The year 2011 was in the news (insofar has tax issues are consult) mainly due to a few high-profile matters in the Supreme Court. The public interest litigation relating to black money (Ram Jethmalani v. Union of India) and the hearing in the Vodafone case are few examples of this. In terms of legal issues however, 2011 saw a number of far-reaching decisions of the courts which may not have been as much in the public eye.
The decision of a Constitution Bench in GVK Industries confirms that the doctrine of territorial nexus applies to Union Laws as well. The Constitution bench, however, did not lay down any principles beyond what had already been laid down by three judges in Electronics Corporation.
Arguments in the Vodafone case concentrated on issues surrounding the planning/avoidance/evasion debate. Several High Courts have also weighed in with their pronouncement on this issue. The Punjab High Court in a Full Bench decision in CIT v. Rockman Cycle Industries, confirmed the assessee’s understanding of the Azadi-McDowell relationship; and confirmed that roving enquires into economic realities at the cost of legal substance are not permitted in law. The Karnataka High Court however, in Richter Holding’s case, left a rather broad window open to the Revenue in cases related to lifting of the corporate veil. In Aditya Birla Nuvo, the Bombay High Court came down heavily on what it saw as an abuse of the Mauritius Gateway. Azadi Bachao Andolan was distinguished, and this decision (also pending appeal before the Supreme Court) has the potential to increase uncertainty in the minds of investors. One way to reduce the uncertainty surrounding tax issues in foreign investment has always been in the form of making an application for an advance ruling. Previously, the AAR has been sympathetic to the effective use of treaty benefits (for instance, in E-Trade Mauritius). However more recent advance rulings create some difficulties even in this regard. The AAR relied on Section 245 R (2), proviso-(iii) (which states that the authority shall not allow any application relating to an issue which is design for the avoidance of tax) and also made several observations tending to blur the ratio of Azadi. It appears that the tax payer shall have no repose until the Supreme Court conclusively decides the matter. One hopes that the Supreme Court in Vodafone will provide definite guidance in this regard.
The other burning issue for the past couple of years has been that of whether payment for supply of off-the-shelf software amounts to royalty. A few years ago, it appeared that the issue seen settled at the tribunal level, where in several well-considered judgments (for instance, Sonata) had held that there is a distinction between ‘copyright’ and ‘copyrighted articles’. Consequently, it was held that payment for supply of software would ordinarily be a payment for use of ‘copyrighted article’ and not ‘copyright’. Hence, it would not amount ‘royalty’. However, the past year saw divergences among various tribunal benches resurface. Matters were carried to various High Courts, but certainty once against continues to elude the assessee. The Karnataka High Court decided in favour of the department in Samsung, the Delhi High Court decided the issue against the department (DIT v. Ericsson). The Bombay High Court has admitted appeals on this issue as involving a substantial question of law.
In so far as the issue of deemed dividend is concerned, the issue was decided in favour of the assessee by the tribunal in Bhaumik’s case. Bhaumik was approved in passing by the Bombay High Court; however the same High Court has since admitted departmental appeals, thus signifying that the issue is not yet completely resolved. Decisions of the other High Courts in the past year (CIT v. National Travel Services, CIT v. Ankitech) also do not conclusively point to one out-come.
In procedural matters, particularly on the issue of reopening U/s. 148, assesses had found relief in a Full Bench decision in Kelvinator’s case (256 ITR 1, subsequently approved by the Supreme Court). However the Bombay High Court in Indian Hume Pipe and the Delhi High Court in Dalmia Private Limited have perhaps strengthened the arms of the department in reopening completed assessments, whether within or beyond four years. In Indian Hume Pipe, the Court held (in the context of a reopening beyond four years), “The full and true disclosure which the statute contemplates must be judged in the context of Explanation 1 to Section 147. The assessee cannot merely rely upon the fact that if the Assessing Officer had followed an enquiry with due diligence on the basis of the account books or other evidence produced by the assessee, he could have discovered material evidence. The mere production of account books or other evidence from which material evidence could with due diligence have been discovered by the Assessing Officer does not necessarily amount to a disclosure within the meaning of the first proviso to Section 147… The assessee did enclose copies of the certificates which do bear the date of allotment. However, in our view, it is evident that the Assessing Officer had clearly not applied his mind to the question…”
Another important issue, one which was decided against the assessee, is the issue of whether non-compete fee payments are deductible revenue expenditures. The Delhi High Court in Pitney Bowes v. CIT approved the Special Bench decision in Tecumseh case. It is submitted that neither Tecumseh nor Pitney Bowes lay down an absolute proportion that non-compete fees are always capital expenditure. The issue is a mixed question of law and fact: useful reference can be made to the Delhi High Court decision in Eicher’s case 302 ITR 349. On the point of whether non complete receipts are taxable, the Supreme Court in Guffic’s case has held that Section 28(va) inserted with effect from 1-4-2003 is not retrospective. However, the scope of Section 28(va) itself does not appear to have been specifically considered by the higher judiciary (except in stray observations).
There is greater clarity, however, on at least one issue, that is the issue of treatment of subsidies. The effect of the decisions of the Supreme Court in Sahney Steel and Ponni Sugars is that the purpose behind the subsidy must be examined. If the subsidy is to increase day-to-day profitability, it is a revenue receipt. One issue remained to be answered – i.e. whether a subsidy given after completion of construction can also be treated a capital receipt. In Ponni Sugars, the Court had held that what matters is the substance and essence. The form is not material. However on the facts of Ponni Sugars, the subsidy was meant for repayment of a loan taken for construction purposes only. In Chaphalkar Brothers, the Bombay High court had to decide whether a subsidy given in the form of entertainment duty rebate (given after completion of construction, and with no conditions as to user of the amount) would also be treated as a capital receipt. The revenue argued that in the absence of a condition that the subsidy is to be used solely for making repayments of loans taken for capital purposes, the subsidy must be treated as tending to increase the day-to-day profitability. The court held that the subsidy would be a capital receipt, on the basis that the purposes of the subsidy in that case was stated to be for the promotion of the multiplex industry. It appears that the end-user of the subsidy amount is only one factor which would indicate the true purpose of the subsidy. It is a not a conclusive factor. If it is established on facts that the subsidy is otherwise for capital purposes, the principle in Ponni automatically applies and it is immaterial that there is no condition relating to end-use.
There is greater clarity, however, on at least one issue, that is the issue of treatment of subsidies. The effect of the decisions of the Supreme Court in Sahney Steel and Ponni Sugars is that the purpose behind the subsidy must be examined. If the subsidy is to increase day-to-day profitability, it is a revenue receipt. One issue remained to be answered – i.e. whether a subsidy given after completion of construction can also be treated a capital receipt. In Ponni Sugars, the Court had held that what matters is the substance and essence. The form is not material. However on the facts of Ponni Sugars, the subsidy was meant for repayment of a loan taken for construction purposes only. In Chaphalkar Brothers, the Bombay High court had to decide whether a subsidy given in the form of entertainment duty rebate (given after completion of construction, and with no conditions as to user of the amount) would also be treated as a capital receipt. The revenue argued that in the absence of a condition that the subsidy is to be used solely for making repayments of loans taken for capital purposes, the subsidy must be treated as tending to increase the day-to-day profitability. The court held that the subsidy would be a capital receipt, on the basis that the purposes of the subsidy in that case was stated to be for the promotion of the multiplex industry. It appears that the end-user of the subsidy amount is only one factor which would indicate the true purpose of the subsidy. It is a not a conclusive factor. If it is established on facts that the subsidy is otherwise for capital purposes, the principle in Ponni automatically applies and it is immaterial that there is no condition relating to end-use.
The above cases are in no manner exhaustive of the several issues which have been decided in the preceding year. In sum, though, 2011 was a year where a few tax cases made headlines; yet, behind the public gaze, issues continue to simmer and give more food for thought.