10 January 2008

Experiences with the Income Tax Department -- 1

I do not know if you have been subject to an income tax scrutiny.

It is an interesting process, interesting in the sense that the Chinese are said to have meant when they invented the curse, “May you live in interesting times”.

Thinking of the Chinese also puts me in mind of a dragon eating its own tail and endlessly going round and round in circles. An income tax scrutiny has no end. It goes on and on. I filed my return in 2001. The income tax officer concerned passed an adverse assessment. I went to the Income Tax Commissioner of Appeals which decided in my favour. The Income Tax Department filed an appeal, and in August 2007 it was again decided in my favour by the Income Tax Appellate Tribunal, which had pretty damning things to say about the substantive part of the assessment.

There you would have thought the matter would end. But yesterday I learnt that an income tax commissioner had recommended that the department appeal again to the next authority. I or a representative was given time until 5 pm the same day to explain the matter.

Why, I asked myself, does the income tax department or certain officers in it feel free to harass honest tax payers without fear of recrimination. Shakespeare may have been right when he had Cassius say about Caesar: “He would not be a wolf, but that he sees the Romans are but sheep”.

Conducting a business is a precarious activity at the best of times. The threat of competition, changes in the business environment, new technologies, currency movements and the like mean that the businessman has to constantly keep his eye on the eight ball. Taking it off for a moment could mean the extinction of his business. Little wonder that the average businessman who has the threat of a long litigation hanging over his head chooses to settle rather than fight a case, which as my example shows, could go on forever. Knowing that few businessmen will fight encourages the tax official to do as he pleases.

The second important reason is lack of information. A, B, C and D may be harassed in the same way, but because they do not know each other, they have no way to share information. If they could, patterns would be clearly seen, both in the actions of certain officers and in techniques used to exert pressure on tax assessees.

I find it surprising that in this age of Web 2.0 no one has thought of using the networking possibilities of the Internet to share information of their experiences with the income tax department. This series of blog entries is an attempt to start off the process and encourage others to “open source” the income tax department.

11 January 2008

Experiences with the Income Tax Department - 2

When one sets out to write about something as weighty as income tax, one is in two minds about how to proceed.

Should one launch straightaway into a discussion of the relative merits of treating certain moneys (sounds more dignified in the plural) as (a) business income or (b) compensation for transfer of a capital asset, with a delightful digression into whether, if the aforesaid b is true, the asset should be treated as a short-term or a long-term capital asset.

I am sorely tempted to adopt this course. For there is pleasure sure in hurling back Tyagi vs Shankar 1992 at an opponent who has the temerity to throw CIT vs Alakananda et al 1985 at you knowing fully well it has been superseded by Sanger vs Moni 1994.

But though it is likely that a discourse of this nature will be greeted with delirious cheering by a captive audience of card-carrying members of the National Association of Income-Tax Consultants, I rather suspect that the reader with one hand on a mouse will need no more urging to click on to more congenial reading.

I shall therefore endeavour to narrate my experience in plain English, except where a certain amount of jargon cannot be avoided, for which I ask in advance the forgiveness of the reader.

Much of this narrative will be told by way of letters written to and by various characters featuring in it, a method which readers will recall was used by Bram Stoker in Dracula. They will also agree that the method is appropriate because in both cases blood suckers are involved.

12 January 2008

Experiences with the Income Tax Department -- 3

The story proper begins in 2000.

That was the year of the first Internet mania. People were talking in terms of hits, eyeballs and ADRs. In the popular jargon, new issues were replaced by initial public offers. A higher form of life called the venture capitalist struck roots in India. In certain circles the dollar seemed to be the new Indian currency, and the smallest unit thereof was a million dollars.

Sabeer Bhatia became the darling of the Indian elite. People looked up to Gururaj Deshpande, and one-PC-in-bedroom startups dreamt of becoming the next Exodus Communications, a successful US company set up by two Indian boys who had come good (it was later to go bankrupt but that is to run ahead of the story). Chain mails claimed that 40% of NASA's engineers were Indians, as were 50% of Microsoft's; it was obviously only a matter of time before the Microsoft chairman would be a Mr Ghate. Anecdotal evidence had it that US VCs were rejecting venture capital solicitations if the team did not include at least one Indian. India was the flavour of the day. And big companies realised it was a good idea to buy small Indian start-ups, scale them up, and collect a few hundred million dollars through an ADR. No one wanted to spoil the party by thinking of what would come after that.

Who was I to complain? At the height of the mania, I sold a website. The realisation was nowhere near the figures being bandied about for other websites, but it was enough to catapult a journalist into relative opulence. And there was the pleasure of knowing I would not have to work for a couple of years. There were sundry expenses too, but detailing them would distract attention from the main issues.

To normalise the figures, let us say that I received Rs 100 and of this Rs 50 was paid to a software developer named X. Since I received a net of Rs 50, about Rs 17 was paid in tax. In 2001 I filed my return. The joy derived from the enhanced bank balance apart, it also gave me immense gratification to pay a large amount in tax. I had graduated from the Indian Institute of Technology, Bombay in 1984 but the jobs I held thereafter did not have even a remote connection with technology. So there was always a feeling of guilt that though the government had spent considerable money on my education I had not repaid it. Now here at one stroke I was paying back the subsidy on my education several times over.

On 25 November 2002 I received a letter from Mr Joe Sebastian, Jt Commmissioner of Income Tax, Mumbai, asking me to present certain documents and make myself available for a meeting with him. This, I thought, was a routine letter. I had heard that the Income Tax Department occasionally felicitated honest assessees who paid a large amount in tax. So, if not a bouquet I hoped for at least a single nicely-shaped rose at a quiet ceremony at Aayakar Bhavan. I would be modest, of course, in accepting it. The Walter Mitty in me was soon to be woken up with a rude start. A little later I learnt from my chartered accountant that the income tax official scrutinising my return was inclined to view it harshly. This came as an unpleasant surprise and I decided to engage an income tax consultant.

On 13 January 2003 I was summoned for a meeting and accordingly presented myself along with my accountant and the tax consultant. From the outset it was clear that Mr Sebastian's attitude was hostile. After hearing an account of how the site was developed he dropped a bombshell. "I am going to disallow the entire amount paid to Mr X,"ť he said.

To say that I gaped at him open-mouthed would be a bit of an exaggeration, but it is probably safe to say that even a moderately enterprising fly could have easily pushed its way into my mouth at that moment. The reason for the shock and disbelief should be apparent. He was threatening to treat my income as Rs 100, whereas I had received only Rs 50. So I would have to pay another Rs 17 in tax, along with whatever penalty he thought fit to impose, which would amount to an income tax rate of 67% or more. Even worse, I would probably have to start working again, not a bright prospect since I had moved to a small town where the prospects of employment were bleak.

After I recovered somewhat I asked, "So what does that make the money I paid to Mr X. A gift?" Mr Sebastian smirked. He added, however, that this was only a preliminary opinion and he was ready to hear our arguments.

The journalist in me was quite curious as to how this gent could really hope to make his threat stick. Anyway I decided to call his bluff, and asked my CA and tax consultant to ask Mr Sebastian to state in writing what he had just told us.

A note of warning at this stage. The tone of this blog so far has been mostly one of light banter. But that is about to change. And it could hardly be otherwise. If you had hanging over you a threat to lop off half your bank balance you would hardly be blowing kisses to Mr Joe Sebastian, be he ever so beautiful.

I have friends who bury their woes in a few pegs of liquor at the Press Club. Me, I write letters.

14 January 2008

My Experiences with the Income Tax Department - 4

22 January 2003

Dr A.P.J. Kalam,
President of India,
Rashtrapati Bhavan,
New Delhi

Re: Request for investigation into harassment by income-tax officer

Your Excellency,
Like you I am a devotee of science. I have worshipped at the shrines of Newton and Maxwell. I still remember my wonderment at the age of 16 when I realized while studying for the IIT entrance examination that I had actually understood Newton’s laws of motion, not merely the words of the law as before, but the reality. My hard work was rewarded by admission into the IIT Bombay. Now at the age of 40 I have attempted to pass on some of that wonderment about science to my eight-year-old son, taking him to planetariums and science exhibitions and so on.

But in recent days I am beginning to think that my interest in science has been a waste of time and that I would have been better off had I set my sights on becoming an income-tax commissioner. Perhaps I should advise my son to do the same. I should perhaps point out to him that if he becomes an income-tax commissioner he will be paid much more than most scientists in India. And that the fabulous opportunities for ill-gotten gains as an IT commissioner would put in the shade anything that he would earn as a scientist or technologist in India.

I shall briefly summarize the reasons for my distress and anger. In 1998 I began development of a search engine when the net was yet in its infancy in this country. Thanks to my foresight I was able to sell my website in 2000 for a sum of Rs 100 [normalised figure]. Out of this Rs 100 I paid Rs 50 to the software developer, Mr X. All the money received and paid was through cheques. I paid an income tax of more than Rs 17 for the year 2000-01. Now Mr Joe Sebastian, the joint income-tax commissioner handling my returns in Mumbai, whom I met on 13 January 2003, says that he is 80:20 of the opinion that the money paid to Mr X will not be allowed as an expense. He says he will consider the software to be a capital asset transferred to me before the sale at zero cost of acquisition, which means that I have to pay tax on Rs 100 whereas my income is only Rs 50. Now this seems to be a silly statement since the software was developed to my specifications and cannot be treated as a capital asset. I do not believe that Mr Sebastian’s claim will stand in any court of law and I am not asking for intervention in my personal case; I intend to fight the matter up to the Supreme Court if necessary.

What I am requesting is an investigation into the assets of Mr Sebastian and his family members and into his background as an income-tax official. He is obviously a corrupt officer. His statement that he is 80:20 convinced of his current opinion is obviously a hint that the 20% can become 100% if he is suitably compensated. On January 14 I submitted a written statement to Mr Sebastian asking him for his opinion in writing.

Mr Sebastian obviously believed that since I stood to lose about Rs 17 in additional tax, I would be terrified and pay up whatever bribe he asked. In this he committed a grievous error. I have managed to survive in this corrupt country without paying a bribe so far and I have no intention of doing so in future. Three days after my last examination in IIT Mumbai (in November 1984) I landed in Baba Amte’s ashram when most of my classmates were headed to the United States. I worked at the ashram for more than two years; I also accompanied Baba to Punjab at the height of terrorism. At that time I risked my life; Mr Sebastian is only threatening to take away my money and it is a risk I am prepared to bear.

If I win the case after fighting it out for two years 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. Officers like him are the legal equivalent of the Mumbai underworld; whenever a big business transaction takes place they believe they are entitled to a cut.

I am writing this to urge you to use your good offices to compel an investigation into Mr Joe Sebastian and other corrupt officers (I am told an honest income-tax officer is a contradiction in terms). If a toothcomb is used to go over every case that he has handled during the past five years I guarantee that you will find that the exchequer has lost crores of rupees and he has benefited to a huge extent. When I run such a huge risk by refusing to pay a bribe I believe it is only just that the government respond by thoroughly investigating him, forcing him to disgorge his ill-gotten gains, and making him pay a financial penalty that will bankrupt him as a salutary example to others.

There is only so much an honest tax-payer can do. The real action must come from the government. Failure to do that is an open encouragement to corruption.

Yours sincerely,

Philip George

Cc: Jaswant Singh, Minister of Finance and Company Affairs, Government of India, New Delhi

Cc: Secretary, Department of Revenue, Ministry of Finance and Company Affairs, Government of India, New Delhi

Cc: P. Shankar, Central Vigilance Commissioner, Satarkta Bhavan, General Pool Office Complex, INA, New Delhi 110003

15 January 2008

My Experiences with the Income Tax Department -- 5

On 6 February 2003, Mr Sebastian sent me a show-cause notice. The germane part of it is as follows:

"... In view of the above, you are requested to explain within 7 days of the receipt of this letter, why the sale or transfer of the Internet Portal software and data should not be treated as sale of a capital asset belonging to Mr Philip George, having absolute ownership over the same, within the meaning of section 45 of the IT Act, 1961 and charged to tax as capital gains in your hands instead of business income as treated by you in your return of income."

The reader will note that though Mr Sebastian's threat was to disallow the entire payment made to the software developer, there is no mention of this everywhere. But the threat is there all right in the above statement. Think of it as a grenade with the pin left in.

On 25 February 2003 I was summoned by Mr Sebastian to record my statement. It was explained to me that though statements to the police could later be denied in court the same was not true of a statement to the Income Tax Department. And that although I was accompanied by my accountant and tax consultant I could not consult them during the course of the questioning.

Thus began an interrogation lasting about two and a half hours. At several points Mr Sebastian seemed annoyed that I was not quite giving him the answers he wanted. I then told him that if he wanted to put words into my mouth, he was free to ask the questions, dictate the answers, and sign the statement himself. After this the questioning proceeded pleasantly enough.

At the end I asked him for a copy of the statement that I had just signed. He said that I was entitled to a copy only if the assessment turned out to be adverse. This seemed a little odd, but I let it go; one never knew what obscure rules governed the income tax department.

16 January 2008

My Experiences with the Income Tax Department --6

The reader will recall that in January 2003 I had written a somewhat agitated letter to the president of India. The reader is probably under the impression that when such unsolicited epistles land on the reception desks of persons in high office they are routinely put through the shredder. Not so.

On 10 June 2003, Y.D. Sharma, Joint Director of Income Tax (Vigilance)-I, Mumbai, sent me a letter asking me to confirm that I had written a letter to the president and asking me for supporting evidence.

On 19 June 2003 I replied. A couple of excerpts from the letter follow:

"When I met Mr Sebastian on 13 January 2003 I specifically asked him whether my presence was required again since I would be going to Kerala. He stated that it would not be necessary to meet again; in fact he did not even record my appearance before him asking for my signature...

"On 25 February 2003 I again appeared before Mr Sebastian in response to an order communicated to my chartered accountant. In that meeting, I reiterated all that I had stated in my previous meeting ...

"Nearly four months have elapsed since my two-and-a-half-hour inquisition by Mr Sebastian on 25 February during which he unsuccessfully tried to put words into my mouth. I have yet to hear from him."

But this inactivity on Mr Sebastian's part was to soon change. Indeed the vigilance inquiry was to rouse him into a frenzy of activity, much of it highly suspicious.

I shall quote from a letter written by my tax consultant on 22 October 2003:
"Without prejudice to your proceedings it may not be out of place to highlight certain irregularities/discrepancies confronted by us for record since these events are not in keeping with healthy images of the Department. Please note that the narrations given below are bare facts.

"On 25-02-2003 you have recorded a lengthy statement of Philip George on oath but denied our right of procuring a copy of the statement recorded with a curt reply that the copy is provide to the assessee only when the statement is used for finalizing an adverse assessment order. Prima-facie, it sounds funny but we preferred to remain calm abiding by your decision. You have, however, obliged by quick delivery of the said recorded statement in response to our written request.

"After a gap of 5 months you had once again fixed up a hearing on 21-07-2003 vide your notice u/s 142(1) dated 07-07-2003 calling for details which are already available on your records. Books of accounts were also produced for your examination. Our presence was recorded on loose sheet of paper, since the assessment records were in the custody of Vigilance Branch, as reported by you.

"Thereafter on 22-09-2003 you had directed us on phone to appear before you on 24-09-2003 to authenticate the loose paper order sheet of 21-07-2003. No such ceremony of 'Authentication' was performed but our signature were obtained on old order sheet recording dated 25-02-2003 (when Shri Philip George's statement was recorded) for regularization. Very surprisingly, either on the same day or a day after i.e. 24-09-2003 you have dispatched another notice u/s 142(1) dated 15-09-2003 fixing the hearing on 30-09-2003 calling for some fresh requirements. The said notice was received by us on Saturday, the 27th of September at 2.30 pm and the same is being responded in this letter."

18 January 2008

My experiences with the Income Tax Department -- 7

Readers who have not abandoned the field after the complex manoeuvres of Mr Sebastian described in the previous blog will admit bafflement.

You would imagine that if in March 2003, the chief commissioner of income tax had stepped up to Mr Sebastian and asked, "What have you been doing these past two months to justify your salary from the exchequer," the latter would have answered, "Look, I have met Philip George and his representatives in January and again in February and here are their autographs to prove it."

But we know that he couldn’t have answered thus.

In January and February Mr Sebastian displays a studied indifference to autographs. Autographs interest him not at all. Were an autograph to accost him on the streeet and tap him on the chest Mr Sebastian would respectfully decline to make acquaintance.

But after the vigilance inquiry is set into motion his non-enthusiasm for autographs undergoes an overnight change. He embraces them with gay abandon. Of autographs he cannot have enough. When he spots an autograph on the horizon he gallops to retrieve it for his collection.

Not only does he make sure to collect autographs at all current meetings, he collects autographs to substantiate meetings that have occurred more than half a year before. He is even beginning to like the sight of his own autograph, sending out written statements calling for information that has been submitted to him much earlier.

On other fronts too his disposition turns cheerful. In February he had declined to give me a copy of the statement signed by me, a document in whose copyright I could claim the greater share, since his was confined to the questions. But in August when we make a written demand for the statement, he complies immediately.

I am a bit slow on the uptake. Friends sometimes refer to me as Philip Tubelight. Typically I start to smile after the laughter following a joke has died down. So I must admit it took me a long time to figure out Mr Sebastian's actions.

Why would he deny me a copy of the statement I had made? Why would he summon my tax consultant etc to substantiate their presence on the day I had made my statement, which was more than six months before? And why would he call for documents that had already been submitted to him much before?

It was only much later that I realised that his reluctance to give me a copy of my statement was really intended for my own good. And that such concern for the tax assessee is widespread within the income tax department. Indeed it would be appropriate to describe the standard pattern of action as a modus operandi, a term I use with extreme reluctance, being usually reserved by the police for such gents as AB Jeb Katra and CD Batua Chor.

This is how it works. On the second or third meeting with the assessee the official scrutinising the returns points out a long series of holes in the accounts and outlines the consquences that could follow. In some cases he even hands out a written statement pointing out the holes. The statement will be on a plain piece of paper and it won't be signed. The idea is to strike the fear of God (or the income-tax department, which is more or less the same thing) into the assessee. The typical assessee caves in at this point, forks out a suitable amount under the table after mutual agreement, and the scrutiny is finalised. The holes are ignored; if they have been written down the paper is torn up and no further mention is made of them. Sometimes, to give the scrutiny a semblance of authenticity a few minor expenses are disallowed.

In my case too Mr Sebastian intended something of the sort. If he declined to give me a copy of the signed statement it was really for my own good. There was no point letting it be lost and fall into the wrong hands. Not in his wildest moments did he imagine that the threat to lop off half my wealth would be ignored by me. What he did not know of course was that soon after our first meeting I had filed a complaint and a vigilance inquiry had been set into motion. When questions about the case began to be addressed to him he had to quickly cover his tracks. That explains the attempt to backdate previous meetings, and officially set up records calling for information that had already been submitted to him.

21 January 2008

My experiences with the Income Tax Department -- 8

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."

22 January 2008

My Experiences with the Income Tax Department -- 9

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.

23 January 2008

My Experiences with the Income Tax Department -- 10

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.

24 January 2008

My Experiences with the Income Tax Department -- 11

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.

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