Section 115BAB – An Analysis

First, the Income Tax Amendment Ordinance 2019 had inserted a new section 115BAB in the Income Tax Act 1961 to provide for concessional rate of tax for new manufacturing companies. Subsequently the Income Tax Amendment Act 2019, made few modifications in terms of adding some safeguards to avoid misuse of the section.

I am putting together this article as a guidance for anyone looking to take benefit of the new section and are in the process of setting up a new manufacturing unit.

Author discusses Which Company eligible for claiming lower Income tax rate, Meaning of Manufacture or Production for section 115BAB, Anti Abuse Provisions under Section 15BAB, Related Party Transactions & Transfer Pricing with reference to Section 15BAB and Taxability at higher Income Tax rates.

Which Company eligible for claiming lower Income tax rate?

A new domestic company will be eligible to claim a lower tax rate of 15% (Plus Surcharge and Cess, making it an effective tax rate of 17.16%) if an only if all of the following conditions are cumulatively satisfied: –

1. The assessee is a domestic company, this section is not applicable to other entity types.

2. Such company is incorporated on or after 1^st October, 2019.

3. The company has commenced the manufacture or production of an article or thing on or before 31st March, 2023.

4. The business of such company is not formed by splitting up or re-construction of a business already in existence.

5. Such company does not use second-hand machinery (except imported second-hand machinery) whose value is more than 20% of the value of the total Plant & Machinery used by the company.

6. The company does not use any building previously used as a Hotel or Convention Centre and for which a deduction under Section 80ID has been allowed.

7. The company is not engaged in any other business other than: –

• Manufacture of an article or thing.
• Research in relation to such manufacture or production
• Distribution of such article or thing manufactured or produced by it.

8. The company is not engaged in the following businesses: –

• Software Development
• Mining
• Conversion of marble blocks or similar materials into slabs
• Bottling of gas into cylinders
• Printing of books
• Production of cinematograph films
• Any other notified business (not notified till the date of writing this article)

9. The company does not claim any of the deductions/exemptions/benefits mentioned below in computing the total income for the purpose of income tax viz: –

• Tax Holiday for Units in Special Economic Zones (Section 10AA)
• Additional Depreciation u/s 32((iia)
• Investment Linked deduction u/s 32AD
• Benefits u/s 33AB or 33ABA
• Accelerated R&D allowance (Clause (ii), (iia), (iii) of Sub Section (1), Sub Section (2AA) or Sub Section (2AB) of Section 35)
• Allowances u/s 35AD, 35CCC or 35CCD
• Deductions under Chapter VIA under the heading C: Deductions in respect of certain incomes, excluding deduction for additional employment u/s 80JJAA
• Depreciation us/ 32 has been claimed without additional depreciation u/s 32(1) (iia)

10. The company informs the Income Tax Department of exercising such option to claim lower tax rate in the prescribe form on or before the due date of filing income tax return for the company for the first AY. Option once exercised can not be withdrawn.

So, as it can be seen, 10 Conditions need to be cumulatively satisfied in order to be eligible for the lower tax rate.

Meaning of Manufacture or Production for section 115BAB

As it can be seen from the above-mentioned conditions that the company should be engaged in the business of manufacture or production of an article or thing.

Now a question may arise as to what do these words imply.

Firstly, for the purpose of this section, the following activities are expressly excluded from being manufacture or production viz: –

1. Software Development

2. Mining

3. Conversion of marble blocks or similar materials into slabs

4. Bottling of gas into cylinders

5. Printing of books

6. Production of cinematograph films

7. Any other activities as are notified (no such activities have been notified till the date of writing this article)

Moreover, the word manufacture has been defined in the Income Tax Act 1961 under section 2(29BA) as follows: –

“manufacture”, with its grammatical variations, means a change in a non-living physical object or article or thing, —

 (a) resulting in transformation of the object or article or thing into a new and distinct object or article or thing having a different name, character and use; or

 (b) bringing into existence of a new and distinct object or article or thing with a different chemical composition or integral structure;

The word production has not been defined under the Act; however, it would be prudent to derive such meaning from the definition of ’manufacture’.

Anti Abuse Provisions under Section 15BAB

The anti abuse provisions are contained under sub-section (6) of Section 115BAB.

Such anti abuse provisions can be divided into the following categories: –

1. Related Party Transaction and transfer pricing adjustments

2. Taxability at higher rate

Related Party Transactions & Transfer Pricing

According to section 115BAB(6), where the assessing officer is satisfied that owing to the close connection with any person the transactions are so arranged, that they result in the company having greater profits that would otherwise accrue, AO may determine such profits on reasonable means.

In case such transactions are greater than the limit specified for domestic transfer pricing, such profits will be determined having regard to the arms length price for such transactions.

Hence transactions between companies claiming lower rate under this section and other group and related parties must be at arm’s length or reasonable basis and not in a manner to evade or reduce tax liability for the group as a whole.

Taxability at higher Income Tax rates

From the reading of the provisos to sub section (1) of section 115BAB, the following can be inferred: –

1. Adjustment to profits as mentioned above will be taxed at 30% rate of income tax

2. Any income derived from other business activities apart from manufacture or production of an any article or thing or research or distribution related thereto, shall be taxed at 22% rate of income tax and no deduction of any expenditure will be allowed against such income.

3. Short term capital gains on which depreciation is claimed shall be taxable at 22% tax rate.

4. If in any previous year the conditions mentioned in this article, are not satisfied, on and from the AY relevant to such previous year, the option of lower tax rate shall cease to apply.

Conclusion

One must read the section and relevant notifications and rules carefully before planning to opt for this section to avoid unwanted difficulties and litigation going forward.

Brief About the Author- The author CA Mikdad Merchant is a Chartered Accountant specialising in consulting and advisory for tax and finance matters for manufacturing and allied industries. The author can be reached at mikdadm@insciteadvisory.com / +919920017619