Gautam Nayak Chartered Accountant

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1 Gautam Nayak Chartered Accountant Capital gains vs. Business Income, Treatment of Derivative Transactions,14A, Other Issues. The Chamber of Tax Consultants - Education Course on Capital Market 30 th April 2016

2 Recent Developments in Capital Markets Securities held by Foreign Portfolio Investors included in definition of capital asset Transactions on which Commodity Transactions Tax paid are not to be treated as Speculative transactions Exemption from capital gain tax on income generated from transactions occurred in foreign currency on a recognised stock exchange located in International Financial Services Centre. Amendment in section 56(2)(vii) Receipt of shares on Amalgamation, Demerger. Tax on dividend income received exceeding Rs. 10 lakhs and resulting compliance of filing return of income on receipt of such income. Proposed amendment in Rule 8D to provide disallowance not to exceed exempt income & limiting the disallowance to 1% of average monthly value of investments yielding exempt income. Effect of GAAR from Fund Manager not to be a PE of Fund on fulfilling prescribed conditions. Circular no. 6/2016 Taxability of surplus on sale of shares and securities. Takeover, Buyback through stock market mechanism STT leviable Exemption 2

3 Capital Gains v. Business Income

4 CBDT Instruction No.1827 of 1989 o G. Venkataswami Naidu & Co. 35 ITR 594 (SC) various tests o H. Mohammed & Co. 107 ITR 637 (Guj) selling outright vs. deriving income from exploitation o Sardar Indra Singh & Sons Ltd. 24 ITR 415 (SC) connection with assessee s business o SBH 151 ITR 703 (AP) connection with business o Karam Chand Thapar & Bros. P. Ltd. 82 ITR 899 (SC) accounting treatment not conclusive o Decision ultimately on facts of each case 4

5 Draft CBDT Instruction of May Whether purchase & sale of securities allied to usual trade or business / incidental to it or occasional independent activity 2. Whether purchase made solely with intention of resale at profit or for long term appreciation and/or for earning dividends & interest 3. Whether scale of activity substantial. 4. Whether transactions entered into continuously & regularly during the year. 5. Whether purchases made out of own funds or borrowings 6. Stated objects in Memorandum and Articles of Association of a corporate 7. Typical holding period for securities bought and sold 8. Ratio of sales to purchases and holding Time devoted to the activity and extent to which it is the means of livelihood. 9. Characterization of securities in books of account and in balance sheet as stock in trade or investments. 10. Whether securities purchased or sold are listed or unlisted. 11. Whether investment is in sister/related concerns or independent companies. 5

6 Draft CBDT Instruction of May Whether transaction is by promoters of the company. 13. Total number of stocks dealt in. 14. Whether money has been paid or received or whether these are only book entries. Total effect of all factors to be considered Observations Mere draft, not actually issued Factors culled out from various case laws Supported by Press Release Though not binding on AO, can act as a guide to deciding issue Referred to in a few decisions 6

7 CBDT Circular No.4 of June 2007 Whether investment or stock-in-trade is matter within knowledge of assessee Whether investments or trading transactions mixed question of fact and law Power in MoA not decisive Substantial nature of transactions, magnitude of purchases and sales, and ratio between purchases & sales & holding are good guide Motive of earning profit vs. objective of deriving income by dividend Possible to have both investment & trading portfolio 7

8 Recommendations of Easwar Committee Disputes continue on application of principles to facts of each case Taxpayers experience difficulty in proving intention in acquiring the shares Particularly individual taxpayers, who are not well-versed in keeping accounts Some clarity should be provided in the Act that will bring in clarity if certain objective criteria are met Surplus on transfer of shares and securities held for a period exceeding 12 months, in all cases, to be chargeable as capital gains if they are not held as stock-in-trade. Surplus on transfer of shares and securities held for a period not exceeding 12 months, upto a sum of Rs.5 lakh, to be chargeable as capital gains if not held as stock-in-trade. Cases not covered by above proposed amendment shall continue to be assessed on basis of existing principles laid down by the courts and summarised by the CBDT. Recommendations did not find place in the budget proposed amendments Circular No. 6 of 2016 introduced to reduce litigation Circular binding on AO but circular not as effective as amendment in Act. Circular can be withdrawn without parliamentary approval. 8

9 CBDT Circular No 6 of February 2016 Determination of character of investments in shares & securities essentially fact-specific determination led to lot of uncertainty & litigation in the past Courts have laid down various parameters to distinguish investment from stock in trade CBDT summarised said principles through instruction no dated 31 st August 1989 and circular no. 4 of 2007 dated 15 th June 2007 for guidance of field formations Disputes on application of principles to facts of individual case Taxpayers find it difficult to prove intention in acquiring such shares/securities No universal principle in absolute terms can be laid down to decide character of income from sale of shares & securities Since major part of transactions takes place in listed shares & securities, to reduce litigation, further instructions to modify earlier circulars. 9

10 CBDT Circular No 6 of February 2016 Where an assessee himself prefers to treat his listed shares and securities as stock in trade, the income arising on transfer of the same would be income from business and profession. This would be irrespective of the period of holding of such securities. If for listed shares and securities the period of holding is more than 12 months and the assessee desires to treat the income arising on transfer of the same as capital gains, the same shall have to accepted by the AO. However the stand once taken by the assessee would have to be followed consistently by him and he would not be allowed to take a different/contrary stand in subsequent assessment years. For cases other than those covered above, the issue would be decided based on the principles established by the earlier CBDT circulars. The provisions of Act shall continue to apply and guidelines provided in this circular shall not apply to such transactions where the genuineness of the transaction is itself questionable. Applicable to all listed securities shares, debentures, g-secs Disputes relating to STCG will continue Impact where both stock in trade and investments 10

11 Capital gain vs. Business Income PMS Appointment of Portfolio Manager Impact on tax treatment as investment/business Appointment of Agent Agent infrastructure v. own infrastructure Purpose of appointment of agent Discretionary PMS full freedom to PMS Manager mere reporting to investor on regular basis 11

12 Capital gain vs. Business Income PMS Churn by Portfolio Manager Impact Mere increase in volumes not determinative All other factors need to be considered Sar investment Pvt. Ltd. v. Dy. CIT 40 SOT 566 (Ahd) Larger volumes may be due to: omodifying earlier investments to adhere to PMS Manager strategies oresponding to changes in market environment rebalancing of portfolio Category of Portfolio Strategy Buying risky shares does not change an investor into businessman Strategy based on risk appetite of individual 12

13 Capital gain vs. Business Income PMS ARA Trading & Investments P Ltd v Dy CIT 47 SOT 172 (Pune) Cannot be said to be trading by the client objective to maximise investment value When neither the purchase nor sales are decided by the assessee but for that purpose the portfolio manager is assigned, then the term "dealing" cannot be attached with the assessee Radials International v ACIT 367 ITR 1 (Del HC) The source of funds of the assessee was its own surplus funds. 71 per cent of the total shares - held for a period longer than 6 months, and resulted in an accrual of about 81 per cent of the total gains 45 transactions made daily not an accurate reflection of holding period PMS agreement is an agreement of agency and must not be considered with an intention to make profit. Investments managed through PMS could not be 'business income' simply because of the services of Portfolio Management Service having been engaged. 13

14 Capital gain vs. Business Income PMS CIT v. Kapur Investments (P.) Ltd. 234 Taxman 149 (Kar) Assessee was in business of finance and films. Borrowed funds and invested in shares through PMS. Since profits huge and regular in nature, AO taxed as business income. HC - investment through PMS cannot be business. Only a case of a more careful and prudent mode of investment Funds lying can always be invested (for earning higher returns) in the shares either directly or through professionally managed Portfolio Management Scheme and it would not mean carrying on the business of investment in shares. Such profits either directly or through PMS will remain Capital Gains Act does not prohibit the assessee from making investments in capital assets after using borrowed funds 14

15 Capital gain vs. Business Income PMS Salil Shah Family (P.) Trust v. ACIT 144 ITD 390 (Mum) Assessee, a private family trust, invested its corpus in purchase of shares and securities through PMS. Due to large volume, frequency and multiplicity of transactions, AO held that assessee s intention was to earn quick profit. Income taxed as PGBP. ITAT - perusal of PMS agreement shows intention to appoint managers is to invest its corpus in shares & securities for wealth creation. Finding by CIT(A) that Portfolio Managers are agents working for and on behalf of the assessee. All investments decisions are made by PMS provider and gains are on account of assessee. Assessee has no control in decision making of discretionary PMS. No borrowed funds, and hence to be taxed as Capital gains. 15

16 ICDS - Impact on Securities Transactions ICDS VIII Securities Applicable to securities held as stock in trade not applicable to investments Derivatives excluded Closing stock to be valued at lower of cost or net realisable value on bucket wise basis (not on scrip wise basis) 4 buckets shares, debt securities, convertible securities, other securities Unlisted and thinly traded securities to be valued at cost not quoted with regularity (frequency not specified) Cost to comprise of purchase price, and include acquisition charges (brokerage, fees, tax, duty or cess) FIFO to be applied in case cost cannot be determined using specific identification not only for demat securities Pre-acquisition interest to be reduced from cost of interest-bearing security no provision re reduction from sale price 16

17 New transactions under STT net Initial Public Offer for Sale transactions are brought in STT net. Until June 2012, transactions wherein existing shareholders transferred shares to public did not come under the purview of STT. W.e.f transactions of sale of unlisted equity shares under an offer for sale to the public in an initial public offer, where the shares are subsequently listed on a RSE. If such shares are Long Term, long term capital gains would be exempt (period of 36 months as unlisted security) Available only for IPO and not for FPO Also w.e.f the tender offer for acquisition of shares under takeovers, buybacks and delisting is amended. Now option of offering shares through a broker, who issues a contract note for sale to tendering shareholder after acceptance of offer is completed by offeror or company STT charged on such transaction Shareholder gets benefit of long-term capital gains exemption or concessional rate of tax of 15% for short-term capital gains, as the case may be. 17

18 Period of holding Convertible Debentures CIT v. Naveen Bhatia (62 taxmann.com 87)(P & H) A question arose before the High Court that whether the period of holding of shares received on conversion of debentures to be reckoned from the date of purchase of convertible debentures or the actual date of allotment of shares on conversion? The high Court explained that Section 47(x) indicates that the conversion of convertible debentures into shares would not constitute transfer. Section 49(2A) clarifies that the cost of acquisition of shares shall be the cost of convertible debentures As a necessary corollary, it would be but logical to reckon the date of acquisition of the convertible debentures as the date of acquisition of such shares received on conversion of convertible debentures. Reliance placed on Smt.Roda v. ITO (ITA No.1069/AHD/96) In case of convertible debentures, a right is appended to the debenture for the debenture holder to receive shares on conversion after the stipulated period. 18

19 Period of holding - Amendment Notification No 18/2016: Method of Determination of period of holding of capital Assets 17 th March 2016 Amendment in Rule 8AA. In the case of a capital asset, being a share or debenture of a company, which becomes the property of the assessee in the circumstances mentioned in clause (x) of section 47 of the Act, there shall be included the period for which the bond, debenture, debenture-stock or deposit certificate, as the case may be, was held by the assessee prior to the conversion 19

20 Tax treatment of Derivative Transactions

21 Derivative transactions Can derivatives be Capital assets? Nature of Derivatives Whether distinct from underlying shares CIT vs. Tata Services Ltd. 122 ITR 594 (Bom) Whether any advantage in treating derivatives as Capital assets? Section 10(38) & s.111a equity shares Hedging transactions Purchase and sale in case of futures sales 21

22 Derivative transactions For Investor Whether derivatives transaction and subsequent share purchase/sale part of the same transaction or separate transactions? If separate, whether transfer of derivatives on physical settlement? If separate, whether income/loss from derivatives to be computed separately and not to be adjusted in cost/sale price of shares? Loss on lapsing of option whether allowable as capital loss? 22

23 Derivative transactions Delivery Settled Derivatives Right to purchase asset resulting in delivery of asset Whether transfer of derivative and acquisition of share or merger of existing right into asset? Derivative and share separate assets so long as delivery not taken Merger into asset on delivery JHP Securities P Ltd v ITO ITA No 1249/Mum/2008 dated conversion of warrants into shares does not give rise to transfer Right to purchase asset & asset rights entitlements & rights shares Arjan Khimji & Co 121 ITR 421 (Bom) not applicable contracts held to be not connected Date of delivery would be date of acquisition of share Cost would be amount paid for derivative plus amount paid on delivery 23

24 Derivative transactions Mask Investments Ltd. v. ACIT 53 SOT 532 (Ahd) Derivative by itself cannot be termed as an investment or stock in trade. The entire transactions of purchase/sale of securities/shares through derivatives and later on dealing with those shares/securities will determine whether an investment is made or stock-in-trade is procured. The intention of the assessee has to be examined to determine whether the asset is to be treated as investment or stock- in- trade 24

25 Derivative transactions Allowability of Loss on Lapsing of Options Dy. CIT v. BPL Sanyo Finance Ltd. 312 ITR 63 (Karn) Forfeiture of share application money allowable as capital loss CIT v. Chand Ratan Bagri 329 ITR 356 (Del)- Forfeiture of amount paid towards convertible warrants capital loss deductible Ajay C Mehta v Dy CIT 114 ITD 628 (Ahd) - extinguishment of warrants amounts to transfer however no consideration accruing as a result of transfer computation provisions fail capital loss not allowable 25

26 Derivative transactions 'Turnover/Gross receipts' in respect of Speculative transactions [Para 5.15 of ICAI Guidance Note on Tax Audit, 2014 edition]: A speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Thus, in a speculative transaction the contract for sale or purchase which is entered into is not completed by giving or receiving delivery so as to result in the sale as per value of contract note. The contract is settled otherwise and squared up by paying out the difference which may be positive or negative. As such, in such transaction the difference amount is 'turnover'. In the case of an assessee undertaking speculative transactions there can be both positive and negative differences arising by settlement of various such contracts during the year. Each transaction resulting into a positive or negative difference, is an independent transaction. Further, amount paid on account of negative difference is not related to the amount received on account of positive difference. In such transactions, though the contract notes are issued for full value of the purchased or sold asset, the entries in the books of account are made only for the differences. Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of such transactions for determining the liability to audit under section 44AB. 26

27 Derivative transactions 'Turnover/Gross receipts' in respect of Speculative transactions Banwari Sitaram Pasari v. ACIT 140 ITD 320 (Pune) Business of online trading of commodities is speculation activity and in speculation activity, there is no physical delivery of commodities given or taken. Co-ordinate Bench of Mumbai Tribunal in case of Growmore Exports Ltd. v. Asstt. CIT 78 ITD 95, after considering section 18 of Sale of Goods Act 1930 observed that no property in said units passed on to assessee inasmuch as assessee never acquired property in units as the units contracted to be bought were future unascertained goods. Similarly, it could not pass on the property to the party to whom the units were contracted and therefore, there was no 'sale' or 'turnover' effected by the assessee in the legal sense for the purposes of getting the accounts audited u/s 44AB of the Act. Om Stock & Commodities (P.) Ltd. v. DCIT 150 ITD 645 (Mum) Sections 44AB- 271B- Value of transactions of online trading in commodities through MCX without taking delivery do not constitute turnover for computing the limits u/s 44AB of the Act. There is no element of turnover where there is no physical delivery of commodities given or taken. 27

28 Derivative transactions CIT v. New Ambadi Estates (P.) Ltd 20 taxmann.com 180 (Mad) Sections 44AB- 271B- Value of transactions of online trading in commodities through MCX without taking delivery do not constitute turnover for computing the limits u/s 44AB of the Act. There is no element of turnover where there is no physical delivery of commodities given or taken. 28

29 Derivative definition s.43(5) Section 43(5): Transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips Exceptions: (b) contract in respect of stocks & shares entered into by dealer or investor to guard against loss in holdings of stocks & shares through price fluctuation (c) contract entered into by member of forward mkt/stock exchange in course of jobbing or arbitrage to guard against loss which may arise in ordinary course of business as a member (d) eligible transaction of trading in derivatives referred to in s.2(ac) of SCRA carried out in recognised Stock exchange electronically through stock broker regd u/s 12 of SEBI Act supported by time stamped contract note indicating unique client ID no and PAN (e) eligible transaction in respect of commodity derivatives carried out in recognised assn chargeable to CTT 29

30 Derivative transactions Impact of FMC Merger with SEBI Commodity derivatives whether still eligible? Merger wef repeal of FMC Act All recognised associations under FCRA deemed to be recognised stock exchanges under SCRA Whether commodity derivatives are securities as defined in SCRA? S 2(h) includes derivatives S 2(ac) - derivative includes (A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; (B) a contract which derives its value from the prices, or index of prices, of underlying securities Currency futures traded on stock exchanges Still liable to CTT leviable on transactions in recognised assns 30

31 Derivative transactions s.43(5) Clause (b) of proviso to section 43(5): ACIT v. Dinesh K Mehta (HUF) 39 SOT 488 The purpose of contract is to guard against loss in holding of stock or shares through price fluctuations. The assessee cannot enter into a transaction purported to be a hedge in respect of shares he does not hold Unlike clause (a) of proviso, clause (b) requires actual existence of shares or stocks which are to be guarded against price fluctuations 31

32 Explanation to s.73 CIT v. DLF Commercial Developers Ltd. 218 Taxman 45 (Del) Whether loss on derivative transactions disallowable under expln to s.73? Definition of derivative u/s 43(5) restricted for the purposes of sections 28 to 41 Under expln to section 73, business of purchase and sale of shares is deemed to be speculation business Tempting to hold that the expression 'derivatives' is defined only in s 43(5) and it excludes such transactions from the odium of speculative transactions Doing violence to Parliamentary intendment Definition enacted for only a restricted purpose or objective should not be applied to achieve other ends or purposes Wherever the context and setting of a provision indicates an intention that an expression defined in some other place in the enactment, cannot be applied, that intent prevails, regardless of whether standard exclusionary terms (such as 'unless the context otherwise requires') are used 32

33 Explanation to s.73 CIT v. DLF Commercial Developers Ltd. 218 Taxman 45 (Del) Objective of section 73 apparent from the tenor of its language is to deny speculative businesses the benefit of carry forward of losses Explanation to s 73 has been enacted to clarify beyond any shadow of doubt that share business of certain types or classes of companies are deemed to be speculative. That in another part of the statute, which deals with computation of business income, derivatives are excluded from the definition of speculative transactions, only underlines that such exclusion is limited for the purpose of those provisions or sections. By all accounts the derivatives are based on stocks and shares, which fall squarely within the Explanation to section 73. Therefore, it is idle to contend that derivatives do not fall within that provision. 33

34 Derivative transactions A.K. Capital Markets Ltd. v. DCIT 156 ITD 528 (Del) Assessee earned other income from which it sought to set off its loss from trading in Futures & Derivatives Whether assessee covered by explanation to section 73 The explanation provides that if only income which is included in gross total income falls under interest on securities, income from house property, capital gains and income from other sources or under all the aforesaid specified heads it could not deemed to be carrying on a speculative business for the purpose of section 73(1) Since positive income is under IFOS and loss is not considered while computing Gross total income. If loss considered as income adjustable u/s 72 which is prohibited u/s 73. Section 72(1) prohibits consideration of the speculation loss while computing the income The assessee would not be deemed to be carrying on speculative business for the purpose of section 73(1) 34

35 Derivative transactions ITO v. Emperorr International Ltd 60 taxmann.com 307 (Del Trib) Assessee incurred loss in derivative trading and earned profit on commodity trading Assessing officer treated the transactions as speculative and did not allow set off Held: Profit earned from trading in commodity were delivery based and hence cannot be termed as speculative Derivative transactions were on Recognised Stock Exchange Loss on derivative trading was an eligible transaction as provided u/s 43(5)(b) and hence cannot be speculative Reference to the judgment of R.B.K Securities (P.) Ltd v. ITO 118 TTJ

36 Section 14A

37 Section 14A - Amendment Finance Act 2016: Budget Speech : I propose to rationalize the formula in Rule 8D governing such quantification. The said Rule is being amended to provide that disallowance will be limited to 1% of the average monthly value of investments yielding exempt income, but not exceeding the actual expenditure claimed. Amendment would be made in Rules, hence not incorporated in Finance Bill 37

38 Is dividend exempt income or tax paid income? Can a claim be made that the dividend income is really a tax paid income and not an exempt income of the shareholder, with the tax liability being discharged by the company instead of by the shareholder? Godrej & Boyce Mfg Co Ltd 328 ITR 81 (Bom) The payment by a domestic company under s. 115-O(1) of additional income-tax on profits declared, distributed or paid is a charge on a component of the profits of the company. The company is chargeable to tax on its profits as a distinct taxable entity and it pays tax in discharge of its own liability and not on behalf of or as an agent of its shareholders. In the hands of the shareholder as the recipient of dividend, income by way of dividend does not form part of the total income by virtue of the provisions of s. 10(33). Income from mutual funds stands on the same basis; Whether taxability of income to be seen qua recipient or qua character of income? Intention vs language 38

39 Is dividend exempt income or tax paid income? Explanatory Memorandum to Finance (No 2) Act 2014 Prior to introduction of dividend distribution tax (DDT), the dividends were taxable in the hands of the shareholder. The gross amount of dividend representing the distributable surplus was taxable, and the tax on this amount was paid by the shareholder at the applicable rate which varied from 0 to 30%. However, after the introduction of the DDT, a lower rate of 15% is currently applicable but this rate is being applied on the amount paid as dividend after reduction of distribution tax by the company. Therefore, the tax is computed with reference to the net amount. Similar case is there when income is distributed by mutual funds. Due to difference in the base of the income distributed or the dividend on which the distribution tax is calculated, the effective tax rate is lower than the rate provided in the respective sections. In order to ensure that tax is levied on proper base, the amount of distributable income and the dividends which are actually received by the unit holder of mutual fund or shareholders of the domestic company need to be grossed up for the purpose of computing the additional tax. 39

40 Is dividend exempt income or tax paid income? Draft Report of Justice R.V Easwar (Retd) Committee A further dispute which arises in the application of the section is what constitutes exempt income. In terms of the existing provisions, an income is treated as exempt if the said income is not includible in the total income of the assessee regardless of the fact that it has suffered economic taxation. In other words, legal taxation is the basis at present for determining whether an income is exempt or not. As a matter of principle, tax provisions must be designed on the basis of the economics of taxation and a deviation, if any, should be only on consideration of externalities, ease of compliance and administration and anti-abuse. Income like dividend suffers economic taxation by way of DDT and therefore in an economic sense cannot be construed to be exempt income. Such income, in the view of the Committee, having suffered DDT in the hands of the payer-company, should be treated as having been taxed in the hands of the recipient. In view of the above, the Committee recommends that the provisions of s. 14A should be designed to appropriately reflect the principle of economic taxation Accordingly, income which has been subject to DDT should be deemed to form part of the total income of the assessee for the purpose of the section. 40

41 Quantum of disallowance more than expenses? Can amount of disallowance exceed amount of expenses claimed by the assessee? Rule 8D merely computation provision disallowance governed by s.14a S.14A requires non allowance of deduction of expenditure expenditure should have been first claimed CIT vs. Hero Cycles Ltd [2010] 323 ITR 518 (P&H) : [2009] 323 ITR 518 (P&H) ACIT vs. Iqbal M. Chagla (2015) 67 SOT 123 (Mum) Adani Port Infrastructure Pvt. Ltd. Vs. DCIT Circle (1) ITA No.1383/Ahd/2013 (Ahmedabad) Gillette Group India (P.) Ltd. vs. Asstt. CIT (2012) 16 ITR (Trib) 57 (Del.) 41

42 Quantum of disallowance more than expenses? Draft Report of Justice Easwar Committee Under the existing provisions, the application of Rule 8-D sometimes results in an unintended outcome whereby the amount of such expenditure exceeds the total amount otherwise claimed as expenditure; obviously, the disallowance cannot exceed the amount claimed. Sometimes disallowance under the Rule also results in the disallowance exceeding the exempt income. The Committee recommends that the law should be amended appropriately. The Committee accordingly recommends the following amendments to s 14A: (A) After sub-section (3), the following sub-section may be inserted and shall be deemed to have been inserted with effect from the 1st day of April, 2001, namely:- (4) The amount of expenditure determined under sub-section (2) shall not exceed the aggregate of the amount of expenditure claimed under any provisions of the Act (other than the provisions of sections 32 to 35E) in respect of any income forming part of the total income. 42

43 Quantum of disallowance-more than exempt income? Can the amount of disallowance exceed the exempt income of the year? Disallowance cannot exceed exempt income. Joint Investments P Ltd v CIT (2015) 372 ITR 694 (Del) CIT v Smt. Leena Ramachandran 339 ITR 296 (Ker) Daga Global Chemicals Pvt. Ltd v ACIT (2015) ITA No. 5592/Mum/2012 (Mum) Draft Report of Justice R.V Easwar (Retd) Committee Sometimes the disallowance under the Rule also results in the disallowance exceeding the exempt income. The Committee recommends that the law should be amended appropriately. 43

44 Disallowance in absence of exempt income Does the disallowance apply in a situation where there is no exempt income at all during the year? No disallowance if no exempt income earned CBDT Circular No 5 of 2014 dated CIT v. Holcim India (P.) Ltd (2015) 272 CTR 282 (Del) Cheminvest Ltd v CIT (2015) 378 ITR 33 (Del) CIT v. Shivam Motors (P.) Ltd. [2015] 230 Taxman 63 (All) CIT v. Lakhani Marketing Inc. [2014] 226 Taxman 45 (P & H) CIT v. Corrtech Energy (P.) Ltd. [2014] 223 Taxman 130 (Guj) CIT v Subrata Roy (2013) 219 Taxman 133 (All) 44

45 Disallowance in case of strategic investments Would the disallowance be applicable where the expenditure is incurred by a company in relation to shares of a subsidiary, or shares of a company held for strategic business purposes? No 14A disallowance on strategic investments Holcim India Pvt Ltd (2014) 272 CTR 282 (Del) EIH Associated Hotels v. Dy. CIT [ITA No (Mds.) of 2012] Selvel Advertsing Pvt Ltd 37 ITR (Trib) 611 (Kol) Garware Wall Ropes Ltd 65 SOT 86 (Mum) J.M. Financial Ltd. v. Addl. CIT [ITA No (Mum.) (J) of 2012, dated CIT v. Oriental Structural Engineers (P.) Ltd. [2013] 216 Taxman 92 (Mag.)(Del) L & T Infrastructure Development Projects Ltd 37 ITR (T) 10 (Chen) Interglobe Enterprises Ltd. v. Dy. CIT (2014) 40 CCH 22 Del Trib Coal India Ltd v Addl CIT (2015) 172 TTJ 103 (Kol) 45

46 Disallowance in case of stock in trade Would the disallowance apply to a situation where the shares are held as stock in trade? Would such shares be regarded as investments, income from which does not or shall not form part of the total income, for the purposes of the formula under rule 8D? CIT v India Advantage Securities Ltd (2015) ITA No 1131 of 2013 (Bom) CCI Ltd v. JCIT (2012) 250 CTR 291 (Kar) CIT vs. Gulshan Investment Co. Ltd (2013) 142 ITD 89 (Kol) 46

47 Disallowance in case of personal investments Can such disallowance be applied in relation to the personal investments of a professional or sole proprietor, who maintains books of account for his profession/business, with separate balance sheet and income and expenditure account for the profession/business, and a separate balance sheet and capital account for his personal income? What if he does not maintain books of account for his personal income or a personal balance sheet? Pawan Kumar Parmeshwarlal v ACIT ITA No 530/Mum/2009 dated Justice Sam P Bharucha v Addl CIT 53 SOT 192 (URO)(Mum) CIT v Om Prakash Khaitan 376 ITR 390 (Del) 47

48 Rule 8D vs ICDS IX Should the interest computed under one formula be reduced from the total indirect interest expenditure, while taking the figure of indirect interest under the other formula? Which formula should be computed first by taking the figure of indirect interest expenditure, the formula under paragraph 6 of ICDS IX, or the formula under clause (ii) of Rule 8D(2)? o Formula under para 6 of ICDS IX A* B/C where A - borrowing costs incurred during the previous year except on borrowings directly relatable to specific purposes; o Formula under Rule 8D(2)(ii)- A* B/C where A - amount of expenditure by way of interest other than the amount of the expenditure directly relating to income which does not form part of total income, incurred during the previous year Sequence of sections? Act to prevail over ICDS first give effect to Act, then ICDS 48

49 Income from Other Source

50 Taxation of Dividend Income Amendment proposed by Finance Bill 2016 Section 115BBDA - applicable to resident individuals, HUFs, or firms where total income includes income exceeding Rs. 10 lakhs by way of dividends declared by a domestic company - dividends taxable at 10% without deduction in respect of any expenditure, allowance, set off of loss Dividends, other than deemed dividend u/s2(22)(e) Dividend distribution tax payable by company No allowance for basic exemption if no other income Not applicable to holding companies - applicable to LLPs Whether on entire dividends or only on dividends exceeding Rs.10 lakh? Applicability of section 14A to shares after amendment 50

51 Allotment of Rights Shares Allotment of shares - whether receipt of shares for section 56(2)(vii)/(viia) Explanatory Memorandum to Finance Act 2010 These are anti-abuse provisions which are currently applicable only if an individual or an HUF is the recipient. Therefore, transfer of shares of a company to a firm or a company, instead of an individual or an HUF, without consideration or at a price lower than the fair market value does not attract the anti-abuse provision In order to prevent the practice of transferring unlisted shares at prices much below their fair market value, it is proposed to amend section 56 to also include within its ambit transactions undertaken in shares of a company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where the recipient is a firm or a company (not being a company in which public are substantially interested) Sudhir Menon HUF v ACIT (2014) 148 ITD 260 (Mum) Khoday Distilleries Ltd v CIT (2008) 307 ITR 312 (SC) 51

52 Allotment of Rights Shares Sudhir Menon HUF v ACIT 148 ITD 260 (Mum) True, the shareholders get the right to acquire the additional shares on the passing of the board resolution, but the receipt of the property is only on their allotment, on which date the shares, a specified property, is in existence. Till such allotment the shares do not exist as such, and in a sense come into existence on their allotment. In this view of the matter, the plea of the rights under reference being not a property specified under the provision or the provision being sought to be applied by the Revenue to a non-existing property, is without basis. As long as, therefore, there is no disproportionate allotment, i.e., shares are allotted pro rata to the shareholders, based on their existing holdings, there is no scope for any property being received by them on the said allotment of shares; there being only an apportionment of the value of their existing holding over a larger number of shares. There is, accordingly, no question of s. 56(2)(vii)(c), though per se applicable to the transaction, i.e., of this genre, getting attracted in such a case. A higher than proportionate or a non- uniform allotment though would, and on the same premise, attract the rigour of the provision. In case of issue of bonus shares, no property is being conveyed to the shareholder in as much as the property therein is comprised in the existing shareholding of the 52

53 Allotment of Rights Shares allottee. There is as such no case of a gift; the shareholder only receiving his own property, albeit in a different form. A 'right' share, on the other hand, is placed differently. To the extent it is allotted to a person not against his existing shareholding or, even so, albeit disproportionately, there is, depending on the terms of the allotment, which is the mode of acquisition and, thus, its receipt, scope for value or property being passed on to him, which cannot be said to be in lieu of or as recompense of his existing property. The section would, therefore, apply, though the extent of income, if any, chargeable thereunder would depend on the actual allotment and its terms. 'Receipt' is a word or term of wide import, and would include acquisition of the subject matter of receipt - defined capital assets in the present context, by modes other than by way of transfer as well. We find no reason to limit or restrict the scope of the word 'receipt' in the provision to cases of 'transfer' only. Doing so would not only amount to reading down the provision, which the tribunal is even otherwise not competent to, being not a court of law, but reading it in a manner totally inconsistent with the unambiguous language and the clear intent (of the Legislature) conveyed thereby, but also its context as well as the drift of section, in complete violence thereto. 53

54 Allotment of Rights Shares Khoday Distilleries Ltd v CIT (2008) 307 ITR 312 (SC) There is a vital difference between creation and transfer of shares. The words allotment of shares have been used to indicate creation of shares by appropriation out of the unappropriated share capital to a particular person. There is a difference between issue of a share to a subscriber and the purchase of a share from an existing shareholder. The first case is that of creation, whereas the second case is that of transfer of chose in action. In this case, when twenty shareholders did not subscribe to the rights issue, the appellant allotted them to 7 investment companies; such allotment was not transfer. Thus, s. 4(1) (a) was not applicable as held by the Tribunal. 54

55 Allotment of Bonus Shares Sudhir Menon HUF v ACIT (2014) 148 ITD 260 (Mum) In the case of issue of bonus shares (as also on demerger), no property is being conveyed to the shareholder in as much as the property therein is comprised in the existing shareholding of the allottee. There is as such no case of a gift; the shareholder only receiving his own property, albeit in a different form. 55

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57 Thank you! 57