Soli Dastur on Finance Bill 2012

This is a note on the speech made by Mr. S. E. Dastur on the direct tax provisions contained in the Finance Bill, 2012 on 20^th March 2012

 ·         Vodafone Case

The basis of the Vodafone was whether the assessing officer had jurisdiction to issue the notice under section 201 of the Act. The assessing officer would definitely have power to examine the question whether it had jurisdiction to issue notice. The Supreme Court judgment prevents the assessing officer to examine this issue as according to theApex Courtthe transaction was not liable to tax inIndia.

The government brought retrospective amendments to undo the decision of the Supreme Court. The review petition before the Supreme Court has been dismissed. It is doubtful that a retrospective amendment contained in the Bill could be the ground for review. However, as and when the Bill becomes an Act, a further question may arise whether another review petition would be maintainable on the ground of change in law with retrospective effect i.e. there is an error apparent on the face of the record.

It has been held by Courts that change in law with retrospective effect affecting an order or judgment can be ground for the review. In Mohammad Azamat Azim Khan, v. Raja Shatranji and others AIR 1963 All 541 it was held that review is possible in light of the altered law. In Re Cauvery Water Disputes Tribunal AIR 1992 SC 522 : 1993 Supp (1) SCC 96, the Supreme Court held that legislature cannot set aside an individual decision inter-parties, though it can change the basis of such decision. It would be unjust and contrary to all sense of equity to hold overturn Vodafone.

• Overcoming Vodafone

The Bill has adopted two approaches to overcome Vodafone judgment:

(i)           First by addition of an Explanation to section 2(14) to expand the meaning of “property” to include rights of management or control, etc. However, to determine cost of acquisition of these rights would be difficult and therefore, ratio of CIT v. B. C. Srinivasa Setty 128 ITR 294 (SC) would still be helpful. And also by addition of second Explanation to section 2(47) to expand the scope of “transfer”; and

(ii)               Addition of Explanations 4 and 5 to section 9(1)(i).

• Royalty

Intended insertions of Explanations 4, 5 and 6 to section 9(1)(vi) are not justified. These provisions are aimed at undoing various decisions given by the Courts and Tribunals in the favour of assessee such as that of the Delhi High Court in Ericsson AB and Asia Satellite Telecommunications Co.

• Specified Domestic Transaction

The new provision regarding Specified Domestic Transaction is fall out of the observations made by the Chief Justice in CIT & Anr. v. Glaxo Smithkline Asia (P) Ltd. (2010) 236 CTR (SC) 113 : (2010) 195 Taxman 35 : 47 DTR 65. Accordingly, Transfer Pricing provisions shall be applied to arrive at Fair Market Value (“FMV”) in case of a Specified Domestic Transaction. These transactions are referred to in sections 40A(2), 80A, 80-IA(8), 80-IA(10), transactions referred to in any other section under Chapter VI-A or section 10AA to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable. In a case falling under section 80-IA(8), the officer is empowered to determine the FMV in case goods are transferred from one undertaking to another undertaking of the same assessee, while under section 80-IA(10) two assesses are involved.

The most appropriate method shall be applied to determine the arm’s length price and if there are more than one such prices, then average of all such prices shall be the arm’s length price. Detailed records of all Specified Domestic Transactions are required to be kept. The department can take different view about Specified Domestic Transactions from year to year though the order in earlier years on similar facts and circumstances may be in favour of the assessee.

• 92CA(1) : Necessary or Expedient

The AOs have been making reference to TPO merely on the basis of value of transaction. The Commissioners have been granting approval for reference to the TPO routinely and under a list forwarded by the AO and without exercising his mind to the transaction, which is not in the spirit of the provisions of law. There must be something of relevance in the transaction for it to be referred to the TPO. The AO must satisfy himself of the necessity and expediency before making any such reference.

• Apathy of Courts towards Assessees

The BombayHigh Court in Coca Cola India P. Ltd. v. ACIT [2006] 285 ITR 419 had laid down some principles to be followed by the department to prevent misuse of provisional attachment and coercive recovery of demand. However, today the Court is not willing to use the whip it had created which only adds more woes to a hapless assessee. Is the Court becoming cruel only to be kind?

• GAAR

The Bill intends to incorporate into the Income-tax Act, the most obnoxious part of the proposed Direct Tax Code rightly called GAAR i.e. General Anti-Avoidance Rule. These provisions arms the AO with all the tools required to declare an arrangement as “impermissible avoidance arrangement” and then proceed to deny tax benefit, or a benefit under a treaty in such manner as he would deem appropriate. Inspite of the Supreme Court declaring in Vodafone case that one can only “look at” and not “look through” the transaction, now the AO would look into the transaction and reclassify it the way suits him. Though government is supposed to come out with guidelines and notifications as to how GAAR provisions are to be applied, the experience has shown otherwise. These provisions should never be passed into law. It would be like “giving razor to the monkey”.

For example, in the following cases the AO may deny tax benefit for the reason that the main purpose there is to obtain tax benefit:

Ø      Industry set up in backward area;

• 54EC investment of sale proceeds of property;
• Transaction involving demerger – the real intention is to sell the assets;
• Loss on sale of shares on the stock exchange is not allowed, therefore, any sale under private arrangement was only with purpose to set off loss.
• Dividend stripping;
• Saleand lease back transactions.

All these will go contrary to views taken by theApex Courtin last 50 years.

• CBDT Chairman’s letter dated 7^th February 2012

The letter of CBDT Chairman of 7^th February 2012 puts tax collection above the administration of law, when he sets highest weightage to achievement of revenue collection target while writing Annual Performance Review of the officer and his placement in the coming financial year. This is no good for democracy.

• DTAA

The Bill intends to extend GAAR provisions into the arena of DTAAs. The AO can relocate the place of residence of any party, or of situs of an asset, or of a transaction.  This would amount to empowering the AO to override a treaty entered into between two sovereigns.

Certificate of Residency – Condition of producing the certificate of residency would no longer remain the sufficient proof. The question arises whether CBDT Circular No. 789 dated 13 April 2000 would still be effective.

Explanation 3 to be added to section 90 provides that a term defined in the notification shall be deemed to have effect from the date DTAA came into force. This is virtually empowering the department to rewrite the treaty. A country having self-respect will not enter into a treaty with any country whose officers are empowered to obliterate the promises of the sovereign. A notification issued by the Board defining “may be taxed” is a case on this point. A question arises whether the phrase “may be taxed” is a term at all.  However, by notification it has been defined to mean that the income will be taxed inIndiaand then credit shall be given.

• Dispute Resolution Panel (“DRP”)

It has been representatives’ experience appearing before the DRP that one cannot get any substantive relief before it. The assessees do not get a proper hearing neither all options available to the assessee in terms of relief is allowed. The new to be inserted Explanation after section 144C(8) is only going to make situation worse. Now the DRP can enhance the variation. It can consider any matter arising out of the assessment proceedings relating to the draft order whether or not the assessee raised the issue.

• Miscellaneous Amendments

Ø  Section 2(15): Even if 12A or 12AA registration are not revoked, if first proviso to section 2(15) becomes applicable then sections 11 or 12 benefit shall not be available to the organisation. In such an event it is not clear whether such organisations can still issue 80G certificates to any donor. This will affect the revenue augmentation of charities because such institutions mostly receive their fund in last month of the financial year as such donations are accompanied by tax benefit. If issuing 80G certificate in such an event is held to be illegal then the trustees may personally become liable.

• Alternate Minimum Tax (“AMT”): As per new to be added section 115JC, where the income-tax payable by a person, other than a company, is less than the AMT, he will pay tax @18.5% on his adjusted total income.
• Section 68: The newly to be added proviso to section 68 is intended to overrule Lovely Exports 216 CTR 195 (SC). In the event cash credit consists of share application money, share capital, share premium, etc., the company will have to give proof of the source of such sum credited to the satisfaction of the AO.
•   Section 2(19AA): It has been inserted with an intention to do away with the requirement of issuing shares to itself in a case of demerger.
• Section 50D: Where the value of consideration is not ascertainable or determinate, then FMV shall be taken as the full value of consideration.
• Section 149: The time limit for reopening assessment of income in relation to any asset (including financial interest in any entity) located outsideIndiahas been increased to 16 years.

When God Is Elevated.

Mr. R.V. Easwar, the President of the Income Tax Appellate Tribunal (ITAT) has been elevated as a Judge of the Delhi High Court. He will take oath of his office on Monday 17^th October 2011.

Easwar, in Hindi, literally means God. Mr. Easwar’s has upheld the reputation of his namesake by maintaining a high level of knowledge and integrity as a judge of the ITAT. In one of the rare occasions, the ITAT Bar Association today extended a full court farewell to Mr. Easwar in recognition of his public service and contribution to the income-tax law.

However, on his path leading to the High Court Mr. Easwar and the High Court both had to face many roadblocks. There is an inherent bias in the higher judicial services in not seeing a tribunal as the part of mainstream justice delivery system, though the High Courts exercise superintendence over all courts and tribunals situate in its jurisdiction.

Today with the increasing number of laws and their complexity more and more judicial functions are being discharged by tribunals. In case ofIndiathis is even truer as the government remains the largest single party involved in litigation with its citizens. Therefore, a huge legal talent is consumed by various tribunals including ITAT, Customs Excise and Service Tax Appellate Tribunal, the National Company Law Tribunal (the function is still being discharged by the Company Law Board) and their like dealing with special kind of cases which can not be satisfactorily adjudicated by the civil courts because of the complexity and the different nature of adjudication process. Appeals against the orders and judgments of these tribunals lie with the jurisdictional High Courts. However, the High Courts have been facing difficulties in finding specialist judges to effectively hear appeals from these tribunals. An aversion to elevate the tribunal members to the High Courts has only squared up the problem.

In the entire 70 years’ history of the ITAT only 32 members have been elevated to various High Courts despite the fact that its first President Mr. M. Monir later became the Chief Justice of the Lahore High Court in undivided India and finally the Chief Justice of Pakistan. The Bombay High Court has elevated only 2 members to its Bench though the principal bench of the ITAT sits in Bombay with the President and some of the best of its members. This tells enough about the deep prejudice that mainstream lawyers and judges harbour against tribunal judges though they may be highly qualified in their specialized field of law.

In the month of April this year, the secretary of Delhi High Court Bar Association filed a writ petition before the Delhi High Court challenging the recommendation of a collegium of the judges of the High Court to elevate Mr. Easwar to its Bench. The petitioner made some preposterous arguments including:

1. Mr. Easwar has not held a judicial office.
2. He is not at present a practicing advocate.
3. He is not eligible to be appointed as a District Judge.
4. He has not held an office of the Tribunal in Delhi after 2008.
5. And above all, he has ceased to be impartial and independent as he has been acting as a member of the ITAT.

Mr. Easwar is a qualified chartered accountant and a post-graduate in law. Before joining the ITAT as a member in 1991, he practised as a lawyer for 18 years in Madras. The petitioner advocate forgot that he was at the fulcrum of an incident where the law secretary tried to usurp the authority and independence of the ITAT, which matter finally went before the Supreme Court and resulted in solidifying the independence of the ITAT. (See Income Tax Appellate Tribunal vs. V. K. Agarwal (1999) 235 ITR 175 (SC)). Therefore, the High Court for right reasons dismissed the writ petition paving the way for elevation of Mr. Easwar to its Bench. (See judgment of the Delhi High Court in D.K. Sharma vs. UoI & Ors dated 8^th April 2011 in writ petition no. 2231/2011).

We can now only hope that this precedent set by the Delhi High Court is continued with and able judges from the tribunals are given their proper due.

Transfer Pricing and Domestic Transactions

Chapter X of the Income-tax Act, 1961 (“the Act”) lays down special provisions to prevent avoidance of income tax in respect of any income arising from an international transaction between two or more associated enterprises, which is popularly called transfer pricing provisions. It provides that any income or any expense or interest arising from an international transaction between two or more associated enterprises shall be determined having regard to the arm’s length price by any of the following methods, whichever is most appropriate, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons and other prescribed factors, namely – (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; or (e) transactional net margin method. These provisions are aimed at multinational business entities which are susceptible to indulge in transferring income from a high tax jurisdiction to a low tax jurisdiction or from a profit making group company to a loss making group company situate in different tax jurisdictions, thus taking benefit of tax arbitrage.

The Act does not lay down a similar provision to prevent tax arbitrage by domestic entities. However, the Act does provide for determination of “fair value” while determining “income” of an assessee arising of certain domestic transactions in certain cases, viz.

• Section 40A(2)(a) provides for the disallowance of excessive or unreasonable expenditure paid to related entities.
• Section 80-IA(8) & (10) provides for the disallowance of tax holiday in respect of “super normal” profits made by the assessee in the eligible business arising out of inter-unit transactions of goods or services or due to arrangement of the course of business between related entities.
• Section 43(1) defines the “actual cost” in respect of a depreciable asset to mean the cost of acquisition less that portion of cost which has been met directly or indirectly by any other person. This is to prevent adoption of a higher cost with intent to reduce tax liability in certain cases.
• Section 28(iv) provides that value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession shall be profits and gains of business or profession.
• Section 50C provides for the adoption of stamp valuation in respect of land and/or building as “the full value of the consideration” where the consideration received is lower than the stamp valuation.

However, recently in the case of Commissioner of Income Tax & Anr. v. Glaxo Smithkline Asia (P) Ltd. (2010) 236 CTR (SC) 113 : (2010) 195 Taxman 35 : 47 DTR 65, the Supreme Court took up the issue as to whether transfer pricing regulations should be limited to cross-border transactions or whether the transfer pricing regulations be extended to domestic transactions too? The Court observed that in the case of domestic transactions, the under-invoicing of sales and over-invoicing of expenses ordinarily would be revenue neutral except in two circumstances involving tax arbitrage:

 (i)    If one of the related companies is loss making and the other is profit making and profit is shifted to the loss making concern; and

(ii)  If there are different rates for two related units (on account of different status, area bases incentives, nature of activity, etc.) and if profit is diverted towards the unit on the lower side of tax arbitrage.

Facts of the case

This special leave to appeal to the Apex Court arose from the Delhi High Court’s Order in Writ Petition No. 2111 of 2006 reported as Glaxo Smith Kline Asia P. Ltd. v. CIT (Delhi) (2007) 290 ITR 35 (Delhi). In the present case, the petitioner was engaged in the business of manufacture and sale of fast moving consumer products. The petitioner had only one employee – the company secretary. The administrative services relating to marketing, finance, human resource, secretarial services, etc. were provided by Glaxo Smith Kline Consumer Healthcare Ltd. (“GSKCH”), a widely held public company. The petitioner would reimburse the costs incurred by GSKCH for providing various services plus 5% as per the agreement (“cross charges”). Since the agreement did not provide any basis for allocation of costs incurred towards various services provided to the petitioner, services of a chartered accountants’ firm was availed to determine the basis for allocation of reimbursable costs.  On the basis of chartered accountants’ report, cross charges were worked out and claimed during the relevant assessment years. The AO held that the payment of cross charges/administrative expenses to the extent of 7% of net sales were justified and disallowed the balance. The CIT upheld the order of the AO. The same approach was adopted by the AO for the subsequent assessment years as well.

The Tribunal allowed the petitioner’s appeal holding that “there is no provision to disallow any expenditure on the ground that such expenditure is excessive or unreasonable unless the case falls within the scope of section 40A(2). It is not the case of the Department…” The petitioner succeeded before the High Court also on this ground. However, the Department, in the subsequent years, took shelter of section 245 to deny refund of the excess tax paid by the petitioner. The High Court held that the Revenue was not entitled to set off the refund due to the petitioner on account of cross charges against the outstanding demand of tax on such account for the subsequent years.

Hence, this Special Leave Petition was filed before theApex Courtto decide on the following issues:

 (i)    Whether the assessee company and its service provider are related companies in terms of section 40A(2) of the Act?

(ii)  If the answer to the said question was to be in the affirmative, whether the allocation of cross charges was the correct test applied by the assessee? In other words, whether allocation of cross charges should be allowed or disallowed by the Department?

Held

TheApex Courtrelied on the concurrent finding of the authorities below that the two companies were unrelated companies within the meaning of section 40A(2). The Court found the entire exercise to be revenue neutral and therefore, dismissed the Department’s petition.

Comment

The Apex Court suggested amendments for consideration by the Finance Ministry in certain provisions like sections 40a(2) and 80-IA(10) to empower the AO to apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under the transfer pricing regulations to domestic transactions between related entities. The Court also capitulated on maintenance of books of accounts and other documents reflecting transactions between such entities and audit of such transactions by chartered accountants. The Court has reiterated the legal position regarding non-applicability of transfer pricing provisions to domestic transactions. The Court has also accepted that domestic transactions are by its nature revenue neutral. Therefore, the burden of proof would lay on the department to draw any conclusion the contrary.

The intent of the Supreme Court behind making this suggestion is to decrease the litigation relating to allowance and disallowance of expenditures and adjustment of incomes by providing a well defined price determination regime and bringing in objectivity to domestic transactions. However, experience relating to transfer pricing regulations in international transactions indicates to the contrary. The lack of comparables and uniqueness in the business of each company would only make the matter more complex and perhaps a rise in transfer pricing litigations relating to domestic transactions would become inevitable. In addition, it would also increase the compliance cost for the assessee and oversight cost for the department. The matter, therefore, requires a cost-benefit-analysis before taking any further steps. However, considering so many tax arbitrage avenues available to domestic units, one would be surprised why provisions similar to transfer pricing adjustments have not been put in place till date. From the Department’s point of view, this would provide level playing field to both domestic and transnational units and would also plug the leak of revenues from domestic entities.

Fraud on Client by Advocate is Criminal Contempt of Court

In B.N. Shivanna vs. Advanta India Limited and Another (2011) 4 SCC 216, the appellant had been working with the respondent company Advanta India Limited. The Company retained the appellant after he was enrolled as and advocate and joined the Bar. He used to report to the Company’s officials about the progress of cases pending before several courts in Karnataka.

The appellant designed a grand plan to make some quick money. He made the Company officials believe that some 500 hundred criminal cases have been filed against the Company and its officials before various subordinate courts in Karnataka for producing/selling spurious seeds. He also sent a policeman with forged summons/warrants to the head office of the Company. The appellant then advised the Company to file petitions before the Karnataka High Court for quashing these criminal proceedings. He got the Company to pay him Rs.10,000.00 towards court fees against each case apart from the miscellaneous expenses and his professional fees. This way he got some Rs.72 lakhs from the Company. To satisfy the Company of the outcome for the proceedings filed he forged an order of the High Court.

In due course the Company’s officials came to know that no fees were payable in criminal cases filed. They also came to know that no cases have been filed against the Company or them before the subordinate courts and that the order of the High Court was forged. The Company wrote a letter to the Registrar of the High Court. The High Court suo motu initiated criminal contempt proceedings and convicted the appellant sentencing him to undergo a simple imprisonment of six months and a fine of Rs.2000.00 and in default of payment of fine to undergo further simple imprisonment of one month.

Therefore, these appeals were filed before the Supreme Court. The appellant tried to take shelter behind technicalities. The apex Court relied on its decision in Amicus Curiae vs. Prashant Bhushan (2010) 7 SCC 592 and Bineet Kumar Singh, In re (2001) 5 SCC 501 to dismiss the appeals.

In Prashant Bhushan’s case the Court had held that in a rare case, even if the cognizance is deemed to have been taken in terms of the Supreme Court Rules, without the consent of the Attorney General or the Solicitor General, the proceedings must be held to be maintainable in view of the fact that the issue involved in the proceedings had far-reaching greater ramifications and impact on the administration of justice and on the justice delivery system and the credibility of the Court in the eyes of general public than what was under consideration before this Court in the earlier cases.

In P.N. Duda vs. P. Shiv Shanker (1988) 3 SCC 167, State of Kerala vs. M.S. Mani (2001) 8 SCC 82 and Bal Thackeray vs. Harish Pimpalkhute (2005) 1 SCC 254 the Court had stressed on the mandatory compliance with procedures to maintain a contempt proceeding. However in Prashant Bhushan’s and the present case the same has been done away with if the issue involved in the proceedings has far-reaching greater ramifications and impact on the administration of justice and on the justice delivery system and the credibility of the Court in the eyes of general public.

In the present case the apex Court has quoted itself from Bineet Kumar Singh case at pp.506-07, para 6 where the Court has explained the object of initiating the contempt proceeding:

“…The sole object of the court wielding its power to punish for contempt is always for the course of administration of justice. Nothing is more incumbent upon the courts of justice than to preserve their proceedings from being misinterpreted, nor is there anything more pernicious when the order of the court is forged and produced to gain undue advantage. Criminal contempt has been defined in Section 2(c) to mean interference with the administration of justice in any manner. A false or misleading or a wrong statement deliberately and willfully made by a party to the proceedings to obtain a favourable order would undoubtedly tantamount to interference with the due course of judicial proceedings. When a person is found to have utilized an order of a court which he or she knows to be incorrect for conferring benefit on persons who are not entitled to the same, the very utilisation of the fabricated order by the person concerned would be sufficient to hold him/her guilty of contempt, irrespective of the fact whether he or she himself or herself is the author of fabrication.”

Thus, an advocate as the officer of the court has been assigned with the duty to prevent the utilization of an incorrect or fabricated order (and as a consequence an incorrect or fabricated document too) which he knows to be incorrect. An advocate runs the risk of inviting contempt proceedings against himself if he knowingly utilizes an incorrect order even though he may not have authored that order. An advocate is also under an obligation of not to use an order which he believes or come to know is incorrect because it wrongly confers benefit on a person not entitled to including his client. Interestingly though this may create an ethical, moral and existential paradox for an advocate vis-à-vis his duty as an officer of the court and his duties towards his client. But in this case the morality and ethics should prevail over existential issues for the greater good.

The Child is Father of the Man

                        – William Wordsworth; The Rainbow

The Rainbow is a wonderful piece of poetry in which the child is depicted as her own father as the grown up person. But in law a child can not be her own father.

A body corporate (and its nominee) is prohibited from holding any share in its parent. Any allotment or transfer of shares in the holding company to the subsidiary is void.[1] However, the subsidiary can hold the shares in its parent as the legal representative of a deceased member or as a trustee (except where the holding or the subsidiary is the beneficiary under the trust or is not merely interested as the security holder in respect of the shares).[2] As the legal representative or the trustee, the subsidiary can exercise voting right at the meeting of the holding company in respect of these shares but in no other way.[3]

The subsidiary can, however, continue to be the member of the holding company in respect of the shares acquired before it became the subsidiary.[4] In case of holding company limited by guarantee or an unlimited company shareholding would include any other form of interest.[5]

Under the Income-tax Act, 1961 one of the pre-requisites of a valid ‘demerger’ is that in consideration of the demerger, the resulting company (i.e. the company in which the undertaking(s) is demerged) will issue its shares to the shareholders of the demerged company on a proportionate basis.[6]

The Income-tax Act, therefore, requires that the holding company will issue its shares to the subsidiary in the event an undertaking of the subsidiary of the first subsidiary is demerged into the holding company. Otherwise, the demerger will not be in compliance with the Income-tax Act. However, such issue of shares by holding to the subsidiary will be against the provisions of section 42 of the Companies Act, 1956. Can the law require it’s subject to do the impossible?

In re Himachal Telematics Ltd. and Himachal Futuristic Communications Ltd.[7], which involved the merger of two group companies, as a result of the merger, one company was to hold shares in its own holding company in violation of section 42 of the Companies Act and the other was to buy its own shares in violation of section 77 of the Companies Act. The single judge bench of the Delhi High Court held that even so the court can grant sanction to the scheme because the provisions relating to amalgamation etc. are in different part of the Companies Act than sections 42 and 77 which are concerned with incorporation matters and, therefore, they do not apply to matters of merger, etc. Further, the Court has, under sections 391 to 394 of the Companies Act, plenary as well as residuary powers to sanction a scheme and to provide for any statutory violation by suitable orders. The Court went on to discover the legislature’s intent conducive to the interest of the shareholders and therefore, removed the obstacle in the way.

Though, the decision of the Delhi High Court in the above case has invented a handy tool for structuring transactions, I am yet to reconcile with the reason of  the High Court. Section 42 falls in Part – II of the Companies Act dealing with ‘Incorporation of Company and Matters Incidental Thereto’ and it has been brought onto the statute book ‘to maintain the separate operational identity of a holding company and its subsidiary thereby to preserve the respective shareholders’ control over them. In the absence of any such provision, the affairs of a holding company and its subsidiary may, in the hands of unscrupulous company managers become inextricably involved and confused to the serious detriment of shareholders.’[8] Section 42 lays down a condition precedent to the grant of certificate of incorporation and is required to be maintained at all times during the existence of the company. It is difficult to understand that sections 391 to 394 would provide an instrument to the shareholders to do a thing strictly prohibited at the time of incorporation. Moreover, as the law does not expect us to do the impossible, similarly, it is not supposed to give us a tool going against its own reason to overcome a hurdle.

 

---

[1] Sub-section (1) and (4) of section 42 of the Companies Act, 1956

[2] Sub-section (2), (supra)

[3] Sub-section (3), (supra)

[4] Sub-section (3), (supra)

[5] Sub-section (5), (supra)

[6] Sub-section (19AA) of section 2 of the Income-tax Act, 1961

[7] (1996) 86 Comp Cas 325 (Del)

[8]Pg.649, A. Ramaiya, Guide to the Companies Act, 17^th edn 2010.

Article 227 : No Magic Wand

In the case of Shalini Shyam Shetty & Anr. vs. Rajendra Shankar Patil [(2010) 8 SCC 329], Justice A. K. Ganguly  writing the judgment for himself and Justice G. S. Singhvi observed: [the Supreme] Court unfortunately discerns that of late there is a growing trend amongst several High Courts to entertain writ petition in cases of pure property disputes. Disputes relating to partition suits, matters relating to execution of a decree, in cases of dispute between landlord and tenant and also in a case of money decree and in various other cases where disputed questions of property are involved, writ courts are entertaining such disputes. In some cases High Courts, in a routine manner, entertain petition under Article 227 over such disputes and such petitions are treated as writ petitions.

The Court observed that “…This is sought to be justified on an erroneous appreciation of the ratio in Surya Dev Rai vs. Ram Chander Rai and others [(2003) 6 SCC 675] and in view of the recent amendment to Section 115 of the Civil Procedure Code by Civil Procedure Code (Amendment) Act, 1999. It is urged that as a result of the amendment, scope of Section 115 of CPC has been curtailed. In our view, even if the scope of Section 115 CPC is curtailed that has not resulted in expanding High Court’s power of superintendence. It is too well known to be reiterated that in exercising its jurisdiction, High Court must follow the regime of law.

As a result of frequent interference by Hon’ble High Court either under Article 226 or 227 of the Constitution with pending civil and at times criminal cases, the disposal of cases by the civil and criminal courts gets further impeded and thus causing serious problems in the administration of justice.”

The Case

The present case was one of a pure dispute between landlord and tenant both of whom were private parties, the High Court entertained a writ petition under Article 226 and Article 227 of the Constitution of India.  The High Court did not pass any order on the writ petition, inter alia, on the ground that there were concurrent findings of fact. If the findings had not been concurrent, the High Court might have interfered. However, the High Court did not hold that a writ petition is not maintainable in a dispute between landlord and tenant in which both are private parties and the dispute is of civil nature.

An appeal has been filed by the original defendant before the Supreme Court challenging the judgment and order of the Bombay High Court rendered in the writ petition.

Submission

It was urged before the Supreme Court that petitions under Article 227 of the Constitution are filed against orders of Civil Court and even in disputes between landlord and tenant. Under the Bombay High Court Rules, such petitions are called writ petitions.

Held

The Supreme Court held that “[No] writ petition can be moved under Article 227 of the Constitution nor can a writ be issued under Article 227 of the Constitution. Therefore, a petition filed under Article 227 of the Constitution cannot be called a writ petition. This is clearly the constitutional position. No rule of any High Court can amend or alter this clear constitutional scheme. In fact the rules of Bombay High Court have not done that and proceedings under Articles 226 and 227 have been separately dealt with under the said rules.”

The apex Court also observed that to a proceeding under Article 227 of the Constitution only the appellate side rules of the Bombay High Court apply. But to a proceeding under Article 226, either the original side or the appellate side rules, depending on the situs of the cause of action, will apply. Therefore, High Court rules treat the two proceedings differently in as much as a proceeding under Article 226, being an original proceeding can be governed under Original Side Rules of the High Court, depending on the situs of the cause of action. A proceeding under Article 227 of the Constitution is never an original proceeding and can never be governed under Original Side Rules of the High Court.

The Court further observed that writ proceeding by its very nature is a different species of proceeding. Writs can be issued by High Courts only under Article 226 of the Constitution and by the Supreme Court only under Article 32 of the Constitution.

The history of Article 227 has also been traced by the Supreme Court in its Constitutional Bench judgment in Waryam Singh and another vs. Amarnath and another [AIR 1954 SC 215]. This Court observed: “…The only question raised is as to the nature of the power of superintendence conferred by the article. … This power of superintendence conferred by article 227 is to be exercised most sparingly and only in appropriate cases in order to keep the Subordinate Courts within the bounds of their authority and not for correcting mere errors. … Though this Court has a right to interfere with decisions of Courts and tribunals under its power of superintendence, it appears to me that that right must be exercised most sparingly and only in appropriate cases. … Article 227 of the Constitution does not vest the High Court with limitless power which may be exercised at the Court’s discretion to remove the hardship of particular decisions. The power of superintendence, it confers, is a power of a known and well-recognised character and should be exercised on those judicial principles which give it its character. In general words, the High Court’s power of superintendence is a power to keep subordinate Courts within the bounds of their authority, to see that they do what their duty requires and that they do it in a legal manner. … …Superintendence is not a legal fiction whereby a High Court Judge is vested with omnipotence but is a term having a legal force and signification. The general superintendence which this Court has over all jurisdiction subject to appeal is a duty to keep them within the bounds of their authority, to see that they do what their duty requires and that they do it in a legal manner. It does not involve responsibility for the correctness of their decisions, either in fact or law. … The power of superintendence is not to be exercised unless there has been an (a) unwarranted assumption of jurisdiction, not vested in Court or tribunal, or (b) gross abuse of jurisdiction, or (c) an unjustifiable refusal to exercise jurisdiction vested in Courts or tribunals. … if only there is a flagrant abuse of the elementary principles of justice or a manifest error of law patent on the face of the record or an outrageous miscarriage of justice, power of superintendence can be exercised. This is a discretionary power to be exercised by Court and cannot be claimed as a matter or right by a party.

“In exercise of its jurisdiction under Article 227, the High Court can set aside or reverse finding of an inferior Court or tribunal only in a case where there is no evidence or where no reasonable person could possibly have come to the conclusion which the Court or tribunal has come to. This Court made it clear that except to this `limited extent’ the High Court has no jurisdiction to interfere with the findings of fact. … The High Court, under Article 227, cannot assume unlimited prerogative to correct all species of hardship or wrong decisions. Its exercise must be restricted to grave dereliction of duty and flagrant abuse of fundamental principle of law and justice.”

The Supreme Court goes on to quote the ‘Principles of Interference’ by the High Court under Article 227 laid down in Surya Dev Rai vs. Ram Chander Rai and others:

“… (4) Supervisory jurisdiction under Article 227 of the Constitution is exercised for keeping the subordinate courts within the bounds of their jurisdiction. When a subordinate Court has assumed a jurisdiction which it does not have or has failed to exercise a jurisdiction which it does have or the jurisdiction though available is being exercised by the Court in a manner not permitted by law and failure of justice or grave injustice has occasioned thereby, the High Court may step in to exercise its supervisory jurisdiction.

…(5) Be it a writ of certiorari or the exercise of supervisory jurisdiction, none is available to correct mere errors of fact or of law unless the following requirements are satisfied: (i) the error is manifest and apparent on the face of the proceedings such as when it is based on clear ignorance or utter disregard of the provisions of law, and (ii) a grave injustice or gross failure of justice has occasioned thereby.

…(7) The power to issue a writ of certiorari and the supervisory jurisdiction are to be exercised sparingly and only in appropriate cases where the judicial conscience of the High Court dictates it to act lest a gross failure of justice or grave injustice should occasion. Care, caution and circumspection need to be exercised, when any of the above said two jurisdictions is sought to be invoked during the pendency of any suit or proceedings in a subordinate court and the error though calling for correction is yet capable of being corrected at the conclusion of the proceedings in an appeal or revision preferred there against and entertaining a petition invoking certiorari or supervisory jurisdiction of the High Court would obstruct the smooth flow and/or early disposal of the suit or proceedings. The High Court may feel inclined to intervene where the error is such, as, if not corrected at that very moment, may become incapable of correction at a later stage and refusal to intervene would result in travesty of justice or where such refusal itself would result in prolonging of the lis.

…(8) The High Court in exercise of certiorari or supervisory jurisdiction will not covert itself into a Court of Appeal and indulge in re-appreciation or evaluation of evidence or correct errors in drawing inferences or correct errors of mere formal or technical character. …”

The jurisdiction under Article 227 on the other hand is not original nor is it appellate. This jurisdiction of superintendence under Article 227 is for both administrative and judicial superintendence. Under Article 226, the High Court normally annuls or quashes an order or proceeding but in exercise of its jurisdiction under Article 227, the High Court, apart from annulling the proceeding, can also substitute the impugned order by the order which the inferior tribunal should have made.

Jurisdiction under Article 226 normally is exercised where a party is affected but power under Article 227 can be exercised by the High Court suo motu as a custodian of justice. In fact, the power under Article 226 is exercised in favour of persons or citizens for vindication of their fundamental rights or other statutory rights. Jurisdiction under Article 227 is exercised by the High Court for vindication of its position as the highest judicial authority in the State. In certain cases where there is infringement of fundamental right, the relief under Article 226 of the Constitution can be claimed ex-debito justicia or as a matter of right. But in cases where the High Court exercises its jurisdiction under Article 227, such exercise is entirely discretionary and no person can claim it as a matter of right.

Conclusion

In the light of above discussion, the Apex Court formulated a 15 point principle on the exercise of High Court’s jurisdiction under Article 227. The Court inter alia held that in cases of property rights and in disputes between private individuals writ court should not interfere unless there is any infraction of statute or it can be shown, that a private individual is acting in collusion with a statutory authority.

According to the author, the Supreme Court’s observations in the present case assumes even greater importance in the present environ when the reputation of the Indian judiciary is at stake. The current practice of the Bombay High Court in relation to Article 227 is disapprobable for the following reasons:

(a)     Judges allow indiscriminate use of Article 227 because it is painful to decide a case within the strict framework of general laws and practice (as opposed to the supposedly inherent power of a High Court under the Constitution) as it requires greater knowledge and effort to apply the general law;

(b)     The instrument of article 227 can be misused by a corrupt system of lawyers and judges to circumvent the law;

(c)      The above practice is against the will and intent of the Parliament in the sense that it is being used to revive a practice that Parliament intended to end by amending section 115 of the CPC;

(d)     The practice is in contempt of the decisions of the Supreme Court;

(e)     It deprives the exchequer of revenues which it would have earned by way of court fees in case of a suit or similar proceeding; and

(f)       It is unfair to other litigants as it delays disposal of their cases and distorts the process of administration of justice.

Revisiting the Recital Clause in an ICD Document

A typical recital clause of an inter-corporate deposit document would read like this:

WHEREAS

A.     The borrower is engaged in the business of inter alia, trading goods and products, selling agents of petroleum and petroleum products as authorized by its object clause of its memorandum of association.

B.     The borrower urgently requires a sum of Rupees three crores only for its business purposes and has approached the lender for an inter-corporate deposit facility of a principal amount of Rupees three crores only from the lender which the lender has agreed to.

C.     The borrower and lender thus desire to record such agreement for the grant of the facility by the lender to the borrower upon the terms and subject to the conditions as stated hereinafter and on the basis of the representations and warranties, covenants and undertakings made by the parties to each other and recorded herein.

In the above recital we note the following:

(i)                The borrower is in need of money.

(ii)              The borrower, thus, approaches the lender with a proposal to deposit the requisite sum with it.

(iii)            The lender deposits the sum with the borrower at the agreed terms and conditions.

When would we like to make a deposit of a sum with a bank or any other entity and what do we do then? We would like to make deposit of a sum with a bank etc. when we have extra fund. In such an event, we would go to a bank etc. and make a request to them to accept the sum as deposit for agreed terms and conditions, which will invariably be the standard terms and conditions applicable to all without any concessions.

In Pennwalt India Ltd and Others v. ROC, Maharashtra and Others ((1987) 62 Comp Cas 112) the appellant company had deposited amount exceeding 30% of its subscribed capital and free reserves with various public companies without taking prior approval of the shareholders by passing a special resolution under section 370(1)(a) of the Companies Act, 1956 (“the Act”). In the above case the Bombay High Court held that the dividing line between a loan and a deposit is undoubtedly thin: the two, however, are not synonymous. It may not be possible to interchange the terms “loan” and “deposit” under the Act unless there is an express provision to that effect or the context makes it clear that the terms are interchangeable. Both in the case of a loan and a deposit there is a relationship of a debtor and a creditor between the party giving money and the party receiving money.  But in case of a deposit, the delivery of money is usually at the instance of the giver and it is for the benefit of the person who deposits the money. In the case of a loan, however, it is the borrower at whose instance and for whose needs the money is advanced. Ordinarily, though not always, in the case of a deposit, it is the depositor who is the prime mover while in the case of a loan, it is the borrower who is the prime mover. The other more important distinction is in relation to the obligation to return the amount so received. In the case of a deposit which is payable on demand, the deposit would become payable when a demand is made. In the case of a loan, however, the obligation to repay the amount arises immediately on the receipt of the loan. It is possible that in the case of deposits which are for a fixed period or loans which are for a fixed period, the point of repayment may arise in a different manner. But, by and large, the transaction of a loan and the transaction of making deposit are not always considered identical. The nature of the two is somewhat different and that is the reason why a distinction is made between the two for the purpose of calculating the period of limitation.

On the basis of the above ratio, the High Court held, allowing the appeal, that as non-compliance section 370 of the Act involved penal consequences, it could not be given an interpretation wider than that warranted by the actual words. Without any provision to that effect, the word “loan” as used in section 370 could not be given a wider interpretation so as to include deposits.

The present provision in the Act dealing with inter-corporate loans and investments is section 372A, which was inserted by the Companies (Amendment) Act, 1999. The present provision is similarly worded and requires that prior approval of the shareholders shall be obtained by passing a special resolution, in the event a company makes any “loan” to any other body corporate exceeding 60% of its paid-up share capital and free reserves. A non-compliance of the section is punishable with imprisonment and fine. Therefore, the ratio of the Bombay High Court’s judgment in Pennwalt India still holds the ground.

Therefore, making of inter-corporate deposits is still out of the purview of section 372A of the Act which requires special resolution to be obtained by the company in certain circumstances. However, by way of abundant caution, it is suggested that the recital and other operative clauses of an inter-corporate deposit agreement should be drafted in a manner to achieve the above legal distinction between loan and deposit, e.g., “…the lender is interested in placing its funds as deposits with the borrower (for whatever reason) to which the borrower has agreed (because it needs the funds for its business etc.)…”

However, the above may not give any respite from tax liability on interest earned by the company on the inter-corporate deposits. In Bajaj Auto Holdings Ltd v. Dy. CIT ((2006) 281 ITR (AT) 154 (Mumbai)) the Mumbai bench of the Income-tax Appellate Tribunal held that the scope of section 2(7) of the Interest-tax Act, 1974 is enlarged so as to include interest not only on loans, but also advances. There is no specific provision in the Interest-tax Act, which grants exemption in respect of interest on inter-corporate deposits. Thus it was held that interest-tax is leviable on the interest income earned by the company on inter-corporate deposits.