Certain provisions of the Income-tax Act have given rise to substantial controversies and litigation. These provisions are being discussed herein. It is very much necessary and desirable that the Govt. should pay its immediate attention to suitably modify or clarify these provisions so as to avoid or reduce litigation in respect thereof.
1. Disallowance u/s. 14A r/w. Rule 8D of Income-tax Rules
Provisions u/s. 14A read with Rule 8D of Income-tax Rules have given rise to substantial controversies. Issues are whether Rule 8D is applicable retrospectively or prospectively from AY 2008-09, how dissatisfaction is to be recorded before invoking Rule 8D by the Assessing Officer, whether provisions are applicable even in case of stock-in-trade, whether disallowance can be made even more than the actual expenditure incurred, whether in a case where Assessing Officer is not satisfied with the amount of disallowance made by the assessee, mandatorily Rule 8D(2) is to be invoked or disallowance needs to be made on a reasonable or rationale basis, whether interest disallowance can be made even when the assessee has substantial funds of his own, whether disallowance can be made on account of interest even if the assessee has proved that all the loans have been taken only for the purpose of business, whether disallowance on account of administrative expenses at 0.5% is to be determined irrespective of facts of the case and the quantum of exempt income, whether in case of corporate assessees expenditure incurred on statutory compliances can also be considered for the purpose of disallowance or same should in any case be allowed, whether disallowance can be made even in the case where investments have been made for the purpose of commercial expediency in subsidiary or group companies, etc. The above controversy has arisen for the reason that Rule 8D provides for determination of disallowable of expenditure on ad hoc basis and no consideration for facts of the case are made by the AO. As a result, in many cases amount of disallowance determined by the AO, on the face of it, appears to be unreasonable and unjustified.
2. Reopening or revision of assessment
Section 147 of the Act empowers the Assessing Officer to reopen the finalised assessment. Similarly Section 263 of the Act empowers the Commissioner to order for revision of the Assessment Order. There are lot of controversies in regard to scope of above sections. In spite of the fact that provisions of Section 147 of the Act, requires specific reasons to be recorded by the Assessing Officer for his reasons to believe that income has escaped assessment, reasons are recorded by the Assessing Officer without proper application of mind and even without reference to specific material on the basis of which he has formed his belief that income has escaped assessment. Even in cases where proviso is applicable and assessment is reopened after the expiry of four years, no specific averment is made to the effect that there has been escapement of income on account of failure on the part of the assessee to disclose fully and truly all material facts necessary for the assessment. Non-compliance of the requirement of provisions of Section 147 of the Act by the Assessing Officer for the purpose of issuing notice for reopening of the assessment has given rise to lot of controversies and the issue regarding reopening of assessment is a major cause of litigation. The casual approach adopted by the Assessing Officers is resulting in loss to the revenue as well as harassment to the assessees. It is very much necessary that the officers should be properly trained and guidance should be issued so as to check the menace for unwarranted reopening of the assessments by the Assessing Officers. Similarly, provisions of Section 263 of the Act are resorted to even in the cases where the issue has already been considered by the Assessing Officer in the course of assessment proceedings. Provisions of Section 263 have also been amended vide the Finance Act, 2015, w.e.f. 1-6-2015 by inserting Explanation 2 providing that in certain cases the orders passed by the Assessing Officer will be deemed to be prejudicial to the interest of revenue. This amendment is also likely to raise controversies and litigation as same are against the scope and purpose of main section. It is stated in this regard that provisions of Section 147 or Section 263 are being invoked in disregard to the factual position that the issue had already been examined and assessment order had been passed after scrutiny of the case. On account of internal instructions of the department, these provisions are being invoked in cases where audit objections have been raised by the Internal Audit or AGCR Audit irrespective of the fact whether such audit objections are valid in law or not. As a result lot of controversy and harassment is being caused. The observations of the Hon’ble Supreme Court in the case of Parashuram Pottery Works Co. Ltd. vs. Income-Tax Officer, (1977) 106 ITR 1 (SC) are not being honoured. The Hon’ble Supreme Court in above case had observed that: “It has been said that the taxes are the price that we pay for civilisation. If so, it is essential that those who are entrusted with the task of calculating and realising that price should familiarise themselves with the relevant provisions and become well-versed with the law on the subject. Any remission on their part can only be at the cost of the national exchequer and must necessarily result in loss of revenue at the same time, we have to bear in mind that the policy of law is that there must be a point of finality in all legal proceedings.”
3. Provisions regarding taxability of capital gains
Section 45 of the Income-tax Act provides for taxability of capital gain in case of transfer of capital asset subject to other provisions relevant to the determination of capital gain i.e., Sections 45 to 55 of the Act. Lot of controversies have arisen in regard to taxability of capital gain with reference to meaning of “transfer”, “capital asset” and the year in which the transfer has taken place and with regard to other provisions related to exemption of capital gains in certain cases. Controversies have also arisen for the reason that specific provision has been made for determination of capital gains in a particular situation whereas there is no provision for the reverse situation. As regard to the meaning of term “capital asset”, though it has been held by the courts that the term has very wide scope and will include all rights and assets of the assessee, still controversies have arisen in the situation such as whether right to obtain the conveyance of the property is a capital asset, whether mortgage is a capital asset, whether an undertaking or running business is a capital asset or a fixed deposit held by an assessee is in the nature of capital asset. The issue had also arisen in the case of Vodafone International Holdings B.V. vs. Union of India (2012) 341 ITR 1 (SC), whether controlling interest in a company or control of the Holding Company over the subsidiary company is in the nature of capital asset or not u/s. 2(14), which defines the term capital asset. The term “transfer” has also remained a matter of controversy and particularly, the issue whether transfer is in one year or another year is continuously a controversial issue and in many circumstances litigation is going on in this regard, particularly, in the context of Real Estate Development Agreements. Section 45(2) provides that profit or gain arising from conversion of a capital asset into stock-in-trade is taxable as capital gain in the year in which such stock-in-trade is sold or otherwise transferred, though same is to be determined on fair market value of the asset on the date of such conversion. There is, however, no specific provision in regard to the situation where stock-in-trade is converted in capital asset by the assessee. Similarly, section 45(3) provides for determination of capital gain in case of transfer of capital asset by a partner to the firm on the basis of value of the asset recorded in the books of account of the firm, but there is no specific provision covering the reverse situation except case of dissolution of firm, which is covered in section 45(4) of the Act. Similarly, section 50 of the Act provides that in a case where depreciable asset is transferred at a value more than the written down value of the block of the asset, such excess amount will be chargeable to tax as short term capital gain. There is, however, no provision for allowability of loss either as a capital loss or as a business loss in the situation where total block of asset is transferred at a value which is lower than the written down value. In such a case there is also a doubt whether depreciation can be claimed u/s. 32 on the remaining value of the block in subsequent years, since there is no asset with the assessee which can be used in the business. Section 50B of the Act which provides for taxability of capital gain in case of slump sale is also a source of litigation so far as issue is whether transfer is on slump sale basis or on item wise basis for the reason that transferee in any case has to record entries in his books on the basis of item wise value for the purpose of claiming of depreciation and to record cost of acquisition. There is also controversy in regard to the expenditure which can be considered to be cost of improvement, particularly the interest cost incurred by the assessee on loan taken for the purpose of acquisition of the asset. There are many controversies in terms of sections 47 and 49 of the Act also which provides that the transactions will not be regarded as transfer and cost of previous owner will be taken as cost of acquisition by the assessee. As regards determination of indexed value in term of section 48 of the Act when asset has been inherited or received in succession by the assessee, whether in view of the language of Explanation defining the term “Indexed Cost of acquisition”, same is to be calculated from the year in which the asset was acquired by the assessee or from the year in which the asset was acquired by the original owner from whom it has been inherited to the assessee. Provisions of sections 54 and 54F of the Income-tax Act which provide for exemption in the cases where residential house has been purchased or constructed within the specified period, have also resulted in lot of controversies. In a case where a new house has been booked by the assessee with a builder and possession of which has been received after the expiry of specific period, it is an issue of controversy whether the condition will be deemed to have been complied with or not since possession has been received after the expiry of the specific period. In case of acquisition of flat from a builder, the issue has also been in controversy as regards the period of holding for the purpose of computation of capital gain at the time of sale, whether the period during which there was booking and payments had been made to the builder is to be counted as period of holding or only the period after getting the possession from the builder is to be considered for determination whether it is a long term asset or short term asset. Lastly the provisions of section 50C of the Act have opened a pandora box of controversies and number of issues have arisen in the context of applicability of section 50C of the Act determining the deemed sale consideration based on notification by the respective State Govt. for the purpose of levy of stamp duty. Applicability of deemed sale consideration is resulting in many situations in a harsh and unjustified tax liability. In many cases, actual sale consideration as on date is substantially lower than the notified rates and the assessees are facing serious problem in this regard, particularly for the reasons that for the purpose of payment of stamp duty, which is normally the liability of the purchaser, parties are not interested in litigating the same for the reason that the registration of documents will be delayed and accordingly, transaction will not be completed between the parties. Disputing the valuation in Income-tax proceedings is quite difficult and particularly when the returns are now being filed on-line and in the returns the notified rate as well as actual consideration are required to be given. The liability of additional tax will be automatically determined by the computer system and there will be a substantial dispute in regard to the matter. It is also a disputed issue whether value determined by a Departmental Valuation Officer on making reference by the Assessing Officer needs to be accepted by the Assessing Officer and by the assessee. It is also not clear whether provisions of section 50C will be applicable in the situation when asset is converted into stock-in-trade, asset is transferred to firm or asset is taken over by the Govt. in compulsory acquisition or in case of transfer of block of asset u/s. 50 or in the case of sale of undertaking u/s. 50B or for the purpose of making the investment in new residential house u/s. 54 or 54F of the Income-tax Act. The controversy has also arisen with reference to applicability of decision of the Hon’ble Supreme Court in the case of CIT vs. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC) that capital gain is not chargeable in the situation when computation provision fails or cost of acquisition is nil, except in the cases which have been specifically provided for by way of amendments in Section 55 of the Act. Notwithstanding the decision of the Hon’ble Supreme Court in the case of K. P. Verghese vs. ITO (1981) 131 ITR 597 (SC) that sale consideration cannot exceed the actual value received by the assessee, in many circumstances dispute is raised by the Assessing Officers on the basis of vague or unreliable information and capital gain is determined on the basis of notional sale consideration which has not been received by the assessee. Last but not the least, there is a big controversy in the context of share transactions, whether the income is chargeable under the head “capital gain” or as “business income”. This controversy has taken a serious turn after amendment in Income-tax Act w.e.f. 1-10-2004 pursuant to levy of Securities Transaction Tax providing for exemption of long term capital gain in case of shares and for lower rate of tax for short term capital gain.
4. Taxability of deemed dividend u/s. 2(22)(e) of Income Tax Act.
Provisions of Section 2(22)(e) of the Act, were inserted in the Income Tax Act w.e.f. 31-5-1987 pursuant to omission of provisions of section 104 of the Income-tax Act, to check the tax evasion by closely held companies by not declaring the dividend but passing on the funds to the shareholders by way of loans or advances. These provisions have led to lot of controversies as regards determination of accumulated profits, taxability of the amount when loan is given to the concern, taxability of the amount, which is given as loan in earlier years and also the date on which the shareholding is to be determined, particularly in case of issue of shares on demerger or amalgamation of companies. The provisions have also proved to be very harsh where loans are given only for a short duration and same had been repaid by the shareholder. The Hon’ble Supreme Court has taken a view in case of Taru Lata Shyam vs. CIT 108 ITR 345 (SC) and Ms. P. Sarda vs. CIT 229 ITR 444 (SC) that notwithstanding the amount has been refunded, same is chargeable to tax as deemed dividend for the reason that repayment of loan is not excluded from the provisions of section 2(22)(e) of the Act. In many situation loan or advance is given to Group Companies in the normal course with a view to assist the Group Companies, but assessees are unintentionally caught under the provisions of section 2(22)(e) of the Act and have to litigate the taxability of the amount.
5. Levy of penalty u/s. 271(1)(c) of the Income-tax Act
Section 271(1)(c) of the Income-tax Act provides for levy of penalty in case the assessee has furnished inaccurate particulars or has concealed the income. The Assessing Officer as a matter of routine are initiating penalty proceedings and penalties are also being levied without proper consideration of facts and circumstances of the case and the scope of provisions for levy of penalty. Accordingly, the litigation is going on before appellate authorities in each case where penalty is levied. The issues for controversy in this regard are for scope and meaning of term “concealment” or “furnishing of inaccurate particulars”, whether concealment or furnishing of inaccurate particulars is intentional or for any other reason which may be a genuine mistake, whether the penalty is leviable where due disclosure has been made in the return by way of notes, whether penalty is leviable where issue is debatable, whether penalty is leviable where disallowance or addition is based on estimate made by the Assessing Officer or on a ad hoc basis. Penalty is also levied by Assessing Officer when income is assessed under different head or in a different year or in a case where claim had been made in the original return but same was surrendered suo motu in the revised return before initiation of assessment proceedings. Controversy is also for levy of penalty when disallowance is accepted by the assessee or where disallowance has been upheld in appeal by the appellate authorities. The issue for levy of penalty also arises in the cases where there are losses either under business head or capital gain and tax is payable on book profit and the tax liability of the assessee as per the return and as per assessment remains the same and no benefit for carry over of loss is available even in subsequent years.
6. Computation of book profit for levy of tax u/s. 115JB of the Act
Determination of Book Profit for the purpose of levy of tax under section 115JB (earlier sections 115J and 115JA) had been in controversy on number of issues and still controversies are going on with regard to the adjustment of amount of expenditure incurred in relation to exempt income excluded in computation of book profit, adjustment on account of “Provisions” made for liabilities by debited to Profit & Loss Account following the Mercantile System of accounting, adjustment on account of prior period expenses, adjustment in respect of bad debts written off against provisions which have been added back in earlier years and adjustment of loss on actual sale of securities adjusted against provision made for diminution in value of investments made and added in earlier years. Controversy is also in regard to adjustment on account of income or expense not credited or debited to Profit & Loss Account but specific note in respect thereof is given in the Accounts and such income or expense is directly taken or adjusted in Reserve in Balance Sheet. Normally a question arises where depreciation for earlier years is provided for by making adjustment in Reserve or capital gain on sale of asset is directly taken to Reserve, whether deduction is allowable in respect of such deprecation or capital gain is to be added in book profit. The issue also arises in regard to determination of “amount of loss brought forward or unabsorbed depreciation, whichever is less” to be adjusted in computation of book profit, whether to be determined on year-to-year basis or on the basis of cumulative figures.
7. Deemed speculation loss in respect of share transactions
Explanation to Section 73 of the Act provides that where any part of the business of a company (other than a company whose gross total income consists mainly of income which is chargeable under the heads “Interest on securities”, “Income from house property”, “Capital gains”, and “Income from other sources” or a company the principal business of which is the business of trading in shares or banking or granting of loans and advances) consists the business of purchase and sale of shares of other companies, in such a case loss on sale and purchase of shares is to be deemed as speculative loss. The aforesaid Explanation has created controversy in certain cases and the provisions are applied by the Assessing Officers even beyond the intention behind inserting the Explanation. Accordingly, in many cases of genuine transactions for purchase and sale of shares also the Assessing Officers take a view that loss is in the nature of speculative loss. Controversy also arises in regard to the criteria to determine the scope of terms “mainly of income” or “principal business” Issue also arises whether granting of loans and advances in case of NBFC companies can be deemed to be main business or not. The issue has also arisen whether a transaction which is not of speculative nature in terms of section 43(5) of the Act being based on actual delivery of shares, can still be deemed to be speculative in view of this Explanation.
8. Exemption in respect of income of Charitable Trusts and Societies
Section 2(15) of the Income-tax Act, which defines the term “charitable purpose” was substituted vide Finance Act, 2008 w.e.f. AY 2009-10 to provide that advancement of object of general public utility shall not be a charitable purpose if it involves the carrying on of any activity in the nature of trade, commerce or business. The aforesaid amendment had given rise to lot of litigation for the reason that in many cases in order to carry on the charitable object it is necessary to charge a small fee or consideration for the services rendered. Such an activity cannot be said to be in the nature of trade, commerce or business just for the reason that fee or charges are being recovered. Dispute had even arisen in case of Institute of Chartered Accountants of India in respect of rendering of various services for charge of the fee. The Courts have held that if the activities are being carried on as part of charitable object, it cannot be said to be in the nature of trade, commerce or business. Vide Finance Act, 2015 w.e.f 1-4-2016 by way of proviso to section 2(15) it is being provided that such activities will not be deemed to be trade, commerce or business, if same are undertaken in the course of carrying on the objects of general public utility, provided the aggregate receipts from such activities do not exceed 20% of total receipts of Trust or Institution. The proviso will also not resolve the issue as controversy is in regard to the nature of the activities as such, whether in the nature of trade, commerce or business, if some fee is charged would continue. Further, condition of 20% will also not resolve the issue as in many cases, the activities of charitable nature have to be carried on by the Trusts or Societies on the basis of recovery of charges from general public and it is not always possible to run the activities if charges not made. Condition that receipt for these activities should not exceed 20% of total receipts would mean that at least 80% of total receipt should come from donations or from any other source, which may not be possible. Controversy in cases of Trusts are also being raised by the Department on account of various other reasons such as that whether section 11(1) exemption is available in respect of income derived from the property only and not in respect of income received as a result of activities or even donations, whether accumulated funds have been applied for particular purpose, whether there was violation in investment pattern, whether loans given to any other charitable institutions is application of income, whether shortfall in income over expenditure can be met out of corpus funds, etc. Controversies have also arisen in the cases of educational institutions and hospitals, which institutions claim exemption under section 10(23C) of the Act. Many time approvals to such educational institutions and hospitals are not being granted or renewed by Commissioners on the ground that their activities are resulting in surplus. In regard to this issue recently the Hon’ble Supreme Court in the case of Queen’s Educational Society vs. CIT (2015) 372 ITR 699 (SC) has held that a surplus arising from activities would not mean that institution is being carried on “for profit”. It can now be expected that this issue will not be raised by the department. The controversy also arises in cases of charitable trusts or institutions in regard to certain activities which the Department considers to be of business nature. Exemption in respect of receipts from such activities is not allowable on the ground that separate accounts have not been maintained in terms of section 11(4A) of the Income-tax Act. On this ground the Department has raised issue even in respect of income from chemist shop and lab charges recovered in a hospital or a canteen or stationery shop run in a school. Even in respect of transportation facilities provided to students in a school this issue has been raised. Issue has also been raised in certain cases, where auditorium has been given on normal hire charges by a charitable institution as a part of carrying on its charitable activities.
9. Deduction of tax at source under various provisions
The Income-tax Act requires deduction of tax at source under provisions of sections 192 to 195 of the Act. Controversies have arisen in respect of nature of transactions, whether tax is deductible therefrom or not and the rate at which tax is deductible. Though CBDT has issued certain circulars with regard to scope of provisions but controversies are there. In various circumstances alleging non-deduction of tax at source demands are raised on account of tax, penalty and interest. Expenses are also disallowed u/s. 40(a)(i) or 40(a)(ia) of the Act. These demands or disallowance of expenses give rise to litigation. The controversy also arises in regard to liability for deduction of tax at source in the cases where provisions for expenses are made in accounts at the year end. It is also a controversial issue whether tax is deductible u/s. 194I of the Act from payments made to hotels for stay of employees or for holding any seminar, conference etc., considering the same as rent. Controversy also arises in certain cases whether tax is deductible on gross amount or on the amount of income and also whether tax is deductible from reimbursement of expenses. In the context of section 195 of the Act, which is applicable to remittances made to non-residents or to foreign parties, there have been substantial litigation as regards the liability of an assessee under above section and also as regards the scope of payments which are subject to TDS under section 195 of the Act. Scope and meaning of terms “fee for technical services” and “royalty” in terms of DTAAs and provisions of section 9(1)(vi) and (vii) are source of big controversy and litigation. Even payments of commission for import or export to foreign parties rendering services in their countries are being contended by the department to be in the nature of “fee for technical services”. Irrespective of provisions of section 5(2) of the Act which provides for taxability of income of a foreign party which has accrue or arises in India, all the payments which can be said to be in the nature of “fee for technical services” are being claimed subject to taxability in India and, therefore, subject to TDS u/s. 195 of the Act irrespective of the fact that the foreign party has no existence in India and no services are rendered in India and by no stretch of imagination by a common sense it can be said that income of the foreign party should be chargeable to tax in India. The difficulty has further been aggravated by the provisions of section 206AA of the Act which requires the foreign party to obtain PAN. Any foreign party which is not having a regular dealing in India would not obtain PAN in India and would obviously not file return of income also. In such a case, undue tax liability is levied by the department on the payers and even proceedings are taken for not deduction of tax at source. Controversy also arises in the cases where the Indian party has taken a reasonable and bona fide view that tax is not deductible and has made remittance without deduction of tax at source after filing necessary forms i.e. Form 15CA and 15CB whereas subsequently the department contends that tax should have been deducted. The controversy for deduction of tax at source which had arisen in the case of Vodafone International Holdings B.V. vs. Union of India (2012) 341 ITR 1 (SC), is a glaring example to the level of dispute or the liability, which an Indian party may suffer on account of subsequent allegation for non-deduction of tax at source by the department.
10. Transfer Pricing issues
Substantial litigation is presently going on in regard to determination of ALP under section 92C of the Income-tax Act in relation to “international transactions”. Adjustment in ALP is made almost in every case of substantial amount and demand is raised. Reference to Dispute Resolution Panel does not prove to be effective in resolving the issues. Various Benches of ITAT are burdened with large number of cases of transfer pricing adjustments. Controversies are in regard to a particular method to be applied, selection of comparables, determination of average, whether adjustment is to be made only with reference to international translations or is to be made in total profit on TNMM basis, whether adjustment is also to be made on notional basis on account of interest, share premium etc. More controversies and litigation are going to arise in the coming time for the reason that domestic transactions have also been included in the scope of provisions of section 92C of the Act.
In conclusion, it is stated that efforts have been made herein to list major controversies presently going on under the provisions of Income-tax Act. Apart from controversies listed hereinabove, there are many more issues which are subject matter of controversies and litigation. The issue for consideration by the Govt. authorities is that why so many controversies are there in the provisions of Income-tax Act. Any new section added in the Act or even any amendment made, results in controversy and litigation. It can be submitted that the controversies are broadly arising for two reasons, firstly, drafting of relevant provisions are not being made after full consideration of necessary circumstances. Language is not finalised and after due deliberation with the stakeholder. Most of the amendments are made through Finance Bill in a secretively manner. As a result, language is not perfect so as to lay down the clear legal proposition. Amendments are also not made in consonance with the business requirements. Therefore, same leads to litigation being unreasonable and unjustified. Secondly, main issue of litigation is lack of proper guidelines for implementation and the applicability of legal provisions in the facts and circumstances of the assessees. Attitude of the Assessing Officers invariably is to impose the liability on the assessees even though he at his heart may not be convinced with the legal interpretation being adopted by him. The Assessing Officers, most of the times, are working for fear of audit objections and allegation of not acting in the interest of the department. In order to resolve the controversies, it is very much necessary that there should be a proper and effective mechanism at CBDT level to clarify the issues from time-to-time and issue necessary guidelines for the Assessing Officers so as to bring uniformity in the approach of the Assessing Officer. The Committee which may be entrusted this important job at CBDT level should also have representation from profession and industry and any clarification or guidelines should be issued after thorough and careful consideration adopting reasonable and justified approach and not only the approach as a tax gatherer. Long back there used to be Direct Taxes Advisory Committee having similar composition. The Committee should also consider the judgments of High Courts or even of Tribunal and after a reasonable thought position of the Govt. should be clarified and all the litigation, if it is not in consonance with the stand of the department, should be withdrawn. It may also be stated in this context that the adjudication process provided in the Act with a view to avoid controversies and litigation such as provisions of section 264 for revision by CIT, provisions of section 144C regarding reference to Dispute Resolution Panel and provisions of sections 245 and 245R for reference to Authority for Advance Ruling are also not serving the effective purpose as on date for the reason that the authorities referred above are primarily looking at the point of the department. Reasonable and justified approach is not being adopted keeping in view the purpose and object of the provisions under which the authorities were constituted. It may be stated in the past that certain effective measures are necessary on the part of the Govt. to avoid the controversies and to reduce the litigation which is very much necessary and desirable in the interest of the department and also the assessees and to make the business like environment to boost even foreign investments in order to make the policy of the Govt. “Make in India” successful and also to “ease of doing business”.
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