Tuesday, January 31, 2012

Additional compensati​on received for property redevelopm​ent from developer a capital receipt, not taxable

Additional cash compensation received by member of a housing society from developer at the time of redevelopment of society property, is capital receipt; Compensation not income u/s 2(24), however compensation would reduce acquisition cost while computing capital gains on sale of redeveloped flat in future: Mumbai ITAT

The ruling was delivered by a Mumbai ITAT bench of Shri Pramod Kumar and Shri B. R. Mittal.
Kushal K Bangia V. ITO [TS-51-ITAT-2012(Mum)]

IPO accountablity to go beyond Investment Bankers

Incidences such as violation of Initial public offering (IPO) rules by promoters or investment bankers and misuse or diversion of IPO proceeds are nothing new in the Indian capital market. The market regulator Security And Exchange Board Of Indian (SEBI) is relooking at the entire IPO process. It is planning to put extra liability of overseeing the utilization of the issue proceeds on investment bankers besides the existing responsibility of verifying the information published in an IPO offer document. Agencies such as auditors and legal advisors also play crucial roles in the IPO process. The problem is no one wants to take the responsibility of any wrongdoing. Several auditors do not want to share crucial documents related to tax benefits, end-use of IPO proceeds, project funding etc. And this makes the due-diligence task of investment banker tougher as they cannot vet each and every detail themselves. This is practically not possible in the kind of fee they get. Also, there lies a clear conflict of interest among issuer companies, auditors and investment bankers.
The solution lies in streamlining the standard disclosures of financial information in the offer document. In addition to that, not only merchant bankers but other involved professionals such as statutory auditors should also be made more accountable for the listing procedures.

More debt buybacks through open market operations (OMO) in order to address the strain on liquidity.

The RBI didn't go into a monetary easing overdrive in its latest policy review despite slowing growth. However an infusion of liquidity was more than welcome. The Reserve Bank Of India (RBI) recently cut the Cash Reserve Ratio (CRR) by 0.5%. The CRR refers to the share of deposits banks must hold with the central bank. This move is expected to release around Rs 320 bn into the system. But that's not all. The RBI is open to more debt buybacks through open market operations (OMO) in order to address the strain on liquidity. Since late 2011, the central bank has already bought back about Rs 719 bn of government bonds from the secondary market. This was in order to reduce pressure on yields and ease a cash crunch after the government hiked its borrowing plan for FY12. Thus even though policy rates were not cut, increased liquidity is expected to push rates downward. This is definitely good news for growth.

Healthcare spendings is threat to G20 ratings

As if the current problem of deteriorating finances is not enough, developed countries are expected to see some more pressure on their fiscal balances. And the major culprit in this regard is expected to be healthcare expenditure. With a vast chunk of the population included in the social security net coupled with the fact that the proportion of aged people is increasing, healthcare spending in the developed economies such as the US, Europe and Japan is set to soar.
That is why ratings agency S&P has warned that it may downgrade 'a number of highly rated' Group of 20 countries by 2015 if their governments fail to enact reforms to curb rising health-care spending and other costs related to aging populations. Unfavourable demographics is not the only factor that is piling on the pressure. More expensive new technologies and broader treatment coverage may account for as much as two-thirds of the projected increase in health-care spending. So reforms to curb healthcare expenditure are badly needed. But with so many problems already keeping governments on their toes, are they aware of the seriousness of this issue? And if so, are they ready to tackle the same? It does not look like the case if one were to go by the evidence at hand.

Sunday, January 29, 2012

Rupee climb linked to fund inflows, RBI intervention

While RBI’s measures will make sure the rupee does not depreciate further, foreign fund flows would be essential for rupee appreciation. Expects the rupee to stabilise around 49 in the medium term.

However, renewed concerns from the debt-ridden euro zone may lead to another round of depreciation in the current quarter, though there may not be any sharp downward movement. “The dollar-rupee pair could move back higher towards the 50.50-51.00 mark but sharp depreciation is unlikely, due to the prospect of sustained RBI intervention. We could  expects the currency pair to move towards the 47.50-48.50 range by the end of next financial year. Ratings agency Crisil said in a report that the rupee may rise to 48 per dollar by March 2012
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  • Active forex intervention in both spot and forward markets
  • Higher interest rates on deposits for non-resident Indians
  • Relaxing external commercial borrowings norms
  • Prohibition of cancelling and rebooking of forward contracts
  • Cut in interbank net open positions
  • Past performance facility on currency hedging for importers cut from 75% to 25%
  • Banks asked to report hedging status on loans over $25 million
  • Governor says above measures may stay                         
  • Banks to be asked to work out board-approved hedging policy for borrowers

The Fed versus the RBI

One consequence of the tight monetary policy has been slowing growth rates. The RBI has recently indicated its concern over growth, and may reverse its tight monetary policy in the future. Nonetheless, their focus is and remains inflation first, and growth second.
On the one hand, we have the Fed, whose policies are primarily driven by growth and employment figures, at the expense of inflation. On the other hand, we have the RBI, whose policies are primarily driven by inflation, at the expense of growth. So which approach is the best?
The answer depends on which sector of the economy we are concerned with. In a tight monetary policy environment with high interest rates, business investment suffers, and consumer access to credit suffers. On the other hand, savers benefit due to high interest rates, and most of the population benefits due to lower inflation.
In contrast, a loose monetary policy has the opposite effects. Businesses benefit as they can borrow more cheaply and debtors benefit as they pay lower rates. Savers suffer due to receiving low interest rates, and those on fixed incomes suffer from higher inflation.
If we are looking at the economy as a whole, things once again depend on what is more important. Is it better to have higher growth at the expense of higher inflation, or is it better to have lower inflation at the expense of lower growth? Both the RBI and the Fed have differing views on this last question, and this forms the basis of their policies.
In general, having a balance is a good thing. Both the Fed and the RBI have monetary policy stances that are too extreme. A balanced monetary policy should place importance on both growth and inflation, as both statistics are vital to the well functioning of any economy

Much awaited event in the world of IPOs (Initial Public Offers) is finally just round the corner.

The much awaited event in the world of IPOs (Initial Public Offers) is finally just round the corner. We are referring to the IPO of the popular social networking site Facebook. The company plans to file for its offer sometime next week. The IPO is estimated to be anywhere between US$ 75 bn to US$ 100 bn. It had revenues to the tune of US$ 4 bn in 2011. This means that the company would try and look at a valuation of nearly 25 times its revenues. If it actually manages to get the valuations it seeks, it would be one of the highest premium IPOs. However, the question would still haunt the minds of all value investors. Does any company that does not have a long track record of delivering superior results deserve such high valuations? Is it just another phase like the do tcom bubble wherein all popu lar sites get ridiculously high valuations just because they are in the field of social networking? Isn't it also equally important to be profitable and value accretive?

India least prepared for a new crisis?

There's bad news for investors in India. As per The Economist, if a fresh crisis were to strike the global economy in the near future, India has the least monetary and fiscal flexibility amongst all the BRIC nations to weather the storm. In contrast, as today's chart of the day shows, China still has a lot of room left to make up for the slackening of its economy in the event of a crisis. In other words, China's GDP could suffer a lot less than India's GDP in the near term

Friday, January 27, 2012

Synopsis of the Week

In a truncated week, Nifty clocked its 4th consecutive weekly gain, closing up 3%. The Credit Policy surprised positively with CRR being cut by 50bps and RBI hinting at further cuts in the same. Result Season has been robust so far with more positive surprises than disappointments. PSU bank results have shown higher slippages but still more or less on expected lines. The only fear is that the banks have still not recognized majority of big issues like SEBs, KF Airlines. Nifty is now at the 200 DSMA, will the year of the Dragon be the Year of India….

Could Austerity measures making Europe's crisis worse?

If an entity improves its credit profile, the interest rate that it pays should fall, right? However, this does not seem to be happening with the Euro nations currently. The Economist points out how despite reducing their deficits, borrowing costs for countries like Germany, France, Spain and Italy have not gone down. This clearly indicates that investors seem to be focusing on short term rather than long term. As austerity is likely to hurt near term economic growth, people who are more interested in making money from speculation, will therefore focus on this near term trend and make their moves. From the economy's point of view however, this move is proving to be counterproductive. This is because an economy which is already under pressure from reduced Government spending will be hurt even more if its cost of financing goes up. Thus, going slow on fiscal tightening and not rushing things would be the way to go we think.

Indian govt to miss fiscal deficit target by wide margin

The news just got worse for the Indian government. The fiscal deficit that has been worrying them has just burgeoned to Rs 1.5 lakh crores. This is nearly three times what was estimated just three months ago. Sluggish direct tax collections, mushrooming subsidy bills, and dismal disinvestment inflows have led to these fiscal troubles. The situation is so bad that the government is now counting on higher dividends from the cash rich PSUs to help bridge some of the gap. The combination of food, fertiliser and fuel subsidy has played havoc with the government's estimates since the budget was presented in 2011. It is no longer a question as to whether they will achieve the target but more a question of by how much will they miss the same.
current position is around 8.5%.of GDP.

Tuesday, January 24, 2012

RBI cuts CRR, policy rates unchanged

And while we are on the topic of the RBI, the central bank has in its latest decision decided to inject liquidity into the system. In its third quarter review of monetary policy, the central bank cut the cash reserve ratio (CRR) by 0.5% bringing it to 5.5%. This move is expected to ease liquidity by injecting Rs 320 bn in the system. Policy rates on the other hand remained unchanged. But, there were also a few ominous warnings in the review. The RBI reiterated that sustained policy and administrative action is needed to stem the inflation problem. As mentioned earlier, the rocky fiscal position that India is in spells a threat to inflation. Concerns on high fuel prices, manufacturing inflation and rupee depreciation post upwards risks to prices. While the projection for headline inflation was left at 7%, India's GDP growth expectation was cut to 7% from 7.6% previously. Weak global growth and slower industrial production are to blame. Now, next on every investor 's watch list has to be the latest Union Budget. We hope this will put forth the policy action India needs badly.

Friday, January 20, 2012

Sebi gets cracking on listing day price manipulations


The capital markets regulator, Securities and Exchange Board of India (Sebi), today announced several measures aimed at checking manipulators and reducing wide fluctuations in the share prices of companies making their stock market debut.
At present, there is no limit on share price movements on the day of listing of shares following a public offer. This was allowed to enable price discovery but also leads to huge fluctuations on either side. From day two onwards, the circuit filters which cap stock movements to five per cent, 10 per cent or 20 per cent, depending on the size, come into play.
Sebi now plans to introduce this circuit filter on listing day itself. The new rules, to take effect four weeks from now, will include extending the ‘pre-market call auction’ window on listing day and delivery-based trading for the first 10 days.
“In light of the high volatility and price movement observed on the first day of trading, it has been decided to put in place a framework of trade controls for Initial Public Offer (IPO) and re-listed scrips,” said the regulator in a circular.
Further, for issues of ~250 crore or less, only delivery based trades will be allowed for the first 10 days after listing. The pre-open call auction window, which currently is used for Nifty and Sensex stocks, will be used for arriving at an equilibrium price on the first day of trade of an IPO and relisting stocks. However, unlike index stocks, where the window is for 15 minutes, IPO stocks will have a one-hour window between 9 and 10 am. The first 45 minutes will be for order entry, modification and cancellation, the next 10 minutes for order matching and trade confirmation, and the remaining five minutes shall be the buffer period to facilitate transition from preopen session to the normal trading session.
In case the equilibrium price is not discovered for relisted stocks, all orders shall be cancelled and the scrip shall continue to trade in the call auction mechanism until the price is determined. For IPO scrips with issue size of less than ~250 crore and re-listed scrips, a 100 per cent margin shall be required for the order to be eligible in the pre-open session.
Under normal trading, stocks with issue size of less than ~250 crore will trade in a price band of five per cent of the equilibrium price. For issues greater than ~250 crore, the price band will be 20 per cent of the equilibrium price. In case the equilibrium price is not discovered in the call auction, similar price bands linked to the issue price will be applicable.
Market experts said the move would definitely help reduce volatility. “These were much-need steps. Introduction of trade-to-trade on issue size of below ~250 crore will help in reducing manipulation considerably, if not totally,” “The immediate impact will be fewer issues. All operators driven IPOs will be out,”  “The process of trade to trade will hurt the market. No jobber will come. That will affect liquidity in the stock. Brokers who participate in IPO funding will also take a hit.”
Regulator introduces circuit filters and pre-open call auction for IPO stocks and relisted scrips on Day One
Under normal trading, stocks with issue size of less than ~250 crore will trade in a price band of five per cent of the equilibrium price

Transfer of shares of foreign company by non-resident to non-resident does not attract Indian tax even if object is to acquire Indian assets held by the foreign company

Vodafone International Holdings B.V. vs. UOI (Supreme Court)

A Cayman Island company called CGP Investments held 52% of the share capital of Hutchison Essar Ltd, an Indian company engaged in the mobile telecom business in India. The shares of CGP Investments were in turn held by another Cayman Island company called Hutchison Telecommunications. The assessee, a Dutch company, acquired from the second Cayman Islands company, the shares in CGP Investments for a total consideration of US $ 11.08 billion. The AO issued a show-cause notice u/s 201 in which he took the view that as the ultimate asset acquired by the assessee were shares in an Indian company, the assessee ought to have deducted tax at source u/s 195 while making payment to the vendor. This notice was challenged by a Writ Petition but was dismissed by the Bombay High Court. In appeal, the Supreme Court remanded the matter to the AO to first pass a preliminary order of jurisdiction which the AO did. This order was challenged by the assessee by a Writ Petition which was dismissed by the High Court (329 ITR 126 (Bom). On appeal by the assessee, HELD allowing the appeal:

Thursday, January 19, 2012

S. 271(1)(c): CA’s opinion does not necessarily make claim “bona fide”

 Chadha Sugars Pvt. Ltd vs. ACIT (ITAT Delhi)

The assessee obtained the opinion of a Chartered Accountant on whether expenditure on fees to the Registrar of Companies for increasing authorized capital can be claimed as revenue expenditure. The CA relied on judicial precedents and opined that the issue was debatable and a claim could be made on the basis that if two views were possible, the view in favour of the assessee should be taken. The assessee claimed deduction and even the tax auditor did not qualify the same. The AO relying on Punjab State Industrial Development Corp 225 ITR 792 (SC) & Brooke Bond 225 ITR 798 (SC) disallowed the claim and levied s. 271(1)(c) penalty which was upheld by the CIT (A). Before the Tribunal, the assessee pleaded that as it had relied on the opinion of an expert in making the claim, its action was bona fide & penalty could not be levied. HELD dismissing the appeal:

In view of the two decisions of the Supreme Court which held the field when the return was filed, the claim was patently disallowable. The claim was also not discernible on the face of the record and the details of expenses had to be gone into in order to decipher the claim. The argument that the assessee does not have expertise in taxation matters and so it relied on expert opinion is not acceptable because the opinion was furnished for accounting purposes. An accountant’s view is not really material for deciding the deductibility or otherwise of an expenditure. The assessee knew about the problem at the time of filing of return, but still made the claim. Not only this, the claim was pursued even up to the level of the CIT (A) in gross disregard for the decision of the Supreme Court, which the assessee came to know at least after receiving the assessment order. Therefore, the claim was not only wrong but also false and it was persisted with for some time. The fact that the assessee did not even seek explanation from the tax auditor or the CA gave the impression that the whole thing was a sham.

S. 271(1)(c): Despite Surrender After Detection, Penalty Can be Waived

P.V. Ramana Reddy vs. ITO (ITAT Hyderabad)

Pursuant to a search & s. 153A assessment on the basis of seized papers, statements etc; the assessee offered additional income of Rs. 2.68 crores on the basis that he was unable to explain the old records. Some of the other additions made by the AO were partly deleted by the CIT (A) & Tribunal. The AO & CIT (A) levied s. 271(1)(c) penalty on the ground that the assessee’s offer of additional income was not voluntary or bona fide. On appeal by the assessee to the Tribunal, HELD allowing the appeal:

Though the assessee owned the unaccounted transactions only after search action, when an assessee admits his mistake and that he has committed a wrong and offers the additional income to tax, it cannot be said that his statement is false or not bona fide. Neither the CIT (A) nor the Tribunal were completely clear about the exact amount of concealment and there was no conclusive evidence as some additions had been deleted. S. 271(1)(c) gives discretion to the AO to exonerate the assessee from levy of penalty even in case where the assessee has concealed the income or furnished incorrect particulars of income. Penalty should not be imposed merely because it is lawful to do so. The AO has to exercise his discretion judiciously. If an assessee files a revised return though at a later stage or discloses true income, penalty need not be levied. No doubt, merely offering additional income will not automatically protect the assessee from levy of penalty but in a given case where the assessee came forward with additional income though after detection because he was not in a position to explain the seized material properly and expresses remorse in his conduct un-hesitantly, the AO has to exercise the discretion in favour of such assessee as otherwise the expression ‘may’ in s. 271(1)(c) becomes redundant. In a case of admitted income, concealment penalty is not automatic. The discretion vested in the AO should be used not to levy penalty. On facts, the case was most befitting to exercise such discretion because there was divergent opinion while deleting or sustaining the addition and there was no conclusive proof that the assessee concealed income or furnished inaccurate particulars of income. The assessee’s offer was to avoid litigation. If the AO had clinching evidence of concealment, he should not have accepted the assessee’s offer and should have proceeded on the basis of material on record (VIP Industries 112 TTJ 289, Siddharth Enterprises 184 TM 460 (P&H) & Reliance Petro Products 322 ITR 158 (SC)

Wednesday, January 18, 2012

RELIANCE COMM: FCCB re-financing removes immediate overhang; Structural issues unaddressed; Maintain Neutral

Reliance Communications has announced a tie-up to re-finance FCCB redemption of USD1.18b due on March 1, 2012. Duration of loan is 7 years at an interest of ~5%. The funding would be provided by ICBC, CDB, EXIM and other Chinese banks.

- The re-financing removes an immediate overhang, but structural issues remain unaddressed, viz, continued market share loss and high leverage (net debt of ~INR320b, ~5x net debt/annualized EBITDA).

- RCom stock is up ~50% in the past one month. At CMP of INR90, the stock trades at EV/EBITDA of 7.5x FY12 and 5.8x FY13. Maintain Neutral.

Import duty on gold import increased; Higher prices to dampen near-term jewelry demand

Government of India has revised import duty on gold from fixed INR300/10gm to 2% ad valorem. At current gold prices, the import duty works out to INR548/10gm, up 83%. We believe this will increase jewelry prices by INR320/10gm and further impact the near term demand and volume growth.

India is one of the largest importers of gold with CY10 imports at 959 tons worth USD41b. 9MCY11 has seen imports of 753 tons worth USD36b.

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INDIA ECONOMICS: Dec-2011 inflation at two-year low of 7.5%; RBI may cut CRR by 25bp and defer rate cuts

Dec-2011 inflation at 7.5% was the lowest inflation in two years and reflected a rapid deceleration from ~10% during Sep-Oct 2011

While this gives background for RBI to cut rates, we believe it will choose otherwise, for a variety of reasons: (1) Core inflation stays above RBI’s comfort level, (2) Latest IIP print of 5.9% may alter the views of adverse growth-inflation balance, and (3) From a communication standpoint too, a lagged response to inflation may serve to convey RBI’s resolve to control inflation while growth revival is deferred

However, we expect RBI to effect a 25bp cut in CRR along with continued OMO (INR614b done already). This is because LAF balance is twice the comfort level of RBI. Government’s recourse to WMA at INR490b and continued borrowing in the busy fourth quarter will pressures on yields. In the absence of a CRR cut, expect 10-year GSec yields to harden back to 8.5%.

India's Current Account was worst in 2011

Today's chart of the day shows that India had the worst current account position in 2011 as compared to its peers both in the developed and developing world. Given that India's trade account has been running into a deficit, the same has had an impact on the overall current account deficit as well. The country's trade deficit has widened largely on account of rising prices of petroluem, gold and silver, which account for a significant chunk of its import bill. Although the rupee depreciating against the dollar should bridge this gap to a certain effect, the change has not been significant uptil now. Meanwhile other BRIC nations (i.e. China, Brazil and Russia) have fared better than India on this front.

Tuesday, January 17, 2012

More pains seems to be intensifying as S&P has downgraded the Euro zone's rescue fund's rating

The Euro zone crisis seems to be intensifying. In the latest news on the zone, ratings agency Standard & Poors (S&P) has downgraded . The Eurpean Financial Stability Fund's rating has been downgraded to AA+. In addition to this, the ratings of two of its guarantors, France and Austria, have also been cut down. The result is that the EFSF's ability to raise cheap funds has now come under risk. The cheap funds have been raised by EFSF to fund the numerous bailouts that the Euro zone has undertaken. If it is unable to raise funds, then it would have to cut down on the loans that it hands out to the member countries. Though other rating agencies have not followed S&P's move, the funding capability of EFSF has come under question. Not that it matters. Because the size of funds required by the Euro zone to come out of its troubles, are so huge that even EFSF would find it tough to bail them all out.

Investment Bankers need to be more accountable now.

Many investors have burnt their fingers by putting their hard-earned money in shady Initial Public Offerings (IPOs) which are often subject to manipulation by investment bankers and promoters. As a result of this, the investor confidence has been on a downward spiral. In a recent probe, the Security And Exchange Board Of Indian (SEBI) has actually found out that cases where proceeds from the IPO were either misused or diverted.
To make sure that such cases don't recur, the market regulator is planning to tighten the noose around investment bankers. The job of investment bankers may not get over once the company gets listed on the stock exchanges. SEBI is planning to make the book running lead managers (BRLMs) managing the IPO responsible for the end-use of the proceeds. Chances are that the investment bankers may have to submit a quarterly report to SEBI on the status of the proceeds for a period of up to one year after raising the funds. I give a thumbs up to this important move. It will certainly make promoters and investment bankers think twice before taking investors for granted.

Monday, January 16, 2012

Iron & Steel tops the list of restructured debt

The steel industry has been under pressure for some time now. This is due to weak global demand, mainly due to the euro crisis, scarcity of iron ore due to mining clampdown in Karnataka and Orissa and high coking coal prices. All these factors are forcing steel makers, especially smaller ones, into debt restructuring. Corporate debt restructuring (CDR) aims at preserving viable corporates that are affected by certain internal and external factors and minimise the losses to the creditors and other stakeholders through an orderly and coordinated restructuring programme. As today's chart of the day shows, the share of iron and steel in the aggregate debt restructured by this process as on September 30 was the highest at 30.9% with 28 cases. To add to the woes of steel companies, many banks have started to restrict sanctions of fresh loans to the sector because of fe ar of increase in non-performing assets (NPA). Thus unless there is some clarity on mining issues and global pickup in demand for steel, the sector may see more cases of companies undergoing debt restructuring. After iron and steel, the sectors with the highest proportion of restructured debt include textiles, sugar, cement and petrochemicals.

Long-term & short-term gains from PMS transactions taxable as business profits

M/s. Radials International vs. ACIT (ITAT Delhi)

The assessee offered LTCG & STCG on sale of shares which had arisen through a Portfolio Management Scheme of Kotak and Reliance. The investments were shown under the head “investments” in the accounts and were made out of surplus funds. Delivery of the shares was taken. The AO & CIT (A) held that as the transactions by the PMS manager were frequent and the holding period was short, the LTCG & STCG were assessable as business profits. On appeal by the assessee, HELD dismissing the appeal:

In a Portfolio Management Scheme, the choice of securities and its period of holding is left to the portfolio manager and the assessee has no control. Only the portfolio manager can deal with the Demat account of the assessee. While, at the time of depositing the amount, the assessee will make entry in his books of account as investment in PMS, he is not aware of the transactions in the shares being entered into by the portfolio manager on his behalf as his agent. Since the assessee comes to know about the purchase and sale of shares under PMS after the expiry of the quarter, the accounting treatment in the books of the assessee in respect of shares purchased/sold by the portfolio manager under PMS cannot be entered in the books of the assessee. It is at the end of the year the shares available in the DEMAT account can be entered. Therefore, at the time of deposit of amount, the intention of the assessee was to maximize the profit. As the purchase and sale of shares under PMS is not in the control of the assessee at all, it cannot be said that the assessee had invested money under PMS with intention to hold shares as investment. The portfolio manager carried out trading in shares on behalf of his clients to maximize the profits. Therefore, it cannot be said that shares were held by the assessee as investment. The fact that the transactions were frequent and its volume was high indicated that the portfolio manager had done trading on behalf of the assessee. The fact that the shares remaining at the end of the year were shown under the head ‘investment’ makes no difference. Even the LTCG is assessable as business profits and s. 10(38) exemption is not available. The fact that the AO took a contrary view in the preceding year is irrelevant. There is no difference between similar transactions carried out by an individual in shares and the transactions carried out by portfolio manager. There is, however, a difference between investment in a mutual fund and PMS.

AO’s decision to refer to TPO must be based on material & not be arbitrary

M/s Veer Gems vs. ACIT (Gujarat High Court)


The assessee entered into transactions with a party named Blue Gems BVBA. In the preceding year, the assessee treated the transactions as an “international transaction” for transfer pricing purposes. However, in the present year, the assessee claimed that though the said party was a “related party”, it was not an “affiliated entity” as defined in s. 92CA. However, instead of deciding the issue, the AO made a reference to the TPO to determine the ALP and the TPO asked the assessee to show-cause why the transaction with the said party was not subject to transfer pricing proceedings. The assessee filed a Writ Petition to challenge the action of the AO/TPO. HELD by the High Court:

The AO has jurisdiction to make a reference to the TPO only if there is an “international transaction”. Though the question as to whether there is an “international transaction” may be disputed, the AO is not obliged to grant hearing to the assessee, invite and consider the objections with respect to the question whether there was an “international transaction” before making a reference to the TPO. The AO’s opinion has to be based on available material and would have “ad-hoc” finality. The power cannot be exercised arbitrarily or at whims or caprice. S. 92C (1) has inbuilt safeguards to ensure that the reference is made only in appropriate cases with approval of the higher authority. At the stage of framing the assessment in terms of the TPO’s report the AO is entitled (despite the amendment to s. 92CA(4)) to consider the objections of the assessee that in fact there had been no “international transaction”. If the assessee succeeds in establishing such fact, the AO would have to drop the entire transfer pricing proceedings. Even the DRP has the power to consider whether there was an international transaction or not and it can annul the computations proposed on the basis of the TPO’s order. However, the TPO has no jurisdiction to decide the validity of any such reference and his task is only to determine the ALP. On facts, as the parties were closely related and the assessee had accepted in the preceding year that the transactions were subject to transfer pricing, the AO’s reference could not be interfered in writ proceedings.

Onus on AO to show foreign co has a PE in India. Under India-France DTAA, even dependent agent is not PE in absence of finding that transactions are not at ALP

Delmas, France vs. ADIT (ITAT Mumbai)

The assessee, a French company, engaged in the operation of ships in international traffic, claimed that it did not have a PE in India and that no part of its income was chargeable to tax in India. The AO & DRP held that as the assessee had an agent in India which concluded contracts, obtained clearances and did the other work, there was a PE in India under Articles 5(5) & 5(6) of the DTAA. On appeal by the assessee, HELD allowing the appeal:

(i) In order to constitute a PE under Article 5(1) & 5(2), three criteria are required to be satisfied viz; physical criterion (existence), functionality criterion (carrying out of business through that place of physical location) & subjective criterion (right to use that place). There must exist a physical “location”, the enterprise must have the “right” to use that place and the enterprise must “carry on” business through that place. An “agency” PE will not satisfy this condition because the enterprise will not have the “right” to use the place of the agent. Under Article 5(6) of the India-French DTAA (which is at variance with the UN & OECD Model Conventions), even a wholly dependent agent is to be treated as an independent agent unless if it is shown that the transactions between him and the enterprise are not at arms’ length. The Department’s argument that as the AO had not examined whether the transactions were done in arm’s length conditions, the matter should be restored to him is not acceptable because the onus was on the Revenue to demonstrate that the assessee had a PE. The onus is greater where the very foundation of DAPE rested on the negative finding that the transactions between the agent and the enterprise were not made under at arms length conditions. A negative finding about transactions with the dependent agent not being at ALP is sine qua non for existence of a DAPE under the India-France DTAA. The AO could not be granted a fresh inning for making roving and fishing enquiries whether the transactions were at arm’s length conditions or not (Airlines Rotables 44 SOT 368 followed);

(ii) (Observed, on a conceptual note, taking note of revenue’s plea but without deciding) If as a result of a DAPE, no additional profits, other than the agent’s remuneration in the source country – which is taxable in the source state anyway de hors the existence of PE, become taxable in the source state, the very approach to the DAPE profit attribution seems incongruous. Further, before accepting the DAPE profit neutrality theory, as per Morgan Stanley 292 ITR 416 (SC), the arm’s length remuneration paid to the PE must take into account ‘all the risks of the foreign enterprise as assumed by the PE’. In an agency PE situation, a DAPE assumes the entrepreneurship risk in respect of which the agent can never be compensated because even as DAPE inherently assumes the entrepreneurship risk, an agent cannot assume that entrepreneurship risk. To this extent, there may be a subtle line of demarcation between a dependent agent and a dependent agency PE. The tax neutrality theory, on account of existence of DAPE, may not be wholly unqualified at least on a conceptual note.

S. 72: Gains arising from “business assets” not eligible for set-off against B/fd business loss

Nandi Steels Ltd vs. ACIT (ITAT Bangalore Special Bench)



The assessee sold land & building used for business purposes. Though the gain was offered as capital gains, the assessee claimed, relying on Cocanada Radhaswami Bank Ltd 57 ITR 306 (SC) and other judgements, that as the assets were “business assets”, the gains there from were eligible for set-off against the brought forward business loss u/s 72. The issue was referred to a Special Bench. HELD by the Special Bench against the assessee:

S. 72 (1) allows brought forward business loss to be set-off against the “profits & gains of any business or profession” of the subsequent year. The expression “profits & gains of business” means income earned out of business carried on by the assessee and not just income connected in some way to the business or profession carried on by the assessee. The land & building were fixed & capital assets used by the assessee for its business purposes. The gains arising there from were assessable as capital gains and were not eligible for set-off against the brought forward business loss u/s 72 (Express Newspapers 53 ITR 250 (SC) followed; Cocanada Radhaswami Bank 55 ITR 17(SC) distinguished; Steelcon Industries reversed)

Note: Digital Electronics Ltd 135 TTJ 419 (Mum), J.K. Chemicals Ltd 33 BCAJ 36 & Sri Padmavathi Srinivasa 29 DTR 1 (Vish) are impliedly overruled

Transfer Pricing: TPO is duty bound to eliminate differences in comparables’ data

Demag Cranes & Components (India) vs. DCIT (ITAT Pune)



In a Transfer Pricing matter, the Tribunal had to consider whether for purposes of making adjustment under Rule 10B (1)(e)(iii) ‘working capital’ constituted a ‘difference between the international transactions and the comparable uncontrolled transactions of between the enterprises entering into such transactions’ and if so whether the said difference ‘could materially affect’ the amount of net profit margin of relevant transactions in the open market. HELD by the Tribunal:

Rule 10B(e)(iii) provides that “the profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market“. While the “differences” are not specified, it covers “any differences” which could materially affect the amount of net profit margin. The litmus test to be applied is if the ‘difference, if any, is capable of affecting the NPM in open market? If yes, then the TPO is under statutory obligation to eliminate such differences. The revenue cannot say that difference is likely to exist in all accounts and so the demands of the assessee should be ignored. The revenue’s stand that the assessee is ineligible for any adjustments if he provides the set of comparable is not correct because under Rule 10(3) it is the duty of the AO/TPO/DRP to minimize/eliminate the difference which is likely to materially affect the price. It is the settled proposition that ‘working capital’ adjustment is an adjustment that is required to be made in TNMM. The revenue’s contention that the ‘differences’ specified should refer to only (i) the factor of demand and supply; (ii) existence of marketable intangibles i.e. brand name etc; (iii) geographical location and the like is not acceptable. Further, as the difference in the Arm’s length Operating Margin of the Comparables before and after making the adjustment for working capital was up to 3.77%, it was “material” and had to be eliminated (Mentor Graphics 109 ITD 101 (Del), E-gain Communication 118 ITD 243 (Pune) Sony India 114 ITD 448 (Del) & TNT India followed)

CIT vs. Radhe Developers (Gujarat High Court)

S. 80-IB (10): “Housing Project” eligible even if Developer not “owner” of land

The assessee entered into a ‘development agreement’ with the owner of the land pursuant to which it agreed to develop the land. Deduction u/s 80-IB(10) in respect of the profits arising from the said activity was claimed on the ground that it was “derived from the business of undertaking developing and building housing project approved by the local authority”. The AO & CIT (A) rejected the claim on the ground that the assessee was not the “owner” of the land and that the approval of the local authority to, and the completion certificate of, the “housing project” was given to the owner and not to the assessee. However, the Tribunal allowed the claim. On appeal by the department to the High Court, HELD dismissing the appeal:

Sunday, January 15, 2012

The future of the European Union definitely looks bleak.

First it was the US which saw its credit rating getting downgraded for the first time in history. Now, it is raining downgrades in Europe. S&P, a global credit rating agency, downgraded France and Austria, two AAA rated countries. Plus, it slashed the ratings of seven other countries, among them Italy and Spain. If this wasn't bad enough, the agency also gave 14 out of 16 countries a negative outlook. This means that a further downgrade is possible within the next two years. Germany, Netherlands, Finland and Luxembourg, on the other hand managed to hold onto their ratings. This mass downgrade confirms our fears that the Eurozone crisis is far from being resolved. Not surprisingly the euro slumped more than 1% to a 17-month low against the dollar. The future of the European Union definitely looks bleak.

Rupee will continue to remain under pressure

While the first half of 2011 for Reserve Bank of India (RBI) was mainly a fight against inflation, the second half was dominated by worries of a depreciating rupee. To give you the exact numbers, the USD-INR exchange rate rose from the comforts of about 44 in August 2011 to a high of 54.3 around mid-December 2011. That was a whopping 23.4% decline for the rupee. The exchange rate has moderated a bit now to about 51.53. This has been mainly due to some measures initiated by the RBI and the finance ministry.
One measure was, of course, RBI's direct intervention in the market to curb the rupee decline. The RBI has also started a new swap line with the Bank of Japan which has helped prop up dollar liquidity to a certain extent. Moreover, the finance ministry announced certain small measures to attract dollars. One was allowing private foreign investors to invest directly in the Indian stock markets. In addition, interest rates on non-resident Indians (NRE) have also been freed. However, all these measures have their own limits and cannot drastically change the fundamentals of our currency which suffers due to a high current account deficit. The looming slowdown in growth will only make things more challenging. So it is quite likely that the rupee will continue to remain under pressure and may even see new lows in the coming times.

Friday, January 13, 2012

Watch out next monetary policy

The October industrial production performance sent shivers down the spine of the central bank and the government as poor set of numbers contributed to the 4.7% fall in the index. So much so that the RBI started worrying about the impact of higher interest rates on growth and maintained status quo in its latest monetary policy. So a much stronger show in November has certainly given the RBI something to cheer about. The Index of Industrial Production (IIP) grew by 5.9% during the month. What contributed to this growth was the strong show put up by consumer goods. This category grew by 13.1%, with durables rising 11.2% and non-durables by 14.8%. But capital goods remained a dampener with the sector contracting for the third straight month and highlighting the fact that the investment climate in the country has probably reached its lowest point. Overall, whether this positive trend can be sustained in the coming months remains to be seen though. More important will be what the RBI chooses to do with this data. Will it begin a series of rate cuts or will it continue to maintain the same rates in its forthcoming monetary policy? That will be the event to watch out for.

Thursday, January 12, 2012

Policy Reforms

The steep fall in Indian Rupee has led to troubles for quite a few companies. But some of the worst hits are those that have taken on ECBs (External Commercial Borrowings) in their books. Naturally if the value of rupee depreciates, the loan size for such companies increases. Nevertheless there is a way around this and that is hedging. But as per a report of the Reserve Bank of India (RBI) only 40% of the total ECBs in India are hedged. Many companies prefer not to hedge their foreign currency risks to avoid the financial costs related to such transactions. However, the lack of hedging increases the risk related to these companies particularly when the rupee depreciates sharply as it has done in recent times. As a result RBI has told banks through which the companies avail the ECB route, to ensure that the companies hedge their forex exposure. Further the apex bank has mandated banks to monitor the unhedged portion of the ECB of large companies whose forex exposure exceeds US$ 25 m on a monthly basis

Tuesday, January 10, 2012

Promoters -Companies allowed Placement Route

In a move that will help the governments divestment programme, the Securities & Exchange Board of India (Sebi) today introduced two new methods— institutional placement programme (IPP) and offer for sale of shares through the stock exchange —to help companies comply with the minimum public shareholding norms.
Under the Securities Contracts Regulation Rules (SCRR), all listed companies should have a minimum of 25 per cent of public shareholding.
Using the IPP route, companies can increase public shareholding by as much as 10 per cent either by way of fresh issue of capital or dilution by the promoters through an offer for sale. Under IPP, shares can only be issued to qualified institutional buyers, while 25 per cent of the offer should be reserved for mutual funds and insurance companies. According to the rules, every IPP issuance should have at least 10 allottees and no single investor shall receive allotment for more than 25 per cent of the offer size. Further, companies planning to raise money under IPP will have to file a red herring prospectus with Sebi along with the Registrar of Companies and stock exchanges.
Under the sale of shares through stock exchanges, companies through a separate window offered by the stock exchange will be able to offer at least one per cent of the paid-up capital, subject to a minimum of ~25 crore. This facility can be availed by only those promoters who are active and eligible for trading. The promoter or the promoter group of the company will not be permitted to bid for the shares.

Saturday, January 7, 2012

Is the worst over for world economy?

The Indian stock markets were up by 2.8% during the week. All the sectors ended in the green for the week apart from FMCG (down by a negligible 0.1%). Positive global cues along with lower food inflation number presented a possibility of a revival in the Indian economy. In fact, food inflation entered into the negative territory (-3.36%) for the first time in about 6 years, raising hopes that RBI could start cutting interest rates soon.
Amongst the other world markets, the investor sentiments were optimistic. Barring the Asian markets of China (down by 0.5%) and Japan (down by 0.8%) and that of France (down by 0.7%), all the global stock markets ended the week higher from where they started.

Friday, January 6, 2012

Indian -OpenValue Opportunity

On January 1, 2012, the Indian government announced the opening up of its equity markets to direct investments from Qualified Foreign Investors (QFIs). As per guidelines issued by India’s finance ministry, QFIs are defined to include individuals, associations or groups resident in an eligible country outside India. India had earlier opened up it’s equity markets to Foreign Institutional Investors (FIIs) who are permitted to invest in Indian equity markets subject to caps. Over time, these limits have been relaxed and investments at higher threshold levels have been permitted in specific sectors or companies subject to approvals by India’s central bank. This latest move to attract direct inflows from QFIs into Indian equity comes in the backdrop of negative news flows and significantly higher volatility in Indian equity markets

So while the opportunity is now available for individual investors to take direct stakes in Indian companies, is this a good time to invest into Indian equity? A 20% depreciation in the exchange rate coupled with a 20% decline in the broad market index during 2010 means that Indian equities are on average 40% cheaper than they were over a year ago. Amongst BRIC economies, Indian equities have corrected most steeply in 2010. Sure, local macro-economic fundamentals look a lot shakier than they were over a year ago and there could be more bad global news in the offing. For a value investor however, current valuations for well managed front line companies look compelling and they have looked so for nearly a quarter now

Big Economies face $7.6trillion debt in 2012



Governments of the world’s leading economies have more than $7.6 trillion of debt maturing this year, with most facing a rise in borrowing costs.
Led by Japan’s $3 trillion and the US’s $2.8 trillion, the amount coming due for the Group of Seven nations and Brazil, Russia, India and China is up from $7.4 trillion at this time last year, according to data compiled by Bloomberg. Ten-year bond yields will be higher by year-end for at least seven of the countries, forecasts show.
Investors may demand higher compensation to lend to countries that struggle to finance increasing debt burdens as the global economy slows, surveys show. The International Monetary Fund cut its forecast for growth this year to four per cent from a prior estimate of 4.5 per cent as Europe’s debt crisis spreads, the US struggles to reduce a budget deficit exceeding $1 trillion and China’s property market cools.
“The weight of supply may be a concern,” Stuart Thomson, a money manager in Glasgow at Ignis Asset Management Ltd, which oversees $121 billion, said in a December 28 telephone interview. “Rather than the start of the year being the problem, it’s the middle part of the year that becomes the problem. That’s when we see the slowdown in the global economy having its biggest impact.”
Competition for buyers
The amount needing to be refinanced rises to more than $8 trillion when interest payments are included. Coming after a year in which Standard & Poor’s cut the US’s rating to AA+ from AAA and put 15 European nations on notice for possible downgrades, the competition to find buyers is heating up.
“It is a big number and obviously because many governments are still in a deficit situation the debt continues to accumulate and that’s one of the biggest problems,” Elwin de Groot, an economist at Rabobank Nederland in Utrecht, Netherlands, part of the world’s biggest agricultural lender, said in an interview on December 27.
While most of the world’s biggest debtors had little trouble financing their debt load in 2011, with Bank of America Merrill Lynch’s Global Sovereign Broad Market Plus Index gaining 6.1 per cent, the most since 2008, that may change.
Italy auctioned 7 billion euros ($9.1 billion) of debt on December 29, less than the 8.5 billion euros targeted. With an economy sinking into its fourth recession since 2001, Prime Minister Mario Monti’s government must refinance about $428 billion of securities coming due this year, the third-most, with another $70 billion in interest payments, data compiled by Bloomberg show.
Rising costs
Borrowing costs for G7 nations will rise as much as 39 per cent in 2011, based on forecasts of 10-year government bond yields by economists and strategists surveyed by Bloomberg in separate surveys. China’s 10-year yields may remain little changed, while India’s are projected to fall to 8.02 per cent from about 8.39 per cent. The survey doesn’t include estimates for Russia and Brazil.
After Italy, France has the most amount of debt coming due, at $367 billion, followed by Germany at $285 billion. Canada has $221 billion, while Brazil has $169 billion, the U.K. has $165 billion, China has $121 billion and India $57 billion. Russia has the least maturing, or $13 billion. CARRYING THE BURDEN
Bond and bill redemptions and interestpayments in 2012 for G7 countries, Brazil, China, India and Russia
Country 2012 bond, bill redemptions- Interestpayments
Japan                      3,000            117
United States         2,783             212
Italy                         428                72
France                      367               54
Germany                  285               45
Canada                      221              14
Brazil                        169              31
United Kingdom       165              67
China                         121             41
India                            57             39
Russia                         13                9
Figures in US$ billion Source: Bloomberg

Goverment stand on Minority Shareholders right

Government's fund raising agents! We could not think of a better term for job description of regulatory heavyweights like the Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI). Both entities have been working overtime to ensure that the government coffers are full. Or at least that is what the government is coercing them to.
The RBI has been busy buying government bonds at a time when liquidity is tight. With the government exceeding its borrowing limit, private corporate are getting crowded out in the debt market.
At least when it came to equities, the government had to earlier compete with the private sector in raising capital. But the latest SEBI guideline gives a head up to the government on that too. We are referring to the announcement allowing promoters to sell shares through an auction on the stock exchanges (institutional placement programme, IPP).
Prima facie, the approval seems to enable the government to milk its cash cows at a time when it is badly strapped for funds and markets do not facilitate easy share sale options. Thanks to the muted sentiments in Indian markets, the government's ambitious Rs 400 bn disinvestment plan is on the verge of getting junked. Hence the only way to sell share in PSUs at attractive prices is through auction on the exchanges. Also, through the IPP route, all listed companies would be able to comply with minimum of 25% public shareholding.
However, we fail to understand why SEBI chose to come out with this kind of a regulation when there are enough means available for promoters to part sell their stake and liquidate their holdings. Also, the fact that in case of stocks with low liquidity, the auction price may come in at a good premium than market price will be akin to enjoying a preferential status over minority investors. Perhaps this has to do with the fact that the Government is extremely concerned about its ballooning fiscal deficit and has therefore forced SEBI to bring out this regulation. If this is indeed the case then it is not a good sign as regulators ought to protect the interests of minority shareholders and not act as an agent of rich promoters and majority shareholders like the Government of India.

Monday, January 2, 2012

Which way Rupee will go?

It would be difficult to predict where the rupee will head against the dollar in 2012. Will it revert back to reasonable levels of Rs 45/US$? It all depends on how the growth of the Indian economy pans out and what the government does to keep its finances in check. This means that the policy paralysis at the Centre will have to end and the government will gave to focus on reforms to instill confidence once again in investors. More importantly, efforts have to be made to reduce deficit. Indeed, a rising deficit only strengthens the case for a weaker rupee.

RBI went on a rate hike spree

GDP growth slowed, industrial production numbers contracted, capital market activity declined. The BSE-Sensex was also down since the start of the year. But, this is probably the only graph related to the Indian economy which had a positive slope in 2011. Seven rate hikes were implemented by the Reserve Bank of India in 2011. This followed six in 2010, in an attempt to curb inflation. Now with inflation slowing, the central bank has signaled the end of the monetary tightening by hitting the pause button in December. We are now looking forward to a few rate cuts next year.

Sunday, January 1, 2012

FY 2011-12 Insight

Indian firms have had a bad year in 2011. Higher interest rates have not just hurt their net margins but have also hurt their expansion and investment plans. As a result, many of them turned offshore to get cheaper loans. However, as global crisis continued to spread its tentacles, overseas banks have become cautious with their lending. As a result, overseas borrowing has all but dried up for anyone other than the highest rated borrowers. This has put several smaller and comparatively riskier companies in a dilemma. They have to either resort to taking expensive rupee debt to fund their expansion plans. Or end up facing a period of stagnant growth. For those looking to restructure their existing debt, things are even worse. They either risk taking on more expensive debt or defaulting on their existing loans. Not a happy choice no matter what angle you look at it from.

The year 2011 is certainly not going to be a very memorable one for investors. In fact, in 2011, the BSE-Sensex recorded its second worst performance in the last 14 years, second only to 2008 when the US financial crisis struck. The benchmark index has tanked by about 24% than its previous year's closing, making it one of the worst performers in the global stock markets.