FDI and Issue of Shares For Consideration Other Than Cash: Discussion Paper

The DIPP has released a discussion paper on the subject of "Issue of shares For Consideration Other Than Cash" with specific reference to Foreign Direct Investment. The paper has considered the following issues:

• issue of shares against import of capital goods, machinery or equipment including second hand equipment
• issue of shares against services
• issue of shares against import of raw materials and trade payables.
• issue of shares against pre-operative or pre-incorporation expenses.
• share swaps
• issue of shares against intangible assets including franchisee agreements
• issue of shares against one time extraordinary payment including arbitral awards

The discussion paper has also outlined some specific issues that may arise in this regard.

GE India Technology: Interesting observation on 'Territorial Nexus'

In GE India Technology v. CIT, the Supreme Court has laid to rest the controversy surrounding the interpretation of s. 195 of the IT Act, 1961. The controversy had arisen through the judgment of the Karnataka High Court in CIT v. Samsung. In Samsung the Karnataka High Court had held that a resident Indian would necessarily have to deduct tax at source u/s 195(1) of the Act while remitting money to a non resident irrespective of the sum eventually not being chargeable to tax in India. The High Court had further held that the only way by which a resident can remit the entire sum to a non resident is by obtaining a “No Objection certificate” (a declaration that the sum in question is not chargeable to tax in India) from the department u/s 195(2) of the Act.

However in GE India the Supreme Court has effectively overruled Samsung and has held that tax has to be deducted at source only when the remitting sum is eventually chargeable to tax in India. The court has further held that s. 195(2) is based on the “principle of proportionality” and it only gets attracted incases of composite payment in which only a certain proportion of payment has an element of “income” chargeable to tax in India. In other words a resident Indian has to make an application when the payment is certainly chargeable to tax but the Resident is unsure about which portion of the payment is chargeable to tax. In case the Resident fails to apply for an application in cases enumerated above, he has to then necessarily deduct tax at source u/s 195(1). In my humble opinion the Supreme Court has arrived at the correct conclusion.

In arriving at the above mentioned conclusions, Kapadia, C.J. has made to an interesting observation:

“The interpretation of the Department, therefore, not only requires the words “chargeable under the provisions of the Act” to be omitted, it also leads to an absurd consequence. The interpretation placed by the Department would result in a situation where even when the income has no territorial nexus with India or is not chargeable in India, the Government would nonetheless collect tax”(emphasis mine)

This observation though an obiter can potentially be used to argue that the principle of “Territorial Nexus” forms an essential element of the Indian Tax jurisprudence. The observation also manifests that the finding in Linklaters (discussed here) and Ashapur wherein the ITAT, Bombay had held that the principle of “Territorial Nexus” is only limited to territorial tax systems, is incorrect. However this observation can also be used to argue that no territorial nexus is required to tax an income of a non resident. Kapadia C.J. above observes that “......even when the income has no territorial Nexus or is not chargeable to tax in India, the government can nonetheless collect tax.” This implies that the Government can collect tax when the income of the non resident has a territorial nexus with India or is specifically chargeable to tax under any of the provisions of the Act (even though the provision is not based on any territorial nexus test).

Concluding, though two contrasting interpretations are possible of the above observation, nonetheless the latter interpretation as stated above would open the doors for a constitutional challenge of the provision  which seeks to tax the income of a non resident without their being sufficient territorial nexus.

CCI v. SAIL: Conclusions of the SC

Here are some of the important conclusions reached by the Supreme Court in the CCI v. SAIL &Anr.(civil appeal no. 7779 of 2010):


“In terms of Section 53A(1)(a) of the Act appeal shall lie only against such directions, decisions or orders passed by the Commission before the Tribunal which have been specifically stated under the provisions of Section 53A(1)(a). The orders, which have not been specifically made appealable, cannot be treated appealable by implication. For example taking a prima facie view and issuing a direction to the Director General for investigation would not be an order appealable under Section 53A (emphasis mine).”


“Neither any statutory duty is cast on the Commission to issue notice or grant hearing, nor any party can claim, as a matter of right, notice and/or hearing at the stage of formation of opinion by the Commission, in terms of Section 26(1) of the Act that a prima facie case exists for issuance of a direction to the Director General to cause an investigation to be made into the matter.”(emphasis mine)


“The Commission, in cases where the inquiry has been initiated by the Commission suo moto, shall be a necessary party and in all other cases the Commission shall be a proper party in the proceedings before the Competition Tribunal. The presence of the Commission before the Tribunal would help in complete adjudication and effective and expeditious disposal of matters. Being an expert body, its views would be of appropriate assistance to the Tribunal. Thus, the Commission in the proceedings before the Tribunal would be a necessary or a proper party, as the case may be.” (emphasis mine)


“During an inquiry and where the Commission is satisfied that the act is in contravention of the provisions stated in Section 33 of the Act, it may issue an order temporarily restraining the party from carrying on such act, until the conclusion of such inquiry or until further orders without giving notice to such party, where it deems it necessary. This power has to be exercised by the Commission sparingly and under compelling and exceptional circumstances. The Commission, while recording a reasoned order inter alia should : (a) record its satisfaction (which has to be of much higher degree than formation of a prima facie view under Section 26(1) of the Act) in clear terms that an act in contravention of the stated provisions has been committed and continues to be committed or is about to be committed; (b) It is necessary to issue order of restraint and (c) from the record before the Commission, it is apparent that there is every likelihood of the party to the lis, suffering irreparable and irretrievable damage or there is definite apprehension that it would have adverse effect on competition in the market.” (emphasis mine)


“In consonance with the settled principles of administrative jurisprudence, the Commission is expected to record at least some reason even while forming a prima facie view. However, while passing directions and orders dealing with the rights of the parties in its adjudicatory and determinative capacity, it is required of the Commission to pass speaking orders, upon due application of mind, responding to all the contentions raised before it by the rival parties.” (emphasis mine)

At first blush the finding of the Supreme Court seems to be correct. However I shall analyze the decision in greater detail in a subsequent post.

COMPAT's POWERS: SAIL v. JINDAL

The Supreme Court has delivered its judgement in the dispute between the CCI and COMPAT. I will discuss the judgement in a subsequent post.

The order of the COMPAT has been previously discussed on this blog here.
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News and Reflections

The Law News E-Media had reported that a professor and two students of the National University of Juridical Sciences had written a letter to the Editors-in-Chief of the Outook and the India Today news mags expressing their displeasure on the law school rankings. In case you have not already read the newsreports and the letter, do check 'em out from these links below:

http://www.legallyindia.com/201008201213/Law-schools/nujs-ers-threaten-outlook-a-india-today-law-school-rankings-with-press-council-complaint

http://www.barandbench.com/brief/2/933/nujs-takes-on-outlook-for-faulty-ranking-methodology

You can access any of these links above to read the letter reportedly sent to those mags.

There was a specific complaint in the said letter that the said mag had invited NUJS to place ads. I quote and italicise the relevant portion of the letter:

(pardon the long quote)

"We wish to bring to your notice the fact that NUJS had received such an offer to advertise in your magazine in that particular issue by one Manish Kumar <manishk@outlookindia.com> (who claims to be the Assistant Manager of OUTLOOK) for varying rates starting from Rs. 1,00,000 and going up to Rs. 5,00,000.

The text of his email reads as below:

“From: manisk kumar [mailto:manishk@outlookindia.com]

Sent: Tuesday, May 18, 2010 10:40 AM

To: 'registrar@nujs.edu'

Subject: Proposal for professional college issues.

Dear Sir,

Outlook – India’s Best Professional Colleges Survey – 2010

Outlook, India’s most popular and respected English news magazine is bringing out its eagerly awaited annual survey and ranking of The Best Professional Colleges in India, through a special issue in June 2010. For the past four years, Outlook’s ranking of the leading engineering and medical colleges has set the benchmark for tracking academic excellence. This year, we are expanding the breadth of the survey by covering six other professional streams – architecture, fashion design, hotel management, law, mass communication, and social work.

For parents and students, this special issue is an invaluable guidebook. For colleges and institutes, it’s a matter of prestige to be featured in this survey -- there is high peer recall of Outlook’s ranking.

The survey is based on both objective and perceptual data across relevant parameters. Conducted by leading market research firm MDRA, the survey would also undertake a random physical audit of institutes. Authenticity and evaluation process would be the key elements of this survey. Our research team is contacting close to 1,300 colleges and institutes for the survey. A brief on the categories:

Engineering – More than 600 institutes recognized by AICTE.

Medical – Over 300 (MCI approved) and approximately 100 of Dentistry (DCI approved).

Mass Communication – 60+ institutes are being contacted.

Hotel Management – More than 60 institutes.

Law – Around 50, recognized by Bar Council of India and All India Bar

Social Welfare – 50+ institutes are being contacted.

Architecture – 50+ institutes are being contacted.

Fashion Design – 60 institutes.

The survey will be based on the following parameters:

Selection Process

Academics

Industry Exposure/Placements

Faculty

Infrastructure

We invite you to advertise in this special issue dated: June 28th. Released on: June 18th. Deadline: June 10th

Full Page : Card Rate -Rs. 490,000 Special Rate: Rs. 2,00,000

Half Page : Card Rate: Rs. 3,00,000 Special Rate: Rs. 1,00,000

We look forward to your participation. Thanking you and with warm regards

Yours truly,

Manish Kumar

Assistant Manager

Outlook Group

(The entire email chain is attached as Annexure A.)

Was this email and its offer to advertise for a heavy sum in the very same issue where the rankings were to appear, done with a view to subtly inform the college that if it advertised, it faced the prospect of a better ranking? We would appreciate a clarification from you in this regard.

NUJS did not place any advertisement with your magazine. However, NLIU Bhopal did (see attachment: Annexure B). Both colleges had similar marks in the ranking i.e., 779.4: however, NLIU Bhopal was ranked at number 4, while NUJS was ranked at number 5. On what basis does one get precedence over the other? Shouldn’t both have been ranked at number 4 and the next in line should have been number 6. Isn’t this the standard practice? Please elaborate.

In any case, we hope that you will desist from this questionable practice in future. Sponsorships and paid advertisements in the very same issue in which you rank colleges taint the objectivity of ranking and create an impression of bias."

This allegation reminds me of the paid news issue that has been in the news for almost a year. On the paid news issue, have a look at these articles:

P. Sainath, The medium message and the money,
P. Sainath, Politics and the Praetorian Guard ,
Sathya Prakash M R & B K Ravi, India’s Prosperity Paradox and the Mass Media Disconnect,
Ashwin Mahesh, Invisible India is the elephant in your bedroom ,
Report of the Press Council of India on Paid News
Archna Shukla, Should Private Treaties be Made Public to Newspaper Readers?

DTC: Concern for FIIs

In the economic times there is an interesting article carrying the title DTC: Cause of Worry for FIIs. Some aspects relating to the taxability of FIIs has been a matter of previous discussions on this blog. Here are some of the excerpts of the article in the economic times:

"The Bill provides that the income earned by FIIs will be deemed as capital gains. This would not have much impact on the FIIs as most FIIs at present offer their income to tax as capital gains. The deemed characterisation under the Bill implies that income from derivative transactions, which are currently treated as business income, will now be taxed as capital gains. Considering that most derivative contracts have a maturity period of between 30-90 days, the income from the derivative transactions will be subject to tax at 15%. "

"For FIIs investing from favourable treaty jurisdictions, all capital gains will be tax exempt. Though, structures without much commercial substance are likely to face challenges with the advent of general anti-avoidance rule ('GAAR'). As per the proposed GAAR, if the structure has been set up to obtain an unintended 'tax benefit' or involves treaty shopping, the Indian tax authorities will have the ability to lift the corporate veil or deny the treaty benefits. While the detailed rules and safe harbours are still to be announced, it is apprehended that holding structures set up in tax favourable jurisdictions such as Mauritius and Cyprus will be presumed to be set up for tax avoidance and the onus to prove otherwise will be on the taxpayers. This uncertainty might tilt the balance in favour of certain well established jurisdictions such as Singapore, which already have an objective substance test built into their tax treaty with India. For those FIIs who have traders based in jurisdictions from where they invest, it may be easier to meet the commercial substance test."


"The significant impact on the FIIs will be as regards the taxation of their investors. The Bill deviates from the current law and has sought to tax offshore transfer of shares in companies which hold at least 50% or more investment in the form of Indian assets. As a consequence, non-residents investing in an open-ended offshore fund set up as a company may be subject to Indian tax upon redemption of offshore shares. This might create unintended cascading tax burden on the investors in the offshore funds set up as collective investment vehicles, and which have more than 50% asset allocation to India."



I shall explore some of the points in detail at a latter point.

Changes Proposed to be Brought by The Direct Tax Code Bill, 2010

The Direct Tax Code is proposed to be brought in to consolidate and amend the regime relating to Direct Taxes in India so as to establish an economically efficient, effective and equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio. Also the secondary purpose of the Code is to reduce disputes and minimize litigation. The Code proposes to bring all forms of Direct Taxes under a single code. A Discussion Paper was released in August 2009; subsequently a revised discussion paper was brought out in June 2010 which incorporated certain suggestion made with regard to the Discussion Paper. Finally, the Bill was tabled in the Parliament on 30th August, 2010. The post highlights certain changes which are to be brought by the Direct Tax Code Bill, 2010.

• Tax Rates

The tax slabs have been widened (First Schedule Paragraph A). The lowest tax rate of 10% is applicable to salary income of Rs2-5 lakh, 20% on income of Rs5-10 lakh and 30% on income above Rs10 lakh.

• Residential Status of Individuals

Residential Status of Individual under the Direct Tax Code has undergone a significant change. The requirement of being present in India for 730 days in the preceding seven years, essential for qualifying as an ordinary resident and the categorization of Resident but not ordinary Resident has been done away with (Clause 4).

• Residence of Companies

Under the Direct Tax Code a company would be treated as a Resident if it is an Indian Company or if its place of ”effective management” at any time of the year is in India (Clause 4) in contrast to the requirement of being “wholly” situated in India under the Income Tax Act. 'Place of effective management' under Clause 314(192) is defined as either the place where the Board/Executive directors of a company make their decisions or, in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company or the place where such executive directors or officers of the company perform their functions. This has been done to enlarge the scope of taxability of companies by bringing in more number or Companies under the banner or Resident Companies.

• Income from Salary

The broad head of Income from Salary under the Income Tax Act has been renamed to “Income from Employment” under the Direct Tax Code. Clause 23 (e) has removed the cap of 1 lakh towards the Employer’s contribution towards approved Superannuation fund.

• House Property

No taxation on deemed income basis. The concept of fair market value (S.23) for calculation of income from house property has been done away with primarily because computation of notional rent has been a predominant cause of litigation. Income from the letting of house property will be computed on the basis of contractual rent (Clause 26), i.e. the amount of rent received or receivable, directly or indirectly for the financial year less specified deductions (Clause 27). Standard deduction on account of repairs and maintenance has been reduced from 30% to 20% [Clause 27 (1) (b)].

• Branch Profit Tax

The Direct Tax Code introduces a Branch Profit Tax (BPT) on branch profits of foreign companies in addition to the income tax on income attributable to a Permanent Establishment (PE) or an immovable property in India, as reduced by the income tax payable on such attributable income. The Rate of Tax as proposed in the Second Schedule Para D (4) is 15%.

• DTAA

The Direct Tax Code in Clause 291(8) lays down that between the Code and a DTAA the provisions of the Code will apply to the extent that the provisions of the Code are more favorable to the assessee.

• Wealth Tax

The existing exemption limit (30 lakh) for the chargeability of Wealth Tax under the Act has been increased to 1 Crore. (Second Schedule Para E).

• Minimum Alternate Tax

The Direct Tax Code has brought in the concept of Minimum Alternate Tax so as to overcome the problem of excessive tax incentives. Where the normal income-tax payable for a financial year by a company is less than the tax on book profit, the book profit shall be deemed to be the total income of the company for such financial year and it shall be liable to income-tax on such total income (Clause 104 Direct Tax Code).