Opting for lower rate of tax under section 115BAB and getting covered under the Transfer Pricing Audit – Whether exercising the option worth the pain for compliances?

1. Background:

Section 115BAB of the Income Tax Act, 1961 (hereinafter “the Act”) is applicable to a “new domestic manufacturing company” which is set up or registered on or after 1st October 2019 but before 31st March 2023.

Therefore, section 115BAB is not applicable to any domestic manufacturing company which is an old company, i.e. the company set up or registered before 1st October 2019, or any company which does not fulfill the terms and conditions stipulated as per the provisions of section 115BAB.

1.1 The section provides for lower rate of income tax under sub-section (1) of section 115BAB as listed in para 2 hereunder to the eligible domestic manufacturing companies effective assessment year beginning from 1st April 2020 ie, assessment year 2020-21.

1.2 However, the section is applicable only at the exercise of the option by the domestic company, if such company exercises, such option, in writing, by filing the prescribed form 10-ID electronically, as provided under Rule 21AF of the Income Tax Rules 1962 (hereinafter “the Rules”), on or before the due date for filing the return of income under sub-section (1) of section 139, as provided under sub section (7) of section 115BAB.

2. Lower rate of income tax specified under section 115BAB:

2.1 The following rates of income tax are applicable to a domestic manufacturing company set up or registered on or after 1st October 2019 if the option of the applicability of section 115BAB is exercised, on or before the due date for filing of income tax under sub-section (1) of section 139 on fulfillment of certain terms and conditions:

SL. No. Particulars of income liable to tax Tax rate
1 Income from the business of:
1.1 manufacture or production of any article or thing: 15%
1.2 research in relation to the business of manufacture or production of any article or thing
1.3 distribution of such article or thing manufactured or produced by it
2 Income which is:
2.1 not incidental to manufacturing or production of an article or thing, for which no specific rate is provided in this section –further  no deductions or allowance is allowed while applying this rate 22%
2.2 from short term capital gains on sale of assets on which no depreciation is allowable under the provisions of the Act
3 Income from the business transactions  arranged in a manner or for some other reason, the profits earned by the company is more than the ordinary profit earned in such business, any such more profit as determined by the income tax officer 30%
4 If the assessee company does not fulfill the prescribed conditions 30%

2.2 As compared to the normal rate of tax at 30%, the rates applicable as per section 115BAB are significantly lower except where the tax is assessed by the income tax officer considering the profits earned by the company is more than the average profit on an assessment made by him due to some arrangements or some reason.

3. Claiming deduction is cumbersome with a lot of iffs and buts

3.1 Any domestic manufacturing company opting for the above lower rate of taxation to be applied is required to fulfill a number of terms and conditions as stipulated under sub-sections (2), (3) and (4) of section 115BAB as under:

(i) the company has been set-up and registered on or after the 1st day of October, 2019, and has commenced manufacturing or production of an article or thing on or before the 31st day of March, 2023

(ii) the business is not formed by splitting up, or the reconstruction, of a business already in existence:

(except as provided in section 33B, which inter alia provides  for (a) re- establishment (b) reconstruction or (c) revival by the of the business, subject to conditions provided in the said section 33B)

(iii) Does not use any machinery and plant previously used for any purpose;

However, in the following cases, it shall be presumed that any machinery and plant used by any person outside India shall not be regarded as used for any purpose if:

(a) Any such machinery and plant were not used in India previously

(b) Such machinery and plant is imported from outside India

(c) no deduction on account of depreciation in respect of such machinery or plant has been allowed or is allowable under the provisions of this Act in computing the total income of any person for any period prior to the date of the installation of machinery or plant by the person.

Any machinery or plant or part thereof previously used before installation by the company and the value of such machinery, or plant or part previously used does not exceed 20 per cent of the total value of machinery or plant used by the company, the condition stated in para (c) shall be regarded as have been fulfilled.

(iv) does not use any building previously used as a hotel or a convention center which has claimed and allowed the deduction under section 80-ID

(v) is only engaged in the manufacture or production of any article or thing and research in relation to, or distribution of, such article or thing manufactured or produced by it.

(vi) the manufacturing or production of the following articles and things are not considered as a manufacturing or production of any article or thing under this section:

a. development of computer software in any form or in any media;
b. Mining
c. conversion of marble blocks or similar items into slabs
d. bottling of gas into cylinder;
e. printing of books or production of cinematograph film;
f. any other business as may be notified by the Central Government in this behalf;

In view of the above restrictions, the companies engaged in the manufacture  or production of any article or thing as listed in the above table are not eligible for option for lower tax rates stipulated under section 115BAB, otherwise also.

(vii) No claim for deduction is made by the company under the following sections:

a. section 10AA or
b. clause (iia) of sub-section (1) of section 32or
c. section 32AD or
d. Section 33ABor
e. Section 33ABAor
f. sub-clause (ii) or sub-clause (iia) or sub-clause (iii) of sub-section (1) or sub-section (2AA) or sub-section (2AB) of section 35,or
g. Section 35Ad, or
h. Section 35CCC or
i. Section 35CCDor
j. under any provisions of Chapter VI-A under the heading “C.—Deductions in respect of certain incomes” other than the provisions of section 80JJA

(viii) Set off of any loss or allowance for unabsorbed depreciation deemed so under section 72A is not to be allowed where such loss or depreciation is attributable to any of the deductions referred to in the list as per (vi) above.

The above loss or allowance for depreciation shall not be further allowed and will be deemed to have been given full affect and allowed.

However, a company having depreciation claim on account of amalgamation may continue to claim the depreciation if all the other conditions are fulfilled by it.

3.2 So if any domestic manufacturing company opts for the lower rate of taxation to be applied under section 115BAB, then it is required to fulfill a cumbersome procedure with a number of restrictions and the compliance of terms and conditions stipulated/ attached to it.

3.3 In view of the above:

3.3.1 disallowances; and

3.3.2 fulfillment of all these cumbersome terms and conditions,

it may not be beneficial/worthwhile for many companies which are otherwise eligible for the lower tax rates, to opt for applicability of section 115BAB, if they have substantial claims for deduction and allowances under the various sections.

3.4 Therefore, isn’t it better not to opt for such a lower tax rate with so much jugglery and working? A sane person would not opt for such option given the plethora of disallowances and compliance with other terms and conditions.

3.5 Non fulfillment of any of the conditions, otherwise also, makes the company liable to the normal rates of taxes.

4. Compulsory Reporting under the Transfer Pricing Audit

Recently, the Central Board of Direct Taxes (hereinafter “the CBDT”) vide its Notification No. 82/2020/F. No. 370142/30/2020-TPL dated 1st October, 2020 modified the annexure to form no. 3CE by amending the Rules by insertion of Income-tax (22nd Amendment) Rules, 2020 and replaced a new clause at serial no. 24 in the annexure to form 3CE applicable for transfer pricing audit as under:

24 Particulars in respect of specified domestic transaction in the nature of any business transacted between the persons referred to in sub-section (6) of section 115BAB:
Has the assessee entered into any specified domestic transaction(s) with any persons referred to in sub-section (6) of section 115BAB which has resulted in more than ordinary profits expected to arise in such business? Yes/No
If “yes”, provide the following details:
(a) Name of the person with whom the specified domestic transaction has been entered into
(b) Description of the transaction including quantitative details, if any.
(c) Total amount received/receivable or paid/ payable in the transaction –
(i) as per books of account;
(ii) as computed by the assessee having regard to the arm’s length price.
(d) Method used for determining the arm’s length price [See section 92C(1)].

5. As can be observed from the above table, the new clause at serial no. 24 inserted in Annexure to form 3CE in place of the existing clause requires the assessee to provide the details of the transactions covered under sub-section (6) of section 115BAB of the Act.

6. Since the transactions under sub-section (6) of section 115BAB are required to be reported under the Transfer Pricing Audit as per the revised Form 3CE, it creates more paper work in the form of:

(a) working of arm’s length price and obtaining comparatives

(b) maintaining documents required under the transfer pricing provisions

(c) electing an appropriate method and justification for opting such method for comparison.

(d) attending assessment before the Transfer Pricing officer requiring more man hours and costs of professionals for attending the above assessment

7. Conclusion:

In view of the above analysis, it would be better for the companies to not use the option under section 115BAB and opt for normal rates of taxation and claim all the deductions and allowances, for which the companies are eligible and spare the additional burden of compliances, unless the savings in the taxes are significant by exercising the option under section 115BAB.

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