Is slump exchange taxable as slump sale; the debate continues

Recently, the Hon’ble Madras High Court in the case of M/s Areva T&D India Ltd v CIT has given a ruling that transfer of an undertaking wherein shares were issued as consideration would not be taxable u/s 50B of the Act.  

Facts of the case

The facts of the case were that the assessee had transferred its Non-Transmission and Distribution business (non T & D business) to its subsidiary company namely M/s.Alstom Industrial Products Limited for a total consideration of Rs.413 million being the fair value of the non T & D business as determined by the valuers by their joint report dated 05.1.2006. As per the net worth of the undertaking worked out to Rs.29,33,04,531/-, that the capital gains arising out of the transfer worked out to Rs.11,96,95,469/-, that after setting off the long term capital loss of the earlier years amounting to Rs.1,78,27,854/-, the taxable capital gains for the assessment year worked out to Rs.10,18,67,615/-. 

The assessee contended that the aforesaid gain was not taxable as the transfer of undertaking as the transfer of non T & D business was by way of a scheme of arrangement under Sections 391 and 394 of the Companies Act, 1956 and could not be considered as a ‘sale of business’ and that any transfer of an undertaking otherwise than as a result of sale will not qualify as a slump sale and thus, the provisions of Section 50B of the Act could not be applied to their case. 

The lower authorities including the Tribunal did not agree with the contention of the assessee and the matter reached ultimately reached to the Madras High Court.

Decision of the High Court

The Hon’ble Court noted that in terms of section 50B of the Act, any profits or gains arising from slump sale shall be chargeable to income tax as capital gains arising from the transfer of long term capital assets and shall be deemed to be the income of the previous year in which the transfer took place. 25. Section 2(42C) of the Act defines the expression ‘slump sale’ to mean the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.

Section 2(47) of the Act defines the term ‘transfer’ in relation to capital assets and it is an inclusive definition, which includes i. sale, exchange or relinquishment of an asset; ii. extinguishment of any rights; iii. compulsory acquisition; iv. conversion of asset as stock in trade of a business; v. maturity or redemption of zero coupon bonds; vi. any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882; vii. any transaction, which has the effect of transferring or enabling the enjoyment of any immovable property. 

The Court noted that the argument of the Revenue was that plea of the assessee that the transaction was not a slump sale, but an exchange would also be covered within the definition of the expression ‘transfer of capital asset’ because it is an inclusive definition and transfer includes exchange. Therefore, it would fall within the definition of the expression ‘slump sale’ as defined under Section 2(42C) of the Act and consequently, Section 50B of the Act would stand attracted. 

The Court further noted that admittedly, the word ‘sale’ is not defined under the Act. Therefore, necessarily one has to rely upon the definitions in the other Statutes, which define the word ‘sale’. Section 54 of the Transfer of Property Act, 1882 defines the word ‘sale’ to mean a transfer of ownership in exchange for a price paid or promised or part paid and part promised. The word ‘price’ is not defined either under the Income Tax Act, 1961 or under the Transfer of Property Act, 1882, but is defined under Section 2(10) of the Sale of Goods Act, 1930 to mean money consideration for the sale of goods. Therefore, to bring the transaction within the definition of Section 2(42C) of the Act as a slump sale, there should be a transfer of an undertaking as a result of the sale for lump sum consideration. Therefore, necessarily the sale should be by way of transfer of ownership in exchange of a price paid or promised or part paid and part promised and the price should be a money consideration. If there is no monetary consideration involved in the transaction, then it would be not possible for the Revenue to bring the transaction done by the assessee within the definition of the term ‘slump sale’ as defined under Section 2(42C) of the Act. 

The Court also referred to Section 118 of the Transfer of Property Act, 1882 which defines the term ‘exchange’ by stating that when two persons mutually transfer the ownership of one thing for the ownership of another, neither thing nor both things being money only, the transaction is called an exchange. 

The Court then referred to the decision of the Bombay High Court in the case of CIT Vs. Bharat Bijlee Ltd. reported in (2014) 365 ITR 258]. In the said case, there was a transfer of lift division and the assessee claimed it to be an exchange and not a sale. The Assessing Officer held that the transaction would squarely fall within the definition of the expression ‘slump sale’ under Section 2(42C) of the Act. This order was confirmed by the CIT(A), which was reversed by the Tribunal. Challenging the same, the Revenue was on appeal before the Bombay High Court and relied on the decision of the Delhi High Court in the case of SREI Infrastructure Finance.

The Bombay High Court distinguished the decision in the case of SREI on the fact that in that case the consideration for transfer was a combination of money and shares whereas in the case before the Bombay High Court the consideration was only on account of issue of shares and held that a transaction of exchange is outside the purview of slump sale.      

The Madras High Court then referred to the decision of the Apex Court in the case of Motors and General Stores Pvt. Ltd. to explain the meaning of the term ‘consideration’. The Hon’ble Supreme Court observed that there was an exchange of properties described for 5% tax free cumulative preference shares of the company and the valuation was done for the purpose of stamp duty and in essence, the transaction was one of exchange and there was no sale of the properties for any monetary consideration. Accordingly, the Apex Court held that ‘consideration for transfer’ cannot be said to be sale in case of exchange of properties.  

The Madras High Court finally relied upon the judgement of the Apex Court in the case of State of Madras Vs. Gannon Dunkerley & Co. (Madras) Ltd. [reported in 1959 SCR 379] wherein it was held that in order to constitute a sale, it was necessary that there should be an agreement between the parties for the purpose of transferring title to goods, which, of course, presupposed capacity to contract, that it must be supported by money consideration and that as a result of the transaction property must actually pass in the goods and unless these elements were present, there could be no sale. Thus, if merely title to the goods passed but not as a result of any contract between the parties, express or implied, there was no sale. 

Relying upon the aforesaid judgement the Madras High Court held that the transfer, pursuant to approval of a scheme of arrangement, is not a contractual transfer, but a statutorily approved transfer and cannot be brought within the definition of the word ‘sale’ and accordingly decided the matter in favour of the assessee. 

With the aforesaid judgement of the Madras High Court, the balance tilts in favour of the fact that a slump exchange pursuant to a court recognised scheme is not a slump sale. Be that it may, if one were to read the proviso and sub-section (1) to Section 50B together and in a harmonious way, it is clear that it applies to all types of “transfers” that can be categorized as a “slump sale”. Sub-section (2) to Section 50B of the Act also refers to transfer of an undertaking or division by way of sale i.e. “slump sale” and prescribes the mode of computing and calculating capital gains on such transactions. 

Taxpayers can definitely take benefit of this ruling, but my sense is that very soon the definition of slump sale would be changed to negate the aforesaid decision. 

Importance of Form 26AS in ITR filing process

Form 26AS is an annual statement which has details of the tax credited against the PAN of a tax payer. This form can be accessed from the Income Tax Department’s e-filing portal by a tax payer using his/her Permanent Account Number (PAN). You can refer to your Form 26AS for details of your income (on which taxes have been deducted) as well as the taxes that have been paid by or on your behalf by the deductor (could be your employer, bank etc.) to the government treasury.

The Form 26AS, i.e., one’s tax passbook, will come with a few rather significant changes this year. Along with a new format, effective from June 1, 2020, your Form 26AS will now contain information regarding tax refunds and demands (if any) against your name. These changes were notified by the government via a notification dated May 28, 2020.

The government introduced section 285BB in the Income-tax Act, 1961 via Finance Act  2020 and inserted a new Rule,  114- I via a notification dated May 28, 2020 for making changes in Form 26AS.

In its new avatar, the Form 26AS will become a potent tool in the hands of the tax authorities, which is why it is important for a tax payer to know about these changes. 

What is new in the Form 26AS

From an Annual Tax Statement, the new Form has now become an Annual Information Statement. The old Form contained information only about details of tax deducted at source (TDS) against your PAN, tax collected at source (TCS) on your PAN and details of other taxes paid. The new Form 26AS has two parts: Part A and Part B. 

Part A of the Form contains general information about the tax payer against the following fields:

  1. Permanent Account Number 
  2. Aadhaar Number 
  3. Name
  4. Date of Birth/Incorporation 
  5. Mobile number 
  6. Email address 
  7. Address

It is important to note that the new Form contains a field for mobile number and email address of the tax payer which hitherto was not captured. This indicates the importance of the mobile number and email address in the scheme of things where all correspondence with the tax authorities will be done only through a faceless mechanism.      

Part B of the Form contains the following information:

1. Information relating to tax deducted or collected at source 

2. Information relating to specified financial transactions (SFT)

3. Information relating to payment of taxes 

4. Information relating to demand and refund 

5. Information relating to pending proceedings 

6. Information relating to completed proceedings 

7. Any other information in relation to sub-rule (2) of rule 114-I

Information against point numbers 1, 3 and 4 continue to be the same as in the earlier form and therefore the focus of this article is on the information sought to be disclosed in the Form against other items that have been inserted.

Verification of details in 26AS vis-à-vis TDS certificates

While 26AS is your tax passbook but just like a bank passbook, it could have unintended errors.. Therefore, while preparing your ITR you must tally the income details and tax deducted shown in the Form 26AS with the details as per your records. If there is a mismatch in either the quantum of income or the TDS then this should be brought to the notice of the deductor who would have to revise the TDS return basis which the entry in your 26AS will get rectified. 

This exercise is required to avoid any enquiry from the tax department in case of a mismatch between your return and the Form 26AS. The reasons for mismatch could be amount of tax deducted from salary is not correctly reported by the employer, TDS deduction is reported in wrong section, incorrect PAN being punched in the TDS return by the deductor or even as a result of an incorrect PAN inadvertently being given by you to the deductor.

Information relating to specified financial transactions

Rule 114E of the Rules read with Section 285BA of the Income-tax Act casts an obligation on different categories of persons to report certain financial transactions carried on by a class of persons. Basis this report furnished by different categories of persons mentioned in the Rule, a statement of financial transactions carried out by a person during a particular year will be collated and be a part of the Form 26AS of the tax payer.

Transactions that would now form a part of Form 26AS are mentioned below:

  1. Payment made in cash for purchase of bank drafts or pay orders or banker’s cheque of an amount aggregating to Rs 10 lakh or more in a financial year, payments made in cash aggregating to Rs 10 lakh or more during the financial year for purchase of pre-paid instruments issued by the Reserve Bank of India under section 18 of the Payment and Settlement Systems Act, 2007 (51 of 2007), and cash deposits or cash withdrawals (including through bearer’s cheque) aggregating to Rs 50 lakh or more in a financial year, in or from one or more current account of a person.
  • Cash deposits aggregating to Rs 10 lakh or more in a financial year, in one or more accounts (other than a current account and time deposit) of a person.
  • One or more time deposits (other than a time deposit made through renewal of another time deposit) of a person aggregating to Rs 10 lakh or more in a financial year.
  • Payments made by any person of an amount aggregating to Rs 1 lakh or more in cash; or Rs 10 lakh or more by any other mode, against bills raised in respect of one or more credit cards issued to that person, in a financial year.
  • Receipt from any person of an amount aggregating to Rs 10 lakh or more in a financial year for acquiring bonds or debentures issued by the company or institution (other than the amount received on account of renewal of the bond or debenture issued by that company).
  • Receipt from any person of an amount aggregating to Rs 10 lakh or more in a financial year for acquiring shares (including share application money) issued by the company.
  • Buy back of shares from any person (other than the shares bought in the open market) for an amount or value aggregating to Rs 10 lakh or more in a financial year.
  • Receipt from any person of an amount aggregating to Rs 10 lakh or more in a financial year for acquiring units of one or more schemes of a mutual fund (other than the amount received on account of transfer from one scheme to another scheme of that mutual fund).
  • Receipt from any person for sale of foreign currency including any credit of such currency to foreign exchange card or expense in such currency through a debit or credit card or through issue of travellers cheque or draft or any other instrument of an amount aggregating to Rs 10 lakh or more during a financial year.
  1. Purchase or sale by any person of immovable property for an amount of Rs 30 lakh or more or valued by the stamp valuation authority referred to in section 50C of the Income-tax Act at Rs 30 lakh or more.
  1. Receipt of cash payment exceeding Rs 2 lakh for sale, by any person, of goods or services of any nature (other than those specified at Sl. Nos. 1 to 10 of this rule, if any.)

This data is compiled based on the information received by the authorities from various sources such as ‘Annual Information Report’, Online Tax Accounting System (OLTAS) and the Central Information Branch of the Government of India.  

How the reporting of this information will help the tax payer

A tax payer can verify his actual transactions with the transactions reported in his Form 26AS before filing his ITR. This will minimise the errors on account of omission of certain transactions while filing ITR.as this will serve as a ready reckoner. At the same time, it will not be possible to conceal the effect of any such transaction that it may have on the ITR.

It is important to note that while these transactions are perfectly legitimate, the authorities will now be able to verify the amount spent vis-à-vis your income. Let us say a person declares his income as below Rs 5 lakh but his credit card spends are more than Rs 10 lakh. From now, such situations will be apparent from the tax payer’s Form 26AS.  

Information related to pending and completed proceedings

A new feature of the Form 26AS is that information related to all pending and completed proceedings for that particular assessment year will be available at a glance. This information will help the tax payer to match his records with the data being uploaded by the tax authorities.      

Other information

India has signed agreements with many countries to share/exchange information about tax-payers income/asset details in other countries. Any such information received by the Indian Government from the Government of a foreign State would be reflected in the Form 26AS. Besides this, the Government has now mandated charitable and scientific research institutions which receive donations or contributions to furnish a statement of such donations or contributions received to the income-tax authority. The same will also be reflected in Form 26AS.

How to access Form 26AS

As mentioned above, this form is available in the tax payer’s account on the Income Tax Department’s e-filing portal: https://incometaxindiaefiling.gov.in

Once you log in, click on the ‘View Form 26AS’ tab, either under ‘My Account’ or ‘Quick links’ tabs. You need to then choose the relevant assessment year (i.e., year following the financial year) for which you want to download the statement. 

Conclusion

While the CBDT’s press release states that “The new Form 26AS is the faceless hand-holding of the taxpayers to e-file their income tax returns quickly and correctly”, with the information now available at a glance, the chances of it being misused cannot be ruled out. With these changes, Form 26AS is going to be even more important as this could be used by banks and other institutions who lend money to tax payers to do their due diligence.

GST on Salary Paid to Director

Recently, the Authority for Advance Ruling (AAR) in Rajasthan has given a ruling in the case of M/s Clay Craft India Pvt. Ltd. (the Company) wherein the AAR has held that the salary paid to the director of the company is liable to GST under the Reverse Charge Mechanism.  This ruling has therefore, opened up this debate as to whether a director of the company is employee? Presuming but without conceding that a director is not an employee, this Ruling would result in an absurd situation where all companies paying salary to directors would have to start paying GST under the reverse charge even though their output at present may not be subject to GST on account of various exemptions. Let us critically examine the Ruling.

The facts of the case were that the Company had six directors to whom salary was being paid and each director was working in the Company and performing a separate managerial function. The Company was deducting tax at source under the provisions of section 192 of the Income-tax Act, by treating the said directors as employees of the Company. The Company was also complying with the Provident Fund Regulations inasmuch as PF on salary paid to directors was being deposited. Besides salary, the directors were also paid commission for certain other services rendered by the directors for which the company was depositing GST under the Reverse Charge Mechanism. On these facts the AAR held that the directors are not employees of the company and that the Company is liable to pay GST in terms of Notification No. 13/2017-Central Tax (Rate) dated 28/06/2017. The relevant extract of the Notification is given as under: –

S. No. Category of Supply of Services Supplier of Service Recipient of Service
6 Services supplied by a director of a company or a body corporate to the said company or the body corporate. A director of a company or a body corporate~ The company or a body corporate located in the taxable territory.

The Ruling as pronounced by the AAR requires an urgent judicial review lest overzealous officers of the GST department start sending notices to other Companies. The reasons for saying this are as under:

  1. Position under the Companies Act 2013

1.1 The various sections which are relevant for the purposes of our discussion are reproduced below:

  • Section 2(34) of the Act defines a Director to mean ‘a director appointed to the Board of a company’ ; Section 2(53) defines the term Manager and means ‘an individual who, subject to the superintendence, control and direction of the Board of Directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, whether under a contract of service or not’; Section 2(54) defines a Managing Director to mean ‘a director who, by virtue of the articles of a company or an agreement with the company or a resolution passed in its general meeting, or by its Board of Directors, is entrusted with substantial powers of management of the affairs of the company and includes a director occupying the position of managing director, by whatever name called’; 2(94) defines a Whole-time Director to ‘include a director in the whole-time employment of the company
  • From a reading of the aforesaid definitions as provided for in the Companies Act, the undisputed conclusion that emerges is that any director who by conduct or a director who is entrusted with any specific powers of management works under the control and superintendence of the Board of Directors. In other words, such a director works under a contract of employment and therefore there is an employer employee relationship. It may also be noted that under the Companies Act salary can be paid only to a whole-time director who is an executive director and by definition is under the whole-time employment of the Company.
  • The corollary to the above is that other directors are non-executive directors. Such non-executive directors generally do not take part in the day-to-day activities of the company. They only attend the meetings of the board of directors or its committees and thus, work only at a periodic interval on a part-time basis. Thus, such non-executive directors, who are not entrusted with day-to-day operations, cannot be treated as an employees. Therefore, any compensation paid to a non-executive director is not salary as there is no employer employee relationship.
  1. Position under the Income-tax law
  • Under the Income-tax Act, the sine qua nonfor taxing the income as salary is the existence of an employer employee relationship. Once such a relationship is established then income will be taxed as salary.
  • From a reading of the position under the Companies Act as explained hereinabove, it was clear that an executive/managing director/whole-time director is an employee of the company. This position stands accepted by numerous judgements of various Courts notable among them being CIT V Gautam Sarabhai [1984] 19 Taxman 353 Gujarat and Hon’ble Supreme Court in the case of Ram Pershad vs CIT 1973 AIR 637.
  1. Position under the GST Law

3.1    Section 7(2)(a) of the Central Goods & Services Tax Act, 2017 (“the CGST Act, 2017”) deals with ‘scope of supply’. The relevant extract is reproduced as under:

“(2) Notwithstanding anything contained in sub-section (1),—

  • activities or transactions specified in Schedule III;or
  • such activities or transactions undertaken by the Central Government, a State Government or any local authority in which they are engaged as public authorities, as may be notified by the Government on the recommendations of the Council,

shall be treated neither as a supply of goods nor a supply of services.”

3.2    Schedule III of the CGST Act, 2017 deals with ‘activities or transactions which shall be treated neither as a supply of goods nor a supply of services’. The relevant extract is reproduced as under:

“1. Services by an employee to the employer in the course of or in relation to his employment.”

Thus, services provided by an employee to the employer in the course of or in relation to his employment shall be treated neither as a supply of goods nor a supply of services,

3.3    Further, Reverse Charge Notification No. 13/2017-Central Tax (Rate) dated June 28, 2017 provides that GST shall be paid on reverse charge basis on services supplied by a director of the company or body corporate. The relevant entry is reproduced as under:

S. No. Category of Supply of Services Supplier of Service Recipient of Service
6 Services supplied by a director of a company or a body corporate to the said company or the body corporate. A director of a company or a body corporate~ The company or a body corporate located in the taxable territory.

3.4    Merely because there is an entry for reverse charge to tax services rendered by a director does not mean that all directors of companies cease to be employees of a company. If such were the intention of the legislature then in Schedule III where services by an employee are exempt, a carve out would have been made for a director. In the absence of any such carve out to read the law in a manner that a director cannot be an employee is incorrect.

3.5    It is therefore imperative to understand the nature of services being provided for by the director to ascertain whether the director is in employment of the company or not. Once it is established that he is in employment of the Company then salary paid is outside the ambit of GST.

3.6    It is also imperative to understand that the rationale behind the aforesaid entry to tax under reverse charge is to tax remuneration/compensation paid to directors which is outside the scope of salary. Had this entry of reverse charge not been there then sitting fee etc. paid to a non-executive director would not have got taxed unless the director was liable to be taxed under the forward charge mechanism i.e. where is turnover is more than 20lakhs in a year.

Conclusion

The AAR in my considered view failed to appreciate the legal position under various other statutes and got swayed by the fact that the Company was paying GST on reverse charge on commission being paid to directors. It did not examine whether in the instant case there was an employer employee relationship. Once such a relationship exists, then there cannot be any payment of GST under the reverse charge mechanism. However, if such a relationship does not exist then GST would have to be paid under reverse charge. I may also add that any commission paid to a whole-time director is also a part of salary and the Company in the instant case should not have been paying GST under reverse charge.

Critical analysis of the GST Law

It has been more than 2 years since the GST legislation was introduced in India.  Over the period of two years numerous changes have been made to the law by issuance of various circulars/notifications. GST which was to be a “Good and Simple Tax” is becoming a complex piece of legislation consuming precious manhours in order to ensure compliance that has been thrust upon the taxpayers.

In my view, ten steps which the legislators should urgently consider making the law simple are –

  • One nation one tax

GST law was introduced by proclaiming it to be one nation one tax. This concept is a misnomer. The current legislation is far from being one nation one tax.  If it were then why should there be an embargo on adjusting input tax paid in one state with the output tax of another state. Therefore, there are as many taxes as there are number of States and UT’s, (37 to be precise), credit for which cannot be claimed by a taxpayer in another State. This artificial barrier must be removed in order to make business simple and cost effective.

Due to the dual structure of GST, businesses are forced to set up offices in other state to claim credit of the input tax paid.  This is then re-invoiced basis the cross-charge mechanism.  There is ongoing litigation just to decide whether the entity has to pay IGST or CGST & SGST.  The moot question here is that why should business not be allowed to freely carry on the activities without grappling with these location issues? If a Company has to litigate to know which tax it has to pay i.e. whether IGST or CGST & SGST then it is a failure of the law.

  • Multiple rates

One of the drawbacks of the GST law is the multiple rate system. This not only makes the law cumbersome but prone to litigation. Selling a product in loose quantity vis-a-vis in a packed condition or as part of a goodie bag attracts different rates of tax.  This distinction should stop.  The judiciary is already burdened with pending cases and multiplicity of rates will only add to further litigation.

  • Frequent changes

One of the basic principles of fiscal legislation is that the law should be simple for the taxpayers to understand and follow. Since 1stJuly, 2017, the time when GST was enacted, innumerable notifications and circulars have been issued under the GST law which in itself proves that the law as conceptualized is far from being simple. A complete overhaul of the law is required.

  • Complex returns

The whole scheme of the formats of the returns under GST law is based on the premise that all taxpayers are dishonest and therefore maximum information should be sought from the taxpayers in the return.  The annual return for 2017-18 which was supposed to be filed by December 2018 has seen multiple extensions.  Information is being sought in the return which was never indicated to the taxpayer under the law and therefore taxpayers are struggling to fill the format of the return and give the required data.  Precious manhours in the country have been lost which is very unfortunate as these manhours should be used in something which is far more productive and not merely wasted for reconciling data.

  • Matching concept

The GST law in its current form envisages a matching concept whereby output of one person has to be matched with the input of the other person.  This matching makes the law extremely complicated. Under the Income Tax law also, there is a matching concept i.e., a taxpayer is given credit of the tax deducted at source only if the TDS is reflected in his form 26AS.  This exercise is, however restricted to interest, rental and other contractual/service income. The main activity of purchase and sale of goods is outside the scope of TDS and therefore it is easy to match the 26AS to claim credit of TDS.  However, GST being applicable for almost all goods and services a taxpayer is supposed to reconcile the entire debit side of his/her statement of profit and loss with the output of multiple vendors with which he does business. This is a mammoth task which again uses precious manhours just to reconcile data. This brings me to the point raised earlier, that the Government presumes that all taxpayers are dishonest and that is why this requirement to reconcile the auto populated GST 2A with the input credit claimed.

  • Deeming fiction

Under the law there is a concept of place of supply which in-turn determines the tax that is supposed to be charged i.e. IGST or CGST/SGST.  For various types of situation, the law deems a ‘particular place’ to be the ‘place of supply’ for levying tax.  As a result of which tax is sought to be levied when in effect no tax ought to be paid. The case in point here is “intermediary services”. The intermediary renders services to a foreign principal and earns money in convertible foreign exchange yet he is liable to pay tax.  This is against the general rule wherein place of supply is deemed to be the place of the recipient. Such instances are forcing businesses to relocate abroad to remain cost-effective.

  • Seamless credit

One of the features of the GST law is the flow of seamless credit across the value-chain.  However, there are multiple situations artificially created in the law which deny the credit to the recipient of the goods/service even though the goods/services are utilized for the furtherance of business. One example which comes to mind is of the input credit of hotel accommodation expenses in a state where the taxpayer is not registered, though has business activity. Therefore, this restriction should be removed, and free flow of credit should be allowed.

  • Reverse charge

The concept of reverse charge for payments to unregistered dealers, which has temporarily been suspended should be deleted permanently. This only adds to the compliance burden as a registered person has to first raise a self-invoice, pay the tax and then claim input credit. This will force businesses to stop dealing with small vendors who will be then out of business.

  • High rates of tax

Higher the rates of tax, higher is the non-compliance.  India is already a highly taxed and compliance driven economy and the high rates in GST are hurting the economy far from doing any good. Many items are deemed to be a luxury and are being taxed at 28% whereas they are a necessity.

  • Other miscellaneous issues

Keeping certain products outside the GST law not only goes against the concept of seamless credit which is the backbone of the GST law but creates complications for the taxpayers. There are certain products which are still subject to VAT under the respective state laws as against GST. Further the law envisages a peculiar situation where a supplier of goods/service is liable to pay tax on the supply even though the customer does not pay, and the debt eventually goes “bad”. This is a double whammy for the taxpayers and needs to be addressed.

Conclusion

Simpler the law is, higher will be voluntary compliance. In its present form the GST law is complex and is not a simple tax as proclaimed by the Government. This will increase litigation and will use precious manhours for unproductive activities, which the country cannot afford to. If we have to realize the dream of our Hon’ble Prime Minister of making India a five trillion-dollar economy, then amongst other action points, an overhaul of the GST law should be on the top of the list.

 

 

New Skill Sets Required for E-Assessments

The Revenue Secretary inaugurated the National e-Assessment Centre recently. More than 58,000 notices have been issued to taxpayers under this scheme and the assessment for Financial year 2017-18in such cases shall be done as per the new e-assessment scheme. As this is a faceless tax assessment regime new skill sets are required by taxpayers/authorised representatives to negotiate this regime.

At this juncture, I am reminded of my principal under whom I completed my CA training. He used to always advocate that any document/letter/report prepared should speak for itself and there should be no need for the author of the document to explain its contents. If one keeps this thought at the back of one’s mind during the e-assessment proceedings, the chances of a favourable assessment order would increase manifold.

So how does one ensure that the document being uploaded speaks for itself? Following are the steps that should be taken in this regard:

  1. Structure of the response to be filed

The response being filed to the questionnaire must be properly structured. Point wise reply should be given to each question being asked. If the reply for any question is long, then it should be broken into small paragraphs and numbered. If for any question the reply is not ready, then against that point it should be stated that ‘Details are under preparation and will be submitted on the next date’.

It is important to note that in the next reply you must corelate all the questions of the questionnaire. For eg. if the questionnaire had 25 points and you answered point no. 1, 4, 6, 7, 8, 10, 12, 14, 19, 21, 22, 23, 24 and 25 in the first reply, you ought to mention against point number 2,3,5,9,11,13,15,16,17 &18 that details will be submitted in the next reply. In the next reply against point no. 1, 4, 6, 7, 8, 10, 12, 14, 19, 21, 22, 23, 24 and 25 mention ‘details furnished vide letter dated XXXX’

  1. Linking of documents being uploaded

Besides the main reply many a times there will be documents which would have to be uploaded say for eg. an agreement. While scanning that agreement, it should mention an Annexure number say ‘A’ and the main reply should give a reference to that Annexure. If there are multiple annexures, then Annexures should be serially numbered and there reference should be given in the main reply.

  1. Effective use of language

The reply should be drafted using simple language and should avoid unnecessary jargon.

  1. Use of diagrams, tables and flow charts

Use of diagrams, tables and flowchart is a very effective tool to making the person reading the document understand the issue on hand. If a question relates to a restructuring that was undertaken by the assessee, then it would be worthwhile incorporating a diagram explaining the restructuring which could then be followed by a text. If the question is regarding a computation, then a tabular presentation would work very well

  1. Conclusion paragraph

While replying to a show cause notice always incorporate a conclusion paragraph summarising the points raised by you rebutting the show cause notice.

  1. Read the reply again

This is the golden rule which is ignored. Before uploading the reply, you must read the full reply once and linking it with all the information being uploaded.

The scheme does permit an interaction with the authorities. However, such interaction is limited to video conferencing and that too is in certain circumstances only. Therefore, the documents uploaded assume a lot of importance.

 

Happy drafting!

Angel tax

The tax department in an overdrive mode has started questioning the valuations of start-up companies inasmuch as the premium received by such companies on issuance of shares is being questioned/challenged by the tax authorities.

It is not the first time that the tax department has targeted a particular class of tax payers.  A few years back when India was the leader in providing BPO services, the tax authorities started questioning the BPO’s and went all out to prove that these companies were not rendering IT enabled services.  Consequently, the deduction claimed by such companies was denied and huge tax liability was fastened on such companies.  What followed was litigation with no benefit to the exchequer. The Government eventually phased out the sections which provided exemption/ deduction to IT enabled services.

Similar is the case with start-up companies.  The tax authorities have started rejecting the valuation reports obtained by the start-up companies and stepping into the shoes of the valuer by determining the fair value of the shares.  Consequently, the difference between the value determined by the Assessing Officer and the value at which the shares have been issued is being subjected to tax in accordance with section 56(2)(viib) of the Income-tax Act, 1961.

The rules issued for the purposes of valuation provide that the valuation can be conducted either by the net asset value method or the discounted cashflow method. In a start-up company the application of the NAV method may not be possible as most of these companies are technology companies which cannot be valued on NAV basis.

At this juncture, one needs to appreciate the difference between price and value.  Value will always be different for different persons whereas price will always be the same for a similar product.  Therefore, the value of a start-up for an investor will vary and cannot be compared with the value determined by the Assessing officer.  Further, valuation is based on certain datapoints at a given point of time which may change at a later date.  Therefore, questioning the valuation of a start- up which is backed by a reasoned valuation report is not justified. Another argument against the action of the tax authorities is that the amount received is on capital account and therefore should not be taxed.

Consider a case where a start-up issues shares at Rs. 150/- per share and collects Rs. 140/- as premium.  The tax authorities subsequently challenge the valuation and determine the fair value  of the shares at Rs. 40/- per share as a result of which the excess premium of Rs. 110/- is subjected to tax.  An innovative tax officer will then take a plea that since Rs. 110/- per share was not towards issuance of capital and has been deemed as income, the cost of acquisition of the share in the hands of the investor should only be Rs. 40/- and not Rs. 150/- thereby taxing the difference once again as capital gain in the hands of the investor as and when the shares are sold by the investor.

I hope that the government takes necessary steps to resolve this issue and promote the start-up movement which is gaining momentum and is essential for the growth of the country.

 TeDiouS compliances under GST Law

The Government has notified 1st October 2018 as the date for implementation of provisions for deduction of tax at source (TDS) under the GST Law. The concept of TDS is an inherent part of direct tax collection mechanism wherein it aims to collect tax from the very source of income. Similarly, under the provisions of GST Law, the specified recipients of supplies (i.e., deductors) are required to deduct tax from the payment made or credited to the supplier of taxable goods and/ or services (i.e., deductee), where the total value of such supply, under a contract, exceeds rupees 2.50 lakh. TDS mechanism under the GST Law aims to collect tax at the time of payment. Also, it seeks to provide an additional trail of taxable supplies to the Government especially in case of B2C transactions to ensure disclosure of taxable supplies by suppliers so as to curb tax evasion. However, given the state of responsiveness of GST Portal and difficulties faced by the industry in adhering to existing compliances, practically, the implementation of TDS provisions now would only add to the compliance burden.

The TDS mechanism under GST may not prove to be very effective for certain reasons such as (i) TDS under GST would not significantly advance the flow of taxes to the Government as otherwise also the supplier is required to deposit tax by 20th of next month irrespective of the receipt of the consideration towards such supplies, (ii) the persons specified as deductors, except Public sector undertakings (PSUs) are mainly the final consumers, who are otherwise not liable for GST registration, for TDS compliances, such persons (final consumers) shall have to bear the burden of entire set of compliances like registration, determination and deduction of tax, depositing the same through e-payment, issue the necessary certificate & filing of returns, (iii) instances of non-compliances and mis-matches in TDS are likely to occur and (iv) there is no need of TDS mechanism in case of supplies to PSUs as the supplies shall be automatically verified while availment of input-tax credit thereon by the PSUs.

In view of the above, the difficulties posed by the TDS mechanism under the GST Law seems to outweigh the expected benefits. The Government should therefore, seriously reconsider the implementation of TDS provisions under the GST law.

 

GST Implementation: The Indian Experience

Goods and Services Tax (GST) marked its beginning on the midnight of July 1, 2017, with the sound of gong in the historic Central Hall of Parliament House, reminiscent of India’s tryst with destiny on the midnight of August 15, 1947, releasing Indian Economy from the web of multiple indirect taxes and bringing in the largest tax reform since independence.

The implementation of GST on completion of its first year seems to be largely effective and efficient from the standpoint of various stakeholders, (i) consumers, for whom GST unlike international experience, it has not shown any initial inflationary trend in India, (ii) for industry, the subsuming of multiple central and state levies into one GST along with seamless input-tax credit has been a boon and (iii) for Government, GST regime has resulted in significant increase in the tax base and tax collections thereof. Besides, the highs the GST bag contains some lows also viz. (i) business were saddled with compliance burden which was in stark contrast to ‘ease of doing business’ being propagated by the Government (ii) The number of amendments and tweaking in law by way of circulars, notifications, press release, clarifications, orders etc. have added to the complexity of GST Law (iii) carrying forward of legacy of interpretation and classification disputes which is further worsened by contrary advance rulings pronounced by Authority for Advance Rulings of various states.

In its present avatar GST is only a Good but not a Simple Tax. If the Government actually wants to make it into a Good and Simple Tax then it should look at making the law simpler in terms of the compliance burden and start trusting the tax payers.

DISCOUNT NOT EQUAL TO CAPITAL EXPENDITURE

Is discount equal to capital expenditure? My answer is a big NO.

DISCOUNT  ff CAPITAL EXPENDITURE

It was reported in the leading newspapers that Flipkart has recently lost an appeal wherein the income tax department has held that the heavy discounts offered by the e-marketing companies, which are at present classified as marketing expenditure are in the nature of capital expenditure. Flipkart along with other big e-commerce companies have been classifying such expenditure as marketing expenses and have been claiming it as a deduction from revenue, resulting in losses for tax purposes on a year on year basis.  The tax authorities have taken a view that discounts offered by Flipkart are in the nature of capital expenditure as the heavy discounts being offered is nothing but a brand building exercise which has an enduring benefit. On the other hand, Flipkart claims that discount offered by them is the cost to company and must be therefore deducted from the total revenue.

The moot question here is whether discounts being offered result in brand building and can discounts be characterised as capital expenditure which results in a benefit that is of an enduring nature. Discounts are given to achieve high volumes and thus directly hit the revenue for the period in which discount is given and depending upon the accounting treatment followed it could be accounted for as a separate line item of expenditure or netted off from revenue. The tax authorities cannot sit in the chair of the businessman to decide as to what price should a product be sold at. This principle is judicially very well settled, and it is unfortunate that the officers at the lower level do not follow the decisions of the higher courts.

When examining the question, whether expenditure is capital or revenue in nature, one has to be guided by commercial considerations and only when the advantage is in the capital field, the expenditure can be disallowed applying the enduring benefit test. If the advantage consists of merely facilitating trading operations or increasing profitability or enabling the management to conduct business more efficiently, while leaving the fixed capital untouched, the expenditure is still on revenue account. In the instant case the discounts given by Flipkart are unequivocally on the revenue account.

One also needs to bear in mind that the enduring benefit is not a conclusive test for holding an expenditure as capital expenditure. The Supreme court in the case of Empire Jute Co. limited had held that there can be an expenditure which gives enduring benefit, but the expenditure can still be classified as revenue expenditure. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable.

Thus, in my view the stand taken by the income tax department in Flipkart’s case is erroneous and based on a myopic view. On one hand the Government is trying to increase its position on index of ‘Ease of doing business’ and on the other hand the tax department is ensuring that the tax payer is harassed and drawn into needless litigation. It is very unlikely that the reasoning given by the tax department would stand the test of judicial scrutiny in higher courts.

 

Steps that the Government should take to make GST actually a Good and Simple Tax

It has been 4 months since the GST legislation was thrust upon the taxpayers. I use the word ‘thrust upon’ because the Government did not heed to the suggestions to make the law simple. The whole scheme of the Act and the associated compliances are based on the notion that all taxpayers are dishonest and therefore full control must be kept by the respective department. Numerous extensions have taken place in filing of all returns which has added to the confusion. No doubt the Government has issued many FAQ’s and held seminars but that was too little and too late. The damage has already been done. Across various states traders and service providers have started various methods to evade tax. This will continue to happen till the time the law is made simple and less complex for the taxpayers. As a concept GST is great but its implementation in India has caused the mess where we all find ourselves. This is what the Government needs to do:

  1. Reverse charge

Section 5(4) of the Integrated Goods and Services Tax(IGST) and section 9(4) of the Central Goods and Services Tax Act need to be deleted permanently. This only adds to the compliance burden. There is no revenue loss to the Government. A registered person has to first raise a self-invoice if he takes a supply from an unregistered person, pay the tax and then claim the input credit. Continuing with this will force businesses to buy from registered persons and make small shopkeepers redundant who are not liable to register because of the exemption linked to turnover.

  1. Multiplicity of Rates

Multiple rates add to the confusion. Selling a product in loose quantity attracts a different rate, if packed will attract a different rate. Why have these distinctions? It is but obvious that tax payers will find loopholes in drafting and try to fit the product in another rate than what the Government wishes it to be. The end result-more litigation. The judiciary is already burdened, and multiplicity of rates will further increase litigation.

  1. Multiple returns

The tax payer has to file 3 returns in a month. GSTR-1, GSTR-2 and GSTR-3 for outward, inward and payment of taxes for the month respectively. In GSTR-1, the tax payer is obliged to file invoice wise details of his outward supply. In GSTR-2, the taxpayer is supposed to match all his input as per his records with the outward supply details filed by his vendors/suppliers. This is the most complex part in the entire GST compliances. Every month the tax payer will reconcile all his inputs invoice by invoice and report to the same to the Government. Imagine the time, effort and money spent in doing this unproductive compliance.

The Government should keep it simple and ask the taxpayers to only file its outward supply details on a quarterly basis and trust the taxpayers in so far as claiming of input tax credit is concerned. There is no harm in learning the best practices from other countries where compliance has been made simple. Let the form GST 3B be made the only form to be filed on a quarterly basis.

  1. High rates of tax

Higher the rates, higher the incentive to evade tax. India is already a highly taxed and compliance driven economy and the high rates in GST will hurt the economy more than by doing any good. Taxing goods at 28% or 43% (including cess) is not the way going forward. Majority of the population buys cars only because the Government has miserably failed to provide effective public transport. Yes there are Metros to commute but given the population size is the Metro enough? The answer is an emphatic No.

  1. One Nation One Tax

This concept is a misnomer. The current legislation is far from one tax. If that were it, then why can’t the taxes paid in one State be adjusted the output of other States. Therefore, there are still 29 SGST’s and CGST’s credit for which cannot be claimed by a taxpayer in another State. The law should allow input credit in respect of tax paid anywhere in India and these artificial barriers should be removed. How the revenue collected has to be distributed is for the Government to decide. Why should the tax payer be made to suffer on this account. To claim credit again entities will be set up in different jurisdictions which will only increase litigation. Therefore the Government should permit set off of input credit of all states with the output tax of any State.