Delhi High Court
Case BriefsHigh Courts

   

Delhi High Court: In a case, where petition was filed by a son against the assessment order and the notice for initiating scrutiny proceedings under the Income Tax Act, 1961 (Act) issued in the name of his deceased father, the Division Bench of Manmohan and Manmeet Pritam Singh Arora, JJ. held that the order and notices issued in the name of the deceased assessee were null and void and the scrutiny proceedings in the name of the deceased assessee without bringing on record all his legal heirs was declared to be wrongly conducted.

Background

The petitioner was the son of Late Virendra Kumar Bhatnagar (deceased assessee) who died on 10-03-2018 and upon demise of the deceased assessee, the petitioner filed an application for registration as a legal representative of the deceased assessee in the records of the Income Tax Department (ITD). The said application was accepted, and the petitioner filed an Income Tax Return (ITR) of the deceased assessee for assessment year (AY) 2018-2019 in the capacity as his legal representative. In the ITR, it was verified and declared that the ITR had been filed by the petitioner in his capacity as a representative of the deceased assessee. In 2019, a statutory notice was issued in the name of the deceased assessee under Section 143(2) of the Act by the Assessing Officer (AO) for the AY under consideration for limited scrutiny.

Submission on behalf of the Petitioner

Counsel for the petitioner contended that the said notice suffered from a fundamental jurisdictional error as it was issued in the name of a dead person and scrutiny proceedings were proposed in the case of a dead person. Further, the said notice had neither mentioned the name of the legal heirs nor the PAN of the said legal heirs and the AO had not taken any step to bring together all the legal heirs of the deceased assessee on record at the time of issuance of the notice.

In 2021, two more notices were issued by the AO in which even though the name of the deceased assessee was mentioned, the AO had added a suffix “through legal heir Vikram Bhatnagar”. Counsel contended that such an amendment was impermissible and adding a suffix could not cure the fundamental defect of not issuing notice to all the legal heirs of the deceased assessee.

Further, it was submitted that the AO concluded the assessment proceedings and passed the consequential assessment in September 2021 in the name of the deceased assessee bearing his PAN. The assessment had been completed for the complete financial year (FY) 2017-2018, irrespective of the fact that the deceased assessee expired on 10-03-2018 and the relevant period of previous year for assessment was from 1-04-2017 to 10-3-2018 and not the complete year.

Therefore, it was submitted that the notice issued in 2018 under Section 143(2) of the Act was in the name of the deceased assessee and bearing his PAN, without bringing on record the legal heirs of the deceased assessee, the consequential order passed in 2021 under Section 143(3) for the complete FY 2017-2018 and the accompanying notices of demand and penalty issued under Sections 156 and 270(A) of the Act respectively, were illegal and without jurisdiction.

Submission on behalf of the Respondent

Counsel for the Respondent submitted that there was no dispute in facts and agreed that the notice and the assessment order had been issued in the name of the deceased assessee and for the PAN of the said assessee.

Analysis, Law, and Decision

In relation to the issue of validity of the notice issued against a dead person and the validity of the proceedings held subsequent thereto, the Court relied on Savita Kapila v. CIT, 2020 SCC OnLine Del 2540, where this Court held that:

  1. The sine qua non for acquiring jurisdiction to reopen an assessment was that such notice should be issued in the name of the correct person. This requirement of issuing notice to a correct person and not to a dead person was not merely a procedural requirement but was a condition precedent to the impugned notice being valid in law.

  2. A notice issued against a dead person was invalid unless the legal representative submits to the jurisdiction of the AO without raising any objection. Therefore, notice issued in the name of the deceased assessee was null and void.

The Court noted that the death of the assessee was communicated by the petitioner and the ITR also disclosed that the same had been filed by the petitioner in his capacity of a legal representative of the deceased assessee. Hence, the Court opined that the scrutiny proceedings had been wrongly conducted in the name of the deceased assessee without bringing on record all his legal heirs as per the requirement of the law.

The Court held that the jurisdictional notice was issued against the dead person and the assessment order had also been passed against the dead person on his PAN without bringing on record all his legal representatives, therefore, the said assessment order and the subsequent notices were null and void and hence, were set aside.

[Vikram Bhatnagar v. Assistant Commissioner of Income Tax, 2022 SCC OnLine Del 3899, decided on 9-11-2022]


Advocates who appeared in this case :

For the Petitioner: Advocate Rohit Jain;

Advocate Aniket D. Agrawal;

Advocate Mansha Sharma;

For the Respondent(s): Senior Standing Counsel Ajit Sharma;

Advocate A. Renganath.

Ministry of Finance
Legislation UpdatesStatutes/Bills/Ordinances

   

On 16-9-2022 the CBDT has issued revised guidelines for compounding of offence under the Income-Tax Act, 1961 to simplify and facilitate compounding of offences under Income Tax Act, 1961 with reference to various offences covered under the prosecution provisions of the Act.

Key Points:

  • Offence punishable under Section 276 of IT Act, 1961 have been made compoundable. Section 276 deals with Removal, concealment, transfer or delivery of property to thwart tax recovery.

  • Offence under Direct Taxes Laws where case of an applicant, who has convicted earlier with imprisonment for less than two years being previously non-compoundable has now been made compoundable.

  • Relaxation of time: Time limit for acceptance of compounding application has been relaxed with the approval of Chief Commissioner of Income Tax from the earlier limit of 24 months to 36 months now. In such cases where relaxation has been provided compounding charges would be @1.5 times more than the normal compounding charges.

  • Complexity in procedure has been simplified now by intimating the applicant that the application is found acceptable or non-acceptable along with compounding charges.

  • Compounding charges for failure to pay Tax Deducted at Source (TDS) and Tax Collected at Source (TCS) @2% per month up to 3 months and 3% per month beyond 3 months have been reduced to 1% and 2% respectively.


*Disha Srivastava, Publication Assistant has reported this brief.

Legal RoundUpLegislation Roundup

   

MINISTRY OF CORPORATE AFFAIRS

Record keeping requirements modified vide Companies (Accounts) Fourth Amendment Rules, 2022

On 05-08-2022, the Ministry of Corporate Affairs (MCA) has notified Companies (Accounts) Fourth Amendment Rules, 2022 in order to amend the Companies (Accounts) Rules, 2014. The amendments have been made in the provision relating to ‘Manner of books of account to be kept in electronic mode'.

READ MORE

Physical verification of the Registered Office of the company by Registrar vide Companies (Incorporation) Third Amendment Rules, 2022

The Central Government notifies Companies (Incorporation) Third Amendment Rules, 2022 to amend the Companies (Incorporation) Rules, 2014.

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MINISTRY OF CONSUMER AFFAIRS, FOOD AND PUBLIC DISTRIBUTION

Commodities like garment or hosiery included in the exemption list vide Legal Metrology (Packaged Commodities) (Third Amendment) Rules, 2022

On 22-08-2022 , the Ministry of Consumer Affairs, Food and Public Distribution notified the Legal Metrology (Packaged Commodities) (Third Amendment) Rules, 2022 in order to amend Legal Metrology (Packaged Commodities) Rules, 2011.

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MINISTRY OF LAW AND JUSTICE

Indian Antarctic Act, 2022

On 8-8-2022 the Ministry of Law and Justice notified Indian Antarctic Act, 2022 to define Antarctic environment, Indian expedition etc. The Act give effect to the Antarctic Treaty, Conservation of Antarctic Marine Living Resources, and the protocol on Environmental Protection to the Antarctic Treaty. It shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint.

READ MORE

Establishment of Family Courts in Himachal Pradesh and Nagaland vide the Family Courts (Amendment) Act, 2022

On 12-8-2022 the Ministry of Law and Justice notified the Family Courts (Amendment) Act, 2022 to further amend the Family Courts Act, 1984.

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Constitution of National Board for Anti-Doping Agency vide National Anti-Doping Act, 2022

On 12-8-2022 the Ministry of Law and Justice notified the National Anti-Doping Act, 2022 to define Anti-Doping rule violation, athlete support personnel, National Sport Federation etc. The Act provides for constituting National Board for Anti-Doping Agency (‘NADA’) as a statutory body headed by a Director General appointed by the Central Government. It shall come into force on such a date as the Central Government may, by notification in the Official Gazette, appoint.

READ MORE

Retired CJI & Retired Judges of the Supreme Court entitled to a security cover vide Supreme Court Judges (Amendment) Rules, 2022

The Central Government has notified Supreme Court Judges (Amendment) Rules, 2022 further to amend the Supreme Court Judges Rules, 1959. The Amendment inserts a proviso to rule 3 B, stating that the chauffeur (equivalent to the level of Chauffer in the Supreme Court) and secretarial assistant (equivalent to the level of the Branch Officer in the Supreme Court) must be deployed with a retired Chief Justice and a retired Judge of Supreme Court for a period of one year.

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Supreme Court Judges (Amendment) Rules, 2022: Lifetime domestic help, chauffeur & secretarial assistant for Retired CJI and SC Judges

On 27-08-2022, the Central Government Supreme Court Judges (Amendment) Rules, 2022 to further amend the Supreme Court Judges Rules, 1959.

READ MORE

MINISTRY OF ENVIRONMENT, FOREST AND CLIMATE CHANGE

Battery Waste Management Rule, 2022

On 22-08-2022, Ministry of Environment, Forest and Climate Change has notified Battery Waste Management Rule, 2022 for management of waste, produced by batteries in the environment. The Rules will replace Batteries (Management and Handling) Rules, 2001.

READ MORE

Cabinet approves signing of an MoU between India and Nepal in the field of biodiversity conservation

The Union Cabinet has approved the proposal of the Ministry of Environment, Forest and Climate Change for signing an MoU with the Government of Nepal on biodiversity conservation, with a view to strengthen and enhance the coordination and cooperation in the field of forests, wildlife, environment, biodiversity conservation and climate change.

READ MORE

MINISTRY OF FINANCE

GSTN introduces single click Nil filing of GSTR-1

On 02-08-2022, the Goods and Service Tax Network has introduced a Single click Nil filing of GSTR-1 on the GSTN portal in order to improve the user experience and performance of GSTR-1/IFF filing. Taxpayers can now file NIL GSTR-1 return by simply ticking the checkbox File NIL GSTR-1 available on the GSTR-1 dashboard.

READ MORE

CBDT notifies submission of COVID-19 related documents by the employees to the employer

This notification shall be deemed to have come into force from the 1st day of April, 2020 and shall apply in relation to the assessment year 2020-2021 and subsequent assessment years.

READ MORE

Aircraft Operators to share international passenger data with National Customs Targeting Centre-Passenger vide Passenger Name Record Information Regulations, 2022

On 08-08-2022, the Central Board of Indirect Taxes and Customs has published the Passenger Name Record Information Regulations, 2022 which deals with collection of data of international passenger from aircraft operators for risk analysis for the purpose of prevention, detection, investigation and prosecution of offences.

READ MORE

CBDT exempts non-resident from the purview of S. 206C(1G) of IT Act, 1961

The Central Government has notified that the provisions of section 206-C (IG) of the Income Tax Act, 1961 shall not apply to a person (being a buyer) who is a non-resident in terms of section 6 of the Act and who does not have a permanent establishment in India.

READ MORE

New Form 29D introduced for Application by a person under S. 239A of the IT Act, 1961 vide Income-tax (26th Amendment) Rules, 2022

The Central Board of Direct Taxes has notified Income-tax (26th Amendment) Rules, 2022 to amend Income-tax Rules, 1962.

READ MORE

MINISTRY OF RAILWAYS

Ministry of Railways issues guidelines for implementation of GST implications on recovery of liquidated damages

On 10-08-2022, the Ministry of Railways has issued guidelines for implementation of Goods and Service Tax (‘GST’) implications on recovery of liquidated damages which were given by the Central Board of Indirect Taxes and Customs (‘CBIC’) vide circular dated 03-08-2022.

READ MORE

MINISTRY OF ROAD TRANSPORT AND HIGHWAYS

Central Motor Vehicles (Twelfth Amendment) Rules, 2022

The Central Government has notified Central Motor Vehicles (Twelfth Amendment) Rules, 2022 to amend the Central Motor Vehicles Rules, 1989.

READ MORE

MINISTRY OF PETROLEUM AND NATURAL GAS

Annual Charges for Clearing Corporations revised vide PNGRB (Levy of Fee and Other Charges) Amendment Regulations, 2022

On 02-08-2022 the Petroleum and Natural Gas Regulatory Board has notified PNGRB (Levy of Fee and Other Charges) Amendment Regulations, 2022 in order to amend Petroleum and Natural Gas Regulatory Board (Levy of Fee and Other Charges) Regulations, 2007.

READ MORE

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

Sponsors which invest in various companies on behalf of the beneficiaries of insurance policies excluded from the definition of ‘Associate' vide SEBI (Mutual Funds) (Second Amendment) Regulations, 2022

The Securities and Exchange Board of India has made SEBI (Mutual Funds) (Second Amendment) Regulations, 2022 to further amend the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. They shall come into force on the thirtieth day from the date of their publication in the Official Gazette.

READ MORE

SEBI issues Circular on enhanced guidelines for debenture trustees and listed issuer companies on security creation and initial due diligence

On 04-08-2022, the Securities and Exchange Board of India (‘SEBI') issued enhanced guidelines for debenture trustees and listed issuer companies on security creation and initial due diligence to protect the interest of investors in securities and to promote the development of and to regulate the securities market.

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SEBI makes Block mechanism mandatory for all Early Pay-In transactions

On 18-08-2022, SEBI has issued a circular on making the facility of block mechanism mandatory for all Early Pay — In transactions by making amendments in circular no. CIR/HO/MIRSD/DOP/P/CIR/2021/595 dated July 16, 2021.

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SEBI issues circular on participation of financial account aggregators in Account Aggregator framework

On 19-08-2022, SEBI has issued a circular on participation of financial account aggregators in Account Aggregator framework. The Account Aggregators (AAs) framework is introduced by the Reserve Bank of India (RBI) for the easy availability of information and data as required. Account Aggregators (non-banking financial companies) are the one who collect and share data in the securities market.

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SEBI amends SEBI (CRA) Regulations, 1999; allowing disclosures to be used in fair assessment of Credit Rating Agencies

On 25-08-2022, the Securities and Exchange Board of India (‘SEBI’) has issued a circular on Enhanced Disclosures by Credit Rating Agencies (‘CRA’) and Norms on Rating Withdrawal amending the SEBI (Credit Rating Agencies) Regulations, 1999, to protect the interest of investors in securities and to promote the development of, and to regulate, the securities market by enhancing transparency.

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RESERVE BANK OF INDIA (RBI)

RBI increases Individual borrowing limit of USD 750 million to USD 1500 million vide FEM (Borrowing and Lending) (Amendment) Regulations, 2022

On 28-07-2022, the Reserve Bank of India (RBI) has issued Foreign Exchange Management (Borrowing and Lending) (Third Amendment) Regulations, 2022 to further amend the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018.The amendment temporarily increases individual borrowing limit of USD 750 million or equivalent per financial year to USD 1500 million or equivalent.

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RBI issues Master Circular- Credit facilities to Scheduled Castes & Scheduled Tribes

On 01-08-2022, the Reserve Bank of India (‘RBI’) issued Master Circular — Credit facilities to Scheduled Castes (‘SC’) & Scheduled Tribes (‘ST’) to help the SCs/ STs by increasing self-employment, generate income to make themselves self- liquidating and help in easy loan sanctioning. The Master Circular consolidates the circulars issued by RBI on the subject till date.

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RBI issues Master Circular on Credit Facilities to Minority Community

On 02-08-2022, the Reserve Bank of India (‘RBI’) issued Master Circular on Credit Facilities to Minority Communities, consolidating all circulars issued on the subject till date. It lays out details about the credit facilities available to the minority communities, and how the same has to be made available to them.

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RBI notifies change in Bank Rate

On 05-08-2022, the Reserve Bank of India has issued a notification regarding the change in the bank rate. The Bank Rate is revised upwards by 50 basis points from 5.15 per cent to 5.65 per cent. This shall come into force with immediate effect.

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RBI amends Gold Monetization Scheme, 2015; Guidelines issued for Renewal/ Redemption of Medium and Long-Term Government Deposit

On 04-08-2022, the Reserve of India (‘RBI’) amended the RBI (Gold Monetization Scheme, 2015) with immediate effect.

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RBI issues Overseas Direct Investment vide FEM (Overseas Investment) Regulations, 2022

On 22-08-2022, the Reserve Bank of India (‘RBI') has issued the Foreign Exchange Management (Overseas Investment) Regulations, 2022 to facilitate business between Indian and foreign entities.

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Case BriefsSupreme Court

Supreme Court: In the case where the Revenue had challenged Bombay High Court’s judgment affirming Income Tax Appellate Tribunal (ITAT)’s order for writing off assessee’s ₹ 10 crores as a bad debt, the 3-judge bench of UU Lalit, S. Ravindra Bhat* and Sudhanshu Dhulia, JJ has summarised the law on writing off a bad debt and has held that merely stating a bad and doubtful debt as an irrecoverable write off without the appropriate treatment in the accounts, as well as non-compliance with the conditions in Section 36(1)(vii), 36(2), and Explanation to Section 36(1)(vii) of the Income Tax Act, 1961 would not entitle the assessee to claim a deduction.

The Court explained that before the amendment in 1989, the law was that even in cases where the assessee had made only a provision in its accounts for bad debts and interest thereon, without the amount actually being debited from the assessee’s Profit and Loss account, the assessee could still claim deduction under Section 36(1)(vii) of the Act. With effect from 1 April 1989, with the insertion of the new Explanation under Section 36(1)(vii), any bad debt written-off as irrecoverable in the account of the assessee would not include any ‘provision’ for bad and doubtful debt made in the accounts of the assessee. In other words, before this date, even a provision could be treated as a write off. However, after this date, the Explanation to Section 36(1)(vii) brought about a change. As a result, a mere provision for bad debt per se was not entitled to deduction under Section 36(1)(vii).

After going through the scheme of the Act and various authorities of the Supreme Court, the Court summarised the following points:

(i) The amount of any bad debt or part thereof has to be written-off as irrecoverable in the accounts of the assessee for the previous year;

(ii) Such bad debt or part of it written-off as irrecoverable in the accounts of the assessee cannot include any provision for bad and doubtful debts made in the accounts of the assessee;

(iii) No deduction is allowable unless the debt or part of it “has been taken into account in computing the income of the assessee of the previous year in which the amount of such debt or part thereof is written off or of an earlier previous year”, or represents money lent in the ordinary course of the business of banking or money-lending which is carried on by the assessee;

(iv) The assessee is obliged to prove to the AO that the case satisfies the ingredients of Section 36(1)(vii) as well as Section 36(2) of the Income Tax Act, 1961.

Coming to the facts of the case, the assessee had contended that an amount of ₹ 10 crores was deposited with one M/s C. Bhansali Developers Pvt. Ltd. towards acquisition of commercial premises in 2007. It was contended that the project did not appear to make any progress, and consequently, the assessee sought return of the amounts from the builder. When the latter did not respond, the assessee resolved to write off the amount as a bad debt in 2009. It was also contended that the amount could also be construed as a loan, since the assessee had ‘financing’ as one of its objects.

The Assessing Officer as well as the Appellate Commissioner of Income Tax [CIT(A)] had disallowed the sum of ₹ 10 crores claimed as a bad debt in determining its income under “Profits and Gains of Business or Profession”. The ITAT, however, allowed the assessee’s plea.

The Court noticed that there was nothing on record to suggest that the requirement of the law that the bad debt was written-off as irrecoverable in the assessee’s accounts for the previous year had been satisfied. Another reason why the amount could not have been written-off, was that the assessee’s claim was that it was given to M/s Bhansali Developers Pvt. Ltd. for acquiring immovable property – it therefore, was in the nature of a capital expenditure. It could not have been treated as a business expenditure.

Hence, it was held that the assessee’s claim for deduction of ₹ 10 crore as a bad and doubtful debt could not have been allowed. The findings of the ITAT and the High Court, to the contrary, are therefore, insubstantial and have to be set aside.

[CIT v. Khyati Realtors Pvt Ltd, 2022 SCC OnLine SC 1082, decided on 25.08.2022]


*Judgment by: Justice S Ravindra Bhat


For Petitioner(s): ASG N. Venkataraman, Advocate H. Raghavendra Rao and AOR Raj Bahadur Yadav

For Respondent(s): AOR Kavita Jha and Advocate Aditeya Bali

Case BriefsSupreme Court

Supreme Court: Dealing with an important question relating to appellate jurisdiction of the High Courts under Section 260A of the Income Tax Act, 1961 (the Act) against judgments of Income Tax Appellate Tribunals (ITAT), the bench of UU Lalit, S. Ravindra Bhat and PS Narasimha*, JJ has held that appeals against every decision of the ITAT shall lie only before the High Court within whose jurisdiction the Assessing Officer who passed the assessment order is situated.

Interestingly, Section 260A is open-textual and does not specify the High Court before which an appeal would lie in cases where Tribunals operated for plurality of States. Hence, as Benches of the ITAT are constituted to exercise jurisdiction over more than one state, each state having a separate High Court, question arose as to which of the High Court is the appropriate Court for filing appeals under Section 260A. The Supreme Court observed that the decision of the High Court of Delhi in the case of Seth Banarsi Dass Gupta v. Commissioner of Income Tax, 1978 SCC OnLine Del 43, wherein it was held that the appropriate High Court would be the one where the Assessing Authority is situated, continuous to hold the field.

However, due to a difference of opinion between the Punjab and Haryana High Court and the Delhi High Court, a further question arose before the Supreme Court relating to the jurisdiction of the High Court consequent upon administrative order of transfer of a ‘case’ under Section 127 of the Act from one Assessing Authority to another Assessing Officer located in a different State.

The Punjab & Haryana High Court took the view that such a transfer would not change the principle laid down in Seth Banarasi Dass Gupta. However, the Delhi High Court in CIT v. Sahara India Financial Corporation Ltd, 2007 SCC OnLine Del 1762 and CIT v. Aar Bee Industries Ltd, 2013 SCC OnLine Del 2356 has held that an administrative order of transfer of cases will also have the consequence of transferring even the jurisdiction of the High Court.

The Supreme Court, however, reversed the judgments of Delhi High Court on this aspect and held that the appellate jurisdiction of the High Court stands on its own foundation and cannot be subject to the exercise of executive power to transfer a ‘case’ from one Assessing Officer to another Assessing Officer.

“Even if the case or cases of an assessee are transferred in exercise of power under Section 127 of the Act, the High Court within whose jurisdiction the Assessing Officer has passed the order, shall continue to exercise the jurisdiction of appeal. This principle is applicable even if the transfer is under Section 127 for the same assessment year(s).”

The Court further observed that if it is the accepted principle to determine the jurisdiction of a High Court under Section 260A of the Act on the basis of the location of the Assessing Officer who assessed the case, then, by the strength of the very same logic, upon transfer of a case to another Assessing Officer under Section 127, the jurisdiction under Section 260A must be with the High Court in whose jurisdiction the new Assessing Officer is located.

Stressing on the ‘need for order’ and consistency in decision making, the Court noted that a decision of a High Court is binding on subordinate courts as well as tribunals operating within its territorial jurisdiction. It is for this very reason that the Assessing Officer, Commissioner of Appeals and the ITAT operate under the concerned High Court as one unit, for consistency and systematic development of the law.

The Court also explained that the decisions of the High Court in whose jurisdiction the transferee Assessing Officer is situated do not bind the Authorities or the ITAT which had passed orders before the transfer of the case has taken place. This creates an anomalous situation, as the erroneous principle adopted by the authority or the ITAT, even if corrected by the High Court outside its jurisdiction, would not be binding on them.

“The legal structure under the Income Tax Act commencing with Assessing Officer, the Commissioner of Appeals, ITAT and finally the High Court under Section 260A must be seen as a lineal progression of judicial remedies. Culmination of all these proceedings in question of law jurisdiction of the High Court under Section 260A of the Act is of special significance as it depicts the overarching judicial superintendence of the High Court over Tribunals and other Authorities operating within its territorial jurisdiction.”

[Commissioner of Income Tax v. ABC Papers Ltd, 2022 SCC OnLine SC 1036, decided on 18.08.2022]


*Judgment by: Justice PS Narasimha


For Revenue: ASG N. Venkatraman

For Assessee: Advocate Rohit Jain

Bonus Share
Op EdsOP. ED.

   

Introduction

A company accumulates its equity capital via investments from various investors. Generally, these investors are concerned less with the company’s affairs and more with their return on investment. The company issues cash dividends and/or bonus shares to reward these investors’ interest.

Cash dividends involve actual cash outflow from the company’s coffers and attract dividend tax which the investor bears.1 However, on the other hand, bonus shares are free shares (as its cost of acquisition is taken as nil) issued to the investors in proportion to their already existing shareholding in the company. These are issued out of accumulated profits/reserves of the company, and no additional cash inflow or outflow is involved.2 Hence, a question on the taxability of allotment of bonus share arises.

In IRC v. John Blott, a case from 1921, the House of Lords addressed this moot question by observing that since the allotment of bonus shares does not change the company’s coffers and nothing enters the allottee’s pockets, the issuance of bonus shares could not be taxed on similar lines as taxation of cash dividends.3 Various Indian courts have made similar observations.4

However, recently, there have been cases wherein the assessing officers (AO) have extended the literal interpretation of Section 56(2)(vii)5 of the Income Tax Act, 1961 (IT Act) to conclude that issuance of bonus share is a transfer of property, other than immovable property, without consideration and hence, is income from other sources (IOS) in the hands of the assessee. Therefore, tax is leviable on those bonus shares aggregate fair market value. Although, the Indian courts have struck down this extension of literal interpretation on various occasions.

This article aims to understand the basis and extent of the feasibility of such interpretation and elaborate on why the decision of various courts to reject such interpretation is correct. The paper first lays Section 56(2)(vii) of the IT Act to understand how the issuance of bonus shares could not be taxed as IOS and then elaborates on some recent judicial decisions supporting the same.

Section 56 of the Income Tax Act, 1961

Section 56(2)(vii) of the IT Act deals with levying tax on deemed income arising on transfer of gifts, etc. which has the value of more than a certain amount under the head “income from other sources”. It stipulates that “where an individual or Hindu Undivided Family (HUF) receives, from any person, any property other than an immovable property without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property shall be taxable as IOS”.6 This provision applies mutatis mutandis to a company or a firm.7

By imprinting dictionary meaning on the term “receive” in the above provision, it would mean receiving or actual receipt of something, including money, letter, or a gift, by way of a transfer. Likewise, the term “property” in Section 56 means to include “shares and securities” under the head of an assessee’s capital asset. This implies that Section 56(2)(vii) applies when the nature of the property being transferred is a capital receipt and not a revenue receipt.

Following the above logic, allotment of bonus share constitutes a property transfer without consideration for Section 56 and shall be subjected to tax. However, a holistic understanding of the purpose of enacting Section 56 and interpreting the term “consideration” would prove that the same is not warranted.

Purposive approach to Section 56

On reading Section 56(2)(vii), we could see that any sum of money or any property-in-kind received without consideration or for inadequate consideration by an individual or HUF is chargeable to income tax as IOS. The provision addresses deemed income received due to the transfer of property without consideration, like in the case of gift transfer. Such deemed income was taxed under the Gift-Tax Act, 19588. However, it was repealed, and to have a preventive measure against tax evasion in the guise of gifts transfer and prevention of money laundering, Section 56(2)(vii) in the form of an anti-abuse provision, was enacted.9

Further, recognising this anti-abuse nature of Sections 56(2)(vii)/(vii)(a) and broadening the scope of donee-based taxation of gifts or IOS, the Finance Bill, 201710 introduced Section 56(2)(x) to include any other assessee (other than an individual, HUF, a firm, or a company in certain cases) who receives a sum of money or property without consideration or for inadequate consideration.11

Furthermore, the Karnataka High Court, in the case of CIT v. Ranjan Pai when faced with a similar challenge, ruled in favour of the assessee, basing their verdict on the premise that there was no material evidence pertaining to the assessee’s intention of evading tax liability, which the Court considered as one of the primary objectives of enacting and levying tax under Section 56(2)(vii).12

When bonus shares are issued, the primary purpose is to incentivise the investor for their contribution. Even though these shares are allotted without any cash inflow or outflow, bonus shares are taxed at a later stage when the allottee transfer or sells these shares under the head “capital gains”.13 In this scenario, since there is no cost of acquisition, it is taken as nil14, and the full selling price is considered gains to compute capital gains tax.15 Hence, in a nutshell, tax is not evaded. It is only deferred to a later stage. Therefore, subjecting allotment of bonus share under Section 56(2)(vii) does not fit the purpose of enacting the said provision and thus, should not be taxed as such.

Meaning of “consideration”

Similarly, the term “consideration” as used in Sections 56(2)(vii)/(vii)(a) is neither defined nor explained anywhere in the IT Act16. In the conventional sense, “consideration” refers to something done in place of or in return for something else,17 including any inconvenience or harm endured.18 The term “consideration” as used in Sections 56(2)(vii)/(vii)(a) might thus be interpreted to encompass the decrease in the fair market value of the shares previously held by such shareholders (as a detriment).19 Hence, it can be contended that the issuance of bonus shares is actually not bereft of any consideration and should be considered for tax purposes under Section 56.

Therefore, it can be construed that Section 56(2)(vii) does not warrant levying of tax on the allotment of bonus share. Various courts in India have made similar observations.

Judicial development

In 2014, the ITAT, Mumbai in Sudhir Menon v. CIT20, dealt with this issue of taxability of bonus share under Section 56. In this case, the taxpayer was offered proportional bonus shares with a face value of INR 100 each. Half of the shares were subscribed by the taxpayer, with the remaining shares being distributed to the other shareholders. The assessing officer used the shares’ year-end market value and treated the difference as insufficient compensation under Section 56 of the Income Tax Act because of the higher value.

The Tribunal determined that the issuance of bonus shares is a capitalisation of the company’s profit that does not result in an increase or decrease in a shareholder’s wealth or shareholding percentage. A bonus issue merely increases the market liquidity of shares, whereas a proportionate allotment does not affect shareholders. As a result, it is exempt from taxation under Section 56 of the Income Tax Act.

However, the Tribunal did rule that in the event of a disproportionate issue of bonus shares, where the value of the property being passed is greater than the value of his existing property, he may be subject to tax under Section 56.21

The ITAT, Delhi, in 2019, relied on this decision in CIT v. Mamta Bhandari, holding that Section 56 of the ITA did not apply to the allotment of bonus shares when the shareholder’s shareholding did not increase or decrease. The shareholder does not receive property in a proportional allotment of bonus shares because what they receive is the split shares from their own holding. Due to the issuance of bonus shares, the shareholder gets his own value of the existing shares at a lower overall value. As a result, Section 56 of the ITA is not applicable.22

Following the above Tax Tribunal decisions, a similar case was appealed to the Karnataka High Court from the Bangalore ITAT.23 According to the ITAT, when a shareholder receives the bonus issue, there is a decrease in the overall value of the shares he owns, which is offset by the bonus issue shares. As a result, such an issue should not be taxed as “income from other sources”. The Income Tax Department then appealed the matter. The High Court upheld the ITAT ruling and reiterated that the allotment of bonus shares made on a pro rata basis could not attract tax liability under Section 56.

The Court determined that a company’s issuance of bonus shares is merely a reallocation of funds from its reserves to its capital. It does not result in an inflow or outflow of funds for the company. Furthermore, shareholders who receive such a pro rata allotment do not gain any benefit that can be taxed under Section 56.24 Hence, it is clear that the issuance of bonus shares shall not attract tax liability under Section 56.

Conclusion

When a company allot bonus shares, it does not change its capital structure.25 In other words, the issuance of bonus shares increases the number of shares accessible on the market but does not affect the total value of the company’s stock. Simply capitalising the reserves and transferring the numbers from the “reserves/surplus” column to the “share capital” column without actual cash inflow or outflow does not influence the company’s total net worth.

Neither does it increase or decrease the wealth of the shareholder. His shareholding remains unchanged. It is only that his existing shareholding further splits on a pro rata basis. There is no actual transfer of the property. Issuance of bonus shares only reduces the value of the shares of the existing shareholders proportionately.26 On the contrary, while selling these bonus shares, since the acquisition cost is taken nil, the entire selling price is considered as gains and is taxable at that stage.

In other words, allotment of bonus share does not attract tax liability under Section 56(2)(vii) as it does not match the purpose of enacting the said provision and following the interpretation of the term “consideration”, it further does not fulfil the criteria of levying tax under the said provision.

As a result, the author believes that the definition of “shares and securities” in Section 56(2)(vii) should be limited to those shares and securities that would otherwise command a price and whose absence is due to nefarious tax evasion motives, rather than bonus shares, which are supposed to be without any outflow by their very nature. Hence, the issuance of bonus shares does not attract tax liability under Section 56(2)(vii) of the Income Tax Act.


† Fifth year student, BA LLB (Hons.), West Bengal National University of Juridical Sciences, Kolkata. Author can be reached at <kartik218023@nujs.edu>.

1. Tax Guru, “Income Tax on Dividend Received from Company”, 4-6-2022, <https://taxguru.in/income-tax/income-tax-dividend-received-company.html> (last visited 8-6-2022).

2. Tax Guru, “Taxability of Bonus Shares under the Income Tax Act”, 1961, 8-10-2018, <https://taxguru.in/income-tax/taxability-bonus-shares-income-tax-act-1961.html> (last visited 8-6-2022).

3. IRC v. John Blott, (1921) 8 TC 101.

4. See CIT v. Madan Gopal Radhey Lal, AIR 1969 SC 840; CIT v. Dalmia Investment Co. Ltd., AIR 1964 SC 1464; CIT v. Mercantile Bank of India Ltd., 1936 SCC OnLine PC 33.

5. Income Tax Act, 1961, S. 56(2)(vii).

6. Income Tax Act, 1961, S. 56(2)(vii).

7. Income Tax Act, 1961, S. 56(2)(vii)(a).

8. Gift Tax Act, 1958.

9. Sumeet Khurana and Rajat Juneja, “Taxing ‘Bonus Shares' — The Question is of Timing!”, <https://database.taxsutra.com/articles/f71b0d371e2d106d969d4598adc9f7/expert_article#_ftn17> (last visited 8-6-2022).

10. Finance Bill, 2017.

11. Memorandum Explaining the Provisions of the Finance Bill, 2017, at 22, <https://www.taxmann.com/bookstore/bookshop/bookfiles/samplechapterGTA.pdf> (last visited 8-6-2022).

12. CIT v. Ranjan Pai, 2020 SCC OnLine Kar 4981.

13. Income Tax Act, 1961, S. 45.

14. Income Tax Act, 1961, S. 55(2)(aa)(iii-a).

15. Tax Guru, “Taxability of Bonus Shares under the Income Tax Act, 1961”, 8-10-2018, available at <https://taxguru.in/income-tax/taxability-bonus-shares-income-tax-act-1961.html> (last visited 8-6-2022).

16. Income Tax Act, 1961.

17. CIT v. Jaykrishna Harivallabhdas, 1997 SCC OnLine Guj 255.

18. Oregon Home Builders v. Crowley, 170 P 718, 87 Or 517, 171 P. 214.

19. CIT v. Dalmia Investment Co. Ltd., AIR 1964 SC 1464.

20. 2014 SCC OnLine ITAT 118.

21. Sudhir Menon v. CIT, 2014 SCC OnLine ITAT 118.

22. 2019 SCC OnLine ITAT 16913.

23. CIT v. Ranjan Pai, 2020 SCC OnLine Kar 4981.

24. CIT v. Ranjan Pai, 2020 SCC OnLine Kar 4981.

25. Sudhir Menon v. CIT, 2014 SCC OnLine ITAT 118.

26. CIT v. Mamta Bhandari, 2019 SCC OnLine ITAT 16913.