VHVK E-Newsletter June 2019
June 2019
Volume III Issue 3
VHVK Law Bulletin
This third issue of VHVK Law Bulletin 2019 brings to you latest developments in business and corporate law. Our current issue covers (i) Supreme Court’s ruling on 120-day limit for filing of written statements in commercial disputes, (ii) Supreme Court’s striking down of condition on pre-deposit by claimants initiating arbitration in public procurement contracts, (iii) Bombay High Court’s reiteration that put options are not forward contracts, (iv) optional regime of lower GST rates for residential apartments, (iv) Income Tax Appellate Tribunal allows interest expenditure incurred by investment companies earning dividend income, and (v) National Company Law Appellate Tribunal (NCLAT) affirms the right of bank with nominee director on board to participate in oppression/mismanagement action.
Written statement must be filed within 120 days, Supreme Court clarifies
In SCG Contracts v K S Chamanka Infrastructure, the Supreme Court clarified that in commercial disputes, courts lack power to entertain written statements from defendants beyond the statutory limit of 120 days (30 days plus 90 days in courts’ discretion) from the receipt of summons by defendants.1 In doing so, the Supreme Court relied on the amendments made to the timeframes applicable under the Code of Civil Procedure, 1908, by the Commercial Courts Act, 2015. The ruling is consistent with the legislative goal of speeding up the resolution of commercial disputes.
For several years now, defendants in lawsuits have been under an overall limit of 120 days to file their defence through written statements. Courts have the power to extend the 120 day limit in exceptional circumstances, but have been cautious in exercising the power. When it comes to commercial disputes, now recognized as a separate subset, the Commercial Courts Act removed courts’ powers to receive written statements beyond 120 days. This reflects the goal that commercial disputes must be resolved expeditiously and checks temptations for defendants to delay proceedings.
In SCG Contracts v Chamanka, however, the Delhi High Court accepted the defendant’s written statement beyond the statutory period of 120 days. In doing so, the Delhi High Court relied on its inherent powers to pass orders “necessary for the ends of justice or to prevent abuse of the process of the Court” (Code of Civil Procedure, 1908, section 151). The Supreme Court disagreed. Referring to the amendment made to the Code of Civil Procedure under the Commercial Courts Act and the exclusion of commercial disputes from the general power to pardon delay in filing written statements. Given this scheme of the rules, the Supreme Court held that courts cannot rely on their inherent powers to receive written statements in commercial cases, filed beyond the statutory limit of 120 days. The ruling from the Supreme Court can have a beneficial effect in expediting the resolution of commercial disputes.
Pre-deposit condition for invoking arbitration illegal, Supreme Court rules
In another important ruling, the Supreme Court struck down a condition in a public procurement contract requiring contractors to make a pre-deposit before initiating arbitration proceedings against government agencies.2 Even while recognizing the principle of sanctity of contracts and the high bar for judicial interference with government contracts, the Supreme Court ruled against a condition imposed by Punjab Water Supply & Sewerage Board (PWSSB) that contractors must make a pre-deposit of 10 percent of the claim amount, before they initiating arbitration against PWSSB. The decision from the Supreme Court strengthens the principle that legal remedies must not be unreasonably curtailed.
In ICOMM Tele Ltd v Punjab Water Supply and Sewerage Board, the tender conditions laid down by PWSSB were, arguably, onerous and the stated intention was to “check frivolous claims” from contractors. To invoke arbitration contractors, as noted, had to make a pre-deposit of 10 percent of the claim amount. The deposit amount would be forfeited if the claim failed. If a contractor was successful in the claim, the deposit amount will be refunded in the proportion of the amount awarded to the contractor to the claim amount. In effect, the contractor would suffer a penalty for commencing arbitration unless it was completely successful and gets the entire claim amount awarded. These provisions on pre-deposit were challenged by ICOMM Tele Ltd, a contractor that had a dispute with PWSSB.
In dealing with ICOMM’s challenge, the Supreme Court recognized the deterrent effect the pre-deposit condition can have in checking frivolous claims. At the same time, the condition as framed was arbitrary and unfair. This met the established bar for judicial interference with government contracts. The court termed the condition as inhibiting legal remedy and contrary to the goal of promoting arbitration as a fair, speedy, and inexpensive alternative to litigation in courts. The decision of the Supreme Court is consistent with the standard of judicial intervention in dealing with onerous conditions government agencies impose in awarding public procurement contracts.
Put options are not forward contracts, reiterates Bombay High Court
In an equity investment that did not go well, the investor (Edelweiss Financial) exercised its right under the investment agreement to require the company promoters to purchase the shares. This provision is similar, at least partly, to a put option in which the holder of a put option can compel the other party to buy the securities covered by the put. In Edelweiss Financial Services v Percept Finserve, the Bombay High Court followed its earlier ruling that put options were not forward contracts, hence not prohibited under the Securities Contracts Regulation Act, 1956, as it operated prior to 2013.3 The issue is not relevant after 2013 when the Securities and Exchange Board of India (SEBI) permitted forward contracts, including call/ put options.
The transaction in Edelweiss, the case recently decided by the Bombay High Court, occurred in 2012 prior to the 2013 SEBI circular that permitted forward contracts. During that time, forward contracts were prohibited. However, in dealing with the question whether a put option amounted to a forward contract, the Bombay High Court had taken the view in 2012 that it did not.4 In fact, this ruling was instrumental in SEBI’s decision to permit forward contracts in the following year (2013).
Bombay High Court’s rulings in Edelweiss (2019) and MCX (2012) are significant for their liberal/practical approach in interpreting market practices in line with current and emerging trends. In holding that put options are not forward contracts, the court relied on the fact that both elements in the transaction – namely, delivery of securities by sellers and payment by buyers happened together, contemporaneously. With the express permission granted for trade in options and derivatives in 2013, these rulings would be relevant for any disputes arising from prior transactions that might still be winding their way through litigation.
Conditional reduction of GST rates for apartments, available from 1 Apr 2019
In an apparent effort to reduce housing costs, Government of India recently offered an optional, lower tax structure for apartments.5 The new structure offers significant reduction in rates – from 8 percent to 1 percent for affordable housing apartments, and from 12 to 5 percent for other residential apartments, including commercial apartments located in residential projects. These rate reductions come with some conditions, mainly denial of Input Tax Credit (ITC) and requirement of minimum purchases from GST registered suppliers. The principle appears to be reduce profit margins for developers while protecting the interests of tax collections to the extent possible.
Quite arguably, the older tax rates – ranging between 8 and 12 percent – were a significant element of the total cost for home buyers. Displaying sensitivity to this aspect, the government has now stepped in with an optional lower tax regime for builders and home buyers. The only class of apartments excluded from the new structure is commercial apartments located in non-residential projects. In effect, the changes mainly benefit home buyers. As mentioned, the lower tax structure is optional and in choosing it, developers will be subject to important conditions. These include:
- No Input Tax Credit (ITC) is available for purchases made for the construction projects.
- At least 80 percent of the purchases of inputs and input services for the projects must be made from GST registered dealers.
- For any shortfall in input purchases below the 80 percent threshold, developers must pay GST at 18 percent on the value of the remaining purchases under the Reverse Charge Mechanism (RCM).
- Cement purchases from unregistered dealers are subject to 28 percent tax under RCM.
- Capital goods purchased from unregistered dealers will be taxed at applicable individual rates under RCM
The new rules seek to strike a delicate balance – between reducing tax rates for housing while avoiding significant impact on tax collections. In opting for the new regime, developers will be mindful of the impact it has on their costs, both from loss of Input Tax Credit and any additional tax liability under the Reverse Charge Mechanism. This must be weighed against the competitive advantage developers can derive from offering lower tax rates for home buyers. The practical outcome of making a choice between two regimes remains to be seen.
Earning dividend income does not automatically exclude interest expense, ITAT clarifies
In an important ruling for income tax payers receiving dividend income, the Income Tax Appellate Tribunal (ITAT) ruled that this would not automatically lead to disallowance of any interest expense they might claim in their tax assessment.6 Dividend income is tax free and the question in the case was whether the interest expense the taxpayer incurred was related to the earning of the dividends on which no tax is payable. In the absence of a direct correlation between the dividend income and the interest expense, the Delhi Bench of ITAT ruled that the interest payments can be deducted in computing taxable income.
When an item of income – example, dividends – is tax exempt, any expense incurred for earning that tax-free income cannot be deducted in computing taxable income (Income Tax Act, 1961, section 14A). The rule checks efforts by taxpayers to reduce tax liability for non-exempt income by using expenses incurred for earning tax-free income. In Nice Transport, the company had dividend income as well as income from trade in securities. It argued that its main business was trade in securities and the dividend income it received was only an incidental and a smaller part of its business income. As such, the interest expense it incurred was not directly or solely for earning dividend income, which is of course tax exempt. In the circumstances, there is no justification for applying Section 14A to disallow the interest payments made by the company, treating them as expense incurred for earning dividend income.
Accepting the submissions, ITAT Delhi ruled that the interest paid by the taxpayer must be deducted in computing its taxable income. The decision from ITAT is in keeping with the object of Section 14A, which is only to check tax avoidance by deducting expenses incurred for earning tax-free income.
Bank with nominee director can be a party on oppression action, NCLAT agrees
As a lender, State Bank of India (SBI) had a nominee director on the board of the borrower-company.7 In Usha Martin Ventures v Usha Martin, an action under the oppression and mismanagement remedy in the Companies Act, 2013 (section 241), SBI moved to be impleaded as a party and this was allowed by the National Company Law Tribunal (NCLT). This order was challenged by the petitioner, but this has been rejected by the Appellate Tribunal.
Actions under the oppression/mismanagement remedy are, essentially, quarrels among shareholders. Generally in these cases, it might be unnecessary for lenders or other creditors to intervene and have a say in the proceedings. There is also no incentive for creditors to participate in the litigation, which involves significant financial costs and investment of senior executives’ time. In Usha Martin, however, SBI was more than a simple lender. It had a nominee director on the board of the respondent company, against which allegations of oppression and mismanagement were made. In this background, SBI sought to participate in the litigation and the National Company Law Tribunal permitted it to do so.
The matter was carried in appeal to the Appellate Tribunal by the petitioner, but SBI prevailed. Considering that it had a nominee on the respondent-company’s board, National Company Law Appellate Tribunal (NCLAT) upheld NCLT’s order permitting SBI to participate in the proceedings involving the company.
VHVK Law Bulletin is issued for information purposes only and does not constitute legal advice. For more information on any of the material covered here and/or their implications for your situation, please obtain competent legal advice.