Enhancing microfinance -K. V. RAMANAND

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Microfinance institutions need to be permitted to operate as a business or an industry with an objective to make profits and grow.

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Currently, over Rs 20,000 crore is channelled by private sector MFIs amongst around 28 million borrowers.

"Give a man a fish, you feed him for a day. Teach him how to fish, you feed him for a lifetime," goes the Chinese saying. Microfinance is hailed by many as the panacea to alter the social fabric of rural India.

The depressing levels of poverty, particularly in rural India, motivated policymakers (such as the RBI and the Registrar of Cooperative Societies) to embark on the Self-Help Group (SHG), bank linkage programme to channelise the much-needed capital to the remotest parts of the country with the hallowed twin objectives of social and economic uplift.

SIDBI and NABARD, leading Indian financial institutions, played a stellar role by lending directly. They also paved the way for extensive private sector participation in this industry by funding private sector players.

The emergence of the concept of microfinance and private sector institutions was primarily to supplement and enhance the outreach of the traditional banking sector through the length and breadth of the country.

The benign objective was to protect the poor from the usury they were subjected to from unorganised moneylenders. Microfinance industry operates on the fundamental concept of small loans disbursed amongst a group of close knit people and subtly leverages on social and peer pressure to ensure full and timely repayment.

This industry has an envious record of loan recovery (almost 97 per cent). More importantly, the sector also seems largely immune to the global financial turmoil as it tends to operate on a regional basis. Therefore, it is highly susceptible however, to the regional issues and trends.

Organised phenomenon

What started as a local initiative by a few dedicated individuals with a social/community objective to mobilise and channel local resources has become a parallel organised banking phenomenon.

The style under which the entities operate ranges from for profit corporate entities such as NBFCs (non-banking finance companies to Section 25 companies and societies and trusts. Even the spectrum of regulators is widespread and ranges from the RBI to the Registrar of Cooperatives.

For long, this sector depended on the traditional sources of borrowed capital. There were many restrictions on free access to capital.

Public deposits were not available based on the nature of the entity and sources were primarily from the community and grants. Priority sector norms enabled microfinance institutions (MFIs) access to bank funds. Currently, over Rs 20,000 crore is channelled by private sector MFIs amongst around 28 million borrowers.

Lately, this sector has attracted funds from global development financial institutions and, more importantly, the global private equity funds. Private equity players have invested approximately $300 million in this sector in about 25 transactions since 2006.

This availability of capital in turn saw many socially-oriented entrepreneurs launching MFIs of their own. In all, over 3000 MFIs operate currently in India. This led many to draw comparisons between the credit-card boom for the middle class and the poor man's credit mechanism, the microfinance industry.

Key concerns

This rapid growth has led to many concerns being raised, primarily around the usage of funds by the borrowers and the rates charged by the lenders. In many cases, the lending rates range from an effective 25 per cent per annum to 32 per cent per annum.

Concerns were raised by activists whether this mechanism was fuelling rural consumerism by encouraging "unnecessary" spending by making credit easily available.

Is the credit being used for "productive" purposes? Is the credit going for measures that alleviate the impoverished status of the borrowers or is it meeting their short term consumption requirements? Other serious considerations are with regard to the systems and processes at the lending institutions to monitor and control disbursements and collections.

The MFIs have a requirement to strengthen their internal process and corporate governance standards. This is mandated by the rapid growth of the industry and also the need to operate from discrete and remote locations.

Considering the widespread presence of operations, many a times in remote areas with minimal access to communication networks, there is serious inherent risk in operations. Technology, therefore, will be a great enabler and can play an important role in the stability and growth of this industry by minimising risks and also significantly reducing costs.

We believe that the microfinance industry is a path breaking tool in achieving the stated twin objectives. The best and the most effective way of reaching there is by a judicious mix of active private sector participation with a calibrated approach of support and regulation by the Government and its agencies.

MFIs need to be permitted to operate as a business or an industry with an objective to make profits and grow. The regulatory set-up should be focused on prevention of any frauds or scams considering the high growth this sector is witnessing. The long-term growth of this industry is ensured if the MFIs practise self-regulation and direct the funds for productive purposes at a healthy margin without just being focused on growing the business by maximising (not optimising) disbursals at the highest possible rates of interest.

Sharing of information about borrowers and their payment track record/defaults will go a long way in preventing sizeable write-offs. This will also prevent multiple borrowings by the same borrower from multiple entities. In some instances, the new borrowings were apparently to service the old ones.

Regulatory supervision

The Government and other regulators should enable the MFIs to operate in an unhindered manner but with a clear and strict oversight. There has been a lot of debate about the need to regulate the interest rates on microfinance loans. The best that the regulators can do is to encourage this sector that enables multiple players to enter and participate aggressively, thereby increasing competition and the enhancing the need for efficiencies to survive and grow.

In a very positive development, leading players in this industry have come forward to set up a Microfinance Institutions Network (Mfin) that will interact on behalf of the industry with the regulators to ensure sustainable growth of the industry. It hopes to enhance information sharing amongst the members about the regulations, operational benchmarks and also borrower profiles and, more importantly, act as a self-regulating initiative.

While corporate diktats suggest a full-blown stress on growth and profits, the nature of the industry and the target segment it caters to position the players uniquely with the need for socioeconomic consciousness. This is a challenge for the captains of the entities that operate in this segment. However, we can be certain of one thing here — like some of the events that transformed the country, like the IT revolution, the concept of microfinance is destined to make a significant difference to the populace.

(The author is Executive Director, Corporate Finance, KPMG)

Transformation in lease classification -MOHAN R. LAVI

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The proposed amendments consider a 'right-of-use' model where both lessees and lessors record assets and liabilities arising from lease contracts.

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Classification of leases into operating and financial leases has not been very ambiguous, with clear rules for sometime now. But this is proposed to be radically altered by the International Accounting Standards Board (IASB), considering its revised Exposure Draft on International Accounting Standard 17 — Accounting for Leases.

Normally, a finance lease is one where the lease term exceeds the life of the asset, there is a transfer of title at the end of the lease term, an option to purchase the asset is built into the agreement or the present value of lease payments exceed a substantial portion of the fair market value of the asset.

Operating lease has been negatively defined — that is, one that is not a finance lease. It has been estimated that $640 billion of lease commitments do not appear on the balance-sheets of companies (as they are classified as operating leases and expensed), resulting in unclear financial leverage and gearing ratios.

Lessee

The proposed amendments consider a 'right-of-use' accounting model where both lessees and lessors record assets and liabilities arising from lease contracts. The assets and liabilities are recorded at the present value of the lease payments. They are subsequently measured using a cost-based method.

A lessee has acquired a right to use the underlying asset, and it pays for that right with the lease payments. A lessee would record: an asset for its right to use the underlying asset (the right-of-use asset), and a liability to pay rentals (liability for lease payments). The right-of-use asset would originally be recorded at the present value of the lease payments. It would then be amortised over the life of the lease and tested for impairment. A lessee (under IFRS) could revalue its right-of-use assets. The right-of-use asset would be presented within the property, plant and equipment category on the balance-sheet but separately from assets that the lessee owns.

Lessor

The accounting would reflect the exposure of the lessor to the risks or benefits of the underlying asset. When the lease transfers significant risks or benefits of the underlying asset to the lessee, the lessor would apply the de-recognition approach. When the lessor retains exposure to significant risks or benefits of the underlying asset the lessor would apply the performance obligation approach. The de-recognition approach requires the lessor to take part of the underlying asset off its balance-sheet (derecognise it) and record a right to receive lease payments. It is possible that a lessor could record a gain on commencement of the lease under this approach.

The performance obligation approach requires the lessor to keep the underlying asset on its balance-sheet and to record a right to receive lease payments and a liability to permit the lessee to use the underlying asset (a lease liability).

The lessor records income over the expected life of the lease. Many lease contracts include variable features.

For example, leases often include options to renew or terminate the lease, contingent rentals (for example, rentals that vary depending on sales) or residual value guarantees.

The proposals would require lessees and lessors to determine the assets and liabilities on the basis of the longest possible lease term that is more likely than not to occur. Lessees would always include contingent rentals but lessors would only include contingent rentals that they can measure reliably.

Lessees and lessors must also include estimates of residual value guarantees. Including these items informs investors about expected cash flows. Current requirements generally exclude such items, making it more difficult for investors to estimate future cash flows.

The proposed amendments would entail a revision to Indian Accounting Standard 19 on Leases since both differ conceptually. The frequent issue of revised standards by the IASB is forcing the Institute of Chartered Accountants of India (ICAI) to keep pace.

The ICAI is mulling whether to move over to the brand-new IFRS- 9 (Part 1 of 4 of which is now out) or to go ahead with IAS 39 on Financial Instruments from next year. A standard on financial instruments being extremely important, it would probably be better to implement IAS 39 and assess the impact instead of going in for a half-baked IFRS-9. The only constant in the accounting world these days is change.

(The author is a Bangalore-based chartered accountant.)

Auditors owe a duty to all shareholders -Businessline

Court raps SEBI for not acting on Price Waterhouse petition.

Our Bureau

Mumbai, Aug 25

The SEBI Act (Section 11) has wide amplitude and empowers the regulator SEBI to take within its sweep a CA, if his activities are detrimental to the investors or the securities market, the Bombay High Court observed in its order on the Price Waterhouse vs SEBI case.

The order was made available on the Court's Web site on Wednesday.

The Court on August 13 had ruled that SEBI can regulate the securities market but cannot regulate the profession of Chartered Accountants. SEBI has the powers to issue show cause notices to CA firms and individual CAs.

High Court proceedings

Among the observations made by the High Court was that "by taking remedial and preventive measures in the interest of investors and for regulating the securities market, if any steps are taken by the SEBI, it can never be said that it is regulating the profession of the Chartered Accountants." SEBI was also empowered by law so far as listed Companies were concerned, said the Court order.

"The auditors on their part have been appointed by shareholders by majority and they owe a duty to all shareholders and are required to give a correct picture of the financial affairs of the company," observed the High Court.

The High Court also rapped SEBI for not acting on the petition given to it by PW which prompted the audit firm to move court. The High Court observed that, as a result, the question as to whether the SEBI has committed error in not passing any order on the application has become academic.

In sum, the Court said that a CA firm like PW by virtue of being auditors of Satyam which was at one point considered a blue chip company with a defining influence on the securities market can be said to be persons associated with the securities market within the meaning of the SEBI Act.

While SEBI had no powers to debar a CA firm or a CA from practising, it could safeguard investor interest by taking appropriate remedial steps including keeping a person (including a CA) at a safe distance from the securities market.

The PW petitions were rejected and their prayer for leave to appeal to Supreme Court was also rejected. SEBI has been directed not to undertake inquiry proceedings against PW for a period of four weeks so that the audit firm could file a special leave petition against this High Court order in the Supreme Court.

Satyam case

PW which had been issued a show cause notice by SEBI in the Satyam fraud, had sought direction from the High Court on whether SEBI has jurisdiction over CA firms and CAs in this matter as they were governed by ICAI.

SEBI had initiated proceedings against PW in the Satyam case under provisions of Section 11,11B and 11(4) of the SEBI Act against PW with respect to fabrication and falsification of accounts, non compliance with auditing standards and dissemination of misleading and spurious information.

Point of taxation Draft Rules– Gennie of the Magic Lamp

 

CA. Pradeep Jain

CA. Preeti Parihar

CA. Ridhi Anchalia

Introduction-

 

"Alladin & his magic lamp" - hearing the stories since ages. Gennie fulfilling the desires sound too good, but what if it comes out and becomes uncontrollable… too difficult to put him in again… Now let's take a look into its latest version – "The Government and drafts rules for determining the point of taxation". The government has come out proposing new rules namely - Point of Taxation (for Services Provided or Received in India ) Rules, 2010 (hereinafter referred as the draft rules). These rules have been drafted in order to provide for certain provisions that do not exist in the current act and rules, as such, forming the backbone of litigations. In order to provide specifically for such essentials, these rules have been drafted. Let's have an overview of these rules via this piece of article.

 

Need for Enactment-

 

The Chapter V of Finance Act, 1994 was introduced in India inter alia just on 3 services which reached to 126 services till date. This has now become a trend of bringing more and more services under the net of taxable services. But till date, there are no expressed provisions in the Finance Act, 1994 regarding the transitional period of a new service, point of taxation of a service, continuous supply of service, interest free security deposit, etc. As such, as and when these issues arise, litigation arises. Though there are Circulars issued by the Board for clarifying these issues, yet a need is always felt for specific provisions in the Act or the rules. To cope up these needs, government has come up with new draft rules namely – "Draft Point of Taxation (for Services Provided or Received in India ) Rules, 2010". These rules are kept open for public comments.

 

Proposals –

 

Treatment of advances:

The draft rules propose to levy the service tax on the date the advance is received by the service provider. This step is merely a clarificatory one as the section 67(3) of the Chapter V of the Finance Act, 1994 (hereinafter referred as the Act) already deals with the issue. This section says that the value of advances is to be included in the value of taxable service provided or to be provided. This rule says that the service tax on advances is payable at the time of receipt. Even if this draft rule is not prescribed, there is no ambiguity as the Service tax Rules, 1994 already takes care of it. As per rule 6(1) of the said rules, service provider is required to pay the service tax on the 5^th/6^th of the next month in which the payment is received. However, since the new draft rule clarifies that the service tax is payable at the time of receipt of payment or issuance of invoice, the service tax so determined at the relevant time would be final and the service provider will not have to review these bills and amend them.

Interest free deposits:

It is further provided that no service tax is payable on the interest free deposits. This is a well come step. Department has initiated proceedings on the service providers who have received security deposits from the recipients of service. Receipt of interest free deposit is a common practice in the Renting of immovable property service, supply of tangible goods service. The service providers receive an interest free refundable deposit at the time of letting out property/supply of goods. This is done to secure themselves against any loss caused to their property or goods by the recipient of service. This rule will relieve a no. of assessees who are burdened by the show cause notices on this issue.

 

Change in rate & point of taxation:

 

Levy and collection of service tax revolves around three aspects – providing of service, raising invoice and payment of consideration. If all the three arise at the same time, there is absolutely no problem. But practically all the three transpire at the different points of time. In such case, the litigation arises if the service tax rate changes in between the chain of these three. Now these draft rules have been proposed to prescribe the point of taxation in such cases. This has been prescribed as follows:-

 

EVENTS OCCURING BEFORE CHANGE OF RATE		CHANGE IN RATE	EVENTS OCCURING AFTER CHANGE OF RATE			POINT OF TAXATION
Service provided		SERVICE TAX RATE CHANGES	Invoice raised	Payment received		Date of receipt of payment or issuance of invoice whichever is earlier
Service provided	Invoice raised		Payment received within 30 days of invoice			Date of raising invoice
Service provided	Invoice raised		Payment received after 30 days of invoice			Date of payment
Invoice raised			Service provided		Payment received	Date of payment **
Invoice raised	Payment received		Service provided			Date of receipt of payment or issuance of invoice whichever is earlier

** A supplementary invoice will be issued for recovery of balance service tax.

 

Transitional provisions for new service:

 

In case where the service has been provided at the time it was not taxable but the consideration is received after it is brought under the service tax net, whether taxable? No answer in the Act. Due to absence of provisions in this regard, the department used to come up with show cause notices where the amount was received after the levy of service tax.

 

Now, the draft rules have prescribed in respect of new service that –

 

Ø  In case the invoice has been raised and the payment is received before the levy, no service tax is payable even if service is provided after it becomes taxable.

 

Ø  If the payment has been received, and invoice has been issued within 14 days (as prescribed under rule 4A of the Service Tax Rules, 1994); service tax will not be payable.

 

Ø  In cases where the service has been provided before it becomes taxable, no service tax is payable.

 

These steps will resolve the matters lying in the litigation chain and will give foundation to litigation- free transitional provisions for new services.

 

Continuous Supply of service:

 

The continuous supply of services has been defined in Rule 2 as a service which continues to be provided for a period exceeding 6 months. The proposed rule prescribes that the rate of tax will be the rate applicable on the date the payment becomes due as per the contract. If the payment is linked to completion of certain events, service tax is payable when those events are completed. If none of the above two conditions is specified in a long term contract, then the service provider is required to pay the service tax at the time of raising of invoice, or receipt of payment, whichever is earlier. Presenting in tabular form:-

 

Contract clauses		Service tax becomes due on
Date of payment prescribed		Date of payment as prescribed, whether or not it is actually received.
Date of payment is NOT prescribed	Payment is linked to achievement of targets	Date of achievement of targets whether or not payment is received on that date.
Date of payment is NOT prescribed	Payment is  NOT linked to achievement of targets	Date of issuance of invoice or receipt of payment whichever is earlier.

 

The rule also says that if payment is received before and services are provided afterwards, then they will not be taxable. So the services will only be taxable if payment for the services will be received after the services are taxable. In case of continuous supply it becomes difficult to judge the extent of services received. It has been prescribed that the clauses of the rule shall be read sequentially. If this rule is implemented, this would be the most difficult task to handle for both government as well as the assessees. This rule links payment of service tax to the date of payment prescribed in contract whether or not payment is actually received. This will impose undue hardship on the assessees in case the payment is not received or a reduced payment is received, service tax being already paid. Further, if contract says, the payment is linked to achievement of targets; the service tax becomes due on achieving these targets, irrespective of payment being actually received. What is this – of course neither this is receipt basis, nor billed basis. This is the third thing which, instead of simplifying the things, will make them complicated. Suppose in the year end, the service provider pays the service tax on the basis of targets achieved, how will he keep the records of "targets so achieved for the purpose of service tax". How will he correlate the payments received alongwith targets achieved and service tax paid. No accounts are being kept for memorizing the targets achieved; of course the payments and raising of invoices are maintained. Even if paid, how will it be traced in the Balance Sheet. The figures of Balance Sheet will not tally anyways. Further, the accounting of service tax paid on the basis of targets achieved; will not commensurate with the general accounting practices. Further, the service provider will have to maintain a database for memorizing about the targets achieved, service tax paid, consideration received, quantum of service tax recovered. Again there will be problem if the consideration is not received in toto, or received at a lower amount. Hence, rising graph of the post-payment issues.

 

Associated Enterprises:

 

The associated enterprises have not been left untouched from the new rules. The concept was brought into Finance Act, 1994 during year 2008. At implementation stage, it was prescribed that mere book entries between the associated enterprises will be taxable. These rules do not alter this basic concept. It merely extends it and proposes to levy service tax on the date which is Earliest of the following three dates:-

 

Ø  Date of payment, or

Ø  Date of debit or credit entry, or

Ø  Date of issue of debit or credit notes.

 

As per Rule 4(7) of the Cenvat Credit Rules, 2004, credit in respect of input service is allowed after the date of payment of consideration. Initially when the above concept of associated enterprises was implemented, it was demanded that the credit should also be allowed on the date of payment of service tax by the service provider. But this was not done and the same situation will continue even after these draft rules.  

 

Royalties and similar payments:

 

In the services which involve payment of royalties or any other payment of like nature, the amount of consideration is not known at the time of performance of service. The payment is received in piecemeal in such cases for subsequent use of benefits. In such cases, the rules provide that the service will be deemed to have been provided at the time the payment is received or the invoice is raised. Since such payments may require sufficient time for generation of income, it is very difficult to correlate the rates of service tax changing during this period. In absence of specific provision regarding this, the provisions of the Act were used as they suited to the Department/assessee. These rules will definitely provide a sound basis for proper levy and collection of the service tax on such services.

 

Before Departing-

 

The new rules framed out by the government in the veil that these rules will bring clarity in the Chapter V of Finance Act, 1994. But is this the real fact that the government now wants to resolve the old issues. It is for resolving the old issues or preponing the tax liability in the service tax, not clear. If the payment of service tax is linked to the achievement of targets, or provision of service, it would not serve the purpose of aligning the service tax with the VAT or other taxes. Instead, it will be defeating the prime objectives of framing the provisions of receipt basis. Receipt basis was implemented as realisation in service sector is very slow and normally lower than the billed amount. If these draft rules are implemented, this ultimate purpose will be defeated. Moreover, what will be the position of the Cenvat Credit? At present, as per rule 4(7) of the Cenvat Credit Rules, 2004, credit of input services is allowed only after the payment of invoice is made. If this system is followed, whether they will amend the Cenvat Credit Rules, 2004 or will leave them as it is, to add one more issue in the litigation. Further, the accounting aspect of the service tax will be difficult and would not commensurate with the normal accounting practices. It will be difficult to trace out the defaults as there is not set practice system for this type of accounting. Further, it will be almost impossible to tally the figures of service tax records and Balance sheet. Over and above all, the chances of errors – both intentional and unintentional will increase. Further, there is recent trend in the departmental audit teams to make out paras by comparing the figures of Service tax return & records, with the Balance sheet. If these rules are implemented, Balance sheet will not tally with the return in any way. So, what will be the basis of finding the authenticity of the figures shown in the service tax return? Whether government will prescribe new sets of accounts to be maintained for the Service tax purpose or will it go to "Octopus baba"? Not clear. Even otherwise, if the government wants to switch over from receipt basis, there can be a sweat and simple alternative of imposing the service tax on the billed basis. In other words, simply putting the service tax on the raising of invoice will solve many of the above referred problems. Anyhow, if these draft rules are implemented, new controversies will arise which will result into many more audit paras, whether or not understandable. It will complicate the complete system rather than simplifying them. Let's see, whether the 'Alladin' rubs the 'magic lamp' or not...

MCA Guideliens on Name Availability

MCA's guidelines for deciding cases for availability of names     MCA's Guidelines for filing Annual Return for Financial Year 2009-10
	MCA's Guidelines for filing Annual Return for Financial Year 2009-10

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Best Wishes

CA. V.M.V.SUBBA RAO
Chartered Accountant
Door No.24-2-1885,
I Floor, Flat No.5,
Siddivinayaka Residency, I Cross,
Central Avenue, MSR Nagar,
Magunta Layout,
Nellore-524 003
Andhra Pradesh
India
Mobile:+91 - 0 9390221100
           +91 - 0 9440278412
e-Mail: vmvsr@rediffmail.com
           vmvsr@yahoo.co.uk
http://pdicai.org/MyPage/203038.aspx

Circular on Works Contract

Circular No. 128/10/2010-ST

F.No.354/141/2010-TRU

Government of India

Ministry of Finance

Department of Revenue

Central Board of Excise & Customs

(Tax Research Unit)

*****

North Block, New Delhi,

24 ^thAugust, 2010.

To

Director General (Service Tax),

Director General (Central Excise Intelligence)

Director General (Audit)

Chief Commissioner of Central Excise and Service Tax (All)

Commissioner of Central Excise and Customs (All)

Commissioner of Central Excise and Service Tax (All)

Commissioner of Service Tax (All)

Madam/Sir,

Subject: Service tax on on-going works contracts entered into prior to 01.06.2007 – regarding –

It has been brought to the notice of the Board that the following confusions/disputes prevail with respect to long term works contracts which were entered into prior to 01.06.2007 (when the taxable service, namely, Works contract came into effect) and were continued beyond that date:

(i) While prior to the said date services like Construction; Erection, commissioning or installation; Repair services were classifiable under respective taxable services even if they were in the nature of works contract, whether the classification of these activities would undergo a change?

(ii) Whether in such cases of continuing contracts, the Works Contract (Composition Scheme for payment of Service Tax) Rules, 2007 under Notification No. 32/2007-ST dated 22/05/2007 would be applicable?

2. The matter has been examined. As regards the classification, with effect from 01.06.2007 when the new service 'Works Contract' service was made effective, classification of aforesaid services would undergo a change in case of long term contracts even though part of the service was classified under the respective taxable service prior to 01.06.2007. This is because 'works contract' describes the nature of the activity more specifically and, therefore, as per the provisions of section 65A of the Finance Act, 1994, it would be the appropriate classification for the part of the service provided after that date.

3. As regards applicability of composition scheme, the material fact would be whether such a contract satisfies rule 3 (3) of the Works Contract (Composition Scheme for payment of Service Tax) Rules, 2007. This provision casts an obligation for exercising an option to choose the scheme prior to payment of service tax in respect of a particular works contract. Once such an option is made, it is applicable for the entire contract and cannot be altered. Therefore, in case a contract where the provision of service commenced prior to 01.06.2007 and any payment of service tax was made under the respective taxable service before 01.06.2007, the said condition under rule 3(3) was not satisfied and thus no portion of that contract would be eligible for composition scheme. On the other hand, even if the provision of service commenced before 01.06.2007 but no payment of service tax was made till the taxpayer opted for the composition scheme after its coming into effect from 01.06.2007, such contracts would be eligible for opting of the composition scheme.

4. The Board's previous Circular No. 98/1/2008-ST dated 04.01.2008 and the ratio of judgement of the High Court of Andhra Pradesh in the matter of M/s. Nagarjuna Construction Company Limited vs. Government of India (2010 TIOL 403 HC AP ST) are in line with the above interpretation.

5. Trade Notice/Public Notice may be issued accordingly.

Yours faithfully,

(J.M. Kennedy)

Director (TRU)

Tel: 011-23092634

IFRS, direct tax code set to make next fiscal challenging for CAs -Mr G. Ramaswamy, Vice-President, ICAI

Accounting professionals geared up for implementation of IFRS.

 

The financial year 2011-12 is going to be more vibrant, especially for the accounting professionals, with the implementation of Direct Taxes Code (DTC) and the convergence of Indian accounting standards with IFRS (International Financial Reporting Standards), according to Mr G. Ramaswamy, Vice-President of the Institute of Chartered Accountants of India (ICAI).

Speaking to presspersons on the sidelines of the inauguration of the national conference on 'Direct taxes and allied laws', organised by the Direct Taxes Committee of ICAI here on Friday, he said the next financial year will be a great year for the country.

The professionals will be geared up for the implementation part, and the corporates on the compliance part. This will lead to increase in the revenue collection also, he said. Stating that a lot of developments are taking place with regard to the implementation of IFRS, Mr Ramaswamy said that the ICAI is gearing up its members and industry towards the achievement of the committed date of April 1, 2011. The IFRS will be implemented in a phased manner from 2011-14.

"We are conducting national workshops and meetings throughout the country creating awareness, involving professionals and those who are interested in it. Special e-learning courses and certificate courses are available for chartered accountants," he said.

The ICAI also has mutual recognition arrangements with accounting bodies in England and Wales and Australia. "We are also in dialogue with Canada, Singapore, Malaysia and New Zealand institutes. We are coordinating with them," he said. On the Direct Taxes Code (DTC), he said that for the first time, a proposed legislation was open for debate throughout the country. Tax payers, academicians and chartered accountants have given their views. Stating that the final version will be tabled in Parliament, he said the deadline for DTC implementation is April 2011.

He said the Central Council of ICAI has proposed an amendment on the type of action to be taken in the case a firm is involved in cases of violation. "The Central Council has debated on that. We are proposing an amendment. So we are giving suggestions to the Government," he said.

NETWORKING

On the networking of CAs, he said today, 70 per cent of chartered accountants are small and medium practitioners. If the Chartered Accountants (Amendment) Bill 2010 is passed in Parliament, more number of CAs can come together and form an LLP (limited liability partnership) firm. Apart from CAs, these firms can include cost accountants, advocates, valuers, actuaries, and may be MBAs (finance).

END USE AUDIT

An LLP firm can give a host of service, he said, adding that LLPs will be one of the important mediums for the CA firms.

Mr Ramaswamy said that ICAI is already interacting with the Comptroller & Auditor General for end use audit.

Giving the example of National Rural Employment Scheme (NREGS), he said it is being implemented throughout the country through State Governments. So, there should be checks and balances.

"We have already made representation to the Comptroller & Auditor General that NREGS should be audited by the CAs. That will help small and medium practitioners also. It can be monitored throughout the country by CAs. With this, end user can be identified properly," he said.

Stating that the Comptroller & Auditor General is very positive on this, he said, "They have collected information about the CAs available throughout the country. We have given district-wise data. We are pursuing them to make it mandatory."

Dividend-stripping transactions, a sham? -T.C.A. RAMANUJAM

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Mere receipt of dividend subsequent to purchase of units in a mutual fund cannot go to offset the cost of acquisition of the units.

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Chief Justice Kapadia of the Supreme Court has delivered a remarkable judgment analysing the concept of tax avoidance in dividend-stripping transactions. The court examined the impact of various sections in the Income-Tax Act, 1961 in arriving at the taxable income in the Walfort case.

As per the facts of this case, Walfort Share and Stock Brokers P. Ltd purchased units of Chola Freedom Technology Mutual Fund on March 24, 2000. This was the record date for declaring dividend. The company became entitled to a dividend at Rs 4 per unit and the amount earned was Rs 1,82,12,862. The NAV (net asset value) stood at Rs 17.23 on this date. It fell to Rs 13.23 soon after declaration of the dividend. The company sold all the units on March 27, 2000. It received an incentive of Rs 23,76,778 for the transaction. In its income-tax return, the company claimed exemption of the dividend amount of Rs 1,82,12,862 under Section 10(33) of the I-T Act. It also claimed a set-off of Rs 2,09,44,793 as loss incurred on the sale of units.

The assessing officer (AO) disallowed this loss. He pointed out that this was a dividend stripping transaction and not a business transaction. It was entered into primarily for the purpose of tax avoidance. The loss was artificially created by a pre-designed set of transactions.

Return on investment?

Before the Supreme Court, the Revenue argued that the amount received by the company as dividend constituted a return on investment. It has to be adjusted against the cost of the purchase of the units in such an event, there will be no loss suffered by the company on subsequent redemption.

Alternatively, it was argued, the price of units included the price of dividend embedded there in. Dividend represented a price paid for the units and it is an expenditure incurred for obtaining exempt income which should be disallowed under Section 14A.

"Loss" is a commercial concept and will not take in "tax loss" created or contrived without suffering commercial loss. Section 94(7) is meant to curb tax avoidance involving "dividend stripping transactions".

The court had to decide whether "return on investment" or "cost recovery" would fall within the expression "expenditure incurred" in Section 14A. It had to reconcile the provisions of Section 14A with those of Section 94(7), which was inserted by Finance Act, 2001 w.e.f. April 1, 2002; Section 14A was inserted w.e.f. April 1, 1962.

Section 10(33) recognises receipt of tax-free dividends. This cannot be called "abuse of law".

Even assuming that the transaction was pre-planned, there is nothing to impeach the genuineness of the transaction.

The McDowell case has to read in conjunction with the Azadi case ( 263 ITR 706). A citizen is free to carry on business within the boundaries of the law. Mere tax planning without any motive to evade taxes through colourable devices is not frowned upon. However, after April 1, 2002, losses to the extent of dividend received by the company could be ignored by the department under Section 94(7) which curbs short-term losses.

The loss to be ignored would be only to the extent of dividend received and not the entire loss. Losses over and above the amount of dividend received would still be allowed. Parliament has not treated dividend-stripping transactions as sham or bogus.

If the Revenue's argument is accepted, it would mean that before April 1, 2002, the entire loss will be disallowed as genuine, but after this date only a part of it would be allowable under Section 94(7). This will not be a reasonable interpretation.

Different fields

Sections 14A and 94(7) operate in different fields. The former deals with disallowance of expenditure incurred in earning tax-free income, while the latter refers to disallowance of loss on the acquisition of an asset which situation is not there in cases falling under Section 14A. Section 94(7) applies to cases where the loss is more than the dividend. Section 14A does not deal with acquisition of an asset. Under Section 94(7), there is acquisition of an asset. Loss arises when sale takes place under Section 94(7). There is a conceptual difference between loss, expenditure, cost of acquisition, and so on, while interpreting the scheme of the Act.

A mere receipt of dividend subsequent to purchase of unit, on the basis of a person holding units at the time of declaration of dividend on the record date, cannot go to offset the cost of acquisition of the units.

Para 12 of the Accounting Standard 13 relied upon by the Revenue will have no application in cases where units are bought at the ruling NAV with a right to receive dividend as and when declared in future and did not carry any vested right to claim dividends which had already accrued prior to the purchase.

There can be no question of AS-13 coming to the aid of the department. The Supreme Court upheld the ruling of the Bombay High Court and dismissed the appeal of the Revenue.

(The author is a former Chief Commissioner of Income-Tax.)

Indian IFRS — adoption or convergence? -DOLPHY D'SOUZA

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The advantage of adopting full IFRS is that it would certainly help entities that are seeking foreign listing.

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The Institute of Chartered Accountants of India (ICAI) issued Ind-AS 41, an exposure draft (ED) on the Indian equivalent of IFRS 1, First-time Adoption of IFRS. Ind-AS will be a separate body of accounting standards which may not always be the same as IFRS issued by the International Accounting Standards Board (IASB) (hereinafter referred to as "IFRS").

Thus, if an Indian parent has foreign subsidiaries, which are already using IFRS, the Indian parent will not be able to use those financial statements in its transition (as well as on an ongoing basis) to Ind-AS and will have to convert the already IFRS compliant subsidiary to Ind-AS.

Further, companies which are already IFRS compliant, for example, to comply with foreign listing requirements, will not be allowed to use these financial statements to claim compliance with Ind-AS. This will create considerable workload for global Indian companies.

Many entities around the world are able to make a dual statement of compliance on their financial statements, which is an unreserved statement that the financial statements are in accordance with IFRS and the standards notified in their local jurisdiction. This is only possible where there are no differences between IFRS and the standards notified locally.

The advantage of making a dual statement of compliance is that the financial statements can be used within India as well as in almost all major capital markets in the world which accept IFRS financial statements. If Indian companies fail to make dual statement of compliance, they may need to reconvert again from Ind-AS to IFRS, at the time of foreign listing.

The positives

Any Government would be challenged in making a decision as to whether to adopt full IFRS or to make certain deviations which are deemed necessary. The advantage of adopting full IFRS is that it would certainly help entities that are seeking foreign listing. Also, Indian entities that have several foreign subsidiaries which use IFRS would prefer to have the entire group on IFRS, rather than for different companies of the group to be on different national versions of IFRS.

However, such companies as a percentage of total companies in India may be small and hence the Government may not deem fit to impose full IFRS on all the companies in India for the sake of this relatively small advantage. Therefore, what kind of changes from IFRS should the Government consider when notifying Ind-AS? Certainly not the ones that are being contemplated, for example, the discount rate and the accounting for actuarial gains and losses with regard to measurement of pension obligation.

With regard to accounting for actuarial gains/losses, multiple options, including deferring actuarial gains/losses, are available under IFRS which entities in other countries are using. Indian entities should not be deprived of that benefit, as is evident from the relevant exposure draft issued by ICAI. It is interesting to note that Australia started off eliminating multiple options when it first notified the IFRS standards. However, it later fell back to allowing the full range of options under IFRS.

Overall, Ind-AS should not make any departures from the full IFRS standards unless they are required in the rarest of rare cases. This will ensure that we receive the full benefit of adopting full IFRS standards.

Unwarranted departure

So far it appears that the departures that are expected to be made (discount rate on long term employee benefits or accounting of actuarial gains/losses) are unwarranted.

As the standards are not yet notified, and as companies make strong representations, it is not clear at this stage what further exceptions would be made to the full IFRS standards. The Government will have to exercise judgment on what departures to make; this could be in the area of foreign exchange accounting, loan loss provisioning in the case of banks, completed contract accounting in the case of real estate companies, and so on.

There has to be a solid technical argument for making these exceptions, and a balance achieved between interest of various stakeholders, such as the company, investors, national interest, and so on.

More importantly, the accounting treatment should fairly represent the substance of the transaction. That, under no circumstances, should be compromised.

(The author is Partner & National IFRS Leader, Ernst & Young)

On markets and scams -D. MURALI

India's political and social structures have preserved entrepreneurs, if not exactly cut them loose, observes Raghav Bahl in Superpower? ( www.penguinbooksindia.com). Even as the state invested in big-ticket capital assets in the early decades after Independence, land continued to stay in private hands, he reasons in the chapter titled 'Entrepreneurs, consumers and English speakers'.

"India's sprawling rural economy has always been entirely 'capitalist' in its orientation. Even the urban economy allowed private enterprise to grow under a somewhat draconian regime of licences and approvals… The Bombay Stock Exchange (BSE) is among the oldest in Asia. Capital and credit have always been available, albeit for a 'price,' for private enterprise."

Harshad Mehta episode

Of interest to finance professionals is a section in the chapter, captioned 'the story of two stock markets,' opening with how Harshad Mehta, who, in his late thirties, 'pulled off a stock market scam in India which would have put Bernie Madoff to shame.' The year was 1992 and there was much excitement around a freshly minted, rapidly privatising economy, the author narrates.

"It was easy to spin get-rich-quick stories in an unregulated casino. For a man who had barely scraped through his accounting studies at college, Harshad Mehta was a deadly combination — a legendary crook and a master storyteller. He siphoned off a billion dollars from several Indian banks to rig the stock prices of ninety blue chips."

As some of you may recall, 'stocks doubled, trebled, quadrupled, and Mehta became the cult deity of wealth.' But his house of cards collapsed when the bubble burst. "He died in custody on the last day of 2001 as India's biggest defaulter, owing nearly $170 million to several banks. He also left behind an unsolved mystery of 2.7 million missing shares and seventy-two cases of conspiracy, cheating, and fraud."

Shock therapy

Looking back, Bahl says that the Mehta scam was a shock therapy for India's stock markets. Although over a century old, the BSE — set up under a banyan tree in 1875 — was little more than a privileged brokers' club in the early 1990s, he reminisces.

"It traded for barely a couple of hours every day on the outcry method. Shares were held in physical form, and trades were squared off once in fifteen days. Upcountry brokers were forced to transact on a rickety phone network. Companies could cancel share transfers on the flimsiest of excuses, like signatures not matching or papers lost in transit." As a result, the system was prone to delay, abuse, price fixing, insider trading and frequent breakdowns, informs the author.

Jolted by the scam, the government set up a tough securities regulator, but wealthy brokers continued to defy it, one learns. The breakthrough came in the form of NSE (National Stock Exchange), a digitally savvy exchange with equity put up by government financial institutions. The 'game changer,' which began trading in 1994, allowed the same equity instrument to be traded on both exchanges in the same city and across similar trading hours, and banked on dematerialised shares and electronic depositories.

"Over ten thousand terminals in over 400 cities gave instant trading access to members. In eleven months flat, the new exchange logged up higher trading volumes than its 120-year-old competitor. The transaction settlement period dropped from fifteen to two days. To survive, BSE had to set up its own electronic system." Bahl is proud that today the Indian stock market is among the largest in the world, next only to NYSE in terms of the number of shares listed, deals transacted and the size of retail investor participation.

Stock exchanges in China

What has been the story in China, where stock exchanges took birth around the same time that we were reinventing ours? The aim of the Shanghai Stock Exchange (SHSE) set up in December 1990, and the Shenzen Stock Exchange (SZSE), set up in April 1991, was to sell shares of State Owned Enterprises (SOEs), but 'an inexperienced China opted for a very complex system,' recounts the author.

Sample this, from his description: The same company could not list on both exchanges — it had to choose one. Five different types of shares could be issued: A-shares (sold in local Chinese currency to local individuals); B-shares (sold in either US or Hong Kong dollars to foreign investors); C-shares (issued to Chinese state institutions or departments, but tradable only 'over the counter' in institution-to-institution sales, rather than on the main exchanges); H-shares (equity issued by mainland companies on the Hong Kong stock exchange); N-shares (issued on the NYSE); and 'a sixth — and the strangest — category was 'non-tradable' shares held by the government or its agencies.'

Silos in markets

So, the majority of shares in early listed companies were not floated, with only the shares sold to the general public being tradable, and thus making for very thin volumes and huge price volatility, explains Bahl. Since China wanted to keep a tight control on its currency and foreign capital flows, it was forced to create these silos to isolate each currency, geography and class of investor, he notes.

"The early years were wracked by a dizzy gyration in stock prices… Contributing to the messy situation was a 'quota system' for selecting SOEs to float their shares; each province was given a fixed quota of companies they could bring to the market." What suffered was the quality of paper floated as an effect of 'the shadow of politics' or 'the unseen hand of political patronage,' which explains the non-failure of any initial float, and non-delisting of any publicly listed company.

'Grey' transactions

Such a fragmented structure created frictions at each margin, besides creating a playground for 'grey' transactions that illegally moved capital across prohibited boundaries to profit from price differences, finds Bahl. "A company with A, B and H shares today has three wholly different valuations; often, A-shares have traded at three times the value of B-shares or H-shares, puzzling investors."

He points out that while common sense dictates that B-shares should command a premium, as foreign investors have superior access to information and analytical skills, that is not the case, perhaps due to 'a speculative frenzy in China's domestic stock market that has taken A-shares to 'bubble' levels.'

The book cites Morgan Stanley's statistics that a third of reported corporate earnings in China in 2007 came from speculative gains in stock markets.

"For instance, the apparel company Youngor had earned nearly 99 per cent of its profits from subscribing to shares of China Life, Bank of Ningbo and Citic Securities. Although some norms have been tightened, banks in China have lent freely at very low rates to help companies build up their investment portfolios."

Five more crises

To those who dismiss the Indian bourses as unhealthy, post Harshad Mehta's scam in the early 1990s, it may come as a surprise that Indian markets have weathered five crises since then, as Bahl chronicles.

In 1995, the BSE was closed for three days after payment problems on a company which had crashed, he begins. "In 1997, a mutual fund closed shop after defrauding investors; in 1998, the president of the BSE was sacked for allowing prices of three companies to be manipulated; in 2001, another price-rigging scandal by another ambitious broker was busted; and finally, in 2005, thousands of fake accounts were unearthed, that were getting illegal allotments of newly floated shares under the quota reserved for individual investors." Stating that wherever there is a stock market, there will be a scam, Bahl avers that since 2005 no major scandal has erupted in India's stock markets.

What is the scene in China? It is still in the throes of a learning curve, grappling with frequent scams in its still maturing stock markets, he feels. An example cited in the book the November 2009 arrest of 39-year-old Huang Guangyu, the chairman of Gome Electrical Appliances, the country's biggest electronics retailer.

"Forbes had listed Huang as China's second wealthiest individual, estimating his worth at $2.7 billion. Caijing reported that Huang was detained for an alleged stock manipulation case involving a company controlled by his elder brother. He was eventually fined $120 million and handed a fourteen-year jail term…"

Engaging comparison of two countries, in crisply-written chapters.

 

Vedanta's clever siddhanta -S. MURLIDHARAN

By timing its action before the new takeover code is implemented, Vedanta has side-stepped two potentially irksome issues — 100 per cent takeover and pricing parity for public shareholders.

 

The Achuthan panel report recommendations could perhaps have been at the back of the mind of the reclusive Anil Agarwal, the promoter of Vedanta Resources Plc, a company listed in the London Stock Exchange and which controls the Indian metals major Sterlite Industries Ltd when he decided to acquire a controlling interest in Cairn India Ltd from Cairn Energy UK with jet speed.

A staggering $9.6 billion would be forked out by Vedanta to Cairn Energy reportedly from the combined coffers of Vedanta and Sesa Goa, another group company of Vedanta in India which it acquired a few years ago. For all one knows, Vedanta is scouting for funds in the foreign markets, including in London, where takeover financing is otherwise granted generously but the environmental issues that have come to baulk some of Vedanta's plans in Orissa seem to have come in the way of raising the moolah.

Be that as it may, what Vedanta seems to be keen on is to rush before the new takeover code, assiduously worked out by the Achuthan panel, is brought into force to its detriment. Incidentally, the panel recommendations are still being mulled by the public whose reactions would be considered by SEBI (Securities and Exchange Board of India) before implementing them.

Foreign companies have acquired Indian companies in the past but this would be the first instance of a foreign company promoted by an Indian coveting an Indian company by, curiously in the process, wresting control from an unadulterated foreign company.

Successfully sidestepped

The panel has suggested two seminal changes that could strike at the roots of the takeover game in India. First, is the public offer requirement to buy out all the remaining shares from the public resulting in a 100 per cent buyout as opposed to the extant norm that requires buying out of a further 20 per cent of the voting capital of the company this time around from the public after having purchased at least 25 per cent from the promoter. Back of the envelope calculations show that the cost of acquisition of $9.6 billion could double to roughly $20 billion, making perhaps the acquisition not only the largest ever in India but also more disquietingly for Vedanta a pyrrhic victory. Vedanta obviously would not like to score such a pyrrhic victory.

Vedanta would also have reckoned with the grim prospect of having to pay Rs 405 per share to the Indian public shareholders, the price that it has agreed to pay to Cairns Energy UK if the new takeover code as recommended by the panel is implemented.

For, the panel has rightly put its foot down and recommended abolition of room for chicanery that consists in camouflaging 20 per cent of the negotiated price with the promoter (Cairns Energy UK) as non-compete fee which has nothing whatsoever to do with cost of acquisition of controlling interest.

The takeover history is replete with instances of the two sides in a negotiated deal playing footsie to rob the small shareholder of his rightful due. Now Vedanta too would profit from this chicanery — Rs 405 per share for Cairn Energy UK but only Rs 355 per share to the Indian public shareholders.

That Vedanta has not gone the whole hog — it could have pared down the price payable to the public by about Rs 80 — is as much a small mercy as it is a reflection of cold calculations; the public might lose interest in the public offer.

Be that as it may, the point is through its timely action, Vedanta has side-stepped two potentially irksome and burdensome issues — 100 per cent takeover and a parity of pricing for public shareholders. Vedanta obviously does not consider it prudent to assume a huge debt burden which would become inevitable if a company is to be acquired lock, stock and barrel. Furthermore, it knows pretty well that it has nothing to gain by making Cairn India a closely-held company.

Daiichi Sankyo walked into the space vacated by the Singh brothers in Ranbaxy. In other words, the existing promoters were asked to ship out completely. Their entire 34 per cent holdings were acquired.

On the contrary, Vedanta has agreed to allow Cairn Energy UK to have a toehold in Cairn India Ltd by allowing it to retain a minimum of 10.6 per cent stake. One wonders why. Is this a huge display of naiveté?

In any case, this flies in the face of non-compete fee and indeed in a way gives a lie to such a claim. It is indeed odd to find quarter being given to the one who has been paid a non-compete fee. Non-compete fee and continued interest in the business are incompatible phenomena.

That Cairn Energy would continue to stay invested in Cairn India belies its claim of having received non-compete fee from Vedanta and proves that it was only making life that much easier for the acquirer by playing footsie with it.

Apart from the chicanery involved in camouflaging a good chunk of the negotiated price as toward non-compete fee, staying put in an acquirer's company albeit in a minor capacity gives the outgoing promoter enough power to constantly breathe down the neck of the acquirer when his purported intention is to break free of him.

People in the know have all along known that non-compete fee in the context of takeover is a pure hogwash but one is at a loss to find a savvy businessman exposing himself to the potential danger of being constantly snapped at the heels by the one who has sold out. Even if the claim of non-compete agreement were to be believed, it is a tad ironical that the acquirer would not brook competition from the seller but would stoically put up with his intrusive presence inside the company.

(The author is a Delhi-based chartered accountant.)