Weekly Round-up on Tax and Corporate Laws | 15th to 20th April 2024

This weekly newsletter analytically summarises the key stories reported at taxmann.com during the previous week from April 15^th to 20^th, 2024, namely:

1. NCLAT sets aside insolvency proceedings against ‘Sporta Technologies Pvt. Ltd.’ parent company of Dream 11;
2. Sum received from employer on account of out-of-court settlement isn’t taxable as profit in lieu of salary: ITAT;
3. Application for cancellation of GST registration can’t be rejected merely on ground of pendency of DRC-01 proceedings: HC;
4. Classic Malabar Parota and Whole Wheat Malabar Parota to be classified under HSN 1905 & taxable at 5%: Kerala HC;
5. Govt. allows 100% FDI under automatic route for manufacturing of components, systems or sub-systems for satellites; and
6. NFRA heavily fined the Auditors for rationalizing the actions of the company.

1. NCLAT sets aside insolvency proceedings against ‘Sporta Technologies Pvt. Ltd.’ parent company of Dream 11

The NCLAT, in the matter of Bhavit Sheth vs. Madan Bajrang Lal Vaishnawa [2024] 161 taxmann.com 580 sets aside the insolvency proceedings against ‘Sporta Technologies Pvt. Ltd.’, the parent company of Dream 11. The NCLAT held that the application filed by the operational creditor u/s 9 was clearly barred by Section 10A of the IBC. Further, the NCLT committed an error in admitting the Section 9 application.

Brief facts of the case

In the instant case, the appellant (i.e. suspended director of corporate debtor) filed an appeal challenging the order passed by the Adjudicating Authority (NCLT). The NCLT admitted the section 9 application filed by the Interim Resolution Professional (IRP) of operational creditor.

The case revolved around a Leave and License agreement entered into between the corporate debtor (Sporta Technologies Pvt. Ltd.) and the operational creditor (Reward Business Solutions Pvt Ltd.). The corporate debtor doing business as Dream 11, operates as a sports technology company providing multiple fan engagement avenues like fantasy sports, content, etc.

Disputes arose regarding lease rental payments, leading to a demand notice and the operational creditor’s subsequent initiation of the CIRP. The appellant contended that the section 9 application filed by the operational creditor was barred by section 10A of the IBC since the date from which the debt fell due was mentioned as March 2020.

Further, the appellant contended that the amount claimed in the demand notice was for the period from March 2020 to April 2021. The entire amount claimed in the Section 9 application was for the 10A period except for the month of April 2021. Thus, no application could have been filed by the operational creditor for the default committed during the 10A period and the application filed by the operational creditor was hit by section 10A.

On the other hand, the respondent (i.e. IRP) submitted that no lease rent has been paid by the corporate debtor. Although it enjoyed the property, no lease rent has been paid even after March 2021. Further, the demand notice dated 20.04.2021 was sent, and the default took place after 10 days, which continued.

Issue placed before NCLAT

The main issue was whether the application filed by the operational creditor was barred by Section 10A of the IBC.

Section 10A of IBC read as follows

Notwithstanding anything contained in sections 7, 9 and 10, no application for initiation of the corporate insolvency resolution process of a corporate debtor shall be filed for any default arising on or after March 25th, 2020, for six months or such further period, not exceeding one year from such date, as may be notified in this behalf:

Provided that no application shall ever be filed for initiation of the corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period.

NCLAT Observations

The NCLAT noted that section 9 of IBC does not refer to a period of the date of default rather, it empowers the operational creditor to file an application if payment is not received within 10 days of the service of the demand notice. The purpose and object of sections 9 and 10A are entirely different. The scheme of sections 8 & 9 clearly indicates that a demand notice can be issued only when there is a default, thus, the default has to be prior to the demand notice.

In the present case, a demand notice was issued dated 20.04.2021, and the default was mentioned as March 2020. The lease rental period claimed was from March 2020 to April 2021.

NCLAT Ruling

The NCLAT held that the application filed by the operational creditor u/s 9 was clearly barred by Section 10A, and the NCLT committed an error in admitting the Section 9 application by the impugned order dated February 9th, 2024. The corporate debtor was freed from the CIRP.

Further, the IRP fee and expenses as fixed by the NCLT must be paid by the operational creditor to the IRP if they have not already been paid. The operational creditor is at liberty to file a fresh application for default committed by the corporate debtor subsequent to the 10A period and also has the liberty to seek appropriate remedies for their dues in accordance with the law.

Read the Ruling

2. Sum received from employer on account of out-of-court settlement isn’t taxable as profit in lieu of salary: ITAT

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.

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).

Read the Ruling

3. Application for cancellation of GST registration can’t be rejected merely on ground of pendency of DRC-01 proceedings: HC

The High Court of Delhi has recently held that an application seeking cancellation of GST registration can’t be rejected on the ground of pendency of DRC-01 proceedings since proceedings under DRC-01 are independent of proceedings for cancellation of GST registration and could continue despite cancellation of GST registration. This ruling is given by the Honorable Delhi High Court in case of Chetan Garg v. Avato Ward 105 State Goods and Service Tax.

Facts

The petitioner filed an application for cancellation of registration on the ground that he did not intend to carry on the business under the said GST number. A query was raised on the said application, and petitioner duly responded to the said query. However, the application for cancellation was rejected due to the pendency of the proceedings under DRC-01.

Thereafter, he filed writ petition and sought direction to cancel GST registration, and it was contended that merely pendency of the DRC-01 could not be a ground to decline the request of the taxpayer for cancellation of the GST Registration.

High Court

The Honorable High Court noted that the proceedings under DRC-01 are independent of the proceedings for the cancellation of GST Registration and can continue despite the cancellation of GST registration. The recovery of any amount found due can always be made irrespective of the status of the registration.

Thus, it was held that merely pendency of the DRC-01 can’t be grounds for declining the request of the taxpayer to cancel the GST Registration. Therefore, the Court directed that the GST Registration of the petitioner shall be treated to be cancelled with effect from date from which he sought cancellation of GST registration.

Read the Ruling

4. Classic Malabar Parota and Whole Wheat Malabar Parota to be classified under HSN 1905 & taxable at 5%: Kerala HC

The High Court of Kerala has recently held that Classic Malabar Parota and Whole Wheat Malabar Parota are classified under heading no 1905 and are liable to be taxed at the rate of 5% as per Serial No. 99A of Notification 1/2017-Central Tax (Rate). This ruling is given by the Honorable Kerala High Court in case of Modern Food Enterprises (P.) Ltd. v. Union of India.

Facts

The petitioner was engaged in the manufacture and supply of food products and filed an application for the advance ruling to determine the classification and rate of tax on its products. It was contended that its products would qualify as ‘bread’ and should be taxable at 5% under GST. However, the AAR held that the products would be taxable at 18%, and it filed an appeal before the Appellate Authority for Advance Ruling (AAAR). The AAAR also held that the products would be taxable at 18%. It filed writ petition against the order.

High Court

The Honorable High Court noted that the products are made from fine flour (Maida) or whole wheat flour (Atta), and thin round sheets of dough are semi-cooked in hot places (Tawa/Skillet) using oil. These are packed and can be consumed after heating them.

The Court also noted that these products are akin/similar to products mentioned in HSN code 1905 of Chapter 19 with the heading Preparations of cereals, flour, starch or milk; pastrycooks’ products as ingredients used and process applied in their preparations are somewhat similar to products mentioned in Chapter heading HSN Code 1905. Therefore, it was held that the said products manufactured and supplied by the petitioner would be liable to be taxed at 5% as per SI. No. 99A of Notification No. 1/2017-Central Tax (Rate).

Read the Ruling

5. Govt. allows 100% FDI under automatic route for manufacturing of components, systems or sub-systems for satellites

The Ministry of Finance vide Notification dated April 16th, 2024[1], has notified the Foreign Exchange Management (Non-debt Instruments) (Third Amendment) Rules, 2024. An amendment has been made to Schedule I of the existing rules. The Govt. has allowed 100% FDI under the automatic route for satellite component manufacturing and FDI up to 74% under the automatic route for satellite manufacturing and operations. These amendments are effective from April 16th, 2024. The amendments are discussed below-

(a) 100% FDI is allowed via automatic route for satellite component manufacturing

As per the amended norms, 100% FDI is allowed under the automatic route for manufacturing components, systems or sub-systems for satellites, ground segments and user segments[2].

(b) FDI up to 74% is allowed via automatic route for satellite manufacturing and operations

The Ministry of Finance has allowed FDI up to 74% under the automatic route for satellite manufacturing and operations, satellite data products[3] and ground and user segments. However, FDI beyond 74% is allowed via the government approval route only.

(c) FDI up to 49% is allowed via automatic route for launch vehicles, associated systems and spaceport creation

FDI up to 49% is allowed under the automatic route for launch vehicles and associated systems or sub-systems as well as the creation of spaceports for launching and receiving spacecraft[4]. However, FDI beyond 49% is allowed via the government approval route only.

Further, the investee entity must adhere to sectoral guidelines issued by the Department of Space from time to time.

Before this amendment, FDI was allowed to establish and operate satellites via the government approval route only.

These measures signify a proactive approach aimed at establishing India as a key player in the global space industry while adhering to sectoral guidelines. By allowing 100% FDI under the automatic route for satellite component manufacturing in India, the Government seeks to strengthen domestic manufacturing capabilities, thereby fostering innovation and advancement within the space sector.

Read the Ruling

6. NFRA heavily fined the Auditors for rationalizing the actions of the company

NFRA is a statutory authority set up under Section 132 of the  Companies Act 2013 to monitor the implementation of the auditing and accounting standards and oversee the quality of service of the profession associated with ensuring compliance with such standards.

M/s Pathak H.D. (PHD) & Associates and M/s Price Waterhouse & Co LLP (PW) were appointed as the joint statutory auditors of Reliance Capital Ltd (RCL) for a term of 5 consecutive years at the Annual General Meeting of the Company. PW filed form ADT-4 with the MCA as per the provisions of section 143(12) of the Act and resigned from the audit. Thus, the audit report for the FY 2018-19 was signed only by PHD.

The Director General of Corporate Affairs (DGCoA), Ministry of Corporate Affairs (MCA), Government of India informed NFRA that PW had resigned from the audit without issuing an audit report for FY 2018-19. Therefore, NFRA sou moto examined the Audit File of M/s Pathak H.D. (PHD) & Associates and observed the following non-compliances-

• When both firms are engaged as joint auditors, PW raised concerns about potentially irrecoverable loans and investments amounting to approximately ₹12,571 crores made to group companies, which were portrayed as recoverable. Despite this, PHD failed to show any evidence in the Audit File of performing any audit procedures to examine and conclude the disputed matters while it was functioning as a joint auditor, thus violating the provisions of standards of auditing (SA) 299.
• The auditor justified the negative net worth of the group companies borrowers by considering the nature of Compulsory Convertible Debentures (CCDs) issued to the company as equity instruments. NFRA found that the auditor failed to apply the provisions of Ind AS 32 in these transactions. Even if, as per the terms of the contract, CCDs are classified as a compound instrument, then the full amount cannot be considered as equity. The value will have to be split between the debt and equity components and not just equity.
• The auditor failed to obtain direct balance confirmations from the borrowers and relied upon the mail provided to them by the company. The balance confirmations were not in compliance with the requirements of SA 505.
• The auditor failed to verify the charge from the Ministry of Corporate Affairs for the borrower entity and an assessment of whether the value of the assets on which the charge has been created covers the full value of the loans.
• The auditor failed to check the possibility of shell companies established to route the funds to other entities where borrower entities had no employees, and assets only in the form of loans and advances, and investments were held with minimal capital.
• The auditor failed to raise questions when the company sold Compulsory Convertible Debentures (CCDs) at a value more than its fair value (1.62 times) and then the transfer of funds between multiple entities in multiple tranches on the same day.
• The auditor provided the view to the Board or Audit Committee on the matter raised by the PW by examining the matter and the issues raised. NFRA observed that auditors audited the same disclosure stated in its audit report. This has amounted to self-reviewing the information prepared by the Auditors themselves.
• Auditor failed to obtain sufficient appropriate audit evidence as required by SA 500 regarding compliance with the Lending Policy despite observing marked deviations from the auditee’s lending Policy documented in the Audit File.
• The auditor gave no adequate consideration to fraud risk factors and the risk of material misstatement due to fraud.

NFRA in the exercise of powers under Section 132 (4) (c) of the Companies Act, 2013, order imposition of a monetary penalty of ₹3 crore (Rupees Three Crore) on the Audit Firm M/s Pathak H.D. & Associates; imposition of monetary penalties of ₹1 crore (Rupees One Crore) and ₹50 Lakh on EP and  EQCR Partner. In addition, EP and EQCR partners are debarred for 10 years and 5 years, respectively, from being appointed as auditors in any form.

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[1] Notification No. S.O. 1722(E), Dated: 16.04.2024

[2] “Ground Segment”: Supply of satellite transmit or receive earth stations including earth observation data receive station, gateway, teleports, satellite Telemetry, Tracking and Command (TTC) station, and Satellite Control Centre (SCC) etc.
“User Segment”: Supply of user ground terminals for communicating with the satellite, which are not covered under the ground segment.

[3] “Satellite Data Products”: Reception, generation or dissemination of earth observation or remote sensing satellite data and data products including Application Interfaces (API).

[4] “Creation of Spaceports for launching and receiving Spacecraft”: – A spaceport (also referred as launch site) may be regarded as the base from which spacecraft are launched, and consists of facilities involving devices for transportation to, from and via outer space.