Golden Jubilee Residential Refresher Course (GJRRC) · slide 3 Case Studies on International...

Golden Jubilee Residential Refresher Course (GJRRC)

Case Studies on International Taxation

(including Royalty & Capital Gains)

Pinakin Desai

20 January 2017

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Case study 1: Monetising demonetisation: Section 115BBE

20 January 2017Case Studies on International Taxation (including Royalty & Capital Gains)

Section 115BBE:

►Total income of taxpayer consisting of income referred u/s 68, 69 to 69D, whether reflected in return of income

or not, taxable @ 60%

►In addition to tax @ 60%, surcharge (25% of tax) and cess (3% of tax and surcharge), totaling to 77.25%.

(Refer sixth proviso to section 2(9) of Finance Act 2016)

►No deduction for expenditure, allowance or set off of loss

►Section not restricted to cash deposits made between 8 November 2016 and 30 December 2016

►Provisions are effective from Assessment Year 2017-18 as an ongoing provision.

Section 271AAC:

►In addition to tax payable u/s 115BBE, penalty “may be” leviable @ 10% of tax amount (6% of income)

►No penalty if and taxes are duly paid @ 60%+SC+EC before end of previous year and income declared in ROI

► However, no immunity even if income is included in ROI1 and taxes paid as SA tax

►No penalty u/s 270A, if penalty is leviable u/s 271AAC (S. 270A(2))

►Penalty is discretionary as section uses the term ‘may’

►AO to grant opportunity for levying the penalty (Section 274)

Monetising demonetisation: Section 115BBE

1 If income is offered to tax, penalty may not be leviable u/s 270A of ITA.


Scrap Sale:

►Onus on taxpayer to substantiate that amount is received from scrap sale

►Where scrap is over and above the normal level, taxpayer may need to provide reasons for the same.

►In case where scrap is generated during the production, taxpayer may relate the same with excise

returns.

►Unexplained amount ‘may’ be charged u/s 68

Deposit of High Denomination Notes:

►Addition to income only if source remains unexplained.

►Onus on taxpayer to provide proof of sufficient cash balance

►Taxpayer’s claim supported by evidence, no case for to income.

Loan receipt:

►Heavy onus on taxpayer to prove genuineness of transaction when lender is a close relative

►Non co-operation of lender during the assessment proceedings may be a negative factor



Amount represented by cash sales:

►Onus on taxpayer to prove that amount represented by cash sales

►AO can verify the correctness of transaction by checking regular trend of business in past, invoices,

purchase and sale of goods verified with inventory records etc.

►Mere non maintenance of address of buyer may not be sufficient for making additions.

►Taxpayer to maintain PAN of taxpayer if value cash sales (per transaction) exceeds INR 2 lakhs

► Failure to collect PAN may call for levy of penalty u/s 272B of Rs. 10,000

► Failure to report cash sales > 2 lakhs may call for penalty u/s 271FA of Rs. 100 for every day

where failure continues.

Difference in value of building based on DVO report:

►AO may make reference to DVO without rejecting book u/s 142A

►No addition merely based on DVO report in absence of cogent evidence

►Addition justified u/s 69B if based on cogent evidence.



Discrepancy in stock statement submitted to bank:

►Alternative 1: Stock reported to bank did not exist and was fictitious

► Onus on taxpayer to prove that stock did not exist and was inflated to obtain higher credit facilities

► In absence of any evidence with taxpayer, AO may include in total income of taxpayer u/s 69 of

ITA

► Tax Authority and Court may not accept the claim of taxpayer that stock did not exist as authorities

may not recognize sub standard morality of taxpayer [Refer, Coimbatore Spinning and Weaving

(95 ITR 375)(Mad)]

►Alternative 2: Reported correct stock to bank but by over stating consumption in

ROI

► Taxable as business income

► Liable to levy penalty u/s 270A

►Alternative 3: Excess reported stock acquired out of unexplained source

► If source of funds not explainable addition may be justified u/s 69

► Income taxable @ 60% u/s 115BBE


Case study 2: Fair value of shares issued by a company: S. 56(2)(viib)


Fair value of shares issued by a company: S. 56(2)(viib)Apr 14 Subscription to 10,000 shares at par (Rs. 10) by the promoters of Rs.

1 Lakh

2014-16 Development of IP technology

July 16 Contribution of Rs. 10L by unrelated domestic investor (1000 shares

of Rs. 10 issued at premium of Rs. 990)

Jan 17 Subscription of Rs. 10L of CCD by S of par value of 100 at premium of 400 basis internal DCF valuation of share at Rs. 500 (Rs. 10 L).

Mar 17 Better technology development by the competitor

Mar 17 Founder promoters lost hope in future of the company

Apr 17 Conversion of CCD into equity (1:1) at the insistence of new buyer

Apr 17 Transfer of all shares to competitor at Rs. 200


Fair value of shares issued by a company: S. 56(2)(viib)

► S. 56(2)(viib) taxes CHC in respect of excess consideration received for issue

of shares from residents (other than VCU)

► Tax u/s. 56(2)(viib) = aggregate consideration received (minus) FMV of

sharesDate Chronology

► R.W. Rule 11UA, FMV of shares at the option of company is higher of the

following as at the date of receipt of consideration for share issue:

► Determined as per Rule 11UA. Break up value as per normative formula linked to the

audited balance sheet

► As substantiated by the company to A.O’s satisfaction basis its assets including

intangibles

► The FMV under DCF determined by merchant banker / accountant


Issues under consideration

► What is the scope of trigger of charge u/s. 56(2)(viib) viewed in light of object

and purpose of the section?

► Is it a SAAR to discourage issue of shares at huge premium?

► Is infusion at premium in July 2016 at value > 11UA valuation from an

unrelated party basis negotiation covered by s. 56(2)(viib)?

► Is CCD infusion covered by s. 56(2)(viib)?

► Can the charge triggered get evaluated at the stage of conversion?

► How is the amount received determined at the stage of conversion of CCD?



► Par value issue at formation stage for cash is beyond s. 56(2)(viib)

► July 16 issue to an unrelated party based on intense negotiations but not

supported by formal valuation

► Normative 11UA value is only one of the specified alternative method available

at the option of the company

► Value can also be substantiated by the company independent of valuation

report

► Onus of substantiating value to the satisfaction of A.O. is on taxpayer

► Fiercely negotiated value with third party and contemporaneous

correspondence may prima facie support bonafide of valuation; expert

valuation is not must

► Company may be advised to formalise the valuation as of July 2016

► Valuation report as of January 2017 of an Expert valuing share at Rs. 500 (as

against valuation of Rs. 1,000) needs to be explained



► January 2017 : Issue of CCD

► CCD is not shares

► Supported by an internal valuation report – though, valuation is not by an accountant

/ merchant banker

► Company will need to substantiate valuation unless it can obtain expert valuation

report of an amount Rs. 500

► If supported by well-reasoned opinion of accountant / merchant banker, A.O. cannot

ignore the same unless report is proved to be perverse

► Conversion of CCD into equity may be regarded at fair value having regard to

intrinsic value which may be obtained from the third party:

► Company had liability to return CCD: Rs. 100 on liquidation

► Company had inability to convert CCD worth Rs. 200 into share

► Company extinguishes liability of Rs. 200 and receives Rs. 200 towards shares

Case study 3 : Exit from business enterprise – GAAR implications


Facts

► J1 (Jaipuria) family (comprising of P, Q and

R), wishes to divest business of RRL

► J2 (Jodhpuria) family had insisted on slump

sale of business by RRL (Option 1)

► U family offers to purchase shares of RRL

(Option 2)

► Concern on transfer of business license

► J1 family did not agree to dividend

declaration by RRL prior to share transfer to

U family

► Contemporaneous discussions with tax

advisors: Net of tax returns higher for share

sale

► Tax efficiency was one of the motivating factors

for share sale option

► Each of the sellers (P, Q and R) invested the

proceeds in residential house (s.54F)

P Q R

J1

family

RRL

Business

U family

J2 family

Option 2

Option 1

Option 1: J2 family offer to buy RRL

business

Option 2: U family offer to buy RRL

shares


A.O.’s SCN in assessment of RRL

► Main purpose of implemented arrangement is

tax benefit for RRL as there is avoidance of:

► 30% tax on STCG payable on itemised sale (or)

► 20% tax on LTCG payable on slump sale (or)

► Avoidance of applicability of s.50C (or)

► Consequential avoidance of DDT

► Facilitated s.54F exemption by promoters

► Substance of the transaction (i.e. acquisition of

business) is different from the form [s.96(1)(c)]

► Transfer of business is by means and manner

not ordinarily employed for bona fide purpose

[s.96(1)(d)]

► Tax benefits 9 to 11 Cr. (being difference of

tax incidence between Option 1 and Option 2)

P Q R

J1

family

RRL

Business

U family

J2 family

Option 2

Option 1

Option 1: J2 family offer to buy RRL

business

Option 2: U family offer to buy RRL

shares


Possible arguments of Tax Counsel of RRL

► Defenses against main purpose being tax benefit:

► GAAR to be applied in cases of aggressive abuse, as a weapon of last

resort:

► GAAR is not a weapon to extract maximum possible tax

► Evaluate main purpose from arm-chair of a businessman

► GAAR does not foreclose “choice principle” - share transfer resulted in

better net-of-tax return

► Main purpose of the arrangement was to transfer shares and is

implemented in absolute transparent manner – and at ALP

► Tax reduction if at all is only incidental



► Defenses against main purpose being tax benefit (continued):

► Share transfer consequences materially different compared to transfer of

business:

► Past litigations, tax demands, historical cost, etc. inherited by new

shareholders;

► Corporate entity and associated goodwill is preserved for new shareholders;

► Concerns on transfer of critical license, employees, assets, contracts, etc.

► Mechanics of integration with buyer’s business may vary

► Stamp duty / VAT implications may differ

► To invoke GAAR, A.O. should indicate a reasonable alternative (‘counter

factual’) - Sale of business by RRL is not an effective counter factual as

business licenses are not transferred to buyer



► Defenses against tainted element tests:

► Substance of share transfer is no different from its legal form

► Sale of shares is one of the ordinarily accepted modes of bona fide

business transfer

► Other defenses:

► Chapter X-A is subject to charging provisions - GAAR cannot result in

tax on notional income (In reality, RRL has not earned any income at all)

► No DDT on RRL in absence of actual distribution or declaration of

dividend in terms of s.115-O


In the assessment of Mr. R

► H2 gifted to son a week prior to share sale –

sale of shares was virtually decided

► R occupied H2 for six months post the gift

while H3 was acquired and getting furnished

► Son got married a year after sale of shares

(marriage fixed as of date of gift)

► H2 continued to be occupied by son’s family

and not sufficient to house the joint family

► Son is in independent occupation of H2 post

marriage; meets cost of H2

► A.O. alleges that:

► Gift was with main purpose of s.54F exemption

► Gift lacks commercial substance, Mr. R stayed

in H2 post gift

③ Investment in

residential house

to claim s.54F

R

H1 (let

out

① Gift

R’s

Son

H2

(SO)

R

H1 (let

out)H3 (self

occupied)

② Sale of shares


In the assessment of Mr. R

► Mr. R’s defenses:

► H2 was gifted so that son has his own

house

► Mr. R has divested himself of

ownership rights in H2

► H3 was acquired to accommodate the

family’s needs

► Tax exemption, an incidental

advantage

► Availing s.54F exemption in terms of

express provisions in the Act is not

‘reduction’ or ‘avoidance’ of tax per

s.102(10)

③ Investment in

residential house

to claim s.54F

R

H1 (let

out

① Gift

R’s

Son

H2

(SO)

R

H1 (let

out)H3 (self

occupied)

② Sale of shares

Case study 4: S.79 and carry forward


Section 79

Facts

►ICo3 is a manufacturing company

►It has substantial accumulated losses and

unabsorbed depreciation shown as under:

►ICo2 to sell certain percentage of its stake in

ICo3 in FY 2016-17

100%

100%

76%

ICo1

Listed Co.

ICo 2

Pvt. Co.

Ico 4

Pvt Co.

ICo 3

Unlisted Public Co.

Mfg.

business

ICo 5 Pvt Co.

24%

Financial Years Business

Loss

Unabsorbed

depreciation

FY 2012-13 5 Cr. 50 Lacs

FY 2013-14 7 Cr. 60 Lacs

FY 2014-15 8 Cr. 70 Lacs

FY 2015-16 10 Cr. 20 Lacs

Total 30 Cr. 2 Cr.


Section 79 (contd…)

General principles

►Section 79: shareholders carrying voting power of atleast 51% in the year of incurrence of loss must

remain same till losses of CHC are set off

►Section 79 overrides the provisions contained in Chapter – VI (ie S. 66 to S.80) but does not override

Section 32 which provides for depreciation/ unabsorbed depreciation

►Section 79 does not apply to WHC as defined under Section 2(18)

►Is ICo3 WHC today ?

►Had ICo2 been public Co; List Co holding > 50%/ 40% of ICo2 would suffice

►Change in shareholding from one qualifying to another qualifying holder is permissible

► If post change in such shareholding, WHC turns CHC in that FY, section 79 likely to apply

Particulars Yes/ No

Is ICo3 Public Company ? Yes

Is ICo3 Listed company ? No

Held by 100% subsidiary of List Co

throughout the year

Yes > 40% held by 100%

subsidiary of List CO


Section 79 – Proposed scenarios (contd…)

100%

100%

76%

ICo1

Listed Co.

ICo 2

Pvt. Co.

ICo 4

Pvt Co.

ICo 3

Unlisted

Public Co.

Mfg.

business

ICo 5 Pvt

Co.

24%

Scenarios Current

%

(ICo2)

Sale

%

Proposed

Buyer

Resid

ual %

(ICo2)

Reasoning Section 79

Scenario 1 100% 51% Investor

(CHC)

49% Atleast 40% of ICo3

(being mfg. company) is

with ICo2. Thus, ICo3

continues to be WHC

under 2(18).

Not

attracted


(CHC)

24% ICo3 cease to be 2(18)

company and change in

shareholding >49%

Applicable

Scenario 3 100% 76% WOS of

any listed

company

24% WOS of listed Co. is

2(18) company and

hence ICo3 continues to

be WHC under 2(18)

Not attracted

Scenario 4 100% 76% ICo 4 24% ICo3 cease to be CHC

and change in

shareholding >49%

Applicable


buying at

close of FY

(ie 31

March)

24% ICo 3 continues to be

WHC under 2(18), since

held throughout the year

by WHC and no 79

limitation

Not attracted

Case study 5: Can you earn income from your own contribution? [Section 56(2)(vii)]


► Mr. Flipdealzone Pvt Ltd was formed by Mr. Master with initial capital of Rs. 1,000

contributed at Par

► Date Chronology: Equity issue to Mr. M

► Issue of CCPs (Convertible Post 2 years @FV as of date of conversion)

Can you earn income from your own contribution? [Section 56(2)(vii)]

Date No. of

shares

Par

value

Premium Amount

contributed

Book value post

allotment

Dec 14 10,000 10 - 1 L 10

Jan 15 1,000 10 990 10 L 910

30 Dec 15 1,00,00 10 Nil 10 L (Aprx) 20

Date No. of

shares

Par

value

Amount

contributed

29 Dec 15 10,000 100 10 L


► Likely objections of tax officers

► Basis Mumbai ITAT decision and having regard to the object and purpose of the

section, fresh issue of shares is covered by s. 56(2)(vii)

► Infusion in December 2015 at Rs. 10 triggered s. 56(2)(vii) taxation by considering

11UA value of Rs. 910 basis balance sheet prior to the date of issue:

► CCPS infusion on 29 December will need to be treated at par with equity and having

regard to conversion rate as per Rule 11UA valuation.

► Tax and treaty implications and TDS obligation in respect of CCPS issue to the NR

HNI

Issues


Scope of section 56(2)(vii)

►Taxation of shares for a consideration < normative Rule 11UA value.

►Introduced ‘to plug loop holes to prevent money laundering’

►‘purported gifts from unrelated persons now to be taxed as income (FM speech

on 2004 – 05 budget).

►To curb bogus capital building and money laundering and to act as an anti-

avoidance measure’ (Circular no. 5 of 2005 and 5 of 2010)

►SC in K. P. Verghese struck down literal interpretation of section 52(2) to avoid

manifestly absurd consequences

►Deeming fictions need strict construction; benefit and benefit of doubt to go to

the taxpayer

►Taxation is of real enrichment and real benefit after considering all economic

sacrifices of the shareholder



Is fresh issue covered by section 56(2)(vii):

►Is fresh issue / allotment of shares equal to receipt of shares? Arguably, no as:

► Receipt by individual of a property from any person

► In the context to be restricted to transfer of existing shares

► Shares are inchoate right and do not come into existence till the stage of issue or

allotment

►Likely objections of tax officer

► It is inconsistent, to restrict the scope of the term “receipt” to cases only of “transfer,”

considering the unambiguous and clear intent, conveyed by the literal reading of S.

56(2)(vii).

► “Receipt” is of wide import and includes acquisition by modes other than by way of

“transfer.”



Issue on 30 December 2015 at par when pre-issue 11UA value is Rs. 910:

►Rights to the existing shareholder and hence diminution in existing value to

consider

► No enrichment – no property received – cannot receive from self

► Even as per Sudhir Menon HUF (148 ITD 260), rights to the existing shareholders

on proportionate basis does not trigger s. 56(2)(vii).

►Valuation for freshly issued shares need to be based on balance sheet post

issue:

►Rule 11UA values shares as of the date of receipt of shares.

► Non existing shares cannot be valued

► Valuation date covers the whole of the day



Impact analysis for issue of preference shares to HNI (unrelated party):

►Preference shares to be valued as per Rule 11UA on commercial principles by

Merchant Banker

►Different from equity in terms of voting, preferential dividend and repayment of

capital, etc.

►No exemption for NR unless treaty relieves charge

►US treaty may not relieve charge:

► Benefit is accruing or arising in India

► Meaning of ‘income’ interpreted on an ambulatory basis

►In any case, no obligation of TDS as company neither makes payment nor

credits the shareholder in respect of income taxed u/s. 56(2)(vii)


Case study 6 : Interest free lending from holding company – Ind-AS / GAAR implications


Facts

► In 2015, HCo (a listed company) infused

funds in its direct and indirect WOS by way

of ZOFCD (0% optionally fully convertible

debentures).

► ZOFCD’s terms:

► 0% coupon rate

► Tenure of 20 years

► Convertible into equity at option of issuer

► Fixed conversion rate

► WOS deployed funds into operating assets

► WOS are currently loss-making

► Under Ind-AS, WOS records ZOFCD as

equity equivalent (as WOS does not have a

contractual obligation to repay ZOFCD

holder).

HCo

HCoWOS

(Indirect)

HCoWOS

(Direct)

100%

100%

Issue

ZOFCD

Funds

infusion for

commercial

purposes


Issues

► Issues around Ind-AS/GAAR:

► Can A.O. impute notional interest

income on ZOFCD in hands of Hco

under GAAR?

► Can HCo urge that ZOFCD is to be

regarded as equity investment for tax

purposes to resist notional taxation?

HCo

HCoWOS

(Indirect)

HCoWOS

(Direct)

100%

100%

Issue

ZOFCD

Funds

infusion for

commercial

purposes


Can A.O. impute notional interest income on ZOFCD in hands of HCo?

► Tax Authority’s contentions:

► Consistent with legal form, the instrument is a debt instrument

► ‘A part of’ the arrangement has main purpose of tax avoidance [s.96(2)

r.w.s.102(1)]

► There is ‘reduction’ or ‘avoidance’ of tax and/or ‘reduction in total income’

[s.102(10)]

► Such rights / obligations are not ordinarily created in an arm’s length

dealing [s.96(1)(a)]

► Interest charge may or may not result in tax neutrality on an overall basis

– But, tax benefit to be calculated qua impact on HCo’s current income

alone


Can A.O. impute notional interest income on ZOFCD in hands of HCo?► Likely contentions of HCo:

► GAAR codifies substance-over-form rule and targets egregious structures; tax

consequences cannot overstep commercial realities of arrangement

► Interest-free lending by Parent to WOS is an ordinary feature; not irrational to

expect such arrangement in case particularly of loss incurring WOS

► No tax in absence of ‘real income’, Chapter X-A cannot override ss.4/5

► ‘Tax benefit’ is when there is reduction of tax payable on “accrued” income:

GAAR is not a revenue spinner; it does not widen scope of charging

provisions

► S.98 only permits re-allocation of accrued of income and does not authorize

increase of income base

► GAAR does not foreclose “choice principle”


Can HCo urge that ZOFCD is equity investment for tax purposes? Ind-AS impact

► Likely contentions of HCo:

► Commercial accounting principles govern tax unless specific provisions exist to the

contrary

► Skewed debt equity ratio suggests that ZOFCD is quasi equity and hence equity

capital

► ‘Substance-over-form’ principles common to both GAAR and Ind-AS, treatment

under Ind-AS is relevant for tax purposes also

Such contentions may be counter productive

in certain other facts


Is charging interest a soother?

► Without prejudice, if OFCD is interest bearing, can A.O. suggest

that OFCD is equity and hence payment to OFCD holder is

effectively dividend which is not deductible and also subject to

DDT?

► Likely contentions of borrower (WOS):

► Judicial principle: Legal form and ‘look at’ approach relevant for tax

purposes, unless transaction is a sham or tax avoidant1

► Ind-AS classification has no bearing on legal rights and obligations –

instrument continues as debt for corporate law purposes

► In any case, DDT levy is on “distribution” of dividend; notional GAAR

implications is not the basis for DDT levy

1 Vodafone International Holdings B. V. v. UOI (2012)(341 ITR 1)(SC)

Thank You

“This Presentation is intended to provide certain general information existing as at the time of

production. This Presentation does not purport to identify all the issues or developments. This

presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-

making. The presenter does not take any responsibility for accuracy of contents. The presenter does

not undertake any legal liability for any of the contents in this presentation. The information provided is

not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional

advice should be sought before taking action on any of the information contained in it. Without prior

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Golden Jubilee Residential Refresher Course (GJRRC) · slide 3 Case Studies on International...

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