Query

When notice u/s. 143(2) of the Income Tax Act was issued in the name of erstwhile existing company (amalgamating company) then whether the assessment order passed by the Assessing Officer in the name of amalgamated company is legal and valid?

Answer

When notice u/s 143(2) was issued to the company, there was no amalgamation scheme. However after serving the notice, amalgamation took place between two companies and even the scheme was sanctioned by the Court after serving the notice u/s 143(2) of the Act. The fact of amalgamation was brought into the notice of Assessing Officer, despite the same, Assessing Officer passed the assessment order in the hands of amalgamated company. Hence, issue arose as to whether assessment order passed by the Assessing Officer was legal and valid in the eyes of law.

This issue came-up before the Delhi High Court in the case of CIT v. Sony Mobile Communications India Pvt. Ltd. The Counsel for the Revenue distinguished the judgement of Supreme Court in the case of Pr. CIT v. Maruti Suzuki India Ltd. (2019) 416 ITR 613 (SC) and relied upon the judgement of Supreme Court in the case of Pr. CIT v. Mahagun Realtors (P) Ltd. (2022) 443 ITR 194 (SC). It was contended by the Revenue that in the case of Maruti Suzuki jurisdictional notice had been issued by the Assessing Officer to the company which was not in existence i.e. the amalgamating company whereas in the case of Sony Mobile, jurisdictional notice u/s 143(2) was issued to the erstwhile company, when it was in existence. Hence, Revenue submitted that assessment framed in the name of amalgamating company after amalgamation is an irregularity which can be cured by taking recourse to section 292B of the Act. Revenue also submitted that in any case upon amalgamation, the amalgamating company dissolves and therefore, liability to tax devolves upon the amalgamated company. The Counsel for the assessee brought into the notice of the Court that during the assessment proceeding, the Assessing Officer was duly informed about the amalgamation, that had taken place. Despite the same, Assessing Officer proceeded on the wrong course framing the assessment in the hands of amalgamating company which was not in existence.

Delhi High Court has discussed the issue at great length, considering various judgements rendered by Supreme Court and various High Courts, particularly the judgements in the case of CIT v. Spice Enfotainment Ltd. (2020) 18 SCC 253 (SC) and Sky Light Hospitality LLP v. ACIT (2018) 405 ITR 296(Del).

In the case of Spice Entertainment, Delhi High Court have held that upon notice u/s 143(2) being addressed, the amalgamated company had brought the fact of amalgamation to the notice of Assessing Officer. Despite this, Assessing Officer did not substitute the name of amalgamated company and proceeded to make an assessment in the name of non-existent company which rendered it void. Hence, Delhi High Court held that it was not merely a procedural defect. Moreover, participation by the amalgamated company would have no effect since there could be no estoppel against law. Hon’ble Supreme Court dismissed the SLP filed by the Revenue against the judgement of Delhi High Court in batch of appeals.

In the case of Sky Light Hospitality LLP, Delhi High Court, in the peculiar fact of that case held that wrong name given in the notice was merely a clerical error which could be corrected u/s. 292B of the Act. Even Hon’ble Supreme Court dismissed the SLP filed by the assessee against this judgement.

Delhi High Court in the present case has discussed the issue in great detail and observed that in the case of Maruti Suzuki, Supreme Court has considered both the judgements and had held that there is no conflict between the two decisions. Ultimately, Delhi High Court, after considering the judgement of Supreme Court in the case of Maruti Suzuki as well as Mahagun Realtors have held that even after the Assessing Officer, in the present case, was informed on December 06, 2013 that the amalgamation had taken place, and was furnished a copy of the scheme, he continued to proceed on the wrong path. This error continued even after the Dispute Resolution Panel had made a course correction. This was not a mistake curable by recourse to the powers available u/s 292B of the Act. Accordingly, Hon’ble Delhi High Court held the order of assessment as invalid.

Note – This judgement is important in the cases where the jurisdictional notice is issued in the correct name but before passing the assessment order, change takes place which is brought into the notice of Assessing Officer, still Assessing Officer passes the order in incorrect name e.g. when jurisdictional notice is issued in the name of alive person but thereafter assessee expires and the said fact is brought into the notice of Assessing Officer still Assessing Officer does not bring the legal heirs on record and passes the assessment order in the name of deceased; such assessment order is invalid.

Query

When notice u/s. 143(2) of the Income Tax Act was issued in the name of erstwhile existing company (amalgamating company) then whether the assessment order passed by the Assessing Officer in the name of amalgamated company is legal and valid?

Answer

When notice u/s 143(2) was issued to the company, there was no amalgamation scheme. However after serving the notice, amalgamation took place between two companies and even the scheme was sanctioned by the Court after serving the notice u/s 143(2) of the Act. The fact of amalgamation was brought into the notice of Assessing Officer, despite the same, Assessing Officer passed the assessment order in the hands of amalgamated company. Hence, issue arose as to whether assessment order passed by the Assessing Officer was legal and valid in the eyes of law.

This issue came-up before the Delhi High Court in the case of CIT v. Sony Mobile Communications India Pvt. Ltd. The Counsel for the Revenue distinguished the judgement of Supreme Court in the case of Pr. CIT v. Maruti Suzuki India Ltd. (2019) 416 ITR 613 (SC) and relied upon the judgement of Supreme Court in the case of Pr. CIT v. Mahagun Realtors (P) Ltd. (2022) 443 ITR 194 (SC). It was contended by the Revenue that in the case of Maruti Suzuki jurisdictional notice had been issued by the Assessing Officer to the company which was not in existence i.e. the amalgamating company whereas in the case of Sony Mobile, jurisdictional notice u/s 143(2) was issued to the erstwhile company, when it was in existence. Hence, Revenue submitted that assessment framed in the name of amalgamating company after amalgamation is an irregularity which can be cured by taking recourse to section 292B of the Act. Revenue also submitted that in any case upon amalgamation, the amalgamating company dissolves and therefore, liability to tax devolves upon the amalgamated company. The Counsel for the assessee brought into the notice of the Court that during the assessment proceeding, the Assessing Officer was duly informed about the amalgamation, that had taken place. Despite the same, Assessing Officer proceeded on the wrong course framing the assessment in the hands of amalgamating company which was not in existence.

Delhi High Court has discussed the issue at great length, considering various judgements rendered by Supreme Court and various High Courts, particularly the judgements in the case of CIT v. Spice Enfotainment Ltd. (2020) 18 SCC 253 (SC) and Sky Light Hospitality LLP v. ACIT (2018) 405 ITR 296(Del).

In the case of Spice Entertainment, Delhi High Court have held that upon notice u/s 143(2) being addressed, the amalgamated company had brought the fact of amalgamation to the notice of Assessing Officer. Despite this, Assessing Officer did not substitute the name of amalgamated company and proceeded to make an assessment in the name of non-existent company which rendered it void. Hence, Delhi High Court held that it was not merely a procedural defect. Moreover, participation by the amalgamated company would have no effect since there could be no estoppel against law. Hon’ble Supreme Court dismissed the SLP filed by the Revenue against the judgement of Delhi High Court in batch of appeals.

In the case of Sky Light Hospitality LLP, Delhi High Court, in the peculiar fact of that case held that wrong name given in the notice was merely a clerical error which could be corrected u/s. 292B of the Act. Even Hon’ble Supreme Court dismissed the SLP filed by the assessee against this judgement.

Delhi High Court in the present case has discussed the issue in great detail and observed that in the case of Maruti Suzuki, Supreme Court has considered both the judgements and had held that there is no conflict between the two decisions. Ultimately, Delhi High Court, after considering the judgement of Supreme Court in the case of Maruti Suzuki as well as Mahagun Realtors have held that even after the Assessing Officer, in the present case, was informed on December 06, 2013 that the amalgamation had taken place, and was furnished a copy of the scheme, he continued to proceed on the wrong path. This error continued even after the Dispute Resolution Panel had made a course correction. This was not a mistake curable by recourse to the powers available u/s 292B of the Act. Accordingly, Hon’ble Delhi High Court held the order of assessment as invalid.

Note – This judgement is important in the cases where the jurisdictional notice is issued in the correct name but before passing the assessment order, change takes place which is brought into the notice of Assessing Officer, still Assessing Officer passes the order in incorrect name e.g. when jurisdictional notice is issued in the name of alive person but thereafter assessee expires and the said fact is brought into the notice of Assessing Officer still Assessing Officer does not bring the legal heirs on record and passes the assessment order in the name of deceased; such assessment order is invalid.

Jurisprudence deals with law and audit deals with facts and synchronisation of both helps in effective discharge of tax audit function given the reporting requirement in Form 3CD on various contentions provisions. In this article we are going to discuss the reporting requirements under various clauses and impact of jurisprudence in understanding the requirement.

Guidance note on tax audit

Guidance note on tax audit in para 9.16 and 34.17 provides that the tax auditor may rely upon the judicial pronouncements while taking any particular view. Further para 67.4 states that if the claim of the assessee is well-founded and settled by judicial pronouncement, the tax auditor may accept the claim but he has to record in his working papers that admissible amount has been reported on the basis of such judicial pronouncement. In appropriate circumstances, such judicial pronouncements etc. should be mentioned in the report. Para 74.8 also states that if reliance has been placed on any judicial decision, a reference of the same may be given by the tax auditor as observations in clause (3) of Form No. 3CA or clause (5) of Form No. 3CB, as the case may be.

Therefore the reliance of jurisprudence in tax audit has a statutory recognition in the guidance note on tax audit issued by Institute of Chartered Accountants of India.

Impact of qualification in tax audit report

Tax audit report is an opinion of auditor which may differ with the view of Assessee. The view of auditor at times may be conservative resulting in qualifications and disclaimers which may not be accepted by Assessee while filing return of income and can be rebutted if confronted during assessment. The view taken by auditor is an expert opinion or view and the other view is always possible. In this regards the decision of Delhi High Court in case of PCIT v. Escorts Limited [2018] 98 taxmann.com 291 (Delhi) holds that Auditor’s opinion though relevant and material would not be final and conclusive even when against the Assessee. Auditor’s report in a way is a third party and an independent report that can be equated with an expert opinion. It may be accepted or rejected or partly accepted and partly rejected. It has to be considered with other material. It cannot be treated as final or binding on the Assessing Officer, or for that matter even on the Assessee, except when mandated by a statutory provision, which requires an unqualified auditor’s report or certification. In the absence of statutory provision it would not be right to hold that a reservation or qualifying note in the audit report would be a conclusive and bind finding against the Assessee. Similar view has been taken in case of Rajkot Engg. Association v. Union of India [1986] 162 ITR 28 (Guj).

Mistake in tax audit reports

‘To err is human’ and therefore it is possible that a mistake could have crept in the tax audit report. In such situation it is advisable to rectify the same by filing a revised report. In case of ACIT vs. J.P. Yadav [2022] 138 taxmann.com 320 (Allahabad – Trib.) it is laid down that if Assessee contends inadvertent error in Form No. 3CD, he should submit revised tax audit report/ addendum issued by the tax auditor. Further even department should not take advantage of a mistake in audit report. In case of Baroque Pharmaceuticals (P.) Ltd. [2022] 137 taxmann. com 94 (Gujarat) it is held that reopening notice merely relying on a technical mistake committed by an auditor was unjustified.

Further if mistake is notices subsequently and not rectified the same may invite the implications under Section 271J of the Act where a penalty of Rs.10,000 per report is levied on incorrect reporting. Therefore it is advisable to revise the report giving reason for revision of the report. It is pertinent to note that ICAI guidance note on revision of audit report requires that the auditor should communicate the fact of revision and the revised report to all the stakeholders and recipients of original report so that they may not refer the original report, now revised.

Implications of reporting in Form 3CD vis-à-vis processing under Section 143(1)

Section 143(1) of the Act now has a specific power to make adjustment to the returned income in respect of those items which have been indicated as inadmissible by the auditor in the tax audit report. This has created chaos in various cases where the Form 3CD required information which did not mean inadmissible amount but has been misunderstood as inadmissible. For eg. Payments made to related parties have to be disclosed irrespective of the fact that they may not be unreasonable or excessive. However Centralised Processing Centre misunderstood the reported amounts as unreasonable and adjusted the return by making addition thereof.

A similar situation arose in context of clause 16(d) of Form 3CD which was discussed in case of Brajesh Agrawal v. ADIT [2023] 151 taxmann. com 63 (Allahabad – Trib.). Clause 16(d) of the audit report requires details of ‘any other item of income not credited to profit and loss’. The tax auditor reported the certain non-business income amount under clause 16(d) of Form No. 3CD though the guidance note of ICAI suggests disclosure of items covered in S.28 of Act which have not been credited to P&L. On such facts it was held that a mere mistake on the part of the tax auditor in reporting the income not forming part of business income of the Assessee in clause 16(d) would not ipso facto lead to addition or adjustment in the business income particularly when the Assessee has already declared the said income in the return of income under respective heads of income.

Due to this automatic processing it is advisable that reporting of items already considered for taxation may be made in Form 3CB in observations to avoid any double taxation.

Applicability of Tax Audit

“Turnover” is the starting point which is most debated due to the plethora of case laws interpreting the word. One basic question which arises is whether the GST, Excise, Sales tax, etc. have to be included and Gross turnover has to be considered or not. This will also be relevant for reporting on the clause that whether the taxes u/s 43B of Act have been passed through profit and loss account. This has been answered by Supreme Court in the case of Chowringhee Sales Bureau (P) Ltd v. CIT (1979) 87 ITR (SC) would include the receipts of excise duty and sales tax, etc. Therefore it has to be considered in computing turnover and in turn would be passed through profit and loss account.

Another issue which is arising in context of traders in shares who have executed intraday transactions in shares and do not take delivery. In such case where the transaction is completed in intra-day without taking delivery, only the difference (irrespective of positive or negative) has to be aggregated for computing turnover as held in case of Growmore Exports Ltd. (78 ITD 95)(Mum). This turnover ignoring the negative and positive is only and only considered to decide the applicability of tax audit and not for incorporating in books of accounts.

Clause 13 – Method of accounting

There are only two methods of accounting i.e. Mercantile and cash system. An Assessee has to choose either of them as hybrid system of accounting is not permissible. However in practical life no entity can be said to follow strictly mercantile and certain items like Interest on refund, dividend, etc. are recognised. There can be one principal method of accounting for the major source however it is permitted to have a different method of accounting for a separate source of income. In case of J.K. Bankers v. CIT (94 ITR 107)(All) it is held that it was open to the assessee to follow one system of accounting in respect of one source and another system in respect of the other source. If an assessee followed the mercantile system in respect of its income from business, it does not mean that the Assessee could be compelled to adopt the same system in respect of the income failing under other provisions.

Clause 18 – Depreciation

For claiming depreciation twin conditions of ‘ownership’ and ‘use’ need to be satisfied. However question arises mainly when the legal and beneficial ownership are separate. The crucial test here is that of beneficial ownership and thus even if the legal registration is in name of another person still depreciation would be available. In CIT v. Podar Cement (P.) Ltd. 1997 (5) SCC 482 it is observed that the term ‘owned’ in section 32(1) should be assigned a contextual meaning and keeping in view the underlying object of the provision vesting of a title in the Assessee though short of absolute ownership should also entitle the Assessee to the benefit of section 32(1). In case of CIT v. Aravali Finlease Ltd. [2012] 21 taxmann.com 147 (Gujarat) it was held that where vehicle in question, though registered in name of director of Assessee- company, was used for purpose of business of company, income derived from leasing vehicle was shown as income of company, and entire fund for purchase of vehicle had also gone from coffers of company, Assessee was entitled to depreciation on said vehicle.

As regards the condition of use the question arises as to whether the asset has to be continuously be used every year for claiming the depreciation. If a unit shuts down temporarily whether for the period it is not under active ‘use’ the depreciation can be denied. In case of Swati Synthetics Ltd. [2010] 38 SOT 208 (MUM.) it is held that the condition/requirement of section of words ‘used for the purpose of business’ as provided in section 32(1) for the concept of depreciation on block of assets can be summarized, that use of individual asset for the purpose of business can be examined only in the first year when the asset is purchased. In the subsequent years use of block of assets is to be examined. Existence of individual asset in block of asset itself amounts to use for the purpose of business.

Clause 21(a) : Penalty or fine

Penalty or fine for infraction or violation of law is not allowable under Income tax under Section 37 of the Act however the penalty for breach of contract or compensatory nature should be allowable as deduction.

It may be noted that Late filing fee of GST and Income tax is not regarded as penalty and therefore not required to be reported in this clause. Further in the regular course of the business certain procedural non-compliances are not unusual, for which Assessee is required to pay some fines or penalties. In Mangal Keshav Securities Ltd. v. ACIT [2017] 85 taxmann.com 226 (Mumbai) it is held that these routine fines or penalties are “compensatory” in nature; these are not punitive. These fines are generally levied to ensure procedural compliances by the concerned persons. Their levy depends upon facts and circumstances of the case, and peculiarities or complexities of the situations involved. Sometimes elements of discretions of levying authorities are also involved therein.

Clause 21(a) Personal Expenses

Personal expenses would include expense on the person of the assessee or to satisfy his personal needs or purposes not related to the business for which deduction is claimed. The payment as per contractual agreement or normally accepted business practices to the employees are not considered for the purpose of this clause. In case of CIT v. U.P. Asbestos Ltd. [2014] 52 taxmann. com 452 (Allahabad) it is laid down that section 40A is to prevent the abuse of fund by the company for personal interest. There should be dividing line between personal interest and the interest of the company. A personal interest means the expenditure incurred not for the purpose of company but for own interest of the office-bearers of the company or their sons and relatives but in case an expenditure is incurred by the company to send someone for training or higher education and after returning back in pursuance to contractual obligation, such person joins the company itself, then in such circumstances, it may not be treated as expenditure for personal reason because of relationship with an office-bearer.

Clause 21(d) : Genuine payments in Cash

In clause 21 for Form 3CD, reporting of amount paid in cash over Rs.10,000 being disallowable under Section 40A(3) of Act needs to be done. This provision is contemplating disallowance of expenses paid in cash in excess of Rs.10,000 being an anti evasive provision to prohibit circulation of black money. However the ambit gets increased in some cases to cover genuine payments also resulting in disallowance while processing of return in S.143(1) intimation. For instance cash payment of electricity bills to Electric companies which are now independent corporations and not government. These payments of electricity bills are undoubtedly genuine but have to be reported under Section 40A(3) of Act by auditors. However from tax professional’s perspective it does not call for disallowance as the purpose of provision is not to cover such transactions. In such cases the same may be reported in Form 3CB instead of 3CD with appropriate note that the Assessee has not considered the same as disallowable based on following judicial pronouncements

  • Padigela Rajeshwar Ginning Ind. ITA 1137/Hyd/2011
  • Trivedi Corporation (ITA 2844/Ahd/2006)
  • M.R. Soap 32 TTJ 505 (Del)

Clause 25: Old creditors beyond 3 years

Section 41(1) brings to tax those creditors the liability of which has ceased to exist. Normally creditor which are older than 3 years are sought to be taxed by department holding that limitation period is expired. However the same would not be required to be reported by auditor till the Assessee writes it back in the books of accounts. It is held in following cases that merely if unpaid creditors are standing in books beyond 3 years and even are not confirmed by creditors would not become income of Assessee:

  • Sugauli Sugar Works (P.) Ltd. [1999] 102 Taxman 713 (SC)
  • Vardhaman Overseas 343 ITR 408 (Del)
  • Silver Cotton Mills Co Ltd (254 ITR 728) (Guj.)

Clause 26: Section 43B – Advance payment

In certain cases the liability of disputed dues is paid under protest in advance and in the year of attaining finality respective provision is made. Question arises that the provision in respect of tax, duty and cess is allowable on actual payment basis. In this regards attention is invited to the decision of Supreme Court in case of CIT v. Modipon [2017] 87 taxmann.com 275 (SC) where it is held that advance deposit of central excise duty in PLA constitutes actual payment of duty within meaning of section 43B entitled to benefit of deduction. Various other courts have also consistently held that advance deposit of taxes/duty constitutes actual payment of duty within the meaning of section 43B and, therefore, the assessee is entitled to the benefit of deduction of the said amount.

Clause 27(b) Prior period expenses Prior period has a different meaning in Accounting Standards and for the purpose of Income tax. As per accounting standards it is charges or credits which arise in the current period as a result of errors or omissions in the preparation of the financial statement of one or more prior years. However for Income tax audit expenditure/income is treated as being of an earlier year only when the liability to pay / the right to receive has accrued or arisen in an earlier year, in other words though the expenditure/ income relate to an earlier year, if the liability materialized/ crystallized during the year. In SMCC Construction India Ltd. v. ACIT [2013] 38 taxmann.com 146 (Delhi) it is held that expenses of earlier years are allowable in current year if crystallized during that year.

Clause 31: Acceptance or repayment of loans through book entries

Section 269SS and 269T require that loans and advances if accepted otherwise than account payee cheque are liable to penalty and are required to be reported in Tax Audit report. Many times it is seen that transactions through Journal entries in books of accounts are also considered as violation of S.269SS and 269T by auditors and is reported in audit report. This though is correct from reporting perspective however may create great hardship to the Assessee in form of penalty as the objective of the anti-evasive provision is only to cover cash loans and not book entries. The provisions have been considered and interpreted by various courts to hold that transaction through book entries would not be contravention and are not liable for penalty. In following cases acceptance or repayment through book entries has not been considered violative of Section 269SS or 269T of the Act.

  • Natvarlal Purshottamdas Parekh 303 ITR 5 (GUJ.)
  • Noida Toll Bridge Co. Ltd (262 ITR 260) (Delhi HC)
  • Worldwide Township Projects 2014 (6) TMI 47
  • Dinesh Jain – 2014 (6) TMI 140 – ITAT DELHI

Conclusion

Different provisions in Income tax have different ramifications and we need to understand the provision and its reporting requirement under Form 3CD based on such jurisprudence. Such jurisprudence read with the Guidance note issued by ICAI serves as a proper guide to audit and report to the requirements. The interplay between tax laws and legal principles ensures that tax audits are conducted fairly, protecting the rights of taxpayers and upholding the rule of law. As tax laws continue to evolve, jurisprudence will remain a cornerstone in shaping the future of tax audits, balancing the need for revenue generation with the imperative of justice.

 

History

The social audit movement was first started in U.S.A. Later it gathered momentum in U.K., Japan and one or two Western countries. In spite of this development the subject has not yet attained the status of a science in many countries. In India, social audit finds a place in company legislation.

The history of social audit goes back as far as the 1950s. Initially, the social audit was conceived as a means to make business more accountable to the community. It was also perceived to be a method to communicate both economic and non-economic impact of business to the community members. Social audit also refers to a very different kind of evaluation process in which an organization assesses and thereby improves its social performance. It gained relevance after the constitution’s 3rd amendment, which dealt with Panchayat Raj Institutions. Article 243J of the Constitution provides for the audit of Panchayat’s accounts. In India, Social Audit was first made statutory in 2005 through the Rural Employment Act.

Relevance

With the introduction of the Companies (Corporate Social Responsibility Policy) Amendment Rules 2020, Social Impact Assessment came under compliance. Through this amendment, it has been made obligatory for a company incurring CSR spending of Rs. 5 crore or more in the immediately preceding financial year, in pursuance of Section 135, to undertake an impact assessment for their CSR projects. With the launch of the social stock exchange, social audit has matured with well- defined deliverables.

What is Social Audit ?

Social Audit is also a way of measuring, understanding, reporting and ultimately improving an organization’s social and ethical performance.

Social audit –

  1. Assesses whether the project/program/ project-based activity is operating in accordance with the stated strategic intent and planning.
  2. Assesses the stated performance in terms of impacts/`outcomes.
  3. Suggests ways to improve the impact measurement and/ or performance by way of a management letter.

Social Auditing is a process that enables an organization to assess and demonstrate its social, economic, and environmental benefits and limitations. It measures the extent to which an organization lives up to the shared values and objectives it has committed. Social auditing assesses the impact of an organization’s non- financial objectives through systematically and regularly monitoring its performance and the views of its stakeholders.”

Difference between Social Audit and Financial Audit

The distinguishing features between the social audit, and financial Audit is given below:

Features of Financial Audit are as follows:

  • Involves Audit of financial statements and transactions.
  • Covers nonfinancial matters limited only to those aspects that provide additional information to stakeholders of the business who are mainly interested in the entity’s financial status.
  • Financial Audits are done keeping in mind the objective of issuing an opinion on the state of financial affairs.
  • Deals mainly with the study of financial data.

Features of Social Audit are as follows:

  • Looks at the impact caused on the society by the organization
  • Takes an “outside in” approach of looking at organization, dealing more with how the non-financial stakeholders view the business rather than how the managers/ owners of the organization plan it to be.
  • Deals with the study of social impact parameters, most of which can be gathered from outside the organisation which is being audited.
  • Involves the stakeholders of the enterprise and adopts a triple bottom line approach.

Who does Social Auditors?

The social audit process involves assessing the organization’s policies, practices, and performance in labor practices, community involvement, and environmental impact. External auditors hired by the organization typically conduct social audits, and the results are often made public. They are called Social Auditors .

Scope of Work for Social Auditors

The social auditor managing the audit programme should:

  1. Communicate the relevant parts of the audit programme, including the risks and opportunities involved, to relevant interested parties and inform them periodically of its progress, using established external and internal communication channels;
  2. Define objectives, scope and criteria for each individual audit;
  3. Select audit methods- The audit methods chosen for an audit depend on the defined audit objectives, scope and criteria, as well as duration and location ensure the audit teams have the necessary competence ;
  4. Provide necessary individual and overall resources to the audit teams
  5. Ensure the conduct of audits in accordance with the audit programme, managing all operational risks, opportunities and issues (i.e. unexpected events), as they arise during the deployment of the programme;
  6. Ensure relevant documented information regarding the auditing activities is properly managed and maintained
  7. Review the audit programme in order to identify opportunities for its improvement
  8. Assessing the demonstration of the social intent of the organisation
  9. Identify stakeholders and the targeted beneficiaries.
  10. Alignment of the objectives and goals with the NITI Aayog’s SDG India Index. NGRBC guidance etc.
  11. Assessment of implementation and review mechanism, e.g. variances between intended and actual targets, staff capacity development, benchmarking, key impact indicators, internal or external audit.
  12. Assessment of the methodology for data collections techniques, research methods, desk review of existing documents.
  13. Review stakeholder’s responses to evaluation questions in the impact report
  14. Evaluate subject matter information: whether the evidenced changes are traceable to the intervention and how much could have happened irrespective of the intervention, what are the unintended negative impacts as a result of the intervention and are they reported.
  15. Assessment of Evaluation criteria viz. the Key Impact indicators based on the subject matter information, quantitative and qualitative evaluation criteria to be identified against which impact needs to be mapped.
  16. Final assessment, including the audit opinion.
  17. Prepare audit report in compliance with SSE

Social Audit Standards

The development of sustainability reporting standards like the Global Reporting Initiative, ISO 26000: Guidance on Social Responsibility, Principle of Responsible Initiative (PRI), and Sustainability Accounting Standards Board (SASB) has contributed to our understanding of social responsibility.

Also the Social Audit Framework developed by ICAI provides a social auditor guidance for conducting a social audit. The social audit framework is applicable from the date of its hosting on ICAI website. Social Audit Framework does not cover any elements of a financial audit or review, which may be covered by relevant auditing/review standards.

List of Social Audit Standards (SAS)

The SAS has sixteen thematic areas which is listed below

SAS 100: Eradicating hunger, poverty, malnutrition, and inequality.

SAS 200: Promoting health care (including mental health) and sanitation; and making available safe drinking water

SAS 300: Promoting education, employability, and livelihoods

SAS 400: Promoting gender equality, empowerment of Women and LGBTQIA+ communities

SAS 500: Ensuring environmental sustainability, addressing climate change including mitigation and adaptation, forest, and wildlife conservation

SAS 600: Protection of national heritage, art, and culture

SAS 700: Training to promote rural sports, nationally recognised sports, Paralympic sports, and Olympic sports

SAS 800: Supporting incubators of social enterprises

SAS 900: Supporting other platforms that strengthen the non-profit ecosystem in fundraising and capacity building

SAS 1000: Promoting livelihoods for rural and urban poor including enhancing income of small and marginal farmers and workers in the non- farm sector

SAS 1100: Slum area development, affordable housing, and other interventions to build sustainable and resilient cities

SAS 1200: Disaster management, including relief, rehabilitation, and reconstruction activities

SAS 1300: Promotion of financial inclusion

SAS 1400: Facilitating access to land and property assets for disadvantaged communities

SAS 1500: Bridging the digital divide in internet and mobile phone access, addressing issues of misinformation and data protection

SAS 1600: Promoting welfare of migrants and displaced persons

Scope of Social Audit Standard

The Social Audit Standard should be applied while conducting a social audit. The relevant SAS thematic area should be chosen according to the activity (social project) which is being audited.

The social project may be for a social enterprise (for -profit or not-for-profit (NPO) and may also have appropriate application to other related functions of social auditors.

Compliance with SAS

  • Compliance with SAS is a mandatory requirement for social audit conducted for social enterprises listed on social stock exchange.
  • Social auditors should ensure that guidance available in SAS are followed while conducting social audits. If for any reason a social auditor is not able to perform a social audit in accordance with the SAS, his report should draw attention to the material departures therefrom.
  • Social Auditors are expected to follow SAS in the social audits commencing on or after the effective date specified in the SAS.

Information to be Disclosed during social audit

Both financial and non-financial information should be disclosed. The financial information can be disclosed through profit and loss account, balance sheet etc. Such information is mainly disclosed in quantitative form. The financial information reveals the true position of a company regarding its liquidity and bankruptcy. Non-financial information can be expressed both in qualitative and quantitative data. Quantitative data is generally preferred because they are precise and convincing.

Persons Benefited by the Disclosure of information

  1. Financial Institutions.
  2. Shareholders.
  3. Academic Institutions and Consultants.
  4. Government.
  5. Trade Unions and Political leaders.
  6. Environmentalists.

Conclusion

However, the results of social audits are extremely beneficial to the organization, as it makes us understand its strengths and weaknesses and identify areas for further improvement for the next social audit.

Social audits are a good way for businesses to evaluate how their social initiatives are being received by both their internal and external stakeholders. They strongly influence public relations and the public perception of organizations and companies, making them important to companies that highly value maintaining a positive public image.

Winning or losing of the election is less important than strengthening the country.

– Indira Gandhi

1. Recently, Hon’ble Supreme Court delivered judgment in the case of PCIT v. M/s. Annasaheb Patil Mathadi Kamgar Sahakari Pathpedi Limited – Civil Appeal No. 8719/2022, dated 20/04/2023. In this case, the assessee was a cooperative credit society engaged in the business of providing credit facilities to its members. The assessee claimed deduction u/s. 80P(2)(a)(i) of the Income Tax Act, 1961 (the Act). The Assessing Officer disallowed the deduction claimed by the assessee u/s. 80P(2)(a) of the Act holding that the assessee is a cooperative bank and hence not eligible to claim deduction as per Section 80P(4) of the Act. The CIT(A) held in the favour of the assessee holding that assessee is a cooperative credit society and not a cooperative bank, hence eligible for deduction u/s. 80P of the Act. The ITAT, High Court and Supreme Court upheld the view of CIT(A).

2. The Hon’ble Supreme Court, while dismissing the appeal filed by the Revenue, inter alia held as under:

Apart from the fact that against the relied upon decision in the case of M/s. Quepem Urban Co-operative Credit Society Ltd. (supra),the Special Leave Petition has been dismissed, having heard learned counsel appearing on behalf of the respective parties, the issue involved in the present appeal is squarely covered against the Revenue in view of the decision of this Court in Mavilayi Service Cooperative Bank Limited and Others Vs. Commissioner of Income Tax, Calicut and Another (2021) 7 SCC 90. This Court, in the aforesaid decision has specifically observed and held that primary Agricultural Credit Societies cannot be termed as Co-operative Banks under the Banking Regulation Act and, therefore, such credit societies shall be entitled to exemption under Section 80(P)(2) of the Income Tax Act, 1961.

Ms. Aakansha Kaul, learned counsel appearing on behalf of the appellant/Revenue has tried to submit that the respondent/ Assessee will fall under the definition of Co operative Bank as their activity is to give credit/loan. However, it is required to be noted that merely giving credit to its members only cannot be said to be the Co operative Banks/Banks under the Banking Regulation Act. The banking activities under the Banking Regulation Act are altogether different activities. There is a vast difference between the credit societies giving credit to their own members only and the Banks providing banking services including the credit to the public at large also.

There are concurrent findings recorded by CITA, ITAT and the High Court that the respondent/Assessee cannot be termed as Banks/Cooperative Banks and that being a credit society, they are entitled to exemption under Section 80(P)(2) of the Income Tax Act. Such finding of fact is not required to be interfered with by this Court in exercise of powers under Article 136 of the Constitution of India. Even otherwise, on merits also and taking into consideration the CBDT Circulars and even the definition of Bank under the Banking Regulation Act, the respondent/Assessee cannot be said to be Co- operative Bank/Bank and, therefore, Section 80(P)(4) shall not be applicable and that the respondent/Assessee shall be entitled to exemption/benefit under Section 80(P)(2) of the Income Tax Act.”

3. In the judgment of Annsaheb (supra), Hon’ble Supreme Court relied upon the case of Mavilayi Service Cooperative Bank Limited and Others v. CIT (2021) 431 ITR 1 wherein it was held as under:

“xxx…

39. The above material would clearly indicate that the limited object of section 80P(4) is to exclude co-operative banks that function at par with other commercial banks i.e. which lend money to members of the public. Thus, if the Banking Regulation Act, 1949 is now to be seen, what is clear from section 3read with section 56 is that a primary co-operative bank cannot be a primary agricultural credit society, as such co-operative bank must be engaged in the business of banking as defined by section 5(b) of the Banking Regulation Act, 1949, which means the accepting, for the purpose of lending or investment, of deposits of money from the public. Likewise, under section 22(1)(b) of the Banking Regulation Act, 1949 as applicable to co-operative societies, no co-operative society shall carry on banking business in India, unless it is a co-operative bank and holds a licence issued in that behalf by the RBI. As opposed to this, a primary agricultural credit society is a co-operative society, the primary object of which is to provide financial accommodation to its members for agricultural purposes or for purposes connected with agricultural activities.

xxx…

45. To sum up, therefore, the ratio decidendi of Citizen Co-operative Society Ltd. (supra), must be given effect to. Section 80P of the IT Act, being a benevolent provision enacted by Parliament to encourage and promote the credit of the co-operative sector in general must be read liberally and reasonably, and if there is ambiguity, in favour of the assessee. A deduction that is given without any reference to any restriction or limitation cannot be restricted or limited by implication, as is sought to be done by the Revenue in the present case by adding the word “agriculture” into section 80P(2)(a)(i) when it is not there. Further, section 80P(4) is to be read as a proviso, which proviso now specifically excludes co-operative banks which are co-operative societies engaged in banking business i.e. engaged in lending money to members of the public, which have a licence in this behalf from the RBI. Judged by this touchstone, it is clear that the impugned Full Bench judgment is wholly incorrect in its reading of Citizen Cooperative Society Ltd. (supra). Clearly, therefore, once section 80P(4) is out of harm’s way, all the assessees in the present case are entitled to the benefit of the deduction contained in section 80P(2) (a)(i), notwithstanding that they may also be giving loans to their members which are not related to agriculture. Also, in case it is found that there are instances of loans being given to non-members, profits attributable to such loans obviously cannot be deducted.”

4. The genesis of this controversy can be traced back to Finance Act, 2006 which inserted provisions of S. 80P(4) of the Act wef 01/04/2007. Income Tax Authorities, after this amendment, started taking a vies that the cooperative societies engaged in the business of providing credit facilities to its members would also fall under the term “cooperative banks” and consequently not eligible to claim deduction u/s. 80P of the Act. This misinterpretation gave rise to huge litigation across the country. Now the controversy is settled with the Hon’ble Apex Court holding that cooperative credit societies could not be characterised as cooperative banks and hence eligible to claim the deduction u/s. 80P of the Act.

5. Provisions of S. 80P(4) read:

Section 80P(4) of the Act:

“(4) The provisions of this section shall not apply in relation to any co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank.

Explanation.—For the purposes of this sub- section,—

  1. “co-operative bank” and “primary agricultural credit society” shall have the meanings respectively assigned to them in Part V of the Banking Regulation Act, 1949 (10 of 1949);
  2. “primary co-operative agricultural and rural development bank” means a society having its area of operation confined to a taluk and the principal object of which is to provide for long- term credit for agricultural and rural development activities.”

6. Memorandum explaining the clauses of Finance Bill 2006 which inserted this provision reads:

“Withdrawal of tax benefits available to certain co-operative banks

Section 80 P, inter alia, provides for a deduction from the total income of the Co- operative societies engaged in the business of banking or providing credit facilities to its members, or business of a cottage industry, or of marketing of agricultural produce of its members, or processing, without the aid of power, of the agricultural produce of its members, etc.

The co-operative banks are functioning at par with other commercial banks, which do not enjoy any tax benefit. It is, therefore, proposed to amend section 80P by inserting a new sub-section (4) so as to provide that the provisions of the said section shall not apply in relation to any co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank. It is also proposed to define the expressions “co-operative bank”, “primary agricultural credit society” and “primary co-operative agricultural and rural development bank”.

It is also proposed to insert a new sub-clause (viia ) in clause (24) of the said section so as to provide that the profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members shall be included in the definition of ‘income’.

This amendment will take effect from 1st April, 2007 and will, accordingly, apply in relation to the assessment year 2007-08 and subsequent years.”

Apparently, the objective behind the introduction of sub-section (4) to Section 80P of the Act is to bring in parity between the commercial banks that are not eligible for deduction u/s. 80P of the Act and the cooperative banks that are functioning at par with such commercial banks but enjoying full tax exemption. However, the intended object was to withdraw tax exemption from co-operative bank alone. Credit co-operative societies were to continue to enjoy tax exemption u/s 80(2) of the Act. The amendment was not at all intended to deny benefit of S. 80P to cooperative societies that are engaged in the business of providing credit facilities to its members.

7. In fact immediately after the insertion of S. 80P(4), Central Board of Direct Tax vide its clarification No. 133/06/2007- TPL dated 9th May, 2007, clarified that the existing sub-section 80P (2)(a)(i) shall be applicable to a co-operative society carrying on credit facility to its members. If the intention of the legislature was not to grant deduction u/5 80P (2)(a)(i) to co-operative societies carrying on the business of providing credit facilities to its members, then this section would have been deleted.

8. In order to correctly interpret and understand the provisions of S. 80P(4) of the Act, it is apposite to understand the meaning of the word “cooperative bank” used in Section 80P(4) of the Act. The Explanation to Section 80P(4) of the Act refers to the definitions provided under Part V of the Banking Regulation Act, 1949. The relevant definitions prescribed under Part V of the Banking Regulation Act, 1949 read:

(cci) “co-operative bank” means a state co-operative bank, a central co-operative bank and a primary co-operative bank;

(ccvii) “central co-operative bank”, “primary rural credit society” and “state co-operative bank” shall have the meanings respectively assigned to them in the National Bank for Agriculture and Rural Development Act, 1981 (61 of 1981);

The definitions of “central co-operative bank” and “state co-operative bank” as prescribed under Section 2 of National Bank for Agriculture and Rural Development Act, 1981 is reproduced as under:

“d) “central co-operative bank” means the principal co-operative society in a district in a State, the primary object of which is the financing of other co-operative societies in that district:

Provided that in addition to such principal society in a district, or where there is no such principal society in a district, the State Government may declare any one or more co- operative societies carrying on the business of financing other co-operative societies in that district to be also or to be a central co- operative bank or central co-operative banks within the meaning of this definition;

(u) “State co-operative bank” means the principal co- operative society in a State, the primary object of which is the financing of other co-operative societies in the State:

Provided that in addition to such principal society in a State, or where there is no such principal society in a State, the State Government may declare any one or more co-operative societies carrying on business in that State to be also or to be a State co- operative bank or State co-operative banks within the meaning of this definition;”

(ccv) “primary co-operative bank” means a co-operative society, other than a primary agricultural credit society,—

1. the primary object or principal business of which is the transaction of banking business;

2. the paid-up share capital and reserves of which are not less than one lakh of rupees; and

3. the bye-laws of which do not permit admission of any other co-operative society as a member:

Provided that this sub-clause shall not apply to the admission of a co-operative bank as a member by reason of such co-operative bank subscribing to the share capital of such co- operative society out of funds provided by the State Government for the purpose;

(cciia) “co-operative society” means a society registered or deemed to have been registered under any Central Act for the time being in force relating to the multi-State co-operative societies, or any other Central or State law relating to co-operative societies for the time being in force;

(cciv) “primary agricultural credit society” means a co-operative society,—

1. “the primary object or principal business of which is to provide financial accommodation to its members for agricultural purposes or for purposes connected with agricultural activities (including the marketing of crops); and

2. the bye-laws of which do not permit admission of any other co-operative society as a member:

Provided that this sub-clause shall not apply to the admission of a co-operative bank as a member by reason of such co-operative bank subscribing to the share capital of such co- operative society out of funds provided by the State Government for the purpose;

9. A perusal of the relevant provisions of Banking Regulations Act, 1949 reveals that Co-operative bank is defined in clause (cci) of s.5 (as inserted by sec. 56 of the said Act) and co-operative credit society is not included therein but its identity is kept separate by way of independent definition as per clause (ccii) of Sec. 5 of the Banking Regulation Act, 1949. On plain reading of the Banking Regulations Act, nowhere it is suggested that the term “Co-operative Bank” also includes ‘Co-Operative Credit Society”. It is well settled principle in the interpretation of the ‘taxing provisions’ that the same are to be strictly construed and there is no room for any intendment. There is no presumption as to tax. Nothing is to be read or nothing is to be implied. One has to fairly look into language used by the Parliament. The Parliament has adopted the definition of the Co-operative Bank by reference to Banking Regulations Act. Co-operative Credit Society is distinct and separate from the co-operative Bank nor can it be coloured as a Primary Co-operative Bank within the meaning of Banking Regulations Act. As per the definition of Primary Co-operative Bank in view of cl. (cci) of sec 5 of the Banking Regulations Act, 1949, in case primary objects or principle business is transaction of banking business, the society will be primary co-operative bank. In case it is not so the society shall not be a primary co-operative bank and consequently, the same shall not be a co-operative bank as defined in Part V of the Banking Regulation Act 1949.

10. In order to invoke Section 80P(4) of the Act, it is to be established that the assessee cooperative society falls within the definition of “cooperative bank” as prescribed under Part V of Banking Regulation Act, 1949. As defined under Part V of the Banking Regulation Act, 1949, a cooperative bank means a state cooperative bank, a central cooperative bank and a primary cooperative bank. AS against the same, a cooperative society is considered as a primary cooperative bank only if all the following 3 conditions are fulfilled:

  1. the primary object or principal business of which is the transaction of banking business;
  2. the paid-up share capital and reserves of which are not less than one lakh of rupees; and
  3. the bye-laws of which do not permit admission of any other co- operative society as a member:

11. No co-operative society can carry on the business of banking unless it has requite statutory permissions from prescribed authorities. In this context, it is relevant to understand the meaning of the word “banking”. The word “banking” has been defined under Section 5(b) of the Banking Regulation Act, 1949. The same has been reproduced as under:

“banking” means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise;

12. Further, Section 22 of the Banking Regulation Act, 1949 requires the cooperative societies to get licence from Reserve Bank of India for carrying on banking business. The relevant extract of Section 22 of the Banking Regulation Act, 1949 reads:

“(1) Save as hereinafter provided, no co- operative society shall carry on banking business in India unless—

(a)***

(b)it is a co-operative bank and holds a licence issued in that behalf by the Reserve Bank, subject to such conditions, if any, as the Reserve Bank may deem fit to impose:”

Thus, without obtaining a license from the Reserve Bank of India, no cooperative society can carry on banking business in India. The basic requirement of being a primary cooperative bank is to carry on banking business as its primary business. Hon’ble Karnataka High Court in the case of CITv. Sri Biluru Gurubasava Pattina Sahakari Sangha Niyamitha Bagalkot – [2015] 56 taxmann.com 280 (Karnataka) in this context held as under:

“8… Therefore, as the assessee is not a co-operative bank carrying on exclusively banking business and as it does not possess a licence from the Reserve Bank of India to carry on business, it is not a co-operative bank. It is a co-operative society which also carries on the business of lending money to its members which is covered under section 80P(2)(a)(i),i.e., carrying on the business of banking for providing credit facilities to its members. The object of the aforesaid amendment is not to exclude the benefit extended under section 80P(1) to such society.”

13. The predominant test for banking therefore, is acceptance of deposit from public. When the primary business of any cooperative society is to “accept the deposits from public for the purpose of lending to public or investment”, then such cooperative society can be held as a cooperative bank. But if any cooperative society is engaged primarily in the business of accepting and lending the money only with its members and not with general public, such business cannot be considered as banking business and resultantly such cooperative society cannot be considered as a cooperative bank so as to apply provisions of S. 80P(4) of the Act. Even if a cooperative society has entered into transactions with non-members which are insignificant/ miniscule, then also such cooperative society cannot be considered as a cooperative bank as held in the case of Quepem Urban Co-operative Credit Society Ltd. v. ACIT – [2015] 58 taxmann.com 113 (Bombay) as the primary business of such cooperative society is not to accept the deposits from general public. In such case, the cooperative society will only get deduction u/s. 80P of the Act to the extent of income earned from transactions with its members.

14. Thus, a co-operative society not primarily engaged in the business of banking as defined in the Banking Regulation Act, 1949 and not holding a valid licence from Reserve Bank of India to carrying on business of banking cannot be considered as a cooperative bank so as to apply section 80P(4) of the Act.

15. In the end, one can only hope that now with series of judgments by Supreme Court and High Courts, the controversy is put to rest and co-operative society carrying on the business of providing credit facilities to its members are not denied the benefit of S.80P(2) of the Act.

“We live in a wonderful world that is full of beauty, charm and adventure. There is no end to the adventures we can have if only we seek them with our eyes open.”

– Pandit Jawaharlal Nehru

 

The division of time for penning articles on taxation laws and its’ principles and the issues of constitutional impact has been for sometimes recognized the necessity coupled with occasion for publication in the AIFTP Journal for the larger benefit of the professional fraternity. Accordingly, in terms of the time left with me, ordinarily not intervening with the fixed schedules of my professional work in courts across the country, the articles are penned for publication.

This time I thought it essential to devote a kind of attention to the doctrine of the common law principles as well as its’ scope for application in India. Accordingly, the undernoted inking on the subject of the article is as under:

Let me authoritatively state that the common law principle had found its’ origin and stripes of pace for the existence, development and growth of the society in England. The significance behind the principle is that once upon a time the Britishers ruled almost all parts of the universe. Therefore, in their rule, the common law rule has given birth. The meaning that can be ascribed is that the law made never binds the crown unless the crown is specifically or expressly or by necessary implication is named therein. The reason of the rule as stated to be that a statute is presumed to be enacted only for the subjects (people) and not for the king. I am reminded of the words of PLOWDEN saying that it is to be intended that when the king gives his assent for a statute, he does not mean to prejudice himself or to bar himself of his liberty and privileges, but assents that it is a law among his subjects. A reference is being made to a decision in Willion v. Berkley (1562) 1 and also in AG v. Donaldson (1874) 10M & W117, in Madras Electric Supply Corporation v. Borland (1955) 1All ER 753. A statement of recent times of the rule is found in a passage from the judgment of LORD DUPARCQ to the effect that the maxim of law in early times was that no statute bound the crown unless the crown was expressly named therein, “Roy n’est lie par ascun statute, si il ne soit experiment nosme’. However, the longtime established rule, of course, subject to one exception, to say that the crown may be bound, as has often been said by necessary implication. Therefore, it is to say that from the very terms of the statute, it would be manifest from the term of the statute that the legislature intended to bind the crown too, then the result is the same, as if, the crown had been expressly named. Let me make a reference to a decision in Bombay Province v. Bombay Municipal Corporation in AIR -1947 PC 34 as further referred to in Premchand Nathu & Company v. Land Officer (1963) 1 All England Reports 216 & in Lord Advocate v. DUMBARTON DISRICT COUNCIL (1990) 1 All England reports Page 1.

Whatever might have been the historical Origin of the rule whether based on immunity by royal prerogative or otherwise, there is a consensus of judicial opinion that the rule as at present known is merely a rule of construction “LORD MAC DERMOTT in Madras Electric Corporation case observed that the appropriate rule is that in an Act of Parliament general words shall not bind the crown to its’ prejudice unless by express provision or necessary implication. After making a review of the earlier cases, LORD KEITH spoke for the house of Lords that the rule of construction is to the effect that the crown is not bound by any statutory provision unless there can somehow be gathered from the terms of the relevant Act an intention to that effect.

The common law rule has been applied in the colonies and the Common Wealth in the sense that “the executive government of the state is not bound by the statute unless the intention is apparent”. In the case of ROBERTS v. AHERN (1904) 1 CLR 406, the common law rule was also applied in America as a rule of construction in a decision in USA v. United Mine Workers of America (1946) 330 US 358 and further followed in the case of USA v. Reginald P.WITTEK (1948) 337 US 346. The categorical follow up is that the laws are prima-facie made for the people and not for the king. But the said rule of law is no-a-days regarded even in England as an overstatement. Reference is made to a decision in AG v. HANCOCK (1940) 1 All England Report, Page 32. Attempts, however, were made to lay down certain categories as to when a crown is bound although not specifically named. LORD COKE in Cambridge case (1616) 11 COREP66 indicated three kinds of statues that bound the kind without expressly naming him namely statutes for maintenance of religion, learning and the poor, secondly statutes or suppression of wrong and thirdly statutes that tend to perform the will of a founder or donor. Similarly, in BACON’S abridgement it was quoted where an Act of Parliament is made for the public good, the advancement of religion and justice and to prevent injury and wrong, the king shall be bound by such Act. The only safe rule that may be valid in all cases, to decide whether a given statute binds the crown by necessary implication, it is to read the statute in entirety and to see whether it is manifest from the very terms of the statute that it was the intention of the legislature that the crown shall be bound.

The immunity of the Crown inspite of the rule was affected by other factors, Section 1 of the Crown Proceedings Act, 1947 enables the Crown to be sued directly in such situations where prior to the Act a claim might have been enforced by petition of right. Section 2 of the above stated Act in general permits actions to be brought against the crown in respect of torts committed by its agents or servants by a breach of its’ duties giving rise to a tortious liability. Although the rule still holds the field in England, it has not escaped its’ criticism. The rule originated in the middle ages, when it had perhaps some justification. Its’ survival, however, is due to little but vis inertia. The chief objection to the rule is its’ difficulty of application.

Now let me examine the extent of the Rule;

According to English law, the protection of the Rule presumption that the Crowned is not bound by statutes extends to three classes of personnel namely, the sovereign personally, secondly, his servants or agents acting, as such, and three persons who though not strictly the servants or agents are considered to be in consimili casu, class (ii) covers not only officers of the state with ministerial status, but all sub-ordinate officials as also servants holding statutory office and class (iii) has not maintained and the performance of the functions also taken into account in deciding, whether a particular person falls under class (ii). The third category, who perform some of the regal functions as also other functions not consequential to that category. Whether a non- profit earning statutory corporation not subject to control by the Crown or a Minister and the revenues claimed immunity from local rates and the question before the House of Lords was whether the corporation could claim Crown privileges as it was performing a public duty. Such privilege claimed was negative in Mersey Docks & Harbour Board v. Cameron. In the case of Greig v. Edin Burgh University, the claim of exemption from local rates was claimed by a university was rejected.

Whether common law rule is applicable in India. The Privy Council in the case of Director of R &D v. Corporation of Calcutta, held that the common law rule to the effect Crown was not bound by the statute unless named expressly applied in India before the constitution in the case of Bombay Province v. Bombay Municipal Corporation, reported in AIRA 1947 PC 34. The said judgment when continued after the constitution was overruled in the case of State of West Bengal v. Corporation of Calcutta, reported in AIR 1967 SC997. As a result of the said decision, the rule that applies in India is that a General Act applies to citizens of as well as to the state unless either expressly or by necessary implication exempts the state from its’ operation. When a penal enactment providing for imprisonment or fine, which goes to the government is made applicable to the government or a government department. However, as per article 285 of the constitution of India property of the Union is exempt from taxation impose a state law, unless the Parliament provides, otherwise in the case of Municipal Corporation, Amritsar v. Senior Superintendent of Post Offices, Amritsar Division in (2004) 3SCC 92. A company registered under Companies Act, 1956 is not a government company, even it its’ share capital is wholly subscribed by the Government. Therefore, even in case, where the Act does not apply to the government, an agency of instrumentality of the government, which is not a department of the government will be bound by the Act. The exemption from payment of taxation in terms of article 285 does not extend to the companies with the same degree of in respect of statutory corporation like Food Corporation of India.

Therefore, simultaneously, article 289 exempting property of a state of Union taxation have no application to indirect taxes, such as, customs duty, central excise duty, sales tax in New Delhi Municipal Council v. State of Punjab (1997) 7SCC 339.

Therefore, the Union is liable to sales Tax under a state Act. Thus, the rule of common law in strict sense has no applicability in India. Of course, it used to have some application in our country before the advent of the constitution of India. So also every company registered under the Companies Act, though wholly funded by the government is not a government company. Therefore, the rule of common law has no applicability. The reason simply being is England is ruled by the Crown, whether a king or queen, whereas from August 15th, 1947, India being a democratic country is ruled by the people. Hence, there will be nothing like England to view that laws made by the House people is not applicable to the government, why because in India, it is a rule of people and every act, action or deed is accountable to the people, while the laws made in England would simply apply to the common people/subjects and will not bind the Crown.

In the possible brief narration the origin and growth of common law rule and its’ applicability to our country has been stated with reference to the relevant decisions of English courts and how common law rule is not applicable in our country is also explained with reference to nuances of law coupled with judicial decisions.

Hope this will throw some light on this topic to the advantage the members of the fraternity.

//JAI HIND //

1. S. 80IA: Special Deduction – Interest from investment deposit u/s. 32AB was not eligible for deduction.

The Assessee is a Co-operative Ltd., a multi- state Co-operative Society engaged in the business of manufacture of fertilizers such as Urea, Ammonia. The issue before the high court was that, the tribunal has decided deduction or coverage under section 80-IA of the Income-tax Act, 1961 in respect of Interest income earned by the Assessee from investment deposit under section 32AB of the Act in IDBI Bank against the assessee and denied the deduction. The Honourable High Court observed that, the assessee had deposited certain amounts in the account maintained under section 32-AB with the Development Bank. The deposits so made were out of the sale proceeds i.e. income chargeable under the head Profits and gains of business or profession. The Interest was earned on the said deposits and the assessee claims that the interest earned should be included in the income derived from the industrial undertaking and accordingly was eligible for deduction u/s. 80-IA of the Act. The High Court held that S. 80-IA of the Act does not apply and cover income in the nature of profits and gains of business or profession but is restricted only to income derived from an industrial undertaking after a certain date etc. The expression derived from refers to the first or the immediate cause/ source of income earned, which would be the deposits in the bank and interest paid by the said bank and not the industrial undertaking.

The aforesaid interest income, therefore, cannot be treated as income derived from the industrial undertaking covered u/s. 80-IA of the Act. Krishak Bharati Cooperative Ltd. v. Jt. CIT, ITA No. 595 of 2014 dt.15/09/2014

The Assessee filed SLP, and the Honourable Supreme Court dismissed the same since investment made in bank was derived from sale proceeds i.e. income chargeable under head profits and gains of business or profession, interest income earned on same could not be included in deriving income from industrial undertaking covered under section 80-IA.

Krishak Bharati Cooperative Ltd. v. Jt. CIT [2022] 289 Taxman 75 (SC)

2. S.142 (2A) : Inquiry before assessment (Special audit) Assessee failed to furnish necessary details and reconciliation of books of account and several replies to queries of AO, Notice for Special Audit is justified.

The Revenue enquired from the Assessee of the reason for not filing advance tax. As well as enquired as to why advance tax deposited for the first quarter of the current year, i.e., financial year 2019-20 was only Rs.14 crores, while the corresponding amount for the preceding year was Rs. 19 crores. This query was replied vide e-mail and letter dated August 16, 2019, pointing out that the advance tax deposited in the preceding year had led to refund claim of Rs.40 crores, which when provided for, showed little variation in earlier years’ deposit. On September 9, 2019, the Pr. CIT wrote to the Assessee directing payment of “correct amount” of advance tax for the relevant quarter. The said amount was deposited on dated September 13, 2019 and on the very same evening, revenue issued notice under section 142(1), reproducing the initial questionnaire of 53 queries making incorrect reference to filings by the Assessee and asking to show cause as to why special audit under section 142(2A) not be ordered. The Assessee filed response thereto making reference to details already filed and clarified. The Assessee filed evidence/correspondence in response to the initial questionnaires issued. However, Revenue thereafter passed an order under section 142(2A) of the Act. The Assessee file petition before the High Court.

The Honourable High Court after observing the facts of the case held that, the satisfaction recorded by the AO was in consonance with the principles enunciated in section 142(2A). The suspicions expressed by the AO were on the basis of the complexity of the accounts recorded upon objective considerations. The AO had applied his mind and the anomalies and discrepancies that had been pointed out in the order were sufficient to the test of judicial review while questioning the subjective satisfaction for appointment of a special auditor. On a perusal of the record, it was also clear that apart from the show cause notice, the AO had given several other opportunities to the assessee calling upon it to furnish its response along with documentary evidence. The direction for special audit was valid. NBCC (India) Ltd. v. Addl. CIT [2020] 422 ITR 429 (Del)(HC)

The Assessee filed SLP, and the Honourable Supreme Court dismissed the same, stating that assessee had not submitted satisfactory reply to these queries and failed to produce its ledger, accounts and documents as called for – Non-specific reply of assessee revealed complexity in accounts of assessee and raised doubts about correctness of transactions and thus AO ordered for special audit under section 142(2A) was justified.

NBCC (INDIA) Ltd. v. Addl. CIT, SLP APPEAL (C) NO(S). 4718 of 2020, dt.06/07/2023 (SC)

3. S.170: Succession to business otherwise than on death (Validity of assessment)- Liberty to file review petition against High Court ruling that where company merged into another company under an approved scheme and thereby lost its existence, notice issued u/s. section 148 in name of non-existent company was bad in law.

Notice u/s. 148 was issued for AY 2012-2013 on 31st March 2019. The Assessee states that the company ECD Electrons and Electrolysis Pvt. Ltd. was merged with Lenient Finvest Pvt. Ltd. vide a Court’s order dated 7th November 2014. Lenient Finvest Pvt. Ltd. was later merged into Vahanvati Consultants Private Ltd., the Assessee by an order passed by National Company Law Tribunal, Mumbai and the appointed date was 1st April 2013. The Assessee states that on 31st March 2019 when the notice u/s. 148 of the Income-tax Act was issued, ECD Electrons and Electrolysis Pvt. Ltd. was no more in existence. Also points out that an order u/s. 271 (1)(c) of the Act was passed by the ACIT on 31st March 2018 for the dues of ECD Electrons and Electrolysis Pvt. Ltd. showing the assessee to be Appellant. The Assessee submitted that, though the revenue were always aware that ECD Electrons and Electrolysis Pvt. Ltd. was no more in existence, then also issued a notice u/s. 148 in the name of a non-existing company. The High Court following the Maruti Suzuki India Ltd. [2019] 416 ITR 613 (SC) held that, issuance of notice and assessment order thereafter passed in name of non-existing company is a substantive illegality and not a procedural violation of nature adverted to in section 292B, where assessee company was amalgamated with another company and thereby lost its existence, order passed subsequently in name of said non- existing entity would be without jurisdiction. Vahanvati Consultants (P.) Ltd. v. ACIT, WP No. 2828 of 2019 dt.11/08/2021 (Bom)(HC)

The revenue filed SLP, and the Honourable Supreme Court disposed of same stating that make a factual distinction between the positions as it obtained in that case with the facts of the present case. To file a review petition before the High Court bringing the distinguishing features on the record of the High Court.

ACIT v. Vahanvati Consultants (P.) Ltd. [2022] 287 Taxman 176 (SC)

4. S.145: Method of accounting – Change of (Completed contract method) – accounting for contemporary period of said contract was justified.

The Assessee-sub-contractor, engaged in business of construction, had undertaken a project in Iraq as sub-contractor of a company, namely IRCON, and claimed to have completed a portion of construction work but had not received full consideration. During year, he entered into a supplementary agreement with IRCON for deferred payment of contract dues in view of war conditions between Iraq and Iran and resorted to completed contract accounting method. The view of the AO, that departure from mercantile system of accounting to completed contract method would not reflect a fair and reasonable picture of profit earned from year to year and, therefore, added difference between amount of certified bills and expense to total income. The Honourable High Court held that assessee was justified in resorting to completed contract system for contract work under execution in Iraq in contemporary period and consequently, bills certified as relating to work completed could not be recognized as receipts and brought to tax for assessment year under consideration. CIT v. Bhageeratha Engineering Ltd., ITR193 to 197 of 1997 dt.24/06/2021 (Ker)(HC)

The Revenue filed SLP, and the Honourable Supreme Court dismissed the same stating that, undertaking of construction work for a project in Iraq, deferred payment of contract dues in view of war prevailing between Iraq and Iran, departure from mercantile method to completed contract method of accounting for said contract was justified in contemporary period.

CIT v. Bhageeratha Engineering Ltd. [2022] 289 Taxman 10 (SC)

 I. Introduction to BEPS

Tax challenges due to cross border transactions is not new to the tax payer and to the tax departments across the globe. It is equally true that the global consensus to resolve the tax challenges for appropriate taxing rights to respective jurisdictions including challenges related to Base Erosion related issues have received a significant momentum in the recent past. Base Erosion and Profit Shifting (“BEPS”) refers to the actions of Multinational Entities (“MNEs”) to arrange its affairs in a cross-border scenario, in a manner that they erode the tax base from one jurisdiction and shifting the profits to low (or nil) tax countries. This is primarily achieved by exploiting the mismatches between different countries’ tax regimes.

In this article, we shall try to explain the concept of BEPS Pillar II proposals which are expected to be implemented from 2024. Additionally, our aim is to also delve into the opportunities and challenges in relation to its implementation from the perspective of the tax department, tax payer as well as tax consultants.

The G20 countries along with Organisation for Economic Cooperation and Development (“OECD”) undertook the OECD/G20 Inclusive Framework (IF) on Base Erosion and Profit Shifting, popularly known as “BEPS project”.

In the first phase of BEPS Project (BEPS 1.0), various Action Plans were identified to counter specific BEPS measures. For example:

  1. Action Plan 3 dealt with Controlled Foreign Country regime,
  2. Action Plan 5 dealt with countering Harmful Tax Practices
  3. Action Plan 6 dealt with Prevention of Treaty Abuse (including Principal Purpose Test),
  4. Action Plan 8-10 providing Transfer Pricing related measures
  5. Action Plan 13 provided for Country-by- Country reporting.

The outcome of the Actions Plans under BEPS 1.0 was implemented through a Multilateral Instrument (“MLI”) which operated to amend multiple tax treaties without the need to separately negotiate each bilateral tax treaties between the countries. Some of the BEPS 1.0 measures were also implemented through changes in the domestic tax laws.

On the aspect of “Tax challenges arising from Digitalisation”, i.e. Action Plan 1, BEPS 1.0 failed to achieve any consensus. Thus, the second phase of the BEPS Project (BEPS 2.0) titled “Two- Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy” (“Two-Pillar Solution”) was formulated with the aim to end tax avoidance.1 Initially over 135 jurisdiction joined the Statement on Two Pillar Solution to address the tax challenges from digitalisation of the economy.2 This Two- Pillar solution is set to reform the international taxation rules and ensure that multinational enterprises pay a fair share of tax wherever they operate and generate profits in today’s digitalised and globalised world economy.

The Two-Pillar Solution, as the name suggests, consists of two parts:

Pillar One – Under Pillar One, the mechanism of allocating taxing right on share of profits from a business transaction to a country where the end customers are located, or where the goods and services are consumed (market jurisdiction), has been devised. This Pillar also uproots the century old principle of allocation of taxing rights on business income to a jurisdiction if and where the Permanent Establishment is constituted. Traditionally, a permanent establishment is constituted only by virtue of physical presence in a jurisdiction for a specified period. Pillar One also provides mechanism for simplifying taxation of baseline marketing and distribution activities. As per the latest Economic Impact Assessment published by OECD in January 2023, the estimated annual global revenue gains for all the jurisdictions taken together will be of USD 21-36 bn (2021) or USD 12-25 bn per year on average over the period 2017-2021.

Pillar Two – It primarily tackles the harmful race to the bottom on corporate taxes, by ensuring that the MNE groups pay a minimum corporate tax of 15% in each jurisdiction in which they operate as per Global Anti-Base Erosion Rules (“GloBE”). This tax up to the effective rate of 15% could be levied by the resident jurisdiction itself, else the ultimate parent company jurisdictions would have the right to tax such income while the parent entity bears the tax costs. Pillar Two also contains a Treaty based right [Subject to tax Rule (“STTR”)] to developing countries to recover additional tax @ 9% on specified cross-border intra-group payments, including interest, royalty etc. between group companies, if such payments are not already taxed at or above the said rate. As per the latest Economic Impact Assessment published by OECD in January 2023, estimated gains for tax collection for all the jurisdictions taken together will be of USD 175 bn to USD 261 bn, with a central estimate of USD 220 bn. Previous estimate was of USD 150bn.

II. Brief operation of Pillar Two rules

As stated above, Pillar Two broadly contains two parts – STTR and GloBE. These parts are elaborated as under:

1. STTR

STTR aims to restore the taxing rights to developing countries which might have been ceded during treaty negotiations, in respect of payments which has higher potential of eroding the tax base of a country, i.e. Interest, royalty etc., if the resident country is not taxing these payment above the specified rate.

India and other developing countries have been advocating for STTR being implemented as part of Pillar Two since it strengthens the tax base of the developing countries and its application is not circumscribed by very high turnover thresholds.

The broad features of STTR are as follows:

  1. STTR is a treaty-based provision. The amendment to bilateral treaties would be made through a Multilateral Instruments (“STTR MLI”). As per our preliminary understanding of the STTR provisions, this STTR MLI could be materially different from the MLI under BEPS 1.0, since the required amendment to treaty is already stipulated and there is no option for jurisdictions to accept to certain clause and make reservations with reference to another. Final position will be clear very soon since the STTR MLI shall be open for signature from 02nd October 2023. The BEPS Project members can elect to implement STTR either by signing the MLI or by amending the bilateral treaties to include STTR when requested by developing jurisdiction members.
  2. STTR is an additional tax, over and above the existing tax under the bilateral agreement, to be applied on “Covered income”, if the covered payments are taxed at a rate below 9% in the residence jurisdiction or is allowed a preferential adjustment, i.e. an exemption or

    deduction of such income. The additional tax shall be limited to the difference between 9% and the rate at which the “Covered income” are taxed in the residence jurisdiction, further reduced by the tax already recovered in the source state as per the tax treaty between the countries.

  3. STTR applies to “Covered income” paid by Connected persons (intra-group). Two entities are considered as connected persons if –
    1. One possesses directly or indirectly more than 50% beneficial interest in the other
    2. In the case of a company, one company has direct or indirect holding of more than 50% of aggregate vote and value of the company’ share or of the beneficial equity interest in the other company
    3. When the entities or companies are under common holding of more than 50% of the beneficial interest (in case of company, more than 50% of aggregate vote and value of company’s share or of beneficial interest in the company)
  4. “Covered income” means the following:
    1. Interest
    2. Royalties
    3. Consideration for use of, or the right to use, distribution rights in respect of a product or service
    4. Insurance and re-insurance premiums
    5. Fees to provide financial guarantee or other financing fees
    6. Rent or any other payment for the use of, or the right to use, industrial, commercial, or scientific equipment
    7. Income received in consideration for the provision of services
  5. Threshold for applicability: The aggregate amount of “Covered Income” from one jurisdiction to another in a fiscal year should exceed Euro 1 million, for application of STTR. This threshold is reduced to Euro 250,000 if the GDP of the contracting states is less than Euro 40 billion.
  6. Non-applicability: STTR does not apply where the recipient is an individual, a non-profit organisation, Government or its political sub-division, international organisations, investment funds fulfilling certain conditions etc.
  7. Mark-up threshold: Except in the case of interest and royalties, the STTR shall apply to Covered Income, only if the recipient party has earned a mark-up of 8.5%, i.e. where the amount of Covered Income exceeds the costs incurred in earning that income plus a mark-up of 8.5%. (India has recorded its reservation on the mark-up percentage which it considers too high and it finds the guardrails ineffective).

With reference to STTR application, the payer jurisdiction might not gain any taxing right if the residence jurisdiction taxes the income at the minimum rate required under the STTR.

2. GloBE Rules

GloBE Rules stands for Global Anti-Base Erosion Rules. GloBE Rules provides for a coordinated system of taxation intended to ensure that large MNE groups pay a minimum level of tax on the income arising in each jurisdiction where they operate.3 The GloBE Rules signifies a global effort to end the race to the bottom. The minimum tax rate benchmark considered under the GloBE Rules currently stands at 15%. Some important aspects of GloBE Rules are discussed hereunder:

a) Applicability

GloBE Rules are intended to apply only to large MNE groups. Those MNE groups which have annual turnover of Euro 750 million or more in the Consolidated Financial Statements (“CFS”) of the Ultimate Parent Entity (“UPE”) in at least two out of four Fiscal Years immediately preceding the tested Fiscal Year. The MNE groups which shall satisfy the conditions for applicability of GloBE Rules, are referred hereinafter as “in-scope MNEs”.

b) Mode of Implementation of GloBE Rules

GloBE Rules shall be implemented through amendments in the domestic laws of the implementing jurisdictions.

c) Qualified Domestic Minimum Top-up Tax

GloBE Rule requires that each jurisdiction shall apply an effective tax rate (“ETR”) of 15%. If a jurisdiction hosting constituent entity of an in-scope MNE group does not apply the ETR of 15%, the jurisdiction where the parent jurisdiction is located, shall have the right to recover tax to the extent of shortfall in the ETR. This additional tax is called as “Top-up Tax”.

In essence, the taxing rights otherwise held by the low-tax jurisdiction (where ETR is less than 15%) is vested on the parent entity jurisdiction, though for the limited purposes. In order to obviate such ceding of tax rights, the low-tax jurisdictions are provided with an option to apply a domestic tax in line with the GloBE Rules, to ensure a minimum ETR of 15%. This domestic tax is called Qualified Domestic Minimum Top-up Tax (“QDMTT”). Where the QDMTT satisfies the minimum tax requirements consistent with the GloBE Rules, no Top-up Tax shall arise. This is achieved by two means –

 

  • QDMTT is allowed as a deduction against Top-up tax required under GloBE Rules. However, under this approach, the MNE group shall carry out both QDMTT and GloBE calculations to claim the credit.

 

  • If QDMTT introduced by a jurisdiction meets the standards specified under the QDMTT Safe Harbour conditions, the GloBE calculations need not be undertaken for such jurisdiction. One of the conditions mentioned in the QDMTT Safe Harbour is that the QDMTT computations should be same as computations required under GloBE Rules, except where GloBE framework requires QDMTT to depart from GloBE Rules.

d) GloBE Rules – broad implementation steps (not comprehensive)

GloBE Rules require complex calculations with multiple adjustments to ascertain the additional tax payable in respect of a low-tax jurisdiction. As stated above, the underlying requirement is to ensure ETR of 15% in each jurisdiction where the in-scope MNE group is operating. In this backdrop, the broad steps under GloBE Rules, applicable to in-scope MNEs are discussed as under:

Step 1: Apply CbCR Safe Harbour

The GloBE Rule provides for a Safe Harbour based on certain thresholds computed with the amounts reported in CbCR and the financial statements, subject to certain adjustments, to bring the CbCR data at par with GloBE principles. These thresholds shall be applied on a jurisdictional basis. On satisfying the CbCR Safe Harbour conditions, the Top-Up Tax for a given jurisdiction shall be deemed as Nil. The intent is to allow certain low-risk jurisdictions some extra time to undertake complete GloBE calculations.

Since the top up tax for the jurisdiction satisfying the CbCR Safe Harbour would be zero, GloBE calculations need not be undertaken in respect of jurisdictions satisfying the CbCR Safe Harbour.

Step 2: Calculation of GloBE Income (“Income”)

Broadly, GloBE Income is calculated by making certain specified adjustments to Financial Accounting Net Income or Loss at each Constituent entity level. The starting point for calculating GloBE income or loss, is the bottom-line net income or loss of the Group Entity before making any consolidation adjustments that would eliminate income or expense attributable to intra-group transactions. As expressly stated in the model rules, elimination of income and expenses from intra- group transactions that occur in the accounting consolidation process are not taken into account in the computation of a Constituent Entity’s Financial Accounting Net Income or Loss (Rule 3.1.2). Few exceptions for inclusion or exclusion of intra group transactions such as dividend and intra group financing arrangements have been included in the model rules. Alternatively, the rules also provide for MNE to elect elimination of intra – group transactions within the same judication (Rule 3.2.8).

Step 3: Check for De-Minimis Exclusions

GloBE Rules provides for top-up tax in respect of some jurisdictions to be considered as zero if the Average GloBE Revenue and Average GloBE Income in such jurisdiction for a tested year is below the specified threshold. This benefit applies for in the year in which the threshold is met. Therefore, the De-minimis threshold shall be checked on a yearly basis. 

Step 4: Calculation of Covered Taxes (“Tax”)

Covered Taxes for the purposes of GloBE Rules shall be computed by making specified adjustments to current tax expense of a constituent entity, as recorded in the financial accounts of a constituent entity.

Step 5: Calculation of Effective Tax Rate (ETR) = Tax / Income

ETR is the proportion of Covered Tax to the GloBE Income. The ETR is computed on a jurisdictional basis.

Step 6: Calculation of Top-up Tax % = 15% – ETR

Top-up tax percentage is the shortfall in the ETR to the benchmark rate of 15%, which is the minimum tax required.

Step 7: Calculation of Excess Profits

The Top-up tax is required to be computed on the profits in the jurisdiction. Under the GloBE Rules, the top-up tax is required to be computed after excluding certain nominal return on the payroll costs and average tangible assets. This exclusion of return on payroll cost and tangible asset is called as Substance Based Income Exclusion (“SBIE”). The rationale for this exclusion is that, in the jurisdictions where the MNEs has business substance with the presence of personnel and tangible assets, the Top-up Tax shall apply only on Excess profits. The nominal rate for 5% is prescribed for SBIE under the GloBE Rules. However, for the initial period of around 10 years from the implementation of GloBE Rules, a higher rate has been provided as a transitional measure.

Step 8: Top-up Tax = Excess Profits * Top up Tax % – QDMTT

Top-up Tax is derived by applying Top-up tax percentage to the Excess profits. QDMTT being creditable against Top-up Tax, this amount needs to be reduced.

Step 9: Allocation of Top-up tax

The Top-up tax is allocated to the parent jurisdictions as per the Income Inclusion Rule (“IIR”). The IIR requires the allocation of tax to ultimate parent jurisdictions in proportion of its ownership in the low-tax constituent entity. A top-down approach is generally followed for IIR application i.e if UPE does not collect the IIR then the step-down parent jurisdiction will be allowed to collect the same.

The Undertaxed Profits Rule (“UTPR”) is a back- stop for IIR. It applies in the form of additional cash tax expenses in jurisdiction where UTPR is in operation, if IIR could not applied on the profits.

e) Applicability of GloBE Rules

The Pillar Two is likely to be effective in 2024, whereas the UTPR is likely to be effective from 2025.

f) STTR creditability

The STTR related documents released by OECD states that STTR is creditable against tax due under GloBE4. However, the mechanism and operation of such credit is not provided in detail by OECD.

III. Opportunities and Challenges

The Pillar Two implementation across the globe, presents multifarious opportunities, while not devoid of challenges, for various stakeholders. An attempt has been made to throw some light on the opportunities and challenges for the stakeholders:

1. Tax Department

a) Opportunities

For the tax department or the Governments in general, Pillar Two brings in immense opportunities to generate tax revenue, by aligning themselves with the Global consensus on minimum tax. The GloBE Rules and STTR, expands the taxing rights where the parent entities are housed in a jurisdiction. As stated above, Pillar Two is likely to raise over USD 200 Billion in terms of additional tax revenue. The tax department of respective jurisdiction either individually or on aggregate level will also be able to review undue tax advantages obtained by MNEs paying effectively nil or very small amount of taxes by arranging their affairs resulting in base erosion.

At India level, the tax department may get an opportunity to collect the IIR if the UPE is located at India. At the same time, in the case of UPE or other parent jurisdiction of the subsidiary companies located in India does not collect the IIR, India will also get the opportunity to collect the taxes under UTPR route. As regards the enactment and implementation of QDMTT, India may not get substantial additional taxes since the benchmark tax rate are generally above 15%.

b) Challenges

The foremost challenge for low-taxed jurisdictions is to retain the investments made by MNEs, which primarily might have been made for availing attractive tax rates.

Another important challenge lies in the complexity of the GloBE Rules and the attached difficulty in administering or application of the same. Tax departments in some developing jurisdictions might not have sufficient trained personnel to apply GloBE Rules effectively. In some cases, it needs to be evaluated whether assistance could be sought from Tax Inspectors Without Borders – a OECD/UNDP partnership.

Another aspect that needs to be considered is that with Pillar Two allocating top-up tax to even to non-UPE jurisdictions, the tax department should focus on all the in-scope MNE group which is having any presence in its jurisdiction, irrespective of whether the Ultimate parent entity is in its jurisdiction or not. Therefore, the administration for collection of UTPR seems to the most complex exercise for any tax department.

Further, the tax departments now need to process additional data with GloBE return also being filed on a jurisdiction-by-jurisdiction basis, in addition to CbCR which the in-scope MNEs would be filing.

With reference to India- it might not be a low-tax constituent entity since the lowest corporate tax rate exceeds 15%. However, one still needs to test the GloBE Income of an entity, since the income is subject to certain exclusions and income, and then calculate the ETR. Thus, a QDMTT at India level might have limited application. However, the Indian tax department might apply full-fledged GloBE Rules to MNEs have UPE in India and in respect of entities where the Indian companies hold ownership interest. Considering the availability of intellectual talent with Indian tax department, India is expected to implement and administer the Pillar II with the highest level of efficiency.

 2. Taxpayers

a) Opportunities

We need to look at BEPS 1.0 (consisting of 15 action points) and BEPS 2.0 (Pillar I & II) holistically. The tax payer had in the recent past and will have in the future an opportunity to reaffirm or rearrange the affairs of the MNE in the way it can be logically substantiated. Substance over form seems to be the only answer to complex transactions and structures. Aggressive tax planning will be scrutinized in greater detail. Additionally, the codified law to address the tax evasion provisions will provide support to the tax payer to substantiate its structure more objectively and thus avoids subjectivity in interpretation by the tax department.

b) Challenges

Some of the challenges that a taxpayer may face are enumerated below:

  • The applicability of STTR is not restricted to MNE groups to whom GloBE Rules apply. Thus, it can apply to all MNEs having presence in developing countries making cross-border payments above the threshold limits (Euro 1 million). The MNE groups are therefore required to consider doing a STTR impact assessment to ascertain potential additional tax costs that might arise.
  • For the in-scope MNEs under GloBE Rules, the complexity of GloBE Rules and its implementation at global scale will be a herculean challenge. The collection of data required in respect of each constituent entities might consume time and resources. MNEs shall also therefore undertake a full-fledged impact assessment of GloBE Rules on its constituent entities, in line with the global developments.
  • The in-scope MNEs need to align their accounting systems to cater to the data requirements under the GloBE Rules. It is important that this integration exercise is undertaken before the beginning of the year when GloBE Rules come into effect.
  • Since the CbCR data will be a primary document to avail Safe Harbour, the accountability for the data contained therein certainly would increase manifold.
  • For any multinational company including Indian UPE need to ensure that the jurisdictional ETR is above 15% and pay the taxes in the Low Tax Jurisdiction (LTJ) as per QDMTT or at UPE jurisdiction under IIR or UTPR. The global tax and transfer pricing department need to improve their capabilities to ensure proper compliance of Pillar II.

3. Tax professionals

a) Opportunities

The Pillar Two implementation presents immense professional opportunities for tax professionals. Some of the them are discussed below:

  • The Pillar Two implementation opens significant global opportunities for tax professionals, since the legal framework under Pillar II would be applied almost uniformly across the global. With tax professionals across the world reading and interpreting same taxation related language, the professional opportunities truly should become borderless.
  • The Pillar II bringing into effect a new legal framework, it can provide an early- starter benefit to professionals who wishes to advice on this subject.
  • In addition to tax advice, the professional can also advice on the system design for their client to extract inputs for Pillar II application.
  • With Pillar II requiring the MNEs to file a separate GloBE Return, the compliance related work opportunity is also enhanced. Going forward, support during assessments/audits by the tax department seems imminent.

b) Challenges

There are certain challenges that a tax professional might face with reference to Pillar Two implementations. On overcoming these challenges, the professional opportunities mentioned above would manifest more prominently:

  • The complexity of the subject requires the professionals to invest high amount of time to improvise their capabilities.
  • Another major challenge for a tax professional is to understand and grasp the accounting concepts and terminology dealt with under Pillar Two.
  • GloBE rules also have an interplay with CFC rules. This needs to be understood and implemented properly to avoid double payment of taxes.

IV. Conclusion

With Pillar Two of the BEPS 2.0 likely to be operational in less than six months, the world is all set to witness a paradigm shift in the international tax regime. As may be seen, the Pillar Two components, viz. STTR and GloBE Rules are both complex and exhaustive. They have their own share of uncertainties attached to them in terms of interpretation and its administration.

The challenges attached to Pillar II currently outweigh the opportunities for the professionals and the tax departments. The primary challenge is of data collection for GloBE Rules application. Taxpayers might have to spend substantial time & resources integrating their accounting / ERP systems for suitable data extractions.

The Council of the European Union (EU) unanimously adopted the EU Minimum Tax Directive in December 2022. As per the said directives, it ensures that the GloBE Rules are implemented in a coordinated manner throughout the EU from 2024. Few other developed economies such as Japan, South Korea, UK have either adopted the domestic legislation or in the process of the adopting the legislation. India is yet to legislate the model rules for implementation of GloBE rules. Additionally, as already stated in the article, STTR MLI will be available for signature from 2nd October 2023.

Change seems to be the only constant for the developments in international tax challenges and opportunities. Let’s prepare and update ourselves in the interesting times ahead!

“A person should be courageous and honest in worshipping the truth, without being concerned about receiving worldly benefits.”

– Lala Lajpat Rai

  1. https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.htm
  2. https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-october-2021.pdf
  3. OECD (2021), Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two): Inclusive Framework on BEPS, OECD Publishing, Paris, https://doi.org/10.1787/782bac33-en.
  4. https://www.oecd.org/tax/beps/pillar-two-subject-to-tax-rule-in-a-nutshell.pdf

 

Abstract

In furtherance to the first and second parts where the basics of a Will and other aspects were covered, the author aims to cover the taxation aspects in this article. As there is no consumption of goods or provision of services, the question of Goods and Services tax doesn’t arise. This Article aims to cover the direct tax aspects under the Income-tax Act, 1961 (Act) and Black Money (Undisclosed Foreign Income and Assets) Act, 2015.

1. Introduction

2. In the hands of the Testator

2.1. Filing of Return

2.1.1. By the Legal Representative

2.1.2. By the Executors

2.2. Capital Gains

2.3. Scrutiny

2.4. Recovery

3. In the hands of the Legatee

3.1. Filing of Return

3.2. Inheritance tax

3.3. Gains on Sale of Inherited Assets

4. Dénouement

1. Introduction

In India after the abolition of Estate Duty in 1985 and Wealth tax in 2015, the re-introduction of Inheritance tax is speculated and rumoured in both, professional spheres and High Net Individual Circles. Without indulging in any conspiracy theories, this article will deal with the direct tax implications on inheritances.

2. In the hands of the Testator

2.1. Filing of Return

2.1.1. By the Legal Representative

The term “legal representatives” is defined under section 2(29) of the Act, which adopts the definition under 2(11) of the Code of Civil Procedure, 1908. It states, ‘Legal representative’ means a person who in law represents the estate of a deceased person and includes any person who inter-meddles with the estate of the deceased and where a party sues or is sued in a representative character, the person on whom the estate devolves on the death of the party so suing or sued. The term legal representative includes an heir, executor, administrator or other legal representative.

The term ‘Legal representative’ is different from the term ‘representative assessee’ as used for the purposes of sections 160 to 167 of the Act.

The Hon’ble Supreme Court held that the personality of the deceased assessee, which ceased after his death, is extended for the duration of the entire previous year in the year of death. Therefore, the income received by him before his death and that received by his heirs and legal representatives after his death but in that previous year becomes assessable to income tax in the relevant previous year.1

According to section 159 of the Act, when a person dies, testate or intestate, their legal heirs are responsible for filing the return of the deceased assessee/person. For the purposes of the Act, the legal representative of the deceased assessee would be deemed to be an assessee.2 Section 159 of the Act creates legal fiction only for the purpose of assessment proceedings for that year. Any income accrued during the year of death may be apportioned up to the date of death and legal representative may be charged in respect of the income which accrued to the deceased up to the date of death.

The legal representative is not required to have a separate PAN. The legal representative could be more than one person as under section 13(2) of the General Clauses Act, words used in singular will include their plural also.3

If the assessee died before the assessment proceedings were completed, the assessing officer is required to bring the legal representative of the deceased on record and proceed from the stage where it was as on the date of death of the assessee.4

A penalty can also be imposed on the return filed by the deceased or by the legal representative. Further, penalty proceedings can be initiated or continued against the legal heir for a default committed by the deceased5. However, prosecution for any offence would abate with the death of the deceased. Conversion of the inherited assets into another form will not preclude the department from recovering the dues of the deceased, the new assets would be proceeded against in the same way as the original assets.6

 2.1.2. By the Executors

In the event, that the deceased assessee dies testate and appoints the executor(s) in his or her Will, the executors will take over the estate and will be the assessee for the purpose of the income generated from the estate of the deceased.

The executors will take over the responsibility of administering the estate of the deceased according to the Will. An executor is undoubtedly a legal representative.7 The Explanation to section 168 provides that “executors” include an administrator or other person administering the estate of a deceased person. The reference in the Explanation to “other person” administering the estate of a deceased person” is intended to apply to those persons who are found to be administering without having been appointed by the Court as administrator, the estate of a deceased person who has left behind a will without naming an executor, and in respect of whose will it is not necessary to obtain letters of an administration and have an administrator appointed by a Court.8 It will also include an executor, administrator under the Indian Succession Act, and any person administering the estate of a deceased person.9

However, section 168 of the Act will not apply where a person has died intestate, irrespective of the fact that an administrator has been appointed by a Court.10 

The executor shall be assessed in respect of the income of the estate separately from his personal income. Thus, there would be a requirement to obtain a separate PAN to file an Income-tax return in the capacity of an executor.

In case where there is more than one executor, the income of the estate of a deceased person shall be chargeable to tax as if the executor were an association of persons (AOP). The executor would continue to be chargeable to income tax under section 168 of the Act until the estate of the deceased is distributed completely to the beneficiaries thereof.11

Where the estate is partially distributed, then the income from the assets distributed gets excluded from the income of the estate (executor) and gets included in the income of the beneficiary/ legatee. The Legatee is chargeable to tax on income after the date of distribution. Even, if the executor is the sole beneficiary, it does not necessarily follow that he receives the income in the latter capacity. The executor retains his dual capacity and hence, he must be assessed as an executor till the administration of the estate is not completed except to the extent of the estate applied to his personal benefit in the course of administration of the estate.

Further, the residential status of the executor shall be decided according to the residential status of the deceased person during the year in which his death took place.

In case of a testate death (where a valid Will is created before the death) income earned after the date of death shall be taxable under section 168 of the Act in the hands of the Executor/ Administrator.12 Therefore, in the financial year in which the person expires, two income-tax returns shall be filed. One by the legal representative till the date of his death under section 159 of the Act and thereafter as legal representative/executors for income on his estate under section 168 of the Act.13 It is clear that sections 159 and 168 operate in different spheres. The former is concerned with the income of the deceased and the latter with the income from the estate of the deceased.14

It is mandatory for the department to assess the income of the deceased in the hands of the executors and it is not up to their discretion.15

2.2. Capital Gains

When a person dies and there is a Will in place, the assets will be transferred to the beneficiaries according to the Will.

According to Section 47(iii) of the Act, any transfer of capital assets by way of a Will shall not amount to transfer. Hence, there will not be an incidence of Capital Gains tax on such inheritance by Will. The language employed in section 47(iii) of the Act will apply only to actual transfers and not deemed transfers.16

It is pertinent to note that where the deceased person entered into a transaction that resulted in capital gains and subsequently passed away, the legal heirs could avail of the deduction under section 54 or 54F of the Act, if applicable. A legal representative cannot be differentiated from the deceased assessee, where the deceased assessee was liable to pay the tax, they cannot be denied the benefit of section 54 of the Act which forms part of the scheme of taxation of capital gains.17 The word “assessee” must be given wide and liberal interpretation so as to include his legal heirs also.18

On the issue regarding the taxability of the unutilised deposit amount in the case of an individual who dies before the expiry of the stipulated period, the Central Board of Direct Taxes (CBDT) vide Circular No 743 dated May 06, 1996 [1996] 219 ITR (St) 50 had clarified that the said amount cannot be taxed in the hands of the deceased. This amount is not taxable in the hands of legal heirs also as the unutilised portion of the deposit does not partake the character of income in their hands but is only a part of the estate devolving upon them.

According to Rule 13 of the Capital Gains Account Scheme, 1988, if a depositor in respect of whose deposit account a nomination is in force, dies, the nominee or legal heir, if they desire to close the account or accounts and obtain the payment of the balance standing to the credit in the account of the deceased depositor, shall make an application to the deposit office in Form H or as near thereto as possible with the approval of the Assessing Officer who has jurisdiction over the deceased depositor, and the deposit office shall pay the amount of balance standing to the credit in the account of the deceased depositor including amount of interest accrued, by means of crediting such amount to any bank account of the nominee.

Where there is more than one legal heir of the deceased depositor, the legal heir making the claim individually may do so by producing the letter of disclaimer or letter of authorisation from other legal heirs in their favour.

Before granting the approval for closure of the account the Assessing Officer shall obtain from the legal heir a succession certificate issued under Part V of the Indian Succession Act, 1925, or a probate of the will of the deceased depositor, if any, or letter of administration to the estate of the deceased in case there is no will in order to verify the claim of such legal heir to the account of the deceased depositor.

2.3. Scrutiny

Where the assessee expires before the initiation of assessment proceedings, the Assessing Officer is required to issue a Notice in the same of the legal heirs of the deceased assessee. Issuance of a Notice in the name of a deceased person is bad in law.19

The assessing officer is required to bring the legal representative of the deceased on record and proceed from the stage where it was on the date of death of the assessee.20 The legal heirs of the deceased assessee are under no obligation to inform the income-tax department about the death of the taxpayer and therefore, whether the PAN record was updated or not or whether the department was made aware by the legal representatives or not is irrelevant.21 However, it would be prudent for the legal representative or the executor as legal heir to register on the income-tax e-filing portal.22

2.4. Recovery

According to Sections 159(6) and 168 of the Act, the tax liability of the legal representative/heir or the executors of the deceased shall be limited to the estate of the deceased person.

The personal properties of the legal representative cannot be proceeded against for recovery of the tax due by the deceased by invoking section 159 of the Act, except in a case where it is found that the assets of the deceased have come into his hands and he has not properly accounted for the same.23

3. In the hands of the Legatee

3.1. Filing of Return

Once the assets are distributed, the legatee should include the same in their books and income, if any, generated from the said inherited assets should be included in the return of the legatee.

In the event of a partial distribution of assets, the legatee should include the assets so distributed in their return of income and any income generated from the same should be offered to tax in the capacity of a legatee.

3.2. Inheritance tax

With a view to avoid hardships in genuine cases section 2(24) i.e., the definition of “income” was amended vide Finance Act, 2004, inter alia, to exclude receipts under a Will or by inheritance.

Similarly, receipt of money, movable property or immovable property without consideration under a Will or by inheritance, irrespective of whether the testator is a relative or not is exempted from tax by virtue of proviso (III) to section 56(2)(x) of the Act.

Even a sum received by the taxpayer from the legal heir of a deceased in consideration of the taxpayer giving up his right to contest the Will of the deceased is not chargeable to tax under the then prevailing section 56(2)(vii) of the Act (Now corresponds to present section 56(2)(x) of the Act). 24

3.3. Gains on Sale of Inherited Assets

 

According to section 49 (1) of the Act, in the case where the property is acquired by way of gift, will or inheritance i.e., without consideration; on sale of the said property by the recipient, for the purpose of computation of Capital Gains, they would be allowed the cost of acquisition by the previous owner and the period of holding since the acquisition by the previous owner.25,26

4. Dénouement

In this article, some of the direct tax implications of a Will are covered. The series of articles which is proposed to be written on the law governing Wills is aimed to cover, aspects such as Intestate succession, Will of Non-residents, implications of the law of evidence and other relevant aspects.

  1. CIT v. Amarchand N. Shroff [1963] 48 ITR 59 (SC)
  2. Rudra Gouda v. Asstt. CIT [2018] 93 taxmann.com 333 (Kar)(HC)
  3. First Addl. ITO v. Mrs. Suseela Sadanandan [1965] 57 ITR 168 (SC)
  4. CIT v. Dalumal Shyanumal [2005] 276 ITR 62 (MP) (HC)
  5. Tapati Pal v. CIT [2002] 124 Taxman 123(Cal)(HC)
  6. M. Abdul Khalick & Co. v. ITO [1975] 101 ITR 43 (Mad) (HC)
  7. Estate of Late Rangalal Jajodia v. CIT [1971] 79 ITR 505 (SC)
  8. CIT/CWT v.P. Manonmani [2000] 245 ITR 48 (Mad) (FB)
  9. CIT v. Navnitlal Sakarlal [1980] 125 ITR 67 (Guj)(HC)
  10. CIT v. P. Manonmani [2000] 245 ITR 48 (Mad)(FB)
  11. Navnit Lal Sakarlal v. CIT [1992] 193 ITR 16 (SC)
  12. CIT v. P. Manonmani [2001] 245 ITR 48 (Mad)(HC)(FB)
  13. B. D. Gupta & Sons v. ITO [2015] 60 taxmann.com 38 (Delhi – Trib.)
  14. Raghunathdas Kakani v. Addl. CIT [1980] 122 ITR 952 (MP) (HC)
  15. CIT v. Mrs. Usha D. Shah [1981] 127 ITR 850 (Bom)(HC)
  16. CIT v. Bharani Pictures [1981] 129 ITR 244 (Mad)(HC)
  17. C.V. Ramanathan v. CIT [1980] 4 Taxman 432 / 125 ITR 191 (Mad)(HC)
  18. Late Mir Gulam Ali Khan v. CIT [1986] 28 Taxman 572 / [1987] 165 ITR 228 (AP)(HC)
  19. Sumit Balkrishna Gupta v. ACIT [2019] 414 ITR 292 (Bom)(HC)
  20. CIT v. Dalumal Shyanumal [2005] 276 ITR 62 (MP) (HC)
  21. Savita Kapila, legal heir of late Shri Mohinder Paul Kapila v. ACIT [2020](273 Taxman 148 (Del) (HC)
  22. DCIT v. Barclays Global Service Centre Private Ltd ITA 46/Pun/2021 dated January 02, 2023 (Pun) (Trib)
  23. UOI v. Mrs. Sarojini Rajah [1974] 97 ITR 37 (Mad)(HC)
  24. Purvez A. Poonawalla v. ITO ITA No. 6476/Mum/2009 (Mum)(Trib)
  25. CIT v. Manjula J Shah [2013] 355 ITR 474 (Bom)(HC) 
  26. Arun Shungloo Trust v. CIT [2012] 18 taxmann.com 261 / 205 Taxman 456 (Del)(HC)

 

Introduction

Many a times, tax professionals provide Investment related services knowingly or unknowingly either for the tax panning or for the wealth planning for a client. This activity may trigger the applicability of Investment Adviser Regulations which comes under SEBI’s ambit.

This article analyses the impact of SEBI’s Investment Adviser Regulations on tax professionals and their practice. To do so, it briefly explains the following concepts: SEBI and its role, BASL and its role, Investment Adviser, Investment advice, Financial planning as per this regulation and how it relates to Investment advice. It also discusses the implications for tax professionals who advise their clients on tax planning and other matters, the precautions they should take, and whether they need to register as Investment Advisers.

SEBI and its Role in the Indian Securities Market

The Securities and Exchange Board of India (SEBI) is the Regulator of the financial markets in India. It acts as a watchdog for all the capital market participants. It was established in 1988 and was given statutory powers in 1992 with the passage of the Securities and Exchange Board of India Act, 1992. SEBI plays an important role in regulating the securities market of India. It ensures that the three main participants of the financial market are taken care of i.e., issuers of securities, investors, and financial intermediaries. Its main purpose is to provide an environment that facilitates the efficient and smooth functioning of the securities market. Here are some of the key roles and functions of SEBI in the Indian securities market: –

    • Regulatory Oversight

SEBI formulates and enforces rules and regulations to govern various participants in the securities market, including stock exchanges, brokers, mutual funds, and listed companies. It monitors and regulates activities such as insider trading, fraudulent and unfair trade practices, and market manipulation to maintain market integrity.

  • Investor Protection

    SEBI’s primary concern is to protect the interests of investors in the securities market. It does so by ensuring that companies disclose accurate and timely information to the public. SEBI also regulates collective investment schemes (like mutual funds) to safeguard the interests of investors in these schemes.

  • Market Development

    SEBI promotes the development and growth of the securities market by introducing reforms and initiatives to make it more competitive and efficient. It encourages the use of technology and innovation in trading, settlement, and clearing processes.

  • Supervision of Market Intermediaries

    SEBI regulates various market intermediaries, such as stockbrokers, and depository participants, to ensure that they follow prescribed norms and maintain high standards of professionalism.

  • Listing and Disclosure RequirementsSEBI prescribes listing requirements for companies looking to get their securities listed on stock exchanges. It ensures that these companies meet minimum standards of corporate governance and financial disclosure.
  • Surveillance and Enforcement

    SEBI employs surveillance mechanisms to monitor market activities for irregularities and potential violations of regulations. It takes enforcement actions against entities and individuals found guilty of violating securities laws.

  • Research and Education

    SEBI conducts research and provides educational resources to enhance awareness and knowledge among market participants and investors.

  • Regulatory Framework

    SEBI continually updates and revises the regulatory framework to align it with evolving market dynamics and global best practices.

SEBI (Investment Advisers) Regulations, 2013

Since, Investment Adviser is one of the Financial Intermediary and regulated by SEBI, Regulations, Circulars and guidelines are issued by it which are to be adhered by the Investment advisers. The regulations are known as SEBI (Investment Advisers) Regulations, 2013 (“ IA Regulations ”) which were first notified by SEBI in the official gazette on 21st January 2013 to regulate and streamline the activities of individuals and entities offering investment advisory services. These regulations were implemented to ensure transparency, accountability, and investor protection in the financial advisory sector. While the primary objective of these regulations was to safeguard investors’ interests, they have also had a significant impact on tax professionals in India who offer financial advisory services.

IA Regulations provide that no person shall act as an investment adviser or hold itself out as an investment adviser unless he has obtained a certificate of registration from the SEBI. No person, while dealing in distribution of securities, shall use the nomenclature ‘Independent Financial Adviser (IFA)’ or ‘Wealth Adviser’ or any other similar name unless registered with the SEBI as Registered Investment Adviser (“RIA”). Hence, registration is compulsory for carrying out investment advisory activities. In India, there are 1328 registered Investment Advisers as on 31st July 2023.

Let us first understand the concept of Investment adviser and certain Key definitions related to it.

Key Definitions

According to Reg. 2 (1) (m) of IA Regulations, “investment adviser” means any person, who for consideration, is engaged in the business of providing investment advice to clients or other persons or group of persons and includes any person who holds out himself as an investment adviser, by whatever name called;

as per Reg. 2 (1) (g) “consideration” means any form of economic benefit including non-cash benefit, received or receivable for providing investment advice;

as per Reg. 2 (1) (l) “investment advice” means advice relating to investing in, purchasing, selling or otherwise dealing in securities or investment products, and advice on investment portfolio containing securities or investment products, whether written, oral or through any other means of communication for the benefit of the client and shall include financial planning:

Provided that investment advice given through newspaper, magazines, any electronic or broadcasting or telecommunications medium, which is widely available to the public shall not be considered as investment advice for the purpose of these regulations;

And as per Reg. 2 (h) “financial planning” shall include analysis of clients’ current financial situation, identification of their financial goals, and developing and recommending financial strategies to realise such goals;

Hence, it is clear that to be RIA, the person must provide investment advice for consideration and also include the person who helps his clients to accomplish their financial goals by recommending them financial strategies after analysing their financial situation.

IA regulations provide for smooth functioning of RIA by providing them a Code of Conduct of Investment Adviser and guidelines for do’s and don’ts. Due to this, there is transparency, proper disclosure including disclosure on Conflict of Interest and thereby increases Investor confidence.

The industry has various investment advisers, both registered and unregistered. Sometimes, tax professionals may also give advice to their clients that could be regarded as investment advice, unless they exercise due diligence and care. In today’s complex and busy world, clients expect tax professionals to advise them not only on tax planning but also on investment planning. This may result in these professionals providing investment advice and falling under the scope of Investment adviser, either directly or indirectly.

Services Provided by Tax Professionals A tax professional is broadly a person who practices in Income Tax Law (generally known as Income Tax Practitioner) and Goods and Service Tax Law (generally known as GST Practitioner, previously called a Sales Tax Practitioner).

According to section 288 of the Income Tax Act, 1961, an income tax practitioner is a person who can act as an authorized representative of an assessee before any income tax authority or the Appellate Tribunal. The income tax practitioner may be a chartered accountant, a lawyer, a person who has passed any accountancy examination, a retired government officer, or any other person prescribed by the Board. Rule 54 of the Income Tax Rules, 1962, specifies the conditions and qualifications for persons other than chartered accountants and lawyers to act as income tax practitioners.

Section 48 of the CGST Act 2017 defines the eligibility criteria and educational qualification of GST practitioners as having a graduate or postgraduate degree in commerce, banking, business administration, or business management, Chartered Accountants, Company Secretaries, Cost and Management Accountants, Advocates, retired government officials, sales tax practitioners under existing law and tax return preparers under the existing law.

In India, there are various Tax Professionals who are engaged in providing wide range of advisory services including but not limited to

 

  • Business Tax Services
  • Transfer Pricing
  • Mergers and Acquisitions
  • Valuation Services
  • Data Analysis and Tax Technology Services
  • Representation Before Tax Authorities
  • Indirect Tax Compliance
  • Personal Tax Services including Tax planning, retirement planning, estate planning and many more.
  • Management Consultancy

These services are essential for individuals, businesses, and organizations to ensure compliance with tax laws and optimize their financial situations. The question of whether the tax professionals providing such advisory services are considered investment advisors and are required to be registered under the IA Regulations, is not a simple one. It is also not a one-size-fits-all answer. Before we come to any conclusion, let us first understand the difference between tax-related advice or tax planning and investment advice or financial planning.

Tax related Advice v. Investment Advice

Investment advice is often incidental to tax- related advice, either for tax planning or for structural planning. Sometimes, they coincide or overlap. Therefore, it is essential to educate the clients about the difference between tax advice and investment advice. When tax professionals do tax planning for the client to reduce the tax liability in an ethical manner, they only advise the client to invest a certain amount of money in specific assets to avail the tax benefit provided by the Government of India. However, if the tax professional advises the client to invest in particular investment products, including securities dealing, etc., they do so after analysing the client’s current financial situation and their financial goals. This falls under the domain of financial planning and is considered as investment advice as per IA Regulations.

Tax related advice and investment advice are complementary aspects of financial planning. While tax advice focuses on optimizing tax situations and ensuring compliance with tax laws, investment advice is more on growing and managing your wealth through investment strategies. Depending on the client’s financial goals and circumstances, the client may need both types of advice to create a well-rounded financial plan. However, tax advice may overlap with Investment advice in certain circumstances.

Let us take a simple example where Tax advice might overlap with Investment advice/ recommendations. Mr. A approaches a Tax Professional, Mr. B for filing of his Income Tax return and for tax planning. After verification of details and documents provided by Mr. A, it is found that tax payable for that particular financial year is very high. Then, Mr. B advises Mr. A to do a certain amount of investment say in ELSS, or Tax-free bond, Capital gains saving bond which are allowed as a deduction under Income Tax Act to reduce the tax payable substantially or to make it Nil. This is pure and pure tax planning by Mr. B in the normal course of practice. However, in this case, if Mr. A approaches Mr. B to seek an advice pertaining to some Investment in financial products or any Investment planning to achieve his specific financial goal such as Child Education, Marriage retirement planning etc. along with tax planning, then that comes under the purview of Financial planning and shall be considered as Investment Advice. Accordingly, Mr. B is required to get himself registered as an Investment Adviser.

BASL and its role in IA registration SEBI vide regulation 14 of IA Regulations, has granted recognition to BSE Administration and Supervision Limited (BASL), a subsidiary of BSE Limited (BSE) as Investment Adviser Administration and Supervisory Body (IAASB) through a circular dated June 18, 2021. [Ref. SEBI circular no. SEBI/HO/IMD/IMD-I/DOF1/P/ CIR/2021/579 dated June 18, 2021]

Accordingly, any person desirous of obtaining a certificate of registration as an IA is required to first obtain membership of BASL and then make an application for grant of certificate of registration in the format of Form A as specified in the First Schedule to the IA Regulations along with necessary supporting documents specified therein.

The process for seeking membership from BASL and registration from SEBI as an IA is specified in BASL circular no. 20220718-1 dated July 18, 2022 and is available on BASL website (https://www. bseasl.com) at “Circular » BASL Circulars”.

Exemptions form Registration as Investment Adviser

There are certain exemptions also provided by SEBI from RIA registration, subject to certain specific conditions, which are as under: –

  • Any person who gives general comments in good faith in regard to trends in the financial or securities market or the economic situation where such comments do not specify any particular securities or investment product;
  • Members of Institute of Company Secretaries of India (ICSI), Institute of Cost and Works Accountants of India (ICMAI), and Institute of Chartered Accountants of India (ICAI) who provide investment advice to clients, incidental to their professional services;
  • Any advocate, solicitor or law firm, who provides investment advice to their clients, incidental to their legal practice;
  • Insurance agents or brokers registered with IRDAI;
  • Pension advisors registered with PFRDA;
  • Mutual fund distributors registered with AMFI who can provide basic advice to client’s incidental to distribution activity;
  • Any stockbroker or Portfolio manager, Merchant banker registered with the SEBI;
  • Fund manager of Mutual fund scheme;
  • Any fund manager, by whatever name called of a mutual fund, alternative investment fund or any other intermediary or entity registered with the Board;
  • Any person who provides investment advice exclusively to foreign clients.

SEBI has granted exemption from registration to certain categories of professionals – CAs, CSs, CMAs and Advocates who provide investment advice to clients incidental to their professional or legal practice. SEBI has clarified through a FAQ that such classes of professionals have been exempted only to the extent investment advice is incidental to their respective profession. Hence any investment advisory services provided by specified professional which is not incidental to their respective practice shall require the said professional or firm of professional rendering the service to seek registration from SEBI under Regulation 3 of the SEBI (Investment Advisers) Regulations, 2013.

ICAI Code of Conduct v. Investor Adviser Definitions

As mentioned earlier, tax professionals like Chartered Accountants who give investment advice to their clients that is incidental to their professional services are exempted from seeking registration under the IA Regulations. However, if they provide investment advisory services in securities as an activity which is not incidental to their main activity, then they need to register as an IA.

The ICAI’s Code of Ethics and Professional Conduct outlines the fundamental principles and rules that members must adhere to in their professional activities. These principles include integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour.

If a Chartered Accountant is providing investment advice, they must ensure that their conduct aligns with these ethical principles. They should act with integrity, providing accurate and unbiased advice to their clients. They should also maintain confidentiality regarding client information and act professionally at all times. The same principles are also stated in the Code of Conduct of the Third Schedule of IA Regulations.

Compliance requirements as per SEBI (IA) Regulations

Chapter III of SEBI IA Regulations constitutes the provisions to be complied with by RIA.

Some of the important provisions are provided as under: –

  • Certification and Qualification requirements at all the times (Reg. 7)
  • General Obligations and Responsibilities (Reg. 15)
  • Risk Profiling of the Client (Reg. 16)
  • Suitability of the advice given (Reg. 17)
  • Disclosure to Clients (Reg. 18)
  • Maintenance of Records (Reg. 19)
  • Redressal of client grievances (Reg. 21)
  • Client level segregation of advisory and distribution activities (Reg. 22)
  • Implementation of advice or execution (Reg. 22A)

Challenges for Tax Professionals in meeting Compliance Obligations under IA Regulations

Tax professionals who also provide investment advisory services may face several challenges when it comes to meeting compliance with IA Regulations issued by SEBI. These challenges can include:

  • Dual Regulatory Compliance: – Tax Professionals who provide investment advice may need to comply with both the regulations of their respective tax or accounting profession’s governing body (e.g., ICAI for CAs) and SEBI’s Investor Adviser Regulations.
  • Registration and Documentation: – Investment advisers need to register with SEBI and maintain proper documentation of their advisory activities.
  • Conflict of Interest: – Tax Professionals need to ensure that their advice is not influenced by potential conflicts, such as receiving fees or commissions from financial products they recommend.
  • Disclosure Requirements: – IA Regulations mandate clear and comprehensive disclosure of fees, charges, and conflicts of interest in a transparent manner.
  • Client Onboarding and Risk Profiling: – Establishing a robust client onboarding process and risk profiling is essential for compliance.
  • Client Suitability: – Tax Professionals must assess and ensure that investment recommendations are suitable for their clients’ financial goals and risk tolerance, as required by IA regulations.
  • Fiduciary Responsibility: – Investment advisers have a fiduciary duty to act in the best interests of their clients.
  • Regulatory Changes: – Tax professionals must be proactive in monitoring and adapting to evolving regulatory requirements.
  • Continuous Education: – Tax professionals may need to invest time and resources in acquiring the necessary knowledge and skills related to investment advisory services. Continuous education and training are essential to stay competent in this field.
  • Compliance Costs: – Complying with regulatory requirements, such as registration fees and ongoing compliance costs, can impact the profitability of a tax professional’s investment advisory practice.
  • Enforcement Actions: – Failure to comply with SEBI regulations can lead to enforcement actions, including fines and suspension or revocation of registration. Tax professionals need to be aware of the consequences of non-compliance.

Potential benefits of Complying with Investment Adviser Regulations

Complying with IA Regulations, as those issued by SEBI, can provide several benefits to individuals and entities providing investment advisory services. These regulations are designed to protect the interests of investors and ensure the integrity of the financial advisory industry. Here are some of the benefits of complying with these regulations.

  • Enhanced Investor Trust and Confidence:

    – Investors are more likely to trust and have confidence in advisers who adhere to regulatory standards, which can lead to stronger client relationships.

  • Access to a Broader Client Base: – Compliance with regulations can open doors to a broader client base, including institutional investors and high-net-worth individuals who may require advisers to meet regulatory standards.
  • Client Satisfaction: – Clients are more likely to be satisfied with advisers who follow clear and transparent processes, provide suitable advice, and communicate effectively.
  • Professional Development: – Regulatory compliance often requires ongoing education and professional development. This helps advisers stay updated with industry trends, best practices, and changes in regulations, ultimately benefiting their clients.
  • Legal and Regulatory Compliance: – Compliance with IA Regulations reduces the risk of legal actions, penalties, or regulatory sanctions for non-compliance.
  • Professional Credibility and Competitive Advantage: – Clients may choose advisers who are registered and compliant over those who are not, as it provides an extra layer of assurance regarding the quality of service.
  • Investor Protection: – Regulatory compliance is designed to protect investors from fraudulent or unethical practices. It ensures that advisers provide suitable and transparent investment advice based on clients’ needs and risk profile.
  • Improved Risk Management: – Compliance requirements often include risk assessment and management procedures. Investment advisers who follow these guidelines are better equipped to identify, assess, and mitigate potential risks in their advisory services.
  • Market Integrity: – By adhering to ethical and regulatory standards, investment advisers play a role in maintaining market stability and fairness.
  • Reduced Reputational Risk: – Compliance helps mitigate reputational risks associated with unethical or fraudulent behaviour. A tarnished reputation can be challenging to recover from and may result in the loss of clients and business opportunities.

Thus, complying with IA Regulations offers numerous advantages, including building trust with clients, ensuring legal compliance, protecting investors, and enhancing an adviser’s professional standing. While compliance may require effort and resources, the long-term benefits often outweigh the associated costs and contribute to a sustainable and reputable advisory practice.

Disclosure by Tax Professionals of Potential Conflicts when providing investment advice

Disclosures of potential conflicts of interest are a fundamental component of ethical and regulatory requirements when tax professionals provide investment advice. These disclosures are essential to ensure transparency, protect the interests of clients, and maintain the integrity of the advisory relationship. Here are key considerations regarding the disclosure of potential conflicts:

  • Timely and Clear Disclosure
  • Written Disclosure
  • Nature of Conflicts
  • Client Consent
  • Record Keeping
  • Regular review
  • Regulatory requirements
  • Third Party Relationships

Case Studies and Examples

A. An Advocate or a Chartered Accountant rendering service of advising the client with the fair price for a strategic acquisition of a listed company. Whether this will be treated as an investment advisory service incidental to the respective profession?

  • This service is incidental to their respective profession and hence, covered by exemption provided U/ Reg. 4

B. As per Reg. 4 of SEBI (IA) Regulations, if any Professional is exempt from registration, then can they provide investment advisory services to their clients without being registered as RIA?

  • Exemption U / Reg. 4 is only provided when professionals are providing investment advice to their clients as a part of their regular professional services. If these professionals engage in the business of offering investment advisory services and this activity is not merely incidental to their primary professional role, then they are indeed obligated to seek registration as an investment adviser from SEBI. [SEBI Order against Ms. Archana Matta (PAN BECPS4207N) In the Matter of Unregistered Investment Advisory Services Dated September 27, 2018].

C. A CA is advising client for Retirement planning through investment in equities/ mutual funds – Let us examine the following issues:

  1. Whether this will be treated as an investment advice incidental to the professional services of CA?
  • According to Section 2(2) (iv) of the Chartered Accountants Act, 1949, the Council permits a Chartered Accountant in practice to offer various “Management Consultancy and other Services”, including ‘Investment Counselling in securities’ (Clause (xx) – Para 2.2.3 of Page 11 of the Code of Ethics – Volume II (Revised 2020 edition) published by ICAI). As per clause (xx), the investment advisory services in the above example are related to the professional service of a Chartered Accountant. One may argue that a member of the specified profession can perform only those activities that have been approved by their regulatory body and therefore, any activity done by the specified professional is normally considered to be relevant to or incidental to their professional services and hence covered by exemption provided under SEBI IA Regulation. If such interpretation is accepted, then such professionals may not be required to register with SEBI at all. This needs to be examined based on the facts and circumstances of each case. However, it is advisable to have harmonious interpretation of prevalent laws.
  1. Whether a Chartered Accountant in Practice would be considered as indulging in other activity not permitted to members in Full-time Practice and in violation of the Code of Ethics, if he registers with SEBI as Investment Adviser?
  • – If it is concluded that the investment advisory service(s) provided by the Chartered Accountant (or any other specified professional) is not incidental to their professional services, the member will have to register with SEBI as Investment Advisor. In the said scenario, the professional/ regulatory body may consider it to be a case of a member indulging in other activity not permitted to members in Full-time Practice and may initiate disciplinary proceedings against the member. A similar analogy could be of a specified professional enrolling with a Life/ General Insurance Company as an Insurance agent. The Ethical Standards Board (ESB) of ICAI in May 2022 has opined that members in practice are permitted to register as Investment Advisor with SEBI. Similarly, ESB of ICAI in May 2017 has permitted a CA in practice to register with SEBI as Equity Research Analyst subject to certain restrictions. This is an emerging concept and can be concluded only upon necessary clarification from Regulatory bodies of other professions.

 

  1. Whether the exemption from registration for rendering Investment advisory service incidental to the professional service is available to Firm?
  • Regulation 4 of SEBI IA Regulation provides for a list of persons exempted from seeking registration U/Reg 3. Clause (e) provides exemption to – “Any advocate, solicitor or law firm……..” while clause (f) refers to members of ICAI, ICSI, ICMAI and

    ASI and hence, it may lead to an interpretation that an exemption in case of Advocate is for individual as well as the firm while in case of other professional(s) the exemption is only for the member. This may not be the spirit of the law but, one would have to wait for clarification from SEBI in this matter.

  1. Whether Tax professionals other than Specified Professionals (CA, CS, CMA and Advocate) can claim exemption if they provide tax advisory or incidental services to their clients?
  • Sec. 288(2) read with Rule 54 of the Income Tax Act and Sec. 48 of the CGST Act allow various categories of person(s) to practice as tax professionals. professionals (ITP/STP). Reg. 4 of SEBI IA Regulation exempts CA (Clause-f) and Advocate (Clause-e) from seeking registration U/Reg 3. However, other classes of tax professionals who provide investment advice are not exempted and may have to register with SEBI as RIA for providing any tax advisory and incidental services related to securities as defined in Sec 2(h) of the Securities Contract Regulation Act and are considered as investment advice as per IA Regulations. SEBI may have exempted CAs and Advocates as they are bound by the code of ethics of their regulatory body vis- à-vis other categories of tax professionals.

Conclusion

Getting a SEBI RIA license has several benefits. Investors also get quality services from RIAs who have the qualification, certification and experience required by the IA regulations. Moreover, RIAs do risk profiling and check the suitability of the investment advice as per SEBI guidelines, which helps investors achieve their investment goals. The RIAs act in a fiduciary capacity towards their clients and disclose all the conflicts of interest as they arise. Furthermore, the execution and investment advisory services are separated to reduce conflict of interest. This brings transparency during the investment advice process. Therefore, it is advisable for tax professionals to register with SEBI if they provide investment advisory services that fall under the scope of investment advice as per IA Regulations and if their professional regulatory body permits such activity. Investors should also seek advice from SEBI registered RIAs only. Tax professionals who comply with these regulations and provide high-quality financial advisory services can gain the trust and confidence of their clients in the long run. However, they will need to plan carefully and adhere to the highest ethical standards to deal with the complexities of regulatory compliance and increased competition. 

In conclusion, whether an income tax practitioner providing investment advice to clients is required to be registered with SEBI as an investment advisor depends on various factors such as the nature and scope of the services offered, the fee or consideration charged, and the exemptions available under the SEBI regulations. It is advisable for income tax practitioners to carefully evaluate their activities and consult an expert for his professional advice if they have any doubts regarding their regulatory obligations

References

  • Securities and Exchange Board of India (Investment Advisers) Regulations, 2013 [Last amended on July 04, 2023].
  •  Frequently Asked Questions (FAQS) On SEBI Registered Investment Advisers [Last amended on August 07, 2023].
  •  Master Circular for Investment Advisers dated July 05, 2023.
  •  ICAI Code of Ethics (Revised 2020).
  • Opinion of Ethical Standards Board of ICAI – June 2022 Edition

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