Supreme Court rules revaluation of capital assets of a firm by credit to partners’ capital accounts post admission of partners taxable as capital gains

This Tax Alert summarizes a ruling, dated 24 November 2022, of the Supreme Court (SC) in the case of Mansukh Dyeing and Printing Mills^[1] (Taxpayer) on taxability of revaluation of capital assets of a firm by credit to partners’ capital accounts in their profit-sharing ratio (PSR) as a deemed transfer of such capital assets by the firm to the partners under old section 45(4) of the Indian Tax Laws (ITL) as it stood before substitution vide Finance Act, 2021. Old section 45(4) stated that, with effect from (w. e. f.) tax year (TY) 1987-88, profits or gains arising from the transfer of a capital asset by way of distribution on the dissolution of a firm or otherwise shall be chargeable to tax as income of the firm.

In the present case, in TY 1992-93, the Taxpayer admitted four new partners who contributed small amounts of capital to the Taxpayer. Shortly thereafter, the Taxpayer revalued land and building (held as capital assets) and credited huge gains on revaluation to capital accounts of all the partners in their PSR and two of the existing partners withdrew small amounts from their capital balance. The tax authority invoked old section 45(4) on the basis that huge gains on revaluation of capital assets credited to partners’ capital accounts was “in effect” a distribution of those capital assets by the Taxpayer to the partners, as the enhanced capital balance immediately became available to all the partners for withdrawal.

The Taxpayer contended that old section 45(4) was inapplicable as there was neither a transfer by way of distribution of capital assets by the Taxpayer to the partners, nor any transfer on account of dissolution of the Taxpayer or otherwise. The Taxpayer contended that there can be no income just due to revaluation of capital assets in the books of the Taxpayer, unless the capital assets themselves are also transferred.

SC held that, in the present case, credit of revaluation gain to partners’ capital accounts can be said to be in effect distribution of the capital assets valued at their fair market value (FMV). SC held that the partners’ capital accounts stood enhanced upon revaluation, which became available for withdrawal and in fact some of the partners had withdrawn such amounts subsequently from their capital accounts. Therefore, as per SC, such revaluation could be said to be a “transfer”, falling in the category of “or otherwise”, in terms of old section 45(4). SC also affirmed a Bombay High Court ruling in case of A.N. Naik Associates ^[2], which held that the word “or otherwise” covers not only distribution of capital assets on dissolution but also subsisting partners transferring the firm’s capital assets in favor of a retiring partner. SC distinguished its earlier ruling in case of Hind Construction ^[3] which regarded revaluation of goods to be non-taxable as inapplicable to the present case, as its earlier ruling dealt with pre-amended provisions where the term “or otherwise” was absent

HC interprets scope of intermediary services in case of sub-contracting service agreements

This Tax Alert summarizes a recent ruling of the Punjab and Haryana High Court (HC). The issue involved in the writ petition was whether the services provided by the petitioner under sub-contracting agreement fell within the scope of intermediary service and, therefore, ineligible for refund.

Petitioner contended that the services were provided on own account, and not in the capacity of agent. Hence, they do not qualify as an intermediary.

Further, reliance was placed on Circular issued by Central Board of Indirect Taxes and Customs (CBIC) which clarified that sub-contracting services do not fall under the ambit of intermediary.

Revenue contended that the petitioner fulfills all the ingredients to qualify as an “intermediary”. Also, the principle of res-judicata does not apply in taxation matters.

HC held that agreement clauses do not indicate that services rendered by petitioner fall under the ambit of an intermediary. Further, there is no change in the scope of “intermediary” services in the Goods and Services Tax (GST) regime vis-a-vis the service tax regime.

Applying the principles of consistency, Revenue cannot take a different view for periods where there is no change of facts. Accordingly, HC allowed the writ petition.


Comments

• Amidst divergent advance rulings on the scope of intermediary, this HC ruling is likely to provide certainty w.r.t tax position to be adopted by taxpayers engaged in a similar line of business.
  
  This could also potentially result in tax cost savings.
• As per the settled principle, decision of the High court, unless overruled or in the absence of any contrary rulings, shall have a binding effect across jurisdictions in India.
• Taxpayers facing similar demands/refund rejections may persuade adjudicating/ appellate authorities by drawing support from the above HC ruling.
• Earlier, constitutional validity of place of supply provision relating to intermediary service was challenged before the Division Bench of Bombay High Court. Considering the split verdict, the final decision is awaited.

GST e-invoice is mandatory on supplies under Reverse Charge

It is to apprise you that recently the Goods and Services Tax (‘GST’) portal has issued new FAQs on e-invoices. One of the FAQs is as under:

“Question: Do you need to upload RCM Invoices also?

Answer: Yes, if you are eligible for e-Invoicing, all the invoices including RCM invoices issued by the Supplier need to be registered.”

From the above FAQ, GST portal is suggesting to mandatorily issue an e-invoice for RCM transactions from un-registered suppliers.

| Comments

• Although one may issue e-invoice for RCM transactions as a conservative approach. In our view, legally, there is no such requirement of preparing e-invoice for RCM transaction. The basis of our view is explained in ensuing points.

• Notification No. 13/2020-Central Tax, dated March 21, 2020, provides that a registered person having specified turnover shall prepare an e-invoice “in respect of supply of goods or services or both to a registered person or for exports”. [Emphasis Supplied]

• The above emphasised words clearly show that e-invoice is applicable in respect of following supplies:

• Supply of goods or services or both to a registered person; or
• Exports

• Kindly note that under Section 31 of the CGST Act (pertaining to invoice), supply of goods or services to a registered person [Section 31(1) & (2)] is differentiated from supply received from an unregistered supplier [Section 31(3)(f)].

• Therefore, if the intention of Government was to apply e-invoicing provision to RCM self-invoices, it would have clearly specified the same in the above-mentioned notification.

Business Process Outsourcing service is not an “Intermediary” service | Punjab & Haryana High Court

This is to update you on a recent judgement pronounced by the Punjab and Haryana High Court (‘HC’) in the case of M/s Genpact India Private Limited (‘the Company’), wherein it has been held that the Business Process Outsourcing (‘BPO’) services provided by the Company does not qualify to be an ‘intermediary’ service, and consequently, the HC held the said service qualify as exports and directed the revenue to grant refund of unutilised input tax credit (‘ITC’).

A brief synopsis of the judgment is captured hereinbelow for reference:

Background

• The Company entered into a Master Service Sub-Contracting Agreement (MSA) with Genpact Incorporated (GI), an affiliate entity outside India for providing various services to customers of GI, which inter-alia included the following:
• Maintaining vendor/ customer master data;
• Scanning and processing vendor invoices;
• Book keeping/ finalising books of accounts;
• Generating ledger reconciliations;
• Managing customer receivables;
• Developing, licensing and maintaining software as per client’s requirements;
• Technical IT support;
• Data analytics, management of inventory, assistance in sourcing and supply chain management etc.

• On applying for refund of unutilised ITC, the Company was initially granted partial refund, and certain amount was held as ineligible – against which the Company filed an appeal before Joint Commissioner CGST (Appeals).

• However, the partial refund sanction order was further reviewed by the Principal Commissioner, and contested on grounds that the ‘services qualified to be intermediary services and hence do not qualify as exports under GST’.  

• Joint Commissioner CGST (Appeals) disallowed the appeal filed by the Company and allowed the appeal filed by the Revenue denying export status and consequently refund to the Company.

• Aggrieved by the order passed by the Joint Commissioner, CGST (Appeals), the Company filed a writ petition before the Punjab and Haryana High Court.

Summary of contentions

Company’s contention

Department’s contention

Company is engaged in providing services ‘on its own account’ and is not facilitating any supply of services between GI and its customers.    Company is responsible for all the risk related to performance and pricing of the said services.   Clauses from the MSA were referred to, and it was contended that there is no separate agreement entered into between the Company and GI’s customers and therefore, the Company should not be regarded as an agent/ broker in the nature of an intermediary.   Turnover of the Company is the entire charge for the services rendered, unlike in the case of intermediary, where the turnover is typically a commission or facilitation fee.   As the Company was allowed refund on similar scope of services under service tax regime, and that the definition of intermediary has not undergone a change under GST regime – as per the ‘principle of consistency’, refund should be granted under the GST regime as well.

As per the MSA, the Company is engaged in providing services on behalf of GI and supplying support services to enable GI to supply main services to its customers.   In terms of the MSA, GI was responsible to appoint dedicated account representatives for each customer for overall coordination between the Company and customers.  Department argued that an arrangement where GI possess the authority to take decisions with regards to action taken by the Company implies a principal-agent relationship.   With regards to issuance of refund in pre-GST regime, it was contended that the ratio of res-judicata shall not apply in the matters pertaining to different assessment years.

Summary of the Ruling passed by the High Court

• Hon’ble HC observed the following while perusing the clauses under MSA:
  • The Company is providing the BPO services which has been sub-contracted by GI.
  • The Company execute the delivery of BPO services to the customer of GI.
  • The Company would be responsible for all risks related to performance of services which would be akin to services provided on ‘its own account’.
  • The Company would share the details of provision of services which would enable GI to raise invoices and receive remittances from GI’s customers.
  • The Company issues invoices to GI and receives payment from GI.

• For the purpose of classifying a service as intermediary, the High Court observed that there are three conditions to be satisfied –
  • The relationship between the parties must be that of a principal-agency relationship;
  • The service provider must be involved in the arrangement or facilitation of provision of service provided to the principal by a third party;
  • The person must not actually perform the main service intended to be received by the service recipient itself, and the scope of intermediary is to mediate between principal service provider and the beneficiary which specifically excludes any person providing services ‘on his own account’.

• On perusal of various clauses of MSA, the Hon’ble HC noted that main contractor i.e. GI is receiving commission from its customer for the services rendered by the Company pursuant to the arrangement, and the Company is receiving fees/charges from GI as a sub-contractor.

• Further, it was held that the MSA executed between GI and the Company, in no manner indicates that the Company is acting as an ‘intermediary’ and has facilitated the services so as to fall within the scope and ambit of the definition of ‘intermediary’ under Section 2(13) of the IGST Act.

• Hence, it was ruled that the service provided by the Company is to be considered as ‘export of service’ and refund shall be granted.

Comments

• The ruling should help address disputes involving export status and refund eligibility for IT/ ITeS service providers engaged in providing BPO services on sub-contract basis under principal to principal arrangements.

• Reference here is made to Circular 159/2021 dated 20 September 2021, wherein the scope of intermediary services was clarified – specifically, sub-contracting was held not to be intermediary services.  The present ruling appears to uphold the said concept.

• The ruling also lays down an important principle that, the nature of the arrangement, as evidenced from the contract documentation shall determine the relationship between the parties including their qualification as an intermediary. 

• This ruling should be an important point of reference and reliance in distinguishing various types of BPO services from the concept of an intermediary, subject to the arrangement being principal to principal basis for the rendition of an agreed set of services.    

CBIC issues clarifications on refunds due to inverted tax structure under GST

This Tax Alert summarizes a recent Circular ^[1] issued by the Central Board of Indirect Taxes and Customs (CBIC) clarifying issues relating to refund of unutilized input tax credit on account of inverted tax structure (ITS) under Goods and Services Tax (GST).

CBIC had, through Notification ^[2] dated 5 July 2022, amended the formula prescribed for refund on account of ITS under Rule 89(5) of Central Goods and Services Tax Rules, 2017 (CGST Rules). Further, vide another Notification ^[3] effective from 18 July 2022, CBIC restricted refund due to ITS in case of supply of certain goods falling under Chapter 15 (edible oils) and Chapter 27 (coal).

On the applicability of the said amendments, CBIC has clarified the following:

• The new formula would be applicable for refund applications filed on or after 5 July 2022, as it is a prospective amendment. For applications filed before 5 July 2022, formula that existed before the amendment shall apply.
• The restriction on refund imposed in respect of edible oils and coal, shall apply prospectively, i.e., for all refund applications to be made on or after 18 July 2022.

Comments:

• Clarification on issues concerning refunds may ensure uniformity in the implementation of the provisions of the law and eliminate unwarranted litigation.
• Registered persons dealing with edible oil and coal may explore the possibility of refund, contending that amendment should not apply for past period credits. There are divergent rulings on the said matter in pre-GST era.

[1] Circular No. 181/13/2022-GST dated 10 November 2022
[2] Notification No. 14/2022-Central Tax dated 5 July 2022
[3] Notification No. 9/2022- Central Tax (Rate) dated 13 July 2022, effective 18 July 2022

Central Government allows International Trade settlements in INR for Export Promotion Schemes under FTP

This Tax Alert summarizes recent Notification^[1] and Public Notice^[2] issued by the Directorate General of Foreign Trade (DGFT) amending the Foreign Trade Policy (FTP) and Handbook of Procedures (HBP) to allow Indian Rupee (INR) settlement for benefits/fulfillment of Export Obligation (EO) under export promotion schemes. The same is effective 9 November 2022.

Earlier, the Reserve Bank of India (RBI) issued a circular^[3] allowing international trade settlement in INR through a Special Rupee Vostro Account subject to fulfillment of prescribed procedures. Further, DGFT had also issued a Notification^[4] allowing invoicing, payment, and settlement of export and imports in INR as per RBI Circular.

Considering the increased interest in the internationalization of INR, changes have been made in the following provisions of FTP and HBP concerning export promotion schemes to align with the RBI Circular:

• Para 2.46 of FTP allows import for exports subject to conditions. One such condition is export consideration should be realized in convertible foreign exchange. Amendments have been made to allow such realization in INR as well. However, if goods have been imported following INR settlement scheme as per RBI Circular, same shall be exported adhering to the procedure as per the Circular unless otherwise specified by DGFT.
• Permit exports benefits/EO fulfillment against INR receipts (Para 2.53 of FTP).
• Consider INR receipts as well for counting export performance to determine Status Holders recognition (Para 3.20 of FTP).
• Allow realization of export proceeds in INR for Advance Authorization (AA), Duty-Free Import Authorization (DFIA) schemes (Para 4.21 of FTP), and Export Promotion Capital Goods (EPCG) Scheme (Para 5.11 of HBP).

CommentsThe present amendments to consider INR receipts for export promotion schemes is a trade-friendly measure supporting international trade transactions in Indian currency.
[1] Notification No. 43/2015-2020 dated 9 November 2022
[2] Public Notice No. 35/2015-2020 dated 9 November 2022
[3] A.P. (DIR Series) Circular No.10 dated 11 July 2022
[4] Notification No. 33/2015-2020 dated 16 September 2022

GST Council clarifies on issuance of recurring SCNs in enforcement cases

This Tax Alert summarizes the Office Memorandum¹ issued by the GST Council to address the varied practices followed by Central and State authorities in issuing recurring show cause notices (SCNs) and other actions in cases where enforcement action has been initiated.

Central and State tax administrations have the power to take intelligence-based enforcement action, irrespective of whether the taxpayer is covered under Central or State tax jurisdiction. Divergent practices are followed on issuing recurring SCNs and other consequential actions in situations where an officer of the Central tax authority initiates intelligence-based enforcement action against a taxpayer administratively assigned to the State tax authority and vice versa. In few cases, the authority initiating enforcement action also issues the recurring SCNs, whereas in other cases, the same is left to the jurisdictional authorities.

Accordingly, GST Council has clarified the following:

• A taxpayer administratively assigned to a State tax authority can also be subjected to enforcement action by the Central tax authority (and vice versa). In such cases, all consequential actions relating to the case, including but not limited to appeals, review, adjudication, rectification, etc., will vest with the enforcement initiation authority. However, refund shall be granted by jurisdictional tax authority only.
• Issuance of recurring SCNs does not involve a fresh investigation. Therefore, such recurring SCNs may be issued by jurisdictional tax authorities as they can access taxpayers’ records and returns, check whether grounds of SCN still exist, and take a view for issuance of recurring SCN based on facts. 

Comments

• Earlier, Central Board of Indirect Taxes and Customs (CBIC) vide letter dated 5 October 2018 had clarified that both Central and State tax officers are authorized to initiate intelligence-based enforcement action irrespective of the administrative assignment of the taxpayer.
• The present clarification aims to address certain administrative issues arising out of enforcement actions initiated by Central or State tax authority, irrespective of their jurisdiction.
• Businesses are likely to face difficulty since they will be required to submit relevant documents and resolve queries from the department multiple times for the same issue.

CBIC issues Instruction relating to Pre-deposit for disputes under Central Excise and Service tax

This Tax Alert summarizes a recent Instruction¹ issued by the Central Board of Indirect Taxes and Customs (CBIC) prescribing pre-deposit payment methods for disputed cases under Central Excise and Service Tax (earlier regime).

CBIC noticed instances of rejection of appeals by the Commissioner (Appeals) for non-compliance with the pre-deposit requirement as mandated under earlier regime. Pre-deposits in such cases were made through GST DRC-03. Earlier, Bombay HC had also directed CBIC to issue Instructions in this regard².

CBIC has clarified the following:

• GST DRC-03 is prescribed for payment of tax, interest, penalty, or any other amount under provisions of the Central Goods and Services Tax (CGST) Act 2017, read with rules made thereunder. Goods and Services Tax (GST) law further provides for use of Form GST APL-01 for filing an appeal with pre-deposit option through electronic cash / credit ledger. Therefore, GST DRC-03 is not a prescribed mode for pre-deposit under GST.
• In terms of transitional provisions under Section 142 (6)(b), 142 (7)(a), and 142(8)(a) of the CGST Act, CENVAT credit, tax, interest, fine, or penalty recoverable under earlier regime, shall be recovered as arrears of tax under CGST. Pre-deposit is a requirement for exercising the right to appeal and is neither in the nature of duty nor can be treated as arrears under earlier regime. Hence, it is not covered under transitional provisions. Consequently, GST DRC-03 is not a valid mode for making pre-deposits under the earlier regime. Taxpayers should therefore use only CBIC-GST Integrated portal³ for making such pre-deposits.

Comments

• CBIC has distinguished pre-deposits from payment of tax and arrears. However, there are contrary rulings under erstwhile as well as GST regime for treatment of pre-deposit as duty payment.
• Non-acceptance of pre-deposit made through GST DRC-03 prevents utilization of Input tax credits and is likely to have a significant impact on working capital.
• While the clarification aims to resolve procedural ambiguity, one may need to evaluate its impact on pending appeals where pre-deposits were already made through GST DRC-03.