or
(b) he, or the partnership, has a fixed base regularly available to him, or it, in that other State
for the purpose of performing his activities ;
but in each case only so much of the income as is attributable to those services.
2. For the purposes of paragraph 1 of this Article an individual who is a member of a partnership shall
be regarded as being present in the other State during days on which, although he is not present,
another individual member of the partnership is so present and performs professional services or other
independent activities of a similar character in that State.
3. The term "professional services" includes independent, scientific, literary, artistic, educational or
teaching activities as well as the independent activities or physicians, surgeons, lawyers, engineers,
Taxation Page 108
 teaching activities as well as the independent activities or physicians, surgeons, lawyers, engineers,
architects, dentists and accountants.

The law firm does not have any office in India - therefore, no fixed base in India
During some of the FY, the employee's stay in India had exceeded 90 days and the firm payed the taxes
For this FY - the stay of the employee's had not exceeded in India - and also, the activities had not been
performed in India - the firm claimed that they will file NIL returns for this FY

The Dept. claimed that the entire amount should be taxable in India - this is because the fees being
payed is for the services provided in India

The HC again referred to Sec 9(1)(vii)(c)

The Bombay HC goes on to say that for the application of clause (c), there is a requirement of
utilization and rendition
For that part of the income where the rendition of legal services did not take place here in India - the
court placed emphasis on the Ishikawajima judgement - it followed Ishikawajima - the entire income
cannot be taxed because utilization of services may have taken place in India but the rendition of
services has not taken place in India - firm has rendered advice from UK whereas the clients have
utilized the services in India

For that part of the services which are rendered from outside - the Dept. cannot tax the entire income

The court here did not consider business connection at all - the assessing officer did not bring up the issue
of business connection

Worley Parson
In one of the judgements delivered by the AAR (Authority for Advanced Ruling) - a mis-reading of the
clause was pointed out - as to the application of clause (c) when clause (b) was applicable
The AAR was doubtful about the application of clause (c)
Further, there was a doubt about where the 'rendition of services' has come from - when the term
'rendered' is not present in any of the clauses (b) or (c)

There was a second level amendment —

Sec 9(2)
Explanation.—For the removal of doubts, it is hereby declared that for the purposes of this section, income
of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of
sub-section (1) and shall be included in the total income of the non-resident, whether or not,—
(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.

After this amendment - the requirement of rendition + utilization was done away with - this amendment
takes us back to the position before Ishikawajima where only utilization is required

Linklaters LLP v. ITO 2010

This is a Bombay Tribunal judgement delivered in 2010 - immediately after this amendment
UK based law firm - rendered certain legal services to clients with projects in India - part of the services
being rendered form inside India and part of the services being rendered outside India
During a relevant particular FY - they filed a NIL return
The firm said they are neither falling under Article 15 nor are they falling under Article 7

Taxation Page 109

Article 15 - performance + 90 days in India
Article 7 - business profits - it is not read individually - Article 7 is not standalone - Article 7 is read
with Article 5 - the firm said that there is no PE

The tribunal said that the amendment has already been put in place - there is no requirement of
rendition of services - the tribunal will look only at the utilization of services - if that has happened in
India, then the entire income is taxable in India

Does performance, rendition, and furnishing of services amount to one and the same thing?

In this matter, the Dept. said that the firm does not fall under Article 15 - because the requirement of
90 days had not been fulfilled
The Dept. said that the income falls within Article 7 and Article 5(2)(k) read together

Article 5(2)(k)
the furnishing of services including managerial services, other than those taxable under Article 13
(Royalties and fees for technical services), within a Contracting State by an enterprise through
employees or other personnel, but only if:
(i) activities of that nature continue within that State for a period or periods aggregating more than
90 days within any twelve-month period; or
(ii) services are performed within that State for an enterprise within the meaning of paragraph 1 of
Article 10 (Associated enterprises) and continue for a period or periods aggregating more than 30
days within any twelve-month period:
Provided that for the purposes of this paragraph an enterprise shall be deemed to have a permanent
establishment in a Contracting State and to carry on business through that permanent establishment if
it provides services or facilities in connection with, or supplies plant and machinery on hire used or to
be used in, the prospecting for, or extraction or production of, mineral oils in that State.

Article 5 talks about PE

The Dept. said that this case falls under Article 7 - there are business profits (it includes professional
profits) - you need to have a PE and for that purpose, the Dept. said that it falls under Article 5(2)(k)(i)
Therefore, the requirement of PE has also been fulfilled

The court did not read the proviso of Article 5(2)(k)

The court said that this case falls under Article 7 and not Article 15 —
Professional services rendered by an indv. are governed by Article 15
Professional services rendered by an enterprise governed by Article 7 read with Article 5(2)(k) -
under Article 7 it is not only business profits, even professional services ought to be included and
not just commercial and industrial kind of services

The law firm said that even if it is Article 5(2)(k) - it is talking about furnishing of services and not
rendition of services
The tribunal said that there is no difference b/w furnishing and rendition of services i.e. they can be
used inter-changeably

As regards taxability under the domestic laws - the arguments based on Ishikawajima and Clifford
Chance are no longer acceptable - the amendment vide Finance Act, 2010 has settled that only
utilization of services in India is sufficient - the tribunal will not look at rendition of services anymore -
the judgements of Ishikawajima and Clifford Chance are not good in law

Taxation Page 110

 Within the treaty - only that part of income which is attributable will be taxed - not the entire income
The tribunal refers to Article 7 of the treaty - and says that it has the 'force of attraction' principle
All those incomes which are directly or indirectly attributable to the PE will be taxable - the tribunal
said that PE has been already established under Article 5(2)(k) - therefore, the tribunal held that the
entire income is taxable

30-Mar-16

Linklaters
Article 7 applies and not Article 15
We always have attribution of profits to a particular jurisdiction - whether you will attribute the income
of those activities which took place in India or the entire income?

Force of Attraction Rule

The words "profits indirectly attributable to the PE" used in Article 7(1) - incorporates the "force
of attraction" principle
The taxability is attached to the entire income - whether it is directly attributable or indirectly
attributable to the PE

Article 7(1) The profits of an enterprise of a Contracting State shall be taxable only in that State unless
the enterprise carries on business in the other Contracting State through a permanent, establishment
situated therein. If the enterprise carries on business as aforesaid, the profits of the enter price may be
taxed in the other State but only so much of them as is directly or indirectly attributable to that
permanent establishment.

Directly attributable - if there is a PE of a non-resident - that PE participates in the income generation

activity - this is directly attributable to the PE
When can you say that the PE is indirectly contributing to the generation of income?
Here the tribunal says that this incorporates the "force of attraction" principle
If the PE has contributed in the income generation not only within the territory of India but also
outside India - the former is directly attributable - but the latter is indirectly attributable to the
Indian PE (because the Indian PE has contributed to income generation in projects outside
India) - both these incomes become taxable in India

Article 7(1)(b) and 7(1)(c) of the UN Model Convention - the tribunal said that these provisions and the
provisions of the DTAA are akin to one another
When an enterprise sets up a PE in another country - it brings itself in the fiscal jurisdiction of that
another country to such a degree that such another country can properly tax all profits that the
enterprise derives from that country - whether the transactions are routed and performed through the
PE or not

Whether the DTAA actually reads the term 'indirectly attributable' in such an expansive manner is
questioned in the next case
Under the force of attraction principle - it seems as if the PE acts as a magnet to attract profits
Even if the PE has not participated - the country will be able to tax the income
This is a very broad understanding of the force of attraction principle

This interpretation is similar to the interpretation of Sec 9 - there is an interpretation of attributability under
this section as well - where we say that anything which has territorial nexus is taxable

Taxation Page 111

In the Linklaters case - there were some staff of Linklaters who came down to India - for the purpose of
activities of consultancy in India, there was a PE established and therefore, the income is taxable - what the
tribunal says is that once these staff go back, the income generated even abroad will be taxable - despite the
fact that the PE has not really participated in the income generation at all

Linklaters provided consultation for projects going on in India - staff came to India, exceeded 90 days, and
therefore, Linklaters paid taxes under Article 15
There is no fixed base of Linklaters in India
For one FY - no one from the office came down to India - no fixed base in India - no branch office in
India - for that FY, Article 15 should not apply - Linklaters filed NIL returns

The Dept. said that we are not reading Article 15 - we will read Article 7 with Article 5(2)(k) - the Dept. used
the interpretation of Article 5(2)(k) to establish a PE - the Mumbai tribunal says that Article 15 does not
apply - Article 7 and Article 5(2)(k) applies
Linklaters says even if Article 7 and Article 5(2)(k) is applicable - this PE has not participated in consultancy
services throughout the FY
The Dept. uses the force of attraction principle - any income w.r.t. services rendered to an Indian project
which is similar to the services rendered by the PE will also be taxable in India in the hands of the assessee

This is a very expansive reading of the force of attraction principle

The result is that the entire profits relating to services rendered by the assessee, whether in India or outside,
in respect of Indian projects is taxable in India [here also, you first need to establish a PE - when there is a
PE - which was established by resorting to Art. 5(2)(k)]

The force of attraction principle is activated only upon successful establishment of a PE in India

Clifford Chance 2013

CC argues that they fall under Article 15 - for one FY, the period of stay of the attorneys from the firm
did not exceed 90 days - therefore, for that FY, only the income from professional services that were
performed in the country is taxable

The Assessing Officer says that Article 15 applies only to individuals and not law firm partnerships
Article 7(1) applies to law firms

31-Mar-16

Clifford Chance v. DCIT

2009 Clifford Chance Bombay HC decision - if services have not been rendered in India - then the
income is not taxable
Linklaters Mumbai tribunal decision - the entire income is taxable in India if the services have been
utilized in India - now rendition does not have to be looked into but only utilization needs to be looked
into

The Assessing Officer never classified the income as FTS

The AO relied on Article 7 of the UN

SLIDES

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Tutorial | Tax Avoidance & Tax Evasion

28-Mar-16

Tax Avoidance
Method that you use is not illegal
Legal means to not pay taxes
Not patently illegal

Tax Evasion
The method is patently illegal

Tax Mitigation
Completely legal - you fulfill the criteria for the exemptions provided for in the statute itself

Impermissible avoidance arrangement - the arrangement can be anything

Taxation Page 113

Tax Evasion and Tax Avoidance

31-Mar-16

Tax Planning - a legitimate arrangement that citizens enter into - to arrive at the minimum tax payable

Tax Evasion - forthright flouting of legal provisions - under-reporting of income, non-disclosure of income,
over-reporting of losses, etc.

Tax Avoidance
General Anti-Avoidance Rules (GAAR)
Special Anti-Avoidance Rules (SAAR)

Whether the avoidance and the arrangement which was resorted to by the assessee- if it is an acceptable
arrangement, then it becomes tax planning - if it is not an acceptable arrangement, then it becomes tax evasion

What is pertinent is what amounts to an acceptable arrangement - judicial interpretation, GAAR, SAAR

It is important that these lines of distinction b/w acceptable and unacceptable arrangement have to be properly
drawn

Ritchi v. CIR 1929

The position in the English judiciary - Lord Clyde - no man in this country is under the smallest obligation,
moral or other, so to arrange his legal relations to his business as to enable the revenue to put the largest
possible shovel into his stores

IRC v. Duke of Westminster

Lord Tomlin - every man is entitled if he can to order his affairs so that the tax attaching under the Acts is
less than it otherwise would be
There was the Duke - the English Income Tax statute allowed certain deductions - for the maintenance of
the estate, the Duke would hire certain people - if the Duke paid salaries, that was not deductible - but if
the Duke paid annuity to the employees, that was deductible - the Duke entered into a contract with some
of his staff that the Duke would not pay any monthly salary but will pay a lump sum amount under a
covenant
Whether this arrangement is tax evasion or tax avoidance?
The cardinal principle is - given that a document or transaction is genuine, the court cannot go behind it
to some supposed underlying substance
The arrangement made by the Duke was upheld by the court (dissent by Lord Atkin - that the substance
was actually remuneration and therefore, the arrangement should have been held as tax evasion)

01-Apr-16

IRC v. Duke of Westminster

The cardinal principle - when a document is considered to be genuine, then the court cannot go behind it
for some underlying substance

This interpretation has been more or less the position in the UK judiciary - literal interpretation to all the
transactions - no further questions asked

IRC v. Plummer

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IRC v. Plummer
There was a charity (charity gets some exemptions, at the same time the charity can make investments in
income generating activities) - it would make capital payments to the taxpayer in consideration for the
assessee's covenant to make certain annual payments to the charity

This arrangement was brought into question - House of Lords held this scheme to be valid

There were other arguments that this kind of arrangement is dubious in nature and should be held
invalid - but the prevailing jurisprudence in UK was only to look at the formal genuineness of the
transaction

The Duke of Westminster principle was to look only at whether the formality of the transactions was legal and
valid
In this principle - you do not look at the whole transaction and what it is accomplishing - you will look only at
the formality of the transaction

WT Ramsay
The assessee company was contemplating some kind of capital gain from one of their properties
They created 2 different sets/kinds of loans - Loan A and Loan B - on Loan A they would keep
decreasing the rate of interest and on Loan B they would keep increasing the rate of interest which was
equal to the decrease in the former
In the time duration of the loan - one loan became higher in value than its original worth and the other
loan became lower than its original value
The final situation was that there was a capital gain on one loan and a capital loss on the other loan - such
that one set off the other

Lord Wilberforce - he observed that "while obliging the court to accept documents or transactions found
to be genuine as such, it does not compel the court to look at a document or a transaction in blinkers,
isolated from any context to which it properly belongs - if it can be seen that a document or transaction
was intended to have effect as a part of a nexus or series of transactions, there is nothing in the doctrine
to prevent it being so regarded - to do so is not to prefer form to substance or substance to form - it is
the task of the court to ascertain the legal nature of any transaction which is sought to attach a tax
consequence"

In this case, the court take a different view and says that if you are entering into this kind of arrangement -
nothing prevents the court to look at the whole arrangement
This is a move away from the literalist interpretation - it is not that the Duke of Westminster principle has
been overruled - if you read the judgement closely, this principle has not been overruled

What Westminster said was that if a transaction is genuine, the court should not look behind the
transaction to unearth any other thing
What Ramsay is saying is that there is no curb on contextualizing the transaction as a whole - if the
transaction comes in a series of transactions, the court is not precluded from looking at the series as a
whole

Does Ramsay then overrule Westminster?

Furnace v. Dawson
There was a family run company - they wanted to sell shares of the company to a purchaser
They get some legal advice - if you sell the shares directly, you will have to pay capital gains tax
immediately
They set up a company called Greenjacket in Isle of Man - they exchanged the shares of their company
against the shares of Greenjacket - thereafter, Greenjacket sold off the shares to the purchaser
Taxation Page 115
 against the shares of Greenjacket - thereafter, Greenjacket sold off the shares to the purchaser
The legal provisions in that jurisdiction was that if you have received money for the shares, you have to
pay capital gains tax immediately - but if you have received something else in exchange of the shares, the
capital gains tax could be deferred

The underlying objective was to defer the payment of tax

The House of Lords held that - "steps inserted in a pre-ordained series of transactions with no
commercial purpose other than tax avoidance should be disregarded for tax purposes, notwithstanding
that the inserted step had a business effect"

Ramsay said that transactions should be looked at as a whole rather than in a dissected manner
Ramsay says that we take upon ourselves the obligation to look at the genuineness of the
document/transaction - but that in no way limits us to looking at the transaction in an isolated manner -
this is giving a tweak to the Westminster principle - it is not explicitly overruling the Westminster principle
Furnace said that if a transaction does not have any commercial purpose other than tax avoidance, then that
should be disregarded

The combined effect of Ramsay and Furnace is that - the courts began to closely look at the legal effects of the
transactions - they did not consider themselves bound by the labels given by the parties themselves

The Duke of Westminster principle has in effect been overruled

The court started to scrutinize all arrangements very suspiciously

Craven v. White
It was held that the revenue cannot start with the question as to whether the transaction was a tax
deferment or a saving device but the revenue should apply the 'look-at' test to ascertain its true legal
nature
The court observed that genuine strategic tax planning has not been abandoned

This case tries to bring back the balance - you cannot start with suspicion of every tax scheme or
arrangement

If the transaction has some business effect, that will be honoured - but if the underlying commercial purpose is
only tax avoidance, then the tax benefit that was sought to be achieved, that will not be given effect to

In India - we were following the understanding that the tax payers are free to enter into arrangements to come
to the minimum tax liability

Jiyajeerao Cotton Mills v. CIT, Bombay

Every person is entitled so to arrange his affairs as to avoid taxation but the arrangement must be real an
genuine and not a sham or make believe

01-Apr-16

CIT v. A Raman & Co.

Reiterated the observations found in the Duke of Westminster case & Fishers Executors [(1936) AC 395]
"Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not
prohibited - a taxpayer may resort to a device to divert the income before it accrues or arises to him"

CIT v. BM Kharwar
"The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a
transaction - if the parties have chosen to conceal by a device, the legal relation, it is open to the taxing
authorities to unravel the device and to determine the true character of relationship - but the legal effect
Taxation Page 116
 authorities to unravel the device and to determine the true character of relationship - but the legal effect
of a transaction cannot be displaced by probing into the substance of the transaction"

McDowell & Co. v. CTO

State govt. of AP had imposed an excise duty on the manufacture of liquor
Whenever a manufacturer removes liquor from the distillery - he can only do so after paying the excise
duty - the point of collection is at the factory level because it is easier to collect the tax before it is moved
anywhere else

McDowell would ask the buyers to directly pay the excise duty - other manufacturers would collect it
from the buyers by including it in the total billing
McDowell would create 2 sets of bills - one bill was for the excise duty and one bill was for the liquor -
McDowell would ask the buyers to pay the excise duty separately

The other manufacturers would have to pay the sales tax on the total bill amount (which included the
excise duty)
McDowell would only pay sales tax on the second bill which was the liquor price - the amount of excise
duty was excluded from the total bill amount

The SC held that the excise duty which has been paid directly by the buyers need not be included in the
total amount for the sales tax turnover - i.e. SC upheld the arrangement in 1977 - there is nothing in the
rules that mandates the inclusion of the excise duty to the total sales turnover

The AP govt. amended the statute - that the excise duty has to be included in the total sales turnover
The case reached the SC again in 1985 —
Whether the liability to pay the excise duty was on the assessee?
If this liability was on the assessee whether the amount of the excise duty which was paid by the
buyer was to be included in the total turnover?

In this matter the SC made certain observations about tax avoidance - 5 judge bench decision
Justice Ranganath Mishra & others - "tax planning may be legitimate provided it is within the
framework of law - colourable devices cannot be part of tax planning and it is wrong to encourage or
entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious
methods - it is the obligation of every citizen to pay the taxes honestly without resorted to
subterfuges"

The court does not elaborate as to what amounts to 'colourable device'

Justice Chinappareddy - he discusses Duke of Westminster - while the techniques of tax avoidance
progress and are technically improved, the courts are not obliged to stand still - he refers to
Westminster principle
"The ghost of Westminster has been exorcised in England, should it be allowed to rear its head
in India?"
"The courts are now concerning themselves, not merely with the genuineness of transaction
but with the intended effect of it for fiscal purposes - it is neither fair nor desirable to expect the
legislature to intervene and take care of every device and scheme of tax avoidance - it is up to
the court to take stock to determine the nature of the new and sophisticated legal devices and
consider whether the devices could be related to the existing legislation with the aid of emerging
techniques of interpretation to expose the device for what they really are and to refuse to give
judicial benediction"

The SC in this case decided against the assessee - the arrangement was not allowed
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 The SC in this case decided against the assessee - the arrangement was not allowed

Justice Ranganath Mishra's judgement can be used to argue that nowhere has tax planning been done away
with - only colourable devices are not allowed - so only if the department can prove that the arrangement
under consideration is a colourable device, then arrangement will not be allowed

Justice Chinappareddy - the legislature cannot foresee all the loopholes that can be exploited by the assessee
for avoiding payment of tax - the court will have to step in to determine whether the legislature intended for
that benefit to be conferred on the taxpayer or not - if the statute is silent on something and the taxpayer seeks
to exploit that silence to gain some benefit - then the court will step in to see whether this benefit was intended
by the legislature or it is legislative oversight to have left such a gap and this benefit was never intended by the
legislature

We can always question whether the court can actually do such a gap-filling - especially in tax statutes which
have to be strictly interpreted

02-Apr-16

UOI v. Azadi Bachao Andolan

India had signed a DTAA with the Mauritian govt. in 1981 - India was a closed economy then - we
opened our economy in the 90s - during the 90s, the investment in the country began to surge
It was agreed that when capital gains would arise - the country would continue to charge the capital gains
tax
At the time - a lot of investments in India was routed through Mauritius - under the DTAA, if there was
an investment in an Indian company by a Mauritian resident and then he alienates the shares of the Indian
company, the tax would be gathered by the Mauritian govt.
India did not tax them - at the same time, there was some exemption under some specific Act (the
Mauritian domestic tax legislations) - therefore, there was no tax being levied - these investors were
doubly non-taxed
There were shell companies set up in Mauritius - the only objective was to invest in India - there would be
no tax liability, neither in India nor in Mauritius

Circular No. 682 dated 30th March 1994 - the govt. of India clarified that capital gains of Mauritian
residents by alienation of shares in Indian companies shall be taxable only in Mauritius
Several foreign investors began to utilize this loophole to create shell companies in Mauritius and invest in
Indian companies

The Dept. was further suspicious that Indian money was also being routed through shell companies in
Mauritius to avoid payment of capital gains tax
The Indian Income Tax Dept. issued show-cause notices to these foreign investors - due to this, the
foreign investment was being pulled out by these foreign investors - this was also problematic

CBDT Circular No. 789 (2000) - the govt. clarified that where ever a certificate of residence is issued by
Mauritian authorities, such certificate will constitute sufficient evidence for accepting the residential status
for applying the DTAA

This circular was challenged by Azadi Bachao Andolan (NGO)

○ By issue of this circular, the CBDT is overstepping its authority i.e. this circular is ultra vires
○ This circular enables the taxpayers to treaty-shop - the taxpayers who are not residents of the two
Contracting Parties, they step in and start taking benefit of this DTAA
The demand by the NGO was that this circular should be quashed

Taxation Page 118

The demand by the NGO was that this circular should be quashed

The HC ruled in favour of the NGO - on the grounds that there was excessive exercise of delegation i.e.
the CBDT has overstepped its authority by issuing such a circular - this curtails the power of the
Assessing Officer to enquire as to the residential status of the assessee - this is impeding the statutory
authority vested in the Assessing Officer to determine the residential status of the assessee and the CBTD
cannot do so by way of such a circular

The SC upheld the circular - the SC also made certain observations as to treaty-shopping
Treaty-shopping happens when an entity of another nation takes advantage of the treaty benefits
The SC said that CBDT was justified in issuing appropriate directions vide the Circular No. 789 - by
virtue of this circular, it is merely issuing appropriate directions - it does not in any way take away or
curtail the jurisdiction of the Assessing Officer - therefore, it is erroneous to say that the circular is ultra
vires the powers of the CBDT

It was argued by the NGO that the taxpayers who are claiming the treaty benefit are not paying any taxes
in Mauritius - therefore, by virtue of the provisions of the DTAA itself, these taxpayers should not be able
avail of the benefits of the DTAA
Article 1(e) of the Indo-Mauritian DTAA - the term person will include individuals, company or any other
treaty which is treated as a taxable unit in any of the Contracting States
These companies are not taxable units in Mauritius and therefore, these companies do not constitute
'persons' under the DTAA - and therefore, the DTAA should not be applicable to them

The SC makes a distinction b/w 'liable to tax' and 'actually being taxed' - it is sufficient if the entity is
labile to be taxed and it is not necessary that the entity must actually have paid taxes
The SC says that these companies are liable to tax - it is only by virtue of some exemptions that the
companies are not actually being taxed - therefore, the treaty benefits will be applicable to these
companies

Treaty-shopping is unethical - but the SC says that if you want to prevent treaty-shopping, there should be
a limitation of benefits clause - the limitation of benefits clause, limits the benefits of the treaty to those
entities who fulfil the criteria specified
The SC says that there is no limitation of benefits clause in the Indo-Mauritian DTAA and therefore,
there can be no restriction on the entities who claim benefit of these treaty provisions

The SC also observed that developing countries often tolerate treaty-shopping because the loss of revenue
is off-set by the benefits of foreign investment - this observation has been criticized because these are
policy observations that the court should not enter into

The respondents argued that McDowell's had changed the concept of fiscal jurisprudence in this country
and any tax planning which is intended to and results in avoidance of tax must be struck down by the
court

The SC says that we are unable to agree with the view that Westminster's principle is dead in England -
there are references to other Indian cases
Banyan & Berry v. CIT (1996 Gujarat HC)
Interpretation of McDowell's - the court in McDowell's no-where said that every action and
inaction on the part of taxpayer which results in reduction of tax liability is to be viewed with
suspicion and be treated as a device for avoidance of tax, irrespective of legitimacy or
genuineness of the act
The facts and circumstances of McDowell's decision leave us in no doubt that the case has not
affected the freedom of citizens to act in a manner according to his requirements within the
framework of law unless the same is a colourable device
Taxation Page 119
 framework of law unless the same is a colourable device

Madras HC judgement
The decision in McDowell's cannot be read as laying down that every attempt at tax planning is
illegitimate and must be looked upon with dis-favour

The SC (in light of the cases referred to) found that there is nothing in this matter which amounts to tax
avoidance - rather this arrangement is a permissible tax planning

This decision tries to bring in some balance - every arrangement cannot be looked at with suspicion

The correctness of the Azadi Bachao Andolan and the reading of McDowell's was challenged again in the
Vodafone case
It was contended before the SC by the Revenue Dept. that the ruling in the Azadi Bachao Andolan w.r.t
the reading of McDowell's case should be overruled - the decision in Azadi Bachao Andolan so far as it is
departing from the principle in McDowell's should be overruled

Does ABA says that the Westminster principle is not dead in UK?

If we closely read Justice Chinappareddy's judgement in McDowell's - he says that Westminster principle
is dead - Justice Ranganath Mishra also says that Justice Chinappareddy has a separate concurring
judgement with which we also agree - this implies that the whole bench in the McDowell's case agrees
that the Westminster principle is no longer applicable i.e. it is obsolete - therefore, it is contended that the
ABA case has misread the McDowell's judgement

In the ABA case - the govt. was trying to save the foreign investments - even when the govt. knew that there
were shell companies, the govt. did not want to unravel the arrangement - therefore the govt., used the
McDowell's case in one way
In the Vodafone case - the govt. is trying to unravel the whole transaction and lift the corporate veil to attach
tax liability - therefore, the govt. is trying to opt for a diametrically opposite reading of the McDowell's case

Vodafone
The Revenue may invoke substance over form or piercing the corporate veil test only after it is able to
establish that the transaction is a sham or it is a tax avoidant
In this matter - the corporate business purpose of this transaction is not taken as a colourable device -
there is no nullity of commercial purpose that the court sees in the Vodafone case
The structure of the holding and the subsidiary companies is such that each company has its own legal
personality - unless the transaction can be shown to be a sham, there cannot be any lifting of the
corporate veil
The Caymen Islands Co. was incorporated much earlier and was part of the Hutchinson group - it is not
devoid of commercial purpose
According to the SC - this structure of Hutch was developed over a period of time and was consolidated
over subsequent years - it serves as a special purpose vehicle for the Hutchinson group
The SC looked at some sort of timing test - this structure serves a commercial purpose and it has been
serving this purpose for quite some time
Further, Vodafone in not a temporary entity which is investing in the Hutch group - it is a substantial
entity and is here to stay
Based on these observations, the SC says that the insertion of this company in the overall structure of the
holdings was not for the purpose of tax avoidance - therefore, it is not a colourable device used by Hutch
or Vodafone

The SC upheld the corporate structure of the holding and upheld the transaction - there was no tax
avoidance involved in this arrangement
Taxation Page 120
 avoidance involved in this arrangement

04-Apr-16

Exemplifying Tax Avoidance/Evasion

Killick Nixon Ltd. v. DCIT (Bombay HC)

The assessee had incurred capital gains
The assessee had a piece of land - long term capital gain of Rs. 49.72 crores
The assessee had to sell off this land because it was acting as guarantor to Vysya Bank and the land had
some liability attached to it - the assessee had to pay up the original amount borrowed and the interest
incurred - because the Vysya Bank defaulted on payment

KNL had to sell off the land to Geekay Co. which belongs to the Rathi Group
KNL used part of the amount from the sale to fulfill the loan amount and the balance amount was
retained by the company
It was on the remaining amount on which capital gains tax was to be paid
The gain of Rs. 49.72 crores was sought to be set off against long term capital losses of Rs. 1.4 crore and
short term capital loss of Rs. 49.2 crore on sale of shares

The AO enquired into how the loss emerged —

KNL had invested some Rs. 48 crores in 4 different wholly owned subsidiaries - the shares of these
subsidiaries had been bought at a premium worth Rs. 140 per shares
At around the time of sale of the land - the shares of these subsidiaries were sold to Radha Financial
Services at Rs. 5 per share

Rathi Group had provided the Rs. 48 crores to KNL to invest in the 4 subsidiaries
The subsidiaries invested this amount into Kosha Investments
Kosha Investments was a company of the Rathi Group

The AO also found that the Director Chairperson of the Radha Financial Services had been in
communication with the Director of KNL regarding the purchase of shares at Rs. 5 per share

The AO therefore concluded that the capital loss which is sought to be generated is a fake one
This is a colourable transaction - this arrangement is not part of tax planning and it cannot be allowed -
this arrangement is a sham and a colourable transaction

The Dept. claimed that KNL knew that there would be a surplus amount generated from the sale of the
piece of land - and it has hurriedly sold off the shares of its own subsidiaries to generate a loss which
could be set off against the surplus

Even after paying off the loan - KNL did not sue Geekay Co. for the recovery of the default amount - the
Dept. claimed that this shows that KNL and Rathi Group are working in unison to avoid payment of
taxes on the capital gains

The Bombay HC said that - whenever there are reasons to believe that the apparent is not real; then the
taxing authorities are entitled to look into surrounding circumstances to find out the reality and apply the
test of human possibilities
The judgement of the Supreme Court in Vodafone International v. UOI makes it clear that a colourable
device cannot be a part of tax planning
Where a transaction is sham and not genuine, it cannot be considered to be a part of tax planning or
legitimate avoidance of tax liability
Taxation Page 121
 legitimate avoidance of tax liability
On facts, as the purchase and sale of shares was found to be a sham, the loss cannot be allowed

GGAR

Sec 95 - non-obstante clause

Does this mean that if treaty provisions are more beneficial - even then GAAR provisions will apply?

Sec 96(2) - if a part or step of the scheme is mainly for a tax benefit - then the whole arrangement will be given
the colour of an arrangement for a tax benefit - the whole arrangement then will become impermissible
This section has perhaps originated precisely to address situations like Vodafone

GAAR - it had started off with the position that if one of the purposes is tax benefit, then GAAR provisions
would apply - it has been narrowed down to the present form - however, after narrowing Sec 95, perhaps Sec
96 is too broad

The jurisprudence with regard to tax planning and arrangements is such that the whole series of transactions
has to be looked at instead of one transaction in isolation - in this context, Sec 96(2) differs from the judicially
developed position - because you look at one step in isolation to determine the fate of the whole arrangement

There is no consistency in the way in which the Dept. is evaluating transactions - in some sections, the Dept.
will look at steps in isolation and in some other sections, the Dept. will consider the entirety of the
arrangement

Sec 97(1)(a)(iv) - has roots in the Vodafone case - Vodafone wanted to enter into the Indian telecom market -
the main substance of the transaction in that case was not the Caymen Islands Co. but an entry into the Indian
market

Sec 97(4) specifically addresses the Vodafone judgement by the SC - it tries to overrule the judgement
implicitly

Taxation Page 122

Transfer Pricing

06-Apr-16

Transfer pricing regime - to curb the tendency of companies to shift from high tax jurisdiction to low tax
jurisdiction

Say there is a sale transaction b/w Co. A and Co. B which is a related entity
If Co. A is selling off 100 units at Rs. 100 per unit to Co. B
But Co. A, if it were selling off the same 100 units to some other unrelated entity, would sell the units at
Rs. 150 per share
Such a transaction is not happening at arm's length
In such a transaction, the IT Dept. will step in and activate the transfer pricing regulations and tax
according to the arm's length price

Chapter 10 of IT Act - Sec 92 to 92F deal with transfer pricing regulations - they were introduced in 2001

Sec 92.
(1) Any income arising from an international transaction shall be computed having regard to the arm's length
price.
Explanation.—For the removal of doubts, it is hereby clarified that the allowance for any expense or interest
arising from an international transaction shall also be determined having regard to the arm's length price.
(2) Where in an international transaction or specified domestic transaction, two or more associated
enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any
contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or
apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard
to the arm's length price of such benefit, service or facility, as the case may be.
(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in
relation to the specified domestic transaction shall be computed having regard to the arm's length price.
(3) The provisions of this section shall not apply in a case where the computation of income under sub-
section (1) or sub-section (2A) or the determination of the allowance for any expense or interest under sub-
section (1) or sub-section (2A), or the determination of any cost or expense allocated or apportioned, or, as
the case may be, contributed under sub-section (2) or sub-section (2A), has the effect of reducing the income
chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the
books of account in respect of the previous year in which the international transaction or specified domestic
transaction was entered into.

If there is any transaction that is entered into - the entity will quote a particular value

Say Co. A and Co. B are associated enterprises - there is a project in some country - there is an
apportionment agreement w.r.t a particular income (say 30% and 70% respectively) - if the entities were not
associated enterprises, the apportionment would have been at 50% each - then transfer pricing regulations
shall be applicable

Say Co. A is trying to develop a new product - the contribution of Co. A and Co. B was 70% and 30%
respectively - but when it comes to apportionment of income, the percentage is inverted - here also transfer
pricing regulations will be applicable

Taxation Page 123

Sec 92B. (1) For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction"
means a transaction between two or more associated enterprises, either or both of whom are non-
residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of
services, or lending or borrowing money, or any other transaction having a bearing on the profits, income,
losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or
more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or
expense incurred or to be incurred in connection with a benefit, service or facility provided or to be
provided to any one or more of such enterprises.

International transactions - either or both the parties are non-residents

Prevent loss of revenue occurring to a particular jurisdiction - transfer pricing gets activates when the
companies are present in two different jurisdictions - because if the companies are in the same jurisdiction,
the tax will be paid to the same Revenue Dept.

'intangible property'

Sec 92F(ii) defines arm's length price

Sec 92F(ii) "arm's length price" means a price which is applied or proposed to be applied in a
transaction between persons other than associated enterprises, in uncontrolled conditions;

Uncontrolled conditions - when it is in accordance with the current market value

Definition of Associated Enterprises

Sec 92A. Meaning of associated enterprise.
(1) For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, "associated
enterprise", in relation to another enterprise, means an enterprise—
(a) which participates, directly or indirectly, or through one or more intermediaries, in the
management or control or capital of the other enterprise; or
(b) in respect of which one or more persons who participate, directly or indirectly, or through one
or more intermediaries, in its management or control or capital, are the same persons who
participate, directly or indirectly, or through one or more intermediaries, in the management or
control or capital of the other enterprise.
(2) For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if,
at any time during the previous year,—

3 requirements —
• International transaction
• Associated enterprises
• Not arm's length price

To determine the ALP - there are various mechanisms listed in the statute - but the statute does not tell you
which method should be applied to which kind of transaction - this has been left to the assessee - the statute
simply mandates that the assessee should use the most appropriate method (this has led to a lot of litigation
because the method considered most appropriate for the assessee might not be considered to be most
appropriate by the Dept.) —
Comparable Uncontrolled Price Method
What is price quoted by an industry or assessee in similar kind of business in an uncontrolled
situation

Taxation Page 124

 situation
The transactions being compared must be in a comparable situation - you cannot take a loss
making enterprise and compare it to a profit making enterprise

Resale Price Method

If an entity acquires a product and then merely re-sells it - the price margin in the resale that the re-
seller earns in a controlled transaction is compared to a resale price margin earned by a re-seller in
an uncontrolled transaction
This method is most preferable or appropriate for transactions entered into for resale of the
acquired goods

Cost Plus Method

It is suggested that CPM is useful when the tested party is supplying made to order goods to its
related party - CPM focuses more on functional comparability - this is appropriate in transactions
where manufacturing activities are broadly the same for similar kinds of goods
This method determines ALP by comparing the gross margin
The gross margin applied by the manufacturer reflects its functions, assets and risks

This is more appropriate for made to order goods

Profit Split Method

The ALP is determined by evaluating the allocation of profits or losses b/w controlled transactions
to that of uncontrolled transactions
Ratio of profits and losses - would the entities have resorted to the same ratio if they were
unrelated entities

Transaction Net Margin Method

The ALP is determined by comparing the net profit on cost of sale that the manufacturer or
service provider earns from a controlled transaction as compared to a comparable controlled
transaction

Any other method that the Dept. may apply

These methods are not operable in a particular sequence - the statute does not prescribe any preference for
any method

Transfer pricing regulations - apply to international transactions as well as specified domestic transactions

OECD - BEPS (Base Erosion and Profit Shifting Report)

Any group of companies whose group revenue exceeds 750 million euros - then the group is required to
maintain 3 tiered documentation

In India - we are prone to adopt this OECD Report

Any company whose group revenue exceeds Rs. 5395 crores will be required to maintain 3 tiered
documents
○ Local file - local material transactions that happen in that FY
○ Master file - this master file shall contain standardized information relevant for all members of the
group company - this master file shall be furnished to the tax authority of the country in which
each entity is operating
○ Country by country report (CBC Report) - it requires the multinational enterprise to report
annually and for each tax jurisdiction, the amount of revenue, profits, employment, capital, tangible
Taxation Page 125
 annually and for each tax jurisdiction, the amount of revenue, profits, employment, capital, tangible
assets in each jurisdiction

07-Apr-16

Marketing Intangibles
Brand Value
Brand Building

LG Electronics India Pvt. Ltd. v. ACIT (2013) 152 TTJ 273(Delhi)

LG India is a wholly owned subsidiary of LG Korea
LG India had entered into a royalty agreement with LG Korea - by virtue of this royalty agreement, LG
India obtained the right to use the technical information, designs, drawings and industrial property
rights for the process of manufacturing, marketing, selling and servicing the agreed products in India
The legal ownership over the designs, drawings, etc. will rest with LG Korea - the royalty agreement
gives LG India the right to exploit the designs, drawings, etc. in the Indian markets

The royalty payment is at the rate of 1%

As a consequence of manufacturing, selling and marketing activities - the Indian Co. undertakes certain
advertising, marketing and promotional activities (AMP) - the Indian Co. therefore incurs some AMP
expenses
You will calculate what percentage of expenditure is diverted to AMP activities
The Dept. found that LG is incurring some 3.85% of the expenditures - which is way higher than the
expenses incurred by the other comparable companies like Videocon and Whirlpool (they were
spending 1.39%)

Based on this difference - the Dept. concludes that LG India is creating marketing intangibles for LG
Korea for which LG India is not receiving any payment
The Dept. invokes transfer pricing regulations - the amount which is in excess of the limit (i.e. the
amount being spent by comparable companies) should be taxable in the hands of LG India

Bright line test - prevalent in US, Australia, New Zealand - a line of demarcation within AMP
expenses - you arrive at a particular rate of expenditure and if any company spends beyond that rate, it
is presumed to be a non-routine expense

The Revenue alleges that the benefit of this excess expenditure is going to the Korean Co. and nothing
is being compensated to the Indian Co. - i.e. it is presumed that because you are an AE, the benefit of
the excess expenditure (which is brand building) is going to the Korean Co. and its other group
companies world over - by not claiming any compensation from the Korean Co., the Indian Co. is
reducing its own profits - if it were not an AE, then the Indian Co. would definitely have asked for
some sort of compensation for such brand building expenditures - therefore, an arm's length pricing
needs to be applied

Because you are an AE (and not an independent entity) - you operate under some controlled
conditions - the costs, the profits sharing ratios, etc. - they are not what you would have arrived at if you
were operating independently

Maruti Suzuki
Maruti Udyog Ltd. entered into business with Suzuki in Japan - at the time they were unrelated entities -
they entered into business when the economy was liberalized in 1990s
Maruti and Suzuki got involved - the Jap. Co. bought certain controlling powers in the Indian Co.
Taxation Page 126
 Maruti and Suzuki got involved - the Jap. Co. bought certain controlling powers in the Indian Co.

Till this point of time the cars of Maruti were using the logo M - now you have replaced it with logo S
The expenditures on AMP were slightly higher - the change of logo as well as expenses goes to the
brand building of Suzuki - the benefit of this brand building goes to Suzuki and not Maruti - and no
compensation for this is being received by Maruti

The Dept. claimed that Suzuki is piggy-backing on Maruti to enter the Indian market
The argument by the Maruti group was that they were facing international pressure and needed
technical support - and not the other way around

The HC observed that if Maruti was obligated to use the logo then there is some pressure - if Maruti is
voluntarily changing the logo, then it would not amount to any sort of control or pressure from the Jap.
Co. - therefore, only in the former case, transfer pricing should apply

The SC said that the HC had overstepped its bounds - it made observations on merit - the matter was
transferred back to the transfer pricing officials

LG Electronics
When promotional and marketing expenses are being incurred - should it be presumed that the benefit
is incurred for the parent company?

Can you retain the legal ownership of a property and yet part with the economic ownership of that
property (i.e. the right to exploit and utilize the product can be assigned to some other entity)
When LG India is incurring excessive promotional expenditures - the legal owner of the brand value is
the Korean Co. and not the Indian Co.

LG India argued that these expenses actually benefit the economic owner and not the legal owner

What goes into brand building?

Why would you want to buy a LG product and not a Whirlpool or Videocon product?
Why would you buy an Apple product?

Promotional and marketing activities

Technical superiority i.e. better products

It cannot be claimed with certainty that it is only promotional and marketing activities that go into
brand building - there are several complex factors that go into brand building
It would be fallacious to say that only AMP activities that go into brand building

The Dept. says that when you are incurring excessive AMP expenditure, the benefit is being taken away
by the legal owner
The Indian Co. argues that the benefit actually accrues to the economic owner - it increases sales

The first issue is about the presence or absence of international transaction

To invoke transfer pricing regulations, there should be an international transaction
If there is no written or oral agreement, can we still consider the AMP as an identifiable
international transaction?
The Indian Co. contends that in the absence of any mutual agreement, there is no international
transaction - and therefore, no transfer pricing regulations can be invoked

Taxation Page 127

 The Dept. says that the moment you spend the amount on AMP - it is alleged that the excess amount is
going towards the brand building of the parent company

AMP expenses are meant to augment your sales - these are expenses for revenue generation

The tribunal referred to the definition of 'transaction' under Sec 92F(5) - transaction includes provision
of services
The tribunal says that the definition of international transaction is inclusive in nature - therefore, AMP
expenses would amount to a provisioning of services from LG India to LG Korea

The second issue was whether there can be a distinction b/w economic ownership and legal ownership
The tribunal said that this distinction exists in the commercial sense but for taxing purposes, this
distinction does not exist

The expenditure in excess of the bright line are non-routine expenses and therefore, the matter should
be remanded to the appropriate forum
In effect, despite no written or oral agreement, there is a an international transaction and the transfer
pricing regulations can be applied
Bright line test - not in Indian statutes, but derived from other jurisdictions

11-Apr-16

LG Electronics (SB Delhi ITAT)

Bright line test is an acceptable criteria - although it was contended that our statute does not make any
reference to a bright line test
Legal ownership and economic ownership have commercial significance - but this distinction does not
hold any sense under the taxing statute

Sony Ericson Mobile Communications Private Ltd. v. CIT (Delhi CIT)

AMP expenses under question
Sony Ericson is an Indian importer of Sony Ericson mobiles - Sony (Jap. Co.) and Ericson (Swedish
Co.) - joint venture - wholly owned Indian subsidiary
The Indian subsidiary is engaged in importing and selling, distributing, promoting and marketing mobile
handsets under the brand name of Sony Ericson in India - it also provides certain support services to
the buyers
The assessee concedes to the fact that the various member groups (other AEs) of the Sony Ericson
group own significant ownership rights in the intangible property (in the brand name, trademark and
logo) of Sony Ericson - but the Indian subsidiary does not have any such rights
The assessee contended that it is merely importing these handsets and subsequently it is performing
distribution and marketing functions by selling these handsets in the Indian markets
The transfer pricing officer observes that the AMP expenses are to the tune of Rs. 115 crores while the
sales are Rs. 1638 crores
The extent of AMP expenses is 7.06% - this figure when compared to the other competitors - the other
companies are spending only 3.35%
The transfer pricing officer says that this 3.35% should be considered as a bright line - till that limit, the
expenses are of a routine nature - whatever were the non-routine expenses, additional taxes have to be
paid on those
The benefit of these non-routine expenses goes to the foreign entity - the Indian subsidiary does not get
any reimbursement or compensation for the same - then this amount should be adjusted with the
profits of the Indian subsidiary
Taxation Page 128
profits of the Indian subsidiary
The profits of the Indian assessee should be enhanced to the extent of the non-routine expenses and
the taxes should be paid on the same

The ruling of the special bench was brought into question —

Whether the excessive AMP expenditures constitute an international transaction subject to transfer
pricing regulations?
In LG Electronics - the special bench had held in favour of this particular finding

The Delhi HC also holds that AMP expenses (when in excess) constitute an international
transaction - however, the HC holds that distribution and marketing are intertwined and may
be examined as a bundled or inter-connected transaction
Here in this matter, the assessee has itself propounded that they do have an agreement
pertaining to marketing and promotional activities - the assessee admitted that they had a
separate agreement for marketing and promotion - the HC finds that AMP expenses here
amount to an international transaction and therefore, transfer pricing regulations will apply

The first threshold of the application of TP provisions is satisfied

The HC is cautioning the Dept. that since at times the distribution and marketing activities
are bundled up together - then it may not be open to the Dept. to split them up into separate
activities and tax them as separate taxable events
If the AE as a distributor is supposed to undertake some integral marketing mechanisms -
then the Dept. cannot artificially separate these activities

Bright line test

The Delhi HC reverses the entire judgement of LG Electronics (Special Bench)
Whether the Indian jurisdiction and Indian Income Tax Act recognizes the bright line test?
The Delhi HC rejected this bifurcation of routine and non-routine expenses - it ruled
that if there is any excess expenses are being incurred - it cannot be presumed that these
are non-routine expenses which are going to the brand building of the foreign AE
The HC rules that 'the value of a brand depends on the nature and quality of goods, and
the services sold or dealt therewith - treating brand building as equivalent to or a direct
result of advertisement and sales promotion would be largely incorrect'
The companies (assessee) do not undertake advertisement with a purpose to increase the
value of the brand but to increase sales and thereby earn higher profits

Whether there is no significance of the distinction b/w economic and legal ownership?
LG Electronics - rejected this bifurcation - only commercial significance and no legal
significance under the taxing statute
The Delhi HC has accepted the bifurcation b/w legal and economic ownership -
economic ownership of marketing intangibles would arise due to the advertising and
promotional activities undertaken by the Indian assessee
If you are a long term AE - and you undertake promotional and advertising expenses - in
the long term, your sales in the market you are targeting will enhance - the benefits of
these expenses will be reaped by the economic owner and not the legal owner

Merely because a company is expending into AMP activities - it does not directly result in
brand building - the value of a brand depends on a lot of other considerations

The HC says that if an entity is a low risk distributor - undertaking minimal marketing and
Taxation Page 129
 The HC says that if an entity is a low risk distributor - undertaking minimal marketing and
distribution activities and expenses - who is entitled to lower returns but of a fixed nature - then
the issue of AMP expenses to such a distributor is not relevant

As a distributor, you may be offered a lower cost/purchase price for the products - your gross
profits would be higher - in return for intensive AMP activities - then such a scheme would not
trigger transfer pricing regulations - the HC says that in such an arrangement, the excessive AMP
expenses cannot be read such that transfer pricing regulations will be applicable

The hidden costs of the AMP expenses might already have been recovered in the kind of
arrangement that the Indian subsidiary has with the foreign AE

The Delhi HC accepts that the benefit of the promotional activities will be reaped by the economic
owner

Transfer pricing regulations get triggered if the nature of transaction b/w the Indian Co. and the foreign
(non-resident AE) is such that profits are being shifted, that the tax billings here is lower - if you are already
being remunerated for the expenses that you are incurring, then there is no question of profit shifting

The Delhi HC's acceptance of bifurcation of economic and legal ownership - equips you to make the
argument that the AMP expenses (after a certain point, depending on the arrangement and the circumstances
of the case) are going towards brand building which is reaped by the legal owner and NOT the economic
owner

Summary
Whether AMP expenses amount to international transaction?
Both decisions held yes
Whether the bright line test - bifurcation of routine and not-routine expenses - is applicable in India?
LG Electronics - BLT test is accepted
Delhi HC - BLT does not have any statutory backing in India
Whether AMP expenses are brand building services?
LG Electronics - non-routine expenditures amount to brand building
Delhi HC - it will be incorrect to consider brand building as directly attributable to AMP expenses
Whether economic ownership on intangibles is a reality and relevant for TP regulations?
LG Electronics - concept of economic ownership does not hold water - not relevant for taxing
purposes - only commercial value
Delhi HC - accepted the concept of economic ownership

Maruti Suzuki India Ltd. v. CIT 2015

AMP expenses of MS were higher when compared to other competitors
The Dept. alleges that these excessive expenditures are not acceptable
The Dept. first applied the BLT to arrive at a particular percentage
The Dept. compared this percentage with the competitors in the market
They arrived at the conclusion that MS had spent much more than comparable competitors
Based on this conclusion, the Dept. said that this is an international transaction
Therefore, the Dept. adjusted the excessive expenditure in the hands of the assessee

The court said that the first condition to be applied for invoking TP regulations is to determine whether
there is an international transaction
The Delhi HC said that the application of the TP regulations has to be such —
Show that there is an international transaction
Taxation Page 130
 Show that there is an international transaction
Determine the price of such a transaction
Determine the ALP by one of the 5 methods prescribed by the statute
Compare the price of the transaction with the determined ALP (step 2 price v/s step 3 price)
Deficit will be adjusted in the hands of the assessee

The Delhi HC observes that the Dept. has first applied the BLT - the Sony Ericson case has already
established that the BLT does not have any statutory backing
The Dept. here has applied BLT - found a deficit and based on this deficit, the Dept. has inferred an
international transaction and thereafter, invoked the TP regulations
The Delhi HC says that this process is not acceptable - it has to be first separately proved that there is
an international transaction
Else, the Dept. will find that any assessee whose AMP expenses are excessive will be constituted as
engaging in an international transaction

LG Electronics has been overruled by Sony Ericson

But w.r.t. existence of international transaction - the judgements had concurred

This judgement of Maruti Suzuki can be said to have overruled the decision of Sony Ericson w.r.t
existence of international transaction
The HC observes that since Sony Ericson has expressly negated the use of BLT for determining the
existence of international transaction, the very basis of alleging that there is an international transaction
in the Maruti Suzuki case is invalidated
The Delhi HC says that —
Sony Ericson has expressly negated the use of BLT both as forming the base and for determining
the existence of an international transaction - consequently, the very basis of an international
transaction is invalidated
The burden to show the existence of an international transaction and to ascertain the price of such
a transaction rests with the Dept.

11-Apr-16

The Delhi HC said that you cannot infer an imaginary international transaction by using the BLT - there is
no other international transaction other than what is imaginatively deduced by the Dept.

Even where such a transaction is otherwise established - the Delhi HC in Maruti Suzuki held that because
there is no machinery provided in the statute to determine the ALP of AMP expenses - the Delhi HC cited
the CIT v. BC Srinivasan Shetty case - if computation provision fails, then the charging provision also fails -
in the absence of machinery (computation) provisions, the imaginary international transaction is invalidated

The Delhi HC refers to OECD guidelines - the guidelines acknowledges that marketing activities which are
undertaken by enterprises which do not own trademarks or trade name is a complicated exercise - whilst
high returns may be attributable to the marketing efforts of a distributor, there are other parameters for
determining the assessment of brand building or brand value

Maruti Suzuki is unique to India - it is not a joint venture in any other jurisdiction - any benefit that arises
from the AMP expenses by Maruti Suzuki will not actually accrue to the foreign AE at all - the benefit will
be reaped by the Indian subsidiary

The HC contemplated that even where such kind of transfer pricing provisions are important they will be
important for determining exit charge, where termination is effected between the Indian subsidiary and the
Taxation Page 131
important for determining exit charge, where termination is effected between the Indian subsidiary and the
foreign AE - it is at this time, you will determine who takes away what part of the brand

If the foreign AE or the Indian subsidiary is exiting this arrangement - that is the time when you will
determine the division of the brand name

E.g. Hero-Honda de-merger - the advertising measures prior to the split were being incurred together - it is
at the moment of the de-merger i.e. at the time of exit - where you will determine the price (according to
who incurred what benefit from the advertising expenses) - that is the point where the TP regulations
become relevant
There is no relevance of applying TP regulations otherwise

Vodafone 'Transfer Pricing'

Vodafone had sought to enter the Indian markets - Vodafone India Services Pvt. Ltd. is a wholly owned
subsidiary of the non-resident company
The Indian subsidiary (VIS) had issued certain equity shares at a premium of Rs. 8,519 to its non-
resident holding company
The value was arrived at in consonance with the relevant Indian Act - against the issue of these equity
shares, VIS received Rs. 246 crores
Vodafone had already suffered due to the previous case - as abundant caution, Vodafone had filed the
requisite documents with the Dept. - VIS had expressly clarified that this transaction does NOT fall
under transfer pricing regulations but as a matter of abundant caution, the form is still being filed and
information is being provided
The TP Officer rejected the price at which the shares are being issued - the TP Officer applied the net
asset value of VIS and arrived at a value of Rs. 53,775 per share - hence there is a deficit per share -
consequently the TP Officer held that VIS has received a lesser amount from his holding company - the
issue of these shares has occurred at a subsidized rate - some Rs. 1,300 crores should have been
received by VIS
The TP Officer held that the excess amount should be deemed to be a loan to the holding company -
since the amount (of loan along with the interest applicable) has not been received - TP regulations
should apply and the amount should be taxed in the hands of VIS
The Dept. here is claiming that VIS has incurred a cost which has not been reimbursed - this is a loan
on which interest is also applicable - therefore, TP regulations will be applicable

Whether issue of equity shares at a premium to a non-resident AE amounts to income at all in the first
place?
When you refer to the term income - Sec 2(24)(xvi) - any consideration received for issue of shares
which exceeds the fair market value of the shares amounts to income

In the present matter, the court held - what is being sought to tax is capital not received from the non-
resident - whereas, under the ambit of the Act, what is covered is premium which is received in excess
of the fair market value
The share premium actually received constitutes income

The Dept. is trying to tax the share premium which has not been received from the holding company -
the HC says that this is a legal fiction that the Dept. is trying to extend - which is not envisaged by the
statute - this kind of extension is not allowed even by way of a legal fiction
The income has to exist in reality - it cannot be a notional kind of income - here, there is a 'deemed'
loan amount on which there is a 'deemed' interest payable which is allegedly not received by the Indian
subsidiary

Taxation Page 132

The HC held that for Chapter X to apply - you need some income - that income has to be covered by
the statute - that income should exist in reality - the income should not be some sort of fiction
The threshold of the definition of income must be satisfied - hence, in this case, TP regulations cannot
be invoked

The HC never went to the applicability of the method for determining share premium or the value of
the shares at all - because in this case, the case was exhausted at the threshold of whether what is sought
to be taxed is income at all?
[The HC does not take the line of argument that if the other method of valuation is correct, then it
would not be tax on share premium not received - because then the income would be deemed to accrue
to the Indian subsidiary - there would be no deemed loan]

4 essential ingredients of taxing statute —

Subject of tax
Person liable to pay the tax
The rate at which tax is to be paid
The measure or value on which the rate is to be applied

The court here says that the Dept. has confused the measure to tax as a notional income - the income
needs to exist in its real concrete form - the measure cannot be confused as the notional income

The HC cites BC Srinivasan Shetty case - there is an absence of charging provision on such income i.e.
on capital income on issue of shares on premium to a non-resident

When you receive share premium - you put it as capital reserves of the company - can you impose tax
on such reserves?
Inbound capital investment is not taxable under the statute - in this particular case, inbound capital
investment is sought to be taxed
The HC nullifies this attempt on part of the Dept.

Taxation Page 133

Tax Planning

12-Apr-16

IP, Manufacturing, Sales Marketing, Auxiliary, Logistics, Control & Management

Lesser risk - lesser profits

Higher risk - more profits

Companies can split up the functionalities that the entity undertakes and lower the risk thereby lowering the
profits to a certain extent as well

It makes sense for the company to spread out and decentralize - in different jurisdictions - the companies will
try to look at those jurisdictions where the tax liability is lower

The govt. cannot dictate the way in which companies operate

NOTES till now - from Diksha

Apple Inc. (US)

US also suspects that Starbucks, Google are also having the same structure as Apple Inc.
The way in which Apple has distributed its manufacturing, functionalities, etc. - Apple has not paid any
taxes to the US govt. since the past 5 years
Apple Inc. is incorporated in California (US)
It has a subsidiary Apple Operation International (Ireland) - this has various subsidiaries
Apple Operations Europe (based in Ireland) with a subsidiary Apple Sales International (based in
Ireland)
Apple Distribution International
Apple Retail Holding Europe with subsidiaries - Apple Retail Belgium, France, Germany
Apple Asia Ltd. (based in Singapore)

Apple Inc. has entered into a cost sharing agreement with AOI and ASI - these companies will contribute
to the R&D of the Apple products
Legal ownership of all those products lies with Apple Inc. - the worldwide rights of those products
lies with Apple Inc. in US
Whereas economic ownership of those designs and products is distributed b/w Apple Inc., AOI and
ASI - whatever is sold in US, that rests with Apple Inc. - whatever is sold worldwide, that rests with
AOI and ASI in Ireland (this does not get passed on to the US govt.)

In the US, there are provisions which allow for the deferring of payment from CFCs (Controlled Foreign
Companies) - by using this provision, whatever is received by AOI is not then received by Apple Inc.

Ireland does not have incorporation test - it only recognizes control and management test to determine
residency
US does not have control and management test

AOI is the repository of the economic ownership - but is controlled from California - AOI does not pay
any taxes to US because it is not incorporated in the US - AOI does not pay any taxes to Ireland because
it is controlled from US - as a consequence, AOI claims that it is not a resident of either of the
countries - AOI would pay only 2% taxes to Ireland whereas in US, they would have to pay 35%

Taxation Page 134

 countries - AOI would pay only 2% taxes to Ireland whereas in US, they would have to pay 35%

ASI has entered into third party manufacturing agreements with entities in China - ASI contracts the
assembly of Apple products with third party entities in China - the ownership of the finished products is
passed on to Apple Distribution International which then distributes the products to Europe, Asia-
Pacific, India, Middle East, etc.

ASI is the repository for Apple Inc. for worldwide distribution - it enters into contracts with off shore
subsidiaries of Apple Inc. and oversees the distribution worldwide

Ireland never sees the finished products entering its jurisdiction - ASI never takes physical delivery of the
finished products - as and when the products are shipped out from the Chinese entities, they are diverted
to the retail distributors in various other jurisdictions

If you do not assign risks to your retailers and distributors - then the profits at that level reduces

Therefore, ASI only pays taxes for those products sold in Ireland - but ASI retains all the rights to exploit
the product - the off shore subsidiaries, retail distributors, etc. pay to ASI - ASI pays to AOI - AOI does
not pay back to Apple Inc. because AOI retains the worldwide economic ownership and rights

AOI does not have any physical presence in Ireland - they have no employees
The mailing address of AOI, AOE and ASI is the same

The reason why Apple Inc. remains in US is because the IP rights in US are very strong - if there is any
infringement, then the US jurisdiction can be called upon

BEPS plan - when you create intangible goods - it is difficult to determine the exact price of the IP - and to
determine what is the contribution attributable to each entity
When you enter into cost sharing agreements - there is nothing to stop you from doing so

Currently, companies enter into cost sharing agreements and distribute the economic ownership - the
jurisdictions will tax the companies based on economic ownership
BEPS - wants to change and shift their own jurisdiction - rather than look at economic ownership - what
BEPS is suggesting is that they will look at the actual R&D contributed by each jurisdiction - the nexus b/w
the jurisdiction and the IP based on the R&D actually contributed by that jurisdiction

In the Apple Inc. structure - the directors of AOI and ASI were employees of Apple Inc. - there was no real
R&D contribution from AOI and ASI

The US govt. suspects that Starbucks and Google also have a similar structure

These arrangements are entered into by companies - whether they are acceptable or not depends on the
response of your jurisdiction

Taxation Page 135

Indirect Taxes

13-Apr-16

Indirect taxes - incidence/burden of the tax can be shifted - the final resting place of the tax will be the
ultimate consumer

Indirect taxes - it is possible to pass on the burden of taxes to the next person in line - as consumers of the
goods and services, we end up bearing the brunt of all these taxes

Excise Act 1994

Excise duty - tax imposed on the activity of manufacture of production of a particular good
The activity which is to be taxed is manufacture or production - the moment the activity is undertaken,
the tax becomes payable
When excise duty is imposed - the activity sought to tax us manufacturing or production - the point of
collection will be the factory - before the product merges into the market - the tax has to be collected

It is possible that what is a manufacturing activity for you would form the input for the other person in
line - your output could be the ingredient or raw material for the next person in line
When you pass on the tax burden to the next person in line - the next person also does the same

You pay excise duty at every stage

Excise duty is imposed by the Central govt. - except alcohol for human consumption, narcotics and
petroleum products

Central Sales Tax

If it is a sale - then you pay a sales tax
The distinction b/w CST and State VAT - if you sell a good within the boundaries of one State (intra-
State sale), then VAT is applicable - if it is an inter-State sale, the CST becomes payable

CST is imposed by the Union - inter-State sale falls within List I - but the proceeds of this levy and the
revenue generated therefrom, will be collected and retained by the State from which the movement of
the goods begins
A State which has good resources and manufacturing capability - you stand to gain within this
system

Intra-State sale falls within List II

State VAT

Service Tax
Imposed by the Central govt. - there is a revenue sharing w.r.t amount collected

Indirect taxes - watertight compartmentalization as to which level of your federation will tax what - strict
bifurcation on levy

Cascading effect of taxes

Taxation Page 136

There were State Sales Tax (prior to State VAT)

State Sales Tax - at each stage you are paying taxes on your sub-total which includes value added + purchase
price (which includes taxes paid in the earlier stage)

State VAT - at each stage you are paying taxes only on the value added - the assessee is provided with a credit
w.r.t. taxes already paid (after producing evidence)

Credit based system of applying VAT - you will have to consider what is your output tax minus your input tax

In this system - every person is tied up to a person before him and a person after him - it becomes necessary
to have challans and receipts for the taxes paid by the person before him

Unless you provide the govt. with the proof and evidence of payment of taxes - then you will have to pay the
full amount of taxes

Under the present regime of State VAT - we have not purely done away with the cascading effect

If you have paid CST - then there is no credit for the payment of CST - because CST goes to the treasury of
the State of origin
If the prior tax was a State VAT - only then you will get credit
There is no cross-credit available b/w the taxes - if you are claiming a credit for a State VAT, then the credit
must pertain to that State VAT - if it is excise duty or CST, then the State govt. will not provide any credit

Excise duty is also called CENVAT - credit system - there are designated rules for this credit system

State VAT - certain kind of scheduling

If it is natural and unprocessed products - no VAT is applicable
Precious stones, semi-precious metals, gold - State VAT at 1%
Items of basic necessities, capital goods - State VAT at 4%

18-Apr-16

GST

Compartmentalization in the imposition of taxes in built within the constitution

The difficulty with the current tax regime —

• Multiple kinds of taxes
• Multiplicity of rates
• Distinction b/w goods and services
○ Service tax - there was a gradual expansion of the ambit of service tax - it is only now that we have
a blanket application with a negative list - initially, in 1994, when the levy was first imposed, only 3
services were taxed - there has been a gradual expansion of the base of service tax
• Cascading effect of tax
○ There are intricately crafted credit rules in each state - there are numerous kinds of legislations, each
with their own rules and exemptions crafted into them

If there are any products or services which are exempt from the imposition of taxes - you cannot claim any
kind credit on these products or services - therefore, the cascading effect still applies to these goods and
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kind credit on these products or services - therefore, the cascading effect still applies to these goods and
services

The ultimate customer will have to bear all the burden of the taxes imposed
Say there is a private hospital - this is exempt from service tax - the private hospital will incur expenditures
(purchasing beds, equipment, provision of medical facilities, etc.) - the private hospital will be paying taxes on
these purchases and expenditures - since the ultimate service is exempt, the private hospital will not get any
credit for paying the taxes - the private hospital will pass on the burden of the taxes to the ultimate consumer
i.e. the patients seeking treatment in the hospital - the price of the services will be have the inbuilt burden of
these taxes

• Various documents and records have to be maintained - it is an administratively un-wielding in nature

• Goods and services are treated differently
• Water-tight compartmentalization of taxes
○ When there is a composite transaction which involves sale and services - and if the authority
imposing the levy on sale and services is different - then what happens?
○ Say restaurant - sale of food - service also
○ Flipkart - basic element of sale - but service also
○ The bifurcations b/w sale and service (or other kinds of composite transactions) has some clarity
by way of the rules formulated by the govt. - how much percentage of the income is for the sale
and how much percentage is for the service
○ These bifurcations would become more and more complicated in highly composite transactions -
and in new upcoming transactions
○ There have been a range of controversies - where there have been disputes regarding whether the
transaction is a sale (and hence taxable by the state) or a service (and hence taxable by the Centre)
 E.g. whether purchasing a sim card is liable to sales tax or service tax - there is a SC
judgement - which decided that when you buy a sim card, you are not buying any good - the
customers are not interested in controlling the electromagnetic waves - the customers are
interested in the communication i.e. the service provided

GST will subsume —

CENVAT
CST
State VAT
Octroi
Cess
Surcharges
Service Tax

GST - one levy on all goods and services - concurrently imposed by the Central and the state govt.
• Dual concurrent levy
○ CGST
○ SGST

The range of taxes will be subsumed within one particular levy

You are broadening the base of the tax - the economist argument is that when the base of the tax is
broadened, then the rate of the tax will go down

There will be some kind of parity b/w goods and services

There will be least number of exemptions

Taxation Page 138

There will be least number of exemptions

Under the current regime - on a particular transaction we pay —

Service tax 14.5%
State VAT 4%
Excise duty 10% (average)
CST from 2 to 4%
Surcharge
Cess
The total tax paid is very much higher - around 30%

The rate at which the GST will be fixed - will be a revenue-neutral rate (RNR)
A RNR is a rate which does not adversely impact the revenue generation of the govt.
Under the new regime - there will be a broadening of the base, minimize the kind of exemptions
granted - and therefore, ease out on the rate of the taxes
Under the GST - there will be cross-credit available - since all the goods and services are subsumed
under one levy itself - this would remove the cascading effect from the system as far as possible

IGST - Inter-State GST

The erstwhile CST will under the new regime become IGST
For those goods and services - the IGST will apply

What is happening is that the system is more or less remaining the same - only the various kinds of taxes are
subsumed under one levy
As a dealer - you will have to be registered, maintain records, with as many states as you are dealing in
As a tax-payer (manufacturers, service providers) - the new proposed system is also cumbersome
Administratively, the GST regime is still as cumbersome as before

Alcohol for human consumption will not be subsumed under GST

Initially GST will not apply to certain petroleum products - there are 5 categories of petroleum - they are
essential inputs for any kind of factory/service provider - again, credit will not be given on these and
therefore, the cascading effect will affect these products

Tobacco and its tobacco products will be subsumed under GST - the Central govt. can also impose certain
excise duty on tobacco products

The new system is shifting from an origin-based regime to a destination-based regime

Under the current system - the CST was imposed by the state from which the goods are moving
Under GST the tax will be imposed on the place of supply

Under the new system - if a state does not have purchasing power - these states will stand to lose - the states
which can consume more will generate more revenue

In the Bill - the Central govt. will provide compensation to the states which suffer a loss of revenue due to
the imposition of the GST

There will be a GST Council - the Union Finance Minister, State Finance Minister, etc. - their function, will
be to decide and make recommendations for the apportionment of IGST, compensation packages for the
state govt., rates applicable, definition of place of supply

Bill has been passed by the Lok Sabha but has not been passed by the Rajya Sabha

Taxation Page 139

Bill has been passed by the Lok Sabha but has not been passed by the Rajya Sabha
The demands by the opposition —
○ The rate of GST ought to be specified in the constitution (i.e. the GST rate should be put into the
constitutional amendment bill - there is a need to amend Schedule VII because there is no entry
regarding concurrent levy) - but this is not feasible because for a change in the rate, a constitutional
amendment will be required
○ The current Bill says that compensation will be provided 'up to 5 years' - this would mean that the
Central govt. can stop paying compensation after a year also - so it should be mandated for 5 years

Taxation Page 140

 Cases | End Sem

Business Connection
1. CIT v. R D Aggarwal
Business Connection

2. Barendra Prasad Ray. v. ITO

Business Connection - UK solicitor - argued case in India - Indian firm
Criticized judgement - one off incident used to estd. a business connection

3. Western Union Financial Services Inc. v. ADIT

Business Connection - Western Union
Business connection - something more than just business - element of
continuity - this connection can be of various forms - it may include
carrying on a part of main business or activity incidental to the non-resident
or it may merely be a relation which facilitates or assists the carrying on of
that business

Income from Other Sources

4. East India Housing and Land Development Trust v. CIT
5. CIT v. National Storage Private Ltd.
6. Manohar Singh v. CIT
7. Sultan Brothers Pvt. Ltd. v. CIT
8. Karnani Properties v. CIT
9. CIT v. Shambhu Investment Pvt. Ltd.
10. Pfh Mall v. ITO, 2008

Capital Gains
11. CIT v. BC Srinivasan Shetty
12. CIT v. DP Sandu Bros., Chembur (P) Ltd.
13. Vodafone Case

Capital Gains - Joint Development Agreements

14. Chaturbhuj Dwarkadas Kapadia v. CIT
15. Binjusaria Properties Pvt. Ltd. v. ACIT
16. CIT v. Sadiq Shaikh

Capital Gains - Sale of Shares

17. ACIT v. Nagindas P Sheth
18. Management Structure and Systems Ltd. v. ITO

Capital Gains - Non-Compete Fees

19. DCIT v. Mediworld Publications Pvt. Ltd.
20. Ramesh Tainwala v. CIT
21. Hami Aspi Balsara v. ACIT
Taxation Page 141
21. Hami Aspi Balsara v. ACIT
22. Savita Mandhana
23. Sumeet Taneja v. ACIT

Clubbing Provisions
24. CIT v. CM Kothari & LRs

International Taxation - PE
25. C.I.T. V/s. Visakhapatnam Port Trust
26. Western Union Financial Services Inc. v. ADIT
27. DIT v. Morgan Stanley & Co. Inc.
28. E-Funds Corporation v. DIT

Taxation of Non-Resident Law Firms

29. Ishikawajima Harima Heavy Industries Ltd. v. DIT
30. Clifford Chance v. DIT (2009)
31. Linklaters LLP v. ITO
32. Clifford Chance (2013)

Tax Avoidance & Tax Evasion

33. IRC v. Duke of Westminster
34. IRC v. Plummer
35. WT Ramsay
36. Furnace v. Dawson
37. Craven v. White
38. CIT v. A Raman & Co.
39. CIT v. BM Kharwar
40. McDowell & Co. v. CTO
41. UOI v. Azadi Bachao Andolan
42. Banyan & Berry v. CIT
43. Vodafone
44. Killick Nixon Ltd. v. DCIT

Transfer Pricing
45. LG Electronics India Pvt. Ltd. v. ACIT
46. Maruti Suzuki
47. Sony Ericson Mobile Communications Private Ltd. v. CIT
48. Maruti Suzuki India Ltd. v. CIT (2015)
49. Vodafone 'Transfer Pricing'

Tax Planning
50. Apple Inc.

Taxation Page 142