Law on s. 192 TDS obligation on medical reimbursement & LTC explained.

ACIT vs. Infosys BPO (ITAT Bangalore)

 

The assessee recruited employees under a contract of employment which provided the salary as a ‘cost to company’ or ‘CTC’. Having determined the CTC, the employee was permitted to choose what would be the various components of his salary and for this purpose a basket of allowances was made available for the employee to choose from. The maximum allowance for each such allowance was fixed by the assessee. The said allowances included a component towards medical expenditure & leave travel concession (LTC). If the employee submitted proof of having incurred the expenditure towards medical treatment, he was allowed exemption to the extent provided in proviso (iv) to s. 17(2) of the Act. Likewise, if the employee submitted proof regarding leave travel, he was allowed exemption u/s 10(5) read with Rule 2B. The AO held that as Proviso (iv) to s. 17(2) and s.10(5) used the expression “actually incurred”, the exemption towards medical reimbursement and LTC could be conferred only for amounts paid as reimbursement after they were incurred by the employee and not before. She held that as the assessee was paying medical reimbursement & LTC as a component of salary every month, without the employee having incurred expenditure, the same had to be considered as salary disbursement for purposes of TDS u/s 192. The assessee was accordingly treated as being in default. On appeal by the assessee, the CIT(A) reversed the AO. On appeal by the department to the Tribunal, HELD dismissing the appeal:

Though TDS has to be effected at the time of payment of salary, s. 192(3) permits the employer to increase or reduce the amount of TDS for any excess or deficiency. Even assuming that the case of the AO that at the time of payment the assessee ought to have deducted tax at source is sustainable, the assessee, on a review of the taxes deducted during the earlier months of the previous year, is entitled to give effect to the deductions permissible under proviso (iv) to s.17(2) or exemption u/s10(5) of the Act in the later months of the previous year. What has to be seen is the taxes to be deducted on income under the head ‘salaries’ as on the last date of the previous year. The case of the AO that LTC and Medical reimbursement should be paid at the time the expenditure is incurred or after the expenditure is incurred by way of reimbursement and not at an earlier point of time and that if it is so paid, then, even though the payment would not form part of taxable salary of an employee, the employer has to deduct tax at source treating it as part of salary, is contrary to s.192(3) and cannot be sustained. The reliance placed by the AO on the expression “actually incurred” in s.10(5) & Proviso (iv) to s.17(2) cannot be sustained. In any event, the interpretation of the word “actually paid” is not relevant while ascertaining the quantum of tax that has to be deducted at source u/s192. As far as the assessee is concerned, his obligation is only to make an ”estimate” of the income under the head “salaries” and such estimate has to be a bona fide estimate. The primary liability of the payee to pay tax remains. In a situation of honest difference of opinion, it is not the deductor that is to be proceeded against but the payees of the sums. On facts, as the assessee had granted exemption towards medical expenditure and leave travel after verifying the details and evidence furnished by the employees, it could not be treated as an assessee-in-default.

Rupee rebounds as RBI sells dollars to oil companies.

 The Indian rupee has rebounded from the record low it hit yesterday after the Reserve Bank of India said it would sell dollars to the country's major oil companies. With oil India's biggest import item, the action is aimed at removing $400-500M worth of demand a day for the dollar from the spot market and reducing downward pressure on the rupee. The USD-IRN was -1.9% at 67.465 at the time of writing, while shares were +2.25% and 10-year bond yields -16 bps at 8.805%

Equities rebound on possible delay to action against Syria.

 U.S. stock futures and European shares were higher at the time of writing, while most indices in Asia rose, following the emergence of divisions in the U.S. and U.K. that could delay military intervention in Syria. Meanwhile, gold and oil, which rose because of the tension, were lower.

The repercussions of excess debt are glaring. Take the example of West. Most countries are facing dire consequences of allowing excesses in their economies. In Asia, the situation of Japan is not good either. In fact, the finance minister of Japan has requested to set aside approximately US$257 bn towards funding interest payments for FY15. This is almost equivalent to GDP of Portugal which roughly stood at US$245 bn in 2012, as reported by IMF!

In the past, incessant spending to revive the sagging economy resulted in higher debt. Increasing welfare cost of the ageing population also added to the debt pile. In fact, right now, Japan's debt is almost two times the size of its economy. Increasing debt has raised concerns over how the country will finance its interest payments. If it increases tax rates then consumer spending will slowdown. This will further hurt economic growth. And if it plans to service the payments by printing additional money, yen would come under severe pressure. It seems like after the rupee debacle, another Asian currency is on the verge of a collapse.

S. 32: A finance lease designed as a sale-and-lease back has to be treated as a sham transaction

Hathway Investments Pvt. Ltd vs. ACIT (ITAT Mumbai)

 

The assessee, an investment company, bought electric meters from the Gujarat State Electricity Board (GSEB) which were leased back to GSEB simultaneously. The assessee claimed 100% depreciation on the purchase cost of the meters. The AO and CIT(A) rejected the claim on the ground that the circumstances like no physical possession of the meters given etc showed that the transaction of ‘sale and lease-back’ was a “sham” and that it was one merely of giving finance and that the assets were held as a security for the finance given. On appeal by the assessee to the Tribunal HELD:

A distinction between an ‘operating lease’ and a ‘finance lease’ has been made by the Special Bench in IndusInd Bank 135 ITD 165 (Mum) (SB) on the basis of which it can be said that a ‘finance lease’ is a ‘sale’ which is given the colour of a ‘lease’ by the parties for their mutual benefit and to avoid tax. In such transactions, it has to be seen whether the sale transaction is a real transaction or a sham transaction with the object of enabling the alleged purchaser to claim himself as the owner of the goods, which are further claimed to be leased back to the original owner of the goods. In a sham transaction of sale and lease back the ownership of the goods is not transferred to the alleged lessor, but is shown to be done, so as to enable the purchaser to claim ownership for the goods for the purpose of tax relief. On facts, the ‘sale and lease back’ transaction is a sham transaction done with the object to facilitate the benefits of depreciation to a person who otherwise is not eligible to claim the same. The intention of the parties was not that of sale or lease but was a loan transaction. The rates of interest/ rental have been fixed taking into consideration that the equipments are eligible for 100% depreciation and it is provided that if the claim of depreciation is changed, the rental in the shape of interest will accordingly change. Such clauses cannot be a part of any lease agreement but finance agreement only because in a normal lease agreement, the lessee is not concerned as to what benefits are available to the owner/ lessor under the Income-tax Act. The contention that as the transaction is with a State Government undertaking, it would be highly improper to impute any collusiveness or colourable nature of the transaction is misconceived. The argument that there is no bar for the assessee for making tax planning so as to reduce its taxes, provided it is within the framework of the law, is also not acceptable as u/s 23 of the Indian Contract Act, even if the consideration or object of an agreement may not be expressly forbidden by law, but if it is of such a nature that, if permitted, it would defeat the provisions of law, the same will not be lawful. Engaging in sham transactions with the object of reducing tax liability cannot be said to be a case of tax avoidance but is one of tax evasion (ICDS 350 ITR 527 (SC), IndusInd Bank 135 ITD 165 (Mum)(SB) & Development Credit Bank referred)

Contrast with ICDS 350 ITR 527 (SC) where it was held that even a “financier” satisfies the “ownership” &“user” test for depreciation and with Development Credit Bank (ITAT Mumbai) (the AM was common) where it was held that IndusInd Bank 135 ITD 165 (Mum)(SB) is no longer good law

Rupee fall continues.

The Indian rupee's collapse shows no sign of abating, with the currency hitting yet another record low of 68.71 to the dollar as the tension in the Middle East adds to the Fed's prospective tapering and domestic economic problems as reasons to sell. However, shares have recovered from earlier losses and were +0.2% at the time of writing. The collapse in the rupee is causing havoc for companies, as it's boosting import costs at the same time that consumer spending is falling.

Prospect of intervention in Syria again weighs on markets.

The increasing likelihood of Western military action against Syria has again rattled markets across the globe, although U.S. stock futures were slightly higher at the time of writing after sharp falls on Wall Street yesterday, while gold and oil continued to climb. Many Asian and European share indices fell, with some emerging-market asset classes continuing to suffer, whether they be equities or currencies.

The worst hit currencies.

At the time of writing this, the rupee is trading at 68.75 per US dollar. Frightfully close to the prediction of breaching the 70 per dollar mark. Fiscal concerns over the Food Security Bill and the Syria issue have brought the currency lower by 10% in the last 10 days. The sword of sovereign downgrade, to junk status, hangs mercilessly over India's economic fortune. Meanwhile, the government is least interested in paying any heed to the warnings of the RBI. The only solace is the fact that several other emerging market currencies have also lost significant value in 2013, albeit much lesser than the rupee.

Source: Hindustan Times

S. 80-IB: Though Duty Drawback & DEPB were held not eligible for deduction in Liberty India 317 ITR 218 (SC), answer could be different if business model shows dependence on Duty Drawback & DEPB for survival

Arvind Footwear Pvt Ltd vs. DCIT (ITAT Lucknow)

The assessee claimed that the “duty drawback” receipt of Rs. 1.53 crores was eligible for deduction u/s 80-IB on the ground that the said duty drawback refund was a refund of customs and central excise duty on inputs used in manufacturing of its products. The AO & CIT(A) rejected the claim by relying on Liberty India 317 ITR 218 (SC) where it was held that duty drawback was not “derived” from the industrial undertaking. On appeal by the assessee to the Tribunal HELD:

Though in Liberty India it was held that duty drawback and DEPB arises from an independent source and is not “derived” from the industrial undertaking, in Dharam Pal Premchand 317 ITR 353 (Del) (SLP dismissed) it was held that refund of excise duty had a direct nexus with the manufacturing activity & was eligible for s. 80-IB deduction. Accordingly, though duty drawback & DEPB was held in Liberty India to be an independent source of income and to not have a “first degree” nexus with the undertaking, this was in the context of a fact-situation where the duty drawback& DEPB did not arise from core activities of the undertaking and was an additional, ancillary or supplemental profit. There can be situations in which duty drawback itself could be more than the overall profits and in such situations, the duty drawback may not be seen on standalone basis or as an independent source of income because the overall profit is only a part of the duty drawback receipt, and the commercial motivation of running the industrial undertaking is earning only that part of duty drawback receipts. On the present facts, the duty drawback was more than the entire operational profit and so it cannot be an open and shut inference that the duty drawback receipts are an independent source of income and have no first degree nexus with the business activity of the industrial undertaking. There is still room for consideration of the plea that but for the duty drawback the assessee would not have carried out the business activity in the industrial undertaking, because, that would have meant carrying out business for incurring losses. If that be so, the duty drawback receipts can be said to derived from the undertaking and to be eligible for s. 80-IB deduction. The question whether the duty drawback is an incidental profit or a profit of the first degree depends on the business model followed by the assessee.

Japan needs $257B just to service its debts.

 Japan's Ministry of Finance reportedly wants to allocate a record ¥25.3T ($257B) to service the country's mammoth debt of ¥1,000T ($10T) - which is double the size of its economy - for the next fiscal year. The expected provision is 13.7% higher than for this FY. The speculation comes as Japan debates whether to increase sales tax, a move seen as important for dealing with the country's debt but also as possibly hurting its nascent growth.

Growth in Chinese industrial profits accelerates.

Net income at Chinese industrial companies rose 12% on year in July, up from 6.3% in June, providing further evidence that the economy is stabilizing following a two-quarter slowdown in growth and a credit squeeze in June. The data helped Chinese shares buck the global downtrend and rise 0.3%. Meanwhile, a deputy governor of the People's Bank of China, believes that the Fed's tapering may only have a "limited" impact on his country compared with other emerging nations.

German business confidence rises again.

Germany's Ifo index of business confidence has risen to its highest level since April 2012, increasing to 107.5 this month from 106.2 in July and topping consensus of 107. The current assessment and the expectations indices improved as well. The business climate indicator for manufacturing increased significantly and also hit the highest level in 16 months, with companies expecting exports to strengthen.

Rupee dives to more fresh lows after food bill passed.

India's rupee has dropped to another record low of 66.075 to the dollar and shares have plunged after the country's Lower House of Parliament approved a $20B plan to provide cheap grain for the poor, or almost 70% of the country's 1.2B people. The bill has prompted concerns that it will add to India's fiscal deficit. The currency has plummeted this year for a variety of reasons, including the lack of economic reform and the Fed's prospective tapering.

Nifty August Futures - Important Levels for Tuesday, 27.08.2013.

TREND DECIDING LEVELS : Today, the Important Trend Deciding Levels Levels on Lower side is  5445-5430.  Below this, next important level is  5400-5380.     (This levels, Either Acts as a support while Nifty is moving in downward direction or Acts as a down side Break out/Break down Trigger level which fuels further downward movement from here).

Today, the Important Trend Deciding Levels on Higher Side is 5475-85.  Above this, next important level is  5500-5520.  

  (These levels, Either Acts as a hurdle while Nifty is moving in upward direction or Acts as a Upside Breakout Trigger level which fuels further upward movement from here).

Disclaimer :

The stock Tips and recommendations given in this blog is for information and educative purpose only. No representations can be made that the tips given here will be profitable or that they will not result in loss. Trading involves risk of loss of money. The Tips in this news letter are given with the understanding that readers acting on this information assume all the risks involved and that they are trading at their own risk. The above recommendations are based on the theory of price related technical analysis and they do not reflect the fundamental strength or weakness of the respective stocks.We shall not be responsible for any loss incurred for acting on the tips given above.

Gold breaks $1,400 before falling back.

Gold futures broke through $1,400 earlier, climbing to as high as $1,405.70 an ounce after weak U.S. housing data last week weakened expectations about the Fed's prospective tapering. However, Bullion has since pulled back and was -0.1% at $1,395 at the time of writing. The metal has been on a remarkable run since dropping to almost $1,200 an ounce in June, and is now approaching bull-market territory, which is defined as a rise of 20%.

Wal-Mart pulls back in India amid probe.

Wal-Mart (WMT) has "stopped expanding" in India despite the retailer and its joint venture partner Bharti Enterprises starting to do "reasonably well," a retail analyst tells the FT. The move comes as the Indian government examines whether Wal-Mart's $100M convertible debenture investment in Cedar Support Services, the parent of Bharti Retail, amounts to an illegal foreign direct investment in supermarkets.

These are dark times for Indian economy with a lot of things going wrong. Slow growth, current account deficit and plunging rupee - all point out to the government's apathy and policy paralysis over years. And even now, the government instead of acting to minimize the damage is just making it worse. As per a leading financial daily, Nokia believes India is the least favourable market to operate. In fact, is thinking to quit India and shift its operations to China. The issue stems from lack of clarity on tax policies. The same may lead to hefty penalties against the firm. It is not a small issue related to just one firm. A lot of other MNCs such as Cadbury and Vodafone have had similar experiences in India. Nokia's reaction should be taken as feedback about how foreign companies feel about operating in the country. Lack of transparency and policy paralysis is the reason why foreign companies are not stepping in despite relaxing the FDI limits. India already stands vulnerable and is hardly in a position to take further blows. When so much seems to be going wrong, we cannot afford to annoy and lose the few MNCs that are present in the country. Hope the policymakers are listening.

Brazil launches $60B blitz to boost the real.

Brazil's central bank will today embark on a $60B program aimed at supporting the real (BZF), which has dropped 9.1% vs the dollar in this month alone. On Monday-Thursday, the bank will sell $500M worth of foreign-exchange swaps every day, while on Friday it will auction $1B of dollar loans. The program adds to swap and credit-line actions of $45B that the bank has already announced this year, not that they've done much good. The real was at 2.4428 to the dollar at the time of writing.

Moody's warns of downgrade on major banks.

 Moody's has put Goldman Sachs (GS), JPMorgan (JPM), Morgan Stanley (MS) and Wells Fargo (WFC) on review for downgrades as the agency considers reducing its assumption about how much government support they're likely to get. Bank of America (BA) and Citigroup (C) are also on review, but the "direction (is) uncertain," due to their standalone credit strength.

Emerging-market currencies continue to suffer.

 Emerging-market currencies have again fallen following the release of the latest FOMC minutes. The recent spike in U.S. debt yields has caused borrowing costs to increase globally, which, along with the rising dollar, has not been healthy for emerging markets with large current account deficits, such as India. The country's rupee, along with Turkey's lira, hit new record lows, while the currencies of Indonesia, Malaysia and Thailand dropped to multi-year troughs.

Eurozone business growth hits two-year highs.

Eurozone flash manufacturing PMI has increased to a 26-month high of 51.3 in August from 50.3 in July and exceeded consensus of 50.8. Services also showed expansion, as did the composite figure. "The upturn is being led by Germany," while "a long-awaited recovery seems to be taking shape in the periphery." However, a "big question mark" still hangs over France.

The Reserve Bank of India's (RBI) has finally come to the banking sector's rescue. The central bank has come up with norms that would ease the pressure on the banks' investment portfolios. One measure is to allow banks to shift some of their bonds to the HTM (Held to maturity) category. This is an accounting technique by which the banks would no longer be required to report mark to market losses on this part of the portfolio at least. The RBI has also allowed banks to retain their SLR holding in the HTM category at 24.5%. Earlier it had planned to reduce this percentage. So these measures would help the banks' bottom line to some extent albeit only because of accounting changes.

The bigger relief for the market is that RBI has announced measures to infuse more liquidity in the market. This should bode well for the corporate world which has seen its investment plans come under pressure due to the monetary tightening by RBI. But the question is whether these measures are sufficient to kick start the slowing investment cycle? We think not. The measures provided by RBI do come as a relief but the relief is only temporary. For long term relief the government still needs to remove the structural roadblocks. The RBI has done its job and is still doing it. Now it's time for the government to do the same.

Euro Pared Gains Against Dollar Ahead of FOMC Minutes.

While Sterling stays firm against dollar ahead of FOMC minutes, other European majors, Euro and Swiss Franc, pared some of this week's gain. The greenback also strengthened against other commodity currencies. In particular, USD/CAD took out 1.0444 resistance today and suggests further upside in near term. Data released today saw UK CPI trends total orders improved much more than expected to 0 in August, comparing to expectation of -8. Public sector net borrowing cane in smaller than expected at GBP -1.6b in July.

 

Markets are expecting Fed to taper the $85b per month quantitative easing program in September but that would likely be by a small step of $10b reduction. Such expectation has pushed treasury yields to highest level in nearly two years. Meanwhile, DOW dropped more than 4% since early August. Today's FOMC minutes might reveal that policy members are more upbeat on the economic outlook and acknowledge the improvements in the labor markets.

RBI moves to restore liquidity but rupee continues free-fall.

The Reserve Bank of India has said it will buy government bonds on Friday and take other measures to inject liquidity into the banking system. The move comes after a series of tightening measures unsuccessfully attempted to stem the free-fall in the rupee and instead caused a cash crunch. Yields on 10-year government bonds were -57 bps at 8.35% at the time of writing, but Indian shares were -1.9% and the USD-INR was +2% at 64.391.

Moody's upgrades outlook on U.S. states.

Moody's has lifted its collective outlook on U.S. states to stable from negative, citing increasing revenues following improving labor and housing sectors, consumer confidence and stock-market performance. Credit quality is strong, with 30 states holding the two highest ratings, AAA or Aa1. Due to its massive pension gap, Illinois has the lowest rating among states, A3, while the local government outlook remains negative.

Markets await FOMC minutes.

U.S. stock futures and European shares were lower at the time of writing, while Asian shares traded mixed, as markets awaited today's publication of the minutes of the latest FOMC meeting. Ten-year Treasury yields were slightly up at 2.83%. "The minutes should continue to reinforce this theme of tapering at the September meeting as long as the labor market holds up," says RBS's Michelle Girard. "They should also repeat another tune dear to FOMC hearts, 'tapering is not tightening.'"

Indonesian turmoil continues.

Indonesian shares were -3.2% at the time of writing, adding to yesterday's sharp decline. Stocks have been flirting with bear-market territory having slumped around 20% from their highs in May. The rupiah dropped as well and was 10,787.5 to the dollar, with the USD-IDR +2.8%. The turmoil comes amid worries about slowing economic growth, high inflation, a widening current account deficit, concerns that capital outflows will speed up, exposure to China, and the Fed's prospective tapering.

Global stocks drop on India, Indonesia turmoil, Fed worries.

Japanese shares (DXJ, EWJ) slumped 2.6% as the turmoil in India and Indonesia  hit stocks with exposure to those countries. Trading around the world has continued to be otherwise dominated by the obsession with the Fed's prospective tapering as markets await the release of the latest FOMC minutes tomorrow.

JPMorgan probes keep on piling up.

The Department of Justice is reportedly investigating JPMorgan (JPM) over whether it manipulated U.S. energy markets. The speculation comes less than a month after the bank agreed to pay $410M to the Federal Energy Regulatory Commission to settle charges related to such manipulation. For those trying to keep up, the probe adds to inquiries over the bank's hiring practices,the London Whale, metal warehouses and mortgage bonds.

RBI steps in to stem rupee's freefall.

The Indian rupee has experienced a roller coaster day, dropping to another record low of 64.175 before recovering to 63.565 at the time of writing amid speculation of intervention by the Reserve Bank of India. The USD-INR was -0.5% after being higher earlier, while shares were -0.3%. The rupee's precipitous slide over the past few sessions has been prompted by the announcement last week of measures that smelled like capital controls, as well as longer-term factors such as fears about Fed tapering and frustration at the lack of economic reform.

Banks rally after RBI eases cash, bond holding rules.

The Bank Nifty surged 5.4 percent in early trade after the Reserve Bank of India eased cash and bond holding rules for banks on Tuesday.

 

The RBI relaxed rules on mandatory bond holdings for banks, which would help protect lenders from large mark-to-market losses and said it would buy long-dated government bonds worth 80 billion rupees.

 

Government bonds rallied and the rupee was marginally stronger on Wednesday after the RBI said late on Tuesday it will buy bonds and eased bond-holding rules for banks to ease tight cash conditions.

 

The benchmark 10-year bond yield fell as much as 69 basis points to 8.21 percent. It was last trading at 8.28 percent.

 

The rupee also posted some gains on the back of strong local stocks, with banking shares leading the gains. The rupee was at 63.19/20 versus Tuesday's close of 63.25/26.

 

Interest rate swaps were also sharply down. The five-year OIS was down 60 basis points at 8.35 percent, while the one-year was down 44 bps at 9.45 pct, traders said.

Euro Rises as on Bundesbanks' Monthly Report

Euro strengthens today as Bundesbank discussed ECB's forward guidance in its monthly report. Bundesbank noted that ECB is "not tied" and if price pressures are "higher than currently assumed", an increase and interest rates "is not ruled out".

 

Also, Bundesbank said Germany will return to "normal steady growth" in the second half of the year. And, "the significantly increased economic activity in the spring means that the German economy has returned to its normal utilization."

 

EUR/USD edges higher to 1.3374 but is kept below 1.34 level so far. Meanwhile, EUR/JPY broke last week's high of 130.72 to resume recent rebound.

 

Sterling also rises against dollar and yen today as the Confederation of British Industry raised growth forecast for 2013 to 1.2%, up from prior 1.0%. 2013 growth projection was also revised up to 2.3%, up from prior forecast of 2.0%.

 

CBI noted that the UK economy has "started to gain momentum and confidence is picking up". Nonetheless, it would like to see a "full-blown rebalancing" before calling it a "sustainable recovery". And, it hoped that increase in business investment and trade would begin to emerge in 2012 as Eurozone starts growing again. It expected business investment to contract -2.8% in 2013 and bounce back by growing 7.3% in 2014.

Japanese trade surges on weak yen.

Japan's exports climbed 2.2% in July, the fastest since December 2010, while imports jumped 19.6% and the trade deficit hit ¥1.02T, the third-largest ever. The weak yen was a major factor, helping to make sales abroad cheaper but imports more expensive. "The (export) details are encouraging because you can see that exports to Japan's main markets are bouncing back," Sales to the U.S. increased 18.4%, to China 9.5% and to the EU 16.6%.

Almost $20B flees bond funds in August so far.

Outflows from U.S. bond mutual funds and ETFs have risen to $19.7B in August so far from $14.8B in July, TrimTabs says, making this month's figure the fourth-highest on record. Since the beginning of June, $103.5B has left bond funds, or 2.7% of total assets. The sell-off, which has been prompted by fears of Fed tapering, has sent Treasury yields upwards, with the 10-year hitting 2.871% today, the highest for just over two years.

In order to curb the rising current account deficit (CAD) the government recently raised import duty on gold. However, this has had very little impact on gold consumption. In fact, in the June quarter, India's gold consumption rose to 310 tons. This figure registered in June quarter is the highest ever seen in the last 10 years. It is true that the impact of current increase in duty will be evident in the future quarters. But considering India's huge gold appetite, this may not be the case. India is the world's largest buyer of gold. In fact, India and China accounted for 60% of the world's total demand in June ending quarter. Increase in jewellery demand predominantly due to falling prices was one of the reaso ns of increase in consumption. Apart from that, demand for gold bar and coins was also buoyant.

It may be noted that India almost entirely depends on imports to meet its domestic demand for gold. And in 2013, the demand is expected to be in the region of 900-1000 tons. As such, rise in duty may not have the desired impact considering India's appetite is so high. Thus, we believe if government continues with its policy to increase import duty it may well lead to gold smuggling rather than curbing the demand.

RBI attempts to boost rupee backfiring.

Measures by the Reserve Bank of India to try to boost the rupee seem to be backfiring - for now - with the currency hitting a record low of 62.13 to the dollar. The USD-INR was +0.6% at 61.815, while shares were -3.9% on fears the RBI is losing credibility. Earlier this week, the RBI said it would cap forex outflows for local firms and residents, steps that could be perceived as "quasi-capital controls."

Inflation seen slowing.

July CPI data is due out this morning, with economists expecting that inflation slowed to 0.2% from 0.5% in June. Core CPI is seen holding steady at 0.2%. An especially low reading could give the Fed further pause for thought as it considers when to start winding down its bond-buying.

BOE voted 8-1 in favor of forward guidance as U.K. unemployment stuck at 7.8%.

The Bank of England's Monetary Policy Committee voted 8-1 in favor of adopting forward guidance, which includes a proposal not to raise interest rates from 0.5% until unemployment has dropped to 7% from 7.8% currently, subject to conditions related to inflation and financial stability. Some policy members believe there is a "compelling" case to restart bond purchases, although they held off calling for more QE in order to assess the effect of forward guidance.

As expected, U.K. unemployment held steady at 7.8% in April-June, the same rate as in January-March. The number of unemployed fell 4,000 to 2.51M. With the needle not moving despite GDP growth of 0.6% in Q2, BOE interest rates may well be staying at 0.5% for a while to come.

VIX Soars After Strong US Data.

Thursday equity market route finally lead to a surge in implied volatility that could see the VIX recover some of the gains made last June.  Stronger than expected employment data released by the Department of Labor eroded stocks as treasury yields rose to their highest levels since August of 2011.  Tic data showed that investors continue to exit fixed income markets, while inflation data showed that consumers where not bidding up prices.

 

On Thursday traders focused on jobless claims as opposed to the manufacturing Philly Fed number or the inflation recorded by Consumer prices.  The large decline in claims is what caught investors’ attention. Initial jobless claims; fell by 15,000 to 320,000 in the week ended Aug. 10, 2013 according to the Labor Department. The claims number is the lowest it has been since the US financial crisis.

 

Also released on Thursday was US (TIC) data showed 70 billion of sales in long term securities in the US which reflects a large amount of investors exiting the debt market. US headline CPI came in unchanged, compared to a .2% increase that was expected by economists. The core rates showed a .1% increase which was half of expectations. 

 

The large cap S&P 500 index declined nearly 1.5% which set off a rally in the VIX which climbed nearly 13%.  The VIX tested resistance near the 200-day moving average, which also coincides with the 50-day moving average.  A close above these levels would lead to a test of 18% and then the June highs near 22%.  Complacency has engulfed the equity markets over the past 6-weeks, but higher bond yields have led investors to purchase premium to protect their portfolios.

 

Momentum on the VIX is strong with the MACD (moving average convergence divergence) printing in positive territory with a strong upward trajectory.  The MACD generated a buy signal in early August and continues to point to a higher VIX.  The RSI (relative strength index) is printing near 57 which is on the upper end of the neutral range.

Eurozone exits recession as Germany, France, Portugal grow.

Eurozone GDP expanded 0.3% on quarter in Q2, signalling an end to the region's recession. The growth represented a recovery from contraction of 0.3% in Q1 and topped consensus of +0.2%. Germany expanded again in Q2 after GDP was flat in Q1, boosted by domestic demand, fixed capital formation and a trade surplus. France exited recession, as did - most surprisingly - Portugal, whose economy grew 1.1%.

In yet another move to curb current account deficit (CAD) the government has raised taxes on gold imports. This is the third time that import taxes have been raised in the year. But the efficacy of this move is questioned. There is a fear that increasing taxes will not curb gold imports but rather open the doors for smuggling. And rightly so. Taxes are being raised to curtail demand. But in India the demand for gold still continues to rise. And with the festive season approaching soon, the demand may get a further fillip. This would mean that traders would find unethical ways to meet this demand. This can result in smuggling of the yellow metal. Further, it may be noted that majority of the gold demand in India is met via imports. Hence, cutting that source out via increasing taxes means that supplies in the channel may dry. But with demand remaining intact gold premiums would rise. This entices imports via unethical means like smuggling. While the taxation move is to curb CAD perhaps government should find other ways to increase capital flows in order to fund the deficit. Else gold smuggling would prosper and may lead us back to the days of Gold Control Act!     

Current account deficit and currency depreciation.

India is not the only emerging economy feeling the heat of current account deficit on its currency. Several others like Brazil, South Africa, Turkey and Indonesia have seen their currencies lose value against the US dollar over the past couple of months. In fact even countries like Philippines and Russia that have a current account surplus have seen their currencies depreciating by 6% and 4.5% respectively since April 2013.


                   

Source: RBI Economic Survey

Dollar and Yield Rose on Fed Tapering Expectations

Dollar strengthened overnight as markets are starting to build a consensus that Fed will taper the bond purchase in September.

 

According to a Bloomberg survey, 65% of economists expected Fed to reduce the $85b per month bond buying. The expectation was also reflected in treasury yields which saw 10 year yields jumped to close at 2.715%, just shy of 2013 high of 2.737%. 30 year yield also rose sharply to close at 3.756%, just shy of 2013 high of 3.792%. Dollar index rose to as high as 81.879 overnight too.

 

However, note that the dollar index is still limited well below 82.49 resistance and there is no confirmation of reversal yet. Focus will remain on whether dollar could extend the rally during the second half of the month.

 

EUR/GBP spiked lower to as low as 0.8354 last week but quickly recovered back to above 0.8580. Main focus will be on UK job data and BoE minutes today. BoE pledged last week to keep monetary policy accommodative until unemployment rate drops to 7%.

 

Also, BoE inflation report showed projection that unemployment rate won't break drop below 7% level at least until 2016. Any present surprise in employment data would prompt speculation that BoE would normalize policies sooner.

 

Other focus today include Q2 GDP data from France and Germany, as well as Eurozone. French GDP is expected to grow 0.2% qoq, German GDP is expected to rise healthily at 0.6%. Eurozone as a whole is expected to pull out of recession with GDP growing at 0.2% qoq.

Freddie Mac spends fortune to prop up market share.

Freddie Mac (FMCC.OB) is reportedly spending hundreds of millions of dollars per year to hold onto market share instead of sending the money to the Treasury. The cash is going to lenders as compensation payments to make up for Freddie's MBSs trading at a lower price than those of Fannie Mae (FNMA.OB). Despite the payments, Freddie's market share has declined to the low 30s from its long-term average of 40%.

German investor confidence jumps.

The German ZEW survey of investor confidence has climbed to 42 in August from 36.3 in July and topped consensus of 40. The current situation print leapt to 18.3 from 10.6 and slayed forecasts of 12. "The first signs of an end to the recession in important eurozone countries may have contributed to the indicator's rise," ZEW said, as well as "robust domestic demand in Germany."

EU banks must slash €3.2T in assets for Basel III.

EU banks need to reduce their balance sheets by €3.2T and raise nearly €50B in capital over the next five years in order to comply with Basel III, the FT reports, citing an RBS study. The banks "most in need of fresh capital" are Barclays (BCS), Crédit Agricole (CRARY.PK), and — not surprisingly — Deutsche Bank (DB). Smaller banks will need to cut €2.6T in assets, a prospect that suggests lending to small businesses could dry up.

Japan's Q2 GDP growth slows and misses estimates.

Japan's economic expansion decelerated in Q2 to an annualized 2.6% from 3.8% in Q1 and undershot consensus of 3.6%. Growth was dragged down by an unexpected drop in capex, although private consumption topped forecasts. The reading has intensified the debate about a proposed increase in sales tax. "There is no need to raise the sales tax in a hurry," says Koichi Hamada, a key adviser to Prime Minister Shinzo Abe. Doing so "might hurt the economy."

India's balance of payments position in a very precarious situation.

Last week the US dollar-rupee exchange rate hit an all-time low of Rs 61.8 per dollar. India has just US$ 280 bn of forex reserves. Enough to cover only seven months of import bills! This is the lowest import cover since 1996! This is also the lowest import cover among BRIC nations. Everything seems to be working against India. Foreign fund inflows are drying. As per an article in Firstpost, stock markets have witnessed net inflows of US$ 2.3 bn since April 2013. However, there has been an outflow from debt funds of about US$ 5.7 bn. In addition, India has to repay liabilities worth US$ 172 bn by the end of fiscal 2013-14. Given the limited forex reserves, the RBI does not have much ammunition to intervene in the forex market and curb the rupee fall.

Is 2013 for India worse than 1998 ?

Since the Indian Rupee turned southwards, a lot of articles have started to crop up on how things are similar to what they were in 1998. 1998 was the peak of the Asian financial crisis when the rupee had come under pressure. The Reserve Bank of India (RBI) governor at that time had taken several measures including raising interest rates to arrest rupee's fall. At that time too India faced a slowing economy.

Jump to 2013, and things are eerily similar. This may make one get the sense of deja vu. As seen in the chart, the statistics show that at the moment things are actually worse than what they were in 1998. Barring GDP growth, which is expected to be around 5%, every other number paints a gloomy picture. Industrial growth has slowed down. The current account deficit (CAD) is worse. India's short term debt as a percentage of total debt has surged, which means repayments and interest would be a problem. Unfortunately because of the structural issues being faced on the policy implementation front, things are not expected to improve any time soon. At least on the domestic front. The export situation is no better either due to the depressed global economic scenario. Therefore unless the government can come up with some radical changes, the short term outlook for India is not very bright.
 

Source: The Mint

S. 271(1)(c) penalty is valid even if claim is disclosed and as per CA certificate

CIT vs. HCIL Kalindee ARSSPL (Delhi High Court)

 

The assessees claimed deduction u/s 80IA on the ground that it has executed an eligible infrastructure project. A copy of Form No.3CB, 3CD and Form No.10CCB was filed with the return in support of the claim. In the assessment order, the AO denied 80-IA deduction on the ground that the assessee had not executed the work but had given a sub-contract to another party and that it was not eligible u/s 80-IA(13). The assessee accepted the denial of the claim. The AO levied penalty u/s 271(1)(c) for filing inaccurate particulars of income which was upheld by the CIT(A). The Tribunal relied on Reliance Petroproducts 322 ITR 158 (SC) and deleted the penalty on the ground that the claim for deduction u/s 801A was on the basis of a certificate of the CA, was bona fide and all the material facts relevant thereto had been furnished. On appeal by the department to the High Court, HELD reversing the Tribunal:

While it is true that the Income-tax Act, 1961 is one of most vexed and complicated legislation and requires highest degree of interpretative skills and there are divergent views on interpretation of its provisions and while it is also true that penalty for concealment cannot be imposed merely because assessee’s interpretation or claim is rejected, such cases have to be distinguished from cases where the claim of the assesse is farcical or farfetched. Dubious and fanciful claims under the garb of interpretation, are a mere pretense and not bona fide. Absurd or illogical interpretations cannot be pleaded and become pretense and excuses to escape penalty. “Bona fides” have to be shown and cannot be assumed. The fact that the claim for deduction u/s 80IA was duly supported by the Chartered Accountant’s Certificate and prescribed forms signed by the CA cannot absolve and protect an assessee who furnishes in-accurate particulars because then in all cases where a form/certificate is furnished by the CA but a wrong claim of deduction is made, no penalty u/s 271(1)(c) can be imposed. Merely because the assessee complies with the statutory procedural requirement of filing the prescribed form and certificate of the Chartered Accountant cannot absolve the assessee of its liability if the act or attempt in claiming the deduction was not bona fide. On facts, the assessee’s claim was not tenable due to the Explanation to s. 80IA (13) which stipulates that benefit is not available to a contractor carrying on a works contract. The assessee has not shown any “tangible material” or basis as to why a clear statutory provision which excludes works contracts was ignored.

Contrast with Nalin P. Shah (HUF) (Bombay High Court) and the virtual dissent there by the Tribunal. See also the line of cases on inadvertent mistake not attracting s. 271(1)(c) penalty

French industrial output in surprise fall.

 French industrial output dropped 1.4% on month in June vs -0.3% in May and missed consensus of +0.1%. The surprising decline contrasts with the government's recent upbeat tone about the economy, with President Francois Hollande last month saying that the "recovery is here." Still, it's worth pointing out that Q2 industrial production rose 1.4% on quarter and 0.2% on year.

Japanese debt tops ¥1 quadrillion.

Japan's national debt has passed ¥1 quadrillion for the first time, increasing 1.7% on quarter in Q2 to ¥1,008.6T ($10.46T). That's more than twice the size of Japan's GDP, and larger than the combined economies of Germany, France and the U.K. The rise in debt comes as Japan debates whether to increase sales tax to 8% in April from 5% and then to 10% in 2015 in an attempt to shore up its finances.

China economic data adds to positive picture.

A bit of a data dump from China today has added to the impression that the country's economy is stabilizing. Chinese industrial production rose 9.7% on year in July vs +8.9% in June and topped consensus of 9%, while retail sales and urban investment were decent. Meanwhile, inflation stayed tame at 2.7%, which Merrill Lynch says provides room for a mini fiscal stimulus. One concern, though, is that the manufacturing sector remains mired in deflation, with PPI falling 2.3% on month.

BOJ leaves monetary policy unchanged.

As expected, the Bank of Japan has maintained its pledge to expand the monetary base by ¥60T to ¥70T a year. The BOJ also kept its assessment of the economy unchanged, saying that it's "starting to recover moderately," and noted that "inflation expectations appear to be rising." BOJ Governor Haruhiko Kuroda warned that Japan needs to keep its fiscal discipline, stressing that the government can increase its sales tax as planned and pull the economy out of deflation.

Chinese trade data beats estimates.

China's trade data for July topped expectations and provided evidence that the economy might be stabilizing following two years of slowing growth. Imports surged 10.9% on year vs expectations of +2.1%, while exports rose 5.1% vs +3%. "Together with the rebounding official Purchasing Managers’ Index...July trade data are supportive of a better economic outlook for China," says Bank of America's Ting Lu.

As if a swiftly depreciating rupee, bloating current account deficit and high inflation were not enough. The new RBI governor has much more to deal with that he must have envisaged. The latest alert is on the health of Indian banks. As per Firstpost, rating agency S&P has in a detailed report highlighted the deteriorating quality of banking entities.

Having analyzed the June quarter performance of PSU banking entities, this report is no surprise to us. In fact one can safely say that the condition of asset quality of PSU banks in particular is much worse now than it was in 2008. And the possibility of upward movement in interest rates makes the chances of further deterioration in asset quality more real. While the real culprit has been the restructured assets, the government's arm twisting policies are equally to blame. The onus of ensuring that problem of NPAs does not become a system wide malaise falls on RBI. And therefore Dr Rajan will have to ensure that the RBI takes a firm stance.

Sterling Soared after BoE Inflation Report

Much volatility was seen in Sterling on BoE's inflation report. The central bank made the largest change to the monetary policy framework since 2009 and linked the policy to unemployment rate, which was a surprise to the markets.

BoE pledged to keep current policy unchanged at least until unemployment rate drops to 7%. And the MPC emphasized that 7% level is a "threshold", but not a "trigger". And, the sustainable rate would be well below that at around 6.5%.

In the updated projections, BoE expects unemployment to fall from current 7.8% to 7.1% in Q3 of 2016, the end of its forecast horizon. That is, unemployment won't fall below the above mentioned 7% threshold. And BoE wouldn't probably raise rates until early 2017. Sterling initially sold off after the release.

However, it should be noted that BoE also gave itself an opt-out if inflation threatens to soar much higher than the 2% target. And the central bank could indeed tighten if medium-term inflation expectations stay above 2.5%. Markets took that as a sign that BoE is not ready to tolerate higher inflation. And currently, CPI in UK stands at 2.9%. Sterling rose sharply after initial knee-jerk reactions and broke 1.5433 resistance against dollar. The pound is also strong against Euro and yen.
 

BOE provides Fed-style forward guidance.

As expected, the Bank of England has provided explicit forward guidance for the first time, saying its key lending rate will stay at a record low of 0.5% until the U.K.'s unemployment rate drops to 7% from 7.8% in March-May. The BOE also doesn't intend to "reduce the stock of asset purchases financed by the issuance of central bank reserves" until the unemployment threshold is met. The bank could add to its QE if necessary.

Prospect of Fed tapering hits global stocks.

Japanese shares (DXJ) slumped 4% after two Fed policy makers, including the dovish Charles Evans, said the U.S. central bank could start tapering as early as next month. The remarks sent the dollar lower against the yen, which in turn helped drag down the Nikkei. The USD-JPY (FXY) was -0.6% at ¥97.08 at the time of writing. Fear of tapering hit other bourses around the world as well, with U.S. stock futures solidly in the red.

There are two things that drive property prices. One is demand and second in artificial scarcity. While there is very little that can be done about demand, however artificial scarcity created by builders is something that is hurting buyers the most. It may be noted that most builders are holding on to their inventories despite slowing sales thereby creating artificial scarcity in the market. While slowing sales impacts their cash flows until now they were able to arrange for external liquidity through banks. However, most of them are facing difficulty in making repayments as cash flows from their existing projects have dried due to sky rocketing prices. Further, they are also facing difficulties in getting fresh loans since banks have tightened their screws in lending to the realty sector. Also, restructuring of bank loans has been ruled out by RBI. Thus, the temporary relief option is also no longer available.

As a result, the only option in the hands of builders is to reduce prices. If not, they may default on their bank loans. As such, most real estate developers are in a precarious situation now. Under the greed to acquire land banks most of them have leveraged their balance sheets. And in such an environment where sales are not taking place due to rising prices servicing interest costs has become a matter of grave concern. With no external form of liquidity available to them we feel reducing property prices is the only option in their hands now.   

Euro and Sterling Supported by Data.

Euro and Sterling are firm against dollar after release of solid factory data. German factory orders rose 3.8% mom in June.

UK industrial production rose 0.3% mom, 1.2% yoy in June while manufacturing production rose 1.9% mom, 2.0% yoy.

UK BRC sales monitor rose 2.2% yoy in July. Also, Italian GDP contracted for the eighth consecutive quarter in Q2, by -0.2% qoq. But that was better than expectation of -0.4%.

The data added to confidence that the worst is over for Italy and recession is slowly bottoming out. Latest projections from Bank of Italy showed forecast that the economy would eventually grow in Q4 and as a whole, GDP would contract by -1.9% this year. However, economists warned that confidence is still fragile and political uncertainties could derail the recovery.

Transfer Pricing: Law on adjustment for notional interest on interest-free loan & excess credit period to AE explained

Micro Inks Ltd vs. ACIT (ITAT Ahmedabad)

 

The assessee advanced an interest-free loan to its wholly owned subsidiary called Micro USA. It claimed that the said loan was in the form of equity capital and was advanced to meet the business needs of the subsidiary and that no interest was required to be computed thereon. The assessee also extended credit of 165 days to the said subsidiary in respect of the goods supplied by it which it claimed to be in the normal course of business. The TPO held that the assessee ought to have charged interest on the loans advanced by it and that the credit period should not have exceeded 120 days. He computed notional interest at the rate of 11% on the loan and excess credit period and made an adjustment. The CIT(A) upheld the adjustment in principle though he reduced the interest to LIBOR. On cross appeals, HELD by the Tribunal:

(i) The question which really needs to be adjudicated is whether, in the context of s. 92A, but for the management, capital or control being in the same hands, the AE would have entered into the transaction on the same terms. In other words, whether there is such a commercial justification for the values at which transactions have been entered or not, so as not to attract the adjustment in the arm’s length price, has to essentially depend on factors other than the factors regarding management, capital or control. In still other words, merely because the entity receiving interest free funds is a subsidiary wholly owned by the assessee cannot be reason enough to justify such loans or advances being interest free and not warranting an arm’s length price adjustment, so far as transfer pricing provisions are concerned;

(ii) On facts, the assessee’s claim that the loans were in the nature of “quasi capital” deserves to be accepted. Under the RBI’s guidelines, while a loan from the EEFC account could be given without permission, the subscription to the equity capital required permission. The assessee applied for the permission and on receipt of it converted the loan into equity capital;

(iii) Further, the entity receiving the interest-free advance was not only a wholly owned subsidiary of the assessee company but also played a very significant role in its sale and distribution chain. Micro USA was a significant part of the marketing apparatus of the assessee and there was a significant commercial relationship between the two. The relationship between the assessee and Micro USA was not that of a lender and borrower simplicitor;

(iv) Further, in applying the CUP method, an adjustment has to be made under Rule 10B(1) “to account for differences …. which could materially affect the price in the open market”. There are significant differences between a typical transaction of loan of money and this transaction. LIBOR cannot be adopted in this situation because (a) the transaction is not a simplictor financing transaction but is a transaction of investing in a subsidiary as quasi capital pending formal approval of the RBI and (b) it is not a case of granting advance to a business concern without significant and decisive commercial considerations. The monies were given for strengthening the assessee’s marketing apparatus in the USA and to keep alive its biggest exports customer. The comparable uncontrolled price for interest on such a transaction in which advances are made pending capital subscription in a company which plays strategically significant commercial role in assessee’s business would be nil;

(v) As regards the excess credit period allowed to Micro USA, no adjustment can be made because it was part of the arrangement that specified credit period was allowed. The cost of funds blocked in the credit period was inbuilt in the sale price. Also, the question of excess credit period arises only when the goods are sold to third parties and the credit period allowed to the AE is more than the credit period allowed to others. Here, as similar products are not sold to any other concern, the question does not arise (Perot Systems 130 TTJ 685 (Del) distinguished; VVF Ltd (Mum) followed).

India's trade balance is quiet poor when compared to its peers.

India's current account deficit has been in the limelight in recent times because of the impact it has had on the rupee. The latter has steadily declined against the US dollar and touched a record low of 61.6. The problem is further compounded by the fact that India still imports quite a lot of oil. And when the time for payment comes, the demand for dollars rises, further exerting pressure on the rupee. Today's chart of the day shows, that India's trade balance is quite poor when compared to its peers. Only the US fares much worse than India. The country's BRIC peers notably China, Russia and Brazil have generated surpluses. While the Indian government has been focusing on improving the country's energy security so that the dependence o n imports reduces, it also needs to put plans in place to make exports more competitive.

 

                           

                              *Data for China, Brazil, India is till June 2013. For the rest it is till May 2013
                                                  Data Source: The Economist

Industrial output, retail data add to U.K.'s growth picture.

U.K. industrial production and retail-sales data have added to the positive picture of the U.K. economy, which grew 0.6% in Q2. Output expanded 1.1% on month in June and comfortably topped consensus of +0.7%, boosted by a 1.9% increase in manufacturing. Comparable retail sales rose 2.2% on year in July and also topped forecasts. Today's figures add to strong PMI readings for last month.

Transfer Pricing: Scope in the context of expenditure (royalty payment) explained

Reebok India Co vs. ACIT (ITAT Delhi)

 

The assessee paid royalty at the rate of 5% to its associated enterprise and claimed that the same was at arm’s length basis by applying the CUP method. The TPO and DRP determined the ALP of the royalty at Nil on the basis that (a) the approval given by the Government for payment of royalty did not automatically mean that the transaction was at arm’s length; (b) the assessee had not furnished a cost benefit analysis, (c) the technology had in fact not helped the assessee in earning better margins. It was held that as the technology had not contributed to the assessee’s profitability and there was no commercial benefit received, no independent enterprise would have make payment for royalty for the technology and so its ALP had to be determined at Nil. On appeal by the assessee to the Tribunal, HELD reversing the TPO & DRP:

(a) The TPO’s argument that the assessee need not have paid for the technology as it did not derive any benefit therefrom is not acceptable. The assessee is free to conduct business in the manner it deems fit and the commercial and business expediency of incurring any expenditure has to be seen from the assessee’s point of view. The Revenue cannot step into the shoe of the assessee and decide what is prudent for the business. On facts, the very survival of the assessee in the industry depended upon the licence and technology & know how provided by the AE. There has been a considerable increase in the sales figures and the growth in revenue clearly demonstrates the benefits derived by the assessee from the use of technology;

(b) the payment of royalty was approved by the Government of India. Though it is not conclusive proof, the said approval of the Government has to be given consideration while considering the arms length price of the transaction;

(c) Under Rule 10B(1)/ s. 92C(2), the arm’s length price has to be determined by one of the five methods which is found to be most appropriate method. While the assessee rightly considered the CUP method for determining the ALP, the TPO’s conclusion that the arms length price of the royalty payment should be NIL without specifying any cogent basis is not sustainable (EKL Appliances 345 ITR 241 (Del), Ericsson 146 TTJ 708 (Del), ThyssenKrupp Industries 154 TTJ 689(Mum), Dresser Rand 55 SOT 167 (Mum), SC Enviro Agro 143 ITD 195 (Mum) etc followed)

Transfer Pricing: Foreign associated enterprise can be taken as ‘Tested Party’

General Motors India Pvt. Ltd vs. DCIT (ITAT Ahmedaba)

 

The assessee bought CKD Kits from General Motor Daewoo Auto & Technology (GMDAT), a foreign associated enterprise. The assessee claimed that to determine whether the transactions were at arm’s length, GMDAT had to be selected as the tested party on the ground that the functions and risks of the assessee are more complex in nature and that numerous adjustments would have to be made if the assessee were taken as the selected part. The TPO & DRP rejected the assessee’s contention on the basis that (a) a foreign entity could not be a tested party, (b) GMDAT is a complex entity owing valuable intangibles & (c) the data for comparability of GMDAT is not available. On appeal by the assessee to the Tribunal, HELD:

While there is nothing in the transfer pricing law as to the selection of the tested party, the tested party normally should be the party in respect of which reliable data for comparison is easily and readily available and fewest adjustments in computations are needed. It may be local or foreign entity, i.e., one party to the transaction. The object of transfer pricing exercise is to gather reliable data, which can be considered without difficulty by both the parties, i.e., taxpayer and the revenue. It is also true that generally least of the complex controlled taxpayer should be taken as a tested party. But where comparable or almost comparable, controlled and uncontrolled transactions or entities are available, it may not be right to eliminate them from consideration because they look to be complex. If the taxpayer wishes to take foreign AE as a tested party, then it must ensure that it is such an entity for which the relevant data for comparison is available in public domain or is furnished to the tax administration. The taxpayer is not then entitled to take a stand that such data cannot be called for or insisted upon from the taxpayer. This is supported by the United Nation’s Practical Manual on Transfer Pricing for Developing Countries which stated that a foreign entity (a foreign AE) could also be taken as a tested party for comparison. The revenue’s argument that GMDAT should not be selected as a ‘tested party’ as it does not fall within the ambit of TPO’s jurisdiction and he can neither call for any additional information nor scrutinize their books of accounts is not acceptable because the Revenue can get all the relevant particulars around the globe by using the latest technology under its thumb or direct the assessee to furnish the same (Ranbaxy Laboratories 110 ITD 428 (Del), Mastek Limited, Development Consultants 136 TTJ 129 & Sony India 114 ITD 448 (Del) followed; Onward Technologies (Mum) & Aurionpro Solutions (Mum) not followed/ distinguished)

 

China's service sector continued to expand in July.

China's services sector grew last month, with the HSBC/Markit PMI holding steady at 51.3, while the "official" non-manufacturing PMI rose to 54.1 from 53.9 in June. However, the HSBC/Markit composite PMI, which combines manufacturing and services, slipped to 49.5 from 49.8 after manufacturing data last week showed contraction. "Without a sustained improvement in demand, services growth is likely to remain lacklustre."

Eurozone business activity returns to growth.

Eurozone business activity expanded for the first time in 18 months in July as composite PMI increased to 50.5 from 48.7 in June, while services PMI rose to 49.8 from 48.3. Germany's recovery gained momentum and the downturns in major economies such as France, Italy and Spain eased further. With manufacturing leading the way, the data raises "hopes that the region can finally claw its way out of its longest-running recession."

The recent noise, argument or confusion  in the Indian markets has created fear amongst the market participants. The story goes like this. National Spot Exchange Ltd (NSEL) had to suspend some contracts under the direction of Forward Markets Commission (FMC). It is alleged that NSEL extended settlement dates of the contracts and also permitted selling of goods that traders didn't have in their warehouses. It may be noted that NSEL is a platform where traders trade commodities. However, delivery is compulsory in this case. Thus, any trader who has sold any contract needs to have the goods located in his warehouse. This is to ensure that delivery is done at the requisite date. Failure to do so can result in default.

Inability by NSEL to oversee that its members had the goods required for delivery resulted in cancellation of many contracts for the fear of default. While there is an ambiguity over this entire issue relating to cancellation of contracts, it is clear that regulatory policies were inept. Both government and FMC are indulging in blame game citing that none of them is the regulator of NSEL.

The real losers in this entire episode have been investors. The stock of Financial Technologies, the parent firm of NSEL, dropped 76.2% in the last 8 trading sessions. It's high time that risk management and regulatory policies are given due importance in India. Else investors will continue to be a scapegoat in this entire blame game.

Job growth seen slowing.

U.S. July unemployment data is due out this morning, with economists estimating that nonfarm payrolls rose by 185,000 vs 195,000 in June and that the jobless rate inched down to a four-year low of 7.5% from 7.6%. The data will come after figures yesterday showed that weekly jobless claims fell to a 5 1/2 year low. As usual, the numbers will be scrutinized for what they could mean for the Fed's QE program.

S. 14A/ Rule 8D: Scope in the context of shares held as stock-in-trade explained

DCIT vs. Damani Estates & Finance Pvt. Ltd (ITAT Mumbai)

 

In AY 2008-08, the assessee, a trader cum investor in shares, offered Rs. 10 lakhs as disallowance u/s 14A. It claimed that the amount invested in shares was funded by its own, non-interest bearing funds and that there was no direct expenditure relatable to the investments. The AO applied Rule 8D and computed the disallowance at Rs. 1.40 crore. On appeal, the CIT(A) upheld the stand of the assessee as to the quantum of the disallowance. On appeal by the department, the Tribunal had to consider (i) whether s. 14A applies to shares held as stock-in-trade?, (ii) whether it could be said that the expenditure having been incurred for the share trading business, no expenditure can be said to be in relation to the dividend income?, (iii) whether it can be argued that the investment in tax-free securities is made out of own funds and no disallowance of interest on borrowed funds can be made?, (iv) whether Rule 8D(2)(ii) which deals with interest expenditure not directly attributable to any particular income or receipt requires modification if the dominant purpose is to earn share trading income?, (v) Whether Rule 8D(2)(iii) which prescribes the ratio in respect of indirect expenditure can be modified if the dominant purpose is to earn share trading income? & (vi) whether the allowance for depreciation u/s 32 has to be excluded in computing the disallowance? HELD by the Tribunal:

 

(i) S. 14A gets attracted on incurring of expenditure in relation to tax-exempt income. The purpose for which the shares are purchased and held would not impact the applicability of s. 14A. S. 14A comes into play irrespective of the head of income (on account of it arising qua a trading asset) under which the income is assessable. The fact that the share trading business yields both taxable income in the form of share trading profit and tax-exempt income by way of dividend income makes no difference to the applicability of s. 14A. Accordingly, s. 14A applies to shares held as stock-in-trade;

 

(ii) The argument that all expenditure has been incurred for the share trading business and that there is no additional expenditure incurred for earning dividend is not acceptable because though the expenditure is incurred for the purpose of the business of share trading, the said business yields taxable and non-taxable income. It is the integral activity of purchase and holding the shares which generates two separate streams of income. Accordingly, some of the expenditure has to be attributed to the dividend income;

 

(iii) The argument that investment in shares yielding tax-free dividend income has been made out of own funds and so no interest expenditure has been incurred in relation to the dividend income is not acceptable. No presumption of investment of own funds, on ground of its sufficiency, on the basis of Reliance Utilities and Power Ltd 313 ITR 340 (Bom) can be drawn;

 

(iv) If Rule 8D(2)(ii) which quantifies the interest on the investments, income from which is not taxable, on a proportionate basis, is applied literally, it will lead to absurd results because then the entire interest relatable to the average share holding will be attributed to the tax exempt dividend income even though the shares are bought and held primarily for share trading income. Rule 8D(2)(ii) needs to be scaled down by bifurcating the expenditure so arrived at between the tax-free and the taxable incomes. Given that the dominant objective of the share holding is to earn share trading income, an ad hoc ratio of 20% toward tax-exempt dividend income will be reasonable. Accordingly, in arriving at the disallowance u/r 8D, the amount as per Rule 8D(2)(ii) qua shares held as stock-in-trade would be restricted to 20% thereof;

 

(v) Rule 8D(2)(iii) which prescribes the ratio of indirect expenditure required to support an investment need not be modified because though the expenditure prescribed for disallowance is based only on one variable, i.e. the average value of investments, the prescribed allocation ratio of 0.5% of the investment value qua indirect expenditure is very nominal and not harsh;

 

(vi) Depreciation – an economic and accounting concept – statutorily recognized and provided, is only a charge on capital account, i.e., a capital expenditure. It has to be excluded in computing the s. 14A disallowance (Daga Capital 117 ITD 169 (Mum)(SB), Dhanuka & Sons 339 ITR 319 (Cal) & American Express Bank followed; CCI Ltd 71 DTR (Kar) 141, Leena Ramachandran 339 ITR 296 (Ker) & Yatish Trading not followed; Godrej & Boyce 328 ITR 81 (Bom) & Walfort Shar and Stock Brokers 326 ITR 1 (SC) referred/ followed).

Note: Though the appeal against Daga Capital 117 ITD 169 (Mum)(SB) is pending in the Bombay High Court, given the conflict on whether s. 14A applies to stock-in-trade or not (Damani Estates & American Express Bank hold that it does while Yatish Trading, India Advantage &Gulsha Investments hold that it does not) the matter deserves to be referred to a 5 Member Special Bench in view of the High Court verdicts in CCI Ltd 71 DTR (Kar) 141 & Leena Ramachandran 339 ITR 296 (Ker)

Fed downgrades economic view.

The FOMC slightly downgraded its view of the U.S. economy yesterday, saying it's expanding at a "modest" pace vs. "moderate" at the last meeting. However, the Fed didn't provide any hint about any alteration to the future course of QE.