09 March 2008

Income Tax Officer Arrested in Nanda Case

Another day in the life of an income tax officer. From a PTI report.

Arms dealer Suresh Nanda, charged with receiving kickbacks in defence deals, his son and two others have been arrested by CBI for allegedly conspiring to fudge their account books seized by the IT department during a raid last year.

They were arrested in Mumbai on Saturday night by the investigative agency after registering a case against Nandas, Income Tax Deputy Director Ashutosh Verma and chartered accountant Bipin Shah, official sources said on Sunday.

Verma, an Indian Revenue Service officer of 1999 batch, is alleged to have helped the Nandas in fudging account books seized during a raid in February last year, they said.

Nanda's chartered accountant and the income tax officer were also accused of trying to manipulate IT orders in the favour of Nandas. The IT department had searched 20 premises of arms dealer Nanda, in Delhi and in Mumbai and claimed to have recovered cash worth several lakh of rupees and a large number of documents.

Damn surprised, aren't we?

Category: Income-Tax

24 January 2008

My Experiences with the Income Tax Department -- 11

[A single-page version of this blog can be seen here]

The reader may be surprised that, far from having embittered me, my five-year-old-and-continuing encounter with the income tax has actually been a source of some amusement to me. But it wasn't always so.

When the encounter began I was convinced that the department was full of crooks to the extent that "an honest income tax officer is a contradiction in terms". I never expected to win an appeal as long as the process was still within the confines of the department. It was therefore quite a surprise when I won at the stage of Commissioner of Income Tax (Appeals). I now believe that the system leaves some scope for an honest tax payer to fight and win. You do not have to succumb. And no matter the number of bad eggs in the IT Department you must remember that at some stage it passes out of the control of the department. I am thus in some ways more of an optimist than I was five years ago.

But I think there is a bigger philosophical issue, the issue of "moral hazard" (thanks to Niranjan Rajadhyaksha for jogging my memory on this term).

Here is what Wikipedia says about the subject: "Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions."

This is what I meant when I wrote at the time: "If I win the case after fighting it out for two years [oh, the optimist in me!] it will be at the cost of much time, money and mental tension, all of which could have been devoted to earning more money for myself and indirectly for the exchequer. The income-tax department too will have to spend a lot of resources to fight me. The only winner in the case will be Mr Sebastian. If the IT department loses the case he loses nothing. But he stands to gain Rs 10 lakh or more (I estimate that is the order of the bribe he expects) at zero risk to himself."

The chapter headings of the Income Tax Officer’s Concise Manual on Harassing the Tax Payer read as below:
1. Pass an adverse assessment order, never mind that it won’t stand scrutiny at any stage.
2. Don’t bother to present a cogent defence when the tax payer files an appeal.
3. When the tax payer wins the appeal file an appeal against the verdict.
4. Don’t bother to present a cogent defence when the appeal comes up for hearing
5. When the tax payer wins the appeal file an appeal against the verdict.
6. Don’t bother to present a cogent defence when the appeal comes up for hearing.
7. When the tax payer wins the appeal file an appeal against the verdict

See the problem? No higher authority bothers to ask the assessing officer or the officers who file appeals why they acted as they did. They run no risk whatsoever. And it doesn’t take much effort to file an appeal. All it takes is a clerk who can type out a single page. But the tax payer has to hire consultants and lawyers to fight it out for another year or two. The pain is all on one side.

As it stands the only way an income tax officer can be prosecuted today is if he is caught red handed accepting a bribe. And the department has long gone beyond the stage when it can be caught in such a simple-minded fashion. These days I am told the tax payer is asked to leave money in a magazine in the officer’s bathroom. "Hey, I just picked up the magazine with the intention of returning it to the owner. Never looked into it."

On the issue of moral hazard Wikipedia goes further to say: "A special case of moral hazard is called a principal-agent problem, where one party, called an agent, acts on behalf of another party, called the principal. The agent usually has more information about his actions or intentions than the principal does, because the principal usually cannot perfectly monitor the agent. The agent may have an incentive to act inappropriately (from the view of the principal) if the interests of the agent and the principal are not aligned."

In this case the principal is the government. And as long as the government is interested merely in total tax collections and will not act in any way whatsoever against the kind of crook who writes foolish assessment orders (take a look at this case) or files stupid appeals the tax payer can only expect to be harassed while the tax official amasses tens of crores of rupees. Remember the scandal a few years ago when someone in the finance ministry was caught accepting bribes to post income tax officials to Mumbai?

The system can improve only if some risk is placed on the income tax officials. Imagine that a crook of the kind mentioned above is summoned by a very high-level judicial officer. The conversation may proceed somewhat as follows: "You are allowed to plead temporary insanity at the time of writing the assessement order/filing the appeal. Tests will also be conducted to verify that you are indeed above the idiot class. If you fail the tests you will be acquitted of all charges and your job. If you pass the test and do not plead insanity you will have to present a defence of your assessment order/appeal."

I am not optimistic enough to expect something like the above to happen anytime soon. Until it happens the crooked tax official will have a field day. The only way out at present is to make the crook think twice by making public the utterly foolish assessment reports he writes or the utterly foolish nature of the appeals he files. In terms of moral hazard, there needs to be a change in the zero-risk nature of the actions he takes.

Category: Income-Tax

23 January 2008

My Experiences with the Income Tax Department -- 10

[A single-page version of this blog can be seen here]

Along with the double corrected assessment sent on 18 December 2003 Mr Sebastian sent a demand notice asking me to pay up the additonal tax. Among other things it said: "If you do not pay the amount within the period specified above, you shall be liable to pay simple interest at one and one-half per cent for every month or part of a month from the date commencing after end of the period aforesaid in accordance with Section 220(2)."

Now one and one-half per cent per month amounts to 18% a year. That's a lot of money. Naturally I paid up pronto.

In October 2004 the Commissioner of Income Tax (Appeals) passed an order in my favour. Naturally, it was time for the Income Tax Department to pay up the extra tax I had paid with an interest rate of 18%. I could almost hear myself telling friends: "See, honesty pays."

But when the money arrived, calculations showed that the tax department had paid at an interest rate of only 6%. Apparently, when you wanted to punish assessees who dared to fight, the last thing you wanted them to do was to laugh all the way to the bank. We inquired about what had happened to the rest of the money. I quote below the reply of Mr J.D. Mahadik, assistant commissioner of income tax. It makes no sense at all to me. The income tax department, it seemed, wanted to change the rules of the game whenever it lost. The casual reader will want to skip it, unless he is suffering from insomnia.

"Please refer to your representative’s letter on the above subject wherein it is alleged that the refund was issued to you along with interest u/s 244 (1A) which was calculated at the imaginary rate of 6%.

"It is seen from your letter that you have not under gone thoroughly with ITNS-150 which was enclosed alongwith the order passed u/s 250 of the IT Act. In the ITNS-150 it is clearly mentioned that the interest was due to you u/s 244 A(1)(b) and not u/s 244 (1A). it is calculated as per the provision of the IT Act, 1961. For you kind reference I am giving the details of interest rates applicable u/s 244A(1)(b), which are as under:-

PeriodRate of Interest
From 01.06,2002 to 07.09.2003Two third per cent per month
From 08.09.2003 and onwardsHalf per cent per month

"Further, I would like to bring to your kind notice, that the issue pertains to Asstt. Year 2001-02 hence the provision of the section 244(1A) is not applicable in your case. Section 244(3) the governing section of 244(1A) is reproduced as under, for you ready reference.

"244(3) 'The provisions of this section shall not apply in respect of any assessment for the assessement year commencing on the 1st day of April, 1989, or any subsequent assessment years.'

"I hope that the above explanation will clarify your confusion between Section 244A(1)(b) and section 244(1A)."

To which my only honest answer could have been: "Sorry, Mr Mahadik. It has only confounded my confusion."

If Mr Mahadik was not trying to put one over me, he won't mind my bringing the above bit of correspondence to the public notice.

More in the next.

Category: Income-Tax

22 January 2008

My Experiences with the Income Tax Department -- 9

[A single-page version of this blog can be seen here]

There’s a little postscript to this.

As we mentioned, on 28 November 2003 Mr Sebastian completed his assessment. I had received Rs 100 as payment for the site etc, and paid out Rs 50 to the software developer. Of this Rs 10 was disallowed as expense, so that I had to pay tax on Rs 60 although my income was only Rs 50.

On 2 December 2003 Mr Sebastian discovered that he had committed an error in his original calculation. By his recalculation my income increased by about 22% to Rs 73 and the tax by an equivalent amount. If he continued to have any afterthoughts at this rate, the tax would soon exceed the income and I would have to beg, borrow or steal (probably all three) to pay any taxes plus penalties he thought fit to impose.

Of course, he had committed an error, adding back to my income most of the taxes I had paid. When my representative met him Mr Sebastian refused to be convinced, insisting that there was no error and he had applied his mind. By now we had come to know our man well. It was not that he would not be persuaded. He just liked his persuasion in black and white.

On 17 December 2003 we sent him a note setting out the various additions and subtractions. As was to be expected Mr Sebastian’s response was immediate. On 18 December 2003 he sent me a correction of his correction, not just reverting to the figure of 28 November but going a bit below that. We couldn’t have spurred him to action faster if we had lighted a fire below his chair.

In previous episodes the attentive reader will have observed Mr Sebastian more or less rewriting the rules of income tax besides being well on the way to inventing a new variety of non-Boolean logic. Now he sees Mr Sebastian engaged in no less revolutionary a task than the reinvention of the science of accounting, a science that had heretofore trudged its way from weary day to weary day, basically unchanged since an Italian monk invented double-entry bookkeeping in the 15th century.

In hushed awe, the reader will ask: "When, if ever, in history has a single man wrought revolutions in so many fields of human endeavour?" The mind's eye rests on Newton and then it scans, in vain, all subsequent decades until it finally settles on Mr Sebastian.

More in the next.

Category: Income-Tax

21 January 2008

My experiences with the Income Tax Department -- 8

[A single-page version of this blog can be seen here]

On 28 November 2003 Mr Sebastian completed his assessment order. When I received it I couldn’t help laughing out aloud. Of course, having about 15% of your wealth chopped off is no joking matter. But you must remember that at the start Mr Sebastian had threatened to disallow the entire payment made to the software developer, Rs 50. Now, after meditating on the case for a year and trying his worst, the best he had come up with was to disallow Rs 10. And the logic was so warped that it seemed obvious to me that the assessment would be thrown out at any subsequent hearings before a neutral authority.

The assessment order was all of 20 pages long, 20 pages of sheer torture, and since the Geneva convention bans torture I shall not inflict it on the readers.

Those who are familiar with the world of newspapers and magazines will know that there is a category of employee called the rewriter. The rewriter’s job is to take copy written by the reporter in the heat of battle, remove the dross, and polish the metal that is left until it sparkles. I have tried to do a bit of rewriting with Mr Sebastian’s assessement order (it would be incomprehensible otherwise). But in this case after removing a considerable amount of dross, what I am left with is merely a smaller mass of dross. That cannot be helped. I am not an alchemist.

Pages 1 to 15 are devoted to proving that the sale of the website etc amounted to a transfer of a capital asset and was not business income. Readers will have heard stories of people who bought shares of Wipro in paper form, forgot about them for 25 years, and woke up one day to find the shares were worth crores of rupees. If they sell the shares, the profit they make would be treated as a capital gain, that is, a gain from the sale of a capital asset. The primary feature of such capital gain is that the buyer of the asset has not carried out any substantial changes on the asset, and that the gain is a consequence of an inherent rise in value of a basically unchanged asset.

If I had bought a url like www.business.com or www.sex.com for $70 and sold it for a few million dollars a couple of years later, the profit could have been termed as a capital gain, because it came from the inherent rise in worth of the url and not from any modifications I had carried out on it.

Alternatively, I may have developed an ingenious toy solely for the amusement of my own child and the neighbourhood tykes, but then Mattel spotted it and paid me a million dollars for it. The sale would amount to a transfer of a capital asset because it was developed with no business intention in mind.

My own website was a search engine that I had worked on for more than two years at the time of the sale. I had catalogued sites for more than two years and had drawn up the features that the software should have, etc. In January 2000, in a comparison between various Indian search engines by an Indian PC magazine, mine had been rated the "most accurate Indian search engine". In other words, it was hardly something that I had bought and left to age in the cupboard. Also, I had promoted it through advertisements (at considerable cost) and in my columns, hardly something I would have done if I had developed it for my own amusement.

Mr Sebastian’s logic was obviously silly, and both the Commissioner of Income Tax Appeals in its order of 28 October 2004 and the Income Tax Appellate Tribunal in its order of 30 August 2007 rejected Mr Sebastian’s contention that the transfer amounted to the sale of a capital asset.

Having argued that the transfer of the website amounted to a capital asset sale, Mr Sebastian had a slight problem. How ought he to explain the fact that the domain name bought for $70 had increased in value several hundred times. His explanation was that it came about because of the software. To understand his logic (or the absence of it) you have to descend to his level.

Think of the transfer of the web site as the sale of a big lump of concrete, a capital asset. Now this big lump of concrete contains a smaller lump of concrete, the software that runs the site. But in thinking of it thus Mr Sebastian ties himself up in more knots. On page 7 and at several other places he concedes that I was the owner of the software at all times. But then on page 16 he talks of the “cost of acquisition” of the software.

I do not know if the reader is in the habit of acquiring things that belong to himself. But apparently Mr Sebastian thinks it commonplace. I suppose that to do it properly you have to stand in front of the mirror and say to yourself, "Would you mind passing me the software? Here is the money I am willing to pay to acquire it." In this case of course Mr Sebastian goes a step further. He has me paying the software developer to acquire software that, Mr Sebastian agrees, belongs to me in the first place.

The warped logic goes further. The reader will recall that I had paid Rs 50 to X. According to the agreement with the buyer of the site X and I had to work with the buyer for six months, modifying the software, improving it, installing it on the buyer’s servers, recruiting and training the buyer’s employees to catalogue sites etc.

Now Mr Sebastian neatly divides the Rs 50 I had paid to the software developer into two parts. One is the cost of acquisition of software (though why I should pay for software that was mine in the first place was something that does not seem to have occurred to him) and the other was payment for working with the buyer for six months.

Without thinking it necessary to offer any reasons as to how he had arrived at the division, he decides that the cost of acquisition of the software (a capital asset, in his opinion) is Rs 40, which he will allow as part of the cost of the capital asset that I had sold, but will disallow Rs 10.

In a letter to the vigilance officer I couldn’t resist taking a dig at Mr Sebastian:

"Reducing this to a mathematical equation I would write:
x < 50
Therefore x = 40

"This is the kind of logic that would merit a fourth standard fail. You will observe that any number between 0 and 50 would satisfy the above equation. Mr Sebastian’s threat to me was that he would make x = 0. Now he has been kind enough to make x = 40. I suppose a Rs 10 lakh bribe would have made x = 50. Who knows, I might even have got a substantial refund.”

The problem of course is that when Mr Sebastian divided the sum paid to Mr X into two parts, he should have done the same with the Rs 100 paid to me by the buyer. After all, the agreement clearly said: "'Consideration' means the amount to be paid by the company in consideration for the transfer of the Internet Portal, Search Engine, Software, Database and for the Development Work and recruitment for the Company to be carried out by the vendors as mentioned herein."

But then Mr Sebastian’s objective was not to accurately reflect the merits of the case. It was to get his own back on an assessee who not only did not fork out the necessary but actually had the temerity to file a complaint against him.

This is what the appellate tribunal had to say about Mr Sebastian’s decision to disallow Rs 10 of the Rs 50: "After considering the rival submissions and perusing the relevant material on record, it is observed that the total quantum of payment of Rs [50] made by the assessee to [X] has not been disputed by the Assessing Officer. This amount is specified in the Memorandum of Understanding and has been paid in full by the assessee and also accounted for by [X]. We are unable to appreciate the stand point of the learned Assessing Officer in allowing the deduction of Rs [40], thereby disallowing the remaining amount of Rs [10]. We therefore approve the finding of the learned CIT(A) in this case."

More in the next.

Category: Income-Tax

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