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Investigation Manual

Techniques of Investigation for Assessment, Volume - 3 Chapter

Heading

1

Multinational Corporations

2

Information Technology

3

E-commerce

4

Chain stores & retail franchising

5

Newspaper and journals

6

Printing & publishing

7

Motion picture industry

8

TV channels

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Cable TV operators

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Entertainment industry

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Advertisement Expert group constituted by CBDT Acknowledgments ©Directortate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter - I

MULTINATIONAL CORPORATIONS 1. During the last decade of the twentieth century, especially after the liberalisation of economy, there has been substantial growth in the business operations of multinational companies in India. Upto the end of eighties the operations of multinationals in India were limited to supply of plant and machinery, technical know how and operations through FERA companies in which multinationals held majority stakes or

through joint ventures with Indian partners. However, recent years have witnessed the trend towards shift of full scale manufacturing, distribution and assembly functions to India through fully owned subsidiaries of multinationals.

Cross border activities 2.1 International - Import and export of goods and merchandise is the most traditional international activity of a corporation. Goods are produced in the domestic market and then exported to foreign buyers. Apart from goods some transfer of know-how may also be done to earn profits from foreign markets where direct operations may not possible due to local regulations. 2.2 Multinational - As international business expands, there is a tendency for a corporation to reach closer to the consumer, and the cheaper sources of inputs. It needs to produce abroad as well as sell abroad in order to profit from cheaper inputs and cheap labour in some cases. When the domestic corporation expands its operations across borders, incorporating its business activities in other countries, it is classified as a multinational. While still maintaining a domestic identity and a central office in a particular country, the multinational corporation now aims to maximise profits on a world-wide basis. The corporation is so large and extended that it may be outside the control of a single government. Besides subsidiaries, a multinational corporation may have joint ventures with individual companies, either in its home country or foreign countries. 2.3 Transnational - As the multinational corporation expands its branches, affiliates, subsidiaries, and network of suppliers, customers, distributors, marketers, and all others that fall under the firm's umbrella of activities, the once traditional "home country" becomes less and less well defined. Such corporations are termed as 'transnational corporations‟. Examples of such corporations are Unilever, Philips, Ford, Sony, Schlumberger, Royal Dutch Shell and Asea Brown Boveri which are intricate networks with home offices defined differently for products, processes, capitalisation and even taxation.

Tax avoidance 3.1 The primary purpose of multinationals like any other business organisation is maximisation of profit. As such they often resort to avoidance or evasion of tax through various devices. They also, like resident companies, exploit various loopholes in law and resort to methods which may be similar to those resorted by domestic companies. However, some of these methods are peculiar to scale of operations carried out by the multinational companies. The stage of operations in the host country and the rate of tax in the home and the host country also play a role in the tax planning of multinationals. While it is difficult to give a comprehensive list of devises resorted to by multinationals, some of the commonly adopted methods are discussed below. 3.2 Multinationals carrying business without a permanent establishment : Under tax laws of many countries business profits of non-resident companies are not taxable in the absence of a business connection or a permanent establishment. To take advantage of this provision multinational corporations, especially those which are only exporting goods or know how etc., tend to do so without maintaining a permanent establishment. However, after a stage they can not avoid appointing a local agent or opening a local branch. In such cases it is not possible to tax their profits unless the agent is a dependent agent or there is permanent establishment whose activities are not restricted to auxiliary and preliminary activities. Multinationals, often exploit these provisions and carry out business operations but claim that there is no dependent agent or a permanent establishment in India. They may also claim that there is no „business connection‟ and hence the incomes which fall under the category of "business profits" are not taxable in India. In some cases all activities ranging from advertisement, negotiation of contract and conclusion of contract, except the actual signing of contract and payment are done by the branch in India and still it is claimed that the activities of the branch are limited to preliminary or auxiliary activities. In such cases the facts and circumstances need to be carefully examined by making suitable enquiries to see if the agent is rendering such services on a regular basis and can be held to be a dependent agent. In the case of a branch, the role played by the branch in negotiation and conclusion of contract also needs to be examined. The multinational companies, sometimes enter into contract to provide plant and machinery along with erection and commissioning services. A composite contract is made for the whole deal. However, at the time of remittance of payment it is claimed that as no permanent establishment was maintained in India the business profits are not taxable in India. In such cases the Assessing Officer

should examine the contract carefully and "unbundle" the component which would fall under 'fees for technical services' or 'royalty'. It is only the profit from sale of plant and machinery which would fall under the head business profit. The payments for erection and commissioning services would fall under the head fees for technical services on which tax would need to be deducted at source under Section 115 of the Act or at the rate prescribed in the relevant DTA Agreement. 3.3 Multinationals carrying operation through a branch - Multinationals often use the vehicle of a branch in the initial phases of their manufacturing operations in a foreign country. This is especially so in cases in which losses are expected to arise in the initial years of operations as such losses can be set off against the income of the parent company in the host country. In such cases the Assessing Officer should examine if any inflation of expenses, especially head office expenses has been resorted to. 3.4 Operations through a locally incorporated publicly held or wholly owned subsidiary - Once the business of multinational in the host country expands beyond a certain level the usual practice is to float a company with majority share holding or a fully owned subsidiary. Transfer pricing (which is dealt with separately) is a device which is used most often by such companies to reduce their tax liability by shifting taxable profits to associate concerns in low tax jurisdictions.

Other devices 4.1 Other methods utilised by multinationals and their expatriate employees are as under : 4.2 Failure to file return - Deliberate failure of resident aliens to file tax return in the country in which they are residing is quite common, because it is easy for persons who spend a portion of each year in a different jurisdiction to frequently make inconsistent claims of residence. 4.3 Failure to report all income subject to tax - Another important practice in this category is the willful or negligent failure to report all items of international income which are subject to tax. The items more often omitted are salaries, wages, and noncommercial incomes, like interest and dividends, income form real estate and royalties. 4.4 Fictitious deductions - In a variety of circumstances fictitious business expenses may be claimed as deductions particularly if the purported recipient of the expense payment is outside the taxing jurisdiction and is therefore not subject to scrutiny by tax authorities of that jurisdiction. For example, if the tax payer purchases goods outside the taxing jurisdiction, false invoices may be prepared to show a purchase price greater than that actually paid by the tax payer. In many cases, commissions, royalties, technical service fees and similar expenses will be paid by a resident of the taxing jurisdiction to a related nonresident and claimed as deduction, even though the related nonresident has done nothing to earn such fees. 4.5 Suppression of business Income - Taxes on business income are frequently reduced by omitting to keep accurate books and records within the taxing jurisdiction. Generally, a second set of books of accounts, which is accurate is maintained outside that taxing jurisdiction, but those records are normally beyond the reach of the authority of that jurisdiction. In respect of incomes to which the rule of territoriality often applies, some of the devices most frequently employed to shift profits properly allocable to the source country, include   

the establishment of artificial transfer prices for imports and exports; the improper allocation of profits and losses; and licensing agreements under which the user of technology is obliged to purchase imported inputs, equipment and spare-parts.

Such devices, which transnational corporations are particularly well situated to use, are of great concern to the host country. It may also be advantageous purely for tax purposes for a company of a particular country to conduct operations with partners in another country to create a relay in the form of a company established in a third country where taxes are low. 4.6 Credit for fictitious tax - A tax payer residing in one country and receiving international income from another country may seek to reduce tax in the first country, which allows a foreign tax credit as a method of reducing double taxation, by claiming fictitious or excessive credits for taxes allegedly paid to the other country. 4.7 Improper characterization of income or expense items - Tax is also reduced by improperly characterizing an income or expense item in order to make use of an exemption or a reduced rate of tax. 4.8 Inconsistent characterizations - A tax payer may characterize a particular transaction in one way in country A, and in a contrary way in country B, in order to obtain tax benefits in each country. For example,

advances by a parent in country A to a subsidiary in country B may be treated as equity in country A - in order to avoid the necessity for reporting interest income to country A, but as debt in country B - in order to avoid a capital stock taxes in country B. Payments made by a subsidiary in country A to its parent in country B may be treated as the purchase price of goods in country A, but as royalties or dividends in the country B. 4.9 Flight to evade payment of tax - Where the taxing jurisdiction determines that a resident alien has taxable income or assesses tax against him, the individual may flee the jurisdiction to escape tax. 4.10 Fake bank loans - Another technique for international tax evasion may consist of purportedly borrowing funds which are actually owned by the borrower. This not only enables the borrower to make open use of funds previously concealed in the name of a nominee or in a numbered bank account, but also gives him a pretext for claiming fictitious interest deductions. For example, a resident of country „A‟ who has deposited unreported income in a numbered bank account in country „B‟ may arrange to „borrow‟ an equivalent amount from the bank at say 12% interest. If the bank is paying 10% interest to him on his numbered account, he will actually be out of pocket only to the extent of 2% but in the return which he filed in country A, he will treat the receipt of the unreported income as a „loan‟ and will claim a deduction for the entire 12% interest charge which he pays to the numbered bank account in country „B‟ and may arrange to have the bank in country B forward funds to an unrelated bank in country C from which he will borrow an equivalent amount. Similarly use of dummies, nominees, numbered bank accounts, and bearer securities are some other means to diversify income or to introduce investments. 4.11 Use of related tax haven entities to reduce taxes - Associate enterprises incorporated in tax havens are also used by multinationals for their tax planning. The following situations are worth considering 

  

A commonly used method is to transfer income-producing assets at an artificially low cost from the taxing jurisdiction to a controlled entity in a foreign tax-haven country where the potential income from the assets will be subject to tax at a lower rate, or escape tax entirely. These assets may be stocks, securities, rental properties and intangibles such as licensed patents, trade marks and copy rights which will generate continuing passive investments income, or property or any kind which will be resold by the tax haven entity to an unrelated third party at a gain. Nominal transfer of income-producing functions to a tax haven entity that may be only a shell corporation which is incapable of performing the services unless it uses personnel and / or property of the controlling entity. Payment of deductible expenses to a tax-haven entity. Payment of deductible expenses which benefit a tax haven entity.

Transfer Pricing 5.1 The expression 'transfer pricing‟ relates to transactions in goods and services between related enterprises. The prices charged between related parties in relation to goods, services, tangibles, and loans are broadly considered in transfer pricing issues. The transfer pricing process determines the amount of income that each party earns. Taxpayers and the tax authorities focus exclusively on related party transactions, which are termed controlled transactions, and have no direct impact on independent transactions, which may be called uncontrolled transactions. 5.2 The arm‟s length principle - The evolution of the concept of transfer pricing has led to the development of arm‟s length principle. An arm‟s length price is a price that would be charged for the same goods or services between two parties dealing on independent basis. The principle governs the evaluation of transfer pricing in case of transactions between related parties. The application of the principle is generally based on a comparison of the conditions in a controlled transaction between related parties, with the corresponding conditions in transactions between unrelated parties. The Principle is laid down on the basis of adjusting profits with reference to the conditions, which would have existed between independent parties under comparable circumstances. It covers cases of under invoicing or over invoicing of goods and services regardless of whether any resulting shortfall in the tax revenue is due to deliberate tax avoidance or merely due to adoption of incorrect pricing method for taxation purposes. The

application of arm‟s length principle requires that enterprises be treated as operating as separate and independent entity. The tax laws permits adjustment in pricing in accordance with the principles of arm‟s length, considering the price to be charged by independent enterprises. Many countries of the world, notably USA, Canada, UK, Germany, France, the Netherlands and countries in Asia Pacific Region like Australia, Japan, Korea and China have laid down in their respective Income tax legislation specific provisions dealing with transfer pricing. 5.3 Methods of application of arm‟s length principle - There are a varieties of ways to determine whether the arm's length principle is followed in transactions between related parties. The guidelines issued by the Organization for Economic Cooperation and Development (OECD) contain a description of specific methods which are followed by several countries in transfer pricing regulations. Some countries do not prescribe any specific method though they agree with the principles of OECD guidelines. Some of the commonly used methods are discussed below: 5.3.1 Comparable uncontrolled price method (CUP) - The CUP method compares the price charged in a controlled transaction to the price charged in a comparable uncontrolled transaction in comparable circumstances. This method is most direct and reliable way to apply the arm‟s length principle. In practice it is difficult to apply the CUP method as it is unusual for multinationals to have the details about comparable transactions. Therefore, the OECD report suggests that multinationals and tax authorities should take a more adaptable approach, possibly working with data prepared for CUP purposes, supplemented by other appropriate methods. 5.3.2 Resale price method (RPM) - Under Resale price method, the arm‟s length price of goods purchased from a related party is determined by deducting an arm‟s length gross profit from the resale price of goods resold to an unrelated party. The method is ordinarily used in cases involving the purchase from a related party and resale to an unrelated party of property in which the reseller has not added substantial value to the goods. 5.3.3 Cost plus method (CPM) - The Cost plus method is generally applied when the manufacturer is a contract manufacturer or when determining the arm‟s length charge for services. Under this method the arm‟s length price is determined by adding an appropriate mark up to the cost of production. The appropriate mark up is the percentage earned by the manufacturer on unrelated party sales which are similar to inter company transactions. 5.3.4 Profit split method - Under this method the net income form transactions is allocated to the respective entities based on the value of their contributions to the net profit. 5.3.5 Transactional profit method - The TPM method deals with the profits that arise from particular transactions. The profits in this case maybe assessed in different ways- in relations to total sales, operating expenses incurred or assets. 5.3.6 Other methods - The OECD guidelines also permit the use of other methods when none of the above methods yield satisfactory results and accurate information isn't available to estimate the arm‟s length price. In such a case any other method maybe adopted provided they result in conclusions consistent with the arm‟s length principle.

The Indian scenario 6.1 The concept of arm‟s length principle is also recognized in our tax laws. The principle is incorporated in the term “fair market value” as defined in Section 2(22B) and Section 40A(2)(b) of the Act. The arm‟s length principle is also followed in determining ordinary profits under old Section 92 of the Act and forms the basis of provisions incorporated under Section 9(1) (i) of the Act dealing with “business connection”, Section 80IA dealing with close connection and Section 2(22)(e) dealing with deemed dividend. 6.2 Income from Transactions with Non-resident (Old Section 92) - The transactions with related parties are at times coined solely with a view to obtaining tax advantage. The courts all over the world have consistently condemned transactions having no commercial justification and recognized the right of tax authorities to tax the reasonable profits accruing from such transactions. 6.3 The arm‟s length principle is also recognized in Section 92 of the Income Tax Act as existing prior to its amendment by Finance Act, 2001. The Section dealt with income derived from transactions with nonresidents. The Section gives power to an Assessing Officer to determine profits accruing to a Resident, which may reasonably be taken as to have been derived from business with non-resident, if it is found that the transactions between the parties have been so arranged that owing to close connection between them the transactions produce to the Resident either no profit or less than ordinary profits. The following conditions must be satisfied before an AO can invoke the provisions of this Section -

    

The business is carried on between a resident and a non-resident. A close connection exists between the parties. As a result of arrangement between the parties, the resident earns either no profits or less than ordinary profits. The Assessing Officer shall determine the amount of profits which may reasonably deemed to be derived therefrom, and The profits so determined shall be included in the total income of the resident.

6.4 Section 92 (corresponding to Section 42(2) of IT Act, 1922) empowers the Revenue to charge the resident assessee in respect of profits which on dictates of ordinary commercial principles & expediency should have resulted from transactions with nonresident irrespective of whether or not the resident made the profit. There is thus the concept of deemed or notional profit embedded in the provision. What is required to be established on record is “business transaction” between the resident assessee and a nonresident who have a “close connection”. 6.5 In order to invoke the provisions of this Section it is essential that business is carried on between a resident and non-resident. Normally, as defined in Section 2(13) of the Act, business includes any trade, commerce or manufacture or any adventure in the nature of trade. The essential pre-requisite is that business must be carried on between a resident and non-resident which normally implies regular course of activities. It cannot be applied to isolated transactions like export of machinery as capital contribution to a foreign company. (CIT Vs. Kusum Products Ltd. (1993) 71 Taxman 611, 615-16(Cal). 6.6 The Assessing Officer has been given powers to determine the amount of profit, which may reasonably be deemed to have been derived from such business and to include such amount in the total income of the resident. It is also to be noted that it is only the income of the resident , which is affected. So far as the income of the non-resident is concerned, the same will have to be determined with reference to Section 9 and Sections 160/161 of the Act. 6.7 In one case two nonresident companies in the business of playing ships entered into an arrangement with their Indian subsidiary engaged in the business of repairing ships. Under the arrangement the resident Indian company recovered only the cost without charging any profit from repairs of ships it did for the non-resident associates. Supreme Court in that case [ MAZAGAON DOCK LTD V CIT.(1958) 34 ITR 368 (S.C.)] held that the dealings between parties formed concerted and organized activities of a business character and the non-resident companies carried on business in association with the resident company. The provisions of section 42(2) [ now Section 92] were accordingly held as rightly invoked. The apex court, rejecting all contentions of the assessee, held that profits, if any foregone, must be taxed separately. According to the court the fact that the dealings were such as to yield no profit to the nonresident was immaterial. 6.8 Under the old law, Rules 10 & 11 of I.T. Rules 1962, prescribed following alternative modes of calculation of arm‟s length profits   

The percentage of turnover so accruing or arising as A.O may consider reasonable; The amount which bears the same proportion to the total profits & gains of business as receipts so accruing or arising bear to the total receipts of the business; or Any other manner the AO may consider suitable.

Since the law did not define the term “Close connection” & determination of profit were based on definitive ground of reasonableness, the job of AO was difficult as he had to collect the requisite material for applying the provisions of Section 92 of the Act. 6.9 It does not call for an extensive reasoning to persuade one to appreciate that old Section 92 basically tries to deal with the practice of “parking profits” in an off shore tax haven. It is also apparent that the provision aims at reconstructing profits rather than income or expenditure. It is also doubtful as to how the scheme can tackle transactions involving supply/acquisition of property with or without transfer of services.

6.10 In view of the above discussion above tax authorities need information to evaluate relationship as also to ascertain respective tax liabilities of parties involved when trans-border transactions/relationship are involved. Artificial/Engineered transfer pricing between related parties as a mode of parking profits where incidence of tax is lower/lowest has been made subject matter of scrutiny in assessment vide Sections 40A(2) & 80IA of the IT Act, 1961. 6.11 Section 40A(2) stipulates that any expenditure incurred on extra commercial considerations can be denied deduction as admissible revenue expenditure of business. An „associated enterprise‟ for purpose of Section 40A(2) is determined with reference to the assessee in whose case the disallowance is to be made. An enterprise may be an individual or an artificial entity like a company, a partnership firm, an Association of persons or a Trust. One enterprise may be deemed to be associated with another not only if it has members or relatives in common but also if it has a substantial (business) interest in the other. „Relative‟ in relation to an individual is defined [Sec.2(41)] to mean the spouse, brother, sister or any lineal descendant /ascendant of the assessee individual. 6.12 It may be noted that in fixation of arm‟s length prices profits the provisions of old Section 92 conspicuously omit factors like, volume of business, after sale or associated services, considerations of capacity utilization, compulsions of maintaining confidentiality, credit terms, dictates of competitive prices & market forces etc. Therefore, it becomes a theoretical exercise to compare circumstances under which unrelated parties transact vis-a-vis that of related parties. Further, the law did not specifically lay down any specific documents to be provided by a taxpayer, and therefore, the AO could consider only calling general information in respect of transfer pricing cases.

Case Studies 7.1 In a case of MNC, it was found that the company had suppressed export profits and had shown loss on export sales of Rs. 1,87,50,394/-. The exports sales were contracted in Indian Rupees as against the normal practice of such sales in convertible foreign exchange. The materials exported were components required in manufacture of escalators, which cannot be sold indiscriminately. Scrutiny revealed that the assessee company had „close connection‟ with an overseas company, and the foreign company held shares in Indian company. There was also no apparant reason for resident company to negotiate the contract at a lesser price than what was fair and reasonable. As the losses claimed in the transactions were not found to be genuine the Assessing Officer determined profits applying Section 92 of the Incometax Act. The benefit of Section 80 HHC was also denied as the sale proceeds had not been received in convertible foreign exchange in India. 7.2 In another case of a pharmaceutical company it was found that the company was importing certain drug formulations from Germany, from a company with which it had close business connection. The management of the German company had control and interest in the Indian company and as such cross border transactions were with a related party. It was also found that German company had not been charging arm‟s length price for the supply of raw material as the prices were much higher than the prevailing international price. The resident company was buying similar goods from Korea at much cheaper rates. This showed that inflated price was paid to German Company because of close connection between parties. The AO invoked the provisions of Section 92 of the Act and redetermined profits after applying the arm‟s length principle. 7.3 The issue of applicablility of Section 92 was also considered in another case of an Indian company which was a subsidiary of a US based multinational company. The company was dealing in medical equipments. It was found that the commission received by Indian company from foreign based multinational was not based on arm‟s length principle. Further the gross profit on the goods purchased from the parent was approximately 50% less than the gross profit on goods purchased from third parties. The AO held that it was the case of transfer pricing and accordingly made additions u/s 92 of the Act.

Transfer Pricing - New Provisions in Section 92 to 92F 8.1 The Finance Act, 2001, introduced a new set of provisions relating to transfer pricing by amending existing Section 92 and incorporating Sections 92 to 92 F in the Act. The amended provisions are st effective from 1 April, 2002 and accordingly apply from AY 2002-2003 onwards. These provision are exhaustive in many respects and generally in line with international practices prescribing methodologies, documentation requirements and penalties. 8.2 The object of introducing the new provisions is explained in the Memorandum to the Finance Bill 2001 as under -

“The increasing participation of multinational groups in economic activities in the country has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same multinational group. The profits derived by such enterprises carrying on business in India can be controlled by the multinational group, by manipulating the prices charged and paid in such intra-group transactions, thereby, leading to erosion of tax revenues. With a view to provide a statutory framework which can lead to computation of reasonable, fair and equitable profits and tax in India, in case of such multinationals enterprises, new provisions are proposed to be introduced in the Income-tax Act. These provisions relate to computation of income from international transactions having regard to the arm‟s length price, meaning of „associated enterprises‟, meaning of „international transaction‟, determination of arm‟s length price, keeping and maintaining of information and documents by persons entering into international transactions, furnishing of a report from an accountant by persons entering into such transactions and definitions of certain expressions occuring in the said sections”. 8.3.1 Transfer pricing transaction - The amended Section 92 provides that any income arising from international transaction shall be computed having regard to arm‟s length price. It further provides that cost or expenses allocated or apportioned between two or more associated enterprises shall be at arm‟s length price. The provisions would apply to all transactions between members of a MNC group including supplies of material, components, finished products, payments for intangible viz. Intellectual property, royalties, interest and loans and payments for technical assistance and know-how. 8.3.2 Arm‟s length principle - The transfer pricing regulations, of almost all countries of world recognise the arm‟s length principle. This principle is also incorporated in the proposed Section 92(2) of the Income Tax Act. The arm‟s length principle suggests that two „Associated Enterprises‟ (AEs) should be treated as independent enterprises and all transactions would be considered at the market price. The arm‟s length principle is also incorporated in Article 9 of the UN/OECD Model Conventions. The said Article provides that transactions between Associated Enterprises should be evaluated as if they are independent of each other and, if it is found that owing to special conditions between two countries, prices are not comparable with those of the independent enterprises, then suitable adjustments be made for the price differentials. The principle is also recognised in Double Taxation Avoidance Agreements (DTA) that India has signed so far with other countries. 8.3.3 Associated Enterprise (AE) - Section 92 A contains the definition of „Associated Enterprises‟ which is quite elaborate and wider in scope than that prevails in conventions not only of OECD/UN but also of many other developed and developing nations. The basic criteria to determine „associated enterprises‟ are management, control and/or capital. In addition to these criteria some other criteria are also prescribed in the Section to determine AE‟s such as           

Holding of 26% voting power; Advancing of loans of not less than 51% of the total assets of the borrowing company; Guarantees for not less than 10% on behalf of the borrower; Appointment of more than 50% of the Board of directors or members of the governing board. Dependence on the enterprise possessing exclusive rights for manufacturing / processing of goods or articles by using know-how, patents etc; Dependence up to 90% or more for raw materials and consumables on another enterprise; Influence on prices for goods or articles manufactured or processed; One individual (or his relative jointly or separately) controlling two different enterprises; One Hindu Undivided Family (HUF) (or relative of member of HUF – either jointly or separately) controlling two different enterprises; Firm/AOP/BOI holding not less than 10% interest in the other firm/AOP/BOI; Any other relationship of mutual interest to be prescribed.

The amended law provides that „associated enterprise‟ will come into existence if any of the above criteria is met with at any time during the previous year. 8.4 Methods for determining arm‟s length price - The regulations prescribe the application of an arm‟s length test in all transactions relating to transfer pricing. A number of methods may be used to determine arm‟s length price, in particular      

The comparable uncontrolled price (CUP) method; The cost plus method; The resale-price method; The profit-split method; The transactional net margin (TNM) method; and The comparable profits (CP) method.

Section 92 C recognises only the first five method for determining arm‟s length prices in international transactions. Apart from this, the CBDT has reserved its right to prescribe additional methods. 8.4.1 Most appropriate method - The law provides that the arm‟s length price shall be determined by following most appropriate method, having regard to the nature of transactions or class of transactions or a class of „associated persons‟ or functions performed by such persons or such other relevant factors as may be prescribed in this behalf. 8.4.2 Transfer Pricing Adjustment (TPA) - Section 92 C provides that the Assessing Officer may determine the arm‟s length price in relation to any „international transaction‟ under the following circumstances : (a) When the price charged or paid in an international transaction is not in accordance with provisions of the Act; or (b) Any information an/or document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in the Act or the rules made thereunder; or (c) The information or date used in computation of the arm‟s length price is not reliable or correct; or (d) The assessee had failed to furnish, within the specified time, any information or document which he was required to furnish by an notice issued under he Act However, the provisions lay down that Assessing Officer must give an opportunity to the tax payer by serving a notice calling upon him to show cause, why the arm‟s length price should not be so determined on the basis of material or information or document in his possession. 8.4.3 It is further provided that in cases where the total income of the tax payer is enhanced after the transfer pricing adjustments, deduction under Section 10A (in respect of industrial undertaking in free trade zones) or Section 10B (in respect of newly established hundred percent export oriented undertakings) or under Chapter VI A (Business and other deductions) shall not be allowed in respect of such enhanced income. 8.5 Documentation - Section 92D provides that every person who has entered into an international transaction shall keep and maintain such information and documents as may be specified by rules made by the Board. The Board may also specify by rules the period for which the information and documents are required to be retained. It is also laid down that during the course of any proceedings under the Act, an Assessing Officer or Commissioner (Appeals) may require any person who has undertaken an „international transaction‟ to furnish any of the information and documents specified under the rules within a period of thirty days from the date of receipt of a notice issued in this regard. The period may be extended by a further period not exceeding thirty days. 8.6 Penalties - The transfer pricing provisions also give authorities power to levy penalty to curb tax avoidance by abuse of legislation. The approach in this regard is similar to Section 271(1) of the Income Tax Act. The concepts of „good faith‟ and „due diligence‟ have been incorporated in the legislation. Therefore, no penalty would be levied if the tax payer is able to prove to the satisfaction of the Assessing Officer or the Commissioner (Appeals) that the price charged or paid was computed in accordance with the provisions contained in Section 92C in good faith and with due diligence.

8.6.1 The penalties prescribed in this regard are as under (1) In a transfer pricing case, if the assessee is unable to prove good faith and due diligence in arm‟s length price, a penalty upto 300% of the amount of tax sought to be evaded may be levied. Explanation 7 to Section 271(1), also lays down that the amount added or disallowed in computing income under Section 92C(4) shall be deemed to represent income in respect of which particulars have been concealed. (2) Where the assessee has failed to maintain the prescribed information or documents, the assessee may be liable for penalty @ 2% of the value of each „international transaction‟. (3) Where the assessee fails to furnish information or document as required by the Assessing Officer, penalty @ 2% of the value of the „International transaction‟ may be levied for each such failure. (4) Where the assessee fails to furnish a report from an accountant penalty of Rs.1,00,000/- may be levied. 8.7 Audit requirements - The regulations also contain provisions relating to audit requirement in respect of „international transactions‟. Section 92 E provides that every person who has entered into an international transaction during a previous year shall obtain a report from an accountant and furnish the same with tax authorities. The Auditor‟s report on transfer pricing transactions must be submitted on or st st before the 31 October of the relevant assessment year in case of a company and on before 31 July in case of other tax payers. 8.8 Rules governing taxation of transfer pricing cases - The Central Board of Direct taxes vide its st notification S.O.808(E) dated – 21 August, 2001 have notified detailed rules in regard to transfer pricing provisions covered by section 92 to 92 F of the Income Tax Act. 8.8.1 Rule-10 A - This Rule provides definitions of various expressions used in computation of arms length prices. The terms defined are    

Uncontrolled transaction Property Services Transaction

8.8.2 Rule-10B - This Rule concerns the methods of determination of arms length price under Section 92 C of the Act. It also provides the manner in which arms length price will be determined under each prescribed method. The Rule further lays down the comparability factors with reference to which an international transaction shall be judged with an uncontrolled transaction. The Assessing Officer must keep in mind the following aspects while examining a transfer pricing case.   

The specific characteristics of the property transferred or services provided. The functions performed and risks assumed by the respective parties The contractual terms between the respective parties.

Conditions prevailing in the markets in which the parties operate. 8.8.3 Rule-10 C - The Rule provides the manner of selection of most appropriate method for determination of arm‟s length price in relation to the international transaction. 8.8.4 Rule-10D - The Rule lays down the nature of information & documents to be kept and maintained under Section 92D. The prescribed documents need not be maintained in case the value of „international transaction‟ does not exceed one crore rupees.

8.8.5 Rule-10 E - The Rule prescribes the form of report to be furnished under Section 92E of the Act. It may be worthwhile to state that with the notification of rules a lot of clarity and certainty has been brought in transfer pricing regulation. However, as these are new provisions the AO will have to refer the case studies available under tax laws of other countries where similar provisions exist. 8.9 Guidelines for applying arms length principle - As already stated, the new provisions relating to transfer pricing lay down that the income arising from „international transactions‟ between „associated enterprises‟ shall be computed having regard to arm‟s length price. 8.9.1 While the primary responsibility of determining and applying an arm‟s length price is on the assessees, Section 92C(3) empowers the AO to determine the arm‟s length price and compute total income accordingly. Rule 10B (2) lays down the comparability factors of an „international transaction‟ which should be considered while examining a transfer pricing case. 8.9.2 The following aspects should be borne in mind in applying arm‟s length principle.      

Comparability analysis Characteristics of property or services Functional analysis (taking into account the assets used and the risks assumed) Contractual terms Economic circumstances Business strategies

8.10 Selection of most appropriate pricing method - The law provides that most appropriate method shall be the method which is best suited to the facts and circumstances of each transaction and which provides the most reliable measure of arm‟s length price. Organisation for Economic Cooperation and Development (OECD) recommends following approach for selecting appropriate pricing method. 8.10.1 Selection criteria - The following factors may be considered in this regard :    

Extent of comparability between controlled and uncontrolled transaction Quality and reliability of data Complexity of transaction Number, magnitude and accuracy of adjustments

8.10.2 Besides, in making comparability analysis the AO is advised to consider following other factors apart from the one prescribed in rules.     

Geographic markets Size of transactions Market share strategy Start up Alternative available to buyer and seller

8.10.3 Methodology - The Assessing Officer may consider following steps in determining arm‟s length price under various methods prescribed in the regulations. 8.10.4 CUP method - Under Comparable Uncontrolled Price (CUP) method, price charged for property or services transferred in a controlled transaction is compared to price charged in a comparable uncontrolled transaction. The sources of data in these situations are Internal CUP  External CUP -

Internal company data.

   

Company price list Web site Trade direction Govt. Publications

The steps involved in determining the arm‟s length price under the CUP method are  

Identify price charged or paid in a comparable uncontrolled transaction; Adjust such price to account for material differences which would affect the price in open market;

The following factors may be taken into consideration for making adjustments - Quality of product - Contract terms - Level of market - Geographic market - Intangibles associated with sales - Alternative available to buyer and seller

-

The

adjusted

price

is

take

as

the

arm‟s

length

price.

8.10.5 Resale price method (RPM) - This method begins with the resale price of the product sold to an independent enterprise from which resale margin is reduced to arrive at arm‟s length price. The steps involved in applying this method are    

Identify price at which goods, articles or things are ultimately resold to an unrelated enterprise. Deduct reasonable expenses & normal profit margin Adjust resultant price for material differences, if any, in the transactions being compared The adjusted price thus arrived at is taken to be arm‟s length price in respect of purchase of goods, articles or things by the assessee from the associated enterprise.

The analysis of international transaction under Resale price method may be considered in the following manner     

Comparability under this method is dependent on the similarity of functions performed, risks borne and contractual terms The amount of resale margin will be influenced by the level of activities performed by the reseller. Inventory level of goods Contractual terms Level of market

8.10.6 Cost plus method (CPM) - This method begins with the cost incurred by the supplier of property or services in a controlled transaction. An appropriate mark up is then added to this cost, in the light of functions performed and market conditions. The price arrived at after adding the cost plus mark up to

these costs may be regarded as an arm‟s length price of controlled transactions. The steps involved in applying this method are     

Determine the cost in respect of goods, articles, or things or intangible property transferred to the associated enterprise. Determine the normal profit margin arising from the transfer of similar property or services by the assesses or by an unrelated enterprise. Adjust the normal profit for material differences, if any, between the transactions being compared and the enterprises entering into such transactions. Costs are increased by the normal profit margin or adjusted profit margin as the case may be. The price so arrived at is the arm‟s length price in relation to supply of the property or services.

8.10.7 Profit split method - Under this method, the arm‟s length price is determined through a division of the consolidated profits of the „associated enterprises‟. The commonly applied methods in this regard are contribution analysis and residual analysis. The method is applicable in cases involving multiple transactions which are so interrelated that they cannot be evaluated separately. The steps involved in applying this method are    

Determine combined profits of the associated enterprises. Evaluate relative contributions of each enterprise towards earning of profits based on functions performed, assets employed and risks assumed. Split combined profits in proportion to relative economic contributions. The profit thus apportioned is taken into account to arrive at the arm‟s length price.

8.10.8 Transactional net margin method (TNMM) - The transactional net margin method examines the net profit margin that a tax payer realises from a transaction with an associated enterprise. The net margin is calculated with reference to appropriate base say costs, sales and assets etc. The net margin of the tax payer from the controlled transaction is determined by reference to the margins earned in comparable uncontrolled transactions for establishing arm‟s length price. The comparability of the transaction under this method are judged with reference to following    

Specific characteristics of the property or services Functions performed Contractual terms Market conditions

The main limitation of this method is that comparable data of net profit margin is not easily available for analysing transactions. The steps involved in applying this method are    

Compute net profit margin of associated enterprise transactions. Compute net profit margin of comparable uncontrolled transactions. Adjust latter net profit margin for material differences which can affect net profit margin in open market. The net profit established is taken into account to arrive at the arm‟s length price.

Exchange control implications to transfer pricing 9.1 To ensure that there is no under-invoicing of merchandise exports, an exporter needs to file a declaration before the Customs Department showing the full export value of the goods and receive the

foreign exchange corresponding to such value into India. Customs authorities certify the value declared by the exporter. Similarly, to guard against over-invoicing on imports, the Reserve Bank of India has directed authorized dealers to exercise due precautions while releasing foreign exchange for importers. The Assessing Officers need to look into these aspects before deciding issues relating to transfer pricing.

Implications under the Companies Act 10.1 Under the provisions of the Companies Act, 1956, the financial statements of a company are required to give a true and fair view of the state of affairs of the company. The auditors are also required to opine in their report on whether or not the accounts portray a true and fair view of the state of affairs of the company. As related party transactions could have a significant bearing on the financial position of a company, it would be worthwhile to study the auditor‟s report and comments made in the Balance-sheet in regard to cross-border transactions. At present the statutory auditors of public companies also are required to include in their report an opinion on whether related party transactions are at arm‟s length. For this purpose, auditors generally apply broad level tests to determine whether the transactions are at arm‟s length. As and when transfer-pricing legislation in India matures, the auditors would be in a position to take a close look at transfer pricing issues.

Recent developments 11.1 Accounting Standard for related party transactions - Recently Institute of Chartered Accountant of India, have issued a Draft of proposed Accounting Standard on related party disclosures. The Exposure draft requires a disclosure of related relationships and transactions (including pricing policies) necessary for an understanding of the effects of related party transactions on the financial statements. It is pertinent to state here that currently the Auditors are required to comment on the arm‟s length pricing in transactions with only specific related parties, i.e. the parties in which either directors are interested or are under the same management. The proposed Accounting Standard however has a broader definition of „related parties‟ and will, therefore, require a specific disclosure of transactions which are currently not being commented upon. Secondly, the disclosures would tend to alert any Assessing Officer to examine whether or not the disclosed related party transactions are at arm‟s length. 11.2 Segment reporting - The ICAI has also announced an Accounting Standard on Segment reporting, st effective accounting periods commencing on or after 1 April, 2001 which requires corporates to furnish detailed information on each business segment, including country wise breakup with the Balance sheet. This would provide ready-to-appreciate data in respect of various activities carried on by an entity. This would facilitate analysis of transfer pricing both by the taxpayer and tax collector.

Transactions resulting in transfer of income to Nonresident 12.1 Under the Indian Income Tax Act, a Resident is taxed on world income basis irrespective of the place of accrual, whereas a non resident is chargeable in respect of income received / accrued / arose or deemed, under explicit provisions of the Act, to have been received or have accrued or arisen within India. 12.2 At times, an Indian taxpayer may transfer ownership over an asset located abroad in favour of a nonresident while contriving to secure benefits to himself or his own men, relations, dependents and the like . To discourage such schemes aimed at reducing a resident assessee‟s tax liability, Section 93 has been enacted to provide that the income arising to the non resident in consequence of such transfer of assets shall be deemed to be income in respect of which transferor is liable to Indian taxation. the enactment is almost on the lines of Sections 60 to 64 of the IT Act. 12.3 The provision conforms to the basic principles of taxation in India that a transfer of asset to evade taxes or deferred revenue is ab initio void. Only that income is subject matter of Section 93 which arises

to a nonresident from a transfer of assets either alone or in conjunction with “associated operation” [defined in Section 93(4)(b)]. The essential requirement for application of the fiction is that the Resident must have “power to enjoy” the income arising, on account of the transfer, to the non resident. It is not necessary that the transfer must be by the resident assessee [MCt.M CHIDAMBARAM CHETTIAR V CIT, (1996) 60 ITR 28 (SC)]. Strictly speaking, Section 93 although providing for adjustment of income in the hands of the Indian party to a transaction between a resident & a non resident, does not require artificial determination of any price/ value as such. 12.4 The following ingredients must exist for invoking the provisions of Section 93 of the Act     

There must be a transfer of assets : by reason of that transfer, income traceable to the said assets becomes payable to a person who is a nonresident : the resident by means of the transfer alone or in conjunction with associated operations, acquires a right to enjoy such income : the income from the said assets, if it were the income of the resident would have been chargeable to income-tax : and in that event, the income of the nonresident would be deemed to be the income of the resident for all the purposes of the Act.

Treatment of Head Office expenses 13.1 Section 44 C of the Act lays down the provisions for determining the Head Office expenses which are allowed as a deduction in computing the income of a nonresident in India. The term 'head office expenses' is defined to include following expenses:    

Rent, rates, taxes, repairs or insurance of an premises outside India used for the purpose of business or profession. Salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or profits in lieu of or in addition to salary, whether paid or allowed to any employee or other person employed in, or managing the affairs of, any office outside India, Traveling by any employee or other person employed in, or managing the affairs of, any office outside India, and Such other matters connected with executive and general administration as may be prescribed.

13.2 The head office expenses attributable to the business or profession of the assessee in India, are allowable as expenditure subject to a ceiling of 5% of the adjusted total income. For the purpose of this Section 'adjusted total income' means income computed prior to making deduction under Sections 32 (2), 43A, 33, 33A, 36 (1) [ first proviso] or chapter VI-A and without making adjustment for the brought forward losses. If the adjusted total income of the assessee is a loss, the deduction under this Section is determined on the basis of the average of adjusted total income of the preceding three assessment years. If the income is not assessed for three years then adjusted income for the preceding two or preceding one year as the case may be is taken into account.

Applicability of Double Taxation Avoidance Agreements to MNCs 14.1 As is obvious from its name a Double Taxation Avoidance Agreement (DTAA) is entered into by two countries to avoid income of their residents having operations in both the countries, getting taxed twice, first in the country of residence and then in country of source. These agreements are therefore very important in the cases of multinationals. Although the primary objective of DTAAs is avoidance of double taxation, their provisions are sometimes misused by multinationals to avoid taxation in the country where

income generating activity or asset is situated and sometimes both in the country of source as well in the country of residence. 14.2 Tax treaties of most countries are based on either the OECD model or the United Nations Model (UN model) for Agreement on avoidance of double taxation and prevention of fiscal evasion. Under the OECD model the taxation rights are usually assigned to the country of residence of the taxpayer. Under the UN model the taxation rights are given to the country of source of income though concessional rates are prescribed for various types of income subject to fulfillment of certain conditions. Our treaties, especially with the developed countries are based on the UN model. 14.3 The following are some of the common issues arising in assessments relating to cases of multinational corporations 14.3.1 Permanent Establishment - Permanent Establishment is one of the most important concepts relating to taxation of business income of an enterprise of a country from operations in another country. Permanent Establishment postulates the existence of a substantial element of an enduring or permanent nature of a foreign enterprise in another country, which can be attributed to a fixed place of business in that country. It should be of such a nature that it would amount to a virtual projection of the foreign enterprise of one country into the soil of another country. [CIT vs. Vishakhapatnam Port Trust (1983), 144 ITR 146 (AP) ] The phrase “place of business” used in the definition refers to the localization of a business activity by reference to a physical space or object. The business activity is not restricted to a place of business. It is sufficient that it is carried on "through" the place of business. The business may be carried by the employees in the State in which the fixed place of business is situated. Thus, it is clear that concept is broader than a single focal point or headquarters from the fact that an enterprise may maintain several permanent establishment in the same state. 14.3.2 In some of tax treaties building site or construction or assembly project has been included in the definition of permanent establishment, provided the activities last more than the specified period viz, six or twelve months. Sometimes the "supervisory activities" or installation of assembly project is also covered in the definition of permanent establishment. All the issues need to be addressed in the context of the treaty, which has relevance in a particular case. In Vishakhapatnam Port Trust case 144 ITR, 146 the Court after examining European and Indian authorities, concluded that an engineer's activities did not constitute a permanent establishment under the general construction project category of the applicable tax convention. 14.3.3 Following are some examples of a Permanent Establishment usually included in the DTA Agreements:           

A place of management A branch An office A factory A workshop A sales outlet A warehouse used for delivery of goods A mine an oil or gas well, a quarry or any other place of extraction of natural resources. An offshore oil rig in territorial waters A building site, construction, installation of a project which is carried on for a specified period (this period may be 6 months or 12 months depending on the Agreement) Business carried on through dependent agents even though the enterprise does not have a fixed place of business. An agent is called a Dependent Agent if he has the authority to conclude contracts on behalf of the enterprise and he exercises this authority regularly.

14.3.4 Most DTA agreements include a provision which specifies certain activities which do not constitute a Permanent Establishment even if they are carried out through a fixed place of business. These are :     

Use of facilities for mere storage or display of goods of the concern. Maintenance of a fixed place for mere storage and display of goods. Maintenance of a fixed place for purchase of goods or collecting information. Maintenance of a fixed place of business for the purpose of any preparatory or auxiliary activities. Maintenance of a stock of goods belonging to the enterprise solely for processing by another enterprise.

14.3.5 Although 'fixedness' of the place of a business is a prerequisite for determining whether a Permanent Establishment exists it does not exclude a case where a company changes its address during the period under consideration. Thus, a company which is running its business in the other State through a branch or office etc. but which shifts such office etc. to one or more places during the year will still constitute a Permanent Establishment. Further, it is not essential that the business at the fixed place of business must be carried on through some personnel of the company. For example a company carrying on its business through automatic vending machines in the other country will be held to be maintaining a fixed place of business, and therefore having a Permanent Establishment. Ownership of fixed place of business or the fact that the business is conducted through a public place are issues which do not have relevance in determining if a Permanent Establishment exists. Thus, a company which has a certain area earmarked to it on a permanent basis on a dockyard or Customs warehouse and which conducts its business through such area was held to own a Permanent Establishment. 14.3.6 In the opinion of the OECD Fiscal Committee, its twelve-month test applies to each individual site or project. Unless a particular project is totally unconnected with every other project in the host country, the time spent on one or more of those other projects may be aggregated with the time spent on the project in question. The criterion is not the number of contracts upon which the projects are based, but rather upon whether together they form a coherent whole commercially and geographically. 14.3.7 If an enterprise (general contractor) which has undertaken the performance of a comprehensive project, subcontracts part of such project to other enterprises (subcontractors), the period spent by a subcontractor working on the building site must be considered as time spent by the general contractor on the building project. The subcontractor himself has a Permanent Establishment at the site if his activities there last more than twelve months. 14.3.8 A dependent agent will constitute Permanent Establishment even though the definition in Article 5 (1) is not directly satisfied. By contrast an independent agent (including a broker, general commission agent or other agent of an independent status) will not result into a Permanent Establishment of an enterprise. Dependent agency is defined merely in terms of the 'regular' 'habitual, or unqualified exercise of contractual authority by an agent in the taxing State. 14.3.9 Even if the requisite contractual authority exists, no Permanent Establishment can exist if such authority is exercised by an independent agent acting in the ordinary course of his business; or the authority is limited to the type of preparatory or auxiliary activities which may be conducted through a fixed place of business without creating a Permanent Establishment; or the agent is only a purchasing agent. 14.3.10 In Tekniskill [Sendirian] Berhad vs CIT (222 ITR 551), the Authority for Advance Rulings (AAR) held that a Malaysian Company which supplied skilled workers to a Korean Company for enabling the latter to execute certain contracts awarded to it in the Indian territorial waters near Bombay by the Oil and Natural Gas Commission [ONGC] from September 1993, did not have a PE in India and was not, therefore, liable to tax in India in terms of India's tax treaty with Malaysia.

14.3.11 In another case reported in 224 ITR 473, the issue was whether a company incorporated in Mauritius which is beneficiary of a private investment trust can be charged to Income Tax in India if it does not have a PE of its own in India and a share in the income of the trust under the head 'Profits and gains from business or profession' is allocated to it under Section 161? The AAR held that in case of companies incorporated in Mauritius, there will be no Income-tax liability in view of Article 7 of India's DTAA with Mauritius. 14.3.12 Sometimes a question arises as to whether a project site office would constitute PE in terms of DTA Agreements. The issue was decided by Authority for Advance Ruling in P-13 of 1995 [228 ITR 487]. In this case the question before the Authority was whether the offices of the French company at project site will be treated as Permanent Establishment under Article 5 of the DTA Agreement from the first day of commencement of its business in India. Under the contract, the French company was required to maintain two offices in India which were also to be the places from which the execution of the contract was to be looked after and managed in India. The Authority held that in these circumstances it can be held that there is a Permanent Establishment in India from the day the offices are set up by the foreign company 14.3.13 AARP. No. 8 of 1995, 223 ITR 416, Switzerland - India - The applicant in this case was a Swiss company which wanted to set up a subsidiary company in India to provide consultancy services from India to it for use outside India. It entered into three agreements with the subsidiary for providing clerical and secretarial assistance, assistance in responding to tenders and for follow up of tenders and signing of contracts respectively. The issue for consideration was whether the transactions gave rise to a business connection in India entailing tax liability on the applicant in India on the deemed income accruing or arising in India within the meaning of Section 9 (1) (i) of the Income-tax Act. The Authority held that intimate and continuous relationship between the parent and the Indian subsidiary will constitute a business connection for the purpose of the Section 9 (1) (i) of the Act. It also held the nature of activities of subsidiary are also covered by Article 5 (2) (1) of the India Switzerland DTA Agreement. As the activities are to be carried on for a period exceeding 90 days the subsidiary company would be a permanent establishment of the Swiss company in India. The extent of income deemed to accrue or arise in India will however depend on the actual working of the applicant and the subsidiary company. 14.3.14 AAR NO. 296 OF 1996, TVM V. CIT, 192 TAXMAN 578 - The applicant in this case was a company called TVM which was incorporated in Mauritius which entered into a contract with an Indian company called TVI. The shareholders of both TVM and TVI were common although the directors were different. TVI was engaged in developing software program and TVM was involved in making and distribution of television programs. TVM was also engaged in sale of airtime on its channel to parties in India. TVI was also soliciting orders from purchasers of airtime in India and passing such orders to TVM for scrutiny and acceptance for which it was getting commission. The issue for consideration before AAR was whether the amount received by TVM for selling airtime was taxable in India. The AAR held that the consideration was not taxable in India, as there was no Permanent Establishment of TVM in India. 14.3.15 P. NO. 14 OF 1997, NETHERLANDS-INDIA, 100 TAXMAN 1 - Applicant in this case was a Dutch company having a project office in India. It was engaged in execution of dredging contracts in India. The company sought a ruling on the question whether provisions relating to the Minimum Alternative Tax on the basis of book profits under Section 115 JA would be applicable to it. The Authority held that since the assessee was being taxed in respect of the business profit, on the basis of returns filed and it has been claiming loss on account of depreciation on plant and machinery used for dredging, it was liable to pay tax on the business income as per the provisions of DTA Agreement between India and the Netherlands. 14.3.16 The above discussion shows the importance of the concept of Permanent Establishment in the cases of multinational corporations carrying on business in India. Again the advent of Internet and new applications of information technology has added a new dimension to the concept of Permanent Establishment. It is now possible to carry out business through a web site which can be stored in a computer in any part of the world and such web site can easily be shifted from one computer to another.

Whether such a web site or the computer on which such web site is stored would constitute a Permanent Establishment is a moot point which is subject of considerable debate at present. However for the time being no consensus has been reached on this subject. 14.4 Business Profits - In most DTA Agreements rules for taxation of business profits are included in Article 7. It is usually provided that business profits arising out of activities conducted through a Permanent Establishment will be computed under the ordinary commercial principles allowing legitimate business expenses as deductions. Under most of The Indian treaties the Head Office expenses of a Permanent Establishment are allowable as per the provisions of Section 44C of the Income tax Act. No deduction is allowable for any amounts paid (except for reimbursement of actual expenditure incurred) on account of royalties, fees for technical services, commission, management services or interest by the Permanent Establishment to the head office. However, in case of a Banking company interest paid to the parent company is allowable. 14.4.1 Most of the treaties also include "arm's length rule". According to this the transactions between a Permanent Establishment and the Parent company should be carried out in such a manner as would be the case if these were two separate and independent entities. If transactions are carried out in a manner which gives an artificial advantage to either of the entities then the Assessing Officer is authorized to carry out adjustment in the profits of the Permanent Establishment. Another rule popularly termed as "force of attraction rule" is also included in most of the Indian treaties with the developed countries. This rule provides that if a Permanent Establishment is maintained, profits of an enterprise of a country carried out in the other country from following activities would also be taxable in that other country:  

Sales in that other country of goods or merchandise of the same or similar kind as those sold through that Permanent Establishment, Other business activities carried on in that other State of the same or similar kind as those effected through the Permanent Establishment.

This provision is meant to counter any avoidance of taxation through surreptitious business deals carried out in the other country which are not included in the accounts of the Permanent Establishment. 14.4.2 The issue of taxability of business profits of multinationals has also come for consideration in case of companies engaged in the business of software, satellite services, hotels, e-commerce and solicitors services. On close scrutiny of the facts it was found that business profits attributable to permanent establishment were taxable in India as the companies were rendering services in India and maintaining permanent establishment. It is, therefore, necessary that AO examines all these issues carefully and records a proper finding on the basis of facts and circumstances of each case. 14.5 Interest - Most of the Indian treaties provide that interest arising in a contracting State and paid to a resident of the other State may be taxed in the country of residence of the taxpayer. It may also be taxed in the country of source under the domestic law of the country of source. However if certain condition prescribed in the treaty are fulfilled, tax in the country of source is charged at a concessional rate. One of these conditions prescribed in most of the treaties is that the recipient of interest should be the beneficial owner of interest. Most of the treaties also include the arm's length rule in the Article relating to taxation of interest. Thus, if the loan transaction on which interest accrues is between two Associated Enterprises then any unreasonable amount of interest charged can be denied the benefit of the concessional tax rate, and is taxed under the general rate applicable under the domestic law. 14.6 Dividend - Most tax treaties prescribe rules for taxation of dividend similar to those discussed above for interest income. Dividend can be taxed in both, the country of residence of the taxpayer as well as in the country of source. The latter allows concessional rate of tax subject to beneficial ownership of dividend and other conditions which may differ in different treaties.

14.7 Royalties and Fees for technical services - Royalties and Fees for technical services may be taxed both in the country of residence of the recipient as well as in the country of source of such payments. However, under most treaties the country of source limits the incidence of taxation on such payments to a concessional rate in cases where the recipient is the beneficial owner and is resident of the other contracting State. The term Royalty is usually defined to include payments for the use or the right to use of any copyright of a literary, artistic or scientific work or the use or the right to use industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific equipment. Cinematography films, audio or video tapes used for radio or television, patents, trademarks, designs or models, plans secret formulas or processes are certain items, payments for use or for right of use of which qualify as royalty payments. Fees for technical services is usually defined as payment for any managerial, technical or consultancy services. It however does not include payment to any employee, an individual or payments for independent personal services. Most treaties include the arm's length principle in the Article relating to taxation of royalties and fees for technical services. Thus, if the royalty or fees is paid by one associate enterprise to another associate enterprise and the payment exceeds the amount which would have been payable if the two enterprises were independent enterprises then the excess payment can be denied the concessional rate of taxation allowable under the treaty. 14.8 Capital gains - Under the provisions of Article 14 of the Indian treaties relating to Capital gains, gains derived from alienation of immovable property are taxable in the country where the immovable property is situated. If the gains are derived from alienation of movable property forming part of a Permanent Establishment, or from the alienation of a Permanent Establishment itself, such gains are taxable in the state where the Establishment is situated. Gains from sale of shares of a company are taxable in the country of which the company is a resident. However gains from sale of shares of a company the property of which consists directly or indirectly primarily of immovable property situated in a contracting State are taxable only in that State. Another exception is gains on sale of ships and aircraft operated in international profits. Gains from their sale are taxable only in the country of which the alienator is a resident. 14.9 Independent personal services - Income of an individual who is a resident in a State from performance of professional services in other contracting State is taxable only in the country of which the individual is a resident. However, such income may also be taxed in the country of source if following conditions are fulfilled:  

The professional has a fixed base regularly available to him in the other contracting State for the purpose of performing his activities. Total stay of the professional in that other State adds up to a period of 90 days or more in the relevant fiscal year. However, only such income which is attributable to that fixed base or derived from activities performed in that other State can be taxed in that State.

14.10 Exchange of information - All of our treaties include an Article relating to exchange of information. The Competent authorities of the contracting States are empowered to exchange such information as is necessary to carry out the provision of the DTA Agreement or of the domestic laws covered by the Agreement and for prevention of fraud or evasion of tax. This Article is of great importance and can be used by an Assessing Officer in cases where information about evasion tactics adopted by multinationals is required to be gathered from the country of which the enterprise is a resident. Joint Secretary (Foreign Tax Division) in the Central Board of Direct Taxes is the Competent Authority under our tax treaties. An Assessing Officer who wants to make use of this provision should prepare a self contained note about the case giving relevant details and listing out precise points on which information is required and send it to Joint Secretary, Foreign Tax Division in CBDT through the concerned Commissioner of Income tax for taking up the matter with the Competent Authority of the other State. The information received from the Competent Authority is to be treated as confidential and should be used by officers involved in assessment, collection, appellate or prosecution proceedings in the concerned case. 14.11 Non discrimination - All tax treaties include an article relating to non discrimination which provides that the nationals of one contracting State shall not be subjected to any taxation or requirement

connected therewith, which is more burdensome than the taxation and connected requirements to which nationals of the other State are subjected in similar circumstances. Apart from this Article, Section 90 of the Income tax Act also provides that if a case is covered by a DTA Agreement provisions of the Income tax shall apply to the extent they are beneficial to the assessee.

Methods of elimination of double taxation 15.1 When the same item of income is taxed twice i. e. once in the country of source and again in the country of residence of the taxpayer it results in double taxation which is removed under tax treaties by two methods: 15.2 Exemption method - Under this method the income from the State of source is treated as fully exempt in the country of residence. This is called full exemption method. There is another method under the head Exemption method which is called exemption with progression. Under this method the income from the country of source is considered as exempt but it is taken into account in the country of residence for the purpose of rates of tax to be imposed. 15.3 Credit method - Under the Credit method, the country of residence grants a credit of tax paid in the country of source against the tax chargeable under its own laws. However the credit is limited to that part of income tax which is attributable to the income taxable in the state of residence.

Foreign Exchange Management Act 16.1 Upto May 2000 all transactions of multinationals in India which involved foreign exchange were governed by Foreign Exchange Regulations Act (FERA). With effect from 1st June 2000 all such transactions are governed by a new Act called Foreign Exchange Management Act 2000, (FEMA). This is a simplified version of FERA. It does away with a number of controls and restrictions included in FERA. However the activities of multinationals in India continue to be subject matter of various restrictions under FEMA. A branch, office or agency in India which is owned or controlled by a resident outside India is considered as a “person resident in India”. Such an office, branch etc. can not make any remittance to or for the credit of any person resident outside India in any manner except with the general or specific permission of the Reserve Bank of India. FEMA has allowed a resident of India to carry out a number of current account transaction and even some capital account transactions subject to restrictions prescribed by the Reserve Bank of India (Sections 5 and 6). The RBI continues to regulate the establishment in India of a branch, office or other place of business by a person resident outside India. The Act also lays restrictions on acquisition or transfer of immovable property in India other than a lease not exceeding five years by a person resident outside India, and borrowings or lending in foreign exchange by a resident or a branch in India of a non resident .

Case studies on DTA agreements 17.1 Case of an American CRS company 17.1.1 M/s. G. International was a MNC company incorporated in United States of America. The company entered into Participating Carrier Agreement with various international and domestic airlines. As per the agreement, the company had to provide display of schedules and fares, building of connections, display of flight availability status and provision of booking capability. All this information was to be updated by the participating carrier or the foreign company through its own sources. The travel agents in India could get connected to the mainframe computer of the foreign company with the help of hardware and software of the foreign company. The hardware and software of the foreign company was provided to the travel agents by an Indian company, M/s. I.G. Enterprises Pvt. Ltd. The terms of agreement with M/s I.G. Enterprises Pvt. Ltd. also applied to M/s G. India Pvt. Ltd. As per the agreement the Indian company was to provide the marketing services exclusively for the foreign company in India and also the hardware and

software of the foreign company. The agreement also provided that on the request of the Indian company the connectivity to computers will be provided by the foreign company. The foreign company, due to its contract with SITA, used to request SITA to provide lease lines to the travel agents. Once that was provided, the Indian company used to get connectivity code from the international company, which was passed on to the travel agent. With the help of that code the travel agent could get connected to the mainframe computer of M/s G. International. When a customer requested for booking with an airline, the travel agent, with the help of certain commands, got the necessary information on his screen about the availability of seats made the fare calculation, prepared the itinerary, got the details of connecting flights and informed the status to the customer. After the customer gave the confirmation, the ticket was booked for him by the travel agent. 17.1.2 The Assessing Officer, after examining the facts of the case found that all the business activities were completed in India as the travel agent was based in India, the customer was in India, the ticket was issued in India and the hardware and software was placed in India. He was of the view that under the Double Taxation Avoidance Agreement between India and USA, the profit earned by M/s G. International is taxable in India under the head „Business Profit‟ as the foreign company can be said to have “permanent establishment” in India. He gave following reasons for holding that a “permanent establishment” exists in India : 



The income is earned through hardware and software installed in India which is owned by MNC. The computer hardware at the travel agent‟s desk becomes an extension of the mainframe when the booking is done. Both the hardware installed in India and the mainframe situated outside India are connected through lease lines. These lease lines are also provided by the MNC. The activities of M/s G. India Ltd. are devoted wholly and exclusively for the foreign company. They are also economically dependent on the said company. In the Balance Sheet of M/s G. India Ltd. there is no other receipt other than the receipts from M/s G. International. Their close business connection and the nature of dependent agent is clearly reflected in the agreement entered by M/s G. International and the Indian company. The main features of the Agreement are as under : o M/s G. India will act as a division or a subsidiary of the foreign company. o M/s G. International will appoint M/s Interglobe as sole and exclusive distributor of foreign company. o The foreign company will arrange for provision and operation of communications network services through M/s G. International‟s contractual relationships with SITA or other such network provider. o M/s G. International may impose a licence fee for any software product supplied to M/s Interglobe, whether that software product is for use by subscribers or otherwise. o M/s G. India shall be responsible for entering into contracts with subscribers who wish to use M/s G. International‟s CRS Services in the Market Region. o All computer hardware for use by subscribers in the Market Region shall be provided by M/s G. International at no cost to Indian company. o M/s G. International and, M/s Interglobe shall devise an adequate training program for the relevant employees of Interglobe engaged in the distribution of M/s G. International‟s CRS Services. o M/s G. International shall provide to Interglobe on regular basis all information needed in relation to marketing activities, product delivery, development and specification progress.

17.1.3 The Assessing Officer held that in view of above, Indian Company is nothing but a dependent agent permanent establishment of M/s G. International and therefore its income is taxable in India under Article 7 read with Article 5 of the Double Avoidance Agreement between India and USA. He also held that the Indian company was economically dependent on the foreign company as all the receipts of the Indian Company are from the foreign company. None of the travel agents can get access to the data till

the foreign company provides the code data. Further, the connectivity to the agent and installation of modem is as per instruction of the foreign company. The Assessing Officer also held that as there was close business connection between foreign company and the Indian company, the income of the foreign company was taxable in India. 17.1.4 Before the CIT (Appeals), the assessee argued that income of foreign company was not taxable for the following reasons:  

   



The company is incorporated in USA and its control and management is located wholly outside India. The company provides services to travel industry by utilising CRS system located in USA. It earns booking fees from various airlines when a travel agent books a ticket on any flight using CRS services. It had entered into an agreement Indian company which acts as a distributor of CRS in India. Further, the foreign company has no control over Indian company as it did not have any share holding or power to appoint a director in the Indian company. The relationship between the assessee and the Indian company is not that of an agency as neither party can bind the other in its relationship with a third party. The assessee had entered into independent agreements with various airlines for providing CRS services for which fees are received on per booking basis. The assessee has no PE in India as it was not carrying on operations from a fixed place of business in India. The company had not kept any substantial machinery in India and therefore, cannot be said to be having a PE in India. The major activity of processing and display of information took place outside India as the CRS, being the software, was located outside India. The company had only provided an access to the travel agents and thus cannot be said to be carrying on independent operations in India. The agreements with airlines were entered outside India and the fees were also received outside India.

17.1.5 The CIT (Appeals) after examining the facts and circumstances of the case held that the company was maintaining a permanent establishment in India, and was therefore liable to pay tax in India. He noted that the assessee had invested substantial money in computers access to which were given to the travel agents without receiving any charges. The property in these computers vested with the assessee. He also noted that the assessee was making display of information on these computers on a continuous basis by using these lines and therefore, there is a business connection in India. He also held that the relevant provisions of the DTAA between India and USA were applicable and income of the PE was to be assessed in India. He also held that Article 5 can not be construed to mean that there would be no permanent establishment unless the fixed place is owned by the assessee. The fixed place can be made available either free of rent or in lieu of some services received. There is no need of quid pro quo between the place on one hand and rent or services on the other. As the assessee company had a permanent establishment in India, it was liable to pay tax in India. 17.2 Case of a British company 17.2.1 M/s ABA was a company incorporated in the United Kingdom carrying on business of air transport service. As per Aircraft Rules of 1937, “Air transport service means a service for the transport by air persons, mails or any other thing, animate or inanimate for any kind of remuneration whatsoever, whether such service consists of a single flight or series of flights”. The company also rendered technical/ engineering / traffic handling services to the other airlines. This was a separate business activity undertaken by the company for which qualified engineers and technicians were employed. M/s ABA had a separate engineering set up in all the metropolitan cities. The engineers certified the air worthiness of the air crafts of certain other airlines also before their take off. As per the agreements between the airlines, the payment was made on per flight basis in US dollars and was cleared through IATA clearance

house for services rendered in India. The services rendered by the foreign company in India inter-alia were as under :     

Communications including dispatch and receipt of all messages in connection with services performed by the Handling Company using the carrier‟s originator code or double signature procedure. Ramp to flight deck communication. Fuelling and / or defuelling. Aircraft maintenance. Material handling including periodic inspection of the Carrier‟s spare parts and/ or spare power plant. It also covered provision of suitable accommodation for the carrier‟s spare parts and special equipment.

17.2.2 Article 8 of Double Taxation Avoidance Agreement between India and United Kingdom provides that profits derived from the operation of aircraft in international traffic by an enterprise of one of the Contracting States shall not be taxed in the other Contracting State. For the purpose of this Article, the term operation of aircraft shall include transportation by air of goods or persons or any other activity directly connected with such transportation. 17.2.3 According to the assessee, the income of foreign airline is not taxable in India as the services rendered were covered by Article 8 of DTAA between India and United Kingdom. As per this Article, income derived from operation of aircraft in international traffic is exempt from tax. The Article also covers the profits or income derived from any other activity directly connected with operation of air crafts. The assessee made following submissions in this regard:  



The exemption extends to income beyond ticketing and cargo receipts. The certification of air worthiness of aircraft's is an activity directly connected with air transportation. The provisions of Article 8 cover other classes of profits as well, which by reason of their nature or their close relationship with the profits directly, obtained from transport may also be placed in a single category. In this regard reliance was placed on the commentary of OECD Model Treaty. The activities referred to above are separate business activities to the extent they are rendered to other airlines. The receipt is on an hourly basis as per terms and conditions with other carriers depending upon the nature of services offered. It is not correct to say that receipts are in the nature of cost recoveries.

17.2.4 The Assessing Officer examined all the issues and held that profits arising from incidental activities were not exempt under Article 8 of the DTAA. According to him, these receipts were taxable in India for the following reasons:      

These services are separate business activities and are not covered under the category of „Air Transport Services‟. These services are rendered by M/s ABA to other airlines. The receipt from this service is not recovered by M/s ABA from the passengers and is not part of the face value of the ticket. The services rendered are incidental to air transport business of M/s ABA as far as its own flights are concerned. However, when these services are rendered to other airlines it cannot be said to be in the nature of air transport operation. The business of M/s ABA would not be effected if they do not render these services to other airlines. Its air services will continue as per normal course. As per OECD commentary, separate business activities are not covered under air transport operation.



These services are rendered by M/s ABA to other airlines by exploiting their manpower which is idle at the time when there is no flight, and as such cannot be termed as „air transport operation‟.

The Assessing Officer, held that M/s ABA is liable to pay tax in India as it is also deriving income through separate business activities, which do not come within the ambit of the term “ air transport operations”. 17.2.5 The C.I.T. (Appeals) held that the assessee was operating air craft in international traffic and also undertaking a number of other activities. There is a common management and finance in respect of all the activities. According to him, the whole of the profit of the enterprise was not exempt from tax by virtue of Article 8 of the DTAA. He also held that only such profits are taxable under Article 8 as are derived from the activities of air transport and not for other activities. He also held that the assessee company had a permanent establishment in India and therefore, was liable to tax in respect of business profits accruing to the “permanent establishment”. 17.3 Case of a Swedish company 17.3.1 The assessee was a company incorporated in Sweden and taxable entity of Sweden. It used to undertake projects on turnkey basis in telecommunications field covering following:    

Hardware supply. Software supply. Installation and commissioning. After sales services.

The company entered into agreements with various cellular operators for supply of hardware and software as well as installation and commissioning of equipments. The assessee claimed that its income is not taxable in India in view of provisions of DTAA with Sweden and Income Tax Act 1961. 17.3.2 On enquiry it was found that the assessee company had an associate company by the name of M/s ERTC India AB which had a branch in India. This company was incorporated in Sweden. The associate company entered into installation contracts with various cell operators. Subsequently, another company, M/s. ERC Pvt. Ltd. was formed in India as a 100% subsidiary of the Swedish company. The contracts entered into by M/s ERTC were later assigned to the Indian company. 17.3.3 The issue for consideration was whether the foreign company can be said to have a 'permanent establishment' in India in terms of DTAA between India and Sweden. The term “permanent establishment” means fixed place of business through which the business of the enterprise is wholly or partly carried on. It also includes other situations as covered in Article 5 of the Double Taxation Agreement between Indian and Sweden. 17.3.4 The Assessing Officer held that the foreign company is liable to pay tax in India under the provisions of Income Tax Act as well as the tax treaty between India and Sweden. He noted that before the contract was signed in India, a number of employees of the assessee company and other associate companies visited India to do net work survey and negotiate terms of the contract. During the visits of these employees the branch office of the foreign company provided various facilities. The employees of the branch office used to attend meetings and undertake follow up actions with the customers. Besides, the supply of equipment was a continuous process. The testing of the equipment was also carried out in India. The Assessing Officer held that considering the facts, it could be said that the foreign company has business connection in India and thus liable to tax in India. He also held that the income is taxable in view of Article 7 read with Article 5 of Double Taxation Avoidance Agreement between India and Sweden. According to him, the company had a permanent establishment in India for the following reasons:

   

The permanent establishment existed in the form of a dependent agent establishment. The foreign company had a branch in India which provided a fixed place of business. The office of Indian company was used as a fixed place of business. The employees of the foreign company were frequently visiting India and using facilities provided by the Indian company.

17.3.5 The assessee contended that it was not liable to pay tax in India as none of the conditions prescribed for the presence of a PE in India were fulfilled in the case. It stated that as the foreign company is a tax resident of Sweden, the beneficial provisions of India–Sweden Tax Treaty will apply in view of the provisions of the Section 90 (2) of the Act. According to assessee, the receipts of the foreign company for rendering services cannot also be treated as „Royalty‟ or „Fees for Technical Services‟. On the contrary, these receipts were in the nature of „business profits‟ which were not taxable in India as the company had no permanent establishment in India, as prescribed under the provisions of DTAA with Sweden. 17.3.6 The CIT (Appeals) held that having regard to the nature of the activities of the foreign company it cannot be said that the assessee had a PE in India. The necessary consequence of this finding was that the assessee is liable to tax on its business profits in Sweden only. The next important issue considered was whether payments received for licensing of the software were royalties or business profits. The AO was of the view that the software supplied cannot be termed as „goods‟, but a kind of intellectual property right. The software was not sold, but licensed to the operators. The C.I.T. (Appeals) held that on the facts and in the circumstances of the case, the licencing of software amounted to transfer of copyright and not transfer of an article. Therefore, the case of the assessee falls within the mischief of Article 12 of DTAA which deals with payments for royalties. He, therefore, held that the receipts arising to the foreign company are in the nature of royalty and thus taxable in India.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter - II

INFORMATION TECHNOLOGY

Introduction

1.1 This is the era of Information Technology (IT). After the Industrial revolution, no phenomenon has affected the world as much as this information explosion. The advancements made over the last three or four decades in silicon chips, connectivity and the telecommunication sector have made this possible. Giant strides taken in computer technology have put mankind on the super highway of information dissemination. IT is threatening to change the facet of some of the mankind‟s long-held concepts and perceptions. It is having an impact on every walk of life and in particular the commercial world involving trade and commerce. The long jumps made in telecommunication sector have shrunk the world into a global village. Satellite communication has enabled instantaneous passage of information, rendering distance and time irrelevant. The advent of e-mail has done away with the concepts of geographical territory and the medium of conventional post. On the touch of a button, a message is conveyed across the globe. 1.2 Computer as a tool was invented for the sole purpose of computing and its applications in early stages was limited largely to mathematical solutions and scientific applications. In the initial days since the computer occupied a huge space, it was limited to educational institutions and scientific laboratories. The revolution in the microchip technology resulted in smaller computers and personal computers (PCs). The advancement made in this technology is truly mind-boggling. We are already talking of „artificial intelligence‟ (AI) by which the computer itself will be able to act and start behaving like a human being by applying reason and logic. The stand-alone PCs were linked by network locally and then slowly to different places and then across the nations thanks to the Internet. This again was made possible by cable connectivity. The challenge was in making the machine to understand our language to execute our tasks and this could happen thanks to various machine languages developed by the software companies. 1.3 The technological advancement made on the information highway has given birth to new concepts like e-commerce, digi-cash, e-cash, e-banking, remote banking etc. The traditional understanding of the present commercial world will be totally revamped. Commerce in future will be done in cyberspace with no geographic or any other barrier. The impact of this on income tax is still in the realm of conjectures. The answer lies in the future as the ramification and the extent to which this is going to affect are yet to be gauged. The information explosion has not ceased or abated. Literally, the sky is the limit for the advance to stop and hence all that we can do at the moment is to assess the development as of date and find its impact on the existing tax structures. Various studies have been conducted by the OECD countries, in particular by the US Treasury Department and the Australian Tax Office (ATO). Their views are rather inconclusive and the attitude appears to be to „wait and watch‟ and allow things to develop and then bring necessary legislation for collecting revenue. This will be discussed in the course of this paper.

Indian scenario 2.1 The future of the Indian IT despite a flight of talent to financially greener destinations, lies in transcription technologies, e-commerce and customer relationship management (CRM). Already Indian cities show a record growth of transcription companies offering ready-made services to clients in the US and UK. Though the portal management and e-commerce are still in their adolescence, a boom is predicted in on-line transactions. The Government of India has created a new ministry called Ministry for Information Technology and also brought out Information Technology Act, 2000 to provide framework for electronic contracts. The law paves the way for legal recognition of electronic documents and digital signatures. The importance and indispensability of IT is increasingly realised by both Government agencies and the commercial bodies. Even some State Governments have initiated e-governance programs. 2.2 What ails Indian IT is the poor telecommunication infrastructure. The lack of infrastructure forces companies to invest on high cost items like satellite links and high speed lines. Not all firms are able to afford such capitals cost both in terms of money and time. Thus, cost could be a major constraint for the IT Industry. On the flip side, the various governments like Central and State are slowly becoming econscious and turning out to be a major customer of the Infotech Industry.

Computer hardware 3.1 Hardware production had never been a major commercial activity in India. What was being done was only assembly of imported chips and peripherals. The assembled item is sold under some brand name. Smuggling of chips and other hardware items into India is not uncommon. Recent studies show that hardware industry is slowly losing its share in favour of software and services industry. The hardware market is estimated to account for Rs. 9000 crores per annum. Sale of PCs account for 1% of the total sales of the global market at around 1,80,000 pieces. The Indian strength in Hardware is in design and integration of computers rather than the manufacture of components. Peripherals such as keyboards, floppies, floppy drives, power supplies and printers are being manufactured in India. Computer chip manufacturing almost absent in India. A large portion of the chips is smuggled from Singapore, Hong Kong, and Taiwan. Despite the recent reduction in import duty, the „grey market‟ continues to flourish. The high cost of hardware forces programmers to develop cost effective and efficient programs that gets the best out of the machines. 3.2 The cost of hardware in India is very high. This accounts for the low hardware penetration as compared even to a city state like Singapore. The industry blames the high duty structure for the high cost. Excise duty at 16 per cent and special additional duty at 4 per cent account for 20 per cent or the hardware cost. Besides, there is this general 10 per cent surcharge levied on import duty. Also, there is no common sales-tax structure. There are some procedural issues on excise duty still to be addressed, like the value of 'pre-loaded' software not being considered in the transaction value of IT hardware. The industry's wish-list includes income-tax exemption for earnings from technology and design exports.

Internet 4.1 The third dimension, other than hardware dimension and software dimension, to the IT revolution is the advent of the ubiquitous Internet. The Internet, the electronic substitute for the print medium, a non physical entity transcending limitations of space and time, connects people seamlessly irrespective of geographical boundaries and creates virtual communities that coexists and interact with one another on an “as is where is” basis. Thus, Internet is a major development in this sector. The progression is from the stand alone PCs to local area network to Internet. With high-end application, sophisticated softwares have been developed to perform complex tasks and we are witness to a total revolution sweeping the globe. This knowledge-based industry has no bounds like the human mind and intelligence. It is changing all aspects of our life for the better. We are going to perform many things by sitting with a PC in the comforts of our home without venturing out. To cite an example, booking a railway or air ticket, that too without the help of an agent! Truly, Internet has come to stay. It is the order of the day now. Further, it is no more a vehicle of communication alone. It is expected that commerce would henceforth be through this technology. As a natural corollary, it would leave its impact on taxation. Hence, it is time for having a review of commercial legislation and the taxation, as the challenges posed by it are gigantic. In order to appreciate the same one should understand what e-commerce is and what challenges it is going to bring about in its wake? 4.2 Few developments promise to change our society as fundamentally as the emerging global computer communication network. The relevance of factors like distance and location is diminishing. National borders are blurred in the process, as there are no border checkpoints for information traveling through cables or via satellite. Distance and location have disappeared. Internet is expanding at a phenomenal rate. It has gone far beyond the educational and research sectors to which it was confined initially and is now covering the commercial sector. People can sit at their PCs at home or in their business and carry out transactions of buying or selling around the world. Merchants in one‟s own country or overseas can offer goods and services on the Internet, which can be purchased and immediately paid for through the new form of money - electronic cash. What is more, in such a convenient arrangement the purchaser can remain anonymous particularly if the goods can be transmitted electronically. Indeed, there are no border checkpoints, no customs officers and no tax officials. This sounds like an opportunity, which no one would want to miss. Here lies the challenge to the Income tax department.

4.3 People could be enticed to do cross-border business via communication networks and anonymous electronic payment mechanisms without declaring income at all for taxation purposes. Yet another related problem is that of money laundering which too might be easier than previously. As with the abovementioned problems, money laundering is possible not only because of the technical developments in computing, electronics and cryptography but also because of the lack of appropriate legal mechanisms to regulate the use to which the technology can be placed and to how the users are to be responsible for their application. 4.4 As usual, technology appears to have left society somewhat behind. So are the existing laws and regulations on banking and taxation sufficient to cover the above perceived problems as well as many possible other ones? In addition, even if India changed the relevant laws and regulations would that checks the issues of cross-border transactions. 4.5 No or very little experience has been gained with the new electronic payment technologies to see where action needs to be taken. No one knows whether any changes to existing laws to cope with the problems will be able to cover any new technological loopholes. Many similar problems have been around to varying degrees with other forms of money, in particular ordinary cash. However, it is not just the technology and the legal issues, which cause problem, but also the new jargon which develops with it.

Internet : related concepts 5.1 Internet has two key infrastructure elements viz.,  

the operation of the Internet; and web site, a basic business unit on the Internet

5.2 The Internet operation can be described as infra a) IP numbers. The Internet relies for its operation on a numbering scheme called IP numbers. IP numbers are somewhat like telephone numbers. They identify devices attached to the Internet. Any device connected to the Internet can establish a connection to any other device connected to the Internet by „dialing‟ its IP number. b) Data packets Communications sent over the Internet (e.g. software) are divided into „packets‟ for their journey over networks from point A to point B. The following points concerning IP numbers and packets are worthy of note:

1. IP packets have a fixed size. If a message (which may, as indicated above, represent a

2. 3.

great many things) is bigger than the size of a packet the message will be split into a number of packets for its journey across the Internet from the source, say, Mumbai to its destination, say, Los Angeles. The data element of packets may be encrypted. Only the sender and recipient may have the key to decrypt the message; and If a global register of all IP addresses were kept (like a giant telephone directory), it would (subject to some qualifications) enable a third party, by consulting the directory, to identify the sender and recipient of the packet.

c) WWW (World Wide Web) Digital information can be sent from any place connected to the Internet to any other place so connected. A key point about Internet addressing from a tax perspective is that it provides a way to transfer digital information (including electronic money and digital goods) from any device with an IP address to any other device with an IP address regardless of national boundaries. Hence, very different enforcement considerations arise in respect of flows of digital "goods" to physical goods. Shrink-wrapped software in a cardboard box, for example, may go through Customs in the normal way. An identical piece of software sent via the Internet from an US web site to an Indian consumer will not. 5.3.1 The other key infrastructure element is web site. It has the following physical characteristics: 





Web sites are computer programs residing on computers (known as servers) which are connected to the Internet. They possess IP numbers enabling them to be contacted by other computers (known as clients), normally using specialised protocols [i.e., standard rule of operation] enabling sophisticated and, for financial transactions, secure two way communication between the client (say a prospective customer), and the server (say an Internet business). Only a small part of the overall development cost of a web site is represented by computer hardware. The most valuable constituent elements of a commercial web site are software, data and goodwill. It is not difficult to remotely program a web site, or to change the location of the computer where it is hosted. In addition, a web site, which from a business perspective is logically integrated, may physically be dispersed across a range of computer servers, possibly in different countries. Another significant issue relates to the basic business unit of the Internet, a web site. Web sites are actually a collection of computer programs and relevant data. From an owner's perspective, they are powerful, flexible, configurable at a distance over the Internet, and can be left to run unattended. From the perspective of an investigator, these characteristics can significantly increase the evidentiary 'distance' between the economic activity on the one hand and the controller and the beneficiaries on the other.

5.3.2 The business function of web sites are as follows    

    

A web site - which may in business terms be thought of as an Internet sales or distribution centre - may fulfill a variety of important business functions, including: on-line registration of customers; 24 hours, 7 day a week operation without corresponding labour costs; Reducing dependency on, (and high costs of), conventional production distribution methods, by enabling products for sale to be ordered and in some case shipped electronically, with contracts for sale automatically generated by customers' use of Hypertext Markup Language (HTML) forms; showcasing products for sale; reducing costs through automation of functions such as ordering and payment processing and through reduced rent, utilities bills and the like; through 'just in time' business operations, reducing the need for large stock inventories and other capital intensive requirements of conventional business; reducing support costs by providing automated help, product updates, etc. This is done both asynchronously, using protocols such as file transfer and e-mail, and synchronously, with various online "chat" protocols; and generally reducing "middlemen" costs by centralising a variety of important business functions in the web site. The sophistication of automated functions is certain to grow, with consequent adverse impacts on intermediaries in the production / distribution / service chain to the end consumer.

5.3.3 Web site - Before embarking on a discussion of the business model, an explanation of a typical Internet transaction will be useful. A diagram showing a basic business model for the Internet is given in ANNEXURE I. All references in square brackets, e.g. [User] are to entities in the business model diagram. 5.3.4 A typical transaction - Madhuri [User] is sitting at her computer having just logged on to the Internet. She logs in using a computer and modem to an [Internet Service Provider, ISP], which charges her Rs 60 per month for up to 20 hours usage. The ISP essentially acts as a retailer: it buys bandwidth from a wholesaler of bandwidth [Network Provider], typically a telecommunications company such as VSNL, and resells it in the form of Internet connections, often with a range of value added services. Madhuri has a list of CDs she wants to buy, and having checked the Indian and Internet prices, she understands she will save about Rs. 20 from buying them on the Internet. To access the Internet site [web site] she uses software provided free by Internet Explorer [software architects]. She types in the address of the web site, which may be something like http://www.cdrom.com, and in a few moments, the details of that site, generally a combination of text and pictures, are being loaded on her computer. The site contains details of thousands of commercially available CDs; on many, "Sound Bits" can be played as teasers to buy. A decision to purchase the CDs [producers of CDs are content providers in the model] is effected using a couple of analogies from the supermarket world, the "shopping trolley" [revocable commitment to buy] and "check out" [irrevocable commitment]. The site is well designed, which means that each step up to the point of irrevocable commitment is well-explained and carefully incremental, so at no point does the buyer feel threatened by what may be an unfamiliar process. Asked for her credit card details Madhuri uses her Visa credit card [Payment Providers: Citi bank, Payment System Provider: Visa], where the flow of funds will be similar to conventional credit card transactions. The web site also presents Madhuri with options for delivery, typically ranging from conventional mail (cheap but slow) to express shipment by a specialised freight forwarder (more expensive but fast). Some freight forwarders also offer users the service of tracking the progress of their parcels in transit using the Internet. 5.3.5 Web site - framework 





Signatures can serve a range of purposes, including adoption (“By signing this, I acknowledge responsibility for the contents of this document”), and authentication ("This is Ram's writing"). Inability to implement these functions on the Internet would present serious stumbling blocks to both commerce and taxation. Technology has been developed to mimic conventional signatures for electronic documents. It uses the so-called public key / private key encryption technique. One popular (and free) implementation of it, available for most kinds of popular operating systems (DOS, Windows, Mac, OS/2 etc) is "Pretty Good Privacy", or PGP. There are US export controls on the US version of PGP, however there is an international version which provides comparable functionality. PGP (and other public key / private key encryption schemes) address the issues of adoption and authentication, and a further one of message security (I do not want anyone but the intended recipient to be able to see this message). It works as follows:

5.4 Public key /private key encryption - Every user has two keys, a public key and a private key. The keys take the form of several lines of text generated by the computer program using a special algorithm. The public key is "published" on the Internet. If anyone knows my e-mail address on the Internet, he can discover my public key (if I've got one, of course). The private key is kept secret. If I want to send a secure message (call this message to X, I look up X's public key on the Internet and encrypt m with X's public key. This transforms the "plain text" message m to unintelligible gibberish, m1. Only X can decrypt m1 with her private key. No one else's private key will work. If X is not a very trusting soul, and needs to

feel reassured that the message is definitely from me, then I first "sign" m with my private key before encrypting the result with X's public key. X reverses these steps when she gets the signed and encrypted message, checking the enclosed signature against my public key to verify that it is from me.

SOFTWARE PRODUCERS Software - what is 6.1 Computer understands only the machine language , otherwise called assembly language. In order to make the machine understand our instructions and perform the task to achieve the end-result. The commands are given in a particular fashion in accordance with ASCII [American Standard Code for Information Interchange]. The process of conversion of our language into machine language is known as software production. This is basically a knowledge-related exercise. Of late, this word has acquired legal recognition also as the word has been defined in Sections 9, 10A, 10B and 80-HHE:In Section 9 of the Income-tax Act, in subsection (1), in clause (vi), for Explanation 3, the following Explanation shall be substituted with effect from the 1st day of April, 2001, namely 'Explanation 3 - For the purposes of this clause, "computer software" means any computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program or any customized electronic data; Under Section 10A soft ware is defined as [w.e.f 1-4-2001] Explanation 2 - For the purposes of this Section, (i) "computer software" means,(a) any computer program recorded on any disc, tape, perforated media or other information storage device ; or (b) any customized electronic data or any product or service of similar nature, as may be notified by the Board, which is transmitted or exported from India to any place outside India by any means ; Under Section 10B soft ware Explanation 2 - For the purposes of this Section, -

is

defined

as

[w.e.f

1-4-2001]:

(i) "computer software" means,(a) any computer program recorded on any disc, tape, perforated media or other information storage device ; or (b) any customized electronic data or any product or service of similar nature, as may be notified by the Board, which is transmitted or exported from India to any place outside India by any means ; In Section 80HHE of the Income-tax Act, with effect from the 1st day of April, 2001 in the Explanation below subsection (5), for item (b), the following shall be substituted,-'(b) "computer software" means,-(i) any computer program recorded on any disc, tape, perforated media or other information storage device ; or (ii) any customised electronic data or any product or service of similar nature case may be notified by the Board, which is transmitted or exported from' India to a place outside India by any means;'.

Indian software scene 7.1 At the moment India‟s share in the total global software market is low, yet India still enjoys an edge over other nations in terms of human resource reserve. India possesses the world‟s second largest pool of scientific manpower which is also English speaking. Further, the quality of Indian software is good and manpower cost is relatively low. It provides a good opportunity in the world market. The Government of India has recognised software as major thrust area for exports and domestic market. It has established

the National IT Task Force to make recommendations for enterprise computing and growth of Ecommerce systems.

The industry - how it functions 8.1 When the industry started taking roots, it was essentially doing offshore jobs for the US software manufacturers. Later, it established its own setup and started sending the IT professionals to do the job in the US. Now, the Indian industry is poised to be an equal partner with the US industry. 8.2 Software companies also take recourse to a practice called „body shopping‟, by which trained software professionals are sent to their foreign partner to execute jobs on certain fixed terms and conditions. The software professional is paid a certain amount and the company, which executes such projects, is paid certain amount. 8.3 National Association of Software and Service Companies, NASSCOM, is the apex body and chamber of commerce of India‟s software-driven IT industry. Its role includes promotions of the industry, eenterprise, interaction with the governmental agencies and also acts like a watchdog for curbing the software piracy.

Medical transcription 9.1 Since maintenance of a secretarial setup by a medical practitioner is an expensive one in a developed country and also bothersome, reputed doctors have a partner in India who does necessary secretarial services. The foreign doctor transmits his requirement by voice-mail to his service provider in India which would be transcribed and attended to and the necessary output will be transmitted back to the doctor, for which certain service charges are charged. This is called medical transcription. Medical transcriptionists take dictated medical records and produce an accurate hard copy for the medical practitioner. The skills needed are thorough knowledge of the medical terminology, computer skills and accurate listening, spelling and typing skills. These charges are much less than what would have been otherwise in their own country. Practically, there will not be any time loss because of the time lag between the countries and because of faster communication. Hence, this "medical transcription" is one potential area for generation of revenue.

Manipulations 10.1 Certain companies earn quick money in a short time by adopting practices, which may not look illegal. There is a practice called „roof to roof hopping‟. Some companies enable persons in India make calls abroad without incurring charges at ISD rates. This results in loss of revenue for the Telecommunication Department. On the other hand, a company indulging in such a practice gets some lump-sum payment from the user, which is much less than the ISD rates. Such receipts are not normally accounted for in the hands of the company as the methods adopted in earning them are not legal. 10.2 Certain „virtual corporations‟ are formed from some specific devious purposes. On executing the same, the money made is distributed by transfer abroad and the "virtual corporation" vanishes. This could be a potent tax evasion method. 10.3 Rogue operations - Rogue operations are those that are set up primarily with the intent to avoid taxation and other regulations in other countries. Such developments can already be observed on the Internet. Services that require licensing or are otherwise illegal in some countries, like gambling, are being offered from offshore locations, often by questionable operators. The locations chosen are usually those with little legislation and control. For example, some gambling services obviously targeting the regulated US market are offered from Antigua or the Cayman Islands. It is conceivable that such locations will also host rogue financial services in future.

10.4 Letter box companies - It is unlikely that such services [supra] would draw investment from the general public, as the operators do not have the reputation required to be attractive for secure investment. However, in the same locations, it is easy and cheap to set up letterbox companies [refers to a company with an offshore address but does not operate from that address]. With the ready availability of access to funds held there through Internet banking, as well as payments using such funds, tax avoidance schemes employing letterbox companies at offshore locations become easily accessible. The motivation for investment at the first group of locations need not be primarily tax avoidance, but more competitive overseas investment opportunities. Nevertheless, it is still easier to neglect any declaration of profits from such investments than when they are held through in agent in India. And in addition reporting is not enforceable. 10.5 “Smurfing” is the name given to a suspect transaction, which means breaking up large transactions into a number of smaller ones to avoid the reporting requirements of the legislation. A computer could be programmed to break large transactions into thousands of small ones, conducting many thousands of small transactions each day. Detection could be extremely difficult. It seems likely that some form of effective monitoring computer programs is required for the future. These could be developed to detect “suspicious transactions”, particularly smurfing. 10.6 Computer money utilising blind signature technology, or any other technology that conceals the identity of the payer, poses a further problem with “suspect transactions. It is not easy to find a solution to this problem. Of course, the customer could be forced to disclose the “blinding factor”, but the thing that makes the transaction suspect, the country of payment or the identity of the payee, gives no indication as to whom the customer/payer might be. One solution might be a variant of the “key escrow” schemes for encryption generally, but it is not easy to see how this might be applied in the computer money context. 10.7 Tax havens - It is likely that many of the existing so-called „tax haven‟ countries will capitalise on the improvement in international communications infrastructure and bandwidth, and will attempt to become major players in the Internet economy. The cost of establishing a Web shop is not prohibitively expensive - even less to relocate one to another jurisdiction - with the result that many Webshop owners will be tempted to set up operations in such jurisdictions. This will result in a significant loss of revenue from „mainstream‟ jurisdictions. For the same reason, on-line banks and other payment providers will be established in such tax havens, with the result that revenue collecting authorities will be unable to have access to investigate information. 10.8 Finally, the Internet is expected to provide a high level of mobility for Internet businesses, highly skilled labour and capital. This is expected to result in a tax driven migration of businesses to the Internet, and of Internet businesses to low tax jurisdictions. The expected migration of the location of Internet businesses to low tax countries will require India to take strong measures to discourage the development and use of low tax countries.

Computer system frauds 11.1 There are two kinds of computer systems - open systems and closed systems. Open systems are those which have external connections, either through proprietary networks, international telephone or packet switching systems, to the Internet or some other external communication channels. Closed systems are self-contained and have no means of remote access. Obviously, open systems are more vulnerable to unauthorised intrusion and are the prime targets of hackers. 11.2 Simply put, any dishonesty that takes place in, around, because of or is in any way related to information technology is a computer fraud. It is a onetime „smash and grab‟. A computer fraud has the following elements Element

Method

Way in

Breach of trust or contrived (i.e. how the system is accessed)

Manipulation

Creation of false accounts

Conversion

Of false credits, cheques & goods

The following are the methods of manipulation that have come to light 11.3 Falsification of input - Most known cases of computer fraud involve the falsification of data before or during their introduction into computer. Input can be examined under two headings: Transaction data and transaction codes. 

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Transaction data - The most common and easiest method of fraud is to suppress or falsify transaction data before their introduction into computer. False data may be created at the preparation stage, on manual entry, through bar codes or other automated means and may be recorded or unrecorded, inflated or suppressed. Transaction code - Transaction Codes are used to identify different accounting requirements of entered data. Standard packages, such as those used to run general and nominal ledgers may be vulnerable to fraud because customised manuals do not refer to unwanted codes, screen menus or options. Bar codes and automated input - Bar code labels and punched or magnetic tapes are vulnerable to falsification. The main problem arises because it is difficult to confirm, by visual inspection, that the code is correct.

11.4 Manipulation of master files - Master files may be manipulated either by entry or false data through an approved input process or by use of utilities which can directly access, change or remove data elements at their physical address in a computer file. A master file might be amended only shortly while a transaction is being fraudulently processed and returned to its previous state or the amendment may be long-term. 11.5 Suspense accounts manipulation - Typically, companies maintain a cash suspense account to hold incoming or outgoing funds until they can be posted to the account of the third party concerned. They are vulnerable to manipulation and conversion. 11.6 Manipulation of output - Computer output may be duplicated, suppressed or altered as a means of concealing or achieving a fraud. 11.7 Program patches - A fraudulent routine or „patch‟ may be introduced into an application program, a utility, in a job-controlled language (JCL) module, or in an operating system during either development or maintenance. The usual objective is to divert processing to an exceptional routine, when a specified condition, or trigger, is encountered. The trigger may be the date of a transaction, a quantify of goods, the name of a customer or a combination of various factors determined by the programmer and almost impossible to guess by any one else. Program frauds are relatively infrequent and call for high skill levels. However, sometimes programs seem to have a mind of their own.

Tax treatment 12.1 Let us attempt to find what could be the possible approach of a software manufacturer in his accounts to bring down his liability. 

The treatment given to the receipts arising from body-shopping arrangement by both the computer professional and the company, for the purpose of tax should be closely examined.

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

    

If the accounts are computerised, one has to see what the applied internal controls are. The manner of data feeding, the stage at which the data can be altered and the persons who authorised to check and alter the data require to be noted. Most computers and net works have at least one high level user often called the systems manager. He is typically responsible for granting privileges to the users and for ensuring that passwords are issued and changed. Often access rights, or privileges, will be established through authority tables like a user authentication file (UAF) showing who is allowed to do what and to whom. Expenses on development of software – In examining the accounts relating to software development the AO has to see what are the expenses that go into the development of software and how they are accounted for and how are they recorded. He should also see whether such expenses are written off in one year or over a period. This would be relevant as sometime the software is developed over a period of 3 to 4 years. The accounting treatment give to any purchase of software from outside require verification to find out whether it is resold or used for their own purpose. The revenue so generated accounted for or not is another area of verification. The software company may indulge in offering services like job word or teaching. How are the service charges recorded require examination. If the Software Company is imparting training for the use of its software and if any fees are charged, then the manner in which they have recorded require to be looked into. If any expense is deferred, what is the expense that is deferred and reasons for such deferment requires to be seen. If the Software Developer has any offshore projects, the details of such projects are required to be obtained. The terms of agreement also should be gone into to decide the business connection.

Invariably, when the offshore projects are taken up, the foreign partner would insist on establishing a Company locally so that any legal dispute that may arise can be contested in their own land instead of taking it to India. The payment terms and remittances in such projects require to be properly verified. 



 

The flight of talent in the software industry is regular and frequent and very high. In order to retain a software professional in the company, the company may allot its own share/stock through employees stock option (ESOP) schemes so that he remains. Most of the times hidden perquisites in the form of advance of money for purchase of a car or leasing a premises for his occupation or consumer loans are given which escape the TDS provisions as well as taxation provisions. Hence the manner of appointment or terms of conditions of employment require close examination in order to ascertain the true import of taxation in those matters. If there are certain transactions which the Company wants to hold back, the transactions are kept in a file, say, "spread sheets" which should have a suffix "XLS" in MS office environment and if the Company changes the file format to "JPG" and saves it the changes of finding out such file is very remote. Such change of files from one format to another to hide certain transactions can also be a 'malpractice'. Software Piracy is a very lucrative proposition to generate revenue but with very little capital investment. If the company is indulging in such unethical practice then the entire income may be unaccounted by the nature of its very activity. One of the facilities the computer offers is editing the data. Hence, any entry can be suitably changed without leaving a trace. However, this can also be verified by a procedure called „dumping procedure‟. In this procedure, we can ask the computer to list out the entries made. Since the computer records various commands it receives in a sequential order date-wise and time-wise, the various entries made will be listed out sequentially date-wise and time-wise. This would clearly expose any interpolation of data entry.

 

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Important files can be kept hidden easily. A look into the computer for hidden files is always rewarding. All that one has to do is to „un-hide‟ the files using the particular operating system on which software is developed. Software industry being knowledge-based, the challenges it poses to taxation are intricate and many. Crookedness is an extreme form of pervert intelligence. If a programmer chooses to be crooked, the task of combating the fraud becomes that more difficult. In the case of export of software, whether indeed there was any genuine export of software may have to be looked into as more often the revenue officials have found out that in the garb of export many illegal or illicit or unauthorised operations do take place. We are on the eve of total digitalisation of all corporate files and records. Paper documentation will gradually retreat to the background and, in most instances, disappear. Companies will want to convert their data from one carrier to another. However, conversion must not harm the scrutiny of data and the converted data must be reproducible within a specific period. It is therefore important that certain conditions for converting data are established and adhered to. If a taxpayer complies with these conditions, he is no longer obliged to preserve the original document.

12.2 Possible conditions for conversion include:      

The taxpayer must make technical and organisational provisions that ensure that the conversion of data is correct and complete. In principle, the „new‟ data carriers must be available and accessible during the entire retention period. During the retention period, the data must be capable of being reproduced in a readable format within a reasonable time. If these conditions are met, old systems (hardware and software) need not be retained. The data must be made available to the AO in such a way that the scrutiny can be completed within a reasonable period. The cooperation of the taxpayer is essential. The taxpayer is responsible for the technology and methods used to convert the data. After conversion, digitally recorded data may be preserved in digital form or in other forms, provided that they can be made accessible within a reasonable period of time and that an audit can be carried out within an equally reasonable period of time.

This last condition implies that it is not acceptable for the taxpayer merely to print large quantities of electronically recorded data on paper and then hand these over to the AO. The amounts of data that may be retained on paper are limited by the criterion of scrutiny. As long as scruitinising the data is possible within a reasonable period, data may be transferred to paper. As a rule, it may be stipulated that digital data should almost entirely stay digital. However, provided the data remain correct and complete, the taxpayer must be allowed to record data on back-up tapes/ diskettes/ cartridges so enabling the freeingup of system resources. To prevent problems or disputes, it is advisable to come to an agreement beforehand. 12.3 In view of the specific provisions of Section 80HHE (1), upto the Assessment Year 2000-2001, „a deduction of the profits„, was allowed, which meant that the entire export profits were allowed as deduction. However, with effect from A. Y. 2001-2002, a portion of the profit is sought to be taxed in a phased manner as under: Amendment of Section 80HHE --In section 80HHE of the Income-tax Act, with effect from the 1st day of April, 2001,-(a) in subsection (1), for the words "a deduction of the profits", the words, brackets, figure and letter "a deduction to the extent of the profits, referred to in subsection (1B)" shall be substituted;

(b) in subsection (1A), after the words "in respect of which the certificate has been issued by the said company", the words, brackets, figure and letter "to such extent and for such years as specified in subsection (1B)," shall be inserted ; (c) after subsection (1A), the following subsection shall be inserted namely "(1B) For the purposes of subsections (1) and (1A), the extent of deduction of profits shall be an amount equal to-(i) eighty per cent. of such profits for an assessment year beginning on the 1st day of April, 2001; (ii) sixty per cent. of such profits for an assessment year beginning on the 1st day of April, 2002 ; (iii) forty per cent. of such profits for an assessment year beginning on the 1st day of April, 2003 ; (iv) twenty per cent. of such profits for an assessment year beginning on the 1st day of April, 2004, and no deduction shall be allowed in respect of the assessment year beginning on the 1st day of April, 2005 and any subsequent assessment year." ; 12.4 Almost 60 per cent of India's software exports is through on-site services. One of the main demands of the industry is to recognise on-site services as an integral part of computer software exports under Sections 10A and 10B. While these sections do not include on-site services, Section 80HHE explicitly allows exemption for such services. A clarification from the Board is due.

Conclusion 13.1 This paper does not pretend to identify and provide all the answer, as a perfect computer fraud will never be discovered. It is a common experience that any instrument man has invented can be abuse, and certainly, computer is no exception. It is said that paper was patient and the same can now be said of the computer monitor. One should not confuse what we see on display on screen necessarily represent the reality. It is relatively simple especially when using a personal computer, to switch off built in controls or manipulate results. For an investigator, it is not going to an easy job. The clues one gets in examining the books of accounts like totaling errors, erasures, correction fluid, different handwritings and colour of the ink will no more be available in a neatly taken print out of the computer. In investigating the accounts in the PC environment, the investigator should not neglect to follow the same procedures to assess the reliability of the accounting system which he would have otherwise used in investigating the classic set of accounts and records. It is really ironic that even though the world has shrunk so much through the digitisation, the procedures are becoming increasingly impossible.

ANNEXURE - I

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – III

E - COMMERCE

Introduction 1.1 Commerce means buying and selling of goods and services. When buying or selling of goods and / or services is performed electronically, it is called electronic commerce, or in short e-commerce. Ecommerce is defined by US Treasury in „Selected Tax Policy Implications of Global Electronic Commerce‟ as „the ability to perform transactions involving exchange of goods and services between two or more parties using electronic tools and techniques‟. 1.2 The following activities can be, inter-alia, undertaken using electronic tools and techniques       

Sale of goods (retail and wholesale) trading in stock on-line exchange of information Health care advice Offshore banking Software programs Transmission of data including in audio, graphics, video mode

The Internet or the worldwide web with its related technology is the backbone of e-business. It has the potential of revolutionising international business. The term Internet refers to an international network of computer networks. It has the capacity of connecting millions of computers throughout the world and thereby exchange information amongst their users on real time basis. 1.3 Some illustrations of buying and selling of goods, provision of services and licensing in e-commerce are given below 1.3.1 Buying and selling of goods - The vendor advertises the products (goods) on its web site. Potential customers access the web site of the vendor through Internet. The potential customers place an order for the goods on the Internet. Goods are delivered through a local carrier. Payment for the goods is made either by cheque / credit card at the time of delivery or through on-line payment system. 1.3.2 Services - Professional services, Legal advice, Health care services, Information services and Technical services are some of the fast growing activities on the Internet. Subscribers can type queries that can be transmitted to specialists and get responses through E-mail. Payments for the services can be made by cheque / credit card or through on-line payment system. 1.3.3 Licensing - Products under copyright like journals, books, music, designs, drawings and software are available in digitised form. These products are delivered electronically to licensee with limited rights of

user (with restriction of not making copies and selling). License fees are paid by cheque / credit card or through on-line payment system.

What is e-commerce 2.1 E-commerce comprises of   

Use of computer networks to facilitate transactions involving marketing, distribution, sale and delivery of goods and services in the market place. An on-line method of conducting business covering areas like marketing, order entry, processing, advertisement and customer support. The ability to perform transactions involving the exchange of goods and services between two or more parties using electronic tools and techniques.

E-commerce is carried out using Electronic Data Interchange (EDI), Electronic Mail, Electronic Fund Transfer, through network based on technologies like Local Area Networks (LANs), Value Added Networks (VAN) and the Internet. 2.2 Internet commerce can be classified as follows    

Business to business [B2B] Business to consumer [B2C] Consumer to consumer [C2C] Consumer to business [C2B]

2.3 E-business and e-commerce - E-business is using electronic information to prove performance, create value and enable new relationships between businesses and customers. E-commerce is the marketing, buying and selling of goods and services over the Internet. Thus, e-business encompasses all of what has been called electronic commerce - the external channels beyond the boundaries of an organisation - and goes on to include every aspect of the firm‟s strategy and operations.

On-line payment system 3.1 Once the customer selects a product from the web site of an online store and places an order for its supply, he enters his credit card number, which goes to the bank‟s server for authentication. Once the bank ascertains the validity of the card and the credit limit, it gives green signal to the on line store. The order form is then passed on to the online store. Upon delivery of the product to the customer, a confirmation is sent to the bank, after which the customer‟s account is debited. Considering the risk to the credit card holder, in most cases, the credit card details are transmitter in an encrypted format. Cyber laws provide the basic legal frame work enabling the on line payment system. 3.2 In countries where e-commerce has found wide acceptance, the online payment system comprises several types of Service Providers like: Cybercash, Validpay, Billpoint, and e-cash. 3.3 Some web sites e.g. Cybercash provide real-time authorisation, voids, returns, settlement and other payment management capabilities. It also provides multiple Internet payment services, including Credit card. Cybercoin (for cash payments from $0.25 to $10), and the Paynow electronic check services are meant for interactive billing applications. The Credit card service links the online store with the credit card processor providing authorisations in real time at the time of purchase. After the sale, web sites like Cybercash, provide full HTML interface for capturing and settling transactions. The Paynow service provides for payments directly from a bank account. The service is available to both consumer and business purchasers. Validpay.com provides transaction services with secure payment facilities to thousands of online and traditional business customers. Validpay has also formed strategic alliances with

financial institutions and technology partners to deliver comprehensive online authorisation, processing and fraud prevention services. Billpoint is a service that can be used to buy items in auction on e-Bay right from the auction stage or from the Billpoint Invoice e-mail. This enables sellers to ship the items immediately. E-cash uses digital signature technology based on public-key cryptography. Currently, Secure Sockets Layer (SSL) security, is used to protect credit card information transmitted over Internet. SSL protects credit card information from being stolen by anyone monitoring the Internet traffic. 3.4 The concept of online payments apply more to B2C transactions rather than B2B transactions. In B2B transactions, payments are primarily made off-line, as it involves large amounts, as also physical inspection of the product. In any case, the existence of payment gateways is a necessary factor for enabling an e-commerce boom.

Glossary of terms 4.1 Bandwidth (also known as capacity) - In simple terms, bandwidth refers to the quantum of information or traffic that can be carried on Internet in a given amount of time. The simple rule is that the greater the bandwidth, the greater the opportunities for commerce. With low bandwidth, transferring information becomes a slow and painstaking process e.g. transferring contents of a music CD via Internet is not feasible with low bandwidth, but becomes easy with higher bandwidths. Bit - An abbreviation of the term binary digit, a unit of information represented by a zero or one. The speed of information transmission is measured in bits per second Browse - A program used to access the World Wide Web. CD-ROM - Compact Disc with Read Only Memory compatible with computers, compact discs are inexpensive, high-capacity storage devices for storage of data, text and video. Cyberspace - The expanse of computer networks in which all audio and video electronic signals travel from which the users can, with proper addresses and codes, explore and download information. Digital - Information expressed in binary patterns of ones and zeros. Digital signature - Data appended to a part of a message that enables a recipient to verify the integrity and origin of a message. Digitisation - The conversion of an analogue or continuous signal into a series of ones and zeros, i.e. into a digital format. Electronic commerce - The method of performing transactions involving exchange of goods and services between two or more parties using electronic tools and techniques. Encryption - The coding of data for privacy protection or security considerations when transmitted over telecommunications links, so that only the person to whom it is sent can read it. Fiber optic - A modern transmission technology using lasers to produce a beam of light that can be modulated to carry large amounts of information through fine glass or acrylic fibers. Global information infrastructure or GII or Information superhighway - The convergence of previously separate communications and computing systems into a single global network of networks.

Hypermedia - Use of data, text, graphics, video and voice as elements in a hypertext system. All the forms of information are linked together, so that a user can easily move from one form to another. Hypertext - Text that contains embedded links to other documents or information. Intellectual property - A collective term used to refer to new ideas, inventions, designs, writings, films and others; protected by copyright, patents, trademarks etc. Internet - A vast international network of computer networks that enables computers of all kinds to share services and communicate directly. Internet merchandise - Goods, services or other property (typically property in which intellectual property rights subsist, such as music, software etc.) sold via commercial web sites. A distinction can be drawn between those cases where delivery is effected via Internet itself (e.g. downloaded software) and where delivery is effected via conventional means. Internet Service Providers (ISPs) - Organisations which provide individuals and businesses with access to the Internet (including commercial web sites). Modem - An abbreviation of mo(dulator) and dem(odulator), an accessory that allows computers and terminal equipment to communicate through telephone lines or cable; it converts analog data into the digital language of computers. Server - Computers which store information for access by users of a network, including the Internet. Virtual reality - An interactive, simultaneous electronic representation of a real or imaginary world where, through sight, sound and even touch, the user is given the impression of becoming part of what is represented. World Wide Web or WWW: The graphical, hypertext portion of the Internet.

Traditional commerce vs e-commerce 5.1 Similarities - E-commerce is not a business transaction by itself but a method of conducting business transactions. The content of the business transaction done through e-commerce and the content of business transaction carried on through traditional commerce are same. A “sale of goods” remains a “sale of goods” whether carried through electronic means (e-commerce) or through traditional means ( traditional commerce). Services rendered remain services rendered whether carried out through electronic means or through traditional means. A Licensing remains a licensing whether carried out through electronic means or traditional means. 5.2 Differences - There is a difference between traditional commerce and e-commerce in the “methods of conducting business” and in the “concepts of conducting business”. In case of goods (like visual materials, audio materials, computer software, journals, books, music, plans, designs, drawings) and services (like diagnostic services) that can be digitised, delivery can be made electronically in ecommerce, unlike physical delivery in traditional commerce. Some of the characteristics which are present in e-commerce but not in traditional commerce are    

No need of physical presence or contact Lack of identification of parties No physical trails or records New method of payments

Income tax issues in e-commerce 6.1 From the point of view of taxation the transactions relating to e-commerce can be divided into the following categories:   

Transactions relating to sale of goods or rendering of services by a domestic enterprise to another domestic enterprise or to an individual resident in India. Transactions in which goods are sold or services rendered by a domestic enterprise to an enterprise or an individual situated outside India. Transactions in which goods are sold or services rendered by an enterprise or an individual resident in a foreign country to an Indian resident.

6.2 First type of transactions are not likely to cause any more problem to tax authorities than a similar transaction made in the conventional form. Both the parties are resident in India. Such transactions would result in profits that could be unearthed and taxed over the limitation period under the Act, just as in the conventional form. 6.3 Second type of transactions are also unlikely to pose any problem, so long as they are transactions relating to export of tangible goods. Such exports are subject to customs, RBI and other regulations. Money is required to be remitted under the RBI regulations at least for the time being. Further, various tax incentives provided under the Income Tax Act make tax evasion maneuvers unattractive. However, transactions relating to on-line services may pose considerable difficulty if the Indian party takes the payment abroad and keeps it in a bank account in a tax-friendly jurisdiction. Under the new Foreign Exchange Management Act offences relating to foreign exchange will be treated as civil offences. The various incentives provided under the Income Tax Act are being phased out. These factors may give rise to a tendency of not reporting profits from such transactions. Due to the anonymity over the Internet it would be virtually impossible for tax authorities to trace such transactions. The source of profit in respect of the first two types of transactions lies in India. Such profits are taxable in India under the head „profits and gains of business or profession‟. In such cases deductions u/s 80 HHC, 80 HHE, 80-O or 80 RRA will be available subject to the fulfillment of the conditions prescribed under those Sections. 6.4 Taxation of the third type of transactions mentioned above, involves a number of legal problems. These legal positions also differ for tangible and intangible assets. Incidence of tax on income depends upon the residential status of the assessee. Total income of a resident includes all income from whatever source derived which   

is received or is deemed to be received in India in such years by or on behalf of such person;or accrues or arises or is deemed to accrue or arise to him in India during such years; or accrues or arises to him outside India during such year.

Total income of a nonresident includes the first two items above, but these persons are not taxed for the income that accrues or arises to them outside India. The position in most other countries is broadly similar. 6.5 So long as the source and residence occur in only one country, there would be no problem. It is frequently possible that a person may be found to be a resident in more than one country or that the same item of his income may be liable to be treated as accruing, arising or received in more than one country. This may result in the same item of income becoming liable to tax in more than one country in the hands of the same person. In such situations, the countries resolve the mechanism of taxing such transactions through double taxation avoidance agreement. To prevent this hardship of double taxation, Section 90 of Income Tax Act, 1961 has been enacted.

6.6 In most of the Double Taxation Avoidance Agreements (DTAA), two countries agree that income from various sources that are likely to be taxed in both the countries should be taxed only in one of the countries. Country of source normally taxes the dividend and interest i.e. return for financial investments and royalties and technical services fees i.e. return for technology transfers, irrespective of whether there is a permanent establishment of foreign enterprise in the country of source. However, for taxation of sales income (i.e. business income) in the country of source, it is essential that there be a permanent establishment of the foreign enterprise in the country of source. 6.7 Double Taxation Avoidance Agreements are based on the following principles with regard to residence and with regard to source Taxation based on residence  

Country of residence is the place with which a taxpayer has the closest personal links; Country of residence generally taxes its residents on their worldwide income.

Taxation based on source    

Country of source is the country with which income has the closest economic connection Country of source taxes income sourced in that country Country of source normally taxes dividend, interest, royalty and fees for technical services Country of source taxes business income only when there is a permanent establishment (PE) of foreign enterprise in the country of source, to the extent such income is attributable to the permanent establishment.

Wherever a Double Taxation Avoidance Agreement has been entered into between the Central Government and the Government of any other country, then the provisions of DTAA prevail over the provisions of Income Tax Act. 6.7 In the above situations, the following issues arise   

How is the income to be classified? What constitutes the permanent establishment? How much income is attributable to the permanent establishment?

In the context of e-commerce, these issues represent an emerging area of tax jurisprudence, where the legal positions are still to crystallise.

Guiding principles by OECD for characterisation of income 7.1 One of the basic principles of taxation is the Principle of neutrality. This principle postulates that economically similar incomes, should be taxed similarly. In other words, the same tax treatment should be meted out irrespective of whether a transaction is carried out through electronic medium or otherwise. US Department of Treasury and the Organisation of Economic Cooperation and Development (OECD) are two organisations who have engaged themselves in identifying the problems in the taxation out of Ecommerce, and attempting solution of these problems. Both US Department Treasury and Committee of Fiscal Affairs of OECD have affirmed that 

Principle of neutrality should be observed in the taxation of e-commerce transactions also, and



Taxation principles that guide governments in relation to traditional commerce should also guide them in relation to e-commerce.

But there may be difficulties to enforce the same rules in the taxation of e-commerce transactions, as in the taxation of traditional commerce transactions. The approach of both US Treasury and OECD has been to adopt and adapt the existing principles to the e-commerce situations, rather than to go in for entirely new measures. 7.2 The characterisation of income is relevant because different types of income are taxed differently. Business income of a nonresident is taxable in India on the basis of the concept of business connection enumerated in Section 9(1) of the Income Tax Act. The Supreme Court in the case of R.D. Agarwal & Co. Vs. CIT [56 ITR 20] held that a business connection involves a relation, between a business carried on by a nonresident that yields profits or gains and some activity in India that contributes directly or indirectly to the earning of such profits. It predicates an element of continuity. In other words, there has to be a territorial nexus between the income earned and the business activity in India - Wallace Bros. & Co. Ltd. Vs CIT (16 ITR 240). 7.3 Double taxation avoidance agreements normally refer to the concept of permanent establishment, which in theory is akin to the concept of business connection. The concept of permanent establishment is defined in all DTAA treaties. Because of its definition, it is a narrower concept than business connection. Business connection, for the purpose of Section 9, may be held to have been established through an agent. However, such an agent should be one, who is devoted exclusively to the foreign principal. In other words, the agent should be dependent agent. In such an event, the theory of territorial nexus would be deemed to have been satisfied through the agent. 7.4 If an income arises from sale of a product, it is business income. When all rights in a property (risk and reward of ownership) are transferred, it would amount to a sale giving rise to business income. On the other hand, when only limited rights in a property are transferred, the transferor retaining substantial rights therein, the income therefrom would be  

Royalty in the case of intellectual properties, or Lease rent in case of tangible properties.

Royalty is subjected to taxation on gross basis in the country of source, irrespective of whether there is a permanent establishment or not. 7.5 If the result of a transaction is the rendering of services, the income from such services should be characterised as  

fees for technical services, or fees for professional services.

Fees for technical services are taxed on gross basis in the country of source without the existence of a permanent establishment. Fees for professional services are subjected to tax on net basis (after deducting all expenses) in the country of source only if there exists a fixed base, which is conceptually equivalent to permanent establishment.

Taxation of transactions in software 8.1 As per Explanation (b) below Section 80 HHE of IT Act, „Computer software‟ means any computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program that is transmitted from India to a place outside India by any means. Software is

essentially a computer program. Computer programs are covered by the Copy Right Act 1957. Therefore, software would be covered within the term copy right as defined in Copy Right Act 1957. 8.2 The rights in software are a form of intellectual property. If the entire rights in the software are alienated, then it would amount to sale and the income therefrom would partake the characteristics of business income. If only a limited right in the software (like right to use) is transferred, then it would amount to licencing and the income therefrom would partake the characteristics of royalty. 8.3 Section 9 (1) (vi) of the Income Tax Act deems, inter-alia, the following types of royalty income to accrue or arise in India (a) income by way of Royalty payable by a person who is a resident, except where the Royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or (b) income by way of royalty payable by a person who is a nonresident, where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India. 8.4 As per second proviso to Section 9 (1)(vi), royalty does not include payments in respect of computer software supplied by a nonresident manufacturer along with a computer or computer based equipment. Explanation 2 below Section 9(1)(vi) of I T Act defines royalty as consideration (including any lumpsum consideration but excluding any consideration that would be income of the recipient chargeable under the head capital gains) for “the transfer of all or any right (including granting of a licence) in respect of any copy right, literary, artistic or scientific work including.....” The software should be regarded as a copyright and should be classified as a scientific work for the purpose of Clause (v) of Explanation 2 below Section 9(1)(vi) of the I T Act. 8.5.1 Both, the US treasury‟s approach and the OECD‟s approach to software transactions are based on the concept of copyright. 8.5.2 The US treasury‟s approach - It is determined whether the transfer is of a copyright article or copyright. In the case of the transfer of a copyright article (like that of software CD), it is generally the use of the copy right article which is permitted. Therefore, the income from transfer of copy right article is in the nature of royalty. If the transfer in a copy right article is that of significant benefits and burdens of ownership, then the income embedded in the transaction is considered to be sales income. If on the other hand, only insignificant benefits and burdens of ownership have been transferred, then this is treated as a royalty income. In the case of transfer of copyright rights, all the underlying rights in the intellectual property generally stand transferred. If the transfer in a copyright is of all substantial rights, then the transaction is considered to be one of sale, and the income therefrom is business income. On the other hand, if there is no transfer of all substantial rights, the transaction is one of licencing and the income therefrom is royalty income. 8.5.3 The OECD‟s approach - The OECD in 1998 sought to distinguish the software product transaction from a software copyright transaction. When the transfer is only of a program copy, then this is only software product transaction. In such a case, the consideration for the product would be sale consideration. The income from such transaction will be construed as business profits. When a transfer is that of copyright right, then it is recognised as software copyright transaction. Next it is determined whether what is transferred is a complete right or a partial right. If what is transferred is a complete right, then the transaction is a sale transaction and the income therefrom will be business profits. If the transfer is only of partial right, then the transaction is in the nature of licencing and the income therefrom is royalty.

8.6 It could be seen that both the US Treasury and the OECD have tried to maintain the principle of neutrality. In the Indian context, keeping Section 9(1)(vi) of the IT Act and the definition of royalty under different DTAAs, in view, it would be advisable to first determine whether the purchaser has acquired all the rights of ownership. The benefit and burden test can than be applied to determine the extent of rights transferred. Where significant risk and rewards have been transferred, the transaction may be one of sale and the income embedded therein would have to be business profits. On the other hand, if significant risks and rewards have not been transferred, the transaction would have to be treated as that of licencing and the income embedded would be royalty u/s 9(1)(vi) of the I T Act subject to tax under Section 115A on gross basis. 8.7 The above principles will also apply in respect of income arising from transactions in other digitised information like books and music. The income arising out of the sale transaction of digitised information in the form of software, books and music is to be construed as business profits and would be liable to be taxed in the country of source subject to the existence of a permanent establishment or business connection. The income arising out of transactions in digitised information involving a right to use would be liable to be taxed in the country of source as royalty.

Permanent establishment 9.1 Under the DTAA treaties based on OECD‟s model tax convention, the profit of an enterprise of a contracting State shall be taxable only in that State unless the enterprise carries on the business in the other contracting State through a permanent establishment situated therein. The term permanent establishment is defined in each Double Taxation Avoidance Agreement (DTAA). For understanding the concept of permanent establishment, its definition contained in Article 5 of the DTAA between the United States of America and India can be taken as a model and analysed. The term permanent establishment as defined in Article 5 of the DTAA between USA and India is reproduced below “ 1. For the purposes of this Convention, the term „permanent establishment‟ means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term „permanent establishment‟ includes especially : (a) a place of management ; (b) a branch ; (c) an office ; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources ; (g) a warehouse in relation to a person providing storage facilities for others ; (h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on ; (i) a store or premises used as a sales outlet ;

(j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve-month period ; (k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve-month period ; (l) the furnishing of services, other than included services as defined in article 12 (royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel, but only if : (i) activities of that nature continue within that State for a period or periods aggregating to more than 90 days within any twelve-month period ; or (ii) the services are performed within that State for a related enterprise (within the meaning of paragraph 1 of article 9 (associated enterprises). 3. Notwithstanding the preceding provisions of this article, the term “permanent establishment” shall be deemed not to include any one or more of the following : (a) the use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise ; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or occasional delivery ; (c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise ; (d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise ; (e) the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise. 4. Notwithstanding the provisions of paragraphs 1 and 2, where a person, other than an agent of an independent status to whom paragraph 5 applies, is acting in a Contracting State on behalf of an enterprise of the other Contracting State, that enterprise shall be deemed to have a permanent establishment in the first-mentioned State, if : (a) he has and habitually exercises in the first-mentioned State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 3 which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph ; (b) he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise ; or

(c) he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise. 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm‟s-length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. 6. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other. ” [187 ITR 102 (st).] 9.2 The general criteria for determination of permanent establishment are as under 

Permanent Establishment is a fixed place of business through which business of an enterprise is wholly or partly carried on. [Article 5(1)] Positive lists of fixed places of business viz. a place of management, a branch and an office etc. are given. [Article 5(2)]

Both these clauses require that there should be a geographical link between the enterprise situated abroad and the country in which business is done. Article 5(2) requires that if the business activities are part of a construction or installation project, then it should last more than the minimum prescribed period. Further, the activity of the permanent establishment must directly or indirectly lead to income. If the activities that are too distant from the earning of profits, then such activities could not be equated to carrying on of the business. That is why, negative lists i.e. examples of activities viz. use of facilities solely for the purpose of storage, display, delivery of goods that are of preparatory or auxiliary character are excluded from permanent establishment. [Article 5(3)] 9.3 In order to find out whether the activity would constitute a permanent establishment or not, the following questions should be answered  

Is the activity carried on as a part of the business or is merely preparatory or auxiliary to it? Does the activity lead to income?

If the answers to the above two questions are „yes‟, then there is a permanent establishment. If the answers to the above two questions are „no‟, then there is no permanent establishment. 9.4 The existence of a dependent agent who acts on behalf of an enterprise and who has habitually exercised an authority to conclude contract in the name of an enterprise, constitute a permanent establishment. The main characteristic of a dependent agent is that he should have an authority to conclude contract on behalf of the principal. [Article 5(4)] 9.5 The independent agents like brokers, general commission agents who act as such in their ordinary course of business are not construed as permanent establishment. In such cases, the agent is an agent of other principals as well in his ordinary course of business. [Article 5(5)]

9.6 Companies controlling or controlled by other companies are not treated as permanent establishment for the only reason that the company controls or is controlled by another foreign company. [Article 5(6)]

Permanent establishment in e-commerce 10.1 The network technology including the Internet enables persons to carry on various income earning activities at locations where they were never present. Therefore, the concept of physical location of residence (including permanent establishment) would appear to be meaningless in the context of ecommerce. The place of effective management could be different from the location of operation. 10.2 Internet has no physical presence or location. Web site can be viewed and accessed from a computer anywhere from which information can be downloaded. Computer that stores information contained in the Web site for access by users of the net work, including the Internet is called server. Server also describes the software that makes the process of delivering information possible. 10.3.1 In this backdrop, the following questions are to be addressed  

Whether a web site can constitute a permanent establishment ? Whether a server can constitute a permanent establishment ?

10.3.2 Whether the web site can constitute a permanent establishment - A web site is nothing but data and programs in digitised form, which is stored on the server of the Internet Service Provider. Hence, it is possible to argue that a web site is not a fixed place from which business is carried on. In order to constitute a permanent establishment, there has to be a fixed place from which the business is carried on. This presupposes a certain degree of permanence, but not necessarily a permanent place of business fixed to land, e.g. a floating oil rig in territorial waters may constitute a Permanent Establishment. Therefore, it is very difficult to hold that the existence of web site by itself would constitute a permanent establishment. 10.3.3 Whether server can constitute a permanent establishment - A server is a computer which hosts the web site. One of the basic criteria for the permanent establishment is the requirement of a fixed place of business in the country where the business is wholly or partly carried on. A server being computer based web site could easily be removed from one location to other location. Therefore, it is unlikely that the mere existence of a server would be hold to constitute a permanent establishment. 10.4.1 The concept of permanent establishment deals not only with fixed place of business but also with the place of actual carrying on of the business. Keeping in mind, provisions of Articles 5(2) and 5(3) of the DTAA, determination has to be made as to the nature of operation and the extent of operation carried out through the server in the country of source. 10.4.2 Nature of operation - If the operations carried out by the server is merely for storage and display of information, then the server does not play any direct role in economic activity of the host state. Servers carrying on activities of preparatory or auxiliary nature can also not constitute a permanent establishment, in the light of Article 5(3) of the DTAA. 10.4.3 Extent of operation - If the server has a direct role to play in the economic activity in the host State, then such server may constitute a permanent establishment. For example, if the server acts as warehouse for digitised goods like software books, music through which such digitised goods can be traded, then such a server can constitute a permanent establishment. 10.5 Another relevant question that arises is, whether a smart server is a dependent agent and hence a permanent establishment? A smart server can not only provide information but also process orders from the persons making hits on the web site. One view could be that such a smart server has the power to

contract on behalf of the foreign enterprise and therefore is a dependent agent of the foreign enterprise. Hence a smart server can be held to be a permanent establishment within the meaning of Article 5(4) of the DTAA. A contrary view is also possible, because only a person and not a machine could be a dependent agent. Since the server is a machine, it could not be a dependent agent within the meaning of Article 5(4) of the DTAA.

Income attributable to permanent establishment 11.1 As per Double Taxation Avoidance Agreements, business profits of an enterprise of a contracting State are taxable only in that State unless the enterprise carries on business in the other contracting State through a permanent establishment. If the enterprise carries business as aforesaid, the profits of the enterprise may be taxed in the other State only to the extent attributable to the permanent establishment. The profit attributable to the permanent establishment is determined by imagining the permanent establishment to be an entity independent of the foreign enterprise and dealing with the foreign enterprise at arm‟s length. There are no detailed guidelines in the tax treaties for quantification of profit attributable to the permanent establishment, even in a traditional commerce situation. Therefore, it causes practical difficulties in quantification of profits attributable to the permanent establishment. 11.2 In e-commerce situations, where apart from traditional transactions like sale of goods and provision of services, an array of products and services can be transacted, it would be quite complex to determine the profit attributable to the permanent establishment. Therefore, a simple method like profit split method where total profit between the head office and the permanent establishment is split, may be attempted and included under the Double Taxation Avoidance Agreements for quantification of the profit attributable to permanent establishment.

Other issues 12.1 Money laundering itself is not new. However, introduction of systems, such as stored value cards either alone or in association with the Internet, can open up new ways to launder money. In particular, it may simply make transmission of money easier. At an international level, part of the success of money laundering arises because of banking secrecy laws and the absence of exchange of information between revenue authorities of different countries. All that electronic banking and electronic money eventually may do is to make it easier for those who want to transfer money bypassing the international banking system. Even the US has been unable to entice the Caribbean basin nations to renegotiate treaties to allow greater access to financial transactions. 12.2 Computer money utilising blind signature technology, or other such technology that conceals the identity of the payer, poses a further problem. In a typical scheme using blind signature technology, the issuer will be aware of how much computer money has been issued to a customer, but will not know the identity of the „coins‟. The issuer may be aware that a significant amount of computer money is being spent in some country, but will be unable to link it to the customer. Knowing the identity of the „merchant‟ will not be of much use because of jurisdictional problems. 12.3 It is likely that many of the existing „tax haven‟ countries will capitalise on the improvement in international communications infrastructure and bandwidth, and will attempt to become major players in the Internet economy. The cost of establishing a Web shop is not prohibitive - even less to relocate one to another jurisdiction - with the result that many Web shop owners will be tempted to set up operations in such jurisdictions. This will result in a significant loss of revenue from „mainstream‟ jurisdictions. For the same reason, on-line banks and other payment providers may be established in such tax havens, with the result that revenue collecting authorities will be unable to have access to vital information. 12.4 Finally, the Internet is expected to provide a high level of mobility for Internet businesses, highly skilled labour and capital. This is expected to result in tax driven migration of businesses to the Internet, and of the Internet businesses to low tax jurisdictions.

Future trends 13.1 E-commerce is poised to take off in a big way. In this scenario, there are three areas to consider



 

The Internet is not bound by national boundaries, and if the cost of compliance is made too onerous, the owner of a Web shop may consider moving the business overseas to a low tax jurisdiction, with the resultant loss of revenue to India. Such a move could be carried out with comparatively little effort. Even if the Web shop owner decides to keep the Web shop located in India, potential buyers may decide to purchase from an overseas Web shop where tax compliance reporting may not be as stringent, and hence where purchasing could be carried out with greater anonymity. This would result in a loss of revenue to the local Web shops as well as to the exchequer. The Internet payment schemes are currently being introduced to handle „micro payments‟, which may be very low. These are likely to be unaccounted systems. These payments schemes are new and the industry is still immature. Until critical volumes are reached, it is possible that the cost of logging of such low value transactions may approach the value of the actual transaction itself, and this may stifle industry development.

Conclusion 14.1 With rapid expansion of the Internet, global e-commerce is going to assume a major dimension. The opportunities through e-commerce will be available to both large corporations and smaller entities, without restriction of any geographical boundary. Apart from the traditional transactions like sale of goods and provision of services, there will be an array of products and services. 14.2 Recently the US treasury has released a White Paper on the Federal income taxation of global ecommerce. It has reiterated that the concept of neutrality in taxation should be maintained. In other words, it requires that the tax system treat similar income equally regardless of whether it is earned through e-commerce or through traditional commerce. According to this paper, source based taxation would lose its rationale and will be rendered obsolete by e-commerce. It notes that the current concept of permanent establishment and business connections were developed in a different era. Since almost all the taxpayers are residents in some State, it advocates a shift from source based taxation. 14.3 Any shift from source based taxation to residence based taxation would result in diminishing revenues for developing countries like India. This is because:  

Developing countries like India are likely to be big consumer of the goods offered by sellers in the developed countries and Developing countries like India are doing exceedingly well in the field of technology, particularly in computer software. It may not be desirable to levy some sort of presumptive tax like bit tax or poll tax on e-commerce transactions because that would not be a tax on income.

14.4 In this context, taxability of the income from e-commerce transactions like electronic transfer of digitised information of books, music, computer software etc. may have to be statutorily defined and the entire gamut of taxation laws and DTAAs may have to be reviewed.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – IV

CHAIN STORES AND RETAIL FRANCHISING

CHAIN STORES, SUPER MARKETS, etc. Introduction 1.1 The concept of super markets / chain stores is fast catching up in India. Even out of the way small towns now boast one or two super markets. The idea of organised retailing which is behind the concept of super markets / chain stores has gained currency and popularity. 1.2 The principal characteristics of organised retailing are    

centralised procurement and distribution system; effective control over cash and credit card sales; uniform / unified administration and management; and effective inventory control.

A proper understanding of each of these aspects is necessary for embarking upon any meaningful investigation. For facility of reference in this paper we will refer to the super market / chain store as the concern.

Procurement and distribution 2.1 The concern running chain stores or super markets normally has a centralised system of procurement and distribution. It directly procures from the producers / manufacturers / suppliers and makes bulk purchases. The producers offer hefty cash discounts and turnover incentives for the bulk purchases. The concern also enjoys reasonable credit period of, say, one month or so for its purchases. This enables it to sell the goods at less than the marked price / maximum retail price. The sales are either in cash or by credit card. Considering that credit card collections are also normally received within a day or two, practically no credit is extended by the concern to the customer. In view of the above, the concern

does not need any significant working capital or assistance. The centralised procurement and distribution system provides economy of scale in purchases and operations for the chain stores. 2.2 Giving franchise to outsiders is another developing phenomenon in this line of business. By giving franchise, the financial risk is passed on to the franchisee. The arrangement is based on written agreements. The concern ensures continuous supply of goods to the franchisee. It allows him the use of its name. The entire supplies to the franchisee‟s store is made by the concern. The concern gets commission from the franchisee.

Control over sales and stock 3.1 Another important characteristic of the concern is the proper and efficient distribution of goods to its outlets and internal control mechanism over the stock. Usually, about 60 per cent of the sales are by way of cash sales and the remaining 40 per cent by way of credit card sales. Most chain stores adopt computerised cash handling system whereby foolproof control is exercised over the cash collections. 3.2 The proportion of credit card sales is steadily going up. Credit card collections are received in just a few days‟ time. Hence, practically there are no trade debtors in the books. In other words, the concern is not likely to have any major account receivables in its books. 3.3 Effective internal control system to monitor credit card sales collection and accounting of commission due to the credit card agency enables these concern to have surplus cash fund and to secure additional return and also to prevent any malpractice. 3.4 These concern adopt computerised control mechanisms to have proper control of the stock and inventories including packing materials and other sundry items. This effectively checks pilferage by employees.

Uniform / unified system of management: 4.1 These concerns have a uniform and unified system of administration. All sales outlets are made to adopt the same standardised pattern. In areas like trading, billing, accounting and packing uniform procedures are followed.

Income through show windows and displays 5.1 These concerns receive considerable rent from consumer product companies for displaying their products in the show windows. The rent received varies according to the location at which such windows are displayed. Consumer product companies give incentives to these concerns for their employees wearing the former‟s logo on their uniform. In some cases uniforms are supplied by the consumer product companies with their logo free of cost. In addition, additional discounts are given on their products for display of their logo. Whether the incomes from renting and displaying of show windows are properly accounted for and whether proper documentation is available for these transactions - these are the questions that should be asked and found answer to. 5.2 The main modus operandi of these concern is large procurements at heavily discounted prices and sales to customers at prices less than the marked price / the MRP / the local retail price. The discounted prices offered by these retailers attract a lot of custom, huge sales and big profits.

Areas for investigation

6.1 Discounted purchases - These concerns deal directly with the principal suppliers or manufacturers. Since purchases are made in bulk, the cost is low. In addition, the supplier gives cash discount and also turnover discount. These concerns gain substantially from these discounts. They enjoy large discounts and benefits from branded consumer items. It is a matter for investigation whether the discounts received are duly accounted for in its books. 6.2 These concerns procure at a discounted price. It also gets fairly long credit period for its procurements. Hence, their working capital requirements are meagre. Some of the suppliers could be shown as trade creditors in the books. As a normal practice, all trade creditor accounts should be scrutinised. 6.3 Suppliers normally do not charge interest from these concerns. The interest account needs scrutiny to rule out the possibility of any inflated claim of interest. 6.4 These concerns get dealership commission for bulk purchases. Such commission can go unaccounted. To examine this aspect, the sales promotion account of the suppliers have to may be scrutinised.

Accounting of commission 7.1 Generally, these concerns deal directly with the principal supplier on bulk basis. Hence, any commission payment to any intermediary is unlikely. However, some companies claim expenditure on this account. This is not the normal trade practice. Hence, scrutiny of such claims is called for. 7.2 Commission payment to credit card agency is a normal occurrence. The concerns do hard bargaining with the agency to keep the commission low. The commission varies according to the volume of sales. The higher the volume, the lower the commission. Reconciliation of accounts with the credit card agency‟s books may throw up some interesting points.

Manufacture or purchase 8.1 There are several cases where these concerns also manufacture items which are in great demand. Items like various varieties of papads and pickles, traditional sweets / eatables (like snacks, sprill-o-sprill), powders like dal powder, sambar powder, idli mix, dosa mix, snacks and condiments fall in this category. Some of these items are so good that they enjoy tremendous brand loyalty and customer confidence. These items are handmade. Only the input and labour costs are incurred. In order to depress the taxable profits the concern may resort to the subterfuge of showing the manufacture as purchase from the labourers. Such labourers for the sake of mere wages give sale bills. Huge margin / profit is earned by supermarkets on this account. The AO should be alert to this possibility. 8.2 In some instances these concerns themselves grow / produce items like rice, chilies and tamarind. Some concerns purchase the items straight from farmers at low prices. As the sale price is not likely to be lower than that in other shops, their profit margin on these items is bound to be higher. In view of the above, purchases and sales of items like rice, wheat, chilies and tamarind need scrutiny.

Malpractices in sales 9.1 These concerns have to issue bills for every sale. This is necessary for their credibility and internal control. Still, all the sales effected may not find their way into the sales register or cash book. 9.2 Manipulation in billing machines is also a possibility. In cases of such manipulation two sets of sales reports are generated. One report reflects the actual sales made in a particular day. The report shows

lower sales according to the concern‟s convenience. The second report is taken for the purpose of regular sales and entered in the regular books of account. 9.3 In certain concerns it was noticed that though there were billing machines, handwritten bills were issued often. Such hand bills were prepared on small chits of paper and were not recorded in the books. This practice is followed in some outlets, which are manned and controlled by close relatives of the management.

Volume of business 10.1 The turnover is huge in chain stores. These concerns thrive by the sheer fact that they sell more. Big turnovers mean big turnover discounts from suppliers. It should be verified whether the discounts are disclosed in the books. 10.2 The increased turnover gradually leads to expansion. More units and more outlets come up. For instance, in Chennai, Vitan has grown from a handful of shops initially to 17 shops in two years‟ time. Subhiksha, another supermarket chain has opened 45 units all over Chennai in a matter of four years. This is indicative of the size of profits earned in such enterprises. The Assessing Officer may keep this in mind.

Genuineness of claims 11.1 These concern often advertise and offer sizable discounts to customers. Many of such discounts are never given under some pretext or the other. Nevertheless, in the books such discounts are claimed as expenditure. Similarly, several gift schemes are announced without even the slightest intention of being put fulfilled. The AO should examine thoroughly the claims of discounts and gift schemes before allowing the expenditure. 11.2 These concerns also offer gift schemes during festive seasons. Gift items received from suppliers are sometimes sold outside the books after the expiry of the gift scheme period. Investigation of the suppliers‟ accounts may help in bringing the escaped income to tax. 11.3 Advertisement is a major item of expenditure. But, these concerns do no necessarily bear the entire expenditure. Often the supplier chips in to bear the whole or part of the expenditure. Cross verification with his accounts may bring to light any bloated claim of advertisement expenditure on the part of these concerns.

Telephonic orders 12.1 Some of these concerns take orders over telephone and deliver the goods at the customer‟s doorsteps. Generally separate accounts are maintained for this purpose. The concern may choose not to bring these sales into the books. This aspect should be kept in view and the relevant order books perused to rule out the possibility of omissions.

Inflation and suppression 13.1 Like every other business concern a super market also may resort to inflation of purchases and expenses and suppression of sales. Such attempts should be tackled in the same way as in a normal business case.

Other issues

14.1 A major area for investigation in cases of supermarkets and chain stores is stock discrepancy. These concerns make bulk purchases of commodities like wheat, rice, pulses and cereals and repack them in smaller quantities to suit consumer needs. The concerns have evolved foolproof control systems to prevent theft and pilferage. The AO should ascertain the exact system setup by these assessees, and make use of the same when he makes investigations. He should also see whether packing materials, cartons and other sundry items are reflected in the closing stock. 14.2 In view of the large number of items dealt in, it may be difficult to verify the stock with the concern. But, it is not impossible. Verification is always possible with reference to the closing stock inventory which the assessee itself would have taken by the year end. Getting the concern committed to its real stock as per its inventory is a tested way of tackling stock manipulations. This can be achieved by survey u/s 133A or enquiry u/s 142(2) soon after the year end.

DISCOUNT RETAILING What is Discount Retailing (DR ) 15.1 India is an extremely price-sensitive market. The marketing strategy that pays here is to compete on price. Packaging, shop displays, air-conditioning, piped music are all secondary. Indian customer is partial towards low prices. This penchant for value shopping has given a boost to discount retailing. 15.2 DR can take on many forms. Rent a hall. Display your wares. Announce good discounts. Minus the trappings of a super store or the friendly permanency of the neighbourhood grocer, one would expect the venture to fail. But, no. The sale clicks. If the quality of your wares are any good, you make good sales. For an existing retailer DR opens up new avenues. If he goes for new premises, he would have to pay huge rent. He would have the tensions of running it all the time. With a hall, there is just the cost of renting the hall and advertising. That too, for short periods of his choice. Such sales could be held in different areas and cities. There are even retailers who operate almost entirely in this mode. They simply shift between hired halls in different parts of the city. They rely on ads and mailing lists to keep customers informed of this constant, peripatetic sale. 15.3 Any manufacturing process, no matter how good, throws up reject goods. They cannot be sold as first-quality products through showrooms. They need to be sold at some price. This is achieved through a seconds sale or a factory outlet. „Seconds‟ also include perfect products that cannot be sold because of excessive stock or lack of demand in those sizes, or close outs which are the products on the shelves but which have gone out of fashion. They can be sold through sales or dedicated seconds outlets. The latter course is preferred by the companies because it disposes of the products in an organised and continuous way. There are de facto „seconds‟ shops and areas in most cities. 15.4 „Sale‟, as DR is ordinarily called, has already shown its strength. A well known book store‟s „sale‟ in Mumbai in a hall not far from the store this year fetched nearly 4,61,000 visitors over 15 days and added significantly to the shop‟s turnover. The shop is considering more sales in the year and holding them in different areas or other cities. An innovative retail format put through by some Chennai-based concerns has proved a great success. Through a combination of bulk purchasing, streamlined inventory management, low overheads and aggressive marketing, they manage to allow 10-15 per cent discount on nearly all their sales. They effect savings from supply-chain integration and use the savings to fund investments in developing large retail formats like supermarkets or pass them on to the customer in the form of discounts. 15.5 The mainstream marketers do not rate DR highly, at least not yet. They do not view it as a proper retailing channel. The informal atmosphere of a „sale‟ puts them off. There are fears of DR sales undercutting the brand. Their reasons : In DR there are difficulties in estimating size. DR ventures are impermanent („sales‟, fairs). They are mere waste disposal enterprises (seconds outlets). Often, they are on the fringes of legality (grey market shops). Maybe there is some substance in this belief, but there are

overwhelming reasons recommending DR. DR is a format that does not need prime locations or plush interiors. It still attracts in customers. The success is due to two factors - one, economic (lower prices) and, two, psychological (the satisfaction consumers get from a bargain). It may not be a bargain at all, but the customer feels it is. Besides, the Indian housewife needs the reassurance of having made savings to assuage her feelings of guilt at spending. DR does this trick. 15.6 The fast moving consumer goods (FMCG) market is facing threat from both counterfeit products and pass -off products. Counterfelt products are fake products. They bear identical names, packaging, graphics and colour scheme. They even have the genuine manufacturers address printed on. They are like fake currency notes. Pass-off products are look-alikes of genuine products. They use names which sound similar or are similar in spelling. The counterfelters have grown versatile making it difficult for consumers goods industry opines that „the counterfelt and pass-off products trade has reached critical levels and the size and severity of counterfelting in India has no parallel‟. It is seen that in the sphere of DR, especially in the form of hall sales, pass- off products are being sold in large numbers. Thus, while the unsuspecting consumer is taken for a ride, the genuine product manufacturer is cheated of his market share.

Outlook 16.1 International discounters may use discounts to revolutionise the Indian market. The Indian discounters like Subhiksha of Chennai claim that they are already doing that. Informal channels of sales and related activities represent a DR sector that is already well-entrenched and highly successful. They are increasingly taking on a formal status. Markets for export-reject clothes or grey market goods like Chennai‟s Burmah Bazar are now permanent and important sources for goods. Local laws registering hawkers and informal shops and international treaties like the WTO which lower import duties thus giving legitimacy to grey market products are all favouring DR. From all angles of size, importance to customers, competition to legitimate players and now even legal status, these channels have emerged as viable entities. Manufacturers who had been sceptical about a discount channel now see it as a strategic opportunity. 16.2 Innovative DR has good potential. In just 4 years the Chennai group Subhiksha has grown to be formidable with 83 outlets across 12 cities with a turnover of 12.3 crores per month. The other groups are planning discount formats aimed at small retailers and large family customers. Hypermarkets with a large store offering a wide range of products at value prices and the cash and carry format are getting ready. But it is not roses all the way. The success stories have all been in the metros with their large base of affluent customers. Smaller towns with less affluence are bound to be, and in fact are, more pricesensitive. The DR sellers are already finding the going tough in small towns. 16.3 Coming to tax implications and investigations, many of the „hall-type‟ discount retailers are really small people making a living out of the „sales‟. Any detailed investigation may not be necessary in such cases. In the more organised cases, similar investigations as in the cases of other retailers‟ may be conducted. However, it should be kept in mind that in DR cases the usual norms regarding profit margins cannot be applied. Here, the profit margin is bound to be low. The profit lies in the large turnover. The investigative effort should be in the direction of determining the turnover. In the case of counterfeits and pass-off goods, investigations at the manufacturer‟s end will help develop the cases of both the manufacturer and the retailer. Initial information about the identity of the manufacturer is to be gathered through enquires with the retailers, through.

TELESHOPPING AND DIRECT SALES Trends in retail marketing 17.1 In fast moving consumer goods sector (FMCG sector), the business model is built on marketing and distribution strengths of a company. Normally these companies out source the products which they sell

and confine themselves to brand building and creating efficient distribution channels. A lot of efforts and money are required for these activities. 17.2 An innovation in the model is to sell products to consumers on one to one contact basis. The existing FMCG companies can not enter this area because of their contracts with distributors. In India, this concept is pioneered by Realvalue who sold their hand held fire extinguishers through direct selling. They have employed sales personnel who directly met consumers and sold fire extinguishers to them. Other models which came into vogue in this area are „teleshopping‟ and „direct selling / multi level marketing‟. TSN („Tele-Shopping Network‟) is a pioneer in „teleshopping‟ concept and „Amway‟, „Modicare‟ have pioneered „direct selling / multi level marketing‟ concept.

Teleshopping 18.1 The model is built on reaching the consumers through advertisement on television networks. The success of the concept depends on ensuring that the product (which is given a model number) is available only through teleshopping and cannot be bought in neighborhood retail shops. A telephone number is given through which the company can be contacted and on receipt of an order, the product is door delivered. 18.2 In teleshopping model, the products are out sourced from various manufacturers. An exclusive arrangement is entered with the manufacturer that the products can only be sold through the teleshopping network. The cost at which the product is to be sold to the teleshopping network is also predetermined. The teleshopping network then adds its margin and keeps the product on its network. Teleshopping is also understood to mean shopping through telephone. An exclusive model did not develop in India as practically every retail shop provides such teleshopping service. 18.3 The main expenditure for a teleshopping network is the advertisement cost, warehousing cost and delivery cost. To minimise the advertisement cost, non-peak hours bulk time is booked on TV channels. This expenditure can be verified with the concerned TV channel. Warehousing is generally in cheap real estate as no shop front needs to be maintained and the premises is primarily for storing goods. This expenditure can also be verified. Delivery cost will have a correlation with the number of items shipped. 18.4 With the advent of Internet and e-commerce, teleshopping is suffering a set back. The basic disadvantage of teleshopping is that time when the product is shown on a TV channel is fixed and if the program is not watched at that particular time, there is no scope for orders. The Internet on the other hand is accessible at any time and at any place.

Direct selling (multi level marketing) 19.1 This model is built on making the consumer a distributor. A person signs up with the company (there may be a joining fee), buy a set of its products and start selling them to people. On the way, the person also recruits other salespersons who in turn are encouraged to recruit more salespersons. As more and more persons join the scheme, a pyramidal structure of sales persons will develop with the first person at the top. Commission is paid to the person on what he sells and also on what the pyramid under him sells. There are certain incentives and bonuses on reaching certain targets. Amway, Oriflame and Modicare are some of the pioneers in this line. 19.2 At Amway, 15 per cent commission is paid on what is sold by the sales persons. For every Rs 30 of sales, one point value is given. Once somebody gets 200 points a month, he will be entitled to incentive commission. The incentive commission is over and above the normal commission and varies according to the sales. For example, on sales of Rs 72,000 a month, an incentive commission of 12 per cent and on sales of Rs 3,00,000 a month, an incentive commission of 21 per cent is paid. The company organises training sessions and other get togethers to train its members in methods of selling.

19.3 Thus, it can be seen that these companies do not spend much money either on advertisement/ brand development or on building distribution network. The initial products launched by these companies were all high priced and were exclusive products. For example, Oriflame launched a face cream which was priced over Rs 300 i.e. more than four times as expensive as the nearest product in the market. Of late, certain companies like Quantum Marketing have entered the fray. They are selling products of day to day use like soaps, toothpastes and even pickles and sambhar powder at rates comparable to normal market rates for comparable products. 19.4 Like any other FMCG company, these companies also out source their products. The main expenditure for these companies is the commission payments to members. The commission system and incentive system of these companies should be studied properly so that correlation can be arrived between quantum of sales and the commissions shown as expenditure. It is also a fact that some of the member-dealers of these companies make good money. These member-dealers are normally ordinary middle class people who may not be in the tax net. A list of the member-dealers should be collected and passed on to officers of concerned jurisdiction which will help in widening the tax base.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – V

NEWSPAPERS AND JOURNALS

Introduction 1.1 Newspapers and Journals generally being profit making ventures constitute an important segment of the national economy. A „newspaper‟ is defined in Indian Press and Registration of Books Act, 1867 {hereinafter referred to as PRB Act} as 'any printed newspaper,.....a daily, a tri or bi-weekly, weekly, fortnightly or a publication which appears at longer intervals‟. The word 'journal' or „magazine‟ has not been separately defined under this Act. The definition of newspapers is an inclusive definition and the same is applicable for journals also. „Other periodicals‟ are those having periodicities other than daily tri/bi-weekly, weekly, fortnightly, monthly, quarterly or annual.

News gathering

2.1 As is well-known, newspapers begin their function by gathering information relating to occurrence of events of interest to the public through various means. Normally, news is reported by various agencies such as UNI, PTI, CNN, BBC and so on to the newspaper, more or less on a continuous basis. The telephone lines in the newspapers office receive these messages continuously. They are printed on a printer and stored in personal computers (PCs). Similarly, messages are received from foreign correspondents, private correspondents (many of whom freelance), and from correspondents who are the employees of the newspaper.

Printing 3.1 The bulk news is thus collected, segregated and the printouts are handed over to the editorial department. In this department, the news is edited and sent to the press. After proofreading it goes for printing. 3.2 The entire process of news-gathering and printing has been revolutionised with the advent of computers and network connectivity. Earlier teleprinters having auto-printing / manual typing facilities were in use for receiving of news from various sources. Nowadays, computers are used for receiving and storing the information received through telephone network. From the editorial department the edited news is sent to the Pagination Section, where different pages are being made, literally. With the use of computer programs, the process of page-making i.e. accommodating articles, advertisements and photographs in a page has become simple and quick. Similarly, technology has enabled publication of multi-location editions with minimum infrastructure. With the advent of the Internet, most of the leading newspapers and journals are now available on the net, in the form of web sites.

Circulation 4.1 „Circulation‟ is defined as average number of copies sold and distributed per publishing day. A newspaper with a circulation of more than 75000 copies per publishing day is a „big newspaper‟, one with a circulation between 25001 and 75000 copies per publishing day is a „medium newspaper‟, and a newspaper with circulation upto 25000 copies per publishing day is a „small newspaper‟. 4.2 While it is indeed a great achievement of the newspapers that they provide up-to-date printed news for the reading public, it remains a fact that newspapers are published with a profit making motive. A wellbalanced newspaper or journal is one that makes a distinctive appeal to a large following of readers because of its ability to provide the latest and most authentic news and well-written editorial content. The circulation of a newspaper thus depends on its popularity and reach. The more popular a newspaper, the larger its circulation in turn, the greater its fertility as an advertising medium.

Advertisement and other revenues 5.1 The major part of the income of a paper is derived from advertisements, sale of newspapers constituting a minor portion. In fact invariably, newspapers and magazines are being sold at less than the cost of production and the difference is contributed only by advertisement revenue. No wonder then that newspapers endeavour to get as much advertisement revenue as possible. 5.2 The main sources of income of newspapers are thus, advertising revenue(i.e. sale of advertising space), circulation (sale of newspapers), and miscellaneous incomes (such as sale of syndicated articles and features, sale of waste newspaper, drums, unused ink, aluminium plates, etc.).

Expenses 6.1 The important heads of expenditure of a newspaper may be classified as follows:

    

Editorial cost Advertising cost (cost of soliciting and producing advertising copy) Cost of printing Circulation cost Establishment and other administrative expenses

Agencies concerned 7.1 Two important bodies regulating the functioning of newspapers and journals in India are the Registrar of Newspapers for India (RNI) with headquarters at Delhi and the Audit Bureau of Circulation Limited(ABC) with headquarters in Bombay.

Registrar of Newspapers for India (RNI) 8.1 The Registrar of Newspapers for India (RNI) appointed under the Press and Registration of Books Act 1867 is located at West Block-8, Wing No.2, R.K.Puram, New Delhi-110 066. It has branch offices at Bombay, Calcutta and Chennai headed by Assistant Registrars. The RNI maintains a register of newspaper in India and also issues a certificate of registration to publishers. The PRB Act lays down the following functions for the RNI    

Registration of newspapers, Keeping a watch on the regularity of publication, Obtaining from publishers annual data on circulation, ownership and other matters, and Compilation of an annual report on the press in India.

8.2 Registration of newspapers - Any person interested in starting a new newspaper (daily or periodical) first contacts the District or Sub-divisional Magistrate within whose jurisdiction the proposed newspaper is to be printed or published and files a declaration before him in prescribed form, for verification of title. After due enquiry the Magistrate forwards the declaration/application to the RNI for verification of title. After verification the RNI intimates the result to the Magistrate. On confirmation of availability of title by RNI, the publisher should file another declaration with the Magistrate containing details of the publication. Once this declaration is authenticated by the Magistrate the first publication of the issue has to be brought out within a prescribed time. Once the first publication has been brought out a copy of it along with other documents should be filed along with an application for registration of newspaper to the office of the RNI. The RNI after due verification of the documents grants the certificate of registration containing a registration number to the newspaper.

Functions of the RNI 9.1 Verification of circulation claims - As per the PRB Act, the Press Registrar or any gazetted officer authorised by him, shall have access to any premises and to any relevant records or documents relating to a newspaper. In accordance with the above provisions of PRB Act, the Press Registrar can conduct verification of circulation claims of any newspaper registered with the RNI for any year. The verification of circulation claims is done by the RNI either by spot verification of relevant documents and information or by calling for the prescribed documents. Spot inspections are normally carried out by deputing Circulation Officers for the purpose. If the claimed circulation is found supported with the required documents, the assessment letter is issued to the publisher indicating the assessed circulation for the year under check. The result of verification of circulation claims is intimated to the publisher, the DAVP, concerned state government and the newsprint section of the RNI. 9.2 Every publisher has to submit to the Registrar, an annual statement in respect of each newspaper published by him in the prescribed proforma on or before the last date of February each year in respect of the previous calendar year. Where the circulation of the newspaper exceeds 2000 copies per publishing

day, the certificate of actual circulation from a Chartered Accountant has to be furnished along with the annual statement. Non-submission of the annual statement is a penal offence under PRB Act, 1867. 9.3 The Registrar has to submit to the Government each year an annual report on the state of the Press in the country on the basis of annual statements received by him and information obtained otherwise. 9.4 Besides the above statutory functions, the RNI scrutinises the applications for the import of items like printing and composing machinery and graphic art film required by a newspaper. The RNI advises the Chief Controller of Imports and Exports (Ministry of Commerce) regarding the import of such machinery from the essentiality point of view only. 9.5 Earlier, the RNI was vested with the powers of allocation of newsprint to newspapers in accordance with the parameters contained in the Newsprint Allocation Policy in force. This power was vested in the RNI by the Joint Chief Controller of Imports and Exports and Ministry of Finance. However, with the deregulation of import of newsprint following the liberalisation of the economy, the RNI is no longer vested with this power.

Audit Bureau of Circulation (ABC) 10.1 The Audit Bureau of Circulation (ABC) with headquarters in Bombay is a nonprofit making body set up in 1948, represented by the newspapers owners on the one hand and the advertisers and the advertising agencies on the other. These sections have their representatives in equal proportions on the ABC‟s Council of Management. 10.2 The important function of this co-operative association is to prepare and furnish accurate reports of publication and circulation. It makes comprehensive audit of newspaper concerns. Advertising agencies choose newspapers for placing their advertisements on the basis of circulation statistics furnished by ABC. The ABC‟s audit reports throw considerable light on the activities of any particular concern and act as a check on its purchases, stock of newsprint, circulation figures, etc. Wherever necessary, the ABC issues instructions to the newspapers for compliance.

Industrial segments 11.1 The newspaper industry can be grouped into three major segments   

Major national newspapers and journals which are highly profitable Major regional and vernacular newspapers / journals that are either moderately profitable or at least, manage to keep themselves afloat. Small newspapers / journals which are finding it very difficult to operate owing to stiff competition.

The AO should bear in mind the above business segmentation of newspapers and journals / magazines.

News paper on the net 12.1 It was originally feared that television would be a major challenge to the printed paper and would replace it as the principal advertising medium. These fears have vanished. Though television has made inroads into the advertising domain, the newspapers have held on the their own. The share of the newspaper is nearly 50 percent of the total adspend in India. With the onset of internet, a web-based newspaper is becoming a distinct possibility. A net paper is likely to pose a bigger challenge to the printed

paper that the television. The economics of such a newspaper will have many favourable points. A net paper can be run at a fraction of the cost of the printed paper. The saving will be on many items, the chief among them being the newsprint. The circulation costs will dwindle drastically. The net paper will have several advantages. It will be search-based. By keying in the search word, the reader can find the story. A news story once hosted stays on farever. The net paper can be updated round the clock. There is no constraint of space for that paper. The net paper can travel considerably beyond news and provide valueadded services. The net papers will give delivery of news a new dimension and change the way in which news is transmitted. It is too early to comment on the tax issues that may arise in this business.

Tax Investigations 13.1 Manipulations in newsprint - 13.1.1 Earlier, the allotment of newsprint to magazines was made through quotas fixed by the RNI based on past consumption of newsprint. Because of this stringent regulation, a number of malpractices were resorted to by both big and small newspapers :  

Smaller newspapers used to obtain inflated allotment of imported newsprint through bogus consumption figures. The excess newsprint was sold by them to other newspaper clandestinely especially to bigger newspapers at inflated rates. The newspapers were by law required to use certain percentage of indigenous newsprint. However, it was more advantageous to use imported newspaper due to better mileage. Hence, bigger newspapers used to sell indigenous newsprint allotment in the form of scrap sale, etc., in the market and substitute the same with imported newspaper clandestinely procured as above.

13.1.2 Following deregulation of imports, this requirement was withdrawn in 1996-97. Initially, the import of newsprint was placed under the open general licence (OGL). Since this led to indiscriminate imports, it was later modified to permit imports only by actual users. Hence the above malpractices have considerably decreased and the newspapers have freedom to plan the import and consumption of newsprints. Now, the quality of indigenous newspapers has also improved with the arrival on the scene of newsprint mills like Tamilnadu Newsprints Ltd (TNPL) and Mysore Paper Mills Ltd. As a result, the newspaper industry is sourcing more and more of its newsprint requirements indigenously. 13.1.3 There is competition between local mills and the foreign suppliers in terms of pricing. Initially when import was deregulated, there was no import tariff at all. Since the foreign suppliers resorted to dumping in the Indian market, on representations from the local newsprint industry, the Government levied a nominal tariff of 5.5 per cent. In spite of the depreciation in value of Rupee, and tariff, the foreign newsprint is able to compete with indigenous newsprint by reason of its landed cost being lower than the indigenous newsprint due to better GSM (gram per sq.mts.), better quality and lesser wastage. The implication of better GSM is that imported newsprint is considerably thinner than locally manufactured newsprint and hence gives a larger page area for the same weight. 13.2 Inflation of circulation figures - 13.2.1 With the advent of electronic media there has been a big shift of advertisements from newspapers and journals to TV, because TV is an audiovisual medium having a mass reach and appeal even for illiterate minds. Perhaps the only advantage of advertising in newspapers is the retention value of the advertisement. 13.2.2 Owing to competition from television and other newspapers for the same advertisement cake, newspapers and journals resort to inflation of circulation figures for ABC purposes. In such a situation, the excess newsprint shown as consumed is sold as such without being printed. The proceeds thereof is utilised for paying up the value of the inflated sales through the news agency network. The whole mechanism is so fine-tuned right from the manipulation of production and consumption records that it is very difficult for any audit team to detect it. By and large this is done not for reasons of tax evasion but to ensure the survival of the newspaper. In case of doubt it would be advisable for the AO to coordinate with

the RNI as well as with ABC and arrive at the correct figure of circulation of the particular newspaper or journal. 13.2.3 Newspapers often inflate their circulation figures to enhance their advertisement receipts as the advertisement rates depend not only on the prestige of the paper but also on its circulation figures. Besides due to competition some papers resort to drastic cuts in their cover price to maintain and boost their circulation. This is particularly so among the national dailies. The result is that the ratio of the cost of production including commission, etc. to returns from sales of the paper could be as high as 4 :1. In such a scenario there would be serious tax implications if the newspapers choose to inflate their circulation figures. The corresponding production costs of such inflated sales is set off against other incomes without being actually incurred, thus reducing the overall tax incidence. 13.3 Excess claims of wastage - 13.3.1 Earlier, showing excessive wastage on newsprint and realising it without bringing it into the books used to be an important source of black money for newspaper concerns. However, with the advent of sophisticated machinery and advanced printing technology, the actual percentage of wastage has come down. The main factor forcing the newspapers and magazines to cut down wastage is the pressure of competition from other newspapers and magazines. It is noteworthy that newsprint constitutes about 40 per cent of the cost of production. These days, as a cost reduction measure, the magazines themselves try to minimise their wastage. 13.3.2 Gradually, the percentage of newsprint cost in the total revenue has been increasing due to the fact that the increase in newsprint cost is not matched by the increase in the cover price of the newspapers. Moreover, newspapers are sold at less than the cost of production and the difference is made up by advertisement revenue. It is no longer worthwhile to compare newsprint cost vis-a-vis total cost of production and vis-a-vis sales revenue from the sales of newspapers. Hence it is not worth its while to attempt any addition on the basis of excessive wastage unless there is a glaring discrepancy in the wastage claimed as compared to earlier years figures. 13.4 Suppression of advertisement revenue - These days due to stiff competition, most newspapers and journals are unable to charge for the advertisements at the rates fixed by them in the tariff card. Invariably, discounts are allowed to advertising agencies. While discounts may be given to regular customers, the same may not be the case when it comes to casual / non-repetitive advertisements. For such advertisements, the newspaper charges the higher rates mentioned in the tariff card. However, this practice can be used by the newspaper to suppress its advertisement revenue by projecting as though the concessional / discounted rate alone was charged from all the advertisers. 13.5 Malpractice through agency network - 13.5.1 Inspite of the fact that small magazines are not profitable operationally, more entrepreneurs are starting such magazines. One reason is that, if they have unaccounted money, they can make use of this opportunity to legalise it under the pretext of agency deposits without any tax consequences. Assuming they have 500 agents enrolled for their magazines, perhaps 100 could be bogus agents in whose names credits will be shown as agency deposits. 13.5.2 Another malpractice that is often resorted through agency network is of allowing rebates / discounts for unsold copies and incidental expenses. Many of these rebates / discounts may turn out to be bogus and done only with an intent to reduce the sales revenue. In all such cases it is necessary to obtain copies of the accounts in the books of the agents and also obtain confirmation from them with particular reference to the credit notes issued in their favour by the magazines. 13.6 News gathering expenses - Senior and experienced editorial personnel have become rare in recent times. The remuneration payable to them has skyrocketed. Because of their indispensability to the magazines, they demand payments without any tax liability. The magazines disguise these payments as news gathering expenses. Similarly, there could be violations of the TDS requirements envisaged in Section 194-J in respect of payments to freelance contributors / reporters and honorarium paid to authors.

13.7 Employee cost - The terms of remuneration of all the newspaper staff (both editorial and others) are covered by wage boards constituted by the Government once in four or five years. The latest wage board award is the „Manisana‟ award. In these awards the wage boards classify newspapers into different classes based on revenue earned and fix the scales differently for each class. Since there is always a time lag between the notification of these awards, they are given retrospective effect. Newspapers find it difficult to pay the arrears for all the back years in the year of notification. Whenever such extra liability relates to basic and DA portion, it has implications of PF and ESI liability and some of the AOs are disallowing such PF and ESI payments u/s 43B. This aspect also has considerably increased the percentage of employee cost to the total sales revenue.

Ratio analysis 14.1 Like in other cases, in cases of printers and publishers of newspapers also investigations of accounts can be done fruitfully by making a ratio analysis of major heads of income and expenditure for a particular assessee for a period of, say, two or three years. This analysis would indicate the area of specific investigation required and also the business trend. For basic understanding of ratio analysis a reference may be made to the relevant chapter in Volume-I of this manual. 14.2 In the cases of printers and publishers of newspapers it is not possible to give a specific ratio on any particular aspect as each of them may have varying degree of technological support for their businesses. However, the major areas of ratio analysis can be as under Ratio of advertisement income viz. classified - casuals and regular, matrimonial etc. The Assessing Officer may call for column rates for each class of advertisements and the total columns used for advertising for a particular day and the same can be multiplied by the total number of the days and see whether the advertisement income is in proportion to the admitted income.        

Consumption of paper issue-wise (i.e. Edition or magazine-wise) and issue-wise percentage of wastage of consumption of paper News gathering expenses Editorial expenses (production costs for editorial content) Advertising expenses (cost of soliciting and producing advertiser‟s copy) Mechanical expenses (production costs for composing, and press rooms) Circulation expenses (cost of delivering and billing newspapers sales and maintenance of circulation volume) Commission paid and or rebate allowed / claimed Employee expenses

It would be fruitful to analyse the major expenditure claims under the head cash payments v. cheque payments also. This analysis would throw up enough clues to choose the line of investigation.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter - VI

PRINTING AND PUBLISHING INDUSTRY

PRINTING Introduction 1.1 Printing has played a major part in the development of the human civilisation. The great strides taken by the humans in the recent centuries are attributable in a significant measure to the advent of printing and the consequent spread of knowledge. Today‟s printing is a sophisticated process. The finish of the product is also very different from that of yesteryears. 1.2 The printing activity is in three stages: (a) pre-press (b) press and (c) finishing. The „pre-press‟ stage of the activities consists of typesetting; scanning; film processing; and plate-making. The „press‟ stage is the actual printing work. The third stage is the finishing stage from which the final product emerges after stitching and binding.

Pre-press processes 2.1 Typesetting is the first stage. The process has graduated from mechanical typesetting of yore to photo typesetting and now to desktop publishing (DTP). In photo typesetting, photographic method is used to transfer the type image into a medium like film or bromide paper. Photo typesetting is the cheaper process for high volume books with a lot of graphics and colour printing. The technology has advanced from the first generation when magnetic tapes were used for images to the fifth generation where laser is used for transfer of images. 2.2 DTP is a recent innovation i.e. 1986. It involves the use of microcomputers to produce publications which previously required traditional publishing technology. Now, typesetting is done mostly on DTP systems. The process derives its name from the fact that, with the basic hardware, one can produce a publication on the table, without ever needing to go near a typesetting factory or a printer. 2.3 Due to low price of its equipment, DTP enables production of books which would have been too costly to produce using the old technology. DTP is used in all aspects of production in the publishing industry, i.e. writing, designing, graphics and typography. DTP is versatile. It allows an individual or an organisation to print copies of its own publication on the desk top or to produce „camera-ready art work‟ as the basis for traditional printing. Earlier, production of such work required a team of people to put it together. The time taken was large. There was more likelihood of errors. With the DTP technology, a page of a book can now be produced in a matter of minutes. There is no need for a compositor. The originator can lay

out the pages of his publication the way he wants them to appear. He can have a greater degree of control over the final product. He can quickly and cheaply test different designs to produce a variety of trial pages. DTP software facilitates mixing of text and graphics and mixing of English with Indian language(s). The software can easily be integrated into a network solution which helps to share information, files and printers with other terminals / nodes in the network. Software with Indian languages is available locally. Short-run books and manuals, magazines and newsletters for a small circulation are now feasible. DTP enables magazine editors to test their ideas out, producing near typeset quality pages. This enables greater creativity and a wider range of design being put into practice. DTP products excel in their appeal and readability. DTP is paving way for a major revolution in business communications. Computer electronics and laser have given simple solutions and better options to the customer at the prepress stage. 2.4 The pre-press processes use both local and imported machinery. For scanning, while table top scanners are locally made, drum scanners for high quality reproduction have to be imported. For film processing also the equipment used - vertical cameras and negative processors - are locally available. Similarly, plate exposing and developing equipments are also available locally. 2.5 In modern printing processing houses play a major role. The equipment needed for high quality printing is expensive. A single printing press cannot afford to have all of them. Besides, it does not need to own them also. The capacity of the equipment is so large that a fraction of it would be sufficient for a single printer. Here, processing houses play their role and fill a felt need. They have the expensive equipment needed for modern printing. The printers go to them for meeting their processing needs. The processing houses supply banners, inputs for hoarding, slides and CDs for presentation, with the use of digital printing. 2.6 The arrangement between the processing house and the printer is generally based on the standard terms. The processing house charges at rates per sq. cm. for processing. The unit for charging quantity is the number of proofs. The terms which prevail now are likely to change with the arrival of the dry proof system. More number of proofs at a nominal cost or even for free will be possible with that system. In case of other technologies the cost per extra proof may go up. Processing houses presently charge sales tax at 8 per cent in Tamilnadu on their supplied inputs (which are inputs for their customers). From the input supplied, printers make their own image-carriers (e.g. offset plates) or get them made again by another trade house like a plate making unit.

The press stage 3.1 The press stage of the work is the actual printing activity. Printing machinery of various sizes are manufactured locally by manufacturers like Auto print, Manugraph, Swift Machines and HMT Ltd., to name a few. Printing machinery is also imported either as rebuilt (secondhand) or as new on actual user licence.

The finishing stage 4.1 Finishing stage involves processes like cutting, perforating, side and centre-stitching, laminating, punching, creasing, folding, section-sewing and perfect binding. For all these processes machinery is available locally. However, computerised cutting machines and specialised binding equipments have to be imported.

Order procurement 5.1 Orders are initially received through personal contact. By continuous and personalised servicing, orders keep coming regularly from clients. Walk-in jobs are only of a small nature, like visiting cards, invitation cards, etc. Orders may also be received by successfully quoting for tenders. Sometimes,

because you are specialised in a particular kind of printing, e.g. cinema posters, customers come for single-job printing. Otherwise, it is usually jobs emanating from regular and satisfied clients which keep a printer going. 5.2 In the case of bulk printing like calendars, picture posters and greeting cards, „agents‟ are engaged. They go far and wide and procure orders. Calendar work is in a class by itself. Thousands of copies of particular pictures are printed in bulk. Then in smaller lots details of particular enterprises are overprinted depending on orders. In this process both the printer and the particular enterprise are benefited. The enterprise is able to get the calendars at a much less cost. There are also „jobbers‟ who do not have any printing facilities, but who canvass jobs using their personal contacts. Thus, there are four ways in which a printer gets orders, i.e.. directly, or through regular clients by way of purchase orders, or through agents, or through jobbers.

Order processing 6.1 Procurement of raw materials - Frequently used paper and board are usually kept in stock. As and when large requirements arise, paper is procured locally from distributors / dealers of manufacturers. When large quantities of paper are needed, say, for printing balance sheets or books, order is placed directly with the paper mill through the local distributor. The same pattern is followed for purchase of inks, plates, chemicals and binding materials. 6.2 Printing and supplying - The job docket specifies the date of delivery, based on which planning takes place. The pre-press activities are completed and the job scheduled for printing, finishing and supplying. Typesetting may be done internally or externally; but scanning and film processing are usually done externally. This is because the equipments needed are expensive and owning them is not cost effective for a single unit. Plate-making is usually done internally and so also binding and finishing, unless some special requirement like lamination or gold-foil stamp is required.

Payments 7.1 Printing is almost always done on credit. Credit runs through the system. Only for very small one-time jobs, customers pay immediately. The credit period varies from 30 days to, sometimes, even 120 days. Raw materials are bought on credit. Typesetting, scanning, film processing and even binding and finishing services are bought on credit. Units having working capital limits with banks are able to pay faster, but on the whole, the market credit for all services range from 15-90 days. Payments are usually made and received in cheques, except for very small one-time jobs.

Accounting 8.1 A printer has to maintain accounts in order to ascertain his cost and billing and to get adequate control of operations. Besides the usual financial books of original entry, he normally maintains the following books     

Order book Stock account Daily docket cards Daily production register Job card sheets

8.2 The order book contains a chronological record of printing jobs undertaken. The stock account contains detailed accounts of items consumed during the printing process like ink, paper, binding and other material. The daily docket cards are meant for keeping the record of work done by each individual worker. The daily production register is compiled from daily docket cards. It is maintained job wise. The

job sheets contain summary of daily production and details of individual operations. The purpose is to exercise proper control over employees and to have an idea of profit or loss in the course of working.

Outlook 9.1 A long running battle is going on in some states between the Sale tax departments and the printers, on the issue whether printing involves sale of goods and thus attracts sales tax liability. The contention of the printers is that it is merely execution of a work contract. They deny any liability to sales tax. In Tamilnadu, the Sales tax Department is of the view that printed material produced to individual specifications of customers amounts to goods sold. It levies 8 per cent sales tax. This levy is said to have introduced considerable amount of uncertainty and confusion and flight of business from such states to neighbouring states where such levy is not imposed. 9.2 The outlook for the business is neutral. Spiraling paper prices is a major factor affecting the business. It is claimed that the printers are not able to give firm quotations for job works and are losing on the jobs and contracts already accepted. The solution offered includes import of the maplitho and cream wove varieties of paper and reduction in customs duty on all varieties of paper. Another solution given is removal of the ambiguity surrounding the industry to state clearly whether it is, or is not, one of execution of works contract.

Tax investigation 10.1 Like in any other business, in this line also, the orders received may be understated, receipts suppressed and / or expenses inflated. There may be cases of collusion between the person placing the order usually a publisher and the printer. These aspects may be checked by reference to the original records like order book and job cards and by cross-verification. The consumption of ink, paper and stores may indicate the number and extent of the orders executed. The inflation of other expenses can also be verified by looking into the details in the original records. 10.2 In printing, as already indicated, processing houses play a major role. A printer gets many things done from a processing house. It is worthwhile to check whether the service charges paid are reasonable. Here also cross-verification may yield results. 10.3 In a case of search u/s 132 at Delhi, the officers found that the assessee who is both printer and publisher has been constantly indulging in unaccounted purchases of paper, ink and other printing material. The assessee was also doing job works in printing and binding, a good chunk of which it kept outside its accounts. The AO should check any printer‟s case for the above activities. A detailed discussion of the case is given in para 18 of this paper as a case study.

PUBLISHING Introduction 11.1 Book publishing is a business activity with intellectual orientation. In India it has two major streams Indian languages publishing and English publishing. Book publishing in English is a major commercial activity. This is because the Indian „reading classes‟ are essentially English-oriented. They are the ones who can afford buying books. They buy and read English books mostly. The English book, even if published in India, has worldwide market. As compared to this the language publishing activity is smaller, and appears to be less profitable. The exceptions are text book publishing and newspapers and periodicals. 11.2 The business of publishing English books in India can be divided into three categories -

  

Publishing of books by Indian authors Publishing in India of books written by foreign authors (for Indian consumption) and Publishing in the export processing zones in India of books written by foreign authors for export.

The first two types had been here for long. The third type is now catching up. 11.3 A publisher may have a printing press of his own and may be printing his books himself. But this is not common. Most publishers do not have any printing press of their own. They have arrangements with printers and get the books printed in those presses. 11.4 The main raw material in this line is paper. There are three major types of paper - Snow white paper; Ordinary white paper; and News print. The choice of paper depends on the type of publication intended. Though it is not common, recycled newsprint is also sometimes used for printing cheap, inexpensive books.

The process of publishing 12.1 To start the business of publishing licences from the police department and from the Sales tax department are necessary. The first step in publishing activity is the receipt of manuscript from the author. The publisher has an editorial board which goes through the manuscript to decide its merit and marketability. The fact that the script had already been serialised in magazines or newspapers makes the decision easy. In the alternative, the publisher may engage a reviewer on payment. 12.2 The review by the reviewer or the editorial board is an important process. The purpose of the review is chiefly to assess the quality of the work in relation to the readers for whom it is intended. The other purposes include ensuring that the script is free from major mistakes and obtaining suggestions for improving the script. If the reviewer is not paid well, the review may be indifferent and superficial. It may not achieve the intended purposes. 12.3 After the editorial board / reviewer decides in favour of publishing the material, the publisher negotiates the terms of the publication with the author including the royalty. The royalty may be fixed or may be variable as a percentage of the sales. In language publishing normally 10 to 15 per cent of the proceeds is the royalty given to the author. Where the matter to be published is more than a hundred years old no royalty needs to be paid. Certain works or works of certain authors may be nationalised by the government. In that event the royalty is paid by the government to the owner(s). Any publisher could now publish it / them without any royalty obligation. 12.4 The copyright usually rests with the author. He makes over the right to publish a particular edition to the publisher and gets royalty in return. There may be cases where the author may part with the ownership itself of the work for a lumpsum payment from the publisher. This enables the publisher to bring out as many editions as he might choose without having to make any further payment to the author. 12.5 The publisher fixes the price of the book taking into consideration various factors. The demand for the title, the popularity of the author, the quality of the paper used, the targeted audience etc. are major factors. Raw material cost, royalty, printing expenses, marketing expenses and sales prospects are also reckoned. Economy of scale operates in pricing the titles. If the demand is more the price can be fixed low. Reprints generally cost less. The difference between the paperback edition and the deluxe edition is too well known to be discussed at any length. The margin of profit in this line, especially in language publishing, is claimed to be low - as low as 10 per cent.

Marketing

13.1 Publishers having their own sales outlets are not many. The marketing is done largely through retail booksellers. The publisher allows trade discounts of upto 30 per cent to retailers. The retailers get copies from the publisher on credit and settle accounts when sales are effected. They may retain unsold copies for sometime anticipating sales. If the expected sales do not materialise such copies are returned to the publisher. The returned copies pose a major problem as they are bound to be soiled or damaged. Their storage and their selling are both difficult. 13.2 Pre-publication schemes are prevalent in this line. In Kerala such schemes are very popular and many titles are brought out under the schemes. Usually, an advertisement is made in newspapers and magazines about the proposed publication and the terms of the pre-publication concession. The prospective buyer is expected to register his name by a specified date and pay the reduced price in advance either in one lump or in installments. This enables the publisher to get an idea about the demand for the title. It also gets him the sale proceeds (though discounted) in advance. This reduces the interest burden and also the demand on storage. 13.3 Government is a major buyer of the books published in a state. The bulk of its purchases are for the public libraries run by it. In Tamilnadu, the Director of Public Libraries is the authority making the purchases. A committee functions in the Directorate for selecting books for the libraries. It screens the titles received and makes the selection. The Printing and Stationery Department of the state government fixes the rates at which the books will be purchased. In Tamilnadu the current rate is Rs. 2.10 for 16 pages of printed matter. It looks strange but the rate fixed is without any reference to the content or merit of the book. 13.4 Book exhibitions are occasions when sizable sales are effected. Book lovers throng these exhibitions and buy a large number of books. The discounts offered at the exhibitions make book-buying an attractive proposition. The publisher himself may participate in the exhibition or ask the retailers to take part with his (the publisher‟s) titles. The concept of book exhibition as a major social event is catching up in cities and big towns. This augurs well for the publishing industry.

Textbook publishing 14.1 The quality of textbook publishing in India is decidedly poor. Substandard quality paper, inferior printing, shoddy binding, etc. make the Indian textbook markedly inferior to its western counterpart. The books published by medium and small publishers are particularly found wanting. Poor quality paper, inelegant jacket, inferior printing and bad binding are the hallmarks of these books. The inexpensive college books are priced in the range of Rs. 50 - Rs. 100. They are designed to last just a year or two. This helps the publisher in that there is demand for new books every year. 14.2 Reputed publishers who publish quality books do well in this line. The student community provides an assured and large market. If the publisher is careful in selection of the author and in ensuring the quality of the book, the market responds favourably. 14.3 Among the medium and small publishers, the people who are successful are those who publish syllabus-based textbooks for target student population. Their success is attributable to the fact that - the price of the book is low; its language is simple; it strictly covers the syllabus with no additional material; and it contains easily identifiable answers for the questions usually asked in the examinations. 14.4 Photocopying has come to affect the business greatly. The prohibitive prices of standard textbooks have driven the students to this measure. Whole books or portions thereof are copied at a fraction of the cost. This obviates the need for buying the book.

Outlook

15.1 The publishing industry is passing through difficult times. Even though literacy is on increase, readership is shrinking. TV and Internet have affected reading habits of the public. Light magazine reading has almost replaced serious book reading. Glossy magazines with colour photos pose danger to books. Cost of publishing is high. Advertisement on TV is beyond the dreams of even the most affluent publisher. Storage is a major problem. The returned unsold books can be sold only at a great discount or as waste. The publishers find it difficult to get loans from banks. Printed titles are not usually accepted by banks as security. They accept unprinted paper, not the printed book. Often, there are „bruising battles‟ among authors, publishers and booksellers over the revenue from slow-growing book sales. 15.2 The publisher has to get almost all items of work like composing, printing and binding done on contract basis from outside. He has to allow margins to the contractor / printer. He has to recover this from the sale proceeds of the book which may take months to materialise. The above problems besetting the publishing industry cry for early solution.

E- books 16.1 Electronic books involve digital publishing, distinct from conventional publishing. They were canvassed in the West as books of future. A hope was cherished that electronic books will open up new markets much in the same way as paperbacks did half a century back. Books were brought out on computer discs with interactive features. Now, this enthusiasm has waned as consumers have not shown much interest in reading on screen. Digital initiatives of major publishers so far have been losers with heavy expenditure on technology and no matching sales. A realistic picture is slowly emerging. 16.2 Possibilities with e-books are immense. Publishers can now print books in their warehouses from digital files and sell electronic editions to interested readers on the Internet. They can cut out printers and booksellers. Authors can sell books directly to consumers freeing themselves from the hold of publishers. Booksellers, on the other hand, may put on the mantle of publishers. They may print digitised books themselves and sell their own electronic editions. They may sell the contents of books through digital archives of numerous books and also periodicals available online. 16.3 The digital books have one major risk. They will be entirely at the mercy of hacks and pirates since they will be circulating over the Internet. This paves way for technology companies to come in as middlemen with software and services to store and transmit digital books, offering protection from copying. This is a role similar to that of distributors of traditional books. 16.4 How to price an e-book ? - Some publishers are charging just below a printed copy of the same book. Certain others are charging hardcover prices. The position is yet to stabilise. The same is the position with regard to how much to pay to the author. The solutions lie in the future.

Tax investigations 17.1 The persons so minded resort to concealment of income by inflating expenses, underreporting the receipts or suppressing a part of the business altogether. They may even resort to all the three methods. The expenses to be especially checked are the cost of inputs, printing charges and royalty to the authors. Claims of discounts should be checked for possible inflation. Understating the sales or stock is possible. The agreed terms for sales of book between the publisher and the booksellers should be studied to see whether the accounts are in tune with such terms. In suspicious cases cross-verification with booksellers should be done. Book-wise quantitative tally may help in locating stock discrepancies. 17.2 Concealment of income has been noticed in certain cases of text book publishers. The large volume of business allows scope for large scale manipulations. In a case of one such publisher a search u/s 132 in Chennai revealed that the assessee was indulging in inflation of purchases through bills not supported by actual delivery of goods. This was in purchase of paper used for printing text books. The assessee and

the paper supplier colluded in the bogus transaction. The action proved that the assessee consciously inflated purchases through bogus bills. Such bogus purchases came to Rs. 225 lakhs during the period April 1992 to March 1995. The modus operandi was that bills not supported by actual supply of materials were raised by the supplier. The assessee issued cheques for the billed amounts. Thereafter the supplier withdrew cash and paid the assessee after deducting his commission for the accommodation. 17.3 Major booksellers import foreign books and sell them at the printed price. In foreign countries, storage and shelf space are expensive. Unsold copies of books are discarded after some time on the shelf. When a later edition comes out the copies of an earlier edition of a book are usually sold away by the publisher as waste paper. An Indian importer sometimes finds in this a good opportunity to make money. He buys the discarded copies at the scrap rate, imports them into India and sells them at the printed price as if they are new. The import is often over-invoiced to be in accord with the printed price. The inflated purchase price is either retained abroad and spent there or brought into India through other means. Even some reputed booksellers are engaged in this activity. 17.4 Making himself familiar with the trade practices will enable an AO to embark on meaningful investigations. Information is power, not only in the technological sense but also in the conventional sense.

Case study 18.1 In a recent case of search u/s 132 at Delhi the officers found that the assessee, a major publisher, was resorting to both unaccounted purchases of printing material and unaccounted sales of books. It was also doing job works of printing and binding outside the accounts. Nearly 40 per cent of its turnover went unrecorded in the accounts. The money received against the unaccounted sales in the form of cash, cheques and drafts was deposited in a bank account not disclosed to the Department. The unaccounted sales benefited the assessee in two ways - it could save on taxes. It could also avoid royalty payment to the authors referable to the unaccounted sales. Royalty was at ten per cent of the total sales of the books. The royalty was paid only on the accounted sales. 18.2 The assessee‟s modus operandi was as follows: It would receive orders from the party interested in cash purchases without proper bills. It would supply books on the basis of invoices made, as per the rate prevalent on that date. The invoices would be sent along with the books to the buyers. They would not be posted in the books. The price would be received in cash which would go unrecorded in the books. The amount would be deposited in the undisclosed bank account. Such unaccounted receipts would be utilised for making unaccounted purchases chiefly and in a smaller extent for withdrawals relating to the personal and household expenses of the partners. 18.3 The assessee was maintaining duplicate sets of books including duplicate sets of sale bills. It was making duplicate sets of entries in the computer - one set pertaining to regular transactions and the other to the unaccounted ones. The unaccounted set was shielded by a password. It was not accessible through normal commands of the accounting software. Only shortcut keys assigned separately to the duplicate commands could open the unaccounted transactions. The assessee was maintaining the following books for the purpose of controlling the unaccounted transactions: A) Cutting register - The register was divided into different columns like date, invoice no., name of party, place, amount and remarks. Whenever any payment for unaccounted sales was received by the assessee, the corresponding bill number and the party number was struck through. The remaining portion showed the outstandings from the buyers.

B) Party ledger - This contained the names of the parties with the debit and credit entries. The debit entries reflected the unaccounted sales and the credit entries, the payments received against them. C) Invoices with same numbers - Invoices with same numbers had been used on different dates. The numbers printed on the invoices were not serially marked. Different sets of unaccounted bills were prepared with the same invoice numbers. This showed that the assessee indulged in the practice of unaccounted sales with invoices dubiously indexed. 18.4 The assessee had made unaccounted expenditure. It pleaded ignorance about the whereabouts of the recipients. The plea was not accepted . The reasoning was that the assessee had been enjoying the services of these parties for printing and binding and had been making sizable payments to them. The transactions involved transportation of stock of books to and fro their premises. Delivery challans bearing their addresses were a mandatory requirement. Hence the AO was requested to locate the addresses and assessment particulars of these parties and start proceedings under section 158BD.

Imported books 19.1 This is about booksellers, not publishers : Quite a few of them import foreign books and sell them at the printed price. In foreign countries, storage and shelf space are expensive. Unsold copies of books are discarded after some time on the shelf. When a later edition comes out the copies of an earlier edition of a book are usually sold away by the publisher as waste paper. An Indian importer sometimes finds in this a good opportunity to make money. He buys the discarded copies at the scrap rate, imports them into India and sells them at the printed price as if they are new. The import is often over-invoiced to be in accord with the printed price. The inflated purchase price is either retained abroad and spent there or brought into India through other means. Even some of the reputed booksellers are said to be engaged in this kind of activity.

Conclusion 20.1 Making himself familiar with the trade practices will enable the AO to embark on meaningful investigations. Information is power, not only in the technological sense but also in the conventional sense.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – VII

MOTION PICTURE INDUSTRY

Introduction 1.1 The cinema industry, engaged in production, distribution and exhibition of motion pictures, has over a period of time, acquired notoriety for tax evasion. There is no financial activity in the entire sequence of film production, distribution and exhibition which is free from manipulation of accounts and records to evade taxes and convert white money into black. Most of the major players in this industry, i.e. the producers, directors, actors, playback singers, financiers, distributors and exhibitors participate in this in some way or the other, as there is no stigma attached to dealing in black money. Indeed, the practice of making and receiving payments outside the regular books of accounts is often insisted upon by many of the major players. The assessment of various persons and concerns engaged in the cinema industry is thus a real challenge to an Assessing Officer. 1.2 The nature of business in film industry is undergoing far-reaching changes in recent times due to technological and other reasons. It is now possible for a producer to first sell theatrical rights of his film, then sell its music rights, television rights, cable rights, home video rights, DVD rights, Pay-per-view rights, broadband rights and so on. 1.3 Entertainment is perhaps the only business in which India is now a global player at least in volume terms. Every year we produce over 700 feature films, over 5,000 hours of original TV software, and 15,000 music titles that are exported to over 70 countries. Over 14 million cine-goers go to 13,000 theatres everyday, yet India has only 7 cinema seats per 1000 population. Thus, there is a paucity of cinema theatres that has the film Industry in a financial bind. High entertainment taxes, rising maintenance costs and real estate prices mean theatre owners either charge exorbitant rentals or face losses. Because the rents are huge, films fail to recover costs and consequently the distributors lose money while producers don‟t find buyers. One of the solutions thought of is the multiplexes, where in one large compound there are several auditoria (called screens) each of a varying capacity. Depending upon the kind of film, the distributor can release it in a 100 seater cinema or 1000 seater theatre. Another trend is to construct such other attractions as food courts, bowling alleys, and pool parlours even shopping malls alongside the modern cinemas each cross subsidizing the other. These developments are expected to give new lease of life to film exhibitors and producers as well.

Producers 2.1 Producer is the pivotal person in the production of a film. It is he who conceives the idea of producing a film and who plans takes the steps required to coordinate the varied activities necessary for completing the job. Some producers also have their own studios where their pictures are shot. They let out the Studios on hire to others, when they do not require these for their own shooting. Some producers direct their own pictures too, and / or act in them. However, the usual practice is for a producer to engage a director and other artistes for producing a picture. Some producers also have regular technical staff while others employ them only on a contract basis for producing a particular picture. In short, while some

producers are businessmen making films as part of a lasting enterprise, others are merely fair weather birds attempting to cash it on a good thing. 2.2 A producer has to provide the necessary finance for a picture. It is, therefore, his financial interest which is, ultimately, at stake. In view of the highly uncertain nature of this trade, the profit earning capacity of a picture varies considerably and real. Only about 15% to 20% of the films produced in a year become hits at the box office, while 20% to 25% make average earnings. Remaining films i.e. 50 - 60% flop. The speculative nature of the business is well-known. Therefore, due to the uncertain returns, producer normally by try to invest only a minimum of their own funds. A major portion of the funds required is obtained from the market, either by borrowing from film financiers and or by taking advances from distributors, to whom the distribution rights for the exhibition of the film in various territories are contracted to be sold. However, only a producer of repute can sell the picture in advance of production. The selling price of the distribution rights in different territories in advance depends upon the story, the cast, and the past successes or failure of the main persons concerned (producer, director, artists). Obtaining a fair price in advance also depends upon the perceived ability of the producer to release the picture by the date announced earlier. This capacity, in turn, depends upon his financial standing, and on his equation with the „stars‟. Except in the case of well known producers or the pictures with top star casts, it is very difficult for other producers to sell their pictures in advance to distributors. In such an eventuality, the capital has to be obtained from private financiers, that is, those who are regularly engaged as film financiers or other money-lending sharks. The rate of interest is also very high, sometimes it can go upto 40% to 80% p.a., partly in white and mostly in black. 2.3 For producing a picture in colour the minimum capital required nowadays is in the range of Rs. 4-5 crore, and upwards. In view of this the souse of capital invested by the producer has to be scrutinised in detail. Since the production of a picture normally goes beyond a year the accounts of the entire period of production are required to be examined, especially the explanations for the borrowings, as sometimes the funds of the producer himself may be brought into the accounts in the guise of loans, in bogus names. There may be hawala entries, as also bogus credits to be offset by bogus debits by way of fictitious expenses. Finance agreements with film financiers and others, and the securities given for obtaining the loans must also be scrutinised properly. No important borrowing should be accepted without foolproof evidence. There are instances where loans have been indirectly obtained by producers in the names of concerns in which they or their family members or relatives are interested. Large amounts are withdrawn by the producers from the funds of these concerns to finance unaccounted expenses and on-money payments required for production. 2.4 Often such advances are neither reflected in the accounts of the lender nor the borrower. Large cash balances may continue to be shown in the books of the lender though they might have been utilised for the purpose of advance. These amounts are later repaid by the producers from on-money received from the Distributors. This method is resorted to because the financiers are often afraid to come on record as having financed a film, even if they have accounted funds, as there is a tendency amongst persons who have amassed “out-of-books” profits in other businesses, to invest in the film industry on account of a desire for quick and easy profits. It is, therefore, essential to verify the borrowings of connected concerns in their books during the period of production and find out their actual utilisation. 2.5 Even in respect of loans which prima facie appear genuine, it is necessary to examine the finance agreements and to ascertain from the creditors, particulars of the security given by the producer and his near relations. It is commonly known that security of only a first charge or lien on the negatives of the film is unsafe and risky. Consequently, a creditor advancing finance binds the producer for something more substantial, such as the mortgaging of jewellery or real estate etc. When the producer is a limited company, personal and other securities of the directors and their relations are usually be obtained by the creditor. 2.6 The capital raised in the black market, to meet the ever increasing cost of production, is not recorded in the books of accounts of the producer at all, because he does not want to disclose its utilisation. Consequently, a part of the expenses incurred on production is omitted. For instance, the expenses on

location shooting or the shooting of the stunt scenes are either fully or partly omitted. A part of this black money is utilised to pay „on money‟ to the artistes, studio owners and others. This aspect of tax-evasion is essentially different from the suppression of income through the inflation of expenses. This can be revealed only if a complete tally of the production schedules of a producer is prepared with the help of cuttings obtained from the film industry magazines wherein, as a part of publicity, details of visits by film units to various locations, the construction of special sets there, the hiring of crowds and of the other arrangements made by the producer for his artists and others, are given. All this is written about by journalists who are taken to the locations and entertained lavishly by the publicity department of the producer.

Records maintained 3.1 Account books, like cash books, journals and ledgers, etc., that are maintained by any trader or manufacturer, are also maintained by a film producer. However, some records which are particularly necessary in this line of business, have also to be maintained. These are  

     

Stock Register of raw film - This contains day-to-day entries of receipts and issues, as in the case of any other stock register maintained for other commodities. Script Book - This contains particulars of the scenes to be shot on any particular shooting date, the location, and the actors participating in the shooting, etc. The Continuity report, usually given by the Assistant Director gives details of all the scenes actually shot on any particular day and the length of the raw film utilised. A scrutiny of this will enable the AO to find out if the raw film stock issued has been properly accounted for or expenses for shooting have been claimed without actual shooting having taken place. Time Table - This gives particulars of the studio, the name of the picture, and the number of hours for which a studio is hired or put to use. This helps in checking the correctness of the studio hire claimed. Film Editor‟s Report - This shows the total length of the shots rejected, as also the sequences of approved shots. The consumption of raw film claimed can be verified with reference to this register also. Laboratory Registers - These gives details of the footage of negatives, positives and sound films processed for particular picture. Call Sheets - These contain details of the artistes, junior artistes and technicians engaged on any particular shooting day. Rehearsal Book - This contains details of the artistes participating in the rehearsals, together with the details of the scenes shot. Statement given by Controller of production : The production Controller makes the necessary arrangements for shooting. For every day of shooting he also has to give an account of what has taken place. A scrutiny of this statement will therefore, reveal all such details.

With the help of the above records it is possible to have a check on the consumption of raw film and the other expenses claimed by the producer.

Production expenses 4.1 Often producers want to understate their expenses so as to utilise their undisclosed funds particularly in films which do not do very well. In such a case there is no benefit for the producer to incur all the expenses out of disclosed funds (generated out of income on which tax stands paid) and then to claim business loss in respect of the film particularly when by its very nature the business is so uncertain. 4.2 The main channel of concealment of income in the case of producers, however, is through the inflation of production expenses. This is particularly so in respect of the films which do large business. To

a great extent this inflation is, also, necessitated by his having had to pay large sums of money in black, to leading artist over and above the amount of remuneration shown in their contracts. The inflation of production expenses is also necessary to take out funds from books, for making unaccounted interest payments to financiers. Moreover, personal expenses of the producer, and his family members are often debited to the production expenses. It is, therefore, essential to examine the various expenses claimed for producing a motion picture. 4.3 Consumption of film - Consumption of negative film can be checked from the shooting report which mentions daily progressive totals of footage exposed, as also from the bills for processing charge raised by laboratories. The Censor Certificate also states the length of the finally released, the number of prints of the film as well as of its trailer. The distribution agreements give the number of prints and trailers, which the producer has stipulated to deliver to the distributors. Thus, the claim for the positive film consumed can be fully checked from this record, the laboratory bills and the editor‟s report. The producer can be called upon to prove the genuineness of any excessive consumption. Films, both negative and positive, are in short supply and high prices for them are therefore obtainable in the black market. Normally the ratio of final footage of a movie to total exposure is 3:1. For example, if the producer wants to produce a movie running to 15,000 feet, the Director requests the producer to make available to him 45,000 feet of raw stock. This is a rough and ready method to verify the extent of consumption of film. There is also a popular notion that eminent Directors expose more number of reels in order to attain perfection. Similarly an experienced actor requires lesser footage than a new comer. 4.4 Set decorations, costumes, and outdoor shooting Expenses - The claim for expenses on costumes, jewellery, sets and outdoor shooting has to be examined in the same way as any other major outgoings of a business. It is interesting to note that genuine purchases are mostly on credit, and the whole amount is claimed as deduction according to the mercantile system. Yet even till the time of assessment some of the bills might have remained unpaid and their recovery become barred by limitation. It is therefore, advisable to insist on a certificate from the producer that the production expenses provided for and claimed have been fully paid. A meticulous scrutiny of cash purchases and credit purchases will, then be helpful in singling out bogus expenses many of which will be detected under this head. Enquiries with Costume directors and Set assistants, for the role played by them and the expenses incurred on such items may prove useful. There are restrictions for shooting at public places and the permission of the State Government is required to do so. The State Government charges a fee which may vary from state to state for each day of shooting. An equal amount is also tendered as deposit. Information may be gathered from the Department of Publicity and Information which normally sanctions such shootings at public places. 4.5 Remuneration to actors, actresses and other artistes - 4.5.1 As regards the payments to celebrated artists, there are regular contracts between them and the producers. Any “on money” is paid to them by inflating expenses under other heads. Manipulation is also possible in the payments to extras and junior artistes. Such payments should, therefore, be subjected to a detailed check by referring to callsheets, rehearsal book and continuity report. If the information contained in these records is properly cross-verified, bogus claims of payment to artists can be found out. The payments to Junior artistes, the payments are often made through Agents of junior artistes Association. It will be useful if enquiries are made from such agents & association to verify the remuneration received on behalf of the junior artistes. In one case, the Directorate of Investigation at Chennai, gathered information from the “Stunt artistes association‟, that many producers had omitted to show payments made by them to stunt artistes, in their books of accounts. Occasionally a few junior artistes may be called and examined on oath. Another cross-check that may be made in the case of payments to junior artistes is to find out the total footage in the picture in which each artist appears and compare the rate of payment with that for some other well known junior artists, who also appear in the same picture. It is also advisable to check the expenses claimed on mob scenes, battle scenes, storm scenes, and trick scenes etc. by the film editor‟s report, the shooting report and the script, as in many cases the scrutiny may reveal that such scenes were not in fact shot, but were only purchased from dealers in “stock shots”. While examining the cases of these dealers which are mostly low income cases, a list of producers to whom stock shots were sold should also be obtained.

4.5.2 Excessive and bogus payments to orchestra / musicians is another common device to manipulate „on-money-payments‟ to popular playback singers and music directors. It may therefore, be useful to call for the rehearsal book of the music director, which contains particulars of the songs or music recorded, along with the number of musicians employed for that purpose. 4.5.3 Often producers claim a huge staff of “assistants” in various departments among their monthly paid staff. Many of these may only be on paper. One test to apply is to see whether income tax has been deducted at source where the alleged salary exceeds the exemption limit. Another is whether their names have been given as employees to Shops and Establishments Department of the Municipality and the Provident Fund Authorities, etc. Further, the absence of an assistant‟s name on the screen as well as in the booklet of a film might lead to a reasonable presumption that he did not genuinely render any services. The comparison between the emoluments of those whose names appear in the publicity material and of those whose names are omitted will also be revealing. 4.6 Publicity and advertisement - 4.6.1 The expenditure on publicity and advertisement, upto the stage of production is mostly incurred by the producers themselves. After completion of the film this expenditure is met by distributors for their respective territories, subject to the terms and conditions agreed upon. The major expenditure is on newspaper publicity, hoarding and commercial broadcasting etc. The producers usually agree to share a part of such expenditure incurred by the distributor. It is, therefore, necessary to properly check such expenses by examining the books of the distributor, as the producers plead inability to give these details. 4.6.2 A lot of publicity is given to the inaugural function which is held with much pomp and show. An invitation card designed specially for this occasion may cost anywhere between Rs. 250/- to Rs.1,000/- . These are sent to all distributors, exhibitors and connected persons. The function itself may cost a few lakh. It will be useful, if cuttings from newspapers giving prominent coverage (both vernacular & English) are carefully scanned by CIB and extracts sent. Sometimes such inaugurals are also screened on TV specially if persons occupying high positions is public life inaugurate the Mahurat. 4.6.3 If the distribution rights of different territories are sold in advance, the producer gives publicity only during the final stages of the picture and before its release. If these rights are not sold or the movie is cast with new comers, publicity is given even during the shooting of the picture, so as to invite distributors to buy the picture. It has become a common trade practice these days to use the commercial media of TV for publicity using selected excerpts from songs/scenes of the film broadcast for a specific duration, say 10 minutes. There are commission agents, who arrange for airing of such programs, charging a fee of Rs.1 to 3 lakh for publicity for a month. It may be useful if enquiries are conducted with such agencies in this regard. There is also a possibility that a lesser amount may be accounted for since the commercial agents would themselves like to evade taxes. 4.6.4 Besides inflating the production expenses, the producers also sometimes debit production expenses as non-production or overhead expenses. This amounts to debiting the cost of stock in trade as an expense in P & L a/c. For example, although a major portion of the salary or wages may have been incurred as production expenses, the producer may be tempted to debit it as non-production or overhead expenses. This is because production expenses are liable to be amortised, and but by claiming certain expenses as non-production expense, the assessee can deduct the entire expenditure in a single year. It is, therefore, necessary to scrutinise the non-production expenses to find out whether they can be attributed to production. Often even purchase of material necessary for production are debited under general or miscellaneous heads as non-production expenses. 4.7 As per the provisions of Section 285B, a producer of a cinematograph film is required to furnish a statement to the Assessing Officer in the prescribed Form 52A, giving details of all payments over Rs. 25,000 made by him, or due from him to any person engaged by him in the production of a film. This statement is required to be furnished within 30 days from the end of the financial year during which production activity is carried out or within 30 days from the date of the completion of the production of the film, whichever is earlier. With effect from 1.4.2000, the limit of Rs. 25000/- has been raised to Rs.

50,000/-. This provision is applicable to producers of all cinematograph films. Even a small time film producer and producers of video films albums etc. have to file this Form. The producer is required to file details in respect of all persons engaged by him in the production of the film. The words „engaged‟ denotes someone whose services have been utilised for the production of the film. Hence, it would cover all artists, technicians and other persons engaged in the activity to actual production of the film, but not suppliers of goods or materials etc. Form 52A requires the producer of a cinematographic film to furnish the following particulars       

Name and address of the producer Permanent Account Number of the producer Name of the film Date on which the production of the films was started If the production of the film has been completed, the date of completion Financial year to which the statement relates Details of payments of over Rs. 50,000 in the aggregate made by the producer or due from him to each person engaged in the production of the film as employee or otherwise.

Sales 5.1 The receipts of a producer are mainly from the distributors. After the production of a film or even during the course of production the producer generally gives it on lease. For the purpose of such distribution, the country has been divided into several territories. Details of distribution territories are available with IMPPA (Indian Motion Pictures Producers Association). IMPPA has also fixed the number of prints required for each territory. The producer may sometime try to give more than what is required for a territory. The excess print will be given as a loan-print. This loan print will be returned as soon as the first run in any one of the theaters in that territory is over. The fees charged for loan print is generally not accounted. Besides there is an overseas circuit covering most of the countries of the world, except Pakistan and Bangladesh. The film producer earns revenue from the lease/sale of the following types of rights : Theatrical distribution rights      

Overseas rights Music rights Video rights Satellite rights Cable rights 16 mm rights

5.2 The methods of selling of distribution rights by a producer to a distributor are as follows 5.2.1 Outright lease - The producer leases the picture to the distributor for a fixed price for a fixed time. Thereafter he has no financial stake in its success or failure. The producer completely withdraws his interest in the picture which then becomes the absolute property of the distributor till the lease expires. This type of lease is, however, rare and is usually limited to small producers. In this arrangement, the AO may verify whether the producer has accounted for the entire sale proceeds mentioned in the agreement. 5.2.2 Minimum guarantee clause lease - In this the distributor purchases the film on minimum guarantee basis and undertakes to pay a fixed royalty amount for the rights of a particular territory. The cost of the prints and the publicity expenses in such cases are incurred by the distributor though sometimes these are even claimed by the producer but this expenditure is not an allowable deduction in the hands of the latter. After the release of the films, the distributor recovers the cost of prints and publicity and commission @ 20% on these amounts from the proceeds of the minimum guarantee price, and if the exhibition proceeds exceed these amounts, the surplus receipt, called “overflow”, is shared by the distributor and the producer according to the ratio specified in the agreement. This is one of the

common distribution arrangements. In this the producer has to show the minimum guarantee amount as his revenue, and also the overflow amounts. The agreement has to be scrutinised to ensure that the total receipts of the producer have been accounted by him properly. Necessary enquiries can be conducted with the distributor to ensure that the producer has offered the correct overflow for tax. 5.2.3 Advance and commission clause lease - Under this arrangement, the distributor advances a certain sum of money to the producer for acquiring the rights of distribution for a particular territory. He also undertakes to invest money on the cost of the prints and publicity on his behalf. From the proceeds, the distributor then recovers the advance money as well as the cost of the prints and the publicity expenditure incurred by him. The distributor also charges a fixed commission on the gross business at the rate of say 10 or 20% and the balance sale proceeds are then passed on to the producer. In case the film does not generate sufficient funds to cover the cost of the advance, prints and publicity, the deficit amount becomes refundable by the producer to the distributor. Under this method, the cost of the prints and publicity as well as the commission paid to the distributor is reflected in the accounts of the producer on the expense side and the gross receipts from the exploitation of the film are reflected on the income side. In this arrangement, statements of accounts of the distributor, as on the last date of the financial year, have to be verified thoroughly. 5.2.4 Apart from distributing the films in India, the producers, nowadays separately sell the overseas rights of films as also of its music. The method of accounting for sale of music rights is the same as in the case of local distribution rights. However, for the overseas distribution rights, the agreement entered into by the producer with the distributor needs to be examined in detail. 5.3 Of the methods given above, the most popular is the “minimum guarantee”. The outright lease method is generally confined to overseas distributors, because it is very difficult for the producer to have a check on the receipts of the foreign exhibitors and distributors. As Indian films are very popular in countries where there is a large population of Indian origin, such as Dubai, Muscat, Thailand, Malaysia, Indonesia, Kenya, Tanzania, U.K. and Mauritius, the export market for such films is now an important source of revenue to the industry.

Overseas rights 6.1 An intensive scrutiny of the agreements to sell overseas rights of the film is essential. Often, the profits abroad are shared between the purchaser and the producer by making an apparent sale of the film for a very low price. A part of the real price is then paid to the producer outside India in foreign currency. Useful information in this regard can be obtained from the Indian Motion Pictures Export Corporation.

Assessments of Producers 7.1 The production of a film usually takes a long time, sometimes several years. It is only when the picture is complete and released that the profits can be assessed to tax. Considering this peculiar feature, the accounting of income & expenditure in the production of a film is to be investigated differently. 7.2 The expenditure incurred by the producer on the production of a film, which at times can extend to more than one year, is to be treated as capital expenditure and is accounted for in Balance Sheet. Once the film is completed and Certificate for public exhibition is issued by the Central Board of Film Certification, the film becomes a stock in trade in the hands of the producer. It is only at this stage that the producer becomes entitled to claim deduction for the entire production expenses incurred by him. It is important to note that till the film is released for public viewing, a producer is not entitled to amortise the cost of production. At the pre-production stage, the AO may investigate the expenses claimed as deductible & incurred for making the film. Often the accounts of producers show that a major portion of this expenditure is incurred in cash on items like payments made to junior artists, for transport, board & lodging, hiring of equipment etc., and but sometimes it includes personal expenditure also. Further, since the expenditure is usually incurred over several years, scrutiny of major items has to be thorough.

7.3 The cost of production of a film has to be amortised as per Rule 9A of Income Tax Rules. This Rule was enacted under the powers conferred by Section 295(2)(a) of the Income Tax Act, in order to deal with the inherent peculiar features of the film industry. Since the effective life of a film is very short, the write off of the cost of production expenses of a film is permitted within a shorter duration as per the specific provisions of this Rule. According to Rule 9A (ii) the “Cost of Production” in relation to a feature film means the expenditure incurred on the production of the film, not being (a) expenditure incurred for preparation of the positive prints of film; and (b) expenditure incurred in connection with the advertisements of the film after it is certified for release by the Board of Film Censors. 7.4 Thus, the cost of production, as per Rule 9A, is the cost incurred by producer upto the making of the first positive print, including the pre-production publicity but excluding the cost of all the positive prints other than the first, and also excluding post-production publicity. Rule 9A also specifies that if a film is not released for exhibition on a commercial basis at least 90 days before the end of the Previous Year, the cost of production of the film, in so far as it does not exceed the amount realised by the film producer by exhibiting the film on a commercial basis, or the amount for which the rights of the exhibition are sold or as the case may be, the aggregate amount realised by the film producer by exhibiting the film and by the sale of rights of exhibition, shall be allowed as a deduction in computing the profits and gains of such Previous Year and the balance, if any, shall be carried forward to the next Previous Year and allowed as a deduction in that year. The AO must ensure that the provisions of Rule 9A are strictly followed. 7.5 The AO has also to be cautious with reference to the deduction claimed by a producer from the sale proceeds of the film in overseas territories. Till recently, most producers were claiming deduction u/s 80 HHC on the ground that the “sale” of these overseas rights constituted “sale of goods”. Though there were some conflicting views on the validity of this claim, the issue has finally been set at rest by the decision of ITAT Mumbai Bench in the case of A.G. Nadiadwala, holding that the benefits of this Section are not available to producers, since films do not constitute “goods” and there was no “sale” as contemplated u/s 80HHC. Instead these transactions involve merely a lease of the rights of exhibiting the film for a limited period, after the expiry of which, the ownership rights revert back to the producer. Hence, the Assessing Officer has to verify if such a claim has been made by a producer and if so, has to disallow the same. It is only w.e.f. 01.04.2000, with the introduction of u/s 80 HHF into the I T Act that the deduction is now available to the film industry on the export of their software. 7.6 Often procedures claim deductions under Sections 80I / 80IA / 80J etc. It is well-settled that production of a film is not production of an article or thing within the meaning of these Sections. The producer merely gets a cinematograph film exposed. He does not produce a cinematograph film. The deduction under these Sections and Section 32A as it stood earlier may be available to the producers of the cinematograph film like Kodak India, Fuji etc and not to the users of the films who merely expose the films. If exposure of films is taken as a manufacturing process, even a pathologist taking a X-ray of a patient or an owner of a photo studio will also be entitled to deductions under these Sections. 7.7 In some cases, producers claim the film itself to be an industrial undertaking, in other cases the entity producing the film is claimed as industrial undertaking and the film produced by the said entity is claimed as a product of the undertaking. The argument that every film is itself an industrial undertaking, is totally fallacious because if film itself is an industrial undertaking, then there is no product of such an undertaking. Since there cannot be an industrial undertaking without a product, this argument has no merit. For examining the second argument, viz. - every film, is a new product of the industrial undertaking, it is important for the AO to verify whether the producer has complied with the relevant conditions stipulated in the said Sections. Clause (a) of Explanation 1 of subsection (2) of Section 80 IA, provides that the plant / machinery used in manufacture of the product should not have been previously used by the assessee in India. Every producer uses either his old equipment, which have already been used in the production of other films or hires equipment from other parties, which has also been used earlier by other producers in the production after films. In either of these situations the deductions under this

Section cannot be allowed to the producer because the entire plant and machinery used in the manufacturing process, in respect of which the deduction has been claimed, should have been new. 7.8 Another issue which requires verification in a producer‟s case is the deduction claimed in respect of incomplete and abandoned films. Since the expenditure incurred on a film prior to its release is treated as capital expenditure, the expenditure incurred on incomplete and abandoned films, continues to be capital in nature and therefore, a producer would not be entitled to claim setoff of these expenses against receipts from another film subsequently released by him. 7.9 The closing stock is required to be valued as per general accounting standards. However, often it is valued on arbitrary basis. The notes and entries pertaining to closing stocks have to be verified, to ascertain whether the closing stock includes the value of sets, dresses etc., on which substantial expenses are claimed during production and which even thereafter fetch a certain price in the market. 7.10 As per the provisions of Section 285B, a producer is required to furnish in Form 52A, the details of all payment made by him in connection with the production of a film, in excess of Rs. 50,000/- (This limit has been introduced w.e.f. 1.4.2000). Scrutiny of this Form, which has to be submitted within a specified time, is essential because it not only helps in a cross-verification of the expenditure finally claimed by the producer but also in ascertaining whether these amounts have been declared by the recipients in their Returns of income.

Corporatisation of film production 8.1 There has been a recent trend towards corporatisation of film production activities. Its advantages are : i) Limited Liability : In comparison to a sole proprietor or a partnership firm, where the liability is unlimited and several, the liability in a corporate entity is limited to the extent of the share holdings of the company. ii) Large influx of funds : A corporate entity can tap capital markets for raising large funds. Greater amount of funds can be mobilised by way of equity. Banks as well Institutional finance can be collected at relatives ease by corporatising the business. Apart from domestic capital markets, a corporate can even issue GDRs and ADRs, which are increasingly becoming a preferred source of raising finance from foreign markets. iii) Encashing worth : A corporate entity could grow and expand globally, thereby creating goodwill. The worth and the potential underlying a proprietor or a partnership may be encashed by corporatising the business. In today's world of e-business, and especially in film industry, the real worth lies in intangible assets such as patents, trademarks, goodwill, brands, copyrights, etc., rather than the tangible assets. iv) Valuation of brand equity : For an individual producer, the goodwill or technical knowledge acquired by him comes to an end as soon as he expires whereas a company survives even after the death of the individual, and can value its goodwill in its books. v) Increase in net worth : The net worth of the corporate entity could possibly lead to equity participation like Joint Ventures and Collaborations. For example the share capital structure of a corporate may be only Rs. 5 lacs, but its net worth may be to the extent of Rs. 5 crores, the benefit of which can be encashed by entering in to Joint Ventures with multinational companies thereby contributing to expansion of production capacity, transfer of technology, capital etc.

vi) Mergers and amalgamations : The changes taking place all over the globe - technological, political, cultural, etc. require an enterprise to restructure through mergers, amalgamations and takeovers to face the new challenges. vii) Expansion : In today‟s global context an enterprise is forced to expand globally in order to compete with its rivals. A small organisation led by an individual or a few partners cannot think of growth on a large scale without corporatising itself. viii) Foreign franchises : Franchising is an important means of doing business with several countries. It provides to an intermediary, the access to business operations and technology covering an extensive range of marketing and distribution arrangements for goods and services. As the focus of the Indian film industry is shifting towards Western and European countries, franchising has become a vital mechanism for marketing and technological linkages globally.

Case studies 9.1 In the case of a successful feature film M, the producer P.P., entered into an agreement dated, with a distributor C stipulating that P.P. would produce the film M and invest Rs. 75,000/- towards the cost of production and would grant the world rights of distribution to C for Rs. 3 lakhs, to be invested in the production of the said film. Later P.P. transferred the rights of production to a new firm C.C. by an agreement dated 18.1.74, on condition that a sum of Rs. 10,000/- would be paid by the latter to P.P. as directorial charges, out of the net realisation of Rs. 75,000/-. It was further stipulated that C.C. would pay 25% of the net realisation upto Rs. 15 lakhs, and 20% of the balance, if any. After the production of the film and realisation of the cost of production, when the „overflow‟ started coming in, C.C., the new producer, entered into a fresh agreement with P.C., a newly formed partnership firm, stipulating that the overflow rights would vest in P.C. for a consideration of Rs. 60,000/-. Investigations revealed that C.C., who had apparently produced the picture, had not filed any return of income. It was also found that P.C., the newly formed partnership firm, in which the overflow rights were vested, consisted of benamis and persons closely connected with ‟C‟, the original distributor and that all the arrangements were made only to divide the bumper profits over as wide a spectrum as possible. 9.2 In such cases it ought to be verified whether the rights have, in fact, been sold to established distributors or only to some petty concerns unknown in the line of business. The test of membership with the Indian Motion Picture Distributors Association can also be applied in appropriate cases to verify the genuineness of the distributor concerns. A further check can be made with reference to the records of the exhibitors, to verify the accounting of actual receipts according to the agreement. 9.3 Next a verification of receipts from the various distribution territories in India, the overseas distribution, and rights for 16 mm copies of the film, must be carried out to verify whether the producer has accounted the royalty received from gramophone companies, radio stations, and TV exhibition. 9.4 Certain state government give subsidies to the producer if a film is produced in their territory, while others make refunds of a part of the entertainment taxes collected on films with a special purpose or produced in the language of the State concerned. Such incentives must also be kept in mind for arriving at the taxable profits of producers.

DISTRIBUTORS 10.1 Though distribution and exhibition are the last links in the chain bringing the film entertainment to the masses, they are of paramount importance as the film industry‟s success depends on successful distribution and exhibition of the films. Distributors range from those buying rights in the entire States, to those buying rights in a particular district. Typically, a distributor buys the distribution rights to a film for a particular „territory‟ and recovers his costs from the exhibition of the film. He usually bears the downside

but has to share the upside of the film‟s eventual popularity with the producer. The film distributor is a very important player in the film trade for another reason also. He is the source of most of the capital which a producer invests in the production of a film. He looks after the distribution of the film to the exhibitors, and the full exploitation of the business potential of the film. Therefore, in the cases of distributors stress has to be laid on the source of funds invested with the producer, his receipts from exhibitors and the expenses incurred by him for publicity, etc., either on his own account or on behalf of the producer. 10.2 Apart from his own capital and the loans that a distributor might raise from deposits from cinema owners intending to book the film under production, he also raises capital from his friends, relations and the „market‟. It is a general practice among the distributors to take advance deposits from cinema owners who want to book the film for release at their theaters. Quite often, however, bogus borrowings are also entered in the names of cinema owners. It is, therefore, essential that these advances or deposits from exhibitors are put to strict proof. 10.3 Film distribution - The distributors normally make some token payments at the time of taking the distribution rights and generally pay up to 40% of the agreed price as underproduction installments during the progress of the film while the balance 60% is paid against the delivery of prints at the time of release of the film. It must be noted that the various “territories” within India are not of uniform size. Instead, their price is determined on the basis of the price of the biggest territory in India i.e., the Bombay circuit. These “territories” in the film parlance have no relevance to the political map of India. For example, the “territory” of Bombay circuit includes Bombay city and suburbs, parts of Maharashtra, parts of Karnataka, States of Gujarat, Goa, Diu & Daman, Similarly, the “territory” of East Punjab includes the States of Punjab, Haryana, Himachal and Jammu & Kashmir. The table below gives an idea of the relative size of these “distribution territories”.

S. N.

Main territory 1 Bombay circuit

2 Eastern circuit

Sub-territory

Ratio

Bombay city /suburbs

35%

Thane

15%

parts of Maharashtra,

15%

Gujarat, Saurashtra,

25%

Karnataka

10%

West Bengal

25-30%

Bihar

35-40%

Assam

10%

Nepal

10%

Orissa

10%

Total

100

80-100

3 Delhi-U.P.

Delhi, U.P., Eastern U.P.

80-110

4 East Punjab

Punjab, Jammu & Kashmir, Haryana, Himachal Pradesh

35-40

5 Rajasthan

25-30

6 Central In

20

7 C.P. And Berar

35-40

8 Nizam

25-30

9 Mysore

10-20

10 Tamil Nadu / Kerala

10

11 Andhra

5

Total

420-505

Thus, if Bombay circuit is considered as one “territory”, then the entire India consists of about 4.5 “territories”. Therefore, if the rights of a film for the Bombay circuit are sold for say Rs. 2 crores, the entire theatrical rights of all the Indian “territories” would fetch Rs. 9 crores. The total revenue of a film will include the price of music rights, and overseas rights, etc. Also besides the above

Methods of distribution 11.1 After obtaining the distribution rights of a film from the producer, the distributor in his turn gives these to the exhibitors. This is generally done either on a fixed hire basis or on an agreed percentage of the total receipts. Where a fixed hire had been paid, the distributor is not concerned with the actual collection of the exhibitor. However, the prevalent method is to get an agreed percentage of the total receipts of the exhibitor, the major share always going to the distributor for first-run films. The percentage depends upon the quality and reputation of the picture. So far as films in South Indian languages are concerned, the distribution is made according to the territories which are divided into 4 categories viz. A, B, C & D. „A‟ means cities, „B‟ means district head quarters, „C‟ means taluk head quarters, and „D‟ means other places. The cinema theaters in C & D areas are hired on fixed hire basis. There is a tendency to understate weekly receipts by 30% to 35% as no cross verification is made with such centres. The producer / distributor, finds it easier to obtain unaccounted money from mofussil centres than from cities as there are not many checks against evasion at mofussil centres. It may be useful to establish liasion with Entertainment tax authorities as sometimes, during their surprise raids, they come across situations where the viewers are more than the tickets sold. The difference is shared by the Exhibitor and Distributor and sometimes the producer. In cases of arrangements showing uniform percentage of sharing, it is likely that the exhibitors are paying sizable amounts to the distributor outside the accounts. In respect of „A‟ centres, the position is reverse. Here the distributors have to pay unaccounted money to the exhibitors and usually this is adjusted in publicity and other expenses. A point to be remembered is that in respect of very successful films, mofussil exhibitors vie with one another to have the privilege of being the first exhibitor in the area. With demand being more than supply, premiums have to be paid to the distributor for giving preference to one exhibitor or centre over another. It is, therefore, desirable that the CIB also go through some reviews in film weeklies and film magazines like Screen, Film Fare, Stardust etc. so that this point does not get lost sight of when assessments are taken up. 11.2 The right of a film are sold by the producers under the following types of agreements :   

M. G. basis Advance or commission basis Outright sale

11.2.1 M.G. basis - M. G. stands for Minimum Guarantee whereunder the distributor undertakes to pay a fixed royalty amount for the rights of a particular “territory”. Normally, the cost of prints and publicity is incurred by the distributor. After the release, the distributor recovers from the proceeds the MG price, cost of prints and publicity and commission normally @ 20% on these amounts. If the exhibition proceeds

exceed these amounts, the surplus called „overflow‟, is generally shared equally by the distributor and the producer. 11.2.2 Advance or commission basis - In this arrangement, the distributor advances a certain sum of money to the producer for acquiring rights of distribution for a particular “territory”. He also invests money on the cost of prints and publicity on behalf of the producer, which he recovers from the proceeds. He also charges a fixed commission on the gross business at 10-20% and the balance sale proceeds are passed on to the producer. In case the film is unable to cover the cost of advance, prints and publicity, the deficit amount becomes refundable by the producer to the distributor. Under this arrangement, the cost of print and publicity as well as the commission paid to the distributor is reflected in the accounts of the producer on the expense side and gross income from exploitation of reflected on the income side. The producer gets statements from the distributor up to the last date of the financial year for making entries of the cost of print, publicity and commission in the books of account. 11.2.3 Outright basis - In this arrangement, a fixed amount is paid by the distribution for the period of lease of distributor rights and the distributor is not required to render further accounts to the producer. Even if the film is a hit, the entire income is retained by the distributor. 11.3 As in the case of producers, for investigating the cases of a distributors also it is important to ascertain the nature of the distribution agreement entered in to by them with the producers since this is the crucial document to determine the profit arising to the distributors.

On-money payments 12.1 In bigger cities, like Delhi, Mumbai and Calcutta the distributors of new films have to make unaccounted payments to the exhibitors who own reputed cinema halls situated in busy and posh localities. This is basically to generate good market reports for the film on its release. These payments are ultimately adjusted by debiting bogus expenses under the head publicity, etc. In the case of distributors there is not much scope for understating their receipts. The main scope of concealment of income is through inflation of expenses and the main item capable of inflation is the publicity expenses.

Expenses 13.1 Publicity expenses are shared by the distributors with the producer as well as the exhibitor and agreements are entered to cover all situations. The AO must thoroughly scrutinise publicity expenses allegedly incurred by the distributor on advertisements, hoarding, entertainment of press, correspondents / editors etc. 13.2 The exhibitors also inflate the salary and traveling expenses of employees who carry films to various stations. In this regard, a tally can be made with the number of prints of a film issued to the distributor by the producer and the number of trailers released by the distributor.

Other manipulations 14.1 Often, when a film is declared in market reports as a „hit‟, the producers as well as the distributors brings in intermediaries to divert some of the profits. However, as the intermediaries are introduced only for the purpose of manipulation of income, a close scrutiny of the agreements with them would generally reveal discrepancies in dates and other material particulars. A distributor might acquire world rights or the rights for a particular territory. He might then show that he has raised finances by selling those rights to sub-distributors, for a part of his territory. Such sales offer scope for manipulation by way of bringing in unaccounted funds, as also for passing of the profits of the distribution on business to benami parties. Therefore, the finances brought in by a distributor, by way of advances from his sub-distributors, require very close scrutiny.

14.2 Sometimes, a film which flops on exhibition is purchased on minimum guarantee basis by a distributor who may have otherwise suffered losses in earlier years. The loss on the new film acquired by him will only increase his earlier losses. In order to help a near relative or a sister concern having substantial income from their other business including distribution of feature films, the distribution rights of the flop film are transferred to such relative or sister concern so as to reduce the incidence of taxation in their hands. Such distribution rights are transferred after the film is screened and its results are known. A scrutiny of agreements between the producer and the distributor, and that between the distributor and his sub-distributor with particular reference to the dates of such agreements and the dates when these were registered with the Motion Pictures‟ Association will reveal the real state of affairs. 14.3 In case of commercially successful films, there is a tendency to pass on distribution rights to a benamidar, or to a dormant distributor, who is financially derelict due to past losses. Such distributors can accommodate huge profits against previous losses on the payment of small commission. In the case of a leading film production company, whose management also controlled a film distribution company formed for distribution of their own films, several successful films were transferred for exploitation and distribution to a limited company, owning a cotton textile mill, under the control of the same group. The said company was incurring huge business losses. It had to approach the High Court for permission to get the object clause of the Memorandum of Association amended, so as to authorise the carrying on the business of distribution of films. In another case, a leading producer sold the world distribution rights of some of his good films on an outright basis, for a nominal account, to a nonresident. The alleged purchaser in turn sold the films to the real and ultimate distributors for the appropriate prices. Thus an evidence was created that the bumper profits on the resale of these films accrued to the nonresident. However, the AO was able to establish that the deal was, in fact, struck between the producer and the ultimate distributors directly, and the intermediary, was, therefore, interposed solely to evade tax. 14.4 Therefore, in the case of a resale of rights or the creation of a sub-agency, it is important to examine the correspondence that passed at the negotiating stage between the parties concerned. The first payments to the producer, as also the first deposits from during the production stage, are important and reliable indication of the party who has genuinely acquired the rights. It is also helpful to ascertain as to whom the publicity material, etc. were delivered by the producer in the beginning. Such publicity material is the starting point for the distributor to enter the market, and secure deposits from the exhibitors. It will, further, be useful to ascertain from the Indian Motion Picture Distributors‟ Association, whether the alleged distributor was a member of their association at the relevant time. The members of this association enjoy certain privileges and facilities which a genuine distributor would be anxious to secure. Collection of information from film magazines assumes importance in the case of distributors also, as these give definite and reliable information about films from the stage of the announcement of production. 14.5 In view of the short life of a film even in the hands of distributors, Rule 9 B of the I T Rules specifies the amortisation procedure to be followed for amortising the cost of distribution rights of a film. For the purpose of this Rule, the cost of acquisition of a feature film means the amount paid by a distributor to the film producer or any other distributor under an agreement for acquiring rights of exhibition. In case of such acquisition, being on minimum guarantee basis the cost of acquisition means the amount agreed to be paid as minimum guarantee. However, the cost does not include expenditure incurred by the film distributor on preparation of positive prints of the film or for its publicity. In computing the profits arising to a distributor form the distribution of a film, deduction in respect of cost of acquisition is allowed as per Sub-rule (2) to (4). The rights for distribution are generally acquired for a specified period. The major part of the revenue comes in initial weeks of the first release of the film. There are instances where a film producer fails to give delivery of the film due to it is being incomplete. In such cases, the distributor‟s claim for deduction of the advance amount paid by him to the producer assumes importance. The purchase is not complete till delivery of prints of the film is given by the producer to the distributor. 14.6 Some distributors also claim deduction u/s 80 HHC in respect of the income earned by them from sale proceeds of films in the overseas territories. Most distributors claim deduction under this Section on the ground that “sale” of overseas rights constitute “sale of goods”. However, there were conflicting views on the validity of this claim. This issue has finally been set at rest by the decision of the ITAT Mumbai

Bench in the case of A.G. Nadiadwala, where it has been held that the benefits of this Section are not available to these persons since the films do not constitute “goods‟ and there is no „sale” as contemplated by provisions of Section 80HHC. In fact, these transactions merely involve lease of the rights of exhibiting the said films for a limited period, after the expiry of which, the ownership rights revert back to the distributor. However, the position has undergone change w.e.f. 1.4.2000, with the introduction of Section 80 HHF. 14.7 Where a film distributor claims write-off of the advance made by him to the producer of the film, it should be allowed only if   

the advance is actually an advance paid by him, and is not to be recovered from the exhibitor, the advance for which interest is charged, is made by a distributor carrying on a moneylending business and one of the terms is that the distribution rights of the film are to be given to the money lender. the advance is made by a distributor who has made it his business to advance such loans to acquire distribution rights and to sell them later.

Such claims should not be allowed as an admissible deduction in the assessment of the distributor if  

the advance is made for an outright purchase of a film, where it is not the business of the distributor to resell films. the advance is made in consideration of the distributor getting the rights of distribution, the amount to be recouped from the rent received from the exhibitor and the excess to be shared by distributor and the producer.

Since, however, arrangements differ from distributor to distributor, each case will have to be decided with reference to its own facts, bearing in mind the broad principles set forth above. 14.8 Distributors invariably enter into written arrangements with cinema owners regarding the manner of sharing the takings. The film is given either on a fixed hire, or the takings are shared in agreed proportions between the parties. The major share always goes to the distributor, for first-run of the films. It is advisable to examine such agreements for some of the important stations, and to cross-verify whether the receipts shown, accord with the terms of the agreement. 14.9 It is also necessary to examine the receipts on distribution rights and exhibition abroad. For this purpose, it may become necessary to see the correspondence and trace the party who made the initial payment to the distributor for controlling the „overseas circuit‟. Ordinarily, the party making the initial payment is the real distributor. A comparison of the prices paid by the purchaser, for the same territory, for different films, should also set the AO thinking about the reasons for the lesser prices charged for particular films. The AO has also to know what type of films i.e., costume films, family dramas, fantasies, etc. are in demand in a particular country, so as to check the reasonableness of the sale price shown for the film. 14.10 Accounting Standard AS-9 of ICAI provides a framework for revenue recognition in India. Most agreements for film distribution are in the garb of a lease arrangement, to get over problems relating to sales tax complains. Income from distribution is linked to the release of the movie. The terms of agreement provide the legal basis for the recognition of income. After the initial life of a film, it is generally released for a fixed number of years or for fixed amounts per period. If collection of money is certain and there are no further commitments from the producer, there is a legitimate reason to recognise the entire amount as receipts in the first year itself. This is a basic principle of GAAP accounting, which is widely followed for income in the nature of royalty. Unless the producer keeps some commitments to be discharged during the term of the agreement, like delivery of positives, income really can be recognised upfront.

14.11 Amortisation of cost and valuation of closing stock are two very difficult accounting issues in the film business. In a company where multiple films are being produced, the accounting system needs to identify cost of each project, which has to be accumulated over various accounting periods. The cost of any abandoned project is often routed through the Profit and loss account, as a trading loss. Regular revenue cost (like office cost) and cost specifically related to the project, are charged to the revenue account every year.

EXHIBITORS 15.1 Exhibitors include those cinema owners who run their own cinema halls and lessees who have taken cinema halls on lease. Top theaters in major cities who have acquired a reputation, and who have the capacity to attract audiences in a way that can influence the market reports of a new film are much in demand by distributors. They, often demand „on money‟ from distributors. In other cases the exhibitors pay „on money‟ to distributors for getting the rights to run a successful film in their theaters. Both these payments are not recorded, and either way these come out of inflated expenses. Daily receipts from the box office can be easily verified. What should, however, attract the Assessing Officer‟s notice is whether any deposit or advance was paid to the film distributor for booking the film and how it is accounted for and finally adjusted. It is also useful at times, to pick up the printer‟s bills for the printing of ticket books and to verify these with the books issued to the cashier and cross-check the same with the serial numbers in the daily report of sale of tickets. 15.2 The agreement between the exhibitor and distributor should be examined to ascertain how certain expenses are to be shared and it should be checked whether the sharing of expenses has really been done accordingly. 15.3 In big cities tickets of premier shows of successful feature films are often sold at a premium. Often sale of tickets in black market is also organised by the exhibitor. However, the proof of receipt of this money is not easy to come by. In several cases action u/s 132 have yielded seizure of records relating to receipt of „on-money‟. 15.4 It is a common practice with theatre owners to let out their cinema halls to outside exhibitors. However, in many instances such outsiders are only benamidars, relations or employees of the owners and this device is used to split up the income. It is desirable to scrutinise agreements between the parties in order to ascertain whether the hirers are genuine parties engaged in the film exhibition business. There is also a possibility of omitting receipts from morning shows or from hiring of theatre to outsiders. Receipts from refreshment stall hire, cycle stands and other concessions should be particularly verified. There is a widespread practice of understating receipts from canteen contractor(s) and vehicle-shed contractors. These contractors are generally not assessed. Looking to the location and reputation of a cinema house, if the receipts from the contractor appear to be understated, enquiries should be made by examining the contractor. 15.5 Publicity expenses incurred by exhibitor require thorough scrutinised. Besides, the payments to staff need verification. It has to be seen whether their names were intimated to the Shops and Establishment Department or only bogus staff has been shown on the rolls. 15.6 Expenses are sometimes inflated by debiting fictitious commission for procuring films from distributors. In a case the exhibitor had claimed payment of commission to close relations of the partners on the ground that these persons were instrumental in negotiating the exhibition rights of films with the distributors. Contract agreements allegedly entered with these persons were produced. Scrutiny revealed that the letterheads of the assessee firm on which these so called agreements were written bore telephone numbers in five digits which were in fact introduced in that city after the date of the agreement. These agreements were clearly fabricated at a later date and were not genuine. Enquiries made from one of the distributors whose picture had been screened at the assessee‟s cinema hall confirmed that the negotiations for the screening were conducted directly with the assessee without any intermediaries.

15.7 Repairs to theatre buildings and replacement of furniture should attract the attention of the AO. Entries for such expenditure towards the closing date of the accounts should be checked to decide their genuineness, and, to ascertain whether these are of capital nature. If the repairs were substantial, the closing of the theatre for some days might be one of the indicators. The frequency of such expenses from year to year might also provide a clue to the genuineness or otherwise of the claim. Another problem is that capital expenditure is incurred on the theatre buildings by the lessee-exhibitors and such expenses are then either claimed as revenue expenditure or a claim for depreciation is put forward. The claim requires a study of the various clauses of the lease, which will clearly bring out, as to whose responsibility it was to effect repairs. Any claim for depreciation in respect of the capital expenditure incurred by the lessee, has to be disallowed, since the lessee is not the owner of the assets concerned. The same applies to the lessees of studios and laboratories. Also, sometimes, important renovations are made to buildings and furniture without showing the correct expenditure in the books. 15.8 Some exhibitors earning substantial income adopt the device of ostensibly acquiring distribution rights in obscure films to reduce their profits. The genuineness of such „purchases‟ should be scrutinized with great care. The business of the film exhibition gives a steady income and usually there are no business hazards, such as bad debts. As such, any losses claimed by film exhibitors would justify a detailed probe. 15.9 Multiplexes : Typically, film exhibition centres particularly in the metros have to compete with various other avenues of entertainment available to the public at large. The only way to pull people back to the theatres is to make theatres attractive, comfortable and equipped with the latest amenities, thereby offering the audience more than what they expect out of a theatre. Since in a multiplex more than one movie is screened at any given time, a potential viewer finds it very difficult to go home without seeing a movie even though it may not be the one he came to see. Multiplexes have the potential to radically alter the entertainment business in time to come Multiplexes provide the luxurious amenities of the modernday theatre; multiple screen choices, state-of-the-art technology, ergonomic seating. eye-catching architecture and top of the line cafes and food courts. Now with various State governments announcing tax holidays for cineplex (multiple movie theatres) projects, more multinationals are preparing a foray into India. The Gujarat Government has announced a seven year entertainment tax holiday for such projects. 15.10 Exhibitors with brand image : Certain theatres are in the process of creating a brand image. The idea is to offer excellent facilities, thereby enhancing the viewing pleasure and attracting a regular clientele to the branded theatre chains. They can then leverage the brand image with corporates and garner advertising, independent of the movie being screened.

STUDIO OWNERS 16.1 The many „stages‟ in a studio are often hired out to different producers either by the studio owners or their lessees. This business also ensures a steady income provided the expenses are kept under control. The receipts from studio hire can be cross-checked with the Reservation or Booking Register kept by the studio owner, as the „stages‟ have to be booked well in of the dates of shooting in order to enable the owner / producer to build the required sets thereon. 16.2 The claims for salaries, wages and overtime allowances are often inflated Studios engage temporary staff as and when required. The particulars of this staff can be checked with the statutory record kept and returns submitted to the following authorities    

The Factory Inspector. The Shops and Establishment Department. Provident Fund Commissioner. The Employees State Insurance.

16.3 When a studio stage is claimed to be idle, it should be checked whether there are overtime payments to temporary staff on those days. Any such a claim will indicate that the studio was actually taken on hire by some producer. The test of consumption of electricity may also be applied. Expenses on construction of sets and on material like timber, cloth, canvas and colours, etc. should be checked in the same way as in the case of producers. The extra and ornamental fittings on the sets are usually provided by the producers at their own cost. 16.4 Receipts from hiring out sound recording vans to producers should be checked in the same fashion. And those studios which have facilities for the recording of music should be called upon to give the names of producers who recorded songs and music there during the year. This information is useful for cross-checking the income in the cases of playback singers and music directors, especially in respect of incomplete films or abandoned.

FILM PROCESSING LABORATORIES 17.1 Raw stock savings - It is a well known fact that laboratories obtain extra raw stock of positive films from producers to cover wastage. Presently, laboratories take a fixed extra percentage of film. Usually laboratories are able to effect substantial savings from this extra film. This may be still higher in the case of laboratories with a longer experience and better equipment. However, some laboratories neither show any such savings nor maintain proper records, for obvious reasons. This issue needs to be examined properly, and in appropriate cases, the value of the estimated footage saved by the laboratory, has to be added in closing stock. The matter can be verified from such records as „raw stock requisition book‟ and „daily issue register‟. Survey u/s 133A can also unearth the authentic records. The disclosed sales of waste film should also be checked because waste film is used in the manufacture of bangles etc. 17.2 The printing and processing of films carried out by laboratories, releases a waste called „waste hypo solution‟, which contains silver. This has a ready market. Several laboratories show these sale proceeds as a part of their income and some of them have also installed machinery for extracting silver out of the solution. Therefore, if a laboratory has not disclosed sales of „waste-hypo‟, the AO will be justified to investigate the matter fully. This chemical does not require any special storage facility. If accounts of waste hypo are not maintained, income on this account also has to be estimated with reference to comparable cases, after examining some regular purchasers of hypo. 17.3 Most laboratories have small preview theaters for holding trial shows of rush prints and final prints. They also provide editing and film storage facilities. It should, therefore, be verified whether income from these departments is accounted for. The laboratory records may also yield information in respect of incomplete or half complete films, which can be utilised in the assessment of producers, actors and others. 17.4 Laboratories also possess a vital record, useful in assessments of producers and distributors. The financier or the controller of the world rights in a film, safeguards his interest by securing a lien or mortgage on the negative, sound and final prints of the film financed. This is evidenced by a tripartite agreement or arrangement between the financier, the producer and the laboratory owner. Thus, even the producer cannot remove the film from the laboratory without the consent of the financier. The information in the possession of the laboratory is, therefore, useful to ascertain the real financier or controller of world rights, in those cases where benamidars are interposed. Dates of actual delivery of prints by the laboratory also become important in some cases. It may be worthwhile to verify the cash book of the producer for these dates, to find out the arrangements made by him for paying the financier and the laboratory owner, and to trace out the source of funds raised to secure release of the prints. Laboratory records also yield information in respect of incomplete or half-complete films. Such information in addition to that gathered from Censor reports in the Government of India Gazette, and from the Indian Motion Picture Producers‟ Association, is useful in the assessments of film stars / directors etc.

FILM FINANCIERS

18.1 The standard methods of funding films are :     

Low - budget films financed by independent producers or financiers. The established studios. Privately-financed independents. Bank financing. Public offer of shares

Although the demand to declare film production as an “industry" so that funding options from commercial banks would be available, has been accepted, it has not changed the risks associated with films and the consequent perception for funding. Therefore, bank finance is virtually absent in India. 18.2 The main problem in film industry is the high risk associated with it. The returns can compensate that risk, if the venture clicks. On the other hand it is not unusual to find producers rendered insolvent after a venture. Unlike manufacturing operations, a film cannot produce a tangible commodity on a regular basis. Film production has a long gestation period, and till a film is completed it is of no commercial use. The process of completing a film has many facets even after if is shot. Each one of these has to be completed before a film can be formally released. If the film fails, there is very little chance of the funded amount being returned back. All this contributes to private financing of films at exorbitant rates, often with unaccounted funds. 18.3 Financiers wield considerable influence in the film industry through the strings attached to the finance made available by them. While remaining behind the scene, they are capable of holding the entire industry to ransom. In fact financiers derive the maximum benefit from the black money transactions in the industry. It is very difficult for small producers to obtain advance sale proceeds from distributors at the outset of a production, because in their case the distributors get attracted only after the picture is partly shot and shown to them. Therefore, for newly established producer the main source of capital in the beginning is generally from private financiers. The rates of interest charged by the financiers are so exorbitant that in the end, the producer of even a successful feature film is left with very little profit. 18.4 The Film Enquiry Committee (1951) had observed as under in respect of film financiers “A serious defect in the present set up is that the working capital available to the producers is almost totally loan capital, whether from distributors or from other financiers. It is not so much that they need more capital than they can command today, but that they cannot count upon the continuity of their source of finance. Another defect in the financing of production is the high rate of interest charged. At present loans are being obtained at rates as high as 60 to 100 per cent per annum. Interest is not paid directly at this rate, but is usually confined to the legitimate figure of 6% to 9%. The lenders, however, charge a „royalty‟ of not less than 10% on the amount lent, and very often the loan is for a short period of three to six months, the royalty having to be paid again each time the loan is renewed. Royalty and interest are deducted in advance, on each occasion of renewal, making the actual rate of interest very high. The total amount paid within a year for the use the capital thus adds upto an usurious figure. Though this was the position obtaining in 1949-50, the position now is no better. It may even be said to have deteriorated and in fact the low quality of the films produced in India can be attributed to the financiers to some extent”. 18.5 The financiers normally bind over the producers to safeguard their finances by insisting on several guarantees. So, the agreements between the financiers and the producers have to be thoroughly scrutinised. In some cases, the financiers demand the distribution rights of certain territories also. Profits are then made by selling these rights. Certain financiers control the world rights of the film as a security

for the finance provided. Most of the financiers conceal a large part of the interest they charge and hence their assets need to be investigated minutely. 18.6 The Government of India recently extended Industry status to the film industry, to enable it to avail of the cheaper bank finance as compared to the exorbitant interest rates charged by the private film financiers. In consequence the Indian Banks‟ Association (IBA) constituted a working Group to consider the issues related to bank finance for the film industry. Its report classified the film industry into broad segments and specified guidelines for financing activities in each of these segments each segments. These are summarised as under : 18.6.1 Film producers   

The producer should submit a detailed Budget along with a brief synopsis of the story line, production scripts and schedules of the film to be financed. The bank advance should not exceed 40% of the total project cost. Minimum eligibility criteria : A) Corporate production house should have a tangible net worth of Rs.25 Lakh while Non corporate borrowers should have a worth of Rs. 50 lakh. B) For Corporates minimum tangible security should be 50% of bank finance while for non corporates, the same should be 75%. C) The borrower should have produced minimum 3 movies out of which one should have been a hit.

 

The period of advance may be restricted to 12 months for Hindi movie and 6 months for regional languages movies. In exceptional cases an outer limit of 18 months may be considered. Security : A) Laboratory letter for conveying the right of negative B) Collateral security of personal assets, deposits, and guarantees C) Assignment of music, audit, video rights, satellite rights, channel right, export / International rights.

 

Rate of Interest : The banks have been advised to charge a minimum rate of interest of 4% over the Prime Lending rate of interest. Insurance : The producers are also required to insure the project.

18.6.2 Film distributors    

The distributor should be a member of the respective Industry association like IMPDA, etc. and should be a registered partnership firm or a corporate. The distribution agreement should be a tripartite agreement between the distributor, film producer and the banker and the agreement should form the basis for security for bank finance. The period of financial assistance may be 6 to 12 months and in deserving cases an outer limit of 18 months may be considered. A margin of 50% to 60% may be specified.



Collateral security by way of personal guarantees/ equitable mortgage of properties etc as deemed necessary.

18.7 A recent trend has been towards international funding for films targeted at the international audiences. For this the producers approach specialist film funding agencies, with a business plan consisting of     

The script The Budget Letters of Intent from stars and the director. Past credits of the producer. General company information.

Often the funding agencies require the producers to 

   

Link the payment of remuneration to actors and other staff involved in the production, to the performance of the film. That is, they are paid a nominal remuneration for the performance and a bonus is assumed which increases with the increase in the intakes after the release. This reduces the total project cost for the venture, and links cash outflow to the cash inflow thereby improving the prospects for funding the project. Pre-sell the film in certain centres at fixed cost so as to ensure the recovery of fixed cost. Use innovative corporate sponsoring for partial funding of the venture. The chosen products are featured in the movie to gain advertisement revenue. The corporates pay the committed amount on completion of the movie and when it is ready for release. Pre-sell music rights to a reputed music company, to generate cash. Ensure suitable promotion strategies, so that the movie is eagerly awaited before its release.

Modern technology like Internet webcasting is used for giving sneak previews to the audiences and generating audience response and comments on the potential danger spots in the movie that required tackling. 18.8 World Right Controller (WRC) is the financier of the film with whom the entire copyright of the film including the territorial distribution rights, music rights overseas rights and all other rights are mortgaged by the producer till the WRC receives back his investment in the production of the film. Generally, the WRC undertakes to advance a fixed sum of money to the producer for the production of the film. In return, the producer undertakes to pay certain percentage of the "coverage" to the WRC by way of reward for the investment made by the WRC. The "coverage" is defined as the gross receipts by the producer by way of sale of the rights at the time of release of the film. Nowadays, the WRC also take 50% share of overflow, future rights as well as 50% share in the negatives of the film over and above the fixed commission on the coverage. Till the time film is released and all the dues of the WRC are paid, the copyrights as well as the negatives remain in the name of the WRC. The commission paid to the WRC is charged to the Profit & loss account under the head World Right Commission account. However, the 50% share in the overflow and sale of future rights is generally treated as the overriding title and directly credited to the account of the WRC and only the producer's share is reflected in the income side of the Profit & Loss Account.

ACTORS, ACTRESSES, DIRECTORS, MUSIC DIRECTORS AND PLAYBACK SINGERS 19.1 A few artistes in these categories together account for the bulk of the black money in the film industry. The actual ascertainment of the taxable income in these cases is an arduous task because most

of these persons do not maintain proper books of account. The working life span of most of these persons being very short, payment of proper taxes on their income is low on their priority. It would be no exaggeration to say that if these categories of persons decide not to accept their remuneration in unaccounted funds, the circulation of black money in this industry would go down considerably. The biggest recipients of this money are the film stars, i.e.. the actors and actresses. Reliable sources indicate that top male artistes are charging anywhere between Rs. 1 crore to 2 crore for working in a film. Similarly, the best playback singers charge in lakhs. The accounted receipts are often not more than 20% to 25% of this. 19.2 Most of these persons claim maintaining their accounts on cash basis and therefore, all receipts of a particular year constitute taxable income in their hands. In a number of cases, it is found that advances received by them from producers towards projects not yet commenced, are shown as liabilities in their Balance Sheets even though the said amounts constitute taxable receipts in view of the method of accounting followed by them. Hence, it is important for the AO to ascertain the method of accounting followed by these artistes and thereafter determine how they have treated their receipts in a particular year. 19.3 Ordinarily these persons do not maintain proper books of account. They generally file statements of receipts and expenses, simply supported by the producers‟ certificates and expenses vouchers respectively. However, frequently omissions of receipts are detected in these statements. To find out the same it is necessary to maintain a register of the artiste with up-to-date information regarding their work in various movies. This information should be gathered from as many sources as possible. Trade journals are of great help in this regard. Relevant extracts from the assessment records of the produces should also be utilised for this purpose. 19.4 It is common knowledge that top grade artistes, not only get their remuneration as per the contract, but their hotel expenses, cost of journey, local conveyance etc. are also borne by the producers concerned, either as part of terms of contract or on the basis of oral conditions imposed by the artistes. Therefore, it may be necessary to find out the extent of expenditure on journey total hotel, board and lodging expenses, local conveyance and other expenditure, if any, that have been met by the artiste as well as the sources thereof. 19.5 Most of the artistes do not maintain their accounts properly. In their cases, cross verification has necessarily to be made with the TDS returns filed by the producers in Form 16-A, and the information furnished u/s 285 B in Form 52-A, which contains details of payments made to these individuals etc. 19.6 In a number of cases, royalties received by these persons on account of old films, music, songs etc. are not accounted for properly by them. This aspect necessitates a detailed enquiry by the Assessing Officer. 19.7 Often, a systematic effort is made to conceal payments received by these artistes. A few of the practices are given below. 19.7.1 Incomplete films - Omissions of receipts (including advances, signing amounts etc.) in respect of films, the production of which was either not started at all or could not be completed, is common. Such omission is based on the hope that these productions will not come to the knowledge of the department. Information of this type can be obtained from the records of the producer and the TDS returns in Forms 16A , 52A etc. In the case of a producer it was found that after engaging the artistes and after making initial payments to the actor / actresses, he gave up the production of a proposed film. The amounts though paid by cheques, were not shown by the artistes in their returns. Therefore, the statement of receipts accompanying the return must be comprehensively cross checked, date wise, with the information in the artistes‟ register and the intimation received from files of producers.

19.7.2 Benami receipts - The second category is where a major part of remuneration, payable to the artiste, is shown as paid to his or her near relations, secretary or employees for alleged services rendered by them to the producer. Here care will be taken to file returns for such payees, and the income will be got taxed at lower rates. Such arrangements are the result of collusion between the artistes and the producer. 19.7.3 Other receipts - Many top artistes charge appearance fees for appearing in special shows, concerts, inaugurations, promotional shows, sponsorship of products, advertisement films. Many of these receipts are often not accounted properly. 19.7.4 Advances/ loans/ gifts from Producers - This is another potential area for camouflaging the professional income. 19.8 In the case of a leading artiste, it was detected that, simultaneously with her own contract, the producers had entered into contracts with her grandmother, father, secretary, etc., purportedly for services to be rendered by them. Payments at regular intervals were also made to the whole group on the same day, by cheques bearing consecutive serial numbers. The grandmother allegedly designed jewellery and costumes for the actress, and the father was paid for ensuring timely attendance of the actress on the sets. On investigation, it was found that no such services were actually rendered by these persons, who usually stayed at Chennai, while the film was being shot in Mumbai. In fact, their alleged remuneration were higher than those paid to persons who actually rendered such services as full time employees. The names of these relatives also did not appear in the booklet or in the credits of the film. The AO was thus able to establish that amounts paid to them actually represented the application of the income of the actress and was not expenditure for earning that income. In another case, an actor took remuneration in the name of his wife, who allegedly rendered services in the same film, but there was no evidence of such services. The cheques given in her name had gone to the actor‟s own bank account. The above tests were then applied to her remuneration, and the actor had finally to accept that it was in fact his money. In such cases, it is essential to obtain explanations both from the payee and the producer about the omission of the name of the payee from the booklet and credits, which include many names to whom much lower amounts would admittedly have been paid. A comparison of the remuneration paid to others for similar services, give a surer clue, as the payments to the actual costume designer etc. are of modest amounts. 19.9 Often, excess payments, are shown to extras and junior actors / actresses to cover up unaccounted payments made to reputed artistes. Enquiries into the destination of such cheques, and examination of the artistes usually reveal true state of affairs. 19.10 A practice noticed recently is of producers paying remuneration to an actor / actress, in the form the artiste‟s tax payments, or Life insurance premia, or cost of ownership flats / cars etc. In some cases, these are not disclosed. It is useful to obtain written declaration from the artiste, that he was not the recipient of any such benefit from any producer or any third party. 19.11 Another feature that has come to notice is of paying part of the agreed remuneration by showing it as a legitimate cash loan to a near relation of the artiste. It was found in the case of an actress that the producer advanced a huge sum by way of an unsecured loan to her mother, as if it was a genuine accommodation for a film proposed to be produced by the mother, the “loan” had not a single feature of a genuine money-lending deal. The AO was able to prove that this was only a mode of payment of a part of the remuneration of the actress. 19.12 A more systematic effort at avoidance was made by a leading actress, who placed her professional services at the exclusive disposal of a private limited company of which she, her father and sisters were shareholders. The producers could secure services of the artiste by entering into a contract with the company. The company treated the remuneration so earned as its own income out of which it showed monthly salary payments of comparatively small amounts to the artiste. The company claimed heavy

overheads and also embarked upon film production, in which fictitious business losses were shown. Thus, by creating such expenses and losses, the company setoff almost the entire earnings of the actress. 19.13 In yet another case, it was found that an actor entered into an agreement with a company controlled by the actor and the members of his family. Under the agreement, the actor assigned all copy rights, past, present and future in favour of the company and as a consideration agreed to receive guaranteed payment of Rs. 15 crores. The actor also committed himself under the agreement to work for the company for a period of 120 days in a year for next 10 years. The Company also had the right to use the name of the actor in the promotion of sale of any merchandise. In addition to the guaranteed money, the actor was also entitled to 3% of the profits of the company from year to year during the currency of the agreement. It was claimed that the receipt of Rs. 15 crores on account of guaranteed payment was in respect of assignment of copy rights and other rights by the actor and for use of his name i.e.. his „brand‟ exclusively by the company for 10 years and the payment received on transfer of these rights constitutes capital receipts in his hand. It was claimed, that this amount can also not be taxed under the head capital gains since the provisions of Section 55 (2) (a) apply to „goodwill of a business‟ and not to „goodwill of profession‟. In such cases, it becomes essential to examine the term of the agreement carefully and ascertain the specific details of rights including copy rights transferred under the agreement. On examination, it was found that as on the date of the agreement, the assessee did not own any copy rights and as far as the product of performance of the actor during the period of agreement, the same even otherwise vest in the producer i.e. the company and, therefore, there was no question of transfer of such copyrights by the actor to the company. Since no past or existing rights of capital nature were transferred under the agreement and the rights created during the currency of agreement, as per common practice in the trade, vested in the producer, on facts it was held that no copyrights or other rights were transferred in favour of the company by the actor and that the entire receipts including the guaranteed payment were in respect of the performance by the actor for the company and, therefore, the receipts are professional receipts liable to tax. The matter has been confirmed in first appeal. 19.14 One of the devices employed by some artistes to avoid proper taxation is to camouflage the professional receipts as loans from producers, so that they can use them as white money. The liability so created is then wiped out gradually and conveniently over a number of years. Therefore, such liabilities should be critically examined. 19.15 In addition to the above devices, facts remain that large unaccounted are received by these persons from producers. The detection of this is difficult but not altogether impossible. An effort should be made to find out whether near relations of the artiste or persons in his or her employment are making investments in real estate, in a factory, in firms or in other business ventures. Quite often such investments are made out of the artistes‟ unaccounted funds. Such investigations require sustained hard work but as the amount of income concealed is considerable, these may be justified. 19.16 Most of the top artistes are able to give a producer not more than 4 to 8 dates in a month. It is a common practice that stipulated installments of the agreed amount are paid to the artiste on or about the scheduled shooting date. Therefore, after obtaining the shooting dates, either from the artiste or from the shooting script of the film, the cash book of the producer for those days should be critically examined to find out some big outgoings and the producer should then be put to strict proof of their genuineness. The estimated remuneration payable to various artistes, according to the prevalent market rates, are also being openly published in some film periodicals. The amounts mentioned in written contracts should be compared with such market rates to have an idea of the suspected understatement. The artistes, can also be called upon to explain the steps taken, if any, against such periodicals, for the publication of information prejudicial to them. 19.17 A comparison should also be undertaken of the amounts entered in the written agreements of these artistes with different producers over a given period, and an explanation sought for any wide disparities noticed.

19.18 Another source of information is IMPPA, or similar trade associations, who classify important actors and actresses according to the remuneration they ask for and their normal rates per picture. 19.19 Conversion of black money earned by the artistes into gifts, is a common method of converting black money into white. In the case of one playback artist, it was claimed that a maternal aunt gifted jewellery worth lakhs of rupees to her. Enquiries into the financial status of donor revealed that she was not a person of means, and had her own children and other nieces, besides the donee. No gifts had been made to any one except the playback artist. A well-known artiste could not explain the sources of expenditure incurred abroad. She claimed to have borrowed money in India from sources, which on investigation proved incapable of making the loans. The same artiste paid custom duties when she imported goods. The source of that money could not be explained either. 19.20 Sometimes the purchases of vehicles and properties is made in names of near relations or employees of the artiste. The ownership of flashy cars is discussed in various film magazines and hence cannot go unnoticed.

Foreign earnings 20.1 Another issue which is acquiring importance these days relates to the receipts earned by these artistes abroad. While the artists, music directors, singers etc. get such earnings from stage shows etc. performed abroad, some of these artistes also earn royalties from sale of their music abroad. Deduction u/s 80 RR is admissible on most of these amounts received in convertible foreign exchange if the “income has been derived in the exercise of his profession” . Numerous Court decisions exist to the effect that the nexus between the income and the source from which it is derived has to be direct before the said deduction can be claimed in respect of that income. Advances received for a stage show which was never performed or from sale of cassettes of a concert given much earlier would constitute taxable income in the hands of these persons but the connection between the said income and the exercise of the profession being too remote, it is a moot question whether deduction u/s 80 RR would be available for such income. Another aspect to be kept in mind by the Assessing Officer, is that this deduction is to be allowed only on the net income i.e.. after reducing the expenses incurred to earn the same, and not on the gross receipts. Many assessees claim this deduction on their gross receipts, though it is settled law that the deduction under this Section, whose provisions are pari materia with those of Section 80-O, is allowable only on net income.

Other receipts 21.1 In addition to the professional receipts shown, artistes also have income from other sources. For example, the top stars get good remuneration for allowing their names to be used for advertisement of various products. Further, they get some payments for radio and TV interviews and for magazine interviews. It would therefore be useful to obtain and scrutinise periodical statements of total wealth from producers or financiers, are also taxable.

Playback singers 22.1 Playback singers maintain appointment diaries for their daily rehearsals, which can also be called and scrutinised. In their cases it also needs to be ensured that royalties received by them from gramophone companies on sale of their records are fully disclosed. Playback singers are, also in great demand for giving music performances in cultural and social functions. There is a tendency to suppress the income from such programs, including the heavy traveling and hotel expenses received. Efforts should, therefore, be made to obtain the details of such payments from the organizers of the programs, since these are widely publicised through press. These artistes, like the actors, also have a tendency to omit receipts in respect of films, the production of which is ultimately given up.

22.2 These artistes sometime accept part remuneration in the form of instruments like the deferred annuity schemes of the Life Insurance Corporation of India. A cross verification from the producer may show debit of such amount to the account of the assessee. The amount so paid constitutes a constructive receipt in his hands and is as such taxable.

Expenses claimed by artistes 23.1 The expenses claimed by artistes and directors, are mostly in the nature of salaries paid to secretary, driver and fanmail writer, motor car expenses and make-up expenses. Some expenses are claimed on an estimate basis also. The job of the AO is to find out, as accurately as possible, the total outgoings of the artiste during the year, especially under the following heads        

Taxes paid; Insurance Premium paid; Expenses on profession; All types of household and foreign travel expenses, considering the status, lifestyle and past admissions on this score; Payments towards purchase of jewellery, cars, land and houses etc.; Loans advanced; Repayment of loans obtained earlier; Investments in film production, distribution and exhibition, or other business.

It is advisable to obtain this information in writing from the assessee and to reconcile such outgoings with the admitted income of the year. The AO has to be on the look out to tap various avenues of information to find out investments and spending habits of these persons. It is also necessary to ascertain expenses under the following heads, and how these were met    

Foreign trips and tours to hill stations/holiday resorts; Membership of clubs etc.; Expenses on children‟s studies and marriages, etc. Expensive purchases made from departmental stores in India and abroad.

23.2 In many cases the expenditure claimed by these persons as deductible includes substantial amounts of personal expenses which are not allowable. Personal expenses are normally claimed towards traveling (including foreign travel), telephones, salaries, repairs and maintenance of cars and depreciation on assets which have not been used for the purposes of their profession.

Film Software 24.1 An emerging area of film industry relates to development of film softwares, animation films, dubbing of foreign block busters in Indian languages etc. The popularity of film-based programs on TV channels has given fillip to the demand for film-based softwares. The quality of film software developed in India matches with that available in the sophisticated studios of Hollywood. For instance, the facilities for editing, recording and dubbing provided by India's Ramoji Film city is today considered on par with the best in the world.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – VIII

TELEVISION CHANNELS

Introduction 1.1 Airing television entertainment and news programs on TV channels owned by persons other than Government-owned Doordarshan is of recent origin in India. Even today, by the very nature of this business, the number of players in this field are few, though the business is expanding at a fast pace. As such only a few Assessing Officers get exposure to assessment work of cases of TV channels, and those associated with transmission through this media. 1.2 The TV signals emitted from a TV station are first directed or beamed to a satellite, from where they are directed towards specific areas of the earth being targeted by a particular TV channel. The signals emanating from satellites are received through dish antennas, mainly by cable operators, who finally transmit these through cable connections to the ultimate viewers. The players involved in this line of business include the channel owners, satellite owners, producers of serials, sponsors, advertisers and cable operators. 1.3 India has about 68 million Television homes of which at least 28 million are cabled. An estimated 400 million people watch one of the 100 channels visible in India and the total advertisement revenue on TV is about Rs. 3,000 crore which is expected to rise to Rs. 8,000 crore by 2005. Besides, there are export earning of Rs. 500 crore which are likely to rise to Rs. 4,000 crore by 2005; and income from subscription of Rs. 1,800 crore which is likely to rise to Rs. 5,400 crore by then. Thus, the revenues are of the order of a Rs. 17,500 crore. With convergence of voice, data and video, a single cable (optic fiber or hybrid) and set-top box through an ADSL (Asymmetric Digital Subscription Line) or a cable TV connection will offer a wide array of services. With broad band the growth can be exponential. While the established networks like ZEE and SUN go global, the regional Channels are currently the flavour of the broadcast industry with SUN, ENADU, ZEE and now TARA moving aggressively to augment their spread. 1.4 Satellite TV Channels uplink electronic signals which are received in a number of countries in its area of coverage, known as “footprint”. Each satellite has 10-30 transponders depending upon the capacity of satellite. With the advent of digital technology each transponder can carry 8-10 channels. The signal thus uplinked can be normal i.e. Free-to-air or encrypted i.e. Pay channel. Free to air channel can be received by any cable operator while encrypted signals cannot be received without the decoder. Subscription is the main source of revenue for pay channels while advertisement revenue is main source for the Free-to-air channels. Since owning of a satellite and uplinking to a satellite from India was not permitted for NRIs and foreign companies, they hired foreign satellite transponders having India in their footprint. These companies then tied up with Hindi program content providers and advertisement sales

agents in India. Ownership of satellite by public is still not permitted but hiring an transponder abroad and uplinking of channel to Foreign satellites is permitted to companies wholly owned by resident Indians.

Sources of revenue 2.1 Most TV channels provide access to their signals to cable operators and other viewers free of charge. But, there are paid channels also which charge subscription fee for allowing access to their signals. The main source of revenue for the TV channels is, therefore, through advertisements as is the case with Newspaper publishing business. Normally advertisers on TV channels are big corporations which pay for the advertisements out of accounted sources and claim such expenses as outgoings in their accounts. As such the possibility of suppression of advertisement revenues is very limited, particularly in cases of major channels. However, one may exercise checks as discussed in the cases of the Newspaper publishers discussed in chapter V of this Volume. Collection agents promote and canvass for selling space on TV channels and coordinate between TV channels and advertisers or its agents to reach an agreement for selling space, settling complaints, claims, discounts, rebates, etc. The agent has no authority to contractually bind the principal and often foreign telecasting companies do not maintain fixed place of business in India 2.2 There are also cases where advertisements are routed by the concerns running TV channels through some group concerns for diversion of income. This is a common practice in a number of trades and the usual methods of investigations suggested in the cases of other classes of assessees elsewhere in this Manual, would be useful in these cases as well. 2.3 The issues arising in the cases of the producers of TV serial programs are broadly the same as in the cases of the film producers, discussed in chapter VI of this Volume. The techniques of investigations discussed in the cases of film producers are equally applicable in the cases of the producers of TV serials. Section 194J of I.T. Act requires deduction of tax at source from payments made by producers of TV serials to the artistes, technicians, etc. Here again as in the motion picture industry, most of the TV producers incur expenditure in cash. On the one hand the provisions of Section 194J are violated, and on the other hand the provisions of Section 40A (3). While scrutinizing the cases of persons associated with satellite TV channels, one has to look out for violation of Sections 40 A(3), 194J and 195 if any. 2.4 It is to be noted that as in motion picture industry new concerns are formed for every new TV serial and if information is not gathered on a contemporaneous basis it would be very difficult to establish and recover tax after a lapse of time. It is, therefore, essential to enforce TDS provisions strictly. Under Section 285B a person producing a feature film has to file a declaration in Form 52A within 30 days from the date of completion of a picture. He has to give a list of all payments made exceeding a certain amount. This can be an effective tool of contemporaneous enforcement of TDS provisions as also source of information in the regular assessments of the producers as also the payees. Since there is tremendous activity in the satellite TV sector, revenue from producers and TV channels could be substantial in days to come.

Structure of satellite TV channels received in India

Nature of business 3.1 Structure of Satellite TV Channels received in India : Most of the TV channels operating in India, are Indian companies primarily engaged in the business of  

production, or acquisition of TV programs, and procuring advertisements

3.2 Major TV software : The software for the main programmes telecast on the TV channels are as under    

Weekly soap operas - Episodes of these serials are telecast once a week usually during prime time Daily soap operas - These are serials, episodes of which are telecast daily usually on non prime time slots Prime time - This is the period with maximum viewer ship, i.e. between 8 p.m. and 10 p.m. on all days of the week and Sunday morning between 9 a.m. and 11 a.m. This is a period of universal viewer ship. All categories of viewers access

   

their TV during this period and there is no single dominant class or type of viewers. Prime time slots have a high cost in terms of payments to artistes, technicians and hire of expensive betacam equipments. Mega serials - These are serials with very high production values/ costs i.e., mythological, historical and fiction serials. Talk / chat show programs - These have low production costs as they have only single shooting location and with hardly any setup cost. Current affairs & news programmes - Their contents are almost common for all the channels and these have low shelf life. Packing of programmes / count down shows - These programs are essentially telecast on music channels. Their basic content is based film songs or album songs which are provided free by the music companies.

3.3 The advertisement revenues are procured by the Indian companies mainly for the nonresident companies located in USA, UK, Singapore etc. The Indian companies get an agreed percentage of advertisement revenue of the nonresident companies. In some cases the Indian companies also get paid at a flat rate for each hour of TV programs supplied. For some special programs, rates are separately negotiated. With the shift of viewer ship from Doordarshan to other satellite channels, the latter now command around 57% advertising revenue in comparison to their earlier share of less than 40%. This enables them to make better payments for telecast of programs. The revenue of the producers are from :  

Advertising receipts as in the case of sponsored programs telecast on Doordarshan.. Revenue from satellite channels.

If the producer retains the copyrights, then revenue from two additional sources also flow to the producers, viz  

Overseas distribution. Outright sale of rights after first telecast of serials.

Telecasting of programmes 4.1 Doordarshan (DD) : Normally DD does not acquire the copy rights of the program. Instead the producer purchases telecast time from DD for a fixed telecast fee and is allotted Free Commercial Time (FCT) for exploitation through advertisements. The amount of telecast fee and FCT depends on the time-slot during which the program would be telecast. During prime time the FCT may cost anywhere between Rs. 50,000/to Rs. 1,00,000/- per ten seconds while during non-prime time the same may cost Rs. 5,000/- per ten seconds. Thus, in the case of telecast on DD, the producer has to cover not only the cost of production but also the amount of telecast fees. If the program fares well, the producer may have decent earnings but In case it doesn‟t, losses can be high. Telecast of mega serials on DD have high cost of production; i.e. around Rs. 8-10 lakhs per episode. Further, minimum guarantee of Rs. 45 lakhs per episode is charged by Doordarshan 4.2 Satellite channels : Satellite channels usually acquire the program for a fixed price and the copyrights. Therefore, the risk and rewards of the program belong to the channel. Depending upon the popularity of the program, the channel earns revenue through marketing of commercial time. The satellite channel may after the telecast of episodes, transfer the rights of the programs to another local or overseas channel.

4.3 Viewer ship pattern : Viewer ship is determined by the type of program, the time slot and the cross-channel competition at that particular time. The viewer ship pattern is also affected by the telecast of some special programs like a cricket match, or a beauty contest, or election results etc. at the same time. These factors also assume importance when advertisements are to be targeted on selected categories of audience.

Taxability of receipts of the nonresident TV companies 5.1 The income of a nonresident is taxable in India if   

the nonresident has a business connection in India, or services are rendered in India, or the income is received in India.

5.2 A study shows that most of the nonresident companies do not file their any Incometax returns in India. The Indian companies, which file their returns claim deductions under Section 80 HHC on the ground that supply of entertainment programs to their foreign counterparts constitutes exports. The main issues specific to the assessments of TV channels that arise for examination are  

the assessibility of the receipts of the nonresidents from or through the Indian companies, and allowability of deduction under Section 80HHC in the cases of the Indian companies

5.3 A number of tests have evolved for deciding whether or not in a given case, the nonresident has a business connection in India. The general principles of assessments in the cases of the nonresidents are elaborately discussed in Chapter I of this Volume. Board‟s circular No. 742 dated 2.5.1996 provides for computation of income of foreign telecasting companies (FTC) @ 10% of the gross receipts for remittance abroad (i.e., excluding the amount retained by the advertising agent and the Indian agent of the foreign telecasting company as their commission/ charges), in the case of foreign telecasting companies, which are not having branch office, or permanent establishment in India and are not maintaining country-wise accounts. Tax on this income has to be deducted at source under Section 195 of the Act, by persons responsible for paying or remitting the amount. The circular gives general guidelines and is binding on the assessing officers. Some Foreign Telecasting companies have also obtained Advance Rulings from the Authority for Advance Rulings. 5.3.1 AAR No. 296 of 1996 TVM vs. TVM Ltd. CIT 102 Taxman 578 TVM is a company incorporated in Mauritius, engaged in the business of development, operation, marketing, sale and distribution of television programs and broadcasting of TV channels, to be broadcast through a transponder taken on lease ad signals transmitted are received in 68 countries including India. TVM earns revenue by way of advertisement from advertisers. In order to sell air time on its channels to parties in India, it entered into solicitation agreement with TVI an Indian company, wherein TVI will solicit orders and pass onto TVM for its scrutiny and acceptance. TVI should also be responsible for remitting advertisement revenue so collected to TVM and be entitled to commission for the services. TVI has no authority to conclude the contract. TVM directly enters into contracts with the advertisers in India. Questions raised -

(i) Whether the business profits earned by the applicant from sale of air time on the television channel broadcast in, inter alia, India, would be liable to tax in India? (ii) Whether the agent appointed by the applicant to solicit orders from the purchases of air time and to pass on those orders to the applicant for acceptance, could be construes as a Permanent Establishment of the applicant in India? (iii) If the answer to question No. 2 is in the negative, whether any part of the business profits earned by the applicant could still be deemed to accrue or arise in India and, therefore, liable to tax in India? Ruling AAR ruled that the business profit earned by TVM through TVI are profit deemed to accrue or arise in India u/s. 9 of the Act. However none of the business profit will be taxable in India by virtue of Article 7 of the DTAA because TVI is an independent agent and no Permanent Establishment for TVM exists in India. 5.3.2 AAR No. 358 of 1197 Al Nisr Publishing vs. CIT 105 Taxman 308 The Applicant Company is a partnership firm having its head office in Dubai, engaged in the business of publishing, printing and distribution of newspapers, magazines and other publications. The applicant sells advertising space to clients in UAE and other countries including India through agents and accordingly appointed BCL as its sole advertisement representative for solicitation of advertisements from agencies and advertisers in India. BCL agreed that it will not enter into any contract or accept any order on behalf of the applicant or act on behalf of the applicant or bind or attempt to bind it in any way. Questions raised (i) Whether, on the facts and in the circumstances of the case, any business profit or income accrues or arises in India in the hands of the applicant out of advertising revenue received/ receivable from its agent(s) in India: (ii) Whether such advertising revenues remitted out of India by the agent(s) of the applicant are subject to deduction of tax at source u/s. 195 and, if so, what would be the amount on which the tax would be deducted at source? Ruling BCL though an agent for the applicant, is an agent of independent status.

Case studies 6.1 Business connection - In the case of „NRC‟ a nonresident company set up in Hong Kong, it was found on the basis of the following facts that there was a „business connection‟ between it and, an Indian company „IC‟. The Indian company „IC‟ was providing television program and software support for „NRC‟, which owned the channel, and had had hired transponder time from another foreign company „FC‟.

6.1.1 Real and intimate business relationship - The prospectus to the public issue of „IC‟ made it more than clear that the „NRC‟ was incorporated after the Indian company „IC‟, which was approved as the source for telecasting programs in Hindi and other Indian languages, by the other foreign company „FC‟. The relevant clause in the prospectus read as under “Once this source was established, „IC‟ brought a group of NRIs to form the offshore company viz. „NRC‟ to operate the channel by entering into an agreement with „FC‟.” Thus it became apparent that the Nonresident company „NRC‟ was related to the Indian company, „IC‟, from the very beginning. „IC‟ was to produce / procure the television programs to be telecast while „FC‟ had the satellite transponder required for telecasting the same. „NRC‟ was set up after the arrangement between „FC‟ and „IC‟ were firmed up. „FC‟ owned 50% share in „NRC‟ and the balance 50% shares were owned by certain nonresident Indians who also owned shares in „IC‟. „NRC‟ worked as a link between „IC‟ and „FC‟. Further, as per the agreement between „IC‟ and „NRC‟ the former was given exclusive business responsibility to produce or to arrange the programs to be telecast. Even the brand name of the channel operated by „NRC‟ was being used after the name of the Indian Company. All the programs produced and telecast were meant for Indian viewers. The advertisements came almost entirely (more than 95%) from India. It was therefore clear from the facts of the case, that, the nonresident „NRC‟ had a real and intimate business relationship in India. 6.1.2 Continuity of business relationship - The business relationship of „NRC‟ in India was not of a casual nature, nor its transactions were isolated or stray. In fact, the relationship started right from the birth of „NRC‟ in 1992 and continued to prosper with the passage of time. The income of „NRC‟ from India in the first year was Rs. 6.95 crores, which went to Rs. 48.57 crores in next year, and touched Rs. 150 crore in the third year. Every telecast by „NRC‟ on the channel was dependent upon the supply of programs from „IC‟. Therefore, its revenue was dependent upon the popularity of viewer ship in India and efforts by its agent in India in canvassing for the advertisements. Initially, the agreements between „NRC‟ and „IC‟ and between „NRC‟ and „Z‟, a subsidiary of „IC‟, were entered for a period of three years which continued smoothly for the stipulated time. After the expiry of the initial period, the agreements were extended for a further period of two years, on the terms contained in the original agreements. These facts indicated a continuity of the relationship. The bonds between the Indian company and the nonresident companies were such as indicated a permanent and ongoing relationship. However, for convenience sake, agreements were being entered for shorter periods as per the availability of transponder of satellite from „FC‟. 6.1.3 Existence of agent in India - „Z‟, the subsidiary of „IC‟, was made an agent of „NRC‟ in India. The agreement entered in this regard was titled “Agency Agreement” and was approved by the Reserve Bank of India. As per the agreement „Z‟ had been appointed sole agent of „NRC‟ for promoting advertisements on the channel. For all advertisements emanating from India, the agent „Z‟ was to get a commission equal to 15% of the gross advertisement tariff. Advertisers deducted the commission of „Z‟ together with another 15% customary commission payable to advertising agents and the balance, i.e.. the share of „NRC‟ was remitted to it. The agent had set up an elaborate infrastructure which was bigger than that of the parent company, i.e.., „IC‟, for carrying out to responsibility under the agreement. The overall activities of „Z‟ clearly indicated that they were representing „NRC‟ with full power and authority, e.g. as agent they were authorised to negotiate commission, and to give or discount rebate upto a 20% of the advertisement tariff. The entire advertisement revenue of „NRC‟ from India was collected by the agent „Z‟ in its bank account and then remitted to „NRC‟.

6.2 Services rendered in India - Though the satellite uplink of „Y‟ was situated outside India (Hong Kong) and the radio signals were also sent from outside India, yet the following facts indicated that the services were being are rendered in India 







The main activity from which the advertisement income was generated was located in India. Advertisements are given by advertisers for bringing awareness about the products to be sold to target buyers. These target consumers were Indians. The advertisement revenue collected from the Indian advertisers. The advertisements so telecast brought home the visual message to Indian households. Thus, all the corresponding services rendered for the payments made, were also located in India. The advertisers were placing their advertisements on the channel only because the channel had overwhelming viewer ship in India, which was almost 99.50% of its total viewer ship. Advertisers were paying the advertisement charges to „NRC‟ not for pressing the electric button located in Hong Kong, but for the effect it created in India in the form of visual advertisements reaching the target Indian households. The advertisement tariff charged by „NRC‟ for airing the advertisements on the channel was r dependent on the popularity ratings of the different programs aired by the channel in India. These programs were produced in India in Indian context, and for catering to the Indian viewer ship. The programs were an integral part of the advertisement revenues being generated by the channel. A major part of these was reaching „NRC‟, and this was the main source of its revenue. The programs and their acceptability to Indian viewers was vital for the generation of the advertisement revenue, and therefore for the very commercial survival of „NRC‟. Thus the vital commercial activities were located India and these had a direct bearing on the very existence of „NRC‟. Various incidental services were being rendered by the nonresident company „NRC‟ through its agent „Z‟ to its clients, i.e.., the advertisers in India. These related to matters, like choosing air time appropriate to their products, completion of RBI formalities, and shipment of advertisement material, etc. Even though the uplink signal equipments were located outside India the downlink signal equipments, i.e.. the equipment connecting the channel with the cable operators, were all located in India. It is obvious that the advertisers would not pay for signals beamed out in space, unless proper images were also brought back to the viewers in India. Even otherwise, the satellite located in the geo-stationary orbit above the earth was situated in space and it cannot be said whether it is inside or outside of a particular country.

Thus, on the above facts it was held that services were being rendered by „NRC‟ in India through business connection in India. 6.3 Income received in India - Income from advertisement was also mainly received by „NRC‟ in India. For FY 1992-93, ‟Z‟, its sole authorised agent, had collected 90% of the advertisement revenue from India in Indian Rupees in its bank accounts located in India. Thereafter the same was remitted to „NRC‟. The percentage for FYE 1993-94 and 1994-95 were 66% and 58% respectively. Thus, in this case not one but all the three conditions viz. that the nonresident should have business connection in India; services should be rendered by it in India, and the income should be received in India, were satisfied. Therefore, the case of „NRC‟ was held to fall within the ambit of Section 5(2) of the Income Tax Act and its income was held to be taxable in India.

Deduction u/s 80 HHC

7.1 In the case discussed in the preceding paragraph, it was found that the major source of income in the hands of „IC‟ were receipts from „NRC‟ against supply of entertainment programs by the former to the latter at the rate of USD 3800 per hour of programming supplied. Under the agreement, „IC‟ retained the copyrights and / or the broadcasting and other rights acquired by it, while „NRC‟ obtained the rights to use the programs. The master copy of the programs was retained by „IC‟, and only a copy was sent to „NRC‟ at Hong Kong, for the purposes of telecasting. The provisions of Section 80HHC relate to export out of India of any goods or merchandise. Normally a transaction of sale of any goods or merchandise is complete when the seller gives the asset to the buyer for an agreed consideration, as a consequence of which the seller is left with no right in that asset. Thus as per literal interpretation of the provisions of Section 80 HHC, only those transactions will come within its ambit where the sale of goods is complete and is made to a party outside India. In the instant case it was clear that the programs produced or acquired by „IC‟ were not sold to „NRC‟ but the latter was only permitted to telecast the same on the channel for a limited duration against payments which were received on the basis of hours of telecast. Further, „IC‟ retained the copyright and all other rights in the programs. It did not make on outright sale of the program to „NRC‟, unlike many other cases where „NRC‟ purchased the programs from outside producers. „IC‟ also had the liberty to make the programs on video cassettes and sell them in any market for domestic viewing. It also retained the right to sell the programs for satellite telecasting in countries not covered by the channel of „NRC‟. Therefore, in the background of these facts and circumstances, it was clear that „IC‟ had not made sale of any goods within the meaning of Section 80 HHC of the Income-tax Act. The case of the assessee was, in fact comparable to the case of a person who arranges to send a theatre group or dance group for performance abroad and receives foreign exchange for such performance. By no stretch of imagination it can be said that the group was exported. The show was enacted abroad and as per the periodicity of the shows the person earned fees in foreign exchange. In the assessee‟s case the entertainment program remained the permanent property of the assessee as it retained the copyright therein. The so-called buyer was allowed to transmit the program on electronic device for some duration against payment of fees. What the assessee received was compensation or fees and not sale price as there was no sale of the asset, Hence it was held that deduction under section 80HHC of the Act is not admissible in the case of „IC‟. 7.2 This controversy now stands resolved with the introduction of Section 80 HHF w.e.f. 01.04.2000 relating to deduction in respect of profits and gains from export of film software or software rights. The introduction of these provisions also makes it clear that the deduction in respect of such exports was not admissible under section 80HHC.

Valuation of work-in-progress/ closing stock 8.1 In the case of TV channels, episodes of serial programmes completed but not delivered to the broadcaster are treated as work-in-progess / closing stock. Some concerns recognise revenue on the basis of telecast date and not on the basis of delivery to the broadcaster because their agreements with satellite channels provide that the programme can be rejected by the latter. In such situations it is possible that episodes are sent back to the producer for modification in technical aspects or contents. In the absence of any such conditions by the broadcaster, the value of episodes that have been delivered for telecast but not yet telecast should be recognised as revenue. 8.2 At the end of the year, it also becomes necessary to determine the cost which pertains to each episode not telecast or delivered. This issue gains significance because it may be difficult to allocate common costs in respect to the episodes not telecast yet. 8.3 Valuation of closing stock is difficult in case of mega serials with large pre-production and setup costs. These serials achieve break-even only after the telecast of several episodes because for these serials the revenue stream rises very slowly with the TRP (Television Rating Points). Therefore, the costs of initial episodes may be disproportionately high because of pre-production and setup costs and also because the initial episodes are required to have a very high quality to establish high TRP rating.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter - IX

CABLE TV

Introduction 1.1 Growth of cable TV in India has been spectacular during the last 12 years. Till a few years back cable TV was in the domain of small business people as it involved an initial capital of Rs. 1 to 2 lakh. With such a modest capital, a cable TV operator was able to provide upto six channels to 150 to 200 households in a particular locality. He was able to cater to the specific needs of that area with regular feedback regarding the viewers‟ preferences. However, the scenario changed with the entry of big players in almost all the major towns.Presently this industry which is only a decade old boasts connectivity of approximately 24 million viewers and is expected to reach over 46 million viewers by the end of year 2000. With "Information Technology" the buzzword of the century, "cabling" of the nation appears an attainable goal. The potential advertisement revenues and the possibility to facilitate "convergence" gives this industry tremendous growth potential. Television in India is currently available in about 60 million households and is expected to reach 86 million household by the end of 2000. Thus, currently there is a huge gap between the television owning households and cable penetration which is expected to continue at least till 2005. 1.2 The Indian cable TV industry is not restrictive. Any entrepreneur can enter the arena by fulfilling two requirement only i.e. getting oneself registered with the Department of Post and Telegraphs of the Govt. of India, and paying the prescribed fee. It is estimated that Cable TV now connects nearly 24 millions households in India. The rate of growth of this industry during last 6 years has been phenomenal though there is still considerable scope as our country has around 60 millions homes with television facilities and the demand of new TV sets is constantly growing with almost 6 million TV sets being sold every year. A recent study has revealed that cable TV industry is growing at the rate of 25% p.a. With new international and regional TV channels joining the fray, growth could be further accelerated. Already the cable TV market in India is around Rs. 2500 crores annually. With rural market getting special attention and chances of Internet being accessible on cable TV at a reasonable cost, the growth in the industry could be at an amazing pace.

1.3 Despite the fragmented nature of Indian cable TV industry, the country offers cheapest cable TV connections in the world. Average rentals are around Rs. 100/- p.m. in smaller towns and could be little more in bigger cities. According to the estimates of cable TV experts there are around 60,000 cable operators in India and most of them do not serve more than 300 to 400 subscribers though there are some very big players in mega cities who could even be serving more than 5000 subscribers each. It is now apparent that entry of some giants in this industry was not merely for revenue reasons, but as a well planned strategy by the „captains in broadcasting business‟ who wanted to broad base their clientele and check manipulations and malpractices of small local operators as there was a general feeling that these operators could cut off specified channels whenever they so desired, which in the long run had the potential of adversely affecting both viewer ship and advertising revenues of those corporates.

Nature of trade 2.1 With the entry of these corporations, the face of the industry has changed. By using updated technology they are able to cater to wider choices of viewers and are in a position to provide much better services. With enormous financial resources at their command they have easy access to latest global trends in cable TV technology. In view of the demand for incorporation of the latest trends and healthy competition, viewers are decidedly having better service. There has also been an influx of large number of vernacular channels adding variety to the choice of the viewers. New international channels like CNN, Discovery & National Geographic have dramatically altered the profile of the programs as also viewers tastes and now viewers increasingly crave for specialized channels. With tough competition and high administrative costs many cable operators have opted out by either deciding to quit by selling their networks to the Multi-System-Operators ( MSOs) or by playing second fiddle to them i.e. by deciding to become their franchisees. Due to this consolidation, the number of cable operators in the country has fallen to approximately 30,000. Large companies who have set up their own cable networks include InCablenet, Siticable, Asianet, Hathway Cable and datacom. These operators have either bought over small local operators or have formed joint ventures and other strategic alliances with the local operators. Further consolidation in the industry is likely to take place, thereby increasing the subscription base of the large cable operators. 2.2 For efficiently serving and servicing the large clientele, the new MSOs have built control rooms or head-ends which distribute signals to the low end operators or local operators who further distribute it to the viewers. A new cable net-work architecture has made the MSO a focal point with facility of decoders for various pay-channels. Some of the MSOs do provide best of services by laying down high quality hybrid fibre / coaxial cables using trunk-routes. Most of these cables are imported as these corporations want to use „state of the art technology‟ for being in the forefront of the race and for maintaining competitive edge over other players. 2.3 Currently, it is estimated that cable channels attract advertisement worth approximately Rs. 250 - 300 crores annually. With niche marketing and consumer group oriented marketing gaining popularity, the potential of cable networks to provide advertisers the right target audience is becoming increasingly evident. Indeed advertisers can now approach cable networks with subscribers of the desired economic background, culture, etc. and maximise the per Rupee impact of advertising. Starting with 6 channels, cable operators today offer 50-75 channels to their viewers. The revenues of the cable operators vary from Rs. 25 to Rs 150 per subscriber per month, depending upon the number of channels offered. With digital compression in cable television, the number of channels is expected to swell to 200. The revenues of a cable operator are directly linked to the network size and channel menu. Accordingly, with the number of channels increasing significantly, there is potential for cable operators to substantially increase revenues.

Categories of persons involved in the cable TV industry 3.1 Broadly speaking people associated with this industry can be in the following 3 categories -

  

High end operators Low end operators Agents of the Pay Channels

3.2 High end operators - For a high end operator who wants to be in the big league, it is a highly capital intensive industry. There has to be substantial capital investments in cables, boosters, dish antennas, decoders having computers with software like mindware etc. This sophisticated software enables the High end operator to run programs on his own channel, as also to scroll advertisements and create visual effects. His sources of income are primarily from subscription from customers; monthly payment from low end operators, and earnings from advertisement. 3.3 Low end operators - A low end operator has to make monthly payments to the High end operator. He has to generally make capital investment in boosters and cables. Besides payments to the High end operator, his major item of expenditure is on salary to staff. Most of the earlier small cable TV network owners are now working as low end operators to survive in the market. 3.4 Agents of satellite channels - Every satellite broadcaster has an agent distributor for a specific area having an obligation to look after the interest of the channel in that area. The decoders of pay channels are distributed through these agents, and it is their primary responsibility to collect the subscription amount for broadcasting the programs of the channel. Any cable operator keen to have the pay channel has to approach the agent for cable connection as well as the decoder which can either be given on hirepurchase or could be sold outrightly. 3.5 Cable TV operators pass on the data regarding the subscribers to the agents of the satellite channel while seeking connections. However an agent employs its own field staff to cross-verify the figures furnished by the operators. Rates and amounts are fixed according to these findings. Ultimately, the amount is remitted to the satellite broadcaster who gets a certain percentage as commission besides some incentives. Every broadcaster prescribes a ledger which contains details of business and residential addresses of the cable TV operator, his customer codes, decoder code, phone numbers of customers and periodicity and quantum of installment payments. Payments are collected in advance. If there is repeated default in payment, a decoder can even be deactivated. 3.6 The cable TV operators have to pay entertainment tax and the rates of which vary from state to state. The rates may also vary on the basis of a city being a Corporation, a Municipal council or a Town panchayat.

Tax Investigations 4.1 For running the cable TV, every operator has to get registration from the Department of Posts (Government of India) under the provisions of the Cable Television Net work (Regulation) Act, 1995. This registration is granted by the Head Post Master. Fee for registration and renewal of registration is Rs. 500/-per annum. The head Post Master is expected to maintain a register in this regard. Registration is valid for a period of 12 months and can be renewed. The Assessing Officer can get complete details of new and existing cable operators from the office of the Head Post Master of a particular place. As the entertainment tax authorities levy and collect entertainment tax on these connections, details received from Head Post Office can also be cross-tallied from the records of entertainment tax authorities. Any discrepancies in the figures disclosed to the postal authorities and entertainment authorities can be promptly checked and explanation of the operators sought. 4.2 The main malpractice in this trade related to underreporting of subscribers by the High and low-end operators. By suppressing the figures they not only cheat the Satellite TV agents but also defraud the revenue. Where underreporting is suspected by the AO he should get the figures checked by calling the records of the low end operator, the high end operator, and the Satellite TV agents; or by making on the spot enquiry. In suitable cases even a survey could be conducted by him

4.3 High end operators also run their own channels for broadcasting their own programs on a local/ regional basis. They also play songs from movies and screen them at specified periods. At regular intervals advertisements are also shown in those channels. Charges of advertisement may vary from place to place and depend on the duration of the advertisement and number of runs per day. In the absence of any standardised rate structure there is enormous scope for them to suppress/under report the advertising receipts. The AO may have to conduct detailed enquiry from various advertisers to verify the claim of the operator / assessee in this regard. Many operators also bring out monthly booklets giving particulars of monthly programs on the different channels. They also publish advertisements on these booklets. 4.4 Large operators / agents often tend to inflate the expenses under various heads like commission, salary and promotional expenses.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – X

ENTERTAINMENT INDUSTRY

Introduction 1.1 This Chapter deals with the event management and live entertainment aspect of the Entertainment Industry. A very nascent industry, the live entertainment and event management industry has the potential to gross more than Rs. 3,350 crore in less than five years. With globalisation, the number of international performers visiting India to promote their albums and films is increasing exponentially. Indian corporate houses also view events as a novel means of reaching a large select audience, given the response to recently organised product promotion events. Various film-based TV channels and Satellite music channels have increased the popular interest and awareness of the general public in domestic as well as international artistes which has resulted in a phenomenal growth in the live entertainment and event management industry. The possibility of 'convergence' of voice, data, sound and video to be carried over any form of wired or wireless communication holder tremendous potential for entertainment industry.

In this digital domain, content providers - mainly from entertainment, sports, fashion and celebrity world, will become major players. 1.2 The management of an event includes planning, creatively organising and finally executing an event. The event may be in the nature of a show, a concert, a product or a brand launch, an exhibition, a trade fare or a conference. In these events, entertainment is packaged in a novel manner and can be used as a form of advertising and public relations. Big corporate houses consider sponsoring major events featuring popular artists as a means of reaching the average consumer in the market. Events are basically an extended form of advertising and facilitate brand building and direct association with the consumers. 1.3 Event management can relate to international or domestic events. The international events may include promotional activities of international artistes performing in India to publicise their albums or to execute their advertisement contracts and it may also include an international artiste performing in live concerts for a charitable purpose or for a purely ticketing event. The domestic events may be based on films, classical or Indian pop music. Besides event management, live concerts, theme parks, webcast, adventure sports etc. are the other growth areas of entertainment industry. 1.4 As per a report prepared by M/s Arthur & Andersen for the Federation of Indian Chambers of Commerce and Industry, whereas the event management industry had a turnover of Rs. 20 crores a decade ago, it is now touching turn overs of Rs. 200 to 250 crores p.a. This industry is growing with the numerous satellite music channels and film based channels being beamed through the television. The growth is exponential as multinational corporates are coming forward to sponsor events and shows. As per this report, the live concert circuit is probably the fastest growing segment of the entertainment business. It has grown 200% between the years 1995 and 1999. In recent years, a number of international artists have visited India to perform in live events. Multinationals and big corporates are using tailor made events to promote their products. It is estimated that due to this large scale marketing strategy, the event management industry could emerge as a Rs. 3350 crores industry in next five years. 1.5 The Indian based event managers are holding events in a big way in foreign countries such as USA, UAE, UK and South Africa, etc. where there is a presence of a large number of non resident Indians. There is a considerable scope of earning of foreign currency through these events in foreign countries. As per the above report, with an increasing number of Indian companies showing interest in holding and sponsoring live events, the event management industry has a bright future and is estimated to grow at an annual rate of 60% giving a tremendous boost to foreign exchange earnings. As a spin off, this industry would also spur travel and hotel industry, the sound and lighting industry for theatrical applications. It also generates substantial employment which results from appointing volunteers for a particular event. The live concert circuit is the fastest growing segment. 1.6 Companies engaged in providing live entertainment abroad are entering into joint ventures with Internet communication companies to develop live entertainment portals providing a broad range of services such as :    

Webcasting concerts shows and other live events as they happen. E-commerce merchandise for tours and shows, including T-shirts, albums, banners, caps and fan magazines. Information on current and upcoming concerts and shows as well as reviews and ticket information. Community chat rooms enabling fans to share information and experiences on live entertainment.

Main players 2.1 Events such as Amitabh Bachhan Nite, Sharukh Khan Nite, Juhi Chawla Nite, Daler Mehndi show etc. are being organised in India in various town for a long time. People flock to these shows because of the

glamour of the artists who perform in these shows. In most of such programs there is a huge rush of audience. Organising such shows, and making them a success has become a profession in itself. Some of the top program organisers in India presently are            

M/s Wizcraft (Head Office - Mumbai, Branch - Delhi, Bangalore, Chennai). M/s Ovations (Head Office - Bangalore). M/s DNA Networks Pvt. Ltd. (Head Office - Bangalore.) M/s Encompass Productions (Head Office - Delhi with Branch at Mumbai). M/s Procam Sports (Head Office - Mumbai). M/s Fountainhead (Head Office - Mumbai). M/s Cause Celibre (Head Office - Mumbai with Branch at Bangalore.) M/s Show Time India Pvt. Ltd. (Head Office - Delhi.) M/s C.S. Direkt (Head Office - Delhi). M/s Exciting Events (Head Office - Delhi.) M/s CRI Events (Head Office - Delhi.) M/s Laxya Advertising & Marketing Pvt. Ltd. (Head Office - Delhi.)

2.2 The event management for entertainment could be of the following types      

Purely commercial ticketing events. Ticketing events for charitable cause. Non-ticketing events gaining audience by invitation. Events to launch products by big companies. Sports events for a cause involving sale of tickets. Sports events for entertainment involving sale of tickets.

Commercial ticketing events 3.1 In this type of events the event management company engages, on its own initiative, artistes either from India or abroad. The event is declared after the dates with the artistes and their troupe are finalised. Having declared the event, the event managers take following steps    

 

Booking of venue - The venue is selected depending upon the size & class of the audience expected to attend. Seeking permission and No Objection Certificate (NOC) from the Municipal / other local authorities. Permission from the Electricity Board for power, and for keeping standby generators. This may require certain amount of payments to be made. Liaison with the Fire Department for getting at least two Fire Tenders on payment. Printing of tickets of various denominations. All the tickets which are printed have to be presented to the Entertainment Tax Department and stamped by them. Before the entertainment tax department stamps these tickets, they charge the entertainment tax in advance which is paid by the event managers before the tickets are put on sale. Entertainment tax varies from state to state from as low as 10% in Karnataka to 45% in Maharashtra. Permission regarding the loud speakers and music systems to be used in the program. Permission from the Police who are some times to be paid for making the bandobast. This permission also stipulates the duration of the event on the date of the program, as also other terms & conditions.

3.2 Once the necessary permissions / NOCs have been taken, the event manager may organise the program on has own or it may seek contributions from different sponsors. Depending upon the fame, reputation, and popularity of the performing artistes sponsors may come forward for payment of

sponsorship money. If the star cast is not to the liking of the sponsors, the event manager may not get enough sponsorship support. In that case, he has to depend only on the sale of tickets and spot advertisement. Big corporate houses view sponsoring events in which popular artistes are performing as a means to reach their target consumers. As a result, a good and effective manager may be able to raise sufficient sponsorship money. 3.3 For organising the show on the date fixed the event manager takes following steps 

 

 

Advertisement and publicity for the show - through press, banners, hoarding, cinema slides, T V spots etc. Favourable notices in local press prior to the event, go a long way to garner local publicity. Scouting for volunteer helpers to manage the event. Most of the times an event management company may have 12-15 regular staff of its own unless it is a big company which may have staff of 85-100 such as WIZCRAFT of Mumbai. Therefore, for a particular event, the event manager has to invite organisers who are normally called volunteers. These volunteers are paid sometimes on daily basis and sometimes on a contract for the whole duration of the preparation and execution of the show. In bigger cities there are organisations which provide these volunteers to the event managers. Depending on the type of show and the work for which they are contracted, the payment to these volunteers may vary from Rs. 50/- to Rs. 500/- per day. Organising venues for sale of tickets Preparations at the venue - This may involve setting up barricades (procured on hire); erecting the stage, back drop for the stage, music system, high voltage speakers, etc.; arrangement of band in case the artistes are not bringing their own troupe; hiring of sofas and chairs to be placed in different enclosures; arranging for contractors to supply snacks and soft drinks etc. inside the venue; decorations on the stage and in and around the venue; supply of flowers; arrangements for drinking water generators; lighting on the stage, at the venue, in the enclosures as also outside the venue; parking for vehicles; and first aid etc. Arrangement of traveling, lodging, local transport, and other needs of the artistes. Distribution of promotional items to popularise the show to ensure maximum audience. This includes handbills, caps, T-shirts etc. Which are distributed, and also given to the volunteers.

3.4 In the purely ticketing events, the event manager has to initially spend a substantial amount for organising the show on the items mentioned above. The profit from an event is earned through the sale precedes of tickets, and other earnings, e.g. from sponsorship, sale of hoarding and advertisement spaces at the venue, contracts for passing lots, cafeteria etc. From this, the expenses incurred for organising the show are deducted. Generally, the main expenditure is on payment of the fees of the artistes, musicians, sound system, lights, stage setting - in that order.

Events for charitable causes 4.1 Most of the events that are organised are under this category. This is because if the event is devoted to a charitable cause such as for the Spastic Society, for Deaf and Dumb Schools, for destitute children, for old age homes, for the women welfare organisations, for relief work related to some national events / calamity, for welfare of Army / Air force / Navy etc., then on a specific application the entertainment tax on the tickets sold may be exempted. However, for such events there is also a stipulation that 85% of the profit from the event should go towards the charitable purpose / association for which the show has been organised. Since the organisation of such shows is for a charitable cause, often large number of sponsors come forward to offer help for the cause. 4.2 The rest of the formalities and arrangements required are broadly the same as narrated in preceding paragraph.

Non-ticketing events for invited audience 5.1 Various large companies producing consumer goods organise big events to popularise their products. Such large events are being organised by companies such as Pepsi, Coca Cola, ZEE Network, BPL, Times group, Videocon International etc. In these events no tickets are sold. The audience is invited through invitation cards issued by the organising company. 5.2 For these types of events also, the organising companies contact and execute contracts with reputed event manager to organise their show. The event manager makes an estimate of the likely expenditure in organising the event. This is followed by negotiation with respect to the theme of the events, and the artistes to be contacted for the same. The organising company pays to the event manager its professional fee for organising the event. However, on such payment, the organising company is obliged to carry out deduction of tax at source. Service tax is also leviable on payments to the event managers for organising programs for their clients. 5.3 The event manager in turn engages various subcontractors etc. for erection of stage, setting up sound system, arranging for lighting, chairs, barricades, transportation, lodging, traveling etc. The event manager is obliged to deduct tax at source on the payments made by him to the subcontractors for these services. 5.4 The arrangements and formalities required for organising these events are generally the same as discussed in paragraph 3 above.

Events to launch products by big companies 6.1 Such events are on a smaller scale and their main purpose is launch of a new product. However, to make the launch interesting and memorable, the show is organised with professional help through event managers, often with a theme. The audience may include trade barons, dealers from all over the country, celebrities, glitterati, media persons, senior bureaucrats and politicians, etc. 6.2 In these shows also the event manager has a major role to play. He conceptualises the show, and selects the artistes from the point of view of the product being launched, e.g. if it is the launching of a new Television set, film artistes / TV artistes may be invited, perhaps even to perform or at least to be present for the occasion. Their presence adds glamour to the event. If it is launching of a car, some of the international car race champions may be the chief guest. Sometimes substantial payments are required to be made to these celebrities for just being present. 6.3 These shows, are mostly conducted in big hotels or big auditoriums / halls. The formalities for organising these shows may not be as many as discussed earlier. The product is launched through a package of information regarding the product. This may be through product brochures, company magazines or multimedia show, backed by souvenirs, press conferences, and advertisement campaigns etc. The purpose is to create an awareness and identity for the product in the minds of the potential customers. This obviously requires creativity, and innovativeness to catch the attention of target groups. 6.4 The events for launching of new products often combine business with entertainment. During the day, programs may be held in which various salient features of the product being launched are emphasized to dealers and other invitees, while in the evening there may be a cultural or entertainment show followed by dinner. 6.5 Normally, the event manager‟s income is in the range of 15-20 % of the total expenditure on the event. The companies making payment to the event manager are obliged to deduct the tax at source on the payments made.

6.6 Many event managers who were earlier producing entertainment events with big stars are now doing these product launches. The event managers get the payment known as event billing, which includes the cost of design, conceptualisation, technical requirements, invites, etc. But this normally does not include the payment to artistes as in most cases this is borne by the organising company.

Sport events 7.1 Sports have received large audience appeal and spectator loyalty in India over the last decade. This is reflected in huge audiences at the stadiums, major television contracts for the game as also players, and huge sponsorships. Even though cricket is the most sought after game cornering lion‟s share of the Indian sponsorship scenario, yet in the last few years there has been a perceptible increase in the popularity of live telecasts of some other games also. One such example is the National Football League which was launched about three to four years ago and which has become very successful both in the print as well as television media. Various sponsors have patronised this event. However, cricket is still the biggest attraction in India and the Board of Control for Cricket in India, is the richest sports body in the country. The amount of money involved in the cricketing events could be seen from the figures below Title sponsorship

ITC 1996 Wills World Cup

Rs. 38 Crores

Affiliate sponsorship

Coca Cola, 1996 Wills World Cup

Rs. 12 Crores

Television rights

World Tel, 1997 Independence Cup

Rs. 6 Crores

Team sponsorship

Reebok Mumbai Ranji Trophy

Rs. 1.08 Crores

World Cup ‟99 England

Indian advertisers spent

Rs. 54 Crores

The Phillips National Foot ball League was launched in the year 1996. In all 86 matches were played over a three month season amongst the top 12 teams in the country. Most of these matches were covered by Star Sports. Even the print media gave excellent coverage to this. At the end of the league, cash prizes worth Rs. 1.5 Crores were given. The Football League has further picked up since then, and in 1999, Coca Cola, the sponsors, paid prize money and cash incentives to the tune of Rs. 5 Crores. 7.2 Even in Volley ball, a National Volley ball League has been started and it has attracted sufficient crowds. The concept of beach volley ball which has been very successful in the western countries has also started in India and Asian Beach Volley ball contest was held in Chennai in the year 1995. In 1998, Bacardi, organised the Asian Beach Volley ball championship which was highly successful. Mahindra & Mahindra have launched an International tournament in Squash since 1993 mostly held in Mumbai with huge prize money ranging from Rs. 19,25,000/- in 1993 to Rs. 75,25,000/- in 1998. The 1999 version was held at Qatar. The best players in world have been participating in these tournaments. In hockey, India has hosted the „Champions‟ trophy in the year 1996 (December). Top six nations of the World took part in this. The national event was organised by the Kuber Group who met the sponsorship costs. This Champions‟ trophy was televised not only in Asia but also in Europe. Now, it is seen that sponsors like Reebok and Smithkline Beecham have taken over the sponsorship of the Indian hockey team. 7.3 Golf is one of the few games that have a circuit of tournaments in India. The main such tournament is the Classic Indian Open which is a part of the APGA tour. The ITC Classic had sponsored the Indian Open with prize money to the tune of Rs. 1,29,00,000/-. From 1998 onwards, the PGA of India tour has been established with guaranteed prize money of Rs. 1.8 Crores only and as such it will witness the performance of various professionals who would compete. There is also Johny Walker Club Championships that are played across our country. There are more than a 100 Golf courses in India. 7.4 Lawn tennis is another sport with a well defined circuit in India. The present AITA circuit is being sponsored by a consortium of Japanese companies which are called TFI (Telecom Finance International). It was the bronze medal won by Leander Paes at Atlanta Olympics, the French Open, and Wimbledon

doubles titles, which has also brought focus to tennis sponsorship in India. Tennis academies are now flourishing in Delhi, Bangalore and Chennai. Gold Flake (ITC Ltd.) have consistently sponsored the Gold Flake Indian Open. 7.5 With the launch of Star Sports, ESPN, Doordarshan Sports, the sky is the limit for generation of money in sporting events. In the 1999 World Cup, 42 matches were shown live. ESPN - Star Sports joint venture sold six associate sponsorship packages to Indian companies at Rs. 9 crore each. Doordarshan had rights to only 11 World Cup matches but it received Rs. 35 crores as minimum guarantee amount. 7.6 The aforementioned games / sports are also used to hold an event for a charitable cause. This may be organised in a stadium or in a auditorium depending on the game or sports. There have been a number of friendly cricket matches between teams of cine artistes and the popular cricket teams to augment revenue for different causes. A rough chart of the items of receipts and expenses in these events can be as under Receipts

Expenses

Sponsorship money

Fees paid by the event manager to international or local federation of particular game or sport

Gate receipts

Rent of the venue

TV advertising revenues

Money paid to players and artists, etc. for participation as also to referees or umpires, etc.

Sale of ad space on hoarding

Prize money

Food & beverages stalls

Advertising and publicity for the event

Sale of logo / souvenirs etc.

Arrangements at the venue, Police bandobast Hotel bills, Traveling and lodging, food Contract labour and volunteers Expenses on promotional items

If the events are held for charitable purpose, at least 85% of the net income of the show has to be given to the concerned charity, for obtaining exemption from the entertainment tax.

Competitive sport events involving sale of tickets 8.1 This is the main area of the event management of this particular type. There is huge money involved in major cricketing / tennis / squash events. These big events may be managed in two formats 8.1.1 The event may be named as an ICC event (for cricket) or AITA event (for tennis) i.e. it is based on the name of the organising federation. When this is the case, the television rights are sold by the concerned organising federation. In turn, the television channels who have successfully bid for the event may sell various advertisement spots to different sponsors / advertisers. 8.1.2 The second type of events could be such as the Reliance Cup, Pepsi Cup, Coca Cola Cup, Mahindra ATP event, etc. i.e. a particular sport event is named after the main sponsor. In such events, the main sponsor does not get any money from the TV channel as its name itself is linked to the main event. In these events, there are also certain cosponsors whose name is not directly linked to the event but large money is collected from them by the TV Channel for cosponsoring the show.

8.2 The organisers of these kind of mega events have to take care of a number of issues and make meticulous preparations to successfully organise these events. In these events there is live entertainment for the viewers in the stadium and on the television, but these also involve competition amongst the participating teams, that gives rise to a lot of national pride and challenge. The organisation, logistics, and other arrangements required for these events are broadly on the same lines as discussed earlier. In addition there may be some special arrangements depending upon the requirements of a particular sport e.g. a cricket ground.

Entertainment tax 9.1 The entertainment tax levied by various State Governments on sport events is comparatively low. For example in Karnataka, whereas the entertainment tax is 10% on ticket value of Rs. 100/- or more, for all other types of exhibition or amusement etc., but for sport events it is 10% of the ticket value of Rs. 250/or more. The entire entertainment tax for any type of event is to be paid before hand i.e.. before the event is organised. In fact, the stamp of the entertainment tax authority is to be placed on all the tickets to be sold and printed by the organisers. Without the stamp of the entertainment tax authorities, these tickets are invalid. If tickets are sold without such stamp and if caught it results in huge penalties on the organisers. While giving permission for holding a particular event, the entertainment tax authorities can impose various conditions, such as, complimentary passes should not be issued, or that the entire proceeds after deducting the actual expenses incurred towards organising the show should be given for the respective public purpose. 9.2 In cases where there are no tickets but the show is through donation, entertainment tax is to be paid on the amount of lump sum payment relatable to that entertainment. This amount is payable by the event manager.

Case study 10.1 In a typical entertainment program, involving two major film stars of Bollywood, held at Bangalore following types of expenses were noticed in a survey. The payments made to various artistes were as under Name

Amount paid (Rs.)

Main star - 1

1,700,000

Main star - 2

800,000

Support star - 1

300,000

Support star - 2

50,000

Main singer - 1

150,000

Master of ceremonies

75,000

Main compere

20,000

Singer - 2

75,000

10.2 The cash flow statement as given by the local representative of the event manager was as under Receipts

Amount

Payments

Rs. Tickets sold

2,254,800

Amount Rs.

Ground rent (2 days)

78,300

Sponsorship amounts Sponsor - 1 4,33,125

Printing of hand Bills (3000 in English & Urdu)

11,200

Sound & light paid to Reynold

225,000

Video signal charges

25,000

Venue design charges

20,000

Artist fees

245,000

Ambulance with doctor

4,150

Distribution of handbills over 15 days by 6 persons, and by 49 volunteers on show day

41,800

Security charges to police

91,000

Printing of 15000 caps

8,250

Petrol for vehicles - 15 days

5,000

Purchase of show materials Balls, soft toys, flowers, etc.

10,000

Incentive paid for marketing -

17,650

Mobile rent

13,450

Traveling Expenses - B‟loreDelhi -Bangalore 2 trips

30,000

Training man for back stage

500

Sponsor - 2 1,00,000 Sponsor - 3 35,000 Sponsor - 4 75,000 Sponsor - 5 40,000 Sponsor - 6 44,000 Others 55,000

782,125

Banner Income

TOTAL

35,000

3,071,925

Printing of banners

2,450

Conveyance & other misc. expenses for 4 months

35,000

Cash on hand

3,175

TOTAL

866,925

The aforementioned figures give a general idea as to the receipts and payments involved in an event featuring Indian artistes. The above expenditure does not include expenditure on board and lodging, traveling and air tickets, payment to artists, etc. The Receipts and Payments sides also do not tally.

Various other discrepancies were also noticed in this case. Oberoi Hotel, Bangalore, confirmed to have collected a sum of Rs. 1,84,869/- towards boarding and lodging of the cine stars staying in that hotel, which was found not included in the above cash flow statement.

General 11.1 In this business also books of accounts like ledger, cash book, bill book, invoices, etc. are maintained. For the purpose of investigation, the following points can be observed   

 

   



check with the sponsors regarding the money paid. Sometimes there is a possibility of such money being paid in two parts i.e. cash and cheque. check with the Entertainment Tax authorities regarding the details of the tickets actually sold as verified by them. The payments made to various agencies involved such as stagecraft, sound, lighting, barricading, video coverage, police bandobast, traveling, lodging and boarding, payments to fire fighting department, payments to volunteers, payments for hoarding & cable TV, newspapers for advertisement of show, payments for printing tickets, handbills, caps, Tshirts or other souvenirs, payments to charity, etc. should be verified. The receipts from various cosponsors and logo suppliers should be examined. The video cassettes of the show can be watched to find out the stage craft, the logos and hoarding on the stage and in the stadium, as also the number of audience in the stadium. This may give an idea as to the correctness of the claims of the event managers regarding the tickets sold. Various stall owners are allowed to function at the venue. They also make payments to the event organisers for putting up their food and beverages and other stalls. This should be checked. The event managers have to make TDS on payments made by them to various contractors and service Providers, e.g. persons setting up sound system, stage, Shamiana, furniture etc. This should be checked. If the event has been managed on behalf of an organising company, the payment made by the organising company to the event managers involves TDS as also service tax. This should be checked. It must be ascertained as to whether the payment by the organising company to the event manager is towards organisation of the show and does not involve the fees of the artistes. If the payment does not include the fees of the artistes it has to be checked as to whether the organisers of the event have included the payments made directly by them to the artistes in their tax returns. In respect of mega shows of foreign artistes, the sale of television rights is a major issue to be investigated.

11.2 As regards taxation of income arising to foreign artistes from performing in India, a Circular has been issued by the Central Board of Direct Taxes on 10 /02 /2000 bearing No. 787, F.No. 500/87/99 - FTD (243 ITR Statutes). 11.3 A serious issue in respect of the live entertainment programs is stated to be the demand for free entrance passes. As per trade sources, even though they give these passes free, they have to pay entertainment tax on the same. 11.4 As per trade information, sometimes more money is made in smaller shows as compared to the mega events. One example often cited is the Michael Jackson show in Mumbai, which was an all time mega show with sale proceeds of tickets being Rs. 4,45,43,000/- and another Rs. 56,50,000/- received as sponsorship money by the event managers from & different companies. Yet the event resulted in a loss of Rs. 2.81 crores to the event managers, because of a Public Interest Litigation (PIL) filed against the nonlevy of Entertainment Tax on this event by the Government of Maharashtra. As a result, the event

managers had to deposit Rs. 3,33,76,000/- in an escrow account with the Collector of Mumbai pending disposal of the petition by the High Court. The event managers claimed to have spent a sum of Rs. 4,27,69,994/- on publicity of this event which perhaps was far too high considering that Michael Jackson is a super star having tremendous attraction even without so much publicity. This was perhaps a major issue to be examined in this case, as to whether this money was actually paid or was there any kick back involved etc. Whereas Michael Jackson show may have attracted only a young crowd, a Govinda or a Shahrukh Khan show attracts Indians of all ages, young and old, men and women. These may therefore rake in more profits even as expenses may be less. An investigator of an entertainment event has to weigh all these factors and may proceed to examine and investigate.

Taxation of Indian income of foreign entertainer / sportsmen etc. 12.1 Important questions arise relating to taxation of income derived by foreign entertainers/ sportsmen from India. This also involves interpretation of provisions of Double Taxation Avoidance agreements where such agreements exist between India and the country of domicile of the foreign entertainer/ sportsman. Article 17 of the model convention of DTAA deals with taxation of an individual who derives the income from the exercise of his personal skill and activities in the other contracting State. Paragraph 1 of Article 17 provides that income of entertainers and sportsmen who are residents of a contracting State may be taxed in the other contracting State in which their personal activities are performed, whether these are of an independent or of a dependent nature. Article 14 dealing with the activities of independent professionals and Article 15 dealing with dependent personnel services do not apply to entertainers, sportsmen and other such performing artistes.

©Directorate of Income Tax ( Systems )

Investigation Manual

Volume - 3 Chapter – XI

ADVERTISEMENT INDUSTRY

Introduction

1.1 The Advertisement industry is relatively new as far as the Indian economy is concerned. The arrival of multinational companies in India has given this industry an unprecedented boost in recent years. Since the multinational companies have set up base in India for tapping the large number of consumers, the need for extensive advertising has become paramount. In the early days, advertisement was by word of mouth. However, means of communications are now highly developed and multifarious. 1.2 An advertisement agency provides a professional several for development of an effective and strategic communication aimed at the customers, both current and potential, to generate, sustain and increase demand for the client‟s products. For this purpose, the agency creates and produces an advertisement which can then be conveyed to the public through the communication media, like newspapers, publications, magazines, cinema, television, hoarding and so on. Due to a major revolution in the media world the choice now extends to Internet also. Accordingly, the basket of services provided by the advertisement agencies, has also undergone a lot of changes. The services provided now range from initial market survey to brand strategy, brand building, media planning, creating advertisement material and its actual release on the various media. Large advertisement agency have separate departments taking care of different functions, e.g. creative department, client servicing, media planning, media operation, production of films, and accounts etc. There may also be departments looking after direct marketing, public relations, campaigns, exhibitions etc. 1.3 The creative department performs the function of conceiving the advertisement. The people in this department have sittings with clients to discuss the product and decide the preferred method for promotion. Accordingly, they conceive and design the advertisement for the clients. The client servicing department performs the function of interacting with the clients on the one hand and with the creative department on the other, so as to get the advertisement ready for release in time. 1.4 Once the advertisement is ready, the media planning department takes over planning the various media in which the advertisement will be released to optimize the effect. They also obtain the required space on various media at the optimum rate and see to it that advertisements are released in time. The production department‟s job is to transfer the ideas of the creative department in to print, films or other selected medium or software for actual advertising e.g. advertisement in Newspapers, Magazines. It gets the necessary material such as bromides, negatives, print blocks etc., ready and hands over the product to the newspaper publishers for the purposes of printing. In the case of advertisement on Television, a short film is shot, processed and transferred to the requisite software which is then given to the media for broadcasting it. 1.5 The terms and conditions between the agency and a client are governed by rules and regulations of various industry bodies like the Indian Newspaper Society, Advertising Agency Association of India, Advertising Standard Counsel of India, related government laws besides of course, the specific terms in the agreement with the client. 1.6 As per prevailing norms an agency earns a commission of 15% of the cost of placing the ad in the media. For example if it costs Rs. 100 for an insertion in the print media or a television spot, the ad agency will charge the client Rs. 100, retain Rs. 15 as its commission and pay the media Rs. 85. For specialised services like direct marketing etc. a special fees is normally negotiated with the client. In case of global clients dealing with global agencies the commission tends to be much lower than 15% as the volumes are high. In these cases the commission ranges from 7% to 10%. 1.7 An element of profit is also billed into the cost of production of the advertisement. At times apart from the normal profit an extra amount is billed in to cover the cost of several remakes of an advertisement till it receives the approval of the client. The ad agency may have to go in for several remakes to satisfy the client, and retain his account. However in trying to cover their costs, there is a chance of over billing, particularly in cases where the client did not need the number of remakes envisaged.

1.8 Another relatively unknown source of income for an ad agency is the allotment of free commercial time on television and radio and free commercial space in the print media. Both the print and audiovisual media schemes that offer free commercial time and space on the fulfillment of certain targets regarding number of ads placed, or procuring a certain minimum quantum of business. This incentive is available to the ad agency and not to the client. The ad agency may place further ads of its own clients or may even sell the time/space.

Stages in development of an advertisement 2.1 The first step in takes when a client comes with a problem presenting the agency an opportunity to do a job for promotion of his goods and services. The work involves satisfying the needs of the client in terms of effectiveness, impact and lasting value of the message in the advertisement. The ad agency is required to produce an advertisement which is effective in communicating the message to the target audience. When a proposal for advertisement is received, the planning starts. At this stage, the client and officials of the ad agency discuss how they want to promote the product, the image they would like to give to the product, the existing and potential markets, and the competition. Thus, an agreed advertising strategy and a media plan gets evolved. 2.2 The second stage requires inputs from various divisions. The first input is, understanding of the possibilities and constraints of the job on hand. Possibilities in terms of execution of the idea, feasibility of production, and the prevailing social set up of the target audience. While working out the possibilities the constraints are also taken into account. The constraints can be financial, job specific like technicalities concerning the execution of the idea or that the idea may not be feasible at all - requiring modifications. Financial implications are also considered at this stage. 2.3 The strategic inputs involve identification of target audience which may be demographic as well as pshycographic, the existing and potential market of the product, the element of competition and the strategies being followed by the competitors in the same field. 2.4 After this, the final idea is handed over to the creative department for creative rendition of possible solutions. The creative department may discuss the possibilities of providing a solution for the product with the company. This creative department may be in-house or the assignment may be given on job work to people engaged in creating advertisements. A final solution, thus, becomes available to the client and the advertising client. At this stage the client may accept the solution, or go for alternate solutions and ultimately may choose one of such alternatives. 2.5 Having obtained the solution from the creative team, the studio work for designing art work and photography etc. comes into the picture. If it is a print production then after designing of the art work, the printing is undertaken and thereafter the media operations take over. If the product is related to film making or radio spots, then the production style is different. For newspaper ads, the mode of printing is by letter press (ANNEXURE 2) magazines and periodicals use offset printing (ANNEXURE 4), stickers, bunting and dangles are made. Hoarding are either printed or painted. The process is shown in (ANNEXURE 4) 2.6 In making a television advertisement a few more steps are involved. Before making the presentation to the client, a comprehensive rough advertisement is made into a story board i.e. a scene by scene story sketch with the spoken word written alongside. The presentation is made either by photographs copied onto 35 mm slides by means of a copy camera or by converting the sketches onto slides again by means of a copy camera (ANNEXURE 6). The slides are made either from photographs or sketches and are projected on a screen and the images are copied on U Matic tape by means of a Three Tone Video Camera. The film is then edited and special effects are added. If approved by the client, the material is handed over to the producer to be shot and given over to Television or Cinema as decided. Radio commercials are, after the approval of the idea, recorded in a professional recording studio with audio systems and handed over to AIR (ANNEXURE 7).

2.7 The next stage in the advertisement process is the media operation. If it is a printed material, then it is sent for publication and distribution. If it is an audio visual advertisement, TV and Video channels are contacted for on spot viewing. Publication may also result into direct mailing to the target audience. With the advent of the Internet, the target audience can also be approached through advertisements on the Internet. 2.8 The impact of the advertisement is monitored through feed back of the target audience. The target audience are picked up for feedback and a research may be conducted to quantify the impact of the advertisement on the audience. This research data may then be used for better and improved solutions to the clients‟ problems.

Machines and technical processes used in making advertisements 3.1 The actual process used for preparing an advertisement to be released through the print media is laborious and technical. These are enumerated below 3.2 Quarter tone - A photograph is converted to Quarter tone print using a Kleischograph camera with the help of screens which have normally 45 dots per sq. inch. 3.3 Blocks - Images from „artworks‟ are transferred to panchromatic film using an „enlarger‟. Thereafter the image from the negative is transferred to a „micro-zinc plate‟ using photosensitive chemicals spread evenly onto the metal. The plate is then exposed to sunlight or arch light. After proper exposure the metal plate is sent for etching. The etching takes place in an acid bath machine. The unexposed parts are etched out by the acid and what remains is the impressions of the negatives. Then the metal plate is sent for „ROUTING‟ wherein extra parts of metal which have not been properly etched out are removed. The metal place is sent for proofing i.e.. an impression of the Block is obtained on paper. 3.4 Mats - The image of a Block is transferred to a cardboard by using a hydraulic pressing machine. 3.5 Stereo - The mat is kept in a stereo casting machine, and liquid Lead is poured onto it. When cooled, it becomes a solid „stereo. 3.6 Printing - 3.6.1 Letter Press - The advertisement, to be published, is normally in the form of a mat. The mat is converted into a Stereo - which in turn forms part of the News paper page mat (Mat for the entire page) which is finally cast into a page stereo. This is then inserted onto a rotary machine (cylindrical machine). Ink is evenly spread out over the stereo and as the paper comes into contact with it, an image of the stereo is obtained on the paper 3.6.2 Offset - i) Black & white positives - A negative film is obtained using an „enlarger‟ and then converted into a black & white positive. ii) Colour positives - Four colour positives are obtained from the colour art work by using an electronic scanner such as Hell or Cross field. The images are then transferred onto offset plates and proofs obtained by means of a Flatbed proofing machine. Corrections are marked out by the production department of the ad agency on the proof and the positives are corrected accordingly. The final approved positives are then sent to the magazines for publication. 3.6.3 General   

Folders / Leaflets - Printed either by letter press or offset using various types of paper such as, Art paper, Maplitho, Handmade paper etc. Danglers / Show cards / Placards etc. - Printed by offset or letter press on art card, pulp board, duplex boards etc., and then fabricated as per approved design. Buntings - Printed on maplitho or chromo paper and then pasted on nylon string.

  

Stickers - Printed on chromo paper and gummed at the back Silk screen printings - Used in smaller quantities, and for printing on surfaces like fountain pens, ashtrays etc. For transfer of TV and film commercials - VHS / U-Matic / TV monitors are used for testing, player and recording equipments are used.

Similarly for film production, camera, lighting equipments, sound recording systems editing equipments, voice over equipments are used. For radio jingles voice over and recording equipments are also used. 3.7 Thus, the final advertisement as it appears before the viewers is, a finished product emerging through various processes with the use of various material machines, process, and manual professional skilled labour. Following materials are used for the making an advertisement which appears in different media       

Art work - paper, typesetting, photograph etc.. Blocks - copper, zinc - micro line (mounted on wood) Mats - Card board paper. Printing - black and white positives, card board, Ink colour positives, black paper tin etc. Doordarshan and Video - Video films and cinema films slides, radio audio tapes. News Paper Magazines, Publicity material - Mats, sheets, art pulls, positives, sketches Hoarding - tin paint brushes

3.8 The personnel of advertisement agencies are involved in making advertisements beginning from the studio department till the final checking of the advertisement and booking in the various media. A large number of agencies out-source some of this work. Even smaller agencies subcontract their work to other small agencies which specialise in different areas of advertising work. At times, more than 50% of work, except the work requiring dealing with the client, gets out-sourced. The profile of larger advertisement agencies working in India would reveal an annual billing of more than Rs. 500 crores for India alone. Large agency often have 10 to 20 branches employing around 1000 people in all. Since the work entails communication with people, reaching out to maximum number possible, the advertisement agencies have to work in different languages.

Forecast for the industry 4.1 A study of industry trends reveals a possible spurt in growth in the near future. The first sudden growth of the advertising industry was recorded in 1994. Industry pundits relate that phenomena to the growth in the consumer goods industry. The advertising industry which had its peak period during 199495 recording a growth of 49%, suffered a set back from around 1997 to 1999. The growth rate recorded was as low as 7% in 1998-99. Again with a rise in the activity in the consumer Durables market the expenditure on advertising increased by 13% between January and June, 2000. (Figures released by ORG-MARG). The forecast indicates a growth of around 20% p.a. for the industry as a whole. Individual companies may do much better. Apart from the boom in consumer goods industry - the growth in the advertising industry could also be linked to the fact that ten of the top agencies of India have acquired global partners. Another factor could be that almost all agencies have moved from only urban markets to include the rural population as a new market segment.

Controls operating in the advertisement industry 5.1 The Advertising Standards Council of India (ASCI) and the Advertising Agency Association of India (AAAI) have been propagating a self-regulatory code within the industry. Brief extracts are mentioned below: 5.2 The ASCI has adopted the following code -

“ (a) Declaration of Fundamental Principles : i) To ensure the truthfulness and honesty of representations and claims made by advertisements and to safeguard against misleading advertisements. ii) To ensure that advertisements are not offensive in generally accepted standards of public decency Advertisements should contain nothing indecent, vulgar or repulsive which is likely, in the light of generally prevailing standards of decency and propriety, to cause grave or widespread offence. iii) To safeguard against the indiscriminate use of advertising in situations or of the promotions of products which are regarded as hazardous or harmful to society or to individuals, particularly minors to a degree or of a type which is unacceptable to society at large. iv) To ensure that advertisements observe fairness in competition so that the consumer‟s need to be informed on choices in the marketplace and the canons of generally accepted competitive behavior in business are both served. Both the general public and an advertiser‟s competitors have an equal right to expect the content of advertisements to be presented fairly, intelligibly and responsibly. The code applies to advertiser advertising agencies and media. (b) Responsibility for the Observance of this code : As the advertiser originates the advertising brief and sanctions its placement, the advertiser carries full responsibility for the observance of this code. This responsibility embraces the advertisement in its entire content and form (including testimonials and statements or visual presentations originating from other sources). (c) As creators and expert advisors, the advertising agency has full responsibility to ensure the observance of this code in as much as the facts are known to them and to advise their clients in accordance with this code. (d) This code applies to advertisements read, heard or viewed in India, directed to Indian consumers even if they originate or are published abroad. Any written or graphic matter on packaging or contained in it, is subject to this code. (e) Definitions : An advertisement is defined as a paid-for communication, addressed to the public or a section of it, the purpose of which is to influence the opinions or behavior of those to whom it is addressed. (f) Standards of conduct : Advertising is an important and legitimate means for the seller to awaken interest in his products. The success of advertising depends on public confidence. Hence no practice should be permitted which tends to impair this confidence. ” 5.3 The AAAI has set down its standards of practice which cover similar issues. 5.4 Doordarshan and All India Radio also have an extensive advertising standards code. Responsibility for the observance of this code / rules rests equally upon the advertiser and the Advertising Agency.

Investigation - suppression of income 6.1 An advertiser may try to suppress a part of his advertisement activity and thereby the income derived from it. In tackling this, an effective method is to see whether any statutory or regulatory authority is involved in the line for granting permission or licence. The information available with such authority can then be compared with that available with the AO and co-related to the advertiser‟s admitted income. For

instance, advertisement hoardings can be erected only with permission from the local authority. A reference to the municipal records will give the complete picture of all authorised hoardings. The advertiser‟s income from such hoardings can then be worked out easily. (That the advertiser might have erected unauthorised hoardings behind the back of the local authority is another matter. In such cases a survey or spot verification may help.) 6.2 In some cases it may be that, while expenses are claimed in full, the corresponding incomes are not fully disclosed. If there are specific claims of expenses like commission, discount and rebate in regard to a particular activity, it should be seen whether the corresponding income has been admitted. In this line legal disputes between parties and also between the advertiser and the local authority arise often. The details of these disputes, if gathered, may lead to the corresponding income which might not have been admitted. 6.3 In this line of business the tendency to keep away from tax the sale proceeds of scrap and used materials is not very rare. Such disposal may be periodical or may even be once in a few years. A look into the scrap disposal and cross-verification may be worthwhile in appropriate cases.

Investigation - inflation of expenditure 7.1 Inflation of expenditure is not a rarity in this line. The following heads of expenditure are particularly vulnerable : commission, discount, rebate, employee cost, payment to artiste and business promotion. It is worthwhile to examine the books of account and see the proportion of cash discounts / rebate / commission disbursements. If there is something amiss, it will come out. A proper line of investigation can then be drawn to verify whether such claims are correct. Crossverification wherever possible will be fruitful. TDS liability should be examined in suitable cases. 7.2 This industry spans several fields like newspapers, magazines, film industry and cable TV industry. There is a natural propensity for the advertiser operating in a particular field to adopt the practices and tax-dodging methods prevalent in that field. Thus, an advertisement film-maker may be familiar with the methods of tax evasion prevalent in the film industry and adopt them. The AO should see in which field the advertiser is predominantly operating and look for the malpractices peculiar to that field. This focus on the main functional area is bound to be rewarding. 7.3 To tackle inflation of purchases an analysis of wastage from out of the materials purchased for the business is worthwhile. In suitable cases the consumption can be verified with reference to the stock register in the light of the the accepted wastage norms. 7.4 Ratio analysis. As in any other industry, in this industry also, investigation can be done fruitfully by making a ratio analysis of the major heads of income and expenditure of a particular assessee for a period of, say, two or three years. This analysis would indicate the business trend and the areas requiring specific investigation. For the understanding of ratio analysis a reference could be made to the relevant chapter in volume I of this manual. Revenue expenditure or capital? 8.1 In this industry there is a possibility of passing off capital outlays as revenue expenditure. While there may not be any difficulty in recognising revenue expenses as such, care should be taken while dealing with capital expenditure which is projected as revenue. Be it an advertisement film, a hoarding or any other, the AO should ascertain the complete facts and form his own judgment about the revenue or capital nature of the outlay. Faced with the prospect of bumper profits, the tendency on the part of the advertiser will be to claim many a capital

expenditure as revenue. A decision on such claims should be taken after a careful study of all relevant facts and precedents.

ANNEXURE - 1 Development of ideas for Ads CLIENT PROBLEM Agency brief

Media brief

Advertising strategy

Media plan

Rough concept discussed with client, teams PLANBOARD Account - Client servicing Supervisor Account - Client servicing Executive Group Head

- Creative department

Copywriter

- Creative department

Visualiser

- Creative department

Comprehensive rough B/W or colour - Studio photographs department Type setting

- Studio department

Paste-up

- Studio department

Presentation to client

| Test results, Preview and Production

ANNEXURE - 2 Advertisements in Newspapers (Mode of printing - Letter press) ART WORK (Studio department) | Visual of approved art work is converted into a „dotted image‟ required for letter press printing | Dotted image is obtained by converting a B / W photograph by means of a process camera on Panchromatic film using coarse screens 45 dots per sq. inch. | QUARTER TONE PRINT | Quarter tone print is pasted on art work | (An image of the art work is taken on a process negative & transferred onto a micro zinc plate with the help of chemicals. After exposure the metal plate is sent for etching in an acid bath machine & later to a routing machine) | Printing proof of the Block is sent to the agency for checking | Approved Block Sent to Publication

Block impression is transferred to Stereo is cast using stereo cardboard MATs by using casting m/c (Liquid lead poured hydraulic Pressing m/c on MAT on cooling gives solid stereo)

Normally MATS and Stereos are sent depending upon the facilities available with the publication

ANNEXURE - 3 Advertisements in magazines ART WORK (Offset Printing) B/W advertisement

Colour advertisement

Positive Maker supplies black / white positives along with proof

4 colour separations are made from the colour picture by electronic scanner to obtain red, blue, yellow, black positives

Production department marks corrections on the b/w proof

Proofing of positives by proofing m/c

| The positive maker supplies positives after progressive proofs | Production Department checks the progressive proofs for correction | Set of Positives sent for publication | Proof copy of publication sent to agency for correction | Advertisement published in publication

ANNEXURE - 4 ART WORK PUBLICITY MATERIAL ART WORK

| Danglers / Showcards /

Buntings

Stickers

Backing paper Printed by offset

Printed on Maplitho or Chromo paper & then joined by a string

Print obtained on chromo poly

paper is gummed from behind

Same printing procedure as in case of magazines Final print is obtained on art card, pulp board, duplex boards etc Produced as per approved design

Produced as per approved design

Produced as per approved design

ANNEXURE - 5 Art work - hoardings ART WORK (Studio Department)

| PRINTED

PAINTED

Approved artwork is sent for printing with the help of machines to contractor

Black / White art work with colour overleaf is provided to the contractor

Printer sends proof to agency for corrections

Printed posters put on sites by contractors

Contractor puts painted hoarding on site

ANNEXURE - 6 Making of advertisement Films Client‟s findings Agency Brief

Media Brief

Advertising Strategy

Media Plan

Rough concept discussed with Account - Client servicing Supervisor Account - Client servicing Executive Group Head

- Creative department

Copywriter

- Creative department

Visualiser

- Creative department

Rough advertisement | Story board (scene-by-scene story / sketch) | Presentation to client

| Photomatic

Anamatic (sketches converted into slides)

Photographs copied onto 35 mm slides by Copy camera

Coloured drawings copied on a 35 mm slide by Copy camera

May go through a pretest

Slides projected on screen and copied on u-matic tape by 3-tone video camera

Test results

Editing for optimum visual & sound

Remaking of concept

Special effects are added by a SEG m/c

Presentation before client

Presentation before client

Approval by client and production

Approval by client and production

T V channels

Cinema

Film shot on u-matic tape

Film shot on 35 mm by movie camera

Editing and presentation before client

Editing and presentation before client

Release to TV channels

Release to cinema halls

ANNEXURE - 7

RADIO ADVERTISEMENTS Client‟s findings Agency brief

Media brief

Advertising strategy (to whom? what? how? where?)

Media plan (which media? when? where?)

Rough idea (Script) | Scratch recording (Text recording) | Presentation to client | Production | Final recording (in a recording studio) | Release to radio channels

©Directorate of Income Tax ( Systems )

Investigation Manual

Expert Group constituted by CBDT Vide order dated 5.8.99 for rewriting the earlier publication „Investigation of Accounts‟ S / Shri

S.N. L. Agarwala

Chief CIT (since retired)

Ahmedabad

Chairman

K.D. Gupta

Chief CIT

Lucknow

Co-chairman, later Chairman

H.C. Parikh

DGIT (Inv.)

Chennai

Member

S.D. Kapila

DGIT (Vig.)

Delhi

Member

V. S. Wahi

CIT

Mumbai

Member

S.S. Khan

DIT(Systems)

Delhi

Member

A. Selvaraj

DIT (Inv.)

Chennai

Member

A.K. Dasgupta

CIT

Calcutta

Member

M. C. Joshi

DIT(Inv.)

Delhi

Member

B.N. Dutta

CIT

Ahmedabad

Member / Secretary

©Directorate of Income Tax ( Systems )

Investigation Manual

Acknowledgments ( Officers contributing to Volume - III) 1 Sri V. S. Wahi

Commissioner of Income Tax

Mumbai

2 Sri S. S. Khan

Director of Income Tax(Systems)

Delhi

3 Sri A. Selvaraj

Director of Income Tax (Investigation)

Chennai

4 Sri Abhay Kumar

Commissioner of Income Tax

Hubli

5 Sri G. B. Kanungo

Commissioner of Income Tax

Chennai

6 Smt. Vinita Surie

Commissioner of Income Tax

Delhi

7 Sri A. Soorianarayana

Addl Commissioner of Income Tax

Chennai

8 Sri Swatantra Kumar

Addl Commissioner of Income Tax

Mumbai

9 Sri S. Ravi

Sr. A. R. I.T.A.T.

Chennai

10 Sri K V Radhakrishna

Joint Commissioner of Income Tax

Chennai

11 Smt. Alka Tyagi

Joint Commissioner of Income Tax

Mumbai

12 Smt. Ruby George

Dy. Commissioner of Income Tax

Chennai

13 Sri A. Dhanraj

Jr. A. R. I.T.A.T.

Chennai

14 Smt. Jayanthi Krishnan

Dy. Commissioner of Income Tax

Chennai

15 Sri S. Jayraman

Dy. Commissioner of Income Tax

Chennai

16 Sri G. Guruswamy

Dy. Commissioner of Income Tax

Chennai

17 Sri R. Soorianarayana

Inspector

Chennai

©Directorate of Income Tax ( Systems )