Direct Tax Vista

Your weekly Direct Tax recap

Edn. 29 – 25th October 2022

By Vivek Jalan, Partner, Tax Connect Advisory Services LLP

1. Landmark decision for Charitable Organisations seeking exemption: May result in revival of Sec 2(15) cases prospectively; Earlier interpretations of the Apex Court held as erroneous

Aphorisms, Proverbs, Mantras, Upanishads, Quran, Precedents, interpretations, The decision of the Apex Court in the case of M/s NEW NOBLE EDUCATIONAL SOCIETY VERSUS THE CHIEF COMMISSIONER OF INCOME TAX AND ANR., [2022-VIL-23-SC-DT], has it all! It has also received immense media attention.

The Apex Court ruled that the requirement of the charitable institution, society or trust etc., to ‘solely’ engage itself in education or educational activities, and not engage in any activity of profit, means that such institutions cannot have objects which are unrelated to education. In other words, all objects of the society, trust etc., must relate to imparting education or be in relation to educational activities. Where the objective of the institution appears to be profit-oriented, such institutions would not be entitled to approval under Section 10(23C) of the IT Act. The seventh proviso to Section 10(23C), as well as Section 11(4A) refer to profits which may be ‘incidentally’ generated or earned by the charitable institution. In the present case, the same was held to be applicable only to those institutions which impart education or are engaged in activities connected to education. The reference to ‘business’ and ‘profits’ in the seventh proviso to Section 10(23C) and Section 11(4A) merely meant that the profits of business was ‘incidental’ to educational activity i.e., relating to education such as sale of text books, providing school bus facilities, hostel facilities, etc. The reasoning and conclusions in American Hotel Case and Queen’s Education Society case so far as they pertain to the interpretation of expression ‘solely’ were disapproved. The judgments are accordingly overruled to that extent.

While considering applications for approval under Section 10(23C), the Commissioner or the concerned authority as the case may be under the second proviso is not bound to examine only the objects of the institution. To ascertain the genuineness of the institution and the manner of its functioning, the Commissioner or other authority is free to call for the audited accounts or other such documents for recording satisfaction where the society, trust or institution genuinely seeks to achieve the objects which it professes. The observations made in American Hotel Case suggest that the Commissioner could not call for the records and that the examination of such accounts would be at the stage of assessment. Whilst that reasoning undoubtedly applies to newly set up charities, trusts etc. the proviso under Section 10(23C) is not confined to newly set up trusts – it also applies to existing ones. The Commissioner or other authority is not in any manner constrained from examining accounts and other related documents to see the pattern of income and expenditure. It is held that wherever registration of trust or charities is obligatory under state or local laws, the concerned trust, society, other institution etc. seeking approval under Section 10(23C) should also comply with provisions of such state laws. This would enable the Commissioner or concerned authority to ascertain the genuineness of the trust, society etc.

Various important points come out of the judgement as follows, on the basis of which future cases u/s 2(15) may be decided –

1. Section 2(15) cases of denial of exemption on the grounds of ‘objects’ of the trusts were slowly waning as Courts ruled on the ‘predominance of object’. Going forward these may be decided on the basis of ‘sole’ or ‘whole’ object’.

2. It is not a bar for trusts to generate surpluses in a given year or set of years per se.

3. Incase the surplus is generated in the course of providing charitable activities, there is no case for denial of exemption.

4. However, if the surplus is generated by other than charitable activities, then the exemption of the trust may be denied.

5. This judgement would apply prospectively. However, it would also apply to already existing trusts.

2. ‘Unbilled revenue’ is not ‘outstanding receivable’ and hence not to be treated as income, even incase of an AE

Incase of transactions with AE it is sometimes considered immaterial when the invoice is raised and it is alleged that the same could easily be arranged and managed between the AEs. Hence sometimes it is alleged by authorities that even unbilled revenues would be treated as accrued. In this matter it should be noted that either an invoice has to be raised or an account adjustment should atleast be done between AEs to account an income as accrued. In absence of either of the two no accruals of income can be alleged even incase of AEs.

It was thus rightly held in the case of Toshiba Technical Services International Corporation Vs ACIT, International Taxation [2022-VIL-1313-ITAT-AHM], that Outstanding receivables refer to the amounts which have accrued to the assessee and invoice has been raised by assessee but not received at the end of the year. On the other hand, unbilled revenue is the amount which has accrued to the assessee and credited to the profit and loss account as income; however, invoice in relation to the same is not raised on the customers.

Until bill is raised the supplier has no right to recover any amount from the other party, because it is the bill which notifies the other party of fixing liability on it to pay certain amounts. Until then, the supplier has no right to recover any amount. Therefore, with no right of recovery with the supplier, the amounts outstanding on account of unbilled amounts cannot be said to be outstanding “debtors” since no debt has accrued on the other party on account of these amounts. The other party having neither received the bill and as a consequence not accepted the same also, therefore, there is no debt which is accrued on the other party. Hence, outstanding amounts on account of unbilled revenues cannot be termed as outstanding debtors and there is no income which can be said to accrue and consequently is can also be no question of charging any interest for the delayed recovery of the same. Unbilled revenue should be considered as outstanding only when the invoice is raised to the customers.

3. TDS deduction under wrong section – No disallowance of expenses – Section 40(a)(ia)

The question in many TDS cases is whether a short TDS deduction in a different section is a matter of disallowance of expenses. Let us understand the background - Under section 40(a)(ia) of the Act, in case of payments made to resident, the deductor is allowed to claim deduction for payments as expenditure in the previous year of payment, if tax is deducted during the previous year and the same is paid on or before the due date specified for filing of return of income under section 139(1) of the Act. In case of non-deduction or non-payment of tax deducted at source (TDS) from certain payments made to residents, the entire amount of expenditure on which tax was deductible is disallowed under section 40(a)(ia) for the purposes of computing income under the head “Profits and gains of business or profession”. The disallowance of whole of the amount of expenditure results into undue hardship. In order to reduce the hardship, non-deduction or non-payment of TDS on payments made to residents as specified in section 40(a)(ia) of the Act, the disallowance shall be restricted to 30% of the amount of expenditure on which TDS is not deducted. Earlier, 100% of such amount was disallowed.

It was held by The Kerela High Court in the case of CIT Vs PVS MEMORIAL HOSPITAL LTD (KERALA HIGH COURT) that there could be a short deduction of tax at source in a year. But the provisions of sec. 40(a)(ia) cannot be invoked in case of short deduction of tax at source, as the provisions of sec. 40(a)(ia) do not provide for such a contingency unlike the provisions of sec. 201 of the Act, wherein the short deduction of tax at source would also get attracted. The Kerala High Court has thus taken the view that tax is to be deducted u/s 194J and deducted u/s 194C is not a matter of disallowance of expenses. This section is not charging section but is machinery section. For this Court has referred GURUSAHAI SAIGAL VS. COMMISSIONER OF INCOME TAX 48 ITR 01 OF SUPREME COURT.

4. If payer merely receives service without control or possession of equipment, no royalty can arise

The definition of ‘royalty’ and ‘FTS’ have been a matter of long standing deliberations and it continues. If control on process and information etc. remains with service provider and no exclusive right to use equipment/process has been granted in favour of service receiver or its customers no "royalty" as defined under Article 12(3) of DTAA can arise. Further fees for technical services (FTS) to arise under Article 12(4)(a) of India-US DTAA, the supplier of service has to make available technical know-how, skills or experience to the recipient of service.

The same was decided in the case when an Assessee provided online auction services from its Global Market Operations Centres located outside India. In India, assessee provided such services to a wholly-owned subsidiary of assessee in India and received amount from India, but offered Nil income in its return of income - ARIBA INC. Vs DDIT, INTERNATIONAL TAXATION [2022-VIL-1325-ITAT-DEL]

5. Method of Valuation earlier accepted cannot be rejected summarily subsequently

Valuation of shares is an art as well as a science. Various options are given to assessees to choose the method of valuation. One Valuer can choose a method as an appropriate method whereas another valuer can opt for another method based upon his judgement. The question is whether the A.O is empowered to look into the facts as to whether the valuation report is fair and reasonable or whether the valuation report made is mandatory on the A.O. Also whether the valuation report by a CA could be considered as no acceptable in terms of Section 45 of Indian Evidence Act for the reason that projections shown by the assessee in the project report of the cash flow did not materialize in subsequent years or because the valuation report contained certain caveats. Further incase a valuation report on a method of valuation was accepted earlier, whether the same can be rejected summarily subsequently.

It was thus determined in the case of EDUWIZARDS INFO SOLUTIONS P. LTD Vs ACIT [2022-VIL-1322-ITAT-DEL] that it was not in dispute that AO accepted valuation report in order of assessment framed for AY year 2015-16, but for year under consideration, AO had not even gone through the valuation report – AO and CIT(A) have committed an error in not following principle of consistency.

The matter was remanded to AO for purpose of verifying as to either valuation report of Chartered Accountant submitted by assessee is in conformity with Section 56(2)(viib) of the Act read with Rule 11UA(2) of the Rules or not and decide matter in accordance with law by keeping principle of consistency in mind.

(The author is a CA, LL.M & LL.B and Partner at Tax Connect Advisory Services LLP. The views expressed are personal. The author is The Lead - Indirect Tax Core Group of CII- ER and The Chairman of The Fiscal Affairs Committee of The Bengal Chamber of Commerce. He has Authored more than 15 books on varied aspects of Direct and Indirect Taxation. E-mail - vivek.jalan@taxconnect.co.in)