1.1 Tax Rates – Companies/Firms/Limited Liability Partnership
- The Finance Act (No. 2), 2014 had not modified the tax rate, which continue to be at 30% and the recently increased surcharge at 10% on domestic companies whose taxable income exceeds ₹ 10 crores (calculating the tax rate at 33.99% for domestic companies inclusive of surcharge and education cess). Imposition of increased surcharge on tax makes cost of doing business in India significantly high. This has adversely impacted the investors’ sentiments and is a blow to the investments, economic growth and entrepreneurship.
- In addition to this, enhanced dividend distribution tax and lowered depreciation rates, impose a further strain on companies, leading to increased payout of taxes thus leaving inadequate funds for generation of internal resources for ploughing back for expansion, modernization, technology up-gradation, etc.
- It is therefore submitted that the corporate tax rate for domestic companies be reduced to 25 percent in the forthcoming Union Budget 2015.
- Similarly the income tax rates for Unincorporated bodies i.e. Firm, Limited Liability Partnership, etc., should also be reduced to 25 percent from the current 30 percent.
- It would be appropriate to remove the levy of surcharge and education cess on corporate and non-corporate assessees in the forthcoming Union Budget 2015.
1.2 Tax Rates – Individual Taxpayers
The Finance Act (No. 2), 2014 had marginally increased the basic exemption limit to ₹ 2.5 lakhs. Currently, the peak tax rate of 30 per cent is made applicable over an income of INR 10 lakhs for individual taxpayers. However, the income trigger for peak rate in other countries is significantly higher. Hence, there is a need for further raising the income level on which the peak rate triggers, to make the same compatible with the international standards.
The Parliamentary Standing Committee on Finance (PSC) in its Report on the Direct Taxes Code Bill 2010 (DTC Bill) has appropriately recommended the following revised tax slabs for individual taxpayers.
We, would, therefore, like to urge that the recommendations of the PSC should be implemented expeditiously during fiscal year 2015-2016.
The Finance Act, 2013 has levied surcharge @ 10% on individuals having total income exceeding ₹ 1 crore. We are of the view that the increased surcharge on certain category of individuals would tend to discourage entrepreneurship and incentivize people to relocate to other locations. We are strongly of the view the Union Budget 2015-2016 should withdraw the levy of surcharge on individuals having income above ₹ 1 crore.
1.3 Personal Tax
1.3.1 Taxation of Employee Stock Option Plans for migratory employees – Section 17
- Section 17(2)(vi) of the Act, read with Rule 3 of the Rules deal with taxation of Employee Stock Option Plans (ESOPs). It is provided that the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate shall be taxable as perquisite in the hands of the employee. For this purpose, the value of any specified security or sweat equity shares shall be the fair market value of the specified security or sweat equity shares, as the case may be, on the date on which the option is exercised by the taxpayer as reduced by the amount actually paid by, or recovered from, the taxpayer in respect of such security or shares.
- In this connection, what has not been appreciated is that ESOP shares stand on a different footing because on the date of exercise, the shares are subject to lock-in condition and cannot be considered to be a benefit and therefore, ought not to be fictionally treated as benefit and brought under the ambit of perquisites for taxation purposes. The Supreme Court, in CIT v. Infosys Technologies Ltd.,  2 SCC 272, at page 277, had aptly held:
“During the said period, the said shares had no realisable value, hence, there was no cash inflow to the employees on account of mere exercise of options. On the date when the options were exercised, it was not possible for the employees to foresee the future market value of the shares. Therefore, in our view, the benefit, if any, which arose on the date when the option stood exercised was only a notional benefit whose value was unascertainable. Therefore, in our view, the Department had erred in treating INR 165 crores as perquisite value being the difference in the market value of shares on the date of exercise of option and the total amount paid by the employees’ consequent upon exercise of the said options.”
- That apart, it has to be appreciated that if an employee is subjected to tax on the notional benefit as perquisite, there could be situations where he may suffer double loss, first by way of tax out-go and again as a loss on actual sale of shares, which may neither be fair nor warranted, especially when such tax out-go are not allowed to be set- off against capital loss.
ESOPs should not be subject to tax on notional perquisite value and taxed only on capital gains arising from the sale of shares, as was the position till 31 March 2006.
It may be mentioned that only when Fringe Benefit Tax (FBT) was introduced by the Finance Act 2005, these provisions were changed for the purposes of taxation of ESOPs under FBT regime. Unfortunately, however, those very provisions have now been brought back by way of insertion in sub-clause (vi) of sub-section (2) of Section 17 of the Act, after the abolition of FBT, which has caused a lot of anxiety. It is imperative that the earlier tax treatment be restored to facilitate the employers in retaining talented persons in the organization.
- Notwithstanding the above, taxation of ESOPs creates an issue in the case of migrating employees, who move from one country to another, while performing services for the company during the period between the grant date and the allotment date of the ESOP. The domestic tax law is unsettled on the taxation of such migrating employees and does not clearly provide for such cases.
- There was a specific clarification on proportionate taxability of benefits under the erstwhile FBT regime, where the employee was based in India only for a part of the period between grant and vesting. However, there is no specific provision in this regard under the amended taxation regime from 1 April 2009.
- Recently, it has been held by Delhi Tribunal in case of Robert Arthur Keltz that only the proportionate benefit of ESOP pertaining to the services rendered by assessee in India should be taxable in India and not the entire benefit.
A specific clarification should be inserted with respect to taxability of only proportionate ESOP benefit based on residential status of the individual, where an employee was based in India for only a part of the period between grant and vesting.
1.3.2 Taxation of Contribution to Superannuation Fund in excess of INR 1 lakh – Section 17
- Section 17(2)(vii) inserted by the Finance (No.2) Act, 2009, provides that the amount of any contribution to any approved superannuation fund by the employer in excess of INR1 lakh will be taxable as perquisite in the hands of the employee.
- It has to be appreciated that contributions to superannuation fund may or may not result in superannuation benefits to the employees since there are various conditions to be fulfilled by the employees like serving a stipulated number of years, reaching a certain age etc. Further, the pension payments are subject to tax at the time of actual receipt by the employee after his retirement. As such this may lead to partial double taxation for the employee where the contributions had been taxed earlier.
It is recommended that employer contribution to approved superannuation fund be made fully exempt from tax.
1.3.3 Revival of Standard Deduction
- A standard deduction was earlier available to the salaried individuals from their taxable salary income. However the same was abolished with effect from AY 2006-07.
- On the other hand, business expenses continued to remain as permissible deductions from taxable business income.
- It has to be appreciated that standard deduction is not a personal allowance and used to be given as a lump sum for meeting employment related expenses. In many countries like Malaysia, Indonesia, Germany, France, Japan, Thailand etc. allowance in the form of standard deduction is available for salaried employees for expenses connected with salary income. To illustrate in Thailand the deduction is as high as 40 percent of income subject to certain limits.
- The standard deduction for salaried employees should be reinstated to at least INR 100,000 to ease the tax burden of the employees and keeping in mind the rate of inflation and purchasing power of the salaried individual, which is dependent on salary available for disbursement.
- This should also reduce the disparity between salaried and business class with only the latter being eligible for deduction for expenses incurred by them for earning their income.
1.3.4 Transportation Allowance – Section 10
- The transport allowance granted by the employer to the employee to meet his expenditure for the purpose of commuting between the place of his residence and the place of his duty is currently tax exempt up to INR 800 per month in terms of Section 10(14) of the Act read with Rule 2BB of the Rules.
- This exemption limit was fixed in 1998 and seems quite nominal considering the ever rising fuel costs and resultant conveyance costs.
The exemption limit of INR 800 per month needs to be considerably raised upwards, say to minimum of INR 2,000 per month to bring it in line with the rising conveyance costs.
1.3.5 Education Allowance
• The education allowance granted by the employer to the employee to meet the cost of education expenditure upto two children is currently tax exempt up to INR 100 per month per child in terms of Section 10(14) of the Act read with Rule 2BB of the Rules.
• This exemption limit was fixed in 2000 with retrospective effect from 1 August 1997 and seems quite nominal considering the ever rising cost of education.
The exemption limit of INR 100 per month needs to be considerably raised upwards, say to minimum of INR 1,000 per month to bring it in line with the rising inflation and cost of education.
1.3.6 Reimbursement of Medical Expenditure – Section 10
- Any sum paid by the employer in respect of any expenditure incurred by the employee on the medical treatment of self/ family is currently exempt from tax, to the extent of INR 15,000 per annum.
- This limit was last revised long back and needs to be revisited in light of the rising medical and hospitalization costs especially for private hospitals.
- The expenditure incurred by/for retired employees in respect of medical treatment on self/family is currently not exempt from tax.
The current tax exemption limit of ₹ 15,000 per annum needs to be increased to at least INR 50,000 per annum. This could to some extent help to bring the exemption up to speed with the rising medical costs.
Further, the exemption in respect of expenditure on medical reimbursements/hospitalization expenditure in approved hospitals should also be extended to retired employees.
1.3.7 Deduction in respect of Health Insurance Premia under Section 80D
- Currently, a deduction up to INR 35,000 (15,000 for self/ family and 15,000 for parents) is available to an individual under Section 80D of the Act from taxable income, towards health insurance premium paid by him. The limit for parents is increased to INR 20,000 if the parents are senior citizens.
- Unlike many other countries, India does not have a comprehensive health-care system for its citizens. There are Government hospitals but the facilities available are woefully inadequate while the private hospitals are very expensive. Also, the penetration and awareness of health insurance in India is very slow. Most individuals buy insurance only to save taxes.
Therefore, there is a need to raise the above limit to achieve two-fold objective of giving a tax incentive while also encouraging people to obtain larger healthcare cover in wake of the rising costs.
It will be immensely helpful if, till the Government introduces adequate healthcare systems, the quantum of deduction under Section 80D of the Act is increased. A reference to General Insurance Corporation to find out how much they charge as premium for insurance of a family under a comprehensive hospitalization scheme will give an indication about the reasonable higher limit of the deduction.
1.3.8 Tax Exemption in respect of Leave Travel Concession (LTC) – Section 10
- Presently, the economy class air fare for going to anywhere in India is tax exempt (twice in block of four years). However, this exemption is being allowed only for travel within India.
- Lately, owing to low airfares and package tours, a number of Indians prefer going abroad, instead of availing LTC, particularly to neighboring countries like Thailand, Malaysia, Sri Lanka, Mauritius, etc., as the fares thereto are at times less than for travelling to some far away destination within India.
- It is therefore recommended to grant tax exemption for economy class airfare for travel abroad also on holidays so long these are within the overall airfare tax exemption conditions for travelling in India. Here, it is pertinent to note that in a recent ruling by the Chandigarh Bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of Om Prakash Gupta it has been held that amount received by the taxpayer on account of Leave Travel Concession (LTC), which was received by taxpayer on account of travel to both Foreign and Indian destination and the journey concluded by visit to a place in India, is not eligible for income tax exemption as the taxpayer has also travelled to a foreign destination. However, considering the current prevailing trend in respect of foreign travel, there is a need to include overseas travel as well or at least to exempt proportionate expenses pertaining to travel within India in case of joint travel (within India and overseas destination).
- Further, under Rule 2B of the Rules, the amount exempt in respect of LTC by air is to the extent of the economy fare of National Carrier i.e. Indian Airlines. It is suggested that word “National Carrier” should be deleted from Rule 2B.
- Moreover, as per the current provisions, Leave Travel Concession/Assistance is eligible for tax relief for 2 calendar years in a block of 4 calendar years. It is suggested that the concept of calendar year should be replaced with financial year (April – March) in line with the other provisions of the Income Tax Law and further exemption should be made available in respect of at least one journey in each financial year.
1.3.9 Taxation of social security contributions in the hands of Expatriates – Section 17
- In respect of an expatriate employee deputed to India, the home employer and employee may be required to contribute to social security schemes under the local law of country. In most cases, the contributions made to these schemes may not vest on the employee at the time of making the contributions and thereby do not provide any immediate benefit to the employee. Further, the employee contributions may also be mandatory under the law of the home country. Both the employer and employee contributions may be available as a deduction from taxable income in the home country of the expatriates.
- However, currently, there is no provision under the Act, which provides for the taxability or otherwise in respect of such contributions from the taxable income though there have been several favourable judicial precedents to this effect such as L.W. Russel, Galloutti Raoul, Lukes Fole etc.
- Recently, even the Delhi High Court (High Court) pronounced in case of Yoshio Kubo, based on the ratio laid down in the rulings of L.W. Russel and Mehar Singh Sampuran Singh Chawla that employer’s contribution to overseas social security, pension and medical/ health insurance do not qualify as perquisite under Section 17(1)(v) of the Act and are not taxable in the hands of the employees.
It needs to be clarified under the Act, that employer contributions to such social security schemes should be exempt in the hands of the individual employee based on the principle of vesting. Further, the employee contributions should be available as a deduction where the same are mandatory and constitute diversion of income by overriding title.
1.3.10 Provision of treaty benefits while calculating TDS under section 192
- Currently, there is no provision in the Act, enabling the employer to consider admissible treaty benefits (e.g. credits for taxes paid in another country/ treaty exclusions of income), while withholding tax under Section 192 of the Act from salary income.
- This creates cash flow issues for the expatriates who are initially subject to full withholding by their employers and then are required to claim large refunds on account of treaty benefits at the time of filing their tax return. Many of these expatriates may complete their assignments and leave India prior to obtaining their tax refunds which also creates issues with respect to credit of their refund amounts.
Since the credit is otherwise admissible in terms of Section 90/91 of the Act, a suitable amendment may be incorporated in Section 192 of the Act providing for the employer to consider such credits/exclusions at the time of deducting taxes.
1.3.11 Threshold limit under Section 80C of the Act
- Over the years, investments made in various avenues available under Section 80C of the Act have helped the Government to raise funds as well as the individuals to save tax.
- However, with too many investment/expenditures clubbed into the existing overall limit of ₹ 150,000 (including contribution to pension funds under section 80CCC, pension scheme under section 80CCD of the Act), individuals sometimes are discouraged from making further investments.
- There must be a clear distinction between long-term and short-term savings. So far there has not been any significant support in tax policy to actively encourage “long-term savings” which is very much needed. Life insurance and pensions are the main segments of the financial services that address the needs of individuals in the long-term. It would be equally desirable to have many more such tax-exempt investment avenues to mobilize funds for infrastructural and overall economic development. Therefore, the Government may consider separate exemption limits for such important avenues.
- Further, the Government may look at increasing the overall deduction limit to at least INR 200,000 to boost further investment and increase tax savings for the individual.
- That apart, Term deposits for a period of 5 years or more with a scheduled bank, in accordance with a scheme framed and notified by the Central Government, by an individual/HUF is eligible for inclusion in gross qualifying amount for the purpose of deduction under Section 80C of the Act. For other eligible investments viz. bonds and mutual funds the lock in period is 3 years and hence to ensure parity, the period of term deposits for claiming deduction under Section 80C of the Act should also be reduced to 3 years from existing 5 years.
1.3.12 Employer’s contribution to New Pension Scheme (NPS) by non-Central Government – Section 80CCD
- Employer’s contribution to New Pension Scheme (NPS) by non-Central Government employers eligible for deduction up to ten percent of salary in a financial year, irrespective of the employees’ date of joining of employment.
- While the Finance Bill, 2014 has now provided clarity on the applicability of deduction on NPS to non-Central government employees in employment prior to 01 January 2004, it has been made effective prospectively, i.e. AY 2015-16 onwards.
- However, the proposed prospective amendment to Section 80CCD could potentially result in tax demands on employees / employers who have already allowed deduction to employees up to last year and lead to unavoidable litigation. This would make the clause partially harsh for individuals for the prior years. Therefore, the Government should clarify this clause and allow the deduction for earlier applicable years as well.
1.3.13 Deduction for Educational Expenses – Section 80D
- Education of children these days imposes a heavy burden on the middle class. A good beginning was made in 2003 by providing deduction for tuition fees under Section 80C of the Act. But Section 80C of the Act is particularly a provision granting incentive for savings and also considering the long list of eligible investments in this section, there is very little relief to the individual on account of the education fees incurred by him.
It is therefore recommended to de-link deduction for educational expenses for children from section 80C and provide under a separate provision like Section 80D of the Act for medical insurance. A reference to the Ministry of Education to find out the tuition fee for an average middle class household will give an indication about the limit of the deduction.
1.3.14 Deduction in respect of rent paid by assesses not receiving a House Rent Allowance – Section 80GG
- Under Section 80GG of the Act, the maximum deduction available to individuals who do not receive an HRA, in respect of rent paid is only INR 2000 per month. The said limit was last revised in 1998 and is very low in light of the huge rental costs especially in the metro cities.
- In order to encourage people to be self employed, this exemption needs to be revised on lines of current deduction available to salaried employees. As in the case of HRA exemption, the Government may also consider introducing separate limits for metro and non-metro cities.
1.3.15 Limit on Meal expense and Electronic meal card
- Development of city boundaries and shifting of offices outskirts increased travel time and young working population has to rely on food to be provided in offices. Free/subsidized meal facility/ pre-paid meal vouchers enable employees to organize food to accommodate long working hours in today’s fast paced world. Offices rarely have cafeteria on site and rely on outside food courts / caterers to provide meal support to employees through prepaid vouchers. Uniform benefit to all employees across locations and clients is ensured by employers including government / public sector companies, namely LIC, RBI, NTPC, SAIL, Rashtriya Chemicals etc. Accordingly, the scheme of free meals was recognised as a staff welfare measure according to the Circular No. 15 of 2001 issued by the Central Board of Direct Taxes.
- As per the present perquisite rules, if food and non-alcoholic beverages are provided during working hours at office or business premises or through non-transferable paid vouchers usable only at eating joints, the value of facility to the extent of INR 50 per meal is exempt from the tax. Maximum exemption ceiling of INR 50 per meal was introduced way back in 2000-01 and has not been adjusted for inflation thereafter. This limit of ₹ 50 is very meagre and needs to be revised to at least INR 200 per meal by suitable amendment in proviso to Rule 3(7)(iii).
- Reserve Bank of India has changed its policy on paper vouchers and is enforcing Prepayment Card issuers to issue electronic cards to ensure better accountability. Accordingly, many employers these days provide this facility through electronic meal swipe cards. However, the current rules expressly provide exemption to paid vouchers and not electronic cards though such cards were expressly exempted under the erstwhile FBT regime subject to conditions. Accordingly, their treatment is not free from doubt.
Exemption Limit should be raised to INR 200 per meal. The said exemption along with increased limit should not be restricted to paper vouchers only but extended to electronic meal vouchers also.
1.3.16 Housing for all – Deduction for interest on loan taken for self occupied house – section 24
- Deduction available from taxable income towards interest on loan taken for acquisition/construction of self-occupied house property provided such acquisition or construction is completed within three years from the end of the financial year in which capital was borrowed where the capital is borrowed on or after 1 April 1999, is restricted upto a maximum limit to INR 200,000. This restriction on interest deduction has led to a salaried employee paying tax as well as interest on loan.
- At the same time, unrestricted deduction on interest payment on house let out by a person has lead to speculative interest in property market while genuine end user is not able to purchase houses due to high prices and lack of cash flow due to tax as well as interest payment. In order to fulfill Government’s vision of housing for all families and to spur growth, it is proposed that there ought to be no limit on interest deduction for self occupied house and for curbing speculative activity in housing, for any person owning more than one house, interest deduction may be limited to only two houses (i.e. One self occupied and another rented out).
- This will have an effect of shifting the demand from speculators to end users and will aid government’s vision to provide house to every household in five years.
- Limits on amount of interest allowable as a deduction on self-occupied property be removed completely for one residential house for a person.
- For a person owning more than one house, deduction may be allowed for only one additional house if such house were to be let out.
1.3.17 Exemption for payment of Leave Encashment to be raised to ₹ 10 Lakhs – section 10
The exemption limit for leave encashment paid at the time of retirement or otherwise is notified by the CBDT in accordance with the powers given under section 10(10AA) of the Act. The current limit of ₹ 3 lakhs is very old (since 1998) and needs to be raised substantially with immediate effect.
It is suggested that the limit should be raised to ₹ 10 lakhs in line with the increase in the limit of gratuity.
1.3.18 Receipt of amount under Life Insurance Policy – Section 10(10D)(d) of the Act
As per Sec 10(10D)(d) of the Act, any sum received under an insurance policy in respect of which the annual premium payable during the term of the policy exceeds ten per cent of the actual capital sum assured, is taxable in the hands of receiver. Thus, whole of maturity/death claims proceeds of life insurance policy in such case gets taxed under this section. This makes the Life Insurance policies unattractive for middle and higher age groups where the premium paid exceeds 10% of the sum assured.
It is suggested that the Sum assured multiple be lowered to 5 times of the premiums paid or the tax benefits should be linked with the tenure of the policy rather than the sum assured and accordingly, the tax benefit should be given only on policies with a minimum tenure of 10 years.
Alternatively, further, to the extent such amount received is calculated based on premium within specified limit (10 per cent) the said amount should be exempt. In other words exemption should not be eligible for amount calculated with reference to premium in excess of 10 per cent of sum assured.
1.3.19 Income of minors – to increase exemption limits under section 10(32) of the Act
As per section 10(32) of the Act, in case the income of an individual includes the income of his minor child in terms of section 64(1A), such individual shall be entitled to exemption of ₹ 1,500 in respect of each minor child if the income of such minor as includible under section 64(1A) exceeds that amount. The current limit of ₹ 1,500 was fixed by the Finance Act, 1992 and needs to be raised substantially with immediate effect.
The limit should be raised to at least ₹ 10,000/- for each minor child.
1.3.20 Rajiv Gandhi Equity Scheme – section 80CCG
The Finance Act, 2013 has made amendment in section 80CCG of the Act to extend the scope of deduction to provide that the individuals with gross total income up to ₹ 12 lakhs are eligible to invest under the Rajiv Gandhi Equity Savings Scheme (‘RGESS’). The scope of investment has been extended to include listed units of equity oriented funds. The deduction under this section is available to the extent of ₹ 25,000. The deduction will now be available for three consecutive financial years beginning with the year in which the listed equity shares or listed units of equity oriented funds were first acquired.
Currently, RGESS is available only to a “New Retail Investor” i.e. an individual who has not opened a demat account or has not previously transacted in equity or derivatives.
Deduction under the section may also be made available to small investors who have only few investments in their demat account (rather than no investments).
With a view to accelerate the investments in capital markets by the new retail investors, the deduction to the extent of ₹ 50,000 in a financial year instead of the present limit of ₹ 25,000 be allowed to a new retail investor without any limit imposed on the gross total income.
1.4 Taxation of Profits and Gains form Business or Profession
1.5 Deemed Dividend – section 2(22)(e)
Section 2(22) of the Act defines the term ‘dividend’ and sub-clause (e) thereof includes, within the meaning of this term, even an advance or loan, to a shareholder having at least a 10 percent voting-power in a company in which the public are not substantially interested, to the extent that the company possesses accumulated profits. Thus, a payment, which is clearly not a dividend as commercially understood, is, by a fiction of law, deemed to be one. Apart from payment to the shareholder himself, a loan or advance to a firm in which he is a partner with a 20 percent share, or to an association or body of which he is a member and entitled to 20 percent of its income, is also considered, to be deemed dividend, and is taxed accordingly. The object clearly is to prevent tax-avoidance by making an advance or loan (which would not be taxable) instead of distributing the amount as a dividend, which is subject to income tax.
1.5.1 Taxability of genuine inter-corporate loans and advances as deemed dividend
The provision suffers from many inequities:
- It taxes a loan, though it may be quite a genuine one, which is duly repaid within its scheduled short time. Moreover, there is no corresponding tax-relieving provision at the time of recovery of the loan.
- The tax is attracted, notwithstanding that the loan may be advanced at a fair commercial rate of interest and notwithstanding that preponderant majority of persons owning the concern which received the loan are not even shareholders of the lending company.
- At present, no tax is payable by the shareholder on dividend received from companies and only the company pays dividend distribution tax at 15 percent. Therefore, levy of tax on deemed dividend in the hands of shareholder at the normal rate is unjustifiable especially when all other deemed dividends are also subjected to dividend distribution tax. If this suggestion is not accepted, then adequate provisions should be made to exclude genuine transactions from the consequences of these provisions.
- Illustratively, genuine loans and advances, given on current market rate of interest and which are re-paid during the year, should be excluded from the scope of deemed dividend as these are not a subterfuge for payment of dividend. Similarly, where loans or advances are given by the companies to their shareholder employees on current market rates of interest as per the policy of the company, deemed dividend provisions should not get triggered as even otherwise the company is meeting its obligation by paying taxes on such interest income. Also, loans and advances given out of business necessities, needs and exigencies should be excluded.
- Similarly, where loans and advances are given by the Companies to their shareholders on current market rate of interest as per the policy of the Company, deemed dividend provisions should not get triggered as even otherwise the company is meeting its obligation by paying taxes on such interest income.
- Also, loans and advances given out of business necessities, needs and exigencies should be excluded.
- Loan given as part of business transaction and Inter-corporate deposits should be excluded from the application of Section 2(22)(e) of the Act.
1.5.2 The term “accumulated profits” for the purpose of Section 2(22)(e) not to include capital reserves
As per the Companies Act, capital reserves cannot be utilized for distribution of dividend by a company.
This leads to controversies as to whether capital reserves should form part of accumulated reserves for the purpose of Section 2(22)(e) of the Act.
An amendment should be brought in Section 2(22) of the Act to exclude capital reserves from the ambit of “accumulated profits”.
1.5.3 Taxability of deemed dividend in the hands of recipient not being a registered shareholder
The object of sub-clause (e) of Section 2(22) of the Act is to prevent tax-avoidance by making an advance or loan (which would not be taxable), instead of distributing the amount as a dividend to the shareholder, which is subject to income tax. It is recommended that a loan or advance to a company/firm/association or body, which is not a shareholder but where the shareholder or its relative, etc. have substantial interest should not be considered as deemed dividend. Alternatively, the threshold for substantial interest of the shareholder in the recipient concern should be increased to 51 percent.
1.6 Restoration of exemption under Section 10(23G)
Section 10(23G) of the Act provided for tax exemption in respect of any income by way of dividends other than dividends referred to in Section 115-O of the Act, interest or long-term capital gains of an infrastructure capital fund or an infrastructure capital company or a cooperative bank from investments made on or after 1 June 1998 by way of shares or long-term finance in approved eligible businesses including infrastructure projects, developers of SEZs, hotel projects of not less than three star category, hospital projects with at least one hundred beds for patients and certain housing projects. The above exemption played a significant role in attracting investment towards development of infrastructure projects in India. This exemption was withdrawn by the Finance Act, 2006.
Consideration by the Government to restore the above exemption of income from investment in infrastructure and other projects.
In view of the increasing need for huge investments in infrastructure and other vital projects, we plead for restoration of the aforesaid exemption with a view to ensuring low cost of raising capital for such thrust project areas.
1.7 Rationalization of provisions of Section 14A and Rule 8D
As per Section 14A of the Act, no deduction shall be allowed in respect of expenditure incurred in relation to income not includible in the total income. Section 14A(2) of the Act provides that the amount of expenditure incurred in relation to income not includible in the total income shall be determined by the tax authority if he is not satisfied with the correctness of the claim of the taxpayer in respect of such expenditure in relation to income not includible in the total income. This satisfaction is to be arrived at by the tax authority having regard to the accounts of the taxpayer. The determination of the amount of expenditure incurred in relation to the income which is not includible in the total income of the taxpayer is to be done in accordance with the method prescribed, i.e. Rule 8D of the Income-tax Rules, 1962 (the Rules).
- Disallowance to be restricted to the extent of exempt income earned.
- The way in which the Rule 8D stands drafted leads to a situation where the quantum of disallowance far exceeds the income, which is not includible in the total income. This could be absurd at times and runs contrary to the intention of Section 14A of the Act.
- It should be clarified that the disallowance as per the deeming provisions of Rule 8D of the Rules should not exceed the amount of exempt income earned.
- Disallowance of expenses pertaining to Dividend from securitization trust
The modus operandi of securitization trusts is to raise funds from investors such as MFs, banks and NBFCs by issue of ‘pass through certificates’ and buying loans from financial institutions (including banks/ NBFCs) out of the issue proceeds. The securitization trust earns interest income from the borrowers.
The income-tax authorities had been initiating proceedings against securitization trusts alleging that their income was liable for taxation as ‘business income’. However, the trusts argued that since MFs (which are considered to be the largest subscribers in the securitization market followed by banks and NBFCs), being the beneficiaries in the securitization trusts, are exempt as per the provisions of the Act, the securitization trusts should not be liable to pay any tax (based on the principles of trust taxation).
In order to clarify the ambiguity surrounding taxation of securitization trusts, a special taxation regime for securitization trusts has been introduced by the Finance Act, 2013. The same is as outlined below
- Income earned by the securitization trust is exempt from tax provided it is regulated by SEBI or RBI
- Securitization trusts will be liable to pay additional income-tax under section 115TA of the Act (similar to dividend distribution tax payable in case of companies) depending upon the status of the recipients.
- Income received from the securitization trust will be exempt from tax
The intention of amendment was to remove the ambiguities surrounding the taxation of securitization trusts and to reduce litigation.
As per section 14A of the Act, the expenses incurred by banks, NBFCs held to be expended for the purpose of earning the exempt income received from the securitization trust would be disallowed. Banks and NBFCs have previously been able to set-off existing losses/ claim expenses against the income from securitization trust, now the income from securitization trust being exempt in the hands of banks and NBFCs will not be eligible for set-off and the income would be subject to additional income-tax under section 115TA of the Act.
Disallowance under section 14A of the Act on income which has been taxed in the hands of the distributor entity but exempt in the hands of the recipient, results in double point tax incidence in the hands of banks and NBFCs receiving exempt income.
It is urged that exempt income received by banks, NBFCs from securitization trust be excluded for computation of disallowance as per section 14A of the Act. Alternatively, distribution tax be abolished and the dividend be taxed in the hands of banks and NBFCs so that the cascading effect of disallowance in respect of exempt income which has already suffered distribution tax is removed.
- A deeming provision of the administrative expenditure at the rate of 0.5 percent of the average investments, results in adhoc and excessive disallowance.
- This Rule is very harsh and by applying the formula under the said Rule, expenditure that has no connection with the earning of exempt income gets disallowed. A deeming provision of the administrative expenditure at the rate of 0.5 percent of the average investments, results in adhoc and excessive disallowance. There is even more hardship when the investments are made only at the end of the accounting year (say 31 March) which are also subject to disallowance at 0.5 percent as per the deeming provisions.
- Rule 8D be amended such that the arbitrary clause i.e. clause (iii) of Rule 8D(2) of the Rules on disallowance of 0.5 percent of the average investments be deleted. Alternatively, the disallowance for administrative expenses should be made by estimating the time of the personnel and the resources involved for undertaking the activities which would earn exempt income. The aforesaid estimation to be done on reasonable basis after considering the facts of each case and the frequency of such activities.
- It has been noticed that even if exempt income is not earned during a particular year, the tax officers disallow the expenditure in relation to the investments which have the potential to earn tax exempt income.
- Section 14A(1) of the Act reads as:
“…..no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act”
- Based on the provisions of said Section, we recommend that if there is no income, in a particular year, which does not form part of the total income under this Act then the disallowance under Section 14(A) should not be triggered. A clarification to this effect through the amendment in the Act, a notification, etc. would be helpful in reducing unwarranted litigation on this issue.
- It has been noticed that the for the purpose of computing disallowance under clause (ii) of Rule 8D(2) of the Rules total interest expenditure debited to the profit and loss account is considered by the tax officers, even if the interest expenditure has no nexus with earning of exempt income.
- It should be explicitly clarified that the interest expenditure which is not directly relatable to exempt income or receipt is to be excluded from the interest expenditure considered for the purpose of computing disallowance under section 14A of the Act read with Rule 8D of the Rules.
- The disallowance under Section 14A of the Act is required to be made in respect of expenses incurred for earning exempt income. The provisions are harsh in respect of the investments held as stock-in-trade or strategic investments made purely for acquiring controlling interest. The provisions are also harsh where the investments made in the company as per the specific requirement under a statute or contract with government.
- The strategic investments are generally made with the intention of acquiring controlling interest and management of the group for the purpose of enhancing the business objective of the group. The investment idea is therefore business driven and not with the intention of earning dividend income.
- While making such investment and also in respect of investments held as stock-in-trade, the main intention is to maximize business income which is taxable and dividend income are purely incidental.
- Further, in respect of certain businesses like power, infrastructure development etc., the statute/government requires the taxpayer to execute the project only through a Special Purpose Vehicle (SPV) Company. Accordingly, making an investment in a Company is a pre-requisite business model for such businesses.
- When a Bank or an NBFC trades in shares it receives trading income (difference in purchase and sale price) and dividend income. While trading income earned is fully taxable as business profits, dividend income received from such shares which is incidental is exempt from tax.
- It should be specifically clarified that aforesaid investments would not be included for computing disallowance under Section 14A of the Act.
As per clause (f) of Explanation 1 to section 115JB of the Act, expenditure relatable to exempt income which is debited to the profit and loss account needs to be added back for the purpose of computation of book profits under section 115JB of the Act. However, it has been observed that the deeming provisions of section 14A of the Act read with Rule 8D of the Rules are applied by the tax officers to disallow the expenditure incurred in relation to exempt income for the purpose of computing the book profits under section 115JB of the Act. This is against the provisions of section 115JB of the Act and result into disallowance of expenditure in excess of the expenditure actually incurred and debited to the profit and loss account.
A specific clarification be issued to provide that the provisions of section 14A of the Act read with Rule 8D of the Rules cannot be applied for the purpose of computation of disallowance of expenditure under clause (f) to Explanation 1 to section 115JB of the Act. It further needs to be clarified that it is only the actual expenditure incurred to earn exempt income and debited to the profit and loss account which has to be added to compute the book profits under section 115JB of the Act.
1.8 Taxability of Unsold Flats in the hands of Real Estate Developers
- In every business, there is opening stock and closing stock. Real estate business is no exception. It is this stock of flats/apartments held by a real estate developer as at the end of the year which is the subject matter of dispute. The issue relates to the addition on account of annual letting value (ALV) of flats, constructed but lying unsold, assessed on notional basis as “Income under the head House Property” in the hands of real estate developers. The Delhi High Court in the case of CIT vs. Ansal Housing Finance and Leasing Co. Ltd. (2013) 354 ITR 180, has held that the notional annual letting value of closing stock of flats/apartments is liable to be assessed as “income from house property” because the real estate developer is owner of such flats/apartments. It has not been appreciated that the real estate developers are not in the business of renting out of flats and letting out vacant or other properties is not part of the business or objectives of the real estate developers. The assessee cannot be taxed in respect of ALV of flats, notionally because the real estate developers as owners are occupants, and such occupation is in the course of, and for the purpose of business, as a builder.
- In case of real estate developers, most of the developers have unsold stock which also includes a chunk of finished flats, apartments and units etc. the finished units remain unsold either due to indifferent market conditions or due to some legal complications etc. In any case, a real estate developer occupies its stock in trade for the purpose of business, therefore, the stock at the end of the year comes within the purview of exception provided in section 22 of the Act, in as much as, it exclude the property that an owner occupy for the purpose of his business. The closing stock of property is being considered by the real estate developer in arriving at the business profits and to assess the notional ALV of the same again as Income from House Property, when the same is neither let out or is held with the intend of letting out, is unreasonable.
We recommend that a clarification may be issued by the Government to provide that property held as stock-in trade by the developer for the purposes of his business is not to be assessed to tax on notional ALV basis as “Income under the House Property”.
1.9 Depreciation – section 32
- Whether depreciation allowable on Goodwill.
- Oil wells are classified as buildings and therefore, depreciation at a less rate of 10 percent is allowed on the same
- Depreciation allow ability with regard to leased assets.
- Need for Higher depreciation allow ability for plant and machineries.
- Need for additional depreciation for Service industries.
- Additional depreciation for Hotel Industry – Hotel buildings constitute the ‘plants’ for the hotel industry as their usage is round the clock for 24 hours. The industry has to make very heavy investments in renovation, up-gradation and upkeep of the hotel buildings.
- In case of new plant and machinery acquired and installed after March 31, 2005, additional depreciation to the prescribed assessees is allowed @ 20% under section 32(1)(iia) of the Act. In case the new plant and machinery is put to use for less than 180 days in the year in which it is acquired, additional depreciation will be allowed @ 10%. However, there is ambiguity on allow ability of balance depreciation @ 10% in the subsequent year on such plant and machinery.
- In line with the recent Supreme Court decision in the case of CIT v. Smifs Securities Ltd. (2012) 24 Taxmann.com 222 a clarificatory amendment should be brought for specific inclusion of Goodwill in the definition of block of intangible assets. Further, it would be appropriate to provide clarity on allow ability of depreciation on self-generated/purchased goodwill.
- Oil/Gas well be classified as ‘Plant and Machinery’ for mineral oil concerns eligible for special rate of 60% depreciation. However, income tax authorities have considered oil well as building and allowed depreciation @ 10% as against eligible rate of 60% applicable to such plant & machinery. Income tax authorities have relied on definition given in notes forming part of Appendix – I “Table of rates at which depreciation is admissible” wherein ‘building’ has been defined to include roads, bridges, culverts, wells and tube wells vis-à-vis considered that oil well is also covered as building only as it is an inclusive definition. Oil wells are not normal well and require special equipment, knowledge and skill which goes into developing oil well. Therefore, one cannot consider oil well as same as any water well. Oil well is made up of various machineries and ‘cementing’ is just one process to strengthen the structure of such well and therefore by no means oil wells can be considered building. It is recommended that a necessary clarification by way of circular may be issued by the Government to the effect that oil/gas well be classified as ‘Plant and Machinery’ for mineral oil concerns eligible for special rate of 60% depreciation.
- There is lack of clarity as regards the person who is entitled to claim depreciation in a leasing transaction. To avoid litigation on the issue, the provisions of Section 32 read with section 43(1) and 43(6) of the Act, should clearly spell out the allowance of depreciation at the prescribed rates and subject to fulfilment of certain conditions, in respect of leased assets under operating lease/finance lease/sale and lease back cases and other financing arrangements.
- It would be in fitness of things to restore the rate of depreciation on general plant and machinery to 25% from 15% to encourage investment in new plant and machinery entailing up gradation of obsolete technologies.
- Moreover, the Government should extend the initial depreciation under Section 32(1)(iia) of the Act
- to service industries as well which is currently available to only manufacturing sector.
- An amendment should be made in section 32(1)(iia) of the Act to clarify that on new plant and machinery acquired in a year and put to use for less than 180 days, would be eligible for balance additional depreciation @10% in the subsequent year.
1.10 Investment Allowance – section 32AC
The Finance Act (No. 2), 2014 has amended the section 32AC of the Act wherein the taxpayer shall be allowed a deduction of 15 percent of cost of new plant and machinery, for investment made up to 31 March 2017, if such investments are more than ₹ 25 crore in a financial year. Further, the taxpayer eligible to claim deduction under the earlier combined threshold limit of ₹ 100 crore for investment made in financial years 2013-14 and 2014-15 shall continue to be eligible to claim deduction even if its investment in the year 2014-15 is below the new threshold limit.
- The phrase ‘manufacture or production of an article or thing’ has not been defined in section 32AC of the Act which can entail litigation.
- The Memorandum explaining the provisions of the Finance Bill, 2013 states that the proposed investment allowance is meant for a company engaged in the business of manufacture of an article or a thing. However, other sectors like operating cold storage, developing and building an infrastructure facility, generation/transmission of power are equally important for the growth of the Indian economy. Similarly, the investment allowance should be allowed for the other sectors for the overall growth of the economy.
- New asset for the purpose of section 32AC of the Act would not include any office appliance including computers and computer software. It may be noted that the computers and computer software such as servers, ERP systems etc. are intended to enhance overall operational efficiency. Hence, it is ironical that modern technologies tools such as computer and computer software are excluded though they bring about efficiency in manufacture and production of goods.
- The benefit intended to be provided by way of grant of investment allowance under section 32AC of the Act would get diluted on levy of MAT under section 115JB of the Act.
- There is ambiguity as to whether the unutilized investment allowance (in case there is no sufficient income to absorb the investment allowance) would be carried forward to the next year or not.
- The terms ‘acquired’ and ‘installed’ for the purpose of section 32AC of the Act are not defined which will lead to doubts on interpretation and may entail litigation.
- The section stipulates a restrictive condition that the benefit will not be available in respect of investment in any plant and machinery on which depreciation is allowable at the rate of 100%. This situation creates disparity when compared to companies who would be granted investment allowance for investments in plant and machinery on which rate of depreciation is not 100%. There is also ambiguity about whether investment allowance would be available to a company if it invests the prescribed threshold in plant and machinery in the second half of the year on which rate of depreciation is 100%.
- The allowance under Section 32AC of the Act should also be extended to other sectors like those in operating cold storage, developing and building an infrastructure facility, generation/transmission of power, telecom infrastructure service providers, processing/assembling activities, creation of broadband facility, and conversion of LNG into RLNG etc.
- Computers and computer software should be regarded as “new asset” for the purposes of section 32AC of the Act.
- The investment allowance eligible for deduction under section 32AC of the Act should be reduced while computing book profits of the company under the provisions of section 115JB of the Act. Otherwise a taxpayer may have to pay MAT though being eligible for the deduction under normal provisions of the Act. Such reduction of book profits by the deduction amount will give a taxpayer the investment benefit in real terms and thereby attract more industrial and infrastructural investments.
- Specific provisions for carry forward and set off of investment allowance for an indefinite period should be brought in the Act.
- The scope of ‘manufacture or production of any article or thing’ and terms ‘acquired’, ‘installed’ be clearly defined to avoid any potential litigation on interpretation and implementation of the provision.
- Investment allowance under section 32AC of the Act should also be extended to cover those plant and machinery which are eligible for depreciation @ 100%.
1.11 Amortization of certain preliminary expenses – section 35D
- Section 35D of the Act provides deduction to Indian Companies for certain expenditure incurred before the commencement of business or after the commencement in connection with the extension of the undertaking or in connection with setting up a new unit. The benefit of deduction under Section 35D of the Act is limited to the expenditure in the nature of legal charges and registration fees etc. incurred for incorporating the Company.
- Further, the deduction of this expenditure is restricted to 5 percent of the cost of project or capital employed at the option of the company.
- However, legitimate expenditure incurred post incorporation for and until setting up of business, which are neither covered within Section 35D nor can be capitalized to the actual cost of fixed assets, gets permanently disallowed under any of the provisions of the Act even though they are incurred for the setting up the business and becomes sunk cost. Some of this expenditure could be office/sales employees’ salary, audit fees, ROC filing fees, advertisement and business promotion expenditure incurred prior to setting up of business, etc.
- This is more particularly in the case of companies having longer gestation period for setting up their business such as manufacturing entities, insurance business requiring multiple licenses, etc. This affects the cash flow and the spending capacity of the company.
- There is no plausible reason for not allowing these expenses as deduction either as revenue or on a deferred basis in five equal instalments. Therefore, section 35D of the Act should be suitably amended to include all the expenses incurred by Companies post incorporation but during the course of setting up of its business as eligible for deduction.
- Even the ceiling of 5 percent should be removed as there is no rationale behind having such ceiling when the actual expenditure is far higher.
1.12 Tax Incentives – Weighted deduction under section 35(2AB)
- Section 35(2AB) of the Act extends deduction of a sum equal to twice the expenditure incurred towards scientific research on in-house research and development facility as approved by the prescribed authority to companies engaged in the business of
• bio-technology; or
• manufacture or production of any article or thing (other than those specifically excluded for purposes of this tax incentive).
- As can be seen the section extends the weighted deduction of expenditure incurred only in respect of “in-house research and development facility”. India is globally recognised as an attractive jurisdiction for outsourcing owing to its affordable, skilled and English-speaking manpower. Outsourced R&D work is becoming a key area of growth for the Indian services sector however there are no specific tax benefits available to units engaged in the business of R&D or contract manufacturing. There certainly exists a need to provide impetus to such activities in the form of tax and fiscal benefits.
- Further, specifically in the pharma sector, pharmaceutical discovery is a lengthy, risky and expensive proposition. In this business environment, necessitated by the current business needs, sometimes companies incur expenses towards scientific research outside their R&D facility.
- Another anomaly existing in the current provisions is that any expenditure incurred outside the approved R&D facility by pharma companies’ i.e. towards clinical trials (including those carried out in approved hospitals and institutions by non-manufacturing firms), bioequivalence studies conducted in overseas CROs and regulatory and patent approvals, overseas trials, preparations of dossiers, consulting/legal fees for filings in USA for NCE (new chemicals entities) and ANDA (abbreviated new drug applications) as approved by the DSIR which are directly related to the R&D, etc. are currently not covered. Furthermore, Indian companies incur substantial costs in defending their patent rights and applications in and outside India and these sums are not eligible for deduction.
- Extend tax benefits to units engaged in the business of R&D or contract manufacturing rather than just for in-house R&D facilities to provide impetus to R&D in India.
- Benefits should be provided for units engaged in the business of R&D and contract manufacturing by way of deduction from profits linked to investments. Benefits in the form of research tax credits which can be used to offset future tax liability, similar to those given in developed economies can be introduced.
- As discussed above, in view of the lengthy, risky and expensive conception period for pharmaceutical discovery, it should be considered for the existing provisions to specifically allow weighted deduction in respect of expenses incurred outside the R & D facility which are sometimes necessitated by the industry’s business needs. Additionally, it could be clarified that where the risk of doing research is assumed by a company, the entire cost of R&D activities
- whether outsourced or undertaken in-house – is eligible for weighted deduction in the hands of company undertaking the risk.
- The existing anomaly in the current provisions, i.e. any expenditure incurred outside the approved R&D facility by pharma companies’ although in relation to the R&D activity is not eligible for the weighted deduction should be removed. This is will further help promote in-house R&D in India.
Currently, there seems to be an ambiguity in the office of Department of Scientific and Industrial Research (‘DSIR’) with respect to whether a company engaged in the business of development and sale of software or providing IT services or ITES is eligible for weighted deduction on the R&D expenditure incurred by it.
Explicit provisions should be introduced in the Act, to provide that DSIR can approve the R&D facilities of the companies engaged in development and sale of software. It is further recommended that weighted deduction for R &D expenditure be extended to service sector as well.
Section 35(2AB) has been gradually amended to provide increased tax benefits on expenditure incurred towards in- house Research & Development i.e. from 125% to 200%. However, Section 35(1)(iia),which provides tax incentives in respect of payment made to Research & Development company, has remained fixed at 125%. In fact, the conditions specified by the Department of Scientific and Industrial Research (DSIR) for grant of approval for a recognized R&D facility/company under Section 35(2AB) and Section 35(1)(iia) of the Act respectively are the same and hence the tax benefits provided under Section 35(1)(iia) of the Act should be at parity with the tax benefits provided under Section 35(2AB) of the Act in terms of quantum of benefits.
In order to be fair between an R&D company recognized by DSIR under Section 35 (1)(iia) and an in-house R&D centre under Section 35(2AB), the tax benefits under Section 35 (1)(iia) should be increased to 200% from the present level of 125%.
1.12.1 Profit linked incentives for specified industries vis-a-vis investment-linked incentives – section 35AD
- Section 35AD of the Act, extends tax incentives to specified industries (cold chain facilities, 2 star hotels, hospitals, affordable housing, housing projects under a scheme for slum development or rehabilitation, warehousing for storage of agricultural produce, laying and operating a cross- country natural gas or crude or petroleum oil pipeline and production of fertilizer in India, inland container depot, container freight station, bee-keeping and production of honey and beeswax, warehousing for storage of sugar, slurry pipeline for the transportation of iron ore, semiconductor wafer fabrication manufacturing unit) with respect to the capital expenditure incurred for set up and operation of such specified business. Further, once a deduction for the capital expenditure is availed under this section, no deduction shall be allowed in respect of such specified business under Chapter VI-A (Deductions in respect of certain incomes) and section 10AA of the Act.
- With the introduction of Section 35AD of the Act, the envisaged ‘specified businesses’ would instead of enjoying a deduction of the profits earned (as is envisaged under the Chapter VI-A deduction), in addition to depreciation of the capital investment on creation of the assets, would now be eligible to claim a complete deduction for the entire capital expenditure incurred in set up of the specified business. In effect, the deduction under Section 35AD is nothing but an alternate form of accelerated deduction for the capital expenditure in the specified business and no real benefit is being extended to these industries.
- Additionally, with investment linked incentives, the cash flows of these capital intensive industries would suffer on account of levy of MAT. This is because book profits will continue to be higher than taxable profits (given that deduction for capital expenditure is not taken to the profit and loss account other than in the form of depreciation) and hence MAT will be paid by the industry during the “tax holiday period”. While MAT is creditable against normal taxes in future, the period for recovery of MAT paid could result in being longer than under profit linked incentives. Further, given the restriction on the years for carry forward of MAT, it is possible that MAT paid in initial years may not be recovered, especially for those assesses who have a longer period before reaching break-even.
- The profit-linked incentives currently given for infrastructure and crucial sectors should be continued till the end of 12th Five Year Plan i.e. till 2017 to encourage investment and growth of India’s infrastructure sector.
It should be considered to do away with MAT for the infrastructure industry as levy of the same defeats the very purpose of extending tax incentives to the industry, especially given the high rate of MAT now.
1.12.2 Dilution of tax incentive under Section 35AD by insertion of section 73A
- In terms of the Section 35AD of the Act, a taxpayer is allowed a deduction in respect of the whole of any expenditure of capital nature incurred (other than on land, goodwill or financial instruments), wholly and exclusively, for the purposes of any specified business carried on by him during the previous year in which such expenditure is incurred by him.
- For this purpose, ‘specified business’ means any one or more of the following business, namely:-
- setting up and operating a cold chain facility;
- setting up and operating a warehousing facility for storage of agricultural produce;
- laying and operating a cross-country natural gas or crude or petroleum oil pipeline network for distribution, including storage facilities being an integral part of such network;
- building and operating, anywhere in India, new hotels of two-star or above category as classified by the Central Government;
- building and operating, anywhere in India, a new hospital with at least one hundred beds for patients;
- developing and building a housing project under a scheme for slum redevelopment or rehabilitation framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;
- developing and building a housing project under a scheme for affordable housing framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed;
- production of fertilizer in India;
- setting up and operating an inland container depot or a container freight station notified or approved under the Customs Act, 1962;
- bee-keeping and production of honey and beeswax;
- setting up and operating a warehousing facility for storage of sugar;
- laying and operating a slurry pipeline for the transportation of iron ore;
- setting up and operating a semiconductor wafer fabrication manufacturing unit.
- The underlying idea behind allowing the said deduction seems to be intended to enable the taxpayer concerned to set-off the business losses incurred by this write-off against the taxable profits from their existing businesses and reduce their tax liability in the year of deduction and thereby to provide part of the resources of investment required for setting up of the businesses. Unfortunately, however, the incentive so intended cannot be achieved owing to the insertion of another Section 73-A of the Act, which restricts the set-off / carry-forward of losses by specified business only against the profits and gains, if any, of any other specified business carried on by the taxpayer in that assessment year and the amount of loss not so set-off can only be carried forward and set-off against profits from specified business in the subsequent assessment years.
The losses from the specified business under Section 35AD of the Act ought to be made eligible for set-off against profits from other businesses of the taxpayer, and not restricted to be set-off against only the specified businesses, as it is not always the case that the taxpayer would only be carrying on the ‘specified business’. In this light, Section 73A of the Act should therefore be deleted.
1.12.3 Clarification on amendment to Section 35AD(3)
- It appears that the above amendment to Section 35AD(3) of the Act carried by the Finance Act, 2010, seeks to prevent a taxpayer from claiming dual deduction in respect of the same business.
- Accordingly, it appears that if a taxpayer carrying on a specified business does not claim deduction under Section 35AD, he can claim deduction under the relevant provisions of Chapter VI-A or Section 10AA, if the same exist for such business and if the exercise of such a choice is more beneficial.
- A clarification be issued that the taxpayer may exercise a choice (where available to the taxpayer) to avail tax incentive under section 35AD or Chapter VI-A/section 10AA, depending upon which is more beneficial to the taxpayer and thus clear the ambiguity as currently existing.
- Further, it is suggested that a clarification also be issued that in the event the taxpayer opts for the investment linked incentive under Section 35AD of the Act and the same is denied/ rejected at time of revenue audit (could be on account of non-satisfaction of prescribed conditions), in such case the taxpayer is eligible to make an alternative claim under Chapter VI-A or section 10AA, on satisfaction of the conditions provided therein notwithstanding the requirement stipulated in Section 80A (5) of the Act or 10AA of the Act. This is because, a taxpayer who is otherwise entitled to deduction in respect of qualifying profits of the specified business would lose such deduction on account of Section 80A(5) of the Act that mandates a claim for deduction under chapter VI-A be made in its tax return. As the taxpayer would not have claimed deduction under provisions of Chapter VI-A/section 10AA of the Act, in its tax return in view of a claim being made under Section 35-AD of the Act, such taxpayer would be precluded from claiming deduction in view of Section 80-A(5) /section 10AA of the Act, of the Act.
1.12.4 The investment linked tax incentive under Section 35AD is a restrictive tax incentive
- Section 35AD of the Act extended investment linked tax incentive to a taxpayer engaged in building and operating anywhere in India a 2-star or above category hotel. The same is a restrictive tax incentive to the industry as only such taxpayers are eligible which are engaged in both building and operating the hotel. Similar restriction exists for the hospital industry, wherein the tax incentive is available for ‘building and operating anywhere in India a hospital with at least 100 beds for patients.’
- Thereafter, vide Finance Act, 2012 w.e.f. 1 April 2011, a new section 35AD(6A) was inserted, which extended investment linked tax incentive to a taxpayer engaged only in ‘building’ hotel (and transferring the operation to another person). However, similar benefit was not extended for taxpayer engaged in building hospital.
- As can be seen from a plain reading of Section 35AD of the Act, it appears that the benefit under the section would not be available in case the person building the hospital is different from the person operating the hospital. This does not seem to be in harmony with the objective, specifically given the typical operating structure of the industry wherein very often the developer or builder of the hospital is different from the taxpayer who is operating and managing the hotel/ hospital. Considering the said anomaly was removed by the Finance Act, 2012 vide section 35AD (6A) for hotel industry by granting investment incentive to a builder (though not operating the hotel), similar benefit ought to be extended to a hospital industry.
- Further, if a person does not build the hotel/ hospital, but acquires the same by purchase or rent or otherwise for purposes of operation and management thereafter, such taxpayer would not be entitled to the benefits of this section.
- Accordingly, to accord benefit to the industry, as is the very purpose of extending the tax incentive to the industry by amendment of Section 35AD of the Act vide Finance Act 2010, the benefit should be made available to the specified business of ‘building’ or ‘operating’ or ‘building and operating’ a new hotel of two-star or above category anywhere in India. Similar amendment should also be considered for case of hospitals.
- If any asset for which such deduction is allowed, is used for other than the specified business, before the period of eight years after the asset acquisition, then such deduction allowed, as reduced by the amount of depreciation allowable as if no deduction under this section was allowed, shall be deemed to be the business income of the taxpayer of the financial year in which the asset is so used.
- In view of the above disconnect, a clarification is required and it is suggested that the relevant clause be amended to read as under:
“(aa) on or after 1st day of April, 2010, where the specified business is in the nature of building or operating or building and operating a new hotel of two-star or above category as classified by the Central Government.
Similar, amendment to also recommend for the hospital sector and the relevant clause be amended to read as under:
(ab) on or after 1st day of April 2010, where the specified business is in the nature of building or operating or building and operating a new hospital with at least one hundred beds for patients”
- Consequential amendments should also be considered in clause (iv) and (v) of sub-section (8) of Section 35AD of the Act.
- The condition of non-transferability of the asset should be reduced to at least four years since even usage of the asset for four years indicate that the taxpayer intended to use the asset for the specified business. Higher period of non-transferability puts restriction on the transfer of independence of the taxpayer’s business decision and therefore, will prove to be counter-productive to the business growth.
- It should be clarified that if an asset is not used for the specified business due to obsolescence, etc., and at the same time not used in other than the specified business then the deduction allowed under this Section shall not be reversed.1.12.5 Weighted Deduction in respect of Capital Expenditure on certain Specified Businesses – section 35AD
The following specified businesses commencing operation on or after the 1st of April, 2012 has been allowed a deduction of 150% (as against 100%) of the capital expenditure under section 35AD of the Act, namely:-
- setting up and operating a cold chain facility;
- setting up and operating a warehousing facility for storage of agricultural produce;
- building and operating, anywhere in India, a hospital with at least one hundred beds for patients;
- developing and building a housing project under a scheme for affordable housing framed by the Central Government or a State Government, as the case may be, and notified by the Board in this behalf in accordance with the guidelines as may be prescribed; and
- production of fertilizer in India.
The same has been welcomed and is an inducement for setting-up of the above businesses. However, investment linked incentive by way of 100 per cent deduction of capital expenditure under section 35AD was introduced by The Finance (No.2) Act, 2009, with effect from 1st April, 2010 to encourage investment in priority areas for which a specific list (enlarged over the last two years) is contained in the section. The rationale behind the discriminatory tax treatment in between these specified businesses is not understandable.
It is recommended that the weighted deduction of 150% be extended to the entire list in the said section since all the said businesses are extremely important for the Indian economy like natural gas/crude pipe line distribution, hotels etc.
1.13 Deductibility of discount on issue of ESOP
- The deductibility of discount on issue of ESOP as allowable business expenditure under the Act has been subject matter of litigation. Recently, the Special Bench of Bangalore Tribunal in the case of Biocon Ltd. vs. DCIT (ITA No. 368, 369, 370, 371, 1206 of 2010 – Taxsutra.com) held that ESOP is one of modes of compensating the employees for their services and is part of their remuneration. Further, by undertaking to issue shares at a discounted premium, the company does not pay anything to its employees but incurs obligation of issuing shares at a discounted price on a future date in lieu of their services, which is expenditure under section 37 of the Act. However, in absence of clear guidelines on tax treatment of such discount laid down under the Act, the issue has led to unwarranted litigation.
- It should be explicitly provided in the Act that discount on issue of ESOP is a deductible business expenditure. Further, the principles regarding the determination of ESOP discount and its timing for claiming expense while computing taxable income under the Act should be clearly laid down to avoid ambiguity.
1.14 Tax treatment of Corporate Social Responsibility expenditure – Section 37
- One of the highlights of the Companies Act, 2013 is mandatory 2% spend on Corporate Social Responsibility (CSR).
- As per the Finance (No. 2) Act, 2014, the expenses incurred by the taxpayer on the activities relating to CSR referred to in Section 135 of the Companies Act, 2013 shall not be deemed to be incurred for the purpose of business and hence shall not be allowed as a deduction under Section 37(1) of the Act.
- The Companies Act 2013 mandates certain taxpayers to spend 2 per cent of their profit on CSR. These expenditures are made towards the society and for its betterment. As per the Finance (No. 2) Act, 2014, deduction of such expenses shall not be allowed for computing business income on the basis that these payments are nothing but application of income which cannot be allowed as deduction and even otherwise they are charitable payments hence cannot be construed to have incurred for the purpose of the business.
- The Ministry of Corporate Affairs (MCA) has listed certain guiding principles concerning CSR, which helps one to understand the intention of the Legislature. It states that CSR is not charity or mere donation; CSR is way of conducting business, by which corporate entities visibly contribute to the social good; CSR should be used to integrate economic, environmental and social objectives with the company’s operations and growth.
- Even the Courts in India have held that if the expenditure is incurred in advancement of taxpayer’s business, the same is allowable as business expenditure under Section 37(1) of the Act.
- The Act already allows deduction of expenses of the nature referred to in the CSR rules under different Sections such as Section 35AC, Section 35(2AA), Section 80G, etc. This strengthens the argument that CSR expenditure is not an application of income but is expenditure and the same should be allowed as deduction more specifically when such spend is mandated by law.
Accordingly, Explanation 2 to Section 37 should be removed and a deduction of CSR expenses incurred by the taxpayers pursuant to the Companies Act provisions should also be allowed under Section 37 while in computing total income.
1.15 Disallowance – section 40(a)(ia)
- Section 40(a)(ia) of the Act provides that specified payments to residents without deduction of tax at source will result in disallowance of 30% of the related expenditure and the payer is considered as a taxpayer in default and is liable for interest, penalty and prosecution (except in certain cases as stipulated).
- It is recommended that the 30 percent disallowance should be restricted on the part of the payment on which the tax was not deducted/deposited at source and not of the entire payment.
- Prior to Financial Year 2014-15, complete amount (instead of 30 percent now prescribed) of the specified payments on which tax was not deducted, was disallowed under section 40(a)(ia) of the Act. If such amount are duly deposited in subsequent year then for FY 2014-15 onwards, an amount of 30 percent of such payments shall be allowed. Accordingly, a taxpayer will have to face disallowance of 70 percent, even when he has deposited the taxes in the government treasury. Accordingly, it is recommended that the provision of section 40(a)(ia) clarify that if in earlier years the disallowance was 100 percent (and not 30 percent) then on depositing the taxes into the government treasury then 100 percent of the amount should be allowed as deduction (instead of 30 percent).
1.16 Deduction of employees’ contribution to Provident Fund/ESI Corporation – section 43B
- Section 43B of the Act allows deduction towards employer contribution to PF/any other fund for the welfare of the employees if the same is deposited upto the date of filing the return of income. However, deduction for employees contribution to PF/ESI or any other fund is governed by section 36(1)(va) of the Act which mandates that the employees contribution should be credited to the relevant fund by the due date specified under the relevant Act, rule, order or notification governing that fund. Manner of differential tax treatment for employees’ contribution and employer contribution to the same fund is discriminatory.
It is therefore recommended that suitable amendment be made in the Act so as to bring the provisions relating to the Employees’ contribution towards employee welfare funds in line with the employer’s contribution towards such funds.
1.17 Deductibility of provision for leave encashment – section 43B
- As per Clause (f) to section 43B of the Act, any sum payable by an employer in lieu of leave at the credit of his employee shall be allowed only on actual payment and not on mere provision. However, recently the Calcutta High Court in the case of Exide Industries Ltd. vs. UOI (2007) 292 ITR 470, held that amendment to section 43B(f) of the Act was not constitutionally valid and that leave encashment is neither a statutory liability nor a contingent liability and it is a provision to be made for the entitlement of an employee achieved in a particular financial year and therefore, not to be considered for the purpose of computing disallowance under section 43B(f) of the Act.
- Leave encashment is not a statutory liability and even in case of provisions being made the deduction was allowed as business expenditure as per the position laid down by the Supreme Court in the case of Bharat Earth Movers vs. CIT (2000) 245 ITR 428. To overcome the said decision, the Parliament had brought in an amendment in the year 2001 by introduction of clause (f) to section 43B of the Act. The amendment is constitutionally not valid and clause (f) to section 43B of the Act needs to be withdrawn.
- Provision towards leave encashment made by the employer should be allowable as a business deduction. An amendment should be made in section 43B of the Act by deleting clause (f) to section 43B of the Act.
1.18 Valuation mechanism for sale of land or building held as stock-in-trade – Section 43CA
Section 43CA of the Act provides that in respect of transfer of land and building held as stock-in-trade if consideration is less than the assessed stamp duty value, then such stamp duty value will be deemed to be the full value of consideration taxable as business income.
- Case of a dealer in property is quite different from the case of an investor or owner user of a property. Property price decided by a builder may not be same as property value to the investor/owner. Property price may be impacted by various factors including demand/supply. An investor may have capacity to hold on till demand/supply stabilises, whereas a builder may have compulsion to sell due to higher inventory built-up, mounting financial costs, project completion requirements attached to various approvals/incentives etc.
- The price of different units of the same property varies with various factors like available view, wind direction, spiritual beliefs etc. These factors are not adequately considered in Stamp Duty valuation. A vastu (spiritual belief) may fetch premium where as a flat not having cross ventilation may have to be sold at a discount. Therefore, a builder may take a call to follow differential pricing so long in totality he earns well.
The provision should be deleted.
1.19 Deduction under section 80JJAA of the Act
- Currently, section 80JJAA of the Act endows incentive to an Indian company which derives profits from an industrial undertaking engaged in the manufacture or production of goods in a factory, by providing a deduction for an amount of thirty percent of the additional wages paid to the new workmen for a period of three years beginning with the year in which new workmen is employed. The deduction is available subject to the satisfaction of the conditions specified in the section.
- The section was inserted in the Act with the intent to create more employment opportunities.
- One of the conditions stipulated by the section is that new workman should be employed for a period of three hundred days or more during the previous year of employment. In a situation, where workman joined in July and worked till March of the relevant previous year of employment i.e. worked for less than 300 days in Year 1 but for full year in Year 2 and Year 3 and assuming all other conditions prescribed in section 80JJAA of the Act are complied with, the company is still not eligible to claim deduction in any of the years.
- As it can be seen that the deduction is not available to companies engaged in the service sector irrespective of the same being major contributor of the employment in the Indian economy. Such discrimination is unfair.
- In case of an existing undertaking the 10 percent increase in the number of regular workmen is calculated as a percentage of existing number of “workmen” and not “regular workmen” as on the last day of the preceding year. For the purpose of calculating the percentage increase in the new regular workmen during a year, parity should be maintained i.e. only the existing number of ‘regular workmen” as on the last day of the previous year should be considered as a base to calculate the percentage increase in new regular workmen employed during the year. Since only salary paid to new regular workmen is available as a deduction under the provisions of section 80JJAA of the Act, hence the percentage increase should also be seen with respect to regular workmen only. Anything contrary to the same i.e. a large base if taken artificially minimizes the chances of falling within the eligibility criterion of 10 percent as provided by the section.
- Wages is not defined under section 80JJAA of the Act. It is not clear as to whether bonuses or statutory contributions made by the employer are to be included for computation of wages for the purpose of claiming deduction under section 80JJAA of the Act.
- The deduction under this section shall not be available if the factory is hived off or transferred from another existing entity or acquired by the taxpayer company as a result of amalgamation with another company.
- It is recommended that workmen in respect of whom the period of continuous employment of 300 days or more is attained in the previous year succeeding the previous year in which the workmen is employed, the deduction under section 80JJAA of the Act be granted from the succeeding previous year.
- For the purpose of calculating the percentage increase in the new regular workmen employed during a year – as per proviso to clause (i) of Explanation to section 80JJAA of the Act, parity should be maintained i.e. only the existing number of ‘‘regular workmen” as against existing number of ‘workmen employed’ as on the last day of the previous year should be considered as a base.
- The wages to be considered for the purpose of computation of deduction under this section should be clearly defined.
- Extend the benefit of deduction under section 80JJAA of the Act to assessees engaged in the business of providing service. It will provide impetus to the growth of the service industry in India and will also generate employment opportunities.
- The deduction should not be denied in case of genuine amalgamation of the taxpayer company with another company. Certain provisions in the Act do not levy tax on genuine amalgamations of the companies which indicate that legislature approved such amalgamations as genuine and did not levy tax for the growth of the businesses. In order to carry ahead the cause of economic growth in the country the deduction should not be denied in cases of genuine merger/demerger/amalgamation cases.
Apart from above, certain issues which emanate out of the amendments made in Finance Act 2013 is as under:
- The benefit of the deduction should be allowed to all undertakings engaged in the manufacturing of article or thing and not only to factory units to bring all such entities at par as far as allowing the deduction linked with employing of workmen is concerned. Disparity created by the amendment in section 80JJAA of the Act by the Finance Act, 2013 is unjustified.
The objective of introduction of such deduction was to provide more employment opportunities. Generally, while recruiting factory workers, certain middle/high level personnel are also required to be recruited for supervising/directing such workers. Accordingly, the recruitment of new middle/high level personnel should not be deprived from availing such deduction.
- The earlier provision be restored back allowing deduction to an undertaking engaged in manufacture or production of article or thing. It is recommended that addition of any category of employee should be eligible for such deduction.
1.20 Deductibility in respect of subscription to long-term infrastructure bonds – Section 80CCF
Section 80CCF of the Act provided for a deduction to an individual or HUF in respect of subscription towards long term infrastructure bonds (as may be notified by the Central Government) to the extent of ₹ 20,000. This benefit of deduction was introduced by Finance Act, 2010 and was further extended in respect of aforesaid subscriptions made during financial year 2011-12. The rationale of providing this deduction was to promote investment in the infrastructure sector.
It is recommended that benefit of section 80CCF of the Act be restored and further the limit of deduction be extended to ₹ 50,000.
1.21 Income-tax exemption in case of Sale of Carbon Credits
Carbon credit is an incentive available to the industries reducing CO2 emission by investing in energy efficient technology. Considering the ‘Global Warming’ impacts, it is a very important initiative on the part of industries. Energy efficient and carbon emission reduction technologies are substantially costly and results in additional investment for industries. It is very much likely that the income generated from sale of Carbon Credits may or may not compensate additional outflow laid out for earning the same.
- Section 10 of the Act should be amended to provide exemption to income from sale of Carbon Credit entitlements.
- Alternatively, suitable amendment should be made in Section 35 of the Act to allow weighted deduction for expenditure in relation to infrastructure requirement resulting into earning of Carbon Credit.
1.22 Taking/Repayment of Loans and Deposits – section 269SS
Section 269SS of the Act requires that acceptance of any loan or deposit exceeding INR 20,000 may be made only by an account payee cheque or an account payee bank draft.
Further, Section 269T of the Act requires that the repayment of any loan or deposit exceeding INR 20,000 may be made only by an account payee cheque or an account payee bank draft.
- In Section 269SS and 269T, now taking and repaying of loans or deposits by use of electronic clearing system through a bank account (i.e. by way of internet banking facilities or by use of payment gateways) is permitted.
- Also, there may be scenarios where the outstanding loan is squared by setting off against certain other entries or written off in the books, in other words, the loan is settled off by passing of book entries. Now-a-days, securitization of loan is also being considered as an alternative to repayment, by the companies.
- Mode of repayment in form of genuine book entries also be included as valid modes of fund transfers under Section 269SS and 269T of the Act.
- Further, the limit of INR 20,000 may be suitably increased to INR 50,000.
1.23 Capital Gains
1.23.1 Rate of Tax applicable to Short-term Capital Gains – Section 111A
- Section 111A of the Act provides that short-term capital gains on sale of shares of listed companies or units of equity oriented fund should be taxed at 15 percent. The rate was 10 percent till 31 March 2009.
- The difference between normal income and capital gain arising on transfer of assets is well recognized even under the Act. It is a known fact that owner of an asset incurs a lot of expenditure for maintaining an asset. In case such asset is used in business, deduction is allowed for such maintenance and other expenses. However, no such deduction is allowed if such asset is a non-business asset. Thus it makes a strong case that rate of tax in case of capital gains should be different from the rate applicable to other incomes. This distinction is recognized to some extent in Section 111A and 112 of the Act. However, in case of short term gain relating to assets other than listed shares, such difference is not recognized.
- The rate for listed shares should be restored to 10 percent as was the position till 31 March 2009.
- Section 111A of the Act should be amended to provide the rate of tax for short term gain on transfer of assets other than listed shares to be at 20 percent.
1.23.2 Abolition of tax on gains arising from transfer of listed securities
- In case of the assessee who is an investor and is also engaged in the business of trading in securities, there is an ongoing dispute as to the taxability of the gains arising on account of the transfer of the shares held as investment.
- As per National Stock Exchange, India is one of the costliest destinations to trade. STT, along with other taxes, and high brokerage structure makes trading in India almost five-six times higher than in advanced countries.
At present only the long term capital gains arising on transfer of listed shares routed via a recognized stock exchange are exempt. Various courts have laid down guidelines to determine the nature of the gains. The guidelines are purely based on the facts of the particular case and cannot be applied to all the cases. Thus leaving the issue unresolved and causing undue hardships to the assessee/taxpayers.
- Further, the Shome Committee Report on 1 September 2012 on General Anti Avoidance Rules recommended that the Government should abolish the tax on gains arising from transfer of listed securities, whether in the nature of capital gains or business income, to both residents and non-residents.
- Hence, it is recommended that the capital gains tax levied on the transfer of listed securities be abolished.
- In alternative, suitable amendments be brought in the Act, to provide a clear distinction between the income from trading activities & income from investment activities.
1.23.3 Rate of tax applicable to Long Term Capital Gain – Section 112
- Section 112 of the Act provides rate of tax of 20 percent (plus surcharge and cess) for Long Term Capital Gains. However, considering the fact that in computation of capital gains very limited deductions are allowed, rate of 20 percent seem to be on a higher side. It has been observed that owing to this high taxation cost on long-term capital gains, there is always a temptation to understate the value of sale consideration.
- For computing the said capital gains, “indexed cost of acquisition” is deductible from the full value of the consideration. In case of listed shares, Section 112 of the Act provides an option to the taxpayer either to pay 20 percent on post index profit or to pay 10 percent on profit without indexation.
- It is suggested that rate of tax on long-term capital gains be reduced to 15 percent.
- Choice of computation of capital gain with or without indexation benefit should be extended to all assets.
1.23.4 Period of holding of assets in the hands of resulting company – section 2(42A)
- Section 47(vib) of the Act provides that any transfer of a capital asset by the demerged company to the resulting company, being an Indian company shall not be regarded as ‘transfer’ under the scheme of the Act and consequently would not be subject to capital gains tax in India. Furthermore, Explanation 7A to Section 43(1) of the Act provides that in case of transfer of capital asset in demerger to the resulting company by the demerged company, the cost in the hands of the resulting company shall be taken to be the same as in case of the cost of demerged company.
- Therefore, this implies that the scheme of the Act envisages a deferral of capital gains tax in case of transfer of assets under a scheme of demerger such that capital gains tax is imposed on the resulting company when it transfer such capital assets acquired during the demerger.
- However, the provision relating to period of holding of assets as envisaged in Section 2(42A) of the Act does not contain any prescription regarding the period of holding of capital assets to be reckoned from the date the demerged company held the assets. The absence of specific provision on period of holding of capital assets acquired on demerger shall lead to difficulties and anomalies in interpretation and administration of the intention of the Act to provide demergers to be tax neutral.
- This is creating a hardship on the taxpayers as the resulting company, on transfer of such assets, would required to compute capital gains tax without taking the advantage of the period of holding of the previous owner.
- It is important that for the purposes of furthering the objective of the Act to be provide benefits to tax neutral demergers, it should be clarified that the period of holding for capital assets acquired by the resulting company in a scheme of demerger shall be reckoned from the date of holding of the capital assets by the demerged company.
1.23.5 Amalgamation into parent/subsidiary/co-subsidiary – section 47
- Section 47 of the Act exempts various transactions from being taxed under the head capital gains by not regarding such transactions to be ‘Transfer’ for Section 45 of the Act.
- Sub-section (vii) of Section 47 of the Act states:
“any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the amalgamating company, if-
(a) the transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company except where shareholder itself is the amalgamated company
(b) the amalgamated company is an Indian Company.”
- Section 42 of the Companies Act 1956/ 19 of the Companies Act, 2013 does not allow a subsidiary company to hold shares in the parent company. Pursuant to such merger, in case where subsidiary was holding shares in Transferor company, the parent company cannot allot shares to it.
- Section 2(19AA) of the Act defining Demerger specifies conditions which are conflicting in nature. First condition requires that at least 75 percent shareholders of transferor should become shareholder of transferee. Second condition provides that shares should be issued to the shareholders of the transferor company on a proportionate basis. If one logically reads the two conditions, it means that shares should be issued on a proportionate basis to the shareholders of demerged company to whom shares are issued under First condition. However, to avoid litigation, clarity needs to be provided.
- Section 41 of the Act provides that if certain income, relating to business of predecessor, will be taxable in hands of successor even though it may arise post succession. However, similar provision is not there in Section 43B, 35DD etc. of the Act where expenses need to be claimed post restructuring in hands of successor.
- Section 47(vii)(a) of the Act should be amended to provide exclusion to (a) shareholder of amalgamating company being subsidiary of Amalgamated Company (b) Amalgamation of direct subsidiary with step-down subsidiary, (c) Amalgamation involving amalgamating company holding shares in amalgamated companies.
- Section 2(19AA) of the Act be amended to provide that the shares of the resulting company should be issued on a proportionate basis to the shareholders of demerged company to whom shares are issued under First condition. It should be clear that proportionate basis does not apply to all the shareholders.
- A new section be inserted in chapter IV providing that in case of reorganization, deduction in relation (a) to expenditures incurred in pre-reorganisation period but allowable during post-reorganisation period and (b) expenditures incurred during the previous year but allowable on certain criteria for e.g. payment basis under Section 43B, etc. will be allowed to successor as it would have been allowed to the predecessor.
1.23.6 Conversion of one type of share into other type of share of the same company – section 47
- Clause (x) of section 47 of the Act provides that, any transfer by way of debentures, debenture-stock or deposit certificates in any form, of a company into shares or debentures of that company, will not be treated as a ‘transfer’ for the purposes of section 45 of the Act. Sub-section (2A) of Section 49 of the Act provides that, where a share or debenture in a company, became the property of the taxpayer on such conversion, the cost of acquisition to the taxpayer shall be deemed to be that part of the cost of debenture, debenture-stock or deposit certificates in relation to which such share or debenture was acquired by the taxpayer.
- It is noteworthy that while inserting clause (x), the intent of the Legislature may be that no taxable capital gains can arise at the time of conversion of convertible debentures, deposit certificates or shares of the company into debentures or shares of that company, since it amounts to conversion of an asset held by a taxpayer from one form to another and there is no other party involved to whom any transfer is made. In fact, clause (x) of section 47 of the Act was further amended by the Finance Act, 1992 to include ‘bonds’ in the said provision.
- However, it appears that there has been an inadvertent omission in both the foregoing provisions, i.e., conversion of preference shares or warrants into equity shares of a company have not been specifically covered under the said provisions. Similar to Section 49(2A), Section 55(2) (v) of the Act provides that cost of shares received on conversion should be cost of the shares which were converted. Thus, there does not seem to be any difference in taxing of conversion of debenture or share. However, legislature has missed to provide exemption to conversion of shares.
- Section 47(x) of the Act should be amended to include cases of conversion of one type of shares or warrants into shares or other type of shares.
- Section 2(42A) of the Act should be amended to provide that the period of holding of earlier instrument should be considered as period of holding for new instrument.
1.23.7 Tax Neutrality in case of overseas reorganization should be provided even in case with Foreign Transferee company
- The provisions of the Act are framed to provide tax neutrality only in cases where the amalgamated company is an Indian company. Section 47(vii) of the Income Tax Act, 1961 (‘the Act’) provides that a transfer of shares by the shareholder of an amalgamating company would not be liable to capital gains tax subject to the following conditions:
- The transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company, and
- The amalgamated company is an Indian company.
- Clearly, the above exemption would be allowed only in case a foreign company is merged into an Indian company. In other words, if an Indian company merges into a foreign company, as envisaged in the Companies Act, 2013, the amalgamating company and its shareholders would be subject to capital gains tax in India.
- In the emerging global scenario it is important that the merger of Indian companies into foreign companies should be legally recognised and made pari-passu with the merger of foreign companies into Indian companies, particularly for taxation purposes. As mentioned above, the Companies Act, 2013 vide section 234 has allowed the merger of an Indian company with a Foreign Company, stipulating inter-alia the payment of consideration to the shareholders of the merging company in cash, or in Depository Receipts, or partly in cash and partly in Depository Receipts, as the case may be, as per the scheme of merger to be drawn up for the purpose.
Requirement of Transferee Company to be an Indian Company be removed from Section 47(vi), and (vii) of the Act.
1.23.8 Cut-off date for ascertaining cost and Index factor – Section 48/55
- Section 55 (2)(b) (i) and (ii) of the Act provides that in case of asset acquired before 1 April 1981, taxpayer has an option to replace cost of such asset by market value thereof.
- Section 48 of the Act provides that for computation of long term capital gain, “indexed cost of acquisition” is deductible from the full value of the consideration received from the transfer of certain capital assets. Indexed cost means cost of acquisition adjusted for inflation index. Again, base for ascertainment of index factor is 1 April 1981. Cost Inflation Index is notified every year having regard to 75 percent of average rise in the Consumer Price Index for urban, non-manual employees for the immediately preceding previous year to such previous year. It may thus be seen that such indexation benefit is notional and does not take care of full inflationary impact and causes inequities to the taxpayers. Thus, the cut-off date for cost replacement and base for index being 30 year old needs to be revised.
- Further, in case of taxpayer, acquiring assets through specified modes, period of holding of earlier transferor is added to period of holding of taxpayer, however, index benefit is allowed only from the date of holding of the asset by the taxpayer. This seems to be an unintended anomaly and needs to be set right.
- Cut-off date for cost replacement in Section 55 of the Act and for index factor in Section 48 of the Act be shifted to 1 April 2001.
- Index benefit even to the taxpayer acquiring assets through specified modes should commence from the date of acquisition in the hands of original purchaser.
1.23.9 Insertion of Section 50D in the Act
Section 50D is inserted to provide that in cases involving transfer of assets, if the consideration is not determinable, fair value of the consideration received or accruing shall be deemed to be consideration
- Method of determining fair value is not specified.
- Section overlaps with certain other sections providing similar mechanism for determining consideration. e.g. section 45(3) dealing with transfer of a capital asset.
- Method for determination of fair value should be specified.
Applicability of the section should be restricted to the transactions not covered under other similar provisions.
1.24 Abolition of Securities and Commodities Transaction Tax
- The Finance Act, 2013 has reduced the rates of STT on delivery based sale/purchase of units of equity oriented mutual funds on a recognized stock exchange, sale of futures in securities, and sale of units of equity oriented mutual fund to the mutual fund.
- The Finance Act, 2013 has levied new tax called Commodities Transaction Tax (CTT) to be levied at 0.01% on sale of commodity (other than agricultural commodities) derivatives.
- We have made detailed representations earlier justifying its stance on abolition of STT and non-imposition of CTT. In nutshell, we are against levy of any transaction taxes in principle. We advocate complete abolition of STT as it adds to the cost of transaction and serves as major deterrent for the retail investor.
- We also strongly feel that the imposition of a Commodities Transaction Tax (CTT) has send a negative signal to the potential hedgers insuring against price risk. CTT will also impact the volume and liquidity of commodity exchanges, thereby hampering the growth of a nascent market. The commodity transactions in India are already heavily taxed, being subject to a plethora of taxes such as Import Duty, Octroi, Sales Tax/VAT, Market Cess, etc. Further imposition of CTT will impact the volume of trading significantly and would mean exporting our market to other global exchanges, as globally, the cost of a hedging transaction in commodities is significantly lesser than what is paid in India. In light of the above, it is our earnest request to withdraw the imposition of any transaction tax on the commodity derivatives market.
1.25 Long-term capital gains (LTCG) deduction for investment in one residential house – section 54
- The Finance Act (No. 2), 2014, has amended section 54 wherein the LTCG deduction for investment in residential house property will be available only where such investment is made in one residential house property situated in India.
- Restricting the reinvestment to only one residential house could lead to huge taxes payable by individual taxpayers. Therefore, the Government may relook at removing the limit of investing in only one residential house.
- The Government may also look at providing more clarity in this section on whether the said exemption will be available if more than one residential house is sold simultaneously.
1.25.1 Issues under Section 54EC of the Act
- Section 54EC of the Act provides tax exemption on capital gains arising from the transfer of a long-term capital asset if invested in long-term specified assets within a period of six months from the date of such transfer. The investments in such bonds, in a financial year and the subsequent financial year, should not exceed INR 50 lakhs.
- Further, there might be a situation where, the specified assets are not available during the said period of six months. Also, it may be possible that the price/rate/cost at which the specified asset is available during the stipulated period may not be viable for the assessee to invest.
- Purpose behind granting of exemption seems to promote investment in specified assets. There does not seem to be any rationale behind prescribing the monetary limit of INR 50 lakhs per investor or specifying the stringent time line of 6 months. Especially in the context that such funds would in any case be used for meeting the infrastructure requirements.
- Currently, huge amounts are required to be deployed in the infrastructure sector to give the sector the much needed boost and this vehicle could be used for raising such infrastructure development funds. Thus, there is a need to revisit the limits prescribed.
- Moreover, the interest income on such bonds which are presently fully taxable should be awarded ‘non-taxable’ status.
- Proviso to Section 54EC(1) of the Act should be deleted which restricts the investment, with respect to the taxpayer, in such bonds not exceeding INR 50 lakhs in a financial year.
- Recently inserted Second Proviso to Section 54EC(1) of the Act should also be deleted which restricts the investment in the financial year of the transfer and its subsequent financial year, with respect to the asset transferred, in such bonds not exceeding INR 50 lakhs.
- The time period of 6 months should be liberalized and the exemption should be permitted for the investments made before the due date of filing of return of income under Section 139(1) of the Act.
1.26 Income From Other Sources
1.27 Taxability of immovable property received for inadequate consideration – Section 56(2)
Section 56(2)(vii)(b) of the Act provides that receipt of immovable property by an individual or HUF for a consideration which is less than stamp duty value of the property by more than ₹ 50,000, will be taxable as income from other sources on the stamp duty value in excess of the consideration.
- Section 56(2)(vii) of the Act in respect of transfer of immovable property for inadequate consideration was originally inserted by Finance Act 2009, but later on deleted by Finance Act, 2010 with retrospective effect from date of insertion. There do not seem to be any reason for reintroduction of the same.
- The provision levies tax on inadequacy of consideration. Section 50C/43CA of the Act deals with such inadequacy in hands of the seller/transferor. The section 56(2)(vii) of the Act will tax the same inadequacy in the hands of the purchaser as ‘income from other sources’, where sale consideration is less than the stamp duty of the property by an amount exceeding ₹ 50,000 as: Stamp duty value less sale consideration. Both, seller and purchaser, pay tax on same inadequacy of consideration and thus, there is double taxation to that extent.
- Clause (ii) to section 56(2)(vii)(b) of the Act should be deleted as it will lead to double taxation, which could not be the intended objective of the Government.
- Alternatively, section 50C/43CA of the Act may need to be correspondingly modified to exclude such transaction which has been taxed under Section 56(2)(vii)(b) of the Act.
1.28 Other Miscellaneous tax provisions
1.29 Mergers & Acquisitions
1.29.1 Transactions without consideration or for inadequate consideration – section 47/56(2)
- The Finance Act, 2010 inserted clause (viia) in sub-section (2) of Section 56 of the Act with a view to curb abusive transactions.
- Section 47 of the Act and other provisions of the Act exempts certain transactions from taxation. However, proviso to Section 56(2)(viia) of the Act excludes only a part of such exempted transactions from its applicability. Consequently, those transactions which are otherwise exempt under Section 47 of the Act will still be liable to tax under Section 56(2)(viia) of the Act.
- The rationale behind this discrimination is not understandable. Therefore, the view is that all transactions which are specifically exempted from capital gains tax under Section 47 of the Act or other provisions of the Act should be outside the purview of the said Section 56(2)(viia) of the Act.
- Section 56(2)(viia) of the Act is applicable to receipt of shares. The provisions are anti-abusive and intended to curb tax avoidance. Consequently, it should be applicable to transactions liable to tax and not otherwise. Thus, section should be applicable to receipt of shares consequent to transfers which are not covered under section 47, and not otherwise.
- Once the section is made applicable to receipt pursuant to transfers as above, issue of shares will clearly be out of purview of the section, however, for avoiding litigation, it needs to be clarified that the following transactions are also outside its purview:-
Issue of shares including:
i. right issue
ii. Preferential allotments
iii. Conversion of financial instruments
iv. Bonus shares
v. Split/subdivision/consolidation of shares.
- Receipt pursuant to stock lending scheme.
- Receipt by trustee company.
- Buyback of shares.
- By Offshore investors in cases where purchase price is determined by Indian laws in force (e.g. SEBI rules, FEMA guidelines).
Being anti-abuse provision, it should be applicable to transactions between associated concerns and not to other transactions. The amendment will adversely impact genuine cases where the shares are transferred at a pre -determined price for agreed commercial and bonafide considerations. For example:
- Joint venture or investment agreements particularly for unlisted company, frequently make provisions for put and call options to be exercised at agreed prices which are compliant with all relevant exchange control and related laws though they may not necessarily be at fair market value. This is, often, to permit Indian promoters to enjoy some upside benefit if their companies perform better than the rate of return expected by the investor. To visit such promoters with an income-tax liability on a purely notional unrealized gain when they acquire shares from the investors at the negotiated price is clearly unwarranted and, possibly, unintended.
- Likewise, there may be default forced sale provisions in such agreements that allow a non-defaulting party to acquire shares from a defaulting party at a price below market value. Again, to tax the non-defaulting acquirer for the discount would be unfair and possibly, also unintended.
- Primarily, the provisions should be withdrawn.
- All transactions which are specifically exempted from capital gains tax under Section 47 of the Act or other Act should be outside the purview of the said Sections 56(2)(viia) of the Act.
- Section 56(2)(viiia) of the Act should be applicable to receipt of properties being shares in closely held company pursuant to transfers not covered under section 47 and not otherwise.
- Section 56(2)(viia) should not apply to issuance of fresh shares by a company as these are already covered by Section 56(2)(viib) of the Act.
- Section 56(2)(viia) of the Act should not be applicable to non-residents.
- Section 56(2)(viia) of the Act should be suitably amended to provide that it applies to receipt of properties being shares in closely held company from related/connected entities. It must be clear that it is not applicable to genuine business/commercial transactions.
- Section 56(2)(viia) of the Act should be suitably amended to provide that the section should be applicable only if the share being received by the taxpayer is in existence and held by another person.
- Rule 11UA of the rules should be suitably amended to value unquoted equity shares on fully diluted basis.
1.29.2 Carry forward and set off of accumulated losses in amalgamation or merger – Section 72A
- Currently, Section 72A of the Act allows carry forward of loss and accumulated depreciation in case of amalgamation/demerger of the following type of companies:
- a company owning an industrial undertaking or a ship or a hotel with another company,
- a banking company,
- one or more public sector company or companies engaged in the business of operation of aircraft
- Apparently, the benefit is not available to all the companies engaged in the business of providing services. Considering the facts that many multinational companies have entered in the Indian service market and it has become imperative for the small companies to consolidate their resources to survive, the benefit applicable under the provision of Section 72A of the Act should be extended to all companies irrespective of their line of operations.
- More so, section 72A(2) of the Act prescribes stringent condition about continuity of holding of assets by the amalgamating company for at least 2 years prior to transfer and by the amalgamated company for 5 years post transfer. Similarly it requires that the amalgamating company should be in the business for at least 3 years prior to the amalgamation. The conditions in the hands of the amalgamated company are sufficient to control misuse of the provisions and therefore, the conditions applicable to the amalgamating company should be deleted. Also, holding of assets and continuation of business for 5
- years is quite a long period.
- Section 72A of the Act should be amended to allow benefit of carry forward of losses, pursuant to amalgamation, to all Companies irrespective of their line of business especially services business.
- Section 72(A)(2) of the Act be amended to delete conditions under sub-clause(a) relating to amalgamating company.
- Also, section 72A(2)(b) of the Act should be amended to reduce the period of holding assets and carrying on of business to 3 years.
1.29.3 Conversion into Limited Liability Partnership/conversion of firm- into company – Section 47
- Chapter X of the LLP Act allows following conversions:
- Partnership Firm (Firm) into LLP (Section 55 of the LLP Act)
- Private Limited/Unlisted Public Company into LLP (Section 56/57 of the LLP Act)
- The Finance Act 2010 provided tax neutrality to conversion of Company into LLP under Section56-57 of the LLP Act. However, there is no provision allowing tax neutrality to conversion of firm into LLP under Section 55 of the LLP Act. Same should be provided.
- Section 47(xiiib) of the Act provides tax neutrality to conversion of Company into LLP subject to certain stringent conditions. Such conditions should be made less stringent or some relaxation should be provided in application of the same as discussed below:
- It is available only to a Company having Turnover of less than INR 60 lakhs for 3 years prior to such conversion. In the current economic scenario, this limit of INR 60 lakhs needs to be removed. There is no reason, why companies with large turnover, which otherwise qualify, should not be eligible for conversion with tax neutrality.
- Another condition is that all the shareholders of the company, immediately before the conversion, should become partners of the LLP. This condition should be made applicable only in respect of equity shareholders and not preference shareholders, since preference shares are in the nature of quasi equity.
- Further, it is necessary that the aggregate of the profit sharing ratio of the shareholders of the company, in the LLP shall not be less than 50 percent at any time during the period of five years from the date of conversion. This condition should be applicable only to voluntary transfers and not to all the transfers. Say, this condition should not apply in case of dilution resulting from death or disqualification of a partner or amalgamation of a corporate partner.
- For claiming tax neutrality, it is provided that accumulated profits of the company as on the date of conversion should not be paid to the partners of the LLP for a period of three years from date of conversion. Under Income-tax Act LLP is considered akin to a partnership firm and there is no restriction on distribution of the profits of the partnership firm. Further in case of partnership firm there is no requirement to show Reserves and Surplus separately but the same is credited to partner’s capital account. Thus, there should not be any restriction on LLP in relation to payment out of profits. Further, the term accumulated profits is not defined and may include other reserves also.
- MAT payment under Section 115JB of the Act is prepayment of taxes actually becoming due in subsequent years under normal provisions of the Act. Consequently, Section 115JAA of the Act allows credit for such payments in the year the company becomes liable to pay tax under normal provisions of the Act. There is no reason, why such credit should not be allowed to LLP, which is converted from a company eligible to such credits, if it is paying taxes under normal provisions of the Act.
- Section 47(xiii)/(xiiib) and (xiv) requires that the members of the firm/shareholders of the company should continue to maintain profit sharing/shareholding for 5 years. 5 years is a fairly long time, it should be restricted to 3 years.
- Section 47A(4) of the Act provides that in case of non-compliance of any condition provided in Section 47(xiiib) of the Act, the gains on conversion of company/transfer of shares shall be the profits & gain taxable in the hands of the LLP/shareholders in the year of such non-compliance. Similarly, proviso to Section 72A(6A) of the Act provides that in case of non-compliance of any condition provided in Section 47(xiiib) of the Act, the losses/unabsorbed depreciation of the company utilized by the LLP shall be income of the LLP for the year of such non-compliance.
- Section 47A(3) of the Act provides that in case of non-compliance of any condition provided in Section 47(xiii) or (xiv) of the Act, the gains on conversion of partnership or proprietary concern shall be profits & gains taxable in the hands of the Company in the year of such non-compliance. Similar to section 72A(6A), 72A(6) deals with cases covered under section 47(xiii) and (xiv).
- Section 47(xiii) of the Act should be suitably amended to include conversion of a Firm into LLP along with conversion of Firm into a Company.
- Turnover criteria should be removed from Section 47(xiiib) of the Act.
- Words “equity shareholder” should substitute the word “shareholder” wherever it appears in Section 47(xiiib) of the Act.
- Insert proviso under clause (d) in proviso to Section 47(xiiib) of the Act to provide that it should not be applicable to a case where a change in profit sharing takes place consequent to death of a partner or pursuant to any other transaction covered under Section 47 of the Act.
- Condition of non-payment out of accumulated profits specified in clause (f) to proviso to Section 47(xiiib) of the Act should be removed. If not removed, term accumulated profit should be appropriately defined.
- Provisions of Section 115JAA of the Act allowing utilization of MAT credit should be amended to allowed credit for MAT paid by the Company to the successor LLP.
- Sections 47(xiii)/(xiiib)/(xiv) should be amended to reduce period of continuing same profit sharing / shareholding from 5 years to 3 years.
- Words profits & gains in Section 47A(3)/(4) of the Act should be replaced with the income.
1.29.4 Continuation of deduction under Section 80-IA of the Act in case of re- organisation
- Section 80-IA of the Act provides deduction in relation to profits of certain undertakings. It was well settled that in the case of restructuring of any entity owning such undertaking, the benefits of deduction will be available to entity owning the undertaking post restructuring.
- Board Circular Letter F.No. 15/5/63-IT (AI), dated 13 December 1963; specifically provided that in the year of corporate restructuring, the benefit shall be available to transferor entity upto the date of transfer and to the transferee entity for the remaining period of tax holiday.
- Sub-section (12) provided that in the year of restructuring deduction will not be allowable to the Transferor entity but same will be allowed to the Transferee entity as it would have been allowed, had the restructuring not taken place. In totality, this will restrict the total period of deduction to not more than the total period for which the deduction should have been allowed under the provisions of
- the Act.
- However, sub-section (12A) was inserted in section 80-IA with effect from 1 April 2008 to provide that nothing contained in sub-section (12) shall apply to reorganization post 1 April 2007. A view is expressed that post insertion of sub section (12A), benefit of deduction under Section 80-IA of the Act will not be available to the amalgamated/resulting entity.
- Section 80-IA(12A) of the Act be deleted to enable restructuring of eligible entities.
- Section 80-IA(12) should be amended to provide for allowing deduction to the amalgamating/demerged entity for the period till transfer date and to the amalgamated/resulting entity post transfer.
1.29.5 The status of widely held company should be considered on date of transaction only – section 2(18)
- Section 2(18) of the Act defines widely held company. This definition has wide implication on carry forward of loss, taxability under Section 56(2) of the Act and in various other provisions.
- It includes a listed company, only if its shares are listed on exchange as on last date of the relevant year. Further it includes subsidiary of listed company, only if the shares of such subsidiary were held throughout the relevant year by the listed company. These provisions lead to situations which does not seem intended.
- Therefore, it stands logical that the conditions of listing, holding of shares etc. should be subject matter of test on the date of transaction and should not be stretched to be continuing till the end of that financial year.
Section 2(18) of the Act should be suitably amended to provide test of conditions on the date of relevant transaction.
1.29.6 Non-Compliance of conditions applicable to certain re-organisations – Section 47
- Section 47(iv)/(v) of the Act provides exemption to gains arising from transfer of capital assets between a holding company and its wholly owned subsidiary company. Section 47A(1) of the Act provides that in case holding company not continuing to hold 100 percent of shares of the subsidiary company or treatment of the transferred asset as stock-in-trade, within a period of eight years from the date of the transfer of capital asset, the gain exempted under Section 47(iv) / (v) of the Act shall be taxable in the hands of the transferor company for the year of transfer. The period of eight years is too long.
- Further, in any case such income should be taxable in the year of event specified in the section and not in the year of transfer of capital asset.
- Section 47A (1) of the Act should be amended to reduce “period of eight years” to “period of two years”.
- Further, in any case, such income should be taxable in the year of event specified in the section and not in the year of transfer of capital asset.
- Words ‘profits & gains’ in Section 47A(1) of the Act should be replaced with the words ‘income’.
1.29.7 MAT Credit – Section 115JAA
- MAT credit is akin to advance payment of tax.
- Benefit of MAT credit cannot be denied to successors in case of reorganization.
- Section 115JAA of the Act should be amended to provide that successors in case of amalgamation, demerger or any other form of reorganization should be eligible to claim benefit of MAT Credit.
1.30 Amendment to Section 68
Section 68 is amended to insert a proviso to provide that in case of closely held company share application money shall be considered as income of the company unless the investor provides necessary explanation to the satisfaction of the Assessing Officer.
- This amendment is not needed and desirable. Any tax avoidance which is structured through excessive securities premium could be brought under the purview of GAAR provisions through adequate methodology and rules. The overall principles enunciated under GAAR provisions to treat an arrangement as Impermissible Avoidance Arrangement should be applied to the share subscription transaction for determining the taxability of securities premium account in the hands of company.
This amendment may overlap with provisions of Section 56(2)(viib) of the Act and may be taxed twice.
This amendment should be deleted.
1.31 Taxation of Foreign Dividends and Capital Gains – section 115BBD and section 47
- With the rapid growth and development of the Indian economy over the last two decade, many Indian entrepreneurs have expanded their horizons outside India. A large number of Indian Corporate Houses have been making huge investments abroad to tap the foreign markets. The Indian outbound investments have been steadily growing year after year. While some outbound investments have been made directly, many have been structured through holding companies based in low taxed jurisdiction.
- Owing to high tax rates in India, the profits from overseas business are not repatriated back to India. A special tax regime of taxing dividend income from specified foreign companies (with shareholding of the Indian company of 26% or more) at the rate 15 percent is enacted under Section 115BBD of the Act
- Further, capital gains tax regime for unlisted companies not being beneficial compared to total exemption on long term capital gains from sale of shares of companies listed in Indian stock exchange. The gains derived by overseas holding companies from divesture in overseas operating companies are retained at overseas hold Co level.
- The benefit of reduced rate of tax on dividends as per section 115BBD of the Act is restrictive and is available only to Indian companies.
- Long Term Capital Gains earned by Indian Holding Company from transfer of shares in foreign companies is taxable in India at the rate of 20 percent.
- There are no provisions under the Act for availing underlying tax credit on dividends except under very few tax treaties where there are such provisions.
- Capital gains arising pursuant to certain business restructuring overseas (viz. amalgamation of foreign companies held by Indian company, demerger) are not exempt.
- The reduced rate of tax on dividends received from a specified foreign company should be extended to all persons (including a company) as defined in section 2(31) of the Act.
- Inward remittance of forex at this point would be a very welcome step for our economy. It is recommended that tax on dividends from overseas be done away with.
- In the alternative, tax on such dividends should be treated akin to minimum alternate tax, creditable against the normal tax liability and payable only if the tax on normal income is less than the tax on such dividends.
- At times, foreign companies in which Indian company has investment either merge with other foreign companies or demerge a division into a separate company. Though such transactions are generally not taxable in the foreign country, there are no express provisions under the Act which exempt exchange of shares arising from such merger or demerger by the Indian parent. Accordingly, the scope of Section 47 of the Act (dealing with the provisions for transactions excluded from the purview of transfer) should be extended to cover transfer of shares in a foreign company by a resident or domestic company pursuant to a merger or demerger abroad, provided that such merger or demerger is exempt from tax under the domestic tax laws of the foreign country in which such merger or demerger takes place.
1.32 Minimum Alternate Tax and Alternate Minimum Tax – section 115JB/115JC
- The current rate of MAT of 18.5 percent is quiet high and has impacted significantly cash flow of companies who otherwise have low taxable income or have incurred tax losses. Further, this has also diluted significantly the tax incentives offered under Chapter VI-A of the Income-tax Act,1961 (the Act) to eligible businesses and Industrial Undertakings as the difference between the corporate tax rate at 30 percent and MAT at 18.5 percent is not very large.
- The Finance Act, 2011 broadened the scope of MAT by bringing Special Economic Zone (SEZ) developers and units under the ambit of MAT thereby significantly diluting benefits offered under the popular SEZ Scheme.
- Further, an Alternate Minimum Tax (AMT) was also introduced on LLPs, individuals, HUF, AOP etc. which was to be computed on their taxable income as increased by deductions eligible under Chapter VI-A and Section 10AA of the Act.
- Pursuant to above, the Companies/Limited Liability Partnership’s (LLP’s) who have invested large sums in eligible businesses/industrial units in the backward areas are also getting penalized as the benefit of such incentive gets reduced due to the narrow difference between the basic MAT/AMT rate of 18.50 percent and the basic corporate tax rate/LLP tax rate of 30 percent.
- The MAT/AMT credit is allowed to be carried forward for 10 years for set-off but this period is generally not always sufficient. Many companies, particularly investment companies whose core business is investments are not able to utilize MAT credit efficiently and within due time-limits provided.
- Exemption from AMT is provided to certain specified persons if the adjusted total income of such person does not exceed INR 20 lakhs. The limit of INR 20 lakhs is inadequate considering especially the huge amount of investments made by the businesses in relation to exports of goods and services and should therefore be raised to at least INR 50 lakhs.
- Income arising from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund is exempt under Section 10(38) of the Act. The objective of giving such exemption was that Indian residents should invest in the Capital Market for long term, however, by including such income in the book profit the benefit is taken back from the Companies. Taking back
- such benefit from the Companies is not equitable and therefore the proviso to Section 10(38) of the Act should be deleted.
- The Finance Minister in his Budget speech for 2014-15, stated that manufacturing is of paramount importance for the growth of the economy. He further stated that the Government is committed to revive the Special Economic Zones (SEZs) and make them effective instruments of industrial production, economic growth, export promotion and employment generation. Keeping in mind this intention, following changes are recommended under Section 115JB as well as 115JC of the Act.
- In computing the adjusted total income for AMT, investment linked deductions on capital expenditure for specified business (net of depreciation) is to be added back under Section 115JC of the Act.
- The Companies who have invested large sums in eligible business/industrial units in the backward areas are getting penalized as the benefit of such incentive gets reduced due to the narrow difference between the basic rate of MAT/AMT of 18.5 per cent and corporate tax rate of 30 per cent. To provide such benefit, the basic rate of MAT/AMT should be reduced substantially.
- The basic rate of MAT/AMT to be fixed at 50 percent of the basic corporate tax rate (i.e. 15 percent of current rate of 30 percent).
- Companies be allowed to set-off entire past book losses including unabsorbed depreciation before they are subjected to MAT.
- The MAT/AMT credit is recommended to be allowed as carried forward and set-off without any time limit.
- The threshold limit from exemption of AMT should be increased from INR 20 lakhs to INR 50 lakhs.
- We recommend that the tax exemption under Section 10(38) of the Act should also be available while computing MAT. In other words this exemption should not be added back while computing book profits. The amount of weighted deduction under section 35(2AB) of the Act be deducted while computing MAT/AMT. The benefit of investment linked deductions is getting diluted as MAT/AMT at 18.5 per cent applies on book profits. Therefore, these deductions should also be allowed while computing the book profits / adjusted total income under the provisions of Section 115JB / Section 115JC of the Act respectively.
- In computing the adjusted total income for AMT, investment linked deductions on capital expenditure for specified business (net of depreciation) should not be added back under Section 115JC of the Act.
- To attract more industrial and infrastructural investments, MAT/AMT eligible businesses/industrial undertaking to be abolished.
- Recently, the Ministry of Commerce and Industry (Department of Commerce) has recommended the restoration of original exemption from Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT) to SEZ developers and units. In line with these intentions of the Government, the MAT on SEZ developers and units should be abolished.
- As per Section 115JB of the book profit is determined on the basis of the profit and loss account which is prepared in accordance with the provisions of the Companies Act, 1956. Recently, The Companies Act, 2013 has replaced certain provisions of the Companies Act, 1956 and consequently, the profit and loss account of a company is prepared in accordance with the provisions of the Companies Act, 2013. Accordingly, the provisions of Section 115JB should be redrafted to incorporate reference to the relevant provisions of the Companies Act, 2013 for determining the MAT.
1.33 MAT on infrastructure companies
- Infrastructure Industry in India have been experiencing a rapid growth in its different sectors with the development of urbanization and increasing involvement of foreign investments.
- The Indian government has offered various tax incentives under section 80-IA of the Act to the infrastructure companies to boost infrastructure.
- The benefit available to the infrastructure companies under the normal provision of the Act get neutralized since the companies are required to pay MAT on their book profits.
- To attract more and more investment in infrastructure sector, MAT on infrastructure companies should be abolished.
1.34 Dividend Distribution Tax – section 115-O
- As per the provisions of section 115-O of the Act, the domestic holding company will not have to pay Dividend Distribution Tax (DDT) on dividends paid to its shareholders to the extent it received dividends from its subsidiary company on which DDT has been paid by the subsidiary. However, the provisions as it stands as on today gives relief in respect of dividend received from only those companies in which the recipient companies are holding more than half of the nominal value of equity capital.
- Further the Finance Act, 2011 has also burdened the SEZ developers by including them in the scope of DDT.
- DDT currently is payable at the basic rate of 15 percent. Further, dividends distributed by domestic companies and mutual funds will be grossed up for the purpose of computing DDT, translating into an effective tax rate of about 20 percent (after the levy of surcharge of 10%). Since DDT is a sort of surrogate tax on behalf of the shareholders, and if the shareholders were to pay tax on their dividend receipts, the tax impact thereon is likely to be lesser in most of the cases in comparison to the DDT tax burden.
- The earlier DDT rate at 10 percent was lower in line with the withholding tax rate on dividends in most Indian and international tax treaties. The increased basic DDT rate of 15 percent reduces the dividend distribution ability of the Indian Company and the uncertainty with respect to its credit in overseas jurisdictions impacts the non-resident shareholders adversely.
- Currently, DDT is also levied on undertakings engaged in infrastructure development which are eligible for tax benefit under Section 80-IA of the Act. This is detrimental to the growth of the infrastructure sector in the Indian Economy.
- All dividends on which DDT has been paid, be allowed to be reduced from dividends irrespective of the percentage of equity holding keeping in mind that investment companies which do not necessarily own/have subsidiaries as they invest in various companies in the open market, be also made eligible for such benefit.
- The proviso to Section 115-O (1A) of the Act provides that the same amount of dividend shall not be taken into account for reduction more than once. It is recommended that the condition with respect to exempting only one level of corporate structure from the cascading effect should be deleted so that the cascading effect of DDT in multi-tier corporate structure is removed.
- Recently, the Ministry of Commerce and Industry (Department of Commerce) has recommended the restoration of original exemption from Minimum Alternate Tax (MAT) and Dividend Distribution Tax (DDT) to SEZ developers and units. In line with these intentions of the Government and to attract more investment in the SEZs, the DDT on SEZ developers and units should be abolished.
- The tax rate of DDT is recommended to be reduced to 10 percent from the current of about 20 percent (after including the education cess, surcharge and grossing-up of the dividend for the DDT purposes).
- To incentivize the investment in infrastructure sector, it is recommended that DDT on industrial undertakings or enterprises engaged in infrastructure development, eligible for deduction under section 80-IA of the Act be abolished. It is also recommended that further exemption from DDT be granted to the “infrastructure capital company/fund” with the condition that it invests the dividend received from its subsidiary in the infrastructure projects.
1.34.1 Cascading effect of DDT on dividend received from foreign companies – section 115-O
- As per amendment in section 115-O of the Act vide Finance Act 2013, dividend taxed as per section 115BBD of the Act received by the Indian company from its foreign subsidiary (i.e. where equity shareholding of the Indian company is more than 50 percent), then any dividend distribution by such Indian Holding Company to its shareholders in the same financial year to the extent of such foreign dividends will not be not liable to DDT.
- As per Section 115BBD of the Act, dividend received from a specified foreign company i.e. a foreign company in which the holding of the Indian company is 26 percent or more in the nominal value of equity share capital, is subject to tax at a lower rate of 15 percent. However, as per provisions of Section 115-O of the Act, where dividend is received from a foreign subsidiary (i.e. more than 50 percent equity shareholding) which is subject to tax @ 15% under Section 115BBD of the Act, then such dividend will be reduced from the DDT base on any further dividend distributed by the Indian company. In other words, where the Indian company holds 26 percent to 50 percent in nominal value of the equity share capital of the foreign company, then such dividend would not be excluded for computing DDT base of the Indian parent.
- The requirement relating to shareholding of more than 50 percent in the foreign subsidiary for the purpose of section 115-O of the Act should be reduced to, 26 percent or more, in the specified company to remove the cascading effect of DDT. Also, the objective of incentivizing repatriation of funds shall be successful when the dividend received from a specified foreign company and distributed by the Indian company is not liable to DDT, thereby removing the cascading effect.
1.35 Additional Income-tax on distributed income for buy-back of unlisted shares – section 115QA
Finance Act, 2013 has introduced additional income tax of 20 percent to the extent of distributed income paid to the shareholder in a buy back scheme for purchase of its own shares. It has also been provided that income arising to the shareholder as a result of such buy back will be exempt from tax.
- The Memorandum to the Finance Bill states that the purpose of introducing such provisions is to curb avoidance of payment of tax by way of Dividend Distribution Tax (DDT). However, these provisions would also cover genuine transactions within its purview which is against the intent of the law.
- The rate of DDT is 15% under Section 115-O of the Act. However, levy of additional tax on distributed income by way of buyback at the higher rate of 20%.
- The provision suffers from many deficiencies:
– Distributed income has been defined as consideration paid by the company on buy back of shares as reduced by the amount which was received by the company for issue of such shares. The reduction of issue price from consideration paid for computation of distributed income may not be appropriate as it would lead to double taxation under the following situations:-
(a) Where the shareholder has acquired the shares through secondary transaction by paying cost
which is higher than the issue price received by the company.
(b) Where shares are allotted to an individual by his employer/former employer. In such a scenario, the benefit is taxable as a perquisite under Section 17(2)(vi) of the Act. In case, when such shares are sold subsequently by the individual (either under a buy back or otherwise) for the purpose of computing the individual’s capital gains the cost of acquisition is taken as the FMV considered for the perquisite valuation as per Section 49(2AA) of the Act. In case exclusion is not carved out for such shares brought back by employer/former employer under these provisions, it would lead to double taxation of income (in the hands of employee and the company) to the extent of the perquisite value.
1.35.1 Determination of amount received
In light of the definition of ‘distributed income’, the company will have to pay the tax on the difference between the consideration paid upon buyback of shares and the amount received upon issue of such shares.
In case the company has raised capital from different persons at different prices at different points of time, the provisions of the Chapter does not provide whether (i) the company would need to take average price of such shares for the purpose of calculating the distributed income (i.e. determine distributed income at Company level) or (ii) it would need to calculate the distributed income separately in respect of each shareholder participating in the buy-back after taking into the respective cost of acquisition of each such shareholder or (iii) the company would need to determine the distributed income vis-à-vis per share.
In case the company has to calculate the distributed income separately in respect of shareholder, then tracking the actual issue price in case of each shareholder participating in the buyback could get onerous in the following instances:
- shares are in demat mode, where the company’s shareholder register would reflect only the name of the depositary participant and not the names of each shareholder/ beneficiary; and
- in case there has been multiple corporate actions/business reorganizations/mergers & demergers, etc. involving the company as this would alter the initial issue price for each share.
In our view, it would be advisable to compute the distributed income at the company level for each buy-back, as distribution tax, akin to dividend distribution tax, is a tax on the company.
1.35.2 Determination of cost of issue in case of corporate actions such as bonus issuance, share split, share consolidation, merger of company, etc.
The Act does not provide for the manner to determine amount received by the company on issue of shares at the time of corporate actions such as bonus issuance, share split, share consolidation, merger of company, etc. In these cases whilst the company has not received actual cash flow, there would be a change in fair value of the share due to such corporate actions which will impact the cost/number of shares held by the shareholders.
- It has been provided that the income arising to the shareholders in respect of buy back of unlisted shares by the company would be exempt in the hands of the shareholder. This would result in denial of carry forward/set-off of losses resulting from buy back.
- The construct of Chapter XII-DA in the Act, does not enable the shareholder to take benefit of indexation on the cost of acquisition, since the company is paying tax on such distributed income without considering indexation benefit. This is very much detrimental to the interest of long term shareholders since they will be losing out the indexation benefit even if they are holding the shares from a long time. The provision totally ignores the holding period of shares by the shareholder.
- It has been provided that the additional income-tax payable by the company shall be the final tax on similar lines as DDT. In Section 115-O of the Act, for computing the DDT, on distribution of dividends by the company to its shareholders, the recipient holding company is allowed credit for dividends received. No such similar provisions are there in Section 115QA of the Act.
- The profit arising on buy back of shares in the hands of the shareholder company, will remain in its books and may be liable for DDT on subsequent distribution of dividend by the company out of its accumulated profits (which includes profits on buy back of shares). This would lead to double taxation.
- As explained in the Memorandum, the purpose of introduction of this provision is to curb avoidance of DDT. Therefore, provision should tax what was being avoided, i.e. Dividend. Section 115-O of the Act levies tax on dividend as defined under Section 2(22) of the Act which restricts quantum of dividend to the extent of accumulated profits. Buy back is permitted even out of securities premium which, by no stretch of imagination can be considered to be accumulated profit, hence it should not be made liable to tax under new provisions. Companies Act, 1956/2013 does not allow utilization of securities premium for payment of dividend. Even Section 115O of the Act does not levy tax on such distribution.
- Section 46A of the Act is specifically dealing with this type of transactions; clarity on applicability of Section 46A of the Act needs to be provided.
- The transaction of buy back, though, taxable as distribution tax under the newly inserted provisions of the Act may still be taxable as capital gains in the foreign jurisdiction. A mechanism may be provided under the Act for allowing credit of the taxes paid under Section 115QA of the Act to avoid double taxation.
- The provision is applicable with effect from 1 June 2013. The provision gets triggered on payment and therefore, the provision may become applicable to buy back which commenced before 1 June 2013 but got completed and final payment for the same is made after the applicable date.
- Considering the commercial and regulatory difficulties for structuring exit through IPO, put/call options, etc., buy- back of shares provides the VC/PE funds with a likely and feasible exit avenue on which they can possibly rely upon. Levy of distribution tax on exit through such route would be unfair to the VC/PE funds.
- This amendment (provisions inserted through Chapter XII-DA) should be rolled back or the applicability of the provision should be restricted to cases involving avoidance of DDT.
- In the alternative, the rate of tax on distributed income as per the provision of section 115QA of the Act should be restricted to 15% as applicable to DDT.
- The computation of distributed income should be based on cost of shares in the hands of the shareholder and not the issue price of the company in case of situations stipulated above. Further, it should be specified that in case where shares are bought back by an employer/former employer, distributed income would mean consideration paid by the company on buy back of shares as reduced by the Fair Market Value which was considered for the purpose of perquisite valuation under Section 17(2)(vi) of the Act.
- Appropriate guidelines should be issued with respect to determination of the issue price under situations highlighted above.
- A mechanism for availing credit of such tax should be notified as imposing a tax, as a final tax with no credit available is grossly unjustified.
- The applicability of the provision should be restricted to buy back commenced after 1 June 2013.
- It is recommended that that VC funds should be specifically exempted from applicability of the said chapter.
1.36 Transfer Pricing
1.36.1 Transfer Pricing of Marketing Intangibles
- Marketing intangibles are crucial sources of value and its value is derived from the company’s levels of Advertising, Marketing and Promotion expenditures (AMP) which adds intrinsic value to a company. Tax authorities are increasingly scrutinizing the cross border transfer, use and further development of intangibles relating to brand and licenses. The ruling of the Delhi High Court in the case of Maruti Suzuki India, which discusses the creation and compensation for marketing intangibles only, underlines this trend. Further, the Special Bench of the Delhi Tribunal in the case of LG Electronics India Pvt. Ltd. held that Transfer Pricing adjustment in relation to AMP expenditure incurred by the taxpayer for creating or improving the marketing intangible for and on behalf of the foreign Associated Enterprise (AE) is permissible. It also held that the said function can be construed as provision of service by the taxpayer to the AE for which, earning a mark-up in respect of AMP expenditure incurred for and on behalf of the AE, is appropriate.
- In light of the amendment introduced vide Finance Act 2012 which specifically includes marketing intangibles in the expanded definition of international transactions and the Special Bench ruling in the case of LG Electronics India Pvt. Ltd., substantiating the arm’s length compensation for the transfer price of the intangibles would pose great challenges without specific guidance relating to these aspects in the Indian transfer pricing regulations.
- Accordingly, in line with the Organization for Economic Co-operation and Development (OECD) principles, guidance should be issued to recognize certain methodologies /approaches for evaluating the arm’s length character of transactions involving marketing intangibles.
1.36.2 Transfer Pricing of Manufacturing Intangibles
- Compensation for use of manufacturing intangibles has generally been in the form of royalty payouts and is commonly benchmarked by adopting the aggregated approach.
- However, this approach is increasingly challenged by the revenue authorities, who insist on adopting transaction-specific approach, and the taxpayer is required to substantiate the economic and commercial benefits derived from the royalty payout.
- With the removal of the limits exchange control that were prescribed by the FEMA regulations, it is necessary that guidance be provided to test such transactions particularly in cases of start-up or loss making companies.
1.36.3 Transfer Pricing of Intra Group Financial Transactions / Management services
- Management services are services where an entity in a multinational group renders shared services in the nature of legal, administrative, human resources, information technology, finance, sales/ marketing, etc. to its group affiliates.
- One of the important issues that draw the attention of the tax authorities is the arm’s length nature of the compensation paid for such intra-group services to related entities. The entire onus to substantiate the arm’s length payment and establish ‘cost-benefit’ analysis by way of maintaining service agreements, basis of charge out rates, allocation keys, evidence of services / benefits received etc., is upon the taxpayer..
- In the absence of any guidance or industry benchmarks in public domain for testing payments towards intra-group services, detailed guidelines for maintaining specific documentation outlining the various costs incurred in relation thereto and the related benefits derived there from, should be introduced in the regulations.
1.36.4 Interest on Inter-company loans and Guarantee fees
- Transfer pricing of cross-border financial transactions deals with inter-company loans, debentures, corporate guarantee charges, cash-pooling arrangements, debtors discounting, etc., and intends to arrive at arm’s-length outcome in a related-party scenario. Typically, interest rates on loan transactions between third parties depend on factors like borrowers’ credit rating, loan tenor, prevailing market conditions, loan seniority, security to lender(s), etc.
- The Comparable Uncontrolled Price (CUP) method, which is commonly used for arriving at arm’s-length interest rates for intra-group loan transactions, demands a high degree of comparability and necessitates complex adjustments. Pricing a guarantee is even more challenging in the absence of comparable data and warrants application of sophisticated transfer pricing techniques. In India, lack of guidelines often leads to application of arbitrary methods for pricing of inter-company financial transactions. The income-tax tribunals have laid emphasis on the credit quality of the borrower while holding that inter-company loans should attract arm’s-length interest charge. Further, vide the Finance Act 2012, the definition of international transactions has been expanded to specifically include capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business which would now give rise to a whole gamut of such financial transactions to be reported by the taxpayer.
- Given the increasing global trend of cross border financing and inter-company lending, it is of paramount importance to introduce appropriate guidance governing the pricing of inter-company funding. Further considering the increased amount of litigation pertaining to the inter-company loans and guarantee transaction, with no clear view of the higher appellate authorities, appropriate clarification on the approach / methodology to be adopted for analysing these transaction is required.
1.36.5 Transfer Pricing Methods – Profit Split Method (PSM)
- PSM is applicable mainly in international transactions involving transfer of unique intangibles or in multiple international transactions which are so interrelated that they cannot be evaluated separately for the purpose of determining the arm’s length price of any one transaction. The method involves valuation of non routine intangible, assigning the combined profit or loss according to each party based on allocation keys and using of projected financials. Lack of clarity on valuation of intangibles and use of complex analysis for splitting the profit or loss has been experienced as the major reasons for the reluctance in using this method in India, both from a taxpayer and revenue perspective.
- Issuance of guidance for application of this method and valuation norms can bring about clarity to the taxpayer on usage of this method.
1.36.6 Stay of Demand
- In cases where the DRP is proposing an adverse recommendation to the AO, it is not clear as to whether it has powers to issue direction to the AO to grant stay of demand if the taxpayer is intending to prefer an appeal to Tribunal.
- Specific provision may be introduced to also provide for such powers to the DRP, so that the DRP process achieves its stated objective.
1.36.7 Eligible Assessee for filing of objections before the Dispute Resolution Panel
- Section 144C(15)(b) of the Act defines ‘eligible assessee’ as (i) any person who has had a TP adjustment; and (ii) any foreign company. The use of the word ‘and’ in the definition could lead to an interpretation that the conditions need to be satisfied cumulatively i.e. the taxpayer has to be a ‘foreign company’ and should have suffered a TP adjustment.
- It appears that the intention of the amendment is that ‘both’ the above type of taxpayers should be covered within the meaning of the phrase ‘eligible assessee’. Hence, to reflect correctly the intent and prevent anomalous interpretation on account of the wording, ‘and’ should be replaced by ‘or’.
1.36.8 TP Documentation requirement
- The documentation requirements are attracted if the aggregate value of the transactions exceeds INR 10 million.
- This monetary limit has remained static after the introduction of Transfer Pricing Regulations in the Income-tax Act, 1961 and seems to be on lower side especially in case of companies, which has associates in various countries. This limit for maintenance of mandatory documentation requires an upward revision. Also, documentation requirements should be such as to enable the tax authorities to arrive at arm’s length price without subjecting the concerned parties to undue cost, time and harassment.
1.36.9 Adjustments for differences in functions and risks
- The India transfer pricing regulations provide for making reasonably accurate adjustments to take into account differences between international transactions and uncontrolled transactions, considering the specific characteristics relating thereto.
- However, in practice there is no guidance or clarity on the manner in which these adjustments are to be made. For example, adjustments in areas such as differences in levels of working capital, differences in risk profile, differences in volumes, pricing on marginal cost, startup losses or capacity utilization and so on, have generally not been permitted by the revenue authorities in the course of transfer pricing audits as upheld in certain Tribunal decisions as well.
- Accordingly, suitable guidance on the manner of carrying out economic and risk adjustments to comparable and taxpayer’s data is necessary. Further, the Tax Authorities should be encouraged to duly consider in the course of transfer pricing audits, business strategies and commercial or economic realities such as market entry strategies, market penetration, and non-recovery of initial set-up costs, unfavorable economic conditions and other legitimate business peculiarities while determining the arm’s length pricing
1.36.10 Valuation under Customs and Transfer Pricing
- Both Customs and Transfer Pricing require taxpayer to establish arm’s length principle with respect to transactions between related parties. Objective under respective laws is to provide safeguard measures to ensure that taxable values (whether it is import value of goods or reported tax profits) are the correct values on which respective taxes are levied. The above objective, while established on a common platform has diverse end-results as seen below:
- To increase Customs duty amounts, the Customs (GATT Valuation) Cell would prefer to increase the import value of goods
- To increase tax, the tax department would prefer to reduce purchase price of goods
- The diverse end-results create ambiguity in the manner in which the taxpayer should report values under the Customs and the Transfer Pricing. We have judicial precedents which favor and contradict the use of custom valuation in transfer pricing. In the case of Coastal Energy Pvt. Ltd., the Chennai Tribunal endorsed the TPO’s decision to apply the customs data for transfer pricing analysis. Similarly in the case of Liberty Agri Products Pvt. Ltd. the Chennai Tribunal again held that arm’s length price on imports for transfer pricing purposes is to be determined using the rate for customs. Contrastingly, a decision from the Delhi Tribunal in the case of Panasonic Ltd. and another one from the Mumbai Tribunal in the case of Serdia Pharmaceutical highlighted the distinctive objective of Customs valuation and the necessity for separate arm’s length analysis as per transfer pricing provisions. Further, in a Chennai Tribunal decision in the case of Mobis India Ltd., the Tribunal held that customs valuation was not acceptable as comparable for ALP determination as the purpose of customs valuation does not fit in the scheme of TP analysis under IT Act.
- These contradicting decisions necessitate a greater need for convergence of transfer pricing mechanism under the Act and the Customs Regulations.
- There is a need for a common platform that would provide a ‘middle-path’ of arms length price that is equally acceptable under Customs Law and under the Transfer Pricing.
1.36.11 Safe Harbour
- On 19 September 2013, the final SHRs were released after considering the comments of various stakeholders.
- Safe Harbours have been introduced for Software development Services (IT services), Information Technology Enabled Services (ITES), Knowledge Process Outsourcing services (KPO services), Contract Research and Development (Contract R&D) relating to IT services and generic pharmaceuticals, for manufacture and export of core and non-core automobile components and for financial transactions like loan and guarantees.
KPO services and Contract R&D services – Issues and recommendations
- Cost plus margins proposed are too high and above the taxpayer’s expectations – The Safe Harbour ratio of 25%in the case of KPO services is seems to be in a higher range. A downward reduction in the currently prescribed rates would encourage more taxpayers to opt for the Safe Harbour regime.
- Clarity required in categorization (e.g. for ITES v/s KPO and for IT services v/s Contract R&D relating to IT) – Contrary to industry expectations, the categorisation between ITES and KPO services and IT services and contract R&D relating to software development has not been done away with. To provide distinction from routine business process outsourcing services, the definition of KPO services includes only those services that require “application of knowledge and advanced analytical and technical skills”. The definitions of various eligible international transactions, including that of the ITES and KPO and IT services and contract R&D services relating to software development, as provided in the SHRs leave lot of room for subjective interpretations and consequent controversies/disputes on categorisation of services.
- Moreover, the provisions in the SHRs relating to AO’s review of taxpayer’s continued eligibility in subsequent AYs also add to the uncertainty on categorisation of services and eligibility for the Safe Harbours.
- It is recommended that additional/clear criterions are introduced for classification of services. In any case, if such classification is made, it should not be merely based on the nature of services provided and there should be certain other criteria to determine the classification e.g. value of outcome of the activity performed vis-à-vis the ultimate customer etc.
Advancing of intra-group loans – Issues and recommendations
- The credit rating of the borrower is one of the prime considerations for any loan transaction and this has also been duly recognized by the Rangachary Committee (RC) report by recommending different interest rates (for loans above INR 50 crores) for High, Medium, Low and Junk category of borrowers.
- Adoption of 30th June as the date for establishing Base Rate – Considering the dynamic nature of the financial market, the interest rate prevailing as on the date on which loan is granted is of prime importance. Accordingly interest rate closest to the date of lending, as may be available, should be adopted.
- Benchmarking interest rate year on year – Typically the interest rate should be fixed at the time of entering into the loan arrangement. It should be eligible for Safe Harbour throughout the term of the loan and not just the AYs opted for by the taxpayer for Safe Harbour (valid maximum upto a period of 5 years starting with Assessment Year (AY) 2013-14 during which SHR are applicable).
Providing intra-group guarantees – Issues and recommendations
- Downward revision of proposed Safe Harbour rate for guarantee commission/fees: The rate of 2 / 1.75 percent in the case of guarantees below and above INR 100 crores respectively is on the higher side. In many cases the guarantee fee charged by banks could be much lesser.
- The credit rating of the borrower is one of the prime considerations for any guarantee transaction and this has also been duly recognized by the RC report by recommending different interest rates (for loans above INR 100 crores) for High, Medium, Low and Junk category of borrowers.
- The above Safe Harbours may not necessarily cover WOS. It should cover transactions with all AEs.
General issues and recommendations
- Requirement for contemporaneous documentation will continue to apply in its entirety even in case a taxpayer has opted for SHR – Accordingly, the basic objective of simplicity and easy compliance is not being met by the SHR provisions. However, the RC report has recommended that the taxpayers opting for Safe Harbour should be required to maintain only basic documentation like the details of international transaction, shareholding structure, nature of business and industry and functional analysis. It is therefore recommended that the SHR be amended to provide that the taxpayers opting for Safe Harbour should be exempted from all the documentation requirements and should be required to maintain only basic documentation as recommended by the RC.
- Increase in threshold for maintaining mandatory documentation – Based on the RC recommendations it is also recommended that in general, the existing Safe Harbour of INR 1 crore for maintaining of mandatory documentation should be revised to a higher number (RC recommended INR 5 crores) to reduce the compliance burden of small taxpayers.
- It is recommended that a clarification should be issued that the Safe Harbours would not become a basis for the Revenue authorities to challenge the arm’ length pricing of the taxpayer in prior years.
1.36.12 Specified Domestic Transaction
- Section 92BA has been inserted vide Finance Act 2012 by which the coverage of transfer pricing has been expanded to include certain ‘Specified Domestic Transactions’ if the aggregate amount of all such transactions entered by the assessee in the previous year exceeds ₹ 5 crores in the previous year
- The term “specified domestic transaction” has been defined to inter alia mean any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A of the Act. Such expenditure could possibly include capital expenditure made to such a related person. It should therefore be clarified that these provision pertain to revenue expenditure only.
- This amendment also covers a scenario wherein the payment of remuneration by the company to its director or relative of such directors is also required to be at arm’s length. The same casts an onerous responsibility on the company vis – à- vis justification of the arm’s length nature of such payments.
- The threshold limit of ₹ 5 crores for applicability of transfer pricing regulations to specified domestic transactions should be increased to avoid undue hardship for small businesses.
- Necessary guidance for benchmarking director’s remuneration should be provided, as by the nature itself these could be very peculiar transactions depending on the extent of ownership, technical ability, seniority etc.
- This amendment seeks to cover a situation wherein there could not be any loss to the exchequer. The same is not in line with the suggestion provided by the Supreme Court in case of Glaxo Smithkline. The Supreme Court had provided the situation wherein transfer pricing should be applicable in case of transactions between a profit making and a loss unit / company. The other scenario which was envisaged by the Supreme Court was transactions between units / assesses having different tax rates. Other than the scenarios contemplated above, a corresponding adjustment should be allowed and hence provided for on the statue.
- It should be suitably clarified that the transfer pricing provisions would only apply to revenue expenditure referred to in section 40A(2)(a) of the Act, and not to payments made to persons specified in section 40A(2)(b) of the Act.
- ‘Any other transaction as may be prescribed’ covered under section 92BA of the Act may be notified and should be made applicable from prospective effect to avoid undue hardship to the taxpayers.
- The words “close connection” appearing in section 80-IA(10) of the Act needs to be clarified to avoid ambiguity in the application of provisions of section 92BA of the Act.
- Further, clarity should be provided with regard to inter-unit allocation of costs between eligible and non-eligible units i.e. whether corporate cost allocations from a non tax holiday unit of a company to a tax holiday unit of the same company would get covered within the provisions of Section 80-IA(8) and consequently need to be reported as a specified domestic transaction.
- The Advance Pricing Agreement (APA) provisions are being made applicable to only international transactions. The same should also be made applicable to domestic transactions covered by transfer pricing regulations.
1.36.13 Penalty for failure to keep and maintain information and document etc. in respect of certain transactions
- The Finance Act, 2012 has substituted section 271AA with effect from 1st July 2012 which reads as under:-
“271AA. Without prejudice to the provisions of section 271 or section 271BA, if any person in respect of an international transaction or specified domestic transaction-
i. fails to keep and maintain any such information and document as required by sub-section (1) or sub-section (2) of section 92D;
ii. fails to report such transaction which he is required to do so; or
iii. maintains or furnishes an incorrect information or document,
the Assessing Officer or Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a sum equal to two per cent of the value of each international transaction or specified domestic transaction entered into by such person.”
While the quantum of addition itself is disputable in transfer pricing assessments, fixing the penalty on the assessed income would increase the burden of the taxpayer considerably.
Due to retrospective extension of scope of international transaction, the Transfer Pricing Officer (TPO) can ask the taxpayer to pay penalty under the said section 271AA at the rate of 2 per cent of value of international transaction due to failure to keep information in addition to another 2 per cent under section 271G for not furnishing the information besides regular penalty under section 271(1)(c) of the Act. This would result in multiple tax demand on arbitrary values.
- It is, therefore, suggested that penalty should be restricted to tax in dispute and not linked to the value of transaction.
- While the Finance Act 2014 extended the power to levy penalty u/s 271G to the TPO for failure to furnish information / TP documentation, which was earlier restricted to Assessing Officer (AO) or the Commissioner (Appeals), interestingly, there has been no amendment to Section 271AA (which prescribes the power to levy penalty for failure to keep and maintain information and document, etc. in respect of certain transactions), currently provided only to the AO or the Commissioner (Appeals), possibly seeking to limit powers to levy penalty for matters relating to non-compliance with statutory provisions, only to AOs / Commissioner (Appeals), while extending powers to levy penalty to TPOs for matters relating to proceedings in the course of conduct of TP audits.
- Considering that clause (iii) to Section 271AA also states that penalty shall be levied for maintaining or “furnishing” incorrect information or document, as the act of “furnishing” is typically associated with a TP audit proceedings, it is recommended that there should be some consistency on this front.
1.37 Non-resident related provisions
1.38 Amendment to Section 2(14) and Section 2(47) of the Act
Section 2(14) – Retrospective insertion of Explanation expanding scope of the definition of capital asset – it was clarified with retrospective effect that the term ‘property’ includes any rights in relation to an Indian company, including rights of management or control or any other rights whatsoever.
The Finance (No. 2) Act, 2014, has amended the Section 2(14) of the Act wherein it has been specified that securities held by FIIs and FPIs shall be regarded as capital assets.
Section 2(47) – Retrospective insertion of an Explanation to the effect that the term ‘transfer’ includes disposing or parting with an asset or any interest therein or creating any interest in any asset, notwithstanding that such transfer of rights is effected or dependent upon or flowing from transfer of shares of a foreign company.
- It is not very clear as to what is meant to be covered by the term ‘any rights’. The term is very wide and is defined in an inclusive manner.
- The amendment in Section 2(14) read with Section 2(47) of the Act may even cover unintended consequences. For example, creation of management or control rights upon equity infusion in an Indian Company could be treated as transfer.
- Further, ‘the rights in relation to an Indian company’ should not include rights of the company. For example, Company may have its significant asset in the form of certain rights such as hotel license, lease rights, etc. Acquisition of shares in an Indian Company holding such rights should not be treated as creation of interest in such assets which is deemed as ‘transfer’. Lifting of corporate veil in such a manner could lead to severe consequences.
Explanation 5 to Section 9(1) of the Act seems to be inserted for covering indirect transfer of shares in Indian Company. However, the amendment may cover all income through or from such shares.
- Explanation to Section 2(14) of the Act should be amended as under:
- ‘Rights in an Indian Company’ should be restricted to management and contractual rights.
- Explanation. to Section 2(47) of the Act should be amended as under :
- Words “or creating any interest in an asset” should be deleted.
- The transactions which are otherwise not ‘transfer’ as per law (for example – gift) or transactions which do not result in any transfer per se, (for example primary infusion in company for acquisition of shares) should not be covered in the deeming fiction created by amending Section 2(47) of the Act.
1.38.1 Retrospective insertion of Explanations – Section 9
- The Act provides that a capital asset being any share/interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India if the share or interest derives its value substantially from assets located in India. This was introduced through Explanation 5 to section 9(1)(i) of the Act by the Finance Act, 2012 with retrospective effect from 1 April 1962.
- The absence of any definition of the term ‘substantially’ will lead to significant subjectivity, uncertainty and litigation. Hence, it is reiterated that an objective criterion must be laid down to evaluate whether or not an overseas asset is deemed to be located in India so as to trigger indirect transfer provisions. In this context, it may be clarified that an offshore entity should be regarded as deriving its value substantially from India if at least 50 per cent or more of the fair market value of all the assets owned directly or indirectly by such offshore entity are located in India. The valuation mechanism should be appropriately brought out in the Rules to avoid any uncertainty on computational matters. The above recommendation is in line with the provisions of the proposed DTC as well.
- At the onset, it is respectfully submitted that the tax on ‘indirect transfers’ is a new levy and should therefore have prospective application. It is therefore respectfully submitted that the Shome Committee’s recommendation that the provisions relating to taxation of indirect transfer as introduced by the Finance Act, 2012 are not clarificatory in nature and would widen the tax base and consequently should only have prospective application, be accepted and the Act be amended suitably.
- While the intention of the amendment may have been to bring within the tax net offshore transfers structured to avoid India tax, even genuine offshore transactions having some assets indirectly in India could get taxed.
- Accordingly, it is humbly re-emphasized that the following exemptions should be carved out from the provisions of indirect transfer of capital assets in India:
- no Indian tax should be imposed where the shares of the foreign company are listed and traded on a stock exchange outside India. The Parliamentary Standing Committee Report on Direct Tax Code Bill, 2010 and the Shome Committee Report also supports the above position;
- only “transfer of a controlling interest” in a foreign entity deriving its value substantially from assets located in India should attract tax in India. In this regard, a threshold limit of transfer of more than 50 per cent beneficial interest in the capital of a foreign entity and/or transfer of more than 50 per cent voting power of a foreign entity could be prescribed to define “transfer of a controlling interest”. As a matter of fact, the Standing Committee Report on Finance on DTC, Bill, 2010 and the Shome Committee Report also recommends that transfer of small shareholding outside India should not be brought within the India tax ambit;
- even in case of a foreign entity deriving its value substantially from assets located in India, only such portion of the gains ought to be taxable in India as are relatable to Indian assets. It may not seem proper to tax entire gains relatable to global assets in India. The apportionment mechanism should be appropriately brought out in the Rules to avoid any uncertainty on computational matters. The above recommendation is in line with provisions of the DTC as well;
- no tax should be levied on group restructurings wherein the ultimate parent remains unchanged. The Standing Committee Report on Finance on DTC Bill, 2010 and the Shome Committee Report also recommends that transfers occasioned on account of group restructuring outside India should not be taxable in India;
- no tax should be levied on repatriation of funds by the offshore company/entity to its investors on account of buy back, redemption, capital reduction or liquidation by the offshore company to the extent the repatriation amount relates to the amount realized by the offshore company on sale of Indian assets on which taxes have been duly discharged, or on which no taxes or lower taxes are due on account of tax provisions or treaty benefits available, as may be applicable; and
- transactions which are otherwise not ‘transfer’ as per law (for example – gift) or transactions, which do not result in any transfer per se, (for example primary infusion in company for acquisition of shares) should not be covered in the deeming fiction created by amending Section 2(47) of the Act. Also, intra group transfers where the ultimate control is not transferred outside the group even if there is a change in the parent of the foreign company should be excluded. Also, distribution in specie on liquidation or closure of the parent should be excluded.
- In line with the Shome Committee’s recommendations, it should be expressly be clarified that dividends distributed by a foreign company which derives its value substantially from assets located in India ought not to be covered by the ‘indirect transfer’ provisions to avoid any interpretation issue.
- The Finance Minister has clarified in his Budget Speech on 10 July 2014 that no such amendments, creating a new levy of tax, would be proposed ordinarily. Further, the Hon’ble Finance Minister has indicated that any fresh assessments in cases of indirect transfers would be scrutinized by a Committee set-up by the Central Board of Direct Taxes (CBDT) before any action is taken. The assurance of the Finance Minister is a welcome move and is bound to receive a positive response from the investor community.
1.38.2 Taxability of P-Note holders under indirect transfer provisions
- There are no provisions in the Act which exempts the Participatory-Note (‘P-Note’) holders from the applicability of the provisions of indirect transfer on sale of P-Notes outside India
- Therefore, it is recommended that the provisions should be made in the Act so as to explicitly exempt the P-Note holders from the applicability of the provisions of indirect transfer so as to provide certainty to FII investors (who pay taxes in India on their income earned/derived in India) to encourage more foreign investments in India.
1.38.3 Clarification on definition of software royalty – section 9(1)(vi)
In Section 9 of the Act, in sub section (1) of clause (vi), an Explanation 4 has been inserted, with effect from the 1 June 1976, clarifying that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.
- Royalty’ internationally applies to payments for use of a copyright, patent, trademark or such intellectual property. As per international commentaries and jurisprudence, any payments for use of a copyrighted article would not typically get covered under the gamut of the term ‘Royalty’.
- Taxability of the software usage/licensing payments in the hands of non-resident software companies /vendors would go against the internationally accepted principles of taxation.
- Taxation of such software usage payments in the hands of non-resident software companies/vendors would result in passing on of the costs to their Indian domestic counterparts as well as other Indian customers (business as well as personal consumers) causing significant hardship.
- This will also significantly impact the global competitiveness of India Inc.
- The retrospective application of the amendment is grossly unfair and would further aggravate the situation.
- It is suggested to roll back Explanation 4. In view of the international tax practices and keeping in mind the impact on India Inc. it should be clarified that the payments for use of software made to non-residents would not be covered under the definition of ‘royalty’.
- Notwithstanding the above recommendation, the amendment should not have retrospective application.
1.38.4 Clarification on inclusion of Explanation 5 to section 9(1)(vi) of the Act
In Section 9 of the Act, in sub section (1) of clause (vi), an Explanation 5 has been inserted, clarifying that royalty includes and has always included consideration in respect of any right, property or information, whether or not-
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.
- The Explanation 5 conflicts with the existing Explanation 2 to section 9(1)(vi) of the Act in as much as there cannot be any transfer, right to use or imparting without the possession or control in the right, property or information vesting with the buyer/payer. Explanation 5 has the effect of taxing the consideration as royalty even if there is no transfer, right to use or imparting to the payer.
- The provisions of this explanation are also not in line with the internationally accepted principles.
- By virtue of the above amendment, the scope of the term Royalty could get expanded to cover payments which are not even intended and may lead to application of the tax provision which could be detrimental to the taxpayers at large. The mere fact that a transaction involves use of equipment by a service provider, without the customer having control/physical possession of such equipment, payment for such facility/services cannot be treated as Royalty. For example, where a person boards a bus or train by purchasing the requisite ticket, it cannot be said that the person is making payment for availing the bus or train on hire as he does not have the control over such equipment. Rather the customer is merely availing the facility of transportation, the consideration for which facility is not in the nature of Royalty.
- Explanation 5 under clause (vi) of Section 9(1) inserted by the Finance Act, 2012 may be omitted altogether, as this is clearly against the basic principle of the definition of the term Royalty provided under Explanation 2 clause (iva) and as also understood internationally.
- In the alternative, in order to avoid ambiguity, the amendment should be modified to objectively provide the rationale behind the insertion of the Explanation 5 and should list out the specific transactions, which it seeks to cover.
- Notwithstanding the above recommendation, the amendment should not have retrospective application.
1.38.5 Clarification on definition of process royalty- section 9(1)(vi)
In Section 9 of the Act, in sub-section (1) clause (vi), Explanation 6 was inserted, with retrospective effect from the 1 June 1976, clarifying that the expression ‘process’ includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fiber or by any other similar technology, whether or not such process is secret.
- The amendment may result in inclusion of charges for the use of transponder capacity or connectivity/bandwidth within the definition of ‘Royalty’.
- Services in the nature of provision of transponder capacity or connectivity/bandwidth are merely facilities provided. As per international tax practices and supported by the OECD Commentary, payments for such facilities should not be treated as ‘Royalty’.
- The way Explanation 6 has been currently drafted; it even includes payments towards provision of basic telephone service within the ambit of the term royalty. The business income derived by the telecom providers, if classified as royalty, will significantly alter the tax consequences on the payer and the receiver of the consideration for the services provided.
- Taxation of foreign companies for such facilities and subsequent passing on of the tax cost to India Inc. would entail a significant tax outgo for India Inc., especially companies operating in the field of media and entertainment (satellite and broadcasting companies), IT and ITeS companies and Telecom.
- This would also impact their global competitiveness.
- The retrospective application of the amendment is grossly unfair and would further aggravate the situation.
- In line with international practices and the OECD Commentary, it is suggested that the terms ‘transmission’, ‘up- linking’, ‘amplification’, ‘downlinking’ could be specifically defined in the Act to remove ambiguity on its scope/coverage definition of ‘royalty’ and the definition of the term ‘transmission’ should explicitly clarify that payments for the use of a ‘facility’ as a service charge, without any control on the process and where the payer is only interested in the service and not in the use of process, should not be covered within its meaning.
- A clarification should be provided that basic services such as telephone/mobile charges and broadband/internet connectivity charges, electricity charges would be outside the ambit of royalty.
- Notwithstanding the above recommendation, it is suggested that the amendment should not have retrospective application.
- With the insertion of Explanation 4 and Explanation 6 in clause (vi) to sub-section (1) of section 9 of the Act, there is a ambiguity as to whether subscription charges paid for download of e-content, access to online database, reports, journals etc. can fall within the purview of “Royalty”.
- It has been held by various Courts that the information that is available in public domain is collated and presented in a proper form by applying the taxpayer’s methodology and the payment for the same is not to be construed as royalty. It is line with the international standards and supported by the OECD Commentary which provides that data retrieval or delivery of exclusive or other high value data cannot be characterized as royalty or technical fee.
- Taxation of foreign companies/publishers for providing access to such online database or in the form of CD as royalty and subsequent passing on of the tax cost to India Inc. would entail a significant tax outgo for India Inc. and will especially impact the education system in India.
- The retrospective application of the amendment is grossly unfair and would further aggravate the situation.
- It is suggested that the terms ‘transmission by satellite, cable, optic fiber or by any other similar technology’ could be specifically defined in the Act to remove ambiguity on its scope/coverage definition of ‘royalty’ and also a detailed circular may be issued elucidating the types of payments covered within the purview of the said terms and thus constituting royalty.
- It is recommended to suitably exclude the payment for the use/access to online databases, reports, journals etc. and any other payments made by the payer from the purview of royalty, which are essentially made for the use of a ‘facility’ as a service charge and where (a) the payer is only interested in the service and not in the use of process/technology used for transmission (b) does not have any control on the process/technology used for transmission.
- Notwithstanding the above recommendation, the amendment should not have retrospective application.
1.38.6 Taxation of Income by way of Royalty or Fees for Technical Services – section 115A
The Finance Act, 2013 has made an amendment in section 115A of the Act to provide that tax rate in respect of income by way of royalty and fees for technical services received by a non-resident under an agreement entered after March 31, 1976, is to be increased from 10% to 25%.
- In case where India has entered into a Double Taxation Avoidance Agreement (‘DTAA’ or ‘treaty’) with the other country, the final rate of withholding tax would be governed by the DTAA.
It may be noted that most DTAA’s entered into by India, barring a few have a royalty/FTS withholding tax rate of 10% or 15%. For instance, Singapore, Germany, Japan, Netherlands, South Africa and China provide for the tax rate of 10%. However, DTAAs entered by India with countries like UK, USA, Canada and Australia provide for the tax rate of 15%. As per the amendment, payment of royalty/FTS to UK and USA would entail tax rate of 15% as against 10% earlier. This might force businesses to explore entering into such agreements in favourable jurisdictions where the treaty rate is 10%.
Hon’ble Finance Minister, in his speech for Budget 2005-06 mentioned as follows:-
“To encourage technological up gradation, I propose to reduce the withholding tax on technical services from 20 per cent to 10 per cent.”
- It is pertinent to note that India still requires import of technological services/royalties in order to accelerate its growth. In case of royalty/fees for technological service (FTS) provider being a resident of a country not having a DTAA with India, the tax rate will increase from 10 percent to 25 percent. Further, the reality is that in technology agreements, more often than not, the royalty/FTS agreements provides for payment of consideration to non- residents net of any taxes. Such taxes borne by an Indian company are further grossed-up and the actual tax liability borne by them is increased.
Such major hike in rate of tax on import of technology would adversely affect the cost competitiveness of the Indian companies.
- It has been also observed that amendment is effective from 1st April 2014 and the increased rate of tax would apply to all the technology/service agreements entered after March 31, 1976. It severely impact the cost of the Indian businesses wherever the tax cost is to be borne by the payer.
We recommend that the rate of tax on royalty/FTS payments should be rolled back to 10 percent.
1.38.7 Deputation of employees
- Increasing globalization has resulted in fast growing mobilization of labour across various countries.
- Typically, the company deputing the personnel initially pays the salary and other costs on behalf of the company to which such personnel are deputed, which are thereafter reimbursed by the latter company.
- The issue which had cropped up before the Indian tax authorities due to the increasing deputation agreements being entered cross border was whether such reimbursements made by Indian entity to an overseas entity towards salary and other costs in relation to the deputed employees should be taxable in India as being payment in the nature of fees for technical services.
- Since the employees deputed to the Indian company work under the control and supervision of the Indian company and hence are essentially ’employees’ of the Indian company, the amounts paid by the Indian company to the foreign company are merely ‘cost reimbursements’ for the salaries paid on the Indian company’s behalf.
- In order to put an end to this litigation, a specific clarification may be provided by the Government to the effect that as long as the employee reports and works directly for the Indian company and operationally works under the ‘control and supervision’ of the Indian company, payments made by the Indian company to the foreign company towards reimbursement of the salary cost would be treated as ‘pure reimbursement’ and would not be taxable under the Act.
- Further, it should be clarified that such an arrangement would not trigger a creation of PE for the foreign enterprise in India.
1.38.8 Amendment to the Explanation inserted after Section 9(2)
- Retrospective amendment would lead to reopening of the past assessments.
- Section 9 of the Act provides for situations where income is deemed to accrue or arise in India. Vide Finance Act, 1976, a source rule was provided in Section 9 through insertion of clauses (v), (vi) and (vii) in sub-section (1) for income by way of interest, royalty and Fees for Technical Services (FTS) respectively. It was provided, inter alia, that in case of payments as mentioned under these clauses, income would be deemed to accrue or arise in India to the non-resident under the circumstances specified therein.
- The intention of introducing the source rule was to bring to tax interest, royalty and FTS, by creating a legal fiction in Section 9 of the Act, even in cases where services are provided outside India as long as they are utilized in India. The source rule, therefore, means that the situs of the rendering of services is not relevant. It is the situs of the payer and the situs of the utilization of services which will determine the taxability of such services in India.
- This was the settled position of law till 2007. However, the Supreme Court, in the case of Ishikawajima-Harima Heavy Industries Ltd.1 held that despite the deeming fiction in Section 9 of the Act, for any such income to be taxable in India, there must be sufficient territorial nexus between such income and the territory of India. It further held that for establishing such territorial nexus, the services have to be rendered in India as well as utilized in India.
- This interpretation was not in accordance with the legislative intent that the situs of rendering service in India is not relevant as long as the services are utilized in India. Therefore, to remove doubts regarding the source rule, an Explanation was inserted below sub-section (2) of Section 9 of the Act with retrospective effect from 1 June 1976 vide Finance Act, 2007. The Explanation sought to clarify that where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1) of Section 9 of the Act, such income shall be included in the total income of the non-resident, regardless of whether the non-resident has a residence or place of business or business connection in India.
- However, the Karnataka High Court, in a judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT (TDS), has held that the Explanation, in its present form, does not do away with the requirement of rendering of services in India for any income to be deemed to accrue or arise to a non-resident under Section 9 of the Act. It has been held that on a plain reading of the Explanation, the criteria of rendering services in India and the utilization of the service in India laid down by the Supreme Court in its judgment in the case of Ishikawajima-Harima Heavy Industries Ltd. remains untouched and unaffected by the Explanation.
- With a view to removing any doubt about the legislative intent of the aforesaid source rule, the Finance Act, 2010 substituted the existing Explanation with a new Explanation to specifically state that the income of a non-resident shall be deemed to accrue or arise in India under clause (v) or (vi) or (vii) of sub-section (1) of Section 9 of the Act and shall be included in his total income, whether or not:
- the non-resident has a residence or place of business or business connection in India or
- the non-resident has rendered services in India.
- This was made effective retrospectively from 1 June 1976. This retrospective nature of the amendment is a cause of concern amongst taxpayers would therefore be only fair to make this provision only prospectively. Alternatively, a provision be inserted to clarify that past transactions would not be re-opened or contested by the Indian Revenue on the strength of this provision.
- The relevant provisions of section 9 of the Act in force since 1976 have been interpreted by the highest court in India as requiring the taxpayer to also satisfy the condition of ‘rendering of service in India’ to be taxable in India. It would therefore be only fair to make this provision only prospectively. Alternatively, a provision be inserted to clarify that past transactions would not be re-opened or contested by the Indian Revenue on the strength of this provision.
1.38.9 Requirement for Clarity in attribution rules
- There are no clear rules laid down under the Indian income tax law on profit attribution to a permanent establishment of a non-resident/ on income accruing or arising to a non-resident through or from business connection in India. The existing rule 10 of the Rules is very generally worded and the lack of clarity gives rise to unnecessary litigation on the quantum of attributable profits to permanent establishment of the foreign residents constituted in India.
- It would be important to have clear and detailed guidelines on attribution of profits to a permanent establishment of a non-resident in India/having income accruing or arising to a non-resident through or from a business connection in India This will provide certainty to tax payers on their tax liabilities and reduce avoidable litigation. While making such recommended amendments, the international best practices and the rules prescribed as per OECD PE Attribution Guidelines should be taken into account.
1.38.10 Taxation of non-residents on presumptive basis under sections 44B, 44BB, 44BBA and 44BBB of the Act
- Certain sections of the Act provide for taxation of non-residents on a presumptive basis, such as sections 44B, 44BB, 44BBA and 44BBB of the Act. These sections deem a specified percentage of the amounts received by the non-residents for the activities covered by the provisions as income under the Act. In the past there has been considerable litigation on whether Government dues, such as service tax, recovered by the non-residents from the Indian parties would constitute part of gross receipts. As these statutory dues are to be paid over by the non-resident enterprise to the Government, there can never be any income element therein.
- In view of the above, these sections of the Act should be amended to provide that statutory taxes and dues (such as service tax) recovered by the non-resident service provider from the Indian residents would not form part of gross receipts for computing income under the section. This will be fair and will eliminate unnecessary litigation on the issue.
1.38.11 Meaning of terms not defined in a tax treaty – section 90/90A
- Any meaning assigned through notification to a term used in an agreement but not defined in the Act or tax treaty, shall be effective from the date of coming into force of the tax treaty.
(Section 90(3), explanation 3- Amendment retrospective from 1 October 2009, Section 90A, Explanation 3-Amendment retrospective from 1 June 2006)
- Any meaning notified will have a retrospective effect from the date when the tax treaty was signed causing uncertainty and hardship to the taxpayers.
- This provision is also contrary to Government’s intent of reviewing retrospective amendments, which have caused grave concerns to overseas companies over stability in tax policy and considered positions.
- As per the UN and OECD Model Commentaries on Article 3, in case of terms not defined in the tax treaty, when a conflict arises between the law in force when the Convention was signed and that in force when the Convention is applied, the latter should prevail. This has now been expressly codified in the Model Convention.
- Therefore, the accepted principle is that, generally, the meaning ascribed to a particular term at the time when a tax treaty is being interpreted should be applied. Based on the explanation, the definition notified under Section 90(3) or Section 90A(3) of the Act shall take effect from the date of coming into force of the tax treaty and not from the date of the notification itself. In other words, the notification of the definition will have a retrospective effect. Whilst the conventions do recognize the ambulatory approach of interpreting terms not defined in the tax treaty, making such changes with retrospective effect will lead to needless hardship on the taxpayers and an unfair expectation to be aware of a definition, which was not in existence when the arrangement/transaction was put into place. This will lead to uncertainty, re-opening of assessments etc., which can be avoided.
- Even pursuant to a notification, there is more liberal interpretation supplied to a particular term, a taxpayer may not necessarily be able to easily claim refund/credit of taxes paid in earlier years.
- It is recommended that any definition notified under Section 90(3) and Section 90A(3) of the Act should apply prospectively.
1.39 Credit in respect of foreign taxes
- The provisions of the Act rightfully allow reduction of TDS/TCS while computing advance tax liability, however, the same is restricted only to TDS/TCS under provisions of the Act and does not cover TDS in foreign country vis-à-vis income earned by the taxpayer from such country and offered to tax in the return of income.
- However, in terms of provisions of Section 90/91 of the Act, the taxpayer is allowed to claim credit of foreign taxes against its tax liability at the time of filing of its return of income. Further, the interest provisions in Section 234A/234B/234C of the Act for shortfall in payment of advance tax also provide for reduction of foreign taxes while computing such interest liability.
- As a consequence of above disconnect, the taxpayer ends up paying excess advance tax, resulting in a refund situation post claiming of credit of foreign taxes.
- India domestic tax legislation does not contain any guidelines with respect to foreign tax credits with tax treaty countries. Thus leading to double taxation of a particular stream of income and denial/reduction of foreign tax credit.
- As per existing provisions of the Act foreign tax credit is restricted to the tax liability of the taxpayer in India and in certain cases, the taxpayer is not in a position to claim any foreign tax credit because of losses under the Act or in some cases he is only able to claim partial tax credit. The provisions under the prevailing tax law does not allow for carry forward of the unutilized foreign tax credit resulting in permanent loss to the taxpayer in respect of the foreign tax credit which he is unable to claim.
- In case of countries like USA, Canada and Switzerland the local governments at the provincial/state level also levies taxes on income hence taxes on income levied by such jurisdictions also amounts to double taxation of income, however, the relief of taxes paid is being denied by the tax authorities in India on the ground that such local taxes are not covered by the applicable tax treaty.
- Section 209 of the Act dealing with payment of advance tax should be amended to expressly provide that advance tax liability should be computed after reducing credit for taxes withheld in foreign country as the credit is otherwise admissible in terms of Section 90/91 of the Act.
- It is recommended that with Indian companies increasingly going global, clear legislation as part of the domestic law be incorporated which could potentially address, among others, the following aspects: conflict in determining source of income, change in characterization of income, varying audit periods, varying basis of audits and mechanism for allowing full tax credit.
- A mechanism should be expressly provided in the Act for allowing credit for taxes on income levied by overseas provincial/local tax jurisdictions by amending section 90 of the Act.
A suitable amendment may be made in the Act by inserting a provision which allows carry forward of unutilized foreign tax credit to be set off against the tax liability of the company as per the Act in the succeeding years.
1.40 Conversion of an Indian branch of foreign company into subsidiary Indian company – section 115JG
- The Finance Act, 2012, has inserted Section 115JG wherein if a foreign company is engaged in the business of banking through its Indian branch and such branch is converted into a subsidiary company thereof, being an Indian company in accordance with the scheme framed by the Reserve Bank of India then the capital gains arising from such conversion shall not be chargeable to tax.
- Further, the provisions of the Act relating to treatment of unabsorbed depreciation, carry forward and set-off of losses, tax credit in respect of tax paid on deemed income relating to certain companies and the computation of income in the case of the foreign company and Indian subsidiary company shall apply with such exceptions, modifications and adaptations as may be specified in that notification.
- In case of failure to comply any of the provisions specified in the scheme or in the notification, all the provisions of the Act shall be applied to the foreign company and subsidiary company without any benefit, exemption or relief.
- Further, the provisions of section 115JG of the Act do not provide any clarity on certain transitional issues such as value at which closing ‘block of assets’ are to be transferred to subsidiary, treatment of allow ability of expenses to subsidiary earlier disallowed under section 43B in the hands of branch.
- Clarity should be provided on tax treatment of the above mentioned issues to achieve the intended objective of conversion of branch into subsidiary.
- The above provisions mentions about issuing a Notification, however the same has not been issued till date. Accordingly, the Government may issue the required notification so that the purpose of introducing the provision i.e. conversion into an Indian subsidiary, can be effectuated.
1.41 MAT on foreign companies – section 115JB
- The AAR in various decisions held that the MAT provisions does not make distinction between Indian and foreign companies and therefore, MAT provisions are applicable to the foreign companies. On the other hand, there are set of decisions where it has been held that provisions of MAT may not apply to foreign companies. Accordingly, the issue of applicability of MAT on foreign companies has been a matter of litigation before the court.
- Foreign companies having no presence in India are not required to maintain books of accounts under the provisions of The Companies Act, 2013. In order to compute MAT the starting point is to compute book profit based on the accounts prepared in accordance with The Companies Act, 2013, and therefore, the MAT provisions should not be applicable to such companies.
- Accordingly the MAT related provisions should be amended to clarify that It will not apply to foreign companies.
- This amendment would provide much needed clarity to the foreign companies.
1.41.1 TDS on transfer of certain immovable properties (other Requirement for non-residents having no place of business in India to comply with TDS obligations – section 195
The Finance Act, 2012 extended the obligation to withhold taxes to non-residents irrespective of whether the non- resident has-
(i) a residence or place of business or business connection in India; or
(ii) any other presence in any manner whatsoever in India.”
The aforesaid amendment was introduced with retrospective effect from 1 April 1962.
- The amendment will result in a significant expansion in the scope of withholding provisions under the Act and will cover all non-residents, regardless of their presence/connection with India.
- Applicable rules of statutory interpretation read with Section 1(2) of the Act, indicates that Section 195 of the Act as currently in force should not apply to non-residents.
- This view found acceptance in the decision of the Supreme Court in the case of Vodafone International Holdings
- B.V. where it was observed that the provisions of Section 195 of the Act would not apply to payments between two non-residents situated outside India. The Supreme Court also referred to tax presence as being a relevant factor in order to determine whether a non-resident has a withholding obligation in India under Section 195 of the Act.
- Vodafone International Holdings B.V. v. Union of India  345 ITR 1 (SC) [observation from the concurring judgment]
- The amendment by the Finance Act, 2012, however, seeks to expressly extend the scope of withholding tax obligations to all persons including non-residents, irrespective of whether they have a residence/ place of business/business connection or any other presence in India. The amendment should be modified to restrict the applicability of withholding tax provisions to residents and non-residents having a tax presence in India.
- In the alternative, the amendment should be made effective only prospectively. Making such a provision applicable with retrospective effect will operate harshly on persons who may have made payments based on the law prevalent prior to the amendment.
1.41.2 Withholding tax from payments to non-residents having Indian branch/fixed place PE
- The corporate tax rate for non-resident companies being 40 (exclusive of surcharge and education cess) results in requiring a non-resident company to file tax returns to claim refund of excess tax collected. This creates cash flow issues for the non-resident company making operations through an Indian branch unviable, when compared with its Indian counterparts. This additionally requires the non-resident company to mandatorily approach the Tax Authority to seek a lower withholding tax order, the process being time-consuming and non-taxpayer friendly. Often, the non-resident company faces a lot of difficulties justifying its request for a lower withholding tax certificate in the initial years of its operations, when it has no past India assessments justifying its request for a lower withholding tax certificate. From the Tax Authority’s perspective, this results in excess tax collection by way of withholding tax only to be refunded later together with interest in addition to significant administrative burden which may not be commensurate with the benefits of an efficient tax collection mechanism.
- For an effective solution to this issue, one may refer to the Vijay Mathur Report on Non-Resident Taxation (January 2003) which advocates treating non-residents with a branch office at par with residents for the purpose of Withholding tax payments. Illustratively, it provides as follows:
“4.13.2 Non-residents having Branch Office/Project Office in India and performing work covered u/s 194C should be considered at par with the residents for withholding tax purposes and as such the same rate of withholding tax should apply to payments made to them. The Working Group recommends that suitable amendment should be made for this purpose.”
- In line with the aforesaid principle, it is recommended that payments which are in the nature of business income of non- residents having an India branch office or ‘a place of business within India’ should be subject to similar tax withholding requirements as in case of payments to domestic companies (residents). At the beginning of a tax year, the non-resident taxpayer who has an India branch office or ‘a place of business within India’ should be permitted to admit PE and opt for a withholding tax mechanism as is applicable to a resident company. It would go a long way in facilitating ease of doing business in India and the Tax Authority would be in a position to better monitor and regulate such non-resident companies. Further, it would also achieve the stated objective in the Kelkar Report (December 2002) to abolish the system of approaching the Tax Authority for obtaining certificates for deduction at lower rates and minimize the interface between the taxpayer and Tax Authorities.
1.41.3 Refund of tax withheld under Section 195 of the Act
- Currently, for grant of refund of tax withheld under the provisions of Section 195 of the Act to the payer in the case of net-off tax contracts, one of the conditions to be fulfilled is that the recipient should not have filed a return of income in India. In this connection, it needs to be appreciated that if the payer has not issued the TDS certificate to the recipient, the refund of the amount withheld under Section 195 of the Act should be granted to him irrespective of whether or not the non-resident recipient has filed a return of income in India. This is more so because the recipient may have earned certain other income(s) from India which are liable to tax in India and it is in the regard that the non-resident may have filed a return of income in India. In such a scenario, the person making the payment faces an undue hardship vis-à-vis obtaining refund of the tax withheld under Section 195 of the Act.
- The intention of the Legislature appears to be that the non-resident recipient should not have claimed the credit in respect of the tax withheld under the provisions of Section 195 of the Act. Thus, it is suggested that the requirement of non-resident having not filed a return of income in India should be done away with in a case where the payer has not issued any TDS certificate to the payee.
- Further, to safeguard the interest of revenue, a condition may be imposed on the payer for claiming refund that he should substantiate his claim by showing that a revised withholding tax return was filed wherein the credit entry for TDS for the non-resident was reversed.
1.41.4 Mandatory application to AO to determine sum chargeable to tax – Section 195
- Finance Act 2012 has introduced sub-section (7) to Section 195 of the Act under which it is mandatory to make an application to the AO to determine the appropriate proportion of sum chargeable under the Act.
- This provision will apply to notified persons/cases and will apply regardless of whether such transaction is chargeable to tax or not.
- Requiring compulsory clearance from the Income-tax authorities on notified overseas payments will add to the compliance burden and can impact legitimate commercial activities.
- The Supreme Court in the case of GE India Technology Centre observed that, there exists no obligation to deduct tax under Section 195 of the Act unless sum payable to the non-resident is ‘chargeable’ under Act.
- Considering, the volume of international transactions/payments, the imposition of a requirement to obtain clearance from the tax office would prove very onerous and slow down the pace of commercial transactions. It is submitted that the present system of reporting together with withholding tax enforcement provisions are sufficient to ensure appropriate deduction of tax on overseas payments. Hence the section 195(7) of the Act should be deleted.
- In any event, the list of persons/cases to be notified under this provision should be tailored narrowly so as to not affect genuine commercial transactions.
1.41.5 Information to be furnished for making remittance abroad
- As per section 195(6) of the Act read with Rule 37BB of the Rules, a person making remittance to a non-resident is required to submit Form 15CA electronically on the website designated by the income tax department and is further required to get a certificate from a Chartered Accountant in Form 15CB in respect of the particulars filled in Form 15CA.
Recent Amendment to the Income-tax Rules, 1962
- Rule 37BB of the Income-tax Rules, 1962 (the Rules) provides the information that are required to be furnished by a person while making payment to a non-resident. This information is required to be furnished in Form No. 15CA and a certificate from a Chartered Accountant (CA) is required to be obtained in Form No. 15CB. Further, Form No. 15CA shall be furnished electronically to the website designated by the Income-tax department and thereafter a signed copy (in physical form) shall be submitted prior to remitting the amount.
- In August 2013, the Central Board of Direct Taxes (CBDT) had amended Rule 37BB of the Rules vide its Notification No. 58 of 2013, dated 5 August 2013, to broaden the requirement of collecting information and reporting requirements for all remittances outside India. The Rule also prescribes to provide information in cases where amounts are claimed as not liable to be taxed under the Income-tax Act (the Act).
- On 2 September 2013, the CBDT has substituted the above notification with Notification No. 67 of 2013, dated 2 September 2013, which has further revised the scope and the format of reporting of information under Rule 37BB of the Rules. It provides that the person responsible for making any payment including any interest or salary or any other sum chargeable to tax under the Act shall be required to furnish details in the prescribed forms. The notification also provides a specific list of payments which are not required to be reported under the revised rule. The amended Rule shall come into force from 1 October 2013.
- There is an ambiguity with respect to whether the amended rule will apply to transactions which are not chargeable to tax such as import of goods or payments in the nature of FTS/ royalty, which are not taxable in India by virtue of beneficial tax treaty provisions. “Import of goods” is one of the transactions, which was included in the specified list, notified vide the August 2013 notification and then deleted from the specified list in the Sept 2013 notification.
- Form 15CA has to be filed online, however, there is no mechanism in the system to edit or rectify the inadvertent errors made while inputting the data in the fields and the assessee has to again fill in Form
- 15CA and upload it on the website. This leads to creation of duplicate form 15CAs, wherein both the forms with the correct details and earlier form with errors remain in the system.
- Form 15CA can be uploaded/signed on the e- filing portal of Income-Tax Department www.incometaxindiaefiling.gov.in, using Digital Signature Certificate (DSC) of the person who is authorized to sign the return of income as per section 140 of the Act. Accordingly, Form 15CA can be uploaded using the DSC of the managing director or director of the company. In case frequency of payments of foreign remittances is large and further if the payments to foreign offices/suppliers are made through offices at various locations across the country of a single company, it poses great difficulty as it is not feasible for a managing director or a director to put his DSC on each and every remittance made from various locations. The amended Rule 37BB provides that the income tax authority may require the AD to furnish the signed print out of Form 15CA for the purpose of any proceeding under the Act. However, the rule is silent on the period during which the signed Form 15CA may be requisitioned by the revenue authorities. This casts substantial onus on the AD to archive, retain and retrieve these documents.
- The amended Rule 37BB states that any person responsible for paying to a non-resident any interest or salary or any other sum chargeable to tax under the provisions of the Act is required to furnish the prescribed information. Hence, it appears that if the payment is not chargeable to tax under the Act, no information is required to be furnished. However, there is ambiguity in respect of reporting requirement pertaining to exempted salary or interest payments vis-à-vis the new forms that specifically prescribes to report only such payments which are chargeable to tax.
- The companies may face a practical difficulty while remitting the payments. The Banks/Authorised Dealers (‘AD’) may go by the ‘Specified list ‘and may not accept the argument with respect to “chargeable to tax” for those items which are not mentioned in the ‘Specified list’. Further, to prove non-chargeability under the Act or tax treaty, the Bank/AD may ask the client to obtain a CA Certificate or AO’s Certificate or AO’s Order as the case may be.
- One may argue that the specified list provided in Explanation 2 to amended Rule 37BB is “for removal of doubts” and accordingly, it is clarificatory in nature. Thus, the list of payments specified in Explanation 2 is an illustrative list and not an exhaustive list. In other words, those payments which are not chargeable to tax under the Act even though not specified in the list should not be required to be reported. However, practically it would be challenging to convince the Bank/ADs regarding the same.
- It is recommended that a clarification be issued with respect to applicability of the said rule and compliances required there under for exempted interest and salary payments, import of goods/raw materials as well as payments such as royalty/ FTS which are exempt under the tax treaty provisions/not chargeable to tax under the Act. Further, it is recommended that payments for import of goods/raw materials should be added in the specified list of transactions not required to be reported under the revised rule.
- It is recommended that due modification be made in the system of the department so that the data wrongly punched in can be rectified before uploading Form 15CA.
- It is recommended that Form 15CA should be allowed to be accessed and uploaded to the e-filing website of the income tax department by persons duly authorized by the managing director/director of the company. TRACES provide the facility of multiple log-in for single TAN. Under this facility, apart from the main users, four sub-users can be created to do a particular activity/task. The similar mechanism can also be explored and implemented for filing of Form 15CA.The requirement for the AD to produce the signed Form 15CA before an income tax authority for the purposes of any proceeding under the Act, without any time limit may be removed. The earlier position as per CBDT Circular 4/2009 dated June 20, 2009 may be reinstated wherein the payer may be required to submit the duly signed Form 15CA in duplicate to the AD and AD will in turn forward a copy of the undertaking to the assessing officer concerned.
1.41.6 Threshold limit for deduction of tax under section 195
- Currently, there is no threshold limit prescribed under section 195 of the Act unlike in section 194C, 194J, 194I of the Act for deducting tax at source. Thus, making payments to non-residents even for a smaller amount triggers withholding tax and costs onerous responsibility of various compliances to be made by the payer.
- It is recommended that a minimum threshold limit for deduction of tax at source under section 195 of the Act may be prescribed. This will not have much effect on the tax revenues generated from these transactions, however, will provide immense relief to the small payers/payees.
1.41.7 Tax Residency Certificate (TRC)
- The Finance Act, 2012 had provided that in order to be eligible to claim relief under the tax treaty, a taxpayer is required to produce a Tax Residency Certificate (TRC) issued by the Government of the respective country or the specified territory in which such taxpayer is resident, containing certain prescribed particulars. Subsequently, the Central Board of Direct Taxes (CBDT) prescribed the details to be included in the TRC.
- The Finance Act, 2013 has done away with the requirement of obtaining prescribed particulars in the TRC. In other words, the taxpayer can continue to obtain the TRC as issued by the foreign authorities. The Finance Act, 2013 also introduced a provision to clarify that the taxpayer shall now be required to furnish such other information or document as may be prescribed.
- The CBDT subsequently issued a notification amending the Rules prescribing the additional information required to be furnished by non-residents along with the TRC. The details are required to be furnished in Form 10F.
- Even though the requirement to furnish TRC containing prescribed particulars has been dispensed with, however, depending on the jurisdiction, obtaining a TRC certificate may also be a time consuming/difficult process. TRC requirement increases the administrative difficulty for non-residents, especially from the perspective of non- residents having very few/limited transactions connected to India.
- The deductor would like to obtain the TRC at the time of the transaction/ depositing the tax (to ensure that the payee is eligible for the tax treaty benefits), the payee would typically be able to obtain TRC only after the relevant year.
- As per the new Rule an Indian resident who wishes to obtain TRC from Indian income tax authorities, is required to make an application in Form No. 10FA to the tax officer, containing prescribed details. However, no time limit for issue of TRC is specified from the date of application by the assessee. Furthermore, the issue of TRC in Form No. 10FB has been left to the discretion of satisfaction of the tax officer, without providing a substantive definition for satisfaction in this regard.
- It has not been specified as to who shall sign Form 10F. Hence, it should be clarified who is authorized to sign the form.
- The requirement to obtain TRC for a taxpayer to prove that he is a resident of the other state shall be deleted as there may be circumstances wherein the taxpayer who is a bona fide tax resident of the other contracting state is unable to procure a TRC owing to circumstances outside his control. At assessment stage, it is anyway incumbent upon the AO to ascertain complete details before allowing tax treaty benefits. In such a scenario, even though the AO may otherwise be satisfied that the tax treaty benefits must be allowed, only owing to the procedural lapse of not obtaining the TRC which is beyond the tax payer’s control, the AO would be compelled to deny tax treaty benefits, which will cause needless hardship.
- The deductor would like to obtain the TRC at the time of the transaction/deducting the tax (to ensure that the payee is eligible for the tax treaty benefits), it would pose a hardship to the payee to obtain a TRC before the end of the relevant financial year. The procedure so cast would pose onerous responsibility both on the payers/payee resulting in holding of payments by the payer.
- Without prejudice, even if the requirement to obtain TRC must stay, it is recommended that the TRC shall be made mandatory only for cases where the total payment to a non-resident exceeds ₹ 1 crore in a financial year. This would mitigate hardship in respect of small payments.
- It is further recommended that the requirement to furnish TRC should be cast upon the payee at the time of the assessment of the payee and the deductor/payer should not be made liable to collect TRC from the payee at the time of withholding tax.
- The time limit to issue TRC in Form 10FB should be specified and to further specify that in case the tax officer refuses to issue a TRC, the application of the assessee should be disposed by the tax officer by passing a speaking order and clearly specifying the reasons for rejecting the application of assessee.
- It may be specified that persons prescribed under section 140 of the Act for the purpose of signing the return of income would be eligible to sign Form 10F.
1.42 Advance Ruling – Chapter XIXB of the Act
1.43 Extending the facility to residents
- Presently facility to seek Advance Ruling is available only to Non Residents.
- It is recommended that this facility is extended to Residents as well with minimum income of INR 5 Crore being subject to tax
1.43.1 Determination of Residential Status for non-resident applicant
- Clause (b) of Section 245N of the Act defines applicant to inter alia include a non-resident. However, the provision fails to stipulate in specific terms the point of time an applicant is considered to be a non-resident. As it devolves from the other provisions of the Act, as also from the Rulings pronounced, the residential status would have to be determined with reference to a particular year and not with reference to a particular date. Accordingly, it appears that non-residential status of an applicant has to be determined with respect to the previous year immediately preceding the financial year in which the application is made, even though as on the date of application the applicant has become a resident.
- In this context, it is suggested that an express mention on the determination of the residential status is hereby required so that the admission of application is not rejected merely on maintainability.
1.43.2 Time limit for withdrawal of application
- Section 245Q of the Act provides an option to the applicant to withdraw the application within a period of 30 days from date of making an application. Such a time limit fails to serve any purpose since practically even the first hearing does not happen within the time span specified. It is however seen that the applicant is not precluded from withdrawing the application even after the specified time with the permission of AAR.
- In such a scenario and keeping in mind the interest of justice, it is hereby suggested that the period should be suitably extended so as to enable the applicant to withdraw its application anytime before the application is admitted/heard.
1.43.3 Time limit for Commissioner of Income tax to furnish observations and records
- Section 245R of the Act stipulates to provide a copy of the application to the jurisdictional Commissioner of Income tax (CIT) and if necessary to call for relevant records. Further, the Rule 13(2) of the Authority for Advance Rulings (Procedure) Rules, 1996 also empowers the AAR to call for relevant records along with comments from the CIT, if any, on the contents of the application. However, the Section as well as the mentioned Rule is silent on the time frame within which the CIT is required to furnish the relevant records called and provide his comments, if any, on the content of the application. It is seen in many cases that the CIT does not reply within a reasonable period of time which delays the procedure for the admission of the application.
- In view of speedy disposal of the matters, it is suggested that a time limit should be introduced and be made mandatory for the CIT to follow as regards providing his observations and relevant records.
1.43.4 Time limit for disposal of Advance Ruling
- Sub-section (6) of Section 245R of the Act stipulates a time limit of six months from the date of application to pronounce the Advance Ruling. However, as deduced from the Rulings pronounced and reference to handbook issued by the AAR, it appears that the time limit is flexible and not mandatory to follow.
- As the AAR was set-up with an underlying intent to expedite the disposal of income-tax issues, it is hereby suggested that the time limit so specified should be adhered to and made mandatory.
1.43.5 Binding Nature of the Precedent
- Section 245S of the Act which provides for the binding force of the Ruling pronounced, fails to address whether the AAR would be bound by an earlier Ruling pronounced by it. With judicial precedents specifying that the Ruling only has a persuasive value, it is seen that the recent Rulings of AAR taking divergent views from the stand already taken earlier by the AAR for similar legal and factual situations.
- Hence, with a view to establish consistency, correct legal position and to avoid conflicting Rulings on similar facts, it would be appreciated if the Legislature suitably incorporates provisions giving effect the binding nature of the earlier Rulings of the AAR. Alternatively, in case the current bench of the AAR does not agree with a Ruling pronounced earlier, the matter may be referred to a larger bench as done in the Tribunal. Suitable provisions to the above effect may be introduced/inserted.
1.43.6 Admission of applications by AAR where return of income filed by the applicant
- The issue relating to admission of an application under Section 245R(2) of the Act by the AAR, when the income-tax return has already been filed, has been a subject matter of controversy before the Courts.
- The Delhi High Court in a recent ruling in the case of Netapp BV and Sin Oceanic Shipping ASA held that if a company files an income tax return, then it would lose the right to seek a Ruling from the AAR. Since the AO has the right to issue notice after the taxpayer files return, the latter becomes obligated to disclose the details sought by the AO. Accordingly, the issue can be treated as one pending before the AO and therefore, the AAR cannot allow the application for advance ruling.
- Subsequently, Netapp B V and Sin Oceanic Shipping ASA had filed a Special Leave Petition with the Supreme Court. The Supreme Court, in the light of AAR ruling in the case of Mitsubishi Corporation Ltd., set aside the above High Court rulings and restored the matter back to the AAR for fresh ruling in accordance with the law.
- It is pertinent to note that the rationale behind introducing the AAR was to have a significantly faster dispute resolution process as compared to normal litigation process and to sort out complex international tax issues which may not be appreciated by lower level tax authorities. The applicants approach the AAR to seek certainty on taxability of transactions undertaken/to be undertaken by them and upfront crystallisation of tax implications of proposed transactions.
- It should be clarified by way of amendment in the Act that filing of income tax return will not be construed as case pending before the Income Tax Authority and the AAR can still entertain applications where return of income has been filed by the applicant. Till the time the AO issues the notice for assessment dealing with the issue raised before the AAR, the applicant will have the right to apply for Advance Ruling before the AAR and the same will be admitted by the AAR.
- This will help in propagating the mechanism of AAR and will provide an opportunity to a large number of applicants to seek clarity and certainty on various complex international tax issues faced by them.
1.44 General Anti Avoidance Rule – Chapter X-A
- The General Anti Avoidance Rules (GAAR) had first been introduced in the Direct Taxes Code (DTC) in 2009 to curb ‘Impermissible Avoidance Agreement’ (IAA) entered into by a person to avoid taxes. The GAAR had been introduced to deal with aggressive tax planning involving use of sophisticated structures. The Finance Act, 2012 had inserted Chapter X-A, dealing with the provisions of GAAR to be effective from 1 April 2014. Subsequently, Finance Act 2013, amended provisions of Chapter X-A and the current GAAR provisions would come into force with effect from 1 April 2015 (Financial Year 2015-16). The Central Board of Direct Taxes (CBDT) has also notified certain rules relating to application of GAAR.
1.44.1 Factors relevant for determining impermissible arrangements
- The Finance Act 2013 has amended section 97(4) of the Act to provide that factors like, period or time for which the arrangement exists; the fact of payment of taxes and the fact that an exit route is provided by the arrangement, may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not.
- Apart from the circumstances provided for clarifying whether the arrangement lacks commercial substance, the following additional points may also be considered relevant for determining whether the arrangement is an impermissible avoidance arrangement:-
- the form and substance of the transaction;
- in which the scheme was entered into or carried out;
- whether the transaction is a single isolated transaction or a series of transactions;
- the change in the financial position of the taxpayer that has resulted or will result from the transaction;
- the change in the financial position of the party connected to the relevant taxpayer that has resulted or will result from transaction.
All these factors are critical to determine the nature of the arrangement. Therefore, these factors should be considered as a condition in determining whether an arrangement is impermissible avoidance arrangement.
1.44.2 Scope of the term ‘significant’ in section 97(1)
The Finance Act, 2013 provides an additional condition under Section 97(1) that an arrangement shall also be considered to be lacking commercial substance, if it does not have a significant effect upon business risks, or net cash flows apart from the tax benefit.
- It is a fact that any prudent businessman would undertake a transaction with a third-party which will definitely have a bearing on the business risks/ net cash flows of him/ other party. The intent behind the insertion of this provision is to go behind the taxpayers who undertake a transaction which does not have an effect on their business risks/net cash flows.
- The terms ‘significant’ is not defined under the section to quantify the actual risk/ net cash flow in order to conclude that the arrangement lacks commercial substance.
The term “significant effect” needs to be defined appropriately to avoid potential litigation revolving around this.
1.44.3 Treaty vis-a-vis domestic tax laws
The Finance Act, 2013 has inserted a new sub-section (2A) in section 90 of the Act so as to provide that the provisions of newly inserted Chapter X-A shall apply even if such provisions are not beneficial to the assessee.
- Insertion of this provision would nullify the international & global principle on “treaty overriding domestic tax laws”.
- Treaty is a commercial contract/agreement between two countries and vide such contract the Governments of the countries agree to share the taxation revenue arising on transactions between residents of those Countries. Treaty is beyond tax. Treaty is meant to facilitate trade between countries. Such an important agreement cannot be overridden by any specific country domestic tax laws.
- This amendment should be withdrawn since the same is against the internationally accepted principles. Given the resultant serious implications on the non-resident taxpayers, this amendment should be rolled back.
1.44.4 Appeals against directions of Approving Panel
The Finance Act, 2013 has introduced new section 144BA providing that the directions, issued by the Approving Panel shall be binding on the assessee and the Commissioner and no appeal under the Act shall lie against such directions.
- The direction issued by the Approving Panel is as per the Act. Therefore, taxpayer should be provided with a right to appeal against such directions with the Income-tax Appellate Tribunal.
- In the absence of any right to appeal under the Act, the taxpayer will only have an option to file a writ to challenge the directions of the Approving Panel.
The provisions need to be amended to state that the directions issued by the Approving Panel can be appealed with the Income-tax Appellate Tribunal and higher forums.
1.44.5 Other recommendations of the Shome Committee
The Committee under the Chairmanship of Dr. Parthasarathi Shome, after considering the suggestions of various stakeholders, submitted its final report on GAAR to the Government. The Government considered the report of the Committee and accepted some of the recommendations with a few modifications. However, some of the recommendations do not find any reference in the Finance Act 2013. Some of the concerns and suggestions in relation to invocation of GAAR are given below:
- Substantive investments have come to India by way of portfolio investment or foreign direct investment from two jurisdictions Singapore and Mauritius based on the effective assurance that, on exit, no tax would be levied in accordance with the relevant tax treaty. Now, it would be unfair to many stakeholders, both domestic and international, to say that no tax exemption would be provided if they exit after 1 April 2015.
Rationalization of General Anti-Avoidance Rule (“GAAR”) Issues
From a foreign investor’s standpoint, it is critical to have certainty on whether or not offshore foreign investors investing into India would be entitled to treaty benefits, as may be applicable. If GAAR is invoked, treaty benefits could be denied. Moreover, the language of the conditions triggering GAAR including ‘misuse or abuse of provisions of tax laws’, ‘lacks commercial substance’, ‘not for bona fide purposes’ and ‘substantial commercial purpose’ etc. are very widely worded and subjective. This could be amenable to various differing interpretations even among the income tax authorities. This would result in significant uncertainty on whether or not offshore India investment structures set up by foreign investors would be respected and treaty benefits granted. These provisions could also impact transaction closure/costs owing to uncertainty on withholding tax/representative assessee related liabilities etc.
- Grandfathering for existing structures/arrangements/investments
We would like to reiterate our position to grandfather existing structures/arrangements/ investments as part of the GAAR provisions and agree with the Revenue authorities’ perspective that sham, tax avoidant schemes/structures must not enjoy protection/ legitimacy by virtue of grandfathering.
As per Press release dated January 14, 2013 issued by Government of India, it has been stated that investments made before August 30, 2010 i.e. the date of introduction of the Direct Taxes Code, Bill, 2010, will be grandfathered. Further, it has been stated that GAAR is proposed to be effective from 1 April 2016. However, we may also like to re-iterate that GAAR may impact many bona fide structures that have been legitimately put in place.
As per the recently notified Rules (Notification No. 75/2013), the provisions of GAAR shall not apply to any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received by, any person from transfer of investment made before the 30 August 2010. Further the rules also specify, without prejudice to the above grandfathering incentive that GAAR provisions shall apply to any arrangement irrespective of the date on which it has been entered into, in respect of the tax benefit obtained from an arrangement on or after 1 April 2015.
Our jurisprudence has always distinguished between tax planning and tax avoidance/evasion; the sanctity of legitimate tax planning has been upheld by the Supreme Court of India on multiple occasions. Owing to the rigour of the proposed GAAR regime, many structures, which may erstwhile have been considered legitimate may get impacted. Such structures have been in existence for several years and many commercial/legal arrangements would have been implemented on the basis thereof at significant cost. It would be prejudicial and unfair to the taxpayer to mid-way subject him to provisions, which did not exist in law when the transactions were entered into.
In light of the above, in our view, it would be fair to apply GAAR provisions prospectively i.e. from financial year beginning from April 01, 2015 and all the existing arrangements/transactions up to March 31, 2015 be grandfathered.
It is submitted that certain objective criteria/conditions be laid down, which if fulfilled would not result in the triggering of GAAR provisions and its consequential implications on any offshore entity including denial of treaty benefits.
Further, it is recommended that the language clarifying the objective criteria / conditions should also include examples (like incurrence of minimum specified expenditure by the overseas entity) of where GAAR provisions would not be triggered.
It is humbly submitted that in the interest of fairness and consistency, the proposed GAAR provisions should not be made applicable to existing structures/ arrangements/ investments, which are legitimate as on March 31, 2015 and ought to be grandfathered. For instance, any offshore investment vehicle, which is incorporated under a valid local law prior to March 31, 2015, holds a valid tax residency certificate and but for the applicability of the GAAR provisions would have been entitled to treaty benefits, ought to be grandfathered.
- Apprehensions have been raised from stakeholders that the threshold to be prescribed for applying GAAR should be high enough to capture only highly sophisticated structures.
As per the recently notified Rules, the provisions of GAAR shall not apply to an arrangement where the tax benefit arising to all the parties to the arrangement in the relevant assessment year does not exceed ₹ 3 crore in aggregate.
- Many countries do not apply GAAR where SAAR is applicable. It is a settled principle that, where a specific rule is available, a general rule will not apply. SAAR normally covers a specific aspect or situation of tax avoidance and provides a specific rule to deal with specific tax avoidance schemes.
It is recommended that it should be provided that where GAAR and SAAR are both in force, only one of them will apply subject to prescribed guidelines.
- Provisions for avoiding the taxation of the same income in the hands of the same assessee across tax years, if the GAAR provisions are invoked are missing in the amendments brought in so far.
It is recommended that provisions should be enacted in a manner which would ensure that the same income is not taxed twice in the hands of the same taxpayer in the same year or in different assessment years should be specifically incorporated in the law.
1.45 Financial Services – Tax Issues pertaining to Mutual Funds
1.45.1 Amendment in characterization of unlisted shares and units of non-equity mutual funds as short/long term asset – Section 2(42A)
- The Finance (No. 2) Act, 2014 has amended Section 2(42A) of the Act, which provides that unlisted shares and units of non-equity mutual funds should be considered short term capital asset if the same are not held for > 36 months.
- Under the earlier provisions, if shares/units were held for > 12 months, the same were considered to be long term capital asset and was liable to lower rate of tax. Therefore, the investor would have acquired the shares/units on the basis that the same could be sold after 12 months and tax impact will be at a lower rate. This impacts the investor confidence about reliability of tax policies.
- It is recommended that this proposal should be dropped and the erstwhile holding limit for unlisted shares and a unit of a mutual fund (other than an equity oriented mutual fund) as a long term capital assets should be continued i.e. more than 12 months.
1.45.2 Change of rate of tax on sale of units of a mutual fund – section 112
- The concessional rate of tax of ten per cent on long term capital gain no more available to the units of a mutual fund. This amendment in section 112 would again impact debt schemes of Mutual fund (MF)
- This proposal should be dropped and accordingly beneficial rate of tax (i.e. 10 per cent) should continue to be made applicable as earlier on such schemes.
1.45.3 Grossing-up of a dividend distribution tax in relation to mutual fund – Section 115R
- The Finance (No. 2) Act, 2014 has amended Section 115R wherein the Dividend Distribution Tax (DDT) in relation to the unit holders is required to be grossed up. Accordingly, the DDT to be paid after grossing up of the amount distributed as dividend.
- This amendment in section 112 would again impact debt schemes of Mutual fund (MF)
- This amendment should be deleted and the erstwhile method of computation of DDT should continue to be applied on income distributed by a mutual fund. Grossing up effect is especially very steep in the case of mutual funds on account of the higher DDT. (vis-à-vis Dividend on shares)
- MF industry could be adversely impacted as the debt schemes would now be less attractive for investors and would also result into erosion in Assets Under Management (AUM) of debt schemes due to heavy redemption pressure.
- This would also largely impact retail investors who have already invested in debt mutual funds. Further, retail investors would lose out on another investment option;
- The Finance Minister said that the aforesaid amendment is to remove arbitrage opportunity which is available to the investors where investment is made through debt schemes of MF as against the direct investments in banks and other debt instruments. However, there is a difference between direct investment and investment through MF, since investors (especially retail investors) prefers investing through MF due to various reasons (not only for tax arbitrage) viz. expertise of MF in managing the funds, etc.;
- This proposal could impact the liquidity and also further development of corporate bonds market;
1.45.4 Additional income tax on MF redemption receipts/bonus issue – Section 115R
- Section 115R of the Income-tax Act, 1961 provides for levy of additional tax on distributed income to unit holders.
- It is noticed that certain tax officers are taking a view that mutual funds/specified companies are required to pay additional income tax under the said section not only on income distributed by way of dividend but also on payments made at the time of redemption/repurchase of units as well as at the time of allotment of bonus units to existing investors.
- CBDT issued a Circular to clarify that redemption/repurchase of units are not in the nature of distributed income to the unit holders and hence the same are outside the purview of the section. Also, since issue of bonus shares is not akin to distribution of the income by way of dividend, the same would not be subjected to additional income tax under section 115R of the Act.
- If the above interpretation provided in the Circular is to be read in Section 115R, it would lead to purposive interpretation. Accordingly, the clarification issued by way of the CBDT circular should be incorporated in the provisions of the Act to avoid any possible uncertainty and ambiguity in this regard.
1.46 TDS on transfer of certain immovable properties (other than agricultural land) – Section 194IA
Section 194IA of the Act provides that every transferee at the time of payment or credit of sum as a consideration for transfer of immovable property to resident transferor shall deduct tax @ 1% on such sum.
- This provision may lead to lot of practical difficulties. Some of the issues are elucidated below:-
- Considering that the tax would be required to be deducted on the gross transaction value rather than net gains, transferors will have a cash-flow impact in situations where the sales are at a loss or at no gains/cases where capital gains are exempt for the seller. This may lead to a refund situation which can only be claimed by the seller at the time of filing his tax return.
- The provision will pose severe hardship for real estate companies who would be burdened with the task of collecting and preserving the physical copies of voluminous number of TDS certificates for making and substantiating the claim for tax deducted.
- There are going to be difficulties in complying with the provision, in cases where the properties are bought by availing loan from the bank and payment is made directly by bank to the real estate companies or the transferors as the case may be.
- This amendment is for widening the tax base and to bring the transferors in tax net. Considering, the existing inflation, even a builder building one single building will have turnover of > ₹ 1 crore and will be liable to tax audit under Section 44AB and will be under tax net.
- Threshold limit of ₹ 50 lakhs for the applicability of the provision is very low. The provision will pose onerous compliance requirement even on small purchasers.
- Reason given for introduction of this provision is that as per the records of registrars many transactions in properties having value at ₹ 30 lakhs or above was registered without PAN. Thus, issue is with certain transactions only. Entire group of transactions should not be punished for wrong doing in some of them. This is against principle of natural justice. One should punish the wrong doer only.
- The provision should be deleted.
- In the alternative, the provision should be made applicable to secondary transactions and not to first purchase from the builder/developer.
- Further, threshold limit for the applicability of the above provision should be increased from ₹ 50 lakhs to ₹ 1 crore.
1.47 Financial Services – Venture Capital Funds/Private Equity Funds (“PE”) and Venture Capital Companies
1.47.1 Pass through Status to certain Alternative Investment Funds (“AIFs”) – section 10(23FB)
The Finance Act 2013 has accorded the tax pass through status only to the funds registered under the sub-category of “Venture capital funds” (“VCF”) within “Category 1” Alternative Investment Funds (“AIF”) in terms of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (“SEBI AIF Regulations”).
- The Finance Act, 2012 amended section 10(23FB) of the Act providing tax pass through status to a VCF/VCC for any income earned from a VCU referred to in the SEBI VCF Regulations. The beneficiary of a VCF/VCC is taxed as if it has made the investments directly in the VCU. The above amendment in section 10(23FB) of the Act read with section 115U led to the removal of sectoral restrictions encapsulated under the erstwhile section 10(23FB) of the Act and thereby extended the pass through status to income earned by VCF / VCC registered under the SEBI VCF Regulations from Venture Capital (“VC”) investment across all sectors. This amendment was greatly appreciated by the VC industry as a move, which would provide significant tax certainty to investors and thus greatly foster development of domestic VC funds. As a matter of fact, this was in fact the position from Assessment Year 2001-2002 up to Assessment Year 2007-2008 after which the sectoral restrictions were first introduced in section 10(23FB) of the Act.
- Subsequently, in May 2012, the SEBI VCF Regulations were repealed and SEBI AIF Regulations were enacted wherein AIFs were broadly classified into three categories viz. Category I (e.g. – VCFs, social venture funds, SME funds), Category II (PE funds, debt funds, etc.) and Category III (hedge funds, etc.) based on their eligibility criteria, investment restrictions and the positive effect they would have on the economy. The AIF regulations provided that only Category I AIFs would be deemed to be VCF or VCC for the purposes of section 10(23FB) of the Act. Consequently, post the enactment of the SEBI AIF Regulations, all Category I AIFs were sought to be entitled to the tax pass through status under section 10(23FB) read with section 115U of the Act (apart from VCF/ VCCs, which were registered and grandfathered under the erstwhile SEBI VCF Regulations and which are already covered under the Act). However, Category II and Category III AIFs were not covered.
Furthermore, post the Finance Act 2013, it was provided that only the ‘VCF’ sub category of Category I AIF would be entitled to the tax pass through status. Other sub categories of Category I (e.g.: infrastructure funds, social venture funds etc.) would not be entitled to the tax pass through in terms of section 10(23FB) read with section 115U of the Act. This has resulted in the following disparities:
vi. Whilst all funds registered as Category I AIF would have the positive spill-over effects on economy, the tax pass through status is accorded only to the VCF sub-category of AIF-I – therefore, there is a disparity inter se in the tax treatment of different types of Category 1 AIF funds;
vii. Category II and Category III are not entitled to tax pass through status; and
viii. Grandfathered VCF/VCC who continue to be governed by the VCF Regulations will enjoy complete tax pass through status for any income earned from VCUs thus creating a disparity between grandfathered VCFs and the non-VCF Category I, Category II and Category III AIFs.
Such disparities will trigger needless confusion thereby increasing the possibility of litigation between the funds and the revenue authorities and result in additional compliance costs.
Whilst we suggest to bring all AIFs – Category I, Category II and Category III AIFs within the scope of section 10(23FB) of the Act on the ground of revenue neutrality and tax certainty, from the standpoint of adopting a calibrated approach, it is critical that at least all Category I (irrespective of sub-category) and Category II AIFs (constituted as trusts) are immediately brought within the scope of section 10(23FB) of the Act.
Non-VCU income not
- The language of section 10(23FB) of the Act, as it stands currently, grants exemption only to income from investments in VCUs. VCU has been defined to mean a VCU referred in the SEBI VCF Regulations or in SEBI AIF Regulations.
- Section 10(23FB) of the Act does not cover tax pass through status for income from investment in non-VCUs, even though the SEBI VCF /AIF Regulations explicitly permits VCFs to invest in non-VCUs subject to certain limits. Further, SEBI AIF Regulations specifically permits investment by VCF through Special Purpose Vehicle (‘SPV’) (which are the investment holding companies). Whilst investment by a VCF through an SPV may be necessitated due to commercial exigency, the underlying intent is only to make investment in a VCU as permissible under SEBI AIF regulations. Technically, these SPVs may not be a VCU for the purposes of section 10(23FB) of the Act and hence, it is not completely clear whether gains arising from disposal of SPVs also qualify for pass through status under section 10(23FB) read with section 115U of the Act. Therefore it may be explicitly clarified that any investment by VCF through SPVs should also be considered as a direct investment in VCU by VCF and therefore should enjoy the benefits of Section 10(23FB).
- Also, an issue may arise with respect to a company, which may be a VCU (unlisted) at the time of investment but is listed prior to exit and hence, technically, may not be a VCU for the purposes of section 10(23FB) of the Act. Such a consequence seems inequitable and unintentional given that the investment was made at the stage when the investee company was a VCU. Further, an AIF/VCF/ VCC may also earn sundry sources of income such as bank interest, directorship fees etc.
- Akin to a mutual fund whose entire income is exempt under section 10(23D) of the Act, similar blanket exemption provision should be introduced for the whole of the income earned by such SEBI registered funds to be taxed on a pass through basis under section 10(23FB) read with section 115U of the Act in the hands of the investors.
- Consequently, an AIF / VCF / VCC may have two income streams subject to differing tax treatments – income from VCUs would be taxable under the section 10(23FB) and section 115U framework and the balance income would be taxable as per general trust tax provisions (for VCFs / AIF constituted as trust).
- To eliminate any uncertainty in the tax consequences, it would be a welcome move to make an amendment extending the pass through regime to all income earned by a SEBI registered fund under section 10(23FB) of the Act. This will obviate needless litigation between the funds and the revenue authorities and reduce cost of compliance.
- All income earned by erstwhile VCF/VCC registered under the SEBI VCF Regulations, Category I AIF and Category II AIF should be covered under the provisions of section 10(23FB) of the Act so that the tax pass through in terms of section 10(23FB) read with section 115U of the Act is duly available on all incomes earned by such funds, which is extremely critical from a VC / PE industry standpoint.
1.47.2 Interest income of business trust receivable /received from special purpose vehicle – Section 10(23FC)
• The Finance Act (No. 2), 2014, has introduced Section 10(23FC) wherein the interest income receivable / received from special purpose vehicle is eligible for pass through.
- It is recommended that the all income (interest income, capital gains etc.) arising in the hands of the business trust set-up in accordance with the Securities and Exchange Board of India (SEBI) should be eligible for the pass through.
1.47.3 Income characterization – Capital gains vs. Business income
- Venture capital investments typically come from high net-worth sophisticated and long term investors and institutions. Unlike several other types of investments, venture capitalists provide fund to build up resources and enterprises with the intention of enhancing the long term growth and value of companies and target returns on their capital by increasing shareholder value through expansion and development of the company. The objective of VC funds is to make long term investments, as distinguished from other investors such as hedge funds and traders, who deal in securities with much shorter holding periods with the intention to make short term windfall gains. As such, VC funds, by their very nature, are long term investors with comparatively low frequency of transactions. VC funds are not permitted to make investments out of borrowed funds. Moreover, under the extant regulatory framework, a SEBI registered VC fund cannot undertake any activity other than investment activity. Accordingly, the purpose of a VC Fund is to make investment as against engaging into the business of dealing in shares.
- Therefore, any income of a SEBI registered VC/AIF funds (other than Category III AIF which are undertaking derivatives or complex trading transactions) from sale of shares/securities should be in the nature of ‘capital gains’ and not ‘business income’.
The provisions of the Act should be suitably amended to explicitly provide that income from sale of investments by SEBI registered VC/AIF funds (other than Category III AIF which are undertaking derivatives or complex trading transactions) would be treated as ‘capital gains’ and taxed accordingly, including a pass through basis in the hands of the investors. This would simplify the system of taxation, bring certainty and eliminate needless litigation on the income characterization issue.
1.47.4 Issue of shares at a value higher than fair market value to VCF/VCC – section 56(2)
- Though Finance Act 2012 specifically carved out sub category VCF under Category I AIF from the provisions of section 56(2)(viib) of the Act, certain unintended consequences as stated below have arose which impacts the VC industry at large. The industry being tightly regulated by SEBI is facing certain unintended consequences of this provision being introduced. Some of these are:
- Certain unintended transactions (for e.g.; – capital reserve arising pursuant to merger) may also get covered within the purview of section 56(2)(viib) of the Act, which is not desirable.
- It is quite common for VC investors to enter into “ratchet structures” with the issuer company /promoter wherein convertibles are issued and conversion price is formula based and linked to the company’s performance, adjustment of shareholding percentage etc. In certain scenarios, such ratchet could result in the company issuing shares to parties (other than VCF/ VCC) at high premium attracting tax implications in the hands of the issuer company under the above amendment. Thus, the provisions of section 56(2)(viib) of the Act could adversely affect bona fide, arm’s length ratchet structures agreed with resident promoters/other investors wherein they are required to infuse funds or convert at a substantial premium for the adjustment of shareholding.
- Also, this issue is relevant for the angel investment industry investing in start-up ventures, where the immediate valuation of the entity may not be a benchmark for the investment being made by angel investors. Startup ventures, at the stage where angels invest, usually have no revenues or profits and the valuation is based on the potential and promise of the idea, the background and competence of the founding team, etc. and is usually a simple matter of negotiation between the founders and the angel investors. It is often wrong for one party or the other but it is simply impossible to create a frozen logic for such investments, be it DCF or a valuation by merchant bankers, etc. Any such mechanism, or others that may be proposed, would be impractical and unfortunately push the parties concerned to contrive adherence , an extremely undesirable outcome as both founders/angel investors would like to operate within the letter and the intent of the law.
a. Subjecting the valuation of the investment to an FMV by IT Authorities does not work, as explained above. The IT department would not have the domain understanding to value the innovation (in fact even two different angel investors would value the same company differently). This will subject all investments in startup companies to re-evaluation and will open a plethora of disputes / appeals. This will scare angel investors away.
b. This provision characterizes the investment by Angels as Income in the hands of the investee company, which is fundamentally incorrect. The Angel Investor’s investment is to grow the company and create revenues/income in the company. By changing the nature of the inflow into the company, the company and the investor sign away 30% of the investment (less the FMV) to tax: starving the company of critical cash flow investment. So investors who are investing tax paid monies will not invest as this will attract another round of tax albeit through the investee company. This amounts to double taxation
- As this section only applies to domestic investors, it discriminates against them as compared to foreign investors, who are not subject to this clause.
- The above provision may also hinder the ability of investee companies to make genuine arm’s length inorganic acquisitions.
- Exclusion under section 56(2)(viib) of the Act should apply to shares issued to all Category I and II AIFs and not only to the sub category “venture capital fund”.
- It is also noted that despite the fact that the above provisions have been introduced for shares issued from April 01, 2012 onwards, VCUs are being issued with tax demands on premium received prior to April 01, 2012. This causes an unnecessary burden on portfolio companies and increases their litigation and compliance costs. Accordingly, it is represented that appropriate instructions should be issued to tax officers to refrain from this practice.
- There may be instances where the company receives consideration in one tax year but issues shares in the following tax year or in certain cases does not issue shares but refunds the share application money to the shareholder, there is lack of clarity in such cases as to the year in which the provision would apply or whether the provision would apply at all.
- It would be prejudicial to subject the Issuer Company to such adverse provisions which did not exist in law when the transactions were entered into.
- The amendment in Section 56(2)(viib) of the Act should be deleted.
- Given that the said provision is intended to effectively be an ‘anti- avoidance’ provision, the following situations where not ‘tax- avoidance’ ought to be involved merit exclusion. Consequently:-
- Applicability should be restricted to issue of shares in consideration for cash.
- The issue of shares pursuant to otherwise exempt transactions such as merger, demerger, inorganic acquisitions etc. should be excluded from the purview of section 56(2)(viib) of the Act.
- It is recommended that it should be suitably provided for in the section that it would apply only in the year of issue of shares.
- It should be suitably clarified to provide that the section does not require every closely held company that issues shares to a resident to suo-motto offer such income to tax. Further, the tax officer should be empowered to invoke this section only if at the time of assessment; the tax officer is of the view that premium charged by the company from the resident shareholder is in excess of the fair market value of shares issued.
- The provision should not be made applicable to bona fide ratchet structures.
- Investments made by an Investor who is part of a recognized, formal Angel group, should be exempted from this clause, subject to the following definitions and stipulations.
- An Angel Investor group may be defined as a formal group, of which the angel investors are members and collectively invest their own money (directly or through their investment vehicle) in an unlisted entity, at the seed stage, in which there is no family connection and where the investment by an individual is less than ₹ 5 crores and by the angel group, less than ₹ 10 crores.
- Seed stage is defined as a business whose turnover is below ₹ 25 crores; the limits on investments and turnover threshold for the seed stage should be indexed to inflation.
- The value of the shares may be determined as of the date of the issue of the shares or any date earlier than the date of issue of shares, not being a date which is more than 180 days earlier than the date of issue of shares.
- The investee company should not have received more than ₹ 10 crores before the Angel round from any source.
- The valuation of the company, at the time of the angel investment, should not exceed ₹ 50 crores (as valued by the angel group).
- Angel Groups would ensure that there are no investments are made in companies where family members are involved. All Angel Investors all invest through a single shareholder Agreement in which the Angel group entity also holds a percentage of the same investment. This would ensure there is a body reviewing and updating activity in the investee company and will also be subject to Audit.
- Investor KYC information (like PAN nos.) will be made available to the Angel Group & Investee companies.
- Investment by business incubators which have been recognized or promoted by the Government of India should be exempted
- Recognition of an Angel Group could be on the following basis:
a. Number of years in existence: at least 3 years
b. Number of investor members in the Group averaged over the last 2 years: At least 150 members
c. Number of investments made in different companies: at least 25
d. the Angel Group is an entity with a proper Secretariat & operations : for at least 3 years
e. Angel Group entity be recognized either by the Finance Ministry or any other appropriate entity of the government
- The provision should not be made applicable to all Category I and II AIFs.
- The provision should not be made applicable to any issuance of securities under any arrangement
/instrument/transaction existing prior to the said amendment.
- Specific instructions should be issued to tax officer to refrain from challenging the share premium paid by VCF to VCU on subscription of shares prior to April 1, 2012.
1.48 Taxation of Securitization trust
The Finance Act, 2013, has provided a special taxation regime in respect of taxation of income of securitization trusts whereby income earned by securitization trust regulated by SEBI/RBI will be exempt. Securitization trusts distributing income to its investors (other than those exempt from tax) will be liable to pay tax on income distribution. Income received by an investor from securitization trusts will be exempt from tax. Certain issues involved in this new taxation regime are given below:-
- The effect of this change is a mortal blow to the PTC market. Banks, insurance companies, NBFCs and other taxpaying entities will be severely impacted. RBI has guidelines on securitization of standard assets which banks and NBFCs have to follow mandatorily. Also, NBFC-MFI (Microfinance Institutions) securitize a large part of their portfolio with banks, financial institutions, larger NBFCs and corporate and accordingly, tax on distribution of income by securitization trusts would severely impact them also.
- The special tax regime would create challenge under section 14A of the Act as it would entail disallowance under the said section in the hands of the investor who has effectively borne additional income-tax under section 115TA of the Act.
- No credit can be taken by the investor in respect of the distribution tax. As such it becomes a straightforward loss of income for the PTC holder.
- The distribution tax is a tax on gross income; however the net income of the investors in securitized instruments is only a small fraction of the gross income.
- The trustee would need to maintain a list of investors at any given point of time. This is required as there could be a tax exempt investor who could have sold his investment to a taxable investor or vice versa. This change will impact the distribution tax to be payable by the trustee in the subsequent payout.
- There are no grandfathering provisions with respect to existing structures. As transactions worth thousands of crores which were structured through SPVs without apprehending what is proposed in the Budget should not be subjected to a new tax regime.
- In order to offer level playing field to all investors, it is recommended that the income distributed by trusts should not be subject to distribution tax and should be offered to tax by the investors as per the normal tax regime.
- It is recommended that the existing transactions (entered before June 1, 2013) should be explicitly excluded from this new taxation regime.
Loss on equity derivative business
The Delhi High Court in the case of CIT vs. DLF Commercial Developers Ltd. (2013) 35 taxmann.com 280, held that determination of stock derivatives value is dependent on shares and hence the provisions of section 73 of the Act are applicable to derivative business. Accordingly, the loss on account of derivative transactions is not allowed to be carried forward and set-off against non-speculative business income. The HC observed that eligible derivative transactions on recognised stock exchanges are not treated as speculative transactions for business income computation. However, such exclusion, which may be relevant for computation of business income, will still be relevant in interpreting the provision dealing with set-off and carry forward of loss. The Delhi High Court ruling unsettles the principle that Explanation to section 73 of the Act deals only with purchase and sale of shares and is not applicable to exchange traded derivative transactions.
Further, Explanation to section 73 of the Act is severely impacting the corporate arbitrageurs as under an Arbitrage business, a broker buys shares and sells corresponding futures. Both the segments are two legs of one integrated activity and are not separate stand-alone segments. Therefore, as a result, if there is a profit in the Cash segment there would be a loss in the Futures segment or vice-versa. Under an Arbitrage, the Broker does not carry out speculative deals of independent Futures& Options transactions and it also does not carry out independent purchase or sale of shares. However, the Assessing Officers are treating the two activities as separate and treating the loss made in the physical segment as Speculative Loss and the Profits made in the F&O Segment as Business Profits. Thus, a set-off of the two is not being given leading to huge litigation and undue problems for Brokers/ Arbitrageurs. The ratio of the Delhi High Court judgment (supra) that Explanation to section 73 of the Act is applicable to derivative business has created further doubts on treatment of loss made in the F&O segment as non-speculative loss.
An amendment should be made in section 73 of the Act to specifically provide that a transaction in respect of trading in derivatives carried out in a recognized stock exchange by a company is not to be treated as speculative business transaction for the purpose of Explanation to section 73 of the Act.
Further, an amendment should be made in section 73 of the Act to provide that all transactions of the nature mentioned in section 43(5)(c) of the Act are excluded from the scope of Explanation to Sec 73 of the Act, this would ensure that all arbitrage and jobbing transaction by any entity are treated as one activity, i.e. business transaction.
Alternatively, an amendment may be made in Explanation to section 73 of the Act to provide that only purchase and sale of shares (other than on a recognised stock exchange) of other companies, shall, for the purposes of this section, be deemed to be carrying on speculation business.
1.49 Clarification on taxation of long term capital gains arising on transfer of unlisted securities by non-residents – section 112
- The Finance Act 2012 had amended Section 112(1)(c) of the Act to provide a concessional long term capital gains of 10% on transfer of capital assets being unlisted securities in the hands of non-residents (including foreign companies).
- However, the manner in which the term ‘unlisted securities’ has been defined may lead to the unintentional consequence of the 10% concessional tax rate not applying to gains arising on transfer of shares of private companies held as long term capital assets.
- Unlisted securities have been defined vide Explanation (ab) to Section 112(1) of the Act as follows “Unlisted securities means securities other than listed securities”. Explanation (aa) defines
- “listed securities” as follows:
- “Listed securities mean the securities which are listed on any recognised stock exchange in India”.
- Further, Explanation (a) to section 112(1) of the Act, provides that “the expression “securities shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contracts (Regulations) Act, 1956 (32 of 1956)”. The relevant extract of the expression ‘securities’ as defined in section 2(h) of the Securities Contracts (Regulations) Act, 1956 (“SCRA”) is as under:
“Section 2(h) – Securities include –
Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
- For the purposes of section 112 of the Act, it therefore becomes imperative to examine the scope of the term “securities” under the SCRA. Based on various judicial precedents, it has been held that the shares of a private limited company were not securities as defined in section 2(h) of the SCRA. It was held that the shares must be marketable to qualify as a security under the SCRA. As the shares of a private company are not freely transferable, they were not held to be marketable and hence not a security for the purposes of section 2(h) of the SCRA.
- Therefore, based on the above interpretation of the term ‘securities’, the aforesaid benefit of the concessional rate of 10% under section 112(1)(c) of the Act may be available only on long term capital gains arising on transfer of unlisted marketable securities i.e. long term capital gains arising on the sale of shares of a private company may not qualify for the above concessional rate of taxation.
- The intention of the legislature was to extend the benefit of the 10% concessional tax rate on long term capital gains arising on transfer of unlisted securities by any non-resident. However, based on various judicial precedents on interpretation of the term “securities” as per SCRA could lead to litigation on this matter. There appears no basis to exclude gains arising from transfer of private companies from the above favourable regime. Moreover, a significant portion of the investments made by the PE funds in India is actually in private limited companies for several regulatory/ commercial reasons.
In order to create certainty and avoid undue litigation, it is requested that all long term capital gains arising to non- residents on transfer of all unlisted securities should be subject to concessional tax rate of 10% under section 112(1)(c) of the Act with retrospective effect from April 1, 2013. In this regard, we suggest that the term “securities” in Explanation
(a) to section 112(1) should be defined as under:
“shares, scrips, stocks, bonds, debentures, debenture stock, warrants or other securities of like nature issued by a private company, public company, any other body corporate and funds registered with Securities and Exchange Board of India (‘SEBI’) under SEBI (Alternative Investment Funds) Regulations, 2012 and SEBI (Venture Capital Funds) Regulations, 1996 and includes other securities as specified in Section 2(h) of SCRA”
1.50 Clarification on lower withholding tax rates on corporate bonds and government securities – Section 194LD
- Withholding tax rate in respect of interest earned by FIIs and Qualified Foreign Investors (‘QFIs’) on bonds issued by Indian companies and Government securities has been reduced from 20% (for FIIs)/40% (for QFIs) to 5% vide Section 194LD of the Finance Act 2013. This is a welcome change by the Government to encourage foreign debt in India. However, the benefit of reduced rate was made available only if:
- The coupon rate on corporate bonds does not exceed the rate as notified by the Central Government; and
- The benefit will be available in respect of interest income accruing to FIIs and QFIs between the period June 01, 2013 and May 31, 2015 irrespective of the date of investment.
- Currently, on technical reading of the provision, a FII/QFI shall not be able to avail the benefit of the concessional tax rate if its coupon rate exceeds the notified rate of Central Government. Thus, in order to encourage foreign debt investment in India, it is represented that the benefit of reduced withholding tax rate shall be made available to all FIIs/QFIs irrespective of the notified rate (i.e. the coupon rate as notified by the Government).
- Section 194D of the Act inter-alia states that the benefit is available to interest payable on “bonds” of Indian companies.
With the intent to encourage foreign debt investment in India by FIIs/QFIs, it is represented that:
- Section 194LD of the Act to be amended to state that benefit of reduced withholding tax rate shall be available to all FIIs/QFIs irrespective of the notified rate (i.e. the ceiling coupon rate to be notified).
- Without prejudice to above, it is represented that interest up to the notified rate be subject to beneficial rate and any incremental coupon above the notified rate be subject to normal tax rates as
- applicable under the Act or treaty (as opposed to the entire interest income being taxable at the normal tax rates as per the Act/treaty).
- Language of section 194LD may be amended to explicitly cover “debentures” in addition to bonds as well especially considering private corporate debt is typically raised through debentures.
1.51 Assessment and Procedural Aspects
Key suggestions on the issues faced by the taxpayers which requires due attention are submitted below:-
1.51.1 Filing of income-tax returns
- All companies are required to file their tax returns electronically. As per Rule 12 of the Income-tax Rules, 1962, the electronic return shall not be accompanied with the computation of tax liability or any other document (other than the specified reports to be filed electronically). Given that it is not possible to file the computation of income with the return, the assessee cannot state the basis or rationale for adopting a particular tax position in the return on any aspect. Such computation or basis for preparation of return of income can be filed by the assessee only during the assessment proceedings. Hence, non-filing of such documents with the return of income should not be viewed as non-disclosure of material facts or furnishing inaccurate particulars of income or concealment of income.
- Based on the above, it is suggested that appropriate amendments be made to the provisions of the Act, such as section 147 and section 271, to clarify that where any information or document relating to the tax position adopted by the assessee is not filed with the return of income but is submitted by the assessee during the assessment, it would be taken into account for the purpose of determining whether the assessee has disclosed all material facts for the purpose of assessment.
1.51.2 Compulsory filing of income tax return in relation to assets located outside India
Finance Act, 2012 has made mandatory for residents (other than not ordinarily resident in India) to file tax return in India if they have any asset (including any financial interest in any entity) located outside India or signing authority in any account located outside India irrespective of the fact whether the resident taxpayer has taxable income or not.
- There is no minimum threshold prescribed for foreign asset/financial interest reporting. In absence of minimum threshold, there could be diligent reporting of minimal values of bank account balances etc. defeating the purpose of data collection, and overburdening the tax department with irrelevant information. On the other hand, assessees may inadvertently ignore certain details (given the low values), which may trigger a noncompliance which may not be intentional. This could be avoided by prescribing a minimum threshold.
- The time limit of 16 years prescribed by the Finance Act, 2012 for reopening of cases where any person is found to have any asset (including financial interest in any entity) located outside India will pose serious hardships for assessees who have returned to India after staying abroad for long as it is not reasonable to expect them to have the documentation retained for the past 16 years to explain the bonafide. Hence, this will even cover the genuine assessees who would have paid tax on the foreign assets while their stay abroad but are unable to prove their bonafide in absence of any documentation for a such a prior period.
- There are no guidelines on as to what would come within the purview of ‘any asset, ‘financial interest in any entity’. In the absence of any guidance the term may have wide connotation leading to litigation. Clarity would be required on whether assets such life insurance policies, stock options benefits, overseas
- social security schemes and pension plans, paintings, works of art, collection items (such as stamp collection/coin collection) etc. are covered. The reporting requirement could end up to be a meaningless collection of data if suitable guidelines are not issued.
- The provision casts unnecessary burden on the spouse/family members, accompanying the foreign nationals working in India, as they are also required to file their Income-tax return in India (for which first they are required to obtain Permanent Account Number (PAN)), as they qualify as Ordinarily Residents in India based on their physical stay in India even if they are not working, not earning any income.
- In practical situations, many executives of a company are appointed as authorized signatory of company account situated outside India while discharging their duty as an employee of that company. Details of such accounts may not be available with such executives. It has now become mandatory for every resident to report details in the income tax form if they have signing authority in any account located outside India. Such a requirement poses hardship for the assessees who are signatory to accounts held by the entities in which they are employed/directors.
- It is strongly recommended that a minimum threshold be prescribed for reporting of foreign assets.
- The period of 16 years for reopening of cases should be made applicable only for any assessment year beginning from on or after AY 2012-13.
- It should be suitably clarified as to what would constitute “any asset”, “financial interest”.
- In order to minimize this undue hardship with foreign nationals and to make the guidelines more effective, there needs to be clarity on the following aspects:
- Who is required to report?
- What is required to be reported?
- Threshold beyond which reporting becomes mandatory? The above clarity will ensure that the reporting requirement would not end up to be a meaningless guideline of collecting unnecessary data.
• It is recommended that an exception be provided to a resident who is a signing authority to a foreign account by virtue of his employment/directorship.
1.51.3 Claim made during the assessment proceedings
The tax officers reject the claims made by the taxpayers during the course of the assessment proceedings which are omitted to be claimed by the latter in their return of income. The rejection of claim by the tax officer is made on the basis of the judgment of the Supreme Court in the case of Goetze India Ltd. vs. CIT (2006) 284 ITR 323 (SC). The said Apex Court judgment has been distinguished by various courts in plethora of judgments and also not in consonance with the Circular No. 14 dated April 11, 1955 issued by CBDT.
It should be suitably clarified in the Act that the tax officer is duty bound to allow the legitimate claim of the taxpayer made before him during the course of the assessment proceedings and assess the total income/loss after allowing the said claim.
1.51.4 Direction for special audit under sub-section (2A) of section 142 of the Act
The Finance Act, 2013 has made an amendment to section 142(2A) of the Act which widens the power of the Assessing Officer to direct the taxpayer to get accounts audited and furnish the report in certain circumstances. The expression “nature and complexity of the accounts” has been replaced with the “nature and complexity of the accounts, volume of the accounts, doubts about the correctness of the accounts, multiplicity of transactions in the accounts or specialized nature of business activity of the assessee.
- The amendment seeks to enlarge the scope of section 142(2A) of the Act and gives sweeping powers to the assessing officer to direct special audit in most of the cases. This would adversely add to the compliance burden of the assessee especially when there is already a requirement to get a comprehensive audit done as per section 44AB of the Act.
- The conditions prescribed for referring the case for special audit are not interdependent i.e. even one of the conditions could trigger recommendation for special audit. The applicability of this provision merely on the basis of volume of the accounts or multiplicity of transactions in the account is unreasonable as in such a case all big companies with voluminous transaction could be referred for special audit. The amendment will result in unwarranted litigation.
- Reasons such as volume of accounts, multiplicity of transactions in the accounts, specialized nature of business activity of assessee etc. are not defined categorically to state the quantum/threshold etc. for initiating a special audit.
- Applicability of this provision should not be invoked merely on the basis of volume of the accounts or multiplicity of transactions in the account. The provision should be amended to require satisfaction of all the conditions cumulatively for directing for special audit under section 142(2A) of the Act.
- The terms such as “volume of accounts”, “multiplicity of transactions in the accounts”, “specialized nature of business activity of assessee” would need to be defined very clearly in the section in order to avoid litigation/ambiguity in the interpretation of the section.
1.51.5 Reopening of assessment – Section 147
- Under the existing provisions of Section 147 of the Act, the AO can reopen the assessment at any time within a period of 4 years from the end of the relevant assessment year. In certain cases assessments are being reopened by the AO on mere change of opinion/information obtained through roving enquiries, causing undue hardship to the taxpayer.
It is suggested that, if there are no changes in facts and circumstances of the case and the taxpayer has made full and true disclosure of all material facts and reassessment is based on mere change of opinion/information obtained through roving enquiries made by the AO, opening of reassessment without bringing on record any fresh facts, evidences or reasoning in support should be deemed to be invalid. It is suggested to insert an Explanation to Section 147 of the Act to make amendment to this effect.
1.51.6 Time Limit for filing return based on notice of reassessment – Section 148
• The Finance (No.2) Act, 1996 amended Section 148 of the Act doing away with the minimum period of 30 days within which a taxpayer was required to submit his return of income in response to a notice for reassessment. With this amendment, the period within which the taxpayer is required to submit the return of income for the purpose of reassessment is left to the discretion of the AO.
It is suggested that time limit of not less than 30 days be provided to the taxpayer for filing return of income from the date of service of notice upon the taxpayer. It is also suggested that the printed form of notice under Section 148 of the Act should be amended likewise.
Refund to be adjusted against advance tax liability
- While the tax is collected in advance and in a timely manner, when it comes to issue of refund orders, the same is not provided to the assessees without rigorous follow up.
- Where the assessees have huge refund receivable from the tax authorities, they are still required to pay the advance tax without adjusting such outstanding refunds. On one hand there is substantial time gap between the date of filing of tax return and issue of tax refund, on the other hand, the assessee has to pay tax every quarter in advance. Thus, the assessee faces liquidity issues as the amount is locked-up for good period of time.
- A proper mechanism or procedure needs to be put in place with accountability fixed on the tax department to ensure that refunds are disbursed without time lag. Further, a specified time limit should be provided to the tax authorities to grant refund as per Return of Income or due to effect of rectification/appellate order. In the event, such refund is not issued, similar to penal provisions of section 220 of the Act, penal provision with respect to interest entitlement for refund due including interest under section 244A of the Act not granted to Company should also be provided.
A mechanism can be introduced wherein the refund due can be set off against the advance tax liability of the assessee.
1.51.8 Delay in passing of order giving effect to the order of CIT(A)/Tribunal/Court
- Considerable delay is seen in giving effect to the order of the CIT(A)/Tribunal/Court by the AO, particularly where relief/refund is allowed by the CIT(A)/ Tribunal /Court. Due to the delay in giving the effect of appellate order, substantial refund/ relief to be allowed to the taxpayer is withheld by the tax department. Though Section 244A of the Act provides for payment of interest for the delay in grant of refund, no time limit has been prescribed within which the appeal effect is to be given by the AO. As a result, the tax payments made by the taxpayer on funds borrowed at heavy rate of interest is unnecessarily held up by the tax department.
Provisions may be inserted to require the AO to give effect to the order of CIT(A)/ Tribunal / Court within a reasonable period, say six months, failing which the taxpayer should be given an option to adjust the amount of refund (along with interest) while making payment of advance tax for the current year.
1.51.9 Provision for refund of income-tax
- Judicial precedents have held that the taxpayer would be entitled to get refund of income-tax recovered either before the expiry of time limit to file an appeal before the Tribunal or during the pendency of disposal of stay application. However, in the absence of express provisions to this effect under the Act, it is seen that in many cases the Tax Authorities adopting a coercive approach against the taxpayer (recovery proceedings) whereby the taxpayer is required to pay the income-tax, irrespective of merits of case.
Thus, it is suggested that the Legislature should suitably include an express provision whereby the Income-tax Authorities are either:
- restricted to proceed with the income-tax recovery proceedings; or
- refund the income-tax paid during the recovery proceedings, without adjusting against the income-tax arrears, if any, before the expiry of time limit to file an appeal before Tribunal or during the pendency of disposal of stay application in such cases.
1.51.10 Tax paid on interest on income-tax refund
The interest received by a taxpayer under section 244A of the Act on the refund of taxes is liable to tax at the applicable rates.
In certain cases, during the subsequent assessment or appellate proceedings, the taxpayer may have to return back the tax refund and interest received under section 244A of the Act along with applicable interest. This would result in a situation that the assessee is paying tax on a particular income which is never received by him.
Suitable amendments be brought in order to provide a mechanism to enable the assessees to claim a refund of taxes paid on the interest income, which effectively did not reach them.
1.51.11 Rate of Interest on Tax Refunds – Sec 244A
Under section 244A interest is computed @ 6% per annum on tax refunds payable by the Government however in cases of interest payable by the assessee to the Government, such as in section 234B, rate is 12% p.a.
A uniform rate of interest of either 6% or 12% p.a. both for refunds and tax dues payable by the Government and assesses respectively may be prescribed.
1.52 Maintenance of Books of Account in Digital Form – Section 2(12A)
The present law requires the taxpayers to maintain books of account in physical form thus causing a lot of hardship to the assessees in the world of digitization and also leading to wastage of valuable resources.
Section 2(12A) of the Income Tax Act needs to be amended to include books maintained in digital form also as ‘books or books of accounts’ for the purpose of the Income Tax Act. Major corporate entities manage their books of account on automated systems only and the proposed amendment would encourage maintenance of accounts in digital form enabling effective management of cumbersome records.
1.53 Expediting issuance of Income tax Clearance Certificate
- A Liaison Office (LO) can be opened for a period of 3 years. After completion of 3 years, LO has two options – either to continue its operation or close down its operation. Where it wants to close its operations, submission of income tax clearance certificate (ITCC) with Reserve Bank of India (RBI) is a mandatory requirement. Similarly, where a Company wishes to liquidate, it is also required to obtain ITCC. In absence of a specific provision under the Income tax Act, 1961, assessee finds it difficult to obtain an ITCC, from its tax officer and that too in a reasonable period of time.
- The current provisions provide for issuance of ITCC in case of an individual who is not domiciled in India and is going outside India. A similar provision could be introduced for issuance of ITCC to cases like liquidation of Companies, LO closure, etc.
- A time limit should also be prescribed within which the Assessing Officer should issue the ITCC.
1.54 Other Direct Tax provisions related to interest
1.54.1 Calculation of interest for delay in deposit of taxes withheld – meaning of ‘month’ – Section 201
- Interest under Section 201 (1A) of the Act is calculated at the rate of one percent for every month or part of month from the date on which tax was actually deductible to the date on which tax was deducted and at one and a half percent for every month or part of month from the date on which tax was deducted to the date on which tax is actually paid. For instance, where tax was deductible on 30 June and the tax so deducted was remitted on 8 July, interest has to be paid for June and July, i.e. 2 months for a one day delay.
- In order to mitigate this hardship caused to the taxpayer, it is suggested that ‘month’ be defined as a period of 30 days to avoid litigation on this issue. This would make the reckoning of period while interpreting the tax law more meaningful and clear.
1.54.2 Interest payable in case of default in furnishing return – Section 234A
- Where return of income is filed after the due date, interest under Section 234A of the Act is leviable from the due date of filing return till the date of actual filing. Currently while computing the amount on which interest is payable, self-assessment tax paid by the taxpayer is not considered. Consequently, the taxpayer has to pay a higher amount of interest.
- Since interest is not a penalty and the reason for levy of interest is only to compensate the revenue in order to avoid it from being deprived of the payment of tax on the due date, it is suggested that in cases where the tax on self-assessment is paid under Section 140A of the Act before the due date for filing return on income but return has been filed after the due date, such tax on self-assessment should be considered as item of deduction for the levy of interest under Section 234A of the Act. This would be in line with the ruling of the Supreme Court in the case of CIT v. Pranoy Roy  179 TAXMAN 53 (SC)
1.54.3 Interest for deferment of advance tax under Section 234C of the Act
- Interest under Section 234C of the Act is triggered only if advance tax paid is less than 80 percent of the actual advance tax due for the first and second quarters, i.e. 12 percent and 36 percent respectively. This flexibility is not available while discharging advance tax for the third and final quarters. This leaves very little margin for error for companies while projecting business performance.
- Further the economic swings which may happen anytime during the financial year, manner of disclosure of financial information in accordance with accounting standards, etc. may result in deviation of actual results from projections.
As the above factors are beyond the control of an entrepreneur, provisions relating to trigger of interest under Section 234C of the Act should be relaxed as below:
||Minimum % of tax due to be paid as advance tax to avoid interest
This proposal will also align Section 234C with Section 234B of the Act, since interest under the latter Section is triggered only if advance tax paid is less than 90 percent of assessed tax.
1.55 Monetary Limit for Audit of Accounts
Currently the limits for audit of accounts of taxpayers are as follows:-
||Existing Limit (INR Lakhs)
|Sales turnover /Gross receipts of business
|Gross receipts of profession
Given the growth in volume of economic activity, the limits need to be revised as under.
||Proposed (INR Lakhs)
|Sales turnover / Gross receipts of business
|Gross receipts of profession
1.56 Relaxation on mandatory requirement of PAN – Section 206 AA
(a) Mandatory Requirement of PAN results in undue burden in certain cases
Section 206AA of the Act provides that if PAN is not furnished by payee, the withholding tax rate would be 20 percent or rate in force, whichever is higher. The provisions further lay down that no certificate under Section 197 of the Act shall be granted unless the applicant has stated his PAN in the application. It also further lays down that declaration in Form 15G/15H for Nil deduction of tax would not be valid unless PAN is furnished in such declaration. Further, it has been specified that where the recipient of the income has furnished invalid/ incorrect PAN, it shall be deemed that such person has not furnished PAN and accordingly, tax would be required to be deducted at the highest of the specified three rates while making payment to such persons.
- The mandatory requirement to furnish PAN poses a number of practical problems, for example an overseas entity is not amenable to comply with any Indian tax compliance such as obtaining PAN, many senior citizens may not have PAN, as they are within tax exemption limit, so may be the position for many farmers/seed growers etc.
- Further, it must be appreciated that many foreign companies enter into a one-off transaction with an Indian entity for provision of services or goods. Such transaction may not attract any withholding tax implication or a withholding tax rate of 10-15 percent at the maximum (either under the treaty provisions or under Section 115A of the Act). As the transaction may be one-off such foreign companies may not have obtained a PAN or are even unaware of the requirements under the Indian tax laws. Even otherwise, the law also provides relaxation to the non-residents from filing tax return in India in case of certain payments of the nature specified under section 115A of the Act provided tax is deducted at source on such payments as per the provisions of Chapter XVII-B of the Act. However, in absence of PAN, payer of the income would not have any resort but to withhold tax at the rate of 20 percent or even higher as applicable to foreign companies. Such excess withholding may not be viewed favourably by the foreign companies and even act as a detriment for them in case of future transactions.
- On the similar lines as the proposed exemption for PAN requirement, it is further proposed that foreign companies entering into a one-off transaction in India where adequate taxes have been withheld by the Indian entity, the foreign company may be exempted from filing of income tax returns in India. This exemption may be over and above the exemption specifically provided by Section 115A of the Act.
(b) Whether the provisions of Section 206AA will override the provisions of tax treaties
A plain reading of the provisions of Section 206AA of the Act suggests that the provision would override the provision contained in the respective tax treaty resulting in a situation of treaty override. This is because in absence of PAN of the foreign company, the Indian taxpayer would be required to deduct tax at the rate of 20 percent if such rate is higher than the rate specified under the applicable tax treaty. This is likely to create hardships for the foreign company in availing appropriate tax credit in its country of residence for the excess tax deducted over and above the specified rate in the tax treaty and also protracted litigation in the matter discouraging foreign entities from entering into transactions with India as also increasing the cost of doing business with India.
These provisions may act detrimental not only to the recipients of income but also may be detrimental to the payer of such income. A payer may have deducted tax under the specified Section at the specified rates under a bonafide belief that the PAN furnished by the income recipient is correct. In case the same is found to be invalid/ incorrect, the payer may have to deduct tax at the rate of 20 percent or higher. In case the payer has already made the payment of the sum to the receiver, then it would create the problem of recovery of the differential amount from the recipient of the income
Further, considering the uncertainty in the Indian tax systems, practically it is seen that the foreign entities generally prefer a tax protected agreement wherein the tax liability is to be borne by the payer of the income. In such cases, the cost to be borne by the payer of the income would escalate by substantial amount as not only the rate of tax would go up but even such higher rate would be required to be grossed up. This will create liquidity issues for the payer of income as also increasing substantially his costs of doing business and importing foreign technology.
(a) Undue burden on senior citizens and other persons not having taxable income
The provisions of Section 206AA of the Act are detrimental to the interest of not only foreign companies but also persons resident in India, especially the senior citizens. One of the conditions under Section 206AA of the Act specifies that no declaration under Form 15G/ Form 15H is valid unless the person furnishing such declaration has quoted his PAN on such declaration. The condition of mandatorily furnishing PAN on such declaration is likely to create many documentary hassles for senior citizens across the country for whom the only source of income is perhaps interest from deposits with banks. In this regard, reference may be drawn to Section 139A of the Act which requires a person to obtain a PAN inter alia in case his total income exceeds the maximum exemption limit while Form 15G/ Form 15H is to be furnished by persons whose tax on total estimated income for the concerned year is likely to be NIL. Accordingly, the provisions of Section 206AA of the Act seem to be overriding the basic provision laid down under Sections 139A and 197A of the Act. Even if a person was to comply with the provisions of Section 206AA of the Act and was to obtain and quote his PAN, he is likely to face various documentary hassles. There is also a fear, perhaps not without reason, that the Income-tax officers in their zeal to widen the tax net would issue notices to those people who have obtained PAN but have not been filing their tax returns in spite of their income falling within the exemption limit. Further, there is apprehension that this would result in more harassment for such senior citizens. In our country, where an individual is expected to look after their own social security needs, subjecting such senior citizens to such unnecessary procedural requirements would only reflect very poorly on the Government as being insensitive to the needs of our senior citizens. Hence, there is an urgent need to carve out exceptions in these provisions for senior citizens and other persons who do not have taxable income.
(b) Whether tax required to be grossed up in case Section 206AA is applicable
At present, there is no clarification as to whether provisions of Section 195A of the Act would apply to Section 206AA i.e. rate at which tax is required to withheld under Section 206AA of the Act is also to be grossed-up under Section 195A of the Act. This creates uncertainty among the tax payer and may have to bear additional tax. A withholding tax rate of 20 percent after grossing up would be as high as 25 percent. Hence, it is suggested that clarification may be introduced to provide that provision of 195A of the Act would not apply in the case where provisions of Section 206AA of the Act are attracted, since Section 206AA of the Act starts with non-obstante clause.
We suggest that quoting of PAN should be made optional for the following category of persons:
- Individuals, including senior citizens, farmers/seed growers, transporters etc. whose total income do not exceed the exemption limit or are illiterate and the mandatory requirement to obtain and furnish PAN may pose practical problems
- Foreign companies.
- Pure business transactions of purchase/sale of goods.
In addition, the onerous responsibility and consequences faced by the payer of the income in case the recipient furnishes incorrect/invalid PAN should also be relaxed. It may also be clarified that the provisions of Section 195A of the Act relating to grossing up of payments do not apply in a case where provisions of Section 206AA of the Act are attracted
1.57 Tax Deducted at Source (TDS)
1.57.1 TDS on monthly provision entries and year end provision memorandum entries
- Most of the companies record provision entries towards various expenditures on a monthly basis to report performance to their parent entities. These entries are reversed in the subsequent month.
- These accruals are made on very broad estimates to unidentified payees. The tax officers have been insisting that tax be deducted on these provisional entries.
- Year end provisions are made by assessees to follow accrual system of accounting. Very often provision for expenses at the year end is made based on best estimates available with the assessee even if the supporting invoice is received at the subsequent date. As per the current tax regime, tax is required to be deducted on such provisions which often leads to excess deduction and deposit of tax, disputes with the vendor and unnecessary burden posed due to extensive reconciliation.
It is recommended that relief from deduction of tax at source should be given on payments that are accrued but are not due to the payee and for which the payees are not identifiable and represents only a provision made in accordance with accounting policy.
1.57.2 Rationalization of TDS provisions
There is a lot of litigation surrounding applicability of TDS provisions on various payments.
In order to reduce litigation on TDS related issues, it is suggested that in the context of the current scenario, the CBDT should issue a FAQ similar to Circular 715 dated 8 August 1995, clarifying the position on various current issues in respect of TDS.
1.57.3 TDS credit
- The E-TDS system is undergoing issues and there is mismatch of data between TDS Certificates issued by deductors, TDS statements uploaded on TIN system and bank payment details, PAN of the deductees. As a result deductees do not get the full credit for tax deducted. Further, based on the mismatch the tax authority is issuing orders upon the deductor thereby causing unnecessary adversity to the deductor/taxpayer.
- The E-TDS system mandates all the deductors of taxes to process TDS Certificates in Form 16A’s only through TIN- NSDL website. The software of the tax department automatically picks up the address of the deductee from the address appearing in the PAN database maintained by the tax department. As a result, all the TDS certificates are getting issued at the address declared in the PAN application made by the deductee. This has resulted into severe hardship for the companies which have a multi locational set up, since, all the TDS certificates gets dumped at the Registered office of the company (being PAN based address). The accumulation of TDS certificates at the registered office of the deductee makes it difficult for them to co-relate/reconcile them with the accounts which are maintained at different locations and also the units are not able to identify whether the TDS certificate is received from the party or not.
- Under the current scheme of the Act, credit for TDS can be claimed only in the year in which the corresponding income has been offered to tax, resulting into onerous requirement of matching income via-a-vis tax credit claimed on such income, which is practically difficult due to various reasons like non-appearing of TDS credit in the account of payee due to non-filing of TDS returns by the payer or deduction of tax in subsequent year by the payer etc.
- In view of the above, it is suggested that TDS certificates issued by the deductors, which are furnished by the deductees in the tax assessment, should be given due cognizance and refund claims based on such TDS certificates should be processed. Further the tax authority can suitably issue proper notice for the clarification rather than hurriedly issuing orders to the taxpayer concerned.
- It is recommended that suitable instructions be issued by the lawmakers providing an option to the deductee to indicate their TAN in the invoice and further a column/field may be added in the TDS returns asking the payers to furnish the TAN against each deductee (this should however be an optional column), wherever TAN has been provided by the deductee, at the time of submission/filing of TDS returns by the payers. At the same time, it is also recommended that the E-TDS software of the tax department may be amended so that when the TDS returns are processed to generate the TDS certificates, the address should first be automatically picked from the TAN database in respect of the deductee maintained by the tax department and in case no TAN is mentioned in the TDS return, then the address should be picked from the PAN database. This would facilitate generation of the TDS certificate at the TAN address, wherever TAN is provided by the deductee.
- It is recommended that credit for TDS should be allowed to the taxpayer in the year in which such TDS certificate is issued to the taxpayer/payee or in the year in which TDS credit appears on the online database of the payee without having the requirement to claim tax credit in the year in which corresponding income has been offered to tax. This would address the various problems being faced by the payees today in claiming due credit for TDS.
1.57.4 Withholding tax on reimbursements
- With increasing cross border transactions, reimbursements of expenditures/costs incurred on behalf of the Indian Company by the Foreign Parent/Group Company have been subject to scrutiny by the tax authorities. Broadly reimbursements made to the foreign company could be categorized as follows:
- Reimbursement/ allocation of expenditure/costs (shared services/ incidental costs/ third party costs)
- Reimbursement of salaries/overseas social security contribution/personnel related cost of deputed employees.
- Contrary positions have been taken by the judiciary on the issue of withholding tax on reimbursements made by an Indian Company to its Foreign Parent/Group Company with specific reference to the facts of each case. Further with respect to recharge of salary costs of seconded employees, there is ambiguity on the applicability of withholding tax under Section 195 of the Act, notwithstanding the fact that tax has been withheld under Section 192 of the Act upon payment of salary to such employee.
- The consequences of non-compliance with withholding tax provisions are manifold for the deductor in the form of disallowance under Section 40(a)(i) of the Act, interest and penal proceedings.
- To reduce litigation on this issue it is recommended that the CBDT issues a circular / FAQ clarifying with illustrations on the applicability of withholding tax on reimbursements. Specifically, the following need to be addressed:
|Recharge of salary costs of seconded employees if tax has been withheld at source in the employees’ hands
||No withholding tax on payment of recharge to foreign company which has made such payment from perspective of administrative convenience
|Reimbursement of third party costs or incidental expenses or travel costs, on cost-to-cost basis
||No withholding tax under section 195 where
- It is not payment for a service rendered, such as travel cost
- The underlying third party cost would not attract withholding tax in India or if paid from India
- This relates to expenses incidental to the fee
1.57.5 Enhancement of Limits for TDS – section 194C
- Under section 194C of the Act, TDS is applicable in respect of contracts for manufacturing or supplying a product according to the requirement or specification of a customer by using material purchased from such customer. However, in a large number of instances, it is observed that the material which is purchased from the customer represents a small fraction of the total cost and this provision has created huge operating problems since the transaction may be a ‘principal-to principal’ contract for purchase and sale of goods and the profit margin may be very small.
- Currently, any payment for contract services rendered which exceeds INR 30,000 at a time or INR 75,000 per annum requires the person responsible for making such payments to deduct tax at source under Section 194C of the Act.
- Also, any payment for commission or brokerage as per section 194H of the Act, which exceeds ₹ 5,000 (at a time or in aggregate per annum) requires the person responsible for making such payments to deduct tax at source under Section 194H of the Act. These limits have been fixed some years ago. The deduction of tax at source on such small amounts involves deployment of relatively large amount of resources in terms of manpower, systems and other costs at the assessee’ end without any significant benefits to the revenue.
- It is suggested that the provisions of section 194C of the Act be only made applicable in cases where the material purchased from the customer is substantial in nature, i.e., say it exceeds 40% of the total material cost (inclusive of raw materials and packing materials).
- It is recommended that the threshold limit be increased to ₹ 50,000 for single payment and ₹ 100,000 for aggregate annual limit under section 194C of the Act and the threshold limit for deduction of tax at source on commission/brokerage be increased to ₹ 25,000 from the present ₹ 5,000.
1.58 Amendment in the definition of ‘Charitable Purpose’ – section 2(15)
- It may be mentioned that originally the term ‘charitable purpose’ under the section 2(15) of the Act was defined to include relief of the poor, education, medical relief and the advancement of any other object of general public utility. However, the Finance Act 2008 amended the said definition by inserting a proviso to Section 2(15) of the Act as under:
“Provided that the advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application, or retention, of the income from such activity”
Further, the Finance Act, 2011, had amended Section 2(15) of the Act to provide that ‘the advancement of any other object of general public utility’ shall continue to be a ‘charitable purpose’ if the total receipts from any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to any trade, commerce or business do not exceed ₹ 25 lakhs in the previous year. This has been done by inserting a proviso to Section 2(15) of the Act to read as under:
“Provided further that the first proviso shall not apply if the aggregate value of the receipts from activities referred to therein is twenty five lakh rupees or less in the previous year;”
• The aforesaid amendment is vehemently opposed by trade organizations, chambers of commerce, NGOs and other charitable organizations, as it was felt that it would have wide repercussions on the genuine charitable organizations which are rendering laudable service in the country. These are not-for-profit organizations and to be eligible for tax exemption, Sections 11 to 13 of the Act, provide for rigid regulations for charitable institutions as regards inter-alia, investments, application of income, accumulation of profits, audit, timely filing of returns with reports from Chartered Accountants, bar against any private benefit etc., and the tax exemption could be withdrawn for violation of any of such conditions.
We are of the view that the underlying objective of tax exemption for charitable organizations should be the end use of its income and not the generation of income. In this perspective, it is pleaded that the Chambers of Commerce, trade organizations, NGOs and other not-for-profit organizations should be explicitly exempted from tax provided the income generated by them are exclusively utilized for charitable purposes and that they are strictly adhering to the requirements under the Act.
In the alternative, we would like to suggest that at least second proviso to section 2(15) of the Act be substituted to read as under:
“Provided further that the first proviso shall not apply if the aggregate value of the receipts from activities referred to therein is not more than 49% of the aggregate receipts.”
The dichotomy is in respect of different tax treatment to organizations engaged in carrying out specified activities for charitable purpose like relief to the poor vis-à-vis organization carrying out any activity of general public utility though charitable in nature. For instance, the sale proceeds from education material/books by a Non-Government Organization (NGO) working towards the charitable purpose of education may not necessarily affect its tax exempt status. However, where an NGO engaged in ‘any other object of general public utility’ say an old age home earns revenue from sale of books or literature or providing some assistance to its members on subject matter aligned to their main object may impact its tax exemption status, where value of such sale proceeds/consideration exceeds ₹ 25 lakhs.
- The law should provide greater clarity on the tax treatment given to organizations falling within the purview of the residual clause of ‘advancement of general public utility’. There is a dire necessity to provide a thumb rule on what would constitute ‘charitable purpose’ under the residual clause. The nature of activity and the application of income towards the said activity should be the emphasis of grant of tax exemption status rather than the activities from which income is derived.
- The restrictive provisions were inserted with an intention of prohibiting indiscriminate claim of exemption under the pretext or guise of being engaged in charitable activities. However, this has also impacted the low profile organizations genuinely working towards the betterment of society as their activities are falling within the purview of ‘advancement of any other object of general public utility’.
- Even though the Government has provided marginal relief by increasing the limit, such a relief may not be adequate for the organizations to eventually become self-sustainable. This would result in huge dependence on external grants and donations for carrying their charitable activities.
- The law should suitably be amended and the limit prescribed should be increased to enable the genuine organizations to become self-sustainable.
- The Finance (No.2) Act, 2009 had inserted clause (vii) in sub-section (5) of Section 80G of the Act to protect donations upto 31 March 2009 if any institution for fund established for charitable purposes, loses exemption due to the first proviso to Section 2(15) of the Act.
- It is suggested that a similar provision be made in Section 80G of the Act to the effect that donation to such institutions/funds/trusts will continue to be exempt in respect of the donations and the donor will be eligible for tax deduction benefit under Section 80G of the Act, even if the trust loses exemption owing to its receipts from commercial activities exceed the monetary limit or the specified percentage of the total receipts as suggested above. It may also be clarified that these will not lose recognition under Section 12AA of the Act if the receipts exceed the said specified limits/percentage. In other words, in case of excess receipts, the exemption should not be denied in relation to other activities.
Under section 2(15) of the Act, charitable purpose includes relief of the poor, education, medical relief, preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest and the advancement of any other object of general public utility. Different views are expressed by various experts with respect to “vocational training activity” as to whether same amounts to education or not. Some views are expressed that since it is systematic process of learning which enables an individual to earn his livelihood, therefore it is “education”. However since there is no clear cut jurisprudence on this issue, the tax authorities take a cautious approach and do not treat it as “education”.
It is strongly recommends that section 2(15) of the Act be suitably amended to provide that “education” includes vocation training.
- The Finance (No. 2) Act, 2014, has inserted Explanation after sub-clause (iiiac) of section 10 (23C) of the Act whereby the eligible educational institutions, hospitals and other institutions under this Section shall be considered as substantially financed by the government only if the government grant to the institution exceeds such percentage (to be prescribed) of the total receipts (including voluntary contributions) during the previous year.
- Definition of ‘substantially financed by the government’ to provide clarity and reduce litigation on that front
- Percentage to be prescribed must be liberal (around 20 per cent) to bring within its ambit several genuine organizations in the education and healthcare space. This would provide relief to such organizations.
- The Finance (No. 2) Act, 2014, has amended Section 10(23C) of the Act wherein the funds, institutions, universities, etc. approved/registered under Section 10(23C) and 12AA of the Act cannot claim exemption under any other provision of Section 10 of the Act, except for agricultural income or under Section 10(23C) of the Act.
- The amendment of not availing general exemption provisions to charitable organizations (which have been denied exemption) would debar them from availing benefit of certain genuine provisions like section 10(11) – interest on PPF, 10(15) – interest on tax-free bonds etc. The provision seems to be quite stringent. It is recommended that some of such general exemptions should be restored for organizations in case their income becomes taxable (as in case of for-profit entities).
1.59 Definition of Association of Persons (AOP) to be modified – section 2(31)
- The term Association of Persons (AOP) has not been defined in the Act. As per section 2(31) of the Act, ‘person’ includes, inter-alia, association of persons or body of individuals, whether incorporated or not. Explanation to section 2(31) of the Act further provides that an AOP shall be deemed to be a person, whether or not such person or body was formed or established or incorporated with the object of deriving income, profits or gains.
- Since the definition is not provided by the statute itself, one has to refer to the legal jurisprudence for understanding the meaning of term ‘AOP’. The Supreme Court observed in the case of CIT v. Indira Balkrishna (39 ITR 546), “The word ‘associate’ means, according to the Oxford Dictionary, ‘to join in common purpose or to join in an action’”. The essential characteristics of an AOP flowing from the various judicial precedents can be illustrated as follows:-
- Two or more persons join together or associate together;
- The parties should come together out of their own free will (out of volition);
- The association should be for common purpose or common action;
- Mutual rights and obligations;
- Incurrence of common expenditure;
- There should be joint execution and/ or supervision of the work;
- Possibility of reassignment of work amongst members;
- Some kind of scheme for common management.
- Whether an AOP is constituted or not would have to be decided on a conjoint reading and analysis of the above factors to the facts and circumstances of the case. No one factor can be said to be decisive of the subject and the priority of the factors is also not laid down in law.
- The existing provisions of the Act on whether a particular association constitutes an ‘association of persons’ for purposes of Section 2(31) of the Act are thus open to diverse interpretations. While it is recognized that whether an AOP exists or not is both a question of law and fact, yet in the absence of legislative framework defining an AOP in the Act, the matter is often litigative thus creating uncertainty and being costly for both the taxpayer and the exchequer.
The following proviso be inserted to Explanation to section 2(31) of the Act Existing law
Explanation to Section 2(31) of the Act:
“For the purposes of this clause, an association of persons or body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or judicial person was formed or established or incorporated with the object of deriving income, profits or gains.”
Explanation to section 2(31) of the Act:
“For the purposes of this clause, an association of persons or body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or judicial person was formed or established or incorporated with the object of deriving income, profits or gains.”
Provided however that an association of persons shall not be deemed to be a ‘person’ for the purposes of this clause if the members of such association of persons
- receive gross receipts in their respective separate bank account(s) and
- incur their respective expenditure or costs from their respective separate bank account(s); and;
- there is no adjustment inter-se the members to share the (net) profit or loss.
In the above backdrop, it may be stated that in year 1989, CBDT has issued an instruction dated September 21, 1989, wherein, CBDT clarified that companies forming the consortium for execution of turnkey project will not constitute an AOP under the Income-tax Act and further, offshore supply of goods by MNC contractors shall not be liable to tax in India where the title to the goods is transferred outside India for taxability of MNC contractors engaged in execution of power projects. The key principles outlined in the clarification were applied not just for the power industry but also for the entire infrastructure sector as such. The principles outlined in the aforesaid Revenue clarification have also been accepted by the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd and Hyundai Heavy Industries Co. Ltd. (2007) 161 Taxman 191 (SC). However, in the year 2009, the Revenue withdrew its “1989 clarification.
Further, recently, the Authority for Advance Rulings (AAR) has issued couple of rulings, in deference to established judicial precedents, and held that offshore supply of goods by MNC contractors are taxable in India even if the title of such goods is transferred outside India. The AAR has also held that consortium arrangements for execution of infrastructure projects result in creation of Association of Persons (‘AOP‘) although the intention of the contractors is never to create a partnership arrangement. These AAR rulings are now being applied by the Revenue for taxing the MNC contractors in withholding tax/assessment proceedings although, as per the Act, the advance ruling is binding solely on the applicant and not on other taxpayers. There are various tax complexities that are associated with assessments of AOP, including double taxation of non-residents in India and their country of residence (with no possibility of the double taxation being avoided). The said position of the Revenue is causing hardship to the industry and is also resulting in pessimism as regards the uncertain tax environment in India. Large amount of working capital is getting blocked up in withholding tax/payment of tax demands consequent to completion of assessments.
It is judicially well settled that offshore supply of goods by MNC contractors is not liable to tax in India.
A large number of such big infrastructure contracts are awarded by Public Sector Undertakings/Government companies. Many developers require contractors to bid in a consortium with a view to ensure that specific components of the project get executed by an earmarked contractor who has requisite capabilities in this regard (any one contractor may not have the capability to execute the entire project) and yet, derive the comfort that the entire project (comprising of several parts) will be successfully commissioned by the consortium of contractors, although each contractor will be executing its specific part only. The consortium members/contractors undertake their respective scope of work separate and independent of each other and do not share profits/losses with each other. Further, there is a separate consideration earmarked for each contractor and the payment is made directly to respective contractor by the customer. Thus, contractors enter into consortium/agree to jointly undertake the work for better co-operation in their relationship with the developer/provide comfort to developer and for no other purpose.
In certain situations, developers allow MNCs to bid for a tender with an option to sub-contract/assign some portion of work to third party (sub-contractors/assignees) having requisite capability with the condition that the MNC bidder will be overall responsible for the execution of entire project for the comfort of developers.
Consequently, the intention behind consortium/contract split arrangements is never to constitute a partnership/AOP but to meet the business requirements of the developer.
In light of the above, it is strongly recommended that the “1989 clarification” be reissued and the clarification be made applicable to the entire infrastructure sector/EPC contracts. The reissuance of the “1989 clarification” would go a long way in instilling confidence amongst the MNC contractors as regards the stability/fairness of the Indian tax regime, which, in turn, would also encourage MNC contractors to set up their manufacturing hubs in India and thereby result in a multiplier effect on the Indian economy.
As per section 86 of the Act, share of the member in the income of an AOP is not includible in total income of the member. However, such income is not excluded while computing the MAT liability of the member unlike in the case of a partner of firm whose share in the profits in the firm is exempt in the hands of the partner as per section 10(2A) of the Act and also no MAT is payable by the partner on such profits under section 115JB of the Act. The reference to section 86 in section 115JB of the Act is missing. It is unfair to have such a discriminatory tax treatment between a partner of a firm and a member of an AOP.
It is recommended that section 115JB of the Act should be amended to specifically provide that the share of income of a member from an AOP which is otherwise exempt under the provisions of section 86 of the Act should be excluded while computing the liability of the member under 115JB of the Act.
1.60 Wealth Tax
- A residential property owned by the company is charged to wealth tax if it is given to its employees drawing salary exceeding ₹ 10 lakhs.
- It is equally important that residential accommodation provided by a company to its employees drawing salary exceeding ₹ 10 lakhs should not be brought within its tax net. It has to be appreciated that companies need to provide accommodation to its employees considering the remote location of its factory/offices and other reasons like attracting talented persons. Such residential accommodations should not be construed as non-productive assets.
- Vacant Industrial land held for more than two years from the date of acquisition is considered as non-productive asset and charged to wealth tax.
- Vacant industrial land earmarked for future expansion should also be outside its preview even if it is kept vacant after two years of its acquisition.
- Further, considering the changing face of service industry on account of size and infrastructure requirements the exemption benefit of initial two years should be allowed to land held for all business purposes instead of limiting the exemption to industrial purposes only.
- Wealth tax does not differentiate between senior citizen and the normal citizen.
- It should give benefit to the senior citizens like under the Act. It is therefore suggested that wealth tax should not be charged on the wealth of senior citizens.
- Government companies are charged to wealth tax and not treated at par with statutory bodies which are exempted from wealth tax.
- The bodies incorporated under the Central or State Act are exempted from wealth tax but Government companies are charged to wealth tax. It is therefore suggested that the government companies should also not be covered under wealth tax net.
(Please Note- above Detailed Pre Budget Memorandum on Direct Taxes for 2015 was Presented to Government of India, Ministry of Finance,Department of Revenue, Tax Research Unit, New Delhi On 25th November 2014 by Indian American Chamber of Commerce (IACC))