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Direct Tax Vista Your weekly Direct Tax recap With Coverage of Income Tax Act 2025 & Income Tax Rule 2026 Edn. 116 – 19th August 2026 Vivek Jalan, Partner, Tax Connect Advisory Services LLP |
Friends
We are pleased to put forth this issue of DTV as under. Now DTV would analyse the recent developments under Income Tax Act 1961 and International Tax and with also a commentary on how the position would be under the Income Tax Act 2025 and Income Tax Rule 2026. We would also be discussing the new developments under International Trade during the Fortnight.
1. Foreign Assets of Small Taxpayers Disclosure Scheme, 2026 (FAST‑DS 2026)
The Finance Act, 2026 has introduced a compliance window for individuals with undisclosed foreign assets or income. The Foreign Assets of Small Taxpayers Disclosure Scheme, 2026 (FAST‑DS 2026) is designed as a one‑time opportunity for taxpayers to regularize unreported wealth abroad, while ensuring transparency and accountability in India’s tax system.
Objective and Commencement
FAST‑DS 2026 seeks to encourage voluntary disclosure of foreign assets by small taxpayers, thereby widening the tax base and reducing litigation. The scheme commences on 16 August 2026 and remains open until 31 December 2026, with valuation pegged to 31 March 2026. Administration is fully electronic, overseen by the Principal DGIT (Systems).
Eligibility: The scheme applies to:
- Residents in India during the relevant year.
- Non‑residents or RNORs, if they were residents in India when the income was earned or the asset acquired. Grounds for eligibility include non‑filing of returns, non‑disclosure in filed returns, or escaped assessments. Importantly, the scheme covers any previous year, subject to prescribed thresholds.
Scope of Declaration
Taxpayers may disclose:
Category 1: Undisclosed foreign assets or income up to ₹1 crore.
Category 2: Declared Income but unreported assets up to ₹5 crore. Assets exceeding ₹5 crore fall outside the scheme’s ambit, ensuring its focus remains on small taxpayers.
Valuation Rules
Valuation is based on fair market value (FMV), determined as the higher of cost of acquisition or open‑market value supported by a valuer’s report. Special rules govern bullion, jewellery, artworks, quoted/unquoted shares, immovable property, and foreign bank accounts. Currency conversion follows the RBI reference rate, with tolerance up to 20% variance permitted.
Filing and Processing
Disclosures are made electronically in Form 1, with multiple assets allowed in a single declaration. Supporting documents and valuation reports are mandatory. Orders are issued in Form 2 within one month, followed by payment in two months (extendable to four months with 1% monthly interest). Intimation and confirmation are provided in Forms 3 and 4, respectively.
Amount Payable
a. Category 1 (≤ ₹1 crore): Effective levy of 60% (30% tax + 100% additional).
b. Category 2 (≤ ₹5 crore): Flat fee of ₹1 lakh.
Benefits and Immunities
i. Immunity from prosecution under the Black Money Act.
ii. Declared assets/income excluded from total income.
iii. Pending assessments must factor in the disclosure.
Exclusions
Assets linked to proceeds of crime under PMLA, 2002, or assessment years already completed under the Black Money Act, 2015, are excluded to safeguard integrity.
Conclusion
FAST‑DS 2026 offers a time‑bound window with valuation rules, modest levies, and immunity provisions. Taxpayers may come clean with this opportunity, reset their financial record with certainty and gain peace of mind.
2. Deductibility of Bad Debts in Income Tax [ITA’61 (Section 36(1)(vii) - ITA’25 (Section 31(2)]
The Income Tax Appellate Tribunal (ITAT), Ahmedabad, in Hemant Brothers (Firm) vs Assistant Commissioner of Income Tax [2026-VIL-1163-ITAT-AHM], addressed the critical issue of deductibility of bad debts under Section 36(1)(vii) of the Income Tax Act, 1961. This case highlights the evolution of law on bad debt claims and the practical implications for taxpayers.
Legal Framework
Section 36(1)(vii) permits deduction of any bad debt written off as irrecoverable in the accounts of the assessee, subject to Section 36(2). Prior to the Direct Tax Laws (Amendment) Act, 1987, taxpayers had to prove that a debt had become irrecoverable. However, with effect from 1 April 1989, the requirement shifted: mere write‑off in the books suffices for deduction. This amendment simplified compliance and reduced disputes.
Case Facts
The Assessing Officer (AO) disallowed Hemant Brothers’ claim, arguing the write‑off was premature since recovery proceedings were pending and proof of delivery was absent. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the disallowance. However, the assessee produced contract notes and ledger confirmations, demonstrating the genuineness of the debt. Importantly, there was no evidence that the broker involved was a related party.
Tribunal’s Findings
The ITAT emphasized that post‑1989, proving irrecoverability is unnecessary. The act of writing off in the books is sufficient. Pending recovery proceedings do not invalidate the deduction. Moreover, if recovery occurs later, the amount will be taxable in the year of receipt. On this basis, the Tribunal allowed the deduction under Section 36(1)(vii).
Significance
This ruling reinforces the principle that bad debt deduction hinges on accounting treatment rather than evidentiary proof of irrecoverability. It provides clarity for taxpayers and professionals, ensuring consistency in applying the law. The case underscores the importance of proper documentation and accounting compliance in securing tax benefits.
Legal Position under ITA’25 (Section 31(2)): ITA’25 carries forward the post‑1989 principle. “Any amount of bad debt, or part of it, in the tax year in which such amount is written off as irrecoverable in the accounts of the assessee, shall be allowed as deduction…”. There is no requirement to prove irrecoverability; write‑off remains the operative condition. Later recovery continues to be taxable in the year of receipt.
3. Pre-Commencement Expenses – Capital/ Revenue… Works Contractor Vs Developer
The Gujarat High Court in Principal CIT Central Ahmedabad vs Montecarlo Construction Ltd [2026-VIL-212-GUJ-DT] delivered an important ruling on the treatment of pre‑commencement expenditure and the eligibility of a company as a developer under Section 80IA(4).
Pre‑Project Expenditure
The assessee had incurred ₹37.28 crores before the appointed date, even though its business had already commenced in earlier years. The Revenue sought to classify this as capital expenditure, arguing that deduction could only be allowed when income was recognized in the same year. The Court rejected this “matching principle,” holding that where no capital asset is created, expenditure must be treated as revenue. Commercial expediency was applied, and the precedent of Excel Industries Ltd (SC) was followed. The ruling clarified that absence of income recognition in a particular year does not bar deduction of genuine business expenditure.
Developer vs Works Contractor
The Revenue further argued that Montecarlo was merely a works contractor and thus ineligible for deduction under Section 80IA(4). The Court disagreed, emphasizing that the assessee had made the entire investment, bore financial and operational risks, provided security deposits, faced penalties for delays, and managed labour, materials, and defect liability. These attributes established its role as a developer rather than a contractor. The Supreme Court had already dismissed Revenue’s SLP on similar grounds, reinforcing the position.
Key Takeaway
The judgment underscores two principles: genuine pre‑project expenditure without asset creation is revenue in nature, and eligibility as a developer hinges on assumption of risk and responsibility, not mere execution of work.
4. Closing Stock Valuation, Interest Disallowance, and Keyman Insurance: Judicial Clarity
The Gujarat High Court in PCIT 3 vs Poggen Amp Nagarsheth Powertronics Pvt Ltd [2026-VIL-211-GUJ-DT] examined three significant issues in tax assessment: valuation of closing stock, interest on unpaid purchase price, and insurance expenses. The ruling provides clarity on the principles of consistency, commercial expediency, and the treatment of business expenditure.
Issue 1 – Under‑valuation of Closing Stock
The Assessing Officer (AO) added ₹13.23 crore based on stock statements submitted to banks. However, the assessee had consistently followed the same valuation method in its books. The Court noted that stock statements to banks were ad‑hoc estimates prepared to secure higher credit facilities, with no physical verification since the stock was hypothecated, not pledged. Judicial precedents such as Riddhi Steel and Arrow Exim confirm that bank statements cannot override properly maintained books. As the difference was reconciled and no defects were found, the addition was unsustainable.
Issue 2 – Interest on Unpaid Purchase Price (Sec. 40A(2)(b))
The AO disallowed ₹60.98 lakh, alleging excessive interest payments. The CIT(A) and Tribunal deleted the disallowance, applying the principle of consistency. The assessee had paid interest at 6% per annum to suppliers, which was reasonable compared to 15%+ paid to banks. No evidence suggested payments to related parties, so Section 40A(2)(b) was not attracted. The Court upheld that interest payments cannot be disallowed arbitrarily without proof of unreasonableness.
Issue 3 – Insurance Expenses (Sec. 37(1))
The AO disallowed ₹24.47 lakh spent on a Keyman Insurance Policy, arguing it benefited directors personally. However, the CIT(A) and Tribunal found the beneficiary was the company itself. The Court confirmed that Keyman Insurance is allowable as business expenditure when commercial expediency is established.
Key Takeaways
a. Stock statements given to banks for credit facilities cannot override audited books if reconciled and defect‑free.
b. Interest payments to suppliers must be judged against market benchmarks; arbitrary disallowance is impermissible.
c. Keyman Insurance policies are deductible business expenses when the company is the beneficiary.
5. S68 of ITA’61 applies only when actual money is credited during the relevant year, not when amounts are carried forward or journalized [S102 of ITA’25]
The Kolkata Bench of the Income Tax Appellate Tribunal (ITAT) in Rolex Trafin Pvt. Ltd vs ITO, Ward‑11(1), Kolkata [2026-VIL-1365-ITAT-KOL] clarified the scope of unexplained cash credits under Section 68 of the Income Tax Act, 1961. The ruling underscores that Section 68 applies only when actual money is credited during the relevant year, not when amounts are carried forward or merely journalized.
Case Background
The assessee filed a nil return for AY 2012‑13. Share capital and premium were credited through journal entries, while actual funds were received in AY 2013‑14. The Assessing Officer (AO) added ₹6.55 crore as unexplained cash credit, treating journal entries as cash inflows. The CIT(A) upheld the addition, alleging failure to prove genuineness despite submissions.
Assessee’s Argument
The assessee contended that only journal entries were passed in AY 2012‑13, with actual money received in the subsequent year. Identity and creditworthiness of subscribers were established, and therefore Section 68 could not apply to mere carried‑forward entries.
Tribunal’s Findings
The ITAT held that Section 68 applies strictly to credits of money during the impugned year. Carried‑forward or journalized amounts cannot be treated as unexplained cash credits. Supporting precedents included CIT vs Prameshwar Bohra, CIT vs Usha Stud Agricultural Farms Ltd, and DCIT vs Global Mercantiles Pvt. Ltd.
Key Takeaway
The ruling reinforces that Section 68 targets unexplained inflows of money, not accounting adjustments. Under the Income Tax Act, 2025, the provision has been renumbered as Section 102, with the heading changed from “Cash Credit” to “Unexplained Credits.” The substantive test remains unchanged: unexplained credits in the books are taxable, but journal entries alone cannot trigger additions.
6. For Invocation of S263 of ITA’61 (Revision by PCI/CIT), Inadequate inquiry ≠ erroneous order unless prejudice to Revenue shown [S377 of ITA’25]
The Gujarat High Court recently upheld a Tribunal ruling in Iconic Infrabuild LLP [2026-VIL-266-GUJ-DT], clarifying the scope of revisionary powers under Section 263 of the Income Tax Act, 1961 (ITA’61). The case highlights that inadequate inquiry by the Assessing Officer (AO) does not automatically render an order erroneous unless it is shown to be prejudicial to the interests of the Revenue. This principle, now codified in Section 377 of the Income Tax Act, 2025 (ITA’25), ensures a balance between administrative oversight and taxpayer protection.
Case Background
The assessee, engaged in civil construction, filed its return which was accepted after scrutiny under Section 143(3). The AO had examined sundry creditors of ₹3.66 crore, with the assessee furnishing names, addresses, PAN, and transaction details. However, the Principal Commissioner of Income Tax (PCIT) invoked Section 263, alleging inadequate verification of creditors’ genuineness and creditworthiness, and directed a fresh assessment.
PCIT’s Stand
The PCIT relied on Explanation 2(a) to Section 263, which deems an order erroneous if inquiries or verifications “which should have been made” were not conducted. The PCIT argued that the AO failed to obtain bank statements and therefore the order was prejudicial to Revenue.
Assessee’s Defence
The assessee contended that all relevant details had been furnished, including books of accounts and vouchers. The inability to procure bank statements did not invalidate the genuineness of transactions. The AO had exercised discretion after inquiry, and hence the order could not be deemed erroneous.
Tribunal’s Findings
The Tribunal emphasized that this was not a case of “no inquiry.” The AO had conducted inquiries and applied his mind. The PCIT failed to demonstrate why further inquiry was necessary or how the order caused prejudice to Revenue. Reliance was placed on Delhi High Court rulings in Sunbeam Auto and Anil Kumar Sharma, which held that inadequate inquiry does not justify revision unless prejudice is established.
High Court’s Ruling
The Gujarat High Court upheld the Tribunal’s order, reiterating that Section 263 requires two conditions:
a. Error in the AO’s order.
b. Prejudice to Revenue.
Mere inadequacy of inquiry is insufficient. Explanation 2(a) cannot be stretched to empower revision unless actual prejudice is demonstrated. The appeal was dismissed.
Legal Principle
The ruling reinforces that revisionary powers are not unfettered. Section 263 (now Section 377 of ITA’25) is a supervisory tool, not a mechanism to substitute the AO’s judgment with that of the PCIT. Unless both error and prejudice coexist, revision cannot be invoked.
Key Takeaway
For taxpayers, this case provides assurance that genuine inquiries conducted by the AO cannot be reopened merely on grounds of inadequacy. For the Revenue, it underscores the need to establish prejudice before exercising revisionary powers. The codification in ITA’25 streamlines language but retains the substantive safeguard, ensuring fairness in tax administration.
7. Transfer Pricing: Compensation/Subsidy based on performance of sales is operating income and not non-operating
The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) in Chanel (India) Pvt. Ltd vs DCIT, Circle 4(2), New Delhi [2026-VIL-1354-ITAT-DEL] addressed a crucial transfer pricing issue: whether subsidies received from an associated enterprise should be treated as operating or non‑operating income. The ruling provides clarity for distributors and multinational subsidiaries operating under support agreements.
Case Background
Chanel India, a distributor of high‑end fashion products, received subsidies from its associated enterprise to reimburse unabsorbed costs during its initial years of operation. These payments were linked to sales performance and formed part of the distribution agreement. The assessee treated the subsidy as operating income while computing its Profit Level Indicator (PLI) under the Transactional Net Margin Method (TNMM).
TPO’s Stand
The Transfer Pricing Officer (TPO) in reassessment classified the subsidy as non‑operating income, segregating the transactions and making an upward adjustment to the Arm’s Length Price (ALP). This treatment effectively shrank margins, leading to higher tax liability.
Assessee’s Submission
The assessee argued that the subsidy had a direct nexus with distribution activities, was disclosed in financial statements as operating revenue, and was integral to the distribution agreement. It was not a separate transaction but compensation for unabsorbed expenditure.
Tribunal’s Findings
The ITAT held that when compensation is based on sales performance, it can only be operating income. Support payments from associated enterprises to cover losses are operating in nature and must be considered in benchmarking. Reliance was placed on precedents such as Nalco Water India Ltd and MSD Pharmaceutical Pvt. Ltd.
Key Takeaway
The ruling confirms that subsidies or support payments tied to distribution performance are operating income for transfer pricing purposes. Under ITA’25, transfer pricing provisions consolidated in Sections 161‑173 retain this principle, ensuring consistency and fairness in benchmarking multinational transactions.
(The author is a FCA, LL.M, LL.B, MBA and Partner at Tax Connect Advisory Services LLP and also the Chairman of The National Fiscal Affairs Committee of The Bengal Chamber of Commerce and Member of National Taxation Committee of CII. He has Authored more than 25 books on varied aspects of DT and IDT. The views expressed are personal. E-mail: vivek.jalan@taxconnect.co.in)