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Going around in circles

T. N. Pandey on the lack of clarity in the taxation of foreign telecasting channels

,cf301,8.2,9>IN HIS Budget speech, the Finance Minister, Mr Yashwant Sinha, had said that foreign telecasting channels (FTCs) would henceforth be taxed in India in accordance with the provisions of the Income-Tax Act. The use of the word ``henceforth'' i ndicates that the new method of assessment can be followed only prospectively, at best from assessment year (AY) 2001-2002. And, therefore, the assessments already made, often in a summary manner based on circulars issued by the CBDT, would be treated as final. In other words, there would be no reopening of the completed assessments.

Past assessments

The assessments of FTCs, on the basis of CBDT's Circular No.s 742 and 765, have been examined in detail by the Comptroller and Auditor General of India (CAG) in its Report No. 12 on direct taxes.

Facts and issues: According to the CAG, FTCs engaged in telecasting television channels are non-resident entities. A major source of revenue for FTCs is advertisements. They appoint agents/representatives in India to collect the advertisement revenues on their behalf.

The extent of income that could be said to accrue or arise from FTCs' operations in India was considered by the CBDT. According to the Board, being a new area of commercial activity, assessing officers (AOs) were not adopting any uniform basis in computi ng the income of these companies. For determining and assessing FTCs' income better, the CBDT issued guidelines through Circular 742 dated May 2, 1996. The CAG's examination showed that the circular was based on certain presumptions:

* advertising agencies retained 15 per cent of the gross amounts of bills raised by FTCs;

* the Indian agents of the FTCs retained 15 per cent of the gross bills;

* the balance, of approximately 70 per cent of the amount, gets remitted abroad to the FTCs;

* FTCs do not maintain a branch office or permanent establishment (PE) in India;

* FTCs do not/cannot maintain country-wise accounts.

* ten per cent of the gross receipts of advertisement revenues (excluding 30 per cent or so retained by advertising agencies and the Indian agents of FTCs) would be fair and reasonable profit of the FTC.

Basis of taxation: Based on these presumptions, the CBDT prescribed a presumptive profit of 10 per cent of gross receipts meant for remittance abroad or the income returned, whichever was higher. This presumptive income would be subjected to normal tax r ate in force. The rate of taxation for AYs 1995-96 to 1997-98 was 55 per cent; it was reduced to 48 per cent with effect from AY 1998-99. The effective rate, thus, worked out to 3.8 per cent for AYs 1995-96 to 1997-98 and 3.36 per cent with effect from A Y 1998-99 on the advertisement revenues of the FTCs.

The circular stated that these guidelines would be applicable to all pending cases until March 31, 1998, after which the position with respect to reasonableness of the profit rate of such companies would be reviewed based on information/data available fo r the period.

Sequence of events

The report also reveals the following:

* At a CBDT meeting, representatives of FTCs pointed out that they had suffered losses in global operations and that they would earn substantial profits only after 3-4 years. Also, they pointed out that it was not possible to maintain country-wise accoun ts and expressed their inability to file I-T returns.

* The Board decided (February 2, 1996) to issue instructions to AOs to adopt a rate of 10 per cent of the amount remitted abroad for the purpose of tax. It was also decided to apply these criteria to all pending cases irrespective of the assessment year and also allow waiver of penalty on such assessment.

* The Secretary (Revenue) questioned the authority of the Board to issue such a circular and stated that it would also violate the structure of the Act.

* The Secretary (Revenue) was assured by the CBDT Chairman that the results of this exercise would be watched and, in a year or two, a section akin to 44B/44BB or 44AD/44AE would be enacted.

* The Secretary (Revenue) and the Finance Minister thereafter approved the circular on April 4, 1996, and April 16, 1996, respectively.

* Circular 742 was valid only up to March 31, 1998. File note dated April 3, 1998, from the Joint Secretary (FT & TR), stated an urgent need for extension of the guidelines. The Chairman CBDT agreed to the proposal. Circular 765 was issued on April 15, 1 998, and was made effective until further orders. It did not make any reference to the assessment year to which its provisions extended.

* The earlier circular stated that the position with regard to the reasonableness of the rate of profits of such companies would be reviewed. No such review/reassessment was carried out.

* Circular 765 was issued without the approval of the Board, the Secretary (Revenue) or the Finance Minister.

Circular No 765 is still in force.

Validity of circulars

According to the CAG:

a) Circular 742 applies to non-resident FTCs. Their income from Indian operations would be taxed in terms of the DTAAs with these countries where the FTCs were resident. Their income in India can be taxed only if they have a PE in India. The CBDT has pre sumed that FTCs do not have any PE in India. Therefore, the circular suffers from an inherent contradiction. Absence of PE of a non-resident enterprise of the contracting state ipso facto leads to its income being not taxed in the other contracting state as per the DTAA provisions.

b) The FTCs have appointed agents who are Indian entities and have entered into an agreement with them. These agreements need to be approved by the RBI. The Indian agents are seen to be related to a single principal exclusively for marketing of air-time, liaise with local advertisers, canvassing of business, collecting payments and assisting in RBI procedures. These functions and the fact that they were being carried out exclusively on behalf of FTCs led to these agents losing independent status vis-a-v is FTCs.

In the light of these, the CBDT presumption that the FTC did not have any branch/PE in India was not correct. Thus, in terms of DTAAs, the entire income of a foreign enterprise attributable to its PE would be taxable at appropriate rates and not at some presumptive rate. Apart from these specific provisos in the DTAAs, various other tests exist for determining the status of an agent vis-a-vis its principal, which were also ignored by the CBDT.

c) Comparisons with India-based channels such as Sun TV, Udaya, Raj TV, and so on, were ignored by the CBDT. These should have been the basis to ascertain the profitability of telecasting channels. Therefore, the presumption of 10 per cent as a reasonabl e profit lacked adequate consideration of facts available at the time.

d) It was also noticed that some of the FTCs also operated `pay channels', whereby they earned royalties. Further, lease rent on leasing of decoders was also earned by the FTCs. These sources of income were completely ignored while framing the scheme of presumptive taxation.

e) At the time of issuing Circular 742, the then Chairman of CBDT had assured the Secretary (Revenue) that the results of this exercise would be monitored and, in a year or two, a Section akin to 44B/44 BB or 44AD/44AE introduced in the Act. However, nei ther has such an exercise been undertaken nor any proposal made in the Finance Act, 1999.

f) At the time of extending Circular 742 (vide Circular 765 of April 15, 1998), the CBDT was aware of a ruling (CIT vs TVM Ltd) by the Authority for Advance Ruling (AAR) under Section 245Q of the I-T Act. The AAR had, inter alia, held that the guidelines in Circular 742 were general in nature and that assessees were open to accept them if beneficial. Further, it opined that to the extent the guidelines in the circular purported to extend the applicability of presumptive profitability to cases where the FTC did not have a PE in India, the correct position in law was not being laid out.

The AAR concluded that where substance prevails over form, a PE is deemed to exist. Though the AAR rulings are not binding on the Board, the AAR had highlighted important issues relating to profitability and taxation of FTCs as also the lacunae in Circul ar 742. The then Chairman ignored this legal advise and issued Circular 765 extending Circular 742 without having any authority to do so.

g) The FTCs were allowed approximately 30 per cent deductions from the aggregate of their receipts under these circulars. This was a major concession, hitherto not available under presumptive taxation, leading to an unfair advantage for the FTCs. Existin g Sections such as 44B also provide for taxation of presumptive profits. However, deductions from the revenues earned, including those under Sections 28 to 43C, are not available to these assessees.

Even in the case of resident assessees, Sections 44AD (business of civil construction) and 44AE (business of plying, hiring, and so on, of goods carriage) estimation of income is done by applying tax on presumptive profits without the benefit of deductio ns available under Sections 28 to 43C.

Audit conclusions

a) There was no need for Circular 742 to have been issued, as the I-T Act (Section 295(3)(a) read with Section 296) provides for estimation of income of non-residents that cannot be definitely ascertained for taxation purposes.

b) Circular 742 benefits FTCs to the determinant of the Revenue. However, no systems and procedures or management information system were introduced to monitor the assessments of these entities as promised in the notings prior to securing approval for is sue of circular.

c) FTCs have been afforded a special status under the circular, whereby they could avoid the rigours of normal assessment procedure which are hitherto applicable to India-based telecasting companies. Audit attempts to test-check some of the assessment re cords revealed that most FTCs did not file the return of income whereas majority of the Indian agents of the FTCs returned losses.

d) The extension of Circular 742 solely benefits FTCs; the Board has acted without applying its mind and without the Finance Minister's authority.

e) In effect, the circular is invalid and needs to be withdrawn forthwith to avoid legal complications.

Comments on assessments

The report shows that the RBI had granted approval for 10 agreements between nine FTCs and 10 Indian agents. But assessment records of only three Indian agents in New Delhi and two FTCs in Mumbai could be accessed for audit purposes. Their examination in dicated that the advertising revenue from India has been rising.

FTCs also earned royalties for `pay channels' and lease income from rentals of decoders. The Board had not considered this flow of revenue.

The new law

There has been considerable mishandling of FTC assessments, as revealed by the CAG report. However, there is no justification for correcting the situation merely in respect of future years without taking corrective action to retrieve the loss of revenue for the past years.

The Government has been consciously following the policy of retrospective application of tax laws if any benefit not due/intended has been derived by the taxpayers even on the basis of the interpretation of law by the apex court. The Finance Act, 2001 co ntains instances where Supreme Court decisions have been superseded and the new law made to operate retrospectively.