TaxTMI 
TaxTMI 
2016 (6) TMI 99
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....panies Act, 1956 promoted by AT & T Global, upto 26% of the equity capital of the former, i.e., AT & T India. The balance 74% was to be held by AT & T Global, i.e., to the extent of the cap on the foreign direct investment (FDI) under the extant policy regime of the Government of India (GOI) for the telecommunication sector. The date/s of investment is termed as a capitalization date/s. AT & T Global had under the agreement an irrevocable call option to increase its' holding in AT & T India to the extent permissible by laws in India by requiring appellant company to sell shares to it or to its' affiliates at the option price. Similarly, the appellant company also has an irrevocable option to sell these shares at the option price to AT & T Global (or its affiliates), which had the right to first refusal. The option by either could be exercised on or after three years of investment or the elimination of the Indian Government regulation on foreign equity holding levels, whichever is earlier. The option price for the purpose of the afore-said purchase and sale is defined as the equity contribution plus return at 11% p.a. compounded annually on the said contribution over the period of h....
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....scribing a cap on the Foreign Direct Investment (FDI) in the telecommunication ('telecom') sector at 74%. Ex-consequenti, there is no transfer of shares, in the increased value of which, realizable on their transfer, the impugned income is embedded. To the extent of call option fees, defined again in terms of a rate per unit of time - on the investment (i.e., at 5.5% p.a.), which stands allowed and, further, prescribed to fall due (for payment) on each anniversary date (of capitalization), income stands accounted for and disclosed as business income. 4.2 It is, to begin with, important to understand the meaning and connotation of the term 'accrual', the scope of which is the bone of contention between the parties. Section 5 of the Act, which defines the scope of 'total income' of a resident, provides for it to include income that accrues or arises to the assessee during the year. As a legal concept, the same stands defined per a series of decisions by the Apex Court, as a right to receive. The Hon'ble Court in Gajapathy Naidu (supra) succinctly stated the following propositions that are to be considered for the purpose: 'When an Income-tax Officer proceeds to include a particula....
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....sion' (PGBP) or 'Income from other sources' (IFOS) shall, subject to the provision of sub section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. Sub-section (2) thereof further provides that the Central Government may notify from time to time income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income. The assessee is admittedly following accrual method of accounting which, it being a company, incorporated under the Companies Act, 1956, is even otherwise statutorily obliged to in terms of the provisions of the said governing Act. The Central Government has notified two Accounting Standards (AS-I and AS-II) on 25.1.1996 u/s. 145(2) of the Act. The said Accounting Standards have a legal mandate, so that the word 'accrual', to which a clear meaning has been assigned, acquires the force of law. The relevant part of AS-I reads as under: 'ACCOUNTING STANDARDS NOTIFIED UNDER SECTION 145(2) A. Accounting Standard I relating to disclosure of accounting policies: 1. All significant accounting policies adopted in the preparation and presentation of fina....
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....Court has time and again clarified that in the absence of any specific provision, it is the principles of commercial accounting that would hold (viz. Challapalli Sugars Ltd. vs. CIT [1975] 98 ITR 167 (SC)). Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI), which is the regulatory body for the profession of accountancy in India, are also relevant. These Accounting Standards are binding on companies in view of the Companies Act, 1956, so that they again have the force of law (s.209). Rather, as explained by the Apex Court, they represent the crystallized accounting principles as recognized by the accounting policies and, further, those issued by ICAI are required to be followed [J.K. Industries Ltd. vs. Union of India [2008] 297 ITR 176 (SC)]. They provide discipline and harmonization of concepts and accounting principles; the objective being true and fair accounting. Accounting Standard (AS)-1 issued by ICAI, titled 'Disclosure of accounting policies', again, enlists accrual, along with 'Going Concern' and 'Consistency', as fundamental accounting assumptions that underlie the preparation and presentation of financial statements. 'Substance over f....
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....in which the relevant income is to be recognized, i.e., as it is earned (AS-I), and on time basis, i.e., as it accrues (per AS-9). Equally importantly, accrual as an accounting concept is in agreement with that as judicially explained, i.e., as a legal concept. That is, the word 'accrual' as occurring in section 5 signifies the same meaning as in section 145, per the Accounting Standard notified there-under. The entries that stand to be passed in the books of account, it may be further noted, are akin to that which shall stand to be passed where the funds are invested in interest bearing loan/advance, as (say) a deposit with the bank, with a fixed tenure. We may, for better understanding, illustrate these accounting entries (on (say) a FDR of Rs. 1000/- at 10% p.a., compounded annually), as: (Amt in Rs.) 1) Interest accrued but not due A/c Dr. 100/110/121 To Interest accrued A/c Cr. 100/110/121 (being the amount of interest accrued on FDR No. ........ dated ........ maturing on ........ at ...... % p.a. compounded annually). 2) Now considering that the FDR is for 42 months (say), the entire interest accrued for the first three years (Rs.331/-) shall, along with principal ....
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.... 3) Bank A/c Dr. 1000 To Customer A/c Cr. 1000 (on receipt of payment vide cheque no..... dated..... against bill no....... dated.........). In fact, if this basic difference (between debt in praesenti and debt in futuro) is ignored, there would be no difference between 'cash' and 'accrual' method of accounting, or determination of income, i.e., speaking in the context of tax laws, or section 145 of the Act. In particular, which in fact only endorses and subscribes the accounting principles of income recognition as prescribed by AS-9 (of ICAI), which again has statutory force u/s. 209 of the Companies Act, 1956. These entries, are not only in accord and harmony with the principles of commercial accounting, well established, the prime objective of which is to reflect the true state of affairs of the reporting enterprise and, thus, in the absence of anything to the contrary in law, applicable, but also, as shall be seen, consistent with the accounting standards, legally mandated, so that the same have the force of law. 4.3 As the right to the assessee arises on the basis of the Agreement, we next examine the nature of this right, i.e., on facts. The right to call or put, in ex....
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....y, themselves regard the 'option price' and the 'call option fee' as constituting a reasonable return on investment, for which reference be made to clause 2.6 of the Agreement, which reads as under: '2.6 The Sponsors acknowledge that pursuant to the terms of this Agreement and based on the nature of global telecommunications services and the financial prospects of AT&T India, ML will realize in almost all cases an equity return equal to the Option Price and Call Option Fee and further acknowledge that the cost structure of AT&T India is dependent upon allocations of expenses across AT&T's global operations, which allocations shall be made by AT&T in a commercially reasonable manner without specific regard to the profitability or un-profitability of AT&T India. The Sponsors acknowledge that the Option Price plus the Call Option Fee represents a reasonable return on equity investment in the company.' The difference of the return (to the extent of 11%) getting paid only on the transfer of shares, i.e., on divesture, along with the return of capital, is on account of the very nature of the agreement. The same only represents the form in which the return gets received by the assessee....
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....ends it with a character of a financial instrument toward earning income at a defined (agreed) rate, rather than a promoter investing in an enterprise in a defined business, i.e., acquiring a stake in a particular business. Shares, thus, represent only a medium and manner in which the investment takes place, which is regarded as parking of funds by the investor, calculated to yield a definite and stipulated rate of return. The terms of the agreement, when read as a whole, make this abundantly clear, with the agreement in fact making no bones about it. Reference in this context be made to, inter alia, clauses 2.5, 2.6, 4.9, 6.11, 6.13, 6.15, 6.16, 7.3, 7.4, 8.4, 8.5, 8.8, 8.13 - 8.15, 9, 17.2 (c), 17.3 (c), 17.4-17.5 of the Agreement, some of which we reproduce as under: '6.13 Subject to the provisions of the Act, the Board of Directors shall determine all matters by simple majority vote, which majority shall include at least two (2) directors nominated by AT&T. 7.3 Subject to the provisions as contained in the Articles and the Act any resolution at a duly constituted General Meeting shall be adopted by a simple majority vote of the total votes validly cast at such General Meeti....
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....of the shares in the Company, as provided in this Agreement, due to any reason whatsoever, not directly attributable to the actions of AT&T. 17.3 In the following case, ML shall have the right and option to terminate this Agreement by a written notice of thirty (30) days to AT& T: (c) if ML, subject to Section 9.1 of the Agreement, is prohibited from holding some or all of the shares in the Company due to any reason whatsoever, not directly attributable to the actions of ML. 17.4 On termination of this Agreement, as aforesaid, shall not relieve any Party of any obligations or liabilities accrued to it prior to the date of termination and the provisions of Sections 13, 16.1, 17.4 and 24 shall survive termination of this Agreement. Further notwithstanding anything contained in this Agreement: 17.4.1 On termination of this Agreement by AT&T (i) pursuant to Section 17.2(a) or (b) AT&T may elect to require ML to sell its entire shares at their par value, to a person resident in India or other eligible person identified by AT&T and in the event of such election the sale and purchase of shares shall be completed within a period of 120 (one hundred twenty) days from the date of t....
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.... return (exclusive of the amount considered as reinvested and, therefore, not forming part of the principal); GA = Gross Amount; figures in brackets denote negative sums, being notionally received back for reinvestment] The return for the first year (Rs.100/-) yields Rs. 10/- each for the second and the third year, with Rs. 10/- for the first year yields Re.1/- for the third year. Similarly, the return of Rs. 100 for the second year yields a return of Rs. 10/- for the third year, taking the total return for that year to Rs. 21/-. Compounding, as afore explained, involves the concept of merger of principal and return thereon, i.e., capital and income, at defined intervals of time. Clearly, the return for the first and the second year gets included in the principal amount (notionally) for the second and the third year respectively, obliterating the conceptual difference between the principal (capital) and return (of income). The income for each of the three years comprising the gross amount receivable after the end of the third year, i.e., Rs. 1,331/-, is only that reckoned per the FDR agreement, i.e., Rs. 100, Rs. 110 and Rs. 121 for each of the three intervening years and, further....
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....ent, often referred to as the 'due date'. The debt accruing is a debt realizable at a later, subsequent date. We have already, per the accounting entries pertaining to transactions of interest on deposit and sale of goods, sought to emphasize and explain the difference between 'accrual' and 'due' (for payment). Rather, how can, it may be asked, an amount which is itself periodically, i.e., at intervals of time, reinvested, or regarded as so, fetching returns, be due for payment in the interim period. Further, it does not and need not, in order to signify accrual or of having arisen, imply a debt legally enforceable as soon as the right is created. It would though be incorrect to say that the debt so arising is not a legally enforceable debt - the debt, with all its attributes, including as to its realizability and legal enforceability, accrues or arises simultaneously with the accrual or creation of the corresponding right to receive. However, its' realizability being contracted for a future date, the same would stand to be legally enforced only upon the debt becoming liable to be redeemed/discharged. We see no contradiction between the two aspects of the matter, i.e., the characte....
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....k) or the purchaser of goods (or recipient of services) in the present case. In either case, the expenditure and the corresponding liability, even if payable in future, stands incurred. We may for better comprehension, state the relevant entries as under: (Amt. in Rs.) 1) Interest A/c Dr. 100/110/121 To Interest accrued but not due A/c Cr. 100/110/121 (to amount of interest account on loan of Rs. 1000 - for year 1/2/3) 2) Interest accrued and due Dr. 331 To interest accrued but not due Cr. 331 (being amount of interest accrued on FDR, transferred to due account on maturity of the FDR) 3) FDR A/c Dr. 1000 Interest accrued and due A/c Dr. 331 To bank account Cr. 1331 (to the maturity proceeds of FDR transferred to the saving bank account of the depositor on its maturity) 4) Purchase A/c Dr. 1000 To Bills/Trade payable A/c Cr. 1000 (to amount of Bill No........ dated ...... of ..........., due for payment on .........) 5) Bills/Trade payable A/c Dr. 1000 To supplier (by name) A/c Cr. 1000 (Bill No........ dated.........., credited to the account of the supplier on it becoming due) 6) Supplier A/c Dr. 1000 To Bank A/c Cr. 1000 (on payment to the sup....
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....AT & T (clause 8.13). The investment thus can only be regarded or euphemistically termed as in equity shares, and for all intents and purposes, or in substance, is an investment held in the form of shares for a definite period at a particular return - cost to the transferee of shares, toward the time value of the funds. The transfer of shares is, thus, only the manner in which either party exercises the right, being the right to receive and, correspondingly, the right to acquire shares - nothing more and nothing less. Till then, it is an open contract, and the income shall continue to accrue to the assessee by elapse of time. We do not, when we state so, in any manner, hold or mean that the investment in shares is not to be regarded as such. But only that, nevertheless, the right to receive the income, which stands to be embedded in the increased value of shares, liable to be sold (transferred) after a maximum holding period of three years, the income on the said investment accrues to the assessee with time, i.e., to the same extent and in the same proportion as the value of the shareholding is stipulated to increase with time. That is, only represents the form in which the income ....
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....common parlance, with the Act only listing down, per the defining section (s. 2(24)), inexhaustively, the various types of income. Reference in this context be made to Emil Webber vs. CIT [1993] 200 ITR 483 (SC). The nature of income which falls to arise to the assessee is to be in the facts and circumstances of the case, including the fact that the investment under reference only represents an opportunity to the assessee to earn income from an investment, made in the course of its business as an investment company, returning the income by way of 'call option fee' as business income, only business income. There is, in fact, no question of the assessee earning or being entitled to 'call option fee' otherwise, where it acquires the shares in the investeecompany as a stakeholder (promoter). We have, further, found the two 'returns' as para materia. This aspect is in fact not in doubt, and the only question of concern is of the time of accrual of income. Its' nature is referable and ascertainable with reference to the rights inuring, and it is in that respect, only in the nature of interest income, which arises or accrues with a lapse of time. Interest is defined in AS-9 (supra) as a c....
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....he assessee's revenue model and the corresponding income streams. Clearly, the assessee stands allowed all interest incurred in relation to the borrowed capital for the purpose of the investment under consideration as business expenditure. The corresponding revenue, whether realized during the current year or not, is liable to be recognized as income. Of course, there must be no significant uncertainty as to its ultimate collection, and which does not exist - being not contended at any stage in the present case. We do not, when we say so, mean that in every case of accrual of income and the corresponding expenditure (or vice versa), the same would lead to a matching. But only that, firstly, the said accounting concept stands statutorily accepted, being only being only an expression of a recognized principle of the commercial accounting, as well as judicially recognized (refer: Calcutta Co. Ltd. vs. CIT [1959] 37 ITR 1 (SC) and Madras Industrial Investment Corporation Ltd. (supra)) and, two, that in the facts and circumstances case, the nature of income and expenditure being the same, that is, in the nature of interest, both accrue on a day-to-day basis and, therefore, the matching ....
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....t on the relevant supplies. In State Bank of Travancore (supra) another three member constitution decision, the Apex Court, in ratio, clarified that whether the income had really accrued or arisen to the assessee must be judged in the light of the reality of the situation, including the conduct of the parties. Further, the concept of real income, which is certainly applicable, cannot be extended to negate accrual, particularly where it has already accrued, i.e., is to be applied with care and within well recognized limits. The terms of the contract are plain and clear. There is also nothing inconsistent in the conduct of the parties therewith. In the reality of the situation, regard for which it is to be made, the assessee is irrevocably entitled to transfer, and AT & T Global irrevocably obliged as well as entitled to acquire, the shares of the latter's Indian subsidiary (AT & T India) at a price, the increase in the value of which is to enure to the assessee as a function of time over the holding period, at any time after the stipulated holding period of a maximum of three years. The income by way of return on its investments accrues, and the exercise of option, and the transfer....
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....stinct agreements, it shall become plain that no part of the income under the former (managing agency agreement) could enure to the assignor of the managing agency business. The said decision is not applicable. In Canara Bank (supra), the assessee, a banking company, closing its accounts on December 31 every year, reflected interest accrued as on December 31, 1981, as interest relatable to the relevant period. The interest was, however, payable only after December 31, 1981. The same was held as not accrued for the relevant year, following Vijaya Bank Ltd. vs. CIT [1991] 187 ITR 541 (SC), in which case the appellant bank purchased securities, the price of which was contended as determined with reference to their actual value as well as the interest that had accrued on the securities till the date of purchase. The Apex Court found that the price paid was in the nature of capital outlay, so that no part of it could be set off as expenditure against income accruing on those securities. In fact, the securities would yield income by way of interest whereat section 18 of the Act would stand attracted. It was with reference to this that it was held by the Hon'ble High Court that the incom....
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....lder's agreement entered into by it with a parent (foreign) company of the investee-company, a resident, the said agreement stands examined in detail, even as no dispute or doubt with regard to the scope or meaning of its provisions is available on record, i.e., only with a view to ascertain the nature of the rights accruing to or vesting in the assessee per the same. The Agreement was found to unequivocally and unambiguously convey the right to receive the return on its investment (in shares) to the assessee-company and, further, that income therefore accrued to it in the same manner and to the same extent as the increase in the value of its' share holding in the investee-company, at a defined rate per unit of time over the holding period, which was further fixed at a minimum of three years (or such lower time) as occasioned by the elimination of the Indian Government regulation on foreign equity holding levels. This is as the assessee had an irrevocable right to transfer, and the parent company (AT&T) an irrevocable right to acquire the assessee's shareholding in its Indian subsidiary (AT&T India) either to itself or through its affiliates (which have right to first refusal), at ....
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....al of the income in any manner. Even de hors the character of the arrangement as a financing arrangement or any other, the nature of the investment would not be of much consequence as long as there is accrual of income in the facts and circumstances of the case, i.e., by way of right to receive - a receivable, resulting in a debt, realizable even if in future. The right to receive, if construed as a right to receive in praesenti, it may be appreciated, would obliterate the difference between the 'right to receive' and 'due for payment'. Or, in fact, between 'accrual' and 'receipt', used in contradistinction, even as explained in Ashokbhai Chimanbhai (supra). It is only the realizability of the right accrued that is postponed to a later, defined date, signified as the due date, which is at convenient or agreed dates of time. It is only because the debt has arisen and accrued that it becomes liable to be realized, even if at a later date. That, in fact, forms the fundamental or the quintessential difference between cash and accrual systems of accounting, legally recognized and judicially well explained. It would, as such, be incorrect to say that the right (to receive) that vests in....