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Income Tax Appellate Tribunal, “C’’ BENCH : BANGALORE
Before: SHRI B.R BASKARAN & SMT. BEENA PILLAI
IN THE INCOME TAX APPELLATE TRIBUNAL “C’’ BENCH : BANGALORE
BEFORE SHRI B.R BASKARAN, ACCOUNTANT MEMBER AND SMT. BEENA PILLAI, JUDICIAL MEMBER
ITA No.486/Bang/2019
Assessment year : 2015-16
The Income-tax Officer, Vs. M/s True North Fund IIIA Ward-1(2)(1), (formerly Known as India Value Fund Bengaluru. IIIA) No.9/2, Rockline House, M.G Road, Bengaluru-560 001.
PAN – AAAIT 6015 M APPELLANT RESPONDENT
CO No.50/Bang/2019
Assessment year : 2015-16
M/s True North Fund IIIA Vs. The Income-tax Officer, (formerly Known as India Value Fund IIIA) Ward-1(2)(1), No.9/2, Rockline House, Bengaluru. M.G Road, Bengaluru-560 001.
PAN – AAAIT 6015 M APPELLANT RESPONDENT
Revenue by : Shri Pradeep Kumar, CIT (DR) Assessee by : Shri Manish Malik, Advocate
Date of hearing : 09.12.2019 Date of Pronouncement : 29.01.2020
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O R D E R Per B.R Baskaran, Accountant Member :
The appeal filed by the Revenue and the cross objection filed by the assessee are directed against the order dated 12/12/2018 passed by ld CIT(A)-1, Bengaluru and it relate to the asst. year 2015-16.
The grounds of appeal urged by the Revenue are as under:-
“1. The order of the Learned CIT (Appeals), in so far as it is prejudicial to the interest of revenue, is opposed to law and the facts and circumstances of the case.
On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not considering the fact that the assessee, in respect of the Long Term Capital gain accrued, had claimed deduction u/s 10(38) of the Act in both the original return of income filed on 31.08.2015 and the revised return of income filed on 27.09.2016. Later, the assessee, vide letter dated 25.10.2016, had made claim for exemption u/s 10(23FB) of the Act in respect of the said Long Term Capital gain accrued. Therefore, the assessee itself was not certain regarding the provisions of the IT Act, i.e. either Sec. 10(38) or Sec. 10(23FB) of the Act, under which it had to claim the exemption in respect of the said Long Term Capital gain accrued.
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On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not considering the fact that the assessee, being a VCF, required to adhere to the provisions of sec. 10(23FB) of the Act in order to become eligible to claim exemption on any income earned on investments from VCUs. The assessee has sold listed shares of non VCU and thus, the assessee's claim for exemption u/s 10(23FB) of the Act has been rightly disallowed by the AO.
On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not considering the fact that the assessee did not hold the listed equity shares for a minimum period of 12 months to consider the said shares as Long Term Capital Asset as per the provisions of Sec. 2(42A) of the Act and thus, the assessee's claim for exemption u/s 10(38) of the Act has been rightly disallowed by the AO.
On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not considering the fact that the assessee did not sell the unlisted shares of VCU to claim exemption 10(23FB) of the Act.
On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in not considering the fact that though the assessee is maintaining the books of
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accounts in mercantile system of accounting, it has failed to offer the accrued interest income for income tax.
For these and such other grounds that may be urged at the time of hearing, it is humbly prayed that the order of the Ld. CIT (A) be reversed and that of the Assessing Officer be restored.
The appellant craves leave to add, to alter, to amend or delete any of the grounds that may be urged at the time of hearing of appeal.”
In the cross-objection, the assessee has raised following grounds:
“1. On the facts and circumstances of the case, and in law, the learned CIT(Appeals) ought to have adjudicated that as per Explanation 1(i)(c) to section 2(42A) read with section 47(vii) of the Act shares in Mahindra CIE Automotive Limited are long-term capital assets
On the facts and circumstances of the case, and in law, the learned CIT(Appeals) ought to have adjudicated and granted, on merits, the Respondent's claim of exemption under section 10(38) of the Act.
On the facts and circumstances of the case, and in law, the learned CIT(Appeals) ought to have
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adjudicated, on merits, that no interest has accrued, or arisen to or has been received by the Respondent on loans given to Innovative B2B Logistics Solutions Private Limited and as such no interest was taxable.
Without prejudice to Objection No. 3, on the facts and circumstances of the case, and in law, the learned CIT(Appeals) ought to have quashed the Assessing Officer's order of applying 15% notional rate of interest on loans given to Innovative B2B Logistics Solutions Private Limited.
On the facts and circumstances of the case, and in law, the learned CIT(Appeals) erred in exceeding his jurisdiction and making an observation that, income from capital gains out of investment in shares and interest income from Venture Capital Undertakings earned by the Respondent need to be examined in the hands of the ultimate beneficiaries.”
The assessee herein is a Venture Capital Fund. It filed its return of income for the year under consideration declaring Nil income on 31/8/2015. Subsequently the assessee filed revised return of income on 27/9/2016 declaring again Nil income. There are 20 beneficiaries under this fund, out of which 91.3% is held by an investor named “Indium III Mauritius Ltd”. Before the AO, the assessee claimed that it is eligible for exemption u/s 10(23FB) of
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the Act in respect of income from investments made in a venture capital undertaking.
The AO has made two additions, viz., the capital gains earned by the assessee and notional interest income on a loan given by the assessee. The facts relating to both the additions are discussed in brief. The assessee had invested its funds in a Venture Capital Undertaking named “M/s Mahindra Hinoday Industries Ltd” (earlier known as “Mahindra Castings P Ltd) during the financial years 2007-08 to 2011-12 as detailed below:-
At the time of making above said investments, the above said M/s Mahendra Hinoday Industries Ltd., was an eligible Venture Capital Undertaking, in which the assessee could make investments. The shares were also not listed in any stock exchange. Subsequently, during December 2014, the above said M/s Mahendra Hinoday Industries Ltd., got amalgamated with M/s Mahendra CIE Automotive Ltd.. However, Mahendra CIE Automative Ltd was a
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listed company and its shares were traded in stock exchanges. Consequent to amalgamation, the assessee received 1,79,19,704 equity shares in Mahendra CIE Automative Ltd in exchange of shares held by it in M/s Mahendra Hinoday Industries Ltd. It is pertinent to note that the shares of M/s Mahendra CIE Automotive Ltd,. were listed in stock exchange at the time of amalgamation. Hence, the assessee sold shares of M/s Mahendra CIE Automotive Ltd., in the month of Jan 2015 in various tranches and earned capital gain of Rs.246.50 crore.
In the original return of income, the assessee claimed the capital gain as exempt u/s 10(38) of the Act. However, in the notes attached to return of income, the assessee mentioned that its income is exempt u/s 10(23FB) of the Act. In the notes attached to the return of income, the assessee expressed its difficulty in making correct disclosure, since the Income tax utility provided for filing returns of income electronic form created certain glitches. Subsequently, the assessee filed a revised return of income. In the revised return of income, the assessee mentioned that the capital gain is exempt u/s 10(23FB) of the Act. During the course of assessment proceedings, the assessee filed a letter dated 25/10/2016 before AO, wherein also it claimed that the capital gain is exempt u/s 10(23FB) of the Act. In addition to income from capital gain, the assessee also declared interest income of Rs.487.72 lakhs from loans given to other Venture Capital undertakings. The assessee also claimed the same as exempt u/s 10(23FB).
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During the course of assessment proceedings, the AO noticed that the provision of sec. 10(38) of the Act allows exemption of long term capital gain arising on sale of shares, if they are listed shares and are held continuously for more than 12 months, i.e., the AO took the view that, for availing exemption u/s 10(38) of the Act, the status of “listed shares” should be maintained throughout the period of 12 months. In the instant case, the AO noticed that the assessee has acquired listed shares of Mahendra CIE Ltd., only in the month of December 2014 and sold the same in January 2015. In fact, shares of Mahendra CIE Ltd was held for about two months only and earlier to that, the assessee has held unlisted shares for more than 10 months. Since the assessee has not held listed shares for entire period of 12 months prior to its sale, the AO took the view that the assessee is not eligible for exemption u/s 10(38) of the Act.
The AO also held that the assessee is not eligible for exemption u/s 10(23FB) of the Act, since the assessee has sold shares of a “listed company”. It is pertinent to note that, as per Venture Capital Fund Regulations, a Venture Capital Undertaking is defined to mean a domestic company
(i) whose shares are not listed on a recognized stock exchange in India; and
(ii) which is engaged in the business of providing services; or which does not fall in the negative list specified under the VCF Regulations.
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Since shares of M/s Mahendra CIE Ltd are listed in Stock exchanges, the AO took the view that the assessee cannot claim exemption u/s 10(23FB) of the Act.
Accordingly he assessed the gain arising on sale of shares mentioned above (without indexation benefit) amounting to Rs.316.04 crores as income of the assessee under the head Income from Other Sources.
The AO further noticed that the assessee has, inter alia, given loan to M/s Innovative B2B Logistics Solutions Ltd., to the tune of Rs.114.89 crores and assessee has not charged any interest thereon. In the notes to the accounts, the assessee has stated that it has not accounted for interest accrued on above said loan, since there was difference of opinion between the assessee and the above said company over the terms of loan & rate of interest. The AO noticed that the assessee is following mercantile system of accounting and accordingly took the view that the assessee should have accounted for accrued interest on the loan given to M/s Innovative B2B Logistics Solutions Ltd. The AO further noticed that the assessee has charged interest @15% in respect of loans given to other venture capital undertakings. Accordingly, he computed the interest on the above said loan by applying interest rate of 15%, which worked out to Rs.17.23 crores. The AO assessed the same as income of the assessee. It is pertinent to note that the assessee had claimed that its entire income is exempt u/s 10(23FB) of the Act and accordingly claimed exemption in respect of interest income of Rs.4.87 crores receivable from loans given to other Venture Capital
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undertakings. The AO also allowed exemption to the above said amount of Rs.4.87 crores. However, the AO denied exemption u/s 10(23FB) to the interest income of Rs.17.23 crores computed by him on the loan given to Innovative B2B Logistic Solution Ltd. In the remand report submitted to Ld CIT(A), the AO gave following explanations for not allowing exemption u/s 10(23FB) of the Act on the interest income so assessed:-
“The assessee has claimed exemption u/s 10(23FB) of the Act on Rs.4,87,72,436/- being the interest from VCUs which has been allowed as this amount has been taxed in the hands of the investors. Similarly, notional interest is also to be taxed either in the hands of the assessee or the investors. The Assessing Officer do not have jurisdiction over the investors and therefore, it has been brought to tax in the hands of the assessee.”
The assessee challenged both the above discussed additions by filing appeal before Ld CIT(A). Before him, the assessee made detailed submissions and hence the Ld CIT(A) called for remand reports from the assessing officer from time to time. We notice that the AO has furnished remand reports three times. In reply to the remand report, the assessee submitted that its primary claim is exemption u/s 10(23FB) of the Act and as an alternative claim, exemption u/s 10(38) was made.
The Ld CIT(A) considered the Venture Capital Fund regulations, which have been discussed by Ld CIT(A) in paragraph 4.10 to 4.15
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of his order. With regard to the claim for exemption u/s 10(23FB) of the Act, the Ld CIT(A) held as under:-
“4.21 The appellant is a VCF and has made investments in Mahindra Hinoday, a VCU, during the period 2009-2011. This company was (shares) was amalgamated into Mahindra CIE with approval of the High Court on 10th December, 2014, and the Appellant received 1,79,19,704 equity shares of Mahindra CIE as against 1,62,90,640 equity shares held in Mahindra Hinoday. The Appellant sold all the shares allotted in Mahindra CIE on 16 January, 2015; 19 January, 2015; and 21 January, 2015, on the Bombay Stock Exchange and National Stock Exchange for Rs. 4,11,92,52,979, The Appellant earned a capital gain of Rs, 2,46,50,93,394, as computed under the provisions of the Income-tax Act, 1961 (the Act) for the sale of Mahindra CIE shares after taking into consideration the benefit of indexation. No doubt the appellant has fulfilled all the conditions of the Section 10(23FB) of the Act; namely:
a. The fund is a venture capital company or a VCF; and
b. The income is from investment made in a venture capital undertaking (VCU),
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4.22 The only issue is as to whether the status of shares on the date of sale relevant for the purpose of claiming the benefit under Section 10(23FB)? The shares of the VCU having been invested as unlisted shares remained for three and half years as unlisted till Dec 2014 and became listed only in December 2014 listed on the Stock Exchanges and thereafter they were sold in January 2015.
4.23 As per the provisions of Sec 10(23FB) read with the Finance Ministers Speech (243 ITR 46 Statutes) (page 24 & 25 of paper book) in the Lok Sabha, dated May 3, 2000 while moving the Finance Bill 2000-01 for consideration of the House, it is evident that the intent of the legislature has been to incentivise the investments in the unlisted venture capital under takings (VCU). There is no mention of the status of the said investment on the date of sale or exit.
4.24 Even if it is assumed that upon conversion of the investments from unlisted to listed the available tax exemption stops, even in such a situation one should compute the gain made by the VCF in the shares of the VCU till the date of amalgamation. Thus, the gain made from the date of (20092011) initial investments in the shares of the VCU to the date of amalgamation Dec 2014, shall be treated as covered by the provisions of Sec 10(23FB) of the Act as exempt. The
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balance gin made by the appellant upon conversion of shares to listed shares consequent to amalgamation till the date of sale, be considered as taxable. Since, both these events (December 2014 & January 2015) happened during the Financial Year relevant to the Assessment Year 2015-16, the AO may under-take this exercise to split the capital gains into two transactions.”
The Ld CIT(A) has expressed the view that the capital gains arising upto the date of amalgamation should be allowed exemption u/s 10(23FB) of the Act and the balance amount of capital gains shall be taxable. However, in paragraph 5.1 of the order, the Ld CIT(A) has held that the issue relating to denial of exemption u/s 10(38) in the hands of the assessee is academic in nature, since he has held that the income of the assessee is exempt u/s 10(23FB) of the Act.
The assessee had also contended before Ld CIT(A) that it is a contributory trust and the contributions made by the investors/beneficiaries are revocable transfers. Accordingly, it was contended that the provisions of sec.61 and 63 shall be applicable to it. It was also submitted that the assessing officer had accepted the above said position in AY 2014-15. The Ld CIT(A) has discussed this issue as under:-
“4.26 The Appellant is a contributory trust and the contributions made by the investors or beneficiaries in the Appellant are revocable transfers. Where the
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transfers by the investors of a VCF are revocable transfers, section 61 of the Act applies. For AY 2014- 15, the income of the Appellant was accepted as Ni! on the basis that it was a revocable trust. The Appellant vide submissions dated 14 December, 2017; 20 December, 2017; and 28 December, 2017, made before the AO, had submitted that it is a revocable trust.
4.27 In the assessment order for AY 2015-16, the AO has made an addition of Rs. 3,33,27,40,895, to the total income of the Appellant comprising of Rs. 3,16,04,05,895 towards income on sale of shares of Mahindra CIE and Rs. 17,23,35,000 towards notional interest on loans given to Inlog.
4.28 As per section 61 read with section 63 of the Act, the income of the Appellant shall be chargeable to income-tax as the income of the investors of the Appellant and shall be included in their total income.
4.29 Further, it is pertinent to note that section 61 does not distinguish between types of income. Any income of a VCF whether out of investments in VCUs or otherwise, is not taxable in the hands of the VCF. Such income is taxable in the hands of the investors.
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4.30 The investors / beneficiaries of the Appellant have offered their share of capital gains in their respective return of income and paid appropriate taxes
4.31 It is also informed that the details of the beneficiaries were furnished to the AO vide submission dated 16 August, 2017.
4.32 The Appellant has further submitted that the confirmations from the beneficiaries that they have offered their share of income from the Appellant to tax, as appropriate, in their return of income vide submission dated 16 August, 2017, and 1 September, 2017.
4.33 Without prejudice to submissions under Ground nos. 1 to 11, the Appellant submits that the addition of Rs. 3,33,27,40,895, made by the AO to the total income of the Appellant, is not taxable on account of section 61, as well as section 10(23FB), as well as section 10(38) of the Act.
Determinate status of the trust not to be affected if trust deed is capable of identifying the beneficiaries and determining their respective shares
4.34 However, even if one seeks to go by the intention of the legislature in case of Section 10(23FB) the intention of the legislature was to extend the exemption
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to the entire income of a VGF (sic. VCF) which is set up to raise funds for vestment in VGUs (sic. VCUs) as is evident from the Finance Minister's Speech (243 ITR 46 Statutes) (page 24 & 25 of paper book) in the Lok Sabha, dated May 3, 2000 while moving the Finance Bill 2000-01 for consideration of the House, which states as under:
"Venture Capital Fund shall enjoy a complete pass through status. There will be no tax on distributed or undistributed income of such funds. The income distributed by the funds will only be taxed in the hands of investors at the rates applicable to the nature of income".
4.35 In light of the above, it is clear that the intention of the legislature is to treat the entire income of VCFs as exempt from tax under section 10(23FB) irrespective of its nature, and instead tax the same in the hands of its investors at the time of distribution under section 115U on a pass through basis, else it would amount to double taxation once in the hands of VCF and then again in the hands of the investor.
4.36 The subsequent amendment of Section 10(23FB) by Finance Bill 2007 is effective from 1.4.2008 restricting the exemption available u/s 10(23FB) to
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only income of venture capital fund from an investment in venture capital undertaking
4.37 The taxation of domestic Venture Capital Funds (VCFs) and Alternative Investment Funds (AlFs) has undergone various changes over the years. Currently, VCFs1 and Category I/ II AIFs2 have been granted tax pass through status under the Income-tax Act, 1961 (the Act) in relation to specified income. Such income is directly chargeable to tax in the hands of the beneficiaries/investors.
4.38 In the above cases, it is critical that the Fund (set- up as a trust) qualifies as a determinate trust, so that tax levied in the hands of the trustee is in the like manner and to the same extent as it would be leviable upon the beneficiaries. In case where the Fund is treated as indeterminate trust', it could get taxed under section 164(1) of the Act, which provides for taxation at maximum marginal rate under certain circumstances.
4.39 Explanation 1 to section 164 of the Act provides that for a trust to be determinate, (i) the beneficiaries should be expressly stated and identifiable as on the date of the trust deed; and (ii) their individual shares should be expressly stated and ascertainable as on the date of the trust deed.
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4.40 In this connection, it may be noted that the Authority for Advance Ruling held that if the trust deed sets out expressly the manner in which the beneficiaries are to be ascertained and also the share to which each of them would be entitled without ambiguity, then it cannot be said that the trust is indeterminate.
4.41 However, the Central Board of Direct Taxes issued Circular No, 13/2014, dated 28 July, 2014, wherein it had stated that in a situation where the trust deed either does not name the investors or does not specify their beneficial interest, the provisions of section 164(1) of the Act would apply and the entire income should be chargeable to tax at maximum marginal rate in the hands of the trustee in their representative capacity.
4.42 Similar questions arose for consideration before the Authority for Advance Ruling in the case of XYZ, In Re 224 ITR 473 (AAR).
XYZ., In Re 224 ITR 473 (AAR): The Authority for Advance Ruling (AAR) held that if the trust deed sets out expressly the manner in which the beneficiaries are to be ascertained and also the share to which each of them would be entitled without ambiguity, then it cannot be said that the Trust deed does not name the
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beneficiaries or that their shares are indeterminate. The persons as well as the shares must be capable of being definitely pin-pointed and ascertained on the date of the trust deed itself without leaving these to be decided upon at a future date by a person other than the author either at his discretion or in a manner not envisaged in the trust deed. Even if the Trust deed authorises addition of further contributors to the trust at different points of time in addition to initial contributors, than the same would not make the beneficiaries unknown or their share indeterminate. Even if the scheme of computation of income of beneficiaries is complicated, it is not possible to say that the share income of the beneficiaries cannot be determined or known from the trust deed
4.43 In a recent decision, the Karnataka High Court in the case of the Trust (India Advantage Fund-VII in ITA No. 191/2Ol5 dated 2O-02-2017), upheld the decision of the Bangalore Income-tax Appellate Tribunal in ITA No 178/2012 AY 2008-09 and held that for a trust to be a determinate trust, it would be sufficient if the trust deed laid down that the beneficiaries would be the persons who had made, or had agreed to make, contributions to the trust in accordance with the contribution agreement, and their shares were capable of being determined based on the provisions of the
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trust deed. The issue before the Karnataka High Court was: Whether the Tribunal was right in holding the Trust as a determinate trust and not assessing the Trust at the maximum marginal rate as per section 164(1) of the Act?
High Court's ruling: The High Court upheld the decision of the Tribunal on the following principles:
• All that is necessary is that the beneficiaries should be identifiable based on the provisions of the trust deed, and it was not necessary that the beneficiaries should be specifically named in the trust deed. In the present case, the trust deed clearly laid down that beneficiaries meant the persons, each of whom had made or agreed to make, contributions to the trust in accordance with the contribution agreement.
• It is not necessary that the trust deed should actually prescribe the percentage share of the beneficiaries in order for the trust to be determinate. It is enough that the share of the beneficiaries is capable of being determined based on the provision/ formula as on the date of the trust deed and not at the discretion of the trustee. In the present case, the trust deed clearly specified the manner in which the income had to be distributed.
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• If the trust deed authorises addition of further contributors to the trust at different points in time in addition to the initial contributors, the same would not make the beneficiaries unknown or their shares indeterminate.”
The Ld CIT(A) noticed that the beneficiaries have independently offered to tax their respective share of income in the returns of income filed by them. Accordingly, the Ld CIT(A) held that the income of the assessee is exempt u/s 10(23FB) of the Act. The decision rendered by Ld CIT(A) in this regard is extracted below:-
“5.0 In the light of the above facts, especially considering the fact that the beneficiaries/investors have independently offered to tax their share of income received from the appellant, it is held that all the incomes of the appellant arising from the investment in the VCU, irrespective of the fact that the said VCU is subsequently amalgamated into a listed entity, are exempt under the provisions of Section 10(23FB) of the Act. Otherwise it amounts to double taxation both in the hands of appellant and the investors/beneficiaries. Further, denying the exemption under Section 10(23FB) merely on the ground of subsequent amalgamation, which is beyond the control of either the appellant or the beneficiaries, is not in the interest of equitable justice.”
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In view of the above decision, the Ld CIT(A) expressed the view that the issue relating to rejection of exemption u/s 10(38) of the Act is academic in nature. However, he expressed the view that the issue relating to exemption u/s 10(38) of the Act as well as taxability of interest income need to be examined in the hands of ultimate beneficiaries of the Act.
In the grounds of appeal, the revenue is contesting following issues:-
(a) The revenue is aggrieved by the decision of Ld CIT(A) in holding that the income of the assessee is exempt u/s 10(23FB) of the Act.
(b) The revenue is also contending that the assessee should not be allowed exemption u/s 10(38) of the Act.
(c) With regard to the interest income receivable from Innovative B2B logistic Solutions Ltd, the revenue is contending that the same should be assessed on accrual basis in the hands of the assessee.
In the cross objection, the assessee is contesting making following pleas:-
(a) The Ld CIT(A) should have held that the shares sold by the assessee are long term capital assets in terms of Explanation 1(i)(c) to section 2(42A) read with Section 47(vii) of the Act.
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(b) The Ld CIT(A) should have adjudicated the issue relating to denial of exemption u/s 10(38) of the Act.
(c) The Ld CIT(A) should have adjudicated the issue relating to assessment of notional interest on the loan given to Innovative B2B logistic solutions P Ltd.
(d) The Ld CIT(A) has exceeded his jurisdiction in observing that the taxability of capital gains and interest income need to be examined in the hands of beneficiaries.
We heard the parties and perused the record. From the record, we notice that the primary claim of the assessee is exemption u/s 10(23FB) of the Act, as per which any income of a venture capital company or venture capital fund from investment in a venture capital undertaking is exempt. The expressions “venture capital fund” and “venture capital undertaking” are defined as under in the Explanation give below sec.10(23FB):-
(b) “venture capital fund” means a fund:-
(A) operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908), which—
(I) has been granted a certificate of registration, before the 21st day of May 2012, as a Venture Capital Fund and is regulated under the Venture Capital Funds Regulations; or
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(II) has been granted a certificate of registration as Venture Capital Fund as sub-category of Category I Alternative Investment Fund under the Alternative Investment Funds Regulations and which fulfills the following conditions, namely:-…..
(c) “venture capital undertaking” means—
(i) a venture capital undertaking as defined in clause (n) of regulation 2 of Venture Capital Funds Regulations; or
(ii) a venture capital undertaking as defined in clause (aa) of sub regulation (1) of regulation 2 of the Alternative Investment Funds regulations.
There is no dispute with regard to the fact that the assessee is a Venture capital fund and is regulated by the Venture Capital Funds Regulations. The Ld CIT(A) has extracted the submissions made by the assessee on Venture Capital Funds regulations as under:-
“4.10 To appreciate the issue it is relevant to appreciate the provisions of Section 10(23FB) of the Act. As per the provisions of Section 10(23FB) of the Act, the exemption is available to the income of the VCF from investment in a VCU if the following two conditions are satisfied:
a. The fund is a venture capital company or a VCF; and
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b. The income is from investment made in a venture capital undertaking (VCU),
4.11 The Clause (b) of the Explanation to section 10(23FB) of the Act defines venture capital Fund' as below (relevant extracts only):
"(b) "venture capital fund" means a fund -
(A) operating under a trust deed registered under the provisions of the Registration Act, 1908 (16 of 1908), which -
(I) has been granted a certificate of registration, before the 21 day of May, 2012, as a Venture Capital Appellant and is regulated by the Venture Capital Fund Regulations, or......
(II) ………….
………………
4.12 Thus, from the provisions of the above section, the fund needs to comply with three conditions in order to qualify as a VCF within the meaning of clause (b) of Explanation to section 10(23FB) of the Act:
a. The fund is operating under a trust deed registered under the provisions of the Registration Act, 1908;
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b, A certificate of registration should be granted to the fund by the Securities and Exchange Board of India (SEBI) before May 21, 2012, and
c. The fund should be regulated under the VCF Regulations.
4.13 As per the agreed facts, the True North Fund lIlA, formerly known as India Value Fund lIlA (the Appellant), is a trust within the meaning of the Indian Trusts Act, 1882, and is registered under the Registration Act, 1908. Thus it is clear that the Appellant is registered as a venture capital fund (VCF) under the Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 (VCF Regulations). These facts have not been disputed by the AO.
4.14 The VCF Regulations govern inter-alia the category of investors from whom the funds can be raised, minimum investment in a VCU, modes of investment and reporting obligations. In this regard, it is submitted by the appellant that it had made its investments in compliance with Regulation 12 of the VCF Regulations. The Appellant has also made various filings with SEBI as per the VCF Regulations from time to time. Thus, the Appellant qualifies as a VCF within
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the meaning of clause (b) of Explanation to section 10(23FB) of the Act.
4.15 Considering the submissions of the appellant, it is relevant to understand the meaning of the phrase “Investment in a venture capital undertaking”
As per Regulation 2(n) of the VCF Regulations, a venture capital undertaking (VCU) means -
"(n) "venture capital undertaking" means a domestic company -
(i) whose shares are not listed on a recognized stock exchange in India,
(ii') which is engaged in the business of providing services, production or manufacture of article or things,' or does not include such activities, or sectors which are specified in the negative list by the Board with the approval of the Central Government by notification in the Official Gazzette in this behalf"
Also, the third schedule to the VCF Regulations lays down the list of items in the negative list, The activities specified in the negative list are
i. *
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ii. Non-banking financial services [excluding those Non- Banking Financial Companies which are registered with the Reserve Bank of India and have been categorised as Equipment Leasing or f-I/re Purchase Companies].
iii Gold financing **[excluding those Companies which are engaged in gold financing for jewellery].
iv Activities not permitted under industrial policy of Government of India.
v Any other activity which may be specified by SEBI in consultation with the Government of India from time to time,]
As per Regulation 12 of VCF Regulations -
'12. All investment made or to be made by a venture capital fund shall be subject to the following conditions, namely:-
a) venture capital fund shall disclose the investment strategy at the time of application for registration;
b) venture capital fund shall not invest more than 25% corpus of the fund in one venture capital undertaking,
2(ba) venture capital fund may invest in securities of foreign companies subject to such conditions or
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guidelines that may be stipulated or issued by the Reserve Bank of India and the Board from time to time,]
c) shall not invest in the associated companies; and
d) venture capital fund shall make Investment 3[* * *1 as enumerated below.'
(i) at least [66.67%] of the investible funds shall be Invested in unlisted equity shares or equity linked instruments '[of venture capital undertaking]
(ii) Not more than [33.33%] of the investible funds may be Invested by way of :
a) subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed [***],.
b) debt or debt instrument of a venture capital undertaking in which the venture capital Appellant has already made an investment by way of equity.]
c) preferential allotment of equity shares of a listed company subject to lock in period of one year;
d) the equity shares or equity linked instruments of a financially weak company or a sick industrial company whose shares are listed.
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Explanation 1.—For the purpose of these regulations, a "financially weak company" means a company, which has at the end of the previous financial year accumulated losses, which has resulted in erosion of more than 50% but less than 100% of its net worth as at the beginning of the previous financial year
e) Special Purpose Vehicles which are created by a venture capital fund for the purpose of facilitating or promoting investment in accordance with these Regulations.
Explanation.-The investment conditions and restrictions stipulated in clause (d) of regulation 12 shall be achieved by the venture capital fund by the end of its life cycle,]
f) venture capital fund shall disclose the duration of life cycle of the fund,]"
On a perusal of the above said Venture Capital Regulations, we notice that there is merit in the contentions of the assessee that the condition prescribed to the effect that the shares of venture capital undertaking should not have been listed in a recognized stock exchange shall apply only at the time of making investment. This contention is further fortified, if we look at limits prescribed for making investment in a venture capital undertaking under Regulation 12. As per the said regulation,
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(a) at least 66.67% of investible funds shall be invested in unlisted equity shares and
(b) not more than 33.33% of the investible funds may be invested by way of
(i) subscription to initial public offer of a venture capital undertaking whose shares are proposed to be listed;
(ii) debt or debt instruments….;
(iii) preferential allotment of equity shares of a listed company subject to lock in period of one year;
(iv) the equity shares or equity linked instruments of a financially weak company or a sick industrial company whose shares are listed
While clause (a) prescribes a limit of 66.67% for investing in unlisted shares, the clause (b) prescribes a limit of 33.33% for investing in shares which are going to be listed. Thus clause (b) visualizes listing of shares in future, meaning thereby, the subsequent listing of shares should not be a bar for availing exemption u/s 10(23FB) of the Act. It can be noticed that the VCF Regulations prescribes conditions to be followed at the time of making investments only. Thus, there is merit in the contentions of the assessee that the VCF Regulations do not prohibit cases where the initial investments made in unlisted shares of Venture Capital
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undertaking becomes listed shares due to corporate actions. Such kind of corporate actions are usually undertaken on commercial expediency, business exigencies and for the future welfare of the company. The assessee has also made following submissions before Ld CIT(A) on the allegation of violation of Venture Capital Fund Regulations:-
“4.20 The AO has not granted the exemption under section 10(23FB) of the Act, on the basis that the Appellant has sold the shares of a listed company, not being a VCF. In this regard, the Appellant further submitted that:
'The nature of venture capital is such that the investment in a VCU is made at an early stage. At a later stage, the divestment is made when the VCU is able to stand on its own feet. Very often, successful VCUs get listed on the stock market and the divestment happens through sale of shares in the stock market. While the VCF Regulations ordinarily envisage that the companies in which investments are made should be unlisted companies as of the date of the /investment they do not prohibit cases where such investments become listed investments through corporate action. They neither prohibit an unlisted VCU from listing its shares, nor do they prohibit an unlisted VCU from merging into a listed company.
Where an unlisted investment made by a VCF in a VCU becomes a listed investment for any reason, nothing in the
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VCF Regulations suggest that there has been a violation of the regulation; nor do the regulations prohibit the VCF from continuing to hold such listed shares.
The very fact that VCF Regulations envisage investment by way of subscription to initial public offer of a VCU whose shares are proposed to be listed [refer Regulation 12(d)(ii)(a) of VCF Regulations, as provided above] as well as investment by way of preferential allotment of equity shares of a listed company [refer Regulation 12(d)(ii)(c) of VCF Regulations, as provided above], it is clear that investment in a listed company is not prohibited.
Further, as per the erstwhile VCF Regulations, a VCF which seeks to avail benefits under the relevant provisions of the Income-tax Act, 1961 applicable to a VCF, was required to disinvest from such investments within a period of one year from the date on which the shares of the VCU are listed in a recognized Stock Exchange. This restrictive condition on VCFs was removed from the VCF Regulations with effect from 30th December, 2000.
The very fact that the investment by a VCF in listed shares which earlier had to be exited within a period of one year from the date on which the shares of the VCU are listed in a recognized stock exchange, is now omitted, it is evident that a VCF can continue holding its investment in equity shares of a listed company. Considering the fact that the
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above restrictive condition has been deleted, it is clear that a VCF is free to sell its listed investments at any time and the same does not impact the tax benefits it seeks to avail under the Act.
Based on the above, the appellant pleaded that on plain reading of the VCF Regulations, it is clear that sale of shares of a listed company is not prohibited by VCF Regulations, to claim exemption on the initial investment made in the unlisted shares of a VCU."
Hence, we are of the view that there is merit in the submission of the assessee that it is eligible for exemption u/s 10(23FB) of the Act. We have noticed earlier that the Ld CIT(A) has taken the view that the exemption u/s 10(23FB) is available for the capital gains accrued to the assessee up to the date of amalgamation and the balance amount of capital gains may be considered as taxable. The relevant discussion of Ld CIT(A) finds place in paragraph 4.24 of his order, which was extracted earlier. There is fallacy in the decision so rendered by Ld CIT(A). The income from Capital gains is not a “period cost/income” like interest income. Only period cost/income are amenable for split up on the basis of time period. Capital gains arises only on sale of shares and hence, the question of splitting up the same on the basis of time period cannot be made. Accordingly, we are unable to agree with the said decision of Ld CIT(A). Once it is held that the assessee qualifies for exemption u/s 10(23FB) of the Act, its entire income should be granted exemption and accordingly, the question of splitting up does not arise. Accordingly, we modify
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the order passed by Ld CIT(A) in paragraph 4.24 of the order and hold that the assessee is entitled for exemption u/s 10(23FB) of the Act.
We noticed that the assessee has taken a ground before Ld CIT(A) that the assessee is only a contributory trust and hence the income earned by it is taxable in the hands of beneficiaries in accordance with the provisions of sec. 61 r.w.s. 63 of the Act. The assessee has also furnished the list of beneficiaries and accordingly it has submitted that it is a determinative trust. It was also submitted before Ld CIT(A) that the beneficiaries have offered their share of capital gains in the returns of income filed by them. The Ld CIT(A) was convinced with these contentions of the assessee. Accordingly, he has held that the exemption u/s 10(23FB) should be granted to the assessee as it is only a “pass through entity”. The relevant observations made by Ld CIT(A) are extracted below:-
4.34 However, even if one seeks to go by the intention of the legislature in case of Section 10(23FB) the intention of the legislature was to extend the exemption to the entire income of a VCF which is set up to raise funds for investment in VCUs as is evident from the Finance Ministers Speech (243 ITR 46 Statutes) (page 24 & 25 of paper book) in the Lok Sabha, dated May 3,2000 while moving the Finance Bill 2000-01 for consideration of the House, which states as under:
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"Venture Capital Fund shall enjoy a complete pass through status. There will be no tax on distributed or undistributed income of such funds. The income distributed by the funds will only be taxed in the hands of investors at the rates applicable to the nature of income".
4.35 In light of the above, it is clear that the intention of the legislature is to treat the entire income of VCFs as exempt from tax under section 10(23FB) irrespective of its nature, and instead tax the same in the hands of its investors at the time of distribution under section 115U on a pass through basis, else it would amount to double taxation once in the hands of VCF and then again in the hands of the investor.
4.36 The subsequent amendment of Section 10(23FB) by Finance Bill 2007 is effective from 1.4.2008 restricting the exemption available u/s 10(23FB) to only income of venture capital fund from an investment in venture capital undertaking.
4.37 The taxation of domestic Venture Capital Funds (VCFs) and Alternative Investment Funds (AlEs) has undergone various changes over the years Currently, VCFs1 and Category 1/ 11 AIFs2 have been granted tax pass through status under
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the Income-tax Act, 1961 (the Act) in relation to specified income Such income is directly chargeable to tax in the hands of the beneficiaries/ investors.
4.38 In the above cases, it is critical that the Fund (set-up as a trust) qualifies as a determinate trust, so that tax levied in the hands of the trustee is in the like manner and to the same extent as it would be leviable upon the beneficiaries. In case where the Fund is treated as indeterminate trust', it could get taxed under section 164(1) of the Act, which provides for taxation at maximum marginal rate under certain circumstances.
4.39 Explanation 1 to section 164 of the Act provides that for a trust to be determinate, (I) the beneficiaries should be expressly stated and identifiable as on the date of the trust deed; and (ii) their individual shares should be expressly stated and ascertainable as on the date of the trust deed.
4.40 In this connection, it may be noted that the Authority for Advance Ruling held that if the trust deed sets out expressly the manner in which the beneficiaries are to be ascertained and also the share to which each of them would be entitled without ambiguity, then it cannot be said that the trust is indeterminate.
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4.41 However, the Central Board of Direct Taxes issued Circular No. 13/2014, dated 28 July, 2014, wherein it had stated that in a situation where the trust deed either does not name the investors or does not specify their beneficial interest, the provisions of section 164(1) of the Act would apply and the entire income should be chargeable to tax at maximum marginal rate in the hands of the trustee in their representative capacity.
4.42 Similar questions arose for consideration before the Authority for Advance Ruling in the case of XYZ, In Re 224 ITR 473 (AAR).
XYZ., In Re 224 ITR 473 (AAR): The Authority for Advance Ruling (AAR) held that if the trust deed sets out expressly the manner in which the beneficiaries are to be ascertained and also the share to which each of them would be entitled without ambiguity, then it cannot be said that the Trust deed does not name the beneficiaries or that their shares are indeterminate, The persons as well as the shares must be capable of being definitely pin-pointed and ascertained on the date of the trust deed itself without leaving these http://www.itatonline.org ITA No,178/Bang/2012 Page 41 of 76 to be decided upon at a future date by a person other than the author either at his
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discretion or in a manner not envisaged in the trust deed, Even if the Trust deed authorises addition of further contributors to the trust at different points of time in addition to initial contributors, than the same would not make the beneficiaries unknown or their share indeterminate. Even if the scheme of computation of income of beneficiaries is complicated, it is not possible to say that the share income of the beneficiaries cannot be determined or known from the trust deed.
4.43 In a recent decision, the Karnataka High Court in the case of the Trust (India Advantage Fund-VII in ITA No. 191/2015 dated 20-02-2017), upheld the decision of the Bangalore Income-tax Appellate Tribunal in ITA No 178/2012 AY 2008-09 and held that for a trust to be a determinate trust, it would be sufficient trust deed laid down that the beneficiaries would be the persons who had made or had agreed to make, contributions to the trust in accordance with the contribution agreement, and their shares were capable of being determined based on the provisions of the trust deed. The issue before the Karnataka High Court was: Whether the Tribunal was right in holding the Trust as a determinate trust and not assessing the Trust at
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the maximum marginal rate as per section 164(1) of the Act?
High Court's ruling: The High Court upheld the decision of the Tribunal on the following principles:
* All that is necessary is that the beneficiaries should be identifiable based on the provisions of the trust deed, and it was not necessary that the beneficiaries should be specifically named in the trust deed. In the present case, the trust deed clearly laid down that beneficiaries meant the persons, each of whom had made or agreed to make, contributions to the trust in accordance with the contribution agreement.
• It is not necessary that the trust deed should actually prescribe the percentage share of the beneficiaries in order for the trust to be determinate. It is enough that the share of the beneficiaries is capable of being determined based on the provision/ formula as on the date of the trust deed and not at the discretion of the trustee. In the present case, the trust deed clearly specified the manner in which the income had to be distributed.
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• If the trust deed authorises addition of further contributors to the trust at different points in time in addition to the initial contributors, the same would not make the beneficiaries unknown or their shares indeterminate.
5.0 In the light of the above facts, especially considering the fact that the beneficiaries/investors have independently offered to tax their share of income received from the appellant, it is held that all the incomes of the appellant arising from the investment in the VCU, irrespective of the fact that the said VCU is subsequently amalgamated into a listed entity, are exempt under the provisions of Section 10(23FB) of the Act. Otherwise it amounts to double taxation both in the hands of appellant and the investors/beneficiaries. Further, denying the exemption under Section 10(23FB) merely on the ground of subsequent amalgamation, which is beyond the control of either the appellant or the beneficiaries, is not in the interest of equitable justice.”
The assessee has claimed that it is a contributory trust (revocable trust) and hence the income was taxable in the hands of contributors of funds (called as ‘beneficiaries’ here) in terms of sec. 61 to 63 of the Act. We notice that the Ld CIT(A) has appreciated above said contentions of the assessee and accordingly held that,
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since the beneficiaries have offered their respective share of income in their hands, the assessee should not be taxed again. Accordingly, he has held that the assessee should be allowed exemption u/s 10(23FB) of the Act. Though the provisions of sec.61 to 63 and the provisions of sec.10(23FB) operate in different manner, yet the conclusion is that the assessee should not subjected to tax to capital gains and interest income. We also notice that the beneficiaries have offered their respective share of income in their hands, meaning thereby, the assessee also seeks to avail the benefits of sec. 61 to 63 of the Act. The assessee has also submitted that it is a pass through entity, meaning that the income from investments is taxable in the hands of beneficiaries.
It is pertinent to note that the revenue has not challenged the observations of Ld CIT(A) in holding that the assessee cannot be assessed to tax the very same income which has been offered by the beneficiaries in their respective hands. This observation of Ld CIT(A) were, apparently, based on the fact that the assessee is a revocable trust and alternatively it is a pass through entity.
Since we have held in the preceding paragraphs, that the assessee cannot be subjected to tax for capital gains, there was no necessity to examine the question of applicability of provisions of sec.10(38) of the Act to the capital gains earned by the assessee on sale of shares.
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The next issue relates to the assessment of “accrued interest” on the loan given to Innovative B2B logistic solutions Ltd computed by the AO notionally. It is pertinent to note that the assessing officer has allowed exemption of interest income earned by the assessee on the loans given to other Venture Capital Undertakings. He did not allow exemption for interest income computed by him on the loan given to Innovative B2B logistic solutions Ltd on the following reasoning:-
“The assessee has claimed exemption u/s 10(23FB) of the Act on Rs.4,87,72,436/- being the interest from VCUs which has been allowed as this amount has been taxed in the hands of the investors. Similarly, notional interest is also to be taxed either in the hands of the assessee or the investors. The Assessing Officer do not have jurisdiction over the investors and therefore, it has been brought to tax in the hands of the assessee.”
The reasoning given by the AO, in our view, is not in accordance with the law. The loan transactions are governed by the terms and conditions entered between the parties. The assessee has stated in its annual report that there was dispute between the parties with regard to the interpretation of terms and conditions and accordingly it has stated that interest income was not recognized. The AO did not accept the above said reasoning and accordingly proceeded to compute notional interest. However, in our view, the AO is not entitled to give different treatment to the notional interest so computed by him, i.e., he has to give very same treatment that was
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given to the interest income earned from loans given to other Venture Capital Undertakings. The AO has allowed exemption to the interest income earned from other VCU, in which case, the notional interest income computed by him should also enjoy very same exemption. We order accordingly.
The foregoing discussions adjudicates all the grounds urged by the revenue and grounds 1 to 4 urged by the assessee it its cross objection. In ground no.5, the assessee has contended that the Ld CIT(A) has exceeded his jurisdiction by making observation that income from capital gains out of investment in shares and interest income from Venture Capital Undertakings earned by the assessee need to be examined in the hands of ultimate beneficiaries. We notice that the Ld CIT(A) has not given any directions and has only made observations, impliedly in support of his decision that the above said incomes are not taxable in the hands of the assessee. Hence, we are of the view that there is no requirement of interfering with the above said observations made by Ld CIT(A).
In the result, the appeal of the revenue is dismissed and the cross objection of the assessee is treated as allowed.
Order pronounced in the Open Court on 29th January, 2019.
Sd/- Sd/- (Beena Pillai) (B.R Baskaran) Judicial Member Accountant Member Bangalore, Dated, 29th January, 2019. / vms /
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Copy to: 1. The Applicant 2. The Respondent 3. The CIT 4. The CIT(A) 5. The DR, ITAT, Bangalore. 6. Guard file By order
Asst. Registrar, ITAT, Bangalore.
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Date of Dictation ………………………………………
Date on which the typed draft is placed before the dictating Member ……………………. 3. Date on which the approved draft comes to Sr.P.S .……………………………. 4. Date on which the fair order is placed before the dictating Member ……………….. 5. Date on which the fair order comes back to the Sr. P.S. ………………….. 6. Date of uploading the order on website…………………………….. 7. If not uploaded, furnish the reason for doing so ………………………….. 8. Date on which the file goes to the Bench Clerk ………………….. Dictation note enclosed 9. Date on which order goes for Xerox & endorsement…………………………………… 10. Date on which the file goes to the Head Clerk ……………………. 11. The date on which the file goes to the Assistant Registrar for signature on the order ………………………………. 12. The date on which the file goes to dispatch section for dispatch of the Tribunal Order …………………………. 13. Date of Despatch of Order. ……………………………………………..
Dictation note enclosed …………………………………………