The courts, undisputedly, have been holding that an amendment by the Finance Act is normally applicable for future periods unless the statue itself expressly and unequivocally states that it is a declaratory and clarificatory provision and applies with retrospective effect. However, somehow, the tax authorities are continuously inclined to take the contrary position, putting the settled matter to unrest, and inviting unnecessary and avoidable litigation.
The Bombay High Court recently had the occasion to deliver a judgement on the issue of reopening of the concluded assessment of AY 2001-02 based on the transfer pricing officer's (TPO) order (framed by applying the transfer pricing regulations) for AY 2002-03.
The transfer pricing regulations (TPR) were substituted by Finance Act, 2001 with effect from April 1, 2002, provided that any income arising from an international transactions shall be computed based on arms length price.
In the instant case, the assessing officer (AO) made a regular assessment for AY 2001-02. During the assessment proceedings for AY 2001-02, the AO called for details as well as justification for the payments pertaining to research and development (R&D) expenses paid by the assessee to its group company. The AO after examining the nature of the expense and with full application of mind allowed the assessee's claim.
The TPO while passing the order for AY 2002-03 concluded that the payment for R&D expenses to the group company is not at arms length and thus on that basis, the AO disallowed the deduction for AY 2002-03. The AO, on the basis of the TPO's order for AY 2002-03, issued a notice u/s 148 proposing to disallow the R&D expenses paid to the group company in AY 2001-02.
The assessee filed an objection with the AO for reopening of the assessment, which was rejected by the AO arbitrarily and without addressing the objection raised by the assessee. The assessee filed a writ petition before the Honourable Bombay High Court challenging the reopening of the assessment.
The main arguments of the assessee were that since full disclosure relating to R&D expenses were made and the AO, after detailed examination, allowed the said expense, there was no reason to believe that the income had escaped assessment. The assessee also contended that the assessment was sought to be reopened based on the assessment order for AY 2002-03, wherein R&D expenses had been disallowed on the ground that the same were not at arms length. This special provision came into force with effect from April 1, 2002 and was applicable for and from AY 2002-03. Therefore, reopening of the assessment for AY 2001-02 based on the assessment order for AY 2002-03 is not justified.
The assessee relied upon the judgement of the Delhi High Court in the case of CIT v Kelvinator of India Ltd (256 ITR 1) and the decision of the Bombay High Court in the case of German Remedies Ltd v DCIT (285 ITR 26) and CIT v Maniben V Shah (283 ITR 453) and argued that mere change of opinion cannot be the basis for reopening a concluded assessment.
The tax authorities argued that the reopening of the assessment is based on material gathered from the assessment order for AY 2002-03 and is not based on law applicable to the subsequent year.
The Bombay High Court quashed the notice issued by the AO for reopening of the concluded assessment for AY 2001-02 and held that since the TPR came into force from April 1, 2002, reopening of the assessment on the basis of provisions which were not applicable for AY 2001-02 cannot be sustained.
The Bombay High Court, rejecting the tax department's argument that reopening was on the basis of material gathered from AY 2002-03, held that reopening was on the basis of the assessment order for AY 2002-03 wherein it was held that the transactions were not at arms length applying the provisions which are applicable to AY 2002-03. It was also held that the deduction for R&D expenditure allowed in AY 2001-02 was contrary to any provision applicable to AY 2001-02.
The Court further held that the R&D expenses had been incurred by the assessee after obtaining Foreign Investment Promotion Board's (FIPB's) and the approval of the Reserve Bank of India's (RBI) approval. Therefore, reopening of the assessment for AY 2001-02 on grounds that the transaction was not at arm's length is without any merit. (A question arises here as to whether the said observation can be used to argue that if any expense is incurred after obtaining FIPBs or RBI's approval, then the price is at arm's length.)
Thus, the court quashed the notice for reopening the assessment.
The above judgment would certainly go a long way to give relief to the hardship caused to the assessees when the tax authorities multiply the unnecessary and avoidable litigation by reopening the concluded assessments and unsettle the settled positions for years based on the amendments and insertions made by the Finance Act clearly expressed with prospective effect.
Sanjay Tolia , executive director and Shailesh Monani, associate director, PricewaterhouseCoopers