deeming fictions under income tax laws – various issues by milin mehta, vadodara

Deeming Fictions under Income Tax

Laws – Various Issues

By Milin Mehta, Vadodara

Tax Convention – DTC ICAI – 2015 - Rajkot

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“The power to tax involves the power to destroy”, warned Chief Justice John Marshall. To which, a centure later, the reply of Justice Holms was, “The power to

tax is not the power to destroy while this Court sits”. …..

Palkhiwala

• Tax laws, like all other laws, to be respected, must be made respectable,

• Laws, to be respectable, must be fair and intelligible, stable and simple; easy to administer and easy obey.

• Revenues rise with tax cuts; when income-tax is scaled up, income is scaled down.

• If there is widespread tax evasion, it may be more meaningful to search for the cause in the tax system than in the taxpayer.

• Enlightened administration is as assential as enlightened enactment, and it can be good recompense for a bad law.”

Deeming Fiction


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Interpretation of Deeming Fiction

• Purpose for which the Fiction was created and then assume all facts and consequences which are incidental or inevitable corollaries to give effect

• Cannot extend the effect beyond the purpose or beyond the language of the section

• The difference between the reality and the fiction may still persist outside the bounds of the fiction in the same Act and such difference should be ascertained with reference to the subject and context of the section

Subhash Chand v. Asstt. CIT [2012] 49 SOT 732

Deeming Fiction ..


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• Section 52 (2) introduced a concept of substitution of fair market value for the actual consideration received for computing capital gains when the FMV exceeded the actual consideration by more than 15 %.

• The provision was read down by the Supreme Court in the case of K. P. Verghese 131 ITR 597

– What in fact never accrued or was never received cannot be computed as capital gains U/s. 48.

– Therefore, it can be used only when there is evidence that actual consideration is actually understated then for determining the quantum of understatement, FMV can be used.

• The question is whether the ratio of K. P. Verghese applicable also for section 50 C / 43 CA?

Fate of Section 52 – Earlier Avtaar of 50C


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• Section 50 C applies only in cases where it is a capital asset and such capital asset is “land or building or both land and building”.

– Scope of Section 50 C is therefore limited to the same

– Land is a bundle of rights and individual rights separately are not land / building / both

– It is not land / building / any rights therein

• Transfer of Transferable Development Rights (TDRs) / FSI

– TDRs are held to be immovable properties. Would the same qualify to be land / building / both? Section does not use the concept of immovable property

• Giving Development right in the Land (Development Agreement)

– 2 (47)(v)/(vi) r.w. Chaturbhuj decision, it may amount of transfer U/S. 45

– Would it be covered by 50 C / 43 CA?

• Granting of Lease / Transfer of Leasehold Rights

Land / Building / Both


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• When a person receives consideration as a confirming Party

• Example

– A executes Agreement to Sale on 1.4.2000 in favour of B for Rs. 1.00 Cr. (Stamp Duty Value (SDV) on 1.4.2000 – 1.00 Cr.)

– Sale Deed is executed between A and C with B as confirming Party for Rs. 2.00 Crores on 1.4.2015 (SDV on 1.4.2015 is 2.50 Crores)

• Questions

– Whether any additional tax payable by either A or B?• Reference date for A (whether 1.4.2000 or 1.4.2015 for SDV), assuming

substitution of date permissible even for 50C

• B only transfers his right to purchase the land and not land

Confirming Party cases


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• If land / building is held through an SPV, being a private limited company

• Whether transfer of shares of such SPV will amount to transfer of land / building / both and thus covered by 50 C?

– Irfan Abdul Kader Fazlani & Others in ITA 8831/Mum/2011 – Sale of Shares were considered to be sale of building

– Lifting of corporate veil was not permitted.

– Vodafone case referred to

– However, important factor which weighed was that the company was formed several years ago and the asset was also held for several years

• The above decision may not be considered as view that corporate veil cannot be lifted at all

• Pure SPV formed exclusively for holding land / building ???

Underlying Asset being Land / Building


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• Business as a whole is sold as a going concern for a lump sum consideration

– This may include land and building

– Book value of such land and building could be significantly lower than market value

– Total consideration for the undertaking itself could be less than individual value of land / building / both

– Whether Section 50 C can be invoked

• Section 50 C applies when there is a transfer and such transfer is of land / building / both

– Sale of undertaking as slump sale is not sale of each of underlying asset separately

– However, it should fall within the definition of “Undertaking” U/s. 2 (19AA)

Slump Sale Cases


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• If the Assessee does not object before the AO in terms of Section 50 C (2) AO is not obliged to make a reference to the DVO Ambattur Clothing Co. Ltd. [2010] 326 ITR 248 (Mad), Sanjaybhai Z. Patel [2011] 48 SOT 231 (Ahd)

• Once the Assessee objects to the SDV, AO has to to make reference to the DVO. Ajmal Fragrances and Fashions Pvt. Ltd. 34 SOT 57 (Mum), Manjula Singhal [2011] 46 SOT 149 (Jodh)..

• Once the DVO gives his valuation, the AO cannot disregard the value given by the DVO. Bharti Jayesh Sanghani [2011] 128 ITD 345 (Mum).

• If the Purchaser has objected to the SDV before the stamp authorities it does not still debar the seller to object to the said valuation before the AO. B. N. Properties Holdings Pvt. Ltd. [2010] 6 ITR (Trib) 1 (Chennai).

Reference to DVO


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• Section 45 (3) and Section 50 C

– Whether the SDV can be substituted in cases where the asset is introduced as capital contribution by the Partner if the amount credited to the capital account of the partner is less than the SDV

• Canoro Resources 180 Taxman 220 – Transfer Pricing Vs. 45 (3)

• Section 50 Vs. Section 50 C

– If a building being a depreciable asset is disposed off at a value which is less than the SDV, whether S 50 C will apply

– Section 50 only substitutes the cost of acquisition and not the full value of consideration

– Limited deeming fiction

– United Marine Agencies [2011] TIOL 266 (Mum)(SB) held that S 50 does not debar application of Section 50 C

Deeming Fiction over Deeming Fiction


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• If actual consideration is substituted with SDV, impact on Section 54 / 54 F / 54 EC

– Section 54 and 54 EC, the exemption is granted with reference to capital gains and not with reference to “net consideration”

– Therefore, increased consideration to be taken into account for considering the eligibility U/s. 54 / 54 EC.

• Case of 54 F

– Deduction granted in proportion of investment in new asset made to the “net consideration”;

– “net consideration” defined in explanation to S 54 F (1)

– Section 50 C uses the term “for the purpose of section 48” and therefore does not extend to 54F

50 C & Sec. 54 / 54 F / 54 EC, etc.


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• Introduced w.e.f. 1.4.2014 (applicable for AY 2014-15)

• Provisions of 43 CA and 50 C are in pari materia, save and except:

– 50 C applies when the transferor holds the asset as “capital asset”, whereas in 43 CA applies when he holds it as “stock-in-trade”

– Concept of substitution of date of agreement (if earlier than the date of transfer) is available, provided part of the consideration is paid otherwise than by cash either prior to or at the time of execution of such Agreement.

• Primarily covers the cases of real estate developers, land dealers, etc.

• The cases where a capital asset was converted into SIT immediately prior to transfer would also be covered

• Protection of deeming fiction U/s 45 (3) not applicable

Section 43 CA


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• Agreement need not be registered

• Agreement is not a “contract”

– Booking receipt where the terms and conditions are agreed, though not converted into agreement to sale would also be covered

– Booking letter / receipt which does not specify the consideration will not be eligible

• Consideration or any part thereof is received “by any mode otherwise than by cash”

– The concept is wider than by “crossed account payee cheque / draft”, etc.

– Can book entries be covered? i.e. a receivable be converted into booking advance?

– Can receivable of one person be, by exchange of letter, treated as booking advance of another person?

Agreement for substitution of Date of SDV


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• Has received renewed focus of the tax department

• In cases of group companies there could be several instances of deemed dividends and the implication could be very heavy

• Ingredients:

– Company in which public are not substantially interested (Closely held company)

– Payment of any sum by way of advance or loan

– To • a shareholder holding not less than 10 % of voting power; or

• to a concern in which such person is a member or a partner and in which he has substantial interest;

– To the extent to which the Company possesses accumulated profits

– Also covers cases of such company making payment on behalf of or for individual benefit of such shareholders

• 115 O is not applicable to Deemed Dividend U/s. 2 (22) (e)

Deemed Dividend 2 (22)(e)


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• Company as defined in Section 2 (17) will also include foreign company;

– Any Indian Company [2(26)]

– Any body corporate incorporated by or under the laws of country outside India; or

– ….

– Any institution, association or body declared as a company;

– Gautam Sarabhai 52 ITR 921 (Guj)

• Indian subsidiary (not being a private company) of a foreign listed company can be considered as a widely held company, provided

– There is a DTAA with the country of which the holding company is a tax resident;

– The DTAA has appropriate Non-Discrimination Clause

Company


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• Basic Conditions

– It has to be a payment

– Payment has to be of a sum

– As an Advance or Loan

• Payment means actual physical payment – mere creation of debtor credit liability is not sufficient - G Venkataraman 101 ITR 673 (Mad); Parle Plastics Ltd. 196 Taxman 62 (Bom)

• Repayment of the loan not relevant – Smt. Tarulata Shyam 108 ITR 345 (SC)

• Trade Advances / Advances in ordinary course of business not covered Raj Kumar 181 Taxman 155 (Delhi); Ambassador Travels 318 ITR 376 (Delhi)

– Also Abubucker 135 Taxman 77 (Mad) – Advance Rent / Rent Deposit considered; Sunil Chopra 201 Taxman 316 (Delhi) – Advance for Property treated as Advance

Payment


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• Shareholder must be a registered as well as beneficial shareholder – Shakuntala 43 ITR 352 (SC); Rameshwarlal Snwarmal 122 ITR 1 (SC); Bhaumik Colour Pvt. Ltd. 118 ITD 1 (Mum) (SB); H. K. Mittal 219 ITR 420 (All)

– Partner and Partnership Firm

– Trustee and the Beneficiaries

– HUF and Karta

• No concept of directly or indirectly or jointly with relatives, etc. Individual shareholding has to be more than 10 %

• Even in case where the payment is to a concern in which such shareholder is interested, the tax is to be paid only by the shareholder and not by the concern to which payment is made. - Universal Medicare Private Limited, 324 ITR 263 (Bom)

– Delhi High Court – National Travel Service - ITA Nos. 223, 219, 1204 & 309 of 2010 [Firm and Partner are the same] Cotra CIT vs. Raj Kumar Singh 295 ITR 9 (All)

A Shareholder


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• Profits upto the date of payment is to be seen / considered

– Accumulated Profits does not mean profits accumulated upto the end of the immediately preceding year

• Commercial profits are to be considered

– Taxable Profits (due to deeming fiction or otherwise) or tax losses (due to depreciation or incentive provisions, etc.) has no relevance for determination of accumulated profits

– P. K. Badiani v. CIT (1976) 105 ITR 642 (SC)

• Distribution / Deemed dividend so considered earlier is to be reduced - CIT v. G. Narasimhan (1979) 118 ITR 60 (Mad)

Accumulated Profits


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• Section 56 (2) (vii)

– Concept used is “without consideration” and not “without consideration in money or money’s worth” as was used under the Gift Tax Act S. 2 (xii). Relevance of the difference.

– Gift to “individual” or “HUF” only covered. Whether a Gift to a Private Discretionary Trust consisting of individuals as beneficiaries and more than one trustee will be covered?

– Whether the Asset should be “capital asset” in the hands of the donor or donee?

• Section 56 (2) (vii) and shares of a foreign company

– If the shares of a foreign company, which derive its value significantly from assets situated in India, is transferred at lower than book value, then the same also will be covered by the provisions of Section 56 (2) (vii)

• Section 56 (2) (vii) and ESOPs – Whether Section 17 (2) (vi) will apply or Section 56 (2) (vii)?

Other Topics


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• Sudhir Menon HUF TS-146-ITAT-2014 (Mum) held that the shares acquired under the right issue is not covered by the provisions of Section 56 (2) (vii):

– Allotment of fresh shares of the Company are covered. Section 56 (2) (vii) does not only cover cases of purchase / transfer of shares;

– Proportionate allotment of shares to the shareholders does not impact taxation as there is no income

• Exemptions from Section 56 (2)(vii)

– Gift from a relative [Whether definition is two way or one way]

– On the occasion of marriage of the individual

– Under a will or by way of inheritance

– In contemplation of death of the payer or donor

– From any local authority, fund or foundation U/s. 10 (23C)

– Trust or institution registered under 12 AA [No place for foreign charity]

Section 56 (2) (vii) ….


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• We feel that these are absurd provisions and create hardship to the Assessees

“Toute nation a le gouvernement qu‘elle mérite”

French Philosopher Joseph de Maistre in 1811

Meaning

Every Nation has the Government it deserves

Or

Every Nation has the Government it is fit for

Section 56 (2) (vii) / (viia) / (viib)

Thank You

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deeming fictions under income tax laws – various issues by milin mehta, vadodara

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