Under the Income Tax Law (ITL), tax incentives linked to the profits of the relevant business (profit-linked incentives) are available for a specified number of years. Direct Taxes Code (DTC) 2010 proposes to withdraw or substitute these profit-linked incentives with investment-linked tax incentives. These incentives are available to certain specified kinds of businesses. A taxpayer is first allowed to recover all the capital expenditure (excluding that on land, including the land acquired on long term lease, goodwill and financial instrument) and revenue expenditure and would be liable to tax on profits made thereafter. Thus, broadly, the period consumed in recovering such expenditure would be regarded as a period of tax holiday. This article summarizes the change in the tax holiday regime prevailing under the present Income Tax Law (ITL).
Tax incentives under DTC 2010: Salient features:-DTC 2010 proposes to provide investment-linked tax incentives to the following businesses:
1. Prospecting for or extraction or production of mineral oil and natural gas.
2. Developing a Special Economic Zone (SEZ) or units in SEZ engaged in manufacture or production of articles or things or provision of any service.
3. Generating/transmitting or distributing power.
4. Developing or operating and maintaining any infrastructure facility which includes Road, toll road, bridge, rail system, highway project (including housing etc.), water supply project, water treatment system, irrigation project, sanitation and sewerage system, solid waste management system, port, airport, inland waterway or inland port.
5. Operating and maintaining a hospital in specified areas.
6. Setting up and operating a cold chain facility.
7. Laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution etc.
8. Processing, preserving and packaging of fruits and vegetables.
9. Setting up and operating a warehousing facility for storage of agricultural produce.
10. Building and operating two star or above hotel commencing operation on or after 1 April 2010.
11. Building and operating a new hospital with at least 100 beds commencing operation on or after 1 April 2010.
12. Developing and building a housing project under a scheme for slum redevelopment or rehabilitation commencing operation on or after 1 April 2010.
Any taxpayer (irrespective of the status) can avail these tax incentives, except that the tax incentive in case of business of laying and operating cross-country natural gas or crude oil pipeline, is available only to a company registered in India or a consortium of such companies. As a result, under DTC 2010, the scope of entities which can claim incentive deduction for business of developing infrastructure facility is expansive as compared to the ITL. Under the ITL, the benefit in respect of these activities is available only to a company registered in India or a consortium of such companies, whereas under DTC 2010 it is made applicable to all taxpayers. The incentive provisions are, however, subject to additional conditions as may be prescribed by the Central Board of Direct Taxes.
Minimum Alternate Tax (MAT) liability is, however, not relieved, though MAT credit is permitted to be carried forward for 15 years.
The tax incentives are provided by way of allowance of the following expenditure in the year of its incurrence, over and above the operating expenditure incurred for the business:
1. Expenditure on any license charges, rental fees or other charges, if actually paid.
2. Capital expenditure incurred by the taxpayer (excluding that on land, including the land acquired on long term lease, goodwill and financial instrument). Expenditure on infructuous or abortive exploration of any area (in the case of business of prospecting for or extraction or production of mineral oil and natural gas).
3. All revenue and capital expenditure (subject to the above exceptions) incurred before commencement of the business.
The conditions for eligibility of the above businesses for deduction shall be:
- The business is not set up by splitting up or reconstruction of a business already in existence.
- The business is set up without the transfer of machinery or plant previously used for any purpose. However, this condition will be deemed to have been complied with if the total value of machinery or plant previously used does not exceed 20% of the total value of machinery or plant used in the business.
Aggregation of loss: – A loss incurred in any of the above specified businesses shall be regarded as loss from ordinary sources and allowed to be set off against income from ordinary sources and is eligible to be carried forward for an indefinite period.
Withdrawal of tax incentives to the sectors/businesses eligible under the ITL:-Various sectors/businesses, which are presently eligible for tax incentives under the ITL, e.g., export activities of various Export Oriented Units and Technology Park Units, specific area/location-based incentives available to the units established in North Eastern Region etc., would not be eligible for tax incentives under DTC 2010. DTC 2010, however, contemplates grandfathering benefits in respect of the units/enterprises which are eligible for tax holiday as of 1 April 2012, which are referred to under ‘transitional provisions’.
Transitional provisions
General:
DTC 2010 would replace the ITL and, hence, it is provided that the businesses eligible for profit-linked incentives under the ITL regime as of 31 March 2012, whose tax holiday period has not expired, shall continue to be eligible for profit-linked tax incentives for the unexpired period, subject to the following conditions:
- The method of computation of profits shall be as per DTC 2010, except that capital expenditure and pre-commencement business expenses will not be allowed as a deduction.
- The period of deduction shall not include a period for which deduction was not allowable under the ITL. Question may arise as to whether the restriction will apply only during the period of tax holiday or on a perpetual basis. Question may also arise if the limitation on grant of capital allowances, including depreciation, will also extend to assets acquired prior to March 2012 and which have already become part of the block of assets.
- The amount of capital expenditure reduced from the computation shall not be allowed under any other provisions of DTC 2010.
- The taxpayer continues to satisfy the conditions as specified under the ITL in the financial year.
Specific to power sector:
The taxpayer eligible for deduction as of 31 March 2012 is protected under the grandfathering provisions. Furthermore, a power unit needs to commence its activity by 31 March 2011 for being eligible for profit-linked incentive deduction under the ITL. If the power unit becomes functional after 1 April 2011, it may not be eligible for deduction under the ITL and, consequently, will not be grandfathered under DTC 2010.
Also, a successor in the business reorganization of the eligible unit/facility, pursuant to the reorganization after 31 March 2012, will face the challenge as to whether it can be regarded as a taxpayer who was eligible for the deduction under the ITL as on 31 March 2012.
Specific to SEZs:
The deduction in respect of units established in the SEZ, under the ITL, will continue to be allowed a profit-linked deduction under DTC 2010, if the taxpayer begins to manufacture or produce articles or things or provide any service in the SEZ unit on or before 31 March 2014, subject to certain conditions. In respect of an SEZ developer, profit-linked incentives, as available under the ITL, will continue to be allowed under DTC 2010 if the unit is notified on or before 31March 2012.
Our Views:-The GOI has proposed the replacement of profit-linked incentives by investment-linked tax incentives to encourage more investments in the set-up and expansion of specified businesses. It would be important to assess the impact of the proposed change on current structures and business models of such sectors/businesses.
