Note: Please ignore the 2 earlier posts as I encountered some problem in uploading the file links.

Brief : : The benefit of exemption under section 54 is to be extended only when the property sold as well as the property purchased by the assessee are intended to be used as residential houses.

Citation : ITO v Rohini Reddy ITA No. 595/Hyderabad/2006

Judgment :

We have carefully considered the rival submissions and perused the record. Marginal heading of section 54 of the Act, which is relevant in this context, refers to “profit on sale of property used for residence”. Main section speaks of transfer of a capital asset- being building or lands appurtenant thereto and being a residential house – the income of which is chargeable under the head income from house property. It is not the case of the assessee that the roofed structure built on the Banjara Hills land was either self-occupied or let out and there is nothing on record to suggest that it was intended to be used as residence. Considering the market value of the property, the so called “house” constructed on the property cannot be said to be for use of the assessee or for letting out as a residential house. Similarly, the assessee purchased tow plots for a total consideration of Rs. 68,27,300/- which contain small temporary structures covered with asbestos roofing in a corner of the plots. These plots also cannot be said to have been purchased to use the temporary structures as residential houses. Since the expression ‘residential house’ is not defined under the Income Tax Act, a purposive meaning has to be adopted to such expression instead of going by the technical meaning assigned under various enactments or the dictionary meaning given in the dictionary. It is appropriate herein to reproduce the observations of the Supreme Court, as extracted by the Author – Justice G. P.Singh, in the book ‘Principles of Statutory Interpretation’, Seventh Edition, at page 94.

“ The words of a statute, when there is doubt about their meaning are to be understood in the sense in which they best harmonise with the subject of the enactment and the object which the Legislature has in view. Their meaning is found not so much in a strict grammatical or etymological propriety of language, nor even in its popular use, as in the subject or in the occasion on which they are used, and the object to be attained”.

As could be noticed from the marginal heading, the original intention in inserting the provisions of section 54 of the Act and the amendments made from time to time to mitigate the unintended hardship by originally using the expression used by the “assessee or parent of his…” without changing the expression “used for residence” in the marginal heading and also by specifying the nature of building by use of the expression “being a residential house”, it has to be assumed that the intention of the legislature was to extend the benefit of exemption under section 54 of the Act only when the property sold as well as the property purchased by the assessee were intended to be used as residential houses, whereas the totality of circumstances clearly indicate that they were never intended to be used as residential houses either for self-occupation or for letting of. We are, therefore, of the view that the assessee is not entitled to exemption under section 54 of the Act on the sale value of the impugned property.

Definition of Charitable purpose under section 2(15) of the Income-tax Act, 1961

Section 2(15) of the Income Tax Act, 1961 (Act) defines charitable purpose to include the following:-

(i) Relief of the poor

(ii) Education

(iii) Medical relief, and

(iv) the advancement of any other object of general public utility.

An entity with a charitable object of the above nature was eligible for exemption from tax under section 11 or alternatively under section 10(23C) of the Act. However, it was seen that a number of entities who were engaged in commercial activities were also claiming exemption on the ground that such activities were for the advancement of objects of general public utility in terms of the fourth limb of the definition of charitable purpose. Therefore, section 2(15) was amended vide Finance Act, 2008 by adding a proviso which states that the advancement of any other object of general public utility shall not be a charitable purpose if it involves the carrying on of

(a) any activity in the nature of trade, commerce or business; or

(b) any activity of rendering any service in relation to any trade, commerce or business;

for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention of the income from such activity.

2. The following implications arise from this amendment

2.1 The newly inserted proviso to section 2(15) will not apply in respect of the first three limbs of section 2(15), i.e., relief of the poor, education or medical relief. Consequently, where the purpose of a trust or institution is relief of the poor, education or medical relief, it will constitute charitable purpose even if it incidentally involves the carrying on of commercial activities.

2.2. Relief of the poor encompasses a wide range of objects for the welfare of the economically and socially disadvantaged or needy. It will, therefore, include within its ambit purposes such as relief to destitute, orphans or the handicapped, disadvantaged women or children, small and marginal farmers, indigent artisans or senior citizens in need of aid. Entities who have these objects will continue to be eligible for exemption even if they incidentally carry on a commercial activity, subject, however, to the conditions stipulated under section 11(4A) or the seventh proviso to section 10(23C) which are that

(i) the business should be incidental to the attainment of the objectives of the entity,and

(ii) separate books of account should be maintained in respect of such business.

Similarly, entities whose object is education or medical relief would also continue to be eligible for exemption as charitable institutions even if they incidentally carry on a commercial activity subject to the conditions mentioned above.

3. The newly inserted proviso to section 2(15) will apply only to entities whose purpose is advancement of any other object of general public utility i.e. the fourth limb of the definition of charitable purpose contained in section 2(15). Hence, such entities will not be eligible for exemption under section 11 or under section 10(23C) of the Act if they carry on commercial activities. Whether such an entity is carrying on an activity in the nature of trade, commerce or business is a question of fact which will be decided based on the nature, scope, extent and frequency of the activity.

3.1. There are industry and trade associations who claim exemption from tax u/s 11 on the ground that their objects are for charitable purpose as these are covered under any other object of general public utility. Under the principle of mutuality, if trading takes place between persons who are associated together and contribute to a common fund for the financing of some venture or object and in this respect have no dealings or relations with any outside body, then any surplus returned to the persons forming such association is not chargeable to tax. In such cases, there must be complete identity between the contributors and the participants.

Therefore, where industry or trade associations claim both to be charitable institutions as well as mutual organizations and their activities are restricted to contributions from and participation of only their members, these would not fall under the purview of the proviso to section 2(15) owing to the principle of mutuality. However, if such organizations have dealings with non-members, their claim to be charitable organizations would now be governed by the additional conditions stipulated in the proviso to section 2 (15).

3.2. In the final analysis, however, whether the assessee has for its object the advancement of any other object of general public utility is a question of fact. If such assessee is engaged in any activity in the nature of trade, commerce or business or renders any service in relation to trade, commerce or business, it would not be entitled to claim that its object is charitable purpose. In such a case, the object of general public utility will be only a mask or a device to hide the true purpose which is trade, commerce or business or the rendering of any service in relation to trade, commerce or business. Each case would, therefore, be decided on its own facts and no generalization is possible. Assessees, who claim that their object is charitable purpose within the meaning of Section 2(15), would be well advised to eschew any activity which is in the nature of trade, commerce or business or the rendering of any service in relation to any trade, commerce or business.

Loans and advances given by all closely-held companies, that is, in the case of private sector companies whose shares were not listed in a recognised stock exchange on the last date of the relevant previous year, are taxable as dividend in the hands of dominant shareholders, that is, shareholders who have got at least 10 per cent stake in the company.

But this is subject to the condition that at the time of giving of loan the company had accumulated profits. If there were accumulated profits at the time such shareholder took loan, there of course would be a tax on such deemed dividend but the loan can be set off against his actual dividend entitlement when it is declared.

For example, if such a shareholder takes a loan of Rs 2 crore and the company thereafter sets off the loan against his dividend entitlement of Rs 3 crore, the position would be as follows:

deemed dividend taxable in his hands, Rs 2 crore; and

actual dividend on which dividend distribution tax is payable, Rs 1 crore.

But this is not a complete consolation because while DDT rate is 17 per cent, the maximum marginal rate for individuals is 34 per cent.

Date : Wednesday, October 08, 2008

As I write this, I am witnessing the most amazing collapse of the global markets with the indices across the globe coming crashing down.

Let us have a look at the developments that have taken place in the last 24 hours:

1.      Global Central Banks lower rates by 50 basis points.

2.      FED, ECB, BoE, Central Bank of China lowered their rates by 50 basis points.

3.      India had taken this step yesterday itself

4.      Global growth estimates for 2009 cut to 3% as against 3.9% projected earlier

5.      India growth estimates lowered to 6.9% as against 8% projected earlier

6.      Indian Market closes 700 points down breaks 11000 barrier

7.      Dow opens 200 points lower; European markets also down.

8.      IMF has clearly indicated that developed economies are either in or are entering a recession.

9.      IMF – Global outlook subject to considerable downside risks

10. UK banks have kept $50bn on call should the banks need them

11. UK feels that 50bn is not enough but is enough to keep UK out of recession.

The above developments clearly indicate the fact that the market is firmly in a vice like bear grip and it would take more than rate cuts to revive the markets. The market is now driven by fear psychosis coupled with dried up liquidity. It is now only a matter of time that panic sets in and people troop in herds to sell their stock as if there will be no tomorrow.

IMF’s view that most developed economies are either in or entering a recession phase is not very inaccurate. I fully endorse the view – and the worst is yet to come. Amidst the brohua of the stock markets no one is really paying any attention to the real estate and the credit cards segment – I think the next downward wave would come from these two sectors. Even the IT sector would witness some major downsizing. Recession in Europe and US is definitely going to impact the topline and the bottomline of the infotech company.

I have always been forecasting a global meltdown – particularly in the financial sector. The financial sector has been in a fragile zone for quite some time now and it was only natural that a small push in a pressure point would result in the whole market come tumbling down. This push has now come in the form of collapse of Lehman brothers which set off a series of chain reaction having impact across markets.

I have always been against the BPO culture and now more so. With a global recession in the offing the BPO segment is likely to witness a shakeout and the impact of this shakeout will leave a huge and ugly wound on the employment market and this would is going to take one helluva time to heal. We are going to be stranded with thousands of telephone operators with no specific professional or technical skill.

Like Shahrukh said in Om Shanti Om – “Jao mat dost – show abhi baaki hai” – The fun has just begun – so sit back, relax and don’t touch the remote (and more importantly don’t touch any stocks).

Accounting for the auditors Prem Sikka 

In the current financial turmoil, companies are falling like ninepins. 
Lehman Brothers is in administration. Northern Rock, Fannie Mae and 
Freddie Mac have been bailed out and the list of vulnerable banks is 
growing. Bear Stearns and Merrill Lynch have been sold at knockdown 
prices and HBOS has merged with Lloyds TSB. Governments are pouring vast 
amounts of money to bail out financial institutions. Amidst the mayhem, 
we need to ask questions about the role of auditors, who have been paid 
millions of pounds to give opinions on company financial statements. Yet 
companies are sinking within weeks of getting a clean bill of health. 

Ever since the 1998 collapse of Long Term Capital Management (LTCM) and 
its rescue by the US Federal Reserve, it has been acknowledged that 
derivatives are very difficult to value. In this case Nobel prize 
winners in economics could not work out the value of such financial 
instruments. Derivatives are central to the demise of Lehman. Its annual 
accounts mention derivatives contracts with a face value of $738bn and 
fair value of $36.8bn. 

Lehman Brothers, incorporated in the tax haven of Delaware, was audited 
by the New York office of Ernst & Young. On January 28 2008, the firm 
gave a clean bill of health to Lehman accounts for the year to November 
30 2007. The auditor’s report (page 75 of the accounts) says, “Our audit 
included obtaining an understanding of internal control over financial 
reporting, assessing the risk that a material weakness exists, testing 
and evaluating the design and operating effectiveness of internal 
control based on the assessed risk, and performing such other procedures 
as we considered necessary in the circumstances”. Lehman Brothers filed 
quarterly accounts with the SEC for the period of May 31 2008 and on 
July 10 2008 and these (see page 52) too received a clean bill of 
health. Despite the deepening financial crisis, auditors did not express 
any reservations about the value of the derivatives or any scenarios 
under which company may be unable to honour its obligations. Just two 
months later, Lehman collapsed. 

During 2007, Ernst & Young collected fees (see page 43) of $31,307,000 
from Lehman Brothers, compared to $29,451,000 for 2006. The fees for 
2005 and 2004 were $25,324,000 and $24,748,000 respectively. Over the 
last four years, Ernst & Young collected over $110m in fees, of which 
nearly $14m is for advice on tax and other consultancy services. 

The scale of fees raises questions about auditor independence. By 
providing other services auditors begin to perform quasi management 
functions and cannot objectively evaluate the outcome of the 
transactions they themselves have helped to create. The fee of $110m for 
the New York office of Ernst & Young is likely to be significant in 
influencing the financial rewards of local partners and managers. The 
fee dependency exerts pressure on auditors to acquiesce with management. 
Such concerns were raised during the demise of WorldCom, Maxwell, Enron 
and more recently in the insolvency examiner’s report on the collapse of 
New Century. 

Audit opinions are akin to financial mirages. In recent weeks, within a 
short period of receiving clean bills of health Bear Stearns, Carlyle 
Capital Corporation and Thornburg Mortgage hit the financial buffers, 
closely followed by Lehman Brothers. 

Time and time again it has been shown that the basic audit model is 
faulty. Private sector auditors cannot be independent of the companies 
that they audit. This fundamental faultline has not been addressed by 
the post Enron reforms. In addition, the ex-post financial audits are 
too late and cannot alert financial regulators of problems. The 
financial regulators have a wider remit and are also concerned with the 
financial health of the whole system. These shortcomings were recognised 
after the 1929 stock market crash. The draft legislation that created 
the SEC in the 1930s contained a provision making the SEC the auditor 
for public companies, but under pressure from corporate interests, 
legislation was diluted. 

It is time to go back to the future and ensure that audits of major 
companies, at least banks and financial institutions, are carried out 
directly by the regulators. These audits should be on a real-time basis. 
Audits by regulators have the advantage of independence and can address 
regulatory issues. Accounting firms and companies used to softer audits 
will no doubt fight tooth-and-nail to retain their privileges, but we 
can’t continue to indulge accounting firms and pay billions to rescue 
banks. guardian.co.uk ) Guardian News and Media Limited 2008