Monday, May 25, 2009

Service Tax on Renting Immovable Property

A recent decision of the Delhi High Court in Home Solution Retails v. Union of India has caused some interesting issues concerning service tax to resurface. Admittedly, the law laid down by the Court is not new. However, the factual backdrop of the decision, and the debate it has given rise to, make the decision potentially significant.

The question before the Court was whether the renting of immovable property is a taxable service under the service tax regime in India. Sec. 65(105) defines ‘taxable service’. Sub-clause (zzzz) includes within the scope of taxable service ‘any service provided or to be provided, to any person, by any other person in relation to renting of immovable property for use in the course or furtherance of business or commerce’ (emphasis supplied). The issue that arises then is whether the renting immovable property simpliciter is a service, or requires some service to be provided in relation to the process of renting. In this case, the validity of a notification (No. 24/2007, dated 22/05/2007) and a circular (No. 98/1/2008-ST, dated 04/01/2008) issued by the Secretary of the Ministry of Finance, was challenged. The notification was an exemption notification, which exempted the ‘taxable service of renting of immovable property’, from a certain levy of service tax. The circular purported to clarify that the ‘right to use immovable property is leviable to service tax under the renting of immovable property service’. Thus, these two were challenged as impliedly and expressly suggesting that the mere renting of immovable property is a taxable service, and hence, being ultra vires the definition of a taxable service in the Act.

The Court, in this case, held for the petitioners, and declared that the notification and the circular were ultra vires the Act. Interestingly, however, the Court based its decision less on the text of the provision, but more on the concept of ‘service tax’ as mentioned in previous Supreme Court dicta. The Court relied on a 2007 decision in AIFTP v. Union of India [AIR 2007 SC 2990], where the Supreme Court had observed, “[s]ervice tax is a value added tax”. Based on this, the Court concluded that since the process of renting out, in itself, does not add any value, no service tax can be levied on this process, unless some additional services are provided.

It is this conceptual basis of the decision, and the reliance on the decision in AIFTP, which has been questioned in recent analysis of this decision in the Business Standard. It argues that there is nothing in the concept of service tax that necessitates the presence of some value addition. In fact, before 1986 even excise duty was not necessarily value added tax, and the same is the case, to a limited extent, even today. With regard to the reliance on AIFTP, the piece argues that the statement quoted above was an obiter observation, and the primary issue before the Court was whether profession tax is service tax. On this basis, the piece advocates that the decision be appealed by the CBEC before the Supreme Court to clarify the legal position.

Much can be said in favour of this view, and against the Delhi High Court decision. Especially the proposition that conceptually, the levy of service tax does not necessarily need some value addition, is seemingly valid. However, what makes a reconsideration of the Delhi High Court decision by the Supreme Court on appeal unlikely is the fact that both the Act itself (albeit to a limited extent), and prior Supreme Court dicta, seem to favour the interpretation of the Delhi High Court.

First, the provision specifically requires that the service must be ‘in relation to renting of immovable property’. Given this language, deciding that the very process of renting of immovable property is a service requires doing some violence to the provision. While this seems a valid textual argument, an examination of the rest of the Act takes away from its persuasiveness. As rightly pointed out by the ASG, Mr. Malhotra, in Home Solution Retail, sub-clauses (zt) and (zv) also define taxable service as service ‘by a dry cleaner in relation to dry cleaning’ and ‘by a fashion designer in relation to fashion designing’, respectively. Based on this, he argued that if ‘in relation to’ was to be read in the manner suggested by the petitioner, the processes of fashion designing and dry cleaning, by themselves, would not be taxable services, resulting in an absurdity. Thus, the appropriate textual interpretation is dubious, which is why the Court decided the case on the need for value addition.

Coming then to whether this reliance on value addition was appropriate, the Business Standard article is correct is pointing out that value addition is not conceptually essential, and that AIFTP contained only an obiter observation to that effect. However, practically, and in law, even obiter observations of the Supreme Court can be considered binding within certain bounds. A statement made when laying down the legal backdrop for the final decision (which was the case in AIFTP) definitely comes within the fold of these ‘binding obiters’. Although strictly speaking, a similar statement by a lower Court may have been ignored, the same approach cannot be followed when examining the opinion of the Supreme Court. Further, and more importantly, in an earlier decision in 2004 too, the Court seems to have suggested that mere transfer of immovable property cannot be a service. In TN Kalyana Mandapam v. Union of India [(2004) 5 SCC 632], the issue was whether the leasing of mandap premises is a service. In answering the question in the affirmative, the Court also observed, “In fact, making available premises for a period of few hours for the specific purpose of being utilized as a Mandap whether with or without other services would itself be a service and cannot be classified as any other kind of legal concept. It does not certainly involve transfer of moveable property nor does it involve transfer of immoveable property of any kind known to law either under the Transfer of Property Act or otherwise and can only be classified as a service” (emphasis supplied). The highlighted part of the observation clearly shows that the Court believed that if the transaction amounted to a mere transfer of immovable property, it would not be a taxable service.

Thus, in sum, the legal position today is definitely ambiguous, a combined result of legislative inconsistency and the lack of clarity as to the meaning of ‘service’. While a legislative amendment seems the only long term solution to the conundrum, as things stand today, a consideration of the issue by the Apex Court is likely to reaffirm the decision of the Delhi High Court.

Focus: India 2009

(About a week ago, the National Law School at Bangalore hosted Focus: India 2009, which was designed to discuss and facilitate greater dialogue on pertinent economic and legal issues. In the following post, Sandeep Uberoi, Convenor of Focus: India, 2009 reports on the highlights of the event)


Focus India Conference was held on the 15th and 16th of May 2009, a unique and innovative exercise by the students of the National Law School of India University (NLSIU). Unlike other student run conferences which are often focussed on academics and the theoretical aspects of law, this conference focussed on the practice of commercial and corporate law in India and the challenges faced by them. It is due to this emphasis that partners of leading law firms from all over India decided to make their way to the NLSIU campus and share their experience and insights on various legal and economic issues which might affect India in the coming years.


Keeping the current state of the Indian and global economic atmosphere in mind, the conference had eight sessions, viz. India as an Emerging Superpower in the Twenty First Century; Foreign Investments in India; Mergers and Acquisitions: Challenges and the Way Forward; Innovations in the Financial Sector including Bankruptcy and Restructuring; Banking and Finance; Capital Markets; Infrastructure and Project Finance; Competition Law; and Taxation Law. Luminaries in the field of commercial law such as Mr. Cyril Shroff, from Amarchand Mangaldas & Suresh A. Shroff, Mr. Rajiv Luthra, from Luthra and Luthra Law Offices, and Mr. Ajay Behl, from AZB & Partners, came as chairs of various panels with Mr. Cyril Shroff officiating the conference as Conference Chair. Due to the interesting subject matter of the conference and its uniqueness of approach, partners from leading global law firms such as Clifford Chance LLP, Linklaters, Jones Day, Latham & Watkins, Debevoise and Plimpton LLP also attended and gave the an international perspective to the various issues raised in the Conference.


The conference was inaugurated by Dr. Venkata Rao, the newly appointed Vice-Chancellor of the National Law School of India University, and he was pleased to have the honour to host so many of the brightest legal minds in the area of corporate and commercial law in India. He also took this opportunity to create an Advisory Committee consisting of pioneers of corporate law in India, such as Mr. Cyril Shroff, Mr. Shardul Shroff, Mr. Rajiv Luthra, Ms. Zia Mody, prominent industry figures such as Infosys mentor N R Narayana Murthy and Jugnu Uberoi, owner of Uberoi Trading, as well as some alumni of NLSIU such as Ms. Madhurima Mukherjee, and Mr. Umakanth. This high level body will advise NLSIU on various issues such as providing cutting edge global legal education, improving facilities, and expanding internationally. Sandeep Uberoi, final year student and the convener of Focus India stressed upon the idea of Focus India was to “initiative to bring together the legal community to share their views and vision for the future legal policies and practice of India with the student community” and added that Focus India aims to provide a platform to discuss and debate India's role as a superpower and the challenges which will need to be faced to deliver the India story in its entirety.


Mr. Cyril Shroff, as Conference Chair, addressed the issue of legal education in India and the future of the legal services industry in a concise yet comprehensive manner. After Mr. Shroff’s address, the first session discussing India as an Economic Superpower in the Twenty First Century was underway with the charismatic Mr. Luthra officiating events as the Chair. In his introduction to the topic, he raised several key issues which he sought to be answered from the panel, the basic underlying question was whether the optimism about India was based on fact or just hype. After an enthralling session which was filled with Mr. Luthra’s characteristic wit, the next session on Foreign Investments was chaired by Mr. Cyril Shroff who eruditely focussed on the regulatory regime regarding foreign investments, as well as the methods to raise such investments, the final issue dealt with judicial perspectives regarding foreign investments. After lunch, there were parallel sessions on Taxation Law and Capital Markets held in different venues on the NLSIU campus. The former was Chaired by Mr. Ajay Behl, who focussed on discussions related to tax havens and took the Vodafone saga to illustrate the challenges faced and policy responses required. The latter was Chaired by Mr. Sandip Bhagat, of S&R Associates, a leading boutique law firm in India, and had Ms. Madhurima Mukherjee, partner at Luthra and Luthra Law Offices as Co-Chair. The Capital Markets Session was engaging with pertinent questions being raised by the Chairs for the panel to discuss and had a huge draw of interest among the students. Mr. Mohit Saraf, partner at Luthra and Luthra Law Offices, Chaired both the session on Mergers and Acquisitions as well as the one on Infrastructure and Project Finance, both these sessions were highly interactive with the Chair and panellists inviting students to ask questions and clarify concepts.


Each of the sessions was informative and students of NLSIU got a rare chance to interact and learn from leading legal professionals. The success of the Conference was evidenced by the enthusiasm of both the speakers and the audience and that fact that this Conference is now being made an annual affair.


- Sandeep Uberoi

Monday, May 18, 2009

Pyramid Saimira and the Powers of the SEBI

A few weeks ago, the SEBI passed an order (WTM/KMA/60/04/2009) in the Pyramid Saimira case, which raises questions pertaining to insider trading. The order resulted from SEBI’s investigation into the affairs of Pyramid Saimira, highlighted in this post. The particular sequence of events is discussed in several reports, linked here and here.


In its order (though only an interim one), the SEBI analysed the evidence before it in depth. The issue which the Board focused on was whether one Mr. Nirmal Kotecha (a promoter) was “using Mr. Amol Kokane as an instrument for his own trades.” Among the facts which enabled the Board to come to the conclusion that the issue deserved to be answered in the affirmative were the “volume of trades done by Shri Amol Kokane through India Capital Market, the scrips that were selected for trading in his name and the losses incurred by him on these trades, the counterparty details that have emerged from the bank trail and the call/ Short Messaging Service (SMS) charges incurred by Shri Kokane on his mobile number relative to his family’s annual income…” Added to this was a statement by Mr. Kokane that Mr. Kotecha was operating his accounts. From all these factors, the SEBI was able to come to a conclusion as to insider trading, as also foreign exchange and money laundering violations. Accordingly, the SEBI issued several interim directions forbidding certain persons from directly or indirectly dealing in the securities markets; and also stated that the order was to be treated as a show-cause notice to the persons named therein; calling upon the entities/persons against whom the order was issued to file their objections to the order.


On the face of it, the order poses no legal complexities, but what is noteworthy is the detailed examination of the evidence even at the interim stage. Also, the order presents an opportunity to highlight the scope of the powers of the SEBI to issue interim directions. The Board stated that it was acting under Sections 11 and 11B of the SEBI Act, 1992.


Section 11B (inserted by an amendment in 1995) states:


Power to issue directions.– Save as otherwise provided in Section 11 if after making or causing to be

made an enquiry, the Board is satisfied that it is necessary –

(i) in the interest of investors, or orderly development of securities market; or

(ii) to prevent the affairs of any intermediary or other persons referred to in section 12 being conducted in a manner detrimental to the interests of investors of securities market; or

(iii) to secure the proper management of such intermediary or person,

it may issue such directions –

(a) to any person or class of persons referred to in Section 12 or associated with the securities market;

(b) to any company in respect of matters specified in Section 11-A,

as may be appropriate in the interests of investors in securities and the securities market.


(Emphasis added.)


Can an order asking certain persons to show cause as to why action should not be taken against them amount to an order “after making or causing to be made an enquiry”? In exercising it powers under Section 11B, the SEBI is presumably engaged in a quasi-judicial function; meaning that it must comply with the principles of natural justice. In that view, can an enquiry ever be said to have been ‘made’ even prior to giving an opportunity for hearing the alleged wrongdoer?


Of course, in Pyramid Saimira, an investigation had been on for some time. But, let us also consider a more extreme case. Does Section 11B empower the SEBI to take steps without hearing the alleged wrongdoer purely on receiving some information/allegations of malpractices? Can the SEBI say, effectively, that a complete investigation would take too long, and it is necessary to act with a sense of urgency even before the investigation makes any tangible progress?


Perhaps keeping in mind the controversies which could arise in this regard, the SEBI Act was amended in 2002, to introduce Section 11(4). The relevant parts of that Section read as follows:


Without prejudice to the provisions contained in sub-sections (1), (2), (2A) and (3) and section 11B, the Board may, by an order, for reasons to be recorded in writing, in the interests of investors or securities market, take any of the following measures, either pending investigation or inquiry or on completion of such investigation or inquiry, namely:-

(b) restrain persons from accessing the securities market and prohibit any person associated with securities market to buy, sell or deal in securities;

Provided further that the Board shall, either before or after passing such orders, give an opportunity of hearing to such intermediaries or persons concerned.]


(Emphasis added – the text of the Act can be found here)


At first glance, the provisions (considering that quite broad powers are provided under all the sub-clauses) appear to be quite stringent – the SEBI is free to take strict action and give an opportunity to be heard only after the action has been taken. Cases such as Pyramid Saimira show that such a provision is perhaps necessary; given that in cases where insider trading is alleged, quick action would be of utmost importance.


A few important legal questions remain – what is the standard by which SEBI should decide whether there exists a necessity for an order under Section 11(4) r/w 11B? Is mere prima facie satisfaction sufficient? Or must the SEBI go into detail into whatever evidence that is available? In Pyramid Saimira, the SEBI has chosen the safer route – the available evidence was scrutinized in great detail. But, is such a deep appreciation of the evidence always necessary? If not, what test will the SEBI use to decide whether to act under the Sections?


I will try to answer some of these questions in a subsequent post…


Sunday, May 17, 2009

Electoral Verdict to Spur Reforms

With the return of the Congress government to power and with Dr. Manmohan Singh set to continue as Prime Minister, corporate India is likely to witness a series of reforms in the near future. Unlike the previous stint where the Government was hamstrung by coalition politics (but nevertheless achieving a record rate of economic growth), the reforms are likely to be bolder this time around as it appears to largely have a free hand in policy-making. Industry has given its thumbs up to the verdict and the markets are likely to witness a steep climb on Monday when they open for trading, signalling the acceptance of the electoral result.


As far as matters focused on by this Blog are concerned, the key outcome could be the enactment of reforms to company law. The Companies Bill, 2008 was introduced in the Lok Sabha on October 23, 2008. It seems not to have gained much traction since then as that was followed by the Mumbai attacks in November 2008 when the attention of law makers was diverted to more pressing concerns such as safety and security of the country (and rightly so), after which the election process put the issue to the backburner. The issue will hopefully be brought to the forefront so as to achieve an overhaul of Indian company law, which has been pending for over a decade now.


At a broad level, other issues on the agenda include the clarification of the tax regime for limited liability partnerships, finalisation of merger control provisions under competition law and streamlining of the foreign investment policy of the country (particularly with reference to the sectoral limits on foreign investment). This column in the Mint sets out a more detailed list of the key tasks ahead for the new government in terms of economic reforms. Finally, another event that would be viewed with a great sense of anticipation is the full Budget which, reports suggest will be presented in the Parliament session beginning in June (note that the Government had only presented an Interim Budget prior to the elections).

Thursday, May 14, 2009

A Call for Greater Shareholder Rights under U.S. Law

The proposed Shareholder Bill of Rights Act of 2009 in the U.S. that comes in the wake of the financial crisis gives rise to an important debate regarding the rights of shareholders in companies. The rationale for the Bill is the perceived failure of corporate governance that led to the crisis. It is worthwhile to set out the larger objective behind the Bill:


Congress finds that—

(1) among the central causes of the financial and economic crises that the United States faces today has been a widespread failure of corporate governance;

(2) within too many of the Nation’s most important business and financial institutions, both executive management and boards of directors have failed in their most basic duties, including to enact compensation policies that are linked to the long-term profitability of their institutions, to appropriately analyze and oversee enterprise risk, and most importantly, to prioritize the long-term heath of their firms and their shareholders;

(3) such failure has led to the loss of trillions of dollars in shareholder value, losses that have been borne by millions of Americans who are shareholders through their pension plans, 401(k) plans, and direct investments;

(4) a key contributing factor to such failure was the lack of accountability of boards to their ultimate owners, the shareholders;

(5) policies that serve to limit the ability of shareholders to nominate and elect board members has served to minimize the accountability of boards and management to shareholders;

(6) it has always been the intent of Congress that the Securities and Exchange Commission should have the full authority to determine the use of issuer proxy with regards to the nomination and election of directors by shareholders; and

(7) providing a greater voice to shareholders while not impinging on management prerogatives is in the best interests of shareholders, public corporations, and the economy as a whole.


The Bill seeks to make certain key changes to corporate law at the federal level. These include the following:


- Annual stockholder advisory (almost non-binding) votes on executive compensation;

- Nomination of candidates by shareholders holding a minimum of number of shares (and access to proxy solicitation materials supplied by the company);

- Elimination of staggered boards;

- Director elections should ensure that all directors receive a majority of votes cast at an elections; and

- Separation of the position of Chairman and CEO.


These changes spring up some interesting comparisons with the position in India. To an Indian corporate lawyer, some of these changes that have been spearheaded by U.S. shareholder activists more recently may appear trite because such shareholder rights have always been available in India for a number of years (and certainly from the time of the Companies Act, 1956). Some of the comparisons are explored below:


Executive Compensation: In Indian companies, shareholder approval is mandatory for senior management pay by virtue of Sections 309 and 198 of the Companies Act, 1956. Apart from that, they are also subject to ceiling on amounts depending on the profitability of the company. On the other hand, in the U.S., even the present Bill only provides advisory (non-binding) voting powers to shareholders as regards executive compensation.


Director Nominations: Section 257 of the Companies Act, 1956 allows any member to propose a person to stand for directorship of the company, and the company is in turn required to inform its members of the intention to propose such candidate for office of director.


Staggered Boards: This concept, which is prevalent in U.S. companies, ensures that only a third of the board can change each year. Furthermore, shareholders are usually not in a position to remove directors, other than for reasons of “cause”. Hence, it would not be possible for shareholders to replace the board, except through a gradual process of changing a third of the board each year. In the Indian context, Sections 255 and 256 of the Companies Act, 1956 provide for an element of staggering of the board, in as much as they provide that at least two-thirds of the board should consist of directors who retire by rotation. The remaining one-third is appointed in the manner permitted by the articles of association. Despite some shades of similarity between the Indian and U.S. position, there is one stark difference. And that is that Indian directors (whether appointed by general meeting through rotation or in the manner permitted by the articles) are all liable to be removed by the shareholders through an ordinary resolution (simple majority) at a shareholders meeting (Section 284, Companies Act, 1956). This is a significant power in the hands of Indian shareholders.


Director Elections: The seemingly radical proposal in the Bill of Rights is the accepted norm in India. Section 263 of the Companies Act, 1956 provides for a general rule whereby each director is required to be elected by a way of a separate resolution, thereby requiring at least a majority of the votes at a shareholders’ meeting.


Duality of Posts: Although there is no requirement in India for the posts of Chairman and CEO to be occupied by separate individuals, it is indeed the case in practice. Some studies have pointed to the fact that nearly 60% of Indian listed companies have a separation of posts.


This comparison seems to indicate that shareholders’ rights are firmly entrenched in the Indian Companies Act and even progressive corporate law jurisdictions such as the U.S. (including Delaware) are only now moving in that direction. While we often lament that India adopts several corporate governance principles (e.g. in Clause 49 of the listing agreement) from the West, including the U.S., the Bill of Rights is an example of a progressive corporate law, such as the U.S., moving towards what is the stated position in India. Having said that, it is not as if the principles of Indian corporate law provide a sense of optimality. Although shareholders as a body possess significant rights under Indian company law, their exercise is skewed due to the presence of controlling shareholders or promoters who tend to use these powers, sometime to the detriment of the minority shareholders.


For an earlier discussion of governance failure as a cause for the financial crisis and further comparison between Indian and U.S. corporate governance systems, see here, here and here.


Returning to the Bill of Rights, there is an intense debate about the suitability of granting these rights to shareholders. For instance, in a post on the Harvard Law School Forum on Corporate Governance and Financial Regulation and an op-ed piece in the Wall Street Journal, Martin Lipton and Theodore N. Mirvis of Wachtell, Lipton, Rosen & Katz and Jay W. Lorsch of Harvard Business School attribute short-termism among shareholders, primarily hedge funds and institutional investors, as the cause for the crisis. They argue that the Bill of Rights will only exacerbate this problem:


Increased stockholder power is directly responsible for the short-termist fixation that led to the current crises. The bulk of the specific provisions suggested would increase stockholder power. Stockholder power has already substantially increased over the last twenty years. Concomitantly, our stock markets have become ever-increasingly institutionalized. The undeniable fact is that the true “investors” are now professional money managers who are inherently short-term (even quarterly) focused. That “stockholder” pressure pushed companies to generate high financial returns at levels that were not sustainable, with management’s compensation being tied to producing such returns (at stockholder urging). The increase in stockholder power and stockholder pressure to produce unrealistic profits fueled the pressure to take on increased risk. As the government arguably relaxed regulatory checks on excessive risk taking (or, at minimum, did not respond with increased prudential regulation), the increased stockholder power and pressure for ever higher returns contributed significantly to the current financial and economic crises. That pressure became all the more irresistible as it combined with increased stockholder power to oust or discipline managers and directors — power available to enforce the stockholder and activist investor agenda of ever higher short-term returns.


Other arguments the authors make include the substantial concern that this will result in the usurpation by the federal government of matters that are otherwise within the domain of state law (e.g. Delaware). This argument has been supported by others as well, e.g. see Professor Bainbridge.


Hat tip: Shaun Mathew

Tuesday, May 12, 2009

More Uncertainty in the Law on Penalties

Earlier posts have noted and examined a few recent decisions of the Supreme Court and the ITAT on the law governing the imposition of penalties under the Income Tax Act, 1961. In what is perhaps the best restatement of the position of law today, the Pune Bench of the ITAT appears to have altered the course of the law back towards the assessee-friendly Dilip Shroff decision, in Kanbay Software India Pvt. Ltd. v. DCIT (ITA 300/PN/07, decided on 28 April, 2009). A copy of the judgment is available here.


The events leading up to this judgment have generated controversy primarily because there is uncertainty as to the position of law today, although the Supreme Court in Union of India v. Dharmendra Textile Processors overruled its judgment in Dilip Shroff, since it was not clear to what extent Dilip Shroff has been overruled and in what context the requirement of mens rea had been dispensed with. To briefly summarise, s. 271(1)(c) provides that a penalty may be levied on the assessee if he either conceals the particulars of his income, or has furnished inaccurate particulars of his income. The question that arose was whether s. 271(1)(c) had a mens rea requirement – i.e. was it required to be established that the assessee consciously furnished inaccurate particulars or was the mere fact sufficient? In Dilip Shroff, the Supreme Court answered this question in favour of the assessee, holding that since s. 271(1)(c) is a quasi-criminal provision, this was required to be established and that the burden of proof was on the Revenue. Two months after it was decided, another Division Bench of the Supreme Court expressed reservations over its correctness and referred the matter to a larger Bench. The larger Bench held in Dharmendra Textiles that s. 271(1)(c) was not a penal or quasi-criminal provision, but one that fastened a penalty for the breach of a civil obligation, for which it is not necessary to establish mens rea. To this extent, Dilip Shroff was overruled.


Difficulty arose in the application of the Supreme Court’s judgment in Dharmendra. Complaints from across the country suggested that the Revenue was reading the judgment to suggest that every case where the Assessing Officer differed with the assessee on the returns was one fit for the imposition of penalties, even if the difference pertained to a matter of opinion where it was possible to take two views. The facts of the decision in Kanbay Software illustrate this. Kanbay Software Pvt. Ltd. [“KSPL”] is a company engaged in the business of development and export of software, and maintained two units. KSPL set off the losses of the second unit against the profits of the first and claimed deduction under s. 10A of the Income Tax Act. After the Finance Act, 2003 retrospectively amended portions of this provision, KSPL filed revised returns seeking to carry forward unabsorbed losses and depreciation in respect of the second unit, amounting to a total of about Rs. 5.37 crore. However, the Assessing Officer held that the unabsorbed losses and depreciation of one unit had to be set off against the profits of the other unit before deduction under s. 10A, with the result that no loss could be carried forward. KSPL accepted this finding, filed no appeal, and the order became final. However, the Assessing Officer initiated penalty proceedings under s. 271(1)(c), found that KSPL had “furnished inaccurate particulars”, and levied a penalty of Rs. 2 crore.


In appeal before the ITAT, submissions were invited on the true nature and scope of the decision in Dharmendra Textile Processors. The Revenue argued that the effect of the judgment was that penalty is almost an automatic addition to the income of the assessee, and urged the Tribunal to give effect to this judgment, especially since Dilip Shroff had been widely followed. In rejecting this argument, AM Pramod Kumar has carefully considered and explained the import of the judgments on this point. He noted, correctly, that the primary point on which Dilip Shroff had been overruled was its characterization of s. 271(1)(c) as a “penal” or “quasi-criminal provision”. However, a “civil obligation” is not necessarily one that automatically imposes penalty in the nature of additional income. The Tribunal therefore held that for the “civil obligation” imposed by s. 271(1)(c) to be considered to have been “breached”, it is not sufficient to merely show that there is a disagreement between the returned income and the assessed income. Reference was made to the provisions of s. 139 of the Act. S. 139 specifies the form and procedure of filing returns, and was held to imply that the only civil obligation on the assessee is to furnish returns which are correct and complete “to the best of [his] knowledge and belief”. The following observations are relevant:


An addition to income does not always have a causeand effect relationship with the discharge of assessee’s obligations under section 139(1), because even when an assessee duly discharges his obligations under section 139(1), there can still be additions to, or disallowance from, the returned income due to a variety of reasons, viz. genuine variations in perceptions of the assessee visàvis the Assessing Officer about a legal interpretation, the changes in judgemade or statute law between the period when an income tax return is filed and when the assessment is framed, extraneous factors affecting ability of the assessee to establish certain facts based on which deductions are claimed, and even plain inadvertent clerical errors.”


The Tribunal went on to hold that Dilip Shroff had been reversed not on the question of whether this additional requirement was part of s. 271(1)(c), but on who the burden of establishing it lies. In sum, the Tribunal held that there are three possible situations where the question of penalty could arise – (a) where the addition to income is clearly because of the assessee’s contumacious conduct; (b) where it is not possible to establish that the addition is on account of the assessee’s contumacious conduct and (c) an addition is made, but the assessee is able to establish his innocence with a bona fide explanation. In the first case, penalty was always leviable, and this has not changed. In the third case, penalty was never leviable and the ITAT held that this continues to be the position. The law has therefore changed only with respect to the second situation – earlier, the Department was required to establish the link between the added income and his contumacious conduct. Now, the onus of proof is on the assessee.


It is unlikely that the last word has been spoken on this subject. Despite the ITAT’s very carefully reasoned and correct judgment, it does not sit entirely comfortably with Dharmendra Textile Processors, and may therefore only be one of the first chapters in this story.