Tax reforms for infrastructure and energy sector - Standing true to expectations

Riding on the additional taxes amassed under the Income Declaration Scheme and the surplus flow of funds on account of demonetization coupled with the Government's commitment to growth, it was widely expected that the Budget 2017 will provide major boost to Infrastructure and Energy sectors. To a large extent, this Budget has stood true to the expectations for Infrastructure and Energy sectors. The total allocation for Infrastructure development in 2017-18 stands at a record high of Rs. 3,96,135 crores as against total outlay for Infrastructure of Rs. 2,21,246 crores in 2016-17.

The Finance Minister announced significant reforms in Infrastructure sector to boost investments in affordable housing / real estate, measures for stimulating growth, ease of doing business and rationalization of tax provisions in the said sector.

It was a long standing demand of real estate sector to be given the infrastructure status. To give some relief to the real estate sector, the 'Affordable housing' has been granted infrastructure status. Rationalization of tax holiday provisions to promote affordable housing, for instance - condition of period of completion of project for claiming deduction has been increased from 3 years to 5 years, rationalization on size requirement of residential units in certain places and size of residential units to be measured by taking into account carpet area.

To promote real estate sector and to make it attractive from investments perspective, period of holding in case of immovable property has been reduced from 36 months to 24 months to qualify as 'long term asset'. The Budget has also provided clarity on tax incidence in case of Joint Development Arrangements and taxability of notional income in case the property held as stock-in-trade.

As a measure to stimulate growth and access to overseas funds at competitive rates, the Finance Minister has extended the eligible period of concessional tax rate of 5% TDS on interest in case of External Commercial Borrowing made before 1^st July 2020. Further, the much awaited amendment has been announced by granting the said concessional tax rate of 5% TDS on interest in case of rupee denominated bonds (popularly known as 'Masala Bonds') issued outside India before 1^st July 2020.

The Budget 2017 has announced certain tax proposals for Infrastructure and Energy sector with the intent of ease of doing business in India. In order to bring clarity on tax treatment of income from carbon credits, a newly inserted provision provides that such income will be taxable at a concessional rate of 10% on gross basis. In Energy sector, the Government has clarified that income from sale of leftover stock of crude oil from a facility in India after the expiry of agreement will be exempt from tax. In addition, the Budget has also proposed rationalization of MAT provisions by extending the carry forward of MAT credit from 10 years to 15 years, which will benefit the Infrastructure and Energy sector players as generally these companies enjoy 10 year tax holiday and thereafter the MAT credit used to lapse under the earlier provisions.

As an anti-abuse measure, based on the OECD recommendations in connection with the Base Erosion and Profit Shifting project, the Budget has announced thin capitalization norms by restricting the interest deduction to 30% of EBITDA in case of loan arrangement between Indian borrower and non-resident lender, being an associated enterprise. Further, newly inserted section on thin capitalization also provide that a debt issued by third party lender but guaranteed by an associated enterprise will also be deemed to be issued by associated enterprise. The provisions provide for carry forward and claiming interest deduction in subsequent years subject to said limits. The proposed thin capitalization norms will adversely impact the multinational infrastructure groups' financing structures.

On the indirect tax front,  merit rate of customs duty and excise duty as well as standard rate of service tax has remain unchanged. Apart from that, to incentivize Infrastructure and Energy sectors and to promote 'Make in India', duties on certain components are reduced leaving favourable impact on these sectors. In any case, not much action was expected on indirect taxes in light of upcoming GST regime.

While there are quite a number of positives for Infrastructure and Energy sectors in policy reforms as well as tax reforms, certain crucial demands of the sector is still not met. Abolishing of Minimum Alternative Tax provisions is a long standing demand of Infrastructure and Energy sectors as it neutralizes the tax benefits claimed under profit-linked incentives provisions. The proposal for tax consolidation of tax returns in case of Infrastructure and Energy companies does not find any mention in Budget 2017.

All in all, the budget has not thrown any major surprises and was closer to the most of the expectations which Infrastructure and Energy sectors had from this budget.

Impact on MAT from First Time Adoption (FTA) of Ind AS

As the book profit based on Ind AS compliant financial statement is likely to be different from the book profit based on existing Indian GAAP, the Central Board of Direct Taxes (CBDT) constituted a committee in June, 2015 for suggesting the framework for computation of minimum alternate tax (MAT) liability under section 115JB for Ind AS compliant companies in the year of adoption and thereafter.  The Committee submitted first interim report on 18th March, 2016 which was placed in public domain by the CBDT for wider public consultations. The Committee submitted the second interim report on 5th August, 2016 which was also placed in public domain. The comments/ suggestions received in respect of the first and second interim report were examined by the Committee. After taking into account all the suggestions/ comments received, the Committee submitted its final report on 22nd December, 2016.

This article discusses the final proposed provisions only with respect to first time adoption (FTA) of Ind AS and the consequences for companies that fall under MAT.  The final provisions are a substantial improvement from the earlier draft, and provides a lot more clarity, and makes the FTA Ind AS MAT neutral in several cases.  Many of this author's recommendations, in the article published earlier in Tax Sutra, have been accepted in the final provisions.  However, there are certain provisions that are not clear or are confusing.  Hopefully, the CBDT will provide clarifications in due time.

The accounting policies that an entity uses in its opening Ind AS balance sheet at the time of FTA may differ from those that it previously used in its Indian GAAP financial statements. An entity is required to record these adjustments directly in retained earnings/reserves at the date of transition to Ind AS.  The Committee noted that several of these items would subsequently never be reclassified to the statement of P&L or included in the computation of book profits.

The final provisions on MAT for FTA adjustments in Ind AS retained earnings on the opening balance sheet date that are subsequently never reclassified to the statement of P&L are summarized below. It may be noted that those adjustments recorded in other comprehensive income and which would subsequently be reclassified to the profit and loss, shall be included in book profits in the year in which these are reclassified to the profit and loss.

Let's consider, how the above provisions will work at a practical level.  Consider a company has a net worth of Rs 500 crores, and therefore falls under first phase of Ind AS implementation.  Its date of transition to Ind AS is 1 April, 2015; comparative period is financial year 2015-16, and first Ind AS reporting period is financial year 2016-17.  The company is engaged in several businesses and makes the following seven transition decisions at 1 April, 2015 in order to comply with Ind AS.

1. The company's accounting policy for fixed assets is cost less depreciation under Ind AS.  However, as per option available in Ind AS 101 all fixed assets are stated at fair value at date of transition.  The revalued amount is a deemed cost of fixed assets at 1 April, 2015.  In other words, the company's policy is not to use revaluation on a go forward basis as the accounting policy.  The uplift on revaluation is recorded in retained earnings and will never be recycled to the statement of P&L.

1. In the stand-alone accounts the company has several investments in subsidiaries which under Indian GAAP are stated at cost less diminution other than temporary.  Under Ind AS the company will continue to account for them at cost less impairment.  However, as per option available in Ind AS 101 the investments in subsidiaries are stated at fair value at date of transition.  The fair value is the deemed cost of investments at 1 April, 2015.  Subsequently, the investments in subsidiaries are not fair valued but tested only for impairment.  The net impact of upward fair valuation in some cases and downward fair valuation in other cases is recorded in retained earnings and will never be recycled to the statement of P&L. 

1. Under Indian GAAP, the company discloses assets under a service concession arrangement (SCA) as intangible assets at cost and which does not include construction margin.  On date of transition, the company accounts for the intangible assets in accordance with Ind AS 11 (Appendix A), treating them as service concession assets.  Consequently, under Ind AS 11 (Appendix A), the construction margin is also reflected in the value of the intangible asset.  Therefore at transition date, the value of the intangible assets will be increased with a corresponding increase in retained earnings.  The increase in retained earnings will never be recycled to the statement of P&L.  However, the increase in the value of the intangible asset will be amortized in the future years.

1. At 31 March 2015, the Company has a lease equalization liability under Indian GAAP for an operating lease.  Under Ind AS 17, the Company is required to charge operating lease payments in the statement of P&L without equalizing the lease payments, since those lease payments are indexed to inflation.  Consequently on the transition date, the company reverses the lease equalization liability and takes the credit to retained earnings.  The increase in retained earnings will never be recycled to the statement of P&L.

1. The Company has a cash flow hedge reserve at 31 March 2015 under Indian GAAP, which meets all hedge accounting requirements under Ind AS.  The Company decides to continue with hedge accounting.  In accordance with Ind AS 101, the Company is required to maintain the cash flow hedge reserve, and recycle the same to the statement of P&L, in accordance with the principles of Ind AS 109.

1. The Company has a foreign branch and a positive foreign currency translation reserve (FCTR) in Indian GAAP standalone accounts at 31 March 2015.  In accordance with Ind AS 101, it restates the FCTR to zero on 1 April, 2015 - the date of transition.  Consequently the corresponding effect is taken to retained earnings.  The increase in retained earnings will never be recycled to the statement of P&L.

1. In addition to investments in subsidiaries the company has investments in unquoted securities that are held long term for strategic reasons, but which are neither, subsidiaries, associates or joint ventures.  The Company designates these investments as FVOCI (Fair Value through Other Comprehensive Income).  As per this accounting policy choice, the fair value changes are permanently recorded in reserves (not retained earnings) and are never recycled to the statement of P&L.

As per the final provisions in the Finance Bill, 2017, the MAT implication for the above seven FTA items is given below along with the author's observations.

Reference Year for FTA adjustments

The reference year for first time adoption adjustments is also clarified in the proposed final provisions.  In the first year of adoption of Ind AS, the companies would prepare Ind AS financial statement for reporting year with a comparative financial statement for immediately preceding year. As per Ind AS 101, a company would make all Ind AS adjustments on the opening date of the comparative financial year. The entity is also required to present an equity reconciliation between previous Indian GAAP and Ind AS amounts, both on the opening date of preceding year as well as on the closing date of the preceding year. It is proposed that for the purposes of computation of book profits of the year of adoption and the proposed adjustments, the amounts adjusted as of the opening date of the first year of adoption shall be considered. For example, companies which adopt Ind AS with effect from 1 April 2016 are required prepare their financial statements for the year2016-17 as per requirements of Ind AS. Such companies are also required to prepare an opening balance sheet as of 1 April2015 and restate the financial statements for the comparative period 2015-16. In such a case, the first time adoption adjustments as of 31 March 2016 shall be considered for computation of MAT liability for previous year 2016-17 (Assessment year 2017-18) and thereafter. Further, in this case, the period of five years proposed above shall be previous years 2016-17, 2017-18, 2018-19, 2019-20 and 2020-21.

The above provisions are slightly confusing because, the FTA adjustments are made at 1 April 2015, whereas the final provisions allude to FTA adjustments at 31 March 2016 to be considered for computation of MAT.  Does that mean that the FTA adjustments made at 1 April, 2015 are trued up for any changes upto the end of the comparative year, i.e, 31 March 2016?

Other General Accounting Considerations

The positive impact of MAT credit due to extension of MAT set off availability from 10 years to 15 years can only be recognized in the quarter of January-March 17 and not the quarter of October - December 16.  This is because the announcements are made in February and are not substantive enactment for December quarter. They are substantive enactment/enactment only in the March quarter once passed by the Lok Sabha/ Parliament.

Conclusion 

Companies need to make careful choices of FTA options to minimize a negative MAT impact.  They can make those choices up till financial statements for year ended 31 March 2017 are finalized.  However, changes in those choices will cause significant fluctuations in 2016-17 quarterly results.  For example, a company decides to carry forward fixed assets at previous GAAP carrying value as a transition choice to avoid any MAT liability on fair value uplift.  Subsequently, in the last quarter, the final provision treats the fair value uplift on fixed assets to be completely MAT neutral.  Because of the clarity, the Company prefers to fair value the fixed assets from the transition date instead of carrying them at previous GAAP carrying value.  This would mean that the lower depreciation charge in the earlier quarters and the comparative period will have to be adjusted, thereby resulting in significant change in the reported numbers in the last quarter. 

As a bold step, the Government could have considered abolishing MAT, since the fiscal path is to simplify tax and to abolish various tax exemptions.  However, not many were expecting an abolishment since tax exemptions will phase out over a period of time.  However, in future budgets, one should look forward to an abolishment of MAT.

Testing tax proposals for real estate and infrastructure sector

The Budget 2017 presented by the Finance Minister ('FM'), Arun Jaitley with the agenda of “Transform, Energise and Clean India” has incentivized the Real Estate Sector.  The sector found the FM's attention not only on the policy announcements, but also on the taxation front.

The most critical announcement for the sector was according of Infrastructure Status to the Affordable Housing projects.  This move will give a boost to the sector in the terms of opening up of multiple finance and funding avenues at a lower cost and is in the direction of achieving the dream of “Housing for All by 2022”.  Further, the sector also witnessed increased budgetary allocation which would help the momentum.

Some significant proposals on taxation front are discussed below-

• Deduction under section 80-IBA for Affordable Housing Projects

Last year, the FM had introduced profit linked deduction for affordable housing projects.  However, the conditions for availing the deduction were onerous.  Considering various representations, the FM has proposed following changes to relax the eligibility norms-

—   Time limit for completion of project has been extended to 5 years from 3 years;

—   Limit of 30 square metres or 60 square metres shall be measured in Carpet Area instead of Built up Area; and

—   Limit of 30 square metres will not apply to a place located within 25 kms from the municipal limits of the 4 metro cities.  In other words, 60 square metres shall be applicable to non-metro areas.

Impact

The above proposal will make the deduction more effective and provide real stimulus to the developers of affordable housing projects.  Further, extending the time limit for completion of project will bring in flexibility for the developers and the projects can be completed in an efficient manner.  Increasing the limits to 60 square metres that too on carpet area for all locations except for metro cities will generate significant development activities and increase the supply of affordable houses for the middle class people.

• Rationalization of Capital Gains Provisions

On the Capital Gains front, the changes proposed by the FM include-

—   The period of holding for Long Term Capital Gains in the case of land / building has been reduced to 24 months from 36 months.

—   The base for determining the indexed cost of acquisition of an asset has been shifted from 1981 to 2001.

Impact

The above proposals will significantly reduce the capital gains tax liability on both counts viz. the reduction of holding period and also shifting of base from 1981 to 2001, thereby providing higher cost by way of indexation cost benefit.  This will stimulate sale and purchase in the secondary market thereby indirectly boosting the primary market.  Further, the capital gains exemption available under section 54 on reinvestment of capital gains in a new house, will encourage sellers to purchase another new house thereby giving further boost to the sector.

• Clarity on taxability of Capital Gains on Joint Development Agreements (JDAs)

With the land prices reaching sky, JDAs have become new norm for the real estate sector.  While its usage increased, the complexities and ambiguity around taxation also increased with conflicting judicial precedents.  Hence, the need of the hour was to provide clarity with respect to point of taxation and methodology for computing Capital Gains.

In this regards, special provisions for individuals and HUFs have been proposed for taxability of capital gains on JDA predominantly in the area sharing model.  As per the said provisions, capital gains will be taxable in the year of completion of the project.  Further, it also provides that the stamp duty value of the land owner's share in the project on the date of issuance of completion certificate as increased by monetary consideration (if any) shall be deemed to be the full value of consideration.

Impact

This is a very welcome move as it will facilitate unlocking of unused land parcel of the land owners and increase the supply of land in the market for development of purposes, thereby, increasing supply of housing stock and affordability of homes for home buyers.  The biggest beneficiaries of this scheme would be the large organized developers and corporate developers. 

The above proposal will end long drawn litigation on taxability of JDA arrangements.  However, it is worth noting that the amendment only covers individuals and HUF and other assessees are kept outside the scope of the proposal.

Further, the said amendment is prospective in nature which further aggregates the issue of taxability of JDA arrangements for earlier years.  This amendment would also create a controversy for other tax payers (other than individual and HUF) as they could claim income from JDA arrangement as business income and not as capital gains.

• Taxability of House Property held as stock in trade and not sold within 1 year

Over the past few years, real estate developers and the Tax Authorities have been at loggerheads with respect to taxability of notional rental income of unsold stock in trade. 

The Budget proposes that house property held as stock in trade and not sold within 1 year from the end of the Financial Year of obtaining completion certificate will be taxed as notional income under the head Income from House Property.

Impact

There are two ways in which this budget proposal could be viewed at.  The optimistic view is that it relaxes the taxability for initial year and hence is beneficial in nature. 

However, on a flip side, it confirms the taxability under the head “Income from House Property” for unsold stock of real estate developers impacting the developers in a big way given the sluggish market environment.

Further, a million dollar question (whether intended or otherwise) that springs from the above proposal is whether rental income of the real estate developers is taxable as “Income from House Property” or as “Business Income”.

• Restriction on set-off of loss from House Property

A new proposal is introduced to provide restriction of set off of loss under the head house property against any other head of income to INR 2 lakhs.  The balance loss can be carried forward for set off in the subsequent years.

Impact

The above proposal is intended to curb mischief rule and curb tax planning.  It will adversely impact as it will restrict the set off of loss to INR 2 lakhs.  Even in the case of let out properties where there is no limit on deduction of interest on borrowed funds, the above amendment may act as a dampener to demand creation, as the tax shield arising due to interest on borrowings to purchase additional house would get restricted/ deferred. 

• Introduction of Thin Capitalization Provisions

At a juncture where the sector is facing financial crunch and has been raising leverage funds from overseas, the proposal to introduce Thin Capitalization provisions is not a right proposition.  These provisions will restrict the allowability of interest expenditure (exceeding INR 1 crore) payable to non-resident associated enterprises to 30 percent of EBITDA.  The disallowed interest can be carried forward for eight assessment years and deduction shall be allowed in subsequent years subject to the maximum allowable interest expenditure

Impact

Considering the fact that the real estate developers need huge funds for their projects and equity cum NCDs from overseas have been a major mode of funding in the recent past, the said proposal will hamper the momentum.  The impact will be more in the initial years when the EBITDA could be negative or minimal given the accounting policy for revenue recognition.

Though the intention is to restrict the interest deduction to non-resident associated enterprise, interest payments will also get restricted to some extent, given the EBITDA benchmark being applied.

Summing up

The Budget 2017 has several proposals which would provide the desired impetus to the real estate and infrastructure sector, but the sector certainly expected more. 

Importantly, from the point of view of individual tax payers, several asks such as increase in the limit of deduction for interest on housing loan, increase in the limit of deduction under section 80C for principal repayment of housing loans, etc. remained unfulfilled.  A benefit of doubt can be given to the Finance Minister in this regard who could not have been in the position to provide above benefits, considering the overall Fiscal Deficit target.

From the perspective of developers, non-removal of deemed taxation applying stamp duty valuation under section 43CA and section 50C, disallowance of interest applying section 14A, introduction of Thin Capitalization provisions, taxability of unsold stock on notional basis, non-granting of MAT exemption to affordable housing projects, excluding other taxpayers from the scheme of JDA taxation, etc. are few major misses. 

On an overall basis, Budget 2017 is a sincere attempt on part of the FM to resolve some of the issues faced by the sector.  Certainly, there exists areas which missed FM's attention as there is so much which could have been done.  The sector hopes that it would continue to enjoy favourable attention of the FM and some of the unfinished agenda will get addressed in the forthcoming budgets.

Priya Narayanan (Senior Manager), Deloitte Haskins & Sells LLP
Another BEPS recommendation finds its way in the domestic tax law

Budget 2016 saw three Base Erosion & Profit Shifting (“BEPS”) recommendations finding its way into our domestic tax law. One, introduction of a new levy called Equalisation Levy on certain digital transactions; two, introduction of a lower tax rate for income from patents; and three, the country-by-country (cBc) reporting for Transfer Pricing.

This year, one more BEPS recommendation has been implemented: one relating to Thin Capitalization Rules. These rules are not totally new in the Indian tax landscape - there was a proposal to revamp the direct tax law a few years ago. The revamped law, which would have been called as “Direct Taxes Code” (“DTC”) had proposed the introduction of a similar set of rules. While DTC was not enacted, speculations were high that this could very well be introduced sooner or later in the current tax law itself.  

What is in store?

The Finance Bill Budget 2017 tabled by the Finance Minister on 1 February 2017, proposes a new provision called “Limitation on interest deduction in certain cases” in the Act. This provision sets the norms according to which an Indian company or a Permanent Establishment (PE) of a foreign company will be eligible to claim a deduction of the interest expenses against its taxable income. The key highlights are:

-          Applies only if the interest charge claimed exceeds one crore rupees;

-          Restricts claim on interest costs; 

-          Applies to interest costs or similar consideration in respect of debts issued by a non-resident;

-          The non-resident should be an associated enterprise of the borrower;

-          Interest will be tax deductible only to the extent of 30% of earnings before interest, taxes, depreciation and amortization (EBITDA) of the borrower;

-          Any interest in excess of the above (termed as “excess interest”) will be allowed to be carried forward for eight assessment years immediately succeeding the assessment year for which the excess interest expenditure was first computed.

It is interesting to note that guarantee and back-to-back deposit-loan (by extending the line of credit against an overseas deposit) arrangements are covered. That is, if an overseas parent extends a guarantee on behalf of the Indian subsidiary to a third party lender (say, a bank), then such interest costs will also be covered by the new provisions. Another case is where the overseas parent deposits funds with an overseas lender who in turn requests the latter's Indian arm under a line of credit to extend the loan to the Indian subsidiary. 

How does this compare with the BEPS Action 4 report?

BEPS Action Plan 4: Limiting Bases Erosion involving Interest Deductions and Other Financial Payments issued by the Organisation for Economic Cooperation and Development (OECD), discusses the risks in this area that may arise. This is explained in three basic scenarios:

-          Groups placing higher levels of third party debt, in high tax countries;

-          Groups using intra-group loans to generate interest deductions in excess of the group's actual third party interest expense;

-          Groups using third party or intragroup financing to fund the generation of tax exempt income.

In order to pose lower BEPS related risks relating to the above, the recommendations which were issued in the form of best practices and the comparative implementation in Budget 2017 is provided below:

The Government's proposal is largely in line with the best practices issued in the BEPS Action Plan 4, which is heartening to know. 

What are the potential issues that can arise?

Applying these rules for the first time could give some ambiguity on the computation mechanism. Some of the issues that could arise are:

1. Exchange control regulations in India prescribe a debt-equity ratio for External Commercial Borrowings. Now, the income-tax law does not really prescribe the appropriate ratio but merely restricts the interest deductibility.  
2. There could be cases where a company has incurred huge operating losses. This could result in a negative cash flow for the company. Under the current scenario entities which incur losses will also be required to make this adjustment.
3. The restriction applies to interest or similar consideration in respect of debt. The term “similar consideration” is not defined. So in computing the threshold, should one take only the interest costs and other costs paid to the lender or can items such as finance charges also be covered.
4. From a plain reading of the Act, any payment of interest or similar consideration will be reviewed for the threshold/fixed ratio rule. If a Company has borrowed the sum for funding its capital expenditure and the interest element is capitalized, technically, should the 30% be computed in proportion to the depreciation claimed and not the cash outflow from the company to the non-resident?
5. The computation mechanism for the “excess interest” indicates total interest paid or payable in excess of thirty percent will not be deductible. While a doubt could arise as to whether all interest expenses (including that paid to non-associated enterprises) should be included, the Memorandum to the Finance Bill suggests the computation applies only to interest charges paid/payable to associated enterprises. 
6. Let's take another example - where a transaction is entered into by an Indian borrower company with a third party lender which is guaranteed by the overseas parent, then such transaction is deemed to be a debt issued by an associated enterprise. Under this scenario, the question would be whether the guarantee commission payments will be reviewed in arriving at the threshold/fixed ratio rule. Particularly, since the guarantee commission transaction is not a debt under the new provisions. 
7. The exclusion sectors are Banks and Insurance companies. However, there could be other financial institutions which could have huge interest costs. These rules could have a significant impact on such entities. 
8.  Clarity may also be needed on the exchange rate that should be adopted for arriving at the 30% deduction on foreign currency denominated loans. 
9. With General Anti-Avoidance Rules (“GAAR”) coming into force, a doubt may arise as to whether these transactions will be reviewed again under the GAAR provisions. The recent clarification issued by the Central Board of Direct Taxes (CBDT) indicates that transactions will be reviewed under GAAR for aspects which are not explicitly covered in Specific Anti-Avoidance Rule (SAAR). In light of this, should loan arrangements with associated enterprises be reviewed under GAAR as well?

With implementation of GAAR, Place of Effective Management Provisions, now the Thin Capitalisation provisions, the focus seems to be shifting to a “substance over form” approach. It is probable that, like the other regulations, the Government will issue clarifications/guidelines to bring clarity to the taxpayers.

The views in the article are personal views of the authors.

Budget 2017 - Hits and Misses

There is little doubt that India is at a sweet spot given the global economic climate. Globally India is expected to continue to enjoy strong growth, reduced inflation, healthy foreign exchange reserves, lower current account deficit while admirably observing fiscal prudence. This Budget brings with it a fairly clear mandate to provide a thrust to primarily agriculture, rural populous, the poor, youth, infrastructure and affordable housing.
There are quite a few optimistic takeaways in Budget 2017. The major hits are as under:
HITS
►    Tax rates for companies having turnover less than INR 50 crores has been slashed to 25%. This comes as a huge relief for MSME's who were most affected by demonetisation. This is expected to make MSME's more competitive.
►    Earlier, there was no specific provisions for taxing carbon credits. There was also no real certainty as to the nature/ classification of the income thereby leading to uncertainty in taxability and unwarranted litigation. The introduction of new provision taxing income @ 10% gives certainty and clarity on it's taxability.
►    The Finance Minister highlighted his plan to boost foreign investment - liberalise the FDI Policy and phase out the Foreign Investment Promotion Board. This too, is set to pave the way for a different, more liberal FDI regime.
►    Budget 2017 brought with it a new provision with regard to interest to deductor on excess tax withheld. The issue was dealt with by the Supreme Court and by the CBDT vide Circular 11/ 2016. It is great to see legislating what the Supreme Court held and what it said vide above circular.
►    The indirect transfer provisions introduced in Budget 2012 required several clarifications. Budget 2017 provides that transfer of investments made by non-residents in FIIs/ FPIs of Category I & II, would not be treated as indirect transfer with retrospective effect. This is sure to bring some cheer among the FIIs.
►    Introduction of provisions which restrict political parties from accepting contributions in excess of INR 2,000 brings about transparency in political funding.
►    Payment made to related parties covered under section 40A(2) of the Act has been withdrawn from the ambit of specified domestic transaction. This will certainly bring some relief to domestic taxpayers on compliance with Domestic TP provisions.
On the flipside, India Inc. would have expected several things to change - some of which have changed for the better, while some have still been missed. We have a few key misses below:
MISSES
►    The Budget brought with it disallowance of depreciation on capital expenditure and non-availability of investment linked deductions in cases where such capital expenditure is incurred in cash above the threshold of INR 10,000. Given the practical realities of doing business in India, this may certainly serve as a set-back. Further, considering that the depreciation rates have been capped at 40% maximum, there is already enough disparity in recognising depreciation as an effective tax deduction.
►    The Income Computation Disclosure Standards ('ICDS') are a bottleneck to the Government's theme of ease of doing business and achieving certainty. Not only it is resulting in increased compliance costs and multiple accounting systems with introduction of IND-AS, it also causes multiple interpretations of tax rules and business laws. Justice R V Easwar led panel on tax simplification have also echoed similar views. Although application of ICDS has not been deferred as expected, announcement in the Budget to address some of the concerns raised regarding ICDS would have been welcomed.
►    The final guidelines on Place of Effective Management ('POEM') were issued only on 24 January 2017 while the law was clear that it would apply in FY 2016-17.This has left very little time to ensure compliance. It would have been more appropriate to apply POEM only from FY 2017-18 onwards.
►    While Action plan 4 of the BEPS initiative of the OECD prescribes rules on thin capitalisation, in a certain sense, they may not be viable from an India perspective. Prior to considering such a law, one should consider the form of investment by MNC's in India. Given the competitive global investment climate it is well-appreciated that FDI can sometimes become hard to attract. Further interest pay-outs on External Commercial Borrowings ('ECB') are already subjected to transfer pricing and taxed under the Act/ relevant tax treaties. Hence, providing a deduction for the same was only fair. Also India already has sufficient checks and balances in the guidelines for interest pay-outs on ECB's.
►    The Supreme Court of India in the case of Yokogawa, ruled that in case of multiple units, profits made by an entity from a section 10AA unit needs to be considered separately for the purpose of eligible deduction. Budget 2017 now proposes a deduction of lower of the total profit of the entity or the profit made by the 10AA unit. This provision seeks to go beyond the observations and views of the Supreme Court.
►    One of the Prime Minister's pet projects, Make in India has been much-ignored in Budget 2017. The past year saw India upgrade its ranking from 9^th to 6^th largest manufacturer globally. However, given that there is still some bandwidth and potential as well as a corresponding need to generate employment, it was crucial to provide the space with adequate tax sops. One of the measures could have been to extend the deduction under section 35(2AB) in sectors such as defence, solar energy, etc.
►    The Government has introduced sunset clauses limiting deduction w.e.f. FY 2017-18 onwards like section 35AC, 35(2AB) to 150% from 200% for all companies, however, tax rates for large corporates have been left unchanged. Budget 2016 while withdrawing several incentives had promised road map to reduce the corporate tax rate from 30% to 25%. However Budget 2017 continues to offer limited relief thereby defying expectations of large corporates and LLPs. Further, little relief on MAT and widening additional tax on dividends makes India less competitive vis-à-vis other developing countries.
►    Patent box regime introduced in Budget 2016 had a restrictive scope in providing the benefit of lower rate of tax on royalty income derived from patents developed and registered in India. It would have been great to see the scope of these provisions broadened, to cover royalty income from other intangibles such as trade mark, copy rights etc. to give a boost to manufacturing and research in India.
This was a great opportunity for the FM to provide much needed relief to make India Inc. competitive and to attract new business into India. Sustained growth and new jobs need innovative tax policy and one hopes we will see more changes in the final law to address at least some of the above.
Vipul Soni and Hersh Sayta, senior tax professionals at EY also contributed to this article.

Direct-tax proposals - Devil lies in the fine-print!

Like every year, amidst a heap of expectations, hopes, some rumors and some jitters, the Finance Minister laid the Finance Bill 2017 before the Parliament on February 1, 2017. As far as Direct Tax proposals are concerned, while the Budget speech seemed a bit tranquilized, there is a lot to ponder about when one goes through the fine print. As they say, the Devil lies in the detail. Let us see some of the details in the proposed amendments and more importantly the potential implications:

1. 25% tax on companies with turnover upto Rs. 50 crores

The Bill proposes to reduce the tax rate from 30% to 25% for companies with turnover upto Rs. 50 crores. Interestingly, to claim this lower rate of tax in AY 2018-19, the turnover is to be measured for FY 2015-16 - i.e. a gap of 3 years.

It is to be kept in mind that the reduced rate applies only to companies and not to firms / LLPs / proprietorship etc. This does deviate from a level playing field in some sense and will prompt smaller businesses to get back to the drawing board as to which is the best form of entity to be adopted. Several private limited companies have been converting themselves into LLP, who may be a bit dreary to note that they cannot take the benefit of this rate reduction. Having said that, while the tax rate for firms / LLPs remain 30% even for smaller businesses, the non-applicability of MAT and DDT is still a benefit that needs to be weighed while making a choice between company and LLP.

Whether companies use any means of splitting up to take advantage of threshold of Rs. 50 crores is anybody's guess. Remember, any such thinking would now need to cross the bridge of GAAR which is now applicable from April 1, 2017.

2. Relaxation in Deduction u/s 80-IBA for affordable housing

A welcome move of providing certain relaxations in the conditions for claiming deduction u/s 80-IBA for affordable housing. This includes an extension for completing the project from existing 3 years to 5 years. The amendment will however kick-in only from AY 18-19. It seems that the project owners who have already taken an approval from the competent authority may miss the benefit of some of these relaxations which would be a bit unfair. Also, it may deter project owners to seek any new approvals till the end of March 2017 in order to take the benefit of the relaxed provisions. A retrospective amendment would have perhaps bought a lot more cheer.

3. TCS on sale of jewellery

Currently TCS is applicable in case of cash sale of bullion, jewellery and other goods. The Bill proposes to remove jewellery from the TCS net, however the fine print suggests that jewellery could still get covered in 'other goods'. Clarification on this would be desirable.

4. Transfer pricing - Secondary adjustment

The Bill proposes that a secondary TP adjustment should be made in specified cases over and above the primary adjustment. While generally such amendments should be prospective in nature; a technical reading of the provision suggests that secondary adjustments could apply to prior years also if the primary adjustment is more than Rs. 1 crore.

5. LTCG exemption for listed shares

Long term capital gain on sale of listed shares is currently exempt provided the 'sale' of shares is chargeable to STT. It is proposed that the exemption will be available only if the 'acquisition' of shares is also chargeable to STT. While the amendment is technically prospective in nature, there are no grandfathering provisions for shares acquired till date which effectively makes the provision partly retrospective. This may prompt certain investors to sell their shareholdings on or before March 31, 2017 in cases where STT was not applicable on acquisition to avoid any potential tax challenges next year.

6. Cap on interest payments to foreign AE

In line with the BEPS Action Plan, the Bill proposes to restrict allowability of interest above Rs 1 crore paid by an Indian company to a Foreign AE upto 30% of EBITDA of the Indian company. This may create hardships for Indian companies especially in the years in which they have losses or low profits. Cases of interest payment which are spread over more than one AE seem to better placed based on a technical reading. Again, there are no grandfathering provisions for debt structures already in place.

7. Cash transactions above Rs. 3 lakhs

To promote a less cash economy, in line with the expectations, the Budget proposes to levy stringent penalties on persons receiving cash above Rs. 3 lakhs. Whether withdrawal of cash from a bank would also get covered in these provisions may need to be clarified. Currently, only receipts by Government and banking companies are exempted from these provisions. It remains to be seen if the Government exempts any further categories e.g. hospitals.

8. TDS on rent payments by individuals

The Bill has introduced TDS @ 5% for rent payments above Rs. 50,000 per month by individuals/HUF not subjected to Tax audit. This will impact high salaried class people claiming benefit of House Rent Allowance (HRA).

9. 10% tax on dividend in excess of Rs. 10 lakhs extended to all assessees

The 10% dividend tax for dividends received in excess of Rs. 10 lakhs is now extended to all assessees. Earlier, dividend receipt structured through a Family Trust / AOP were potentially exempt.

10. Tax on notional rent income for property held as stock in trade

There was a continuing controversy on taxability of unsold inventory of flats in the real estate sector. A court judgment had held that this should be taxed on notional basis under 'deemed to let out' provisions. The amendment now confirms this position, albeit with a relief of 1 year from the end of FY of project completion till which time the taxability wont trigger. The amendment would possibly deter the developers from holding on to the unsold flats for a longer period and prompt them to clear their inventories at suitable prices wherever possible within the said 1 year.

11. Power to Tax Department to question income upto 10 years ago in search/seizure cases

Another path-breaking change which did not find any mention in the Budget speech is that the Tax Department is now specifically empowered to issue notice for an assessment year upto the 10^th assessment year (currently they can go upto 6years). This will certainly pose a challenge to assessees in maintaining documentation upto 10 years which they may currently not have.

12. Power to AO to delay tax refund

In an interesting amendment, the AO is given the power to hold back the refund of tax due to an assessee under Section 143(1) till the completion of assessment if the AO is of the 'opinion' that grant of refund may adversely affect the recovery of revenue. Previous approval of Pr.CIT/CIT is, however, a must. Only time will tell whether such power would be exercised frequently or only in extreme circumstances.

Concluding remarks

Tax proposals in Annual Budgets over the years have consistently given the tax payers something to think about and thrown up some interesting challenges that needed some level of gearing up. This Budget has not disappointed in maintaining the consistency and perhaps the other side will also not disappoint in living up to the new challenges.

Banks, FI's and NBFCs - Time to revaluate Cenvat Reversal position!

Though the Finance Minister Mr. Jaitely presented few Indirect tax proposals in the Union Budget 2017, in the wake of upcoming GST law, there is a key change proposed which has ramifications for the Banking and Financial Services Industry from the Credit availment perspective.

The Amendment

Rule 6(1) ofCENVAT Credit Rules, 2004 (CCR) mandates a manufacturer or a service provider to reverse the CENVAT credit pertaining to exempted goods or services.

Earlier, this year on 1 April 2016, the government had redrafted the Rule 6 of CCR vide Union Budget 2016 with an intent of simplification and rationalisation of credit reversal provisions. One of such change, was providing an option to the Banking and Financial Institution (including NBFCs), to reverse the CENVAT credit on actual / proportionate basis as per sub rules (1), (2) and (3) to Rule 6 (3) of CCR instead of mandatory ad-hoc reversal @ 50% of CENVAT Credit.

Thus, the amended scenario provided an opportunity to ascertain the most beneficial option for reversal of the CENVAT credit which is used for exempted activities from the following prescribed alternatives:

-          Rule 6(3) of CCR: Pay amount equal to 6% of value of the exempted goods and 7% of value of exempted services subject to maximum of Cenvat credit available as opening balance
-          Rule 6(3A) of CCR: Determined the amount required to be paid as per the proportionate reversal method prescribed under the said rule which is derived based on the value of exempted to total goods and services provided
-          Rule 6 (3B) of CCR: Pay / Reverse every month an amount equal to adhoc 50% of CENVAT Credit availed in that month
 
Here, as an Explanation to the said Rule, the term 'Value' for the purpose of Rule 6(3) and (3A) of CCR has been defined. Further, clause (e) of the Explanation stated that the term 'Value' would not include the value of services by way of extending deposits, loan or advances in so far as the consideration is represented by way of interest or discount.  This was from the intent that companies / industry other than the Financial services sector should not reverse credit due to interest / discount income- if any in their profit and loss account.  
 
Given this, while calculating the reversals of CENVAT credit as per Rule 6(3) and (3A), the Banking and Financial Institutions (incl. NBFCs), were not required to include value of interest or discount received against loans, advances or deposits - which became beneficial to those Banking companies / FI's and NBFC's which had huge income as interest / deposits.
 
To rationalise this anomaly, in Union Budget 2017 w.e.f February 2, 2017 a proviso got introduced under clause (e) to 'Explanation I' which is follows:
“Provided that this clause shall not apply to a banking company and a financial institution including a non-banking financial company, engaged in providing services by way of extending deposits, loans or advances.”
 
Thus, the Banking or Financial Institution, who have opted for option of Rule 6(3)/ Rule 6(3A) would now require to include their interest or deposit income in the value of exempted as well as total services rendered while computing the CENVAT credit reversal amount.
 
To bring in clarity on the proposed amendment, a numerical example is illustrated below: 
-          An assessee engaged in the business of banking company/ financial institution/ NBFC has availed total CENVAT Credit of INR 1 lac.
-          Total turnover is INR 10 lacs out which interest income is INR 5 lacs, other exempt income is 2 lacs and balance 3 lacs is towards taxable services.
-          In such scenario reversal of credit shall be computed as follows:

The Impact
 
While the said amendment, is likely to impact the credit availment mechanism of all banking companies, financial institutions including NFBCs, the companies which are having substantial interest and discount revenues from loans, advances and deposit would be especially impacted if they have already availed the option Rule 6 (3) and Rule 6 (3A), as their reversal amount as per the new amended provisions could be huge.
 
Also, given the fact that the said amendment is notified with effect from February 2, 2017, it has lead to many unanswered questions.
 
For instance, -
-          Whether such amendment be applicable retrospectively since the same is introduced by way of proviso to an explanation?
-          If the company has already opted for Rule 6(3) and Rule 6(3A), whether they would required to re-compute the reversal ratio?
-          Effect on assessee who have availed Option 1 for FY 2016-17 and filed intimation with department? If they have already submitted a letter intimating the reversal ratio to the department for full year of 2016-2017, whether they need to re-submit this letter with the revised ratio?
-          In case the if the amendment is applicable prospectively, the reversal would be required to be made for the month of February 2017 and March 2017
-          Will there be an option to the company to now switch to Rule 6(3B) for the FY 16-17, instead of following Rule 6(3) or Rule 6(3A)? Or, since technically once the option is adopted the same cannot be changed during the financial year, then Companies would be mandated to follow Rule 6(3) and Rule 6(3A) method?
 
Another interesting aspect could be whether, the authorities can contend that this amendment is clarificatory in nature and the intent of the legislature was always to include such interest or discount revenues in the reversal calculation? This may lead to authorities alleging that the Companies have done short reversals of credit and accordingly are liable to pay interest and penalty on short reversals done during the year?
 
Next steps
 
The Banking Company and financial institution (including NBFC) who has availed Rule 6(3) and Rule 6(3A) of the CENVAT Credit Rule need to revaluate their CENVAT Credit reversal ratios and the CENVAT Credit reversal amounts based on the new proviso. Also, the CENVAT Credit position for the next fiscal year to be evaluated by such Companies to identify the most preferred option.
 
It is expected that the department may issue some clarification on how the proviso would be applied to the CENVAT Credit availed for FY 16-17 by the companies and suitably provide some mechanism / relief so that the industry is not adversely affected by this new amendment.
 
The article has been co-authored by Ms. Priyanka Naik, Senior Manager.

Finance Bill 2017 - Minimum Alternate Tax Implications for Ind AS compliant companies

1.         April 1, 2016 marks a paradigm shift in the way Indian corporate entities present and maintain their financial and accounting statements. With effect from this date, Companies (Accounting Standards) Rules 2015 issued under section 133 of Companies Act 2013 ["CA 2013"] mandated phased transition to Indian Accounting Standards ["Ind AS"]. Ind ASs are based on International Financial Reporting Standards and International Accounting Standards ["IFRS" & "IAS"]. IFRSs and IASs being FMV and MTM driven ["Fair Market Value" & "Mark to Market"], there was an apparent nervousness and anxiety in the minds of the CFOs/CEO's/Board of Directors, all being used to historical cost conventions, as to the impact of this, metaphorically speaking, tectonic event on their book profits. And ex-consequenti, impact on their Minimum Alternate Tax ["MAT"] liability under section 115 JB of Income Tax Act [“IT Act”]. 

2.        The seminal reason for this anxiety is traceable to unrealized and notional gains/losses represented by following components of "Other Comprehensive Income" ["OCI"], being item XIV of Part II of Schedule III of CA 2013: 

(i)         changes in revaluation surplus (Ind AS 16, Property, Plant and Equipment and Ind AS 38, Intangible Assets);

(ii)        re-measurements of defined benefit plans ( Ind AS 19, Employee Benefits); 

(iii)       gains and losses arising from translating the financial statements of a foreign operation ( Ind AS 21, The Effects of Changes in Foreign Exchange Rates);

(iv)       gains and losses from investments in equity instruments designated at fair value through other comprehensive income in accordance with paragraph 5.7.5 of Ind AS 109, Financial Instruments;

(v)        gains and losses on financial assets measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A of Ind AS 109.

(vi)       the effective portion of gains and losses on hedging instruments in a cash flow hedge and the gains and losses on hedging instruments that hedge investments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph 5.7.5 of Ind AS 109 ( Chapter 6 of Ind AS 109);

(vii)      for particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liability's credit risk (paragraph 5.7.7 of Ind AS 109);

(viii)     changes in the value of the time value of options when separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the changes in the intrinsic value (Chapter 6 of Ind AS 109);

(ix)       changes in the value of the forward elements of forward contracts when separating the forward element and spot element of a forward contract and designating as the hedging instrument only the changes in the spot element, and changes in the value of the foreign currency basis spread of a financial instrument when excluding it from the designation of that financial instrument as the hedging instrument (Chapter 6 of Ind AS 109).

3.        At the time of settlement/realization/transfers, some of these unrealized gains/losses are subject to Re-classification from OCI section to Profit & Loss Account section, while others are not. They are directly transferred to appropriate sub-head being part of owners' equity. To illustrate the point, the paras below provide some examples of where Re-classification happens and where it does not.

3.1       Reclassification adjustments happen on disposal of a foreign operation (Ind AS 21) and when some hedged forecast cash flow affect profit or loss (paragraph 6.5.11(d) of Ind AS109 in relation to cash flow hedges).

3.2       Reclassification Adjustments do not happen on changes in revaluation surplus recognized in accordance with Ind AS 16 or Ind AS 38 or on re-measurement of defined benefit plans recognised in accordance with Ind AS 19. These components are recognised in OCI and are not reclassified to profit or loss in same or subsequent periods. Changes in revaluation surplus may be transferred to retained earnings in subsequent periods as the asset is used or when it is derecognised (Ind AS 16 and Ind AS 38). In accordance with Ind AS 109, reclassification adjustments do not arise if a cash flow hedge or the accounting for the time value of an option (or the forward element of a forward contract or the foreign currency basis spread of a financial instrument) result in amounts that are removed from the cash flow hedge reserve or a separate component of equity, respectively, and included directly in the initial cost or other carrying amount of an asset or a liability. These amounts are directly transferred to assets or liabilities.

4.         At this stage it is important to remember certain settled key principles of taxation under income tax law.

(i)         In the present context, income is taxable on "accrual" basis, as that this the mandatory basis prescribed for corporates to maintain their books of accounts.

(ii)        Accrual basis of recording income and recognising expenditure means: (a) present right to receive income (b) present obligation to discharge a liability and (c) reasonable probability that on the due date income will be received or liability will be discharged.

(iii)       Under accrual basis, though actual receipt /actual payment are not the conditions precedent for recognizing income/expenditure, yet there is a well-recognized distinction between accrued income/expense versus hypothetical/notional  receipt/expense [Supreme Court in Godhra Electricity (1997) 225 ITR 746). The point is FMV/MTM accounting is largely one-sided. These are management's best estimates of probability of the values of income likely to be received/expenditure to be discharged in the light of available circumstances. If there is material change in circumstances, management is obliged to revise the estimates in the light of changed circumstances.

(iv)       MAT also being a tax on income, it has to follow the basic principles of a valid tax levy. Just to illustrate, Legislature has the freedom to choose the measure on which tax is levied. In case of presumptive tax, a fixed percentage of gross receipts is charged to tax, ie gross receipts is the measure of tax. Under normal provisions of Income Tax Act, Total Income as defined in section 2(45) of IT Act is the measure for levying tax. In case of MAT, book profit as modified by specified adjustments prescribed in Explanation to section 115 JB is the measure of tax. In other words, measure of tax does not change the character of tax.

(v)        Therefore, as a matter of law, there was always a valid justification in law that unrealized/notional gains/losses comprised in OCI should be excluded for computing the base figure on which MAT could be levied.

(vi)       Further, the fundamental basis of MAT is that a company rewarding shareholders by handsome dividends but not paying any tax because of incentive exemptions/deductions available under IT Act should also contribute some tax to the exchequer. Under CA 2013, dividends can be distributed only out of "Free Reserves" [section 2 (43)]. And Free Reserves exclude all unrealized/ notional gains/ losses. The point to be emphasized is, looking to the nexus between Dividend distribution and MAT payment, if a company is prohibited by law to distribute dividends out of unrealized /notional gains, as a corollary it would be unreasonable to expect the company to pay income tax in the shape of MAT on the very same unrealized/notional gains/losses.

5.        It appears that the principles enumerated in para 4 above have largely guided the Legislature as Section 115 JB as proposed to be amended by Finance Bill 2017["FB 2017"], prescribes the following treatment for these notional/unrealized gains/losses arising as a direct consequence of transition to Ind AS, for MAT purposes:

5.1       In the Year of Transition to Ind AS:

5.2       Years Subsequent to transition:

6.         In simple terms, the principles followed by FB 2017 can be stated as under:

6.1       Components of OCI, that WILL BE subject to subsequent re-classification to Profit & Loss account, are to be totally ignored from the ambit of 115 JB in the year of transition.

6.2       Following components of OCI, that WILL NOT be subject to subsequent re-classification to Profit & Loss account, will also be out of the ambit of 115 JB in the year of convergence:

(i)         Revaluation surplus as per Ind AS 16 and Ind AS 38 [PPE & Intangible Assets]

(ii)        FMV of investments in equity instruments as per Ind AS 109

(iii)       Cumulative translation differences of foreign operation as per paragraph D13 of Ind AS 101

7.         What comes out loud and clear is: while all gains /losses subsequently re-classifiable to Profit & Loss Account have been kept out of the ambit of MAT in the year of transition, a very significant quantum of unrealized/notional gains included in OCI and directly transferred to equity [ie not re-classifiable to Profit & Loss Account], are also out of the ambit of section 115 JB, till the year of disposal/retirement/transfer of the relevant asset.

8.         This leaves some residuary adjustments at the time of transition to Ind AS, which are to be spread over a period of 5 years for MAT purposes. It may be emphasized that these residuary adjustments to be considered for MAT purpose should not be very significant in value terms as compared to items kept out of the ambit of MAT.

9.         To summarize, this policy decision of the Legislature largely insulates the tax-payers from the litigation hazards/ misery of the after-effects of the tectonic event mentioned at Para 1 above.

[The views expressed here are personal. AZB & Partners may not subscribe to them]

Individual taxpayers: Short-changed by Budget 2017?

Expectations of individuals from Budget 2017

The Indian Union Budget 2017 was awaited with bated breathe across various sections of society particularly the middle class salaried society and small and medium businessmen expecting substantial tax benefits in light of the anticipated windfall of the Government on account of the demonetisation and also the pain undergone by the common man.  Amongst others, the middle class individual taxpayers who bear a significant burden of taxation on their salary incomes expected significant personal income-tax reliefs in the form of increase in tax slabs or reduction in tax rates or introduction of standard deduction from their salary income. The individual tax payers had also expected increase in limit of deduction under section 80C from INR 1.5 lacs to at least INR 2 lacs.

However, to this extent, the Budget 2017 announced by the Honourable Finance Minister on
1 February 2017 failed to live up to these expectations. The Government's action of reducing tax rates in the lowest tax slab would mainly appease only the lower middle class of individuals. This is because the base income-tax savings for individual taxpayers is INR 12,500, which in today's times is meagre and immaterial.

Limit on setting of loss from 'income from house property'

In fact individual taxpayers were also expecting further relief by way of increasing the allowance limit of INR 200,000 for payment of housing loan interest. While no such relief was granted, the Budget unpleasantly surprised individual taxpayers by limiting set-off of loss from house property (whether self-occupied, let-out or deemed to be let-out) against other income to
INR 200,000 only. The excess loss, if any, has to be carried forward to subsequent assessment year not exceeding 8 assessment years. While justifying the amendment, the Government has stated that it is following best international practices.

However, this move is not in the interest of Indian society at large where purchasing a house is the need of the hour and the government itself is committed to provide house to all. In fact, this move is a big disappointment and dampener for honest taxpayers who borrow money for purchasing houses and are already saddled with high interest payments on account of expensive real estate valuations.

To put the matter into perspective, the extant and proposed provisions for set-off of loss under the head 'Income from House Property' against other income are as under:

Accordingly, since the higher limit of INR 200,000 was already provided in case of self-occupied houses, this further restriction for total loss seems to be targeted at cases of let-out or deemed to be let-out properties.

One may argue that this is a desirable provision which is introduced to tackle issues of hoarding of houses / tax planning by wealthy individuals, who make housing unaffordable for the middle class and lower middle class. This is because the multiple properties of such individuals are often treated as 'deemed to be let-out' i.e. properties which are extra houses used for self-occupation but treated as let-out for notional income purposes. At times, such individuals use these extra houses for tax planning purposes by reducing the high interest costs of such houses against their other income. However, the intention of such amendment may fail where wealthy individuals do not borrow money to purchase multiple properties, which is largely the case.

In fact, to the contrary, this provision would negatively impact the following cases:

1. Genuine cases where the property is let-out, but because the interest costs are higher than the rent received, there is loss arising to the taxpayer. Such loss in excess of INR 200,000 will now not be eligible for setting off against other income in the year of loss. Permitting such excess loss to be carried forward and set-off in the subsequent 8 years against income from house property may be fruitless considering that the annual interest cost itself would be resulting in a loss. In fact, the opportunity of setting off brought forward loss in the next 8 years may never arise considering that home loans in India are mainly for tenures of 15/20/30 years.

2. The additional properties are purchased by the middle class individuals to channelize their savings and create wealth and in the process also take tax advantage of interest payment.  Due to this amendment, the attractiveness for the middle class to purchase / hold property with high interest costs may reduce significantly. As an outcome, it is possible that there could be either fore-closure of home loans by way of advance payment of loans or selling of the property to a buyer who probably does not need a home loan. In either case, banks which are desperate to increase lending in light of the demonetisation would lose out.

3. If the attractiveness for the salaried class to purchase property reduces, the same will impact real estate sector as a whole which would not be desirable in the current times. The only part of real estate sector that could benefit would be the affordable housing sector which has received strong focus and backing of the Government. However, even affordable housing in metros generally result in high interest costs for borrowings (possibly in excess of INR 200,000 annually) on account of expensive real estate valuations. Accordingly, the benefit to affordable housing may also not be completely positive.

Burdening Individuals with withholding tax compliances

Another proposal which has not been met with enthusiasm by Individuals and Hindu Undivided Families (HUFs) (who are not required to undergo tax audit and hence are not required to undertake withholding tax compliances) is the requirement to deduct withholding tax of 5% and undertake compliances, in respect of payment of rent to a resident for land or building or both exceeding
INR 50,000 per month.

One relief is that such taxpayers would not be required to obtain Tax-deduction Account Number (TAN) and file withholding tax returns. Also, relief is provided by requiring tax to be withheld only at the time of payment of rent for the last month of the year or last month of tenancy (where tenancy expires during the year). Also, where landlord does not have a Permanent Account Number (PAN) and tax is to be deducted at higher rate of 20%, the amount of withholding tax would not exceed the amount of rent payable for the last month of the year or tenancy, as may be applicable.

The positive side of this amendment is that it would bring landlords not declaring their rental income for income-tax purposes in the tax net and also curb practice of salaried individuals in claiming fake tax deductions for House Rent Allowance (HRA).  However, there are some pain points created by these provisions which may need addressing, as explained below:

1. Firstly, compliance for individuals and HUFs will increase. Accordingly, any lapse on their part to discharge their obligation could result in tax, interest and penalty exposure for them. This could especially be a challenge for expatriates unaware of Indian tax laws.

2. If the landlord does not agree to bear the taxes, the entire cost may be passed on to the tenant.

3. Senior Citizens and very senior citizens relying on rental income for their living expenses and who may not be having taxable income (on account of 30% deduction for rental income and allowance of tax deduction under section 80C, etc.) would have to bear the burden of reduced cash flow and also of filing tax returns to claim their refunds. Their misery would be compounded by the fact that providing self-declaration in Form 15H for non-deduction of tax on their income has not been extended to the proposed section. Accordingly, the only possible option for such taxpayers would be to file an application with tax authorities for 'NIL' withholding tax - which by itself is a cumbersome process.

4. Lastly, there could be practical challenges to withhold tax at 5% of the total rent paid during the year in cases where:

-          landlord has a PAN but the rent actually payable in the last month on account of sudden termination of tenancy is lower than the withholding tax computed on the total rent paid for the entire year.

-          In the event of some disputes, landlord may adjust rent for last  few months from the security deposit provided at the time of taking property on rent. In such cases, the individual may have to request the landlord to refund money to the extent of withholding tax so that the compliance can be undertaken.

Our view

As can be seen from the above analysis, the proposed amendments could result in larger issues for individuals and the economy at large as compared to the benefit sought to be achieved through these provisions.

In our view, if at all required, the limit on set-off of loss should only be introduced in case of 'deemed to be let-out' properties where most tax planning measures are undertaken. Similarly, suitable relief may be provided for withholding tax compliances in case of rent payments either by way of amendment to provisions in the Finance Act or issue of relevant circulars / instructions.

If the Government does not take note of genuine cases and provide adequate relief, it is possible that the very middle class which has been whole heartedly supporting the Government may begin feeling short-changed by the Budget, especially in light of the comparatively beneficial tax reliefs provided to corporates!

Capital gains under JDA - Ushering in much needed clarity

As a measure for promoting Real Estate Sector, Finance Bill 2017 has brought in much needed amendment to the provisions of Section 45 regarding chargeability of capital gains in the case of joint development agreement entered into by an individual or Hindu Undivided Family (hereinafter referred to as the assessees).

Historical background:

Clause (v) in section 2(47) was introduced in the Income Tax Act from assessment year 1988-89 because prior thereto, in most cases the assessees used to enter into agreements for developing properties with the builders and under the arrangement with the builders, they used to confer privileges of ownership without executing conveyance. transferred by way of agreement to sale but these were not registered To plug in the loophole the clause (v) widened the scope of definition of 'transfer', whereby it brought within the sweep any arrangement or any transaction involving the allowing of possession of property to be taken over or retained in part-performance of a contract of the nature referred to in section 53A of the Transfer of Property Act. The said Section 53A requires following conditions to be fulfilled:

• there should be a contract in writing signed by the transferor;
• it should pertain to transfer of immovable property for a consideration
• the transferee should have taken possession of the property;
• the transferee should be ready and willing to perform his part of the contract.

The amendment to definition of transfer in Section 2(47) triggered the capital gains tax liability in the hands of the owner under the provisions of Section 45 of the Income Tax Act on execution of Joint Development Agreement (JDA) between the owner of property and the developer and in the year in which the possession of immovable property was handed over to the developer of property.

For the purpose of determining the actual date of transfer several intervening stages or events in the course of execution of JDA arrangement therefore required collective analysis and evaluation of their overall effect. The stages/events include date of entering into JDA, date of executing power of attorney authorising the developer for taking various approvals/permissions etc. and for sale of units to customers at his discretion, handing over the possession of the land to the developer for various purposes, receipt of part/full sale consideration from the developer, and transfer of developed units to the customers etc.

All these stages/events needed to be looked into for the purpose of determining the actual date of transfer of the property.

By application of 'doctrine of Legislation by Incorporation' the provisions of section 17(1A) of Registration Act, 1908, were required to be necessarily read into section 53A of Transfer of Property Act and thereafter these provisions were to be read into section 2(47)(v) so as to make complete reading of the law.

Punjab & Haryana High Court in C. S. Atwal v. CIT [TS-414-HC-2015(P & H)] held that the legal requirements of section 53A of Transfer of Property Act are required to be fulfilled so as to attract the provisions of section 2(47) (v) of the Income Tax Act and one of the main requirements in section 53 A being registration of the document as per the provisions of section 17(1A) of the Registration Act, 1908 the provisions of Section 2 (47) could be invoked thereafter.

It bears vital notice that subsequent to insertion of clause (v) in section 2(47), amendments were brought in the source legislation viz. section 53A as well as section 17(1A) and registration of the document became imperative to invoke provisions of section 2 (47) (v) by application of doctrine of incorporated legislation.

The ratio of decision of Honourable Bombay High Court in Chaturbhuj Dwarkadas Kapadia [TS-1-HC-2003(BOM)] delivered on 13^th February, 2003 needed reconsideration in the wake of drastic changes in the source legislation.

The proposed amendment to be inserted in section 45 is a welcome step bringing in the much needed clarity and certainty.

Proposed amendments:

The insertion of new sub section 5A seeks to provide that in case of an assessee being individual or Hindu undivided family, who enters into a specified agreement for development of a project, the capital gains shall be chargeable to income-tax as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority.

It is further proposed to provide that the stamp duty value of his share, being land or building or both, in the project on the date of issuing of said certificate of completion as increased by any monetary consideration received, shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.

It is also proposed to provide that benefit of this proposed regime shall not apply to an assessee who transfers his share in the project to any other person on or before the date of issue of said certificate of completion. It is also proposed to provide that in such a situation, the capital gains as determined under general provisions of the Act shall be deemed to be the income of the previous year in which such transfer took place and shall be computed as per provisions of the Act without taking into account this proposed provision.

It is also proposed to define the expressions "competent authority", "specified agreement" and "stamp duty value" for this purpose.

It is also proposed to make consequential amendment in section 49 so as to provide that the cost of acquisition of the share in the project being land or building or both, in the hands of the land owner shall be the amount which is deemed as full value of consideration under the said proposed provision.

These amendments will take effect from 1April, 2018 and will, accordingly, apply in relation to the assessment year 2018-19 and subsequent years.

It is also proposed to insert a new section 194-IC in the Act so as to provide that in case any monetary consideration is payable under the specified agreement, tax at the rate of ten per cent shall be deductible from such payment.

This amendment will take effect from 1st April, 2017.

[Clauses 22, 25 & 64] 

Tax proposals impacting M&A transactions - 'Substance' now the pivotal factor

The Finance Minister's budget speech for 2017 gave an impression of an “optimistic” budget, though it was the fine print which actually set the boat rocking for many!  While many of the anticipated amendments were not seen to be touched upon, the Finance Bill had some novel amendments including expanding scope of taxation of gifts, restricting tax exemption on long term capital gains on transfer of listed equity shares to only those shares which were acquired after paying STT, interest deduction limitation provisions, widening the net of super rich levy on dividend, secondary adjustments in transfer pricing, etc.

One of the thought-provoking amendment relates to inclusion of a new provision whereby capital gains tax is proposed to be levied on transfer of shares of a company other than quoted shares ('unquoted shares') based on deemed consideration which would be Fair Market Value ('FMV'). This amendment is primarily an anti-abuse measure.  

A reading of the Explanation in the proposed section implies that the proposed amendment applies also to shares of a listed company which are not regularly transacted. Subsidiary of any listed company and foreign company will also fall within the ambit of this new section.

However, it is unlikely that transactions which are exempt e.g. transfer between holding subsidiaries, gifts etc will be impacted.

The current law has some provisions where certain value is deemed to be full value of consideration e.g. stamp duty value for transfer of immovable property in certain cases, value recorded in the books of the partnership firm on capital contribution by partner, etc. However, from the perspective of taxation of capital gains on transfer of shares, it was always prerogative of the parties to the transaction to decide the consideration for transfer. This principle was also upheld by various judicial authorities.  

On account of the proposed amendment, there will be tax outgo for the transferor if un-quoted shares are transferred at value which is less than the FMV of such shares. This will pose challenge to many taxpayers especially those undertaking any internal re-organisation or family arrangement. Nevertheless one may have to wait for the rules to understand whether the FMV will be based on book value or the actual fair value as determined by valuer or something else. Further, recipient of the share may also suffer taxation given widening of scope of taxation of specified gifts.  

Notably, the proposed amendment is different from an existing provision where if consideration is unascertainable, there is a FMV deeming fiction; whereas the proposed amendment is applicable where ascertained consideration is less than prescribed FMV.

Every Budget we see certain amendments which are in the nature of clarifications. The 2017 budget has clarified that conversion of preference shares to equity shares is a tax neutral transfer. Consequential amendments are also proposed with respect to cost of acquisition and period of holding for the equity shares to be same as that of preference shares.

Under the current law, conversion of security from one form to another is regarded as transfer for the purpose of levy of capital gains tax. However, tax neutrality is provided for conversion of bond or debenture of a company to share or debenture of that company. Similar tax neutrality is not expressly stipulated for conversion of preference share of a company into its equity share.  

While this is a longed-for clarification, many taxpayers, always argued that conversion of preference share of a company into its equity share shall not be regarded as transfer based on, inter alia, the following -

• Circular [dated 12 May 1964 (F. No. 12/1/64-IT (AI)] issued to all Commissioners of Income-tax, which is binding on the Department
• Decision of the Mumbai ITAT in the case of ITO vs. Vijay M Merchant [TS-5434-ITAT-1986(BOMBAY)-O] which referred to and applied this Circular (supra) to hold that there is no transfer when one type of share is converted into another type of share and thus the conversion would not lead to a taxable event.

Also a possible contention could be that if conversion is treated as amounting to 'transfer', there will be levy of capital gains tax on one hand; whereas in the absence of any specific provision allowing stepped up cost basis, there could be double taxation in the hands of the shareholder - which is against legislative intent.

The amendment, however, does not cover conversion of equity into preference shares.

With this clarification, there could be a boost in use of preference shares especially convertible preference shares instead of equity; more so in cases where there could be adverse implications on change in voting power due to use of equity shares (e.g. impact on losses). 

One more relevant amendment deals with cost of acquisition in tax neutral demerger of a foreign company. Under the existing law, transfer of shares of an Indian company by a demerged foreign company to a resulting foreign company is not regarded as transfer. However the existing law does not provide for treatment of cost substitution or period of holding substitution for shares of Indian company in hands of the resulting foreign company.

It is proposed to amend relevant sections in the existing law to provide for cost substitution of shares of Indian company in hands of resulting foreign company for a tax neutral demerger. This amendment will consequently enable period of holding substitution to foreign resulting company for the shares of Indian company.

This proposed amendment will apply in relation to the assessment year 2018-19 and subsequent years. As a result, ambiguity continues for past years transactions.

Apart from the above, there are many other amendments which could impact the M&A space. All in all, the avenues adopted by taxpayers for re-alignment of shareholding in listed or unlisted companies, pursuant to say an internal re-organisation or otherwise, may entail tax outgo going forward.  To top it up, the General Anti-Avoidance Rules ('GAAR') would also be an important provision to be considered with effect from April 1, 2017 for any corporate actions.

The tax legislature's endeavour for a fundamental change in approach and mind-set of the taxpayer is clearly reflected from the proposed amendments and that will definitely necessitate business / commercial considerations and substance of any arrangement to be a pivotal factor.

The Settled Controversies set Ablaze by the Union Budget 2017!

The Union Budget 2017 which was announced on February 1^st this year was a unique and an early budget deviating from its erstwhile colonial style of announcing it on the last day of the month of February. The intention behind this move could be to align with the international best practices, however this only time could tell. Though the Finance Minister's speech on Direct Tax proposals was not long, the annexure had a lot to reveal. The Memorandum to the Budget, in its part 'I' which provides for 'Rationalisation Measures' to simplify and rationalize the Income-tax Act, 1961(“Act”) has proposed to amend section 10AA which would largely irrationalise how the schema of the Act operates!

To boost exports a number of export oriented tax regime were made available to Software Technology Park (STP) units, 100% Export Oriented Units (EOUs) and units in a Special Economic Zone (SEZ). sections 10A, 10B and 10AA of the Act govern the said tax incentives. It must also be noted that these provisions are not without their fair share of tax controversies.

One such issue is whether the benefit under section 10A/10AA/10B/10BA of the Act is to be claimed on the profits of eligible units or is to be computed after setting off the losses incurred by any other business of the same taxpayer or losses incurred by any ineligible units (housed in the same legal entity).

It is pertinent to note that the said sections form a part of Chapter III of the Act and which provide for 'Incomes Which Do Not Form Part of Total Income'; however the language employed to the said section literally read as total income of the assessee should be computed and thereafter relief under section 10 should be given.

“10A. (1) Subject to the provisions of this section, a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee.”

………………………” (Emphasis supplied)

Also the words 'exempt' means “free from an obligation from doing something” and the same is not considered in the computation of Gross Total Income (GTI). The word “deduct” means “to subtract or take away from the total” and deductions are first added to GTI and then deducted from it. Thus the benefit of exemption is normally wider than that of a deduction and therefore there was a constant tug between the assessee and the Revenue department. Thus an intriguing question arose whether the said sections offers an exemption or a deduction.

The Honorable Supreme Court in the case of CIT v. Yokogawa India Ltd. (CIVIL APPEAL NO. 8498 OF 2013) had the opportunity to address the said issue. Also this judgment was clarified to be pari materia to section 10B of the Act and the following was concluded;

• section 10A of the Act post 2001 and 2003 amendment had inserted the words' deduction' which indicates that the legislature has changed the nature of the section from an exemption to a deduction section.
• However, while section 10A is a deduction section, it cannot be compared to deduction under section 80HHE and 80HHC (which is placed under Chapter IV-A of the Act), as section 10A is placed under Chapter III of the Act which means some additional benefits are accorded to the 10A units.
• Given the above, the deduction would be prior to commencement of the exercise undertaken under Chapter VI of the Act for arriving at the total income of the Assessee from the gross total income.
• It was held that the discordant use of the expression “total income of the assessee” in section 10A has can be reconciled by understanding the expression as 'total income of the undertaking'.

Though the Honorable Supreme Court referred it to as a deduction, the operation assigned to the section was that of an exemption, that is relief was to be given in Chapter III itself. In effect the deduction in accordance with 10 A should be deducted from profits of the STPI unit. Thereafter the income from business should be computed by giving effect to carry forward and set off of losses at this stage.

It would be interesting to note that language employed in section 10AA is not distinct from the one employed in section 10A of the Act. 

“10AA.(1) Subject to the provisions of this section, in computing the total income of an assessee, being an entrepreneur as referred to in clause (j) of section 2 of the Special Economic Zones Act, 2005, from his Unit, who begins to manufacture or produce articles or things or provide any services during the previous year relevant to any assessment year commencing on or after the 1st day of April, 2006, a deduction of”

………………………” (Emphasis supplied)

The current budget has proposed an amendment with effect from Assessment 2018-19 to section 10AA by inserting an explanation which reads as under:

“Explanation.--For the removal of doubts, it is hereby declared that the amount of deduction under this section shall be allowed from the total income of the assessee computed in accordance with the provisions of this Act, before giving effect to the provisions of this section and the deduction under this section shall not exceed such total income of the assessee.”.

And the Memorandum in this regard reads as below

“section 10AA allows deduction in computing the total income of the assessee, hence the deduction is to be allowed for the total income of the assessee as computed in accordance with the provision of the Act before giving effect to the provisions of section 10AA. However, Courts have taken a view (while deciding the matter pertaining to section 10A which also contains similar provision) that the deduction is to be allowed from the total income of the undertaking and not from the total income of the assessee.

In view of the above, it is proposed to clarify that the amount of deduction referred to in section 10AA shall be allowed from the total income of the assessee computed in accordance with the provisions of the Act before giving effect to the provisions of the section 10AA and the deduction under section 10AA in no case shall exceed the said total income.”

Thus the memorandum gives out intention of the legislation without any hesitation to overrule the judgment of the honorable Supreme Court in the case of Yokogawa Ltd (supra). The Explanation set out above clearly disregards and contradicts the manner in which provisions under Chapter III operate by pre maturely applying the provisions under Chapter IV and VI A. It is important to highlight here that the fundamental placement of the above section under Chapter III of the Act, which deals with exempt income was not changed to Chapter VI (which provide for deduction)This explanation will only make section 10 AA an exception to chapter III. Another interesting aspect is that in the Act there is no further deduction from total income as section 4 of the Act envisages tax is chargeable on total income. A deduction from the total income is an arbitrary concept.

Since the Yokogawa ruling settles the position on 10A and 10B and is a phased out deduction, the amendment bill has proposed to take a position to safe guard the interests of revenue with regards to 10AA and overlooking the correct position of law. The benefit envisaged in Chapter III of the Act is wider than that in chapter VI A and merely by a clarificatory explanation it brings in a lot of ambiguity in how the law itself reads.

Therefore as per the suggested amendment:

• First determine the profits and gains derived from SEZ unit
• Compute balance income and arrive at the gross total income
• Give effect to other deductions and arrive at total income as per the suggested amendment.
• Thereafter determine deduction under section 10 AA applying the formula provided, the profit from 10 AA is not exhausted by set off by losses from other units.

The computation mechanism suggested the benefit to the extent of carry forward and set off of losses from other eligible and ineligible undertaking become restricted. Though the decision in Yokogawa was in the favor of the assessee, the suggested amendment will take an overruling stride by making the deduction assessee wise and not eligible undertaking wise.

The suggested amendment is a clear override of highest judiciary and only will add to the burden of litigation. Also considering that the said provision is available only till April 2021 as amended by Finance Act, 2016, it would be apt to not amend the said provision as suggested in the Finance Bill 2017. The proposed explanation will dig old graves and the horrors of the buried controversies will again haunt !

National Pension Scheme proposals - Only partially meeting the stated objective

Employees' Provident Fund (EPF) and Public Provident Fund (PPF) have been the traditional and time tested retirement plans for Indians for ages. With the objective of further development and regulation of the pension sector in India, the Government of India established Pension Fund Regulatory and Development Authority (PFRDA) in 2003.

The National Pension System (NPS) was launched by PFRDA on 1st January, 2004 with the objective of providing retirement income to all the citizens. Initially, NPS was introduced for the new government recruits (excluding armed forces). With effect from 1st May, 2009, NPS was opened up to all citizens of India including those working in the unorganised sector. The National Pension System Trust (NPS Trust) was established by PFRDA on 27^th February, 2008. The NPS Trust has been set up for taking care of the assets and funds under the National Pension System (NPS) in the interest of the subscribers.

NPS has grown since then and now has over 1 crore subscribers (50% of which are Central and State Government employees) and about Rs. 160,000 crores of assets under management.

For the employed, EPF continues to be the default choice for retirement plans, particularly because it provides an extremely attractive Exempt-Exempt-Exempt (EEE) taxation scheme. NPS, on the other hand, operates under a relatively disadvantageous Exempt-Exempt-Tax (EET) taxation scheme. Despite providing attractive and market linked returns and having a very low cost structure, NPS has struggled in attracting voluntary participation.

The exit and withdrawal rules in respect of NPS were notified through the Pension Fund Regulatory and Development Authority (Exits and Withdrawals under the National Pension System) Regulations 2015. The relevant aspects of the said Regulations are summarized below -

-          Where a subscriber attains the age of 60 years or superannuates as per his service rules, at least 40% of the accumulated pension wealth of such subscriber has to be mandatorily utilized for purchase of annuity providing for a monthly or periodical pension and the balance shall be paid to the subscriber in lump sum. In case, the accumulated pension wealth of the subscriber is equal to or less than a sum of ₹ 2 lakhs, the subscriber shall have the option to withdraw the entire accumulated pension wealth without purchasing any annuity. In case of premature death the entire accumulated pension wealth of the subscriber shall be paid to the nominee(s) or legal heirs of such subscriber.

-          Premature exit from NPS is permitted only where the subscriber has subscribed to the NPS for a minimum period of 10 years. In case of such subscriber, at least 80% of the accumulated pension wealth has to be mandatorily utilized for purchase of annuity and the balance of the accumulated pension wealth, after such utilization, shall be paid to the subscriber in lump sum.

-          The said Regulations, inter-alia, allowed partial withdrawals of accumulated pension wealth of the subscriber, upto a maximum of 25% of the contributions made by the subscriber and excluding contribution made by employer, if any, for prescribed purposes like higher education or marriage of children, purchase or construction of a residential house or treatment of specified illnesses.

The Government, in its bid to bring parity between EPF and NPS first tried to reduce the tax benefits under EPF through its budget proposals in 2016 but had to roll back the same due to severe backlash. Wiser by that experience, it has focused on making NPS more attractive so that it can stand on equal footing with EPF.

As first step towards bringing that parity, vide Finance Act 2016, a new clause 12A was inserted in Section 10 of the Income Tax Act, 1961 (“Act”) that provided that payment from NPS to an employee on closure of his account or opting out shall be exempt up to 40% of accumulated pension wealth of the subscriber at the time of withdrawal. However, the use of word “employee” (instead of the more apt “subscriber”) in this clause has the effect, perhaps unintended, of effectively excluding self-employed subscribers from this exemption.

Vide Finance Bill 2017, in order to make NPS more attractive and beneficial to its subscribers, the following proposals have been made:

-          insert a new clause (12B) in Section 10 of the Act to provide exemption on partial withdrawal not exceeding 25% of the contribution made by an employee in accordance with the terms and conditions specified under Pension Fund Regulatory and Development Authority Act, 2013 and regulations made thereunder. This benefit will be effective on partial withdrawal made by the subscriber on or after 1st April 2017.

-          under Section 80CCD (1) increase the amount of contribution deductible from total income to 20% (from 10% at present) of the gross total income, in case of a self-employed individual. This is with a view to provide parity between a salaried individual and a self-employed.

Additional tax deduction on deposits upto ₹ 50,000 under section 80CCD (1B) will continue to remain the same for all NPS subscribers whether salaried or self-employed.

Do the proposals made by Finance Bill 2017 meet the stated objective of bringing parity between a salaried employee and a self-employed? I fear that the answer is in the negative, for the following reasons.

-          The new clause 12B, just like clause 12A inserted last year, use the word “employee” thus effectively excluding self-employed from the tax relief on partial withdrawal or closure. This looks like an oversight and begs to be corrected.

-          Increasing the deductible amount from 10% to 20% may not necessarily bring about parity for the reason that the 20% amount is still subject to the overall limit of ₹150,000 imposed by Section 80CCE. In contrast, in case of salaried individual, the employer's contribution (upto 10% of his salary) is not subject to the limitation of Section 80CCE.

To conclude, it is clear that the Government wants to attract more and more self-employed individuals within the social security umbrella offered by NPS. However, the budget proposals only partly meet the intended objective.

Limitation on interest deduction - Whether 'actually' in line with OECD's Action Plan 4?

On 1 February 2017, the Honourable Finance Minister (FM) presented his fourth Union Budget for Financial Year (FY) 2017-18 in the Parliament amid high expectations post the recent policy changes in terms of demonetisation and proposed implementation of the Goods and Services Tax. Amongst the various proposals tabled, the Honourable FM has proposed to introduce a new section 94B in the Income-tax Act, 1961 (the Act) to limit the deduction of interest payments on certain funds borrowed by specified companies in India, in line with the Organisation for Economic Co-operation and Development's (OECD's) Base Erosion and Profit Shifting (BEPS) Action Plan 4.

From an income-tax perspective, interest and finance costs in relation to debt are tax deductible expenditures if incurred for the purpose of business or profession by the taxpayer, whereas dividend is not tax deductible. It has been observed by the Memorandum to the Finance Bill that debt is a tax efficient form of financing, and therefore, Multinational Enterprises (MNEs) can structure their capital in a manner that enables them to claim excessive interest payments and achieve higher tax savings at a group level, by relying on higher debt as compared to equity (in technical terms commonly referred to as 'thin capitalisation'). In order to prevent MNEs from cross-border shifting of profits through excessive interest payments, and thus protect a country's tax base, the OECD in its BEPS Action Plan 4, have made recommendations for best practices in the design of rules to address BEPS using debt funding and interest deductions, and the Memorandum states that the proposed introduction of the new section 94B in the Indian laws is in line with such recommendations.

India has regularly voiced its active consent to work on the implementation of the BEPS project recommended by the OECD. In this regard, the Central Board of Direct Taxes (CBDT) also issued a press release dated 8 January 2017, re-emphasizing its commitment to the implementation of the BEPS action plans by constituting a committee to examine all the reports issued by the OECD on BEPS project and chalk out a clear cut roadmap for implementing the recommendations contained in these reports.

The newly introduced provision is proposed to be applicable to any interest or similar consideration paid, exceeding Rs 10 million on or after 1 April 2017 by an Indian company or a permanent establishment (PE) of a foreign company in India, in respect of funds borrowed from a non-resident Associated Enterprise (AE). The said provision also applies in cases where the funds are borrowed from third party lenders in or outside India, and the AE has provided an implicit or explicit guarantee to the third party lender, or has deposited a matching amount of funds with the third party lender.

For the purposes of limiting the interest deduction while computing the income chargeable to tax under the head 'Profit and gains of business or profession', the interest expense claimed by the aforesaid entities shall be restricted to 30 percent of its earnings before interest, tax, depreciation and amortisation (EBITDA), or the actual interest paid or payable to the AE/ third party lender, whichever is less. The portion of the interest that is disallowed as a result of the above computation will be permitted to be carried forward for a period of eight assessment years, and allowed as a deduction in subsequent years, subject to the maximum allowable interest deduction in that particular year. However, the aforesaid provisions should not apply to an Indian company or a PE of a foreign company in India, which is engaged in the business of banking or insurance.

Internationally, countries like United States of America, Spain, Portugal and Greece already have provisions in place to restrict corporate interest deductions as a percentage of EBITDA, prior to OECD's recommendations. Further, countries like Germany, Norway and United Kingdom have recently initiated efforts in restricting the corporate interest deductions in line with OECD's recommendations in Action Plan 4.

The Memorandum to the Finance Bill states that the provision has been proposed in line with OECD's BEPS Action Plan 4. While the Finance Bill has accepted the OECD recommendations in terms of the threshold to be applied on EBITDA and stipulated the same at 30% in the proposed provisions, we have highlighted below the key areas in which the provision varies from the OECD's BEPS Action Plan 4:

As can be seen from the table above, the proposed section 94B will apply only to the funds borrowed from the non‑resident AE, or funds borrowed from third parties and guaranteed by an AE. However, the proviso does not make any reference to the residential status of the AEs. Accordingly, based on the memorandum to the Finance Bill, while the intent seems to be that the section ought to apply only in the case of a non-resident AE, a level of uncertainty exists on whether tax authorities could contend that the funds borrowed from third parties and guaranteed by a resident AE would also be covered under this provision.

Currently, if an enterprise advances a loan to another enterprise that constitutes at least 51% of the book value of the assets of other enterprise, then the two enterprises are deemed to be AEs. Accordingly, based on this provision, in the past, the lending by a foreign bank to an Indian company has led to the foreign bank and borrower being constituted as AEs. In light of the proposed provision, the limit on interest deduction shall also apply to such lending by a foreign bank to an Indian company and could potentially result in disallowance of the excess interest paid on such loans.

Further, taxpayers may face certain challenges to prove the non-existence of an implicit guarantee in third party borrowings. The tax authorities may contend that, since the Indian company is part of an MNE group, therefore, by reason of its affiliation, an implicit guarantee has been issued by the AE, and may attempt to disallow interest on third party borrowings. In this regard, the OECD also clarifies in the Transfer Pricing Guidelines for MNEs and Tax Administrations, 2010, that passive association should be distinguished from active promotion of an MNE group's attributes, in order to determine what amounts to an intra-group service for which an arm's length fee needs to be determined.

The fixed ratio intended to be adopted by India does not take into account the fact that groups in different sectors may be leveraged differently. For example, NBFCs, infrastructure companies, real estate companies, etc., which are highly leveraged companies, will be required to comply with the 30% limit on interest deduction. Accordingly, inclusion of targeted rules for highly leveraged sectors would have been a welcome move, especially given India's focus on the foreign direct investment in infrastructure development.

It therefore becomes imperative for a taxpayer to plan its financing arrangements after considering the aforesaid provision, in order to prevent any double taxation, where the Indian taxpayer will not get a deduction of the excess interest expense, but the recipient AE will be taxed on the entire interest income in its home country, resulting in an increase in the overall tax cost of the MNE group. Keeping in view the aforesaid proposed provisions, Indian companies would need to revisit their current capital structures and financing strategies for the future to prepare for the implementation of the aforesaid amendment. 

The views expressed within this article are the personal opinions of the authors.

This article is co-authored by Arati Amonkar (Director, Transfer Pricing, Ernst & Young LLP)  and Hemang Mehta (Manager, Transfer Pricing)

Joint Development Agreements - Finance Bill 2017 - Some Relief

Transfer

In a typical joint development agreement, the land owner is entitled to certain portion of the developed or constructed area as per an agreed sharing ratio.  The taxability of capital gains does not depend upon the actual realization of the consideration and the liability can arise if transfer as defined in Section 2(47) of the Income Tax Act takes place in a particular financial year relevant to the assessment year.

Decisions on Taxability

The point of taxability in the context of capital gains for the land owner has been subject matter of a number of decisions and some of the decisions are given below:

(i)                The Bombay High Court in Chaturbhuj Dwarkadas Kapadia Vs. CIT (2003) 260 ITR 491, has in the context of development agreements held that the year of taxability is the year in which the contract is executed.  The Court held that in the case of development agreement one cannot go by substantial performance of the contract and the year of chargeability would the year of execution.

(ii)             The Chennai Tribunal in the case of Mount Mettur Pharmaceutical Ltd. Vs. JC (2008) TIOL 657 ITAT Madras has held that “The assessee has entered into an agreement with M/s DBS Properties Ltd. on 12.12.1994. The assessee handed over vacant possession of 52.5% undivided share of the land to M/s DBS Properties Ltd. on 16.4.1996 pursuant to an agreement dated 12.12.1994. In our opinion, the assessee no longer has possession rights in the property and the possession of property is transferred to the builder, who in turn has to pay the balance consideration in the form of 47.5% of total super built-up area of the constructed property and the purchaser is also ready to fulfill the conditions laid down in the agreement entered into with the assessee, and as such, the conditions of clause (5) of Section 2(47) was fully satisfied. Hence, transfer took place w.e.f. 16.4.1996.”

(iii)           The Chennai Tribunal in the case of R. Kalanidhi Vs. ITO (2008) TIOL 666 ITAT Mad. has observed that under the agreement possession was handed over to the vendee for construction and after construction the vendee was to retain half the constructed portion and half portion would remain with the assessee. The Tribunal followed the Bombay High Court judgment and held that under the agreement since all material rights and interest in property coupled with possession was given to the purchaser it constitutes a transfer in terms of Section 53A of the Transfer of Property of Act and was also a transfer for the purpose of Section 2(47) of the Income Tax Act.

(iv)           The Tribunal in the case of Shivram Co-operative Housing Society Ltd. Vs. DCIT (70 ITD 8) has held that since the transfer has taken place in various stages the computation of capital gains has to be worked out on the basis of the sale consideration actually received during the year in respect of the portion of the land transferred in that year only.

(v)             The Advance Ruling Authority in the case of Jasbir Sing Sarkaria (294 ITR 196) has ruled that so long as the transferee by virtue of the position is enabled to exercise general control over the property and to make use of it for the intended purpose, the mere fact that the owner has also the right to enter the property to oversee the development or to ensure performance of the terms of agreement does not introduce any incompatibility.  The concurrent possession of the owner of the buyer / developer who has a general control and custody of the land can very well be reconciled.  Clause (v) of section 2(47) will have its full play even in such a situation.  There is no warrant to postpone the operation of clause (v) and the resultant accrual of capital gain to a point of time when the concurrent possession will become exclusive possession of developer / transferee after he pays full consideration.

(vi)           In the case of Assistant C.I.T. Vs. Akkineni Nagarjuna Rao (2012) 52 SOT 23 , the Hyderabad Bench of the ITAT held that where a plot of land was given for development to the developer under an agreement with a promise by the developer to hand over 35% of the built up area, it is a case of transfer since possession of the land has been handed over.

(vii)        In the case of Vijaya Productions Pvt. Ltd. Vs. ACIT (2012) 134 ITD 19 , the Chennai Bench of ITAT on a reference to a third member , observed that when possession is not taken and money consideration has not been discharged there is no transfer. The power of attorney was only to enable its contractual obligations in planning, implementing and executing the project as construed in Joint Development Agreement.

(viii)      The Cochin Bench of the ITAT in the case of G.Sreenivasan Vs. DCIT (2013) 140 ITD 235 has held that where the Development Agreement is entered into on 14.04.2002 for construction of multi-storied building and possession was given only on 21.04.2004, the capital gains is assessable for the Assessment Year 2003-2004 that is the year in which the development agreement was entered into.

(ix)           The Karnataka High Court in the case of CIT Vs. Dr. T.K. Dayalu (2011) 202 Taxmann 531 has held that where the original agreement is dated 26.01.1996 and has a clause which shows that the possession has been handed over and actual possession was handed over only on 30.05.1996 and an affidavit is filed to that effect, the relevant assessment year would be 1997-1998.  There is no merit in the contention that the capital gains is taxable only in the year 2003-2004 when the entire project was completed.

(x)             The Mumbai Bench of the Tribunal in the case of Chemosyn Ltd. Vs. ACIT (2012) 139 ITD 68 has applied the doctrine of real income and has held that consideration in the form of constructed area of 18,000 sq. ft. as agreed in the development agreement was not actually accrued to the assessee.  The assessee had argued that the constructed area is not actually received by reason of subsequent events and developments and therefore the consideration in the form of constructed area never accrued.  The Tribunal took on record the actual fact of the plot themselves being sold as such subsequently and the differential income being offered for capital gains in the subsequent years to hold that there was no capital gain on the assumed market value of the constructed area.

(xi)           The Hyderabad Bench of the ITAT in the case of Durdana Khatoon Vs. Assistant Commissioner of Income Tax (2013) 24 ITR (Tri) 55 has held that “what is contemplated by section  2(47)(v) is a transaction which has direct and immediate bearing on allowing the possession to be taken in part performance. It is at that point of time that the deemed transfer takes place. According to us the possession as contemplated in clause (v) need not necessarily be sole and exclusive possession, so long as the transferee is enabled to exercise general control over the property and to make use of it for the intended purpose. The mere  fact that the assessee owner has also the right to enter the property to  oversee the development work or to ensure performance of the terms of the agreement, did not restrict the rights of the developer or did not introduce any incompatibility. In a situation like this when there is a concurrent possession of both the parties, even then clause (v) has its full role to play.  There is no warrant to postpone the operation of clause (v) to that point of time when the concurrent possession would become exclusive possession of the developer.”

Finance Bill, 2017

The Finance Bill, 2017 proposes to introduce a non-obstante provision viz. Section 45(5A) to the Income Tax Act with effect from 01.04.2018. The effect of the proposed amendment is given below:

(i)      In respect of individuals or HUF where capital gain arises from the transfer of a capital asset, being land or building or both, under a specified agreement, the capital gains shall be chargeable to income tax as income of the previous year in which the certificate of completion of the whole or part of the project is issued by the competent authority.

(ii)     For the purpose of Section 48, the stamp duty value on the date of issue of the said certificate of his share, being land or building or both, in the project as increased by consideration received in cash shall be deemed to be the full value of consideration on account of the transfer of the capital asset.

(iii)    In case the Assessee transfers his share in the project on or before the date of issue of the said completion certificate, the capital gains shall be deemed to be the income of the previous year in which such transfer takes place and the provisions of the Act other than Section 45(5A) shall apply for determination of the full value of consideration received or accruing as a result of the transfer.

(iv)    Specified agreement means a registered agreement in which a person owning land or building agrees to allow another person to develop a real estate project on such land or building or both in consideration of a share being land or building or both in such project, whether with or without payment of part of the consideration in cash.

(v)     Competent authority means the authority empowered to approve the building plan by or under any law for the time being in force.

(vi)    Stamp duty value means the value adopted or assessed or assessable by any authority of the Government for the purpose of payment of stamp duty in respect of an immovable property being land or building or both.

Issues of Concern

1.       Section 45(5A) requires the Joint Development Agreement to be registered. There are many States which do not provide for mandatory registration of such agreements.

2.       The provisions contemplate issue of certificate of completion by the authority empowered to approve the building plan. There is no concept of completion certificate in many States and planning authorities. A leaf can be borrowed from the service tax law in the context of Section 66E(b) of the Finance Act, 1994 which provides that if there is no requirement of completion certificate under local law, such a certificate can be issued by the architect or chartered engineer or licensed surveyor.

3.       The full value of consideration is identified as the stamp duty value of the share being land or building or both in the project on the date of issue of certificate plus cash received. As an illustration, if under the JDA the land owner is entitled to 20 flats and the developer is entitled to 30 flats, the land owner's share is the building being 20 flats. There is no stamp duty value for these flats since they are allotted under the JDA without any registration of an agreement with the State authorities in some States. How can value be determined?

4.       What is the meaning of the term 'transfers his share in the project'? In the same illustration, if the land owner enters into an agreement to sell 5 of the 20 flats available to him, does it mean that he has transferred his share in the project?

5.       What would be the implications for claiming exemption in the context of Section 54 since the said provision refers to the 'date of transfer' while Section 45(5A) refers to the 'year in which the transfer is taxable'?

6.       The amendment is effective from Assessment Year 2018-19. The disputes for the past period on this issue will therefore continue to be governed by the jurisprudence on the subject. Where a JDA is entered into before 31.03.2017 and power of attorney as well as possession is given after 31.03.2017, would the new provisions apply?

Penalty levy on professionals u/s 271J - Myriad interpretation issues and 3 unanswered questions

Insertion of new section 271J.

 '271J. Without prejudice to the provisions of this Act, where the Assessing Officer or the Commissioner (Appeals), in the course of any proceedings under this Act, finds that an accountant or a merchant banker or a registered valuer has furnished incorrect information in any report or certificate furnished under any provision of this Act or the rules made thereunder, the Assessing Officer or the Commissioner (Appeals) may direct that such accountant or merchant banker or registered valuer, as the case may be, shall pay, by way of penalty, a sum of ten thousand rupees for each such report or certificate.

Explanation.--For the purposes of this section,—
(a) “accountant” means an accountant referred to in the Explanation below sub-section (2) of section 288;

(b) “merchant banker” means Category I merchant banker registered with the Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992;

(c) “registered valuer” means a person defined in clause (oaa) of section 2 of the Wealth-tax Act, 1957.'

This amendment will take effect from 1st April, 2017

Certification of various reports and certificates by a qualified professional has been provided in the Act to ensure that the information furnished by an assessee under the provisions of the Act is correct. Various provisions exist under the Act to penalise the defaulting assessee in case of furnishing incorrect information.

The entry of the Chartered Accountants in the arena of the Certification / Audit under the Income Tax Act, 1961 started with introduction of issuance of Audit Report U/s. 12 A(b) of the Act and insertion of Rule 17 B and Form 10 B in the Income Tax Rules, 1962 with effect from 1^st April, 1973. At the present date there are more than 50 certificates/reports that are to be issued by Chartered Accountants under various provisions of the Income Tax Act and the scope of each  such report/certificate is different. The need for understanding the  implications of these certificates /reports is all the more necessary now with the introduction of this penalty provision.

Since inaccurate details could include facts as well as legal position it is now a complex situation as courts are taking contrary views on the same set of facts. 'Inaccurate',  is something factually incorrect and interpretation of law can never be a factual aspect. The development of law is a dynamic process which is affected by the innumerable factors, and it is always an ongoing exercise.

A decision by Courts in favour of the assessee is followed by amendments in law in the very next year thus creating more confusion. Earlier the tax authorities could take up disciplinary proceedings with ICAI in case of any negligence in issue of certificate/ report. Now the Income tax Act has followed the Companies Act in including penalty provisions against Accountants. Form 3CD from the time of inception till date has undergone a sea change with respect to reporting requirements and every conceivable information is required to be certified by the tax auditor. The responsibility cast on the accountant has increased manifold along with the risk.

Incorrect information -271H  vs  Inaccurate information -271(1)(c) of the Act.

The Apex court in the case of  CIT v. Reliance Petroproducts (P.) Ltd. [TS-37-SC-2010], observed that reading the words 'inaccurate' and 'particulars' used in section 271(1)(c) in conjunction, they must mean the details supplied in the return, which are not accurate, not exact or correct, not according to truth or erroneous. The Supreme Court held that by any stretch of imagination, making an incorrect claim in law cannot tantamount to furnishing  inaccurate particulars. Therefore, it is obvious that it must be shown that the conditions under section 271(1)(c) must exist before the penalty is imposed. The Court further observed that there can be no dispute that everything would depend upon the return filed because that is the only document, where the assessee can furnish the particulars of his income.

Webster's Dictionary, the word "inaccurate" has been defined as: "not accurate, not exact or correct; not according to truth; erroneous; as an inaccurate statement, copy or transcript."

In the case of incorrect information whether it can be used to mean what has been held by the Apex court with respect to inaccurate particulars.

Since the definition of information is “ facts  provided or learned about something or someone."a vital piece of information" synonyms are : particular, facts ,figures, data etc

Hence the meaning of incorrect information can be taken to mean the same as in 271(1)(c) with respect to inaccurate particulars.

CHAPTER XXI  PENALTIES IMPOSABLE

Extract of Clause 87 of Finance Bill 2017

Amendment of section 273B.

87. In section 273B of the Income-tax Act, after the word, figures and letter “section 271-I,”, the word, figures and letter “section 271J,” shall be inserted.

It is also proposed to provide through amendment of section 273B that if the person proves that there was reasonable cause for the failure referred to in the said section, then penalty shall not be imposable in respect of the proposed section 271J.

Since the insertion of section 271J under the section 273B is contemplated the chapter also speaks of procedure to be followed for imposition of such penalty.

Procedure is applicable as per section 274 of the Act as below:

(1) No order imposing a penalty under this Chapter shall be made unless the assessee has been heard, or has been given a reasonable opportunity of being heard.

(2) ⁶ No order imposing a penalty under this Chapter shall be made-

(a) by the Income- tax Officer, where the penalty exceeds ten thousand rupees;

(b) by the Assistant Commissioner, where the penalty exceeds twenty thousand rupees, except with the prior approval of the Deputy Commissioner.]

(3) ⁷ An income- tax authority on making an order under this Chapter imposing a penalty, unless he is himself the Assessing Officer, shall forthwith send a copy of such order to the Assessing Officer'.]

Bar of limitation for imposing penalties has been dealt with under section 275 of the Act.

There are various queries raised  as to the prudence of inflicting penalties on professionals and associated third parties who are already under the scrutiny of their controlling professional bodies and answerable to them in case of misconduct.

The move makes them accountable under all the Acts which is a tight rope walk and poses serious financial implications.

Conclusion

Questions unanswered:

1. Once penalty order is issued against the Chartered Accountant  would they be considered guilty of professional misconduct by ICAI ?
2. Will the above act of the ICAI be considered violative of Article 20(2) of the Constitution since the professional will be penalised twice for the same implication?

3 . Will the penalty notice be issued simultaneously to assessee and accountant? Or only after the assessee's penalty order has been passed will the penalty u/s 271J be initiated against the accountant etc.

Sec.10(38) amendment - Targeting 'Bogus' long-term capital gains

Presently, long-term capital arising on sale of shares of an Indian are exempt from tax under section 10(38) of the Act where the sale is through the stock exchange and the sale transaction is subject to securities transaction tax (STT).

The Finance Bill 2017 has amended the provisions of section 10(38) of the Act to restrict the exemption from long-term capital gains on sale of equity shares only where STT is paid on the purchase of equity shares subject to certain exceptions which will be notified later.

The Finance Minister has considered that there could be genuine purchases where STT is not payable and so has carved out exceptions where the exemption will still continue.  As per the Memorandum Explaining the Provisions of the Finance Bill 2017, exemption will not be withdrawn where purchase of equity shares are prior to 1 October 2004, or purchase are through IPOs,  FPOs, bonus issue, rights issue, acquisition by non-resident in accordance with FDI policy of the Government etc.

The Memorandum explaining the Finance Bill has provided the intent for the amendment to the section to prevent abuse as it has been noticed that the exemption is being misused by certain persons for declaring their unaccounted income as exempt long-term capital gains by entering into sham transactions.

As per Press articles, the Securities Exchange Board of India (SEBI) had taken effective action in the recent past in the matter and more than 200 shell companies were suspended and more than 1,300 entities banned from the market for taking the benefit of bogus long-term capital gain. The prima facie amounts involved in tax evasion were quoted as being over Rs.15,000 crore.

As per the SEBI orders, based on investigation of preferential allotment of shares by certain companies, it had come to the notice of SEBI that this route was misused for conversion of unaccounted income into accounted income and subsequent tax evasion by taking exemption under section 10(38) of the Act for long-term capital gains.

From the orders, the modus operandi followed in such cases has been on the following lines:

a)    The equity shares of the concerned company were listed on a particular Stock Exchange (SE). There is generally no trading history of such companies at the SE. 

b)    The Company then makes a preferential allotment of certain number of equity shares at a low price to various individuals or group entities (preferential allottees).

c)    The equity shares allotted on preferential basis to the preferential allottees are locked-in for a period of one year in terms of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009.

d)    The promoters and the preferential allottees trade amongst themselves. There was no change in beneficial ownerships as the buyers and sellers were of the common group and were acting in concert to provide long-term capital gains benefit to the preferential allottees.

e)    The prices of the shares were rigged

f)    Common man was tricked into buying the shares of such shell companies at high prices by sending SMS to investing public. In the influence of SMS tips investors placed buy orders on the particular date at high price range resulting in purchase of shares from the preferential allottee (i.e. the sellers), resulting in very high capital gains to the preferential allottee which was tax free.

From the above it is observed that such type of preferential allotment was used as a tool for implementation of the dubious plan, device and artifice of the concerned Company and preferential allottees. 

In the process, the Company and preferential allottees used the securities market system to artificially increase volume and price of the scrip for making illegal gains to and to convert ill-gotten gains into genuine one.

Press Reports of CBDT issuing letter dated 16 March 2016 to tax officers for reopening of assessments for taxing long-term capital gains / short term capital loss on sale of penny stock

Based on the prevailing law, the Bombay High Court decision in CIT vs. Mukesh Ratilal Marolia held that since there was purchase and sale of shares and the purchased shares were out of the funds duly disclosed by the Assesse and the sale transactions were genuine, the exemption should be allowed. 

Earlier the exemption under section 10(36) of the Act was provided in case where the shares were eligible equity shares being a constituent of BSE 500 Index of the stock exchange as on particular date and were purchased and sold and purchased through the recognized stock exchange in India.

It can thus be observed that in the past the exemption of long-term capital gains was restrictive for eligible equity shares only.

So the Government has rightly felt the need for the amendment in the Act to deny tax advantage to inflated and bogus capital gains. From the intent it is clear that the Government will include exceptions that are to be notified later for genuine cases like IPO, FPOs, bonus issue, rights issue, acquisition by non-resident in accordance with FDI policy of the Government, ESOP etc.

Budget 2017 - A mixed bag for Real Estate Sector

The real estate sector has been in limelight of reforms over the last year with the relaxation of Foreign Direct Investment ('FDI') norms, Real Estate Investment Trust ('REIT') regulations and the passing of the Real Estate Regulatory Act, 2016.

All these reforms are expected to make the real estate sector more organized and transparent, boost investments, mobilize retail earnings and give a boost to the Government's vision of housing for all by 2022 and 100 smart cities. The proposal of the Budget 2017 announced by the Hon'ble Finance Minister provides for the further boost to the development and organization of the real estate sector as well as to the Government's vision.

Affordable housing

Affordable housing within the definition of the 'infrastructure sector'

Affordable housing ('AH') has received a major backing from the Government in terms of reforms and incentives in the last few years. To further this, the Government has announced that AH will be given “infrastructure sector” status so as to enable it to enjoy the associated benefits.

Giving infrastructure status to the AH sector could mean the follow of the following benefits:

• FDI would be allowed under 100% automatic route for AH projects and such projects will not be required to comply with the FDI norms for construction / development projects;

• FVCIs will be permitted to make investments by way of equity  / convertibles in AH projects without compliance with the FDI pricing norms;

• ECBs will be permitted in AH projects without any limits / additional conditions (which are currently prescribed) and the IFCs and IDFs would also be eligible to fund AH projects (also, indirectly via ECBs).

All the above discussed will give a major boost the AH sector and enable AH projects / developers to access long team funds at low cost.

Extension of incentives for AH sector

In addition to the above, the amended the tax holiday incentives to AH projects by extending the construction period to 5 years and aligning the definition with that of MHUPA is also a welcome move to give further flexibility to developers of AH projects.

Debt investments in India

The Budget 2017 proposes to extend the concessional withholding tax rate of 5% applicable to interest income earned by foreign investors, being FPIs, from investments in rupee denominated bonds ('RDBs') of an Indian company from June 30, 2017 to June 30, 2020. In addition to the above, the Budget 2017 also proposes to provide exemption from capital gains under the domestic tax law on transfer of RDBs between non-residents.

Since debt investments in real estate sector is favored over equity by foreign investors under the FPI route, this should provide further impetus for investments in this sector on account of clarity on concessional tax on interest income over a long term period.

However, the Budget 2017 also proposes to insert new provision to provide that interest expenses claimed by an entity as paid to its associated enterprises shall be restricted to 30% of its EBITDA. The interest which is not allowed as deduction shall be allowed to be carried forward for subsequent 8 assessment years and allowed as deduction to the extent of maximum allowable interest expenditure.

This appears to be an indirect introduction of thin capitalization norms under the domestic tax laws in relation to debt transaction between related parties (an equity shareholder holding 26% or more shares in the company or any lender providing 51% or more of the total debt would be treated as a related entity). This could impact real estate development companies availing debt predominantly from a single foreign private equity fund in which case these provisions could apply.

Capital gains on immovable properties, being land and building

As per the existing provision, immovable property is treated as a long term capital asset eligible for lower capital gains tax rate of 20% and indexation benefits only if the period of holding exceeds 36 months. The Budget 2017 proposes to reduce this period of holding to 24 months. This would further reduce the cost of transaction for immovable property owners.

However, as a counter to the above benefit the Budget 2017 has also proposed that the cost of acquisition for capital asset (including immovable property) acquired before 01 April 2001 shall be allowed to be taken at fair market value as on 01 April 2001 as against 01 April 1981. Cost of improvement shall include only those capital expenses which are incurred on or after 01 April 2001. Accordingly, the indexation of 2001 would be applicable instead of 1981. This would go on decreasing the indexed cost of acquisition (assuming the cost and the market value are the same) and thereby, increasing the overall capital gains.

Joint development agreements ('JDAs')

The issues relating to the taxation of JDAs have always been contentious and complex one ranging from the characterization of income, timing of taxation of capital gains, AOP taxation issues, determination of sale consideration etc., Much was expected of this Budget 2017 to clarify some of the issues faced by the real estate developers under a JDA transaction thereby providing clarity to the taxation of such transactions.

However, such issues have been proposed to be clarified but only in case of individuals and HUFs proposing to provide their immovable property under a JDA to a developer. Budget 2017 proposes to provide that in case of an assessee being individual or HUF ('landowner'), who enters into a JDA, the capital gains shall be chargeable to income-tax as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority. Further, the stamp duty value of his share, being land or building or both, in the project on the date of issuing of said certificate of completion as increased by any monetary consideration received, if any, shall be deemed to be the full value of the consideration in the hands of landowner.

Thus, though providing clarity to individual landowners, the Budget 2017 misses an opportunity to clarify issues on the taxation of JDAs for real estate developers.

Imputation of fair market value ('FMV') as sale consideration in respect of transfer of unlisted shares

The Budget 2017 proposes to impute FMV (to be prescribed) as sale consideration where the consideration of unquoted shares is less than the FMV. This amendment is onerous as it provides discretion to the Income Tax Authorities ('ITA') to impute FMV as sale consideration.

This may have a huge impact on the real estate transactions wherein the shares of the real estate company are being sold. In such cases, the possibility of the ITA imputing a higher value for the real estate housed within the company cannot be ruled out. Thus, it would be imperative that the mechanism to be prescribed for the purpose of calculation of FMV does not provide any discretion to the ITA to impute arbitrary values to the shares.

Thus, as could be observed, the Budget 2017 is a mix bag for real estate sector.

Tax proposals affecting JDA taxability - Beneficial, but not completely...and some grey areas

The Finance Bill 2017 has proposed number of incentives for giving boost to the construction industry such as increase of threshold limit of area of affordable housing, increase in period of completion from 3 to 5 years etc. One of the incentives proposed is insertion of sub-section (5A) in section 45 with effect from 1^st April 2018 i.e. assessment year 2018-19. Sub-section (5A) proposes to provide that in case of an assessee being “Individual” or “Hindu Undivided Family”, who enters into Joint Development Agreement/Specified Agreement, Capital Gains shall be chargeable as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority. In effect it provides a greater time limit for payment of capital gain tax.

Sub Section (5A) further provides that the stamp duty value of the share of the assessee, in land or building or both, in the project on the date of issue of said completion certificate as increased by monetary consideration received, if any, shall be deemed to be the full value of consideration in terms of section 48 of the I. T. Act. The corresponding amendment is made by insertion of Sub Section (7) in Section 48 of the I. T. Act.

Proviso to proposed sub section (5A) provides that the benefit of new sub section (5A) shall not apply to the assessee who transfers his share in the project on or before the date of issue of the said Completion Certificate and that the capital gain shall be deemed to be the income of the previous year in which such transfer takes place and the provisions of the Act excluding the provisions of sub section (5A) shall apply.

Explanation to proposed sub-section defines the expressions “Competent Authority”, “Specified Agreement” and “Stamp Duty Value”

A new section 194IC is proposed to be inserted with effect from 01^st April 2018 so as to provide that in case any monetary consideration is payable under the specified agreement, tax at the rate of 10% shall be deductible from such payment.

This is a very welcome provision bringing to close the controversy as to the year of incidence of capital gain in case of Joint Development Agreement (JDA) - Whether the capital gain arises on entering into the Joint Development Agreement or on receipt of consideration of the land in the form of built up area or in the form of developed land out of the project being constructed or developed on the land or the building of the land owner.

The controversy regarding the capital gain arising on signing of JDA triggered vide Bombay High Court Judgment in the case of Chaturbhuj Dwarkadas Kapadia [260 ITR 491] wherein the honourable High Court held that if the reading of development agreement as a whole indicates passing of complete control over the property the transfer is complete. After the Bombay High Court Judgment, the AAR in the case of Jasbir Singh Sarkaria [294 ITR 196] ruled that the date of execution of irrevocable power of attorney allowing the developer to take possession in part performance of contract of the nature referred to in section 53A of the Transfer of Property Act 1882 is relevant to decide the date of transfer. Similar view was taken by the Andhra Pradesh High Court in the case of Potla Nageshwar Rao [365 ITR 249 (AP)]. After the aforesaid judgments various High Courts and Tribunals followed the ratio laid down by these judgments. The Honorable Punjab and Haryana High Court held a different view in the case of C. S. Atwal [378 ITR 244 (P&H)]. However, the judgment was delivered in the light of the requirement of registration of agreement as per amendment to Registration Act for the purpose of enforceability of Section 53A of the Transfer of Property Act 1882. However, the High Court delivered the judgment on peculiar facts of the case. Similarly, there are few judgments, especially of ITAT Hyderabad Bench which held in favour of the assessee that the capital gain does not arise on entering into Joint Development Agreement where the developer is not willing to perform his obligations or where no approval is granted to the projects.

Since, the general view of the Courts was that if the transaction of transfer of capital asset falls under section 2(47)(v) of the I. T. Act the transaction is complete. The main criterion was the written contract coupled with the possession of the property as visualized by the section 53A of the Transfer of Property Act 1882. Now a days the land prices have sky rocketed and which is almost forming 50 percent plus part of the project cost. The incidence of capital gain on entering into the JDA is very high and practically it becomes impossible to pay the equivalent amount to land owners for satisfying the capital gain tax liability and invest further in construction of the project. Therefore, many of the mega projects are held up due to the reason of either payment of capital gain tax liability on entering into JDA or cost of litigation.

The proposed insertion of sub section (5A) in section 45 of the I. T. Act is a very welcome and beneficial provision and it may go a long way in giving boost to the construction industry. The salient features of proposed amendment.

• Proposed sun-section (5A) begins with non-obstante clause and therefore, it has a overriding effect.
• The proposed sub section (5A) is applicable to the assessee being an Individual or Hindu Undivided Family only. It means the other entities like company, partnership firm, LLP etc., are not eligible to avail the benefit of the proposed sub-section.
• JDA are of different types - Revenue Sharing, Sharing of constructed area or sharing of developed land or combination of the both. As per the wording of the section the provisions are applicable to the JDA where the land owner agrees to retain the built up area in the project or the developed land out of the total built up area or total land in respect of which the specified agreement is entered into.
• The benefit of this newly inserted sub-section will not be applicable to JDA wherein parties agree to share revenue of the project.
• “Specified Agreement” means the agreement in which a person owning land/building or both allows another person to develop the project on such land in consideration of share, being in land or building or both. Therefore, the sub-section will be applicable only to the individuals/HUFs who agree to retain the share in constructed area in building/land.
• In case of JDA which is combination of share of revenue and sharing of built-up area/land the benefit will be available, subject to compliance of other conditions. However, the revenue (monetary consideration) as and when received will be subjected to 10% TDS. The full value consideration in such case will be revenue received plus stamp duty value of the share in the built-up area or land.
• Explanation to sub-section (5A) defines Competent Authority to meet the authority empowered to approve the building plan by or under any law for the time being in force. However, sub-section (5A) talks about completion certificate issued by competent authority. It may be possible that the authority granting approval and authority granting completion are different. In such case litigation may crop up.

At a first glance this amendment appears to be completely beneficial. Is it so? Is it all beneficial to the assessee? It has certain gray areas and is also disadvantageous to which are discussed herein below

• Proviso to sub-section states that the benefit of this section shall not be available to the assessee who transfers his share in the project on or before the issue of completion certificate. Therefore, the sub-section presupposes that the share in constructed area or land is immediately earmarked on approval of building plan. Therefore, subsequently the IT authorities can verify whether the developer/builder has entered into the agreement in respect of the share of the land owner or created any type of encumbrance in respect of share of land owner.
• The land owner cannot enter into any agreement in respect of his own share to alienate or transfer in favour of any purchaser.
• According to proposed amendment the capital gain shall be taxable in the hands of the assessee in the year in which the competent authority issues the completion certificate for the whole of the project or part of the project. This may create a major problem in case of mega project where the part completion certificates are obtained from time to time for the purpose of handing over possession building-wise. Under such circumstances even if a completion certificate issued by the competent authority for one flat/shop or unit will entail capital gain tax liability in the hands of the assessee. Under such circumstances the assessee will have to pay capital gain tax irrespective of the fact that he has not received possession of a single unit. 
• Proposed section does not talk about the completion or part completion out of the share of project which is earmarked for landowner/assessee.
• Full value consideration shall be deemed to be the stamp duty value on the date of issue of completion certificate plus monetary consideration received, if any. JDA are entered considering the market trends, potential of land to fetch market rate, time period required to complete the project, as well as market uncertainties. Therefore, essentially the consideration of the land is discounted for many factors. It can not be equal to stamp duty value of the share even on the date of entering into JDA. Therefore, the basis of stamp duty value, instead of cost of construction of owner's share, is unjustified and is really high.
• It is well-known fact that the stamp duty value is increased by the State Government on year to year basis. Therefore, the stamp duty value which is say Rs. 5000/- per sq ft on the date of entering into JDA may be Rs. 7000/- on the date of issue of Completion Certificate. The assessee would land up paying tax on Rs. 7000/- instead of Rs. 5000/- which could be a considerable loss to the assessee. The assessee may land up paying heavy tax on notional value of stamp duty on the date of completion or part completion.
• In case of assesses owning small piece of land enters into the agreement with the intention to retain the share in built-up area for his own use may be taxed on stamp duty value on the date of completion of the project. However, the situation may be taken care of by exemption under section 54/54F of the I. T. Act.
• In case of JDA of the combined nature - revenue as well as constructed area sharing, the TDS would be deducted in the year of receipt of monetary consideration and he may not have any income to claim such TDS. Therefore, claiming TDS in between years before completion of the project will pose a major problem.
• The proposed amendment is prospective and is applicable from assessment year 2018-19 and therefore, this will not be helpful in resolving the controversy/litigation of earlier years which would continue.

However, taking a holistic view of the proposed amendment it is definitely beneficial and welcome provision. Number of proposals which are held up for the aforesaid reasons will start afresh. Lastly it will go a long way to reduce litigation and the land owners at least will know the year of capital gain tax incidence.

Union Budget 2017 - 'Indirect Transfer' amendments - Goal in sight but some distance yet to be traversed

Indirect Transfers have continued to be in focus ever since Vodafone's acquisition of the Indian mobile telecommunication business of Hutchison as reported by the Indian Press. The much talked about retrospective amendment to the Income Tax Act, 1961 ('the Act') post the SC decision in 2012 came back into focus in fag end of 2016 when the Central Board of Direct Taxes ('CBDT') issued its Circular no. 41 dated 23 December 2016, stating its views on applicability of the Indirect Transfer provisions in the Act to certain daily, real life situations. With this circular being issued, taxpayers and particularly Foreign Portfolio Investors' (FPI) concerns went up manifold as this circular very specifically and unambiguously stated that (a) indirect transfer provisions applied even where a Foreign Portfolio Investor substantially¹ held assets in India which were in the nature of portfolio and not strategic investments (b)  indirect transfer provisions applied even where despite assets being in India not being transferred by the FPI, there was a redemption or transfer of shares or units of the FPI overseas (c) the situation of multi-tier funds was even graver as the indirect transfer provisions applied to redemption/transfers at multiple levels (d)  the provisions applied even to funds whose shares/units were listed on overseas stock exchanges. Additionally the liability to withhold tax for the buyer of foreign share s/units and the risk of FPI in some manner, even if vicariously, being held liable to pay the tax (and that too from Financial year 2012-13²) were expressed as area of grave concern.

FPIs therefore quickly got together and strongly represented to the Govt., by way of meeting various /officers (including Prime Minister's office) to tone down the indirect transfer provisions and in the interregnum, to keep the Circular no. 41 on hold. The Govt. swiftly responded by issuing a Press Release dated 17 January 2016, to keep such circular on hold.

In the Finance Bill presented before the Parliament on 1 February 2017, the Hon. Finance Minister has proposed to add a further Explanation - Explanation 5A to Sec 9(1)(i) of the Act. This Explanation  proposed to be retrospectively inserted with effect from 1 April 2012 states that for removal of doubts, it is hereby clarified that nothing contained in Explanation 5 (the indirect transfer provisions) shall apply to an asset or capital asset mentioned therein which is held by a non-resident, by way of investment, directly or indirectly, in a Foreign Institutional Investor referred to in clause (a) of Explanation to sec 115 AD of the Act (this refers to FPIs) and registered as a category I or category II FPI under the Securities and Exchange Board of India ('SEBI') ('Foreign Portfolio Investors) Regulations 2014.

SEBI categorizes FPIs into three categories for the purpose of regulating them. Category I FPIs are those which are very strictly regulated in their home country, banks and insurance companies for example. SEBI regulates the investments by these entities very lightly and the diligence done while onboarding them is also light.  Next in level of diligence are FPIs that are categorized as Category II. These are typically broad based funds which have more than 20 investors and none of the investors holds more than 49% of the Fund's corpus. The rigour of regulation by the SEBI for these funds is higher than that for Category I funds, but still not very strict. Category III FPIs are the residuary lot of the FPIs  that do not fit into either Category I or Category II. The rigour of regulation for these is high as typically any person (individual, corporate etc.) can now get direct access to the Indian Capital Market by registering as a Category III FPI.

The non-applicability of indirect transfer provisions has been proposed to be restricted assets or capital assets held by a non-resident by way of investment directly or indirectly in a Category I or Category II FPI. The asset can either by way of stock in trade or by way of a capital asset. The asset should be a direct or an indirect investment in the Category I or Category II FPI, even an indirect investment if transferred is eligible for the 'non-inclusion'. This should hopefully take care of the controversy of application of the indirect transfer provisions to multi- tier fund structures where the entity investing into India is a Category I or Category II FPI.

Category III FPIs  and also other foreign funds (that do not usually invest in Indian listed exchange trade securities) like Private Equity Funds, Venture Capital Funds etc. would still continue to be governed by the indirect transfer provisions as would be cases of overseas capital reorganizations. Also, conceptually the issue of taxation of multiple levels has not been sought to be directly addressed by the proposed amendment. In short, despite this being a welcome relief, many other aspects of indirect transfer taxation,  still require careful consideration including inter alia,  the enforcement of these provisions, the casting of a withholding tax obligation on the non-resident buyer and its compliance, the efficacy of reporting by the Indian company of a transaction that would never come to its attention etc. Therefore, though the tax paying community and FPIs have reason to welcome the proposed amendment, both the FPIs and relevant stakeholders in the Govt. should take this as first step towards achieving goal that is in sight but needs traversing some distance yet to reach.

It does appear that this is also the Government's  thinking. The Hon. Finance Minister in his Budget speech also mentioned that a clarification that indirect transfer provisions shall not apply in case of redemption of shares or interests outside India as a result of or arising out of redemption or sale of an investment in India which is chargeable to tax      in India would be issued. This lends hope that the Govt. too has not completely closed out on the thought process on mitigating the rigours of the indirect transfer provisions. Serious and considered thought will have to be given and careful and candid discussions will need to be done by the stakeholders involved to achieve this.

1. In excess of 50% of foreign investors total assets
2. The CBDT has issued a clarification that completed assessments for earlier years would not be reopened. 

Proposed Amendment to Section 10AA: Spoiling the Joy of a (Tax) Holiday

Amid high expectation of sops and benefits across the economy, the Finance Minister, Mr. Arun Jaitely presented the Union Budget 2017-18. In his speech, the FM provided compelling statistics on how the direct tax collection regime is far short on the biggest challenge — expanding the tax base. Addressing this challenge, the FM attempted to optimise tax rates and provide various measures for improving tax administration. The Budget features various pragmatic measures such as scoping out of certain categories of Foreign Portfolio Investors from the impact of Indirect transfers, investor friendly measures for real estate, introduction of thin capitalization regime and rationalisation of transfer pricing provisions for specified domestic transactions.

The FM, in this Budget, has also attempted to clarify the intention of the legislature for various provision like taxation of carbon credits, capital gains in case of joint development agreement and foreign tax credit among others. One such area relates to computation of tax holiday enjoyed by entities located in Free Trade Zone ('FTZ'), Special Economic Zone ('SEZ') and Export Oriented Units ('EOU') from their income derived from eligible businesses.

In the Finance Bill 2017, the FM has proposed to clarify the mechanism for calculation of the benefits under section 10AA of the Income-tax Act, 1961 ('Act') by introducing an explanation to the existing provisions. As per the proposed explanation, the deduction is to be allowed from the total income before giving effect to section 10AA and the said deduction shall not exceed the total income of the taxpayer.

Implication of the Proposed Amendment

As per the provisions of section 10AA of the Act, a taxpayer having an eligible unit located in SEZ is entitled to a deduction of profits from exports. The said section also provides for computation of such deduction.

In past, taxpayers having units eligible for tax holiday under section 10A/10B have been computing profits of the unit and claiming exemption of such profit prior to setting off losses of any other business unit. As a result, taxpayers were carrying forward entire losses under non-tax holiday units to subsequent years (or setoff against income from other heads, as the case may be). While the position taken by the taxpayer was being litigated, the controversy was ultimately settled in favour of the taxpayer by the Supreme Court in the case Yokogawa[1].

While the tax holiday under section 10A/10B of the Act has ended, the above decision brought relief to taxpayers having units in SEZ who are entitled to deduction under section 10AA of the Act, as the provisions of the said section are pari-materia with section 10A/10B of the Act.

Ending the ephemeral joy, the amendment now proposes to alter such position and requires aggregation of income of the units (i.e. inclusive result of eligible and non-eligible units) before giving effect to deduction under section 10AA of the Act. Only the balance loss, if any, would then be allowed to be carried forward (or setoff against income from other heads).

The Legislative Framework, the Controversy and the Clarification

The provisions of the Act have been grouped under various Chapters. Chapter III of the Act deals with 'Income which do not form part of total income'. Similarly, Chapter VI-A deals with 'Deduction to be made in computing total income'. In other words, Chapter III of the Act deals with exemptions and Chapter VI-A deals with deductions. Exempted income does not form part of computation of total income. Whereas, in case of deductions, the income is first included in the total income and deduction in accordance with the provisions of each section is then reduced.

While enacting the provisions of sections 10A/10B of the Act (dealing with tax holidays on fulfilment of specified conditions), the legislature placed them in Chapter III of the Act. Thus, historically, the said provisions were understood to have character of exemptions. Subsequently, Finance Act, 2000 and Finance Act, 2003 (both with effect from Assessment Year 2001-02) amended the provisions of section 10A and 10B of the Act, where the wordings indicated characteristics similar to that of a deduction from the total income of the taxpayer.

Based on the placement and the language of the sections, while determining taxable income of the taxpayer, income of the eligible unit is computed and the same is then excluded before arriving at the gross total income of the taxpayer. Hence, the income eligible for exemption under section 10A would not enter into computation as the same has to be deducted at source level. Losses of any other unit would thus entirely be set off against income under head in accordance with the provisions of section 71 of the Act and any unabsorbed loss would then be carried forward to be set-off as per provisions of section 72 of the Act.

However, in their Circular 7 of 2013 dated July 16, 2013 the CBDT clarified that irrespective of the continued placement of section 10A/10AA/10B in Chapter III of the Act, the provisions, as substituted by Finance Act, 2000, provide for deduction of profits from the total income of the taxpayer. It also clarified that the income computed under various heads of income in accordance with the provisions of Chapter IV of the Act shall be aggregated in accordance with the provisions of Chapter VI of the Act. In other words, first the income/loss from various sources i.e. eligible and ineligible units, under the same head are aggregated in accordance with the provisions of section 70 of the Act and subsequently the income from one head is aggregated with the income or loss of the other head in accordance with the provisions of section 71 of the Act. Subsequent to giving effect to such mechanism deduction in accordance with the provisions of Chapter VI-A or sections 10A/10AA/10B of the Act shall be allowed in computing the total income of the taxpayer.

While the above Circular was challenged by the aggrieved taxpayers, some taxpayers used the Circular to set-off the losses of the eligible unit against the profits of other units.

It would be interesting to note that, subsection (6) of section 10A/10AA/10B permits carry forward and set-off of loss as per provisions of section 72, which is contrary to the characteristic of an exemption.

Supreme Court Decision in Case of Yokogawa
This issue has been debated at various levels and several courts have pronounced conflicting decisions. The matter reached finality when the Hon'ble Supreme Court in the case of Yokogawa (supra) rested the controversy after concluding the following:

• Introduction of the word “deduction” to section 10A, as also other amendments, including permitting a taxpayer to carry forward and set off of losses of eligible units clearly reflects the legislative intent to alter the nature of section 10A from an exemption provision to a deduction provision.
• Where the intention and effect of the statute is clear from the language used, there is no scope to turn to Chapter notes or the marginal notes to interpret section 10A to be an exemption section despite the said provision being included in Chapter III of the Act.
• Deduction of section 10A is attached to the eligible unit. Deduction is to be computed on a standalone basis, without reference to other eligible or non-eligible units of the taxpayer.
• The expression 'total income', as used in section 10A, is to be understood as 'total income of the unit'
• Deduction is to be allowed at the stage of determination of profit and gains of an eligible unit under Chapter IV and without aggregating results, including losses of other units (eligible or noneligible units) of the taxpayer.
• Decision of this Court with regard to the provisions of section 10A of the Act would equally be applicable to cases governed by the provisions of section 10B, in view of the said later provision being pari-materia with section 10A of the Act though governing a different situation.

Overturning the Decision of Supreme Court
The Finance Bill 2017-18 proposes to insert the following explanation after sub-section (1) of section 10AA of the Act:
“Explanation - For the removal of doubts, it is hereby declared that the amount of deduction under this section shall be allowed from the total income of the assessee computed in accordance with the provisions of this Act, before giving effect to the provisions of this section and the deduction under this section shall not exceed such total income of the assessee”
As an outcome of the proposed amendment, , in case of a taxpayer having losses from units which are not entitled for tax deduction are first required to be set-off against the profits of the unit entitled to tax deduction and only the remainder profits shall be entitled for deduction under section 10AA of the Act. The above analogy would also apply where a taxpayer has losses under tax holiday units and profits under ineligible units.
It thus is another attempt to overturn a decision of the Hon'ble Supreme Court by introducing an Explanation to the provisions of a section. The only silver lining here is that the Explanation is inserted prospectively with effect from April 1, 2018.

[1] Commissioner of Income-tax v. Yokogawa India Limited [TS-661-SC-2016]
(This article is co-authored  by CA Arpit Jain, BDO India)

Taxation of Carbon Credit

Carbon Credits

Increased human industrial and commercial activities involving use of fuels emitting Green House Gases (“GHGs”) has been causing increase in global mean temperature (“global warming”) since the era of industrial revolution in 18th century. Rising global warming has led to increasing awareness of need for reduction in emission of GHG concentrations in the atmosphere to 'a level that would prevent dangerous anthropogenic interference with the climate system'.

To achieve this objective as laid by United Nations Framework Convention on Climate Change (“UNFCC”), countries across the globe adopted an international treaty, “Kyoto Protocol” (“the Protocol”) on December 11, 1997 at Japan. The Protocol, which entered into force in February 2005, commits its signatories to internationally binding emission reduction targets.

The Protocol provides a mechanism for measuring the reduction of GHGs known as 'Carbon Credits', wherein, reduction in emission of one metric tonne of carbon dioxide is equivalent to one carbon credit. The Protocol also created mechanism for trading of carbon credits with an intention to incentivize industries for reduced emission of GHGs, including carbon-dioxide, in the process of industrialization. Industries can achieve the same by several ways including switch over to wind and solar energy, forest regeneration, installation of energy efficient machinery, landfill methane capture, recycling, etc.

The Protocol provides for three mechanisms for carbon credit:

• International Emissions Trading (IET) [ Article 17]
• Joint Implementation (JI) [Article 4 and Article 6]
• Clean Development Mechanism (CDM) [Article 12]

IET and JI mechanisms involve acquiring of emission units or joint emission reduction projects only amongst countries committed under the Protocol. Thus only countries with commitments under the Protocol can participate under IET and JI Mechanisms and countries like India, which do not have any commitments under the Protocol can avail carbon credits only under the CDM mechanism.

The CDM allows emission-reduction (or emission removal) projects in developing countries, including countries which are not committed parties. To calculate the compliance of environmental target fixed for participating countries a measure for calculation is adopted in the form of Certified Emissions Reduction (CER) units, each equivalent to one tonne of CO2.

These CERs can be traded and sold, and used by industrialized countries to a meet a part of their emission reduction targets under the Protocol. The CDM projects need to qualify through a rigorous and public registration and issuance process designed to ensure real, measurable and verifiable emission reductions that are additional to what would have occurred without the project.

Entities in countries like India are thus entitled to trade in CER earned from reduction in GHGs with entities in countries with commitments under the Protocol, for a price arrived through set mechanism.

Taxability - Current Provisions

Taxability of receipt on transfer of CER has been subject matter of significant debate in the past. While taxpayers have claimed the same to be capital receipt not chargeable under the provisions of the Indian Income tax Act 1961 (“Act”), tax authorities have been contending the same to be business income chargeable to tax as 'Profits and gains from business or profession'.

There are judicial decisions holding that receipt from transfer of CERs arises due to world concern and awareness for reduced GHG emissions and thus cannot taxed be as business income of the taxpayer. The decisions held that the amount so received has no element of profit or gain and it being capital receipts cannot be subjected to tax in India in light of the provisions of sections 2(24), 28, 45 and 56 of the Act. The same has been discussed at length in the decision of Hyderabad ITAT in the case of My Home Power Ltd. [TS-820-ITAT-2012(HYD)] which was affirmed by Andhra Pradesh High Court [46 taxmann.com 314] which was followed in various judicial decisions, including:

• Subhash Kabini Power Corporation Ltd. [TS-236-HC-2016(KAR)]
• Adisankara Spinning Mills (P.) Ltd. [TS-6067-ITAT-2014(CHENNAI)-O]
• Arun Textiles (P.) Ltd. [TS-5692-ITAT-2015(CHENNAI)-O]
• L.H. Sugar Factory Ltd [TS-5077-ITAT-2002(LUCKNOW)-O]
• Shree Cement Ltd. [TS-35-ITAT-2014(JPR)]

While the above decisions uphold the view that the receipt from CER is not an offshoot of business, a contrary view is taken by Tribunals in the case of Kalpataru Power Transmission Ltd. [2016] 68 taxmann.com 237 (Ahmedabad Trib.) and Apollo Tyres Ltd. [2014] 47 taxmann.com 416 (Cochin Trib.) holding that income on transfer of CERs should be considered as benefits or perquisites under Section 28(iv) chargeable to tax as profits and gains of business or profession.

In our view, there is a good case for holding that the receipt on account of carbon credits is a capital receipt on the ground that the entities would not have been entitled to CERs and would not have been remunerated for “carrying on its business in an environment friendly manner” but for the Protocol and global concerns and awareness of the necessity of environment protection. Substantial reduction in emission of GHGs can be achieved only by business enterprises and not by individual households and accordingly, there will always be some business activity, and more likely manufacturing activity wherein an enterprise would try to achieve reduction in emission of GHGs. However, without global concern for environmental protection, there will be no value of such CERs. Accordingly, CERs are certainly obtained and entitled due to world concerns and while it involves business processes it is not as an outcome of business carried on by a person. Accordingly, since the benefit arises from world concerns and not from the business carried on by the enterprise, the same cannot fall within the provisions of Section 28. Accordingly, receipts from transfer of CERs, being capital receipts, in our view, should not be charged to tax in India in absence of specific provisions in this regards.

Minimum Alternate Tax

As per Guidance Note on Accounting for Self-Generated Certified Emission Reductions (CERs) issued by Institute of Chartered Accountants of India to provide guidance on accounting for carbon credits, states that CERs should be recognized in books when those are created by UNFCCC and/or unconditionally available to the generating entity. Accordingly, CERs are generally credited to profit and loss account. However, considering that receipts from CERs are capital in nature, various judicial decisions in the cases of Shree Cement Ltd. (supra) and L.H. Sugar Factory Ltd. (supra) have held that the same needs to be excluded from computation of book profit u/s 115JB of the Act.

Finance Bill 2017

The Finance Bill 2017 proposes to insert new Section 115BBG from Assessment Year 2018-19 in relation to taxation of carbon credits, which reads as under:

“115BBG. (1) Where the total income of an assessee includes any income by way of transfer of carbon credits, the income-tax payable shall be the aggregate of--

(a) the amount of income-tax calculated on the income by way of transfer of carbon credits, at the rate of ten per cent.; and

(b) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (a).

(2) Notwithstanding anything contained in this Act, no deduction in respect of any expenditure or allowance shall be allowed to the assessee under any provision of this Act in computing his income referred to in clause (a) of sub-section (1).

Explanation.--For the purposes of this section “carbon credit” in respect of one unit shall mean reduction of one tonne of carbon dioxide emissions or emissions of its equivalent gases

which is validated by the United Nations Framework on Climate Change and which can be traded in market at its prevailing market price.”

Further, the memorandum to the Finance Bill clarifies that the said amendment is introduced with a view to encourage measures to protect the environment. Accordingly, the proposed amendment intends to tax receipts from transfer of CERs, which are included in total income of the taxpayer at a concessional tax rate of 10% as against corporate tax rate of 30% plus being levied by tax authorities considering the receipts as business income.

To summarize, the proposed section provides that, where total income of a taxpayer includes any income by way of transfer of carbon credits, gross receipts from transfer of carbon credits (without deduction of any expenditure or allowance) will be subject to tax at the rate of 10% (plus applicable surcharge and cess).

The phrase 'total income' has been defined under Section 2(45) of the Act as total amount of 'income' referred to in Section 5 (Scope of total income), computed in the manner laid down in the Act. Accordingly, receipt from transfer of carbon credit can be subject to tax as per Section 115BBG only if it falls within the definition of 'income' as per Section 2(24) of the Act.

However, it may be noted that no consequential amendment has been carried out in Section 2(24) to treat receipts from sale of CERs as 'income' liable to tax under the Act. It is a well settled principle that when a receipt, not ordinarily in the nature of income, is to be considered as income, it is required to be specifically included in the definition of income under Section 2(24) of the Act.

Following decisions, for instance, were held based on similar principle. The Apex Court in the case of Guffic Chem (P.) Ltd. [2011] 332 ITR 602 (SC), wherein, payment received as non-competition fee under a negative covenant, prior to April 1, 2003 (prior to introduction of provisions of Sec. 2(24)(xii) r.w.s. 28(va)) was considered as a capital receipt not taxable as income.

Similarly, in the case of Lachit Films Vs. CIT [195 ITR 402] (Gauhati), grant in aid received by assesse was considered as financial aid or subsidy, not includible in the total income as grant in aid had not been included in Section 2(24).

Various provisions have thus been included in the definition of 'income' under Section 2(24) in relation to export incentives, receipts from keyman insurance policies, non-compete fees, gifts, capital gains, benefits and perquisites, etc. to bring the same to tax net.

Accordingly, in absence of any consequential amendment to Section 2(24) of the Act, the dispute with respect to taxation of carbon credits continues. Should the controversy in relation to nature of receipts from sale of carbon credits is settled, holding the receipt as capital receipt, it should be possible to argue that the same will not fall within the definition of income and hence should not be taxed under Section 115BBG proposed to be introduced.

Tax clean-up of financial markets

The Government over the past several years has announced and implemented several anti-abuse measures. Some of the key anti-abuse provisions that have been implemented are protocol entered with Mauritius, Cyprus and Singapore, introduction of General Anti Avoidance Rules, specific domestic transactions, etc. In order to further tighten the noose on avenues to reduce the tax liability that are being explored by tax payers, the Government has introduced specific anti abuse provision in relation to gains arising on transfer of long term capital asset being an equity share in a company. Currently, gains arising on transfer of equity shares listed on a recognized stock exchange and are held for a period of more than 12 months are exempt from tax provided the said asset is transferred on or after 1 October 2004 and the Securities Transaction Tax ('STT') was chargeable on such transaction. 

With a view to prevent certain persons from misusing the beneficial provisions for declaring their unaccounted income as exempt long term capital gains by entering into sham transactions, it is proposed that with effect from 1 April 2017 the above exemption cannot be availed in the following cases:

• The assets transferred are equity share in a company; and
• The equity share is acquired on or after 1 October 2004; and
• STT was not chargeable at the time of acquisition of such shares.

However, it is pertinent to note that there could have been certain acquisitions on or after 1 October 2004 which were not subject to STT such as shares acquired in initial public offer, future public offer, bonus, acquisition by a non-resident as per the Foreign Direct Investment policy, etc.

In order to ensure that genuine transactions are not caught within the ambit of the said amendment, Government will notify acquisitions which are not subject to STT.

The proposed amendment, in relation to the above transaction is a welcome move and is in line with the Government's effort to curb black money, implementation of anti-abuse provisions, minimize litigation and simplify and bring certainty in tax laws. However, there is some element of ambiguity in relation to whether shares acquired prior to introduction of STT, initial public offering, merger, demerger & other corporate restructuring will be covered in the list that the Government will notify in due course. If shares acquired in one or more of the modes that is not covered in the notification then it will result into undue hardship and taxing times for persons who have acquired shares without paying STT.
 

Information for the editor for reference purposes only