1. Introduction

Section 179 (‘the section’) of the Income-tax Act, 1961 (‘the Act’) provides for recovery of tax from the directors of a private company in an exceptional circumstance when the same is not recoverable from the company itself. The non-recovery has to be on account of any gross neglect, misfeasance or breach of duty on the part of the director in relation to the affairs of the company. The section places joint and several liability on the directors of a private company unless he is able to prove that non- recovery cannot be attributable to his actions. The section was first introduced in the 1961 Act. The section creates a unique situation where limited liability accorded to a company is set aside by the department who has been given wide powers under the Act to lift the corporate veil of a company directly without involvement of a court. Thus even though the Act and the Companies Act 2013 recognise the concept of a company being a separate legal entity with limited liability, those who are actually running the show behind the corporate shield are not allowed to get away with fraud, misconduct and non-compliance of legal provisions, etc leaving the government remedy-less against any potential loss of revenue.

2. Background and amendments made till date

Section 179 was introduced for the first time in the Income tax Act, 1961 effective for the Assessment Years (AY) commencing from 1st April, 1962 onwards. There was no corresponding provision for recovery of tax in the Income-tax Act, 1922. Section 179 underwent major changes by way of the Income-tax (Amendment) Act, 1975¹ (hereinafter referred to as ‘the 1975 amendment’ for the sake of brevity) wherein the section was substituted by sub- sections (1) & (2) as they stand at present. Prior to the amendment, section 179 was applicable only in case of a private company undergoing liquidation and it would not apply even in case of a private company being dissolved or struck off by the registrar of companies under section 560 of the Companies Act, 1956². Post the 1975 amendment, the language of the section was changed to include all the private companies from whom tax due for any AY(s) had become unrecoverable and those public companies which were functioning as private companies during the relevant Previous Years (‘PY’). Thus notwithstanding the misleading heading of section 179, the directors of a private company though not under liquidation, may be held liable for the dues outstanding against the company if they were found guilty of misconduct, negligence, etc. in conducting the affairs of the private company. These amendments were given retrospective application by the legislature which were effective for AYs beginning from 1st April, 1962.³ The Hon’ble Supreme Court in case of Hardip Singh4 has held that ‘the section will be attracted if any one or more of the three events (stages of winding up) occurred after the commencement of the Act even though the first or the first and second events had happened earlier.’

Subsequently, vide the Finance Act, 2013, an explanation for the expression “tax due” was inserted after sub-section (2) of section 179 which became effective from 1st June, 2013 onwards. “Tax due” has been defined to include “penalty, interest or any other sum payable under the Act”. As per the memorandum explaining the Finance Bill of 2013, the amendment was introduced to clear the position as to what is included within the term “tax due” as some courts interpreted the phrase to hold that it does not include penalty, interest and other sum payable under the Act.

In spite of the 1975 amendment to section 179 of the Act, where the section became applicable to all private companies from whom tax was non- recoverable irrespective of a liquidation process being undertaken, the words “in liquidation” continued to exist in the marginal heading to the section. This position was corrected by the Finance Act, 2022 through which the words “in liquidation” were deleted. Also the explanation to the section was amended to include “fees” within the meaning of the term “tax dues” under the section to avoid any unnecessary litigation and to provide further clarity⁵. These amendments are effective from 1st April, 2022 onwards. Therefore, language of section 179 has been expanded and scope for recovery of tax due is widened under this latest amendment.

3. Analysis of the section

Now that we are up to date with the latest provisions of section 179 of the Act, let us proceed to analyse the said provisions as they stand today. For ease of reference section 179 is reproduced below:

“Section 179- Liability of directors of private company:

1. Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non- recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.
2. Where a private company is converted into a public company and the tax assessed in respect of any income of any previous year during which such company was a private company cannot be recovered, then, nothing contained in sub-section (1) shall apply to any person who was a director of such private company in relation to any tax due in respect of any income of such private company assessable for any assessment year commencing before the 1st day of April, 1962. Explanation.—For the purposes of this section, the expression “tax due” includes penalty, interest [,fees] or any other sum payable under the Act.

1. 1. First of all the section starts with a non- obstante clause, which means that even though under Companies Act 1956 (now replaced with Companies Act, 2013) the director of a company is not personally liable to pay any tax due by the company, under the Act the directors of a private company shall be held liable in case the tax dues are non-recoverable from such private company.⁶
   2. Sub-section (1) can be broken down into two parts

Part-1- “(1) Notwithstanding anything contained in the Companies Act, 1956 (1 of 1956), where any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered,…”

Thus, tax recovery proceedings can be initiated against the directors under this section only in case of private companies and private companies who were subsequently converted into public companies in respect of income of AYs where such a public company was a private company.

Part 2- “…then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non- recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.”

The section fixes joint and several liability to pay unrecovered outstanding taxes on all the individuals who were directors of the Company during the relevant Previous Year (PY). It is necessary that the non-recovery of the tax can be attributed to the actions of the director i.e. gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company during the relevant PY. Therefore, the primary onus is on the concerned director to prove his innocence in the manner of conducting the affairs of the company.⁷

4. Position held by Courts

It naturally follows that a director can be held liable for unrecoverable taxes only from that AY from which he assumed the directorship of the company⁸. But if a director resigns from the directorship during a PY in which taxes were unrecoverable from the company it will not absolve him from all the liabilities incurred during the period he was a director of the company.⁹

Even if the primary onus is on the directors to prove that non-recovery of taxes cannot be attributed to his actions, it does not discharge the Assessing Officer (AO) from his duty of ascertaining that tax for the relevant AYs could not be recovered from the company in the first place. It is expected that the AO has taken effective steps to recover the outstanding tax due from the company but has not been able to recover the entire tax liability. In other words the AO is required to record a categorical finding that tax due for the PY cannot be recovered from the company, in absence of which assumption of jurisdiction by the AO under this section is invalid¹⁰. The AO has to satisfy the preconditions before proceeding against the director. The Hon’ble Bombay High Court in case of Jaison S. Panakkal v. PCIT & Anr11 has relied upon its earlier decisions in Madhavi Kerkar v. ACIT (WP. No.567 of 2016 dated 05/01/2018 and Mehul Jadavji Shah v. DCIT (WP. No. 291 of 2018 dated 05/04/2018) to reinforce the precondition that the directors of the private company against which it intends to initiate proceedings under this section should be issued a notice under this section and such notice should indicate what steps had been taken to recover the dues from such delinquent company and the failure thereof. Thus two preconditions are to be satisfied viz. (a) to take substantial steps to recover outstanding taxes from the private company (b) to issue proper notices to the directors before taking any steps of recovery under this section.

It is also important to discuss that, department is empowered to lift the veil to look into the actual running of the company. In exercise of powers under this section, the department can lift the corporate veil of a public company if it is able to prove that the affairs of the company were arranged in a manner of a private company so as to defraud the revenue. This was the situation before the Hon’ble Gujarat High Court in case of Ajay Surendra Patel v. DCIT12. In this case the Hon’ble Court held that sufficient material was placed on record by the revenue to show that the Company which was a public limited company was actually functioning as a private limited company and that a hypertechnical interpretation should not be given to statutory provisions which frustrates the very object for which it was it has been included in the statute. Subsequently the Petitioner i.e. Ajay Surendra Patel moved an application for review of the order passed by the Hon’ble Gujarat High Court, wherein it was pointed out that the Hon’ble Court had inadvertently held that no substantial business was carried out by the company after resignation of director (Petitioner) and also sufficient opportunity was not provided to the Petitioner before passing the order under section 179 of the Act. Accordingly the order was recalled by the High Court and it is pending disposal.

It is important that a reasonable opportunity of hearing is given to the directors of such delinquent private companies before continuing with recovery proceedings under the section. Recently, the Hon’ble Bombay High Court has held that exercise of jurisdiction by the revenue department was violative of principles of natural justice when the director of the delinquent private company were not given an opportunity of hearing before applying the principle of lifting of the corporate veil¹³.

5. Remedies available to directors under section 179

An order passed under this section is not an appealable order under section 246 of the Act and therefore, a person aggrieved by proceedings initiated under section 179 has to approach the court with a writ petition. Though the courts have allowed the writ petitions and quashed the notices issued and orders passed under the section, on several occasions the issue of proceedings under the section are set aside to the officer of the department to re-initiate such proceedings when jurisdictional conditions were not satisfied by the departmental officer. The aggrieved director also has a right of revision under section 264 of the Act. Such an application shall be filed within a period of one year from the date the order under this section was communicated to the applicant or the date on which he otherwise came to know of it, whichever is earlier.

6. Conclusion

Though directorship is a position of power, it is a double edged sword where they are the first persons to be held accountable in respect of any misconduct or non-compliance by the company. The directors of a company have to be mindful of their actions. Even though the section places joint and several liability on the directors of a private company, a window is available to the director to prove that there was no misconduct, misfeasance or gross neglect on his part in conducting his duties. Even though the primary onus is on the accused director to prove his innocence the department is not given unbridled powers to arbitrarily proceed under the section. It is only when the department has taken considerable steps for recovery against the company and failed can they proceed against its directors.

1. The Insolvency and Bankruptcy Code, 2016 (IBC) has a very important provision – in the form of section 238 – which gives this law an overriding effect over all other laws. Obviously, this provision can be invoked only if the other law is inconsistent with the provisions of the IBC and all attempts to harmoniously interpret the two laws fail¹. In case of any conflict between the IBC and the provisions of the Income-tax Act, 1961 (IT Act), the Supreme Court has already held that the provisions of IBC shall prevail². Similarly, in case of conflict between the provisions of IBC and the Customs Act, 1962, the former shall prevail³.

2. Approving its Division Bench judgement in Monnet Ispat and Energy Limited and relying inter alia on section 238 of IBC, the Full Bench of the Supreme Court in Ghanashyam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited and (2021) 9 SCC 657 held that upon approval of the resolution plan under the provisions of IBC by the Adjudicating Authority viz. the National Company Law Tribunal (NCLT), all past tax dues which do not form part of the approved resolution plan shall stand extinguished and no proceedings in respect of those can be continued.

3. But, does that enunciation bring an end to all controversies that can arise from the interplay between IBC and the IT Act?

Background of enactment of IBC

4. Prior to the enactment of IBC, there was no single law in India that dealt with insolvency and bankruptcy. Provisions relating to insolvency and bankruptcy for companies were be found in the Sick Industrial Companies (Special Provisions) Act, 1985, the Recovery of Debt Due to Banks and Financial Institutions Act, 1993, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Companies Act, These statutes provided for creation of multiple fora such as Board of Industrial and Financial Reconstruction, Debt Recovery Tribunal and NCLT and their respective Appellate Tribunals. Also, liquidation of companies was being handled by the High Courts. Individual bankruptcy and insolvency was dealt with under the Presidency Towns Insolvency Act, 1909, and the Provincial Insolvency Act, 1920 and was dealt with by civil Courts. Thus, the existing framework for insolvency and bankruptcy was found to be inadequate and ineffective that resulted in delays in resolution⁴.

5. IBC was enacted with a view to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals for maximization of value of assets of such persons in a time bound manner. While judicial delays was one of the factors for inefficiencies in the previous regimes, IBC separates commercial aspects of insolvency and bankruptcy proceedings from judicial aspects. IBC gives primacy to resolution of corporate insolvencies rather than directly putting companies into liquidation. It recognizes a wider public interest in such resolution where the assets of companies undergoing resolution are put to value-generating use under a new management rather than liquidating those assets under a process of liquidation. Since the object of IBC is not the mere recovery of dues, it envisages liquidation to be matter of last resort only after attempts of finding a resolution fail⁵.

 Broad scheme of resolution process under IBC

6. An unpaid lender or financier (known as a financial creditor under IBC) or an unpaid seller of goods or services (known as an operational creditor under IBC) is empowered to file an application before the NCLT for initiation of corporate insolvency resolution proceedings against a defaulting company or limited liability partnership (known as the corporate debtor under IBC) if the amount of default is Rs. 1 crore or above. A defaulting company or limited liability partnership is also entitled to suo motu file such proceedings with respect to itself. The NCLT adjudicates upon the existence of a debt and default, and based on parameters prescribed under IBC and evolving through judicial precedents from time to time, either admits the application or rejects it.

7. Corporate insolvency resolution process commences with the admission of the While admitting the application, an insolvency professional is appointed as an interim resolution professional in whom the powers of the board of directors or partners, as the case may be, vest and the powers of such board of directors or partners stand suspended. The corporate insolvency resolution process is a time-bound process and the process must be completed within a period of 330 days. Throughout the period of corporate insolvency resolution process, the interim resolution professional (and later the resolution professional) is required to make every endeavor to protect and preserve the value of the property of the corporate debtor and manage its operations as a going concern, while the corporate debtor awaits prospective suitors (known as resolution applicants under IBC) to submit their proposal for its revival (known as a resolution plan under IBC). During the corporate insolvency resolution process period, a moratorium or a ‘calm period’ is in force during which no suits can be filed or other legal action taken against the corporate debtor. The purpose of this moratorium is to protect the corporate debtor from pecuniary attacks against it in the moratorium period so that it gets breathing space to continue as a going concern in order to ultimately rehabilitate itself⁶.

8. Upon commencement of the corporate insolvency resolution process, the interim resolution professional issues a public announcement in this regard inter alia inviting claims from creditors. All claims must be submitted to and are required to be decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order to take over and run the business of the corporate debtor. Based on claims collated by the interim resolution professional / resolution professional, a committee of creditors is constituted by him. While in the earlier regimes, the management of the insolvent company continued to be possession of the assets of such company, under IBC, this committee of creditors takes decisions pertaining to the manner of resolving the insolvency. The decisions of the committee of creditors are taken by a vote of not less than 51% of voting share (except in matters of special significance such as the approval of a resolution plan which requires a vote of not less than 66% of the voting share of the committee of creditors). Unless the corporate debtor does not have any financial creditors, operational creditors are excluded from the committee of creditors. The voting share assigned to a financial creditor depends on the proportion of the financial debt owed to such a financial creditor in relation to the total financial debt owed by the corporate Thus, IBC marks a paradigm shift in the efforts towards insolvency resolution making a radical departure from the ‘creditor-in-control’ model to the ‘debtor-in-possession’ model. This has fundamentally reset the power balance between corporate debtors and its creditors in the face of a default by corporate debtors.

9. Based on parameters prescribed under IBC, its regulations and criteria as determined by the committee of creditors based on commercial considerations, prospective resolution applicants prepare and submit their resolution plans which are put to the vote of the committee of A prospective resolution applicant completely relies on the claims so collated by the resolution professional. Based on these claims, the resolution plans submitted by the prospective resolution applicants propose payments to the creditors towards their debts (either in full or in part). This phase of corporate insolvency resolution is usually coupled with extensive negotiations between the committee of creditors and the prospective resolution applicants.
10. It is important to note that a resolution plan is not a sale. A resolution applicant does not buy the corporate It is, on the other hand, resolution of the corporate debtor as a going concern⁷. A resolution plan must inter alia mandatorily contain the term of the plan, its implementation schedule, management & control of the business during its term, adequate means of supervising the implementation and demonstrate its feasibility & viability and the capability of the resolution applicant to implement the resolution plan⁸. The committee of creditors then votes on the resolution plans, and if the resolution plan is approved by a vote of not less than 66% of the voting share, such a resolution plan is submitted before the NCLT for its approval. In the absence of the committee of creditors approving the resolution plan with the requisite votes, a corporate debtor is required to be put into liquidation.

11. The Supreme Court has consistently held that the scope of judicial review by the NCLT of a resolution plan duly approved by a committee of creditors is limited to the parameters prescribed under section 30(2) of IBC and that the ‘commercial wisdom’ of the committee of creditors is paramount⁹. This is how IBC seeks to separate commercial aspects of insolvency and bankruptcy proceedings from judicial aspects. The same is on the basis that the financial creditors (which in most cases constitute the committee of creditors) are typically understood to be better equipped to go into the viability of corporate enterprises, both at the stage of grant of the loan and at the stage of default¹⁰.
12. Once a resolution plan is approved by the NCLT, by virtue of section 31(1) of IBC, it is binding on the corporate debtor & its employees, members, creditors including the Central Government to whom a debt is owed, guarantors and other stakeholders involved in the resolution Due to the binding nature of a resolution plan, any liability or debt which is not included in the resolution plan by virtue of a creditor not submitting a claim in respect of its dues before the interim resolution professional / resolution professional gets extinguished. The Supreme Court has held that because the successful resolution applicant takes over the business of a corporate debtor on a fresh slate, he cannot suddenly be faced with undecided claims after the resolution plan submitted by him has been accepted as this would amount to a hydra head popping up which would throw the amounts payable by him into uncertainty¹¹.

Status of past tax dues after approval of resolution plan

13. Many times the Income Tax Department (IT Department) (and even other tax departments) do not file claims in respect of pending tax dues (IT dues) before the resolution professional during the corporate insolvency resolution process and yet pursue their claims against the corporate debtor after it has successfully emerged out of corporate insolvency. The corporate debtor now is obviously the company in a new avatar under a new management.

1. It is in light of the scheme of IBC that the Supreme Court in Ghanashyam Mishra and Sons Private Limited (supra) held that upon approval of the resolution plan under the provisions of IBC by the NCLT, claim towards pending IT dues and other tax dues not filed before the resolution professional and consequently not forming part of the resolution plan or those pertaining to periods prior to the approval of the resolution plan stand extinguished. A similar view has been reiterated by the Supreme Court in the case of Ruchi Soya Industries Limited & Ors. UoI & Ors.12

15. The judgement of the Supreme Court prompted many corporate debtors – through their new managements – to file Writ Petitions before High Courts challenging notices under the IT Act for periods prior to the approval of the resolution In one such case viz. Murli Industries Limited v. ACIT & Ors.13, a Division Bench of the Bombay High Court quashed notices under section 148 of the IT Act on the ground that the notices pertained to assessment years falling prior to the date of approval of resolution plan. Similarly, in The Sirpur Paper Mills Limited and Ors. v. Union of India and Ors.14, a Division Bench of the Telangana High Court quashed notices under section 143(2) of the IT Act for an assessment year prior to the date of the approval of the resolution plan. In other words, the Telangana High Court was of the view that the IT Department could not even undertake scrutiny of a return of income pertaining to a period prior to the date of the approval of the resolution plan.
16. Based on the judgement in Ghanashyam Mishra and Sons Private Limited (supra), in Jet Airways (India) Ltd.¹⁵, the IT Department even withdrew its appeals against the orders of the Income-tax Appellate Tribunal (ITAT) before the Bombay High Court presumably since the claim in respect of the IT dues were not submitted before the resolution professional and the same did not form part of the approved resolution In many cases, the ITAT has dismissed pending appeals of the IT Department upon approval of a resolution plan in respect of the assessee.

17. However, in the context of customs duty claimed by the Customs Department to be payable by a corporate debtor for a period prior to the approval of the resolution plan, a Single Judge of the Madras High Court in Ruchi Soya Industries v. Union of India and Ors.16 has held that though it was never the intention of the Parliament to enact IBC to have such far reaching impact on the tax administration, the decision of the Supreme Court in Ghanashyam Mishra and Sons Private Limited (supra) has held it otherwise. The relevant portion of the judgement of the Madras High Court is as follows:

“69. Though it was also never the intention of the Parliament to enact Insolvency and Bankruptcy Code 2016 (IBC, 2016) to have such far reaching impact on the tax administration, the decision of the Hon’ble Supreme Court has held it otherwise.

70. The entire tax administration of the country is now in a pell-mell. All the tax authorities will have to make a beeline before the National Company Law Tribunal every time to recover tax dues if under any circumstances proceedings are initiated against corporate debtor under the IBC, 2016. This was not the intention when the Act was enacted. …

81. The corporate applicant has indirectly taken over the petitioner in their “Corporate Resolution Plan” before the said Tribunal. It is for the petitioner to prove that the “customs duty” payable to the respondent under the subject Bill of Entry was factored by the Corporate Applicant in the Corporate Resolution Plan submitted before the National Company Law Board.”

18. A Writ Appeal against the above judgement has been admitted and is pending before a Division Bench of the Madras High Court¹⁷. In State Tax Officer (1) v. Rainbow Papers Limited18, the Supreme Court has observed that there was no obligation on the part of the tax authorities to lodge a claim in respect of dues which are statutory dues for which recovery proceedings have also been initiated and a resolution plan which does not factor in the same is not binding on the tax authorities. Furthermore, in Dishnet Wireless Ltd. v. ACIT19, the Single Judge of the Madras High Court has also held that approval of a resolution plan cannot impinge on the rights of the IT Department to pass any fresh assessment order under section 148 read with sections 143(3) and 147 of the IT In a pending Civil Appeal filed by the IT Department in the case of Jet Airways (India) Limited, the Supreme Court has, in an interim order, observed that the pendency of an appeal would amount to a claim by the IT Department²⁰. In this case, it was the further submission of the IT Department before the Supreme Court that approval of a resolution plan would not extinguish “ramifications on the criminal side”. The Civil Appeal is pending final adjudication.

 Consequences of quashing notices and precluding assessment

19. Under the IT Act, usually the starting point for any proceeding that can result in adverse consequences for any person is the issuance of a communication from the IT Department to the assessee (except a search and seizure or a survey proceeding). The communication may be a notice under section 142(1) making an inquiry before assessment, or an intimation under section 143(1) with a tax demand, or a notice under section 143(2) proposing a scrutiny assessment of the return of income, or a notice under sections 147 read with 148A (followed by issuance of notice under section 148). The principles of natural justice are ingrained in the provisions of the IT Act inasmuch as without the issuance of a valid notice, the IT Department cannot proceed ahead to verify whether the assessee has made correct claims with respect to its income, paid the taxes due thereon, whether any interest or penalty ought to be levied and whether any prosecution ought to be initiated.

20. An assessment order making an addition or disallowance then becomes a starting point for further proceedings such as penalty proceedings for misreporting / underreporting of income or underpaying taxes in any manner or for launching prosecution in appropriate cases. Penalty and prosecution provisions in the IT Act are meant to fix culpability for, and act as a deterrent against, committing fiscal By quashing the above notices – which are starting points not only for imposing income-tax liability but also for initiating appropriate action for misreporting / underreporting of income or underpayment of taxes against persons responsible for these acts – effectively the Courts have granted reprieve to persons responsible for these acts.

21. Viewing the notices issued by the IT Department as an attempt to recover income-tax from the company under the new management for periods prior to the date of the approval of the resolution plan is looking at the matter through one side of the legal prism, the other side being that these notices are also starting points for the IT Department to initiate other proceedings and invoke other statutory remedies available to it. The necessary evidence for prosecution is often collected in penalty proceedings. The material relied on in penalty proceedings often has its foundation in the facts unearthed during assessment proceedings. With the quashing of foundational notices under section 143(2)/ 148 of the Act, the IT Department is unable to proceed in any manner or collect the requisite material / evidence to proceed against the erstwhile management in case of any wrong doing.
22. Considering the object and purpose of IBC i.e. to promote resolution of insolvent companies by encouraging new companies to offer resolution plans for them, there is an obvious need to assure the new management that they need not be scared that the taxman will come after them for the faults of the earlier promoters²¹. Keeping this in mind and the express statutory provisions of IBC under section 31(1), the enunciation by the Supreme Court in Ghanashyam Mishra and Sons Private Limited (supra), that IT dues and other tax dues which do not form part of the approved resolution plan cannot be recovered from the company emerging after successful resolution or its new management, is unexceptionable. However, the  legal  consequence  of quashing scrutiny or reassessment notices at the threshold is also virtually a grant of immunity to the erstwhile management for their acts. This is contrary to legislative intent as evident from the clarification issued by the Finance Minister in the Rajya Sabha²² that “Once the resolution plan is accepted, the earlier promoters will be dealt with as individuals for their criminality but not the new bidder who is trying to restore the company” and section 32A of IBC which grants immunity only to the new management against liability for past offences by the old management. The approach of quashing the foundational notices under the IT Act has the effect of preventing (or at least making it more difficult) the IT Department from initiating otherwise permissible action against the erstwhile promoters. For instance, without an assessment order or an order imposing penalty, the IT Department would be unable to launch prosecution against the erstwhile management for tax evasion or other fiscal wrongs, if committed by the erstwhile management.
23. Having said that, the views of the Single Judge of the Madras High Court in Ruchi Soya Industries Ltd. (supra) also do not appear to represent the correct view. It interprets the provisions of IBC in a rather constricted For instance, requiring a successful resolution applicant to prove that the tax dues in respect of which a claim was not filed by the tax department before the resolution professional have been factored in the resolution plan as a pre-condition is contrary to the scheme of IBC. This view also fails to appreciate that a resolution plan can factor in payments only for claims which were filed before the resolution professional.

The middle-path approach

24. The answer may lie somewhere at the middle of the two In order to give full effect to the provisions of the IT Act as well as IBC, it may not be desirable to quash the notices which are foundational to assessment proceedings. Under the IT Act, proceedings for assessment and recovery are different. Permitting the IT Department to continue with the assessment proceedings with a clear direction that the tax demand, if any, at the conclusion of the assessment proceedings shall not be recovered from the company in question now under the new management should be the way forward. This will enable the IT Department to use the findings in the assessment proceedings for initiating appropriate proceedings against the old promoters / management of the company. For instance, section 179 of the IT Act empowers the IT Department to recover income-tax due from the directors of a private company if the recovery cannot be made from the company in certain situations. These provisions may be invoked by the IT Department to recover the tax which would have been payable by the company in question. The Bombay High Court in Murli Industries Ltd. (supra), while referring to a similar provision in the Maharashtra Value Added Tax Act, 2002, failed to take note of section 179 of the IT Act.
25. A harmonious interpretation of IBC with the IT Act does not warrant the in limine quashing of assessment / reassessment notices but only a prohibition on recovery of tax dues pertaining to past years from the company or its new A quashing of the notices at the initial stage itself would seriously jeopardise the remedies available to the IT Department or at least an opportunity to explore ways in which the earlier management could be made accountable for its actions. At the same time, continuing assessment proceedings with respect to the company in its new avatar in order to foist liability on, or take action against, the erstwhile promoters without the participation of the erstwhile promoters may run foul of the well-established principles of natural justice embedded in the IT Act since the company under the new management being aware that the assessment proceedings cannot result in any adverse consequences for them (since they relate to a period prior to the date of approval of the resolution plan), is not likely to participate in the assessment proceedings in the best possible manner. In addition, there may even be serious actual impediments to the participation of the company such as lack of information and documents pertaining to the past years since in many insolvency resolution processes, it is experienced that all information and documents are not available. A successful resolution applicant has to make do with whatever is made available to it and has to solely rely on the resolution professional for the same.

26. While every case is likely to have its own peculiarities, a more fact specific approach would be desirable on these issues. The first step however that the IT Department and other tax departments must undertake to protect the interests of the revenue is to diligently file claims before the resolution professional. Since all companies and limited liability partnerships are invariably assessees of the IT Department, it is quite simple to act on a public announcement regarding commencement of corporate insolvency resolution process and to file a claim, if any, before the resolution professional. The importance of filing a claim before the resolution professional can be gauged from the judgement of the Supreme Court in State Tax Officer (1) v. Rainbow Papers Limited (supra), wherein a resolution plan, not factoring in a claim in respect of tax dues under the Gujarat Value Added Tax Act, 2003 which was filed with the resolution professional, was set aside.

27. In respect of tax claims that may arise for past years owing to information received after the approval of the resolution plan (but before the expiry of the limitation period within which the assessment can be reopened under the IT Act), obviously, the IT Department would be unable to file any claim before the resolution professional. This is where Courts must take a middle-path approach whereby the company under its new management is not made to pay any amount towards tax claims not factored in the resolution plan but at the same time the other provisions of the IT Act which the IT Department may invoke against the erstwhile promoters are also not completely shut Similar should be the approach in case of scrutiny assessments for periods prior to the approval of the resolution plan but picked up for scrutiny after its approval. In Vadraj Energy (Gujarat) Limited v. ACIT23, the Bombay High Court has for instance quashed assessment orders passed in respect of the company after its successful resolution but remanded the matters back to the assessing officer to consider the legal effect of the company having emerged out of insolvency resolution process.
28. The tax departments must also realise that their actions, if held to be contrary to the provisions of IBC and the law laid down in Ghanashyam Mishra and Sons Private Limited (supra), are unlikely to withstand judicial scrutiny. Therefore, unmindful insistence on recovering taxes for past years from the company now under the new management must give way to a more practical and solution oriented approach of exploring alternatives within the statutory framework for taking steps in relation to the past promoters as this is the approach which is likely to yield better results. The respective Boards under the relevant tax laws ought to play a more proactive role in this regard.

Epilogue

29. The divergent views expressed by Courts as above and different fact-situations having implications on the criminal as well as civil side that could arise after the approval of a resolution plan under IBC for the actions of erstwhile managements have opened up new and interesting There are many unanswered and unconsidered aspects under the tax laws that arise with the approval of a resolution plan.
30. Supreme Court’s judgement in Ghanashyam Mishra and Sons Private Limited (supra) does not seem to be the end of all controversies that can arise from the interplay between IBC and the IT Act qua tax assessments and past tax dues. Each case that comes before a Court has its own factual situation or legal peculiarities which may not have been examined earlier. The law on these aspects is likely to develop and evolve further. In the meantime, while approval of a resolution plan may extinguish monetary claims not factored in the resolution plan, an approved resolution plan is only likely to ignite new legal controversies.

Dear Friends,

I write to you amidst the festival season and the busy professional season on account of Tax audit and Income Tax return deadlines.

I am also happy to inform that our Member Mr. Jag Mohan Bansal, Senior Advocate has been Elevated to High Court as Judge of High Court of Punjab and Haryana High Court. Our heartiest congratulations to Mr. Jag Mohan Bansal and we wish him all the success in Life.

The Festival Season has started and we are in the midst of Ganesh Utsav Celebrations and soon the Navratri, Dussehra will start around end September and am sure that we are all geared up to enjoy the festive season after a gap of 2 years where on account of the COVID 19 pandemic, where we were restricted to our homes and could not go out and enjoy the festivities.

I would like to congratulate the Northern Zone team headed by Mr. H. L. Madan and Vice President Dr. Naveen Rattan for successfully conducting a National Tax Conference and NEC at Delhi at a short notice. On the occasion we have also released a public 75 Landmark Judgements under GST authored by Advocates Mr. Sandeep Goyal & Mrs. Aanchal Goyal, Chandigarh. I would like to Congratulate the Publication team for coming out with the publication and the authors for putting in efforts to compile the same.

We also had a successful International Study Tour and RRC at Dubai, which was well organized by the International Conference Team led by the Chairman Mr. Sanjay Kumar from Prayagraj and Co-Chairman Mr. Santosh Gupta from Nagpur and their team. There were over 170 delegates in the tour and it was a good fellowship and learning event. We are also planning to hold another study tour in First week of November, 2022 for the benefit of the members.

We also have a NTC and NEC scheduled at Dwarka, The abode of Lord Shri Krishna, which is being organized by the Western Zone on 1st and 2nd October, 2022. We have had a tremendous response with over 300 delegates so far and we shall be able to cross over 300 registrations. The Conference would also be a relaxing outing after the busy audit season in September. I request all the members to register for a unique experience. The subjects in the conference are also of relevance for the day-to-day practice in Direct and Indirect Tax. We have also planned a Foundation day Fortnight celebrations in November from 10th to 25th November, where all the zones would be involved in conducting various programmers in their respective zones to commemorate the 46th Foundation year celebrations.

The 25th National Convention is at Jaipur on 16th and 18th December, 2022. Details have already been circulated. Kindly register early for the same, the Central Zone is putting in a lot of efforts to make the Convention a success.

We invite suggestions from members for any improvement or betterment in the working of the Federation, as we can together make the Federation the best amongst compatriot bodies.

With these words, I conclude my communiqué with a sincere advice:

“Fill the brain with high thoughts, highest ideals, place them day and night before you and out of that will come a great Results and success.”

I wish you all a very happy Navratri and Dussehra.

With Best Regards,

Yours faithfully,

K. Gandhi

National President, A.I.F.T.P.

Dear Friends,

By the time this issue finds place in the hands of my CA friends all may be coping with the pressure to meet the dead line to upload the Tax Audit Reports. So friends, my sincere advice is to avoid stress which is injuries to health. There are many more deadlines to meet. I am reminded of the beautiful line by Robert Frost

“Whose woods these are I think I know.

His house is in the village though; He will not see me stopping here

To watch his woods fill up with snow.

My little horse must think it queer To stop without a farmhouse near Between the woods and frozen lake The darkest evening of the year.

He gives his harness bells a shake To ask if there is some mistake. The only other sound’s the sweep Of easy wind and downy flake.

The woods are lovely, dark and deep, But I have promises to keep,

And miles to go before I sleep, And miles to go before I sleep”

I am keen to discuss the decision of the Hon’ble Allahabad High Court in the case of Writ Tax No. 554 of 2022 Vikas Gupta vs. UOI dated 8th September 2022. It was a batch of 9 Writ Petitions. In all these Writ Petitions the common issue percolated out of facts which may not be identical but similar. The notices under section 148 were issued, in one of the cases before Hon’ble Court, on 31/03/2021 at 7:05 P.M. i.e. 19:05 hours by digitally signing the approval. Jurisdictional A.O. issued notice u/s. 148, digitally signed on 31/03/2021 at 5:43 P.M., i.e. 17:43 hours. The Assessee challenged the validity of notice on the ground that the notice issued u/s. 148 before the approval was granted by the PCIT is invalid. The Department defended the action of the A.O. relying on the provisions of the provisions of Section 282A of the Income Tax Act, 1961 (the Act), Rule 127A of Income Tax Rules, 1962 and sections 2(d), 2(p) and 2(t) of the Information Technology Act, 2000. The Department’s contention was contained that once the PCIT has pushed in “Generate Tap in TBA system” his satisfaction u/s. 151 of the Act would be deemed to be an authenticated document. The digital signature affixed by PCIT on his aforesaid satisfaction u/s. 151of the Act, subsequent to issuance of the notice by the A.O. u/s. 148 of the Act, would not in validate the notices is issued by A.O.

The Hon’ble Court analyzed the statutory provisions and law on the issue in detail.

The Hon’ble court in para 25 of the decision observed that

“Thus the expression “shall be signed” used in Section 282A(1) of the Act 1961 makes the signing of the notice or other document by that authority a mandatory requirement. It is not a ministerial act or an empty formality which can be dispensed with. “Signed” means to sign one’s name; to signify assent or adhesion to by signing one’s name; to attest by signing or when a person is unable to write his name then affixation of “mark” by such person. The document must be signed or mark must be affixed his mark is the author of it. Therefore, a notice or other documents as referred in Section 282A(1) of the Act, 1961 will take legal effect only after it is signed by that Income Tax Authority, whether physically or digitally. The usage of the word “shall” make it a mandatory requirement.

The Hon’ble court further observed that

The first and foremost condition under sub-Section (1) of Section 282A is that notice or other document to be issued by any Income Tax Authority shall be signed by that authority. The word “and” has been used in sub-Section (1), in conjunctive sense, meaning thereby that such notice or other document has first to be signed by the authority and thereafter it may be issued either in paper form or may be communicated in electronic form by that authority. In the present set of facts, it is the admitted case of the respondents that the PCIT has not recorded satisfaction under his signature prior to the issuance of notice by the Assessing Officer under Section 148 of the Act, 1961.

These findings are of the Hon’ble High Court are very important and of far reaching consequences.

In this issue of the Journal articles on import topics have been compiled. I hope they will be of help to all the professionals. I thank all the professional who have spared their valuable time for contributing to this issue of the Journal.

 K. Gopal,

Editor

As we all know, in recent years there has been introduction of new enactments and also there has been reinforcement of old enactments to deal with economic offences done by the offenders for cleaning up and streamlining economy of our country. It was indeed a global milestone in terms of advancement in enactment of the legislations especially when certain laws like new Benami Law and Black Money Law were implemented and PMLA, 2002 (an Anti- Money Laundering Law) was strengthened. India can now claim on the global platform to be a pioneer in introduction of such laws.

However, the irony is that because of improper implementation on the part of enforcement/ executing agencies and because of certain provisions of these laws being very stringent or vaguely drafted, it happens at times that a third person (i.e. a person who may not be directly connected with the commission of an economic offence) may unfortunately be held ‘liable’ as an offender merely for the reason that he has done any dealing/transaction with a person who is accused of commission of an offence under any of the laws dealing with economic offences such as the Prevention of the Money Laundering Act, 2002, the Prohibition of Benami Property Transaction Act, 1988 (amended Benami Law), the Banning of Unregulated Deposits Schemes Act, 2019, Narcotic Drugs and Psychotropic substances Act, 1985, Foreign Exchange and Management Act or the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 and so forth and so on.

Just to give a striking and live example, suppose an entity say M/s D Ltd. had borrowed a large sum of loan from a bank and after some time said D Ltd. unfortunately became defaulter in repayment of its liability(loan) to the bank. The bank filed a complaint with the CBI alleging that the loan was availed by the Company by fraudulent means and using forged documents and funds were not utilised as per terms of the loan agreement and that there was siphoning of funds by the management of the company whereby funds borrowed from the bank were diverted for the personal benefit of the key managerial personnel of the company. In pursuance of the same, proceedings were initiated after some time under sections 3 & 4 read with section 45 of the Prevention of the Money Laundering Act, 2002 against the said company on the ground that the amount of loan was obtained by way of cheating, fraud or forgery done by the company with the banker (which is a scheduled offence under the Prevention of the Money Laundering Act, 2002). Under these circumstances, the amount of loan taken by the company from its bank may be treated as ‘Proceeds of Crime’ in the hands of the said defaulter company under section 2(1)(u) of the Prevention of the Money Laundering Act, 2002 by the Directorate of Enforcement.

Under aforesaid facts and circumstances, if any other person say Mr. A had bought a property from said M/s D Ltd and the said property was acquired by M/s D Ltd utilising the aforesaid loan amount OR in an another case, if any amount of the aforesaid loan amount has been paid by the said M/s D Ltd to another company say M/s C Ltd. in pursuance to any transaction, then the said property as well as the recipient (M/s C Ltd here) may also be roped into the proceedings launched by the Enforcement Directorate under sections 3, 4, 5, 17, 18 and 50 of the Prevention of the Money Laundering Act, 2002 and their assets maybe attached being alleged proceeds of crime and they (Mr A and M/s C Ltd) may also be held accountable as a person in possession of proceeds of the crime and party to the offence of the money laundering under section 3 of the Prevention of the Money Laundering Act, 2002 unless they are able to demonstrate and establish the bona fides of their transactions with the said defaulter company as per satisfaction of the Enforcement Directorate or the appellate authorities, as the case maybe.

Thus, implications upon the persons who have done any financial transactions with M/s D Ltd. would also be quite serious. Thus, in view of the current scenario as is prevailing in the country at the moment for enforcement of the laws dealing with economic offences, it is essential to know and understand the stringent provisions pertaining to penalties, fines and prosecutions etc. prescribed in these laws for not only the main accused persons but also the other persons who might be implicated for being directly or indirectly connected through the transactions done with the main accused person.

I. The Prevention of the Money Laundering Act, 2002 (Anti- money laundering law)

In 1989, the Financial Action Task Force (FATF)

was established at a summit of seven major industrial nations in Paris, to examine the problem of money laundering which was considered to be posing a serious threat not only to financial system of the countries but also to their integrity and sovereignty. In pursuance to the recommendations made by the FATF, numerous measures were taken by the various countries to combat the menace of money laundering. India also took some measures as soon as an urgent need was felt for enactment of a comprehensive legislation for preventing money laundering and connected activities, attachment and confiscation of proceeds of crime and setting up agencies and mechanisms for coordinating measures for combating money laundering.

That is how, going further in this direction, Prevention of the Money Laundering Act, 2002 was promulgated in pursuance to the Political Declaration adopted by the Special Session of the United Nations General Assembly held on 8th to 10th June, 1998 which called upon the Member States to adopt national money laundering legislation and programme.

The main object of the legislation (i.e. PMLA) is to prohibit the proceeds of crime and to prosecute, punish and penalise the persons involved in the offence of the money laundering.

Authorities/Enforcement Agencies

i) The Directorate of Enforcement (commonly known as ‘ED’)

The original powers and duties under the Prevention of the Money Laundering Act, 2002 to enforce the law have been granted to the Directorate of Enforcement (popularly known as ‘Enforcement Directorate’) which has its office in few major cities of the country.

The Enforcement Directorate has been granted various powers to enforce the law such as-

1. Attachment of properties involved in money laundering under section 5 of the Prevention of the Money Laundering Act, 2002
2. Power of survey, search and seizure under sections 16, 17 and 18 of the Prevention of the Money Laundering Act, 2002
3. Power of arrest under section 19 of the Prevention of the Money Laundering Act, 2002
4. Power of retention of property and records seized or frozen during survey or search under sections 20 and 21 of the Prevention of the Money Laundering Act, 2002
5. Powers of summons, production of documents equivalent to the powers as are vested in the civil court under the Code of Civil Procedure, 1908 as prescribed under section 50 of the Prevention of the Money Laundering Act, 2002

ii) The Adjudicating Authority

The Adjudicating Authority is located at New Delhi (having pan-India jurisdiction) and it decides on the sustainability of actions taken by the Enforcement Directorate with regards to the attachment of property or retention of records/ properties which are alleged by t h e Enforcement Directorate to be involved in the money-laundering.

iii) The Appellate Tribunal

The orders passed by the Adjudicating Authority are appealable to the Appellate Tribunal located at New Delhi (having pan-India jurisdiction). Section 25 of the Prevention of the Money Laundering Act, 2002 provides that “The Appellate Tribunal constituted under sub-section (1) of section 12 of the Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act, 1976 (13 of 1976) shall be the Appellate Tribunal for hearing appeals against the orders of the Adjudicating Authority and the other authorities under this Act.”

iv) Special Courts

The trial for the prosecution of the accused(s) for the offence of money laundering punishable under section 4 of the Prevention of the Money Laundering Act, 2002 is done before the Special Court which is usually Court of Sessions of the District which is designated as Special Court by the Central Government as per Section 43 of the Prevention of the Money Laundering Act, 2002.

It has also been prescribed under section 43 that while trying an offence of money laundering under the Prevention of the Money Laundering Act, 2002, a Special Court shall also try a scheduled offence with which the accused is charged under Code of Criminal Procedure, 1973.

Objective, Scope and Operation of the Prevention of the Money Laundering Act, 2002

As stated above the main objective of the legislation is to prohibit the proceeds of crime and punish and penalise the offenders. Section 3 of the Prevention of the Money Laundering Act, 2002 defines the Offence of Money Laundering as “Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering.”

The Proceeds of Crime has been defined under section 2(1) (u) as “any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property or where such property is taken or held outside the country, then the property equivalent in value held within the country [or abroad.”

It may be noted from the above discussion that the offence of money laundering shall necessarily involve following three stages:

1. Commission of a Scheduled Offence,
2. Generation of Proceeds of Crime &
3. Projecting /claiming the Proceeds of Crime as untainted property.

For the commission of offence of money laundering, it is essential that all of the three acts should have been conjunctively done by the accused. If, even any one of them is missing, thought it may be held that the accused has committed a scheduled offence but that alone would not ipso facto be enough to hold that offence of money laundering under the Prevention of the Money Laundering Act, 2002 has been done by the said accused.

(Scheduled Offence here means any of the offences described under Part A, B, C of the Schedule to the Prevention of the Money Laundering Act, 2002 such as offences under the Indian Penal Code, 1860, the Narcotic Drugs And Psychotropic Substances Act, 1985, the Wild Life (Protection) Act, 1972, the Prevention Of Corruption Act, 1988, the Securities And Exchange Board of India Act, 1992, the Copyright Act, 1957, the Trade Marks Act, 1999, the Information Technology Act, 2000 etc.

Thus from the above, it is evident that the offence under PMLA does not have its independent standing or existence. The offence under the Prevention of the Money Laundering Act, 2002 is piggy backing on a scheduled offence. In case there is no scheduled offence or no proceeds have been generated from the commission of such scheduled offence, then no offence of money laundering can be said to have been committed.

Though an amendment has been made by adding an ‘explanation’ in section 3 and also in section 44 of PMLA by the Finance Act, 2019

w.e.f. 1-08-2019, however, in my considered view the fundamental concept of offence of money laundering remains unaltered, and I am of strong belief that the courts would read and explain the law of PMLA including its recent amendments in that spirit only.

Punishment/Penalties under the Prevention of the Money Laundering Act, 2002

i) Section 4 provides for punishment for money laundering and states that “Whoever commits the offence of money-laundering shall be punishable with rigorous imprisonment for a term which shall not be less than three years but which may extend to seven years and shall also be liable to fine :

Provided that where the proceeds of crime involved in money laundering relate to any offence specified under paragraph 2 of Part A of the Schedule, the provisions of this section shall have effect as if for the words “which may extend to seven years”, the words “which may extend to ten years” had been substituted.”

As stated earlier, the trial for prosecution of an accused shall be done at the Special Courts along with the trial for the prosecution of scheduled offence in terms of relevant provisions of Code of Criminal Procedure, 1973.

ii) Attachment of a Property

As per Section 5 of PMLA, 2002, in case an authorised officer of the Enforcement Directorate has reasons to believe that any person is in possession of the Proceeds of Crime which are likely to be concealed, transferred or dealt with in any manner which may result in frustrating any proceedings related to confiscation of such Proceeds of Crime, then he may make provisional attachment of such property till the decision of the Special Court is rendered as per the provisions of the PMLA. The provisional attachment made by the Directorate of Enforcement is subject to its confirmation by the Adjudicating Authority and the Appellate Tribunal (under PMLA).

iii) Confiscation by the Special Court

Section 8 of the PMLA inter alia provides that

(5) Where on conclusion of a trial of an offence under this Act, the Special Court finds that the offence of money-laundering has been committed, it shall order that such property involved in the money-laundering or which has been used for commission of the offence of money-laundering shall stand confiscated to the Central Government.

(6)Where on conclusion of a trial under this Act, the Special Court finds that the offence of money- laundering has not taken place or the property is not involved in money-laundering, it shall order release of such property to the person entitled to receive

iv) Imposition of Fine

As per Section 13 of the Prevention of the Money Laundering Act, 2002 the Director of the Enforcement has been authorised to ensure that information stipulated under the law is provided by a ‘Reporting Entity’ or by its Director or an employee, or through any other mode, if he finds that some person has failed to comply with obligations cast upon them under the Prevention of the Money Laundering Act, 2002, the Director may either suo-motu, or through an application made by any reporting entity, may impose fine as well.

As per section 2(1)(wa) ‘reporting entity’ means “a banking company, financial institution, intermediary or a person carrying on a designated business or profession.”

The obligations upon the reporting entities has been provided under sections 11 to 15 of the PMLA which talks about maintenance and provision of various records by these entities to the government authorities as has been prescribed.

v) Punishment for false information or failure to give information, etc.

Section 63 of the Act provides that“(1) Any person wilfully and maliciously giving false information and so causing an arrest or a search to be made under this Act shall on conviction be liable for imprisonment for a term which may extend to two years or with fine which may extend to fifty thousand rupees or both.

(2) If any person,-

1. being legally bound to state the truth of any matter relating to an offence under section 3, refuses to answer any question put to him by an authority in the exercise of its powers under this Act; or
2. refuses to sign any statement made by him in the course of any proceedings under this Act, which an authority may legally require to sign; or
3. to whom a summon is issued under section 50 either to attend to give evidence or produce books of account or other documents at a certain place and time, omits to attend or produce books of account or documents at the place or time,

he shall pay, by way of penalty, a sum which shall not be less than five hundred rupees but which may extend to ten thousand rupees for each such default or failure.

Controversies Arising Due To Difference in the ‘Law as per Books’ and ‘Law as per Practice’:

Though the objective of the law (of PMLA) is emphatic and clear, but due to improper implementation coupled with some vagueness left in the drafting of the law which is further aggravated by lack of evolution of the law due to absence of clear judgments coming from the higher judiciary, many controversies have arisen which has led to enormous litigation in the entire country, which indeed could have been avoided.

Firstly, there is a huge controversy on the understanding of precise definition of ‘Proceeds of Crime’. The contention of the Enforcement Directorate in this regard is that it covers not only the assets which are involved in the offence of money laundering but also other assets, especially if the assets involved in money laundering are not available. On the other hand, the persons adversely affected by this law would strongly contend that under the law only those properties are covered under ‘Proceeds of Crime’ which are derived or obtained out of the proceeds generated from the commission of the scheduled offence and also any other asset whose origin can be traced back to the proceeds derived or obtained from commission of a scheduled offence. But, it would in no circumstance, include any asset / property whose origin cannot be traced back to the proceeds generated from the commission of the scheduled offence.

The above controversy has led to enormous litigation causing avoidable hardship to various persons who are facing actions under the PMLA as a result of attachment / confiscation of their records and properties which are wholly unconnected with generation of proceeds from the commission of scheduled offence. Few persons are also facing hardship and harassment on account of their involvement in prosecution before the Special Court along with the main accused.

To my mind, the law in this regard become candid clear if we study the bare provisions of the law along with scheme of the Act (of PMLA) and thus unnecessary controversies on these issues could have been avoided. The whole objective of the Prevention of the Money Laundering Act, 2002 is to prohibit the proceeds of crime and to punish the offender. The objective is not to recover any dues or taxes form the accused, as if there was any loss to the exchequer, as would also be clear from the holistic reading of the law.

It is worth noting that Section 8(6) provides that “Where on conclusion of a trial under this Act, the Special Court finds that the offence of money- laundering has not taken place or the property is not involved in money-laundering, it shall order release of such property to the person entitled to receive it.”

Thus when the law itself provides that even in a situation where the offence of money laundering is found to have taken place, but if it is found by the court that the property attached by the ED is not involved in money laundering, such property attached by the ED, shall be released.

Thus, under these circumstances and clear position of statute, there is no rationale to attach those properties, even at first instance, which are apparently not involved in money laundering.

It would be relevant to mention here that Hon’ble Punjab and Haryana High Court had well clarified the controversy through its detailed and well-reasoned judgment passed in the case of Mrs. Seema Garg and Others vide order dated 6th March, 2020 and clearly held that only that property can be attached as part of proceeds of crime which has been derived from value’ or ‘value thereof’ basis. The said judgment has also been affirmed by Hon’ble Supreme Court by dismissing the SLP filed by the ED.

It is expected that the Government would bring out some clarifications via notification or suitable amendment in law OR there would be a clear judgment from the Hon’ble Supreme Court to put the unnecessary controversy to rest saving many people from avoidable hardships.

i) Burden of Proof

It is generally perceived that the law contained in PMLA envisages reverse burden of proof viz. the burden is upon the accused to prove that he is innocent. This perception seems to have developed because of the peculiar drafting of Section 24 of the Act in this manner which provides that:

“In any proceeding relating to proceeds of crime under this Act,-

1. in the case of a person charged with the offence of money-laundering under section 3, the Authority or Court shall, unless the contrary is proved, presume that such proceeds of crime are involved in money-laundering; and
2. in the case of any other person the Authority or Court, may presume that such proceeds of crime are involved in money-laundering.”

A careful perusal of this provision would reveal that only that part of burden has been shifted wherein the ‘proceeds of crime’ are presumed to be involved in money laundering. However, as discussed above, three stages are involved to reach the stage of money laundering, as narrated hereunder for convenience:

1. Commission of a Scheduled Offence,
2. Generation of Proceeds of Crime &
3. Projecting/claiming the ‘Proceeds of Crime’ as untainted property.

It may be noted from the perusal of Section 24, supra that the ‘burden’ which has been shifted is only about the stage placed at number three only, i.e. projecting the proceeds as ‘untainted’.

WHEREAS the burden to prove the foundational allegation that the scheduled offence has been committed and certain amount of proceeds have been generated therefrom has not been shifted. It goes without saying that the fundamental principle of criminal jurisprudence derived from the Constitution of India and followed by the courts all over the country since ages is that a that person is innocent unless proved guilty and that the burden to prove that a person is guilty upon the person who is alleging it so.

Thus, in my considered opinion, the burden to prove that there is no commission of offence under stages one and two, has not been shifted upon the accused, and thus it still rests on the shoulder of the enforcement authorities / prosecution.

The root cause of the litigations under this law is solely due to lack of clarity in the aforesaid provisions and few other similar provisions of law wherein urgent intervention of our Government or the Courts is needed as soon as possible.

II. The Prohibition of Benami Property Transactions Act, 1988 (newly Amended Benami Law)w.e.f. 1.11.2016:

The Benami transactions were earlier allowed in our country during pre and post- independence period. Ready reference can be made to erstwhile sections 81, 82 and 94 of the Indian Trust Act, 1882 and also to erstwhile section 281A of the Income Tax Act, 1961. All of these sections were repealed in 1988 when the Benami law was introduced for the first time in the country which was then called as The Benami Transactions (Prohibition) Act, 1988 which came into effect repealed sections would reveal that doing the benami transactions was expressly allowed by the then governments through these provisions and few other similar provisions in other Acts.

Though original Act was promulgated in 1988 but it remained in an inactive mode for want of establishment of enforcement agencies. However, in the year 2016 the original law was overhauled and radical amendments were made to enforce the new introduced law with altogether new dimensions.

The new law on benami transaction/property is now proving to be quite stringent and harsh in various situations.

New definition of a benami transaction/ property has now been provided under section 2(9) of the Prohibition of Benami Property Transactions Act, 1988 in a sweeping and widest possible manner.

As we all understand, the main objective of the law contained in PBPT Act is to remove the layer of masking created in the transactions or any kind of impersonation in the title of ownership of the property / assets. It aims to check tax evasion or avoidance of payment of various other statutory dues such as stamp duty etc. and more importantly, it also aims to prevent the people from violating various other laws by prohibiting them from doing the transactions in the name of other persons which could not have been done in their own names such as:

1. Land reforms legislations adopted by States of our country post-independence to redistribute holding of the land amongst the citizens of the country in an even and equitable manner,
2. Corporate laws especially Securities and Exchange Board of India Act, 1992 to maintain legal sanctity of corporate structures,
3. Law prohibiting non-residents to acquire agricultural and other lands in India, transactions done to avoid Insolvency and Banking Code,
4. Local laws of the states to prohibit the non-residents of the state to acquire and old land in the State etc.

And so forth and so on.

(i) Authorities/Enforcement Agencies

The original powers of enforcement is enjoyed by the Benami Prohibition Unit (BPU) which is set up by the Central Board of Direct Taxes and is carved out from the existing cadres of the officers of the Investigation Wing of the Income Tax Department. So far, around 26 BPUs have been set up in the country. Each of said BPUs comprises of an Initiating Officer (who is of the rank of Assistant Commissioner or a Deputy Commissioner) and Approving Authority (who is of the rank of Additional Commissioner or a Joint Commissioner) as action taking officers.

The original action of inquiry/investigation and determination of transaction/property being benami is done by the Initiating Officer after the approval of Approving Authority as per section 19 to and 23 and section 24 read with various other provisions of the Prohibition of Benami Property Transactions Act, 1988.

After the Initiating Officer is sure of his decision based on his investigation and inquiry, he continues his order of provisional attachment till the passing the order by the Adjudicating Authority.

(ii) Adjudicating Authority

The Adjudicating Authority (of PMLA) located at New Delhi was earlier given the charge with Pan-India jurisdiction. However now the charge has been given to the Competent Authority dealing with matters under SAFEMA and NDPS etc. It decides whether the action of the Initiating Officer with regard to the attachment of the properties (which are alleged by the Initiating Officer to be benami) is maintainable or not. If yes, the Provisional Attachment Order passed u/s 24(4) of the Act is confirmed by the said authority. If not, the said order and the reference sent u/s 24(5) of the Act is rejected by the said Authority.

(iii) The Appellate Tribunal

The orders passed by the Adjudicating Authority are appealable to the Appellate Tribunal located at New Delhi (with pan-India jurisdiction). Section 30 of the Prohibition of Benami Property Transactions Act, 1988 provides that “The Central Government shall, by notification, establish an Appellate Tribunal to hear appeals against the orders of [any Authority] under this Act.”

Further section 71 provides that for the time being the Appellate Tribunal set up under section 25 of the PMLA, 2002 shall discharge the functions under PBPT Act also till independent Tribunal is set up under section 30 of PBPT Act.

Thus, the Appellate Tribunal (of PMLA and SAFEMA) is also having jurisdiction to decide appeals against the orders passed by the Adjudicating Authority under Benami Law. However, the said Tribunal is having no coram since last more than two years and thus all the appeals being filed are lying pending for fixation of hearing since long.

But, unfortunately, the BPUs have starting launching prosecution u/s 53 and 54 of the PBPT Act, merely on passing of confirmation order by the Adjudicating Authority even while the Tribunal is not functional and thus judicious application of mind has not yet taken place on the order passed by the Initiating Officer.

(iv) Administrator

Section 2(2) of the Act an administrator is “an Income-tax Officer as defined in clause (25) of section 2 of the Income-tax Act, 1961.

An administrator is in charge of two crucial acts as stated below:

1. To take possession of property under section 29 of the Prohibition of Benami Property Transactions Act, 1988 according to which, Where an order of confiscation in respect of a property under sub-section (1) of section 27, has been made, the Administrator shall proceed to take the possession of the
2. Management of properties confiscated under section 28 of the Prohibition of Benami Property Transactions Act, 1988, wherein the Administrator shall have the power to receive and manage the property, in relation to which an order of confiscation under subsection (1) of section 27 has been made.
3. The Administrator is also empowered to take such measures, as the Central Government may direct, to dispose of the property which is vested in the Central Government under sub-section (3) of section 27, in such manner and subject to such conditions as may be prescribed.

(v) Special Courts

The Central Government has issued notification to set up a Special Court under Section 50 of the PBPT Act for trial of an offence which shall be punishable under this Act by designating Court of Session as Special Court.

It is also provided that while trying an offence under this Act, a Special Court shall also try an accused of an offence under the Code of Criminal Procedure, 1973 other than an offence punishable under the Prohibition of Benami Property Transactions Act, 1988.

It has been provided that the Special Courts shall conduct every trial expeditiously and conclude the trial within six months from the date of filing of the complaint by the Authorised Officer.

Few Startling Facts About Benami Law There are few peculiar features of this new piece of legislation which make it uniquely stinging and harsh, such as:

• Retrospective Operation: It attempts to cover old transactions done even prior to 1.11.2016 (date of notification of new law). The issue currently is pending for an order before Hon’ble Supreme Court.
• No Future Time Limit: No future time limit has been prescribed in the statute for taking action under the new law for transaction being done Thus, it is essential for a buyer to ensure that property being purchased by him is NOT a benami property, else any time in future he may be faced with the action under this law leading to the attachment of the property purchased, if found to be benami.
• Any Property Covered: It covers not only immovable properties like land & building but also movable andother assets g. shares, FDRS, bank accounts etc.
• Any Class: It may hit not only rich but financially poor also, as it has no threshold limit. It is affecting not only urban people but rural also, as it extends to whole of India.
• Any Profile: Provisions of this Act are brought out for setting right not only errant politicians, but also officers in the public service, businessmen, self- employment, employees of PSUs as well as private sectors, Agriculturist, Artists and everyone else who may own or possess wealth in the form of properties which are not found to be registered in their names.

• Any Structure: It is roping in corporate (listed or unlisted) as well as non- corporate entities and individuals as
• Any Intention: Whether there was malafide intention of the offender or not, if Benami transaction has been one, then property transferred/held as benami may be acquired/confiscated under this law.
• Any Motive: Intention or motive may be relevant for prosecution u/s 53, but not for acquisition/confiscation of the
• Inadequate Protection for Bona fide Purchasers: Though protection has been provided to the purchasers of bona fide properties, but it is neither absolute nor is free from ifs and buts. Further, the provisions contained in Section 27(2) in this regard are vague and needs urgent clarification/ suitable amendments.
• Makes no distinction between black money and tax paid money: Any property held benami shall be treated as Benami Property under the law and all consequences of its confiscation and prosecution of offenders shall follow irrespective of fact whether BLACK MONEY was used or tax paid money was used to acquire such property.
• No U-Turn allowed: Once benami transactions is done and benami property is acquired, its re-transfer is not allowed under the law. Thus, its correction or reversal is NOT envisaged under the old or new law. There is no scope under the law for relief by way of any confession or surrender or settlement or compounding etc. Thus, legal consequences of entering into the benami transaction are imminent viz. confiscation of benami property and prosecution of the offender.

• Multiplier Effect: Provisions of the Benami Law are in addition to provisions contained in any other These are not designed to be mutually exclusive. Thus, in any given situation all six principal laws dealing with economic offences viz. Income Tax Law, PMLA, Companies Act, FEMA, Black Money Act as well as Benami Law can be invoked simultaneously if violation has taken place or offence has been committed in the respective laws.
• No compensation for any damage: There is no provision under the law for payment of any compensation to the person whose property is confiscated under the PBPT Act, 1988. Similarly no damage can be claimed for vacation of any wrongful attachment done under this law.

Punishment/Penalties/Fines

i) Attachment

a) Provisional Attachment by the InitiatingOfficer

In case it is found by the Initiating Officer that a particular transaction or property is held Benami, then he may make its Provisional Attachment under section 24(3) of the Prohibition of Benami Property Transactions Act, 1988 after giving adequate notice under section 24(1) of the Prohibition of Benami Property Transactions Act, 1988 upto a period of 90 days from the last day of the month in which the notice under sub-section (1) is issued.

Though the law provides condition precedent for making of Provisional Attachment that when the Initiating Officer is of the opinion that the person in possession of the property held benami may alienate the property during the period specified in the notice, he may, with the previous approval ofthe Approving Authority, by order in writing, attach provisionally the property.

However, it is seen that mostly the Provisional Attachments have been done in many cases all over the country without bringing any material on record to form an opinion with respect to the fulfilment of the aforesaid condition precedent. Thus, such a harsh and invasive power which was meant to be used sparingly in specific cases only is being used routinely and thus causing avoidable hardship to many innocent owners.

Further the law provides an inbuilt protection to bona fide purchasers and owners of property. However no such care is observed to have been taken to avoid any inconvenience or damage to bona fide purchasers of alleged Benami property.

The aforesaid Provisional Attachment can be continued by the Initiating Officer under section 2(4) of the Prohibition of Benami Property Transactions Act, 1988 if at conclusion of the 90 days’ long proceedings it is found by him that the property attached is a benami property. The said attachment then continues till the date of passing of order by the Adjudicating Authority.

b) Adjudication of Provisional Attachment by Adjudicating Authority:

As per section 24(5) of the Act, once the Provisional Attachment Order (PAO) is passed by the Initiating Officer U/s 24(4), he has to prepare a Statement of the Case (also called as ‘Reference) and refer it to the Adjudicating Authority within 15 days from the date of passing of the aforesaid PAO.

After the Reference is received by the Adjudicating Authority Under section 24(5), it issues a notice to alleged benamidar and alleged beneficial owners to furnish such documents, particulars or evidence as is considered necessary on a date specified by the Authority. As per section 26(3), the Adjudicating Authority must pass its order within a period of one year from the end of the month in which the reference under sub-section (5) of section 24 was received.

The Adjudicating Authority decides whether the Provisional Attachment Order so passed by the Initiating Officer under section 24(4) is confirmed or rejected, thereby deciding a property or transaction to be benami or not to be benami.

c) Decision of the Appellate Tribunal, New Delhi on the order of the Adjudicating Authority.

An Appeal is filed before the Appellate Tribunal within a period of 45 days, wherein either of the aggrieved party can come to challenge the order passed by the Adjudicating Authority. The role of Appellate Tribunal is to ponder, adjudicate and decide over the order passed by the Adjudicating Authority either by confirming it or denying it.

ii) Prosecution and imposition of fine Section 3(2) provides that “Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both” and sub-section (3) provides that “Whoever enters into any benami transaction on and after the date of commencement of the Benami Transactions (Prohibition) Amendment Act, 2016, shall, notwithstanding anything contained in subsection (2), be punishable in accordance with the provisions contained in Chapter VII”

Thus from the above it is clear that transactions done on or after 1st November, 2016 are punishable as per Section 53 and Section 54 of the Prohibition of Benami Property Transactions Act, 1988.

a) Punishment and Fine for doing Benami Transaction

Section 53 provides that in following three circumstances in which a person shall be guilty of the offence of benami transaction i.e. if the benami transaction has been done to:

1. defeat the provisions of any law or
2. avoid payment of statutory dues or
3. avoid payment to

It further provides that following person shall be guilty of an offence of Benami transaction:

1. the beneficial owner,
2. benamidar and
3. any other person who abets or induces any person to enter into the Benami transaction, shall be guilty of the offence of Benami transaction.

It also provides that a person found guilty of offence of Benami transaction shall be punishable with rigorous imprisonment for a term which shall not be less than one year, but which may extend to seven years.

It also provides that a person found guilty shall also be liable to fine which may extend to twenty-five per cent of the fair market value of the property.

b) Punishment and Fine for false information

Section 54 provides that “Any person who is required to furnish information under this Act knowingly gives false information to any authority or furnishes any false document in any proceeding under this Act, shall be punishable with rigorous imprisonment for a term which shall not be less than six months but which may extend to five years and shall also be liable to fine which may extend to ten per cent of the fair market value of the property.”

c) Penalty for failure to comply with notices or furnish information

Section 54A is a recent addition in the PBPT Act, 1988 via the Budget of 2019. It says that

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“(1) Any person who fails to,–

1. comply with summons issued undersub-section (1) of section 19; or
2. furnish information as required under section 21,

shall be liable to pay penalty of twenty-five thousandrupees for each such failure.

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From the above discussion, it may be noted that the consequences of doing Benami transaction are very harsh and quite disproportionate beyond any reasonable limits. The quantum of fine may be well beyond the financial capacities of the persons who may be held guilty for the offence of benami transaction. The provisions regarding punishment of other persons who allegedly abets or induces any person to involve in benami transaction or who gives false information/document to any authority under the Prohibition of Benami Property Transactions Act, 1988 are quite harsh and may tend to hit unfairly to even those who may be connected to the main accused person in professional or personal capacity.

Controversy arising under the Prohibition of Benami Property Transactions Act, 1988 Though, undoubtedly our country really needed such a crisp and expedient law to deal with the menace of accumulation of wealth in hidden or pseudo names and to merge the parallel economy with the main economy, however due to lack of clarity in drafting and/or unguided implementation/enforcement of law, the Prohibition of Benami Property Transactions Act, 1988 has become like an unguided missile, causing huge collateral damage (which may not be visible immediately) as would be evident from the following:

1. It would be witnessed from the practical experience that impromptu attachment of the properties has led to chaos and fear in society and business community.
2. Retrospectivity: As discussed above, the benami transactions were legally allowed till 1988 since ancient times. Therefore retrospective operation of this law is like a bolt from the blue and proving to be very harsh. Though, it may be quite shocking to know, but the truth is that not only for past transactions, but no future time limits has been provided even for the current transactions. It is piercing the fundamental principle followed in the Constitution of India viz. Sanctity of Finality of Litigation. The sword of litigation is kept hanging on the heads of the citizens of the country, under this law.
3. The law gives no clear cut protection to bona fide purchasers and the PBPT Act is acting as an unguided missile for want of clarity in law with regards to the bona fide purchaser as its provisions are hitting them unfairly and causing avoidable
4. There is an Urgent Need for Adequate Training and appropriate guidance to the Benami Law Officers who are in the charge of enforcement of the law, as limited knowledge and self-perceived perceptions on their part is causing huge chaos and ordeals to innocent owners of the property.
5. There is an urgent need for adequate training and appropriate guidance to the Benami Law Officers who are in the charge of enforcement of the law, as limited knowledge and self-perceived perceptions on their part is causing huge chaos and ordeals to innocent owners of the property.
6. The concept of Burden of Proof is yet again a hot topic for controversy as though it is well settled legal position that the burden rests on the shoulders of the Initiating Officer to prove that what he alleges is true, but recently the Initiating Officers have been trying to shift this burden completely on the noticee(s) thereby being misadventures and harsh in enforcing the provisions of law.
7. The Appellate Tribunal situated at New Delhi is a combined Tribunal under the Prevention of Money laundering Act, 2002, the Smugglers and Foreign Exchange Manipulators Act, 1976 and the Prohibition of Benami Property Transactions Act, At present it is not having any coram, because of vacancies arising on the retirements have not been filled up, which is leading and creating huge back log of cases to be decided.

Thus, if the intent of our Government is to implement the law in most fair manner, then the least it must do is:

1. Bring out suitable amendments/ clarifications wherever vagueness or gaps are left in the hasty making of the Statute.
2. Train the implementation agencies and enforcement officers and instil appropriate guidance for fair implementation.
3. Set up immediately adequate infrastructure and robust mechanism for the remedial measures by way of fair process of adjudications and appeal.
4. Ensure checks and balances for avoidance of misuse of law by setting up appropriate

In case the Government is not able to take all requisite steps as discussed above due to the reasons of ‘non-priority’ or other constraints etc., then in my considered opinion, it should postpone the unplanned implementation of this law till then to avoid huge collateral damage, as has also been opined recently by Hon’ble Supreme Court.

(Source: This article is published in souvenir of National Tax Conference which was held on 6th & 7th August, 2022 at New Delhi)

I was selected as Income-tax Officer Class-1 on the basis of IAS etc examination held in 1958. After five months of combined foundational training of all services at Mussoorie, we, the probationers, who had opted for Indian Revenue Service (Income-tax), were sent for 18 months training in income tax and allied laws. Fortunately, out of 16 probationers, I and three others completed the prescribed written tests in the very first attempt and within six months of our training, we were sent for practical training. Shri R.D. Shah, who later retired as Chairman of the Central Board of Direct Taxes (CBDT), was our Training In-charge in the rank of Inspecting Assistant Commissioner of Income-tax – a highly committed officer but a meticulous follower of rules and regulations.

Post training, the Board’s policy was not to post the officers in their home State much less in their home town. The then Chairman, CBDT, came to the training college to give a valedictory address and thereafter, met the probationers and enquired about their problems. I stood up and told him that contrary to the policy, I would like to get the posting in my home town at New Delhi. The reason was that without the State posting, I shall not be able to get a Punjabi bride to look after my old parents. There was laughter all around. Despite strong opposition including from our Training In-charge, I stood my ground and gave several other reasons for the first positing to be in one’s home town.

Ultimately, the Board relaxed the policy of not giving the first posting after training in the home town and I was posted at New Delhi. It has now become a general policy of posting the officers, after training, in their home towns and if that is not possible, to post them at least in their home States.

Another interesting feature in my carrier has been my posting as the Chief Commissioner of Income-tax -1, Calcutta. The Income-tax Department had a plot of land for constructing residential flats but the same, over the years, had been encroached. I tried to remove the encroachers but there was lot of resistance reaching violence. I met Shri Jyoti Basu, the then Chief Minister of West Bengal, requesting him to get the encroachers removed. He gave me a counter offer about a new colony that was being developed by the State Government near the Calcutta airport and he could offer me as much land as was needed. This was not acceptable to me and I insisted that the Department’s land should be removed from the encroachers. Ultimately, he agreed. The encroachers were removed but, in the bargain, the Income-tax Department also got a large piece of land near the airport where a very commodious Guest House was set up for the initial and temporary stay of out-stationed officers who were posted to Kolkata. In this way, the Department got double benefit largely because of my persistence for the vacation of the encroachers from the that land.

Another reminiscence is of an incident when I was the Vice-Chairman of the Income-tax Settlement Commission at New Delhi. The Chairman, Central Board of Direct Taxes, with the concurrence of the Revenue Secretary, transferred me from Mumbai to New Delhi on the condition that I shall dispose off the oldest pending case of a foreign company which was lying unresolved for more than 10 years, firstly before the Assessing Officer and later before the Settlement Commission. After studying the case papers running into about 10,000 pages, I discovered it to be a very simple case of applying a reasonable net profit ratio to the receipts because they all were from the Government Departments and their correctness could not be questioned. As was my habit, I would start negotiations by proposing an unreasonable rate of profit so that in the negotiations, a reasonable rate can be arrived at and case settled on a win-win basis. The matter was settled to the mutual satisfaction of the foreign company and the Department and the additional tax, which was quite significant material, was paid within a month of the demand having been raised by the Commission.

It has been my experience that a vast majority of taxpayers do not mind paying a little more tax than what is due if it is based on an agreed assessment and the problem of ascertaining their tax liability is settled for good.

(Source: This article is published in souvenir of National Tax Conference which was held on 6th & 7th August, 2022 at New Delhi)

“Faith is of no evil in absence of strength. Faith and strength, both are essential to accomplish any great work.” – Sardar Vallabhbhai Patel

1. GENERAL BACKGROUND

1. The report is to be given by an Accountant in Form 3CEB as prescribed under Rule 10E. With effect from 1.04.2013, the rule requires electronic filing of the report.
2. Section 2(31) defines a “person” in an inclusive manner. The definition is wide enough to include non-residents including foreign companies. Accordingly, if a foreign company has taxable international transactions with its Associated Enterprise (AE) in India, it is required to comply with the transfer pricing regulations and furnish an Accountant’s Report.
3. Section 92E requires that every person who has entered into an “international transaction” or “specified domestic transaction” during a previous year shall obtain a report from an accountant and furnish such report in the prescribed form and in the prescribed manner on or before the specified date.
4. Transfer pricing law applies to both domestic and international transactions. For domestic transactions the law will apply only if the specified domestic transactions fall above a threshold in terms of the transaction value.
5. Transfer Pricing law in India was introduced through insertion of Section(s) 92A to 92F to Income-tax Act, 1961 and Rule(s) 10A to 10E of the Income Tax Rules The purpose is to ensure that the transaction between ‘related’ parties is at a price that would be comparable if the transaction was occurring between unrelated parties.
6. Section 92F(i) imports the definition of an “Accountant” from Explanation to Section 288(2) which means a Chartered Accountant who holds a valid certificate of practice, subject to certain exclusions prescribed under the Section 92E therefore does not require that only statutory auditor appointed under the applicable law can perform the examination.
7. Rule 10E provides that the requisite report under Section 92E shall be in Form No. 3CEB. The particulars required to be furnished under Section 92E are prescribed in Annexure to Form No. 3CEB.
8. With effect from A.Y. 2020-21, section 92F defines “specified date” as the date which is one month prior to the due date for furnishing the return of income under Section 139(1) for the relevant assessment year. The due date for filing of return of income under for f.y. 2021-22 (AY 2022- 23) under Section 139 for the assesses whose accounts are required to be audited under any law is 31st October, 2022. Therefore, they will be required to furnish report under Section 92E are prescribed in Annexure to Form No. 3CEB by an Accountant before 30th September, 2022.

References to sections and rules in this article, unless otherwise specified, are reference to sections under the Income-tax Act, 1961 and rules under Income-tax Rules, 1962.

2. SCOPE OF EXAMINATION OF AN ACCOUNTANT’S REPORT UNDER SECTION 92E

1. The accountant is not responsible to ensure that the Method used by the taxpayer to determine the Arm’s Length Price ‘ALP’ is the Most Appropriate Method, but he is required to ensure that the method stated to have been used to determine the ALP has actually been selected and applied by the assesse for such determination as provided under section 92C.
2. In many a cases, non-residents are taxable in India in respect of income earned from sources within India, even though they may not have any physical presence (business connection or permanent establishment) in India and therefore statutorily they are not required to maintain regular books of accounts in India. Unless exempted under the provisions of section 115A(5) from filing a return of income in India, they are required to obtain an accountant’s report in Form 3CEB (Also known as ‘Mirror Form No. 3CEB’). In such cases, accountant can place reliance on invoices, agreements, Form 26AS and other documents available with the non-resident taxpayer and accounts, Form No. 3CEB and other information provided by the resident assessee with whom non-resident has entered into international transaction(s) in examination of Mirror Form No. 3CEB.
3. If any document is not maintained, the accountant should suitably qualify or make appropriate disclosure in his report, depending upon the importance and the materiality aspect of the document. Qualification in the report should be comprehensive and self-explanatory and in accordance with “SA 700 – Forming an Opinion and Reporting on Financial Statements” issued by the Institute of Chartered Accountants of India ‘ICAI’.
4. Examination under Section 92E is not an audit. Therefore, it does not require expression of an opinion on the “true and fair view” of the financial statements but it is a restricted examination of accounts and records of the tax payer relating to the International Transaction or the Specified Domestic Transaction entered into by the tax payer.
5. The accountant should obtain from the tax payer a complete list of accounts and records (financial and non-financial) along with the supporting documents, if any, maintained by the taxpayer pertaining to international transactions and /or specified domestic transactions and obtain suitable representation confirming the completeness of the accounts and records pertaining to the relevant transactions.
6. The accountant should take an appropriate Management Representation Letter (MRL) from the assessee in respect of all oral representations given to him. However, it may be noted that mere reliance on MRL in respect of the matters that may be directly verified by the accountant will not be in compliance with the Generally Accepted Auditing Standards.
7. While it is the responsibility of the taxpayer to prepare and provide complete details, the accountant should use his professional skills and expertise to examine the same based on the documents, information and evidences provided to him by the assesse and apply reasonable tests to ensure that no item is omitted in the information furnished by the taxpayer and that the information furnished by the assesse is complete and correct.
8. Where the certifying accountant is not the statutory auditor of the assessee, he should disclose his reliance on the work performed by the statutory auditor and ensure that reasonable checks/tests are applied to the transactions to satisfy himself about the authenticity and the correctness of the ultimate information.
9. In order that the accountant is in a position to explain any question which may arise later on, it is necessary that he should keep detailed notes on the documents and other evidences on which he has relied upon while conducting his examination along with the detailed working papers. Such working papers, amongst others, should include his notes on the followings:-
   1. list of registers, documents and other records examined;
   2. the extent of checking and the basis ofsuch examination and by whom;
   3. information and explanations provided during the course of examination and by whom;
   4. decision on various points taken and the basis;
   5. the judicial pronouncements relied upon while issuing the If there is a conflict in judicial opinion, the view which he has followed and the reasons;
   6. certificates issued by the client;
   7. The assets owned and risks undertaken by each entity of the group in relation to the functions performed
   8. representation letter issued by the management;
   9. reconciliation between the figures to be reported under section 92E and the figures reported in the general purpose financial statements;
   10. Annexure to Form No.3CEB duly filled in and authenticated by the client and provided along with management representation letter.
10. SA 230 –“Audit Documentation” provides that the documentation should serve as a sufficient and appropriate record of the basis for the accountant’s report. The documentation should be prepared on a contemporaneous real time basis and the accountant should document all the matters important in providing evidence that the examination was planned and performed in accordance with the applicable legal and regulatory requirements.
11. Understanding taxpayer’s business operations is an essential part of transfer pricing examination, especially when assessee seeks guidance and professional assistance for preparation/ maintenance of the contemporaneous documentation. This will include an understanding of the followings:-
    1. The taxpayer’s operations;
    2. Industry in which the taxpayer operates;
    3. Key value drivers in the business;
    4. The operations of the taxpayer’s affiliates (domestic and foreign);
    5. The relationships between the taxpayer and its affiliates (domestic and foreign);
    6. The role each entity plays in carrying out the activities and performing the business functions of the controlled group;
    7. The scope, volume and nature of the controlled functions; and
    8. How much control and direction that taxpayer receives from headquarter of the group.
12. The accountant should consider the law that is applicable for the relevant year even though the format of Form 3CEB may not have been amended to bring it in conformity with the amended law.

3. FORMAT OF THE ACCOUNTANT’S REPORT

3.1 The report from an accountant under Rule 10E is to be furnished in Form No 3CEB. The Form No. 3CEB is divided into three parts as follows:-

1. Examination of the accounts and records: The first paragraph is a declaration by an accountant about his examination of the accounts and records of the taxpayer to review the international transaction(s) and/ or the specified domestic transaction(s) entered into by the assesse during the relevant previous year.
2. Expression of an Opinion about maintenance of proper information and documentation: The second paragraph requires the accountant to express an opinion as to whether the tax payer has maintained proper information and the documents prescribed under the law in respect of the international transactions and/ or the specified domestic transactions entered into by him.
3. Certification of ‘true and correct’ nature of the particulars furnished in the Annexure: Third paragraph is an expression of opinion by the accountant as to whether the particulars required to be furnished under Section 92E are furnished in the Annexures to Form 3CEB and whether the particulars furnished are true and correct.

Annexures to Form No.3CEB referred to in paragraph 3 of the report contains twenty five clauses. The accountant has to report whether the particulars furnished are true and correct.

4. CONCLUSION

The scope of an accountants report envisaged under section 92E does not require an accountant to express his opinion on the “true and fair view” of the financial statements of the assesse enterprise.

The section 92E requires an accountant to express an opinion whether “proper information and documents as are prescribed” have been kept by the assessee in respect of the international transactions and/or the specified domestic transaction entered into by him and whether the particulars required to be furnished under Section 92E are furnished in the Annexures to Form No. 3CEB and whether the particulars furnished are true and correct.

The contents of the report prescribed under section 92E and the Annexure are of no less importance. The accountant will have to use his professional skill and expertise and apply such tests as the circumstances of the case may require, considering the contents of the report. In order that the accountant may be in a position to explain any question which may arise later on, it is necessary that he should keep detailed notes about the evidence on which he has relied upon while conducting the examination and also maintain all his working papers.

The accountant should obtain from the assessee a letter of appointment for conducting the examination as mentioned in section 92E. It is advisable that such an appointment letter should be signed by the person competent to sign/verify the return of income in terms of the provisions of section 140 or by any person who has been authorized by the company to make such an appointment. The accountant should get the statement of particulars, as required in the annexure to the report, authenticated by the assessee before he proceeds to verify the same. The accountant is required to submit his report to the person appointing him viz. the assessee.

ICAI has issued “GUIDANCE NOTE ON REPORT ON INTERNATIONAL TRANSACTIONS UNDER SECTION 92E OF THE INCOME-TAX ACT, 1961” (“GN”).

It is advisable to refer the guidance note for the through and detailed guidance.

Introduction

The legislature, from time to time has introduced various anti abuse provisions in order to avoid tax evasion and revenue leakage. Section 56(2)(x) of the Act is one of the special deeming provisions which is introduced to avoid laundering of unaccounted income. The Finance Act, 2017 has widen the scope of section 56 by inserting the section 56(2)(x) of the Act. The Hon’ble Finance Minister in his budget for the Finance Bill, 2017 proposed to introduce a section 56(2)(x) of the Act to bring any money, immovable property or specified movable property valued more than fifty thousand under a tax regime if it is received by any person without consideration or with an inadequate consideration.

Before insertion of section 56(2)(x) the Act, the Income Tax Act, 1961 provided for certain special deeming provisions to tax such transactions entered by the assessee for the value which is less than the stamp duty value/ market value. The said special provisions were introduced mainly to avoid tax evasion and money laundering. The Finance Act, 2002 inserted section 50C of the Act which provides that with effect from 01.04.2003, the transfer of capital asset being land or building or both for a consideration, which is less than the Stamp duty value of such capital assets is taxable under the deeming provisions of section 50C of the Tax. As a result, the stamp duty value of such immovable property is deemed to be the full value of consideration for the purpose of computation of Capital Gains under section 48 in the hands of transferor.

While interpreting the said provisions, various courts have held that the same cannot be attracted to the transactions where an agreement is not registered and the stamp duty value is not determined by the stamp valuation authority. To overcome such situation and to prevent the leakage of revenue, an amendment was proposed vide Finance Act, 2009 to include the transactions in the purview of this section where the amount of stamp duty value is yet to be assessed which was applicable from 1st October, 2009 and shall accordingly apply in relation to transactions undertaken on or after such date. Since, the said provision was not applicable to the assets held as a stock in trade, the Finance Act, 2013 introduced another special provision of section 43CA of the Act to determine the full value of consideration for transfer of an assets other than capital assets for computing business income in the hands of a transferor. The said provisions are mainly attracted in the hands of builders/developers who sold the property held as a stock in trade for the consideration less than the stamp duty value. Thus, the builders and developers are also liable to pay additional tax as per the provisions of section 43CA of the Act the Act if the stamp duty valuation of the property is higher than the consideration received / accrued on the transfer of such immovable property.

Sections 50C and 43CA of the Act are applicable in the case of transferor of an asset and the same do not have any implications in the hands of transferee. Thus, to give similar effect in the case of transferee and to maintain parity under the statute, the legislature introduced section 56(2)(vii) of the Act vide Finance Act 2009 through which any sum of money or any property which is received without consideration or for inadequate consideration exceeding fifty thousand by an Individual or HUF after 1st October, 2009 but before 1st April, 2017 was chargeable to tax under the head “Income from other sources” subject to certain exceptions. Further, the scope of the said section was expanded by introduction of section 56(2)(viia) of the Act through the Finance Act, 2010 with effect from 1st June, 2010. As per section 56(2)(via), any receipt of certain shares by a firm or a Private Limited company is chargeable to income-tax under the head Income from Other Sources if such receipt is in excess of fifty thousand or it is received without consideration or for an inadequate consideration.

Subsequently, the Finance Act, 2012 introduced another section 56(2)(viib) which is applicable in the case of a private limited company. As per this section, if a company received any consideration for issue of shares exceeds the face value of such shares, then, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be taxed under the head Income from Other Sources.

The aforesaid anti-abuse provisions were applicable only in the case of individual or HUF and firm or company in certain cases. Thus, the receipt of sum of money or property without consideration or for inadequate consideration did not attract these anti-abuse provisions in cases of other assessees. Therefore, in order to prevent such practice, a new clause (x) in sub- section (2) of section 56 has been introduced to tax the such receipts in the hands of the recipient under the head “Income from other sources”. The provisions of section 56(2)(x) of the Act came into operation with effect from 1st April, 2017 as per which any money or a property exceeding the value of fifty thousand rupees received by any person on or after 1st April, 2017 shall be chargeable to tax as “Income from Other Sources”.

Further, certain exceptions are also provided to this section by keeping the receipts by certain trusts or institutions and receipt by way of certain transfers not regarded as transfer under section 47 of the Act out of the purview of tax regime. Consequential amendment has also been proposed in section 49 of the Act to determine the cost of acquisition.

Further, in the background of COVID-19 Pandemic, certain relaxation provisions were introduced in Finance Act, 2022 giving retrospective effect from 1st April, 2020. These provisions shall apply from the Assessment Year 2020-21. As per these provisions, the tax benefit has been provided to the assesses on the amount received for medical treatment and on account of death due to COVID-19 Pandemic. The Finance Ministry has released a press statement dated 25.06.2021 to announce that income-tax shall not be charged on the amount received by a taxpayer for medical treatment from employer or from any person for treatment of COVID-19 during FY 2019- 20 and subsequent years. Further, in order to provide relief to the family members of such taxpayer, exemption shall be provided to ex- gratia payment received by the family members of a person from the employer of such person or from other person on the death of the person on account of COVID-19 during FY 2019-20 and subsequent years. Also, it was stated that the exemption shall be allowed without any limit for the amount received from the employer and limited to Rs.10 lakh in aggregate for the amount received from any other persons. This is a good step taken by the government to provide the relief to the assessees for the difficulties faced during Covid-19 Pandemic.

Scope of section 56(2)(x) of the Act:

The provisions of section 56(2)(x) of the Act are anti-abuse provisions which are mainly brought into statute to avoid money laundering. This section applies to all the assesses who receive any sum of money or movable/ immovable property value of which in excess of fifty thousand without consideration or for inadequate consideration. The scope of section 56(2)(x) of the Act is briefly discussed as under:

1. If any person receives a sum of money without consideration or for inadequate consideration which is valued in excess of fifty thousand then, such sum shall be treated as “Income from Other Sources”.
2. If any person receives any immovable property
   1. without consideration and the stamp duty of which exceeds fifty thousand then, the value of stamp duty of such property shall be treated as “Income from Other Sources”.
   2. For a consideration less than stamp duty value of the property then, the difference between stamp duty value and consideration shall be treated as “Income from Other Sources” if such amount is more than fifty thousand or the amount equal to ten percent of consideration, whichever is higher. Vide Finance Act, 2021, this difference has been enhanced from five percent to ten percent in case of such property and up to twenty percent in a case where the property is being a residential unit.
   3. The valuation of stamp duty can be done in accordance with the provision of section 50C of the Act and the assessee can challenge the same as per such section. This provision can be attracted especially in case of a buyer who purchased a property for a consideration less than stamp duty value.
   4. The cost of acquisition of the property shall be determined as per section 49(4) of the Act.
3. If any person receives any movable property
   1. Without consideration and fair market value of which exceeds fifty thousand then, the entire fair market value of such property is treated as “Income from Other Source”.
   2. For a consideration less than fair market value and the difference between fair market value and the consideration is more than fifty thousand then, the aggregate fair market value as exceeds such consideration shall be treated as “Income from Other Sources”.
   3. The fair market value of the property shall be determined in accordance with the method under rule 11U & 11UA of the Income Tax Rules, 1962
4. Section 56(2)(x) of the Act excludes any sum of money or any property from taxability if it is received –
   • From any relative; or
   • On the occasion of marriage; or
   • Under a will or by way of
   • inheritance; or
   • in contemplation of death of the payer or donor, as the case may be; or
   • From any local authority as defined in the Explanation to clause (20) of section 10; or
   • From any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in clause (23C) of section 10; or
   • From or by any trust or institution registered under section 12A or section 12AA or section 12AB; or
   • By any fund or trust or institution or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub-clause (via) of clause (23C) of section 10; or
   • By way of transaction not regarded as transfer under clause (i) or clause (iv) or clause (v) or clause (vi) or clause (via) or clause (viaa) or clause (vib) or clause (vic) or clause (vica) or clause (vicb) or clause (vid) or clause (vii) or clause (viiac) or clause (viiad) or clause (viiae) or clause (viiaf) of section 47; or
   • By way of transaction not regarded as transfer under clause (i) or clause (iv) or clause (v) or clause (vi) or clause (via) or clause (viaa) or clause (vib) or clause (vic) or clause (vica) or clause (vicb) or clause (vid) or clause (vii) or clause (viiac) or clause (viiad) or clause (viiae) or clause (viiaf) of section 47; or
   • From an individual by a trust created or established solely for the benefit of relative of the individual;
   • From such class of persons and subject to such conditions, as may be prescribed.
5. The Finance Act, 2022 has inserted further exceptions for application of section 56(2)(x) of the Act to give relaxation to the assessee on account of COVID-19 Pandemic which provides that if any sum of money or property received –
   • by an individual, from any person, in respect of any expenditure actually incurred by him on his medical treatment or treatment of any member of his family, for any illness related to COVID-19 subject to such conditions, as the Central Government may, by notification in the Official Gazette, specify in this behalf;
   • by a member of the family of a deceased person—
     • from the employer of the deceased person; or
     • from any other person or persons to the extent that such sum or aggregate of such sums does not exceed ten lakh rupees,
     • where the cause of death of such person is illness related to COVID-19 and the payment is received within twelve months from the date of death of such person; and subject to such other conditions, as the Central Government may, by notification in the Official Gazette, specify in this
   • For this provision, the meaning of Family in relation to an individual shall have the same meaning as provided under Explanation 1 to clause (5) of section 10 of the Act.
6. The Finance Act, 2022 has introduced a new proviso which provides that any amount of money or a property is received by any person referred to in sub- section (3) of section 13 of the Act then, the same shall not be covered under the exception provided in section 56(2)(x) of the Act. This proviso shall be applicable with effect from 1st April, 2023.
7. For the purpose of section 56(2)(x) of the Act, the expressions “assessable”, “fair market value”, “jewellery”, “relative” and “stamp duty value” shall have the same meanings as provided in Explanation to clause (vii) of section 56(2) of the Act. Further, the expression “property” shall have the same meaning as provided in clause (d) of the Explanation to clause (vii) of section 56(2) of the Act and the same shall include virtual digital asset.

Certain important issues for consideration –

⮚ Whether the provisions of section 56(2)(x) of the Act are attracted to the issuance of bonus shares

The similar issue had come up before the Mumbai ITAT in the case of Sudhir Menon HUF vs. ACIT [2014] 148 ITD 260 (Mumbai-Tribunal) wherein the Hon’ble ITAT has held that when the additional shares of a company are allotted on pro rata basis to the shareholders including assessee based on their existing shareholding, then, there is no scope for any property being received on said allotment of shares and, consequently, the provisions of section 56(2)(vii)(c) can not apply to difference in book value and face value of additional shares. It is important to note that provisions of section 56(2)(vii) and 56(2)(x) of the Act are coterminous. Therefore, there is no question of applicability of section 56(2)(x) of the Act to the issuance of bonus shares when the provisions of section 56(2)(vii) of the Act are not attracted for the same as held by the Mumbai ITAT in this case. The ITAT discussed the legislative intent to introduce section 56(2)(vii) of the Act and held that the provisions of section 56(2)(vii) (c) of the Act would not attract to the genuine transactions of issuance of the shares to the existing shareholders.

The Hon’ble Delhi ITAT in the case of DCIT vs. Smt. Mamta Bhandari [ITA 5681/Del/2016] has uphold the above ratio laid down by the Mumbai ITAT

Further, the above proposition has been confirmed by the Hon’ble Mumbai ITAT in the case of ITO vs. Rajeev Ratanlal Tulshyan [2022] 193 ITD 860 (Mumbai – Trib.)

⮚ The amendment introduced to section 56(2)(x)(b)(B) of the Act through the Finance Act, 2020 with effect from 01.04.2021 excluded the transaction out of the purview of section 56(2)(x) of the Act if the difference between the stamp duty value and actual consideration of the property is not more than 10% of the total consideration. Whether this amendment should be applied prospectively or retrospectively –

The identical amendment has been introduced vide Finance Act, 2018 by inserting third proviso to sub-section (1) of section 50C of the Act which provides that from assessment year 2019-20 this section will not apply if the stamp duty valuation does not exceed 5% of the consideration received or accruing as a result of the transfer of capital asset. Subsequently Finance Act 2020 increased the limit to 10%. The question arose before the Hon’ble Mumbai ITAT in the case of Maria Fernandes Cheryl vs. ITO ITA No. 4850/Mum/2019 order dated 5.01.2021 that whether the said proviso applies prospectively or retrospectively. The Hon’ble ITAT held that since the said proviso is beneficial to the assessee, the same should be applied retrospectively. The relevant observation of the ITAT is as under:

“Once legislature very graciously accepts, by introducing the legal amendments in question, that there were lacunas in the provisions of Section 50C in the sense that even in the cases of genuine variations between the stated consideration and the stamp duty valuation, anti-avoidance provisions under section 50C could be pressed into service, and thus remedied the law, there is no escape from holding that these amendments are effective with effect from the date on which the related provision, i.e., Section 50C, itself was introduced. These amendments are thus held to be retrospective in effect. In our considered view, therefore, the provisions of the third proviso to Section 50C(1), as they stand now, must be held to be effective with effect from 1st April 2003. We order accordingly.”

The similar issue has also been dealt by Mumbai ITAT in the case of Joseph Mudaliar vs. CIT [2021] 191 ITD 719 (Mumbai – Trib.)[14-09-2021]

wherein it has been held that section 50C and section 56(2)(vii)(b)(ii) are identical provisions. The only difference is section 50C is applicable to the seller of an immovable property, whereas, the later provision is applicable to the buyer of the property. Therefore, a benefit given to a seller of the property in respect of marginal variation cannot be denied to the buyer of the property, since, they stand on the same footing. There cannot be two different fair market value in respect of the very same property, i.e. one at the hands of the seller and the other at the hands of the buyer. Thus, if the difference in valuation between the value determined by the stamp duty authority and the declared sale consideration is less than 10%, no addition can be made under section 56(2)(vii)(b)(ii) of the Act in view of the third proviso to section 50C and 56(2)(x) of the Act. The ITAT further, held that amendment made in section 50C(1) by inserting third proviso by Finance Act, 2018, with effect from 01.04.2019 is curative in nature and thus, the same would apply retrospectively.

Considering the same analogy, the amendment proposed in section 56(2)(x) of the Act vide Finance Act, 2020 to section 56(2)(x)(b)(B) shall have retrospective effect from 1st April, 2017.

⮚ Whether section 56(2)(x) of the Act isattracted to buy back of shares-

The Hon’ble Mumbai ITAT has decided this issue in the case of Vora Financial Services (P.) Ltd. vs. ACIT [ITA 532/Mum/2018]/[2018] 171 ITD646 (Mumbai) wherein it has been held that the

provisions of section 56(2)(via) of the Act should be attracted where the receipt of shares become property in the hands of recipient and the shares shall become property of the recipient only if it is “shares of any other company”. In the present case, the assessee has purchased its own shares under buyback scheme and the same has been extinguished by reducing the capital. Hence, the tests of “becoming property” and also “shares of any other company” fail in this case. Therefore, the tax authorities are not justified in invoking the provisions of sec. 56(2)(viia) for buyback of own shares. To arrive at this conclusion, the ITAT referred to the memorandum explaining the provisions of Finance Bill, 2010 wherein the object behind the insertion of section 56(2)(vii) of the Act is provided as under:

“The provisions of section 56(2)(vii) were introduced as a counter evasion mechanism to prevent laundering of unaccounted income under the garb of gifts, particularly after abolition of the Gift Tax Act. The provisions were intended to extend the tax net to such transactions in kind. The intent is not to tax the transactions entered into in the normal course of business or trade, the profits of which are taxable under specific head of income. It is, therefore, proposed to amend the definition of property so as to provide that section 56(2)(vii) will have application to the “property” which is in the nature of a capital asset of the recipient and therefore would not apply to stock-in-trade, raw material and consumable stores of any business of such recipient.”

It is important to note that even the intention for introduction of section 56(2)(x) of the Act is to avoid tax evasion and money laundering. Therefore, the genuine transaction entered by the assessee cannot be taxed under the said section. Considering the ratio laid down by Mumbai ITAT in the case of Vora Financial Services (P.) Ltd. (supra), the provisions of section 56(2)(x) of the Act should not be attracted to the buy-back of the shares.

⮚ In a case where Mr A entered into an agreement on 31.03.2017 to purchase the immovable property from Mr.B for total consideration of Rs. 1cr and the registration of the same was done on subsequent date, whether the provision inserted in section 56(2)(x)(b)(B) through the Finance Act, 2018 with effect from 01.04.2019 imposing the taxes on difference between stamp duty value and consideration would be applied to the present transaction which is entered in the A.Y. 2017-18

The Hon’ble Mumbai ITAT in the case of Rajib Rathindra Saha vs. ITO [ITA 7352/Mum/2019], [2022] 139 taxmann.com 211 (Mumbai – Trib.) / [2022] 95 ITR(T) 216 (Mumbai – Trib.) [21-02- 2022], has considered this issue in light of the provisions of section 56(2)(vii)(b)(ii) as amended by Finance Act, 2013 came into operation with effect from 01.04.2014. In this case, the assessee had purchased a flat on 16.04.2010 for total consideration of Rs.68,45,550/- for which earnest money was paid on 31.03.2013. The stamp duty for execution of the agreement was paid by the assessee on 18-3-2013 and the agreement was registered on 02.04.2014 and on the date of registration, the stamp duty value of the property was Rs. 87,02,007/. The AO, during the assessment proceedings for the A.Y. 2014-15, held that as the agreement was executed in the year under appeal, the provisions of section 56(2)(vii)(b)(ii) of the Act as amended by the Finance Act 2013 with effect from 01.04.2014 would be applicable.

Thus, the AO made the addition of the difference between the consideration paid by the assessee and stamp duty value i.e. Rs.18,53,457/-. The issue travelled before the ITAT. Before ITAT, the assessee contended that since the assessee had paid stamp duty on 18.03.2013 and had executed the agreement on 31.03.2013 i.e. in the period relevant to the Assessment Year 2013-14. Therefore, the amended provisions of section 56(2)(vii)(b)(ii) of the Act would not apply. Merely for the reason that the agreement was registered on 02.04.2014 i.e. during the year under consideration, the amended provisions would not get attracted. The ITAT observed that the sub-clause (b) to section 56(2)(vii) was amended by the Finance Act, 2013 w.e.f. 01.04.2014 i.e. from Assessment Year 2014-15. As per the amended provisions, where an individual or HUF receives in any previous year any immovable property for a consideration which is less than stamp duty value of such property, the AO can made addition of the difference between the stamp duty value and the consideration paid.

Prior to amendment by the Finance Act, 2013 there was no such provision under section 56(2)(vii)(b) of the Act to make addition in respect of consideration less than the stamp duty value. The scope of section 56(2)(vii) has been enlarged after amendment w.e.f. 01.04.2014. Since, in the present case, the agreement was executed on 31.03.2013 i.e. in the A.Y. 2013-14, the provisions of section 56(2) (vii)(b) of the Act as applicable to the A.Y. 2013- 14 would apply. The registration of agreement on the subsequent date would not alter the situation. The registration of agreement is a compliance of a legal requirement under the Registration Act, 1908. Thus, in the facts of case, the authorities below erred in invoking the provisions of section 56(2)(vii)(b)(ii) of the Act as amended by the Finance Act, 2013.

Now, in the given case, an agreement was entered on 31.03.2017 i.e. in the A.Y. 2017-18. As per the provision inserted in section 56(2)(x)(b) (B) of the Act through the Finance Act, 2018, if the consideration of immovable property is less than the stamp duty value then, the difference of the same shall be chargeable to tax under section 56(2)(x) of the Act.

The said amendment is applicable with effect from 01.04.2019 i.e. from the A.Y. 2019-20. If the ratio of the above decision of Mumbai ITAT is applied to this situation, then, it is to be concluded that as the agreement for purchase of immovable property is entered in the A.Y. 2017-18, the provisions applicable for such year has to be applied to this transaction and the amendment made with effect from 01.04.2019 i.e. from A.Y. 2019-20 will not have any impact on the same.

Conclusion:

Section 56(2)(x) of the Act is a special deeming provision which can be attracted only in respect of those transactions which resulted into the tax evasion and rolling of unaccounted income. The legislature never intended to tax the transactions under section 56(2)(x) of the Act which entered in the normal course of business or trade, the profits of which are taxable under specific head of income. Thus, the provisions of section 56(2)(x) will not have any application to the genuine transactions which fall under the legal parameters of the said section.

The term “Trust” is defined as “an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner” (Section 3 of the Indian Trust Act 1882).

A trust can be a private trust or a public trust. The current article is addressing taxation and compliance of Public Charitable or Religious trust.

The NGO / Trust operate for the benefit and upliftment of the people of the area in which they operate. They play a substantial role with the government in the development of the oppressed class. They are partners of the government in the economic development of the country.

The concept of “Dan” in Hindus or “Zakat” in Muslims is a way of life. It is a belief that the portion of one’s income should be donated for those who are less privileged. Thus in order to see that the funds which are set aside as donation year on year are utilized properly trusts/NGO’s are formed.

The operation of trusts/NGO has become difficult due to the need for increased compliance. There are huge number of amendments to the provisions governing trusts/ NGO’s. It was therefore felt that a comprehensive note be prepared to understand the law governing trusts/NGO’s. Lot of tax professionals avoid trust work due to the trusts incapability to pay market rate of professional fees, however the same has changed and the trusts today are ready to pay professional fees for the complex compliances thrust on them by the government whom they are helping.

Formation of trusts and their Registration.

A public trust can be formed by two or more

persons and is governed by the Bombay Public Trust Act in state of Gujarat and Maharashtra and by the provisions of section 92 of the Code of Civil Procedure, 1908. The NGO’s are also formed as section 8 companies under the Companies Act 2013 or a society under the State Co-operative Society Acts. However, formation of society would require seven members to form a society(Maharashtra).

A trust needs to be formed by a settlor with the first trustees through a trust deed. A trust/ NGO has to be registered before it can start operations. The registration process would differ based on the Act under which the trust is seeking registration (Bombay Public Trust Act/ Companies Act as a section 8 company or under the Co-operative Society Act of the state).

Taxation of Trusts under the Income Tax Act

The Income Tax Act 1961 provides for special

provisions to tax trusts operating for charitable and religious purposes. The intention initially seemed to be to monitor the trusts/NGO operation and give exemption if they are doing charitable or religious work. The sections of income tax which govern the trust taxation are as under

SECTION	EXPLANATION
Section 2(15)	Definition of Charitable purpose
Section 11	Exemption from taxation of income applied for charitable and religious purpose subject to conditions
Section 10(23C)	Exemption for certain Charitable or religious trusts subject to registration and conditions similar to section 11 above.
Section 12, 12A, 12AA, 12AB	Registration of Trusts/ NGO’s under the Income Tax Act to claim benefit under section 11
Section 13	Section 11 not to apply in certain cases
Section 80G(5)	Deduction from Income for Donor at 50% of the eligible amount of the income donated.
Section 115BBC	Anonymous Donation to be taxed in certain cases
Section 115TD	Tax on accumulated Income(assets) on cancellation of registration
Section 115TE	Interest for nonpayment of tax under section 115TD.

*Besides above section 164 talks about charge of tax on trust income

Charitable Purpose-2(15)

Section 11 to 13 of the Income Tax Act 1961 is a code in itself. Section 11(1) provides ”any income, profits and gains derived from property held under trust wholly for religious and charitable purposes shall not be included in the total income”. The exemption is allowable subject to certain conditions. Thus the definition of Charitable purpose is important as only income from property held for charitable purpose is exempt.

“charitable purpose” includes relief of the poor, education, yoga, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility:”

The definition has a proviso which was introduced from 1-4-2009 and further amended from 1-4- 2016, the proviso puts restriction on the activity of “the advancement of any other object of general public utility” by restricting the activity in the nature of trade, commerce or business for a cess or a fee or any other consideration unless the activity is undertaken in the course of actual carrying out of such advancement of any other object of general public utility and the total receipts from such activity is less than 20% of the total receipts.

It is stated that the intention was to prevent trade association and chamber of commerce from claiming exemption as charitable institutions. It was to reverse the decision of Supreme Court in the FICCI case.

The supreme court while considering the proviso in the case of India Trade Promotion Organization vs Director General of Income Tax 250 Taxman 97 held that “in deciding whether an activity is in the nature of trade, commerce or business as used in the first proviso to section 2(15) it has to be examined whether there is an element of profit making. Expression, Charitable purpose cannot be construed literally and in absolute terms. Correct interpretation of the said proviso would be that it carves out an exception and that exception is limited to activities in nature of trade, commerce or business. Thus if dominant and prime objective of the institution is profit making and activities are directly in nature of trade, commerce or business or indirectly in rendering of any service in relation to any trade, commerce or business, then it would not be entitled to claim its objects to be a charitable purpose.”

One should also look at Circular No. 21/2016 dated 27-5-2016 where CBDT clarifies that temporary excess of receipts beyond the specified cut off in the year may not necessarily result in cancellation of registration. It is to be noted a literal interpretation of the proviso would lead to an unintentional result where old age homes run by a charitable trust would loose exemption under section 11 and therefore a purposive interpretation as laid down in India Trade Promotion Organization vs Director General of Income Tax has to be done.

Education-Issue and controversies.

There is also a dispute as to what constitutes “education”. The term should refer only to structured education courses approved by a university or an education board or would include in its fold the generic meaning of education starting from birth to death of a person. Sole Trustee Lokshikhshan Trust vs. CIT 101 ITR 234 the Supreme Court has taken a narrow meaning of the term education. However in the later decisions in the case of CIT vs. Thyaga Brahma Gana Sabha 52 Taxman 395 the Madras HC has taken a view that the raising the artistic taste of the country by public performances of dramas, musical programs etc. would be educational purpose. However if the trust is formed for earning profits through educational institutes on commercial lines then the deduction needs to be denied (Dawn Educational Charitable Trust 233 Taxman 204 where it was running a posh school for the elite on commercial lines) however I am of the view that the said decision needs reconsideration as otherwise all IB schools running as a trust all over India would get their exemptions revoked, one should look at the privy council decision in case of Trustees of the Tribune Trust 7 ITR 415 where it was held that the concept of providing free or concessional rate is not required for general public utility only object of private gain should be absent. Yoga classes on regular basis is held to be education activity under DIT vs. Patanjali Yogpeeth (NYAS) 87 taxmann.com 54 (DEL). Also one should read the case of Director of Income tax vs. Bharat Diamond Bourse (2013) 126 Taxman 365(SC) in which case majority of the objects were charitable and some ancillary objects were not charitable.

Registration under section 12A or 12AB. The provisions for registration of trust under the Income Tax Act has seen a see saw. It initially required renewal every few years and then in 2009 all trusts having valid registrations were told that the same was perpetual and no more renewal was required. The Finance Act 2021, reintroduced the need for all trusts to register themselves under section 12A within a period of three months. However this time was extended regularly due to covid-19 pandemic and the deadline expired on 31st March 2022. Thus all trusts which were registered earlier and who have not taken registration under the new online system, their registrations are cancelled and the consequences under section 115TD would follow.

The online registration process was a simple process where the trust was required to file a form with details attached in PDF form listed below:

1. The registration under the state charity commissioner office/ Companies Act/ State Co- operative Society act.
2. Trust
3. The Old 12A registration
4. Details of Trustees giving address, PAN NO and other details.
5. The last three years accounts and audit report with schedules.
6. The 80G certificate and FCRA certificate if

The registration was granted either for a provisional period of three years or for a regular registration for a period of five years under section 12AB. The entire process was online without any human intervention and the department has issued certificates in almost all cases where application was made. The said certificates have been issued with specific conditions for registration and one should read the same as the registration is subject to these conditions.

One should note that the department has started sending messages to trusts who have been issued provisional registrations for three years to file form 10AB which was to be filed within six months of the commencement of activity by a new trust or within six months of the provisional registration coming to an end whichever is earlier. The difficulty arises as in certain cases where the existing trusts who had registration in earlier section are also given provisional registration which were to be issued to new trusts. The CBDT has issued circular No. 11 of 2022 dated 3rd June 2022 rectifying this mistake unilaterally and making all such registrations regular registration and also removing all conditions of registration which were not as per the provisions of the Income Tax Act “Null” by this circular.

Cancellation of registration.

The earlier power of cancellation of registration under section 12A was provided under sub clauses (3) and (4) of section 12AA. However from A.Y. 2022-23 the power to cancel registration are provided under section are provided under sub clause (4) section 12AB. The said sub clause provides for Principal Commissioner to call for information and then cancel the registration in the following cases.

1. The Principal Commissioner has noticed occurrence of one or more specified violations* during the previous year.
2. The Principal Commissioner has received a reference from the Assessing officer under the second proviso to sub section (3) if section 143 for any previous year.
3. The case has been selected in accordance with risk management strategy, formulated by the Board from time to time for any previous year.

The Principal Commissioner after calling for information and giving an opportunity to the trust to explain, may either cancel the registration or refuse to cancel the registration and send the copy of the order to the Assessing officer of such trust or institution.

*The section provides for the specified violation in the explanation to the section

1. Where any income of the fund or institution or trust or any university or other educational institution or any hospital or other medical institution has been applied other than for the objects for which it is established; or
2. the fund or institution or trust or any university or other educational institution or any hospital or other medical institution has income from profits and gains of business, which is not incidental to the attainment of its objectives or separate books of account are not maintained by it in respect of the business which is incidental to the attainment of its objectives; or
3. Any activity of the fund or institution or trust or any university or other educational institution or any hospital or other medical institution—
   1. is not genuine; or
   2. is not being carried out in accordance with all or any of the conditions subject to which it was notified or approved; or
4. the fund or institution or trust or any university or other educational institution

or any hospital or other medical institution has not complied with the requirement of any other law for the time being in force, and the order, direction or decree, by whatever name called, holding that such non-compliance has occurred, has either not been disputed or has attained finality.

The Principal Commissioner is required to pass an order either cancelling the registration or an order refusing to cancel registration within six months from the end of the quarter in which the first notice is issued.

Income of the trust and its taxability.

Income for a trust has to be determined in the normal commercial sense for claiming exemption under section 11. Income arising from the property held by the trust for charitable or religious purpose is the income of the trust. It will include the interest, rent, capital gain on sale of property, voluntary contributions or other receipts from incidental business activity. Income would also include voluntary contributions received by the trust. [Section 2(24) (ilia)].

The different types of incomes are to be considered as per the method of accounting followed by the trust. However, if the income has not accrued and due the same cannot be included even if the entries are passed in the books of accounts. The mere book entries cannot make the income taxable. (CIT vs. Chamanlal Mangaldas Girdhardas Parekh Ltd 39 ITR 8, CIT vs. India Discount Co. Ltd 75 ITR 191, CIT vs. Toshoku Ltd 125 ITR 525) It is also to be noted that the classification of income under section 14 in to various heads of income is also not applicable to the trust affirmed by CIT vs. Rao Bahadur Calavala cunnan Chetty Charities 135 ITR 485.

The trust receive subscriptions, entry fees or life membership fees in certain cases, these would also be treated as income from property held by the trust. (CIT vs. Cotton Textiles Export Promotion Council 67 ITR 539, CIT vs. Divine Light Mission279 ITR 639, CIT vs. WIAA Club Limited 136 ITR569). Similarly, government grants received with specific conditions like payment of salary or other specific uses are also treated as voluntary contribution and to be included in income (Gem and Jewellery Export Promotion Council 143 ITR 579). We will deal with the allow ability of the 15% under section 11(1) (a) on the said grants separately when we deal with the application of funds.

Corpus Donations.

The voluntary contributions included in income would also include contributions received with specific direction that they shall form part of corpus. The said corpus donations(contribution with specific instructions) are to be excluded from the income of the trust under section 11(1)

(d) subject to the conditions that the same are invested or deposited in one of the modes listed in section 11(5) (this condition is included from the Finance Act 2021 and is applicable from A Y 2022-23). The provisions are applicable from 1-4-2022(A Y 2022-23) and would not apply to old corpus donations taken and used over the years. We will deal with the application of the corpus donations in the following paras as the use of corpus donation is not regarded as application of income.

Anonymous Donations.

Section 115BBC was introduced from A Y 2007-08 The term Anonymous donation is stated to be any voluntary contribution under section 2(24)(iia) “where a person receiving such contribution does not maintain a record of the identity indicating the name and address of the person making such contribution and such other particulars as may be prescribed”.

The said section provides that the trusts or NGO’s registered under section 11 or under section 10(23C) [sub clauses (iiiad), (iiiae), (iv), (v), (vi), (via)] receives anonymous donations higher of 5% of the total donations or Rs 1,00,000/-, would be taxed at 30%.

The said provisions do not apply to trust which have been established wholly for religious purposes or for both charitable and religious purposes.

Gain from transfer of Capital Asset.

The transfer of a capital asset by a trust is covered by section 11(1A). The section provides that if the trust transfers a capital asset held for charitable and religious purpose and the whole or part of the net consideration is used for the used for acquisition of new capital asset, then the capital gains are deemed to have been applied for Charitable and religious purpose.

The term capital asset is not defined under section 11(1A) and as per the Calcutta High Court in the case of CIT vs East India Charitable Trust 206 ITR 152 the definition of capital asset under section 2(14) can be used to ascertain what is a capital asset.

There is no time limit for investment of the net consideration of capital asset, however it should be done by the end of the financial year. One should look at the judgment of Trustees of Dr. Sheth Charitable Trust vs. Seventh ITO 2 ITD 649 in this case the capital asset was sold at the fag end of the year and the investment in new asset was made in the following year after six months, the tribunal held that the benefit of section 11(1A) could not be taken as the trust had not availed the option of accumulation under section 11(2),

It is also not important that the capital asset should be held by the trust for a specific period. It is possible that the asset is sold and a new asset is bought and the said new asset is sold and a third asset is bought still the gain will be deemed to be invested. However if the asset is not available and the new asset is also sold then the gain cannot be said to be reinvested. Dalmia Charitable Trust vs. ITO 27 Taxman 46 (Mag)

Restriction on Investment of Trust funds.

Section 11(5) provides for investment instruments

in which a trust can invest. The said section was introduced from Finance Act 1983. In section 11(2) discussed below and also corpus donations under 11(1) (d) are to be invested in securities listed in section 11(5). The intention is to not allow the use of trust funds to be invested in any high risk instrument. The section provides clauses (i) to (xi) where various instruments are listed and clause (xii) provides for any other form or mode which may be prescribed, Rule 17C provides other list of instruments in which investments can be made.

The section 13(1) (d) provides for forfeiture of exemption under section 11 and 12 if the investment are not made as provided under section 11(5). The said withdrawal of exemption will lead to the taxation of such income at maximum marginal rate. However, would it lead to the withdrawal of exemption for the entire income or would it be restricted to the income from such investment not under section

11(5). It is to be noted that all the high courts have held in favor of trust/ NGO and held that the tax would be levied only on the income from assets which are not held in the manner specified under section 11(5) and the other income would continue to enjoy the benefit. [DCIT vs. Sheth Mafatlal Gaganbhai Foundation trust 249 ITR 533(BOM), CIT vs. Fr. Muller Charitable Institutions 363 ITR 230(KER), CIT vs. Santokha Durlabhi Trust Fund 406 ITR 457 (RAJ), also CBDT issued Circular No. 387 dated 6th July 1984 accepting that only part which is earned by violation of section 11(5) will be taxed at maximum marginal rate]

New Compliance from 1-4-2022 for voluntary contributions received.

The section 80G (5) along with section 35(1A)

has been amended and all trust/NGO’s have to now file a form 10BD annually providing details of donations received by them from A Y 22-23. The said form is in the same lines as the TDS return filed by assesse and on filling of the said form the trust/NGO will be able to download the form10BE which he can issue to a donor. The said form requires details of the donor to be uploaded. The list of details to be uploaded are as under

• Name of the Donor
• Address of the Donor
• Nature of Donation
• Mode of Receipt
• Amount of Donation
• Section code under which donation was received
• PAN NO / Aadhar / Tax Identification Number of donor

This process of uploading details will remove any bogus claim as all deduction claim under section 80G will be cross tallied by the statements filed by the trust/NGO.

The said form 10BD is an annual statement and the same was to be filled for the first time for March 2022. The due date for the filling of the said form was 31st May 2022. The PAN details are a must to file the form. The details filed late would have to pay a fees of Rs 200 per day(Section 234G). The fees is also payable if you amend the form to add a donor detail which you have missed in the first filling. This is a deviation from the Section 234E where the TDS return amendment after filling the return on time would not entail late fees. This does not seem to be the intention of the section but the system in the present levies this late fee on trust. This online filling for charitable trusts would lead to a situation where if there is any discrepancy in the amount of donation received and the amount filed in the form 10BD would be held to be anonymous donation and taxed at 30%.

Application of Income.

Section 11 provides that a trust or a NGO should apply its income for the objects of the trust/ NGO to claim exemption. It provides that the trust/NGO should spend 85% of its income for Charitable and Religious objects as per the trust deed or the Formation document like the memorandum or the bye laws. (Section 11(1) (a). The emphasis is on the application of income and it includes both revenue and capital expenses. The entire capital expenses can be claimed as application of income. The term application in common parlance would mean amount spent. However, the term under section 11(1)(a) has a wider meaning as held in the following cases CIT vs. George Forane Church 170 ITR 62, and CIT vs. Radhaswami Satsang Sabha 25 ITR 472. The Allahabad High Court in the Radhaswami Satsang Sabha had held that the amount irrevocably earmarked and allocated for future spending is also application of income.

However the law has been changed from A Y 2022-23, explanation 4 has been added to section

11(1) which provides that the amount spend from corpus donation would not be allowed as application of income, similarly the amount spend from loan taken is also not allowed as application of income. However the amount which is there after deposited for replenishing of the corpus donations or repayment of loan amount will be allowed as application of income. The law has been further amended from A Y 2023-24 by Finance Act 2022 by providing that the application of amount has to be actually spent and the mere book entries based on accounting system followed by the trust/NGO will not be allowed as application of income. (Explanation added after section 11(7).

The explanation to section 11(1) provides that the donation given by one trust to the other trust as corpus donation will not be allowed as application of income. Similarly application of funds in violation of 40A(3)[payment above Rs 10000 in cash] or 40(a)(i)/40(a)(ia) [Payment without deducting TDS as per law] is not held to be application of income.

The trust/NGO is restricted from taking depreciation on the assets where the entire amount is taken as deduction as application of income under section 11(1) (a). (Section 11(6) from A Y 2015-16. However if the trust chooses to claim the depreciation instead of the whole amount of the asset the same can be opted by the trust. However, the system I designed in such a manner that the 143(1) processing auto adds the depreciation and one would then have to struggle to get the intimation rectified.

The trust /NGO which is registered under section 12AA or 12AB is restricted from taking exemption under section 10 of income earned by it and for which deduction is taken under section 11. Prior to this amendment in A Y 2015-16 there were trusts who were taking exemption under section 10 for dividend income earned by it and thus were avoiding spending money from the trust. Many trusts surrendered their registration after the introduction of the said provisions.

Taxes Paid and Refund of Income Tax One of the common question which is raised is the tax paid by trust is it an application of income. The answer is yes, similarly is the refund of income tax refund received is it an Income. There are conflicting decisions on this issue and the reconciliation of the same is that if the tax paid is taken as application then the refund is to be taken as income, if it is not taken as application then the refund would also not be taken as income.

Option to apply the amount in the following year-Deemed application of funds.(Deemed Application of income) The trust may not be able to apply its income towards the objects due the fact that the amount is not received by it. (Interest accrued but not received, or rent accrued but not received from tenant due to Covid 19 pandemic)

The trust in such a case has an option to not take the amount as application and spend it as an when received by it or in the following year. [Explanation 2 to section 11(1)] There need not be any reason for not using the amount in the current year, so it is possible that the amount is received but the trust is not able to use it. The trust has an option to use it in the following year. If the non use of the amount is due to trust not receiving the amount, then the trust will have to take it as income in the year in which it is actually received, for example a cumulative fixed deposit of five years where the amount is to be received only in the fifth year in this case the trust will be able to use the fund in the fifth year when the money is received.

However the trust is required to file form 9A online before the due date of filling return in order to claim exemption from application of the above amount. Non filling of the above form would lead to the income being taxed as there is no application of income.

Condonation of delay in filling forms. The CBDT has issued a Circular No. 7/2018 dated 20-12-2018 for A Y 16-17 and Circular No. 19 of 2020 dated 3rd November 2020 for A Y 17-18 and A Y 18-19 for the condonation of delay in filling the above form 9A, 10, 10B and form 10BB as the same was made online and the trust may not be aware of the process. One can apply for the condonation of the delay in filling form to the Director of exemption (Income Tax) if in Mumbai or the Principal Commissioner (PCIT) having jurisdiction on the trust. However the notification of 2020 only allowed PCIT to condone delay upto 365 days, however recently by circular no. 15, 16 & 17 dated 19th July 2022, the PCIT has been allowed to condone delay upto three years for A Y 18-19 onwards. The trust who have not filed the forms and the delay is more than three years may apply to the CBDT under section 119(2)(a) for condonation. The CBDT should have allowed the PCIT to delay any delay by the trust without giving a cap on the period of delay, as the non filling of forms is a venial fault and it cannot be anyone’s case to punish the trust for this venial default. The PCIT always have the discretion to reject a malafide or fraudulent delay in filling forms.

Deemed Application by Accumulation for Project.

The trust/NGO can accumulate amounts for a

project or for particular activity of the trust for a period of five years and the said accumulation will be deemed to be an application of the income.

The trust/NGO is required to complete the project or activity from the accumulation in the five years available.

The project for which accumulation is to be made needs to be specific and can be more than one project, however there are contrary views on the singular or plural objects. Kolkata HC in CIT vs. Trustees of Singhania Charitable Trust 199 ITR 819 (against) it has held that there can be only a singular object. However the Del HC has consistently held that the objects could be plural. (CIT vs. Hotel and Restaurant Association 261 ITR 190, DIT(exemp) vs. Eternal Science of Man’s Society 290 ITR 535, Mamta Health Institute for Mothers and Children 293 ITR 380.

However accumulation by simply stating “for the objects of the trust” is held to be inappropriate and the deemed application of the accumulation is not allowed. (DIT vs. Mitsui and Co. Environmental Trust 303 ITR 111)

Conditions for claiming the Deemed Application

• The said amount is to be kept invested in any of the modes specified under section 11(5).
• The trust/NGO has to also file form 10 online to the assessing officer before the due date of filling return of income under section 139(1).

The object for which the accumulation has been done may be changed by an application to the Assessing officer if due to any reason the object for which it is set aside cannot be achieved. (Sub section 3A of section 11)

The amount accumulated will become income of the trust/NGO if the

1. Income is applied for purposes other than the Charitable or religious objects.
2. Amount ceases to be invested in any of the modes specified under section 11(5).
3. Not utilized for the purpose for which it is accumulated with in the five years. (Income of the sixth year)
4. Credited or paid to any other trust registered u/s 12AA or having exemption under 10(23C).

The said provision has been amended and from A Y 2023-24, prior to A Y 23-24 the trust would be liable to be taxed on the accumulation in the sixth year after completion of five years, however the amount not spend will be the income of the fifth year itself after the amendment.

Restriction on use of funds for specifiedpersonsn-(S.13)

Section 13(1) sub clause (a) and (b) denies benefit of section 11 and 12 to income used for the benefit of Private Religious purposes (Ghulam Mohidin Trust v CIT 248 ITR 587(J & K) or for the benefit of any particular religious community or caste. Gujarat High Court in CIT vs. Girdharram Hariram Bhagat 154 ITR 10 has discussed the distinction between public and private endowments or trusts.

“A religious endowment may be either public or private. A public religious endowment necessarily implies that it is a dedication of property for the use or benefit of the public, while on the other hand a private religious endowment is a dedication of property for worship of the family GOD in which public is not interested.” In Rajkot Vishw Shrimali Jain Samaj v ITO 292 ITR (AT) 222 (Rajkot) it was held that the benefit need not be to the entire public and may be available to a specified section of the public

Application of funds for Specified Persons

It further under sub clause (c) blocks any benefit of the trust property or income from such property being used for the benefit of the specified persons* or its relatives as defined in sub section (3) of section 13 read with explanation 1 and 3.

Person includes “another trust” (Champa Charitable trust) vs. CIT 214 ITR 764(BOM). This restriction is intended to ensure that, despite the ostensibly charitable objects of a trust or institution, its income is not diverted away to benefit persons who are closely connected with the creation, establishment and conduct of the trust and or institution.

In DIT vs. Bharat Daimond Bourse 259 ITR 280(SC) the institution established for charitable purposes advanced Rs 70 Lakhs to one of its office bearer (honorary secretary) without interest or with any security or without any agreement. Since the borrower belonged to the prohibited category within the meaning of section 13(3)(a) and 13(3) (cc) the income of the institution will be deemed to have been applied for the benefit of the prohibited category of person and consequently the benefit of section 11 was lost to the institution.

The benefit to specified persons should not arise directly or indirectly and the violation of the said clause would lead to the cancellation of benefit to the entire income of the trust except in the cases covered under sub section 4 and 5. (Welfare and Awakening in Rural Environment vs. DCIT 263 ITR13) However, the Delhi High Court rightly held

that only the dividend income would be liable to tax where the shares were held by the prohibited category mentioned in S. 13(3). (CIT vs. Narinder Mohan Foundation 311 ITR 425)

Investments in violation of 11(5)

The sub clause (d) of section 13(1) denies benefit of section 11 to income generated from investments made in any instrument not specified under section 11(5). The intention is to restrict investment in other than specified instruments. There is exemption and time period provided for those holding such investment from prior to 30th November 1983 when section 11(5) was introduced. This concession was extended till 31st March 1993. Further, there is an exception provided for such assets which are part of corpus of the trust or institution as on the 1st day of June 1973.

The violation of section 13(1) (c) being benefit directly or indirectly to specified persons the entire exemption under section 11 will be denied, however if there is a violation of 13(1)

(d) by investing in instruments other than those specified under section 11(5) then only the income from such investment would be taxed and the entire income would not entire trust income.

*The specified person in section 13(3) are listed below

• The author of the trust or the founder of the institution;
• Any person who has made a substantial contribution to the trust or institution, that is to say, any person whose total contribution up to the end of the relevant previous year exceeds fifty thousand rupees;
• Where such author, founder or person is a Hindu undivided family, a member of the family;

(cc) any trustee of the trust or manager (by whatever name called) of the institution;

• Any relative of any such author, founder, person, member, trustee or manager as aforesaid;

• any concern in which any of the persons referred to in clauses (a), (b), (c), (cc) and

(d) has a substantial interest.

The explanation 1 defines the term relatives of the specified persons and explanation 3 provides that person shall be deemed to have substantial interest in the concern if he hold more than 20% of the voting rights or is entitled to 20% of the profit sharing ratio. However the above does not include the employees of the specified persons (Tata trust 203 ITR 764). It also does not include the manager of the specified persons (CIT vs. Rai Bahadur 252 ITR 84).

Deemed Violation

The sub section (2) of section 13 provides for a list of transactions which are deemed to have been used for the benefit of persons under section 13(3) if they are not entered on the principals of arms length. The list from to (h) is illustrative and not exhaustive. The nature of transaction and the facts in each case would have to be considered before one concludes that there is a violation of 13(3) [Shree Poongalia Jain Swetamber Mandir vs. CIT 168 ITR 516(RAJ)].

Onus: – Although the burden to prove exemption is on the assesse the burden to prove exclusion from exemption is on the revenue.

It is the duty of the revenue to prove beyond doubt with necessary materials and documents that a particular trust cannot avail the exemption under section 11 and falls under the ambit of S. 13 (CIT vs. Kamala Town Trust 279 ITR 89)

Taxation of Net Assets on Cancellation of Registration (S.115TD)

The said section was introduced from Finance Act 2016 from 1st June 2016. It is intended to tax the accreted income at maximum marginal rate if the trust has

• Converted into any form which is not eligible for grant of registration 98[under section 12AA or section 12AB];

• merged with any entity other than an entity which is a trust or institution having objects similar to it and registered 98[under section 12AA or section 12AB] ; or
• failed to transfer upon dissolution all its assets to any other trust or institution registered 98[under section 12AA or section 12AB] or to any fund or institution or trust or any university or other educational institution or any hospital or other medical institution referred to in sub-clause (iv) or sub-clause (v) or sub-clause (vi) or sub- clause (via) of clause (23C) of section 10, within a period of twelve months from the end of the month in which the dissolution takes place,

The accreted income is to be calculated at the market value of assets less the liabilities of the trust related to the assets which are available, the liabilities with regard to the assets already disposed are to be ignored.

The section would not come in to operation if the trust has filed an appeal against the rejection of the registration or has applied for the registration after the amendments to the objects. The application of the section seems to be to cases where there was malafide intention to form trust which were charitable and then to convert the said trusts in to non-charitable and enabling the trustees to enjoy the benefits of the assets which are not taxed.

The above section though introduced in 2016 there has been no amendment in the definition of income under section 2(24)-Income to include taxation of such accreted income. This is important as there is serious doubt as to whether the definition of income in the normal course would include such accreted income. The provision needs to be tested in the court of law with regard to the power to tax accreted income.

Choosing between S. 10(23C) and S. 11 The provisions of Section 10(23C) have been amended to bring the provisions of the said section in line with provisions of section 11. The need to take registration and also regular renewals, utilization of funds, to keep the funds invested in specified securities under 11(5) and restrictions for corpus donations utilization are all similar. However one has to choose between section 10(23C) and exemption under section 11, each trust will have to take in to account advantages and disadvantages before choosing one under which it wants registration. It is felt that the requirements and restrictions are more onerous under section 10(23C) but one has to look at the facts of each case before deciding.

Latest Development

The Finance Act 2022 had amended the section 11 to provide that books of accounts will be maintained by the trust. There was also power taken to notify the books of accounts to be maintained by the trust. The CBDT has notified the books of accounts to be maintained by the trust vide notification G.S.R. 622 dated 10th August 2022. The said notification gives a detailed list of both books and statements and records to be kept by the trust for 10 years. The said notification has made the job of trust doing charities further difficult as there is no threshold limits and small trusts will also have to maintain the entire records as stated in the notification.

The CAG has recently tabled a report on the NGO and trusts before the parliament for returns filed with income tax from A Y 2014-15 to 2017-18. The CAG has brought the attention of parliament towards the various violations by IT department and also by the trusts and the advantages taken by the NGO/ trust which according to them were to not to be granted.

There is a list of suggestions made by CAG which are likely to be brought in to the act by the next budget knowing the Government’s policy of zero tolerance for tax leakages. The report makes interesting reading. What is surprising is that the violation reported by the CAG is for a handful of cases and still there is a recommendation for amendment of the law. In one case of violation or misuse of 15% concession in spending of income received was misused by four trusts in Maharashtra. They donated funds from one trust to another and the 15% benefit was taken by all the four trusts who got the money from the previous trust. This was an aberration of the normal Nobel activity carried out by trust in general and still there is a recommendation to amend the law to not allow donation from one trust to another. The GAAR enacted under the Income tax Act 1961 (Section 96 to Laws cannot be made for exceptions. However over the years this basic principal of law making is missed by the governments. Some of the suggestion are to amend the Form ITR 7, Form 10B and other such suggestions which would lead to more compliance and running of a trust a compliance nightmare.

Conclusion

The compliance for charitable and religious trusts have increased over the years. Besides the compliance under the Income Tax Act, the trust needs to do compliance under the Bombay Public Trust Act / Companies Act/ Society Act. The audit and filling under those laws have also increased. The trust would be further burdened with the FCRA (Foreign Contribution Regulation Act) if it wants to receive donations or contributions from out of India. The process of doing charitable activity is not charitable anymore and the trustees and founders run the risk of being penalized and imprisoned for any error which they may make in the process of work. They should be a determined lot or crazy lot to take on such a daunting task and I on my part salute there efforts to do good work in spite of the hurdles and road blocks which keep increasing from time to time. They are really the “Sevaks” or “Heros” who need to be applauded and recognized by all.

In the digitally aided fast paced world of today intangibles have become a very important part of tax planning of Multi National Enterprises (MNE’s). Specifically, research and scientific activities have become a very important of tax base planning at a group level for multinational enterprises. Whether we look at Alphabet, or Meta or Apple or Amazon or Sandoz or Pfizer the ilk. A very important stream of shareholder ’s residual money is from the effective tax rate that is finally applicable to shareholders. Intangibles are invariably the result long periods of research and development, whether it be IP or marketing intangibles or any other, it is a well-known fact that MNE’s today of any significant size are putting in lot of capital in Research and Development.

Although the term “Research and Development”(R&D) has not been specifically defined under the Domestic Tax Laws, yet all entities in India are entitled to deduction for research and development expenses. A definition of the term Research and Development has not been incorporated into the Income Tax Act per se but Scientific Expenditure as defined u/s 43(4) of the Income Tax Act 1961 “Scientific Research’ means any activity for the extension of knowledge in the fields of natural or applied science including agriculture, animal husbandry or fisheries;” (Deputy Commissioner of Income-tax (Asstt.) vs Mastek Ltd. (Gujarat High Court) Tax Appeal No. 242, 243 AND 263 OF 2000), which is more or less analogous with what a definition of R& D could be.

In the domain of International Taxation, it is generally the MNE’s who engage in research and development activities and they generally represent significant elements of cost, which are invariably in the domain of section 92C viz under and arm’s length price.

Explanation(i)(d) to section 92B provides that scientific research would be covered under the ambit of international transactions.

Section 92C inter alia provides for allocation of profits between associated enterprises on the basis of six approved methods

1. comparable uncontrolled price method;
2. resale price method;
3. cost plus method;
4. profit split method;
5. transactional net margin method;
6. such other method as may be prescribed by the Board.

For the sixth portion Rule 10(AB) prescribes as follows “10AB. For the purposes of clause (f) of sub- section (1) of section 92C, the other method for determination of the arm’s length price in relation to an international transaction 91[or a specified domestic transaction] shall be any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.]”

However, it is interesting to note that neither the rule nor the section provides for any preference to any method or any guidance on how and which criteria to use for an appropriate selection for transfer pricing. Furthermore, there was no clarity on what was the position of the state in matter of risk allocation as such.

The CBDT on its part came out with a circular number 06/2013 [F NO. 500/139/2012], DATED

29-6- 2013 for the purpose. It clarified Inter alia amongst others that

“The Research and Development Centres set up by foreign companies can be classified into three broad categories based on functions, assets and risk assumed by the centre established in India. These are:

1. Centres which are entrepreneurial in nature;
2. Centres which are based on cost-sharingarrangements; and

3. Centres which undertake contract research and development.

While the three categories are not water-tight compartments, it is possible to distinguish them based on functions, assets and risk. It will be obvious that in the first case the Development Centre performs significantly important functions and assumes substantial risks. In the third case, it will be obvious that the functions, assets and risk are minimal. The second case falls between the first and the third cases.”

In particular the circular clearly outlines that there is some leeway between all the three types and in particular the second type will have characteristics of both the first and second types. In the same circular the CBDT has noted the preference of the assessee to perform TP using the Transactional Net Margin Method (TNMM) as opposed to other more simpler traditional methods by classification of the R&D provider as a contract R&D provider with an insignificant risk. The CBDT then delves forward to provide for a guidance on how the same should be tackled in particular with reference to for identification of the Development Centre as a contract R&D service provider with insignificant risk.

The steps are outlined as below

1. The Foreign principal assumes most of the risks associated with the research and development and uses the Indian associated enterprise as a toll manufacturer, and the employees or associated companies of the Foreign Principal also remunerate the employees or the associate enterprise to carry out the tasks entrusted by the Foreign Principal.
2. The foreign principal or its associated enterprise(s) provides funds/capital and other economically significant assets including intangibles for research or product The personnel and other resources are also remunerated by the foreign Principal or is Associated Enterprises for the work done at the Contract R&D centre.
3. The Foreign principal exercises direct control and supervision over the R&D center, not only contractually but functionally too.
4. The contract R&D centre doesn’t take over any significant economic risk both contractually and functionally.
5. The Foreign Principal of the R&D centre isn’t located in a tax haven or a low tax
6. The R&D center doesn’t have any control over the final product and is contractually obligated to pass on the final product and any incidental benefits to the Foreign

It is only if all the criteria above are met that the R&D centre would be considered a low risk entity. The assessing officer shall be free to allocate the TP method considering all the facts and circumstances of the case.

Thus the regime of R&D as a contract toll manufacturer is well defined as per Indian Tax Laws.

GAAR regime will apply in case of R&D centres as well, so anti abuse rules would take an important part in determination of profits to be allocated to R&D centres.

Although, establishing R&D Centers by the way of PE is not illegal, they are generally not established as a PE just owing to the fact that it creates complications in the structure and tax compliance. Furthermore, it is highly likely that the Department of Scientific and Industrial Research would accord any recognition to it, and thus by extension no incentives might be provided to it. Therefore, it would make sense to incorporate and entity for R&D centres.

Super deductions u/s 35 are generally not available to PE’s , it might be made available for in case if some contribution is made to an approved scientific research association being an Indian Entity. Such a super-deduction would generally not be available to the PE if the contribution is made to a non-resident.

In India, certain R&D incentives are available to products manufactured through use of IP owned or leased by Indian owned companies. Thus, accordingly any transfer of an IP to a low tax jurisdiction or a tax haven would lead to a denial of benfits. Further, transfer pricing regulations apply in the case of transfer of IP or the right to use IP between associated enterprises. There are no specific statutory anti- avoidance rules with respect to such transfer. Indian law has introduced GAAR applicable from 1 April 2015.

It might be also noted that India does not have any “patent-box” regimes existing.

Thus in the case of MNE’s in the Indian context it appears that Taxation for Research and Development centers is more about transfer pricing and proper allocation of method rather than other factors.

In case of Intra group facilities the OECD Transfer Pricing Guidelines accept the same as in para 7.41 “Research is similarly an example of an activity that may involve intra-group services. The terms of the activity can be set out in a detailed contract with the party commissioning the service, commonly known as contract research. The activity can involve highly skilled personnel and vary considerably both in its nature and in its importance to the success of the group. The actual arrangements can take a variety of forms from the undertaking of detailed programmes laid down by the principal party, extending to agreements where the research company has discretion to work within broadly defined categories. In the latter instance, the additional functions of identifying commercially valuable areas and assessing the risk of unsuccessful research can be a critical factor in the performance of the group as a while. It is therefore crucial to undertake a detailed functional analysis and to obtain a clear understanding of the precise nature of the research, and of how the activities are being carried out by the company, prior to consideration of the appropriate transfer pricing methodology. The consideration of options realistically available to the party commissioning the research may also prove useful in selecting the most appropriate transfer pricing method.”

Courts in India have on various occasions stepped in to determine what an arms length could be in matters of allocation of research and development costs, either intra group or intra company and that comparables in such cases should be strict. Some of which are enumerated below:

1. DCIT [2022] 137 taxmann.com 246 (Bangalore – Trib.)[29-03-2022]
2. Where selected company performed research and development activities, said company was not functionally comparable to assessee, manufacturer Continental Automotive Components India (P.)
3. Where under Parent Subsidiary Agreement, assessee subsidiary Microsoft- India acted as a R&D service provider and parent Microsoft-USA supplied related intangibles and ownership right on outcome of research, vested with Microsoft-USA, assessee was a contract R&D service provider to Microsoft-USA – Microsoft India (R&D) (P.) Ltd. v. Deputy Commissioner of Income-tax, Circle-16(2), New Delhi – [2018] 97 taxmann.com 360 (Delhi – Trib.)[14-09-2018]
4. Where a company, engaged in carrying out research and development activities, had created large intangibles and earned revenue from different verticals, same was to be excluded from list of comparables to assessee-company, a captive service provider – Huawei Technologies India (P.) Ltd. v. ACIT ([2021] 133 taxmann.com 486 (Bangalore – Trib.)[22-07-2021])
5. A)Where comparable company was engaged in product engineering, acquisition and development, consultancy and solutions and also undertook significant research and development operations, approved by government, it would not be comparable to assessee company engaged in provision of software development services. b) Where comparable company engaged in diverse range of activities, owned high brand value and had also incurred significant expenses in foreign currency, it would not be comparable to assessee company engaged in provision of software development services – Finastra Software Solutions (India) (P.) Ltd. v. ACIT – [2022] 135 com 308 (Bangalore – Trib.)[21-12-2021]
6. A company engaged in pharmaceutical industry, having own intangibles, could be compared with assessee, rendering contract research and development service – Deputy Commissioner of Income tax, Circle-1(1) v. Akzo Noble Car Refinishes India (P.) Ltd ([2018] 90 taxmann.com 15 (Delhi – Trib.)[08-01-2018])
7. Where assessee was providing software research and development services to its AEs, a company engaged in diversified activities of software development, consultancy, engineering services, web development and hosting, was incomparable to assessee b) Where assessee was providing software research and development services to its AEs, a company engaged in business of software products was incomparable to assessee c) Where assessee had two divisions viz, software R&D division and marketing support division, TPO was justified in apportioning unallocated cost between both segments of assessee while making segmental analysis of both divisions – Trident Microsystems India (P.) Ltd – [2019] 111 com 100 (Bangalore – Trib.)[26-07-2019]
8. A company in business of clinical trial services is comparable to a company providing contract manufacture, contract research and development of drugs to its Associated Enterprises b) Where both comparables as well as assessee are situated in India, no adjustment of ALP on account of locational advantage is called for – PCIT vs. Watson Pharma (P.) Ltd. ([2018] 95 taxmann.com 281 (Bombay)/[2018]257 Taxman 65 (Bombay)[20-06-2018])
9. SLP dismissed against High Court ruling that where services rendered by assessee were specialized and required specific skill based analysis and research that was beyond rudimentary nature of services rendered by a BPO, it was to be held services provided by assessee constituted functions of a KPO MC Kinsey Knowledge Centre India (P.) Ltd. v. Principal Commissioner of Income-tax, Delhi-6 [2019]102 taxmann.com 439 (SC)/[2019] 261Taxman 451 (SC)[04-02-2019]