Income-tax Issues in the Gem & Jewellery Industry

Abstract

The Article aims at discussing some of the pertinent income-tax issues prevailing in the Gem & Jewellery industry. The article will be useful for businesses, consultants, chartered accountants and advocates connected with the Gem & Jewellery industry. The Article considers and analyses important judicial pronouncements relevant to the Gem & Jewellery industry.

Table of Contents

Abstract

Introduction
The Income-tax Law
- Businesses
- Investors/Users
Issues for consideration
- Associations in the Gem & Jewellery Industry
- Special Economic Zones & Export Oriented Unites
- Bogus Purchases & Unexplained Income
- Certain Deductions
- Transfer Pricing
- Chapter VI-A Deductions
- Treatment of Wastage
- Survey, Search & Seizure cases
Dénouement

1. Introduction

In January 2021, India’s gold & diamond industry added approximately 7.5 percent to India’s GDP & 14 percent to India’s total produce exports, the gem & jewellery segment is likely to employ approximately 8.23 Mn people by 2022, from approximately 5 Mn in the year 2020. According to MMR study report, the Indian Gem & Jewellery market was valued at

25.30 Bn in the year 2020 with a CAGR of 18.46 per cent over past five years.

According to the data for 2020, Indian women currently own 21733 tonnes of gold. This is approximately 11 percent of the Worlds gold. Further, diamonds were first mined in India, For centuries, India was the only place one could find these precious stones. The earliest known reference to diamond is a Sanskrit manuscript, dated from 320-296 B.C. This shows the history of India vis-à-vis the Gem & Jewellery Industry.

Given the precious nature of stones and ornaments. These are always in the radar of the Income-tax Department, as such precious stones and gold bars can be misused to conceal income.

2. The Income-tax Law

2.1. Businesses

Taxpayers engaged in the business of trading, manufacturing, mining, processing, cutting, polishing et cetera of gem and jewellery have to offer the income under the head “Profits & Gains from Business or Profession”

Where the business is a Partnership Firm or a Limited Liability Partnership, the profits will be taxed at the rate of 30 per cent plus applicable surcharge and cess.

In case of a Company, the applicable rate shall be 25 per cent plus applicable surcharge and cess. A domestic company, subject to conditions mentioned under section 115BAA of the Income- tax Act, 1961(Act) can avail the reduced tax rate of 22 per cent plus applicable surcharge and cess. Similarly, a domestic company satisfying the conditions mentioned under section 115BAB of the Act can avail the reduced tax rate of 15 per cent plus applicable surcharge and cess.

Vide Finance Act, 2012, (2012) 345 ITR (St) 001 section 206C(1D) of the Act was introduced. According to the Memorandum explaining the provisions of the Finance Bill, 2012 (2012) 342 ITR (St) 234, Under the existing provisions of the Income-tax Act, tax is required to be collected at source by the seller at the specified rate on certain goods like alcoholic liquor, tendu leaves, scrap etc. at the time of sale. In order to reduce the quantum of cash transaction in bullion and jewellery sector and for curbing the flow of unaccounted money in the trading system of bullion and jewellery, it is proposed to provide that the seller of bullion and jewellery shall collect tax at the rate of 1 per cent of sale consideration from every buyer of bullion and jewellery if sale consideration exceeds two lakh rupees and the sale is in cash. This would be irrespective of the fact whether buyer is a manufacturer, trader or purchase is for personal use.

2.2. Investors/Users

Prior to the amendment of 1972, “jewellery” was not an exclusion to “personal effects”, thereby not covered under the definition of “Capital Asset”.

Post amendment, as per section 2(14) of the Act, “jewellery, other than stock in trade, is considered as a capital asset. As per explanation 1 to section 2(14) (ii) of the Act, “jewellery” includes—

ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals, whether or not containing any precious or semi-precious stone, and whether or not worked or sewn into any wearing apparel;
precious or semi-precious stones, whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel;

The Hon’ble Supreme Court in the case of H.H. Maharaja Rana Hemant Singhji v. CIT [1976] 103 ITR 61 (SC) on a close scrutiny of the context in which the expression ‘personal effects’ occurs shows that only those effects can legitimately be said to be personal which pertain to the assessee’s person. In other words, an intimate connection between the effects and the person of the assessee must be shown to exist to render them ‘personal effects’. The enumeration of articles like wearing apparel, jewellery, and furniture mentioned by way of illustrations in the definition of ‘personal effects’ also shows that the Legislature intended only those articles to be included in the definition which were intimately and commonly used by the assessee.

The Hon’ble Madras High Court in the case of CIT v. Smt. Saroj Goenka [1983] 140 ITR 88 (Mad) held that loose diamonds could be said to be ‘personal effects’ held by the assessee so as not to attract capital gains tax on their sale.

Therefore, where jewellery is held for more than 36 months from the date of purchase, the same will attract Long term Capital Gains tax and where it is held for less than 36 months, the same will attract Short-term Capital Gains.

Further, it is important to note that, jewellery is included in the definition of property for the purpose of section 56 (2)(x) of the Act which is an anti-abusive provision. Therefore, transfer/ gift of jewellery to any person other than a relative as defined under section 56 of the

Act, for no consideration (gift) or for a short consideration of more than Rs. 50,000/- will attract section 56(2)(x) in the hands of the recipient.

3. Issues for consideration

Some of the issues and controversies pertaining to Income-tax in the Gem & Jewellery Industry are as under:

3.1. Associations in the Gem & Jewellery Industry

As per section 2(15) of the Act, charitable purpose, inter alia, subject to certain conditions, includes he advancement of any other object of general public utility.

The Hon’ble Madras High Court in the case of ACIT v. Madras Jewellers & Diamond Merchants Association [1981] 129 ITR 214 (Mad)(HC) held that where the Assessee association was established for protecting, safeguarding, guiding and furthering interest and welfare of merchants dealing in diamonds, bullion, jewellery, etc., and to create and encourage friendly feeling and unity amongst merchants, the Assessee claimed exemption in respect of income received from survey charges, weighment charges and charges for arbitration; since activities carried on by assessee were for benefit of general public and those were not conducted with a view to make profits assessee was therefore entitled to exemption under section 11 of the Act.

The Hon’ble Bombay High Court in the case of DIT(E) v. Bharat Diamond Bourse [2000] 245 ITR 437 (Bom)(HC) where it was a matter of fact that as a result of setting up of assessee bourse there was substantial increase in diamond exports leading to increased earning of foreign exchange for the country, its predominant activity was to be held to be promotion of trade which was object of general public utility and, therefore, charitable within meaning of section 2(15) of the Act and since it restricted application of its income to its objects only, it was entitled to exemption under section 11 of the Act. However,

the Hon’ble Supreme Court in the case of DIT(E) v. Bharat Diamond Bourse (2003) 259 ITR 280 (SC) held that the Assessee whose principal object was to facilitate diamond trade so that maximum revenue could be earned by way of foreign exchange by the trade and also to make diamond trade more competitive at international level, was an institute established for charitable purpose. Amount lent to without interest will lose the benefit of exemption

The Hon’ble Bombay High Court in the case of DIT v. Bombay Bullion Association Dharamno Kanto Trust [2002] 254 ITR 708 (Bom)(HC)

where Assessee-trust was earning income from weighing activities, popularly known as Dharam Kanta for benefit of public in general; business activities of trust were carried on with assistance of employees under supervision of Committee of Management appointed by Board of directors, who acted for and on behalf of beneficiaries, namely, general public or public at large; it could be said that business activities carried on in manner provided in trust deed were being carried on by beneficiaries of trust, being public, and, thus, there was sufficient and substantial compliance of provision of sub-section (4A)(b) of section 11 of the Act and such assessee-trust was entitled to exemption under section 11(4A) of the Act.

The Hon’ble Income-tax Appellate Tribunal

– Surat Bench in the case of ACIT v. Gujarat Hira Bourse [2021] 130 taxmann.com 355 (Surat- Trib.) Where assessee trust was established with objective to develop world class gems and jewellery park to provide common facilities required to promote exports of diamonds from India and it was not carrying out any trade, commerce or business and only dealt with its members to attain its objects of general public utility, it would not be hit by first proviso to section 2(15) of the Act, hence, benefit of section 11 of the Act could not have been denied.

The Hon’ble Income-tax Appellate Tribunal – Mumbai Bench in the case of Bharat Diamond Bourse v. DIT(E) [2017] 83 taxmann.com 134 (Mumbai) where there was no change in activities of assessee diamond bourse established for promoting diamond export, its registration could not be cancelled on ground that its business receipts exceeded monetary limit specified in proviso to section 2(15) of the Act; conditions specified under section 12AA(3) of the Act was to be fulfilled.

3.2. Special Economic Zones & Export Oriented Unites

In February 2021, India’s gold and diamond export contributed to 14 percent of total merchandise export. Further, the Government has also considered gems and jewellery sector as a focus area for export promotion. A lot of the manufacturing and other ancillary activities pertaining to gems and jewellery are set up in free trade zones.

Firstly, It is pertinent to note that Section 10 AA of the Act was inserted by the Special Economic Zones Act, 2005, with effect from February 10, 2006. Further, Section 51(1) of The Special Economic Zones Act, 2005 (SEZ Act) gives an overriding provision over other laws.

The rule of generalia specialibus non derogant, it is a well settled position in law. i.e. the provisions of a general statute must yield to those of a special one. The same has been upheld by the Hon’ble Supreme Court in the case of Union of India v. India Fisheries (P.) Ltd. [1965] 57 ITR 331 (SC) wherein it was held that If there is an apparent conflict between two independent provisions of law, the special provision must prevail.

The Hon’ble Income-tax Appellate Tribunal – Mumbai Bench in the case of Gitanjali Exports Corpn. Ltd. v. ACIT ITA Nos. 6947 & 6948 of 2011, dated May 8, 2013 (Mumbai-Trib) where the assessee was allowed deduction under Section 10AA of the Act on “Trading activities” as same is covered by definition of “Services” in the SEZ Act.

Similarly, the Hon’ble Income-tax Appellate

Tribunal – Jaipur Bench in the case of DCIT v. Goenka Diamond & Jewellers Ltd [2012] 19 taxmann.com 91 (Jaipur) where the assessee-firm was engaged in the business of trading and manufacturing of precious and semi-precious stones, diamond and studded gold jewellery. It claimed deduction under section 10AA of the Act in respect of profits from the Surat unit. It was held that deduction under section 10AA of the Act is available in respect of trading in nature of re-export of imported goods.

The Hon’ble High Court of Delhi in the case of CIT v. Jayshree Gems & Jewellery [2014] 49 taxmann.com 43 (Delhi) held that Process of jewellery making through job work amounts to manufacturing for purpose of section 10A of the Act.

The Hon’ble Bombay High Court in the case of CIT v. Gem Plus Jewellery India Ltd [2011]

330 ITR 175 (Bom)(HC) [Affirmed by the Hon’ble Supreme Court in the case of CIT v. HCL Technologies Ltd. [2018] 93 taxmann.com 33 (SC)] where it was held that for purpose of application of formula prescribed by section 10A(4) of the Act, export turnover in numerator must have same meaning as export turnover which is a constituent element of total turnover in denominator. Since in computing export turnover Legislature has made a specific exclusion of freight and insurance charges, these two items would have to be excluded from total turnover also for purpose of computing exemption under section 10A of the Act.

The Hon’ble High Court of Madras in the case of PCIT v. Jewels Magnum [2020] 120 taxmann. com 316 (Mad)(HC) held that A medallion is also classifiable as a pendant; therefore, assessee could not be denied exemption under section 10AA of the Act on ground that it had violated approval granted by Development Commissioner, Special Economic Zone for manufacturing gold pendants by saying that product manufactured by assessee was described as medallion

The Hon’ble Income-tax Appellate Tribunal

-Mumbai Bench in the case of Inter Classic Jewellery (I) (P.) v. ITO [2008] 114 TTJ 402

(Mumbai) where during relevant assessment year, assessee in addition to manufacture of jewellery undertook manufacturing activities for others on job-work basis and received service charges. The Revenue authorities excluded service charges from export turnover holding that said income earned by assessee could not be held to be income from manufacturing activity and, therefore, exemption under section 10A of the Act was not available to said income of assessee. It was held that since there was no difference between activities relating to export business carried on by assessee and process carried on by it for manufacturing jewellery for others under job-work contracts, authorities below were not justified in denying exemption to assessee under section 10A of the Act in respect of service charges.

3.3 Bogus Purchases & Unexplained Income Bogus purchases are illegal means by which, tax payers inflate their expenses, thereby reducing taxable The Central Board of Direct taxes vide Instruction No. 2 of 2008, dated August 22, 2008 has directed all the AOs to accept profit of 6 percent in diamond business.

The Hon’ble Income-tax Appellate Tribunal – Mumbai Bench in the case of DCIT v. Lucent Diamond [2021] 128 taxmann.com 262 (Mumbai

– Trib.) held that where the assessee failed to produce any of suppliers to confirm transactions of purchases shown by it, however, at same time, assessee was in possession of purchase invoices and ledger confirmation as well as PAN of suppliers was also placed on record and payment to suppliers was made through banking channels, Commissioner (Appeals) was justified in restricting addition at rate of 6 per cent on account of bogus purchases.

The Hon’ble Income-tax Appellate Tribunal –

Delhi Bench in the case of ACIT v. PC Jewellers Ltd. [2022] 137 taxmann.com 71 (Delhi – Trib.) where assessee purchased diamonds through commission agent from various parties and Assessing Officer made addition on purchases, as income of assessee on account of inflation of purchase price of diamonds on purchases from accommodation entry providers, Commissioner (Appeals) having considered quantitative details, stock and payment made by assessee with regard to these purchases and retraction letter of alleged entry operator with regard to accommodation of purchase bills having been filed, Commissioner (Appeals) rightly held that disallowance made by Assessing Officer was not valid.

The Hon’ble High Court of Gujarat in the case of Sajani Jewels v. DCIT [2016] 71 taxmann.com 90 (Gujarat) where source of expenditure was very much available since in reasons recorded itself, Assessing Officer pointed out that purchases were made by making cheque payments, section 69C of the Act had no applicability.

The Hon’ble ITAT Ahmedabad Tribunal in the case of Chokshi Hiralal Maganlal v. DCIT [2011] 9 taxmann.com 300 (Ahmedabad – ITAT) where during a survey under section 133A, excess stock of gold and silver ornaments was found. Assessee filed its return wherein excess stock found during survey was included in inventory of closing stock. Assessing Officer opined that said disclosure was not consistent with provisions of sections 69, 69A, 69B & 69C of the Act. Taking above view, Assessing Officer separately added amount of excess stock under section 69B of the Act after reducing same from total income disclosed by assessee. It was held that since excess stock found during survey was not separately and clearly identifiable but was part of mixed lots of stock found at premises which included declared stock as per books also, provisions of section 69B of the Act could not be made applicable and therefore, investment in excess stock had to be treated as business income.

3.4. Certain Deductions

The following are instances of certain deduction or expenses which have been a subject matter of litigation:

Hon’ble Income-tax Appellate Tribunal –

Mumbai Bench in the case of Ramesh D. Murpana v. ACIT [2016] 71 taxmann.com 218 (Mumbai) where the Assessee was engaged in business of dealing in gold and diamond jewellery, He borrowed certain amount for advancing security deposit for taking a shop on leave and license basis on monthly license fee for setting a jewellery outlet as an expansion of existing business and claimed interest on such loan as deduction. It was held that interest on borrowing was incurred for purpose of business and was an allowable revenue expenditure.

Hon’ble Income-tax Appellate Tribunal

-Mumbai Bench in the case of DCIT Tribhovandas Bhimji Zaveri [2008] 23 SOT 57 (Mumbai) (URO) where the Assessee-firm claimed deduction of foreign travel expenses incurred on its employees for business of firm, The Assessing Officer disallowed assessee’s claim mainly on ground that assessee-firm was not engaged in export of jewellery and it was a business leader, thus, there was no requirement for such foreign travel. The Ld. Commissioner (Appeals), however, allowed assessee’s claim – The Tribunal held that, even though assessee was a business leader in this line, yet same position could not be maintained unless assessee was aware of latest technologies and designs for jewellery manufacturing, therefore, expenditure incurred on foreign travel in said connection was rightly allowed as business expenditure.

Hon’ble Income-tax Appellate Tribunal – Mumbai Bench in the case of Brightest Circle Jewellery (P.) Ltd. v. ACIT [2012] 24 taxmann.com 130 (Mumbai) where owner of brand of diamond licensed it to another company which in turn sub-licensed it to assessee and assessee sold diamond under said brand name, payments made by assessee to intermediary towards

sales promotion expenses would be revenue expenditure.

Hon’ble Income-tax Appellate Tribunal – Mumbai Bench in the case of Fine Jewellery (India) Ltd. v. ACIT [2013] 30 taxmann.com 323 (Mumbai – Trib.) [affirmed by the Hon’ble Bombay High Court in the case of CIT v. Fine Jewellery (India) Ltd. [2015] 55 taxmann.com 514 (Bom)(HC)] held that Expenditure incurred by assessee, a jeweller, on creation of brand was rightly allowed as deferred revenue expenditure.

3.5. Transfer Pricing

It is known that there is a practical difficulty in furnishing segment wise Profit & loss account of AE segment and non-AE segment in the diamond industry.

If Ld. TPO was not satisfied with benchmarking of assessee under TNMM, nothing prevents them from rejecting assessees’s benchmarking and determining arm’s length price of transaction with AEs independently by applying any one of prescribed methods. However, if the Ld. TPO has accepted benchmarking of assessee under TNMM, imposition of penalty under section 271G of the Act is to be deleted.