Deeming Fictions under Income Tax
Laws – Various Issues
By Milin Mehta, Vadodara
Deeming Fiction
“The power to tax involves the power to destroy”, warned Chief Justice John
Marshall. To which, a centure later, the reply of Justice Holms was, “The power
to tax is not the power to destroy while this Court sits”. …..
Palkhiwala
Tax laws, like all other laws, to be respected, must be made respectable,
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Laws, to be respectable, must be fair and intelligible, stable and simple; easy
to administer and easy obey.
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Revenues rise with tax cuts; when income-tax is scaled up, income is scaled
down.
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If there is widespread tax evasion, it may be more meaningful to search for
the cause in the tax system than in the taxpayer.
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Enlightened administration is as assential as enlightened enactment, and it
can be good recompense for a bad law.”
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Deeming Fiction ..
Interpretation of Deeming Fiction
• Purpose for which the Fiction was created and then assume all
facts and consequences which are incidental or inevitable
corollaries to give effect
• Cannot extend the effect beyond the purpose or beyond the
language of the section
Subhash Chand v. Asstt. CIT [2012] 49 SOT 732
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• The difference between the reality and the fiction may still persist
outside the bounds of the fiction in the same Act and such
difference should be ascertained with reference to the subject
and context of the section
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Fate of Section 52 – Earlier Avtaar of 50C
• Section 52 (2) introduced a concept of substitution of fair market
value for the actual consideration received for computing capital
gains when the FMV exceeded the actual consideration by more
than 15 %.
• The provision was read down by the Supreme Court in the case
of K. P. Verghese 131 ITR 597
– What in fact never accrued or was never received cannot be
computed as capital gains U/s. 48.
– Therefore, it can be used only when there is evidence that actual
consideration is actually understated then for determining the
quantum of understatement, FMV can be used.
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• The question is whether the ratio of K. P. Verghese applicable
also for section 50 C / 43 CA?
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Land / Building / Both
• Section 50 C applies only in cases where it is a capital asset and
such capital asset is “land or building or both land and building”.
– Scope of Section 50 C is therefore limited to the same
– Land is a bundle of rights and individual rights separately are not land /
building / both
– It is not land / building / any rights therein
• Transfer of Transferable Development Rights (TDRs) / FSI
– TDRs are held to be immovable properties. Would the same qualify to
be land / building / both? Section does not use the concept of
immovable property
• Giving Development right in the Land (Development Agreement)
– Would it be covered by 50 C / 43 CA?
• Granting of Lease / Transfer of Leasehold Rights
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– 2 (47)(v)/(vi) r.w. Chaturbhuj decision, it may amount of transfer U/S. 45
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Confirming Party cases
• When a person receives consideration as a confirming Party
• Example
– A executes Agreement to Sale on 1.4.2000 in favour of B for Rs.
1.00 Cr. (Stamp Duty Value (SDV) on 1.4.2000 – 1.00 Cr.)
– Sale Deed is executed between A and C with B as confirming Party
for Rs. 2.00 Crores on 1.4.2015 (SDV on 1.4.2015 is 2.50 Crores)
• Questions
– Whether any additional tax payable by either A or B?
Reference date for A (whether 1.4.2000 or 1.4.2015 for SDV), assuming
substitution of date permissible even for 50C
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B only transfers his right to purchase the land and not land
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Underlying Asset being Land / Building
• If land / building is held through an SPV, being a private limited
company
• Whether transfer of shares of such SPV will amount to transfer of
land / building / both and thus covered by 50 C?
– Irfan Abdul Kader Fazlani & Others in ITA 8831/Mum/2011 – Sale of
Shares were considered to be sale of building
– Lifting of corporate veil was not permitted.
– Vodafone case referred to
– However, important factor which weighed was that the company was
formed several years ago and the asset was also held for several
years
• Pure SPV formed exclusively for holding land / building ???
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• The above decision may not be considered as view that
corporate veil cannot be lifted at all
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Slump Sale Cases
• Business as a whole is sold as a going concern for a lump sum
consideration
– This may include land and building
– Book value of such land and building could be significantly lower
than market value
– Total consideration for the undertaking itself could be less than
individual value of land / building / both
– Whether Section 50 C can be invoked
• Section 50 C applies when there is a transfer and such transfer is
of land / building / both
– However, it should fall within the definition of “Undertaking” U/s. 2
(19AA)
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– Sale of undertaking as slump sale is not sale of each of underlying
asset separately
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Reference to DVO
• If the Assessee does not object before the AO in terms of Section
50 C (2) AO is not obliged to make a reference to the DVO
Ambattur Clothing Co. Ltd. [2010] 326 ITR 248 (Mad), Sanjaybhai
Z. Patel [2011] 48 SOT 231 (Ahd)
• Once the Assessee objects to the SDV, AO has to to make
reference to the DVO. Ajmal Fragrances and Fashions Pvt. Ltd.
34 SOT 57 (Mum), Manjula Singhal [2011] 46 SOT 149 (Jodh)..
• Once the DVO gives his valuation, the AO cannot disregard the
value given by the DVO. Bharti Jayesh Sanghani [2011] 128 ITD
345 (Mum).
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• If the Purchaser has objected to the SDV before the stamp
authorities it does not still debar the seller to object to the said
valuation before the AO. B. N. Properties Holdings Pvt. Ltd.
[2010] 6 ITR (Trib) 1 (Chennai).
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Deeming Fiction over Deeming Fiction
• Section 45 (3) and Section 50 C
– Whether the SDV can be substituted in cases where the asset is
introduced as capital contribution by the Partner if the amount
credited to the capital account of the partner is less than the SDV
•
Canoro Resources 180 Taxman 220 – Transfer Pricing Vs. 45 (3)
• Section 50 Vs. Section 50 C
– If a building being a depreciable asset is disposed off at a value
which is less than the SDV, whether S 50 C will apply
– Limited deeming fiction
– United Marine Agencies [2011] TIOL 266 (Mum)(SB) held that S 50
does not debar application of Section 50 C
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– Section 50 only substitutes the cost of acquisition and not the full
value of consideration
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50 C & Sec. 54 / 54 F / 54 EC, etc.
• If actual consideration is substituted with SDV, impact on Section
54 / 54 F / 54 EC
– Section 54 and 54 EC, the exemption is granted with reference to
capital gains and not with reference to “net consideration”
– Therefore, increased consideration to be taken into account for
considering the eligibility U/s. 54 / 54 EC.
• Case of 54 F
– Deduction granted in proportion of investment in new asset made to
the “net consideration”;
– “net consideration” defined in explanation to S 54 F (1)
– 54𝐹 𝐷𝑒𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐺𝑎𝑖𝑛 𝑥
𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑖𝑛 𝑁𝑒𝑤 𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦
𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 (𝑛𝑜𝑡 𝑆𝐷𝑉)
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– Section 50 C uses the term “for the purpose of section 48” and
therefore does not extend to 54F
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Section 43 CA
• Introduced w.e.f. 1.4.2014 (applicable for AY 2014-15)
• Provisions of 43 CA and 50 C are in pari materia, save and
except:
– 50 C applies when the transferor holds the asset as “capital asset”,
whereas in 43 CA applies when he holds it as “stock-in-trade”
– Concept of substitution of date of agreement (if earlier than the date
of transfer) is available, provided part of the consideration is paid
otherwise than by cash either prior to or at the time of execution of
such Agreement.
• Primarily covers the cases of real estate developers, land
dealers, etc.
• Protection of deeming fiction U/s 45 (3) not applicable
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• The cases where a capital asset was converted into SIT
immediately prior to transfer would also be covered
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Agreement for substitution of Date of SDV
• Agreement need not be registered
• Agreement is not a “contract”
– Booking receipt where the terms and conditions are agreed, though
not converted into agreement to sale would also be covered
– Booking letter / receipt which does not specify the consideration will
not be eligible
• Consideration or any part thereof is received “by any mode
otherwise than by cash”
– The concept is wider than by “crossed account payee cheque /
draft”, etc.
– Can receivable of one person be, by exchange of letter, treated as
booking advance of another person?
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– Can book entries be covered? i.e. a receivable be converted into
booking advance?
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Deemed Dividend 2 (22)(e)
• Has received renewed focus of the tax department
• In cases of group companies there could be several instances of
deemed dividends and the implication could be very heavy
• Ingredients:
– Company in which public are not substantially interested (Closely held
company)
– Payment of any sum by way of advance or loan
– To
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a shareholder holding not less than 10 % of voting power; or
to a concern in which such person is a member or a partner and in which he
has substantial interest;
– Also covers cases of such company making payment on behalf of or for
individual benefit of such shareholders
• 115 O is not applicable to Deemed Dividend U/s. 2 (22) (e)
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– To the extent to which the Company possesses accumulated profits
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Company
• Company as defined in Section 2 (17) will also include foreign
company;
– Any Indian Company [2(26)]
– Any body corporate incorporated by or under the laws of country
outside India; or
– ….
– Any institution, association or body declared as a company;
– Gautam Sarabhai 52 ITR 921 (Guj)
– There is a DTAA with the country of which the holding company is a
tax resident;
– The DTAA has appropriate Non-Discrimination Clause
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• Indian subsidiary (not being a private company) of a foreign listed
company can be considered as a widely held company, provided
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Payment
• Basic Conditions
– It has to be a payment
– Payment has to be of a sum
– As an Advance or Loan
• Payment means actual physical payment – mere creation of debtor
credit liability is not sufficient - G Venkataraman 101 ITR 673 (Mad);
Parle Plastics Ltd. 196 Taxman 62 (Bom)
• Repayment of the loan not relevant – Smt. Tarulata Shyam 108 ITR
345 (SC)
– Also Abubucker 135 Taxman 77 (Mad) – Advance Rent / Rent Deposit
considered; Sunil Chopra 201 Taxman 316 (Delhi) – Advance for
Property treated as Advance
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• Trade Advances / Advances in ordinary course of business not
covered Raj Kumar 181 Taxman 155 (Delhi); Ambassador Travels
318 ITR 376 (Delhi)
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A Shareholder
• Shareholder must be a registered as well as beneficial shareholder –
Shakuntala 43 ITR 352 (SC); Rameshwarlal Snwarmal 122 ITR 1
(SC); Bhaumik Colour Pvt. Ltd. 118 ITD 1 (Mum) (SB); H. K. Mittal
219 ITR 420 (All)
– Partner and Partnership Firm
– Trustee and the Beneficiaries
– HUF and Karta
• No concept of directly or indirectly or jointly with relatives, etc.
Individual shareholding has to be more than 10 %
– Delhi High Court – National Travel Service - ITA Nos. 223, 219, 1204 &
309 of 2010 [Firm and Partner are the same] Cotra CIT vs. Raj Kumar
Singh 295 ITR 9 (All)
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• Even in case where the payment is to a concern in which such
shareholder is interested, the tax is to be paid only by the
shareholder and not by the concern to which payment is made. Universal Medicare Private Limited, 324 ITR 263 (Bom)
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Accumulated Profits
• Profits upto the date of payment is to be seen / considered
– Accumulated Profits does not mean profits accumulated upto the
end of the immediately preceding year
• Commercial profits are to be considered
– Taxable Profits (due to deeming fiction or otherwise) or tax losses
(due to depreciation or incentive provisions, etc.) has no relevance
for determination of accumulated profits
– P. K. Badiani v. CIT (1976) 105 ITR 642 (SC)
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• Distribution / Deemed dividend so considered earlier is to be
reduced - CIT v. G. Narasimhan (1979) 118 ITR 60 (Mad)
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Other Topics
• Section 56 (2) (vii)
– Concept used is “without consideration” and not “without
consideration in money or money’s worth” as was used under the
Gift Tax Act S. 2 (xii). Relevance of the difference.
– Gift to “individual” or “HUF” only covered. Whether a Gift to a
Private Discretionary Trust consisting of individuals as beneficiaries
and more than one trustee will be covered?
– Whether the Asset should be “capital asset” in the hands of the
donor or donee?
• Section 56 (2) (vii) and shares of a foreign company
• Section 56 (2) (vii) and ESOPs – Whether Section 17 (2) (vi) will
apply or Section 56 (2) (vii)?
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– If the shares of a foreign company, which derive its value
significantly from assets situated in India, is transferred at lower than
book value, then the same also will be covered by the provisions of
Section 56 (2) (vii)
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Section 56 (2) (vii) ….
• Sudhir Menon HUF TS-146-ITAT-2014 (Mum) held that the shares
acquired under the right issue is not covered by the provisions of
Section 56 (2) (vii):
– Allotment of fresh shares of the Company are covered. Section 56 (2)
(vii) does not only cover cases of purchase / transfer of shares;
– Proportionate allotment of shares to the shareholders does not impact
taxation as there is no income
• Exemptions from Section 56 (2)(vii)
– Gift from a relative [Whether definition is two way or one way]
– On the occasion of marriage of the individual
– Under a will or by way of inheritance
– From any local authority, fund or foundation U/s. 10 (23C)
– Trust or institution registered under 12 AA [No place for foreign charity]
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– In contemplation of death of the payer or donor
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Section 56 (2) (vii) / (viia) / (viib)
• We feel that these are absurd provisions and create hardship to the
Assessees
“Toute nation a le gouvernement qu‘elle mérite”
French Philosopher Joseph de Maistre in 1811
Meaning
Or
Every Nation has the Government it is fit for
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Every Nation has the Government it deserves
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Thank You
milin.mehta@kcmehta.com