Court-martial Proceedings and Article 33 of the Constitution

With reports that Lt.-Gen. Avadesh Prakash will be court-martialled; it might be an appropriate time to visit some of the legal provisions in this connection. The allegations against the officer are (going by a recent NDTV report) that “Lieutenant General Avadesh Prakash was indicted by an army inquiry of using his position to help a businessman in Siliguri in West Bengal. The internal investigation found that Prakash influenced officers to permit a real estate developer to acquire 71 acres next to the Army's 33 Corps Headquarters in Siliguri in West Bengal. The Army, which had earlier told the government that this land could not be sold to any commercial developer for security reasons, okayed the transfer of the land to Agarwal.” The law in this regard is to be found in the Army Act, 1950. Possibly, a case could be made out under Section 45 of the Act.

”45. Unbecoming conduct. Any officer, junior commissioned officer or warrant officer who behaves in a manner unbecoming his position and the character expected of him shall, on conviction by court-martial, if he is an officer, be liable to be cashiered or to suffer such less punishment as is in this Act mentioned; and, if he is a junior commissioned officer or a warrant officer, be liable to be dismissed or to suffer such less punishment as is in this Act mentioned.”

This Section was recently considered by the Supreme Court in M.M. Malhotra v. Union of India, AIR 2006 SC 80; and the words “manner unbecoming his position and the character expected of him” appear to be of very wide import. The scheme of the Act and the procedure to be followed in a court-martial has been explained in Lt.-Col. P.P.S. Bedi v. Union of India, AIR 1982 SC 1413. Other Sections which might have a possible application include Sections 52, 53 etc. The procedure in relation to a court-martial is found in Chapter X of the Army Act. The power to convene a general court-martial may be exercised by the chief of army staff under Section 109. The question of to what extent these (and other) provisions of the Act are consistent with Part III of the Constitution of India, 1950 has also been considered by the Courts. A challenge to provisions of the Act will be extremely difficult, if not impossible, due to Article 33 of the Constitution. The Supreme Court explained the position thus in Lt.-Col. P.P.S. Bedi v. Union of India, AIR 1982 SC 1413:

“… Article 33 confers power on the Parliament to determine to what extent any of the rights conferred by Part III shall, in their application to the members of the Armed Forces, be restricted or abrogated so as to ensure the proper discharge of duties and maintenance of discipline amongst them. Article 33 does not obligate that Parliament must specifically adumbrate each fundamental right enshrined in Part III and to specify in the law enacted in exercise of the power conferred by Article 33 the degree of restriction or total abrogation of each right. That would be reading into Article 33 a requirement which it does not enjoin. In fact, after the Constitution came into force, the power to legislate in respect of any item must be referrable to an entry in the relevant list. Entry 2 in list I: Naval, Military and Air Force and any other Armed Forces of the Union, would enable Parliament to enact the Army Act and armed with this power the Act was enacted in July, 1950. It has to be enacted by the Parliament subject to the requirements of Part III of the Constitution read with Article 33 which itself forms part of Part III. Therefore, every provision of the Army Act enacted by the Parliament, if in conflict with the fundamental rights conferred by Part III, shall have to be read subject to Article 33 as being enacted with a view to either restricting or abrogating other fundamental rights to the extent of inconsistency or repugnancy between Part III of the Constitution and the Army Act…”

N. Radhakrishnan v. Maestro Engineers: Non-reference to arbitration on account of allegations of fraud

In a previous post, I had discussed a recent decision of the Supreme Court in N. Radhakrishnan v. Maestro Engineers. One of the readers of this blog, Mr. Badrinath Srinivasan, has mailed his comments on the decision, which I reproduce below as a guest post.

The decision seems to be based on two fundamental justifications. One, proof of fraud and criminal misappropriation involved elaborate production of evidence and such a situation can not be properly gone into by the Arbitrator. Two, the party against whom allegations of fraud are made has the right to be cleared of the allegations in public, and not before a private arbitrator.

The decision seems to be a not-so-good development for Indian arbitration for a few reasons:

1. It is fallacious to assume, as the Supreme Court did, that arbitrators are not capable of deciding complicated matters involving complicated questions of fact and of law. Many arbitral proceedings are concerning complex technical issues which arbitrators are much capable of dealing with. For example: PCA, ICSID, WTO arbitrations. Many commercial arbitrations by their very nature involve complex technical issues, which not only require elaborate evidence but also require elaborate expert evidence.

2. There have been several decisions where several High Courts and even the Supreme Court has referred disputes relating to fraud to arbitration. For example, National Insurance Co. Ltd. v. Boghara Polyfab Pvt. Ltd AIR 2009 SC 170: 2008(3) Arb. LR 633 (SC): MANU/SC/4056/2008: (2009) 1 SCC 267; Perma Container (UK) Line Ltd. v. Perma Container Line (India) Pvt. Ltd. and Ors. MANU/MH/1045/2009; Felex Enterprises Private Ltd. v. Mr. V. Sreenivas and Anr. MANU/DE/2431/2009.

3. Non-reference of disputes involving allegations of fraud to arbitration can be traced back to the English Law.. Refusal to refer to arbitration disputes involving fraud, as reflected in the landmark case of  Russell v. Russell, has been abandoned even in England. The English Arbitration Act, 1996 contains no provision in force whereby courts can refuse reference of a dispute regarding allegations of fraud to arbitration.

4. The Supreme Court seems to have relied on a 1961 case decided by the Supreme Court Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak. In that case, the Supreme Court held that where serious allegations were made against a party to the contract, and that party desires that the case must be tried by the open court, court would not refer to the matter to arbitration. However, the court stated that it is not with every allegation of fraud that reference to arbitration would be refused. The court made a distinction between cases in which serious allegations of fraud were made and those in which minor allegations of fraud were made.  In the former cases, dispute would not be referred to arbitration and in the latter, it would be. Thus, the rationale in Abdul Kadir’s case for the court to refuse reference to arbitration was that a person had the right to defend himself in public when charges of fraud are levelled against him. The decision was in no way concerned with the competence of arbitrators to decide disputes concerning questions of fraud. Also, assuming that only “minor” allegations of fraud are made and the dispute is referred to the arbitrator, the arbitrator is in any case bound to decide on such an issue, notwithstanding the frivolousness of such a claim of fraud.

The views of other readers are also invited.

From "Oppression" to "Prejudice"?

In this post, I had noted that the proposed Companies Bill appears to introduce some substantive changes in the law dealing with oppression (covered under Section 397 of the present Act). The proposed Companies Bill, 2009 states, in Section 212:

“212. (1) Any member of a company who complains that—  (a) the affairs of the company have been or are being conducted in a manner prejudicial to public interest or in a manner prejudicial or oppressive to him or any other member or members …  may apply to the Tribunal, provided such member has a right to apply under section 215, for an order under this Chapter.”

This language of “prejudicial or oppressive” is different from the present Section 397’s requirement of “oppression”. The basic difference appears to be that the proposed Section 212(1) allows actions in cases where the affairs of the company are being conducted in a manner “prejudicial” to the public interest or “prejudicial or oppressive” to the shareholders. Under the present Act, the acts complained of must be “prejudicial” to the public interest or “oppressive” to the shareholders (and not “prejudicial or oppressive” to the shareholders).

The impact of this development can be ascertained by a comparative reference to the English position. The earliest statutory development in this field appears to have been in Section 210 of the Companies Act, 1948 (UK). This provided a remedy only in cases of oppression. Furthermore, the facts much be such as would justify an order of winding up on the just and equitable ground (but for the hardship caused to the petitioners). The same requirements are now found in Section 397 of the Companies Act, 1956 (Indian).

Section 210 was interpreted to mean that it allowed for a remedy only when the petitioner was being oppressed qua member – only oppression against the petitioner in his capacity as member was covered. The leading case on this point is a decision from Scotland in Elder v. Elder, 1952 S.C. 49. That case involved two petitioners seeking relief under Section 210. One of the petitioners had been removed from the Board and had been forced to resign from his position as secretary. The other petitioner had dismissed from his post of factory manager. Both these petitioners were shareholders. The re-constituted Board had refused to buy the petitioners’ shares when called upon to do so. These facts were alleged to be oppressive. The Inner House of the Court of Session of Scotland however dismissed the petition, on the ground that the facts did not indicate any oppression of the petitioners in their capacity as shareholders. Thus, the decision seemed to limit the scope of Section 210 to oppression qua member. This was reaffirmed by English Courts in Ebrahimi v. Westbourne Galleries, [1973] A.C. 360 – a leading case on the principles of winding up of small companies which are in the nature of “quasi-partnerships”. It was held that while certain conduct must be oppressive qua shareholder for relief under Section 210 to be available; the “qua shareholder” requirement did not apply if the company was being wound up on the just and equitable ground. Conceivably, on the facts of Elder, while relief under Section 210 may not be available, a petition to wind up the company on the just and equitable ground would be available. The requirements for invocation of Section 210, then, appeared to be that there must be oppression qua shareholder; and the oppression must be such as would otherwise justify winding up on just and equitable grounds. The Supreme Court of India has approved of Elder in Shanti Prasad Jain v. Kalinga Tubes, AIR 1965 SC 1535, in the context of Section 397.

Section 210 (and the corresponding Section 397) with these requirements would seem to be a rather narrow Section. In the Companies Act, 1985 (UK), the scope was enlarged. English law moved away from “oppression” to “unfair prejudice”. Under Section 456, it was no longer necessary to show that the facts justified winding up; and the “qua shareholder” requirement was also diluted. This same position exists under Section 994 of the Companies Act, 2006 (UK). Furthermore, cases have held that “unfair prejudice” is broader than mere “oppression” – it might involve ‘breach of legitimate expectations’ and breach of the standards of fairness. Lord Hoffman has in fact stated that the legislative reforms have served to “free the Courts from technical considerations of legal right and to confer a wide power (to do what is fair)…” – O’Neill v. Philips, [1999] 2 BCLC 1. As Professors Gower and Davies argue, this would mean that “unfair prejudice” seems to encompass not just the rights of shareholders, but also their interests.

The proposed Indian Bill’s language seems to mirror these developments in the transition to “prejudice” from “oppression”. The change in the Section appears to have at least three consequences: (a) the requirement to demonstrate that the facts justify winding up has been done away with; (b) the “qua shareholder” requirement has been diluted; (c) the movement from an oppression-based test to a prejudice-based test is indicative of the widening of scope of the provision to deal with unfairness which would not necessarily amount to oppression. In interpreting this provision, therefore, the existing case-law under Section 397 may not be entirely suitable.



(Note: These three changes are reflective of the position under the proposed Section 212. How the next Section - Section 213 - affects this analysis remains to be seen. Particularly, Section 213(1)(b) eems to indicate that the requirement in relation to winding up has not been done away with. This issue will be discussed in a subsequent post.)

Southern Technologies v. JCIT: Real Income Theory and Provision for NPA

The Supreme Court recently decided (in Southern Technologies v. JCIT) an interesting point of law in relation to the tax treatment of non-banking financial companies (NBFCs). The issue before the Court was whether the Revenue is entitled to treat a “Provision for NPA” as ‘income’ under Section 2(24) of the Income Tax Act, 1961, while computing the profits and gains of business under Sections 28 to 43D. This “Provision for NPA” is required to be debited to the P&L Account in the books of account, in terms of the 1998 RBI Directions.

Section 36(1)(vii) of the Income Tax Act originally provided that the amount of any bad debt written off in the accounts of the assessee is a deductible expense. A retrospective Explanation was added in 2001, however. This was to clarify that a provision for bad debts is not included within the scope of the Section. In yet another retrospective amendment (with effect from 1989), clause vii(a) was added to Section 36(1). This clause provided that a scheduled bank could deduct provisions for bad and doubtful debts. Furthermore, Section 43D of the Act was also amended to provide that income in relation to certain bad and doubtful debts (as prescribed by the Reserve Bank) shall be chargeable to tax only on actual receipt of the income, or on actual credit to the P&L account in the account books. Despite these amendments, which provided some relief to banks, no relief was provided to NBFCs. Sections 36(1)(viia) and 43D do not apply to NBFCs. However, in its 1998 Directions, the RBI required NBFCs to show non-performing assets as income only when income is actually received. Thus, NBFCs are not entitled to show NPAs as income in their books (in terms of the RBI directions); yet they are subjected to tax on that alleged income (as the relevant Sections of the Income Tax Act do not apply to NBFCs). This anomalous situation was challenged by an NBFC assessee in Southern Technologies.

The assessee relied on the “real income theory”. This theory has been developed in relation to writing off bad debts – State Bank of Travancore v. CIT (subsequently overruled on the basis of specific circulars). This is discussed in more detail in this post. In Southern Technologies, the principle was used by the assessee NBFC to contend that it was bound to follow the methods of accounting under the 1998 Directions; and under that prescribed method, a “provision for NPA” actually represented a depreciation in the value of assets. This – the assessee contended – was deductible under Section 37(1) of the Act. The basic contention was that applying the real income theory, the “Provision for NPA” debited to the P&L account under the 1998 Directions and shown accordingly in the balance sheet, cannot be treated as income and added back in computing the profits and gains of business. The Revenue contended that the “provision for NPA” was actually nothing but a reserve; and could be added back. The assessee in rejoinder pointed out the difference between a “provision” and a “reserve”. Essentially, a “provision” (contended the assessee) was a charge on the profits; while a “reserve” was an appropriation of the profits. “Provisions” are a pre-tax charge to the P&L account; while “reserves” are created out of post-tax profits subject to their being adequate net profits. (Perhaps, it might be useful to think of a “provision” as being similar to diversion of income by overriding title; and a “reserve” as being similar to application of income – the former is not “income” while the latter is, under settled principles.) Furthermore, in the case of “provisions” created statutorily, under the real income principle, they cannot be charged to tax or added back unless a specific provision requires so. The Revenue contended that the “Provision for NPA” was in substance a reserve, and could not be deducted unless a specific provision required so. The assessee supported its contention by referring to provisions such as Sections 40A(7), 43B etc. These provisions specifically add back certain “provisions” such as those statutorily required for excise duty, gratuity, provident fund etc. The absence of such a clause in the Act allowing addition back of a provision for NPAs was stated to be indicative for the fact that a “Provision for NPA” – required under the RBI Directions – could not be added back.

The Court rejected this argument of the assessee. It was held that the RBI Directions and the Income Tax Act operate in distinct fields. While NBFCs must accept the concept of “income” as evolved by the RBI under its Directions after deducting the provisions for NPA; this treatment “is confined to presentation/disclosure and has nothing to do with the computation of taxable income under the Income Tax Act.” Further, “… a provision for NPA debited to the P&L account under the 1998 Directions is only a notional expense and, therefore, there would be add back to that extent in the computation of total income under the Income Tax Act…”

The judgment is further analysed by V. Niranjan in two posts on Indian Corporate Law, available as Part I and Part II.

More Judicial Interference in Arbitration?

A recent judgment of the Supreme Court of India has the potential to raise concerns about arbitration and judicial intervention in arbitration. N. Radhakrishnan saw a two-Judge Bench of the Court ruling that in certain situations, civil Courts can continue to hear suits despite the existence of a valid arbitration agreement.

Section 8(1) of the Arbitration and Conciliation Act, 1996, states:

8.Power to refer parties to arbitration where there is an arbitration agreement.- (1) A  judicial authority before which an action is brought in a matter which is the subject of an arbitration agreement shall, if a party so applies not later than when submitting his first statement on the substance of the dispute, refer the parties to arbitration.

On its plain terms, the provision is mandatory – the judicial authority shall refer the parties to arbitration when an action is brought before it in a matter which is the subject of an arbitration agreement. The Supreme Court, however, found it fit to hold otherwise. It was held, “… the facts of the present case does not warrant the matter to be tried and decided by the Arbitrator, rather for the furtherance of justice, it should be tried in a court of law which would be more competent and have the means to decide such a complicated matter involving various questions and issues raised in the present dispute.”

The Court has specifically approved of the following observations of the Madras High Court in Oomor Sait HG v. Asiam Sait, 2001 (3) CTC  269: “… Power of civil court to refuse stay of suit in view of arbitration clause on existence of certain grounds available under 1940 Act continues to be available under 1996 Act as well and the civil court is not prevented from proceeding with the suit despite an arbitration clause if the dispute involves serious questions of law or complicated questions of fact adjudication of which would depend upon detailed oral and documentary evidence… (The) Civil Court can refuse to refer matter to arbitration if complicated question of fact or law is involved or where allegation of fraud is made…”

The merits of this approach are not easily visible. Detail s will be discussed subsequently.

TDS: The True Scope of Transmission Corporation

After a lengthy break, regular posts on this blog will now resume. 

In an earlier post, I had discussed the decision of the Karnataka High Court in Samsung Electronics, where the High Court held 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. I had briefly suggested that the Court’s reliance on the decision of the Supreme Court of India in Transmission Corporation was misplaced. This post looks at the reasoning of Transmission Corporation is greater detail; and argues that the decision of the Supreme Court is in fact one which covers the issue in favour of the assessee. Accordingly, the Karnataka High Court’s view, with respect, merits reconsideration. It must be mentioned that in Frontier Offshore Exploration v. DCIT, ITA Nos. 2037/Mad/2006, the Chennai Bench of the Income Tax Appellate Tribunal was concerned with the scope and effect of Section 195. The true import of the decision of the Supreme Court in Transmission was heavily debated in the case. While the particular case was decided against the assessee by the Tribunal, the arguments made on behalf of the assessee (which also revolve around reading the High Court and Supreme Court judgments together) indicate the correct position of law. The following post includes a summary of the assessee’s detailed arguments in that case.

1.                  To summarise the textual contention, Section 195(2) is not a provision made for the benefit of the assessee. It gives an option to the assessee to approach the Department in cases where the assessee feels that whole of the amount is not chargeable to tax. In such cases, the assessee can approach the Department and seek to determine lower deduction of TDS. However, the assessee need not compulsorily comply with the provisions of section 195(2). A right cannot be converted into an obligation. In case the assessee decides, for whatever reasons, against making an application u/s. 195(2) then it cannot lead to disallowance automatically. This reading is one which must be preferred; as it is beneficial to the assessee and also does not prejudice the Revenue. If the assessee on his own does not deduct, and the sum is later determined to be chargeable, the Revenue can always rely on the penalty provisions. The Revenue’s interest is thus safeguarded – a sum which is chargeable will not go out of the tax net. At the same time, the convenience of the assessee is also given due regard. This construction, which takes into account the assessee’s interest without compromising the Revenue’s interest, must be preferred.

2.                  The effect of Transmission can now be analyzed. It would be appropriate to begin with an examination of the decision of the Andhra Pradesh High Court in that case (which was later appealed to the Supreme Court), which is reported as CIT v. Superintending Engineer (152 ITR 753 (AP). In the facts of that case, the Andhra Pradesh State Electricity Board made payments to three foreign parties. No tax was deducted on any of these payments. In respect of one of the foreign parties, the Board had made an application under Section 195(2). In proceedings under Section 201, the Assessing Officer estimated the tax to be deducted on the whole of the payments in respect of the other two foreign parties (in whose case no application was made). In the one case where the application was made, the profit was estimated and tax to be deducted was determined.

3.                  The High Court observed that two fundamental questions needed to be decided – first, whether the provisions of Section 195 are applicable in cases where the sum paid to the non-resident does not wholly represent the income; secondly, assuming that the first question is answered affirmatively (in favour of the Revenue), whether the Department 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 was chargeable as income under the Act.

4.                  The first question was answered in the affirmative. It was held that the provisions of Section 195 would come into operation whether or not the sums represented wholly income or profits. It is pertinent that this question does not deal with the nexus between chargeability and the application of TDS provisions. The relationship between chargeability and the application of Section 195 turned on the answer given to the second question.

5.                  The Revenue’s attempts to argue that chargeability is not essential for invocation of Section 195 are premised on the answer given to the first question. In reality, the Revenue’s argument should be judged on the cornerstone of the answer given to the second question.

6.                  The second question was answered in favour of the assessee. It was held that the Department could enforce the deduction of tax only in respect of that proportion of the trading receipts which was chargeable as income under the Act. In particular, the High Court has noted that a payer may be under the honest bona fide impression, that no part whatsoever of the gross sum payable to the non-resident was chargeable to tax and hence, it is possible that such a payer did not find it necessary to make an application under Section 195(2). Even in such cases, the High Court noted, where no application was made under Section 195(2), the Department is bound to determine the portion of the income which is chargeable to tax. The TDS provisions are enforceable only in respect of this portion.

7.                  A Supreme Court judgment is authority for what it decides. It must not be read as a statute, but must be read in its context. When a superior Court affirms the lower Court, the two judgments can be said to have merged into one. It is impossible to appreciate the context of the Supreme Court judgment in Transmission, which approved of the High Court judgment in totality, without taking into account the above discussion of the High Court judgment.

8.                  The High Court has noted that there may be several reasons for an assessee to decide against making an application under Section 195(2). Even in such a case, the Department can determine the amount of tax deductible only on the proportion of such sum which is required to be taxed and is chargeable under the Act.

9.                  The Supreme Court has clearly stated, “In the view of the matter, the answers 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 the appropriate proportion of income chargeable under the Act, are correct.” Reading these observations in the context of the High Court judgment, the only conclusion possible is that the obligation of the assessee to deduct the tax under Section 195 is limited only to the appropriate proportion of the income chargeable under the Act. Consequently, when no proportion of the income is chargeable, no obligation to deduct tax arises at all. If there is no obligation, there cannot be any breach of that obligation.

10.              Furthermore, the decision in Associated Cement Co. Ltd. v. CIT (201 ITR 435) does not change this position. Associated Cement deals with the position under Section 194C; and one need not refer to Associated Cement when a direct authority is available on Section 195 itself. In any case, where two decisions of the Supreme Court are available, the later one must be followed. Furthermore, when two contradictory decisions are available, the one in favour of the assessee must be followed. Both these statements are well-settled principles in tax jurisprudence. Transmission is the later case; and on its correct reading, is more beneficial to the assessee. At the same time, it is not prejudicial to the Revenue for the reasons already adverted to. As such, it is submitted that the true interpretation of Transmission as detailed above must be followed.