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Taxsutra Database Special : Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum - Part II

Issue No. 170 / December 28, 2018

We are glad to present to you the 170th edition of ‘Orange Special’ which comprises of Part-II of the series of articles on Section 56(2)(viib)

Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum

Section 56(2)(viib) which was introduced by Finance Act, 2012 has been subject matter of a lot of controversy recently. Huge additions were made to the returned income in some of the cases in the recent past during the regular assessment proceedings, notwithstanding the availability of judicial precedents on the subject matter. In this three-part article series titled Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum, authors Mr. Prashanth (Partner, Guru & Jana, Chartered Accountants) and Mr. Sidanna Baradar (Practice Leader, Guru & Jana) explain the practical difficulties which the taxpayers face while complying with the law, recent decisions on the issues and developments in terms of notifications, etc. The series will be published in three parts, namely:

1. Part I – Introduction to the section, its literal understanding and the issues involved.

2. Part II - Discussion on the issues on the strength of the available precedence.

3. Part III- Recent Notifications, number G.S.R. 364(E), notification No. 24/2018, letter (Instruction) (File No. 173/14/2018-ITA.I) dated 06.02.2018 and other aspects

After discussing controversies surrounding determination of FMV of shares in Part-I of the series, authors in the second part titled Part II - ‘Discussion on the issues on the strength of the available precedence’ deliberate on other aspects along with supporting jurisprudence. Examining if the section 56(2)(viib) is applicable where preference shares are allotted, authors highlight Kolkata ITAT decision in Microfirm Capital wherein the Court set aside the argument that preference shares are quasi-debt and it was not the intention of the legislature to bring such instruments within the ambit of this Section. Authors further ponder over issues such as whether provisions of sec. 56(2)(viib) can be invoked in spite of a satisfactory explanation provided u/s. 68, whether the AO can compare the revenue/profit projected under DCF method vis a vis actual revenue/profit of the company and reject the valuation report. Further, authors draw attention to Chennai ITAT decision in the case of Ascendas India wherein it was clarified that net asset value as per Rule 11UA is only intended for application of section 56 and never intended for arriving at a fair market value for comparing an international transaction to establish Arm’s Length Price for transfer pricing purposes.

Click here to read Part-II of the Article Series titled “Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum”

Click here to read Part-I of the Article Series titled “Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum”

CBDT Updates :

CBDT : No coercive measures on start-ups to recover demand w.r.t additions u/s 56(2)(viib)

CBDT: Carves out exceptions from online application for nil/lower TDS / TCS Certificates

MoF : Action against Illegal Operations of Shell Companies

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Taxsutra Database Special : Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum - Part I

Issue No. 169 / December 21, 2018

We are glad to present to you the 169th edition of ‘Orange Special’ which comprises of Part-I of the series of articles on Section 56(2)(viib)

Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum

1. Part I – Introduction to the section, its literal understanding and the issues involved.

2. Part II - Discussion on the issues on the strength of the available precedence.

3. Part III- Recent Notifications, number G.S.R. 364(E), notification No. 24/2018, letter (Instruction) (File No. 173/14/2018-ITA.I) dated 06.02.2018 and other aspects

In the first article of this series titled 'Introduction to the section, its literal understanding and the issues involved', authors dissect and succinctly explain each aspect of the section in a tabular form as to its applicability, exceptions, determination of shares FMV etc. Discussing dispute surrounding the method of determination of FMV of shares, authors highlight a recent decision of Mumbai Tribunal in the case of Ozoneland Agro [TS-6963-ITAT-2018(MUMBAI)-O] wherein it has been held that it is beyond the jurisdiction of the AO to insist upon a particular system for determination of FMV of shares, especially when the Act allows the assessee to adopt one of the two methods viz., Net asset value (NAV) Method or under Discounted cash flow (DCF) method

Click here to read Part-I of the Article Series titled “Section 56(2)(viib) of Income Tax Act, 1961 - a Legal Conundrum”

CBDT Updates :

CBDT relaxes CbCR furnishing deadline for entities from countries having systemic failure Notification No. 88/2018

CBDT: Registration process of charitable trusts / institutions brought within purview of internal audit - Click here

DIPP : Acts on news reports about angel investors' notices, takes up matter with DoR - Click here

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Taxsutra Database Bulletin : Penny Stock LTCG u/s. 10(48); Manufacture vis-a-vis Additional Depreciation; CBDT Updates and more ...!

Issue No. 158/ Dec 17th, 2018

Key Takeaways from Handpicked rulings

1. [TS-9014-ITAT-2018(MUMBAI)-O] : Remuneration to Directors u/s. 40A(2) : Absent finding by AO to demonstrate that remuneration to directors is excessive and unreasonable having regard to the market rate or business needs or benefit derived by the assessee, disallowance u/s. 40A(2) is unsustainable - ITAT deletes disallowance u/s. 40A(2) on account of remuneration to directors for newspaper publisher, notes that over the years there is incremental increase in payment of remuneration to the directors and there is no quantum jump in the subject year; Explains that while invoking the provisions of sec. 40A(2)(a), the AO must bring material on record to demonstrate that the payment made by the assessee is excessive or unreasonable having regard to the market rate for the goods, services, facilities availed or the business needs of the assessee or commensurate with the benefit derived by the assessee which has not been done by the AO; Noting that the object behind introduction of sec 40A(2) is to prevent evasion of tax through shifting of profit by making payment to related parties, ITAT states that “Therefore, it is of paramount importance to examine whether the assessee has made payment for evading tax through shifting of profit”;

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2. [TS-9018-ITAT-2018(JAIPUR)-O] : Penny Stock LTCG u/s. 10(48) : Absent evidence to show that assessee has paid over and above the purchase consideration or paid in cash, it cannot be held that the assessee has introduced his own unaccounted money by way of bogus long term capital gain - Jaipur ITAT allows assessee's appeals, sets aside CIT(A)'s order and directs the AO to not treat the LTCG as bogus and delete the consequential addition; Holds that when shares were allotted directly by the company to the assessee at par on face value then the same cannot be considered as a penny stock transactions; States that "...once the assessee produced all relevant evidence to substantiate the transaction of purchase, dematerialization and sale of shares then, in the absence of any contrary material brought on record the same cannot be held as bogus transaction merely on the basis of statement of one Shri Anil Agrawal recorded by the Investigation Wing"; Notes that the transaction is established from the evidence and record which cannot be manipulated as all the entries are part of the bank account and D-mat account which is also an independent material and evidence;

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Editorial Note :

Mumbai ITAT in a similar case, facts and circumstances, following the above ruling allowed the LTCG exemption u/s. 10(38) in its ruling reported in [TS-9009-ITAT-2018(MUMBAI)-O],

Recently, Bangalore ITAT in its ruling reported in [TS-600-ITAT-2018(Bang)] has rejected assessee’s LTCG exemption claim citing dubious trading in ‘penny stocks’. Rejecting assessee’s stand that contract notes were placed on record and the payment were made through cheques identifying the company whose shares were transacted, ITAT observed that the financial worth of the company was very meager and which did not justify the manifold increase in the prices.

3. [TS-8948-ITAT-2018(DELHI)-O] : Principles of Mutuality/Benefit u/s. 11 : All ingredients of mutuality exists, interest income earned by assessee-society eligible for benefit under section 11 - ITAT rules in favour of assessee, holds that Interest income is nothing but income derived from property (i.e., maintenance fund from the members) held under the trust as stipulated in sec 11; Holds that “Once the assessee has been granted registration u/s 12A, then it is an incumbent upon the AO to mandatorily compute the income u/s 11 to 13. Such a benefit can only be denied if the conditions laid down u/s 11 to 13 are not fulfilled.”;

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4. [TS-9104-ITAT-2018(BANGALORE)-O] : Manufacture vis-a-vis Additional Depreciation : Activity of Fractional distillation, using natural air to produce commercial gases is ‘manufacture’; Assessee eligible for additional depreciation u/s. 32(1)(ii) - ITAT dismisses Revenue’s appeal, allows additional claim of depreciation u/s. 32(1)(ii) to assessee on additions made to the plant and machinery during AY 2011-12; Notes that the gases produced by the assessee in the process of fractional distillation of air are having different chemical and physical properties and commercial values from the raw material and is in line with the intention of the legislature is to bring in new things, article or product by using the machines etc., and the said products, thing or article are having different commercial name and values;

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CBDT Updates:

1. CBDT- Clarifies scope of Departmental appeal on merits notwithstanding low tax effect - Clarification to Circular No. 3/2018

2. CBDT- Issues final notification u/s. 115JG relating conversion of foreign banks’ Indian branch into subsidiary - Notification No. 85/2018; Notification No. 86/2018

3. IT Dept. - Clarifies no Sec. 194A TDS on Senior citizens’ income not exceeding Rs. 50,000 - Notification No. 6/1/2018

4. MoF : Cabinet approves revised Model MoU between India and foreign Financial Intelligence Units (FIUs) for exchange of information

5. CBDT: Direct tax collection upto November, 2018 records increase of 15.7% compared to last year

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Taxsutra Database Bulletin : Freebies to Doctors, MCI Guidelines; Penalty for accepting & repaying loan/deposits in cash; CBDT Updates and more ...!

Issue No. 157/ Dec 3rd, 2018

Key Takeaways from Handpicked rulings

1. [TS-7045-HC-2018(GUJARAT)-O] : ITAT’s jurisdiction for rectification: The jurisdiction to correct errors vested in the Tribunal is not akin to review powers - HC reverses Third Member ruling who upheld AM’s view that Revenue’s miscellaneous petition deserves to be allowed; Notes that Revenue sought rectification of the ITAT order (which had accepted assessee’s contention that the undisclosed income was agricultural income) on the ground that according to assessee, the undisclosed income belonged to his son and daughter-in-law; Holds that the Tribunal erred in recalling its order that was based on submissions made before it and upon consideration of materials and evidences on record; Noting Tribunal’s findings in its original order that no evidence was collected by the Revenue during the search or post search inquiry to hold that the additional income disclosed was not agriculture income, HC states that “Whatever be the correctness of these findings it cannot be stated that the Tribunal arrived at such findings without proper consideration of materials on record….The Tribunal could not have recalled the entire order under purported exercise of rectification powers.”

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2. [TS-8935-ITAT-2018(DELHI)-O] : Taxability of transfer of software as royalty : Receipts from “Sale of Software” by Irish company not in nature of “Royalty” under Article 12 of India-Ireland DTAA - ITAT rules in favour of assessee, holds its income from sale of software not taxable in India; Notes that treaty provisions between India and Ireland unambiguously require that the use of copyright is to be taxed in the source country; Holds that assessee having transferred the copyrighted product and not the copyrights in the computer software programme, consideration received therefrom is not taxable in India in terms of the Treaty between India and Ireland; Relies on jurisdictional HC decisions in Ericsson A.B. and Infrasoft wherein it was held that software licensing income is not Royalty, not taxable in India; ;

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3. [TS-8936-ITAT-2018(MUMBAI)-O] : Freebies to Doctors, MCI Guidelines : MCI guidelines prohibit doctors from accepting travel facilities for conferences where they are 'delegates' and not where they are ‘faculty doctors’ or ‘consultant doctors’; Expenses on sales staff, hiring materials and participation / sponsorship expenses on employees incurred for business purposes, not in violation of MCI Guidelines - ITAT allows amount spent by assessee (distributor of heart therapy products and related medical equipments) in connection with medical conference attendance of faculty and consultant doctors, finds that the expenditure is towards business exigencies that demand updating of knowledge of the doctors/surgeons to implant/use assessee's products;

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4. [TS-8934-ITAT-2018(CHENNAI)-O]: Penalty for accepting & repaying loan/deposits in cash u/s. 271D & 271E : Absent explanation for receiving and paying out deposits in cash from shareholder-director in violation of provisions of Sec.269SS & 269T, penalty u/s.271D & 271E is confirmed - ITAT confirms penalty u/s. 271D & 271E, peruses the cash flow to note that sufficient funds were available with assessee to meet its requisite expenditure and hence, cash was not required to be taken; Holds that “ It is true that if the assessee really needs emergency funds for business exigencies, taking of cash can be considered as a reasonable cause but that has not been established here, clearly. In fact, the cash flow produced by the assessee clearly negates the claim of business exigencies raised by the assessee.”;

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CBDT Updates:

1. Central Govt. appoints an Adjudicating Authority at New Delhi under the Prohibition of Benami Property Transactions Act, 1988 - Notification No. 79/2018

2. Central Govt. appoints an Adjudicating Authority at New Delhi under the Prohibition of Benami Property Transactions Act, 1988 - Notification No. 79/2018

3. Central Govt. establishes an Appellate Tribunal at New Delhi to hear appeals against the orders of the Adjudicating Authority under the Prohibition of Benami Property Transactions Act, 1988 - Notification No. 81/2018

4. CBDT issues final notification amending Rule 114 and forms for PAN application - Notification No. 82/2018

5. CBDT : India - China sign Protocol amending DTAA incorporating BEPS related changes

6. CBDT : Proposes draft rules & e-filing of forms for application for approval u/s 10(23C)/80G

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Taxsutra Database Bulletin : Taxation of notional share price; Reopening of assessment based on information from DIT(Inv); CBDT Updates and more ...!

Issue No. 156/ Nov 6th, 2018

Key Takeaways from Handpicked rulings

1. [TS-8527-ITAT-2018(DELHI)-O] : Taxation of notional share price u/s. 56(2)(viia) : Sec.56(2)(viia) introduced w.e.f. June 2010 prospective in nature, not applicable to allotment of shares during AY 2008-09 - ITAT allows assessee’s appeal; Holds that Sec. 56(2)(viia) introduced w.e.f. June 2010, bringing to tax receipt of shares for inadequate consideration r.w.s 2(24)(xv) is prospective in nature and hence not applicable to allotment of shares during AY 2008-09; ITAT also relies on AP HC decision in the case of K.N.B. Investments Pvt. Ltd. wherein it was held that mere issuance of shares does not result in any benefit, it was further explained that the word used in Sec. 28(iv) are ‘arisen from business’ where ‘arisen’ signifies that benefit itself must have arisen;

Click here to read the Ruling Copy

2. [TS-5438-SC-2018-O] : Penalty - False claim of depreciation on non-existing asset : Penalty u/s. 271(1)(c) correctly levied since assessee made a false claim of depreciation on an asset that did not exist - SC dismisses assessee’s SLP against HC order that confirmed penalty u/s. 271(1)(c) with respect to depreciation claimed on an asset that did not exist; HC had dismissed assessee’s appeal and sustained penalty on assessee for making a false depreciation claim on a leased asset that did not exist; HC upheld the IT authorities’ observation that by claiming depreciation on machinery which did not exist or which was never supplied, the assessee has, not only concealed particulars of its income, but has also furnished inaccurate particulars of income; It was noted that the false claim came to light only upon search conducted; HC took note of the principles laid down by Karnataka HC in the case of Manjunatha Cotton [TS-936-HC-2012(KAR)-O], stated that “...it is not necessary that there should be wilful concealment for attracting a civil liability of penalty under Section 271(1)(c) of the Act...We are in agreement with the factual findings rendered by the authorities since the petitioner is a leasing company as it is very hard to believe a case where the leasing company had made advances for leasing out a machinery, which never in existence”;

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3. [TS-8621-ITAT-2018(DELHI)-O] : Computation of income for assessee engaged in life insurance business : Provisions of Sec.44 applicable to an assessee engaged in life insurance business even though assessee filed computation u/s. 44 only during appellate proceedings and not earlier; Issuing notice in the standard proforma wherein the irrelevant clauses have not been struck off indicates non-application of mind on the part of the AO while issuing the penalty notice - ITAT dismisses Revenue’s appeal, holds that income of the assessee carrying on business of life insurance and duly registered and governed by IRDA is to be computed u/s. 44 read with the First Schedule (providing for computation of income for insurance businesses) and the profit and gains from the life insurance business are to be computed separately from any other business of the assessee; Clarifies that “...these provisions are non obstante i.e. they override the other provisions of the Act and, therefore, the income chargeable of tax of an insurance company has to be computed in accordance with provisions thereof.”; Noting the overriding nature of Sec.44, ITAT upholds CIT(A)’s allowing of additional ground to allow computation u/s. 44 to be filed at the time of appellate proceedings though the return of income was not filed under the correct provisions of the Act; Separately, deletes penalty u/s. 271(1)(c), notes from the perusal of the notice issued u/s 274 r.w.s. 271 that the AO has not specified as to under which limb of the section the penalty was imposable; Follows Karnataka HC decision in SSA’s Emerald Meadows [TS-5987-HC-2015(Karnataka)-O]

Click here to read the Ruling Copy

4. [TS-8532-ITAT-2018(DELHI)-O] : Reopening of assessment based on information from DIT(Inv) : Sufficiency or correctness of the information is not to be seen at the stage of the reopening of the assessment; The reassessment proceedings empower the AO to verify correctness of the information - ITAT allows Revenue’s appeal, sets aside the order of CIT(A) to the extent of holding the reopening proceedings u/s. 147 as invalid; States that the information obtained from DIT(Inv) regarding accommodation entries which was after carrying out detailed enquiries from the accommodation entry providers, giving out specific details cannot be termed as vague; Notes SC ruling in case of Raymond Woollen Mills wherein it was held that the sufficiency or correctness of the information is not to be seen at the stage of the reopening of the assessment and opines that “the reassessment proceeding is a kind of enquiry, where the assessee is granted opportunity to explain his stand on the correctness of reasons to believe escapement of income….The reassessment proceedings thus, empower the Assessing Officer to verify correctness of the information”;

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5. [TS-6978-HC-2018(KARNATAKA)-O] - Deduction u/s 80P(4) : HC dismisses assessee’s appeal, confirms order of ITAT where it was held that dealings and deposits with non-members lead to non-eligibility for deduction u/s. 80P and matter was remanded for de novo assessment in line with decision of SC in Citizen Co-operative Society Ltd. [TS-5136-SC-2017-O] ; Rejects assessee’s submission that while remanding the matter, the Tribunal has erred in holding that the Pigmi account goes to show that the appellant has accepted the deposit even from non-members, which is totally erroneous, holds that the ITAT while remanding the matter ought not to have recorded any finding on merits of the case;

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