MAT: Some Legal Issues

One of the changes sought to be introduced through the Budget this year was the imposition of alternate minimum tax on Limited Liability Partnerships. This is sought to be achieved by the introduction of Section 115JC into the Income Tax Act, 1961. Section 115JC provides:

115JC. Special provisions for payment of tax by certain limited liability partnerships.—(1) Notwithstanding anything contained in this Act, where the regular income-tax payable for a previous year by a limited liability partnership is less than the alternate minimum tax payable for such previous year, the adjusted total income shall be deemed to be the total income of the limited liability partnership for such previous year and it shall be liable to pay income-tax on such total income at the rate of eighteen and one-half per cent.

(2) Adjusted total income referred to in sub-section (1) shall be the total income before giving effect to this Chapter as increased by—

(i) deductions claimed, if any, under any section included in Chapter VI-A under the heading “C.—Deductions in respect of certain incomes”; and

(ii) deduction claimed, if any, under section 10AA.

In the case of companies, u/s 115JB, the book profits are deemed to be the total income of the company and tax is payable on the book profits. The concept of book profits is defined under Explanation 1 to mean the net profit as shown in the P&L account, subject to certain additions and reductions. This in itself has led to several controversies. Some of these include the issue of whether any additions other than those mentioned in the Explanation can be claimed, and the issue of whether exempt income such as exempt capital gains are also taxed under the MAT net.

In the case of LLPs, the difficulties are sought to be avoided by clearly stating that the adjusted total income means the total income under the Act increased by Chapter VI-A deductions and by Section 10AA deductions. The issue of what additions and deductions are permissible and not permissible, is thus clarified to a great extent. However, as a policy issue, there have been several concerns  over the imposition of MAT on LLPs. Further, the Finance Act also seeks to introduce provisions imposing MAT on SEZ units by making amendments to Section 115JB(6). These provisions have been challenged in the Gujarat High Court, as reported here.

Turning back to some of the more controversial issues in MAT (u/s 115JB), one of the issues pertains to the use of somewhat creative, but permissible, accounting methods. For example, one common technique seen is that of crediting certain capital gains directly to the reserves without routing it through the profit and loss account. Whether or not such treatment is perfectly in accordance with the accounting standards is a debatable point. However, even when the statutory auditors have certified such treatment as being in accordance with the accounting standards, the Department in several instances has taken the view that these gains ought to have been reflected in the P&L account, and have sought to make additions to the net profit as shown by assessees. The Supreme Court in Apollo Tyres v. CIT, 265 ITR 273 had held (on the issue of whether tax authorities can go behind the audited accounts), “we find it difficult to accept the argument of the Revenue that it is still open to the Assessing Officer to re-scrutinize this account and satisfy himself that the accounts have been maintained in accordance with the provisions of the Companies Act…” However, in Bombay Diamond, ITA 7488/Mum/07, the Mumbai Bench of the Tribunal has held that it is open to the AO to consider whether the accounts have been kept in accordance with the provisions of the Companies Act and the accounting standards, even when statutory auditors have certified the same. The second issue is concerned with whether exemption under the regular provisions of the Act – such as exempt capital gains u/s 47(iv) – can also be used in the case of MAT. This issue was decided against the assessee by the Special bench of the Tribunal in Rain Commodities v. DCIT – a decision which may require some reconsideration, as argued here. In Rain Commodities, the contrary judgment in Sutlej Cotton Mills was held to be no longer good law.

Thus, the provisions of MAT continue to give rise to legal controversies, and no easy solutions are in sight. Assessees will have to wait for a detailed decision by a High Court in order for certainty on these issues. Insofar as LLPs are concerned, the provisions themselves appear to try to minimize these controversies. Only the Chapter VI-A and Section 10AA deductions need to be added back to compute the adjusted total income.

Electronic Communication and Meetings under the Companies Act

Over the last month or so, the Ministry of Corporate Affairs (MCA), Government of India has announced a series of “Green initiatives” to convert various processes under the Companies Act from paper to electronic form. This comes more than a decade after the Information Technology Act, 2000 was enacted, and will be welcomed as Indian industry and practitioners have been seeking these changes for a number of years.

The key changes occasioned are as follows:

1. Issue of Certificates: Various certificates to be issued by the Registrar of Companies (ROC) to companies and other stakeholders under the Companies Act will now be issued in electronic form under digital signature of the ROC.

2. Services of Documents: Section 53 of the Companies provides for the method by which a company may effect service of documents. Under the new initiative, a company may comply with this section “if the services of document has been made through electronic mode provided the company has obtained –email addresses of its members for sending the notice/documents through e-mail by giving an advance opportunity to every shareholders to register their e-mail address and changes therein from time to time with the company”.

This is a useful change as it now eases the burden of sending bulky documents such as the annual report to shareholders in physical form, particularly because it is unlikely that many small shareholders would review these in any detail at all.

3. Board Meetings: Meetings of the board of directors may now be conducted using video conference facility. However, each director must physically attend at least one meeting each financial year. More importantly, the participation of a director through video conference facility will be counted towards quorum. There are a number of other checks and balances introduced in the arrangement to ensure authenticity and credibility of the proceedings.

4. Shareholder Meetings: Similar to board meetings, shareholder meetings too can be held using video conferencing subject to inbuilt safeguards.

MCA now requires that listed companies “must provide video conferencing connectivity during such meetings at least five places in India”. This will ensure the shareholders need not travel across cities to attend general meetings, especially when meetings are held in interior locations that are not easily accessible.

While shareholders may participate electronically, the quorum required for the meeting will have to be present physically at the place of the meeting. As far as quorum is concerned, there seems to be a distinction between board meeting and shareholders’ meeting. This may introduce some practical difficulties in closely-held companies with a small number of shareholders where a minimum number of shareholders required to constitute quorum will still have to physically congregate at the location of the meeting.

Overall, these changes are beneficial to a more inclusive process in corporate democracy that generates greater participation in corporate decision-making.

The Bhopal Case: Supreme Court's order on CBI's Curative Petition

We had previously highlighted discussions on the Law and Other Things blog pertaining to the decision of the Chief Judicial Magistrate in the Bhopal gas leak case. The CJM had purported to follow a 1996 judgment of the Supreme Court; in which, the Supreme Court had quashed charges under Section 304 (Part II) of the Indian Penal Code. Last week, a Constitution Bench of the Supreme Court dismissed a curative petition (CBI v. Keshub Mahindra) filed by the Central Bureau of Investigation against the 1996 judgment. The issue in the cases pertained to whether Union Carbide companies and executives were liable to be charged for offences under Sections 304 (Culpable homicide not amounting to murder), 324 (voluntarily causing hurt by dangerous weapons or means), 326 (voluntarily causing grievous hurt by dangerous weapons or means), etc. The 1996 judgment, at the stage of framing of charges, had found that there was no sufficient material to proceed under these Sections, and directed the trial Court to proceed only on the basis of charges u/s 304A (causing death by negligence). A curative petition was filed against this order of the Supreme Court. Last week’s order dismissing this petition has been met with dismay by activists, who wish to highlight the ‘failure of justice’ for the victims of the tragedy; however, a perusal of the Court’s order shows that these  voices of dismay are not quite justified. The Court observed:

“It is clear to us that in the criminal revisions filed by the CBI and the State of M.P. the legal position is correctly stated. But the curative petitions are based on a plea that is wrong and fallacious. As noted above, one of the main planks of the curative petitions is that even though in course of trial before the Magistrate, additional evidences have come on record that fully warrant the framing of the higher charge (s) and the trial of the accused on those higher charges, as long as the 1996 judgment stands the Sessions Court would feel helpless in framing any higher charges against the accused in the same way as the trial court observed that in view of the judgment of the Supreme Court no court had the power to try the accused for an offence higher than the one under Section 304A of IPC. The assumption is wrong and without any basis. It stems from a complete misapprehension in regard to the binding nature of the 1996 judgment. No decision by any court, this Court not excluded, can be read in a manner as to nullify the express provisions of an Act or the Code and the 1996 judgment never intended to do so. In the 1996 judgment, this Court was at pains to make it absolutely clear that its findings were based on materials gathered in investigation and brought before the Court till that stage. At every place in the judgment where the Court records the finding or makes an observation in regard to the appropriate charge against the accused, it qualifies the finding or the observation by saying “on the materials produced by the prosecution for framing charge”. “At this stage”, is a kind of a constant refrain in that judgment. The 1996 judgment was rendered at the stage of sections 209/228/240 of the Code and we are completely unable to see how the judgment can be read to say that it removed from the Code sections 323, 216, 386, 397, 399, 401 etc. or denuded a competent court of the powers under those provisions. In our view, on the basis of the material on record, it is wrong to assume that the 1996 judgment is a fetter against the proper exercise of powers by a court of competent jurisdiction under the relevant provisions of the Code. If according to the curative petitioner, the learned Magistrate failed to appreciate the correct legal position and misread the decision dated 13.9.1996 as tying his hands from exercising the power under Section 323 or under Section 216 of the Code, it can certainly be corrected by the appellate/revisional court.”

On this basis, although the curative petition was dismissed, the Supreme Court clarified that the 1996 judgment should not be seen as limiting the powers of the trial court under Section 323/216 of the Code of Criminal procedure.

Under Section 323, if it appears to the Magistrate, in any inquiry into an offence or a trial before him, at any stage of the proceedings before signing judgment, that the case is one which ought to be tried by the Court of Session, then the Magistrate has to commit the case to the Sessions court. Under Section 216, a court may alter, add to or amend the charge at any time before the judgment is pronounced. What the Supreme Court seems to be saying is that the 1996 judgment is restricted to framing of charges, and if during the course of trial any fresh material on record indicated the possibility of a more serious charge, the 1996 judgment cannot be understood as protecting the accused even then. The proper remedy was not before the Supreme Court by way of a curative petition, but before the appellate or revisional court. Issues of corporate criminal liability were not specifically addressed by the Constitution Bench, but these issues – including attribution of knowledge/intention to companies, liability of officers etc. – are now likely to arise in the appellate proceedings.

The 3/4 Formula to Determine Implied Exclusion

(In the following post, Mr Adithya Reddy, Advocate, Madras High Court, considers the law on implied exclusion of Part I of the Arbitration Act)

“…we hold that the provisions of Part I would apply to all arbitrations and to all proceedings relating thereto. Where such arbitration is held in India the provisions of Part I would compulsory apply and parties are free to deviate only to the extent permitted by the derogable provisions of Part I. In cases of international commercial arbitrations held out of India provisions of Part I would apply unless the parties by agreement, express or implied, exclude all or any of its provisions.”

The above paragraph (para. 32) of the judgment in Bhatia International v Bulk Trading S.A (“Bhatia”) has been the source of several litigations before Indian Courts on the question of what amounts to “implied” exclusion of Part I. The latest judgment on the issue came from the Supreme Court in Videocon Industries v Union of India (“Videocon Industries”). A useful post summarizing the background and findings of the judgment has already been written.

My endeavor in this post is only to try and locate a discernable pattern in all the judgments of the Supreme Court and various High Courts to see if one can arrive at precise criteria to determine if the terms of a given arbitration agreement imply exclusion of Part I. The necessity for such a criteria stems from the fact that Courts often end up spending long hours hearing lengthy arguments and writing elaborate judgments in cases of this nature which essentially involve interpretation of one brief paragraph if not a few lines, in a commercial contract. Two courts interpreting different arbitration agreements with dissimilar terms need not reach the same conclusion, but what no Court, including the Supreme Court, has tried to do is lay down definite requirements which if fulfilled will constitute implied exclusion. This will avoid protracted litigation. In fact providing precise clarity on ‘implied exclusion’ could dissuade several parties from initiating proceedings before Indian Courts.

If we look at the various judicial pronouncements the following emerge as the exhaustive components of an arbitration agreement that are required to be looked at to determine “implied exclusion”:-

a) The seat or place of arbitration which is the “place initially agreed by or on behalf of the parties” and “designated in the arbitration agreement or the terms of reference or the minutes of proceedings or in some other way as the place or "seat" of the arbitration. (Redfern and Hunter as cited in para. 14 of Dozco India Pvt Ltd Vs. Dossan Infracore Ltd) (“Dozco India Pvt Ltd”). As has been settled by the Supreme Court in both Dozco India Pvt Ltd & Videocon Industries, the fact that the arbitration agreement permits the arbitration proceedings to be held in places other than the designated seat will not change the seat of arbitration.

An arbitration with its ‘seat’ (not just a few hearings) in India is an arbitration ‘held in India’ for the purposes of Section 2(2) of the Act and Part I would compulsorily apply. Specifying a place outside India as the seat is therefore a condition precedent to find ‘implied exclusion’ of Part I. But as held in Bhatia, this by itself does not amount to ‘implied conclusion.’

In a first-of-its-kind case the Madras High Court (Financial Software & Systems v ACI Worldwide Corp 2011-2-LW-654 (“Financial Software”)) held that the concerned arbitration agreement impliedly excluded Part I even thought it did not specify the seat of arbitration. This was so because even though the agreement did not specify the seat, the Rules of the Singapore International Arbitration Centre which were the applicable curial law provided that Singapore shall be the seat of arbitration if the parties do not agree on a seat. The rules of the London Court of International Arbitration also contain a similar provision. Specifying a seat of arbitration is not required only in such cases i.e. where the curial law provides for a default seat of arbitration. Otherwise it is mandatory.

b) The ‘proper law' of contract i.e. law governing the contact creating substantive rights in the parties with respect to the dispute. At least two Supreme Court decisions -Indtel Technical Services Private Ltd. v. W.S. Atkins Rail Ltd (“Intdel”) and Citation Infowares Ltd. v. Equinox Corporation (“Citation Infowares”) make it clear that mere specification of proper law of contract as foreign does not amount to an implied exclusion of Part I. As seen earlier, the seat of arbitration has to be specified.

However, interestingly till Videocon Industries all cases that found “implied inclusion” (Max India Ltd. v. General Binding Corporation (2009) 3 Arb LR 162 (DEL) (DB) (“Max India”), DGS Realtors Pvt. Ltd. v. Realogy Corporation MANU/DE/2115/2009 (“DGS Realtors”) and Frontier Drilling A.S. v. Jagson Internatural Ltd (2003) 3 Arb. LR 548 (“Frontier Drilling”) and Financial Software Systems) relied on the fact that the proper law of contract was foreign. It was only in Videocon Industries that the Court held “implied conclusion” even though the proper law was Indian (it relied on the fact that the law governing the arbitration agreement was foreign).

Therefore, specification of proper law of contract as foreign law is neither sufficient nor necessary as criterion to determine “implied exclusion”.

c) The ‘procedural law’ of arbitration agreement i.e. law governing the obligation of the parties to submit the dispute to arbitration and to honour the award. As pointed out by the Supreme Court in Dozco India Pvt Ltd, rarely does this category of law differ from the curial law (which we shall see next). In my view it is this category of law that ought to be crucial, as it was in Videocon Industries, for the simple reason that Courts competent to interpret such law, and not Indian Courts, should decide on all issues of interpretation and scope of the arbitration agreement. The significance of a foreign law governing the arbitration agreement is explained well in the decision of the Gujarat High Court in Hardy Oil and Gas v Hindustan Oil Exploration- a decision that was approved by the Supreme Court in Videocon Industries.

However, in most cases which held exclusion of Part I the law governing the arbitration agreement was not specified. Therefore this is also not a mandatory requirement to determine exclusion of Part I.

d) The ‘curial law’ i.e. the law governing the conduct of the individual reference. The curial law, which is in most cases a set of rules, need not be specified in an arbitration agreement to exclude Part I. While express mention of Indian law as the ‘curial law’ might militate against “implied exclusion” of Part I, non-specification of such law is not material because Courts have presumed such law to be the law of the country in which the seat of arbitration resides. In Dozco India Pvt Ltd, the Supreme Court relied on Mustill & Boyd to hold that “in the absence of express agreement, there is a strong prima facie presumption that the parties intend the curial law to be the law of the 'seat' of the arbitration”. This view was first adapted by the Supreme Court in NTPC v Singer, AIR 1993 SC 998 and was espoused by the Bombay and Delhi High Courts in Frontier Drilling A.S and DGS Realtors. The presumption, though rebuttable, has been applied by Courts.

Therefore, in the absence of specific curial law the specification of a foreign seat (which in any case is mandatory) is sufficient to show the existence of a foreign curial law. As seen in the Financial Software Solutions case, the vice-versa also might be true when the curial law provides for a default seat of arbitration in the absence of a specific seat in the agreement.

What emerges from the above is simple-

a) A foreign seat of arbitration has to be provided for in the contract, to imply exclusion of Part-I.

b) Since Bhatia says that providing a foreign seat (and by implication foreign curial law) is not sufficient, there has to be a mandatory third component which is foreign.

c) Videocon Industries has clarified that the mandatory third component need not be the proper law of contract. It can even be the law governing the arbitration agreement.

While in some cases like in Max India Courts had the luxury of finding even the jurisdiction of foreign courts over disputes being specified, in all cases that upheld “implied exclusion” at least three out of the four of the above components were found to be foreign. And conversely, in all cases that upheld the applicability of Part-I less than three components were found be foreign.

So here goes the formula- Foreign Seat + Foreign Curial Law (can be presumed) + Foreign Proper Law or Foreign Law governing Arbitration Agreement = Implied Exclusion.

The only logical exception to the above formula is a case where the curial law is specifically mentioned to be Indian when the seat is foreign, thereby rebutting the presumption that the curial law is the same as that of the seat of arbitration. In which case, it is my opinion that Courts should stick to the 3/4 formula and require all the three components other than the curial law to be foreign.