Case Details: Saksham Commodities Ltd. v. - [2024] 161 taxmann.com 485 (Delhi)

Judiciary and Counsel Details

• • Yashwant Varma & Purushaindra Kumar Kaurav, JJ.
  • Salil Kapoor, Sumit Lalchandani, Ms Ananya Kapoor, Ms Tarun Chanana, Shivam Yadav, Vibhu Jain, Utkarsa Gupta, Amandeep Mehta & Sanat Kapoor, Advs. for the Petitioner.
  • Sunil Agarwal, Sr. SC Shivansh B. Pandya, Jr. SC & Utkarsh Tiwari, Adv. for the Respondent.

Facts of the Case

The instant writ petitions were filed to challenge the validity of the notices issued under section 153C to the assessee. The contention of the assessee was that the satisfaction of the Assessing Officer (AO) that the seized documents belong to the assessee and have a bearing on the determination of the total income of the assessee was not valid.

High Court Held

The High Court held Section 153C enables and empowers the jurisdictional AO to commence assessment or reassessment for a block of six AYs’ or the “relevant assessment year”, that action is founded on satisfaction being reached that the books of accounts, documents or assets seized “have a bearing on the determination of the total income of such other person”.

The Court held that it would be incorrect to either interpret or construe Section 153C as envisaging incriminating material pertaining to a particular AY having a cascading effect and which would warrant a mechanical and inevitable assessment or reassessment for the entire block of the “relevant assessment year”.

The jurisdictional AO would have to firstly be satisfied that the material received is likely to have a bearing on or impact the total income of years or years which may form part of the block of six or ten AYs’ and thereafter proceed to place the assessee on notice under Section 153C. The power to undertake such an assessment would stand confined to those years to which the material may relate or is likely to influence.

Absent any material that may either cast a doubt on the estimation of total income for a particular year or years, the AO would not be justified in invoking its powers conferred by Section 153C.

List of Cases Reviewed

• • SSP Aviation Ltd. v. Deputy Commissioner of Income Tax 2012 SCC Online Del 1898 [Para 38]
  • CIT V. RRJ Securities Ltd. 2015 SCC Online Del 13085 [para 39]
  • CIT (Central)- III v. Kabul Chawla 2015 SCC Online Del 11555 [Para 48]
  • ARN Infrastructure India Ltd. v. ACIT, Central Circle -28, New Delhi 2017 SCC Online Del 8081 [Para 52]
  • Commissioner of Income Tax v. Sinhgad Technical Education Society (2018) 11 SCC 490 [Para 53]
  • Principal Commissioner of Income Tax – 2 (Central) v. Index Securities Pvt. Ltd. 2017 SCC Online Del 10310 [Para 53]
  • Principal Commissioner of Income Tax, Central – 3 v. Abhisar Buildwell Private Limited Abhisar Buildwell (2024) 2 SCC 433 [Para 54] – Followed.

List of Cases Referred to

• • Agni Vishnu Ventures Pct. Ltd &Ors v. DCIT, ADIT, Madras HC 2023 SCC Online Mad 8017 (para 19).

The post Sec. 153C Proceedings Can Be Initiated Only if Seized Material is Likely to Have Bearing on Determination of Income appeared first on Taxmann Blog.

The Discounted Cash Flow (DCF) Method is a valuation technique used to estimate the value of an investment based on its expected future cash flows. This method is widely used in finance, particularly in the areas of investment analysis, financial modeling, and corporate finance. Here's a detailed breakdown of how the DCF method works:

Key Components of DCF


– Future Cash Flows: These are the amounts of money that an investment is expected to generate in the future. This can include earnings, free cash flow, or any other type of cash benefit expected to come from the investment.

– Discount Rate: This is a rate used to convert future cash flows into present values, reflecting their worth today. The discount rate typically reflects the risk of the cash flows—the higher the risk, the higher the discount rate. Common choices for the discount rate include the weighted average cost of capital (WACC), required rates of return, or hurdle rates.

– Terminal Value: At the end of the cash flow projection period, a terminal value is often calculated to account for the value of the cash flows continuing into perpetuity (or until the asset is sold). This can be done using a perpetuity growth model or an exit multiple.

By Gaurav Sukhija – National Leader (Transaction Advisory) | Kirtane & Pandit

Table of Contents

1. Valuation as a Topic
2. Discounted Cash Flow Method
3. Pillars of Discounted Cash Flow Method

1. Valuation as a Topic

1.1 Valuation Regulatory Requirements

• Valuation for issue and transfer of shares and convertible or redeemable instruments of Indian companies under section 56 of the Income Tax Act
• Valuation for determination of capital gains tax under section 50ca of the Income Tax Act
• Valuation for indirect transfer of shares of foreign company where significant business operations lie in India under section 9 of the Income Tax Act
• Valuation for issue of shares and convertible instruments of Indian companies under Companies Act 2013
• Valuation for issue of shares and fully convertible instruments of Indian companies under RBI FDI regulations
• Valuation for acquisition/investment into shares of foreign companies under RBI ODI regulations
• Valuation M&A under section 230-232 of the Companies Act for the purposes of business combinations
• Purchase Price Allocation in case of acquisition of assets for financial reporting purposes
• Valuation for preferential allotment and takeover code as per SEBI regulations
• Valuations under SEBI alternate investment fund regulations
• Valuation of sweat equity shares
• Valuation for assets of corporate debtor (liquidation value and fair value) as per Insolvency & Bankruptcy Code
• Valuations for financial reporting purposes under IND AS (purchase price allocation, fair value under IND AS 113, impairment assessment under IND AS 36, financial instruments under IND AS 109, IND AS 32 and IND AS 107 etc.

Purpose

• Merger
• IPO
• Acquisition/Investment
• Internal Management Analsys
• Intangible Asset Valuation

Regulatory

• Income Tax Act
• SEBI
• RBI- FEMA
• Companies Act
• IBBI

Accounting

• ESOP
• Purchase Price Allocation
• Impairment Analysis
• 409(A) US ESOP Valuations

Dispute Resolution

• Company Law
• Court Order
• Mediation
• Arbitration

Fund Raise

• Issue of shares
• Transfer of shares
• Valuation for Companies Act – by Registered Valuer
• Valuation for Income tax – by Merchant Banker
• Internal Management Analysis

FEMA

• Transfer/issue of shares
• Overseas invest/divest
• Buyback/capital reduction
• Indirect transfer of shares
• Valuation by Merchant banker or Chartered Acocuntant

Income tax

• Capital gains
• Overseas transfer of/involving Indian assets
• Buyback/capital reduction
• Issuance of shares at premium
• Transfer of shares at premium or discount
• Transfer of acquisition of Intellectual property

Intangible, PPA and other accounting based valuations

• Indian GAAP/Ind AS/US/GAAP/IFRS
• Pre Deal PPA
• Post Deal PPA
• Impairment – Business/shares/intangible/goodwill
• Valuation of options/derivatives and other financial instruments including FCCBs and ESOPs

Companies Act

• Buyback/capital reduction
• Preferential allotment of shares/convertible instruments
• Issue of sweat equity/issue of shares for non cash consideration
• Mergers/Demergers/Slump sales

Portfolio Valuations

• Assessing valuation of various portfolio companies at various intervals

Model Development and Analysis

• Development of a MS-Excel Model as a deliverable
• Sensitivity analysis
• Review of a model for its logical integrity, internal consistency and arithmetical accuracy

1.2 Amendment in 11UA

For Equity shares

• NAV Book value based analysis
• DCF by Merchant banker
• PORI – Price of recent investment – VC amount < next amount
• International methods for NR

1. 1. Comparable Company Multiple Method;
   2. Probability Weighted Expected Return Method;
   3. Option Pricing Method;
   4. Milestone Analysis Method;
   5. Replacement Cost Methods;

For CCPS – either equity share valuation or above methods other than NAV

Special points

• Valuation is valid only for 90 days from the date of valuation report
• Consideration can be max 10% exceeding the valuation

Issues and clarifications

• NAV here can only be book value based
• Is the date of valuation report, date of signing or date of valuation?
• Funding came at 10,000 then what can be the minimum valuation?
• If funding is by both Resident and non-resident, can valuation be done by two different methods in the same report. Can there be two different valuation in same report

1.3 What is a Startup?

1. Upto a period of ten years from the date of incorporation/ registration, if it is incorporated as a private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India.
2. Turnover of the entity for any of the financial years since incorporation/registration has not exceeded One Hundred Crore Rupees.
3. Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

1.4 Should Startup take Exemption?

It has not invested in any of the following assets,─

• building or land appurtenant thereto, being a residential house, other than that used by the Startup for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
• land or building, or both, not being a residential house, other than that occupied by the Startup for its business or used by it for purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
• Loans and advances, other than loans or advances extended in the ordinary course of business by the Startup where the lending of money is substantial part of its business;
• capital contribution made to any other entity;
• shares and securities;
• a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds ten lakh rupees, other than that held by the Startup for the purpose of plying, hiring, leasing or as stock-in-trade, in the ordinary course of business;
• jewellery other than that held by the Startup as stock-in-trade in the ordinary course of business;
• any other asset, whether in the nature of capital asset or otherwise, of the nature specified in sub-clauses (iv) to (ix) of clause (d) of Explanation to clause (vii) of sub-section (2) of section 56 of the Act.

Provided the Startup shall not invest in any of the assets specified in sub-clauses (a) to (h) for the period of seven years from the end of the latest financial year in which shares are issued at premium

1.5 Valuation Process

1. Analyse performance and historical data
2. Broadly analyse the financial forecast
3. Hold discussions with Management
4. Conduct Industry research
5. Conduct valuation using appropriate approaches
6. Prepare valuation Report and discuss the results with Management

1.6 Valuation Methodologies

There are several commonly used and accepted methods for determining the value of shares/businesses, which one can apply in the present valuation exercise, to the extent relevant and applicable, such as:

Cost approach

• Net asset value (“NAV”): The asset based valuation approach is based on the underlying net assets and liabilities of the company on a book/replacement/realisable value basis.

Market approach

• Market prices method: The valuation derived from the quoted market prices of the shares of the subject company.
• Comparable companies multiples method (“CCM”): An approach that entails looking at market quoted prices of comparable companies and converting that into the relevant multiples. The relevant multiple after adjusting for factors like size, growth, profitability, etc is applied to the relevant financial parameter of the subject company.
• Comparable transactions multiples method (“CTM”): Valuation based on price paid in recent transactions which includes reviewing published data on actual transactions involving either minority or controlling interests in either publicly traded or closely held companies. Similar to comparable companies analysis, the transaction price is converted into a relevant multiple and applied, after adjustments for factors like size, growth, profitability, control etc. to the relevant financial parameter of the subject company.

Income approach

• Discounted cash flow method (“DCF”): Discounts forecasted cash flows to the present using a relevant discount rate. The discount rate, weighted average cost of capital (“WACC”) or cost of equity (“CoE”) (depending on the cash flows being used), reflect the return expectations from the asset depending on the inherent risks in the cash flows.

PWC research: The primary valuation approaches remain the income approach (discounted cash flow) and market approach (based on market multiples). The general indication from respondents is that the income approach remains the primary valuation methodology, used by 58% of respondents, while the market approach is also an important methodology, with 42% of the respondents using it as their preferred approach.

1.7 Sources of Information

The valuation analysis was undertaken on the basis of the following information relating to the Company provided to us by the Management and information available in public domain:

• Audited financial statements
• Provisional financial statements as on valuation date
• Projected profit and loss accounts of the Company for a period of five years
• Anticipated working capital requirement and the capital expenditure over the Forecast Period
• Fully dilutive Shareholding pattern as on valuation date
• Other relevant details such as history, shareholding pattern, its past and present activities, future plans and prospects and other relevant information and data

We have also received the necessary explanations, information and representations, which we believed were reasonably necessary and relevant to the present valuation exercise from the Management.

2. Discounted Cash Flow Method

The discounted free cash flow technique is one of the most detailed approaches to valuation of a business. In this technique the projected free cash flows from business operations are discounted at the weighted average cost of capital (“WACC”) and the sum of such discounted free cash flows is the value of the business.

DCF Approach

• Determine free cash flows: The future free cash flows to firm have been computed as follows:

1. 1. EBIT
   2. less: taxes
   3. add: depreciation and amortisation,
   4. add: decrease/(increase) in working capital,
   5. less: capital expenditure.

• Determine explicit period: Explicit Forecast Period cash flows estimated based on the business plan provided by the Management.
• Weighted Average Cost of Capital (WACC)
• Terminal value: The value during the post explicit Forecast Period, estimated using an appropriate method.
• Present value of cash flows from explicit period and terminal value discounted @ WACC
• Separate adjustments for inter alia – cash, surplus assets, etc.
• Value using DCF

3. Pillars of Discounted Cash Flow Method

3.1 Pillar 1 – Projections

• Common sizing
• Initiating coverage reports and analyst reports
• Year on year growth patterns
• Budget or target but not aspirational
• Industry trends: Specifically talking about Total addressable market, Total serviceable market, company capacity, eg. Aeroplane industry % market share, etc.
• Check whether same projections are given to investor or not

Some important terms

• TAM – Total Addressable Market
• SAM – Serviceable Addressable Market
• SOM – Serviceable Obtainable Market
• CAC – Customer acquisition cost
• RoAS – Return on ad spend

Pillar 1 – FCFF (Free Cash Flow to Firm ) or FCFE (Free Cash flow to Equity)

The key difference between Unlevered Free Cash Flow and Levered Free Cash Flow is that Unlevered Free Cash Flow excludes the impact of interest expense and net debt issuance (repayments), whereas Levered Free Cash Flow includes the impact of interest expense and net debt issuance (repayments).

Discounting Method

• FCFF- WACC
• FCFE – Cost of equity (Ke)

3.2 Pillar 2 – Discount Rate

• WACC is a rate of return that an investor would expect to receive if capital were invested in a similar venture.
• The WACC, which is the weighted average of the costs of equity and debt of the business, has been worked out as follows:

WACC = Ke (e/(d+e)) + Kd(d/(d+e)), where:

• Ke represents the cost of equity, i.e. the return required by equity shareholders;
• Kd represents the after-tax cost of debt, i.e. the return required by debt holders;
• e represents the value of equity; and
• d represents the value of debt.

Minority Discounts

• The minority discount relates to the lack of control that minority shareholders have over the operation and corporate policy of a given investment.
• Ranges between 10% to 25%

Control Premium

• Control premium relates to the additional value associated with the ability to control the distribution of cash generated by a company, which includes the ability to influence the timing and size of its dividend distribution.
• Ranges between 10% to 33%

Discount for size margin and business dynamics

• It is comparing our subject company to comparable companies
• Ranges between 25% to 50%

Discount for lack of Marketability

• Marketability can be defined as ‘the ability to convert the business ownership interest (at whatever ownership level) to cash quickly, with minimum transaction and administrative costs in so doing and with a high degree of certainty of realising the expected amount of net proceeds
• Ranges between 20% to 60%

3.3 Pillar 3 – Terminal Value

• Gordon Growth Method: The Gordon growth model (GGM) is a formula used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate.
• H model: The H-model is a quantitative method of valuing a company’s stock price. The model is very similar to the two-stage dividend discount model. However, it differs in that it attempts to smooth out the growth rate over time, rather than abruptly changing from the high growth period to the stable growth period. The H-model assumes that the growth rate will fall linearly towards the terminal growth rate.
• Exit Multiple Method: The method assumes that the value of a business can be determined at the end of a projected period, based on the existing public market valuations of comparable companies.

3.4 Pillar 4 – After Adjustments

• Fully diluted shareholding pattern
• Cash
• Investments
• Debt
• Debt like items
• Land – surplus assets

Valuation Methodologies

The post [Analysis] Valuation and Discounted Cash Flow (DCF) Method appeared first on Taxmann Blog.

A taxing statute is a law that lays out the legal requirements for the imposition and collection of taxes by a government authority. The structure of a taxing statute is typically composed of several key elements to ensure clarity, enforceability, and fairness. Here’s a general breakdown of what a taxing statute usually includes:

– Title and Preamble: The title gives a clear indication of the subject matter and purpose of the statute. The preamble may provide the legislative intent or reasons for the imposition of the tax.

– Scope and Application: This section defines who is subject to the tax and under what circumstances. It outlines the taxpayers and transactions that fall within the scope of the statute.

– Taxable Event: This specifies the event or occurrence that triggers the tax liability. For instance, earning income, purchasing goods, or inheriting property could be taxable events.

– Tax Base: This element defines what is being taxed. In the case of income tax, for example, it might detail how to calculate total income, including what counts as income and what deductions are allowed.

– Tax Rate: This specifies how the tax is calculated. It might be a flat rate, a percentage of the tax base, or a variable rate depending on different conditions or thresholds.

– Provisions for Exemptions, Deductions, and Credits: This section details any exemptions or reductions in taxable amount, such as deductions for educational expenses or credits for energy-efficient home improvements.

– Collection and Enforcement Mechanisms: These are the procedures for how the tax is to be collected and what happens if it is not paid. This could include provisions for tax withholding by employers, quarterly payments by taxpayers, and penalties for late payment or evasion.

– Administrative Details: This covers the operational aspects of how the tax will be administered, including the responsibilities of tax authorities and the rights and obligations of taxpayers.

– Dispute Resolution: This part of the statute outlines the procedures for taxpayers to challenge or appeal their tax assessments or penalties.

– Amendments and Transitional Provisions: Sometimes, a statute will include specific clauses that allow for changes to be made to the law and provide for how to transition from old rules to new rules.

– Effective Date and Sunset Clause: It specifies when the tax will start to be effective and, if applicable, when it is scheduled to end.

The structure and contents of a taxing statute are critical for ensuring that taxes are collected efficiently and equitably, with a clear understanding for all parties involved regarding their rights and obligations.

Table of Contents

1. Drafting of a Taxing Statutes
2. Title
3. Preamble
4. Interpretation of Definition Clause
5. Legal Fiction or the Use of the Expression ‘Deemed’
6. Heading
7. Marginal Notes
8. Explanation
9. Proviso

Check out Taxmann's Interpretation of Taxing Statutes which analyses the complex realm of statutory interpretation, focusing on taxation laws, illustrating the challenges judges face with legislative language and the importance of understanding legislative intent through various interpretation approaches. The second edition brings to light recent developments in tax policy, including the GST regime in India, and offers a comparative analysis of statutory interpretation practices across common law countries. This book is a comprehensive treatise on the evolving principles of judicial interpretation and the structure of tax law, making it essential for those involved in the legal, academic, and practical aspects of taxation.

1. Drafting of a Taxing Statutes

An Act or a Statute expresses the will of the legislature in carefully chosen words. Drafting tax laws is a subspecialty of legislative drafting in general. The approach to drafting a tax law will vary widely from country to country because languages and local drafting styles differ.

Victor Thuronyi in Drafting Tax Legislation¹ states the techniques of drafting a taxing statutes. In view of Victor Thuronyl, in the most general terms, the tax laws should be drafted so as to best fulfil their role in the tax system, which is to specify such matters as how much each taxpayer is liable to pay and what the taxpayer’s rights and obligations are. A well-drafted tax law spells out with precision the matters that are within its scope. But precision is not enough. A law should not be precise at the expense of being complicated and impossible to understand. The easier a tax law is to understand, the lower will be the compliance costs, both for taxpayers and for tax administrators. It is particularly important that a tax law be easy to apply (compared with other public law, for example, a law governing the generation of toxic waste or one governing building codes) because the tax law applies to nearly every physical and legal person in the country with respect to countless transactions every day. The fact that tax law must be applicable to so many transactions in an efficient manner has an important influence on how the law must be drafted. In particular, there is little room for sloppiness. Finally, a tax law must be effective in achieving the policy goals of the legislator, both in terms of the amount of revenue to be raised—with an eye to equity, efficiency, and simplicity—and the items and persons to be taxed. Good drafting goes hand in hand with the specification of policy. These criteria sometimes conflict. For example, a simple statute may be rejected as inequitable, because it does not recognize the differences in situation of different taxpayers. A statute that provides too much certainty may conflict with the goals of equity and revenue raising (because the certainty can be exploited by tax planners). In many cases, however, there is no conflict; complexity that is merely the result of bad drafting can be eliminated while at the same time providing greater certainty and a clearer articulation of the policy.

2. Title

Every bill has a title that describes the nature of the proposed measure. The long title is different from the short title, which is embodied in the first section of the Act itself. The long title of an Act indicates the main purpose of the enactment. It cannot control the express operative portion of the Act² or it cannot limit the plain meaning of the text³. Every Act of Parliament should have a short title ending with the date of the Year in which it is passed. Modern statutes generally contain a section enacting that the Act may be cited by some short title. The short title is, however, given to the Act only for the purpose of facility of reference.

The title is not conclusive of the intent of the Legislature but constitutes only one of the numerous sources from which assistance must be obtained in the ascertainment of that intent in the case of doubt. It will not rectify the defects or omission in the enacting part but may be resorted to merely as an aid in the ascertainment of the legislative intent where the meaning is uncertain by reason of the use of general language of indefinite signification or of words of doubtful import.⁴

3. Preamble

The Preamble is a clause at the beginning of a statute, following the title and preceding the enacting clause. The proper function of the preamble is to explain certain facts which are necessary to be explained before the enactment contained in the Act can be understood. The inclusion of a Preamble in a bill has now become out of fashion⁵ but in many statutes, Preamble is given. The preamble of an Act refers to finding out whether there is delegation of the legislative power or it is discretionary power conferred upon the executive authorities.

In Thangal Kunju⁶ the question arose whether there was any guidance for selective application of Section 5 of the Travancore Taxation on Income Investigation Commission Act. Section 5 enacted that the government might at any time before the last day of Makaram refer to the Commission for investigation and report any case or points in a case in which the government had, prima facie, reasons for belief that a person had to a substantial extent evaded payment of tax on income together with such materials as might be available in support of such belief.

The Supreme Court observed that in order to ascertain the scope and purpose of the impugned section reference was made to the Act itself. The Preamble of a statute was held as a good means of finding out its meaning as if it was key to the understanding of it. The Supreme Court, however, concluded that the Preamble of the Act gave no assistance to the solution of the problem.

In Kathi Raning⁷ the Supreme Court held that the preamble to the Saurashtra Ordinance gave definite guidance to the state government to choose for reference to a special judge only such offences or cases as affected public safety, maintenance of public order and preservation of peace and tranquility.

In RK Garg v. Union of India⁸, it was stated that the preamble of the Act affords useful light as to what the statute intends to reach or in other words afford a clue to the scope of the statute. The Preamble to the Special Bearer Bonds Immunities and Exemptions Act, 1981 made it clear that the Act is intended to canalise for productive purposes black money which has become a serious threat to the national economy.

In the course of the judgment, Justice Bhagwati observed that it is an undisputed fact that there is a considerable amount of black money in circulation that is unaccounted or concealed. The menace of Black Money has reached such staggering proportions that it is causing havoc to the economy of the country and poses a serious challenge to the fulfilment of our objective of distributive Justice and setting up or an egalitarian society. The generation of black money through tax evasion throws a greater burden on the honest taxpayer and leads to economic inequality and concentration of wealth in the hands of unscrupulous, few in the country. Thus, in view of the Supreme Court, there is no exaggeration to say that black money is causing cancerous growth in the country’s economy which if not checked in time is certain to lead to chaos and confusion.

In an English case i.e., Lord Chetwode v. IRC⁹ the Court of Appeal took recourse to the preamble in construing the word ‘income’ in the expression ‘income of’ and ‘income becomes payable’ occurring in 412(1) of the Income-tax Act, 1952. The principal question, in this case, was whether in computing the income of a foreign company for the purposes of section 412 of the Income-tax Act, 1952 it is proper to take expenses of management into account.

Justice Sir John Pennycuick observed that on the natural construction of section 412(1) read in conjunction with the Preamble, the word ‘income’ should be treated as denoting profit i.e., the excess of receipts over outgoing. That means, of course, receipts and outgoings properly attributable to the revenue account.

4. Interpretation of Definition Clause

The interpretation clause usually comes immediately after the short title, extent, and commencement. Otherwise, at the beginning of the Act definition section is given.

Definitions are required:

(a) to avoid tedious paraphrases;

(b) to explain terms which are ambiguous or of uncertain meaning;

(c) to give to a term which has been judicially interpreted a sense other than that given by such interpretation; or

(d) to include or exclude, for the purposes of the Act, something in regard to the inclusion or exclusion of which there might otherwise be doubt.

When a word or phrase is defined as having a particular meaning, it is that meaning and that meaning alone which must be given to it, in interpreting a section of the Act, unless the context otherwise requires.

The definition clause uses expressions such as ‘includes’ or ‘means’ or ‘include and means’.

On the exact connotation of the word ‘includes’ the judicial practice is now firmly established. Includes is generally used in interpretation clauses in order to enlarge the meaning of the words or phrases occurring in the body of the statute. When it is so used these words or phrases must be construed as comprehending not only such things as they signify according to their nature and import but also those things which the interpretation clause declares that they should include.

In Dilworth v. Commissioner of Stamps,¹⁰ the interpretation to be given to such an inclusive definition had been clearly laid down by the House of Lords. The House of Lords held that in the interpretation of statutes, it is well known that when the legislature wants to enlarge the natural meaning of the words or phrases, it uses the word includes and in such a context an inclusive definition means that over and above the natural meaning of the words. The House of Lords further held that the specially provided meaning of the words will also have to be attributed for the purpose of interpretation of that particular chapter of the Act as the case may be.

Thus, the word ‘includes’ in the definition or interpretation clause that extends the meaning of the word does not take away its ordinary meaning. The word ‘includes’ is often used in interpretation clauses in order to enlarge the meaning of the words and phrases occurring in the body of the Statute. When it is so used, these words and phrases must be construed as comprehending not only such things as they signify according to their nature and import, but also those things which the interpretation clause declares that they include¹¹.

The Karnataka High Court in Patil Vijay Kumar¹² held that the encashment of leave although it is not specifically included within the expression ‘salary’ as defined in section 17(1) or in the expression ‘profit in lieu of salary’ as defined in section 17(3)(ii) of the Income-tax Act, 1961 nevertheless it falls within the meaning of the term ‘profit in lieu of salary’ under clause (ii) of sub-section (3) of section 17 of the Income-tax Act. The court observed that the leave salary and allowances and salary and allowances an employee receives for the same period are one and the same. The payment of leave salary and allowances to an employee who surrendered his leave is related to or flows from the relationship between employer and employee and from the terms and conditions of employment.¹³

In N.S. Chettiar¹⁴, the Supreme Court stated that an interpretation clause which extends the meaning of a word does not take away its ordinary meaning. An interpretation clause is not meant to prevent the word from receiving its ordinary, popular, and natural sense, whenever that would be applicable, but to enable the word as used in the Act, when there is nothing context in the subject matter to the contrary, to be applied to something to which it would not be applicable ordinarily.

The judicial decisions mentioned above get support from the views of Maxwell.¹⁵
He observed:

“Sometimes, however, the word ‘include’ is so used in order to enlarge the meaning of words and phrases occurring in the body of the Statute; and when it is so used these words or phrases must be construed as comprehending, not only such things as they signify according to their natural import but also those things which the interpretation clause declares that they shall include. In other words, the word in respect of which ‘includes’ is used bears both its extended statutory meaning and its ordinary, popular, and natural sense, whenever that would be properly applicable.”

Craies on statute law¹⁶ observed:

An interpretation clause which extends the meaning of a word does not take away its ordinary meaning. An interpretation clause is not meant to prevent a word from receiving its ordinary, popular, and natural sense whenever that would be properly applicable, but to enable the word as used in the Act, when there is nothing in the context or subject matter to the contrary, to be applied to some things to which it would not ordinarily be applicable.

In Mahalakshmi Oil Mills¹⁷, the controversy was whether the term “tobacco” and the inclusive clause were wide enough to cover tobacco seeds. In the first place, tobacco seeds hardly answer to the description of either the expression “manufactured tobacco” or the expression “unmanufactured tobacco” in their ordinary connotation; and the expression “cured or uncured” cannot also be associated with tobacco seeds. The expression used in the first part of the definition, though very wide, is, therefore, singularly inappropriate to take within its purview tobacco seeds as well. Secondly, the definition occurs in a statute levying excise duty which is concerned not with the parts of a plant grown on the field but with the use to which those parts are put or can be put after severance.

The other cases in which the word ‘include’ has been construed are P. Kasil- ingam¹⁸, Hospital Mazdoor Sabha,¹⁹ and Taj Mahal Hotel²⁰. Recently, in Orator Marketing²¹, the Supreme Court held that of course, depending on the context in which the word ‘includes’ may have been used, and the objects and the scheme of the enactment as a whole, the expression ‘includes’ may have to be construed as restrictive and exhaustive. Thus, in Orator Supreme Court preferred the contextual interpretation.

5. Legal Fiction or the Use of the Expression ‘Deemed’

The word “deemed” is used a great deal in modern legislation. Where the legislature says that something should be deemed to have been done which in truth has not been done it creates a legal fiction and in that case, the court is entitled and bound to ascertain for what purposes and between what persons the statutory fiction is to be resorted to and full effect must be given to the statutory fiction and it should be carried to its logical conclusion.²²

In the Income-tax Act, 1961 legal fiction is used in the definition of many terms and phrases at more than one occasion. Sometimes it is used to impose for the purpose of the statute an artificial construction of a word or phrase. sometimes it is used to put beyond doubt a particular construction. the effect of a legal fiction is that a position that would otherwise not be obtained is being deemed to be obtained under these circumstances.²³

A well-established rule of interpretation is that the legal fiction should be carried to its conclusion but the fiction cannot be extended beyond the language of the section. In Mother India Industries²⁴, the issue that came up for consideration was that what is the true scope and purpose of the legal fiction created under proviso (b) to section 10(2) of the Income-tax Act, 1922. The counsel for the assessee urged that full effect must be given to the legal fiction created and that the above-mentioned statutory provisions and therefore between the aggregate amount of depreciation and unabsorbed carried forward losses the priority has to be given to the latter matter of set off. Justice Tulzapurkar speaking for the court observed:

“ It is not possible to accept the contention of the counsel for the assessee that because of the legal fiction, the unabsorbed carried forward losses should be given preference not merely over the unabsorbed carried forward depreciation but also over current year depreciation. In other words, it clearly emerges that in the matter of set-off, the unabsorbed business losses of the earlier years will have preference over unabsorbed depreciation that is required to be carried forward under proviso (b) to Section 10(2)(vi) of the Indian Income-tax Act, 1922 and no preference over the current depreciation is intended”.

In Narayanrao Deshmukh²⁵ Supreme Court observed that a legal fiction should no doubt be carried out to its logical end to carry out the purposes for which it is enacted but it cannot be carried beyond that. It is no doubt true that the right of a female heir to the interest inherited by her in the family property gets fixed on the death of a male member under section 6 of the Hindu Succession Act, 1956, but she cannot be treated as having ceased to be a member of the family without her volition as otherwise it will lead to strange results which could not have been in the contemplation of Parliament when it enacted that provision(i.e. section 6, Explanation 1 of the Hindu Succession Act, 1956) which might also be in the interest of such female heirs.

In a decision of the Bombay High Court,²⁶ the exact scope of the legal fiction created under section 41 of the Income-tax Act, 1961 came up for consideration. The legal fiction created under section 41 of the Income-tax Act, 1961 treats something which is a capital receipt as income of the business. The question arose in this case was that whether expenditure admissible as a deduction under section 37 of the Income-tax Act, 1961 is also allowed in computing income under section 41 or not. The Bombay High Court held that as a matter of fact, the brokerage and the traveling expenses are directory referable to and related to the sale and we see no reason why the fiction cannot be extended to cover expenses directly referable to the realisation of the sale price.

6. Heading

The heading is prefixed to sections or a set of sections is preamble to those sections. It (heading) is a shorthand reference to the general subject matter involved. However, though the heading refers to a particular subject, it neglects to reveal allied or cognate matters. Thus, the law is established that the heading of a section cannot limit the plain meaning of the text. In Chandroji Rao²⁷ the question arose was that whether interest payable in respect of compensation under the Madhya Pradesh Abolition of Jagir Act, 1951 is taxable or not. The Supreme Court upholding the decision of the high court observed that the marginal heading cannot control the interpretation of the words of the section particularly when the language of the section is clear and unambiguous. The legislature being well aware of the distinction between compensation and interest thereon employed clear language which leaves no room for doubt that under sub-section (2) interest was payable in its well-known and well under sense and it could never form a part of the compensation money.²⁸

7. Marginal Notes

Marginal notes are inserted as a matter of convenience. They intend to condense the section to a short and accurate phrase. As pointed out by the Privy Council in Balraj Kumar²⁹, marginal notes in an Indian statute, as in an English Act of Parliament, cannot be relied upon for interpreting a section unless there is some ambiguity in the section. The marginal note is not decisive of the true intention.³⁰ It cannot assist the court in arriving at the true meaning of the section.³¹ although marginal note cannot be relied upon for the purpose of interpreting a section it certainly helps the court to resolve that doubt.³²

The marginal note may give an indication as to exactly what was the mischief that was intended to be remedied³³. In Navanagar Transport³⁴ the court observed that the marginal note cannot be regarded as an aid to the construction of the section and it cannot affect the plain and natural meaning of the language used in the section but it can certainly be referred to as furnishing a clue the meaning and purpose of the section. In Navanagar Transport case, the marginal note to the amended Section 23A of the Income-tax Act, 1922 was titled “Power to assess companies to super tax on distributed income in certain cases”. It was held that the marginal notes clearly indicate the drift of the section, namely, that the section is intended for the assessment of companies to super-tax all undistributed profits in certain cases and in the body of the section one finds that such meaning and effect of the section and the section does not authorize the assessment of companies to super- tax on undistributed income in the cases specified in the section.

In Sajjan Mills Limited³⁵ the proper interpretation 40A(7) came up before the Court. This provision was inserted in 1975 and provided for disallowance in respect of payment of gratuity. On a literal/strict construction put on this clause, it was contended by the assessee that the above-mentioned provision i.e. section 40A(7) could only apply if the assessee had made provision for Payment of Gratuity and not in other cases i.e. where Payment of Gratuity is made without making any provision for the same in books of account. This argument was negatived by their lordship of the Supreme Court on the following grounds namely:

“(i) Section 40A contains a marginal note under the heading ‘expenses or payment not deductible in certain circumstances’. Read with the marginal notes of section 40A, the non-obstante clause of sub-section (1) of section 40A has an overriding effect over the provisions of any other section that will have effect notwithstanding anything contained in sections 28 to 37 of the Income-tax Act, 1961.

(ii) On a plain construction of clause (a) of sub-section (7) of section 40A, what it means is that whatever is provided for future use by the assessee out of gross profits of the year of account for payment of gratuity to employees would not be allowed as deduction in the year of account. The embargo is on deductions of amounts provided for future use in the year of account for meeting the ultimate liability to the payment of gratuity. This is subject to exemptions provided in clause (b) of section 40A(7). Clause (b)(i) excludes from the operation of clause (a) contributions to approved gratuity fund and the amount provided for or set apart for payment of gratuity which would be payable during the year of account. Clause (b)(ii) deals with a situation where the assessee might provide by spread-over method and provides that such provisions would be excluded from the operation of clause (a) provided the three conditions laid down by the sub-clause are satisfied.

(iii) The interpretation as suggested by the assessee would entitle the assessee who made no provision to claim a deduction unless the requirement down in the sub-section is fulfilled. This interpretation, if accepted, will lead to a curious result, and if one may venture to say an absurd result, even the assessee who has made no provision from the gross profits of the year will get relief out of payment made towards gratuity to employees.

(iv) Where the intention of the Legislature in enacting the provision in question was to put an embargo on the deduction, the interpretation suggested by the assessee defeats that purpose.

(v) Interpretation suggested by the assessee would lead to a conclusion which would be extraordinary and repugnant to common sense. It will also cause gross injustice to the assessee who has been prudent enough to set apart a sum for payment of gratuity. The principle that fiscal statute should be strictly construed does not rule out the application of the principle of reasonable construction to give effect to the purpose or intention of any particular provision as apparent from the scheme of the Act with the assistance of such external aids as are permissible under the law.”

8. Explanation

The purpose of explanation is often to explain some concept or expression or phrase occurring in the main provision and it is not uncommon for the legislature to accord extended meaning or restricted meaning to such concept or expression or phrase by inserting an appropriate explanation. In Warangal Industries³⁶, the issue arose was whether, under section 41(2) of the Income-tax Act, 1961, the assessee could claim a deduction in respect of unabsorbed depreciation out of the deemed income under section 41 of the Income-tax Act. The income tax officer took the plea that since no business was in existence when the deemed profit under section 41 arose therefore no allowance for depreciation could be granted because depreciation is related to the business which is carried on. Negativing the aforesaid contention, the Bombay High Court observed that by virtue of Explanation to Section 41(2), deeming fiction is created and by virtue of that deeming fiction, the business is no longer in existence for the purposes of Section 41(2) and is deemed to be in existence in the previous year in the course of which the machinery, plant, or furniture in respect of which depreciation has been allowed in an earlier year is sold, discarded, demolished, or destroyed.

The object of explanation was summarised in a Sundaram³⁷ as follows:

1. It is to explain the meaning and intendment of the Act itself.
2. When there is any obscurity or vagueness in the main enactment, to clarify the same so as to make it consistent with the dominant object which it seems to subserve.
3. To provide additional support to the dominant object of the Act in order to make it meaningful and purposeful.
4. An explanation cannot in any way interfere with or change the enactment or any part thereof but, where some gap is left which is relevant for the purpose of preventing the mischief and advancing the object of the Act it can help or assist the true purpose and intendment of the enactment, and
5. It cannot curtail statutory right which any person under a statute has been clothed with or by becoming an hindrance in the interpretation of the same.

In Khandelwal Metal³⁸, an issue arose as to the interpretation of an Explanation to the Customs Tariff Act,1975. Section 3(1) of the Tariff Act, 1975 was sought to be interpreted as levying countervailing duty independently of the provisions of the Customs Act, 1962. It was contended on behalf of the petitioner that brass scrap which is not capable of being produced or manufactured cannot be subject to duty under section 3(1) of the Tariff Act. Rejecting the argument, the Supreme Court observed:

“Any doubt on this point is resolved by… explanation furnishes a dictionary for the interpretation of section 3(1) and provides a clue to its understanding. The explanation provides in so many words that the excise duty for the time being leviable on a like article if produced or manufactured in India means the excise duty for the time being in force which would be leviable on a like article if produced or manufactured in India … The explanation even goes further and provides that if a like article is not so produced or manufactured, then, the duty leviable means the duty which would be leviable on the class or description of articles to which imported article belongs.”

In Vrajlal³⁹, the levy of sales tax on Tendu leaves disposed of by the state government was challenged on the ground, inter alia, that neither the state government nor any of its departments including the forest department or its officers was a dealer within the meaning of the term defined under section 2(a) of the Madhya Pradesh General Sales Tax Act, 1958 as none of them carried on the business of buying, selling, supplying or distributing goods and that Explanation II which was inserted in the said clause (a) did not have the effect of enlarging the concept of dealer as defined in that clause. In this context, it is pertinent to note that for a person to be a dealer within the meaning of clause (a), he must be one who carries on the business of buying, selling, supplying, or distributing goods, and the definition as originally enacted included within its scope the Central Government, State government or any of their departments which carried on such business. This definition was amended by the 1971 Act retrospectively and reference to the central government or State government or any of their departments in sub-clause (i) of clause (a) was omitted from that sub-clause and an explanation was added.

Commenting upon the exact nature and scope of the explanation their lordship of the Supreme Court Justice Madon observed that merely because a particular provision in a statute is labeled as an explanation it does not mean that it is inserted merely with a view to explain the meaning of the words contained in the section of which it forms a part. The true scope and effect of an explanation can only be judged by its expressed language and not merely by the label given to it. The language of the explanation shows that its purpose is to create a legal fiction and that while under the main clause, for a person to be a dealer, he must carry on the business of buying, selling, supplying, or distributing goods, even if the central government or State government or any of their departments or offices does not carry on such business if it buys, sales, supplies or distributes good, it is to be deemed to be a dealer the purpose of the Madhya Pradesh Sales Tax Act, that is, for the purpose of the levy and collection of Tax under the Madhya Pradesh Sales Tax Act⁴⁰.

Sometimes the explanation is to be given a retrospective effect if the language permits such construction. Explanation giving the meaning to the phrase ‘when an assessee is in default’ under section 221 of the Income-tax Act, 1961, by section 53 the Taxation (Amendment) Act, 1975 was given retrospective effect. The effect of the explanation was held that of declaratory in nature and therefore it was given retrospective effect⁴¹. The declaratory Act may be defined as an Act to remove doubts existing as to common law or the meaning or effect of any statute. Such Acts are usually held to be retrospective. The usual reason for passing a declaratory Act is to set aside what Parliament seems to have been a judicial error, whether in the statement of common law or in the interpretation of statute. Usually, if not invariably, such an Act contains a preamble, and also the words ‘declared as well as enacted.

9. Proviso

The word provided is an enacting word and it means it is provided. Usually, it is confined to taking a special case out of general enactments and providing specially for them.

In Indo-Mercantile Bank⁴², Justice Kapoor observed that the proper function of a proviso is that it qualifies the generality of the main enactment by providing an exception and taking out as it were, from the main enactment, a portion which, but for the proviso would fall within the main enactment. Ordinarily, it is foreign to the proper function of a proviso to read it as providing something by way of an addendum, for dealing with the subject which is foreign to the main enactment…

The scope of the proviso has been dealt with by the Supreme Court in many cases⁴³. in Bezwada Municipality⁴⁴, Lord Macmillan observed that the proper function of the proviso is to except and deal with a case which would otherwise fall within the general language of the main enactment, and its effect is confined to that case… where the language of the main enactment is clear and unambiguous, proviso can have no repercussion on the interpretation of the main enactment, so as to exclude from it by implication what clearly falls within its express terms.

In Madurai Mills⁴⁵, the Supreme Court observed that a proviso cannot be construed as enlarging the scope of an enactment when it can be fairly and properly construed without attributing to it that effect. Further, if the language of the main part of the statute is plain and unambiguous and does not contain the provisions which are said to occur in it, one cannot derive those provisions by implication from a proviso.

In Madurai Mills, Mr Manchanda on behalf of the appellant has invited the attention of the court to the third proviso to sub-section (1) of section 12B as originally enacted in 1946 wherein it was enacted, inter alia, that any distribution of a capital asset on the dissolution of the firm or other association of persons on the liquidation of the company shall not for the purposes of section 12B be treated as sale, exchange, or transfer of capital assets. It was argued that the omission of such distribution of capital assets in the first proviso to Section 12B(1) under the Finance (No. 2) Act of 1956 would show that the legislature wanted the distribution of capital assets on the dissolution of a firm or other association of persons on the liquidation of the company to be treated as sale, exchange or transfer. The Supreme Court refused to accept the aforesaid contention and laid down the law as stated above.

The Bombay High Court in Jhumar Mal⁴⁶ held that normally the proviso should be looked upon as a proviso to the section in which it appears and, before the proviso can have application, the section itself must apply and cannot be regarded as an independent enacting clause.

It was stated further that it is equally clear that the legislature may enact a substantive provision in the garb of the proviso and if it appears from the language of the proviso that its application could not be restricted to the main section, the court must look upon it as a substantive provision if it has a clear meaning⁴⁷.

The proviso may become a substantive provision of the Act itself. In Leela Jain⁴⁸, the question arose whether the proviso in the Act was a limiting provision to the main provision or was a substantive provision in itself.

The court observed that so far as a general principle of construction of a proviso is concerned, it has been broadly stated that the function of a proviso is to limit the main part of the section and carve out something which but for the proviso would have been within the operative part.

1. https://www.imf.org/external/pubs/nft/1998/tlaw/eng/ch3.pdf accessed on 26th August, 2023. at pp. 2-3 Chapter 3. Tax Law Design and Drafting Editor: Victor Thuronyi ©1996 International Monetary Fund Volume 1: 1996.
2. Manohar Lal v. State of Punjab AIR 1961 SC 418.
3. Aswini Kumar Ghosh v. Arabinda Bose AIR 1952 SC 269.
4. Craford, Statutory construction at p. 359.
5. Kaul, MN and Shakdhar S.L., Practice and Procedure in Parliament (1969) at p. 415.
6. A. Thangal Kunju Musaliar v. M. Venkatachalam Potti (1956) 29 ITR 349 (SC).
7. Kathi Raning Rawat v. State of Saurastra AIR 1952 SC 123.
8. AIR 1981 SC 2138.
9. (1976)1 All E R 641 (Court of Appeal).
10. Law Reports (1899) Appeal Cases 99 quoted in CIT v. Premanand Industrial Cooperative Limited [1980] 124 ITR 772/3 Taxman 498 (Guj.).
11. CIT v. Taj Mahal Hotel (1971) 82 ITR 44 (SC). In this case sanitary fittings and pipelines in the hotel was held covered in the definition of plant referred to in section 10(5) of the Indian Income-tax Act 1922. Plant includes vehicles, books, scientific apparatus, surgical equipment for the purpose of business or profession. It was observed that the very fact that even books have been included shows that the meaning intended to be given to plant is wide. The court held that we are unable to see how the sanitary fittings in the bathrooms in a hotel will not be plant within section 10(2)(vib). Legislature intended to give it a wide meaning and that is why articles like books and surgical instruments were expressly included in the definition of plant.
12. Patil Vijaykuraar v. Union of India (1985) 151 ITR 48/20 Taxman 363 (Kar.).
13. Ibid at p. 64.
14. CGT v. N.S. Getty Chettiar [1971] 182 ITR 599, 605; AIR 1971 SC 2410.
15. Maxwell, interpretation of statute at 270 quoted in CIT v. Straw Board Manufacturing Company Limited (1975) 98 ITR 78 (P&H).
16. Craies, Statute law (6th edition) at p. 213.
17. Mahalakshmi Oil Mills v. State of Andhra Pradesh AIR 1989 SC 335.
18. P. Kasilingam v. P.S.G. College of Technology 1995 Supp (2) SCC 348/[1995] 2 SCR 1061.
19. State of Bombay v. Hospital Mazdoor Sabha AIR 1960 SC 610.
20. CIT Andhra Pradesh v. Taj Mahal Hotel Secunderabad (1971) 3 SCC 550.
21. Orator Marketing (P.) Ltd. v. Samtex Desinz (P.) Ltd. [Civil Appeal No. 2231 of 2021 decided on July 26, 2021]/[2021] 128 taxmann.com 424/167 SCL 610 (SC).
22. CIT v. Bombay Corporation AIR 1930 PC 54; ITO v. Alfred AIR 1952 SC 663.
23. K. Kamaraj Nadar v. Kunju Thevar AIR 1958 SC 687.
24. CIT v. Mother India Refrigeration Industries (P.) Ltd. (1985) 155 ITR 711/23 Taxman 8 (SC).
25. State of Maharashtra v. Narayan Rao Shyam Rao Deshmukh AIR 1985 SC 716/(1985) 2 SCC 321/[1985] 22 Taxman 38 (SC).
26. CIT v. Bharat lines Ltd. (1986) 159 ITR 541/29 Taxman 76 (Bom.).
27. Chandroji Rao v. CIT AIR 1970 SC 1582 “In our opinion, the High Court rightly rejected the contentions. Section 8 clearly provided that compensation shall be due from the date of resumption. Thus, the amount of compensation became ascertained and payable from the date of resumption. The provision for interest was made simply because the compensation was to be paid in ten annual instalments. A clear distinction has been made between the compensation payable under sub-section (1) and the interest which is payable under sub-section (2). The compensation has to be determined in accordance with the principles laid down in Schedule
    1. That schedule indicates that the determination of compensation had nothing to do with the payment of interest.”
28. Chandroji Rao v. CIT AIR 1970 SC 1582 at pp. 1583-1584.
29. Balraj Kumar v. Jagat Pal Singh ILR 26 All 393 at p. 406 quoted in CIT v. Ahmedbhai Umarbhai & Co. (1950) 18 ITR 472 (SC).
30. CIT v. Lokenath & Co. (1984) 40 CTR 297/17 Taxman 209 (Delhi).
31. Sutlej Cotton Mills Ltd. v. CIT (1950) 18 ITR 112 (Cal.).
32. Sanjiv V Kudva v. CIT (1981) 20 CTR (Kar.) 1.
33. CIT v. Vadilal Lallubhai (1972) 86 ITR 2 (SC)
34. Navanagar Transport and Industries Limited v. ITO (1964) 54 ITR 271 (Guj.).
35. Shree Sajjan Mills Ltd. v. CIT (1985) 156 ITR 585/23 Taxman 37 (SC).
36. CIT v. Warangal Industries (P.) Ltd. [1977] 110 ITR 756 (AP).
37. S. Sundaram v. Pattibhiraman AIR 1985 SC 582, 593.
38. Khandelwal Metal and Engineering Works v. Union of India (1985) 3 SCC 620/[1985] taxmann.com 418 (SC)/AIR 1985 SC 1211.
39. Vrajlal Manilal and Company v. State of Madhya Pradesh (1986) 63 STC 1 (SC).
40. Vrajlal Manilal and Company v. State of Madhya Pradesh (1986) 63 STC 1 (SC) pp. 10-11.
41. CIT v. Sriram Agrawal (1986) 54 CTR (Patna) 367/28 Taxman 81 (Patna).
42. CIT v. Indo Mercantile Bank Limited (1959) 36 ITR 1, 7 (SC).
43. CIT v. Bipinchandra Maganlal & Co. Ltd., Bombay AIR 1961 SC 1040/(1961) 2 SCR 493/(1961) 41 ITR 290 (SC); Sundaram Pillai v. V R Pattabiraman [1985] 1 SCC 591; Hiralal Rattanlal v. State of UP (1973) 1 SCC 216;
44. SM Railway v. Bezwada Municipality AIR 1944 Privy Council 71.
45. CIT v. Madurai Mills Company Limited (1973) 89 ITR 45 (SC).
46. Jummarlal Suraj Karan v. CIT (1963) 47 ITR 809 (AP).
47. Ibid at p 812.
48. State of Rajasthan v. Leela Jain AIR 1965 SC 1296.

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Case Details: ITO v. Avirook Sen - [2024] 161 taxmann.com 462 (Delhi - Trib.)

Judiciary and Counsel Details

• G.S. Pannu, Vice President & MS. Astha Chandra, Judicial Member
• Vivek Bansal & Vishal Chechi, Advs. for the Appellant.
• Anuj Garg, Sr. DR for the Respondent.

Facts of the Case

The assessee, an individual, received Rs. 2 Crore from his employer, INX Media, after his termination from service. The assessee voluntarily settled the case as his reputation was diminished due to extreme harassment and ill-treatment caused by the employer.

Assessing Officer (AO) added said amount along with Rs. 13,08,444 as perquisites in the assessee’s income. The AO treated the receipt as profits in lieu of salary. On appeal, CIT(A) deleted the additions made by AO. Aggrieved-AO filed the instant appeal before the Tribunal.

ITAT Held

The Tribunal held that the payment of ex-gratia compensation was voluntary in nature without the employer having any obligation to pay further amount to the assessee in terms of any service rule. Thus, it would not amount to compensation in terms of section 17(3)(i).

The AO relied upon various Madras High Court judgments wherein it was held that the amount received for encashment of leave salary would be a profit in lieu of salary and taxable under the “voluntary Separation Programme”.

He also relied upon the decision of the Hon’ble Delhi High Court in the case of Deepak Verma (2010) 194 taxman 265 (Delhi) wherein it was held that if the payment is made ex gratia or voluntarily by an employer out of his own sweet will and is not conditioned by any legal duty or legal obligation, either on sympathetic grounds or otherwise, such payment is not to be treated as profit in lieu of salary under sub-clause (i) of section 17(3).

In the present case, the payment of ex-gratia compensation was voluntary in nature without there being any obligation on the part of the employer to pay further amount to the assessee in terms of any service rule. Therefore, it would not amount to compensation in terms of section 17(3)(i) of the Act. The impugned additions were rightly deleted by the CIT(A).

List of Cases Referred to

• CIT v. Deepak Verma [2010] 7 taxmann.com 53/236 CTR 213/[2011] 339 ITR 475/[2010] 194 Taxman 265 (Delhi) (para 7),
• Subhash Chander Goel v. ITO [2016] 65 taxmann.com 216/177 TTJ 353/156 ITD 808 (Chandigarh – Trib.) (para 9),
• G.N. Badami v. CIT [1998] 144 CTR 289/[1999] 240 ITR 263 (Madras) (para 10)
• P. Arunachalam v. CIT [2000] 240 ITR 827 (para 10).

The post Sum Received From Employer on Account of Out-of-Court Settlement Isn’t Taxable as Profit in Lieu of Salary | ITAT appeared first on Taxmann Blog.

Case Details: DCIT v. Standard Match Industries (P.) Ltd. - [2024] 161 taxmann.com 459 (Chennai - Trib.)

Judiciary and Counsel Details

• Mahavir Singh, Vice President & Manoj Kumar Aggarwal, Accountant Member
• S. Sridhar, Adv. Ld. AR for the Appellant.
• R. Clement Ramesh Kumar, CIT-Ld. DR for the Respondent.

Facts of the Case

Assessee-company engaged in the manufacturing and sale of safety matches. During the relevant assessment year, assessee decided to book options contracts based on State Bank of India (SBI) advice to hedge its foreign exchange risk.

The forward contracts were designed to protect the company from adverse market movements by allowing it to lock in an exchange rate in advance for future transactions. However, due to the depreciation of the rupee against the US Dollar and Euro, the company cancelled the forward contracts and incurred a loss of Rs. 945.43 lakhs.

During the assessment proceedings, the AO treated the loss as a speculative loss as the assessee was not able to procure export orders, and adverse market conditions led to the cancellation of export orders.

The CIT(A) reversed the order of AO and treated the loss as a business loss. Aggrieved by the order, an appeal was filed to the Chennai Tribunal.

ITAT Held

The Tribunal held that the assessee did not submit proper evidence to prove that the loss was not speculative in nature. The assessee merely stated that it was not able to procure export orders, and adverse market conditions led to the cancellation of export orders. The assessee was asked to explain the losses claimed with reference to purchase orders and invoices vis-a-vis exchange contracts with banks for specific transactions, at least on a sample basis, but it could not provide such details.

Further, the assessee referred to the proviso to section 43(5) and submitted that it had undertaken forward contract and derivative contract as hedging against any foreign exchange fluctuation to fulfil its commitments of exports.

However, the said proviso provides that a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. The assessee’s case would not be covered by the said proviso.

As the assessee could not substantiate its case and furnish the requisite details/explanations, the matter was restored to the file of the CIT(A) for denovo adjudication.

List of Cases Reviewed

• Vinodkumar Diamonds Pvt. Ltd. (ITA No. 506/Mum/2013)
• Araska Diamond Pvt. Ltd. v. ACIT (52 taxmann.com 238)
• CIT v. MP Sugar Mills (P.) Ltd. [148 ITR 203) [Para 8] – Followed.

List of Cases Referred to

• Araska Diamond (P.) Ltd. v. Asstt. CIT [2014] 52 taxmann.com 238/[2015] 170 TTJ 634/152 ITD 203 (Mumbai) (para 2)
• Addl. CIT v. M.P. Sugar Mills (P.) Ltd. [1984] 38 CTR 112/148 ITR 203/[1983] 15 Taxman 247 (Allahabad) (para 4.4).

The post Loss on Forward Foreign Exchange Contracts to Be Treated as Speculative if No Nexus Established With Business | ITAT appeared first on Taxmann Blog.

Case Details: Harish Chandar T v. ICAI - [2024] 161 taxmann.com 418 (Delhi)

Judiciary and Counsel Details

• C. Hari Shankar, J.
• Alakh Alok Srivastava, Rishabh Bafna & Ms Anubha Shrivastava Sahai, Advs. for the Petitioner. 
• Ramji Srinivasan, Sr. Adv., Ms Pooja M. Saigal, Nipun Gupta, Nikhil Sabri & Ms Namrata Saraogi, Advs. for the Respondent.

Facts of the Case

A writ petition was filed before the Delhi High Court seeking to reschedule the Chartered Accountancy (CA) Intermediate and Final Examinations, scheduled to be conducted in May & June 2024.

It was argued that conducting the exams during the election period would impact the candidates’ right to vote guaranteed under Article 326 of the Constitution of India. The petitioner also submitted that the elections would result in chaos, commotion and violence, affecting the candidates’ ability to prepare thoroughly before the examinations.

It was also argued that the elections would result in the unavailability of hotels and lodging places for candidates who travel to the concerned centres from outside districts or states.

High Court Held

The Delhi High Court held that the mere fact that certain individual candidates may face hardship cannot constitute the basis for the Court to derail the entire CA Intermediate, or Final, examination, which presently is to be undertaken by as many as 4,36,246 candidates.

None of the factors cited by the petitioners can constitute the basis for the Court to direct holding of the CA Intermediate and Final Examinations on any date other than the dates presently scheduled in that regard.

The Institute of Chartered Accountants of India (ICAI) has ensured that no examination is scheduled on a day when the elections are to take place or even a day before. The petitioner was less than fair to the security administration in place in their rather bleak prediction that there is likely to be chaos, commotion and violence during elections.

General elections are regularly conducted, and based on previous experiences, the Court has no grounds to question the ability or effectiveness of the existing security apparatus to guarantee that the elections occur in a fair and unbiased environment.

Further, the plea of violation of Article 21 is based on the petitioner’s prediction that the entire nation is bound to be in a state of turmoil during elections. There is no basis for this presumption. We are headed for elections, not civil war.

The post Elections Ahead, Not Civil War | HC Denies Plea to Delay CA Exams Due to Lok Sabha Elections appeared first on Taxmann Blog.

Capital Restructuring refers to a significant modification in a company's capital structure, which typically involves altering the composition or balance between its debt and equity. This process can include actions such as issuing new shares, buying back existing shares, converting debt into equity, or restructuring existing debts through renegotiation of terms or refinancing. The goal is typically to create a more stable and financially efficient corporate entity that can achieve long-term growth and investor confidence.

By Advocate Anil Chachra

Table of Contents

1. Capital Restructuring Plan – Under Law
2. Capital Restructuring Options Under Merger/Amalgamation, Demerger & Slump Sale
3. Capital Restructuring Options Under – Capital Reduction/Buyback of Shares
4. Capital Restructuring Options Under – Issuance of New Shares/Bonus Shares
5. Restructuring Options Under – Redemption/Conversion
6. Restructuring Options Under – Waiver/Conversion of Loan into Equity
7. Restructuring Options Under – IBC

1. Capital Restructuring Plan – Under Law

2. Capital Restructuring Options Under Merger/Amalgamation, Demerger & Slump Sale

2.1 Capital Restructuring Options Under – Merger/Amalgamation

Amalgamation/Merger – As per Company Law

As per section 230-232 of the Company Act – Overview

Through NCLT Approval

• Section 230 – defines the procedure for compromise or make arrangements with creditors and members
• Section 231 – Power of Tribunal to enforce compromise or arrangement
• Section 232 – Merger and amalgamation of companies
• Section 233-235 – Merger for certain companies

2.1.1 Impact on Company

Amalgamation/Merger – As per Income Tax

• Section 47 (vi) – Any transfer, in a scheme of amalgamation of capital asset by the amalgamating company to the amalgamated company if the amalgamated company is an Indian Company – will not be transfer – Tax Neutral merger
• Section 49(1) – Cost of acquisition of property in the amalgamated company shall be deemed to be the cost for which the previous owner of the property acquired it
• Section 2(42A) – Period of holding shall include the period for which the capital assets in the amalgamating company were held by the assessee
• Section 55(2)(b) – FMV option is available if the property become the previous owner before 1-4-2001

Amalgamation as per Section 2(IB)

• Amalgamation in relation to companies means……..the merger of one or more companies with another company or the merger of two or more companies to form one company…..

1. 1. All the property of the amalgamating company….
   2. all the liabilities of the amalgamating company….
   3. Shareholders holding not less than 3/4th in value of the shares………. [Relevant Extract]

Capital Assets

• Section 2(14) – Capital assets means “ property of any kind held by an assessee……. [Relevant Extract]

Transfer

• Section 2(47) – Transfer in relation to capital asset, includes
  1. sale, exchange or relinquishment of the asset; or
  2. the extinguishment of any rights therein; or ……. [Relevant Extract]

2.1.2 Impact on Shareholders

Amalgamation/Merger – As per Income Tax

Section 47 (vii) – Any transfer, by shareholder, in a scheme of amalgamation of capital asset  being shares held by him in the amalgamated company if

• the transfer is made in consideration of the allotment to him of any share or shares in the [amalgamated company except where the shareholder itself is the amalgamated company, and
• the amalgamated company is an India company; [Will not be treated as transfer]

Transfer of shares in Amalgamation is an extinguishment of right – will be transfer as held in CIT vs. Grace Collis [2001] 115 Taxman 326/248 ITR 323 (SC) – the expression does include the extinguishment of rights in a capital asset independent and of otherwise than on account of transfer- overturned the Vania Silk Mills (P.) Ltd. v. CIT [1991] 59 Taxman 3/191 ITR 647 (SC)

• Deemed Dividend – Section 2(22)(C) – any distribution made to the shareholders of a company on its liquidation………[Relevant Extract]
• Q – What would be the implication of dividend in the merger in the hands of shareholders?
• As per circular no 5 (LXXVI-63) of 1967 – dated 9-10-67 The provision is attracted only in a case where a company goes into liquidation and not where it merges with another company in a scheme of amalgamation without going into liquidation. The Board are, therefore, of the view that the provisions of sub-clause (a) or (c) of section 2(22) are not attracted in a case where a company merges with another company in a scheme of amalgamation.
• Section 49(2) – Cost of acquisition of shares in the amalgamated company – the cost of acquisition of shares shall be deemed to be cost of acquisition to him of share or shares in the amalgamating company
• Section 2(42A)(c) – Period of holding- shall be included the period for which the shares in the amalgamating company were held by the assessee

2.2 Restructuring Options Under – Demerger

2.2.1 Impact on Company

Demerger – As per Income Tax

• Section 47 (vib) – Any transfer, in a demerger of capital asset by the demerged company to the resulting company, if the resulting company is an Indian Company – will not be transfer – Tax Neutral demerger
• Section 49(1) – Cost of acquisition of property of the in the resulting company- shall be deemed to be the cost for which the previous owner of the property acquired it.
• Section 2(42A) – Period of holding- shall be included the period for which the capital assets in the demerged company were held by the assessee.
• Section 55(2)(b) – FMV option is available if the property become the previous owner before 1-4-2001

Demerger as per Section 2(I9AA)

Demerger in relation to companies means……..the transfer pursuant to a scheme of arrangements u/s 230-232 of Companies Act, 2013 by a demerged company of its one or more undertakings to any resulting company

1. All the property of the undertaking………
2. all the liabilities of the undertaking…..
3. Shareholders holding not less than 3/4th in value of the shares………. [Relevant Extract]

Capital Assets

• Section 2(14) – Capital assets means “property of any kind held by an assessee……. [Relevant Extract]

Transfer

• Section 2(47) – Transfer in relation to capital asset, includes

1. sale, exchange or relinquishment of the asset; or
2. the extinguishment of any rights therein; or ……. [Relevant Extract]

2.2.2 Impact on Shareholders

Demerger – As per Income Tax

Section 47 (vid) – Any transfer, or issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company if the transfer or issue is made in consideration of demerger of the undertaking [Will not be treated as transfer].

Transfer of shares in Demerger is an extinguishment of right – will be transfer as held in CIT v. Grace Collis [2001] 115 Taxman 326/248 ITR 323 [SC] – the expression does include the extinguishment of rights in a capital asset independent and of otherwise than on account of transfer- overturned the Vania Silk Mills (P.) Ltd. v. CIT [1991] 59 Taxman 3/191 ITR 647 (SC).

• Q – What would be the implication of dividend in the demerger of the in the hands of shareholders?
• As per clause (v) of exemptions clause of section 2(22).
• Any distribution of shares pursuant to a demerger by the resulting company to the shareholders of the demerged company (whether or not there is a reduction of capital in the demerged company dividend will not be applicable.
• Section 49(2D) – Cost of acquisition of shares in the resulting company – shall be the amount which bears to the cost of acquisition of shares held by the assessee in the demerged company the same proportion as the net book value of the assets transferred in a demerged bears to the net worth of the demerged company immediately before such demerger.
• Section 2(42A)(g) – Period of holding shall include the period for which the shares in the demerged company were held by the assessee.

2.3 Restructuring Options Under – Applicability of GAAR

2.3.1 Impact on Shareholders and Company

Restructuring – As per Income Tax

• Will the GAAR will be invoked if arrangement is sanctioned by an authority such as court, NCLT or is in accordance with judicial precedents etc.?
• As per Circular no 7 of 2017 dated 27 January, 2017
• While the court has explicitly and adequately considered the tax implication while sanctioning the arrangement, GAAR will not apply to such arrangement”

Panasonic India (P.) Ltd., In re [2022] 138 taxmann.com 570 [NCLT-Chd] – At the time of approval of scheme GAAR will not be invoked. At the time of assessment the department is at liberty to invoke GAAR

2.3.2 Important Judicial Pronouncements

• Marshall Sons and Co. (India) Ltd. v. ITO [1996] 89 Taxman 619/[1997] 223 ITR 809 [SC] – Appointed day for amalgamation
• CIT vs. Raskiklal Maneklal (HUF) – Amalgamation is not transfer
• CIT vs. Grace Collis [2001] 115 Taxman 326/248 ITR 323 [SC] – Amalgamation is an extinguishment of right
• McDowell & Co Ltd. vs. CTO [1985] 22 Taxman 11/154 ITR 148 [SC] – Tax Planning vs. colourable device
• CIT vs. Gautam Sarabhai Trust No. 31 [1988] 40 Taxman 178/173 ITR 216 [Guj.] – Received other than shares are taxable
• Principal CIT v. Maruti Suzuki India Ltd. [2019] 107 taxmann.com 375/265 Taxman 515/416 ITR 613 [SC] – Amalgamating company ceased to exist
• Indo Rama Textile Ltd., In re [2012] 23 taxmann.com 390/[2013] 212 Taxmann 462 (Delhi) – Meaning of undertaking in case of demerger

2.4 Restructuring Options Under – Slump Sale

2.4.1 Impact on Company

Slump Sale – As per Income Tax

Prior to 1-4-2021: Section 2 (42C – slump sale means the transfer of one or more undertaking as result of ‘sale’ [Relevant Extract]

CIT vs. Bharat Bijlee Ltd. [2014] 46 taxmann.com 257/365 ITR 258 [Bom.] – Sale means monetary consideration. Transfer by way of issue of shares will not part of slump sale.

w.e.f 1-4-2021: Slump sale means the transfer of one or more undertaking, by any means for lump sum consideration without values being assigned to the individual assets and liabilities in such transfer’. [Relevant Extract]

3. Capital Restructuring Options Under – Capital Reduction/Buyback of Shares

As per Company Law

As per section 66 of Company Act – Reduction of Share Capital – Through NCLT Approval

(a) Extinguish or reduce the liability on any of its shares in respect of the share capital not paid-up; or

(b) Either with or without extinguishing or reducing liability on any of its shares-

(i) Cancel any paid-up share capital which is lost or is unrepresented by available assets; or

(ii) Pay off any paid-up share capital which is in excess of the wants of the company.

As per section 68 – Buy back of shares – ‘Without NCLT Approval’

(a) From the existing shareholders or security holders on a proportionate basis;

(b) From the open market

(c) By purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity

3.1 Restructuring Options Under – Capital Reduction

3.1.1 Impact on Company

Capital Reduction – As per Income Tax

Cancel – paid-up share capital: Book entry by way of adjustment in the books – no specific tax treatment

Pay-off share capital: Book entry by way of adjustment in the books – no specific tax treatment

3.1.2 Impact on Shareholders

Capital Reduction – As per Income Tax

Impact on Shareholders – By paying off the paid-up capital

• Deemed Dividend Implications u/s 2(22)(d) – Any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits. Whether such accumulated profits have been capitalized or not.
• W.e.f. 01-04-2020 – Dividend is taxable in the hands of shareholders.
• Capital Reduction is a transfer?
• The Hon’ble SC in Kartikeya V. Sarabhai v. CIT [1997] 94 Taxman 164/228 ITR 163 (SC) – has held that capital reduction is a transfer.
• CIT vs. G. Narasimhan [1999] 102 Taxman 66/236 ITR 327 (SC) – Capital reduction – is a transfer and liable to capital gain tax

Impact on Shareholders – By canceling the share capital

• No distribution of assets – Cancel the share capital will be the capital loss in the hands Shareholders.
• Recently Mumbai Tribunal in TATA Sons Ltd. vs. CIT [2024] 158 taxmann.com 601 (Mum.-Trib.) relying on Gujrat HC in CIT vs. Jay Krishna Harivallabhdas [1998] 231 ITR 108 (Guj.) has held that:
  • Reduction of capital is the extinguishment of right on the shares and amounts to transfer
  • Loss on the reduction of shares is a capital loss and not notional loss
  • When the assessee has not received any consideration on reduction of capital but its investment was reduced to loss resulting into capital loss – and it will be allowed, [Yes Allowed]

3.2 Restructuring Options Under – Buyback of Shares

3.2.1 Impact on Company

Buyback of Shares – As per Income Tax

• Section 115QA – Tax on distributed income to shareholders- In case of buyback of shares [listed or unlisted] – domestic company shall be liable to pay additional income tax at the rate of 20 per cent on the distributed income.
• Buyback means the purchase by a company on its own shares in accordance with the provisions of section 77A [section 68] of the Companies Act.
• W.e.f. 1-6-2016- section 77A [68] has been replaced with any law for the time being in force relating to companies

Rationale for change in law – 115QA

The Bombay High Court in SEBI vs. Sterilite Industries (India) Ltd. [2003] 45 SCL 475 (Bom.) and in Capgemini India Private Limited held that it is not mandatory for a company to buy back it shares only by following the procedure prescribed u/s 77A [68]of the Act. Company can follow the procedure u/s 100-104 of the erstwhile act.

Judicial Pronouncements

• Recently the Mumbai Tribunal in ACIT vs. Meriton Infotech (P.) Ltd. [2024] 159 taxmann.com 181 (Mum.-Trib.) has held that buyback through capital reduction scheme u/s 100-104 before 1-4-2016 will not be chargeable u/s 115QA.

Now every buyback under any scheme will be chargeable to distribution tax u/s 115QA

3.2.1 Impact on Shareholders

Buyback of Shares – As per Income Tax

• Section 56(2)(X) any implication?
• Held that the provisions of section 56(2)(x) of the Act are applicable only in the cases where the purchased shares became property in the hands of the buyer company and, if the shares are of any other company. However, in the case under consideration the assessee purchased its own shares under buyback scheme the same has been extinguished by reducing the paid up capital of the assessee company. Not applicable as held in
• Vora Financial Services (P.) Ltd. vs. Asstt. CIT [2018] 96 taxmann.com 88/171 ITD 646 (Mum.-Trib.) and followed in VITP (P.) Ltd. vs. Dy. CIT [2022] 143 taxmann.com 304/197 ITD 395 (Hyd.- Trib.)
• Dy. CIT vs. Globe Capital Market Ltd. [2023] 156 taxmann.com 620/203 ITD 758 (Delhi-Trib.)
• Section 10(34A) – Any income arising to an assessee being a shareholder, on account of the buyback of shares by the company u/s 115QA is exempt from tax
• Section 46A [Capital Gain on Buy Back of Shares] – is still applicable?
• Post the implementation of section 115QA – the section 46A – has no relevance

4. Capital Restructuring Options Under – Issuance of New Shares/Bonus Shares

4.1 Issuance of New Shares

4.1.1 Impact on Company

• Section 56 (2)(viib) – ‘Angel Tax’
• Where a company not being a company in which the public are substantially interested, received in any previous year from any person being a resident any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of such shares shall be treated as other income.
• W.e.f- 01-4-2024; now every person [Resident or Non–Resident] will be included
• Exceptions for Start-up Companies and Venture Capital Undertaking.
• FMV shall be determined u/r 11U and 11UA
• Section 56 (2)(viib) vs. Section 68 Interplay
• As held in Sunrise Academy of Medical Specialties (India) (P.) Ltd. vs. ITO [2018] 96 taxmann.com 43/257 Taxman 373/409 ITR 109 (Ker)
• This provision is not controlled by Section 68 which provides that when a resident investor is not able to explain the nature and source for credit seen in the books of account of company or explanation offered is not satisfactory, then entire credit would be charged to income tax for that previous year. However, if an explanation is offered and it is satisfactory in the case of closely-held company, then charge to tax will only be to that portion exceeding fair market value determined, in which public is not substantially interested, which anyway has to occur u/s 56(2)(viib)
• Section 79 – ‘’- Carry forward and set off of losses
• Fifty one percent voting power who beneficially held the shares should be same on the last day of the year in which loss was incurred. [In case of a start-up company all the shareholders should remain same]

4.1.2 Judicial Pronouncements

• In CIT vs. Amco Power Systems Ltd. [2015] 62 taxmann.com 350/235 Taxman 521/379 ITR 375 [Kar.] followed in CLP Power India (P.) Ltd. vs. Dy. CIT [2018] 93 taxmann.com 326/170 ITD 744 (Ahm.-Trib.] held that
  • If Ultimate control by same holding company by transferring its shares to another subsidiary company section 79 is not applicable.
• In Yum Restaurants (India) (P.) Ltd vs. ITO [2016] 66 taxmann.com 47/237 Taxman 652/380 ITR 637 (Delhi). It was held that shareholding are not the same Section 79 is applicable
• Conversion of Cumulative Convertible Debentures into equity – Impact on section 56(viib)

Kol-Tribunal in Milk Mantra Diary (P.) Ltd. VS. Dy. CIT [2022] 140 taxmann.com 163/196 ITD 333 [Kol.-Trib.] has held that

The term consideration“, is a term of wider import when compared with words “amounts” or “money”. Receipt of money is one of the several modes for having a consideration in a transaction. Consideration can partake many forms viz. tangible or intangible, pecuniary or non-pecuniary, direct or indirect. Section 56(2)(viib) contains the words “receives any consideration” which encompasses consideration in all forms and not limited to only receipt of money. In this backdrop what the assessee receives as consideration on the conversion of a debt security of CCDs into equity shares which subsequently forms part of the capital base of the assessee. Thus, when looked from these aspects, section 56(2)(viib) envisages a much wider outlook to the “receipt of any consideration” which cannot be limited to the receipt of money only. The conversion of CCDs into equity shares in assessment year 2013-14 entails receipt of consideration by the assessee which is translated into the total issue price including share premium.

• Rejections of DCF method without finding fault in the valuation report and substitution of net asset method not allowed. As per Rule 11UA assessee has option to select the method of valuation of shares as held in:

1. 1. CIT vs. Vibhu Talwar [2011] 11 taxmann.com 419/200 Taxman 67 (Delhi) (Mag.)
   2. Vodafone M-Pesa Ltd. vs. Principal CIT [2018] 92 taxmann.com 73/256 Taxman 240 (Bom.)
   3. Innoviti Payments Solutions (P.) Ltd. vs. ITO [2019] 102 taxmann.com 59/175 ITD 10 (Bang.)
   4. Dy. CIT vs. Hometrail Buildtech (P.) Ltd. [2023] 155 taxmann.com 578/[2024] 204 ITD 154 (Delhi – Trib.)

• On the valuation date, the valuation can be based only on estimated future projections and actual figures available subsequently cannot be replaced.

1. 1. DQ (Internatinational) Ltd. vs. Asstt. CIT [2016] 72 taxmann.com 142 (Hyd.-Trib.)
   2. Cinestaan Entertainment (P) ltd. vs. ITO [2019] 106 taxmann.com 300/177 ITD 809 (Delhi – Trib.)
   3. Flutura Business Solutions (P.) Ltd. vs. ITO [2020] 117 taxmann.com 567/183 ITD 446 (Bang.-Trib.)
   4. Vodafone M-pesa Ltd. vs. Dy. CIT [2020] 114 taxmann.com 323/181 ITD 242 (Mum. – Trib.)

4.1.3 Impact on Shareholders

• Cost of acquisition of new shares – actual amount paid – section 55(2)(aa)(i)
• Cost of acquisition of bonus shares – Cost of acquisition will be nil
• Period of holding Section 2(42A) – Calculated from the date of allotment
• At the time of sale – Capital gain provisions will get apply – subject to the provisions of section 50CA special procedure for full value of consideration of unquoted shares

4.2 Issuance of Bonus Shares

4.2.1 Impact on Company

No Impact on the company

4.2.2 Impact on Shareholders

• Deemed Dividend Implications u/s 2(22)(a)
• The distribution does not take the form of payment of accumulated profits in cash to the shareholders and does not therefore, entail release of any assets of the company so as to fall within the second condition of section 2(22)(a). As held in
• CIT vs. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC) Shashibala Navnitlal vs. CIT [1964] 54 ITR 478 (Guj.)
• Section 56(2)(X)/56(2)(viia) Implications
• Recently as held by Delhi Tribunal in DCIT vs. Smt. Aruna Chandok that section 56 is not applicable for bonus shares

5. Restructuring Options Under – Redemption/Conversion

5.1 Redemption/Conversion of Preference Shares – Impact on Company

• Redemption of preference shares. No Impact on company
• Conversion of preference shares into equity Section 56(2)(viib) may get invoke as per Kolkata Tribunal in
• Milk Mantra Diary (P.) Ltd. vs. Dy. CIT [2022] 140 taxmann.com 163/196 ITD 333 (Kol.- Trib.)

5.2 Redemption of Preference Shares – Impact on Shareholders

• Redemption of Preference Shares is a transfer?
• As held in Anarkali Sarabhai vs. CIT [1997] 90 Taxman 509/224 ITR 422 (SC) that Such a transaction is nothing but sale of the preference shares by the shareholder to the company will be treated as transfer and any amount received excess over the face value will be chargeable to capital gain.
• Accordingly, Capital loss will be allowed as held in Parle Biscuits Pvt. Ltd. [TS-477-ITAT- Mum]
• In Enzen Global Solutions (P.) Ltd. vs. ITO [2022] 144 taxmann.com 2 (Bang.-Trib.) held that Liability to tax premium on redemption of preference shares arose when the sum was actually received. Capital gains are not as from other sources.

5.3 Conversion of Preference Shares – Impact on Shareholders

• Conversion of preference shares/bonds into equity will be treated as transfer?
• As per section 47(x)/(xb) any transfer by way of conversion of preference shares/bonds of company into equity shares of that company – will not be treated as transfer.
• At the time of sale – Capital Gains
• Holding period as per section 2(42A) will be included from the original date
• Cost of acquisition of the equity as per section 49 (1)(2A) will be the cost of preference/bonds

6. Restructuring Options Under – Waiver/Conversion of Loan into Equity

6.1 Conversion of Loan into Equity

6.1.1 Impact on Company

• Section 269T mandates that loan/deposit have to be re-paid by account payee cheque or electronic clearing system/electronic mode system.
• The issue which arises for determination is whether conversion of loan into equity can be said to be in contravention of provisions of section 269T of the Act.

Judicial Pronouncements

• In case of Arkit Vincom Private Limited vs. ACIT (ITA no 2397-Kol-Tri) held that the transaction with respect to the conversion of loan into equity carried out by the taxpayer through book entries without any physical outflow of funds cannot be considered to the violation of provisions of section 269T. Therefore levy of penalty u/s 271E is to be deleted. Further held in CIT vs.Triumph International Finance (I) Ltd. [2012] 22 taxmann.com 138/345 ITR 270/208 Taxman 299 (Bom.)

6.2 Waiver/Remission of Loan

6.2.1 Impact on Company

Tax Implications on waiver of loans and other liabilities:

Tax implications on waive of loans can be bifurcated based on type of loan & end user as under:

• Tax Implications on waiver of loans and other liabilities: Dependent on its utilization e.g, capital purpose and working capital loan.
• Potential tax implication under section 41(1), 28(iv) and 194R
• Analysis of section 41 [Relevant Extract]

Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee and subsequently during any previous year……

The first mentioned person has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such liability by way of remission or cessation thereof, the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits and gains of the business………

• Q – Whether the waiver or write of loans will be taxable u/s 41?

6.2.2 Erstwhile Law

Tax Implications on waiver of loans and other liabilities: Dependent on its utilization e.g, capital purpose and working capital loan.

Analysis of section 28(iv)

“Erstwhile section” – [Pre-amendment to Finance Act, 2023]

The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession. There are three ingredients:

1. Benefit or Perquisite should arise to the recipient;
2. Should arise from business or exercise of a profession;
3. Whether convertible into money or not

1. Term “benefit or perquisite” – Not defined in the act. To be referred in dictionary and judicial definitions

• Benefit – [Black’s Law Dictionary] defines benefit-advantage, fruit; profit; privilege

CIT vs. Smt. Kamalini Gautam Sarabhai [1994] 208 ITR 139 (Guj.) – rendered in context of 2(24)(iv)

The word “benefit” implies an element of advantage, profit or gain. The word “benefit” occurring in clause (iv) of section 2(24) would mean any advantage, gain or improvement in condition

• Perquisite – Section 17(2) of the Act defines “Perquisite” inclusively – however, this applies to salary income and not“ PGBP”;

[Black’s Law Dictionary] – defines “Perquisite” – A privilege or benefit given in addition to one’s salary or regular wages – often shortened to perk.

2. Arising from business and profession

Arising from business and profession ”The “benefit” or “perquisite” should have a connection with business or profession of the recipient and not with the business or profession of the person providing the perquisite of benefit.

• CIT vs. Bhavnagar Bone, & Fertiliser Co. Ltd. [1987] 32 Taxman 180 (Guj.) and CIT vs. General Electrodes & Equipments Ltd. [1985] 20 Taxman 205/155 ITR 78 (Bom.) This amount had no connection or nexus with the business of the assessee. It did not represent value of any benefit or perquisite arising from the business of the assessee. This amount, therefore, would not partake of the character of the income.
• ITO vs. Undavalli Constructions [2021] 131 taxmann.com 204/191 ITD 749 (Visakh.-Trib.) it is necessary to show and prove the proximate cause or nexus between the alleged benefit or perquisite and the business actually carried on by the assessee. The nexus or the proximate cause must be real, immediate and not illusionary or imaginary. The benefit or perquisite contemplated by sec. 28(iv) must necessarily have a live connection with the business carried on by the assessee and the benefit must accrue or arise in the course of carrying on of such business.
• Gujarat HC – CIT v. Chetan Chemicals (P.), Ltd. [2004] 139 Taxman 301 (Guj.) and further in CIT vs. Gujarat State Fertilizers & Chemicals Ltd. [2013] 36 taxmann.com 230/217 Taxman 229/358 ITR 323 (Guj.). It cannot be said that the assessee-company was carrying on business of obtaining loans and that the remission of such loans by the creditors of the company was a benefit arising from such business.

3. Whether Convertible in to money or not

• Commissioner v. Mahindra and Mahindra Ltd. [2018] 93 taxmann.com 32/255 Taxman 305 (SC). Amount received as cash receipt due to the waiver of loan very first condition of Section 28 (iv) of the Act which says any benefit or perquisite arising from the business shall be in the form of benefit or perquisite other than in the shape of money, is not satisfied.
• Gujarat HC – CIT v. Chetan Chemicals(P.) Ltd. [2004] 139 Taxman 301 (Guj.) and further in CIT vs. Gujarat State Fertilizers & Chemicals Ltd. [2013] 36 taxmann.com 230/217 Taxman 229/358 ITR 323 (Guj.) – It cannot be said that the assessee-company was carrying on business of obtaining loans and that the remission of such loans by the creditors of the company was a benefit arising from such business.
• CIT v. Alchemic (P.) Ltd. [1981] 5 Taxman 55 (Guj.) – The phrase “whether convertible into money or not“ would normally mean something else than money. Section 28(iv) would not apply when the amount received is cash or is considered in terms of money.

4. Purpose of Loan – Capital or Revenue

• CIT v. T.V. Sundaram Iyengar & Sons Ltd. [1996] 88 Taxman 429 (SC) – Taxpayer received certain deposits from customers. Such deposits were not claimed by the customers and hence, taxpayer transferred it to P&L a/c. Although it was treated as deposit and was of capital nature at the point of time it was received, by influx of time the money had become the assessee’s own money. It became a definite trade surplus.
• Logitronics (P.) Ltd vs. CIT [2011] 9 taxmann.com 302 (Delhi) – Where loan was taken for acquiring capital asset, waiver thereof would not be taxable; If loan was taken for trading purpose, waiver thereof would result in income, more so when it was transferred to P&L.
• CIT vs Ramaniyam Homes (P.) Ltd. [2016] 68 taxmann.com 289 (Mad.) – Amount representing principal loan waived by bank under one time settlement scheme would constitute income falling under section 28 (iv)
• Over ruled by SC in Mahendra & Mahendra

6.2.3 Amended Law

Amended Provision of section 28(iv) – w.e.f 1-4-2023

The value of any benefit or perquisite arising from business or the exercise of profession, whether:

(a) Convertible into money or not

(b) In cash or in kind or party in cash or in kind

Comments in the Memorandum for the Amendment

• The intention of legislature while introducing this provision was also to include benefit or perquisite whether in cash or in kind. However, courts have interpreted that if the benefit or perquisite are in cash, it is not covered within the scope of this clause of section 28 of the Act.
• In order to align the provision with the intention of legislature, it is proposed to amend clause (iv) of section 28 of the Act to clarify that provisions of the said clause also applies to cases where benefit or prerequisite provided is in cash or in kind or partly in cash and partly in kind.

Amended section 28(iv)

Four Limbs of amended section 28(iv)

• Benefit or perquisite should arise to the recipient
• Should arise from business or exercise or exercise of a profession
• Whether convertible into money or not
• In cash or in kind or partly in cash and partly in kind

Waiver of Loan – Post amendment – Section 28 (iv)

• The Hon’ble Supreme Court in Mahendra & Mahendra has settled a law that waiver of loan is the benefit in cash and will not be part of section 28(iv).
• Post amendment – all benefits whether convertible into money or not or in cash will be part of section 28(iv)
• Question – Waiver of loans in restructuring would be taxable u/s 28(iv)?
• Question – Whether waiver of such loan can be considered as “arising from” business or exercise of profession? Refer Chetan Chemicals (P.) case decided by the Hon’ble Gujarat High Court

6.2.4 Section 194R

Waiver of Loan – Section 194R Implication – Circular no 12/2022 and Circular 18/2022

• Prior to amendment in section 28(iv) – monetary benefits were not covered within the ambit of section 28(iv) – Mahendra & Mahendra (SC)
• One time loan settlement with the borrowers or waiver of loan granted on reaching settlement with the borrowers by specified institutions [Banks and Public financial institutions] would not be subjected to deduction of tax at source under section 194R.
• Waiver of loan apart from the specified borrower – Applicability of section 194R?
• Write of Bad Debts – Applicability of section 194R?
• The treatment of such settlement/waiver in the hands of the person who benefits from such waiver would not be impacted by this clarification. The taxability of such settlement/waiver in the hands of the beneficiary will be governed by the relevant provisions of the Act.

6.3 Waiver/Remission of Interest

Waiver of Interest – Implication under Income Tax Act

• Interest Expenses is allowed as deduction u/s 36(1)(iii) under Income Tax Act – subject to section 43B
• Waiver of interest amount would constitute income and be taxable under section 41(1) of the Act
• If the interest was claimed and disallowed u/s 43B in earlier years, the same is not taxable under section 41(1)
• It was also held that waiver cannot be taxable under section 28(iv)
• Waiver of interest – Taxable u/s 41(1) if deduction claimed in earlier years

6.4 Waiver/Remission of Loan – Accounting Treatment

Waiver of Loan – Implication under Accounting Standards

• Capital receipt(s) arising out of transaction(s) on capital account, like, profit on sale of capital asset, write back of principal amount of loan etc., not arising in the ordinary course of business, forms part of capital reserve.
• A Transaction on capital account (not arising out of ordinary business activities, is not be regarded as giving rise income which can be credited to profit an loss account.

Waiver of Loan – Implication under Indian Accounting Standards “Ind AS”

• Ind AS 109 states that upon waiver of loan , the difference between the carrying amount of loan and the consideration actually paid towards such waiver would be routed through profit and loss account
• Therefore, if a financial liability (Loan) is extinguished without paying any consideration, the entire extinguished liability would be treated as part of income in the profit and loss statement of the debtor

7. Restructuring Options Under – IBC

7.1 Resolution Plan

Section 5(26) Resolution plan means a plan proposed by resolution applicant for insolvency resolution of the corporate debtor as a going concern in accordance with Part II

Explanation. – For removal of doubts, it is hereby clarified that a resolution plan may include provisions for the restructuring of the corporate debtor, including by way of merger/amalgamation and demerger.

Section 31 – If the Adjudicating Authority is satisfied that the resolution plan as approved by the committee of creditors under sub-section (4) of section 30 meets the requirements as referred to in sub-section (2) of section 30, it shall by order approve the resolution plan

The resolution plan shall be binding on the corporate debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority to whom a debt in respect of the payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed, guarantors and other stakeholders involved in the resolution plan [Q – Whether the Resolution plan will binding to the tax authorities?]

7.2 Distribution of Assets Under IBC – Section 53

Proceeds from the sale of liquidation assets shall be distributed: Section 53

(a) the insolvency resolution process costs and the liquidation costs paid in full;

(b) the following debts which shall rank equally between and among the following:

(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and

(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52

(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date

(d) financial debts owed to unsecured creditors;

(e) The following dues shall rank equally between and among the following: –

(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or
any part of the period of two years preceding the liquidation commencement date; [Meaning thereby that the income tax liability will be part of due to central govt further will not be treated as secured creditors]

(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) any remaining debts and dues;

(g) preference shareholders, if any; and

(h) equity shareholders or partners, as the case may be

7.3 Nature of Income Tax Liability Under IBC

Ghanashyam Mishra Case

• Position as operation creditors – Claims up to initiation of CIRP-income tax liability are part of due to govt. authorities as held by Supreme Court in Ghanashyam Mishra and sons (P.) Ltd. vs. Edelweiss Asset Reconstruction Co. Ltd. [2021] 126 taxmann.com 132 (SC).

That once a resolution plan is duly approved by the Adjudicating Authority under sub section (1) of Section 31, the claims as provided in the resolution plan shall stand frozen and will be binding on the Corporate Debtor and its employees, members, creditors, including the Central Government, any State Government or any local authority, guarantors and other stakeholders. On the date of approval of resolution plan by the Adjudicating Authority, all such claims, which are not a part of resolution plan, shall stand extinguished and no person will be entitled to initiate or continue any proceedings in respect to a claim, which is not part of the resolution plan.

Rainbow Paper Case – Latest

• Position as Secured Creditors – State is a secured creditors under GVAT Act and are to be treated at par with first priority u/s 53 of IBC as held by Supreme Court that State Tax Officer (I) vs. Rainbow Papers Ltd. [2022] 142 taxmann.com 157 (SC)
• As the SC judgment is land of law and statutory authorities need to abide by it
• Tax Authorities are now following the Rainbow Paper case judgment, wherein the Income tax liability is considered as secured creditors.
• Secured creditor means a creditor in favour of whom security interest is created.

7.4 MAT Section 115 JB

Applicability to MAT provisions to IBC

• No specific exemption is available for IBC Companies
• Loan and interest waiver is credited in the Profit and loss account. It will be subject to MAT
• Loan and interest waiver is credited in Capital Reserve will not be subject to MAT
• AO has no power to recast the audited profit and loss account for the books profit as held by SC in Apollo Tyre Judgement

MAT will not applicable even if credited in Profit and loss account

• As waiver of loan is considered as Capital receipt and MAT will not be applicable as held in:
  • JSW Steel Ltd. v Asstt. CIT [2017] 82 taxmann.com 210 (Mum.-Trib.);
  • Shivalik Venture (P.) Ltd. vs. Dy. CIT [2015] 60 taxmann.com 314 (Mum.- Trib.);
  • Shree Cement Ltd. vs. Addl. CIT [2014] 49 taxmann.com 274/[2015] 152 ITD 561 (J.P- Trib.)

MAT will be applicable even if credited in Profit and loss account – Loan Waiver

• However, contrary rulings are also present which state that if an amount is credited to Profit and Loss account – MAT is applicable:
  • B&B Infotech Ltd. vs. ITO [2015] 63 taxmann.com 122/155 ITD 1040 (Bang.- Trib.)
  • Duke Offshore Ltd. Vs. Dy. CIT [2011] 9 taxmann.com 214/45 SOT 399 (Mum.-Trib.)
  • Based on accounting principles, if loan and interest waiver is not credited to profit and loss a/c, MAT may not apply to such wavier

Brought forward loss and depreciation under MAT

• While computing the book profits tax, the brought forward loss or depreciation whichever is less as per books of the company, is allowed to be deducted for computing book profits.
• In case of CIRP cases, as the company would have done for restructuring, the carried forward loss/depreciation would have been wiped out from the books. Consequently there may be a tax on the write back of liabilities.
• To avoid this, Finance Act 2018 allowed aggregate deduction of tax loss/brought forward depreciation in CIRP cases.
• As per amendment made in section 115JB by Finance Act 2018, for companies which have been admitted by NCLT under IBC, total of brought forward losses and unabsorbed depreciation as per books of accounts has to be reduced.
• Hence, as against lower of brought forward losses or unabsorbed depreciation for rest of the companies, substantial relaxation is provided for companies under IBC.

7.5 Change in Shareholding u/s 79

• Section 79 provides that if there is change in shareholding by more than 51% in a company (in which public is not substantially interested), losses would not be carried forward.
• In case of companies referred to in IBC, there would be change in shareholding resulting into lapses of losses as per tax provisions.
• Hence, specific exemption provided under section 79 to IBC companies by Finance Act, 2018 if the resolution plan is approved by IBC and after affording a reasonable opportunity of being heard is provided to the jurisdictional/Principal Commissioner.

7.6 Amalgamation

Income tax implications in case of Merger/Amalgamation

• There are no specific provisions under IT Act dealing particularly with tax implications in case of corporate structuring pursuant to IBC provisions
• Amalgamation need to be complied the conditions as per section 2(IB) of IT, Act
• Tax neutrality for company – No Capital gain implication [Section 47(vi); depreciation shifts to the amalgamated company
• Tax neutrality for shareholders section 47(vii)
• Carried forward of losses and depreciation [Section 72A, Rule 9C]

Carried forward of losses of Merger/Amalgamation

• For Carried forward of losses all conditions as per section 72A (2)(a)(b) must be fulfilled. Compliance of Industrial Undertaking conditions
• On fulfilling the conditions accumulated losses will be allowed to carried forward for fresh period of 8 years as held in (Supreme Industries Ltd. vs. Dy. CIT [2008] 115 ITD 225/[2007 17 SOT 476 (Mum.-Trib.)
• Unabsorbed depreciation can be carried forward indefinitely
• If the conditions as per Section 72A(2) has not been fulfilled, the set off loss or allowance of depreciation will be deemed income of the amalgamated company
• Carried forward and set off Minimum Alternate Tax (MAT) is available to the amalgamated company – As held in Ambuja Cements Ltd. vs. Dy. CIT – [2019] 111 taxmann.com 10/179 ITD 436 (Mum.-Trib.)

7.7 Demerger

Income tax implication of Demerger

• Resolution plan as per section 5 (26) to be on going concern basis and it includes provisions of restructuring of corporate debtor, including by way of merger and demerger.
• Demerger under Income Tax Act is governed by section 2(19AA) which also specifies that the demerger of the undertaking should be on going concern basis.
• Question – Whether the demerger of IBC companies which are already in stress stage will be the ongoing concern basis as per IT Act?

7.8 Conversion of Loan into Equity

• Section 269T mandates that loan/deposit have to be re-paid by account payee cheque or electronic clearing system/electronic mode system.
• The issue which arises for determination is whether conversion of loan into equity can be said to be in contravention of provisions of section 269T of the Act.
• Judiciary in case of Arkit Vincom Private Limited vs. ACIT (ITA no 2397-Kol-Tri) held that the transaction with respect to the conversion of loan into equity carried out by the taxpayer through book entries without any physical outflow of funds cannot be considered to the violation of provisions of section 269T. Therefore levy of penalty u/s 271E is to be deleted.
• Further held in CIT vs. Triumph International Finance (I) Ltd. [2012] 22 taxmann.com 138 (Bom.)

7.9 Deeming Provisions

Deeming provisions Section, 50CA, 56(2)(x)

• No specific exemption provided for IBC Companies
• Section 50CA and 56(2)(x) refers to the fair market value of shares to be determined as per Rule 11UA
• Section 50CA – Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being shares of a company other than quoted shares.
• In case of IBC companies, possible that real fair market value of equity shares is much lower than FMV computed as per rule 11UA
• Possibility of tax litigation cannot be ruled out

7.10 Overriding Effect

IBC has overriding effect over provisions of Income Tax [Section 238]

Where there is a conflict between provisions of the Code and those of the Income tax Act, the Code will prevail over the Act

The Hon’ble Supreme Court in the case of Pr. CIT v. Monnet Ispat & Energy Ltd. [2019] 107 taxmann.com 481 (SC), dated 10-8-2018] has upheld overriding nature and supremacy of the provisions of the IBC over any other enactment in case of conflicting provisions, by virtue of a non obstante clause contained in section 238 of the Code

The Apex Court in case of Alchemist Asset Reconstruction Co. Ltd. v. Hotel Gaudavan (P.) Ltd. [2017] 88 taxmann.com 202 (SC) has also held that even arbitration proceedings cannot be initiated after imposition of the moratorium u/s 14 (1) (a) has come into effect and it is non est in law and could not have been allowed to continue.

IBC has overriding effect over provisions of Income Tax

U/s 178(6) of the IT Act, as amended w.e.f. 01.11.2016, the Code shall have overriding effect. The provisions of section 14 of the Code institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgement, decree or order in any court of law, tribunal, arbitration panel or other authority shall be prohibited during the moratorium period under Insolvency and
Bankruptcy Code.

ITAT Delhi in JCIT, Circle-22(2), New Delhi vs SR Foils & Tissue P. Ltd.

“….in view of the provision of section 238 of CIRP code, the proceedings before Ld. NCLT would have overriding effect

ITAT Delhi in ACIT vs. ABW Infrastructure Ltd.

“It is well settled now that, IBC has overriding affect on all the acts including Income Tax Act which has been specifically provided u/s 178 (6) of the I.T. Act as amended w.e.f. 01.11.2016

7.11 Nature of Income Tax Liability Under IBC – Modification of Notices

Modification and revision of notice in certain cases – Section 156A

It has been noted that in the cases of business reorganization, instances have been found where the Court or Tribunal or an Adjudicating Authority, as defined in clause (1) of section (5) of the Insolvency and Bankruptcy Code, 2016, as the case may be, as a part of the restructuring process, recast the entire liability to ensure future viability of such sick entities and in the process, modify the demand created vide various proceedings in the past, by the Income Tax department as well, amongst other things.

No procedure or mechanism provided in the Act to reduce such demands from the outstanding demand register. Hence, in order to remove this anomaly, it is proposed to insert a new section 156A

“Where any tax, interest, penalty , fine or any other sum in respect of which a notice of demand has been issued under section 156, is reduced as a result of an order of the Adjudicating Authority as define in clause (1) of section 5 of IBC, 2016, the AO shall modify the demand payable inconformity with such order and shall thereafter serve on the assessee a notice of demand specifying the sum payable if any, and such notice of demand shall be deemed to a notice under section 156 and the provisions of this Act shall accordingly, apply in relation to such notice.

Where the order referred to in sub-section (1) is modified by the National Company Law Appellate Tribunal or the Supreme Court, as the case may be the modified notice of demand as referred to in sub-section (1), issued by the AO shall be revised accordingly.”

7.12 Treatment of Tax Proceedings

Tax Proceedings and claims during and after resolution

Moratorium under section 14 of the Insolvency and Bankruptcy Code,2016 (IBC) will also apply to appeals being made by the Income Tax Department against the orders of Income Tax Appellate Tribunal, in respect of tax liability of a debtor under CIRP. Pr. CIT v. Monnet Ispat & Energy Ltd. [2019] 107 taxmann.com 481 (SC) [SC upholding Delhi HC ruling]

In Kitply Industries Ltd .vs Asstt. CIT [2019] 102 taxmann.com 116 (NCLT – Guwahati) as held that Proceeding before the Income-tax Department which has resulted in freezing of the bank accounts is a proceeding of quasi-judicial nature and continuation of such a proceeding during moratorium period is illegal in view of the prohibitions under section 14(1)(a) of the Code.

7.13 Filing of Return of Income

Carried forward of losses and filing of return of income

• Section 80 specifies that loss would be carried forward only if return of income is filed before the due date. No specific amendment for companies and hence, it may be possible that due to ongoing CIRP proceedings, return of income may be filed beyond due date resulting in to losses being lapsed.
• The assessee can approach to CBDT u/s 119(2)(b) of the Act for filing of delay return in case of genuine hardship.
• Section 140 The Income tax return shall be verified by the insolvency professional appointed by such adjudicating authority.

7.14 Income Tax Implication Under IBC – Miscellaneous

NOC from Income Tax Department u/s 281

• Section 281 states that Income Tax Department has the right to recover outstanding tax dues by treating the transfer of assets (including securities) as void
• Exceptions to provision:

1. 1. buyer is a bonafide purchaser without notice; or
   2. where a no-objection is obtained from the Income Tax Department

• Obtaining NOC is a time-consuming process

Stamp duty on transfer of property under IBC

• No specific exemptions on payment of stamp duty upon transfer of property under IBC

Applicability of GAAR

• An arrangement under IBC may have the risk of being considered as an impermissible avoidance agreement and tax consequences may arise if the arrangement leads to significant tax benefits.
• As per a CBDT circular, GAAR will not apply to such an arrangement where a Court or NCLT has explicitly and adequately considered the tax implication, while sanctioning an arrangement.

Deductibility of insolvency resolution process costs

• Section 5(13) of IBC defines “insolvency resolution process costs ”as costs of interim finance, fees of RP, costs incurred by RP in running day-to-day business, and costs incurred to facilitate resolution process.
• As per Section 35DD, costs incurred on amalgamation or demerger are allowed as deduction over five years.
• No clarifications issued by CBDT till date as to whether it should be accounted as a revenue expenditure or a capital expenditure.

Issuance of notice to Corporate Debtor u/s 148

• IT Department cannot raise claims against the Corporate Debtor once the resolution plan is approved.
• The Hon’ble Bombay High Court in Murli Industries Limited vs. Assistant Commissioner of Income Tax & ors. [W.P. No. 2948 of 2021 and W.P. No. 2965 of 2021 dated December 23, 2021] held that the IT Department is not entitled to issue notice against the Corporate Debtor for unpaid tax claims after the approval of the resolution plan by the adjudicating authority.

The post [Analysis] Capital Restructuring Tax Impact on Company and Shareholders appeared first on Taxmann Blog.

Section 37 of the Income Tax Act pertains to the deduction of expenses incurred in the production of income. It states that any expenditure not being capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession."

This means that for an expense to be deductible under this section, it must meet several criteria:
– The expense should not be capital in nature.
– The expense should not be a personal expense of the assessee.
– The expense should be incurred wholly and exclusively for business or professional purposes.

This section is crucial for businesses and professionals as it outlines the types of expenses that can be claimed as deductions from their taxable income, thereby lowering their overall tax liability. It covers a broad range of expenses including rent, wages, utility costs, and more, provided they are directly related to the business activity.

By Rohan Sogani

Table of Contents

1. Overview of Section 37 of the Income Tax Act
2. Conditions for Allowability under Section 37 of the Income Tax Act
3. Meaning of ‘Wholly and Exclusively for the Purpose of Business’
4. CSR Expenditure – Section 37 vs. Section 80G
5. Capital Expenditure vs. Revenue Expenditure
6. Meaning of ‘Offences/Prohibited by Law’
7. Fallout of Explanation 3 to Section 37(1)
8. Case Laws

1. Overview of Section 37 of the Income Tax Act

• Section 37 is a “Residuary Provision”.
• Sub-section (1) allows deductibility of Revenue and Non-Personal Expenditure, excluding those covered under Specific Sections.

Explanations to Section 37(1) inserted from time to time for clarifying the intent of the legislature.

Explanation 1

• Inserted vide Finance Act, 1998 w.r.e.f. 1-4-1962.
• Expenses related to offences or prohibited activities are inadmissible.

Explanation 2

• Inserted vide Finance Act, 2014 w.e.f. 1-4-2015.
• CSR Expenditure not allowable.

Explanation 3

• Inserted vide Finance Act, 2022 w.e.f. 1-4-2022.
• Further Clarification on Explanation 1.

2. Conditions for Allowability under Section 37 of the Income Tax Act

Expenditure shall be allowed in computing the income chargeable under the head “PGBP“, if it satisfies following conditions Cumulatively:

• it is Not an expenditure of the nature described in Sections 30 to 36
• it is Not in the nature of Capital Expenditure
• it is Not in the nature of Personal Expenses
• it is laid out or expended Wholly and Exclusively for the purposes of the business or profession

Explanations 1, 2, 3 to be Considered

2.1 Meaning of Term ‘Any Expenditure’

• Allowance under Section 37 is granted to ‘Any Expenditure’ that meets the criteria outlined in Section 37(1).
• Core definition of ‘expenditure’ revolves around the concept of ‘Spending‘ indicating the act of ‘Paying Out or Away’ of money. In essence, ‘expenditure’ denotes the Irreversible Outflow of Funds.

2.2 ‘Expenditure’ vs. ‘Loss’

Distinction exists between “disbursement/expenditure” and a “loss”.

Expenditure: 

1. Conscious act of paying out or spending.
2. Deliberate choice for outflow of resources.

Loss:

1. Fortuitous or arises from external factors.
2. Entirely involuntary i.e. loss occurs irrespective of a person’s will.

• Business Expenditure must be incurred “Wholly and Exclusively” for business for allowance, while a Business Loss, to qualify, must be of a Non-capital Nature and not only connected with the trade but also incidental to the trade itself.

[CIT v. J. K. Cotton Spinning & Weaving Mills Co. Ltd. [1980] 4 Taxman 1/123 ITR 911 (All.)

• In the case of M. P. Financial Corporation v. CIT [[1986] 26 Taxman 42/[1987] 165 ITR 765 (MP)], it has been observed that the term “expenditure” may, under specific circumstances, encompass:

1. 1. an amount that essentially represents a loss;
   2. even if that amount has not gone out of assessee’s pocket.

• The phrase ‘any expenditure’ within Section 37 of the Income Tax Act is interpreted to include both:

1. 1. ‘expenses incurred’ and
   2. amount classified as ‘losses’,

even if such amount has not gone out of assessee’s pocket

[CIT vs. Woodward Governor India (P.) Ltd. [2009] 179 Taxman 326/312 ITR 254 (SC)].

3. Meaning of ‘Wholly and Exclusively for the Purpose of Business’

• Phrase “Wholly And Exclusively” does not equate to “Necessarily”
• Assessee to determine Whether a Particular Expenditure is Warranted in the conduct of business.
• Expenditure may be undertaken Voluntarily and Without Absolute Necessity.
• State of Madras vs. G. J. Coelho [(1964) 53 ITR 186 (SC)] – established test stating that expenditure incurred under a transaction closely intertwined with the business can be considered an integral part of conducting the business.
• Bombay Steam Navigation Co. (1953) (P.) Ltd. vs. CIT (1965) 56 ITR 52 (SC) – Expenditure may qualify as revenue expenditure, laid out wholly and exclusively for the purposes of the business.
• S. A. Builders Ltd. vs. CIT(A), [2007] 158 Taxman 74/288 ITR 1 (SC) – Phrase “for the purposes of the business or profession” as employed in Section 37(1) encompasses a broader scope than the expression “for the purpose of earning profits”.
• CIT v. Delhi Safe Deposit Co. Ltd. [1982] 8 Taxman 1/[1982] 133 ITR 756 (SC) – True test of an expenditure laid out wholly and exclusively for the purposes of trade or business is it is incurred by the assessee:

1. 1. as Incidental to his Trade;
   2. for the purpose of Keeping the Trade Going and of making it pay and;
   3. Not in Any Other Capacity Than That of a Trader.

3.1 Questioning Expenditure’s Reasonableness: Possible?

• It is not for the revenue to question the Commercial Expediency of the expenditure.
• Commercial Expediency is a matter entirely left to the judgment of the assessee [CIT vs. Globald Motor Service (P.) Ltd. (1975) 100 ITR 240 (Mad.); CIT vs. Sapthagiri Traders Ltd. [2009] 180 Taxman 605/[2008] 305 ITR 438 (Mad.); CIT vs. Textool Co. Ltd. [2009] 184 Taxman 217/315 ITR 91 (Mad.)].

3.2 No Business, No Allowance

If during the relevant period, there was no business, the question of allowability of expenses would not arise [S.P.V. Bank Ltd. vs. CIT [1981] 5 Taxman 155/[1980] 126 ITR 773 (Ker.); J. R. Mehta vs. CIT [1980] 4 Taxman 522/126 ITR 476 (Bom.)].

4. CSR Expenditure – Section 37 vs. Section 80G

• Section 135 of the Companies Act, 2013 – Applicability

To Be Seen With Reference to Immediately Preceding Financial Year

• Explanation to Section 37(1)
  • Expenditure incurred on the activities related to CSR referred to in Section 135 shall be not deemed to be incurred for the purpose of PGBP.

Case Laws

5. Capital Expenditure vs. Revenue Expenditure

• Capital or the Revenue expenditure has Not Been Defined in the Act.
• A clear-cut dichotomy cannot be laid in respect of Revenue or Capital expenditure in the absence of statutory definition.
• ‘Capital’ Denotes ‘Permanency’ and, therefore, it refers to getting something tangible or intangible, property, corporeal or incorporeal rights, so that they could be of lasting or enduring benefit to the enterprise.
• ‘Revenue expenditure’ on the other hand is Operational in perspective and solely intended for the Furtherance of the enterprise Nature/Factual Position of transaction is important.

5.1 Accounting Treatment of Expenditure – Not Relevant

• Entries in the books of accounts are Not Decisive of the nature and character of expenses.
• Legal right is not Self Estopped by the Accounting Treatment adopted by the assessee.
• It is not material and relevant how the company treated these expenses in its books of accounts but what is material and relevant is the Allowability of These Expenses as Revenue Expenses as per provisions of the Income Tax Act, 1961.

[Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC)]

5.2 Tests Emerging from Judicial Precedence

Bharti Hexacom Ltd. [2023] 458 ITR 593 (SC)[16-10-2023]

• Expenses towards “acquisition of concern” is capital in nature; “carrying on a concern” is revenue in nature
• Enlargement of Structure vs operation of existing apparatus
• Mere Payment of an amount in instalment does not convert or change capital payment into revenue payment
• Single Transaction cannot be split in an artificial manner into capital and revenue

6. Meaning of ‘Offences/Prohibited by Law’

Explanation 1 to Section 37(1), any expenditure which is:

• Offence,
• Prohibited by Law

are inadmissible expenses under PGBP.

• A key pre-amendment principle was Compensatory Payments were allowed, Penal Payments were not, as affirmed by the Supreme Court in cases like Mahalakshmi Sugar Mills Co. Ltd. vs CIT [1980] 123 ITR 429 (SC) and CIT vs Hyderabad Allwyn Metal Works Ltd. [1988] 36 Taxman 88/172 ITR 113 (AP).

7. Fallout of Explanation 3 to Section 37(1)

• Explanation 3 was inserted to further clarify Explanation 1 to Section 37(1). It clarifies that “expenditure incurred by an assessee for any purpose which is an offence or prohibited by law” includes expenditure:

1. 1. for purposes considered Offences Under Current Laws in India or Outside India;
   2. providing Benefits or Perquisites, Violating applicable laws by the recipient.
   3. to Compound an Offence under prevailing laws In India or Outside India.

• Section 37(1) not only prohibits expenditures related to offenses under Indian law but also extends to Offenses Under Laws Outside India.
• Explanation 1 was introduced retrospectively by the Finance Act, 1998, w.e.f. 01.04.1962. Explanation 3 has been specified to be effective from 01.04.2022.
• Clause (ii) in this Explanation mainly aimed to address issues related to Freebies Given to Doctors in the Pharma Industry, which were previously allowed in some ITAT judgments, despite a CBDT circular deeming such favours against medical code of conduct.
• Clause (iii) in the Explanation 3 disallows Compounding Fees. Compounding involves settling an offence by paying compensation instead of facing penal consequences.
• Laws Like the Companies Act and SEBI, where compounding mechanisms exist for minor lapses, and penalizing businesses for claiming deductions on such levies, pose challenges in navigating the extensive compliance regime.

8. Case Laws

The post Critical Analysis of Section 37 of the Income Tax Act, 1961 appeared first on Taxmann Blog.

Case Details: Parag Hashmukhbhai Davda v. ITO - [2024] 161 taxmann.com 307 (Rajkot - Trib.)

Judiciary and Counsel Details

• Smt. Annapurna Gupta, Accountant Member & T.R. Senthil Kumar, Judicial Member
• Rajendra Singhal, Ld. AR for the Appellant. 
• Ashish Kumar Pandey, DR for the Respondent.

Facts of the Case

Assessee, an individual, was engaged in the business of share trading and earned commission income from the sub-broker activity of shares. During the relevant year, the assessee’s income from share trading and commission income were accepted in the scrutiny assessment. The assessee filed the return of income without getting the books of accounts audited.

The Assessing Officer (AO) levied a penalty under section 271B as the assessee failed to get his books of accounts audited in terms of section 44AB. In the penalty order, the AO considered the turnover from the sale of shares to be Rs. 6,06,87,030 and levied a penalty of Rs. 1,50,000.

The matter reached the Rajkot Tribunal.

ITAT Held

The Tribunal held that the assessee was engaged in the business of sub-brokerage, and its turnover or gross receipts to be considered for determining whether it was liable to get its books audited under section 44AB was to be confined only to the commission income earned by it.

The sale consideration of the shares sold by the assessee, on which it earned commission/brokerage, is not turnover and cannot constitute its turnover. The assessee’s commission income was Rs. 1,55,614, and the income in the present case falls well below the limit prescribed by section 44AB.

Thus, there was no case for the assessee to have had its books audited in terms of provisions of section 44AB. Therefore, there is no case for levy of penalty under section 271B for not getting the books audited under section 44AB.

List of Cases Reviewed

• ACIT v. Hasmukh M. Shah, 85 ITD 99 (Ahd) (para 14) followed.

List of Cases Referred to

• Asstt. CIT v. Hasmukh M. Shah [2003] 85 ITD 99/80 TTJ 323 (Ahmedabad – ITAT) (para 12).

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Case Details: Bangalore Turf Club Ltd. v. Union of India - [2024] 161 taxmann.com 353 (Karnataka)

Judiciary and Counsel Details

• B.M. Shyam Prasad, J.
• S. Naganand, Sr. Counsel & Smt. Sumana Naganand, Adv. for the Petitioner. 
• Raviraj Y.V., Adv. for the Respondent.

Facts of the Case

The Bangalore Turf Club Limited (the assessee), a recognized Turf Authority, was engaged in organizing thoroughbred horse racing. The assessee was assessed for the relevant assessment year under section 143(3).

During the assessment proceedings, payments made to horse owners were disallowed under section 40(a)(ia) on the ground that TDS under section 194B/194BB was not made. Aggrieved by the order, the assessee filed an appeal before the Tribunal. The Tribunal granted a stay of the assessment order.

Subsequently, the Assessing Officer (AO) issued a notice under section 148 to initiate reassessment proceedings. The assessee contended that the initiation of proceedings under section 147 was barred by limitation as the copy of the reasons recorded was issued after the expiry of six years from the end of the relevant assessment year.

The matter reached the Karnataka High Court.

High Court Held

The High Court held that the time limit prescribed under section 149(1)(b) is for issuing a notice under section 148 after recording reasons and not for furnishing a copy of the reasons to the assessee.

The conditions for the exercise of jurisdiction to initiate reassessment must be complied with within the time limit for issuing the notice. If the power vested to exercise such jurisdiction is shackled, it cannot be reasonably opined that reasons for reassessment had to be furnished within the period of six years.

In the instant case, reasons were recorded for re-assessment before issuance of notice, and the assessee had disclosed primary facts. Thus, there could not be any allegation of failure to truly and fully disclose material facts.

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