Presumptions under the Competition Act

A few sections of the Competition Act, 2002, were recently notified by the Government and have come into force. Particularly important in these are Sections 3 and 4. Section 4 deals with abuse of dominant position; while Section 3 deals with anti-competitive agreements.

Competition law generally classifies agreements as either ‘vertical’ or ‘horizontal’; and deals with the two differently. ‘Vertical’ would refer to agreements between parties at different levels of the production chain – say a manufacturer and a distributor; ‘horizontal’ would refer to agreements between parties at the same level – say between two producers of the same good. Horizontal agreements are, under competition law, often categorized as ‘per se’ illegal. Arguably, Section 3(3) of the Indian Act deals with horizontal agreements while Section 3(4) deals with vertical agreements.

Section 3(3) states:

Any agreement entered into between enterprises or associations of enterprises or persons or associations of persons or between any person and enterprise or practice carried on, or decision taken by, any association of enterprises or association of persons, including cartels, engaged in identical or similar trade of goods or provision of services, which—

(a) directly or indirectly determines purchase or sale prices;

(b) limits or controls production, supply, markets, technical development, investment or provision of services;

(c) shares the market or source of production or provision of services by way of allocation of geographical area of market, or type of goods or services, or number of customers in the market or any other similar way;

(d) directly or indirectly results in bid rigging or collusive bidding,

shall be presumed to have an appreciable adverse effect on competition:

Provided that nothing contained in this sub-section shall apply to any agreement entered into by way of joint ventures if such agreement increases efficiency in production, supply, distribution, storage, acquisition or control of goods or provision of services.

The words used by the Section are “shall be presumed”. Is this a rebuttable presumption or an irrebutable presumption?

At first glance, this appears to be a simple question. “Shall presume” is taken (in the Evidence Act, for instance) to refer to rebuttable presumption; irrebutable presumptions are generally worded in the terminology of “conclusive proof”. However, these definitions (Section 4, Indian Evidence Act) are applicable only to presumptions created under the Evidence Act. Arguably, the same rule does not apply to other statutes.

For instance, consider the Maharashtra Control of Organized Crime Act, 1999 (MCOCA).

Section 17(3) says:

Where it is proved that the accused has kidnapped or abducted any person, the Special Court shall presume that it was for ransom

On the other hand, Section 22(2) says:

In a prosecution for an offence of organized crime punishable under sub-section (2) of section 3, if it is proved that the accused rendered any financial assistance to a person accused of, or reasonably suspected of, an offence of organized crime, the Special Court shall presume, unless the contrary is proved, that such person has committed the offence under the said sub-section (2)

Now, if “shall presume” is always taken to be a rebuttable presumption, why would the legislature use the words “unless the contrary is proved” in Section 17(3)? On a plain reading, Sections 17(3) and 22(2) create different types of presumptions: Section 17(3) must be taken to create an irrebutable presumption, tantamount to “conclusive proof”.

Further, turning to the Competition Act itself, Section 3(3) has a Proviso which states when agreements falling within the presumption would not be affected by the Section. If “shall presume” was anyway intended to be a rebuttable presumption, why include this Proviso? Does a literal reading not support the view that the presumption created is an irrebutable presumption unless specifically falling within the Proviso? There appears to be an arguable case for this. Of course, all these arguments can be rebutted; the point is that it is not entirely absurd to suggest that “shall presume” at times creates an irrebutable presumption. Whether it does so in a particular statute or not, would depend on the context of that legislation.

So what is the actual position under the Competition Act? A newly started blog, Perspectives on Law, offers an interesting analysis of the issue. As I understand it, Perspectives on Law is dedicated to offering arguments from both sides on the specific issue being considered; unlike most other blogs. Here and here, arguments in favour of the presumption being irrebutable are presented. Arguments in favour of the presumption being rebuttable will be presented in subsequent posts; and readers might find the series of posts interesting.

T.R. Andhyarujina on the Kesavananda Review case

A recent issue of SCC (Journal) carries an article by Senior Advocate T.R. Andhyarujina on the Kesavananda review hearing. Shortly after the decision in Kesavananda Bharati, AIR 1973 SC 1461, a Bench was constituted in order to review the judgment. Mr. Palkhivala argued the point, against the review, and the Bench was dissolved.

Mr. Andhyarujina’s article has been made available here, thanks to Something About the Law. Mr. Palkhivala’s written submissions in the review matter are available as an annexure to M.R. Pai’s book, The Legend of Nani Palkhivala. Also, his written submissions in Kesavananda itself are available here.

Ishikawajima, Clifford Chance, Siemens, Jindal Thermal: What Survives after the 2007 Amendment?

Debate over the fate of Ishikawajima has continued in the last few weeks. To briefly recapitulate, after Ishikawajima, the Finance Act 2007 inserted an Explanation to Section 9 with retrospective effect; and the effect of this Explanation has conflicting judicial views. The Bombay High Court in Clifford Chance can be read as having taken the position that Ishikawajima survived the amendment; Siemens indicated that it did not. This controversy is discussed here. Jindal Thermal saw the Karnataka High Court holding that Ishikawajima survived the amendment in its entirety. Meanwhile, the Authority for Advance Rulings (AAR) in Re Worley Parsons commented on the correctness of Ishikawajima itself.

Another decision of the AAR – in Re International Tire Engineering Resources, AAR No. 804/2009, decision dated October 28th, 2009 – once again seems to narrow the scope of Ishikawajima. The Authority has clarified that the principle behind Ishikawajima cannot be applied in the context of Section 9(1)(vi) of the Act. The relevant observations are:

“The power of taxation in this regard cannot be denied to the Indian Government from the standpoint of territorial nexus and by reference to the observations made in Ishikawajima case on the aspect of territorial nexus. First of all, the said observations at pages 445 and 447 (of 288 ITR) were in the context of technical/consultancy services rendered outside India and not concerning royalty. In connection therewith, it was observed that such services should not only be utilized but rendered in India in order to bring the fee for technical services within the net of clause (vii) of s.9(1). This was followed by the proposition that “sufficient territorial nexus between the rendition of services and territorial limits of India is necessary” or that the services should have `live link’ with India. In stating that the services, to fall within the scope of Section 9(1)(vii) should not only be utilized but rendered in India, the Supreme Court apparently had in view the observations in Carborandum Co. vs CIT made in the context of a different provision i.e., Section 42 of 1922 Act. In the instant case, the theory of territorial nexus cannot possibly be invoked by the recipient of income in the nature of royalty. The technical know-how embodied in various documents is received by the applicant in India from time to time and is put to use in India with the assistance and advice offered by the technical personnel of the applicant deputed to India. The role played by the applicant is perceivable at every stage till the plant is set up and the goods are manufactured. No doubt can possibly arise from the stand point of territorial nexus.”

Furthermore, the observations of the Special Bench of the ITAT in New Skies Satellites are also relevant in this regard. The Special Bench has distinguished Clifford Chance, and has treated Clifford Chance’s observations on the 2007 amendments as obiter. The relevant paragraphs are:

“(In Ishikawajima), the assessee entered into a composite indivisible turnkey project for setting up of a gas terminal in Gujarat. The contract consisted of both offshore and onshore services. It was not disputed by the parties that the assessee had a business connection in India and it had a permanent establishment in India. There was no dispute so as it relates to taxability of onshore supplies and on shore services. The dispute related only to the taxability of offshore supply and offshore services component. According to the revenue, offshore component was taxable under Section 9(1)(vi)(c) of the Act as they were payments made by non-resident in respect of services utilised by a business or profession carried on by such non-resident in India or for the purpose of making or earning any income from any source in India and for considering such question that is regarding taxability of offshore supply and offshore service component under the provisions of Section 9(1)(vi) (c) it was observed that to attract the tax liability the services should be utilised in India and they should also be rendered in India. Thus, the question before their Lordships were regarding taxability of the global receipts. So far as it relates to onshore supplies and on shore services, there was no dispute regarding the taxability of the income… In our considered opinion, no help can be drawn by Shri F.V. Irani from the said decision of Hon'ble Supreme Court as the issue considered therein was in respect of global income of the assessee The issue in the present case is regarding taxability of amount received by the assessee as royalty Under Section 9(1)(vi)(c)…

 

The doubt, if any, has been clarified by the insertion of Explanation inserted at the end of Section 9 by Finance Act, 2007 with retrospective effect from 01.06.1976. … It has been clarified by the aforementioned Explanation that where the income is deemed to accrue or arise in India… then, such income shall be included in the total income of non-resident irrespective of the fact that the non-resident has a residence or place of business or business connection in India… Therefore, the ratio of aforementioned decision of Hon'ble Supreme Court in the case of IshikawajimaHarima Heavy Industries Ltd. v. Director of Income-tax (supra) is not applicable… coming to the contention of Shri F.V. Irani regarding the decision of Hon'ble Bombay High Court in the case of Clifford Chance v. DCIT… we have carefully gone through the said decision… Analysing Section 9(1)(vii) (c) it was observed that two conditions have been envisaged to be fulfilled: services, which are source of income sought to be taxed in India must be; (i) utilised in India; and (ii) rendered in India, and it was held that income of the assessee for services rendered in India and utilised in India as disclosed by the assessee in its return was only income chargeable to tax in India and no income could be assessed in respect of services rendered out of India… the scope of explanation was not under consideration of their Lordships of Bombay High Court. Though the reliance was placed by the revenue on the said Explanation, but, Hon'ble High Court while considering the issue has not considered the said Explanation relevant for deciding the issue. It can be seen from the decision that the provisions which was considered by their Lordships were Section 5(2), Section 9(1 )(i) and Section 9(1 )(vii). The provisions of treaty which was considered were Article 15. On finding that test of 90 days was satisfied, it was ruled that the income relating to services rendered out of India could not be taxed under DTAA… Therefore, the said decision of Hon'ble Bombay High Court also cannot be applied to the facts of the present case.”

Two propositions appear from this: that the principle of Ishikawajima may not find applicability outside of Section 9(1)(vii); and the question of whether the Explanation overrides Ishikawajima is still an open one. I will comment on this in more detail subsequently.

CIT v. Samsung Electronics: Chargeability unnecessary for TDS?

 In a decision which may lead to grave practical difficulties in international commercial transactions, the Karnataka High Court has recently ruled in effect that ‘tax’ must be deducted at source in respect of all payments made to non-residents, irrespective of whether or not the sums paid are chargeable to tax in India. The case, CIT v. Samsung Electronics, can be accessed here.

  

In the facts of the case, the assessee made some payments to a non-resident for the purchase of shrink-wrapped software. No deduction of tax at source was made in terms of Section 195. The AO held that the payments were chargeable to tax in India u/s 9(1)(vi) of the Income Tax Act, 1961 as ‘royalty’, and treated the assessee as an assessee-in-default u/s 201 of the Act for non-deduction of tax at source. The CIT(A) upheld this view. On appeal, the Tribunal held that the payments were for shrink-wrapped software, which is ‘goods’ following the decision of the Supreme Court in Tata Consultancy Services.

 The judgment in TCS as also the subsequent decision of the ITAT in Sonata, (2007) 106 T.T.J. (ITAT) 797, make it abundantly clear that payments for shrink-wrapped software would not be chargeable to tax in India. V. Niranjan, in a recent article published in the Journal of Business Law describes the decision in Sonata thus:

  

"The leading case is Sonata Information Technology v Additional Commissioner of Income Tax, International Taxation. The Income Tax Assessing Officer considered that the payment for software import constituted "royalty" under s.9(1)(vi) of the Income Tax Act 1961, on the reasoning that there was no sale of software as there was no transfer of ownership rights and sale, if any, was only restricted to the CDs in which the software is transacted… Royalty is payable only if the copyright itself is transferred, and Sonata correctly observed only a copy of the copyrighted software is licensed to the user. However, Sonata then followed Tata Consultancy Services to hold that it is a sale of goods, which by definition does not attract royalty." [Footnotes omitted]

  

(See: V. Niranjan, “A Software Transfer Agreement And Its Implications For Contract, Sale Of Goods And Taxation”, [2009] 8 J.B.L. 799)

  

Thus, it is clear that the AO in the facts of the Karnataka decision got it wrong – the payment was not chargeable to tax in India. This would have been sufficient to dispose of the appeal – but the High Court’s view was that this evident non-chargeability was completely irrelevant. The Court held that the moment there is a payment made to a non-resident, the provisions of Section 195 are attracted. Non-chargeability is no excuse to avoid deduction of tax at source. The only situation when tax need not be deducted is if the payee files an application before the AO for the grant of a certificate authorizing him to receive the sum without deduction.

  

The effect of such a reading is quite incongruous. For example, one might consider this position along with the stance of the Revenue in the Vodafone case that Section 195 applies even to payments where both the payer and the payee are non-residents. If both these propositions are to be accepted (i.e. chargeability is irrelevant and situs of payment/payer is irrelevant) the conclusion is that an English company paying a sum of money to another English company for reasons entirely unconnected with India, would be an assessee-in-default under the Indian Income Tax Act unless it gets a certificate from the Indian AO! For, the question of whether that payment is susceptible to tax in India is entirely irrelevant. I had discussed the law on the extraterritoriality of Section 195 here. For the moment leaving aside the issue of extraterritoriality, even assuming that the payment is made by a resident, this position is likely to cause grave commercial hardship. Even assuming that a payment is specifically exempted by the Act or by a treaty, a withholding liability u/s 195 will subsist. The only remedy is for the non-resident to file an application – something that is only likely to increase delays and promote uncertainty in commercial transactions.

  

Does the plain language of the provision support the Court’s stance? Section 195 says, “Any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest on securities) or any other sum chargeable under the provisions of this Act (not being income chargeable under the head "Salaries" shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates in force…”

  

On its plain reading, the applicability of Section 195 turns on whether the sum is chargeable or not. Perhaps realizing this difficulty, the Karnataka High Court sought to place reliance on the Supreme Court judgment in Transmission. The Court’s reasoning effectively consisted of reproducing a few paragraphs in Transmission, and concluding that the issue was a settled one.

The facts in Transmission, seen from the Supreme Court judgment, were that appeals were filed by the assessee against an order of the AO treating the assessee as an assessee-in-default. These appeals were allowed by the CIT(A), who stated that the words “any other sum chargeable under the provisions of this Act” in Section 195 do not contemplate trade receipts within their ambit, and Section 195 applies only to cases where the sums paid are ‘pure income profits’. The ITAT was of the same view. On further appeal, the High Court stated that two fundamental questions arose for consideration, which were: (a) whether the provisions of Section 195 are applicable to cases where the sum paid to the non-resident does not wholly represent income; and (b) if Section 195 is applicable in such cases, whether the AO could enforce deduction of tax at source on the gross amount of trading receipts or only in respect of that portion of the trading receipts which may be chargeable as income under the Act.

Before the Supreme Court, the same two issues were raised in appeal. The Supreme Court held, “The scheme of Sub-sections (1), (2) and (3) of Section 195 and Section 197 leaves no doubt that the expression “any other sum chargeable under the provisions of this Act” would mean ‘sum’ on which income-tax is leviable. In other words, the said sum is chargeable to tax and could be assessed to tax under the Act.”

  

Undoubtedly, the Court went on reject the assessee’s first contention; saying, “there is no substance in the contention of the learned Counsel for the Appellant that the expression “any other sum chargeable under the provisions of this Act” would not include cases where any sum payable to the non-resident is a trading receipt which may or may not include ‘pure income’. At the same time, the Court clarified, “the answer given by the High Court that (i) the assessee who made the payments to the three non-residents was under obligation to deduct tax at source under Section 195 of the Act in respect of the sums paid to them under the contracts entered into; and (ii) the obligation of the respondent-assessee to deduct tax under Section 195 is limited only to appropriate proportion of income chargeable under the Act, are correct.”

  

The portions of the judgment underlined above would clearly indicate that the controversy before the Karnataka High Court was not a settled one – if anything, arguably, the issue was settled in favour of the assessee insofar as chargeability being a precondition for application of TDS provisions. It is perhaps time for the Supreme Court to step in and set the record right.

 

Some more Bits and Pieces

1. Among the recent controversies in the Income Tax Act has been the one on Section 14A, following the decision of the Special Bench of the ITAT in Daga Capital. Recent issues surrounding the case have been discussed here.

2. The Clifford Chance tax dispute seems to be headed up to the Supreme Court, with notices having been issued to CC. This post analyses the Bombay High Court judgment which is being appealed.

3. An earlier post had discussed the “General Anti-Avoidance Rule” proposed to be introduced into Indian tax laws through the Direct Tax Code. A recent article in the British Tax Review by Judith Freedman, Geoffrey Loomer and John Vella of the University of Oxford may be relevant for a general understanding of how a GAAR might function. The article can be downloaded here.

Call for Papers: Indian Yearbook of International Law and Policy

The Indian Yearbook of International Law and Policy is currently soliciting submissions for its inaugural issue due to be published in March, 2010. We welcome submissions from academics, practitioners, policymakers and students from within the legal community and have a strong preference for articles that are not descriptive but prescriptive and argumentatively focused. The submissions will go through a two-staged peer review process and if necessary, will also be edited by the Editorial Board. Please send in your submissions by January 10, 2010 under the categories mentioned below. For general queries relating to your submissions, see the ‘Note to Authors’ or kindly write to us at:

indianyearbook(dot)il(at)gmail(dot)com

ABOUT THE YEARBOOK

The INDIAN YEARBOOK of INTERNATIONAL LAW AND POLICY is a peer-reviewed academic publication and aims to provide a forum for the publication of articles in the field of international law, written primarily by experts from the region and elsewhere. The Yearbook seeks to provide an intellectual platform for the discussion and dissemination of Indian views and practices on contemporary international legal issues. It also seeks to encourage interest in all matters relating to international law, exploring new avenues and approaches to its study and has been envisaged as a response to the longstanding demand for the documentation of national practice and policy related to international law.

SUBMISSION CATEGORIES

Submissions may be made under the following categories :

• Articles: 8000-12000 words,

• Comments/Notes: 4000-7000 words,

• Case Comments: 3500-8000 words,

• Book Reviews: 2000-4000 words.

NOTE TO AUTHORS

The prescribed word limits are inclusive of footnotes and submissions are expected to conform to length policy and the guidelines listed below. Kindly go through them carefully before mailing your submissions. We promptly acknowledge the receipt of submissions and a decision on publication takes a minimum of around 4-6 weeks.

The issue is out in print within two months of a decision to publish. Requests for expedited reviews can be forwarded to the Editorial Board when the submission is being considered for publication by other journals. Please mention the name of the journal for which your article is in consideration, one contact person in the Editorial Board of that journal and a date by which you expect our response.

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• Contact Address: Submissions are to be made in electronic form and should be sent to the following e-mail address- indianyearbook(dot)il(at)gmail(dot)com.

• Format: The documents must be in MS Word (.doc) format. All submissions must be double-spaced in Times New Roman. Main text should be in font size 12 and footnotes in font size 10.

• Deadline: The Editorial Board has set January 10, 2010 as the deadline for accepting contributions for the 2010 volume.

• Abstract: Each contribution is expected to be accompanied by an abstract of not more than 350 words and a declaration to the effect that it has not been published, submitted, or accepted for publication elsewhere.

STYLE AND FORMATTING GUIDELINES

• Form of Submission: Submissions must be in electronic form. All submissions must be word-processed, double-spaced in Times New Roman. Main text should be in font size 12 and footnotes in font size 10. All submissions must contain an abstract of not more than 350 words.

• Title: The Yearbook does not recommend any specific guidelines regarding the titles and sub-titles. However, the main titles must be centered, typed in small capitals and emphasized in bold. The titles must be uniform, concise and descriptive.

• Quotations: Quotations should be clearly indicated and it is vital that they are accurate. Double quotation marks should be inserted at the beginning and end of every quotation and where the quotation will run to more than forty words it should be typed as a separate paragraph and left-indented.

• Foreign words: Foreign words not currently absorbed into the English language should be italicized, e.g., “inter alia”, “bona fide” etc.

• References and Citations: Contributors are requested to adhere to the latest edition of the Harvard Blue Book. [The Blue Book: A Uniform System of Citation (Harvard Law Review Ass'n et al. eds., 18th ed. 2005]. All citations and notes are to be shown as footnotes.

For any queries relating to the theme or the structure of your submissions or any general queries relating to the journal, please contact us at indianyearbook(dot)il(at)gmail(dot)com.

NCPRI Convention on the RTI

The National Campaign for People’s Right to Information is holding an RTI Convention in Hyderabad from 30th November to 2nd December. Here is the invitation received from the NCPRI.

_________________________

On behalf of NCPRI, we would like to invite you to participate in the RTI Convention to be held in Hyderabad from November 30-December 2, 2009.

The first day of the convention has a focus on Youth, RTI and Democracy. In the following two days, 1st and 2nd December the Southern regional convention on the RTI will begin with plenaries and thematic workshops conducted by experts to discuss more closely the utility and relevance of RTI with regard to cases of human rights, employment, politics, environment and so on; as well as share experiences. The Hyderabad Central University has kindly offered its premises for the occasion.

The Convention will be a great opportunity for all of us to share our experiences on the Right to Information. Since representatives of various campaigns and groups working on the RTI from across the country will participate in this Convention, it will also work as a

platform for all of us to network with like-minded groups and individuals and take our work forward. In the past year, the issue of amendments to the RTI Act has cropped up time and again. Lately, the 'rumours' have taken more definite shape with both the President and the Prime Minister declaring their intent to bring in amendments. We look upon this meet as an opportunity to also develop concrete strategies to oppose any change to the RTI legislation. We hope you and representatives from your campaign, group and or organisation can join us for the Convention.

For more information please contact via email at ncpri(dot)india(at)gmail(dot)com

Penalty proceedings: Continuing confusion in the law on Penalties

In a recent judgment, Madhushree Gupta v. Union of India, WP No. 5059 and 6272 of 2008, a Division Bench of the Delhi High Court considered the constitutional validity of certain provisions of the Finance Act, 2008, which inserted sub-section (1B) in Section 271 of the Income Tax Act with retrospective effect. The issue pertained to initiation of penalty proceedings under the Income Tax Act.

Prior to the amendment, in Shakti Offset v. Inspecting ACIT, [1967] 64 ITR 637 (Bom.), it was held by the Bombay High Court, “… the opening words of Section 271(1) provided for the Income-tax Officer or the Appellate Assistant Commissioner being satisfied in the course of any proceedings under the Act that the assessed has done one or the other of the defaults mentioned in the sub-clauses and on his being satisfied he may direct such person to pay by way of penalty the amounts indicated in the subsequent provision.” A Constitution Bench of the Supreme Court had occasion to comment on matters of a similar nature in CIT v. S.V. Angidi Chettiar, [1962] 44 ITR 739 (SC). Justice Shah stated in that case, “The power to impose penalty under Section 28 depends upon the satisfaction of the Income Tax officer in the course of proceedings under the Act; it cannot be exercised if he is not satisfied about the existence of conditions specified in clauses (a), (b) or (c) before the proceedings are concluded. The proceeding to levy penalty has, however, not to be commenced by the Income Tax Officer before the completion of the assessment proceedings by the Income Tax Officer.”

Again, in the Ram Commercial Enterprises case, 246 ITR 568 (Del); affirmed by the Full Bench in 309 ITR 143 (Del), the Delhi High Court clarified that if the AO did not record his satisfaction that the assessee had concealed particulars of his income before completion of the assessment proceedings, the initiation of penalty proceedings was bad in law. In fact, in the words of the Full Bench, “In the absence of a clear finding as to the concealment of income or deliberately furnishing inaccurate particulars, the initiation of penalty proceedings will be without jurisdiction.”

To supersede this position, the Finance Act, 2008, inserted sub-section (1B) in Section 271 of the Income Tax Act with retrospective effect Section (1B) reads:

Where any amount is added or disallowed in computing the total income or loss of an assessee in any order of assessment or reassessment and the said order contains a direction for initiation of penalty proceedings under clause (c) of sub-section (1), such an order of assessment or reassessment shall be deemed to constitute satisfaction of the Assessing Officer for initiation of the penalty proceedings under the said clause (c).

In Madhushree, the constitutionality of section (1B) was challenged by the petitioners. The Revenue had contended that the requirement that the AO must arrive at his own satisfaction as to concealment had been done away with by the legal fiction which deemed the order of assessment to constitute the AO’s satisfaction. The Court upheld the constitutionality of the provision, but commented:

“… post-amendment, these provisions remained untouched. In these circumstances we do not see how it can be argued by the Revenue that prior to the impugned amendment satisfaction at both at the initiation stage as also at the stage of imposition was required, however, with the enactment of the impugned provision, that is, sought to be changed by providing for satisfaction only at the stage of imposition of penalty.”

Further:

“The Revenue’s submission that prima facie satisfaction of the AO need not be reflected at the stage of initiation is not acceptable. The presence of prima facie satisfaction for initiation of penalty proceedings was and remains a jurisdictional fact which cannot be wished away even post amendment. If an interpretation such as the one proposed by the Revenue is accepted then s. 271 (1B) will fall foul of Article 14 of the Constitution as it will then be impregnated with the vice of arbitrariness.”

Accordingly, the Delhi decision seems to have re-affirmed the earlier position, and watered down the impact of the insertion of Section 271(1B). That position is however rendered uncertain once again by the judgment of the Supreme Court in CIT v. Atul Mohan Bindal, Civil Appeal No. 5769 of 2009, decided on August 24, 2009. The Supreme Court noticed that Ram Commercial Enterprises had in fact been specifically approved by the Supreme Court in Dilip Shroff; however, Dilip Shroff had been overruled by a larger Bench in Dharmendra Textiles. Accordingly, the matter was remitted to the High Court for fresh consideration post Dharmendra Textiles.

The correctness as well as the effect of Dharmendra and the cases following tat decision have been followed extensively on Indian Corporate Law and the relevant posts can be accessed here. In sum, the position on penalties and the true effect of Dharmendra continues to be controversial; and will perhaps remain so until a clear pronouncement by a larger Bench.

Unconnected Bits and Pieces

1. Mr. Vivek Reddy has written this piece in the Indian Express, discussing the recent controversy over recusal of Judges of the Supreme Court. He analyses Justice Raveendran’s recusal from the RIL-RNRL dispute in view of previous Supreme Court judgments on judges’ recusal.

2. Mr. V. Niranjan has written this post on Indian Corporate Law, discussing recent decisions on the concept of the ‘permanent establishment’ under various DTAAs. In particular, he discusses UAE Exchange Centre v. Union of India (313 ITR 94 – Delhi High Court) and Re Cable & Wireless Networks.(315 ITR 72 – AAR).

Ex Turpi Causa: The Illegality Defence after Moore Stephens and Gray

In the recent decision of Moore Stephens v. Stone & Rolls, the House of Lords had to consider two important issues in commercial law. The first was the question of attribution of the actions of a directing mind and will to the company. The specific issue was whether the fraud of a directing mind would be attributed to the company. Broadly, the House of Lords held by majority that if the company is a vehicle of the fraud (as opposed to the victim of the fraud) the directing mind’s fraud will be attributed to the company. In other words, a directing mind’s fraud will be attributed to the company in all cases, except where the fraud was played directly on the company. I have briefly discussed these aspects of Moore Stephens here.

The other issue before the House of Lords was the scope of the maxim “ex turpi causa non oritur actio”. This maxim essentially indicates that a plaintiff will not be allowed to pursue a cause of action which arises from his own illegal conduct. The underlying rationale is that a Court will not lend its aid to someone who has founded his cause of action upon an immoral or illegal act – Lord Mansfield’s formulation in Holman v. Johnson, [1775] 1 Cowp. 341. The 1994 decision of the House of Lords in Tinsley v. Milligan has come to be regarded classic case on the point. Besides Moore Stephens, another recent decision of their Lordships in Gray v. Thames Trains also comments on the scope of the rule in Tinsley.

Thus, the present formulation of the rule depends on the reading of Tinsley – decided in 1991 – along with two decisions of 2009, Moore Stephens and Gray. What, then, is the present position as to the scope of the ‘illegality defence’? The most recent decision analyzing these cases seems to be the High Court decision of Coulson J. in K/S Lincoln and others v. CB Richard Ellis Hotels Ltd. (decision of October 2, 2009).

The case arose out of a procedural application. The claimants were all special purchase vehicles created by a Danish company to buy some hotels in England. The claimants engaged the defendant to carry out a valuation of the hotels. They claimed that the defendant’s negligence and/or breach of contract in carrying out the valuation resulted in them paying too much for the purchase of the hotels. Damages were claimed on the basis of price paid plus a certain figure. The total price paid for one of the hotels, for instance, was said to have been £5,221,800. That figure was made up of the sum paid to the seller (£4,835,000); as well as an additional figure, calculated at 8% of the price paid to the seller (in this case £386,800). The 8% “uplift figure” was a payment made to a property location agent and not the seller. This 8% uplift figure was at the heart of the dispute between the parties.

The 8% uplift figure was described by the Claimants as being necessitated by “reasons of convenience and tax efficiency in Denmark”. The Defendants claimed that this 8% uplift figure over and above the nominal sale price was to disguise the true nature of the transaction, and amounted to unlawful tax evasion. Further, it was contended that if the purchase was structured to obtain an unlawful tax saving, then the claims would fail on account of the illegality defence – the claimants cannot set up their own tax evasion in order to make out their case. For the purposes of the specific issue, all parties agreed to assume that the transaction was structured in order to facilitate unlawful tax evasion.

Thus, the issue before the Court was whether, assuming that the transaction was structured in order to facilitate tax evasion, the claims must fail on account of the illegality defence. The Court laid down (paragraph 22 of the judgment) the following principles governing the scope and application of the ex turpi causa rule:

a) Contracts which are entered into with the intention of committing an illegal act will not generally be enforced (Moore Stephens) although, in exceptional circumstances, the intended illegality may be so remote to the subject matter of the claim as to make the contract enforceable (21st Century Logistic v. Madysen, [2004] 2 Lloyd’s Rep. 92).

b) In a case where the claimant is not seeking to enforce an unlawful contract but founds his case on collateral rights acquired under that contract, and where illegality does not, of necessity, form part of the claimant's case, the claim may well succeed (Tinsley v Milligan); however, the comments by Lord Phillips in Moore Stephens and by Lord Hoffmann in Gray may indicate that this more generous approach may be confined to property cases alone.

c) The court will not generally assist a claimant to recover the benefit of his own wrongdoing, whether or not the claimant has pleaded or expressly relied on the illegality on making the claim (Moore Stephens).

d) Although the test is no longer to ask if the public conscience is affronted by the allowance of such a claim (Tinsley v Milligan), it seems clear that the underlying principle or policy is one of deterrence; that the courts will not encourage illegal acts by allowing claims based upon them.

Applying these principles, it was held that “the question of fraud/illegality would be relevant to the claims made. It would not lead to the dismissal of the entire claim, but it would lead to a reduction in the amount of the claim by striking out that particular element of the damages calculation…” The principles [(a) to (d)] laid down in the case summarize the present position of law in the context of the illegality defence.

___________

Additional Notes:

1.The Law Commission of England has published a consultation paper on the scope of the ex turpi causa rule, in 2001. The paper is available here, and includes a comparative discussion of the position in other countrie

Union Laws, Territorial Nexus and the Effect of Article 245(2)

A number of posts on this blog have looked at the extraterritorial operation of the Income Tax Act in the context of certain individual section of the Act. For instance, extraterritorial operation in relation to Section 9 was discussed here; extraterritorial operation in relation to TDS provisions was discussed here. This post is a general analysis of the constitutional issues pertaining to territorial nexus, particularly considering the rational for imposing territorial nexus requirements on Union laws despite the existence of Article 245(2) of the Constitution.

The competence of Parliament and the State Legislatures to enact legislation with extraterritorial effects must be analysed by reference to Article 245 of the Constitution of India. The text of the Article reads:

245. Extent of laws made by Parliament and the State Legislatures.-

(1) Subject to the provisions of this Constitution, Parliament may make laws for the whole or any part of the territory of India, and the Legislature of a State may make laws for the whole or any part of the State.

(2) No law made by Parliament shall be deemed to be invalid on the ground that it would have extraterritorial application.

Two issues which must be considered are (A) the application of the so-called “territorial nexus” doctrine, and (B) the impact of sub-clause (2) of the Article.

The “Territorial Nexus” Doctrine:

Article 245(1) effectively mandates that a particular legislature may enact laws for part or whole of the territory for which it is the legislature. Thus, Parliament can enact laws for the whole or part of India; while state legislatures can enact laws for the whole or part of the particular state concerned. It is however obvious that almost all laws will have some direct or indirect impact on persons or events outside the specific territory. Clearly, the law cannot be in contravention of Article 245(1) merely because of such an impact. Faced with such a situation, Courts have evolved the doctrine of territorial nexus – a law will satisfy the requirements of the principle behind Article 245(1) if they have a sufficient nexus with the territory of the legislature enacting the law. The position may be summarized briefly according to the decision of State of Bombay v. RMDC, [1957] S.C.R. 874:

The doctrine of territorial nexus is well established and there is no dispute as to the principles. As enunciated by learned counsel for the petitioner, if there is a territorial nexus between the person sought to be charged and the State seeking to tax him the taxing statute may be upheld. Sufficiency of the territorial connection involve a consideration of two elements, namely, (a) the connection must be real and not illusory and (b) the liability sought to be imposed must be pertinent to that connection. It is conceded that it is of no importance on the question of validity that the liability imposed is or may be altogether disproportionate to the territorial connection. In other words, if the connection is sufficient in the sense mentioned above, the extent of such connection affects merely the policy and not validity of the legislation

Of course, this was a principle laid down in the context of a state law – why will the position be the same insofar as a Union law is concerned, specifically given Article 245(2)?

The Effect of Sub-clause (2) of Article 245 on the Territorial Nexus doctrine:

A doubt which immediately comes to mind in view of the above discussion is as to the relevance of Article 245(2). At first glance, this Article appears to indicate that a nexus requirement is not required in the case of Union laws; and that Union laws without nexus requirements cannot be struck down. It is submitted that this reading is not justified, despite the language of Article 245(2). In order to appreciate this submission, it is essential to go through the legislative history of what is now Article 245(2).

Section 65 of the Government of India Act, 1915, dealt with the legislative power of the Indian legislature at that time. It conferred on the Indian legislature the power to make laws (a) for all persons, for all Courts and for all places and things within British India; (b) for all subjects of His Majesty and servants of the Crown within other parts of India, and (c) for all native Indian subjects of His Majesty without and beyond as well as within British India. Thus, clause (a) was strictly territorial; while clauses (b) and (c) allowed the legislature to make laws with extraterritorial effect outside British India, provided that the nexus requirements therein (‘all subjects of His Majesty’ and ‘all native Indian subjects’ respectively) were satisfied. The inclusion of clauses (b) and (c) was necessitated by a few decisions which would have imposed a strict nexus requirement [Blackwood v. The Queen (1882) 8 AC 82; Provincial Treasurer of Alberta v. Kerr (1933) AC 710]. Thus, clauses (b) and (c) widened the nexus requirement to that extent.

In the Government of India Act, 1935, Section 99 empowered the Federal Legislature to make laws “for the whole or any part of British India”. This was a change from the wording of the earlier provision. Noticeably, Section 99 did not include clauses (b) and (c) above. On this basis, it might have been argued that even laws satisfying the nexus requirement under the earlier clauses (b) and (c) would be void under the new provisions of Section 99. It was to counter this specific argument that Section 99(2) was introduced. Thus, Section 99(2) was included to preclude objections on the ground of extra-territorial effect even given a nexus requirement. As stated by the Privy Council in Wallace Brothers v. CIT, AIR 1948 PC 118, Section 99(2) “… does no more than assume that there may be some laws having an extraterritorial operation validly made pursuant to Sub-section (1).” In other words [Governor-General v. Raleigh Investment, AIR 1944 FC 51]:

…it was probably thought that the simple omission of the corresponding provisions found in the Act of 1915 might lead to the impression that the power to deal with those matters had been taken away from the Federal Legislature. Even the language of Section 99 (1) involves some limitation and it might have been considered safer to avoid all risk of any difference of opinion as to its scope, so far as the topics specified in Sub-section (2) were concerned…

As a matter of law, even after the inclusion of Section 99(2), the territorial nexus requirement was held to be implicit in the expression “laws for British India”. [See also the decision of the Bombay High Court (Kania C.J., Fazl Ali, Patanjali Sastri, Mahajan and Mukherjea JJ.) in A.H. Wadia v. CIT, (1949) 51 Bom LR 287.]

The existence of Article 245(2) is perhaps explained as a result of the historical developments in this regard. Of course, Section 99(2) was not in terms identical to Article 245(2). Yet, the difference between the two appears to be that Section 99(2) would justify extraterritorial operation based on the types of nexus specifically listed thereunder. Under Article 245(2), these headings of nexus are not listed. So, Article 245(2) allows any territorial nexus to justify the Union law. Seen in this historical background, it is submitted that Article 245(2) does not preclude the judiciary from striking down a law which has only extraterritorial effect. All Article 245(2) does is that it indicates that the strengths of that nexus are not a matter to be determined by the Courts. Once a Union law is found to have any (rational) territorial nexus, it must be upheld in terms of Article 245(2). But, a law without territorial nexus will fall foul of Article 245(1) itself [see also Electronics Corporation of India v. CIT, AIR 1989 SC 1707]. This position has been accepted by the Supreme Court in a case which will be discussed later in this note. This reading is perhaps the only way to harmoniously read Articles 245(1) and 245(2).

Article 245(2) does not extend to state laws. What is the implication? One can consider that there is no difference in the position between Union and State laws; and 245(2) was merely a historical relic, originally intended to be nothing but clarificatory. The other implication is that in some cases, despite the existence of some nexus, a State law may be struck down; while a Union law cannot be struck down once some rational nexus exists. In other words, 245(2) clarifies that strength of nexus is irrelevant for Union laws, but might remain relevant for State laws. Settled principles of territorial nexus in rellation to state laws seem to have ruled out the latter argument. In any edvent, in either case, it is clear that Article 245(2) does not sanction extraterritorial legislation without any nexus.

Income Tax Digest of Cases - October 2009

The Mumbai ITAT Bar Association (ITAT Online) digest of cases for October 2009 is available here. The Consolidated Digest from January to October is also available at the link.

"Principal Place of Business" and "Residence" of corporations

The United States Supreme Court will soon be hearing arguments in Hertz Corp. V. Friend (08-1107). The case concerns a corporation which carries on business in more than one state. The question before the Court pertains to the proper test for determining where the “principal place of business” of such a corporation would be situated. Among the various tests which will be considered are the “nerve center” (or location of headquarters) test; the “center of corporate activities” test; the “place of operations” test and the “total activities” test. Descriptions of each test, and an analysis of the various cases in US law applying those tests, can be found in the petition for writ of certiorari. Shantanu Naravane has discussed the case on Indian Corporate Law.

Analoguous questions have arisen under Indian law; particularly under Section 6 of the Income Tax Act. An Indian company is, of course, a resident; but can there be instances of a company incorporated outside India being treated as a resident of India?

Purely looking at the Act (and ignoring the possible applications of tax treaties), “resident” is defined in Section 6. The concept of residence bears no relationship to the concept of citizenship. Section 6 defines the requirements of residence for both natural persons as well as artificial persons. Insofar as a natural person is concerned, the requirement is related to presence in India for the prescribed number of days. For artificial persons, such a prescription in terms of the number of days is not useful. Hence, in such cases, residence is to be determined on the basis of control and management. According to the treatise by Sampath Iyengar, this test refers to “the controlling and directing power, the head and brain” of the artificial person concerned. This perhaps corresponds to the “nerve center” test at issue before the United States Supreme Court in Hertz. Thus, the control and management of an artificial person’s affairs will be situated where decisions are taken in relation to the vital policies of the person [San Paulo (Brazilian) Railway Co. Ltd. v. Carter, (1896) AC 31)]. The test is a de facto one, not a de jure one [B.R. Naik v. CIT, (1945) 13 ITR 124 (Bom.); CIT v. Chitra Palayakat Co. (1985) 156 ITR 730 (Mad.). Also see: Todd v. Egyptian Delta, (1928) 14 TC 119].

As a general rule, therefore, the place of registration of a company ought not to be relevant following this logic. However, Section 6(3)(i) specifically provides that an Indian company is a resident of India. Thus, in the case of a company, the first question must be whether the company is an Indian one or not. If it is, the enquiry is over – the company is a resident. If it is not, then the enquiry must proceed to the next stage of the test of de facto control and management.

A brief discussion of the issues from an international tax policy angle is found here. DTAAs usually define residence specifically; for instance, Article 4 of the India-Mauritius DTAA states:

“ARTICLE 4 - Residents - 1. For the purposes of this Convention, the term resident of a Contracting State means any person who, under the laws of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of similar nature. The terms resident of India and resident of Mauritius shall be construed accordingly.”

The question of what “liable to taxation” means has been thoroughly discussed in Azadi Bachao Andolan v Union of India. (The concept of ‘residence’ under DTAAs in general has also been discussed). The Court observed:

“It is urged by the learned Attorney General and Shri Salve for the appellants that the phrase liable to taxation is not the same as pays tax. The test of liability for taxation is not to be determined on the basis of an exemption granted in respect of any particular source of income, but by taking into consideration the totality of the provisions of the income-tax law that prevails in either of the Contracting States… Merely because, at a given time, there may be an exemption from income-tax in respect of any particular head of income, it cannot be contended that the taxable entity is not liable to taxation. They urge that upon a proper construction of the provisions of Mauritian Income Tax Act it is clear that the FIIs incorporated under Mauritius laws are liable to taxation; therefore, they are residents in Mauritius within the meaning of the DTAC… We are inclined to agree with the submission of the appellants that, merely because exemption has been granted in respect of taxability of a particular source of income, it cannot be postulated that the entity is not liable to tax as contended by the respondents… Liability to taxation is a legal situation; payment of tax is a fiscal fact.”

The Impact of the withdrawal of Circular 23 of 1969: 'Attribution' and 'Business Connection'

(This note is also posted on the Indian Corporate Law blog)

Through Circular No. 7 of 2009, the CBDT has withdrawn Circular No. 23 of 1969 (“Circular 23”). Circular 23 explained the position relating to ‘business connection’ under Section 9 of the Income Tax Act, 1961.

The Circular was relied upon in the arguments in the Morgan Stanley case before the Supreme Court; as also by the Bombay High Court in SET Satellite. These decisions had laid down the broad proposition that in an international transaction, if the non-resident compensates its permanent establishment (“PE”) at arms-length price, no further profits of the non-resident would be attributable to the PE in India.

With the SET Satellite decision set to come up before the Supreme Court, concerns have been raised as to the implications of the withdrawal of this circular. In particular, does the view in Morgan Stanley or SET Satellite need to be reconsidered in light of the withdrawal of the Circulars? Furthermore, what is the extent to which income from a business connection is taxable in India, after the withdrawal of the Circular?

The principle of Morgan Stanley:

The principle enunciated by the Supreme Court in Morgan Stanley on the question of attribution of income to India is as follows:

“The impugned ruling (of the AAR) is correct in principle insofar as an associated enterprise, that also constitutes a PE, has been remunerated on an arms-length basis taking into account all the risk-taking functions of the enterprise. In such cases, nothing further would be left to be attributed to the PE…”

This was followed by the Bombay High Court in SET Satellite:

“In our opinion considering the judgment, if the correct arm’s length price is applied and paid then nothing further would be left to be taxed in the hands of the foreign enterprise…”

In both these cases, Circular 23 was cited before the Court; yet it did not for part of the Court’s reasoning. In SET Satellite, on this issue, the Bombay High Court directly followed Morgan Stanley (the decision has been previously discussed here). In Morgan Stanley itself, Circular 23 is mentioned in the Supreme Court judgment only when the Supreme Court notes that the AAR placed reliance on the Circular. No reliance is placed on the Circular in the reasoning/conclusion of the Supreme Court itself. The reasoning of the Court is premised on the conceptual relation (and not a relation introduced solely by Circular 23) between a correct transfer pricing analysis and attribution of profits. This relation has been discussed in the previous post on SET Satellite.
Now, if Circular 23 played no part in the actual reasoning of the Court, then the withdrawal of that Circular cannot in any manner require that the principle laid down by the Court be reconsidered. Accordingly, while fears have been expressed that the withdrawal of the Circular will strengthen the Department’s case against SET Satellite in the Supreme Court, it is arguable that those fears are misplaced.

The extent to which income from a business connection can be taxed in India:

Circular 23 stated that “Section 9 does not seek to bring into the tax net the profits of a non-resident which cannot reasonably be attributed to operations carried out in India.” Concerns might be raised as to whether the withdrawal of the Circular changes this basic position.

Circular 23 discussed issues related to extent of taxable income under Section 9. The relevant part of Section 9 provides that all income accruing or arising “directly or indirectly, through or from a business connection in India” is deemed to accrue or arise in India. According to the relevant Explanation 1 to the Section:

“in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India…”

Thus, the position that only that income which is reasonably attributed to India is covered under Section 9, is clarified in the Section itself. This position is thus due to the Explanation to the Section and not due to Circular 23. Circular 23 only clarified how this would apply in practice – it did not, indeed it could not have, deviated from the principle of attribution which is mandated by the Section itself.

Circular 23, in paragraph 1, itself states that it is a consolidation and restatement of previous clarifications (or the scope of the corresponding Section in the 1922 Act). Paragraph 3 of the Circular again clarifies that “The following clarifications would be found useful in deciding questions regarding the applicability of the provisions of section 9 in certain specific situations…” From this, it is evident that the Circular does not even purport to lay down any specific legal principle; it only discusses the application of the principle in Section 9 to various fact situations.

Conclusion:

There is at least an arguable case that the withdrawal of the Circular makes no difference to the legal position – either on attribution to PEs or on extent of income taxable under Section 9. What, then, was the need to ‘withdraw’ the Circular? The CBDT claimed that there was misuse of the Circular which resulted in assessees claiming relief not in accordance with the provisions of Section 9. Perhaps, the CBDT wanted to give the Revenue wider scope for ingenuity in argument; however, in my view, the legal position would remain unchanged.

The Death Penalty in India: (Mis)Reading Bariyar?

The debate over the death penalty in India heated up when two Judges of the Supreme Court (one of them being Justice Sinha) disagreed in Swamy Shraddananda on the principles to be adopted in death penalty sentencing, requiring referral of the matter to a larger Bench. The there-Judge decision (discussed here) in Shraddhananda perhaps gave momentum to the move of part of the higher judiciary towards abolition. Following from this, Justice Sinha’s judgment in Santosh Kumar Bariyar makes a strong case for abolition. The argument which runs through these cases is that similar facts have been treated differently in different cases. Whether to impose the death sentence or not is more often than not determined by the personal choices of the judges. This – when it comes to a form of punishment as extreme as the death penalty – is unacceptably arbitrary and contrary to constitutional principles. Bariyar in particular strongly emphasised the arbitrariness point and also advocated a pre-sentencing hearing where it must be specifically proved that the accused is beyond all possible reform. Discussions of the case are found here and here.

Now, a recent judgment (September 18, 2009) of Justice Bedi in Jagdish v. State of Madhya Pradesh imposes the death penalty. The point here is not whether on facts, the death sentence was justified or not. Rather, what is particularly striking is the extremely limited discussion on Bariyar. Here is what the Court says:

“We have also examined the mitigating circumstances referred to in Bachan Singh's case (supra) and in Santosh Kumar Satishbhushan Bariyar…”

There is no other mention of Bariyar in the judgment. Bariyar may or may not have its own faults – but this almost trivial dismissal of the case – implying that it has nothing new to say other than reiterating Bachan Singh – is problematic. As this analysis shows, Bariyar does make an important contribution to death penalty jurisprudence. Love it or hate it, it is hard to trivialize it. Yet, Justice Bedi in Jagdish seems to have done just that. On Law and Other Things, Tarunabh Khaitan mentions, “If the ruling in this case is followed sincerely, DP is all but dead.” Jagdish indicates that it might be too optimistic to hope that Bariyar would be “followed sincerely”.

It might be too simplistic to simply dismiss this as turning on the "personal predilection" of Judges (this is not to say that personal predilection is not a factor in death cases at all). For, even more recently (October 2009), Justice Bedi in Sebastian v. State of Kerala commuted a sentence of death to imprisonment for life relying on Shraddananda. What this would seem to indicate is that the implications of Bariyar have been overlooked. Bariyar – rather than Shraddananda – is the one which makes the strongest case for abolition, raising the Article 14 point most strongly; and also calling for pre-sentencing evidence. These points appear to have been missed by at least some subsequent judgments.

Meanwhile, Indian death penalty jurisprudence continues to become more confusing by the day.