‘Deposits’ are not ‘loans and advances’

A number of corporates have fraudulently raised money in the guise of 'deposits' thereby avoiding the taxation applicability. To curb such a practice, a retrospective amendment to Section 2 (22) (e) to the Income Tax Act can be expected to include 'deposits' within the purview of 'loans and advances'

One of the most frequently asked question in terms of corporate funding is whether‘deposits’ are synonymous to ‘loans and advances’ and can the same be used interchangeably? This debate intensified when reference were made to Sections 295 and 370 under the Companies Act, 1956 (Act, 1956) and Section 2 (22) (e) under the Income Tax Act, 1961 (IT Act).

The controversy surrounding Section 370 under the Act, 1956 was put to rest when theCompanies (Amendment) Act, 1988, amended the section to include ‘deposits’ within its ambit; however the definition under Section 295 (pertaining to ‘loans’ to directors) continued to be neglected. This Section has now been replaced by Section 185 of the Companies Act, 2013 which failed to learn a lesson from the Act, 1956 and continues to carry forward the faulty trend.

With regard to Section 2 (22) (e) of the IT Act, a recent judgment was passed by the Income Tax Appellate Tribunal, Kolkata, in the matter of IFB Agro Industries Ltd Vs. Joint Commissioner of Income-tax which deals with this very pertinent question.
 

Facts of the case

In the present case, IFB Agro Industries (Appellant) received inter-corporate deposit (ICD) to the tune Rs11.20 crore from IFB Automotive Pvt Ltd (IFB), which was treated as deemed dividend u/s 2 (22) (e) of the IT Act by the Revenue. The Appellant contended that since Section 2 (22) (e) of the IT Act applies to only ‘loans and advances’, the ICD, not being in the nature of loan, will not come within its purview.

The Income Tax Appellate Tribunal, taking into view the explanation of ‘deposit’ contained u/s 269T and 269SS of the IT Act, held that ‘deposit’ and ‘loans’ were indeed two different and distinct terms and that if a section recognises only the term ‘loan’ then a deposit received by an assessee cannot be treated as a 'loan' for that section. Relevant extract of the said Order is reproduced below:

“Admittedly, the provisions of section 2(22)(e) of the Act refers to only ‘loans’ and ‘advances’ it does not talk of a ‘deposit’. The fact that the term ‘deposit’ cannot mean a ‘loan’ and that the two terms ‘loan’ and the term ‘deposit’ are two different distinct terms is evident from the explanation to section 269T as also section 269SS of the Act where both the terms are used. Further, the second proviso to section 269SS of the Act recognises the term ‘loan’ taken or ‘deposit’ accepted. Once it is an accepted fact that the terms ‘loan’ and ‘deposit’ are two distinct terms which has distinct meaning then if only the term ‘loan’ is used in a particular section the deposit received by an assessee cannot be treated as a ‘loan’ for that section. Here, we may also mention that in section 269T of the Act, the term ‘deposit’ has been explained vide various circular issued by CBDT. Thus, the view taken by the Ld. CIT(A) that the Intercorporate deposit is similar to the loan would no longer have legs to stand.”

Reference to other judgments

5. In reaching to the aforementioned judgment, reliance was placed on a number of other case laws which proves to one’s satisfaction that the two terms are distinguishable. Reference was made to the landmark judgment in the Durga Prasad Mandelia and Others vs. Registrar of Companies, Maharashtra which settled all controversies by pointing out the distinction between ‘deposits’ and ‘loans’ in the context of Section 370 of the Act, 1956. It contended that though the two terms ‘deposit’ and ‘loans’ may not be mutually exclusive, the intensions and circumstances of both the parties must be considered in each case to come to a conclusion. It also stated that:

“In other words, the word "loan" in section 370 must now be construed as dealing with loans not amounting to deposit, because, otherwise, if deposit of moneys with corporate bodies were to be treated as loans, then deposits within scheduled banks would also fall within the ambit of section 370 of the Companies Act.”

It is post this judgment in the Durga Prasad Mandelia case, that Section 370 of the Act, 1956 was amended by the Companies (Amendment) Act, 1988, to include ‘deposits’ into its ambit, thereby, clearly indication the distinction between ‘deposits’ and ‘loans and advances’.

5. Another judgment referred to was in the case of Housing & Urban Development Corporation Limited vs Jt. CIT (2006), in which a similar view was held. Here, the Special Bench contended that:

“The two expressions loans and deposits are to be taken different and the distinction can be summed up by stating that in the case of loan, the needy person approaches the lender for obtaining the loan therefrom. The loan is clearly lent at the terms stated by the lender. In the case of deposit, however, the depositor goes to the depositee for investing his money primarily with the intention of earning interest.”

5. In the case of Bombay Oil Industries Ltd reported in (2009) 28 SOT 383 (Bom), it was held that inter-corporate deposits were different from loans and advances and the same would not come within the purview of deemed dividend. A similar view was held in the case of Bombay Steam Navigation Company (1953)(P) Limited vs. CIT, wherein it was held that though a loan of money results in a debt but every debt does not involve a loan.

From the above judgments it becomes clear that it is the intension between the parties which demarcates the difference between ‘deposits’ and ‘loans and advances’. Under ‘loans and advances’ it is the borrower who approaches the lender for borrowing money, however, to be termed as ‘deposit’ it is the person advancing the money, who approaches the borrower.
 

What is the entire controversy surrounding Section 2 (22) (e) of the Income Tax Act, 1961?

To analyze the outcome of above case law of IFB Agro Industries Ltd, it is pertinent to first understand the applicability of Section 2 (22) (e) of the IT Act in context of our discussion above.

Section 2 (22) (e) of the IT Act defines the term ‘dividend’ to include within its ambit, the amounts paid by private limited companies, by way of loans and advances, to its shareholders holding 10% or more of the voting power or to a concern in which such a shareholder is a member or partner and has substantial interest.

Thus in essence, any ‘advance or loan’ made by a private company –

1. to a shareholder holding 10% or more of the equity capital of the company; or

2. to any ‘concern’ in which a shareholder holding 10% of the equity capital of the company, is a member or partner and holds ‘substantial interest’,

shall be ‘deemed dividend’ for the purpose of the IT Act.

After having discussed what the section tells us, the one thing that comes to mind is why this section is so disputed?

The reason is the consequence of falling within the purview of this section. If an amount given to the aforementioned persons is treated as ‘loans’ for the purposes of this section, such amounts, being ‘deemed dividend’, will attract income tax liability under the head ‘Income from other sources’ as per Section 56 of the IT Act and accordingly will be taxed @30%.

It is for this very reason that companies avoided coming within the purview of this section, and accordingly, the dispute that arose here was whether amounts extended, as above, would tantamount to ‘loans and advances’ or shall be treated as ‘deposits’ and accordingly would fall outside the purview of this Section.

In the shade various judicial pronouncements in this regard, a number of corporates have fraudulently raised money in the guise of ‘deposits’ thereby avoiding the taxation applicability of this Section. To curb such a practice, a retrospective amendment to Section 2 (22) (e) to the IT Act can be expected to include ‘deposits’ within the purview of ‘loans and advances’, in line with the amendment made to Section 370 of the Companies Act, 1956.
 

Relevance under Section 185 of the Companies Act, 2013

Section 185 of the Companies Act, 2013 (‘Act, 2013’), now enforced, corresponds to Section 295 of the Act, 1956 (which now stands inoperative). Section 185 of the Act, 2013 repeats the same flaw of Section 295 of the Act, 1956, by giving no reference to the effect that loans include deposits, thereby continuing the confusion between the two.

Section 185 provides the following provision relating to ‘Loans to Directors’:

“Save as otherwise provided in this Act, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person”

The Section lays down that no loans can be advanced by a company to any of its directors as also to any person in whom the director is interested. The term ‘any person in whom the director is interested’ has been defined in the Section to mean,inter alia, a company in which a director is a director/ holds 25% voting rights/ where the Board is accustomed to act in accordance with the directions or instructions of the director.

A lot of apprehension is being expressed in connection to this Section. The questions being raised includes whether ‘inter-corporate deposits’ given to companies in which such directors are interested would also come within the purview of this Section and accordingly not permitted?

As per this Section, granting of loans to ‘anybody corporate whose Board of Directors is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company’, is prohibited. Given the above, this becomes a very potent question considering that it is a very common practice to advance money to companies within the same group, being holding/ subsidiary/ associate companies.

In light of the analysis in the above sections, and the various case laws to support the view, ‘loans’ cannot mean to include ‘deposit’. In the absence of any clarification from the Ministry, ‘inter-corporate deposits’ to holding / subsidiary / associate companies will not attract the provisions of this Section and therefore will continue to hold good.

The discussions above proves, time and again, that ‘deposits’ are not ’loans and advances’ and the provisions governing ‘loans and advances’ only cannot said to apply to ‘deposits’ as well. This fact has been well settled in law.

Once the Act, 2013 is fully enforced, the governing sections for deposits would be Sections 73 – 76 and the Rules made thereunder. However, as in Companies (Acceptance of Deposit) Rules, 1975, the draft Companies (Acceptance of Deposit) Rules, 2013 provides that amounts received by a company from any other company do not fall within the meaning of ‘deposit’. Accordingly, the provisions pertaining to inter-corporate deposits will not apply to such amounts given.

Section 372A of the Act, 1956 and the corresponding Section 186 of the Act, 2013 also provides for only inter-corporate loans. Therefore, in the absence of any other applicable provisions, such inter-corporate deposits remain un-governed.

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Why not print Unlimited Money? - Why is it Impossible?

Why not print unlimited money?

Money can be defined as any object that is used as a payment medium for goods and services.

With the progress of mankind, money has evolved from pebbles to paper currency, from paper to plastic currency and from plastic to digital currency and bitcoins.

Be it in whatever form, the main purpose has remained the same as an exchange medium for goods and services and a value store.

If money makes the world go round, why not print and distribute it to everyone? If the poor are poor, why not make ‘em rich by printing and giving them money as they want? Such questions easily arise in everyone’s mind.

Looking at the current economic scenario and the situation of poverty worldwide a question that obviously comes to our mind is that why does not the government print unlimited money and distribute it among the poor and needy so that the disparity in income totally disappears.

Since money gives purchasing power to people, they shall purchase goods and services which In return will bring demand led growth in the economy.  

By printing the requisite amount of money, the poor shall no longer remain the poor and poverty will totally be eradicated from the face of this world.  

Rosier it may sound, but this is not the case.

Had this been the case the fulcrum on which the economy of the world stands shall shake up. Here are the reasons why it is economically, theoretically and practically not possible to print unlimited amounts of money.

Wants are unlimited but means to satisfy them are relatively less or limited.

In our economics classes we were taught that human wants are unlimited. Desires emerge in the minds of a human being and culminate into want for a product. Now if we assume that government prints unlimited money and brings it into circulation by distributing it to people, the disposable income of people will increase and everyone would try to fulfill there demand.

Now, although the spending power of people will increase, the means to fulfill this demand will not, in any scenario, increase beyond a particular threshold.

People will start demanding products and there will be a manifold increase in total demand for all the products.

Let us suppose that a person who has a hypothetical yearly disposable income of rs 10000.

If all of a sudden he gets Rs 100000 which is 10x his disposable income, he will very likely pay off his debt and whatever surplus remains with him , he will likely spend his money on social needs , luxuries and self esteem as is propounded by Herzberg

When millions of people act similarly, this will result in an infinite increase in demand for all the products. Productive capacity remaining largely limited and a total cap on maximum probability of increase in productive capacity, the resultant situation will be of total chaos and a situation where individuals will struggle to acquire everything possible.

Unlimited supply of money causes a decrease in real worth of money through inflation

Monetary Supply in any economy has to go in tandem with the economic activity and productivity in the economy. In an economy that is growing at a normal rate with lower inflation, rate of increase in money supply increases in proportion to the overall economic activity.

Now if there is an increase in total money supply through unlimited printing of money,There will tremendous pressure on other factors of production so that there will be inflation.Inflation is defined as the ‘general increase in price over a period of time’.

In inflationary growth, what can be purchased with a unit of currency decreases over a period of time ……Thus the unit looses its purchasing power and this is what is called as the real value or real worth of money…..

From the above graph it is quite visible that there is a direct correlation between the rate of currency printing and inflation. Thus it can be concluded that beyond a certain level , excessive money supply leads to inflation. Central Banks control this by sucking out excessive liquidity in the system through various monetary and non monetary tools. Thus there is a difference between money and ‘Hot money’…….Hot money leads to speculation

Inflation can and does lead to hyperinflation.

In an economy predominantly dependent upon investments and hot money there are wild swings in growth rate and monetary cycles. In such a situation, Central banks print more money to offset a sudden shortfall in such investments. These were the one of the reasons that led rise to the Asian Financial crises.

Continuous inflation can lead to hyperinflation. Very high inflation leads to loss of confidence in the domestic currency.

The Indian accounting standard 24 issued by the Institute of Chartered Accountants of India defines a hyperinflationary situation as follows:

Money loses purchasing power at such a rate that comparison of amounts from transactions and other events that have occurred at different times, evenwithin the same accounting period, is misleading.

In this age of technology where people are becoming more pro active and react to the developments in the socio economic scenario , prolonged inflation can lead to domestic turbulence and uprising. Hyperinflationary conditions are more likely to occur in case of economies that are suffering continuous warfare and domestic problems.

In hyperinflation money looses all its worth and there is a capital flight from the home country and people are less willing to hold assets in domestic currency,

This further  adds to the domino effect and furthers the effect of this to the other parts of economy and the resultant situation is a total mess where central banks are forced to print money in exotic denominations.

The case of Zimbabwe, Weimar republic and other cases.

Zimbabwe is the first country in the recent period to have underwent hyperinflation. Years of excessive money printing without underlying economic growth have resulted into hyperinflation.

The situation has worsened so much that the Zimbabwean government was forced to print hundred trillion dollar notes which could still not buy a packet of bread or eggs in the period of 1970’s- till now.

A similar situation was encountered in Weimar republic during the first world war when the german mark underwent a rapid devaluation and lead to an inflation rate of over 1000 % in real terms.

Only 10 % or less of total worldwide assets are cash denominated

Lastly, only 10 % of assets in the world are cash denominated or held in cash. All other assets are mere virtual or intangible in nature like government bonds and guarantees.

In an interesting situation , when cash denominated assets reached a high threshold in Weimar germany and people refused to purchase assets due to inflation and uncertainty , they hoarded cash as a safety measure which resulted into a deep and scathing recession during the early twentieth century.

Thus it can be concluded that printing money cannot solve the root economic problem.

 
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How IKEA adapted its strategies to expand in China

Couching tiger tames the dragon

This case study analyses how IKEA adapted its strategies to expand and become profitable in China. It also assesses some lessons the company learnt in China that might be useful in India.

Executive Summary: IKEA is known globally for its low prices and innovatively designed furniture. In China, however, it faced peculiar problems. Its low-price strategy created confusion among aspirational Chinese consumers while local competitors copied its designs. This case study analyses how IKEA adapted its strategies to expand and become profitable in China. It also assesses some lessons the company learnt in China that might be useful in India, where it plans to open its first store by 2014 and 25 stores in 10 to 15 years.

Swedish furniture giant IKEA was founded by entrepreneur Ingvar Kamprad in 1943. He began by selling pens, wallets and watches by going door to door to his customers. When he started selling his low-priced furniture, his rivals did everything to stop him. Local suppliers were banned from providing raw material and furniture to IKEA, and the company was not allowed to showcase its furniture in industry exhibitions. What did IKEA do? It innovated to stay in business. It learnt how to design its own furniture, bought raw material from suppliers in Poland, and created its own exhibitions. Today, IKEA is the world's largest furniture retail chain and has more than 300 stores globally.

In 1998, IKEA started its retail operations in China. To meet local laws, it formed a joint venture. The venture served as a good platform to test the market, understand local needs, and adapt its strategies accordingly. It understood early on that Chinese apartments were small and customers required functional, modular solutions. The company made slight modifications to its furniture to meet local needs. The store layouts reflected the typical sizes of apartments and also included a balcony.

IKEA had faced similar problems previously when it entered the United States. The company initially tried to replicate its existing business model and products in the US. But it had to customize its products based on local needs. American customers, for instance, demanded bigger beds and bigger closets. IKEA had to make a number of changes to its marketing strategy in the US. The challenges it faced in China, however, were far bigger than the ones in the US.

As the company opened more stores from Beijing to Shanghai, the company's revenue grew rapidly. In 2004, for instance, its China revenue jumped 40 per cent from the year before. But there was a problem - its local stores were not profitable.

IKEA identified the strategic challenges and made attempts to overcome them. One of the main problems for IKEA was that its prices, considered low in Europe and North America, were higher than the average in China. Prices of furniture made by local stores were lower as they had access to cheaper labour and raw materials, and because their design costs were usually nil.

IKEA built a number of factories in China and increased local sourcing of materials. While globally 30 per cent of IKEA's range comes from China, about 65 per cent of the volume sales in the country come from local sourcing. These local factories resolved the problem of high import taxes in China. The company also started performing local quality inspections closer to manufacturing to save on repair costs.

Since 2000, IKEA has cut its prices by more than 60 per cent. For instance, the price of its "Lack" table has dropped to 39 yuan (less than five euros at current exchange rates) from 120 yuan when IKEA first came to the Chinese market. The company plans to reduce prices further, helped by mass production and trimming supply chain costs.

High prices were one of the biggest barriers in China for people to purchase IKEA products. IKEA's global branding that promises low prices did not work in China also because western products are seen as aspirational in Asian markets. In this regard, IKEA's low-price strategy seemed to create confusion among Chinese consumers.

The main problem for IKEA was that its prices, considered low in Europe and the US, were higher than the average in China

The company realised this and started targeting the young middle-class population. This category of customers has relatively higher incomes, is better educated and is more aware of western styles. Targeting this segment helped IKEA project itself as an aspirational western brand. This was a massive change in strategy, as IKEA was targeting the mass market in other parts of the world.

IKEA also had to tweak its marketing strategy. In most markets, the company uses its product catalogue as a major marketing tool. In China, however, the catalogue provided opportunities for competitors to imitate the company's products. Indeed, local competitors copied IKEA's designs and then offered similar products at lower prices. IKEA decided not to react, as it realised Chinese laws were not strong enough to deter such activities. Instead, the company is using Chinese social media and micro-blogging website Weibo to target the urban youth.

IKEA also adjusted its store location strategy. In Europe and the US, where most customers use personal vehicles, IKEA stores are usually located in the suburbs. In China, however, most customers use public transportation. So the company set up its outlets on the outskirts of cities which are connected by rail and metro networks.

The China expansion came at a cost. Since 1999, IKEA has been working on becoming more eco-friendly. It has been charging for plastic bags, asking suppliers for green products, and increasing the use of renewable energy in its stores. All this proved difficult to implement in China. Price-sensitive Chinese consumers seem to be annoyed when asked to pay extra for plastic bags and they did not want to bring their own shopping bags. Also, a majority of suppliers in China did not have the necessary technologies to provide green products that met IKEA's standards. Helping them adopt new technologies meant higher cost, which would hurt business. IKEA decided to stick with low prices to remain in business.

As IKEA prepares to enter India, its China experiences will come in handy. It understood that in emerging markets, global brands may not replicate their success using a low-price strategy. There always will be local manufacturers who will have a lower cost structure.

Chinese competitors copied IKEA's designs from its catalogue and then offered similar products at lower prices

It is more important what customers think about the company rather than the other way around.

IKEA wanted to be known as a low-price provider of durable furniture, while Chinese consumers looked at IKEA as an aspirational brand. It is likely that Indian consumers will also look at IKEA in a similar way.

The company also learnt that emerging economies are not ready for environment-friendly practices, especially if they result in higher prices.

IKEA, famous for its flat-pack furniture which consumers have to assemble themselves, realised that understanding the local culture is important - Chinese people hate the do-it-yourself concept and Indians likely do so even more.

IKEA may face some India-specific challenges such as varying laws in different states ruled by different political parties. This could make its operations, especially distribution and logistics, a bit challenging. IKEA already has had to wait a long time to get permission to open stores in India. The delay in policy-making at the state level could be even longer.

Indian customer preferences and economic environment are similar to the Chinese market. 

IKEA will likely have hopes of attracting India's urban middle-class buyers who are keen on decorating their homes with stylish international brands. The company has learnt that doing business in emerging markets is a different ball game for a multinational company. IKEA did well to adapt in China, although it took numerous changes to its strategies and more than 12 years for the company to become profitable in the Asian nation.

FDI in retail in India has been a non-starter, hopelessly mired in special-interest politics:Prof Nirmalya Kumar Ikea's India rollout will be slow: Prof Nirmalya Kumar The success of IKEA in China is an interesting adaptation example by a global retailer. Yet, it may not be much of a predictor of IKEA's fortunes in India. This may have less to do with IKEA and more to do with the economic policies of India. A well-designed foreign direct investment (FDI) policy should have resulted in a rush of much-needed foreign investment to India, upgrading of the supply chain, modernisation of the retail sector, as well as more choices for consumers with lower prices. Instead, FDI in retail, like in higher education, has been a non-starter, hopelessly mired in special-interest politics. The rules are so onerous that a mass retailer such as IKEA will find it hard to meet them without penalising customers with higher prices and lower choice. Also, it will be difficult for IKEA to find the type of location (size, off a highway, with great links to a major metropolis) that is crucial to the success of its business model. This will mean the first store will take much longer to open than Indians expect and the rollout will be painfully slow. Fortunately, as a privately held company with a longterm orientation, IKEA will persevere where more impatient publicly held firms may have given up. For India to kick its economy back to the growth rates necessary for meeting the aspirations of its citizens, we need to roll out the red carpet for foreign investors instead of red tape. Competition law and trade policies are supposed to ensure that a free competitive marketplace exists, with easy entry and exit, not protect existing competitors from new entrants. Capitalism without failure is like religion without sin. Prof Nirmalya Kumar, Professor of Marketing and Director of the Aditya Birla India Centre at London Business School It's essential for successful marketing campaigns to take into consideration the local approach: Yelena Zubareva The main challenge is to adapt: Yelena Zubareva There is no formula for success that fits all marketing strategies when a global brand decides to try a new market, except perhaps unconditional acceptance and responsiveness to changes. The greatest challenge is to adapt constantly. It's essential for successful marketing campaigns to take into consideration the local approach versus the global/regional desire for standardisation. A onesize-fits-all approach is a rare reality. A consistent global brand promise is a desirable asset but what makes a real difference is to be brave and ready to change the target audience and build a differentiating promise. IKEA made all necessary adjustments to make sure there was no mismatch in its growth ambitions and brand promise. Becoming an aspirational brand which is blogging with the Chinese middle-class youth is an unexpected twist in its brand proposition. IKEA demonstrated courage to get the most relevant changes. By courage I mean all big corporations are ready to shift production, work with local sources, overcome legal requirements but not too many of them are ready to adapt a brand proposition that suits the level of development the market and consumer perception require. IKEA is a strong brand that understands that growing globally requires sacrifices and innovation from global teams, and they are ready to listen, respect and learn from the local environment. The European headquarters' excitement to enter new markets with proven best practices is something of the past, proving that the real shift in the global mindset is to recognise that local versus global can bring optimum results. Yelena Zubareva, Regional Marketing Manager, FWS/OEM SHELL

 
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