Role of judiciary in enforcing ethical compliance by tax payers:
Tax payers also tend to distort “ethics” by resorting to unfair accounting and business practices like –
1. Claiming personal expenditure as business expenditure;
2. Claiming capital expenditure as revenue expenditure;
3. Treating revenue receipt as capital receipt;
4. Accounting for amount paid as “Salaries” as business expenditure by classifying the same under different account heads like conveyance, tour and travel, employee welfare etc.;
5. Altering the form of transaction;
6. Breaking up of large value contracts into smaller contracts to avoid attracting TDS provisions;
7. Breaking up of cash payments in respect of an expenditure to escape disallowance of such expenditure;
8. Transferring their income/property to avoid tax, etc.
9. Splitting up the turnover of excisable goods and taxable services in order to claim small scale exemption;
10. Not disclosing correct turnover figures in case of excisable goods and taxable services;
11. Resorting to unfair practices while valuing goods or services for the purpose of paying excise duty, customs duty and service tax respectively;
12. Misclassifying goods and services to avoid excise duty, customs duty and service tax.
The Courts have condemned such unethical practices by tax payers and have respected the importance of compliance with ethical standards in their judgments. Let us consider some cases in this perspective. There are several cases where companies/firms have claimed foreign travel expenses of spouses of directors/partners as a business expenditure. In some cases, the Courts have allowed such expenditure as deduction and in others, such expenditure has been disallowed. Expenditure incurred by the assessee-firm on the foreign tour of the wife of the senior partner was held non-deductible by the Madras High Court in CIT v. T.S. Hajee Moosa & Co. (1985) 153 ITR 422. In CIT v. Ram Bahadur Thakur Ltd. (2003) 261 ITR 390 (Ker.), the High Court held that it was the assessee‘s obligation to prove the business expediency of overseas travel by the wives of directors. The assessee has to discharge such obligation in good faith keeping in mind the ethical standards.
In CIT v. Madras Refineries Ltd. (2004) 266 ITR 0170, social costs incurred by a company have been allowed as deduction. The High Court held that the concept of business is not static. It has evolved over a period of time to include within its fold the concrete expression of care and concern for the society at large and the people of the locality in which the business is located in particular. Further, to be known as a good corporate citizen brings goodwill of t he local community, as also with the regulatory agencies and the society at large, thereby creating an atmosphere in which the business can succeed in a greater measure with the aid of such goodwill. This decision has recognized the concept of corporate social responsibility, which also highlights compliance of ethical standards by corporates.
In M.M.Fisheries (P) Ltd. v. CIT (2005) 277 ITR 0204, the company claimed depreciation in respect of an asset owned by its director in his personal capacity. The High Court held that the company was not entitled to claim depreciation since it had no dominion over the vehicle and even the beneficial ownership did not vest with the company. This is a case where the assessee sought to claim personal expenses of the director as business expenses, which is an indicator of low ethical quotient. Similar disallowance was made by the Madhya Pradesh High Court in Bhilai Motors v. CIT (1987) 167 ITR 147, where motor cars belonging to the assessee firm were used by its partners for personal purposes.
The concept of mutuality means that the contributors and the beneficiaries are identical. Since one cannot make a profit by dealing with oneself, there is no taxable profit involved wherever such concept applies. This concept has however been misused in many cases to avoid tax liability. In CIT v. Trivandrum Club (2006) 153 Taxman 481, the Kerala High Court observed that the doctrine of mutuality would not apply in a case where the marriage hall was being rented out to non-members by making them temporary members only for the purpose of letting out the marriage hall and the amounts received from the non-members formed part of the income of the assessee-club. In this case, the Court has corrected the negative ethical factor brought in by the assessee.
In CIT v. A.N. Naik Associates (2004) 136 Taxman 107, the Bombay High Court observed that the word “otherwise” in section 45(4) takes into its sweep not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favour of retiring partners. When an asset is transferred to a retiring partner, such transfer falls within the expression “otherwise” and the rights of the subsisting partners in that asset of the firm are extinguished. Therefore, there is clearly a transfer and capital gains tax is attracted. In this case, the High Court applied the “mischief rule” about interpretation of Statutes and pointed out that the idea behind the introduction of section 45(4) was to plug in the loophole and block the escape route through the medium of the firm.
It is significant to note that if the tax payers standard of tax ethics goes up, it would drastically reduce the spate of litigations, of the nature described above, pending in various judicial forums.