Weekly Round-up on Tax and Corporate Laws | 17th to 22nd April 2023

This weekly newsletter analytically summarises the key stories reported at taxmann.com during the previous week from 17^th to 22^nd April 2023, namely:

(a) ALP determined by ITAT can be subject to scrutiny; no absolute proposition of law that its decision is final: SC;

(b) DDT rate under Section 115-O applies to NR shareholders unless DTAA specifically protects them: ITAT;

(c) Writ Courts should not encourage bypassing of statutes when the effective remedy was available under SARFAESI: SC;

(d) Bombay High Court upheld the constitutional validity of Section 13(8)(b) and Section 8(2) of IGST Act;

(e) Rejection of refund without providing a hearing opportunity violates principles of natural justice: HC; and

(f) Key non-compliances observed by FRRB in relation to reporting in Auditor’s Report.

1. ALP determined by ITAT can be subject to scrutiny; no absolute proposition of law that its decision is final: SC

The issue before the Supreme Court was:

“Whether the High Court was correct in holding that the determination of arm’s length price by the Tribunal shall be final against which the High Court cannot entertain an appeal?”

The Supreme Court held that the Tribunal must follow the guidelines stipulated under Chapter X of the Income-tax Act, namely, Sections 92, 92A to 92CA, 92D, 92E and 92F and Rules 10A to 10E while determining the arm’s length price (ALP). Any determination of ALP under Chapter X dehors the relevant provisions of the Income-tax Act is considered perverse and may be considered a substantial question of law as perversity itself can be said to be a substantial question of law.

There cannot be any absolute proposition of law that in all cases where the Tribunal determined ALP, the same is final and cannot be scrutinised by the High Court in an appeal under Section 260A of the Income-tax Act.

When the determination of ALP is challenged before the High Court, it is always open for the High Court to consider and examine whether the ALP was determined considering the relevant guidelines under the Act and the Rules.

Even the High Court can also examine the comparability of two companies or the selection of filters and whether the same is done judiciously and based on the relevant material/evidence on record. The High Court can also examine whether the comparable transactions have been taken into consideration properly, i.e., to the extent non-comparable transactions are considered comparable or not.

Therefore, the view that in the matter of transfer pricing, the determination of ALP by the Tribunal shall be final and cannot be a subject matter of scrutiny is not acceptable. The High Court is not precluded from examining the correctness of the determination of ALP.

Consequently, the matter was remitted back to the respective High Court for fresh consideration after examining the arm’s length price in accordance with the relevant provisions.

Read the Ruling

2. DDT rate under Section 115-O applies to NR shareholders unless DTAA specifically protects them: ITAT

The question for consideration before the Special Bench of the Mumbai Tribunal was:

“If a domestic company pays dividends to non-resident shareholders, whether the dividend distribution tax (DDT) shall be payable at the rate mentioned in Section 115-O or the tax rate applicable to non-resident shareholder(s) with reference to such dividend income?”

The Mumbai Tribunal held that the first aspect that needs to be decided is whether DDT is a tax on the company or the shareholder. Can one say it is a tax payable by the shareholder, whose liability is discharged by the domestic company in the form of payment of DDT?

The Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd. [2010] 194 Taxman 203 (Bombay) held that legal characteristic of DDT is a tax on a company paying the dividend and is chargeable to tax on its profits as a distinct taxable entity. The domestic company paying DDT does not do so on behalf of the shareholder, and the company does not act as an agent of the shareholder in paying the tax under Section 115-O.

Although the Supreme Court reversed the Bombay High Court ruling, the observations of the Bombay High Court regarding the legal characteristics of DDT that it is a tax on a company paying the dividend cannot be said to have been diluted or overruled.

Thus, it can be concluded that the charge under Section 115-O is on the company’s profits and not income in the hands of the shareholder.

Regarding the applicability of DTAA, the bench held that it is a tax on its income and not tax paid on behalf of the shareholder. In such circumstances, the domestic company under Section 115-O does not enter the domain of DTAA at all. If the domestic company has to enter the domain of DTAA, the partner countries should have explicitly agreed in the DTAA to that effect.

For instance, in the Treaty between India and Hungary, the Contracting States extended the Treaty protection to the DDT. It has been specifically provided in the protocol to the India-Hungarian Tax Treaty that when the company paying the dividends is a resident of India, the tax on distributed profits shall be deemed to be taxed in the hands of the shareholders, and it shall not exceed 10 per cent of the gross amount of dividend.

Therefore, the DTAA is not triggered when a domestic company pays DDT under Section 115-O.

Accordingly, the bench held that where the dividend is declared, distributed or paid by a domestic company to a non-resident shareholder(s), DDT shall be payable by the domestic company at the rate mentioned in Section 115-O.

However, the domestic company can claim the benefit of DTAA if the Contracting States extend the treaty protection to the domestic company paying dividend distribution tax.

Read the Ruling

3. Writ Courts should not encourage bypassing of statutes when the effective remedy was available under SARFAESI: SC

The Apex Court held that the Writ Courts should not encourage bypassing of statutes when an effective remedy was available to the appellant under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

In the present case, the respondents (i.e. borrowers) had availed of two loans from the appellant bank (i.e. South Indian Bank Ltd.) and their accounts were declared as Non- Performing Assets (NPAs).

On 27-05-2021, the bank issued notices to the borrower under Section 13(2) of the SARFAESI Act, 2002. In response to the said notices, the borrowers addressed a letter dated 28-10-2021 seeking twelve months to repay the loan.

In 2021, the post of Presiding Officer in various benches of Debt Recovery Tribunals (DRT) and Debt Recovery Appellate Tribunals (DRAT) remained vacant. The Supreme Court took note of the situation and requested the concerned High Courts to entertain matters falling within the jurisdiction of DRTs and DRATs under Article 226 of the Constitution of India.

Since the concerned DRT was non-functional, the borrowers filed a writ petition before the Kerala High Court, challenging the notice under Section 13(2) of the SARFAESI Act issued by the bank.

The High Court then directed the appellant bank to consider the proposal placed by the borrowers for repayment and permitted the borrowers to remit the dues accrued in five instalments instead of the twelve.

However, the borrowers did not take advantage of the extended benefit provided to them, despite receiving a reminder. Therefore, the appellant bank issued notices under Section 13(4) of the SARFAESI Act, 2002 to the borrowers. Thereafter, the borrowers challenged these notices by filing another writ petition before the High Court.

It was noted that at the time of filing the petitions, the Debt Recovery Tribunal (DRT) was not operational. However, it became functional in March 2022.

The Supreme Court issued an order through a Special Leave Petition directing pending cases to be transferred to their respective Tribunals once they become operational under the leadership of their designated Presiding Officers.

Despite this directive, the High Court went beyond the requested relief and allowed borrowers to make deferred payments in 20 instalments.

The Supreme Court observed that when a statute prescribes a particular mode, a writ court shall not encourage an attempt to circumvent it. Further, a litigant cannot avoid approaching the Tribunal, which requires the prescription of fees and the use of constitutional remedy as an alternative remedy.

The Supreme Court held that the powers conferred under Article 226 of the Constitution of India are relatively wide. However, these powers should be exercised only in extraordinary circumstances, particularly in commercial matters that involve a lender and a borrower and where the legislature has provided a specific mechanism for redressal.

The Supreme Court further held that where an alternative remedy under the SARFAESI Act was available, the litigant could not have used the constitutional remedy as an alternative.

Read the Ruling

4. Bombay High Court upheld the constitutional validity of Section 13(8)(b) and Section 8(2) of IGST Act

The Bombay High Court has held that Section 13(8)(b) and Section 8(2) of the IGST Act, 2017 are legal, valid, and constitutional. The court has also held that these provisions can only be applied to the IGST Act and cannot be used to levy tax on intermediary services under the Central GST (CGST) and State GST (SGST) Acts.

The petitioner was engaged in providing marketing and promotion services to customers located outside India. It was providing services only to the principal located outside India and, in lieu thereof, receiving consideration in convertible foreign currency from the principal located outside India. The petitioner contended that the transaction entered into by it with the foreign customers would be one of export of service from India earning valuable convertible foreign exchange for the country by an intermediary. However, due to deeming fiction by Section 13(8)(b) of the IGST Act, the place of supply shall be the location of the supplier of services which is in India, and a levy of CGST and SGST would arise. It filed a writ petition assailing the constitutional validity of section 13(8)(b) of the IGST Act.

The coram of the division bench of the Bombay High Court was made of two judges. One Judge of Division Bench Bombay High Court observed that Section 13(8)(b) of IGST Act not only falls foul of the overall scheme of CGST Act and IGST Act but also offends Articles 245, 246A, 269A and 286(1)(b) of Constitution. Thus, as per one opinion, the provision is unconstitutional, the other has expressed his disagreement and has rendered his separate opinion. Therefore, in view of such a difference in opinion, the matter was placed before the Hon’ble Chief Justice.

The Honorable Bombay High Court observed that the fiction which is created by Section 13(8)(b) would be required to be confined only to the provisions of IGST and ruled that Section 13(8)(b) and Section 8(2) of the IGST Act are legal, valid, and constitutional. However, the court has also held that these provisions can only be applied to the IGST Act and cannot be used to levy tax on intermediary services under the CGST and SGST Acts.

Read the Ruling

5. Rejection of refund without providing a hearing opportunity violates principles of natural justice: HC

The Delhi High Court has held that the order rejecting a refund claim is liable to be set aside if the assessee was not given a hearing opportunity in violation of principles of natural justice. The court has also held that the matter shall be remanded to Appellate Authority to decide the petitioner’s appeal afresh.

The petitioner was involved in the export of services and sought a refund of tax paid on the export of services. The application was accepted, but later on, Adjudicating Authority denied the refund on the ground that the petitioner-assessee and service recipient(s) were not distinct persons.

It filed an appeal against the rejection of the refund, and the Appellate Authority proceeded to deny the refund on an absolutely new ground that the petitioner was an intermediary under Section 2(13) of the IGST Act. It filed a writ petition and contended that refund was rejected without any notice or opportunity of hearing, and it was not open for the Appellate Authority to suo moto set up a new case.

The High Court noted that the petitioner was not given an opportunity to meet the case when it was held that it was not entitled to refund being an intermediary. Therefore, the impugned order was passed in violation of the principles of natural justice. The court also held that the matter to be remanded to the Appellate Authority to decide the petitioner’s appeal afresh, including the question as to whether the Appellate Authority has jurisdiction to set up a new case against the petitioner, which was not a subject matter of either show cause notice or enquiry before Adjudicating Authority.

Read the Ruling

6. Key non-compliances observed by FRRB in relation to reporting in Auditor’s Report

The Financial Reporting Review Board (FRRB) of ICAI carries out an assessment of the financial statements of different businesses to ensure adherence to commonly accepted accounting principles (GAAP), compliance with the auditor’s reporting responsibilities, and adherence to disclosure requirements set forth by regulatory bodies, statutes, and applicable rules and regulations. The FRRB was established as a proactive measure to enhance financial reporting and auditing procedures.

The board has published a report titled “Study on Compliance with Financial Reporting Requirements,” which identifies common instances of non-compliance or errors in Ind AS financial statements and audit reports, including CARO. This story has been examined in a tabular format discussing inappropriate reporting, relevant provisions and observations by the board on some of the significant non-compliances and errors under the Audit Report, providing a valuable resource to ensure reporting compliance when preparing the audit report for other entities.

Relevant provisions of SA

If adequate disclosure about the material uncertainty is made in the financial statements, the auditor shall express an unmodified opinion, and the auditor‘s report shall include a separate section under the heading “Material Uncertainty Related to Going Concern” to:

1. Draw attention to the note in the financial statements that disclose the matters set out in paragraph 19;
2. State that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity‘s ability to continue as a going concern and that the auditor‘s opinion is not modified in respect of the matter.

In-appropriate Reporting

We draw attention to Note XX to the standalone financial statements, which more fully describe the uncertainty faced by the company in signing the PPA and various factors affecting the progress of the project resulting in the stoppage of work. However, management is confident that the current situation is temporary and has no going concern issues. Our opinion is not qualified in respect of the above matters.

FRRB Observation

The auditor has not reported under a separate section on going concern as required by SA 570, although there were certain events, as evident from the note on going concern given in the financial statements of the company, which could cast material uncertainty about going concern.

Read the Story