Weekly Round-up on Tax and Corporate Laws | 26th February to 2nd March 2024

This weekly newsletter analytically summarises the key stories reported at taxmann.com during the previous week from February 26^th to March 02^nd, 2024, namely:

(a) Stay granted by High Courts cannot be vacated automatically: Supreme Court;

(b) No Section 194H TDS on income of franchisee/distributor from sale of prepaid coupons/starter-kits: SC;

(c) Proper Officer is required to substantiate why reply is unsatisfactory and provide opportunity before confirming demand: HC;

(d) Claim of Bank-secured creditor would prevail over claim of Sales Tax Dept.: HC

(e) Combine Parent & translated subsidiary SFSs line-by-line, even if it leads to different carrying amounts in CFS for similar assets.

1. Stay granted by High Courts cannot be vacated automatically: Supreme Court

In a landmark judgement, the Supreme Court has struck down the automatic vacation of stay orders. This means that if a High Court grants a stay on a case, it won’t automatically expire after a certain period. The Court must hear the matter and decide whether to vacate the stay.

Facts

In 2018, a three-judge Bench of the Supreme Court, in the case of Asian Resurfacing of Road Agency (P) Ltd vs CBI, criminal appeal nos. 1375-1376 of 2013 issued a directive stipulating that in all ongoing cases where a stay had been granted against civil or criminal trial proceedings, such stay would automatically lapse six months after the date of judgment unless extended by a speaking order.

The court decision in the case of Asian Resurfacing was met with a lot of criticism. People said the judgement was arbitrary and violated the principles of natural justice. The Court was also accused of overstepping its boundaries and trying to legislate. Thus, the matter reached before the larger bench of the Supreme Court for reconsideration.

Supreme Court Ruling

The Apex Court held that the directions issued in that case were obviously issued under Article 142 of the Constitution, which conferred jurisdiction on the Court to pass such a decree or make such order necessary for doing complete justice in any pending case.

This jurisdiction can be exercised to do complete justice between the parties before the Court. However, it cannot be exercised to nullify the benefits derived by a large number of litigants based on judicial orders validly passed in their favour who were not parties to the proceedings.

Further, Article 142 did not empower the Court to ignore the substantive rights of the litigants. While exercising jurisdiction under Article 142 of the Constitution of India, the Apex Court can always issue procedural directions to the Courts to streamline procedural aspects and iron out the changes in the procedural laws to ensure expeditious and timely disposal of cases. However, while doing so, this Court cannot affect the substantive rights of those litigants who are not parties to the case before it.

The right to be heard before an adverse order is passed is not a matter of procedure but a substantive right, and the power of the Supreme Court under Article 142 cannot be exercised to defeat the principles of natural justice, which are an integral part of our jurisprudence.

Therefore, there cannot be automatic vacation of stay granted by the High Court. The Court also said that it was not possible to lay down any time schedules for the conclusion of civil/criminal proceedings.

The Court has also laid down procedures to be adopted by High Courts while passing interim orders of stay of proceedings and dealing with applications for vacating interim stay.

Read the Ruling

2. No Section 194H TDS on income of franchisee/distributor from sale of prepaid coupons/starter-kits: SC

The Supreme Court has ruled that telecom companies are not required to deduct tax at source (TDS) under section 194H on the sale of prepaid SIM cards and recharge voucher.

Facts

The assessee is a cellular mobile telephone service provider. The assessee provides starter kits (SIM Cards) and prepaid coupons of a specified value at discounted prices to its distributors. Further, such SIM cards are sold by distributors to end users. The Assessing Officer (AO) considered that the difference between the discounted price and the actual sale value is commission or brokerage. Accordingly, the AO contended that the assessee failed to comply with the provisions of tax deduction under section 194H.

High Courts order

The High Courts of Delhi and Calcutta have held that the assessee was liable to deduct tax at source under Section 194H. In contrast, the High Courts of Rajasthan, Karnataka and Bombay have held that Section 194H is not attracted.

Supreme Court Ruling

The Supreme Court held that Explanation (i) to Section 194H defines that “commission or brokerage” includes any payment received or receivable, directly or indirectly, by a person acting on behalf of another person for services rendered (not being professional services) or for any services in the course of buying or selling of goods or in relation to any transaction relating to any asset, valuable article or thing, not being securities.

The expression “direct or indirect” used in Explanation (i) to Section 194H is no doubt meant to ensure that “the person responsible for paying” does not dodge the obligation to deduct tax at source, even when the payment is indirectly made by the principal-payer to the agent payee. However, tax deduction at source in terms of Section 194H is not to be extended and widened in the ambit to apply to true or genuine business transactions, where the assessee is not responsible for paying or crediting income.

In the present case, the assessee neither pays nor credit any income to the person with whom it has contracted. The word “indirectly” does not regulate or curtail how the assessee can conduct business and enter into commercial relationships. Neither does the word “indirectly” create an obligation where the main provision does not apply.

The legal position of a distributor is generally regarded as different form that of an agent. The distributor buys goods on his account and sells them in his territory. The profit made is the margin of difference between the purchase price and the sale price. The reason is that the distributor is an independent contractor in such cases. Unlike an agent, he does not act as a communicator or creator of a relationship between the principal and a third party. The distributor has rights of distribution and is akin to a franchisee.

Further franchise agreements provide a mechanism whereby goods and services may be distributed. In franchise agreements, the supplier or the manufacturer, i.e. a franchisor, appoints an independent enterprise as a franchisee through whom the franchisor supplies certain goods or services. There is a close relationship between a franchisor and a franchisee because a franchisee’s operations are closely regulated, and this possibly is a distinction between a franchise agreement and a distributorship agreement.

Franchise agreements are extremely detailed and complex. They may relate to distribution franchises, service franchises and production franchises. Notwithstanding the strict restrictions placed on the franchisees – which may require the franchisee to sell only the franchised goods, operate in a specific location, maintain premises which are required to comply with certain requirements, and even sell according to specified prices – the relationship may in a given case be that of an independent contractor.

An independent contractor is free from control on the part of his employer and is only subject to the terms of his contract. However, an agent is not entirely free from control, and the relationship to the extent of tasks entrusted by the principal to the agent is fiduciary. The distinction is that independent contractors work for themselves, even when they are employed to create contractual relations with third persons. An independent contractor is not required to render accounts of the business, as it belongs to him and not his employer.

Thus, the term ‘agent’ denotes a relationship that is very different from that existing between a master and his servant, or between a principal and principal, or between an employer and his independent contractor. However, servants and independent contractors are parties to relationships in which one person acts for another and thereby possesses the capacity to be involved in liability. Yet, the nature of the relationship and the kind of acts in question are sufficiently different to justify the exclusion of servants and independent contractors from the law relating to agency.

In other words, the term ‘agent’ should be restricted to one who has the power of affecting the legal position of his principal by the making of contracts or the disposition of the principal’s property, viz., an independent contractor who may, incidentally, also affect the legal position of his principal in other ways.

Accordingly, it was held that the assessee would not be under a legal obligation to deduct tax at source on the income or profit component in the payments received by the distributors or franchisees from the third parties or customers or while selling or transferring the prepaid coupons or starter-kits to the distributors.

Read the Ruling

3. Proper Officer is required to substantiate why reply is unsatisfactory and provide opportunity before confirming demand: HC

The Honorable High Court of Delhi has recently held that the proper Officer is required to substantiate why reply is unsatisfactory and provide assessee with the opportunity to clarify or furnish further documentation before confirming demand. This ruling is given by the Honorable Delhi High Court in the case of Paras Enterprises v. Union of India.

Facts

The petitioner was dealing in the manufacturing and sale of electrical goods. The GST authorities had issued a notice and alleged that the petitioner had under-declared its output tax and claimed excess input tax credit. It was also alleged that the petitioner had claimed input tax credit from cancelled dealers, return defaulters and tax non-payers.

The petitioner submitted a detailed reply to the show cause notice and provided full disclosures under each of the heads. However, the GST authorities simply dismissed the reply by stating that it was not clear and unsatisfactory and issued a demand order. It filed writ petition against the demand order.

High Court

The Delhi High Court noted that the GST authorities should have substantiated why the reply was unsatisfactory and should have given an opportunity to clarify or furnish further documentation. Also, the petitioner was not provided with an adequate opportunity to defend the show cause notice through a hearing.

Therefore, the Court held that the impugned order was invalid and directed the GST authorities to re-adjudicate matter again and provide specific details and documents which would be needed from the petitioner, and it would furnish the explanation and documents within a week.

Read the Ruling

4. Claim of Bank-secured creditor would prevail over claim of Sales Tax Dept.: HC

The High Court, in the matter of Madhaviben Jitendrabhai Rupareliya v. State of Gujarat [2024] 159 taxmann.com 642 (Gujarat), ruled that banks which are secured creditors and having charge over the subject property would have priority over unsecured creditor i.e. Sales Tax Department (referred to as Crown’s debt). Thus, the claim of a secured creditor would prevail over a claim of an unsecured creditor.

Brief facts of the case

In the instant case, ‘Helios’ availed various financial facilities from respondent No. 4 – bank (R4) by mortgaging the subject property and a charge was created in favour of R4 and the same was recorded in the revenue record.

Upon Helios having defaulted on repayment of the loan and being declared an NPA, the bank initiated proceedings under the SARFAESI Act before the Debt Recovery Tribunal (DRT).

As Helios also did not make any payment towards the liability of the ‘Sales Tax Department’ (R3), a charge over the subject land was registered. According to the petitioner, the charge was registered by the Sales Tax department after a period of 6 years and 6 months after the charge of respondent No. 4 bank was registered as back as in the year 2000.

Pursuant to a public auction conducted by the bank in respect of the subject land, the petitioner participated in the bidding, and as she was the highest bidder, the bank issued a certificate of sale in her favour in respect of movable and immovable property lying inside the property.

Subsequently, a registered sale deed was executed by the bank in favour of the petitioner. The petitioner applied before Mamlatdar to mutate her name in the revenue record. However, the Mamlatdar rejected the said application on the two grounds that the seller’s name did not tally and that over the land in question, there was already a charge registered in favour of R3 department.

High Court’s Ruling

The High Court observed that when the property was purchased pursuant to an auction carried out by the order passed by DRT, the auction was held to recover dues of the secured creditor, i.e., the bank under an order passed by DRT in relevant proceedings before the DRT. Therefore, being a secured creditor, the bank was enjoying priority under section 26E of the SARFAESI Act.

Legal Ruling

Sec 26E read as follows –

Priority to secured creditors

“Notwithstanding anything contained in any other law for the time being in force, after the registration of security interest, the debts due to any secured creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.”

The High Court ruled that the charge of the secured creditor would precede the charge of an unsecured creditor (crown debt). As a result, it allows the instant petition to direct the respondent authorities to mutate the petitioner’s name in revenue records by quashing and setting aside any charge over property in question by the State or its authorities as there was a first charge of the respondent bank.

Read the Ruling

5. Combine Parent & translated subsidiary SFSs line-by-line, even if it leads to different carrying amounts in CFS for similar assets

A listed company in India has a wholly owned subsidiary incorporated in India and operational outside India. Following the provisions of Ind AS 21, the effects of changes in Foreign Exchange Rates, the subsidiary company considers the US Dollar (USD) as its functional currency. However, the functional currency for the parent company is INR.

Both companies acquired identical leasehold property from the government and capitalised the same under the head ‘Right of Use (ROU) Asset – leasehold land’. The acquisition value of the leasehold land for both the companies is the same. However, converting functional currency to presentation currency i.e. USD to INR has given rise to translation gain in the value of the asset in the books of the subsidiary company over the years. This translation gain accumulates to a material amount, and owing to this, the identical asset is carried at two distinct amounts in the individual balance sheets of the companies.

The issue arises while consolidating the financial statement of both companies since para 19 of Ind AS 110, Consolidated Financial Statements, requires that a parent shall prepare consolidated financial statements using uniform accounting policies for similar transactions and other events in similar circumstances. The auditor observed that the same identical ‘RoU – leasehold land’ is taken at two distinct values even when transactions occurred at similar prices. Thus, it suggested that the transaction must be consolidated at the same value, disregarding the translation gain accrued on the subsidiary’s asset to comply with para 19.

In this regard, para B87 of Ind AS 110 states that if a member of the group uses accounting policies other than those adopted in the consolidated financial statements for like transactions and events in similar circumstances, appropriate adjustments are made to that group member’s financial statements in preparing the consolidated financial statements to ensure conformity with the group’s accounting policies.

The requirement of uniform accounting policies for transactions and other events applies only when the circumstances of transactions or other events are also similar. Though like RoU assets have been acquired by the Parent and subsidiary in like transactions on the same day, the circumstances are not “similar circumstances” since the subsidiary has to recognise the transaction in a functional currency different than INR and then translate it into presentation currency of INR for Schedule III and consolidation purposes under Ind AS 21. Therefore, the requirement stated under para 19 is not violated even if two similar RoU assets of Parent and subsidiary with different functional currencies appear at different amounts in the consolidated financial statement due to translation requirements of Ind AS 21.

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