Direct tax quarterly edition

JHUNJHUNWALA ADVISORS

Direct Taxation – QuarterlyEdition

3rd August 2016

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Jhunjhunwala AdvisorsDirect Tax – Quarterly Update

Direct Tax Quarterly Edition

Tips earned by hotel staff not salary consequently no tax deduction at sourceapplicable

The Supreme Court (“SC”) in the case of ITC Ltd1 reversed the judgment of the Delhi

High Court (“HC”) and held that tax deduction at source (“TDS”) under section 192 of

the Income-tax Act 1961 (“the Act”) was not applicable on distribution of tips by the

taxpayer (engaged in the business of owning, operating and managing hotels) to its

staff / waiters.

The SC observed that tips are voluntary payments by customers of the taxpayer, for

services rendered, and the employees have no vested rights to receive any tips. The

SC further noted that tips are initially received by the employer in his fiduciary

capacity as a trustee from the customers, which are then disbursed to the

employees. The SC relied on its past judgements in the context of other laws wherein

the nature of tips had been considered.

The SC held that tips from customers, though paid to the employees through the

medium of the employer, do not emanate from the employment contract, and cannot

be treated as an amount payable to the employees by the employer its own capacity

based on such contract. Hence, tips are not in the nature of “salary” under sections

15(b) or 17(3)(iii), and the employer is not liable to withhold tax thereon under section

192 of the Act (which applies to only “salary”). Consequently, the employer cannot be

treated as an “assessee in default” under section 201(1) and accordingly cannot

subjected to interest under section 201(1A) of the Act.

Revisionary powers under section 263 of the Act not contingent on issuance ofshow cause notice

The SC in the case of Amitabh Bachchan2 reversed the Bombay HC’s order and

allowed the Revenue’s appeal, restoring the revision order passed by the CIT under

section 263 of the Act. One of the contentions of the taxpayer, upheld by the Mumbai

bench of the Income- tax Appellate Tribunal (“Tribunal”) as well as the Bombay HC,

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was that a revision order passed on the basis of grounds not mentioned in the show

cause notice was bad in law.

The SC held that the law was well settled in the context of analogous provisions

contained in the Indian Income-tax Act, 1922 that, unlike the power of reassessment

which is contingent upon issue of a show cause notice specifying reasons for the

same, the power of revision is not so contingent and the revision order need not be

limited to the issues mentioned in the show cause notice, if one is issued. The SC held

that all that the CIT was required to do was to provide an opportunity of hearing to the

taxpayer before passing the revision order, which was done in the present case.

Delhi HC rejects Revenue’s attempt to re-characterize composite contract asequipment hire

The Delhi HC in the case of Technip Singapore Pte Ltd3 set aside the Advance Ruling

of the Authority for Advance Rulings (“AAR”) and held that income earned by the

taxpayer, a Singaporean company, from a contract with Indian Oil Corporation Ltd

(‘IOCL’), for offshore construction work including mobilization / de-mobilization and

installation services, is not taxable in India as consideration for equipment hire or fees

for technical services.

The Delhi HC rejected the Revenue’s contention that the contract was divisible and

that the work of mobilization / de-mobilization and the work of installation were

separable components, taxable as “royalty” and “fees for technical services”

respectively.

With regard to the Revenue’s contention of “royalty” characterization of the income from

the work of mobilization / de-mobilization, the Delhi HC noted that IOCL did not have

any control over the equipment, which remained throughout under the control of the

taxpayer, and that the taxpayer could not be regarded as having let / hired out the

equipment to IOCL. The Delhi HC held that payment for work of mobilization / de-

mobilization could not, therefore, be termed as “royalty” under Art. 12(3)(b) of the India-

Singapore Double Tax Avoidance Agreement (“DTAA”) (i.e. consideration for use of or

the right to use any industrial, commercial or scientific equipment).

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Further, in response to the Revenue’s contention that the work of installation was

ancillary and subsidiary to the work of mobilization / de-mobilization and should be

regarded as “fees for technical services” under Art. 12(4)(a) (consideration for services

that are ancillary and subsidiary to “royalty” which was in this case the work of

mobilization / de-mobilization in the Revenue’s view), the Delhi HC held that since the

payment for the work of mobilization / de-mobilization was held not to qualify as

“royalty”, the question of taxing income from work of installation as “fees for technical

services” under Art. 12(4)(a) of the India-Singapore DTAA did not arise.

The HC further accepted the taxpayer’s stand that the services under the contract fell

under exclusionary portion of Explanation 2 to section 9(1)(vii) of the Act (viz.

consideration for any construction, assembly, mining or like project undertaken by the

recipient), and held that in the absence of a permanent establishment (“PE”) in India, no

part of the income from the contract could be taxed in India.

Delhi HC quashes CBDT instruction curtailing issuance of tax refunds

The Delhi HC in the case of Tata Teleservices Ltd4 quashed Instruction No. 1/2015

dated January 13, 2015 issued by the Central Board of Direct Taxes (“CBDT”), which

prevented issuance of a tax refund to the taxpayer where a scrutiny assessment

notice had been issued on the basis of section 143(1D) of the Act.

Based on the language and construct of section 143(1D) of the Act, the Delhi HC held

that if the legislative intent was that a tax return was not to be processed at all once a

scrutiny assessment notice is issued, then the legislature ought to have expressly

stated such a prohibition and would have not used the expression ‘processing of a

return shall not be necessary’.

The Delhi HC observed that the CBDT’s power to issue circulars / instructions etc under

section 119 of the Act is hedged in by certain limitations, and if such instructions, being

at variance with the statutory provisions, are prejudicial to the taxpayer, then such

instructions cannot prevail over the statutory provisions.

The Delhi HC accordingly quashed the above instruction and further held that whether

a tax return (in respect of which a scrutiny assessment notice has been issued) should

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be processed or not, will have to be decided by the Assessing Officer exercising his

discretion in terms of section 143 (1D) of the Act.

Opportunity of being heard mandatory before adjusting a tax refund against a taxdemand under section 245 of the Act

The Delhi HC, in the case of Vijay Singh Kadan5, allowed the taxpayer’s writ petition

and quashed the Revenue’s adjustment of a tax refund of a certain year against a tax

demand for a subsequent year (which was in appeal) under section 245 of the Act, on

the ground that the adjustment was made without giving prior intimation and opportunity

to the taxpayer.

The Delhi HC also rejected the Revenue’s stand that it was merely 'withholding' (and

not ‘adjusting’) the tax refund of the concerned year, pending verification of the tax

demands for a subsequent year (which was in appeal), on the basis that the Revenue

was fully aware that the tax demand for the subsequent year was under appeal and the

taxpayer’s stay application in that regard was also pending. The Delhi HC reiterated the

well settled principle that the discretionary power of adjustment of a tax refund against a

tax demand should not be invoked in a mechanical manner but only in cases where the

Revenue is satisfied that the tax demand will not be recoverable but by such

adjustment.

Interest on income-tax refunds is “interest on debt claims” under the India-Italy

DTAA

The Madras HC in the case of Ansaldo Energia SPA6 held that income-tax refunds due

from the Government qualify as “debt claims”, and accordingly, interest on such income

tax refunds under section 244A of the Act is exempt under Art. 12(3)(a) of the India-Italy

DTAA (which exempts from tax in India any “interest” received from the Government).

The Tribunal held that the interest on income-tax refunds was not covered under Art. 12

of the India-Italy DTAA at all and hence is not entitled to the concessional tax treatment

under that Article. In the course of hearing before the Madras HC, the Revenue further

contended that since the taxpayer had a PE in India, interest under section 244A of the

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Act would still be taxable in India as “Business profits” under Art. 7 read with Art. 12(6)

(second part) of India-Italy DTAA.

While the aspect as to whether the taxpayer has a PE in India was pending before the

SC in the taxpayer’s appeal, the Madras HC dismissed the Revenue’s above

contention, by holding that Art. 12(6) (second part) of the India-Italy DTAA did not apply

at all to the current situation. The Madras HC stated that Art. 12(6) of the India- Italy

DTAA only dealt with “place of accrual of income” – the first part dealt with the situation

where the payer is the Government etc and the second part dealt with the situation

where the payer had a PE in India. The Madras HC held that the current case was

covered under the first part of Art. 12(6) and the interest income (being paid by the

Government) accrued in India, and accordingly, the current case did not fall under the

second part of Art. 12(6) of the India-Italy DTAA at all.

Waiver of a bank loan obtained for purchase of capital assets is a taxable benefit/ perquisite

The Madras HC in the case of Ramaniyam Homes Pvt Ltd7 held that waiver of principal

portion of a bank loan obtained for purchase of capital assets would fall within the

purview of section 28(iv) of the Act, and hence, taxable as ‘revenue receipt’. The

Madras HC examined certain landmark decisions in this regard, including the SC ruling

in the case of T.V. Sundaram Iyengar & Sons8.

The Madras HC chose not to follow the ruling of its co-ordinate bench in the case of

Iskraemeco Regent Ltd9 (the Special Leave Petition filed by the Revenue against which

is currently pending before the SC) as well as certain rulings of the Delhi HC, wherein it

was held that section 28(iv) of the Act has no application to cases involving waiver of

principal portion of a loan (taken for purchase of capital assets) as the provision only

covers transactions in kind and not transactions in money. The Madras HC differed with

this proposition and held that section 28(iv) of the Act covers both transactions in kind

and transactions in money and hence waiver of a loan (taken for purchase of capital

assets) would tantamount to a ‘benefit or perquisite arising from business’ within the

meaning of section 28(iv) of the Act.

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The Madras HC further held that there is no distinction, in the accounting sense,

between waiver of a loan taken for acquiring a capital asset and waiver of a loan taken

for trading activities, on the basis that both transactions add to the owner’s equity.

Upfront payment for acquiring a 99 year lease not “rent” under section 194-I ofthe Act

The Madras HC in the case of TRIL InfoPark Ltd10 (‘TRIL InfoPark’) (a Tata Group

company) held that the payment made to Tamil Nadu Industrial Development.

Corporation Ltd (‘TIDCO’) for executing a 99 years land lease does not qualify as “rent”

under section 194-I of the Act, and consequently, no tax is required to be deducted at

source on such payment

The Madras HC noted that amount was paid by TRIL primarily for two things, viz:

(a) to be conferred with the benefit of becoming a JV Company for development of a

certain project (which was won by the Tata Group though a competitive bidding process

even before incorporation of the JV Company), and (b) to be conferred with the benefit

of a 99 years land lease for the project.

The determination of the amount of the above payment was made at the time of

selection of the JV Partner (i.e. the Tata Group) by TIDCO based on the competitive

bidding process, and the project was to be implemented by a JV Company (to be

incorporated later)

While under the Joint Venture Agreement between the JV Partner (i.e. the Tata Group)

and TIDCO, the actual payment of the amount to TIDCO was to be made by the JV

Company, but as per the actual lease agreement of the land entered into by TIDCO

with the JV Company, the lease was granted with retrospective effect from the date of

finalization of the arrangement between the JV Partner (i.e. the Tata Group) and

TIDCO.

Accordingly, the Madras HC held that an amount has been determined even before the

payer (i.e. the JV Company) came into existence for the lease of the land could not be

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regarded as “rent” in order to attract the withholding obligation under section 194-I of

the Act.

Stamp duty expense being a statutory levy, is allowable in the year of payment;

decision in Madras Industrial Investment Corporation distinguished

The Gujarat HC in the case of Prithvi Associates11, reversed the order of the

Ahmedabad bench of the Tribunal, and allowed the taxpayer a deduction of entire

stamp duty paid on a long term contract with a State-owned undertaking as revenue

expenditure in the year of payment.

The Gujarat HC observed that the payment of stamp duty was not for the purpose of

business expediency, but a compulsory levy under the law to be paid at the time when

it was actually paid by the taxpayer, and further had no bearing with the profits of the

future years, and accordingly, held that the same was deductible as revenue

expenditure in the year of payment in its entirety on the basis of the principles laid down

by the SC in the case of India Cements Ltd12 and Taparia Tools Ltd13, wherein it was

held that revenue expenditure incurred in a particular year (including especially a

statutory levy payable in that year) was to be allowed as a deductible expenditure in

that year itself.

The Gujarat HC rejected the Revenue’s contention that the allowance in respect of

the stamp duty expenditure should be spread over the duration of the contract in view

of the matching concept (based on the principles emanating from the SC judgement.

In case of Madras Industrial Investment Corporation14, on the basis that the Madras

Industrial case was in the context of a payment between two private parties and the

principle emanating from this case could not be applied to a compulsory statutory levy

under the law to be paid at the time when it was actually paid by the taxpayer.

Gujarat HC holds that lease equalization is not a 'reserve', and is not to be addedback in computing book profit under the minimum alternate tax provisions

The Gujarat HC, in the case of Sun Pharmaceutical Industries Ltd15, upheld the order

of the Ahmedabad bench of the Tribunal that lease equalization charge debited to the

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Profit & Loss Account is not in the nature of amounts carried to ‘reserve’ and hence is

not to be added back in arriving at book profit for computing minimum alternate tax

(“MAT”) under clause (b) of the Explanation below section 115JA(2) of the Act.

The Tribunal relying on past decisions i.e. Virtual Soft Systems Ltd16 and TVS Finance

and Services Ltd17 held that while such lease equalization charge may be added back

in computing business income under the normal provisions of the Act, but the same is

not in the nature of a ‘reserve’ for purposes of MAT. The Tribunal held that in the

absence of any specific provision in the Explanation below section 115JA (2) of the Act,

such adjustment could not be sustained and accordingly, the HC upheld the order of

the Tribunal.

Retention bonus paid for mitigating attrition of employees of a newly purchasedbusiness fully deductible as revenue expenditure in the year of payment

The Delhi bench of the Tribunal in the case of SAIC India Pvt Ltd18, held that retention

bonus paid by the taxpayer for mitigating attrition of employees of a newly purchased

business was fully deductible as revenue expenditure in the year of payment, and was

not to be amortized under section 35DD of the Act over five years, which deals with

expenses relating to amalgamation.

The business transfer transaction involved transfer of an Indian branch of a foreign

company, on a going concern basis, to the taxpayer in consideration of allotment of

shares by the taxpayer to the foreign company. The Tribunal held that the transaction

was not an amalgamation, and retention bonus paid by the taxpayer was not expense

in connection with amalgamation.

Mumbai Tribunal applies substance over form principle; regards growth in valueof equity shares with pre-determined annual return to be income taxable on ayearly basis

The Mumbai bench of the Tribunal in the case of Mahindra Telecommunications

Investment Pvt Ltd19, applied the principle of substance over form in the context of

equity shares carrying a pre-determined annual return on exit from the company, and

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regarded the growth in value of such equity shares to be income taxable on a yearly

basis. The salient facts were as under:

The taxpayer had 26% shareholding in an Indian JV company, with the foreign partner

holding the balance 74% shareholding.

The taxpayer had a put option and the foreign partner had a call option in relation to

the taxpayer’s shareholding in the JV company. The exercise price was defined as the

original purchase price plus a growth of 11% per annum, which was payable as the

purchase price at the time of the exercise of the option.

In addition, the taxpayer was also entitled to a call option fee @ 5.5% per annum on

the original purchase price, payable on an annual basis.

The Tribunal, relying heavily on accounting principles / practices, held that the

arrangement, in substance, was a financing arrangement and the growth (i.e. interest)

of 11% per annum ‘accrued’ to the taxpayer annually even where the options remained

unexercised.

In our opinion, the said decision is incorrect.

It may be noted that the Delhi HC in the case of Zaheer Mauritius20, in the context of

facts that were substantially similar, regarded the growth in value of such equity shares

to be capital gains upon transfer of the shares. While arriving at this conclusion, the

Delhi HC had noted that there could be a scenario where the options were not

exercised at all and hence there would be no question of any income accruing in that

case.

Also, the Bombay HC in the case of Besix Kier Dabhol SA21 has held that in the

absence of General Anti Avoidance Rules (which provide for re-characterization of debt

into equity and vice versa in the context of tax avoidance arrangements), it is not

possible to re-characterize debt as equity and disallow the interest expenditure.

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Citations

1 ITC Ltd vs CIT [2016] 68 taxmann.com 323 (SC)

2 CIT vs Amitabh Bachchan [TS-254-SC-2016]

3 Technip Singapore Pte Ltd vs DIT [TS-301-HC-2016]

4 Tata Teleservices Ltd vs CBDT [TS-263-HC-2016]

5 Vijay Singh Kadan vs CCIT [TS-233-HC-2016]

6 Ansaldo Energia SPA vs CIT [TS-279-HC-2016]

7 CIT vs Ramaniyam Homes Pvt Ltd [2016] 68 taxmann.com 289

8 CIT vs T.V. Sundaram Iyengar & Sons [1996] 222 ITR 344 (SC)

9 Iskraemeco Regent Ltd vs CIT [2011] 196 Taxman 103

10 TRIL InfoPark Ltd vs ITO [TS-209-HC-2016]

11 Prithvi Associates vs ACIT [TS-347-HC-2016]

12 India Cements Ltd vs CIT [1966] 60 ITR 52 (SC)

13 Taparia Tools Ltd vs JCIT [2015] 372 ITR 605 (SC)

14 Madras Industrial Investment Corporation vs CIT [1997] 225 ITR 802 (SC)

15 Pr. CIT vs Sun Pharmaceutical Industries Ltd [TS-344-HC-2016]

16 CIT vs Virtual Soft Systems Ltd [2012] 341 ITR 593 (Del)

17 TVS Finance and Services Ltd vs JCIT [2009] 318 ITR 435 (Mad)

18 SAIC India Pvt Ltd vs DCIT [TS-349-ITAT-2016]

19 Mahindra Telecommunications Investment Pvt Ltd vs ITO [TS-296-ITAT-2016]

20 Zaheer Mauritius vs DIT [2015] 230 Taxman 342 (Delhi)

21 DIT vs Besix Kier Dabhol SA [2012] 210 Taxman 151 (Bom)

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Disclaimer:

This newsletter has been prepared for clients and Firm personnel only. It providesgeneral information and guidance as on date of preparation and does not expressviews or expert opinions of Jhunjhunwala Advisors. The newsletter is meant forgeneral guidance and no responsibility for loss arising to any person acting orrefraining from acting as a result of any material contained in this newsletter willbe accepted by Jhunjhunwala Advisors. It is recommended that professionaladvice be sought based on the specific facts and circumstances. This newsletterdoes not substitute the need to refer to the original pronouncements.

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