Budget 2021 – Impact Analysis from M&A Perspective

This article has been co-authored by Saurabh Mehta (Director), Deals Tax, PwC India.

Despite the Central Government’s proactive measures during the past year, the Union Budget 2021 was still expected to deliver on global sentiments in India’s run towards economic recovery from the COVID-19 pandemic. The Budget expectations show continued growth momentum. Although the Central Government has maintained status quo on the direct tax front, a few noteworthy changes have been introduced by the Finance Bill, 2021. Most of these proposed changes affect the corporate restructuring and acquisitions and are outlined below.

• REITs / InvITs

Finance Act, 2020 abolished the dividend distribution tax payable by companies by moving to the conventional manner of levying tax in the hands of shareholders. Owing to shareholder-level taxation, companies are required to deduct tax at source (TDS) at prescribed rates, while declaring dividends to shareholders.

Despite the tax pass-through status enjoyed by Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), the Finance Act, 2020 imposed the requirement of deducting tax at source on dividends declared and paid to these trusts. This led to compliance burden and short-term cash flow issues. Finance Bill, 2021 offers respite thereof by eliminating the requirement of TDS on dividends payable to such REITs and InvITs. This move helps in making investments in units of REITs and InvITs more lucrative to investors.

Further, to enable better access of finance to REITs and InvITs, it is also proposed to permit debt financing of REITs and InvITs by Foreign Portfolio Investors, thereby encouraging fund flow in the development of real estate and infrastructure assets.

• Relaxations to real estate sector

The Central Government has incentivized the housing sector by extending the eligibility for availing income-tax holiday on all affordable housing projects approved up to 31 March, 2022, from the current date of 31 March, 2021. It is further proposed to extend tax holiday benefit to notified rental housing projects also.

For transfers of residential properties for a consideration upto ₹ 2 crores, Finance Bill, 2021 proposes to increase safe harbour from the current 10% to 20%, for such transfers made between 12 November 2020 and 30 June 2021, as a first-time allotment.

• Depreciation claim on goodwill:

In a bold move by the Central Government, Finance Bill, 2021 proposes to reverse a landmark Supreme Court ruling, wherein it was held that goodwill of a business is an intangible asset eligible for depreciation.

Prior to this proposed amendment, there was ambiguity on whether goodwill of a business, acquired as a part of business acquisitions or corporate reorganizations is eligible for depreciation. Finance Bill, 2021 settles this controversy by proposing to specifically exclude ‘goodwill of a business or profession’ from being classified as a depreciable asset.

However, this amendment may be a barrier for genuine cases of acquisitions, which inherently factor a price for goodwill. Such genuine transactions will not be eligible for immediate benefit by way of depreciation. Instead, Finance Bill, 2021 allows the price paid towards goodwill as its cost of acquisition if, and when, such goodwill is subsequently transferred.

• Taxability of slump exchange

The definition of ‘slump sale’ under Income-tax Act, 1961 (‘Act’) currently only covers transfer made by way of sale. The term ‘sale’ has not been defined in the Act. Hence, there has been ambiguity on whether the transfer of business in exchange of consideration in kind is taxable.

Finance Bill, 2021 now proposes to tighten the definition of slump sale given in section 2(42C) of the Act, so as to cover inter alia transfer by way of exchange or any other means. It is pertinent to note that this amendment is proposed to be effective retrospectively from 1 April, 2020.

• Rationalising distributions made by firm to its partners

The current provisions of the Act provide for taxability of capital gains arising on distribution of capital assets by a firm to its partners in the event of dissolution or otherwise. Despite multiple divergent pronouncements, the uncertainty still looms on: (i) taxability on distribution of cash and; (ii) taxability in cases of admission and retirement of partners wherein the partners’ capital was increased by revaluing assets of the firm.

Finance Bill, 2021 proposes to levy tax on capital gains in the hands of firm on any distributions made to its partners on dissolution or reconstitution, whether in the form of capital assets or other assets or cash. Goodwill or any other form of upward revaluation to partners’ account, has to be ignored while computing the capital account balance of the partners.

However, Finance Bill, 2021 does not prescribe a manner to determine the nature of capital gains (long-term/ short-term) in the hands of firm/ partners. Clarifications from the Central Government will be welcome in this regard.

• TDS on goods:

Finance Act, 2020 introduced an obligation on specified persons to collect tax at source from buyers, at the time of sale of goods. The term ‘goods’ has not been defined in the Act; and hence, this led to interpretational issues on the applicability of tax collected at source (TCS) on sale of shares and businesses. Moreover, the requirement to collect tax at 0.1% increased the transaction size / ticket size for buyers, resulting in short-term marginal cash flow problems.

In this context, Finance Bill, 2021 addresses the problem by introducing a TDS obligation on prescribed buyers, who are now required to deduct tax at source while purchasing goods from resident sellers. The same can be claimed as tax credit by such sellers. Consequently, the TCS requirement seem to be discarded, for transactions on which TDS is made applicable.

Considering the above changes, the Central Government has indeed announced a Budget with some focus on the M&A ecosystem. This paves the way for a resilient and transparent tax framework. Although some announcements are welcome, certain other proposals, such as eliminating depreciation on goodwill, will be met with skepticism in the corporate marketplace.

Depreciation on Goodwill: A Hard Pill to Swallow for Corporates

This article has been co-authored by Jatan Shah (Senior Manager) and Aashni Shah (Assistant Manager), Deloitte Haskins & Sells.

In case of business acquisitions, goodwill arises when the purchaser pays a consideration which is higher than the valuation of the business. As per the accounting standards, both IGAAP and Ind-AS, such excess consideration is to be recorded as goodwill in the books of accounts of the acquirer.

Accordingly, for tax purpose, such goodwill, being in the nature of a business or a commercial right, was recognised as an intangible asset and since there was no specific exclusion of goodwill as a depreciable asset, depreciation @25% on such goodwill was generally claimed by many corporates. 

Current scenario:

Currently the courts across India have expressed divergent views on this subject matter which has created an air of confusion amongst the corporates. Relying on the favorable Supreme Court decision in the case of Smifs Securities, many corporates have taken a view that depreciation should be available on goodwill and have accordingly concluded their transactions.

In the past, where the consideration paid on acquisition of business was much higher than the actual value of business, the tax authorities had claimed that the restructuring transactions were orchestrated only to claim depreciation on goodwill and thereby reduce its tax outflow.

It was imperative to put an end to this prolonged issue which had created a lot of ambiguity leading to excessive litigation costs and undue hardships on the corporates.

Amendments proposed:

The amendments proposed by the Budget has excluded goodwill from the definition of ‘block of assets’ and the list of assets which are eligible for claiming depreciation under the Income Tax Act, 1961 (‘the Act’). Thus, the benefit which was available to the corporates in the form of depreciation on goodwill recorded in the books of accounts will now no longer be available, thereby creating a higher tax outgo in the hands of the acquirer entity.

The amendment further proposes to prescribe a specific computation mechanism to determine the written down value and short term capital gains in case where depreciation on goodwill has already been claimed by the assessee.

Further, the proposed amendments also provides that the cost of acquisition of such goodwill, will be reduced by the depreciation already claimed thereon.

Subsequent amendments are also proposed to deal with the cost of acquisition and computation of capital gains on account of goodwill, on which depreciation has already been claimed.

Impact on on-going litigations:

While the amendment has put a rest on the disputes for all future restructuring transactions, the fate of ongoing assessments and litigation still remains uncertain. The issue which needs to be pondered upon is, what will be the course of action that will be adopted by the tax authorities.

The proposed amendments are applicable from financial year (FY) starting 1 April 2020 and may not impact any transactions which are undertaken prior to this date. However, there could be a challenge for companies who have already claimed depreciation on goodwill in the current FY and have paid advance taxes taking into consideration such depreciation claim . Such companies might be subjected to interest liablity on such default in payment of advance taxes and they may have to shell out further cash.

Other practical difficulties:

While the aforesaid amendments is a welcome move to curb the transactions which were undertaken only for the purpose of evading taxes, it will cause onerous burden on the acquirers in case of genuine transactions. Depreciation will also not be allowed in case where excess amount is paid towards genuine goodwill of the business. This will lead to a cash outflow towards acquisition of asset without any corresponding tax benefit.

No clarity has also been provided in case of depreciation on other acquired intangible assets such as customer contracts, customer list and workforce, which can still be subject to ambiguity. 

While the long awaited ask for clarity on depreciation on goodwill has been finally addressed by the Budget and it may also reduce litigation going forward, there are certain taxpayers who are left in a soup due to this amendment. Clear internal directives will be required to be issued by the CBDT to control tax authorities from taking adverse actions against taxpayers, where transactions are already concluded.

Information for the editor for reference purposes only

Equalisation Levy – Budget 2021 Impact!

Equalisation Levy (‘EL’) – Recap

EL was introduced by India in 2016, on the lines of the recommendations of the OECD BEPS Action Plan 1 aiming to tax revenues generated by online businesses who would not fall under the tax net applying the conventional tax norms. Scope of the levy was expanded by the Finance Act, 2020 to cover specified e-commerce business thereby subjecting revenues from e-commerce supply or services (‘ESS’) provided or facilitated by an e-commerce operator (‘ECO’) to a EL of 2%. Exceptions were carved out for smaller players or those having permanent establishment in India. Parallelly, income tax exemption for such income was introduced, although some changes were rqeuired on this front.

As one would recollect, the EL regime does not form part of the income tax framework but is housed under a separate code thereby leaving room for double taxation, which has caused considerable angst amongst the ECOs. There was some ambiguity pertaining to overlap between the EL provisions and the other income tax provisions for taxing income earned by such entities.

Amendments proposed by Finance Bill, 2021 (‘FB 2021’)

Syncing dates of EL and corresponding exemption from Income Tax:

While the expanded EL provisions were made applicable from 1 April 2020, the consequential amendment  to Section 10(50) of Income Tax Act, 1961 (‘Act’) provided income tax exemption such income (i.e. subject to EL) only from 1 April 2021 which could have resulted in double taxation of said income arising in the period 1 April 2020 to 31 March 2021. This date mismatch is being plugged by the proposed amendment to Section 10(50) making the exemption effective from 1 April 2020 i.e. FY 2020-21 addressing a much required ask of the industry.

Clarification to avoid double taxation of Royalty / Fees for Technical Services

Proposed Explanation 1 to Section 10(50), the FB 2021 provides that effective 1 April 2020, income referred to in Clause 10(50) shall not include any income which is chargeable to tax in India in accordance with the provisions of the Act, read with the relevant Double Tax Avoidence Agreement, as Royalty or Fees for Technical Services. Similar changes have also been made to Section 163 of the Finance Act, 2016 (‘FA 2016), which is the EL charging provision. In addition to being taxed in case it has a permanent establishment in India, ‘Royalty’ and ‘Fees for Technical Services’ are the typical heads under which the non-resident ECOs see their income being taxed and thus, this clarification will go a long way in avoiding unwarranted litigation.

Retrospective clarification to clarify position on offline/ physical supply of goods and services

For the purposes of charging EL, ESS includes online sale of goods owned/ online provision of services provided/ facilitated by the ECO or a combination of these activities. To reduce ambiguity regarding coverage of any offline/ physical supply of goods and services, FB 2021 proposes to introduce an Explanation to Section 164(cb) of the FA 2016 clarifying that “online sale of goods” and “online provision of services" shall include one or more of the following activities taking place online: acceptance of offer for sale; placing or acceptance of the purchase order; payment of consideration; or supply of goods or provision of services, partly or wholly. While the intent of the provision is to bring clarity, the impact will need to be assessed depending on individual circumstances as the provision still appears to be wide enough to bring the ECO under the EL regime if even one of the parts of the supply/ sevice value chain is via digital means.

Matching coverage of EL and definition of consideration for an ECO

To remove any ambiguity around provisions pertaining to consideration on which EL is applicable, Section 165A of FA 2016 is proposed to be modified to provide that consideration from ESS includes consideration for sale of goods irrespective of whether the operator owns the goods; and that for provision of services irrespective of whether service is provided or facilitated by the ECO.

The above changes are indeed welcome and proof that the Indian Tax Authorities is cognizant of the difficulties being faced by the industry. It is also proof of the Government’s firm resolve to proceed with the levy inspite of the backlash it is facing from the US side which is accusing the Indian Tax regime of levying a unilateral tax on its digital companies!

Finance Bill’2021- Paradigm shift in the provisions relating to Income Tax Search and Seizure Assessments and Income Tax Settlement Commission

Introduction:-

The Hon’ble Union Finance Minister Nirmala Sitharaman has presented the Union Budget 2021 of India on the 1st of February, 2021. Budget 2021 is aimed at reviving an economy that plunged into deepest recorded slump amid the COVID-19 pandemic. In her speech, Hon’ble Madam Sitharaman announced that India’s fiscal deficit is set to jump to 9.5 per cent of Gross Domestic Product in 2020-21 as per Revised Estimates. This is sharply higher than 3.5 per cent of GDP that was projected in the Budget Estimates. A slump in government revenues amid the Covid-19 pandemic has led to a sharp rise in deficit and market borrowing. This was Sitharaman’s third budget under the National Democratic Alliance (NDA) government led by Prime Minister Narendra Modi. In a significant departure from the tradition, this year’s Budget was not printed and was only made available in a digital format.

In significant changes to the taxation process, among other tax measures, the Hon’ble Finance Minister recommend paradigm change to the provisions relating to “Assessment in case of Search or requisition viz. Section 153A to 153D” and Income Tax Settlement Commission.

Proposed Changes relating to Income Tax Search and Seizure and Income Tax Settlement Commission :-

1. Changes relating to Income Tax Search and Seizure Assessments:-

• Existing Legal Framework before 01-02-2021:-

Section 153A of the Income Tax Act’1961- Assessment in case of search or requisition (forming part of Chapter XIV of the Income Tax Act’1961- Procedure for Assessment) provides for assessment in the case of a person in whose case a search is initiated under section 132 of the Act or documents or assets are requisitioned under section 132A of the Act after May 31st, 2003. In such a case the Assessing Officer was obligated to issue notice u/s 153A in respect of 6 preceding years and relevant assessment year(s), immediately preceding the year in which search has been initiated. Thereafter he has to assess or reassess the total income of these six years. It is obligatory on the part of the Assessing Officer to assess or reassess total income of the six years and relevant assessment year(s) as provided in section 153A(1)(b) and reiterated in the 1st proviso to this section. The second proviso states that the assessment or reassessment pending on the date of initiation of the search or requisition shall abate.

At the outset it will be relevant to mention that under the existing search assessment procedure as contained under sections 153A to 153D concerning the assessment in a case where search under section 132 or requisition under section 132A is initiated were brought on the statute only w.e.f. 1-6-2003. Qua the search assessments earlier applicable procedure was contained in Chapter XIV-B (sections 158B to 158BI) wherein only undisclosed income mentioned in the seized documents, etc., relatable to the block of ten years was liable to be brought to tax and for the regular income Assessing Officer had to frame the normal assessments.

Section 153C of the act contains the procedure for assessment of income of persons other than that of the person searched which are covered u/s 153A of the act. Section 153C is a replacement to erstwhile “Section 153BD: Undisclosed income of any other person” contained in Chapter XIV-B which was made  inoperative for searches initiated u/s 132 of the act after the 31st day of May’2003. Section 153C of the act comes into play when the books of accounts, documents , assets seized in a search action from one person actually belongs to/pertains to/relates to some other person who has not been subjected to such a search action.   

• Proposed changes recommended in Finance Bill 2021:-

The Finance Bill 2021 proposes a completely new procedure of assessment in cases of initiation of search on or after 1st April’2021.

The salient features of new procedure are as under:-

• The provisions of section 153A and section 153C, of the Act are proposed to be made applicable to only search initiated under section 132 of the Act or books of accounts, other documents or any assets requisitioned under section 132A of the Act, on or before 31st March 2021.
• Assessments or reassessments or in re-computation in cases where search is initiated under section 132 or requisition is made under 132A, after 31st March 2021, shall be under the new procedure.
• Section 147 proposes to allow the Assessing Officer to assess or reassess or re-compute any income escaping assessment for any assessment year (called relevant assessment year).
• Further, in search, survey or requisition cases initiated or made or conducted, on or after 1st April, 2021, it shall be deemed that the Assessing officer has information which suggests that the income chargeable to tax has escaped assessment in the case of the assessee for the three assessment years immediately preceding the assessment year relevant to the previous year in which the search is initiated or requisition is made or any material is seized or requisitioned or survey is conducted.
• New Section 148A of the Act proposes that before issuance of notice the Assessing Officer shall conduct enquiries, if required, and provide an opportunity of being heard to the assessee. After considering his reply, the Assessing Office shall decide, by passing an order, whether it is a fit case for issue of notice under section 148 and serve a copy of such order along with such notice on the assessee. The Assessing Officer shall before conducting any such enquiries or providing opportunity to the assessee or passing such order obtain the approval of specified authority. However, this procedure of enquiry, providing opportunity and passing order, before issuing notice under section 148 of the Act, shall not be applicable in search or requisition cases.
• Years covered under Assessment : In normal cases, no notice shall be issued if three years have elapsed from the end of the relevant assessment year. Notice beyond the period of three years from the end of the relevant assessment year can be taken only in a few specific cases where the Assessing Officer has in his possession evidence which reveal that the income escaping assessment, represented in the form of asset, amounts to or is likely to amount to fifty lakh rupees or more, notice can be issued beyond the period of three year but not beyond the period of ten years from the end of the relevant assessment year.

These amendments will take effect from 1st April, 2021.

[Refer Clauses 35 to 40 and 42 to 43 of the Finance Bill’2021]

Analysis:-

The Hon’ble Finance Minister made a significant change to the well existing scheme of the Income Tax Assessments pursuant to a search and seizure action. In nutshell, the provisions of Section 153A and 153C shall not apply to search or requisition cases initiated or made or conducted, on or after 1st April, 2021.

While doing so, the reasons advanced in the memorandum explaining the provisions of Finance Bill’2021 are that the existing search assessment framework ( like the erstwhile block assessment procedure  under Chapter XIV-B of the Act) has failed to in its objective of early resolution of search assessments and were proving to be highly litigation-prone. The Bill proposed a completely new procedure of assessment of such cases. It is expected that the new system would result in less litigation and would provide ease of doing business to taxpayers as there is a reduction in time limit by which a notice for assessment or reassessment or re-computation can be issued.

For searches conducted on or after 1st April’2021, then forth, assessments shall be framed under Section 147 read with section 148, 148A, 149,151 of the Income Tax Act’1961.

The mandatory assessment of 6 years immediately preceding the year of search has been done away with and now only past 3 assessment years shall be covered under assessment unless the Assessing Officer has in his possession evidence which reveal that the income escaping assessment, represented in the form of asset, amounts to or is likely to amount to fifty lakh rupees or more, notice can be issued beyond the period of three year but not beyond the period of ten years from the end of the relevant assessment year.

Prima Facie, the cumbersome processes and administrative procedure of recording of satisfaction u/s 153C of the act has not been taken away.  W.e.f. 01st April’2021,  the satisfaction has to be recorded with the prior approval of Principal Commissioner or Commissioner that any money , bullion, jewellery or other valuable article or things so seized or requisitioned belongs and  books of accounts or documents so seized or requisitioned pertain or pertains to any other person other than the person searched.

Interestingly, the concept of dual assessment(s) seems to be revived again as the pending assessments now on the date of search shall not abate. Furthermore, in the erstwhile scheme, by virtue of Section 153B, the assessments were bound to be completed within a period of twelve months from the end of financial year in which the last of the authorization for search under section 132 or for requisition under section 132A was executed. With the introduction of new search assessment procedure by the Finance Bill 2021 pending the passage of the bill and presidential assent, it is apparent that the limitation shall now be governed by Section 153 of the act and shall be dependent on financial year in which the notice u/s 148 was served.

2. Changes relating to Income Tax Settlement Commission:-

• Existing Legal Framework before 01-02-2021:-

Chapter XIX - A of Income Tax Act, 1961 provides for settlement of cases. Income Tax Settlement Commission was set up in the year 1976 on the recommendation of Direct Tax Enquiry Committee headed by former Chief Justice of  India, Shri  K. N. Wanchoo. Chapter XIX – A of Income Tax Act, 1961 comprises of Section 245A to 245M. Section 245C of the Act empowers the assessee to move an application at any stage of a case relating to him and thereby to make a full and true disclosure of income, which has not been disclosed before the Assessing Officer subject to rider contained in section 245C of the Act. The Settlement Commission may allow or reject the application, but in any case in view of provision contained in section 245C of the Act, the application moved under sub-section (1) of the said section, cannot be allowed to be withdrawn by the applicant. The application so moved under section 245C of the Act should be processed by the Settlement Commission in view of procedure prescribed in section 245D of the Act within the specified period provided therein. The provision contained in section 245D provides that the Settlement Commission shall give opportunity to the applicant and to the Settlement Commission, which includes personal hearing or hearing through representative and then pass such order as it thinks fit on the matters covered by the application, which includes any other matter relating to case not covered by the application but referred to in the report of Commissioner, Income-tax.

• Proposed changes recommended in Finance Bill 2021:-

The Finance Bill 2021 proposed the discontinuation of Income Tax Settlement Commission with immediate effect i.e. 1st February’2021. It is proposed to discontinue Income-tax Settlement Commission (ITSC) and to constitute Interim Board of settlement for pending cases.

The various amendments proposed are as under:

• ITSC shall cease to operate on or after 1st February, 2021
• No application under section 245C of the Act for settlement of cases shall be made on or after 1st February, 2021;
• All applications that were filed under section 245C of the Act and not declared invalid under sub-section (2C) of section 245D of the Act and in respect of which no order under section 245D(4) of the Act was issued on or before the 31st January, 2021 shall be treated as pending applications.
• Where in respect of an application, an order, which was required to be passed by the ITSC under section 245(2C) of the Act on or before the 31st day of January, 2021 to declare an application invalid but such order has not been passed on or before 31st January, 2021, such application shall be deemed to be valid and treated as pending application.
• The Central Government shall constitute one or more Interim Board for Settlement (hereinafter referred to as the Interim Board), as may be necessary, for settlement of pending applications. Every Interim Board shall consist of three members, each being an officer of the rank of Chief Commissioner, as may be nominated by the Board. If the Members of the Interim Board differ in opinion on any point, the point shall be decided according to the opinion of majority.
• On and from 1st February, 2021, the provisions related to exercise of powers or performance of functions by the ITSC viz. provisional attachment, exclusive jurisdiction over the case, inspection of reports and power to grant immunity shall apply mutatis mutandi to the Interim Board for the purposes of disposal of pending applications and in respect of functions like rectification of orders for all orders passed under sub-section (4) of section 245D of the Act. However, where the time-limit for amending any order or filing of rectification application under section 245(6B) of the Act expires on or after 1st February, 2021, in computing the period of limitation, the period commencing from 1st February, 2021 and ending on the end of the month in which the Interim Board is constituted shall be excluded and the remaining period shall be extended to sixty days, if less than sixty days.
• With respect to a pending application, the assessee who had filed such application may, at his option, withdraw such application within a period of three months from the date of commencement of the Finance Act, 2021 and intimate the Assessing Officer, in the prescribed manner, about such withdrawal.
• Where the option for withdrawal of application is not exercised by the assessee within the time allowed, the pending application shall be deemed to have been received by the Interim Board on the date on which such application is allotted or transferred to the Interim Board.
• The Board may, by an order, allot any pending application to any Interim Board and may also transfer, by an order, any pending application from one Interim Board to another Interim Board.
• Where the pending application is allotted to an Interim Board or transferred to another Interim Board subsequently, all the records, documents or evidences, with whatever name called, with the ITSC shall be transferred to such Interim Board and shall be deemed to be the records before it for all purposes.
• Where the assessee exercises the option to withdraw his application, the proceedings with respect to the application shall abate on the date on which such application is withdrawn and the Assessing Officer, or, as the case may be, any other income-tax authority before whom the proceeding at the time of making the application was pending, shall dispose of the case in accordance with the provisions of this Act as if no application under section 245C of the Act had  been  made.  However,  for  the  purposes   of   the   time-limit   under sections 149, 153, 153B, 154 and 155 and for the purposes of payment of interest under section 243 or 244 or, as the case may be, section 244A, for making the assessment or reassessment, the period commencing on and from the date of the application  to  the  ITSC  under section  245C  of  the  Act and ending with the date on which application is withdrawn shall be excluded. Further, the income-tax authority shall not be entitled to use the material and other information produced by the assessee before the ITSC or the results of the inquiry held or evidence recorded by the ITSC in the course of proceeding before it. However, this restriction shall not apply in relation to the material and other information collected, or results of the inquiry held or evidence recorded by the Assessing Officer, or, as the case may be, other income-tax authority during the course of any other proceeding under this Act irrespective of whether such material or other information or results of the inquiry or evidence was also produced by the assessee or the Assessing officer before the ITSC.
• The Central Government may make a scheme, by notification in the Official Gazette, for the purposes of settlement in respect of pending applications by the Interim Board, so as to impart greater efficiency, transparency and accountability by eliminating the interface between the Interim Board and the assessee in the course of proceedings to the extent technologically feasible; optimising utilisation of the resources through economies of scale and functional specialisation; and introducing a mechanism with dynamic jurisdiction. The Central Government may, for the purposes of giving effect to the said scheme, by notification in the Official Gazette, direct that any of the provisions of this Act shall not apply or shall apply with such exceptions, modifications and adaptations as may be specified in the notification. However, no such direction shall be issued after the 31st March, 2023. Every such notification issued shall, as soon as may be after the notification is issued, be laid before each House of Parliament.

These amendments will take effect from 1st February, 2021.

[Refer Clauses 54 to 65 of the Finance Bill’2021]

Analysis:-

The Hon’ble Finance Minister made a significant change to the well existing scheme of Settlement of Cases. The Finance Bill 2021 proposed the discontinuation of Income Tax Settlement Commission with immediate effect i.e. 1st February’2021. It is proposed to discontinue Income-tax Settlement Commission (ITSC) and to constitute Interim Board of settlement for pending cases.

The Income Tax Settlement Commission (ITSC) was a quasi-judicial body set up under the Income Tax Act. The objective of setting up of ITSC was to settle the tax liabilities in complicated cases, avoiding endless and prolonged litigation. The taxpayer could approach the ITSC during the pendency of assessment proceedings, subject to certain prescribed conditions. For making an application before the ITSC, the tax and interest on additional income disclosed before the ITSC has to be paid. The order passed by the ITSC is conclusive and no appeal to any authority can be made against the order.

Income Tax Settlement Commission was set up in the year 1976 on the recommendation of Direct Tax Enquiry Committee headed by former Chief Justice of India, Shri K. N. Wanchoo. The purpose, intent and necessity of Settlement Commission is revealed by recommendation in para 2.32 to 2.34 of Chapter of the report:

“2.32 This, however, does not mean that the door for compromise with the errant tax payer should forever remain closed. In the administration of fiscal laws, whose primary objective is to raise revenue, there has to be room for compromise and settlement. A rigid attitude would not only inhibit a onetime tax evader or an un intending defaulter from making a clear breast of his affairs, but would also unnecessarily strain the investigational resources of the department in cases of doubtful benefit to revenue, while needlessly proliferating litigation and holding up collections. We would, therefore, suggest that there should be a provision in the law for a settlement with the taxpayer at any stage of the proceedings. In the United Kingdom, the confession method has been in vogue since 1923. In the U. S. law also, there is a provision for compromise with the taxpayer as to his tax liabilities. A provision of this type facilitating settlement in individual cases will have this advantage over general disclosure scheme that misuse thereof will be difficult and the disclosure will not normally breed further tax evasion. Each individual case can be considered on its merits and full disclosures not only of the income but of the modus operandi of its build up can be insisted on thus sealing off chances of continued evasion through similar practice.

2.33 To ensure that the Settlement is fair, prompt and independent, we would suggest that there should be a high level machinery for administering the provisions, which would also incidentally relieve the field officer of an onerous responsibility and risk of having to face adverse criticism which, we are told, has been responsible for the slow rate of disposal of disclosure petitions.”

The Settlement Commission was a quasi judicial body  and is a premier Alternative Dispute Resolution (ADR) body in India. The application for settlement can be made only during the pendency of the assessment proceedings and once during the lifetime. It is an institution, though within the Tax Department, but independent of the same to settle tax liability to give quietus to a dispute. In other words, the commission functions independently of the Department. It settles disputes relating to tax liability totally and finally. The biggest advantage of approaching ITSC was that it is empowered to grant immunity from prosecution for any offence and also to grant immunity from imposition of any penalty under the laws relating to Income Tax and Wealth Tax. The orders of the ITSC are final and not appealable. The orders are only subject to judicial review in terms of Articles 136 and 226 of the Constitution of India. Thus, time consuming litigation in regular appellate procedure is avoided by Department and assessee as well.

With the advent of Finance Bill ‘2021 , w.e.f. 01St February’2021, the assessee’s subjected to a search and seizure action cannot resort to the route of Settlement for prompt settlement of its cases as the commission itself has been discontinued. The search and seizure cases have also been kept out of the purview of newly introduced Dispute Resolution Committee by the Finance Bill’2021.  The reason for the same appears to be obvious that the government wants to create utmost deterrence on tax evasion and it appears that the intent is that there should not be any room for any compromise and/or tax settlement in such cases.

Inequitable taxation on proactive application by charitable trust

While the Hon’ble finance minister began her speech in the parliament by acknowledging the prerequisite of augmenting the buying power of the citizen to compensate the throes of slowdown and unprecedent contraction of the global economy due to covid-19 pandemic, however the words in the speech could not sync with the action proposed in the finance bill, 2021.

In this article, we shall understand the repugnant impact of the proposed finance bill on the charitable trust which is registered under section 12AA of the Income-tax Act,1961 (‘the Act’) to provide relief to the poor, education, medical relief, advancement of any other object of general public utility etc.

• Clarification in the budget on the computation of total income of the trust

An Explanation 5 is proposed to be inserted in subsection (1) of Section 11 of the Act as “For the purposes of this sub-section, it is hereby clarified that the calculation of income required to be applied or accumulated during the previous year shall be made without any set off or deduction or allowance of any excess application of any of the year preceding the previous year”

• Basis of computation of total income of the trust before the above proposed clarification

The trust or institution registered under section 12AA of the Act is not liable to pay tax if it spends 85% of its total income for charitable purpose. The mechanism of computing total income of the assessee is provided under Chapter-IV of the Act which begins with section 14 and ends with section 59 of the Act. However, the income of the trust is to be computed under section 11 to section 13B of the Act which shall further be subject to the provisions of section 60 to section 63 of the Act.

In light of the said provisions, the computation of income of the trust used to be often questioned by the tax authorities to substantiate the basis of claiming deductions, exemptions and allowances which are provided under various provisions of the Act but were not explicitly provided under the provisions of section 11 to section 13B of the Act.

Central Board of Direct Tax (‘CBDT’) had put to rest the said dispute by issuing a clarification under the Circular No. 29, dated 23-08-1969 by providing that section 11 of the Act uses the word ‘income’ and not ‘total income’ which is provided in section 2(45) of the Act. Accordingly, various trust now takes a position that benefits in the form of deduction or allowance provided under various provisions of the Act shall be available to it.

• Feasibility of claiming excess application of prior years in the subsequent years, before the above proposed clarification

It is worthwhile to note that there is no explicit provision under the Act that enables a trust to set-off the losses incurred in the prior years against the income in the subsequent year nor the same can be disclosed explicitly anywhere in the return of income of the trust in ITR-7. However, the judiciary had on various occasion discussed on allowability to carry forward and set-off of excess application of the prior years against the surplus in the subsequent year. The Principles enumerated from the jurisprudence is provided as follows:-

1. It is the well-settled position that income derived from the trust property must be determined on commercial principles.
2. if commercial principles for determining the income are applied, it is but natural that the adjustment of the expenses incurred by the trust for charitable and religious purposes in the earlier year against income earned by the trust in the subsequent year will have to be regarded as application of income of the trust for charitable purposes in the subsequent year.
3. The amount so applied in the subsequent year will have to be excluded from the income of the trust under section 11(1)(a).

The aforementioned principles were concurred by various courts in the past as follows:-

• Gujrat High Court in the case of Shri Plot Swetamber Murti Pujak Jain Mandal [TS-5781-HC-1993(GUJARAT)-O]
• Bombay High Court in the case of Institute of Banking Personnel Selection [TS-31-HC-2003(BOMBAY)-O]
• Madras High Court in the case of Matriseva Trust [TS-5134-HC-1999(MADRAS)-O]
• Delhi High Court in the case of Raghuvanshi Charitable Trust [TS-133-HC-2010(DELHI)-O]
• Karnataka High Court in the case of Ohio University Christ College [TS-7046-HC-2018(KARNATAKA)-O]

Impact of proposed clarification- More tax outflow on excess application

For the ease of reading, it is hereby reiterated that the proposed clarification in the budget restricts set off or deduction or allowance of any excess application of any of the year preceding the previous year against the income of the previous year of the trust. How such provision shall put the assessee trust in a worser position in the event of accelerated application of receipts for charitable purpose is provided in the following instance:-

• In Scenario-1, the trust had earned Rs.200 and expended Rs. 170 in 2 years and was not liable to any tax considering above judicial precedents.
• In Scenario-2, the trust had earned Rs.200 and expended Rs. 170 in 2 years but was also liable to tax on income of Rs.35 because it had incurred more amount towards charitable purpose in Year-1 but could not set-off such excess application in year-2.
• In Scenario-3, the trust had earned Rs.200 and expended Rs. 170 in 2 years and was not liable to tax because it had applied its income only to the extent of 85% in each of the year -1 and year-2.

From the above analysis, it can be apparently seen that a trust which had applied its income on early basis is liable to higher tax in comparison to the trust which had deferred the application of income to the subsequent year. The action proposed in the finance bill therefore has the effect of deprivation of concession granted and is repugnant to the intended outcome.

The Hon’ble Finance minister may look into the outcome of the proposed clarification as this will adversely impact the tax liability of the trust which had applied excess funds over income in comparison to the trust which had deferred the application of its income for charitable purposes.

Thoughts to ponder

1. One may think that the excess application of income may be out of the borrowed funds and the newly inserted Explanation-4 to section 11 of the Act is providing the allowance in the year of repayment of such funds, so the loss in scenario-2 can be adjusted against the income in year-2 by repaying the excess amount expended out of the borrowed funds. However, it must be noted here that if the amount expended out of the internal accruals of 15% or out of the corpus fund, then such excess expenditure could be a permanent loss to the trust as the same is no more allowable as deduction to the trust.
2. The amendment proposed in the finance bill, 2021 is by way of insertion of explanation in the form of clarification with effect from 01st April,2022. Since the amendment proposed is by way of clarification, whether the same shall be effective from 01st April 2022 or shall have retrospective effect.
3. If the effect of the said clarification is retrospective in nature, can the case of the assessee trust on account of set-off of earlier year excess application be reopened by the tax authorities in the following scenarios:-

• Allowance is to be treated as act prejudicial to the revenue and subject to revision by the Commissioner under section 263 of the Act.
• Clarification enables the tax authorities to amend the order under section 154 of the Act, as mistake apparent from record.
• Allowability of the claim has a reason to believe that income of the trust had escaped assessment.

Thanks for reading and trust the same was useful!

GST Budgetary Proposals – Limited Amendments, Overarching Impact

This Budget, unlike many previous budgets, was keenly awaited since it was announced after a ‘once in a century’ event. With the sharp decline in overall tax collections, although the Goods and Services Tax (‘GST’) had picked up increasing pace in the last few months, there was a wide anticipation of a new Covid Cess. No additional tax was introduced, which has provided a boost for industry; although there is an Agriculture Infrastructure and Development Cess (‘AIDC’). The AIDC replaces basic custom duties or excise duties which are not creditable and hence does not lead to an increase in taxes.

The morning of the Budget day brought cheers for the Finance Minister with the announcement of record GST collections to the tune of Rs 1.20 lakh crores. The largest ever collection of GST is an indicator of a revival of economic activities. Another key reason could be as a result of stringent measures being taken against tax evaders. We are witnessing an increasing number of arrests for fraudulent transactions like fake invoicing, which is contributing to a rise in tax collections as ineligible input tax credits are being identified and weeded out.

This trend of the last few months has been closely adopted by various budgetary provisions. The provisions relating to provisional attachment of property like bank accounts has been significantly widened. It can now be resorted to in the case of any action being initiated by the tax authorities pertaining to assessment, investigation, search and seizure etc. Thus far, provisional attachment could be resorted to in specific situations like non-filing of returns, unregistered persons and summary assessment. Any action by the tax authorities, beyond the permissible situations, had been challenged before various High Courts which had appropriately restricted the powers to invoke provisional attachment for breaches specified in the law. With a view to providing unfettered power to protect the interests of the revenue authorities, the scope has been significantly enhanced to include the coverage discussed above. Given the wide latitude available to the tax authorities, laying down a broad framework within which such powers should be exercised, would be a welcome step.

Another important change is insertion of an additional condition for taking eligible input tax credit. The proposed amendment requires that the invoice details must be uploaded by the supplier and communicated to the recipient in the manner specified in Section 37 of the Central Goods and Services Tax Act (‘CGST law’). This amendment will now provide the statutory basis for the government’s intention of allowing the input tax credit only when the invoice details are uploaded on the GSTN portal. This requirement was one of the primary conditions as envisaged when GST was introduced. However, since GSTR 2 and 3 were discontinued after one month of GST implementation, an argument was possible that if all conditions specified in Section 16 of the CGST law were complied with, the input tax credit cannot be denied even if the invoice details were not uploaded by the supplier. With this new condition, the tax authorities have sought to dispel any doubts and made it mandatory for the supplier to upload the invoice details; otherwise, the benefit of the input tax credit will be denied to the recipient. A related question arises: if a supplier has failed, for any reason, to upload the invoice details within the specified time as per Section 37, and is done belatedly, will it result in denial of input tax credit?

The definition of supply has been expanded to include activities between any person, other than individual, and its constituents or members, as deemed supply, to overcome the principle of mutuality. The Supreme Court in the case of Calcutta Club Vs Union of India had extended the principle of mutuality to service tax law, if the entity in question was an incorporated entity. Whilst the service tax law had introduced a deeming fiction to treat activities between an unincorporated association and its members as deemed supply, it was held not to be applicable if the entity was incorporated. Under the GST law, no deeming fiction had been inserted, regardless of whether or not the entity was incorporated, to treat a transaction between an association and its members as a deemed supply, if it satisfied the test of mutuality. With this amendment, it may no longer be possible to argue against non-taxability of such transactions. However, the question would remain open for past transactions. Whilst the deeming fiction has been introduced with retrospective effect, the argument of the validity of the retrospective amendment may still be litigated.

Also, as a consequence of this amendment, the entry in Schedule II of the CGST law which provided that any supply of goods by an unincorporated association to its members will be treated as supply of goods, has been deleted. This entry had been inserted to provide a deeming fiction of supply to tax such transactions.

In a welcome move, the government has omitted the requirement for mandatory certification of reconciliation statement in GSTR 9C by specified professionals like Chartered Accountant etc. It has replaced the requirement of mandatory certification with self-certification. Thus, whilst the requirement of mandatory certification has been done away, the activity of reconciliation still needs to be carried out and the reconciliation statement needs to be filed alongwith the annual return.

Another amendment which will have far reaching impact on the cash flows of a company is withdrawal of the default option of paying Integrated Goods and Services Tax (‘IGST’) on export goods and claiming a refund thereof. This option had been opted for by several companies as it helped in faster liquidation of accumulated input tax credits. Under this option, it was also possible to take a refund attributable to GST paid on capital goods. Withdrawal of this option would mean that the only recourse available for refund of unutilized accumulated input tax credit, would be to opt for Rule 89 of CGST Rules. Companies had been avoiding this route since it is characterized by a delay in granting a refund, and often disputed by the department on the grounds of ineligibility of input tax credit. Also, the GST paid on capital goods is not available as a refund. Thus, a company with substantial exports will find itself in a sticky situation where not only may it take longer to claim refund of input tax credit but also refund of input tax credit pertaining to capital goods will not be available. This will have an impact on the working capital of the company.

Going forward, if an exporter is unable to recover the foreign exchange within the time limits specified as per RBI guidelines, then the benefit of refund obtained for such exports will be required to be returned along with interest. The intention seems to deny the refund if the foreign exchange has not been realized. But can the company reinstate the input tax credit if it is returning the refund amount in cash? Since the refund obtained earlier was of input tax credit, it would be logical to presume that the input tax credit should be reinstated. Also given that it could be a revenue-neutral exercise i.e. return of cash refund and reinstatement of input tax credit, it would be interesting to see whether demand of interest would be sustainable, especially given the fact that section 50 of the CGST law has adopted the philosophy that interest should be recovered only if there is a net cash tax liability.

Another welcome amendment is giving retrospective effect to Section 50 of CGST law which provides that interest is payable only if there is a net cash tax liability. This had been clarified by the government earlier but providing the statutory mechanism of retrospectivity would remove any ambiguity on this matter for its applicability to the past transactions.

The amendment to GST provisions is also required to be done in all state GST laws. Thus, the majority of the provisions will be made effective by a separate notification, once every state GST law has been amended.

Dissolution or Reconstitution of Firm - Rub Salt Into the Wound?

This article has been co-authored by Shraddha J. Shah (Senior Manager), Tax and Transfer Pricing, Nexdigm (SKP).

BACKGROUND

Section 45(4) of the Income Tax Act, 1961 (IT Act) provides that profits or gains arising from transfer of capital asset by way of distribution of capital assets on dissolution of firm (or association of persons (AOP) or body of individuals (BOI)) or otherwise are chargeable to tax as income of the firm or AOP or BOI.

The applicability of this Section has been under the scanner for situations where distribution of capital asset takes place during existence of partnership firm, assets of the firm are transferred to a retiring partner, or where subsisting partners of the firm transfer assets in favor of a retiring partner. The Bombay High Court ruling[1] accorded wide scope to the words ‘otherwise’ and thereby concluded that the situations mentioned above trigger provisions of Section 45(4) of the IT Act.  However, at a later stage, there were rulings of the Madras High court[2] and the Bombay High Court[3] where a favorable view was adopted, and it was held that where a partner receives an asset at the time of retirement, it is his own share of interest in the firm and thus, not a transfer liable to tax.

Another area of dispute pertained to the aspect as to whether considerations (amount equal to their capital balance or asset equivalent to capital balance) paid to retiring partners is nothing but their share of interest in the firm, then accordingly, no capital gain tax is leviable. The Supreme Court[4] had given a favorable order on this issue, but some adverse decisions have renewed the debate.

ISSUE SOUGHT TO BE ADDRESSED BY FINANCE BILL

The Memorandum to Finance Bill, 2021 noted that there is uncertainty regarding the applicability of Section 45(4) to situations where assets are revalued or self-generated assets recorded in the books of accounts, and also when payment is made to a retiring partner or member in excess of his capital contribution.

AMENDMENT BY FINANCE BILL, 2021

We have summarized below the Finance Bill provisions of substituted Section 45(4) and new section 45(4A) that are proposed to be made applicable from 1 April 2020 (Financial Year 2020-21). These provisions apply to specified entities, namely firms or AOPs or BOIs (other than companies and co-operative societies) in respect of specific circumstances involving specified person i.e. a person who is a partner of such firm or AOP or BOI in any previous year.

For the sake of creating a brief summary, we have referred to firm and partner in the table below. This will also apply similarly in the case of AOPs or BOIs and their members.

For the purpose of both the Sections, balance in capital account is to be calculated without taking into account increase in capital due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset. Self-generated goodwill and self-generated asset are defined to mean goodwill or asset that has been acquired without incurring any cost for purchase or which has been generated during the course of business or profession.

ANALYSIS AND IMPACT

The scope of taxation under Section 45(4) till now that was restricted to capital assets is proposed to be enlarged to cover money and other assets as well. Also, the new provisions incorporating the word ‘receives’ as against the words ‘transfer’, ‘distribution’ in erstwhile provisions widens the coverage.  The applicability is not just restricted at the time of dissolution but also covers cases of reconstitution, thereby encompassing even cases of admission or retirement of partners, conversion of firm or succession of firm by a company. The provisions have not been restricted to the receipt by partner from a specific entity, thus even if a partner receives capital assets or money or other assets from other partners at the time of reconstitution of firm, it shall stand covered by the rigors of Section 45(4) and 45(4A). Apart from firm and limited liability partnerships (treated as firm as per Section 2(23)), if a trust constitutes AOP, these provisions will apply accordingly. However, what will be covered within the ambit of reconstitution in case of a trust as an AOP is unclear.

With respect to the proposed substituted Section 45(4), the decision of Supreme Court and other Courts[5] advocating that what the partner receives at the time of retirement is his own share of interest in the firm, and thus not taxable, are sought to be reversed. Effectively, the new provisions seek to tax share or interest of a partner in the firm and its assets (without revaluation effect). The mode of settlement of the retiring partner’s claim– irrespective of allotment of capital asset or other asset or through money - is taken into account.

The provisions are proposed to be applicable from Financial Year 2020-21. Considering this, if the taxable event as per Section 45(4) and 45(4A) has occurred during the period 1 April 2020 till date, the same shall be taxable in the hands of firm.

Probably, these provisions can be labelled as Exit Tax for partners, but taxable in the hands of the firm. The special purpose vehicles set up by way of partnership firms or limited liability partnerships will be hit by these provisions. Such entities that had operational flexibilities with respect to distribution of profits to partners will have to put on their thinking caps with the introduction of such provisions.

This article has been co -authored by Shraddha J. Shah Senior Manager Direct Tax Nexdigm (SKP)

Taxing Time for Firm on Partner Taking Over Asset or Money Upon Dissolution or Reconstitution

This article has been co-authored by Deepa Sheth (Chartered Accountant).

Taxing time for firm on partner taking over asset or money upon dissolution or reconstitution[1]

Existing Provisions – Transfer of capital asset

As per the existing provisions of section 45(4) of the Income-tax Act, 1961 (‘Act’), profits or gains arising from the transfer of a capital asset by way of distribution of capital assets on the dissolution of a firm or Association of Persons (‘AOP’) or Body of Individuals (‘BOI’)[2] or otherwise, shall be chargeable to tax under the head Capital gains and shall be deemed to be the income of the firm or  AOP or BOI of the year in which the said transfer takes place. Further, the Fair Market Value (‘FMV’) of the asset on the date of such transfer shall be deemed to be the full value of consideration received or accruing as a result of such transfer. With regard to the term ‘otherwise’, it has to be read in conjunction with the words 'transfer of capital assets by way of distribution of capital assets’. Accordingly, several courts have held that the term 'otherwise' takes into its sweep not only cases of dissolution but also cases of subsisting partners of a firm, transferring assets in favour of a retiring partner[3]. Additionally, for the purpose of charging tax on the transfer of a capital asset by way of distribution of capital assets on the dissolution of the firm, one need not look into the definition of the term 'transfer' as mentioned in section 2(47)[4] of the Act.

Loophole in the existing provision – receipt of money

However, there is uncertainty regarding applicability of provisions of section 45(4) of the Act to a situation where assets are revalued or self-generated assets are recorded in the books of accounts; profits from such upwards revaluation is distributed or credited to the capital balances of partners; and immediately thereafter money is being paid to retiring partner which may or may not be in excess of the capital balance.

Some of the judicial precedents on this subject which were in favour of taxpayers are as under:

• CIT v. Dynamic Enterprises [2013] [TS-556-HC-2013(KAR)-O] (Karnataka HC)

The full bench decision of the Hon'ble Karnataka High Court has held that when retiring partner took cash towards value of his share in firm, there was no distribution of capital assets among the partners and there was no transfer of capital asset and therefore no profits or gains are chargeable to tax under section 45(4) of the Act. Similar view was taken by the same High Court in the case of CIT v. Karnataka Agro Chemicals [TS-465-HC-2014(KAR)-O]  [2014] (Karnataka). Further, the Hon’ble Mumbai ITAT[5] in various cases have decided in favour of taxpayer relying on the above decision of the Karnataka HC.

Interestingly, in the case of Mahul Construction Corporation (2017) 168 ITD 120 (Mumbai - Trib), it was held that payment of cash by firm for settlement of retiring partner's revalued capital balances was not held to be distribution of capital asset as contemplated in section 45(4) of the Act and accordingly held that entire revaluation surplus already distributed to retiring partners was not taxable in hands of firm.

• PCIT v. Electroplast Engineers [2019]  [TS-5274-HC-2019(BOMBAY)-O] (Bombay)

Under a deed of reconstitution of the firm, three new partners were admitted. Another Deed of retirement cum reconstitution of the firm was executed by which the original two partners, who constituted the firm, retired from the firm and the remaining three partners redistributed their share in a firm. Goodwill was valued and credited in books of the firm and the retiring partners were partly paid cash towards their share of goodwill in proportion of their share in firm. In this case, the question was whether section 45(4) of the Act would apply even if there was no dissolution but reconstitution of the firm. The Tribunal observed that the firm's assets were revalued and the retiring partners were paid their share of the partnership asset which was affirmed by the High Court. Since there was no transfer of capital asset by way of distribution upon reconstitution of firm, it was held by the Bombay High Court that sum paid by assessee-firm to retiring partners would not constitute capital gain under section 45(4) of the Act.

The taxpayers may not be able to seek shelter relying on these judicial pronouncements once the proposed amendments (which are discussed below) by the Finance Bill 2021 are made effective.

Proposed Amendments by Finance Bill 2021

• Receipt of capital asset

Finance Bill 2021 proposes to substitute the existing sub-section (4) of section 45 of the Act with a new sub-section (4) and also insert a new sub-section (4A) to this section.

As per the newly proposed sub-section (4) of section 45 of the Act, profits or gains arising from the receipt of a capital asset by the partner or member of firm or AOP or BOI at the time of dissolution or reconstitution of the firm or AOP or BOI, which represents the balance in the capital account of such partner or member in the books of the firm or AOP or BOI at the time of its dissolution or reconstitution shall be chargeable to tax under the head Capital gains and shall be deemed to be the income of such firm or AOP or BOI for the year in which such capital asset was received by such partner or member.

Further, for the purposes of section 48 of the Act, FMV of such capital asset as on the date of such receipt shall be deemed to be the full value of consideration received or accruing as a result of such transfer in the case of firm or AOP or BOI. Also, the cost of acquisition of such capital asset in case of firm or AOP or BOI shall be determined in accordance with the provisions of the Chapter IV-E. Further, the balance in the capital account of the partner or member in the books of account of the firm or AOP or BOI is to be calculated without taking into account increase in the capital account of the partner or member due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset[6].

• Receipt of money or other asset

Further, notwithstanding anything contained in sub-section (1)[7] of section 45 of the Act, a new sub-section (4A) has been proposed to be introduced in section 45 of the Act which applies in a case where a partner or member receives, during the fiscal year, any money or other asset at the time of dissolution or reconstitution of the firm or AOP or BOI. Where money or other asset is in excess of the balance in the capital account of such partner or member in the books of accounts of the firm or AOP or BOI at the time of its dissolution or reconstitution, then profits or gains arising from the receipt of such money or other asset by the partner or member shall be chargeable to income-tax as income of the firm or AOP or BOI under the head ‘Capital gains’ and shall be deemed to be the income of such firm or AOP or BOI of the previous year in which the money or other asset is received by the partner or member.

For the purposes of section 48 of the Act, value of the money or the FMV of other asset on the date of such receipt shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of other asset. Further, the balance in the capital account of the partner or member in the books of accounts of the firm or AOP or BOI at the time of its dissolution or reconstitution shall be deemed to be the cost of acquisition. The balance in the capital account of the partner or member in the books of account of the firm or AOP or BOI is to be calculated without taking into account increase in the capital account of the partner or member due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset.

Further, in order to mitigate double taxation, consequential amendment is also proposed in section 48 of the Act to provide that the amount included in the total income of firm or AOP or BOI under sub-section (4A) of section 45 which is attributable to the capital asset being transferred, shall be reduced from the full value of the consideration to compute income chargeable under the head Capital Gains in a manner which is to be prescribed later.

Issues emanating from the proposed amendments

On bare reading of these amendments, some of the key issues emanating are as under -

• Capital Gains vs Business income / Other Sources

Section 45 of the Act covers transactions in respect of transfer of capital asset and thereby any profits or gains arising from such transfer shall be chargeable to tax under the head Capital Gains and deemed to be income of the year in which transfer takes place. However, by virtue of section 45(4A) of the Act, the Finance Bill proposes to cover transfer of other asset or money (not being a capital asset) which may be chargeable to tax under the head Business Income or Other Sources and accordingly it may not be apt to tax under the head Capital Gains.

• Transfer of capital asset vs stock in trade

The above proposals provide that in case of transfer of capital asset, tax is levied on the firm provided such capital asset represents the outstanding capital balances of the partner. However, in case of transfer of other asset, tax is levied on the firm only if FMV of other asset exceeds outstanding capital balance of partners or members in the books of accounts of firm. Thus, for instance, in case where real estate developer firm, holding a plot of land as stock in trade, transfers such land to the retiring partner, then the firm would be taxable on the difference of FMV of land and the outstanding capital balance of the retiring partner in the books of accounts of the firm. In this regard, it is pertinent to note that the actual cost of such stock in trade in the books of such firm (which may be higher than the outstanding capital balance) would not be considered. On the other hand, where the land is held as capital asset by a firm is transferred to the retiring partner, then firm would be taxable on difference of FMV of land and the cost of acquisition/improvement in connection with the land after providing necessary indexation to such cost. Thus, it is pertinent to note that the tax computation with respect to cost of land would change depending on the fact whether such land is held as capital asset or stock in trade by the firm.

• Interplay between section 45(2) and section 45(4A)

This issue can be better understood by way of following illustration:

Land, being capital asset of a firm, is converted into stock in trade. Now, as per the provisions of section 45(2) of the Act, profits or gains arising from transfer by way of conversion of land as capital asset into stock in trade shall be chargeable to income-tax as an income of the year in which such stock in trade is sold or otherwise transferred by the firm. Thus, firm will be locking its tax liability as on the date of conversion which shall be discharged only at the time of sale of such stock in trade. Further, at the time of conversion, the firm revalues such land (at the conversion value on which tax is payable) and distributes such revalued amounts in the capital accounts of partners. Thereafter, let us say few years later, the said land, being stock in trade, is taken over by the retiring partner. In such scenario, how would the provisions of section 45(2) and section 45(4A) of the Act be given harmonious effect is an issue that requires deliberations.

• Reducing revalued amounts from the outstanding capital balances of partner

At the time of dissolution or reconstitution, the proposed amendment requires to calculate the balance in the capital account of the partner in the books of account of the firm without taking into account increase in the capital account of the partner due to revaluation of any asset. However, no timeline has been prescribed within which the effect of such revaluation needs to be given to the outstanding capital account balances. Thus, in case where asset has been revalued by the firm in 2020 (and such revalued amount have been distributed to partners in the same year) and thereafter in subsequent year(s) partner decides to retire and take over the said asset whether the impact of such revalued amounts needs to be given to the outstanding capital balance of the partner? Also, considering the fact that in a given year, the capital account of a partner would comprise of capital introduced by the partner, remuneration and share of profit, interest on capital, drawings and interest thereon, etc and therefore there is a need to prescribe a mechanism to determine the amount which needs to be reduced from the outstanding capital balances of partner.

• Applicability

The above amendments are proposed to be made effective retrospectively, i.e., from 1-April-2020, and would cover transaction entered during the fiscal year 2020-21. As a result, there may be firms wherein partner(s) have retired or firm has been reconstituted (on or after April 2020) and the outgoing partners have taken over capital asset, any other asset or money. In such cases, the firm would now be liable to capital gains tax and may have defaulted in payment of advance tax instalments on account of such capital gains tax. This may also lead to interest implications on the default of payment of the advance tax instalments.

• Loss scenario

By virtue of the above proposed amendments, profits or gains arising from the receipt of a capital asset or other asset by partner or member at the time of dissolution or reconstitution of firm or AOP or BOI shall be chargeable to tax under the head Capital gains in the hands of such firm or AOP or BOI in the year in which such capital asset was received by the partner or member. In a converse case, where the partner or member receives less on his retirement, there has to be suitable amendments to allow such loss in the hands of the firm.

Concluding thoughts

Though the intention of the government in introducing these provisions was to rationalise and plug the loophole which taxpayers have explored in the past, however these proposed amendments have opened up separate set of questions or concerns which requires early resolution.

Removal of Depreciation on Goodwill

This article has been co-authored by Suril Mehta (Associate Director), K C Mehta & Co.

After the landmark Supreme Court judgement of Smifs Securities, goodwill was considered as a capital asset eligible for depreciation. This decision was pronounced in 2012 and has gained fame and since it provided support in claiming depreciation on goodwill generated on transactions like Amalgamation, Demerger, Slump sale, etc. Post Smifs Securities, there have been many judgements on this aspect – most of them have been in favour of the taxpayer.

There are transactions which are taxable, like slump sale, and transactions that are non-taxable, like amalgamation and demerger. Providing depreciation on taxable transactions like slump sale makes sense since there is actual tax incurred on gains. In case of other tax-neutral transactions like amalgamation and demerger, this leads to tax-leakage – transferor does not pay tax, but the transferee gets the tax benefit. This loophole has been exploited by tax-payers by claiming huge depreciation on such restructuring events.

Impact on transactions concluded/ongoing

Depreciation on goodwill is proposed to be no longer available. Hence this impacts depreciation on even the concluded transactions.

Court scheme transactions take time to complete. It is possible that the scheme is commenced in a particular year and finalized in the subsequent year. Under normal Accounting Standards, the appointed date is considered for accounting purpose – i.e. the date provided in the scheme.

In case of Ind AS however, under Ind AS 103 the scheme conclusion date is generally considered for accounting purpose. This leads to doubt in relation to a scheme concluded in FY 20-21 or still ongoing, but having an appointed date prior to 31-3-2020. Here, it may be possible to claim goodwill in FY 19-20 considering validity of appointed date under income tax.

Nomenclature!

The Act refers to multiple intangible assets like know how, patent, copyright, trademark, license, and includes wider terms like other business or commercial rights of similar nature. The reference to intangible assets is now amended to specifically exclude goodwill. However, goodwill is not defined under the Act.

Goodwill generally subsumes other intangibles. However, under restructuring transactions, it is possible to separately recognize specific intangibles like brand name, trademark, customer base, etc. Only the residual amount, after specific intangibles are recognized, will be considered as goodwill. It seems that under the current proposal, only depreciation on goodwill will be impacted and does not impact depreciation on other intangibles. It needs to be seen whether goodwill for tax purpose will include such specific intangibles, and also whether such intangibles will be eligible for depreciation.

Taxable sale transactions

In case of a Slump Sale transaction, the capital gains earned by the seller is taxable. As a corollary, the buyer claims depreciation on the higher consideration discharged. Such a transaction doesn’t lead to tax-leakage.

Unfortunately, the amendment does not bifurcate between taxable and tax-neutral transactions. It should have provided for a tax cost step-up on a taxable transaction like slump sale.

Cost of acquisition/Capital gains: Impact on slump sale

Under the current scenario, goodwill helps in 2 ways:

1. There is a higher base of goodwill for claiming depreciation
2. There is a higher cost base which ultimately reduces capital gains on sale of business/assets

Multiple amendments have been proposed even for removing impact of goodwill on the cost base. Here however, distinction has been made between goodwill acquired via ‘purchase’ and other forms of acquisition. In the former case, goodwill continues increasing the cost base, and capital gains will be payable only on the increased base. In case of transactions like amalgamation and demerger, goodwill will not benefit in lowering the capital gains on eventual sale.

However, unlike other assets, goodwill cannot be sold separately. Goodwill will be sold as a part of other assets, like in case of sale of business. Sale of business generally happens in 2 manners:

1. Asset sale
2. Slump sale

In the former case, goodwill (other than goodwill purchased) may have to be ignored while computing capital gains. However, in the latter case, for computing cost of acquisition in a slump sale transaction, net worth is considered as the cost base. While computing net worth, since goodwill is proposed to be non-depreciable, its actual cost will be considered. In such a case, goodwill generated even on tax-neutral transactions will increase the cost base and reduce capital gains. The proposed amendments are unlikely to impact capital gains on such transactions.

Customs - Budget 2021-22

This article has been co-authored by Ruturaj Bhide (Principal, Dhruva Advisors LLP).

Governments across the globe have recognized and deployed customs duty not only as a revenue source but also as a geopolitical tool. Dr. Parthasarathi Shome in a lecture titled “Role of Customs in International Relations” described the operations of the Customs department to straddle wide variety of objectives: collect customs duty as also countervailing duties (which reflects domestic consumption tax rate), prevent and discourage smuggling especially in demerit goods, collection of statistics so as to assist future policy making.

The Union Finance Minister’s budget speech on 01st February, 2021 has at paragraph 177 added a further dimension to the above list and vocalized that India’s Customs duty policy should have the “twin objective of promoting domestic manufacturing and helping India get onto global value chain and export better” .

Some remarks regarding the changes to the basic custom duty (‘BCD’) rates and overall duty regime in India are:

• Aligned with the Atmanirbhar Bharat programme, to help the textile sector (which generates employment), BCD rates have been reduced for some raw material inputs to the manmade textiles sector
• To encourage domestic value addition, customs duty rate on certain chemicals have been calibrated. Similarly, the domestic electronic manufacturing sector has grown well, with India now an exporter of mobiles and chargers – so that the domestic value addition is enhanced, certain exemptions have been withdrawn or moderate duty rate introduced.
• Continuing to repose faith in the renewable energy sector – specifically solar energy – duty rates on certain commodities including solar invertors and solar lanterns have been raised.
• Support the MSMEs and other under industries (smarting from hike of international prices of iron and steel) with reduction of duty rate.
• Removal of concessions / exemption for leather products that are mainly manufactured by MSMEs in India.
• Revising duty rates or withdrawing certain exemptions for capital equipment and auto parts sector, so as to realize the immense potential it offers in the manufacturing capacities.
• Hike in duty rates for variety of items including plastic builder’s ware, prawn feed, compressors etc.
• Restore the duty rates to the position in July 2019 for gold and silver (to nullify the price rise in precious metals, and disincentivize smuggling).

While there were whispers of covid-19 tax and wealth tax (as a part of the corporate tax regime) no such tax was introduced. Instead, “for the purposes of financing the agriculture infrastructure and other development expenditure” levy of Agriculture Infrastructure and Development Cess (AIDC) is proposed. The background, the Hon’ble Minister explained is “the need to improve agricultural infrastructure so that we produce more, while also conserving and processing agricultural output efficiently”.

This brand new cess will be levied alongside BCD and not over and above it, on the same taxable base (assessable value) as is used to compute BCD. In other words, for the select set of tariff lines (approximately twenty five) the bill of entry (‘BoE’) will have another line item, viz. AIDC, to be levied on imported goods in addition to other duties of customs chargeable. AIDC, for ‘levy and collection’ - assessment, refund, exemptions, etcetera - will depend on the provisions of the Customs Act, 1962 and various regulations made thereunder. Importantly, AIDC will not be creditable and thus add to cost of doing business. At the same time, the Hon’ble Minister has clarified that while introducing the AIDC, care has been taken so as not to put additional burden on consumers (this was achieved by reduction to the BCD rate on most items).

An interesting aspect is the rationale to introduce a fresh levy rather than tinker with BCD rates. AIDC being a cess, will not constitute part of the kitty that the Centre has to devolve to the States, instead Parliament (after due appropriation) will be allowed to utilize the funds collected for the stated objective (and not allocate it to States). Besides, with the introduction of a cess, the tariff rate is left untouched, which approach is perhaps construed more compatible with our WTO commitment.

Another proposal that touches the rate regime albeit indirectly is the novel approach to prescribe a lifespan for conditional exemptions. Henceforth, by virtue of a statutory amendment proposed to the section concerning exemptions, notifications that grant exemptions subject to conditions will have a finite timespan of two years from the date of grant or variation. Precisely, the tenure of a notification will continue to the immediately next 31st March, such that it will remain in force for a minimum of two years. Existing condition-based exemption notifications will be grandfathered and expire on 31st March, 2023. To enhance “efficiency and accountability”, this approach will help prune the exemption list (considering amendments, there are more than a hundred) and unburden the administration from culling out defunct provisions; instead it will require trade and industry to initiate dialogue with the Government to keep relevant notifications valid. This finite lifespan feature will not apply to general exemptions (i.e. those without conditionalities attached).

In the same breath, overhauling the Customs duty structure is underway which involved eliminating 80 outdated exemptions with a participative process from several persons. Now, more than 400 old exemptions will be reviewed.

A bunch of amendments are proposed to the Customs Act, 1962 (‘Customs Act’) that can be described as being the realm of ‘trade facilitation measures’. The noticeable proposals are deliberated here:

• BoE will have to be filed at least one day prior to arrival of goods at the customs station. Hitherto the filing could be up to a day after the arrival of the goods. At present, a holiday is excluded but the proposal will include holidays in the count of days. This amendment is directed to reduce dwell time and enable ease of doing business made possible as India rapidly moves towards digitization. International practices are varied, China allows filing of a BoE within 14 days of arrival of the cargo and similarly U.S.A. allows time up to 10 days, whereas the European Union largely requires filing prior to arrival of the cargo.
• A refreshing proposal is to allow specified amendments on self-amendment basis by the importer and exporters, without approval of an officer.
• Most mature customs jurisdictions have some or the other electronic customs platform available to importer and exporter community. To encourage paperless processing and align with global best practices it is proposed to recognize the use of common portal to serve notice, order etc. and the portal to act as a one-point digital interface for the trade to interact with the Customs. To set up the Common Customs Electronic Portal (‘CCEP’), statutory provisions have been proposed to be amended, seemingly buoyed by the stability that the Goods and Services Tax Network (‘GSTN’) achieved. It is presumed that the Indian Customs Electronic Gateway (‘ICEGATE’), the national portal of Indian Customs of Central Board of Indirect Taxes and Customs (‘CBIC’) that provides e-filing services to the Trade, Cargo Carriers and other Trading Partners electronically will be morphed into the new CCEP, which will facilitate registration, filing of BoE, shipping bills and other documents/ forms, payment of duty, serve notices and orders etcetera. Where previously ICEGATE was available to Customs House Agents, as the world moves towards digitization, the CCEP will hopefully become the “one-point digital interface for the trade to interact with the Customs”. Quite some activity will have to precede the operationalization of CCEP, since ICEGATE is internally linked with various agencies including RBI, banks, the DGFT, DGCIS, Ministry of Steel, Directorate of Valuation and other various partner government agencies involved in EXIM, trade enabling faster Customs clearance.
• Insertion of Section 28BB to the Customs Act, which will require that a show cause notice (under Section 28(1) or Section 28(4)), is mandatorily issued within a period of two years from the date of initiation of audit, search, seizure or summons, etc. The Customs Act provides for differing limitation period (in normal circumstances, and other situations involving mala fides) yet, oftentimes the investigation wing would not abide by these timelines, resulting in loss to the exchequer. In several cases, where duties were collected from taxpayers, the investigation wing would not complete its task and close the investigation, rather let the matter linger on endlessly – the proposal for a statutory timeline will provide relief to those assesses who fall into inquiry and investigations by the revenue authorities and aid the Revenue Department.

Changes to the first schedule to the Customs Tariff Act are being proposed that will come into effect from 01st January, 2022. This is in accordance with HSN 2022, which proposes 351 amendments to the existing Harmonized System of Nomenclature (‘HSN’), covering a wide range of goods. These amendments, it is explained, are necessary to adapt to the current trade through the recognition of new product streams, the changing nature of commodities being traded, advent of new technologies and addressing the environmental and social issues of global concern. HSN 2022, which is the seventh edition of the HSN used for the uniform classification of goods traded internationally all over the world, has been accepted by all Contracting Parties to the HS Convention, and it shall come into force on 01st January, 2022. All Customs administrations and regional economic communities which apply HSN system have to implement the 2022 HS Edition, as required by the HS Convention. India is a contracting party to HS Convention.

Underlying Theme of the Union Budget 2021 -Digitalization and Ease of Doing Business

This article has been co-authored by Ashwin Ramesh (Associate Manager, Economic Laws Practice).

In 2014, the Government of India launched an ambitious program of regulatory reforms aimed at ease of doing business in India. India emerged as one of the most attractive destinations, not only for investments, but also for doing business and has significantly jumped 79 positions from 142^nd position in 2014 to 63^rd position in 2019 in 'World Bank's Ease of Doing Business Ranking 2020'.

Against this backdrop, the Honourable Finance Minister has taken a step forward by announcing various proposals in Union Budget 2021, which are aimed at digitalization and ease of doing business in India, both from the purview of Direct and Indirect Taxes.

A.      Direct Taxes

Faceless Proceedings before Income Tax Appellate Tribunal (‘ITAT’)

Powers are proposed to be provided to the Central Government to notify a scheme for disposal of appeals by ITAT, wherein the need of physical interface/presence is eliminated between the ITAT and parties to the appeal, and that the entire proceedings can be held in virtual mode.

The objective of the new scheme is to impart greater efficiency, transparency, accountability and to optimize the utilization of the resources, through economies of scale and functional specialization.

In addition to the already existing scheme of faceless assessment, appeal and penalty, the proposal to introduce faceless ITAT seems to pave the way for a new era of digital dispute resolution mechanism. The aim is to reduce physical interface, reduce cost of compliance for taxpayers, and to achieve even work distribution in different benches, resulting in best utilization of resources.

While the aforesaid proposal for introducing faceless ITAT may be applauded, considering the fact that the earlier scheme for faceless assessment is still at a very nascent stage, faceless ITAT which appears to be in line with the earlier scheme, may face certain teething issues and concerns. In light of this, it is to be seen at the ground level, as to how the faceless proceedings before the ITAT are implemented and the desired objective is achieved with adequate support of technological infrastructure.

Typically, the scheme should be effectuated in the initial stages in a phased manner, i.e., giving options to the assessee of physical appearance as well as virtual appearance. The same will allow all the stakeholders to embrace the change and issues, if any, in virtual hearings can be simultaneously addressed.

Time Limit for Reopening of Assessment Cases

On the ease of doing business front, the time limit for re-opening of assessment cases is proposed to be reduced from 6 years to 3 years, except for specific cases. The same is likely to bring a huge relief to the assessees. The requirement of maintenance of documents and records will also be truncated to 3 years vis-à-vis 6 years in such cases.

B.      Indirect Taxes

On the Indirect Taxes front, the digital wave has become stronger and the business case for adoption of new technologies in tax administration/procedures has gained further momentum. Taking this forward, the Finance Minister has introduced proposals to digitalize the Customs procedures, for the benefit of the importers/exporters at large.

Common Customs Electronic Portal

One of the key highlights of the proposals is the introduction of a ‘Common Customs Electronic Portal’ for facilitating registration, filing of bills of entry, shipping bills, payment of duty, filing other documents/forms and carrying out other specified functions prescribed under the Customs Act, 1962 (‘Customs Act’) and the Rules thereof.

Further, pursuant to the proposed introduction of the Customs Portal, any order, decision, summons, notice or any other communication under the Customs Act, may be served by making it available on the Customs Portal. Till now, the general modes of service included personal delivery to authorized representative or via post, email, etc.

At present, the Indian Customs Electronic Gateway (‘ICEGATE’) is the electronic portal which provides e-filing services to the importers and exporters. With this development, it appears that the proposal intends to notify a common portal, to offer a host of end-to-end services, including electronic filing, e-payment, filing supporting documents, which seems to be assessee friendly and would aid in efficient tax administration and timely completion of procedural formalities.

Time limit of 2 years for completion of inquiry/investigation under Customs Act

A proposal has been introduced, which specifies that, any inquiry or investigation under the Customs Act, which culminates in the issuance of a notice, shall be completed by issuing such notice, within a period of 2 years, from the date of initiation of audit, search, seizure or summons. This proposal puts a time limit for completion of Departmental proceedings, which was not present earlier, and the same is also likely to be beneficial from the perspective of having the outcome of such inquiries/investigation, within definitive timelines.

Electronic amendment of documents

A Proposal is introduced to cover electronic amendment of documents such as bill of entry, shipping bill etc. in such a manner, that the amendment may be done electronically through the Customs Automated System, on the basis of risk evaluation through appropriate selection criteria. Further, in specified cases, such amendment can also be done by the importer or exporter on the Customs Portal.

Presently, such amendment to the documents viz. bill of entry, shipping bill is permitted for justified reasons. However, the Customs authorities have been citing their inability to undertake such amendments electronically in the system, on account of technical limitations of the system. This has resulted in denial of consequential benefits, such as benefits under Foreign Trade Policy, refunds etc. Hopefully, this proposal should help in resolving such issues faced by the importers/exporters.

In Conclusion

While we laud the efforts of the Finance Minister in bringing the proposals which would significantly facilitate the ease of doing business in India, it is to be seen as to how these proposals will be implemented practically at the ground level, with adequate support of technology and allied infrastructure. The efforts directed towards the digitalization of tax administration would certainly be beneficial to all the stakeholders in the long run, however, in the short run, there is likely to be a discomfort in embracing the change.

Budget 2021 Enforcing Thrust on Ease of Compliance and Reducing Litigation for Taxpayers!

This article has been co-authored by Pratik J Shah (Senior Manager), Parul Shah (Manager) and Neha Katigar (Deputy Manager), Deloitte Haskins and Sells LLP.

With the intent to reduce compliance burden and to bring certainty in the income tax proceedings at the earliest, the time limits for filing of belated or revised returns is proposed to be advanced by 3 months. Illustratively, for AY 2020-21, a taxpayer has the option to file a belated or revised return before the end of the assessment year i.e. 31 March 2021 or before the completion of the assessment, whichever is earlier. Pursuant to the proposed amendment with effect from AY 2021-22, the taxpayer will be required to file a belated or revised return for AY 2021-22 by 31 December 2021 or before the completion of the assessment, whichever is earlier.

Timelines for assessment or processing of income tax return are also proposed to be reduced by three months. The existing timeline and the illustrative timeline pursuant to the amendment is tabulated below:

Further, the time limit for re-opening of assessments under section 147 of the Act is being reduced from 6 years to 3 years. The window for re-opening of assessments up to 10 years is proposed to be available in cases of serious tax evasion only where there is evidence of concealment of income of INR 50 lakhs or more for a year.

Setting up the Dispute Resolution Committee

Considering the success of the Direct Tax Vivad Se Vishwas Scheme to settle long pending disputes and to reduce litigation, the government, has provided for dispute resolution for small taxpayers through constitution of a Dispute Resolution Committee (‘DRC’). Taxpayers with taxable income up to INR 50 lakh and disputed income up to INR 10 lakh shall be eligible to approach the Committee. The DRC will be faceless to ensure efficiency, transparency and accountability.

Substitution of Authority for Advance Rulings (AAR) with Board for Advance Rulings

The vacancy of the posts of Chairman and Vice-Chairman for a long time due to non-availability of eligible persons has hampered the working of AAR and a large number of applications are pending since last many years. In view of the above and to ensure faster disposal of cases, it is proposed to replace the AAR with one or more Board(s) for Advance Rulings. Such Board will consist of two members, each being an officer not below the rank of Chief Commissioner. It has been provided that the applicant or the Department may appeal against the order of the Board before the High Court.

Faceless Income Tax Appellate Tribunal (‘ITAT’)

Along with implementation of the Faceless Assessment, Faceless Appeal and faceless Penalty Scheme being the steps in the digital transformation journey, the government is committed to make the next level of income tax appeal process i.e. appeal to the ITAT, faceless. A new section 255 is proposed to be introduced for launching the National Faceless Income Tax Appellate Tribunal Centre wherein all communication between the ITAT and the appellant shall be electronic. The Scheme will provide an option for face-to-face hearing through video-conferencing, where required.

The above amendments clearly demonstrate the emphasis on digital transformation, creating environment conducive for ease of doing business through reduced compliances, transparency, efficiency, and accountability under the Direct Tax regime.

Information for the editor for reference purposes only

TDS on Purchase of Goods u/s 194Q

This article has been co-authored by G. R. Hari (Partner), Manohar Chowdhry & Associates and Nitish Ranjan (Manager),Manohar Chowdhry & Associates.

The Finance Bill, 2021 has proposed to introduce a new section 194Q to the Income-tax Act, 1961 which requires a buyer to deduct tax at source in case of purchase of goods, the value or aggregate value of which, exceeds INR 50 Lakh in a financial year.

The provisions of this section would come into effect from 01-Jul-2021 and would apply to a buyer, whose total sales, gross receipts or turnover from the business carried on by him exceeds INR 10 Crore during the financial year immediately preceding the financial year, in which the goods are purchased.

It further provides that such tax is to be deducted on purchase of goods only from a seller, who is a resident of India under the provisions of the Act. The rate prescribed for deduction of tax is 0.1% of the value or aggregate value of the goods that exceeds INR 50 Lakh in the financial year.

Tax would be required to be deducted at higher rate of 5%, if the seller does hold a PAN in India. Enabling amendment would be carried out to the provisions of section 206AA of the Act.

As applicable in case of other TDS provisions, liability to deduct tax would arise at the time of credit or receipt of payment, whichever is earlier and would include any sum credited to any account, whether called by name “suspense account” or by any other name.

The above provision of deduction of tax at source on purchase of goods is not applicable in the following cases:

1. where tax is deductible under any of the provisions of the Act; and
2. where tax is collectible under section 206C of the Act except to transaction covered under section 206C(1H);

1. Would the provision of section 194Q and provision of section 206C(1H), both be applicable for a transaction of purchase of goods?

While going through the above, one would be able to immediately recall a similar section introduced vide the last Finance Act, 2020. Yes, the proposed provisions of section 194Q are akin to the provisions of section 206C(1H) of the Act.

The provisions of section 194Q take forward the objective of the Government towards widening and deepening tax base. It is ostensible that the main intention behind the bringing out the provision of 206C(1H) or this newly proposed section 194Q, is not to recover taxes but to widen the tax base.

Sub-section (5) of section 194Q provides for non-applicability of the provision in cases where tax is required to be deducted or collected under any other provisions of the Act except the transaction referred to in section 206C(1H) of the Act. This would mean that while determining liability to deduct tax at source of purchase of goods, one should first assess whether any other provision relating to deduction or collection of tax at source is applicable for such transaction. If the answer is yes, then tax should be deducted or collected in accordance with that section and not as per the provision of section 194Q.

Though, the non-applicability of section 194Q is not extended to the transactions covered under section 206C(1H) of the Act, the second proviso to section 206C(1H) of the Act reads as under:

Provided further that the provisions of this sub-section shall not apply, if the buyer is liable to deduct tax at source under any other provision of this Act on the goods purchased by him from the seller and has deducted such amount.

What emanates from the above is that if a buyer is liable to deduct tax at source under any other provision of the Act on the goods purchased by him and deducts such amount then such transaction will not again suffer collection of tax at source under section 206C(1H) of the Act. Thus, provisions of section 194Q and the provisions of section 206C(1H) are mutually exclusive.

2. Once the consideration for purchase of goods exceeds INR 50 Lakh, is the TDS required to be made on the entire consideration or only on the consideration that exceeds INR 50 Lakh?

Sub-section (1) of section 194Q requires the buyer to deduct tax at source on purchase of goods. It provides for deduction of tax at 0.1% of the sum exceeding INR 50 lakh in a financial year. Thus, the tax shall be deducted at source on the consideration that exceeds INR 50 lakh. Let us say, in case where the first purchase was made for INR 35 lakh and the second purchase was made for INR 40 lakh, the TDS should be made only on the second purchase and only on the amount of INR 25 lakh (i.e. 35 lakh + 40 lakh – 50 lakh). The threshold of INR 50 lakh shall apply year-wise.

3. Shall the threshold for TDS be reckoned for each seller and for the FY 2021-22, should it be from 01-Apr-2021 or 01-Jul-2021?

The provisions of section 194Q requires the buyer to deduct tax at source on purchase of goods. TDS is to be made only in case of a resident seller, where the value or the aggregate value of purchases made from that seller exceeds INR 50 Lakh in a financial year. This condition needs to be evaluated separately for each seller and the amount needs to be evaluated separately every FY.

The question whether the purchase made prior to 01st July 2021 during FY 2021-22 is to be considered while computing the threshold of INR 50 lakh or not, is yet to be addressed by the Central Board of Direct Taxes (CBDT).

As a prudent measure, it is advisable that for the purpose of reckoning the threshold of INR 50 lakh, the purchase/s made prior to 01st July 2021 during FY 2021-22 shall be included. At same breath, it is also added that where the purchases made prior to 01st July 2021 already exceeded INR 50 lakh, the buyer need not to do TDS on that excess amount while paying or crediting further consideration to the account of the seller on or after 01st July 2021.

We also wish to make a mention that the CBDT vide its Circular No. 17 of 2020 while clarifying identical issue in case of application of section 206C(1H) of the Act, which came into effect from 01-Oct-2020 had mentioned that for the purpose of reckoning the threshold, consideration received from 01-Apr-2020 shall be considered.

4. Is buyer required to deduct tax at source at the time of payment of consideration as in case of the provision of section 206C(1H) of the Act or at the time of purchase?

The proposed provisions of section 194Q is to a large extent similar to the provisions of section 206C(1H) of the Act. However, the trigger point for collection of TCS under section 206C(1H) of the Act is receipt of consideration whereas TDS under section 194Q is required to be made at the time of payment or credit, whichever is earlier.

Let us say, Mr. A purchased goods on credit for INR 40 Lakh in the Year 1 and for INR 35 lakh in Year 2. Entire payment for the above two consignments were made in Year 2. In such case, there would not arise any TDS requirement under section 194Q for any of the above years since the purchase made for any of these years do not exceed INR 50 lakh. The threshold of INR 50 lakh is to be reckoned based on the amount of purchase in a year and not the amount of consideration or advance paid in a year.

5. In case of multiple units of the same legal entity whether the threshold of turnover would include purchase from different locations/branches?

In the Explanation to sub-section (1) of section 194Q, the term buyer refers to a ‘person’ and as per the provisions of the Act, a branch office is not a separate person but it is a unit of a ‘person’. Therefore, the purchases made from a single seller from different locations/units has to be aggregated to determine the applicability of the provision of this section.

6. Whether purchase returns should be adjusted for computing the threshold of INR 50 lakh in a financial year?

The threshold of INR 50 lakh is to be computed considering the consideration paid for ‘purchase’ of goods and thus, where the goods are returned, the value of such goods shall be reduced for arriving at the threshold of INR 50 lakh. However, such purchase returns ought to have been made on or before the point of tax deduction as the threshold of INR 50 lakh has to be checked at the point of time when liability to deduct at source arises. Any subsequent returns cannot be considered.

7. Whether charges, namely, freight, packing etc. are part of the invoice should the same be considered for tax deduction u/s. 194Q?

The section uses the phrase ‘…for purchase of goods..’, which clearly indicates that the payment attributable to purchase of goods alone should be considered under section 194Q. Having said that it is imperative to note where such reimbursements are charged on the invoice on an adhoc basis, say as a % of goods sold, instead of actual charges, then such charges could be considered as part of the value of goods for computing the amount of tax deductible at source under section 194Q. Caution needs to be exercised on the applicability of TDS under section 194C in respect of freight charges. However, the amount of GST levied as part of the invoice shall not considered for TDS in view of the clarifications from CBDT vide circular no. 23/17 dated 19-07-2017.

8. Would there be a multiplicity of TDS under section 194Q on the same transaction?

It is made clear that where tax is deductible under any other provisions of the Act, such transaction will not be covered under the purview of section 194Q. Thus, duplication of TDS provisions is avoided. However, it is possible that a transaction which was subject matter of TDS earlier in the hands of a buyer may again be subjected to TDS when the goods are resold. For example, in a case where Bharath Petroleum sells fuel to XYZ fuel station, assuming the threshold conditions are fulfilled, the transaction is subject to TDS under section 194Q. In this case, XYZ fuel station shall deduct tax at source. If Uber cab services for all its cars have fuel filling arrangement with XYZ fuel station, again the same transaction would be subjected to TDS under section 194Q. In this scenario, Uber, being the purchaser will do TDS under section 194Q. Same goods suffering multiplicity of TDS would not be avoidable in the absence of any specific exclusion in the Law. The intention of section 194Q is to widen and deepen the tax base. However, this purpose would get defeated and add more baggage to the already overcrowded compliance culture under Chapter XVII of the Income-tax Act.

Faceless Litigation, Dispute Resolution, Curtailing Reassessment – A Boon to Taxpayers!

This article has been co-authored by Hemlata Bhungare (Chartered Accountant) and Mukti Gosar (Chartered Accountant).

1. Background

The Finance Bill 2021 presented by Hon’ble finance minister Mrs. Nirmala Sitharaman has laid down a foundation for the coming decade post pandemic. This was going to be a crucial budget following a year of economic slowdown, adverse impact on GDP and a global pandemic. The Finance Bill 2021 continues to bring reforms in the direct tax system through injection of tax incentives, rationalization of various provisions and addressing the difficulties faced by the genuine taxpayers. In 2020, the Indian Government introduced faceless assessment proceedings thereby transforming the assessment proceedings digitally with no personal interaction between taxpayer and tax authorities. Thereafter, on similar lines, the Indian Government introduced Faceless Appeals [before the Commissioner of Income-tax Appeals ‘CIT(A)’] and Penalty Schemes, in order to achieve optimum utilisation of resources (within the tax authorities) and eliminating interface between taxpayer and tax authorities. Also, time and again the Indian Government has demonstrated its intention to bring more transparency in its operations and honoured the honest taxpayer. As stated above, one of the objectives of Finance Bill 2021 is to rationalise provisions and thereby simplifying or reducing tax litigation in India. We have encapsulated below some of the key amendments proposed in this area by Finance Bill 2021:

2. Move towards faceless proceedings before the Income Tax Appellate Tribunal (ITAT)

With the digitalisation gaining importance during COVID era, the Indian Government’s push to the digital path for handling tax assessment, penalty and appeal matters has expedited. The recently introduced Faceless Assessment proceedings, Faceless Appeals [before CIT(A)] and Faceless Penalty proceedings are steps in this direction. Now, as a next logical step, the objective of the Indian Government is to reduce human interface and transform ITAT proceedings into faceless regime. This will not only reduce cost of litigation, increase transparency in disposal of appeals but also will help in achieving even work distribution in different benches of ITAT and thereby resulting in optimisation of the resources. The Indian Government, therefore, propose to extend the faceless proceeding at the ITAT level. In relation to the same, a proposal has been provided in the Finance Bill 2021 to introduce a new section 255 in Income tax act, 1961(‘Act’) to notify a scheme for disposal of ITAT appeals without human interface.

The Faceless Assessment proceedings initiated by the tax authorities are at nascent stage and the Faceless Appeals and Penalty schemes are yet to test the water. The experience gained through the faceless schemes will certainly help to lay down a path towards the effective faceless ITAT appeals. However, it is important that these faceless schemes empower and allow taxpayer with a right of being heard (being a basic right of taxpayer) as all of these authorities (i.e. tax authorities, CIT(A) and ITAT) are only the fact finding authorities.

3. Constitution of Dispute Resolution Committee for small and medium taxpayers

The Indian Government proposes a major reform to reduce disputes of small and medium taxpayers and provide tax certainty. The Finance Bill 2021 proposes to introduce Chapter XIX-AA for preventing new disputes and settling issues at the initial stage by setting up one or more Dispute Resolution Committee(s) (‘DRC’). This new dispute resolution scheme (‘DRC Scheme’) is proposed to be incorporated through a newly inserted section 245MA in the Act. The Finance Bill 2021 proposes that DRC shall address and resolve those issues only where:

• the returned income of a taxpayer is less than or equal to INR 5 mn; and
• the aggregate amount of variation proposed in specified order is less than or equal to INR 1 mn.

Further, DRC shall be empowered to reduce or waive any penalty imposed under the Act and also grant immunity from prosecution for any offence under the Act. Further, the taxpayer shall have an option to opt in or opt out of this scheme. However, in the following circumstances, taxpayers shall not be allowed to avail the benefits of DRC Scheme:

• Where the specified order relates to search under section 132 of the Act, or requisition made under section 132A of the Act, or survey initiated under section 133A of the Act, or information received under section 90 or 90A of the Act;
• Where taxpayer is subject to detention, prosecution or conviction under any other law as specified in the scheme

Further, the Finance Bill 2021, proposes to empower the Indian Government to notify conditions so as to impart greater efficiency, transparency and accountability. Further, it appears that similar to Faceless Assessment, Faceless Appeals and Faceless Penalty schemes, the DRC scheme too will be on a faceless basis and thereby eliminating interface between taxpayers and tax authorities.

The above proposed DRC scheme is a positive step taken by the Indian Government to reduce tax litigation of small and medium taxpayer at the initial level itself and thereby reducing the number of tax litigation cases in India as well as cost of tax litigation for taxpayer and tax authorities. However, it appears that the prescribed threshold for eligible taxpayer (i.e. returned income of upto INR 5 mn and total variation of upto INR 1 mn) is on lower side especially considering the existing tax audit limit of 10 mn (for taxpayer not opting for presumptive taxation) or lower monetary limit of tax effect of more than INR 5 mn for filing of appeal by tax authorities before ITAT [as prescribed by the Central Board of Direct Taxes (‘CBDT’]. Therefore, in order to reduce tax litigation at an early stage, it is quintessential that these threshold needs to be revisited in order to ensure that many taxpayers are able to avail benefit of this scheme. Further, the effectiveness of this new DRC scheme will be visible only in the future whether the taxpayer would be faced with similar experience while dealing with the existing Dispute Resolution Panel (which is applicable only in case of non-resident taxpayer or taxpayer having an issue involving transfer pricing matter).

4. Constitution of the Board for Advance Ruling

Presently, the Authority for Advance Ruling (AAR) in India is operating with limited resources which has resulted into large number of cases pending for adjudication and effectiveness of the AAR in timely providing much needed tax certainty to taxpayers. In order to address this issue, it was imperative to either to look for alternative mechanism to provide tax certainty or revamp the entire functioning of the AAR.

The Finance Bill 2021 has addressed this issue by proposing to constitute one or more Board for Advance Rulings (‘BARs’). Accordingly, the Finance Bill 2021 proposes to amend provisions as summarised below:

1. The AAR shall discontinue its operations from a notified date;
2. The BARs shall be constituted comprising of two members, each being an officer not below the rank of Chief Commissioner;
3. Corresponding amendments to the definition of BARs, Member of the BARs, notified date have been proposed to be incorporated in section 245N of the Act;
4. All those applications[2] for which order has not been passed by the AAR, it is proposed to transfer all records and other documents before the BAR.
5. The advance rulings of such BARs shall not be binding on the taxpayer or tax authorities and the order passed by the BARs shall be appealable before the Hon’ble High Court. The appeal can be filled by the taxpayer as well as tax authorities on or before 60 days from the date of communication of order in such form as may be prescribed.

The constitution of BARs is a welcome move and brings out the intention of the Indian Government to resolve tax dispute in a timely manner. Also, presently, there are 3 benches of AAR which have been empowered to provide tax certainty on pan India basis. Now, with Finance Bill 2021 proposing to constitute one or more BARs the number of cases can be shared amongst these BARs. Further, as mentioned above, advance rulings of BARs shall not be binding in nature to the applicant-taxpayer and tax authorities which is a divergent move as compared to existing provisions dealing with rulings of AAR. The taxpayer would need to be wary of this aspect especially from tax certainty perspective. Also, presently, an application for seeking advance ruling before AAR can be filed by resident as well as non-resident taxpayers. However, in case of resident taxpayer, a threshold of transaction(s) value of INR 1 bn or more has been prescribed whereas no such threshold has been prescribed in case of non-resident taxpayer. Accordingly, in order to bring resident taxpayers (seeking for advance ruling) at par with non-resident taxpayer, it is necessary that such threshold may be removed, or much lower threshold may be prescribed for filing an application before BARs. Further, in case of AAR, a timeline of 6 months has been prescribed from delivering a ruling. Thus, it would be interesting to see in the future whether the same timeline or shorter timeline is prescribed by the Indian Government for BARs to deliver a ruling. Also, with respect to statutory fees for filing an application for advance ruling from BARs, it would be noteworthy whether higher fees as prescribed in case of AAR will be followed or such fees are being rationalised keeping in mind the existing statutory fees for filing an appeal before ITAT or High Court.

5. Reduction in time limit for reopening of concluded assessment

Currently, reopening of closed assessment cases can be initiated by the tax authorities for preceding 4 assessment years (‘AYs’) where there has been default on the part of the taxpayer in disclosing material facts at the time of filing of tax return and the income escaping assessment does not exceed INR 0.1 mn. Also, assessment proceedings can be reopened for 6 preceding AYs where income escaping assessment exceeds INR 0.1 mn. Lastly, in case of income escaping assessment relates to assets located outside India, the tax authorities can reopen closed cases upto a period of 16 years from the end of relevant AY.

These existing provisions have resulted into undue hardship to taxpayers as in many of the cases these reassessment proceeding have been initiated by the tax authorities only on account of mere change of opinion or revenue audit objection and therefore Courts have rightfully struck down such reassessment proceedings itself. Thus, it was necessary to reconsider the existing provisions relating to reassessment proceedings. With a view to address the concerns revolving around reassessment proceedings, the Finance Bill 2021 proposes to substitute new section for the existing section 147, section 148, section 149 and insertion of new section 148A in the Act. The Finance Bill 2021 proposes to reopen assessment proceedings only for the preceding 3 AYs unless the tax authorities possess relevant information to conclude that the income escaping assessment exceeds INR 5 mn pertaining to any of the preceding 10 AYs.

Further, a notice to reopen a case shall be issued only where the tax authorities possess information as flagged in case of taxpayer in accordance with the risk management strategy formulated by the CBDT from time to time or any final objection raised by the Comptroller and Auditor General of India. However, these conditions shall not be applicable where reassessment proceedings have to be initiated on account of search, seizure or survey.

The Finance Bill 2021 proposes that before issuing notice to reopen a case, the tax authorities need to mandatorily conduct inquiry, issue show cause notice and enable taxpayer to respond within 7 to 30 days (thereby providing a reasonable opportunity of being heard). The tax authorities shall (within one month from the end of the month in which the response has been received from the taxpayer) pass necessary order along with notice to reopen the case. However, these mandatory requirements shall not apply to search and seizure cases.

Restricting the reopening of assessment proceedings to preceding 3 assessment years in normal scenario shall grant certainty and reduce hardship caused to the taxpayers. Further, mandatory steps to be taken by tax authorities before issuing reopening notice if deployed meticulously by the tax authorities will avoid unwanted initiation of reassessment proceedings in case of many taxpayers. It needs to be observed in the future how tax authorities adopt these revamped procedures for reassessment proceeding which will decide whether these amendments are boon to the taxpayer or it is just an old wine in new bottle.

6. Concluding Thoughts

The above amendments proposed by Finance Bill 2021 can be considered as genuine attempt made to ease the life of the taxpayers. Serious consideration has been given to resolving tax disputes and moving towards a transparent and digitised system. The Finance Bill 2021 indeed has attempted to simplify assessment mechanism, resolve tax disputes and provide tax certainty to taxpayers. Soon it will be now over to the tax authorities to effectively implement these initiatives to usher taxpayer’s confidence in the Indian tax system.

Authority for Advance Rulings – Relevance without Authority?

This article has been co-authored by Rashmi Maskara (Partner), Deloitte Haskins & Sells LLP.

Introduction

The Finance Bill proposed to revamp the Authority of Advanced Rulings and instead constitute Board for Advanced Rulings. This article analyses the pros and cons of the proposed approach.

AAR- Background

Advance ruling as we know today was first recommended by the Direct Taxes Enquiry Committee[1]. It was recommended to constitute an independent body for giving advance rulings.

Subsequently, the need for advance rulings was discussed in the budget speech of 1992-93. It was stated that “in the interest of avoiding needless litigation and promoting better taxpayer relations, a scheme for giving Advance Rulings in respect of transactions involving non-residents, is being worked out and will be put into operation soon. The scope of this can be extended subsequently on the basis of experience gained.”

Soon, vide Finance Act, 1993, a quasi-judicial authority through Authority for Advance Ruling (‘Authority’) was constituted by inserting chapter XIX-B, consisting of section 245N to 245V of the Income Tax Act, 1961 (‘Act’). The intent of introducing the chapter XIX-B as explained by the Central Board of Direct Tax (‘CBDT’) vide its circular no. 657 of 1993 is in line with the budget speech of 1992-93.

Currently, the Authority is functioning through three benches – Principal bench, NCR bench and Mumbai bench. The Authority consists of a Chairman, Member (Revenue) and Member (Law) for Principal Bench and Vice-Chairman, Member (Revenue) and Member (Law) for respective NCR Bench and Mumbai Bench.

The qualification for appointment of each member of the Authority is provided in section 245O(3) of the Act as under:

• Chairman - A person who has been a judge of the SC or Chief Justice of a HC or for at least seven years, a judge of a HC.
• Vice Chairman - a person who has been a judge of a HC
• Member (Revenue) - an officer of the Indian Revenue Service, who is, or is qualified to be a member of the Board
• Member (Law) - an officer of the Indian Legal Service, who is, or is qualified to be, an Additional Secretary to the Government of India

The AAR gives its rulings through a bench of three members i.e. Chairman/ vice chairman, Member (Revenue), and Member (Law). Further, as per the provisions of the Act, the Authority should pronounce the ruling within 6 months.

The reasoning of the Chairman of AAR being a retired judicial member is to give more independence and fairness to Authority on disposing off the cases in a neutral and an unbiased manner.

The above provisions of the Act light up the spirit of establishing the Authority. Having said this, it would be worthwhile to note that the disposal rate[2] of each year for the last decade does not exceed 25%[3].

The poor disposal rate is largely because of vacancy in the office of the Chairman and Vice-Chairman. Due to non-availability of eligible person, the benches of the Authority are not functioning continuously for several months at a stretch. As against a time limit of 6 months provided under the Act, the average time to pronounce a ruling now goes beyond three to four years. This defeats the very purpose of having Authority, as it is not prudent to wait for so long to get tax certainty before undertaking a major transaction.

Finance Bill 2021 Proposal

Finance Bill 2021 has proposed that the Authority shall cease to operate from a notified date and the Government shall constitute one or more Board for Advance Rulings for giving advance rulings. It is proposed that every such Board for Advance Rulings shall consist of two members, each being an officer not below the rank of Chief Commissioner, as nominated by the CBDT.

It is expected that the above proposal will ensure ruling to taxpayers in timely manner. At this juncture reference is made to the Annual Reports (Ministry of Finance) of 19-20[4] which state the aims of objectives of constituting the Authority. It is clear from the Annual report that in addition to providing certainty on a transaction in a timely manner, it is also important that such ruling is provided by an independent adjudicatory body.

Despite Board of Advance Rulings having the same quasi-judicial status as that of the Authority, the proposals would fail to boost investor confidence for the following reasons:

1. The members of the Board of Advance Rulings would be an officer not below the rank of Chief Commissioner. This would imply that the advance rulings would now be pronounced by income-tax authorities exercising quasi-judicial powers.

The approach of officials in tax disputes in the past have shaken the confidence of the investor in obtaining tax certainty. The Authority being a preferred choice to obtain tax certainty may also no longer look lucrative to investors under the proposed scheme of constituting Board of Advance Rulings.

Having said this, considering that advance ruling is no more binding on the taxpayer and the income tax department, and with an option to appeal to High Court, rulings by the proposed board members as a part of proposed AAR may have a bias. The failure of Dispute Resolution Panel is a classic example as how the institutions headed by Tax Administrators in resolving the disputes have not gained confidence with the tax payer.  The proposed revamping of AAR  should not go the DRP path.  The way DRP has become an easy and early route to ITAT, similarly the proposed BFAR system would  become an easy route to High Court and cases will pile up before the High Courts.  Hence, it is important that AAR should be presided over by Independent Members and not appointed by Central Board of Direct Taxes.

Alternative Suggestion

Owing to the above, a complete revamp in the scheme of advance rulings is not warranted. An alternative resolution to the challenge faced in the existing scheme i.e. i.e. vacancy of the member at the Authority, would have been is to ease qualifications for appointing the members from the Bar Council directly or include a President/ Vice-President of ITAT. This would have been similar to practice where several judicial members of the ITAT were elevated as judges in various High Courts. Even industry/ tax experts from the non-government sector who can bring in specific expertise could be considered. This would help in speedy disposal of applications and at the same time would not hamper the independent functioning of the Authority.

The effectiveness of Board of Advance Rulings would be tested in times to come and hope that it does not further impediment the ease of doing business in India. Finally a well-intended objective in establishing an institution should not go down the path of DRP system killing not only the objective but the institution itself for which it was established.

With contributions from Yatik Kothari, Manager, Deloitte

Note: The views expressed herein are the views of authors.

Widening the scope of Equalisation Levy –Finance Bill, 2021

This article has been co-authored by Jason Sanctis (Manager), Deloitte Haskins & Sells LLP.

• Non-resident e-commerce operators who have permanent establishments in India and e-commerce supply or services are effectively connected to those establishments
• Cases where EL is leviable on online advertisement and related activities (as these are covered by different provisions)
• Sales, turnover, or gross receipts are less than INR 20 million during the financial year

Proposed amendments by Finance Bill, 2021

Impact of EQL on various activities/transactions

1. Consideration chargeable to tax as royalty or fees for technical service (FTS).

Under domestic tax law and treaty law, consideration characterized as royalty and fees for technical service (FTS) is taxed at 10% (plus surcharge and cess). Under tax treaties, it is taxed at 10% or 15% (rate depends on tax treaty).

After the Finance Act, 2020, there was ambiguity on whether EQL will additionally apply if a transaction is taxable as royalty/FTS. Some companies were taking a conservative view that both tax under royalty/FTS and EQL is applicable. Finance Bill, 2021 clarifies that EQL should not apply to consideration that is chargeable to tax as royalty or FTS under the Indian income-tax provisions or tax treaties.

Thus, to analyse whether an income is subject to EQL or not, following step process should be followed:

• First determine whether an income is chargeable to tax as royalty or FTS.
• If the income is not chargeable to tax royalty or FTS, then analyse the impact of EL on the same. 

This is a welcome move as it brings certainty.

2. Income subject to EQL is exempt from income-tax in India from 1 April 2020 onwards

Finance Act, 2020 stipulated that income which is subject to EQL will be exempt from income-tax from 1 April 2021. The provisions of EQL are applicable from 1 April 2020, whereas exemption form income-tax came into effect from 1 April 2021.

There was ambiguity on whether EQL and income-tax will apply for the period 1 April 2020 to 31 March 2021. One view adopted by companies was that that income accruing from 1 April 2020 to 31 March 2021 will be subject to EQL as well as income-tax.

Finance Bill, 2021 has clarified that income subject to EQL will be exempt from income-tax from 1 April 2020 onwards.

This is a welcome move as it brings certainty.

3. Inclusion into EQL

The Finance Bill, 2021 has clarified that the term “online sale of goods” and “online provision of services” includes one or more of the following activities taking place online:

(a) Acceptance of offer for sale; 

(b) Placing the purchase order; 

(c) Acceptance of the Purchase order; 

(d) Payment of consideration; or 

(e) Supply of goods or provision of services, partly or wholly.

Accordingly, the above will impact transactions where (a) goods are sold online but delivered offline, (b) service contracts are entered online but provision of service is offered offline, (c) goods / services are provided offline but payment is made online etc.

This clarification expands the scope of EQL. Now, even if one part of the process is carried out online it may come under the purview of EQL. The same has to be analysed based on the facts of each case.

Further, the Finance Bill, 2021, clarifies that EQL is applicable on e-commerce supply or services irrespective of whether the e-commerce operator owns the goods or provides / facilitates the services. This clarification will impact non-residents operating a marketplace model / provide facilitation service, etc.

However, a question that is still unaddressed in context of above is the quantum (or base amount) on which EQL should be applicable:

1. EQL is applicable on gross amount received by website or
2. EQL is applicable on commission / facilitation fee of website

Conclusion

EQL levy provisions are already in force and have been effective from 1 April 2020. The clarifications are a welcome move and will settle certain ambiguities.  However, the clarifications, keep certain points unsettled and could result in expanding the scope of EQL which may cover all e-commerce transactions. EQL impacts firms such as online portals, education service providers, market aggregators, etc. It is pertinent to evaluate the EQL implications in light of the Finance Bill, 2021 clarifications. The next instalment of EQL is for the fourth quarter (for January to March 2021) and is due on 31 March 2021.

Information for the editor for reference purposes only

Proposed Amendments in Finance Bill, 2021 Related to Trusts

The following amendments have been proposed by the Finance Bill 2021 as regards Charitable and Educational Institutions/Trust

1. Increase in the cap on receipt limit prescribed for exemption u/s 10(23C) (iiiad) and (iiiae)
2. Corpus Donations, its parking and effect on Application of Income
3. Double deduction of assets and expenditure financed by loan curbed.
4. Setoff of extra application in one year against the short fall of application in subsequent year not allowable.

We will discuss relevant proposals:

1. Increase in the cap on receipt limit prescribed for exemption u/s 10(23C) (iiiad) and (iiiae)

There is a welcome amendment proposed by increasing the receipt cap from Rs. 1 Cr to Rs. 5 Cr. For eligibility of exemption u/s 10(23C) sub clauses (iiiad) and (iiiae). The CAP of Rs. 1 Cr was brought into the Rule Book in 1998 and needed revision. Educational and Medical Institutions/ Trusts, who exists solely for education / medical and not for profit with receipt not exceeding Rs. 5 Crores in a year will now be eligible (from A.Y. 2022-23) for exemption without going into the process of approval from prescribed authority.

However, one need to keep in mind following:

1. “Existing not for profit” has become a very live litigative issue.
2. Whether accumulation of income by such Institutions/ Trusts is allowable or not is also one more litigative issue.
3. In case any Institution/Trust crosses upper cap of receipt of Rs. 5 Crore in any year, the Institution/Trust should be advised to take appropriate steps in time to get approval under other applicable clauses of S. 10(23C).

2. Amendment as regard Corpus Donations, its parking and effect on Application of Income

The relevant proposal to amend Section 11 [similar amendments are made in S. 10(23C)] is reproduced hereunder:

1. In section 11 of the Income-tax Act, with effect from the 1st day of April, 2022,–– (a) in sub-section (1),–– (i) in clause (d), for the word “institution”, the words, brackets and figures “institution, subject to the condition that such voluntary contributions are invested or deposited in one or more of the forms or modes specified in sub-section (5) maintained specifically for such corpus” shall be substituted;

Existing subclause (d) of S. 11(1) excludes corpus donation being treated as income and accordingly, the exemption is automatic without reference to any other present condition.

Proposed amendment will make such exemption conditional upon parking  Corpus Donation in earmarked investment permitted u/s 11(5) separate from investment of other accumulations and funds. This will mean that Funds arising out of Corpus Donations will have to be separated from other funds of the Institution / Trust.

It may be noted that there used to be an interpretation that no provision of investment or application of income apply to Corpus Donations. They have now proposed specific provisions as regard investment.

2. Explanation 4:  ––For the purposes of determining the amount of application under clause (a) or clause (b),––

(ii) after Explanation 3, the following Explanations shall be inserted, namely:––

  (i) application for charitable or religious purposes from the corpus as referred to in clause (d) of this subsection, shall not be treated as application of income for charitable or religious purposes:

As there was no provision to bar adjustment of capital or other expenditure while computing income applied for objects, whether the funds were out of Corpus or otherwise. It was being interpreted and claimed that expenditure even out of corpus should be counted for working out income applied during the year on the objects (Condition of 85% utilisation).

With the above amendment, there is now a specific bar to give the above treatment while working out income applied during the year.

It is proposed to further add proviso thereto as under:

Provided that the amount not so treated as application, or part thereof, shall be treated as application for charitable or religious purposes in the previous year in which the amount, or part thereof, is invested or deposited back, into one or more of the forms or modes specified in sub-section (5) maintained specifically for such corpus, from the income of that year and to the extent of such investment or deposit; and

This proviso will allow recoupment of corpus  (after being utilised earlier and not treated as application) from non-corpus funds or income to be treated as application of income at that time.

3. Double deduction of assets and expenditure financed by loan curbed.

Repayment of Loan is application of income as per Circular NO. 100 of  24th January,1973. Even Court decision also favoured such interpretation such as in  Maharana Mewar Charitable Foundation [TS-5412-HC-1986(RAJASTHAN)-O] (Raj)

However, Circular as well as Court decisions were silent as to when the loan was taken and utilised for the objects of Institutions / Trusts, whether the money spent on the object was application of income or not. This resulted in double claim of application of income, once when the amount is spent on the object (though financed by borrowing) and secondly, when repayment of loan happens. To Curb this interpretation and double deduction, the following explanation [4 (ii)] has been proposed to be added.

Explanation 4(ii) application for charitable or religious purposes, from any loan or borrowing, shall not be treated as application of income for charitable or religious purposes:

Provided that the amount not so treated as application, or part thereof, shall be treated as application for charitable or religious purposes in the previous year in which the loan or borrowing, or part thereof, is repaid from the income of that year and to the extent of such repayment.

The above explanation will result in loan repayment only to be treated as application and not the expenditure, if financed by the loan.

4. Setoff of excess application in one year against the short fall of application in subsequent year not allowable.

In Matriseva Trust- [TS-5134-HC-1999(MADRAS)-O] (Mad), it was held that excess application in one year can be set off against shortfall in application (85% Rule) in subsequent year/years. Similar view was also taken by Gujrat High Court in Shri Plot Swetambar Murti Pujak Jain Mandal, [TS-5781-HC-1993(GUJARAT)-O] (Guj). There are many such decisions.

This interpretation gave benefit like a carry forward and setoff of losses. To undo this practice, the following explanation is proposed to be added.

Explanation 5.––For the purposes of this sub-section, it is hereby clarified that the calculation of income required to be applied or accumulated during the previous year shall be made without any set off or deduction or allowance of any excess application of any of the year preceding the previous year.”

Just to refresh, the changes made last year, as amended subsequently, requires fresh registration to be applied within the period 01-04-2021 to 30-06-2021

Demystifying the Budget for Exporters

This article has been co-authored by Nikita Brahmankar (Associate Manager), Economic Laws and Practice.

The Government has distinctively undertaken various initiatives to support ‘Make in India’ and ‘Aatmnirbhar Bharat’. In that backdrop, the Government has been granting benefits/ incentives like duty drawbacks, refunds and other benefits through various schemes to boost domestic manufacturing as well as exports.

One such scheme is Merchandise Exports from India Scheme (MEIS) which is now substituted with Remission of Duties and Taxes on Exported Products (RoDTEP) which came into effect from January 1^st this year. Even though the RoDTEP scheme was introduced a month ago the legal framework of the scheme including percentage of benefit is not yet in place. In terms of the Public notice issued by the port authorities, benefit of RoDTEP along with Advance Authorization (AA)/Export Promotion Capital Goods Scheme (EPCG) is not available. Hence, it is important for the exporter to review the benefit available under AA/EPCG vis-a-vis RoDTEP.

Due to a shortage of funds, benefit of MEIS has been restricted to INR 2 crores per IEC on exports made during the period September 1, to December 31, 2020 and the Government is contemplating to keep a lower rate of benefit under RoDTEP for initial period. Clearly, lower outlay of RoDTEP and denial of simultaneous benefit of AA/EPCG along with RoDTEP has placed the exporter community at a greater disadvantage.

Another scheme is Services Exports from India Scheme (SEIS) which grants duty credit scrips to encourage and maximize export of notified services from India. The % of benefit available under SEIS for FY 2019-20 is yet to be notified. Also, the availability of SEIS benefit for exports made 2020-21 onwards is still uncertain.

Uncommonly, there have been various amendments in the GST provisions recently  which have led to further difficulties for the exporters. To pen down a few, by virtue of Rule 96(10) of the CGST Rules, exporters who availed the benefit of IGST exemption under AA or similar schemes are barred from undertaking export on payment of IGST. Further, in the year 2020, export turnover definition for the purpose of Rule 89(4) – which prescribes a formula for refund, has been amended to restrict the export turnover to 1.5 times the value of like goods domestically supplied by the supplier/similarly placed suppliers. However, a corresponding change has not been made in the definition of total turnover. Additionally, ITC for the purpose of refund is also restricted to the extent of ITC reflected in GSTR-2A which effectively led to reduction in refund amount.            

While export businesses were still struggling on account of the unprecedented pandemic and its fallout, the Union Budget 2021 has now proposed various perplexing amendments in respect of zero-rated supplies. According to these amendments an option of export on payment of IGST has been restricted to only notified class of persons or notified supplies of goods/services. This would lead to an extensive blockage of working capital due to the strenuous process of claiming refund of accumulated ITC on account of exports. Although, it would indeed be interesting to see which class of persons/goods/services would be excluded from the generic provision of compulsory zero rated supplies under Bond/LUT. This restriction would majorly impact the exporters as they were streamlining their ITC accumulation by undertaking export of goods/ services on payment of IGST.  

Further, a proviso is proposed to be inserted - which is in line with the Rule 96B of the CGST Rules wherein the Government has prescribed an important condition for realization of sale proceeds within the time limit prescribed under Foreign Exchange Management Act, 1999 (FEMA). In case of non-realization of sale proceeds, the exporter is required to surrender the benefit along with interest.

Section 16 is further proposed to be amended to restrict the scope of zero-rated supplies made to SEZ unit/developer only when the same are made in respect of authorized operations. The said amendment is in consonance with the erstwhile law wherein the benefit of tax exemption in case of supplies to SEZ unit/developer was granted only for authorized operations on submission of Form A2 to the supplier. The said proposition may lead to more hassles for the suppliers to establish that supplies are meant for authorized operations.

The said proposals may ironically lead to more hassles for the exporters.  At a time when the Indian economy is restarting, such curtailment may not augur well with the Government of India’s above vision of ‘Make in India’ and ‘Aatmnirbhar Bharat’.

PoEM, PE Trigger During the Pandemic – Clarifications Awaited...

This article has been co-authored by Prashant Bhojwani.

Over the past year or so, the pandemic has significantly changed the manner in which businesses operate. Travel restrictions have affected the mobility of individuals and temporary closure of business premises have led to employees working from home (public health measures) in different jurisdictions. In fact India had enforced one of the strictest lock downs to curb the rapid spread of the pandemic.

The above situations can create adverse tax consequences for business enterprises. In this context, various countries (e.g. Australia, Germany, etc.) have issued guidance for addressing tax issues emerging from public health measures.  

The Organisation for Economic Co-operation and Development (OECD) also revisited its earlier guidance of April 2020 issued on impact of COVID-19 pandemic on tax treaties. The revised guidance reflects a general approach adopted by countries and provides examples of how some countries are addressing the pandemic impact on tax situations.

Recently, the Indian Government announced Union Budget 2021 including the tax proposals on February 1, 2021. This was an opportune time for the Indian Government to address key tax issues that would arise on account of public health measures. Outlined below are some key tax issues and suggestions for consideration:

Place of effective management

The tax residency of a foreign company is to be determined by its place of effective management (POEM). POEM is defined under section 6(3) of the Income-tax Act, 1961 (the Act) as “a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made”.

On account of the public health measures imposed, there could be situations wherein the board members or senior executives could not travel physically to attend board meetings to the place, where a company is incorporated and would have attended such meetings from India via video-conferencing facility. In this context, the following guidance provided by the Central Board of Direct Taxes (CBDT) vide Circular dated January 24, 2017 is relevant:

“The use of modern technology impacts the place of effective management in many ways. It is no longer necessary for the persons taking decision to be physically present at a particular location. Therefore physical location of board meeting or executive committee meeting or meeting of senior management may not be where the key decisions are in substance being made. In such cases the place where the directors or the persons taking the decisions or majority of them usually reside may also be a relevant factor.”

The CBDT has acknowledged that attending board meetings through video conferencing from India should not create adverse consequences from a POEM perspective. However, if senior executives or directors take decisions in substance sitting in India due to public health measures, it will create issues for foreign companies from POEM perspective. This issue has been addressed by several countries by providing appropriate guidance. As an example, the guidance provided by Australia and Canada is mentioned below:

Australia

If the only reason for holding board meetings in Australia or directors attending board meetings from Australia is because of the effects of Covid-19, then the Australian Tax Office will not apply compliance resources to determine if the company’s central management and control is in Australia.

Canada

In light of the extra-ordinary circumstances resulting from travel restrictions, as an administrative matter, where a director of a corporation must participate in a board meeting from Canada on account of travel restrictions, the Canadian Revenue Agency will not consider the corporation to become resident in Canada solely for that reason.

Further the updated guidance provided by the OECD in respect of corporate residence is also relevant and the same is mentioned below:

“Therefore all relevant facts and circumstances should be examined to determine the “usual” and “ordinary” place of effective management, and not only those that pertain to an exceptional period such as COVID-19 pandemic.

In conclusion, an entity’s place of residence…is unlikely to be impacted by the fact that the individuals participating in the management and decision-making of an entity cannot travel as a public health measure imposed or recommended by atleast one of the governments of the jurisdictions involved.”

While the OECD’s guidance largely addresses treaty situations, issues faced by foreign enterprises from non-treaty countries can be adversely impacted. To address this, it is suggested that an amendment be made in section 6(3) of the Act to the effect that the POEM of a foreign company would not be considered as being in India, if the only reason the majority of directors or senior executives attend online meetings whilst being present in India or that board meetings are physical held in India on account of public health measures. The POEM of such companies should not be considered as being in India for the financial years 2020-21 and 2021-22, if it is not usual otherwise for such enterprises to take decisions in substance from India.

Business connection and Permanent Establishment

Taxation of a foreign company is triggered in India, if such foreign company has a business connection or Permanent Establishment (PE) in India. Section 9(1)(i) of the Act deems “all income accruing or arising, whether directly or indirectly, through or from any business connection in India” as income deemed to accrue or arise in India. Such part of the income is deemed to accrue or arise in India as is reasonably attributable to the operations carried out in India. As per Explanation 2 to section 9(1)(i) of the Act, an agent’s activities would constitute a business connection for the foreign company, if the agent has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident or habitually plays the principal role leading to conclusion of contracts by that non-resident, subject to specified conditions.

Further, Section 92F(iiia) of the Act defines PE to include “a fixed place of business through which the business of the enterprise is wholly or partly carried on”.

The employees could be dislocated from the country in which they normally work. Such employees could be working from home and it is quite possible their home could be in another jurisdiction (say India) or they are stranded in India since travel restrictions were imposed. In such a scenario, the foreign enterprise (i.e. the employer) may have to deal with creation of a PE or business connection in India on account of the home office/ place where the employee has been working and this could potentially lead to tax consequences for such company. Similarly, temporary conclusion of contracts from the home of the employees of agent on account of the pandemic could create PE or business connection for the foreign enterprise in that jurisdiction.

To address the above, there is a need to clarify both in Explanation 2 to section 9(1)(i) of the Act as well as in section 92F of the Act where PE is defined that where under exceptional situations people have worked from India to conclude contracts or play leading role in substance or other activities are carried out from India, a business connection or a PE should not be ordinarily triggered.

Fixed place PE

A home office intermittently used is generally not considered as PE since it is not at the disposal of an enterprise. However, if it was used on continuous basis, it may be regarded as PE. During the pandemic, individuals working from home remotely are doing so as a result of public health measures. This being an extraordinary event should not be considered as giving rise to a PE since it lacks sufficient degree of permanency or continuity and also because it is not at disposal of the enterprise. This also needs to be addressed in section 92F of the Act appropriately.

Agency PE

Also, if an employee of an agent is compelled to work from his home, the agent’s activity should not be considered as ‘habitual’ if they are due to exceptional situations as a public health measure imposed by the government. Consequently, such working by an agent’s employee should not constitute a dependent agent PE provided of course the employee does not continue to do so after stringent measures cease to apply. Appropriate guidance of this nature will help enterprises from treaty countries to avoid unwarranted PE related issues and litigation.

Construction PE

A construction site is not regarded as ceasing to exist when work is temporarily discontinued. Countries may consider certain periods of a type of interruption where operations are prevented, on account of public health measure imposed by the government where the site is located, to be reduced while computing the time period threshold for PE. This is necessary to avoid unwarranted construction and installation PE situations getting triggered due to delays and continuity of work at sites after stoppage due to the pandemic.

Here are some examples quoted from the updated OECD guidelines to show how other countries globally are dealing with this situation:

Austria

If an Austrian employee of a foreign enterprise carries out his work in Austrian home office during the pandemic due to the measures recommended by the respective governments, this is due to force majeure. Therefore, in view of the extraordinary nature of the crisis – and provided that work in the home office does not become the norm – there should be no PE for the foreign enterprise, because the home office lacks sufficient disposal of the enterprise over the home office. In addition, the employer provides an office which in normal circumstances is available to its employees.

Temporary interruptions of construction sites due to the pandemic should in principle not lead to suspension of deadline of Article 5(3) of OECD model - subject to any deviating bilateral agreement.

Canada

A resident enterprise from a treaty country should not be considered to have a PE in Canada solely because:

• Its employees perform their employment duties in Canada on account of travel restrictions, being in force. 
• A dependent agent concludes contracts in Canada on behalf of the foreign enterprise while the travel restrictions are in force, provided that such activities are limited to that period and would not have been performed in Canada but for the travel restrictions.

Germany

An interruption of construction and installation work caused by COVID-19 will not be counted for purposes of time threshold of PE under Article 5(3), provided that:

• The duration of interruption is at least two weeks,
• The personnel of the enterprise (or any commissioned personnel) has been withdrawn from the construction site or have left it, and
• The relevant income will be taxed, e.g. in the jurisdiction of residence of the enterprise or its personnel, where the suspension of the lapse of time results in the enterprise not having a PE in Germany.

Germany would ignore the time of interruption, but it would combine the time spent before and after the interruption (so that PE duration test does not start afresh after the pandemic-related interruption).

Considering that India is an emerging global player and use of technology has enabled people to work from India while being stranded, it is time that India recognizes and demonstrates that it will deal with PE situations in treaty situations reasonably in line with other global players. Also, in so far as it concerns non-treaty situations, it should deal with business connection in line with global best practices and for this, appropriate amendments in law or clarifications would certainly be welcome. India has already done some of the above to cover individual taxation situations so doing for business enterprises (i.e. employers) of such individuals is definitely called for.

Amendments Proposed in Budget 2021: Unsettling the Settled SC Rulings?

This article has been co-authored by Rohit Saboo (Manager) and Umang Goyal (Deputy Manager), Deloitte Haskins & Sells LLP.

Hon’ble Supreme Court order is the law of the land, or is it … ..?

Hon’ble Finance Minister vide the Union Budget 2021 has proposed amendments w.r.t. certain litigious issues like depreciation on goodwill and deductibility of delayed payment of employee’s contribution to labour funds under the Income-tax Act, 1961 [“the Act”]. Considering, both these issues were previously settled by the Hon’ble Supreme Court, it raises a question of whether the Government has overruled the said judgements and does this tantamount to encroaching on judicial power?

This is not the first time that the Government has introduced amendments which have rendered the Hon’ble Supreme Court judgements inapposite [such as in the case of (a) Vodafone International Holding BV[1] for indirect transfer provisions; (b) HCL Comnet Systems & Services Ltd[2] for retrospective amendment under section 115JB of the Act; etc.]. Hence, judicial precedents[3] have already dealt with this issue and have starkly held that parliament has powers within the framework of the Constitution to enact legislation which could modify the principles enunciated by Hon’ble Supreme Court. Therefore, although incongruous to a common man, the actions of the Government in amending the provisions of the Act cannot be considered an encroachment on judicial power.

Thus, under the altered circumstances and proposed modifications to law, judgements of Hon’ble Supreme Court on the aforesaid issues would not hold good.

Having said the above, we have analysed the amendments and its implications in the succeeding paras:

• Depreciation on goodwill:

As per section 32 of the Act, depreciation is allowed in respect of assets which inter-alia include know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. The term “any other business or commercial rights term” had been an issue of debate for years (i.e. whether goodwill will fall under the said definition), until the judgement of Hon’ble Supreme Court in the case of Smifs Securities Ltd[4] put the question to rest and concluded that “goodwill” falls under its ambit. Hence, post the said ruling, there were no two views on the fact that goodwill is a depreciable asset.

However, the Government while acknowledging the Apex court judgement has highlighted that goodwill in general is not depreciable asset and rather it may see appreciation in its value. Further, in the memorandum to the finance bill, reference is also drawn to the existing provisions of the Act[5] which dealt with the meaning of term written down value/ actual cost of asset wherein on a plain reading it is plausible to adopt a view that no value can be attributed to goodwill acquired in a scheme of amalgamation/ demerger and hence, there is no justification in claiming depreciation on the same.

Accordingly, the Government has carved out clear exclusions to state that goodwill shall not form part of block of assets and thereby from AY 2021-22 onwards no depreciation shall be claimed on the same. Besides, in case of tax payers who have acquired goodwill in prior years and have already enjoyed the benefit of depreciation, the Government in an attempt to plug the gap between said taxpayers and those who will forego the benefit of depreciation in its entirety, has notified intention to compute and tax short term capital gain on such written down value [“WDV”] of goodwill forming part of block of assets for AY 2020-21. The computation mechanism is yet to be notified, however a hypothetical overview of the same can be understood by way of following example:

“Where purchase price of goodwill forming part of block of assets for AY 2020-21 was INR 120 and the WDV was INR 100 (i.e., depreciation of INR 20 had been claimed in prior years), in computing short term capital gain, the cost of acquisition would be purchase price reduced by the depreciation i.e., WDV of INR 100.

Hence, depreciation of INR 20 which was claimed as deduction in prior years will now be taxable as short-term capital gain.”

However, the amendments have left a trail of unanswered questions in the minds of taxpayers. While goodwill has been excluded from the ambit of depreciation does this exclusion extend even to acquisition of other intangible assets such as brand; customer base; contracts; etc. which are acquired in the process of restructuring? Can it be said that the intention of the legislature is to cover even such intangibles under the term “goodwill”? While no such indication has been made, one may have to deliberate on various judicial precedents dealing with this issue and the existing provisions of the Act to analyse the same. Also, it would be pertinent to revisit the positions previously adopted by the taxpayers in light of the proposed amendment.

• Delayed deposit of employee’s contribution to labour funds:

Another long-drawn issue proposed to be settled by the Government vide this Finance Act is the controversy prevailing over the allowability of deduction to employers w.r.t. delayed deposit of employee’s contribution towards labour funds.

As per section 36(1)(va) of the Act, deduction w.r.t. employee’s contribution is allowed to the employer only if payment is made within the due date specified in the respective statute. On the other hand, as per section 43B of the Act, employer’s contribution towards labour funds is eligible for deduction, if paid within due date of filing of return of income. The controversy which evolved was whether principles of section 43B of the Act can also be extended/ applied to employee’s contributions?

Judicial forums were divided on this issue. One set of view[6] was that, employee’s contribution should be allowed as deduction to the employer only when it remits the same within due dates specified in the respective statute. The other view[7] was that both employer's contribution as well as employee's contribution would be guided by section 43B of the Act.

At this juncture, it is imperative to understand that the legislative purpose of amendment brought-in by Finance Act 1987 was to penalize employers who mis-utilize employees contributions towards various labour funds and thereby section 2(24)(x) and section 36(1)(va) were introduced.

Further, it was observed by the Government that owing to favorable rulings, employers habitually delayed depositing employees' share of contributions to various labour funds and by such delay deposit, the employers were getting unjustly enriched by keeping the money belonging to the employees. Therefore, reiterating the legislative intent behind introduction of section 36(1)(va) of the Act, the Government has put to rest the controversy.

It is worth noting that although an amendment has been proposed to settle the controversies, it still needs to be analyzed if the same would apply prospectively or retrospectively. Judicial forums at various occasions have held that an explanation inserted merely to clarify confusion in a statutory provision, does not amount to a new levy and since the same is inserted to avoid misuse of the provision, the same would be applicable retrospectively. However, retrospective application of the said amendment, would open door of litigation for such taxpayers for whom the deductions have already been allowed in earlier years. 

Concluding remarks ….

While it is a settled position that Government can amend the legislature irrespective of the prevailing judgements, the Government’s move to introduce amendments which expand the tax base by disturbing the present established position of law, may not be welcomed by the taxpayers who seek a predictable and stable tax environment.

In conclusion, there is no iota of doubt that these amendments have nullified the Supreme Court rulings on the aforesaid issues. However, it would be interesting to see how these amendments are given effect to by the taxpayers and whether the intent of legislature behind introduction of the said amendments would be fulfilled. Hence, the question remains, whether these amendments would settle issues or open a pandora’s box resulting in continued litigation for the taxpayers.

This article has been co -authored by Ms. Priyanka Kalluraya (Deputy Manager, Deloitte)

Is TDS on Purchase of Goods an Efficacious Replacement for TCS on Sale of Goods?

This article has been co-authored by Sanchita Midha (Manager), Felix Advisory.

India Government in its budget for the last year introduced Tax Collection at Source (TCS) provisions on sale of goods. TCS is payable @ 0.1% on the amount of sales consideration which is greater than INR 50 Lakhs and is received by the Seller on or after 1st October 2020.  Due to covid-19 pandemic, rate of TCS got slashed by 25% until 31 March 2021 and thereto effective rate for TCS becomes 0.075%.

‘Seller’ has been defined as a person whose total sales, gross receipts or turnover from the business carried on by him exceeds INR 10 crores during the financial year immediately preceding the financial year in which the sale of goods is carried out.

Several instances got transpired to India Revenue Authorities, wherein seller turnover is less than prescribed threshold of INR 10 crores but the consideration received by him from sale of goods to a particular buyer exceeds the stipulated limit of INR 50 lakhs. There arose no obligation upon seller to collect TCS from buyer in such cases. 

To ensure collection of taxes in such cases, India Government has widened the scope of TDS and has come up with provisions levying TDS on purchase of goods.  Unlike TCS provisions, wherein turnover threshold for Seller is to be considered for applicability of the provisions, turnover threshold for Buyer is required to be examined for the levy of TDS on purchase of goods.

The India Budget 2021 proposes to levy a TDS of 0.1% on a purchase transaction exceeding INR 50 lakhs in a year. In an intent of India Government to reduce compliance burden, obligation for such deduction shall lie only on the persons whose turnover exceeds INR 10 crores. The budget has proposed to insert a new provision (Section 194Q) with effect from 1st July 2021 for the same.

Per the said provision, any person who is a buyer responsible for paying any sum to any resident for purchase of any goods having a value of more than Rs. 50 Lakhs in any previous year then such person shall at the time of credit of such sum to the account of the seller or at the time of payment thereof by any mode, whichever is earlier, deduct an amount equal to 0.1 % of such sum exceeding fifty lakh rupees as income-tax.  Seller would be required to furnish PAN details else withholding would be done by the Buyer at an exaggerated rate of 5% in terms of Section 206AA of the India tax laws.

‘Buyer’ as referred in the provision means a person whose total sales, gross receipts or turnover from the business carried on by him exceed INR 10 Crores during the financial year immediately preceding the financial year in which the purchase of goods is carried out.

It has also been proposed to provide that provisions of Section 194Q shall not apply to:-

1. a transaction on which tax is deductible under any of the provisions of the India tax laws;
2. a transaction, on which tax is collectible under the provisions relating to collection of TCS other than a transaction to which provision related to collecting TCS for the sale of Goods applies.

The above implies, if on a transaction a TDS or TCS is required to be carried out under any other provision of India tax laws, then it would not be subjected to TDS under this section. However, there is one exception to this general rule which is that if on a transaction, TCS is required to be collected on sale of goods [i.e. in terms of Section 206C(1H)] and TDS is required to be collected on purchase of goods [i.e. in terms of Section 194Q], then on that transaction only TDS under Section 194Q shall be carried out.

Further, provision also empowers the Central Board of Direct Tax (CBDT) to issue guidelines, with the previous approval of the central government, for removing any difficulties faced by taxpayers in the implementation of the provision.

The nuances of the provisions relating to withholding of taxes on purchase of goods could be better understood from the ensuing illustration.

The proposed introduction of TDS provisions on purchase of goods seems to be pari-materia with TCS provisions on sales of goods. However, still there are certain vexatious issues such as determining the timeline beginning which threshold limit of INR 50 lakhs is to be computed as the provision is effective 1 July 2021 and adjustment, if any required for purchase return, discount etc. while computing the amount of purchase consideration, definition of term ‘goods’ since the Section 194Q seeks to provide for withholding of taxes on purchase of ‘goods’.

India tax laws does not define the word ‘goods’  Article 366(12) of the Constitution defines goods to include all materials, commodities, and articles.  This is an inclusive definition and does not throw much light on the meaning of the word ‘goods’.  Section 2(7) of Sale of Goods Act, 1930 defines ‘goods’ to inter alia mean every kind of movable property other than actionable claims and money and includes stocks and shares.  On the other hand, Section 2(52) of the Central Goods and Services Tax Act, 2017 (‘CGST Act’), defines the word ‘goods’ to include every movable property except money and securities but includes actionable claims

The expression sale of goods is a term of well recognized legal import in the general law. In that sense, the Author(s) believes that the meaning of ‘goods’ to be used in the India tax laws must be derived from the Sale of Goods Act, rather than the CGST Act, as the former contains the natural meaning of the word.  However, India Government would be required to come up with necessary clarifications etc. in connection with above vexatious issues so as to augment the ease of doing business in India.

Yet Another Tax Imposed on Purchase or Sale of goods..

Extension of taxation ambit has been a regular procedure adopted by the Government in every budget. In Finance Act, 2020 a new sub-section was introduced in section 206C of the Income-tax Act, 1961 (‘the Act’) in sub-clause (1H) requiring collection of tax by seller from buyer on sale of goods.

Further, in Finance Bill 2021 the Finance Minister announced that ‘in order to widen the scope of TDS, it is proposed to levy a TDS of 0.1% on a purchase transaction exceeding Rs. 50 lakhs in a year. To reduce the compliance burden, it is also proposed to provide that the responsibility of deduction shall lie only on the persons whose turnover exceeds Rs. 10 crores.’

This new provision is applicable from 01 July 2021. The basic features of these provisions are provided here:

Typically, these tax deduction provisions are similar to the tax collection provisions as laid out in section 206C(1H) of the Act. Having said that, the immediate reaction would be

-          whether such back-to-back provisions are required with a minimal tax levy at 0.10 percent?

 -          wouldn’t this just increase the compliance burden on the taxpayers, contrary to the ‘ease of compliance’ that is promised by the current Government?

Now that these provisions are anyway proposed, let us understand the intricacies involved in it.

1.      Residential status of the ‘Buyer’

As per the proposed provisions, technically a buyer can be a resident or non-resident. An argument could be taken that the Indian Income-tax Act is extra-territorial to a non-resident (who has no business presence in India) and hence not applicable.

Similar to the other tax withholding provisions, Central Government has been empowered to issue guidelines for removing difficulty in giving effect to the provisions of this section. One can expect exemptions/ clarifications to this effect.

2.      Cascading effect

This is another point where we can expect some clarifications. As of now, tax withholding provisions trigger on Business-to-Business purchases as well as Business-to-Consumer purchases.       

3.      Considering that 206(1H) and 194Q are applicable on the same transactions, is this new provision introduced just to shift responsibility from seller to buyer?

While the provisions of section 206(1H) and 194Q are the same except for few differences like:

It is also clarified in the Memorandum to Finance Bill, 2021 that purchase of goods will be covered under section 194Q and not section 206C(1H) of the Act with effect from 01 July 2021. Therefore, tax collection under section 206C(1H) will attract only in scenarios like – where the buyer’s turnover is less than INR 10 crores and the seller’s turnover is more than INR 10 crores.

One of the advantages of shifting the tax liability to section 194Q of the Act is that the seller can obtain lower withholding certificate.

4.      The above discussion (in point 3) holds good when both buyer and seller are residents. Let us take is one step ahead and understand the implications if one of the parties or both the parties are non-residents?

•          When both buyer and seller are non-residents: When both the parties are non-residents, one could argue that TDS under section 194Q and TCS under section 206C(1H) should not apply as it is an extra-territorial in nature.
•          When seller is a non-resident and buyer is a resident: TDS obligation under 194Q does not trigger as the precondition that ‘seller’ has to be resident is not satisfied

If the seller has presence in India, then tax collection obligation arises under section 206C(1H). However, if the seller has no presence, then an argument could be taken that the transaction is extra-territorial.

•          When buyer is non-resident and seller is resident: Exports are specifically excluded from TCS applicability. As regards to mandate for tax deduction on the buyer under section 194Q, technically there is a requirement. Again here, an argument could be taken that it is an extra-territorial application.

5.      When goods are purchased by a customer from an e-commerce participant, would section 194Q apply or 194-O?

In Finance Bill, 2020 section 194-O was introduced requiring deduction of tax by e-commerce operator while making payment to e-commerce participants. So far as the condition to trigger section 194-O satisfies, tax should be deducted by the e-commerce operator under section 194-O of the Act for the following reasons:

•          Section 194Q specifically exempts transactions that are subject to tax withholding under any other provisions of the Act; and
•          Section 194-O starts with a non-abstante clause and therefore overrides section 194Q

6.      There is a threshold of purchases value provided for determining applicability of section 194Q – does it include purchases prior to 01 July 2021 also?

This provision is applicable from 01 July 2021 and hence, the requirement to withhold tax should be restricted to purchases made on or after the said date.

Similar to clarification provided for section 206C(1H) by Central Board of Direct Taxes in Circular 17 of 2020, one can expect a guidance that it is only for determining the threshold of applicability of section 194Q in a transaction (i.e. value of purchases exceeding INR 50 lakhs), that purchases made during the period April 2021 to June 2021 may be considered.

7.      How to determine purchase value when seller has multiple branches?

Finance Bill, 2021 only provides that the seller must be a resident. Further, it mentions that if PAN is not provided, tax shall be deducted at a higher rate of 5 percent. With this, an inference can be drawn that PAN is the driver for determining taxability and taxable value. Further, a branch has no separate legal identity from the Company. Therefore, purchase value of all branches of the seller should be aggregated to determine the threshold.

8.      How to determine turnover when buyer has multiple branches?

Buyer is defined as a ‘person’. As per section 2(31) of the Act, a person does not include a ‘branch’. Also, as discussed earlier, a branch has no separate legal identity when compared to a seller company. So, turnover should be determined considering the sales made by all branches of the buyer.

9.      What constitutes goods - One of the preliminary aspects that requires analysis here?

Definition of goods is not provided in section 194Q nor in section 206C(1H) of the Act. In common parlance, ‘goods’ means any ‘merchandise or possessions’.

However, further guidance in required to understand applicability of TDS under section 194Q of the Act certain items – like treatment of certain items such as ‘money’, ‘securities’, etc.

One could place reliance of Goods & Services Act – as per section 2(52) of the GST Act, “Goods’’ means every kind of movable property other than money and securities but includes actionable claims, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.

Further, in the context of section 206C(1H) of the Act, Central Board of Direct Taxes has clarified in Circular 17 of 2020 that ‘Goods’ excludes securities and commodities which are traded through recognized stock exchanges.

With the limited guidance available, a view could be taken that exchange/ purchase of items unlisted securities will be subject to TDS under section 194Q of the Act – however, we have to wait for further guidance.

10.  How to determine value of goods that requires tax withholding under section 194Q?

Certainly, there is clarity required on the value of purchase that is subject to TDS under section 194Q of the Act.

Further, when there is advance paid for any purchases, taxes should be deducted on them as withholding requirement triggers at the time of credit or payment whichever is earlier.

11.  Does 194Q cover exchange of goods?

Exchange of goods is not specifically excluded from the ambit of section 194Q. The challenge will really in understanding:

•          When there is receipt of goods in both the sides, both the parties could be considered as buyers – could this result in taxation of same transaction in the hands of both the parties?
•          Further, there is no specific mechanism to determine fair value of goods exchanged

Illustration

Having understood the provisions as it stands today, let us see how it works practically:

Based on the observation of amendments proposed in past couple of years, a message is conveyed that the Government is not just expecting taxpayers to do business and pay taxes due on the profits earned, but also deduct/ collect tax and remit them on a timely basis to make it easier for the  Government.

However, knowing the current condition of Indian economy, maybe it is not a good idea to introduce additional tax and corresponding compliances. This could seriously create working capital constrains for many businesses.

Also, before experimenting such new provisions, the Government should have observed that nearly all buyers of goods worth more than INR 50 lakhs are already subject to GST on same transaction.

So why is the Government creating additional burden on businesses when we talk about  ease of doing business – seems a contradiction !

This article has been co-authored by Veena Ramachandran

Depreciation on Goodwill – A Will Without a Way

“Goodwill may see appreciation or in the alternative no depreciation to its value”. A rationale encompassed in Finance Bill 2021 (Memorandum) that sounded the death knell for depreciation on goodwill.  

The issue of allowability of depreciation on goodwill is more than a decade old. While  a businessman’s contention is very simple (i.e. he should get a tax break against the money he has spent) , the Revenue’s perspective has always been riddled with a sense of reluctance to allow depreciation on goodwill alleging such an asset never existed as part vocabulary of tax depreciation schedule.

As per the tax depreciation schedule, ‘Intangible asset’ means Know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature

Though the Revenue always contended that ‘Goodwill’ never formed part of above content, Supreme Court in case of Smif Securities held that Goodwill is a depreciable asset by bringing it into ambit of “any other business or commercial rights of similar nature’.

Goodwill – When and How does it arise?

As per para 32 of INDAS -103 accounting standard governing ‘Business Combination’ , the acquirer shall recognise goodwill as of the acquisition date measured as the excess of (a) over (b) below:

(a)    the aggregate of:

 (i) the consideration transferred measured in accordance with this Ind AS, which generally requires acquisition-date fair value;

 (ii) the amount of any non-controlling interest in the acquiree measured in accordance with this Ind AS; and

 (iii) in a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree.

(b)   the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this Ind AS.

In simple language, in case of acquisition of a business or undertaking, amount of consideration paid in excess of the fair value of the assets (net of liabilities) is termed as goodwill.

Standalone intangible purchase vs Purchase of Intangible as part of Undertaking/ Division

In case of purchase of an individual asset, the consideration paid is directly accounted as ‘cost of asset’ and the question of ‘goodwill’ does not arise. However, in case of an acquisition of a business undertaking or division either through merger or slump sale, ‘goodwill’ arises. In such a case, the buyer or the acquirer makes  purchase price allocation (fair valuation exercise) among assets and the excess of consideration paid over fair value of asset(net) is accounted as ‘goodwill’.

Proposed Amendment & impact on the business

a)      Retrospective Amendment

Depreciation on goodwill is proposed to be denied to the assessee with effect from April 1,2020. Assessees who have already claimed depreciation on goodwill will be under tremendous hardship to pay interest u/s 234 B/C in FY 2020-21 since their taxable income will increase without such depreciation benefit.

b)      Tussle between Buyer and Seller is on anvil

In case of slump sale, the seller always prefers to make a ‘slump sale’ rather than an itemized sale to avail the benefit of long term capital gain. Now the Buyer of the asset/undertaking may push back to the seller to make such deal as itemised sale to avoid the disallowance of depreciation on goodwill (most likely arises in ‘slump sale’ instance).

However, such push back by the buyer may not always happen for itemised sale considering slump sale does not attract GST whereas itemised sale attracts GST.

In a nutshell, where a buyer has the ability to set off or encash GST input credit, he will certainly prefer itemised sale over slump sale.

c)       Status quo in MAT provisions

‘Goodwill’ is tested for impairment at each reporting date of financial statement. When the value of goodwill depletes, such amount is debited to P&L account as ‘impairment charges’. MAT provision, unlike proposed amendment in Sec.32 of Income Tax Act, allows reduction of such ‘impairment charges’ for the purpose of arriving at the book profit. It is interesting to note that while ‘Goodwill’ is recognized as an asset which may be subject to impairment in accounting, tax provisions do not recognize it to be a depreciable asset.

d)       ‘any other business or commercial rights of similar nature’ – needs more clarity.

Applying the principle of ‘ejusdem generis’, Supreme Court, in case of Smif Securities had held that ‘Goodwill’ will fall under the ambit of  any other business or commercial rights of similar nature and hence eligible for tax depreciation.

Govt., in the memorandum to Finance Bill,2021  has accepted the fact that “ In some other cases (like that of acquisition of goodwill by purchase) there could be valid claim of depreciation on goodwill in accordance with the decision of Hon’ble Supreme Court holding goodwill of a business or profession as a depreciable asset” (emphasis supplied). However, in subsequent para, depreciation on goodwill is denied stating that goodwill may not see any depreciation in value. Accordingly, the rationale of SC ruling is overturned.

Hence the term ‘any other business or commercial rights of similar nature’ should be defined more clearly to bring more clarity and certainty in the tax environment.

e)      Customer Contract – An ‘intangible asset’ eligible for tax depreciation

In case of a business acquisition mostly in case of a slump sale, the acquirer pays an amount to the seller towards getting access to the repository of customer contracts. Although the customers are free to choose to have contract with the acquirer or not, in most of the cases, the acquirer gets those customers in its fold. In effect, the acquirer gets those rights to access the customer base of the seller and hence the transaction should qualify as acquisition of commercial right. This amendment denying depreciation on goodwill should not have any impact on claim of depreciation on customer contract.

f)       Cost of purchased goodwill – WDV on April 1,2020 to be treated as ‘cost of acquisition’

WDV of purchased goodwill as on April 1,2020 will be treated as ‘cost of acquisition’ which can only  be reduced against sale consideration of the relevant undertaking. It means the assessee will not be able to get any benefit of unamortized portion of goodwill unless it sells such acquired undertaking to another person.

When an assessee records ‘goodwill’ upon acquisition of an undertaking, it records the ‘goodwill’ as a lump sum value without assigning it asset wise.

Upon sale of certain assets (forming part of acquired undertaking) ,the related cost of acquisition of the goodwill should logically be apportioned to the extent of asset sold and be set off against the capital gain. We will have to wait for Govt. to prescribe the manner in which the goodwill can be prorated to the cost of asset sold partially out of acquired undertaking.

While it is unlikely that Govt may consider repealing the proposed provision denying depreciation on goodwill, making this provision applicable in prospective will augur a good sense of trust and reliability among the business fraternity towards Govt.

For a change, an assessee is craving for a ‘depreciation’ rather than an ‘appreciation’, which in most likelihood, will remain only as a ‘will’ without a ‘way’. 

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Views expressed by the author are personal in nature

Budget clarifications on ‘Equalisation Levy 2.0’ – Settling the Dust or Raising a Sandstorm?

In the last budget, the Indian Government had expanded the scope of Equalisation Levy (‘EL’) in the Finance Act, 2020 to include a levy of 2 percent, on consideration received or receivable by a non-resident ‘e-commerce operator’ (‘ECO’) from ‘e-commerce supply or services’ (‘EL 2.0’).  This introduction of EL 2.0 without any consultation with stakeholders or any parliamentary debate took everyone by surprise.

EL 2.0 provisions as they were introduced, were drafted in an extremely broad manner with lack of clarity on several aspects including even on the basic scope as to whether should it apply only on digital goods or even on physical goods sold over ecommerce platform? EL has been introduced to tackle the complex issue of taxing digital economy and is an interim measure till the World reaches a consensus on how to tax digitalized businesses, although the scope of Indian EL extends far beyond the digital transactions.

Throughout the year, the stakeholders waited with a bated breath for the clarifications on provisions and guidance on some of the nuanced and ambiguous issues, but none were forthcoming. Due to lack clarity, many companies adopted ‘wait and watch’ approach throughout the year. In the meanwhile, the USTR investigation gave its final report holding the Indian EL to be discriminatory. Finally, recognising that there is ambiguity in law, certain clarifications have been provided in the Union Budget 2021 (the ‘Budget’) intending to iron out the creases, which are as follows -

Exemption from income-tax

The Finance Act, 2020 provided that payments which were chargeable to EL will be exempt from income-tax under the provisions of section 10(50) of the Income-tax Act, 1961 (‘IT Act’). However, this exemption was provided only from April 1, 2021.  Therefore, for the financial year (‘FY’) 2020-21, there was a concern on possible double taxation of same income under the normal provisions of the IT Act as well as EL law. Many representations were made to correct this anomaly and as a welcome move, the Budget now clarifies that exemption under section 10(50) of the IT Act on payments chargeable to EL shall apply retroactively from April 1, 2020 (instead of April 1, 2021). It would have been good for the Government to set at rest anxiety around such issues earlier in the year through press statements and follow up with formal amendment later in the budget.

Overlap between royalty/ fees for technical services (‘FTS’) and EL

There was a concern about transactions that could potentially be covered within the scope of ‘royalty’ or FTS under the IT Act and may also be within the scope of EL. The Budget clarifies that the EL shall not apply on consideration which is taxable in the nature of royalty or FTS under the IT Act read with the relevant tax treaty, retroactively from April 1, 2020.  This clears the air on interplay between provisions of the IT Act and EL law as regards these payments. If the payments are in nature of royalty or FTS then those would be taxable as such at the applicable income-tax rate (tax rate of 10% is provided under the domestic law on such payments) and EL shall not apply on such payments.  However, considering that characterization of payments as ‘royalty’ or ‘FTS’ is a highly litigious issue in India with numerous cases pending before various appellate forum,, the procedural aspects deserve some deliberations. 

Where no royalty or FTS position taken by the taxpayer is challenged by the Indian Revenue Authorities (‘IRA’), will they suo motu grant credit of EL against the income-tax liability or will they grant a refund of EL already paid by the taxpayer?  This could be an issue especially where matter is appealed and litigated for a prolonged period and the time period for the revision of EL returns filed by taxpayer / rectification of EL intimation issued by IRA (which currently is possible for a limited number of years) has expired.  Some administrative clarifications from IRA to this effect would be required to address these concerns, including manner in which interest and penal consequences could apply.

Online sale of goods or services

By way of clarification, the scope of ‘online sale of goods’ / ‘online provision of services’ is defined to include any one or more of the following – (a) acceptance of offer for sale; (b) placing the purchase order; (c) acceptance of the purchase order; (d) payment of consideration; or (e) supply of goods or provision of services, partly or wholly.  This proposal has broadened the scope significantly by bringing any transaction with a cross-border element within the ambit of EL 2.0.  According to this amendment, any activity connected with the sale lifecycle which takes place online, will make the entire transaction subject to EL 2.0. Let us take an example where an Indian subsidiary of a multinational group purchases physical goods by placing a procurement order on the ERP system of the group. Goods are then shipped physically into India. In such a case, it is unclear if an internal portal accessible to all group companies would qualify as an electronic platform and if yes, whether such a transaction of purchase of physical goods will be subject to EL 2.0.

It is also unclear what the intent is behind including payment limb within the scope of EL 2.0. On one hand, there is strong push from the Government to move all payment transactions to a digital platform and on the other hand, a transaction could become subject to EL 2.0 merely because it is being settled through online or electronic mode. Most of the cross-border transactions are settled through payment gateways or online banking channels. If it is a physical transaction in goods or service, is the digital or electronic mode of payment adequate to bring the entire transaction within the scope of EL 2.0? This appears more like a case of tail wagging the dog.

Gross v net consideration

The Budget also clarifies that EL 2.0 will apply on consideration received by an Ecommerce Operator (ECO) irrespective of whether goods are owned by ECO / services are provided or facilitated by ECO.  This indicates that for foreign marketplace operators, EL is meant to apply on the total value of the sale of goods or provision of services facilitated by them (ie gross basis) as opposed to EL being charged only on the fee or commission earned by the marketplace operator. 

There are some fundamental issues with this approach. If the EL 2.0 is a tax on sale of digital goods, it should be paid by the sellers of digital goods. This is sought to be imposed on the foreign marketplace operators (ECO) facilitating the sale, who may not have enough margins to absorb the levy on gross consideration flowing through their platform and may be compelled to pass it to on to consumers or merchants. Let us assume for a moment that EL 2.0 is passed on to the merchants. The exemption from income-tax is given to the ECOs. Will they be allowed to pass on this exemption to the merchants? What happens where there are Indian merchants listing their goods on foreign marketplace which may be bought by Indian customers? In addition to paying income-tax on their income, will they be expected to bear EL 2.0 as well?

Further complexities could arise when the non-resident merchant selling through marketplace is assessed to have a permanent establishment (‘PE’) in India.  The EL 2.0 provisions provide an exclusion where the non-resident has a PE in India and the e-commerce supply or services is effectively connected to such PE.  In case of a PE, the non-resident merchants will be liable to pay income-tax in India, however, consideration received by marketplace operator (not having PE in India) will still be to charged to EL on gross basis, which could then lead to multiple taxation on same transaction in the form of income-tax as well as EL, resulting in higher tax cost being loaded on the transaction.

In another example, if payment gateways are being subject to EL 2.0 on gross consideration of the transaction, then on the same amount, ECO will pay EL 2.0 and the payment gateway will also pay EL 2.0 and both may ultimately recover it from the merchants! This surely cannot be the intent of the Government. The cascading effect of multiple taxes would militate against the basic tenets of taxation.

Conclusion

While it is appreciated that the Budget changes clarify some anomalies and seek to clarify the doubts on core aspects of EL 2.0, there is a need to reflect on and provide clarity on some other aspects to make this levy more viable and acceptable. The interplay between Significant Economic Presence (‘SEP’) provisions under Section 9 of the IT Act and EL 2.0 also merits consideration. The implementation of the SEP has not been deferred further in the Budget and is effective from April 1, 2021. As the ‘revenue’ thresholds and ‘user’ thresholds are yet to be notified, the SEP provisions are yet not operative.  Once the thresholds for SEP provisions are notified, especially for transactions with non-treaty countries, the inter-play between EL and SEP provisions will have to be examined.

Significant Curtailment of Form-C Benefits Under CST and Impact

This article has been co-authored by Onkar Sharma (Principal Associate).

The amendment proposed in the Union Budget 2021 in Section 8(3)(b) of the Central Sales Tax Act, 1956 (CST Act) has been a relatively less talked about indirect tax proposal of the Union Budget for FY 2021-22 (Budget). However, this is a significant change and can drive up the input tax costs of many businesses. 

In this article, we have tried to analyse the amendment at length and decode the implications thereof.

The amendment

Section 8 of the CST Act provides for ‘Rates of tax on sales in the course of inter-State trade or commerce’. Section 8(1) and 8(2) provide for a concessional CST rate of 2% on inter-state sales of goods as described in sub-section 8(3), subject to submission of Form C (as per Section 8(4) and the CST Rules)]. For goods not falling under sub-section 8(3), simply put, CST is leviable at a rate equal to the VAT rate applicable to the sale/purchase of the goods in question under the VAT laws of the seller’s State (which is usually much higher than 2%).

The amendment proposed in the Budget 2021 in sub-clause (b) of Section 8(3), in essence, significantly curtails the scope of this concessional rate of 2% with effect from 1 July 2021. We have tried to highlight the proposed changes in the excerpt of Section 8(3) (b) below, for ease of reference:

“The goods referred to in sub-section (1) -

(b) are goods of the class or classes specified in the certificate of registration of the registered dealer purchasing the goods as being intended for re-sale by him or subject to any rules made by the Central Government in this behalf, for use by him in the manufacture or processing of goods for sale or in the tele-communications network or in mining or in the generation or distribution of electricity or any other form of power for sale of goods specified under clause (d) of section 2"

Impact of the amendment

As is evident, pre-amendment, the benefit of concessional CST rate of 2% would be available in a larger number of scenarios as demonstrated in the table below: 

The definition of ‘goods’ under Section 2(d) of the CST Act is restricted to goods which have been kept out of the GST net, listed below:

“(d) "goods" means--

(i) petroleum crude;

(ii) high speed diesel;

(iii) motor spirit (commonly known as petrol);

(iv) natural gas;

(v) aviation turbine fuel; and

(vi) alcoholic liquor for human consumption”

Several favourable judgments were issued post introduction of GST regarding the continued eligibility of Form C and the consequent concessional CST rate. In most of these cases, the High Courts relied upon the pre-amendment wordings of section 8(3)(b) of the CST Act to hold that issuance of Form C is not restricted only to the goods as defined in Section 2(d). The rationale adopted by the Courts, inter alia, was that Section 8(3)(b) has to be read independent of the definition of ‘goods’ under Section 2(d) of the CST Act, since the context of Section 8(3)(b) so requires (in light of the activities specifically mentioned therein).

The proposed amendment seeks to overturn this argument and disallow the benefit of the concessional CST rate in scenarios (iii), (iv) and (v) in the left column in the table above and under scenario (ii), restrict the benefit only to a scenario where the purchaser intends to use the purchased goods for manufacture or processing for sale of (i) petroleum crude; (ii) high speed diesel; (iii) motor spirit (commonly known as petrol); (iv) natural gas; (v) aviation turbine fuel; and (vi) alcoholic liquor for human consumption. 

Possible interpretations

Admittedly, the post-amendment language “….for use by him in the manufacture or processing of goods for sale of goods specified under clause (d) of section 2” is a little ambiguous.

It is possible that the draftsmen intended to say “….for use by him in the manufacture or processing of goods specified under clause (d) of section 2 for sale” and thus restrict Form C benefit only where non-GST goods are being purchased for manufacture or processing of non-GST goods for further sale. However, it is a settled position of law that there is no room for intendment in tax law and the law has to be read as is. In any case, no such restrictive intent emerges from the ‘Notes on Clauses’ accompanying the Finance Bill which reads as under:

“Clause 141 of the Bill seeks to amend sub-section (3) of section 8 of the Central Sales Tax Act, 1956 by substituting clause (b) thereof, so as to exclude therefrom the goods used in the telecommunication network or in mining or in generation or distribution of electricity or any other form of power.”

Thus, if one literally interprets the post-amendment language “….for use by him in the manufacture or processing for sale of goods specified under clause (d) of section 2”, the following point emerges:

Form C should be available for purchase of non-GST goods if such non-GST goods are used in a manufacturing/processing activity aimed at selling non-GST goods (as listed in clause (d) of section 2 – see above) by the purchaser. The words “specified under clause (d) of section 2", it can be argued, only qualifies the immediately preceding word ‘goods’ and not the words before that. 

Scenarios where benefit of Form C (and concessional CST rate) should continue to be available post-amendment

• Thus, the benefit of Form C should be available in the following scenarios post-amendment: 

• Where A sells crude oil to B who in turn refines the same into petrol / high speed diesel 

• Where B purchases diesel for generation (i.e., manufacture) of electricity in their factory (may be as a backup) with the ultimate goal of selling petrol / high speed diesel. Or, where A purchases diesel for generation (i.e., manufacture) of back-up electricity in their oil field with the ultimate goal of selling crude oil. 

Scenarios like mining companies procuring diesel for mining purposes or manufacturers procuring diesel for usage in manufacture of products liable to GST, will no longer be entitled to avail the concessional rate of CST on the basis of Form C. Thus, the ‘change in law’ clauses in relevant contracts of these companies and costing of their final products post 1 July 2021 may need to be re-examined in light of this proposed amendment.

Proposed Taxation of ULIPs – Related Issues & Compliance Requirements

The Union Budget 2021 is a mixed bag for the life insurance industry where the proposal to increase the foreign direct investment limit from 49% to 74% is a positive for the industry whereas the proposal to tax the proceeds of high premium Unit Linked Insurance Plan (‘ULIP’) is a big negative.

This article discusses the amendments proposed with respect to taxation of proceeds of high premium ULIPs and seeks to point out the ambiguities around interpretation of the amendments so proposed, on which suitable clarification from the government is desirable.  The article also touches upon the increased compliance requirements for life insurance companies on account of the proposed scheme of taxation for ULIPs.

Present scheme of taxation for ULIPs

Clause (10D) of section 10 of the Income-tax Act, 1961 (the ‘Act’) currently provides that any sum received (including bonus declared) under a life insurance policy would be exempt from tax.  The exemption is not available in cases where the premium payable for any of the years during the term of the policy does not exceed the specified percentage[1] of actual capital sum assured under such policy.  This condition is hereinafter referred to as the ‘exemption condition’. 

Thus, in case of any life insurance policy where the exemption condition is not met, the proceeds received under such policy are treated as taxable proceeds.  There is one exception to this i.e. in case of such policy, any sum received on death of the policyholder is treated as exempt from tax.

The above provisions are equally applicable to ULIPs as ULIPs have life insurance component along with investment component.

Proposed scheme of taxation for high premium ULIPs

Having noticed instances of high net worth individuals (‘HNI’) claiming exemption by investing in ULIPs with huge premium, the government has sought to introduce provisions specifically providing for taxation of proceeds received under such high premium ULIPs.  The rationale provided by the government is that allowing exemption in such cases defeats the intention of the legislature of providing benefit to small and genuine cases of life insurance. 

With this rationale, Budget 2021 seeks to introduce provisions relating to taxation of high premium ULIPs where:

1. ULIP is defined[2] to mean a life insurance policy which has components of both investment and insurance and is linked to a unit as defined[3] in the IRDAI regulations.
2. Exemption shall not be available[4] in case of any ULIPs issued on or after 1 February, 2021, if the amount of premium payable for any of the year during the term of the policy exceeds Rs. 2,50,000.  Further, in case of more than one ULIPs that are issued on or after 1 February, 2021, exemption shall be available[5] only with respect to those policies where aggregate amount of premium does not exceed Rs. 2,50,000, in any of the years during the term of any of those policies.

ULIPs not entitled to exemption on account of breach of premium limit as above are hereinafter referred to as ‘non-qualifying ULIPs’.

3. In case of non-qualifying ULIPs, the exemption would still be available[6] for any sum received on the death of the policyholder.
4. Non-qualifying ULIP shall be treated[7] as a ‘capital asset’.
5. Any gain arising from non-qualifying ULIPs shall be taxable[8] as ‘capital gains’ and shall be deemed to be the income of the year in which proceeds (including bonus) are received under such ULIPs.  The income so taxable shall be calculated in the manner prescribed by the Central Board of Direct Taxes (‘CBDT’).
6. The definition[9] of ‘equity oriented fund’ to include a fund set up under a scheme of an insurance company comprising non-qualifying ULIPs.  Accordingly, non-qualifying ULIPs are sought to be treated as ‘equity oriented fund’ and the taxation of gains shall be as short term capital gains (‘STCG’) or long term capital gains (‘LTCG’), as the case may be, in accordance with the provisions of section 111A and 112A applicable in case of EOF.
7. CBDT to issue[10] guidelines with prior approval of the central government for removing any difficulty in giving effect to the provisions of section 10.  Such guidelines issued by CBDT shall be laid before each House of Parliament and shall be binding on the income-tax authorities as well as the assessee.

Ambiguities around proposed amendments

There are certain ambiguities involved in interpretation of the amendments proposed to the above effect.  These are explained in following paragraphs:

• Applicability of exemption condition to non-qualifying ULIPs

The amendments proposed suggest that the existing exemption condition (i.e. premium not in excess of specified percentage of capital sum assured) would continue to operate as a separate condition to be fulfilled in case of ULIP irrespective of whether it is non-qualifying ULIP or not.  If that be the case, in a scenario where the aggregate premium payable in any of the years during the term of the policy does not exceed Rs. 2.5 Lakhs but such premium payable is in excess of specified percentage of the capital sum assured, then the exemption would still not be available as the exemption condition is not met under such ULIP.  A related question arises as to whether in case of such ULIPs, the income would be taxed as ‘capital gains’ or ‘income from other sources’.  This is because the tax treatment as ‘capital gains’ is proposed only with respect to non-qualifying ULIPs i.e. ULIPs where the premium limit of Rs. 2,50,000 is breached (and not where exemption condition is not met).

Therefore, it is only desirable that the government clarifies the aspect of applicability of exemption condition in case of non-qualifying ULIPs and also clarify the manner of taxation of ULIPs where the exemption condition is not met. 

• Applicability of premium limit in case of multiple ULIPs

In case of multiple ULIPs issued on or after 01 February 2021, the amendment proposed suggest that the premium limit of Rs. 2.5 Lakhs needs to be applied at the individual ULIP level and not in aggregation of premiums of all such ULIPs taken together.  However, a possibility cannot be ruled out where the tax authorities dispute such interpretation on the ground that it defeats the intention of law as one may buy more than one ULIPs with each having premium below 2.5 Lakhs and still avail exemption.  The tax authorities may interpret the amendment to mean that in case of more than one ULIPs with each having annual premium of less than Rs. 2,50,000, the exemption would not be available to such ULIP (and subsequent ULIP) upon issuance of which the premium limit of Rs. 2,50,000 on aggregate basis is breached.  If such is the interpretation of the proposed amendment, life insurance companies would have to obtain declaration from the policyholders on ULIPs obtained by him/her on or after 01 February 2021 and the annual premium payable under such ULIPs.

Therefore, it is desirable that the government clarifies the nature of proposed amendment to mean applying the premium limit of 2.5 Lakhs at individual policy level and not in aggregation of ULIPs.

• Taxation of different types of ULIPs

With regard to investment component of ULIPs, insurance companies provide an option to policyholders to choose typically between three types of funds.  These funds are commonly referred to as equity fund, balanced fund and debt fund.  Equity fund invests the corpus mostly in listed equities whereas the other two funds invest relatively lesser amount of corpus into listed equities.  Units are issued under ULIP depending on the specific fund selection done by the policyholder.

The memorandum explaining the provisions of the Finance Bill, 2021 states that the non-qualifying ULIPs are included in the definition of ‘EOF’ so as to provide them same treatment as unit of EOF.  However, the amendment proposed in the EOF definition suggests that only such non-qualifying ULIPs would be treated as EOF where a minimum of 65% of the total proceeds of the fund is invested in the listed equity shares of domestic companies.  Thus, there is an ambiguity as to whether the units of debt fund or balanced fund (where investment in listed equity shares may be below 65% of the total corpus of such fund) would be treated as units of EOF or not.  If they are not treated as units of EOF, the tax treatment of gains arising on redemption of such units would be similar to that of units of a debt oriented fund (‘DOF’). 

It is noteworthy that the tax treatment in case of EOF and DOF differs significantly in terms of period of holding considered for treating units as long term capital assets, applicable tax rates for LTCG & STCG, availability of indexation benefit in case of long term asset, etc.  Further, ULIPs allow policyholders to switch between three types of funds during the term of the policy.  Given this, insurance companies would be required to make significant changes to their IT systems to track whether the ULIP was EOF or not at anytime during the term of the policy and to provide for computation of capital gains accordingly.

In view of these challenges, it is desirable that the government makes it clear beyond doubt its stated intention to provide the same tax treatment of units of EOF to the units of non-qualifying ULIPs irrespective of its different types of funds. 

In absence of any such clarification, one would expect CBDT to bring out stated intention of the government while prescribing the manner of calculation of capital gains by way of rules. 

Besides the above, the proposed amendments would increase the compliance burden for life insurance companies, as explained below.

• Compliance with provisions requiring deduction of tax at source

Under the existing provisions, life insurance companies are required to deduct tax at source from any sum payable under a life insurance policy, that is chargeable to tax under the provisions of the Act.  Hence, insurance companies would now be under an obligation to deduct tax from the sum payable under non-qualifying ULIPs.

In case of any such payment to residents or non-residents, tax is typically required to be deducted on the income component comprised therein.  As the gains arising on redemption of units could be LTCG and/or STCG, insurance companies would have to carry out necessary changes in their IT systems that enable and facilitate computation of taxable capital gains in the manner to be prescribed by CBDT. 

As discussed earlier, in case of redemption of units of debt fund or balanced fund, the tax treatment of DOF may apply, and in which case, the indexation benefit may also have to be considered for computation of LTCG arising on such units. 

• Compliance with Securities Transaction Tax provisions

Given the government’s intention to provide units of non-qualifying ULIPs same tax treatment as applicable to units of EOF, amendments are also proposed in the Finance (No. 2) Act, 2004 whereby the sale or surrender or redemption of units to the insurance company on maturity or on partial withdrawal of such non-qualifying ULIPs would be liable to securities transaction tax (‘STT’).  STT would be levied at the rate of 0.001% and to be borne by the recipient of sale/surrender/redemption proceeds.  Again, these proposals would increase compliances such as collecting and discharging the STT liability, filing of STT return, etc. for the life insurance companies.

In a nutshell

By introducing proposals to tax the proceeds received under high premium ULIPs and providing for the tax treatment same as that of EOF, the government has sought to bring parity between mutual funds and ULIPs.  However, there are certain ambiguities involved in interpretation of the proposed amendments which need to be suitably addressed by the government.  One would hope that the government takes necessary steps in this direction to avoid unnecessary litigation around interpretation related issues.

Issues in the Amendments Proposed in Finance Bill, 2021

1. Disallowance in respect of employees contribution to ESI, PF etc.

There is no distinction as regards payment of employee’s contribution and employer’s contribution to these funds. Same have to be made together. Hence, same should be treated in the same manner. Further, once employees’ contribution is received by the employer and it is considered as income, thereafter, deduction is allowable for employee’s as well as of employer’s contribution on the same basis. On this basis Hon’ble High Courts and also the Supreme Court had laid down the law as regards allowability of employees’ contribution also in terms of section 43B of Income Tax Act. Hence, the amendment needs to be withdrawn.

2. TDS on purchase of goods

Vide Finance Act 2020, sub-section (1H) was inserted in Section 206C of the Act to provide for collection of TCS by the seller. Now, the provisions on same lines are being inserted in section 194Q for TDS by the buyer. Amount of tax is to be collected or deducted is very small and it has been clarified that the intention of these provisions is not to collect tax but to ensure that concerned assesses are in tax net. It is humbly stated that the presumption that the assesses, who have turnover of more than Rs.10 crores, whether as buyer or seller and has been buying or selling goods to an assessee of Rs.50 lakhs or more would not be in tax net appears to be unreasonable, illogical, and unjustified. Such assesses would also be registered under GST, apart from requirement of KYC at various places, even for bank accounts and the assesses are required to submit PAN. Moreover, department has access to all the data submitted to GST department and even available with banks etc. The provisions are quite difficult for implementation and companies have to get their software amended. Even last year there had been practical problems and the problems will be further added by the provisions proposed to be inserted vide Section 194Q of the Act.

3. TDS/TCS at higher rate in case of non-filers of returns

By insertion of Section 206AB and 206CCA it is proposed to provide that TDS/TCS will be deducted/collected at double the rates in case the assesses, who have not filed their return for last two years and amount of TDS or TCS has been more than Rs.50,000/-. It will further increase difficulty of tax deductors and before making every payment even to small assesses it would be necessary to find out whether he is covered under the provisions of above sections and tax is required to be deducted or collected at higher rate. In case TDS/TCS is being deducted in the case of the assessee and amount of TDS/TCS has been Rs.50,000/- or more, definitely he has been having PAN and 26AS is also available in his case at the website of the Department. Since department has full information regarding such assesses, necessary action should be taken by the department in case they are not filing their returns rather than imposing undue burden on assesses for TDS/TCS. Hence provisions deserve to be dropped.

Further, “specified person” in whose case provisions of above section will be applicable has been defined to mean an assessee who has not filed return in respect of two assessment years relevant to two previous years immediately prior to the previous year in which tax is required to be deducted, for which time limit for filing return of income has expired. Now, say deductor has to deduct tax while making payments during the period April,2022 to July,2022. Two previous years prior to the year are year ended 31st March, 2021 and 31st March,2022. Return of income for year ended 31st March, 2022 is to be filed  by 31st July,2022.  Then, how one can decide, whether to deduct at higher or not? Hence, definition of Specified person needs to be corrected.

In the interest of simplification, the provision can be that every person in whose case tax deductible is beyond a limit, say Rs. 5000/- in specified sections, he has to submit to the deductor copy of acknowledgement for filing return for the latest assessment year for which time limit for filing return of income has expired, one month prior to the date of raising invoice for services rendered. This will ensure filing of returns in time and will simply file the procedure.

4.Taxability of interest on contribution to PF

By way of amendments in clauses (11) and (12) of Section 10 of the Act it is being provided that in respect of contribution to Provident fund in excess of Rs.2,50,000/- interest will be taxable. Accordingly, PF trust has to maintain separate record for contributions up to Rs.2,50,000/- and exceeding the above amount and interest credited on contributions exceeding the above amount has to be separately determined for the purpose of deduction of tax at source on accrual basis.

It is stated that in regard to Provident fund and other funds there are number of restrictions and limits under the Act. For example, PF contribution made by the employer in excess of 12% is taxable, interest beyond prescribed rate is taxable, contribution to superannuation fund beyond 15% is taxable, and gratuity in excess of 8.33% is taxable as per relevant provisions in Schedule IV to Income Tax Act and Income Tax Rules. There is also limit for contribution to National Pension Scheme of 10% of salary. Further, there is limit of Rs.7,50,000/- on employer’s contributions made by the employer  to all above funds. At the time of withdrawal also amounts are exempt subject to certain conditions. Imposing a condition one after another is quite difficult to be implemented and it is also resulting in double taxation. For example, for certain years up to A.Y. 2020-21 contribution to superannuation fund by the employers in excess of Rs.1,00,000/ Rs.1,50,000 was taxable but there has been no corresponding exemption available for amount received by the employee on his retirement or otherwise from superannuation fund. Similarly, there is no exemption available at present also in respect of amounts included in taxable income being in excess of Rs.7,50,000/-. Further, there is also difficulty in deciding out of which contribution amount is disallowable on account of above mentioned limit of Rs.7,50,000. Now, another restriction has been imposed in respect of interest credited to PF account relating to employee’s contribution. The purpose and intention of the government may be justified but multiple restrictions and limits deserve to be avoided. In case it is proposed to restrict the contribution to PF there should be direct limit imposed in this regard. It can very well be provided in regard to employee’s contribution as well as employer’s contribution that same will be only up to a particular limit of salary or at the particular percentage in respect of employees having a salary exceeding a particular amount.

5. Exemption to senior citizens from filing income tax returns

By inserting Section 194P, it is being provided that in case of senior citizens of 75 years or more will not be required to file their returns of income in case apart from pension income there is is only interest income on deposits in the same bank in which pension is being received and full amount of tax has been deducted by the bank. The restriction of interest income on deposits in the same bank is unreasonable and unjustified. Many times it is not desirable to keep all the funds in one bank and making deposits in different bank then in which pension is being received is also necessary because of difference in rate of interest on fixed deposits. Certain banks are giving better rate of interest as compared to other banks. Therefore, this restriction should be done away. It can also be stated that details of interest received from all the banks will be duly available in 26AS of the person and the declaration can be duly submitted in regard to interest income by the person to the bank in which pension is being received. On the basis of such declaration the bank can deduct tax even on interest income received from other banks.

6. Reduction in time limit for filing belated/revised

It is proposed to reduce time limit from March of the relevant assessment year to December for filing belated/revised returns by the assesses. By keeping the limit of December, in certain cases time available for revision of return will be very short. Sometimes it becomes necessary to revise the return. Since the assessment process normally will start only after March, the time limit of March should be maintained. In the alternative, the time limit for filing revised return should be three months from normal due date or December of relevant assessment year, whichever is later.

7. Constitution of Dispute Resolution Committee.

By inserting section 245MA, it is proposed to provide that assesses having returned income upto Rs.50 lakhs and disallowances upto Rs.10 lakh can approach Dispute Resolution Committee for resolving the dispute relating to disallowances made by the Assessing Officer. There are, however, number of restrictions in this regard to the effect that certain category of assesses cannot opt for resolution of dispute by the committee, such as, in search cases and also in cases of certain other assesses. There is no dispute as far as the category of cases which have been excluded and theoretically saying those categories do not deserve any sympathetic attitude, but the issue is that the limit being provided in the section is only of Rs.50,00,000/- of returned income and addition of Rs.10 lakhs. In the cases of such a small amounts in the present context it is not desirable to continue with disputes and involve the assessee as well as the government in litigation. Therefore, either the limit of disallowances should be further increased or all the assesses can be covered under the scheme in order to avoid litigation.

Further, Sub-section (2) provides that Committee has the power to waive or reduce penalty in case of a person whose dispute is resolved. The scope of above power needs to be explained. Whether the committee can reduce or waive penalty or grant immunity from prosecution even in the cases where relief is not granted as regards the disallowances or waiver is to be granted only in the cases where dispute is resolved by deleting the disallowances. It is stated that once the disallowance has been deleted, penalty and prosecution will automatically not be there and therefore, power should be only in cases where relief is not granted by the Committee but still the penalty and prosecution is waived. In this regard it can also be stated that Constitution of committee and its attitude is also very important for the effectiveness of the process. Same is yet to be seen and experienced.

In this regard it can also be stated that in such cases it may not be advantageous to opt for the process of going to Dispute Resolution Committee and it may be better to opt for the course of Section 270AA of Income Tax Act. In above case on payment of tax the assessee is entitled to waiver of penalty and prosecution. In such a small cases tax may not be a material consideration.

8. Constitution of Board for Advance Ruling.

In place of Authority for Advance Ruling it is proposed to constitute a Board for Advance Ruling. In this regard it is stated that the Constitution of Authority for Advance Ruling was better since it was being chaired by a Retired Judge of Supreme Court and therefore, there was better confidence of assesses in the Authority and it was expected that rulings will be given in an unbiased manner. The only difficulty has been of delay and of litigation even by the department. In regard to the rulings given by the Authority, the process could be made effective by constituting more benches and by ensuring that ruling is not disputed by the department. Even if the Board is constituted, it is desirable that one of the members should be from outside the department and preferably a judicial person. Further, ruling given by the Board should be binding on the department. In case the ruling is a appealable, the whole purpose is frustrated.

9. Discontinuance of Income Tax Settlement Commission

It is proposed to discontinue with the process of settlement before Income Tax Settlement commission. In this regard it is stated that: –

• Firstly, the system of settlement before Income Tax Settlement Commission was providing an option to the assesses to settle their disputes rather than going in litigation. It was in the interest of department as well as of the assesses to settle the dispute at the earliest. There should be some mechanism available in the Act for settlement of disputes. Hence, the system deserves to be continued.
• In the alternative, there is no justification for abandoning the working of the Commission abruptly with effect from 1st February, 2021. It could be provided that all pending matters will be decided by the Commission and there will be no fresh applications filed. In fact it could also be provided that applications can be made only by 31st March, 2021, in such a case many assesses might have opted for settlement before Settlement Commission and litigation could be avoided in such cases.
• Because of restriction of not working with effect from 1st February,2021, orders cannot be passed even in the cases which have already been heard by the Commission. It is quite undesirable and unjustified that even the cases which have already been heard are not being decided by the Commission and as a result assesses will suffer on account of time, efforts and also financially in getting the matters again argued before the Interim Board.

10. Faceless proceedings before ITAT

It is proposed to adopt method of faceless proceedings before ITAT also as in the case of assessments and in appeals before CIT(A). It is emphatically stated that proceedings before ITAT all together are on different footings and cannot be compared with assessment proceedings or appeal proceedings before CIT(A).  ITAT is in the nature of court and also final fact binding Authority. Therefore, it is necessary that in order to give justice, proper opportunity of hearing should be provided to the assesses. It is also known that cost of proceedings before High Court and Supreme Court is quite high. Therefore, many assesses are not in a position to pursue their matters further before High Court or Supreme Court. Therefore, they should get full opportunity to get justice from ITAT for which proper hearing is necessary. It may further be stated that there is complete transparency in hearing the matter before ITAT, since hearings are in open court. Further, jurisdiction of ITAT is also dynamic since benches are constituted on weekly or fortnightly basis. Personal hearing also facilitate in disposal of cases very fast. In case, appeals have to be decided on the basis of written submissions, there will be lot of burden on members of ITAT to go through all the papers and it may not be possible for the members to decide the cases after fully examining the contents and the documents and therefore, assesses may not get justice. Hence, the process of faceless proceedings before ITAT is unwarranted. There can, however, be virtual hearing, except in the cases of certain category or where assessee or department makes a request for personal hearing.

11. Amendments in provisions for re-opening of Assessments

The amendments proposed in provisions for re-opening of assessments are welcome amendments and same are likely to reduce the litigation. Further, it is also a welcome provision to provide an opportunity to the assessee before issuing notice u/s 148 of the Act. Reduction in period for re-opening of assessment is also a welcome step. There are, however, certain issues in language of newly proposed sections. In this regard following suggestions are being made: -

1. In clause (ii) of Explanation 1 to section 148 it is provided that final objection raised by CAG to the effect that assessment is not in accordance with provisions of Income Tax Act will be deemed to be information available to the Assessing Office for issuing notice. It is stated that, as per well settled legal position by the Supreme Court legal interpretation is to be made by the Department in regard to provisions of Income Tax Act and not by CAG. Therefore, the position has been that observation of CAG as regards legal interpretation does not constitute information for re-opening of assessment. Further, in view of scheme for faceless assessments it is expected that department will act on team basis and interpretation of every provision of the Act will be same in all the cases and it will be after due consideration. Therefore, now, position will not be that a particular Assessing Officer has taken a different interpretation which is not correct as per law. Therefore, above clause deserves to be deleted. In the alternative, the term “final objection” needs to be elaborated.
2. Clauses (i) & (ii) of Explanation 2 provide that search and survey cases shall be deemed to have information which suggests that income chargeable to tax have escaped assessment. There is no requirement of any material on the basis of which it can be concluded by the AO that there is escapement of income. It is quite likely that in many cases of search and survey, no material has been found which suggests any escapement of income. Therefore, re-opening of assessment in such cases is not warranted. Accordingly, escapement should be deemed only when there is some material on the basis of which the AO is of the opinion that there is escapement of income. Further, notice for re-assessment should be issued only in respect of assessment year for which escapement is deemed and not for all the three preceding assessment years.
3. In terms of clause (b) of Section 148A of the Act, an opportunity is to be provided to show cause why notice u/s 148 should not be issued on the basis of information available with the AO and for this purpose time allowed will not be less than 7 days. Period of 7 days is too short. Therefore, it is suggested that time period of not less than 15 days should be provided.
4. As per Section 149, notice is to be issued within a period of 3 years or within a period of 10 years, as the case may be and for this purpose period of giving opportunity to the assessee in terms of Section 148A(b) is to be excluded. Fourth proviso to Section 149, however, provides that in case the period of limitation available to the AO for passing an order under clause (d) of Section 148A is less than 7 days, such remaining period shall be extended to 7 days and the period of limitation in sub-section (1) shall be deemed to be extended accordingly. The time limit provided in clause (d) of Section 148A for passing the order by the AO is one month from end of the month in which reply is received by the AO. As such there is no time barring limitation as far as passing of the order under clause (d) of Section 148A though there is time limit for issuing notice u/s 148 of the Act. It appears that in the proviso instead of reference to passing of the order under clause (d) of Section 148A, reference should be made for issuing notice u/s 148 of the Act.
5. There is also some confusion in the language of clause (i) of Section 151 of the Act. In terms of clause (i) Principal Commissioner or Principal Director is the specified Authority if the notice is issued within 3 years. The language, however, reads that “if three years or less than three years have elapsed from the end of the relevant assessment year” the language should be “if period of three years has not elapsed from end of the relevant assessment year”.

Amendments Relating to Search, Seizure and Reassessment – An Analysis

A. Background :

1.  With the advancement of technology, the Income Tax Department is now collecting all relevant information related to transactions to tax-payers from various third parties u/s. 285BA and from other law enforcement agencies. Therefore, assessment, re-assessment, re-computation of income to a large extent can be information driven.

2. In view of the above, the Union Budget, 2021-2022 proposes to introduce a completely new system of assessment or re-assessment or re-computation of income escaping assessment and the assessment of search, seizure and survey related cases.

B. Amendments proposed:

3. The existing provisions of section 153A/153C are proposed to be made applicable to  search initiated u/s. 132 or requisition made u/s. 132A on or before 31st March, 2021.  Re-opening of a case of other person, other than searched person, document pertaining to or assets belongs to whom are found during the course of search conducted on or before 31st March, 2021, will continue to be governed by provision of Section-153C r.w.s 153A/153B of the Act. Thus, assessment of such other person can be re-opened u/s. 153C of the Act even after 31st March, 2021 and judicial decisions rendered by various High court interpreting provisions of section 153C would continue to apply.  Similarly pending assessment of a person searched u/s 132 or requisitioned made u/s 132A prior to 1st April 2021 will continue to be governed by provisions of section 153A/153B of the Act.

4. As per existing provision, notice u/s. 148 can be issued –

(a) Within four years from the end of the relevant assessment year only when there is an information with the AO suggesting income chargeable to tax has escaped assessment for relevant assessment year.

(b) Beyond four years but not beyond six years relevant to the assessment year, if income having escaped assessment amounts to or is likely to amount to one lakh rupees or more for that year and there is failure on the part of assessee to make a return u/s 139 or in response to a notice issued u/s 142 or section 148 or to disclose fully and truly all material facts necessary for his assessment u/s 143(3) if any framed earlier.

(c) Beyond four years but not beyond sixteen years relevant to the assessment year unless income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment.

5. Proposed new provisions of re-assessment, will cover the following cases :

1. Re-assessment of cases other than search, seizure and survey.
2. Re-assessment relating to search, seizure and survey conducted on or after 1st April, 2021.

6. Proposed amendments relating re-assessment of cases other than search, seizure and survey.

(i)  Enquiry u/s 148A before issuing Notice u/s. 148:

Following Steps will be taken as per Section 148A:

• Issuing of notice u/s 148A by AO seeking explanation of the assessee for information which suggests that income has escaped assessment as to why his case should not be reopened u/s 148.
• Obtaining of Approval of specified authority as per section 151, before issuing notice u/s 148.
• Passing of an order stating that whether it is a fit case for issue of notice under section 148 and serving of copy of such order along with notice u/s 148 on the assessee.  

(ii)  Basis for issuing Notice u/s. 148:

Notice u/s 148 can be issued if AO is in possession of:-

• Any information which has been flagged by the Risk Management strategy formulated by the Board or
• final objection raised by CAG stating that assessment of relevant assessment year has not been framed in accordance with the provisions of the Act.

(iii)  Time limit for Issuance of Notice u/s. 148 :

• Within three years from the end of the relevant assessment year or
• Within ten years from the end of the relevant assessment year if the AO has in his possession books of accounts or other documents or evidence which reveal that the income chargeable to tax, represented in the form of asset, which has escaped assessment amounts to or is likely to amount to fifty lakh rupees or more for that year [as per section 149(1)(b)].

The Act also provides a safeguard to certain cases which cannot be reopened beyond 31st March 2021 under the existing provisions of 149(1)(b). For example, as per existing provision of Section-149(1)(b), notice can be issued within six years from the end of the relevant assessment year provided certain conditions are fulfilled. Therefore, up to 31st March, 2021, notice u/s.148 can be issued as per existing provision of Section-149(1)(b), for A.Y. 2013-14 (after extended time limit as provided in “The Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act 2020”). Now, by virtue of amendments proposed by Finance Bill, 2021, no notice u/s. 148 can be issued for any assessment year prior to A.Y. 2013-14.

It should be noted that as per existing provision of Section-149(1)(c), the re-opening can be made within sixteen years from the end of relevant assessment year if income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment for that year.  However, in newly proposed Section-149, no provision for re-opening in relation to any asset/income outside India beyond ten years is included. Therefore, for all such cases, action may be taken under the Black Money (Foreign Income and Assets) and Imposition of Tax Act, 2015.

7. Proposed amendments relating re-assessment of search, seizure and survey cases:

• No enquiry u/s 148A is required to re-open in the case of a search u/s. 132 or requisition u/s. 132A of the Act. Similarly, no enquiry u/s 148A for re-opening three assessment year prior to year of survey u/s 133A is conducted. However, for reopening of any of assessment year prior to such three years in survey cases, inquiry u/s 148A is mandatory.
• Basis for issuing Notice u/s. 148:  The AO shall be deemed to have information suggesting income escaping assessment in a case where:-

(a) search u/s 132 or requisition u/s 132A or survey u/s 133A has been conducted (for reopening three assessment years as stated herein above) or

(b) the AO is satisfied, with the prior approval of specified authority u/s 151,  that  any  money,  bullion,  jewellery  or other valuable article or thing, seized or requisitioned in case of any other person on or after the 1st day of April,2021, belongs to the assessee;

OR

the AO is satisfied, with the prior approval  of specified authority u/s 151 that any books of account or documents, seized or requisitioned in case of any other person on or after the 1st  day  of  April,  2021,  pertains  or  pertain  to,  or  any information contained therein, relate to, the assessee, in the case of search u/s. 132 or requisition u/s. 132A or survey u/s. 133A, conducted on or after 1st April, 2021 [analogous to existing provisions of Section 153C].

• Time limit for issuing notice u/s 148 and Assessment Years Covered:
• For Three Assessment years stated herein above: The AO can issue notice for the three assessment years immediately preceding the assessment year relevant to the previous year in which particular event occurs. Thus, the re-opening of three assessment years as stated herein above would be automatic in case of assessee in  whose case search, seizure or survey is conducted. In such cases, no approval of higher authority is required to be obtained prior to issuing notice u/s 148.
• For any assessment years beyond three years but within ten years: The AO can also issue notice for  any such year(s), if he is having evidence revealing income chargeable to tax, represented in the form of asset, has escaped assessment amounts to or is likely to amount to fifty lakh rupees or more for that year. In such cases, prior to issuing notice u/s 148, as per sub-section (2) of section 149 r.w.s 151, approval of specified authority [Principal   Chief   Commissioner   or   Principal Director  General  or where  there  is no Principal  Chief Commissioner or Principal Director General, Chief Commissioner  or Director  General ] is required to be obtained
• The provisions of section 149(1) shall not apply in a case, where a notice u/s. 153A or 153C r.w.s. 153A, is required to be issued in relation to a search initiated u/s. 132 or requisitioned u/s 132A, on or before the 31st day of March, 2021.

8. Time for Completion of assessment re-opened u/s 148:

As per Section 153(2) of the Act, order of re-assessment has to be passed within twelve months from the end of the financial year in which notice u/s 148 is issued. Therefore, unlike provisions of sections 153B, time limit for completion of re-assessment of search and seizure cases starts from the date of issuing notice and not from the date of conduct of the search or seizure. However, time limit to issue notice u/s 148 is subject to provisions of section 149. For example, if a search is conducted on 1st April 2021, re-opening of three years would be automatic and therefore there shall be deemed escapement of income for A.Y. 2019-20 to 2021-22. However, to cover A.Y. 2019-20, notice u/s 148 needs to be issued on or before 31st March 2022. Similar condition applies to re-open any of the preceding ten years relevant to the year in which search, seizure and survey is conducted 

9  Judicial decisions rendered by various Courts may not be helpful to the assessee after above amendment:

• As per decision of Hon'ble Gujarat High Court in the case of Saumya Construction , Delhi High Court in the case of Kabul Chawla [2015] [TS-5656-HC-2015(DELHI)-O] and other various decisions of the Hon'ble Courts, AO was not empowered to make additions not related to incriminating material found during the course of search for unabated assessment. There is now no bifurcation of abated assessment and unabated assessment as were prevailing in assessment order passed under Section 153A of the Act. Once the AO has legally reopened the assessment after fulfilling all the conditions laid down under amended Section 148, and addition in reassessment order is also made based upon information possession of AO, he is empowered to make other additions on the basis of data found during the course of reassessment proceedings.
• In Indian & Eastern Newspaper Society vs CIT (1979) [TS-5019-SC-1979-O] the Supreme Court extensively considered the powers and duties of both the internal audit party of the Income-tax Department (prior to 1960) and those of the C & AG under the Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 and opined that neither statute recognises the power on such authorities to pronounce on the law and that their pronouncements on law cannot amount to “information” on the basis of which assessments can be reopened under Section 147.  As per amended Section 148 of the Act, reassessment notice can be issued based upon final objection raised by CAG stating that assessment of relevant assessment year has not been framed in accordance with the provisions of the Act.
• As per existing provisions and judicial pronouncements, onus was on AO to prove that there was failure on the part of assessee to disclose material facts when reassessment notice is issued after four years from end of relevant  Assessment Year but before completion of six years and this condition is completely removed in amended Section.

10 Conclusion

The provisions of section 148 and 148A of the Act introduced in Finance Bill proposes a completely new procedure of assessment/reassessment in cases discussed herein above and radical changes made in bill, would reduce litigation and would provide considerable ease of doing business to taxpayers as there is a reduction in time limit by which a notice for assessment or reassessment or re-computation unless case of assessee is falling in the bracket of  ten years from the end of the relevant assessment year and AO has in his possession books of accounts or other documents or evidence which reveal that the income chargeable to tax, represented in the form of asset,( yet not defined in proposed Act) which has escaped assessment amounts to or is likely to amount to fifty lakh rupees or more for that year.

India’s Customs Tariff Policy: No Longer Evolving

This article has been co-authored by Mohammad Asif Mansoory (Senior Associate).

The two T’s of cross border i.e. tension and trade, are best addressed with a clear policy. Well the good news is that Union Budget 2021 sets out India’s tariff policy for cross border trade in clear and unambiguous terms. The proposals propel India’s flagship ‘Make in India’ program and lends weight to its vision of ‘Atmanirbhar Bharat’.

Pre-budget expectations were running high that India will set the record straight on the customs tariff front to reinforce its intention of becoming a global manufacturing hub. The Finance Minister, through Union Budget 2021, more than lived up to the anticipation and made significant feasible policy and legislative changes to secure the interest of domestic manufacturers against cheap imports.

The budget moves, on customs tariff, focused in letter and spirit on (a) safeguarding indigenous industry; (b) promoting value addition in certain sectors to be part of the Global value chain; and (c) reducing cost of inputs and correcting the problem of inverted duty structure.

Carefully incentivizing raw material imports and blocking that of finished goods or ones that are indigenously manufactured in quantities that not just suffices domestic demand but also caters to the export market. Custom duties for industries, for example, chemicals, cut and polished stones, safety glasses and parts of signalling equipments, metal products such as screw, nuts where there is sufficient local capacity were hiked to discourage imports., etc.

To promote value addition in certain sectors, import duty has been freshly imposed or hiked, as the case may be. This has been done for goods such as solar inverters, parts of mobile phones, compressors for refrigerator/ air conditioners. This aims to enable manufacturers to onshore majority value addition processes undertaken in course of the manufacturing.

The next measure involved correction of duty rates that either led to inverted duty structures or were causing an unwarranted increase in price of raw materials. Beneficiaries include sectors such as textiles, ferrous and non-ferrous metals, naptha, precious metals, etc. This has come as a huge relief to the importer communities as they have been advocating this cause with the Government for a long time. It is indeed heartening to see that policy makers are not just hearing but also positively acting on representations.

With all the jubilation about tariff moves, what made an enormous buzz is the new agri-infra development cess proposal. While it was feared that the cess would be inflatory, the actual picture is different. Although it is a new levy, the cess will not add a duty load on importers, since corresponding basic customs duty has been suitably adjusted in most cases. This is emphasized by the fact that several affected sectors, alcoholic beverages for example, have made it clear that this cess will not lead to increase in pricing of the final product.

Simply put, the undercurrent of these proposals, is that India has taken a definitive stand on its tariff policies. The policy has clearly challenged cheap imports, discouraged pseudo manufacturing such as assembling/ aggregation and encouraged exports from the India.

In a bid to further showcase its intent on the tariff policy front, the Finance Minister indicated that lawmakers will now review as many as 400 old customs exemptions on stringent norms of requirement and anything which is not in sync with the Government’s vision will be cancelled. This is unheard of; it’s a painstaking job and it is being well done.

Expect more and more rationalization. The government is on the look out of inefficiencies and would weed it out as soon as identified. For instance, several end-use based exemptions today warrant varying compliances. The government has taken up the mettle to standardize these compliances at the earliest.

Further, new exemptions would not come for indefinite period. The same, if at all, would be notified for a purpose and with a life span of about two years. If one observes carefully, this roadmap suggests that the administration would act to help and support, but the beneficiary has to eventually stand and learn to manage on its own.

Finally, the peculiarity of this new explicit policy is that it makes room for adjustments in a jiffy. Metal prices, steel in particular is exponentially rising and the Government has already cautioned domestic players. In a bid to ensure that costs of such items do not disrupt cost sheets of various other projects, infrastructure included, the government is taking head on measures. Illustratively, anti-dumping duty/countervailing duties on various steel products from China/ Indonesia, etc are being temporarily suspended or revoked to balance out product prices and support projects and industry against inflation.

A few naysayers have denounced these policy measures. They may indeed be protectionist in their approach; however, they clearly lay out the long-term plan for achieving India’s vision of being a global manufacturing hub. This also sends out a clear message to industries which have not been particularly impacted by these current tariff changes. Businesses should augment future plans to suit India’s evolving policy towards localisation as in time all industries will be similarly impacted. India is only aiming for a higher and meaningful value addition by onshoring of critical manufacturing processes. The trade constituents will have to be aligned accordingly. 

Union Budget 2021 - Personal Income-Tax Proposals

This article has been co-authored by Aabhishek Khurana (Manager), Ernst & Young LLP.

The Budget that puts India on the flight to growth!

Widely touted as the ‘Budget like never before/Once in a 100 years Budget’, 01 February 2021 was without an iota of doubt firmly etched in everyone’s mind, particularly the aam janta’s, who had for all this while been reeling under the impact of the pandemic and were eyeing this Budget as their ‘Budget of hope’ – one that would assuage their endured pain with some (if not major) tax reliefs.

The Government on the other hand has been very pro-active in terms of grabbing the bull (the mammoth COVID-19 crisis) by its horns in a remarkable style by announcing a slew of measures in the form of stimulus packages that have acted as nothing short of ‘economic vaccines’, but have at the same time spiralled the country’s fiscal deficit to a different level altogether – presently pegged at 6.8% of GDP for next year following an unprecedented 9.5% of the GDP for the current year.

Our Hon’ble FM, Mrs Nirmala Sitharaman, embarked on Part A of her speech by articulating the Government’s vision of an Atmanirbhar Bharat and laying the foundation of India’s first ‘digital’ Budget on six distinct pillars – all of them duly emphasising the Government’s perseverance of resurrecting the Indian economy and getting the high growth trajectory back.

Waxing eloquent about how the Government’s mantra has been to ‘Spend, spend and spend’ over the pandemic-struck period in her interview(s) after the Budget, the FM proposed a massive push towards public, healthcare and infrastructure spending fundamentally in this Budget – a masterstroke that seems to have been given a ‘big thumbs up’ by the stock market players and has elevated the equity markets to new pinnacles on a daily basis ever since the Budget day.  

Given the aforementioned much-needed splurging from the Government’s side, one could gauge that the primary focus of the Government was to jump start the growth engine (considering its ambition of bringing the fiscal deficit down to 4.5% of the GDP by FY 2025-26), and in a way insinuated that a lot of tax goodies may not be on offer this year.

While the FM did put forth some commendable proposals for the Aam Aadmi from her ‘Made in India’ tablet (for instance - reducing the compliance burden on resident senior citizens aged 75 years and above, announcing relaxations as regards mismatch in taxation for residents receiving withdrawal proceeds from their overseas retirement funds in countries to be notified, setting up of a Dispute Resolution Committee for small/medium taxpayers, furthering ease of compliance in the sense that dividend/capital gains details from listed securities/interest income from banks & post offices will now get pre-populated in the tax return forms etc.), it was largely a ‘tax neutral Budget’ for the individual taxpayers with no fresh concessions as well as no additional adverse levies (such as the much-hyped COVID cess and the increase in the LTCG tax rate on equities) being proposed.

Having said that, in continuance with the Government’s stance of targeting the affluent class/high-salaried individuals, the FM unfurled a couple of interesting proposals on the personal income-tax front. Now let’s decipher these two key propositions to comprehend their likely impact:

Taxation of interest earned on the excess contributions made towards specified funds

As on date, sections 10(11) and 10(12) provide for tax exemption of any payment from the Public Provident Fund (‘PPF’) and the accumulated balance becoming due and payable to an employee from a Recognized Provident Fund (‘RPF’) respectively (subject to the satisfaction of certain stipulated conditions).

To curb instances of HNIs/high-salaried employees taking undue advantage of this leeway by parking substantial sums of money in their PPF/RPF accounts and consequently earning tax-free interest thereon, the FM proposes to introduce a cap on such tax-free interest under the above sections.

Going forward, it is proposed that the interest earned on one’s own/employees’ contributions made on or after 01 April 2021 towards PPF/RPF of more than INR 2.5 lakhs per year will get taxed.

Giving rationale behind the introduction of this measure, the Government later on clarified that this decision has been based on the principle of equity amongst contributors and aimed at ensuring that these HNIs/high-salaried employees do not benefit at the cost of other taxpayers. Providing statistics, the Government indicated that this proposal is expected to impact around 1% of the EPF-registered members, with certain individuals contributing a staggering amount of more than INR 1 crore per month in their PF accounts as their own PF contribution share [including Voluntary Provident Fund (‘VPF’) contributions].

As most of our readers would recall, an amendment was brought in under the income-tax laws last year, which seeks to tax the aggregate amount of employer’s contribution towards the Recognized Provident Fund, Approved Superannuation Fund and National Pension Scheme in excess of INR 7.5 lakhs as a perquisite in the employees’ hands. Moreover, any accretions (interest, dividend etc.) attributable to the taxable portion of such employer’s contributions were also made taxable (pertinent valuation/computation mechanism not notified till date).

This year’s amendment to tax the interest on the excess amount of own contributions in PPF/RPF accounts seems to be on similar lines, even as the taxpayers are yet to come to terms with the preceding year’s amendment.

The said interest income is proposed to be taxed under the head ‘Income from Other Sources’, but the stage at which this will get taxed (year on year taxation vs taxation at withdrawal stage) has been subject matter of debate amidst taxpayers at large. Some concerns have also been raised around the retrospective applicability of this proposal (i.e. interest accrued on/after 01 April 2021 on excess contributions made prior to the said date), basis the way the bare text of the proposal has been worded. While retrospective applicability may not pose a challenge here (since the Annexure to the Budget Speech explicitly refers to the excess contributions made on/after 01 April 2021), the stage of taxation of the impugned amount is indeed a grey area.

One could argue that since the relevant amendment has been proposed to sections 10(11) and 10(12) (the exemption sections), and the charging sections have been left unaltered – the taxation kicks in at the stage of withdrawal and not on an annual basis. At the same time, some noted CBDT officials (in their interviews given to leading news dailies/Budget sessions held by industry chambers) seem to have suggested that the Government’s intent is to tax these amounts on a yearly basis, in line with the taxation of interest on fixed deposits/bank account balance - thereby opening a Pandora’s box of questions – with issues like late notification/credit of interest by the concerned authorities for the preceding year (not available till the tax return filing date); segregation of yearly interest on employees’ contributions not being in place as of today; how and in what manner will the taxes be withheld on the taxable interest portion; record keeping/tracking issue etc.

Another noteworthy controversy here is that whether the amounts contributed towards PPF and RPF should be aggregated and the threshold of INR 2.5 lakhs be considered as one. Here, due heed needs to be paid to the fact that the amendment refers to the phrase ‘in that fund’ – thus signifying that the threshold of INR 2.5 lakhs is ‘per fund’ and not a cumulative limit i.e. the employees’ PPF[1] and RPF/VPF contributions should not be combined, but should be reckoned independently.

One can only hope that the Government comes out with the essential computation mechanism/norms with reference to the taxation of such accretions [for both employer (pending since a year) and the employees’ contributions exceeding the prescribed limits)] as early as possible to lay all the confusions to rest and address the ambiguity on this front.

Taxation of income/gains received under high premium Unit Linked Insurance Plans (‘ULIPs’)

Another proposal that has hogged the limelight and must have come as a bolt from the blue for the individuals (HNIs especially), is the proposition to bring the ULIPs issued on or after 01 February 2021 with annual premium/aggregate premia exceeding INR 2.5 lakhs in any fiscal year during the policy tenure under the ambit of taxation (barring amounts received in case of death of the policyholder).

Per the prevailing income-tax provisions, the amount received from ULIPs is exempt under section 10(10D), provided the relevant conditions specified thereunder are fulfilled (no monetary capping notified in terms of the annual premium per se). It has been a longstanding demand of the mutual fund industry to bring in parity between mutual fund and ULIP taxation (gains from mutual funds are taxed at the redemption stage, whereas ULIPs enjoy a tax-free status – assuming the required conditions are met).

While this Budget does not change anything in relation to the taxation of gains emanating from redemption of units of mutual funds, tax exemption shall be available only with regard to the gains/income arising from ULIPs (issued on/after 01 February 2021) having annual premium/aggregate premia of up to INR 2.5 lakhs.

The logic behind the plugging of this loophole seems to be that ULIPs are principally purchased by HNIs to derive higher returns through equity investments and the insurance cover available thereunder is not as much as one gets under a plain vanilla life insurance policy, thereby defeating the desired objective behind the granting of the tax exemption with respect to life insurance policies at this juncture.

However, this new provision will not affect any existing/old ULIPs issued before 01 February 2021, and therefore the concerned policyholders need not worry about any retrospective impact that this provision might have. 

Also, whilst the stage of taxation as regards the above PPF/RPF related amendment may not be crystal clear, there is absolutely no uncertainty in connection with the taxation stage in case of ULIPs – the taxation will trigger on the portion of gains/income as ‘Income from Capital Gains’ (non-exempt ULIPs are proposed to be treated as ‘capital assets’) at the time these ULIPs mature/are surrendered (i.e. in the year of receipt) in accordance with the Rule(s) to be framed by the Government entailing the computation mechanism. Also, the treatment accorded to ‘equity oriented’ mutual funds has been extended to such taxable ULIPs.  Further, Security Transaction Tax is also proposed to be levied on such ULIPs at the maturity/partial withdrawal stage.

Despite the above, there are a number of teething issues on which clarity is needed. Some of these are illustrated below:

1. Will all non-qualifying ULIPs be treated as ‘equity oriented’ funds as per section 112A and if not, how will ULIPs not qualifying as ‘equity oriented’ funds be taxed (say, debt-based plans)?
2. How will ‘switch-in/switch-out’ (one fund to another within the same policy) related aspects be dealt with?
3. In case the aggregate premia paid exceeds INR 2.5 lakhs in a particular year, whether the policyholders will be able to pick and choose the policies for which tax exemption can be claimed? (eg – Total premia for 3 ULIPs purchased on or after 01 February 2021 exceeds INR 2.5 lakhs, but the aggregate premium amount of any 2 such policies doesn’t breach the threshold of INR 2.5 lakhs – whether gains from these 2 policies continue to be tax-free?)
4. What happens in case of ULIPs purchased in joint names – whether the limit of INR 2.5 lakhs needs to be apportioned between the policyholders or seen as one limit?
5. How will the threshold of INR 2.5 lakhs be tracked in case ULIPs are bought from two or more insurance companies on or after 01 February 2021?

Admittedly, this proposition is not very straightforward, which to a certain extent has been acknowledged in the form of a proviso being inserted – empowering the Revenue Authorities (with the Central Government’s approval) to issue clarifications from time to time for removing any difficulties/interpretational dispute(s). It is hoped that appropriate clarifications are quickly issued so that there is certainty for both the investors and the insurance entities.

Like all her past Budgets, the FM this year too recited a couplet (as follows) before commencing with her Direct Tax proposals:

''A King/Ruler is the one who creates or acquires wealth, protects and distributes it for common good.''

This verse echoes perfectly with the spirit of both the abovementioned proposals (having the Government’s Robinhood touch to them) of discouraging the HNIs from planning their finances/taxation in an aggressive fashion, while simultaneously benefitting the genuine/bona fide taxpayers.

The FM seems to have struck the right chord by judiciously confronting a strenuous task of tackling an array of issues such as coping with the pandemic-induced economic distress and ensuring consequential revival, creating adequate number of jobs, spurring demand led growth to enable the country to march towards its towering aspirations of becoming a USD 5 trillion economy.

All said and done, it appears that the FM has rightly focused on promoting growth levers in the economy and we truly hope that the desired multiplier effect in terms of more jobs and increased growth is achieved.

(The authors acknowledge support from their colleague CA Stuti Parikh)

Disclaimer - Views expressed are personal

Re-opening of Tax Assessments - No More a Hanging Sword

In the past 1 year, several significant initiatives have been taken by the government to radically reform the tax administration. These measures include roll out of Faceless E-assessments for all assesses which would increase transparency and would be driven by real time information and data analytics with minimal physical interface. This has replaced the decades old tax administration of jurisdiction-based assessments by local tax administrators and physical interaction with the taxpayers.

The Union Budget 2021 has made the second greatest move by proposing to restrict the re-opening of assessments and introduce adequate safeguards. It is proposed to reduce the period for reopening of assessments from 6 years to 3 years except in cases of income escaping assessment of Rs. 50 lacs or more. Historically, re-opening of assessments by Indian tax authorities for several years has always been a hanging sword on the taxpayers under the Income-tax Act, 1961 (‘the Act’). The finality of tax assessments within a reasonable period is a pre-requisite for instilling certainty and building trust with the taxpayers.

The Finance Bill, 2021 proposes to replace the existing provisions of section 147, 148 and 149 of the Act and insert a new section 148A in the Act. The key proposals are:

Change in Time Limit for Re-opening of Assessments from the Earlier 4 to 16 years to 3 to 10 Years

Under the existing provisions of section 147, if the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may  assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section or recompute the loss or the depreciation allowance or any other allowance, for the assessment year concerned.

Under the new proposed section 147, if any income chargeable to tax, has escaped assessment for any assessment year, the Assessing Officer may, assess or reassess such income or recompute the loss or the depreciation allowance or any other allowance or deduction for such assessment year. Further, the Assessing Officer also has the power to assess or reassess the income in respect of any other issue, which has escaped assessment, and such issue comes to his notice subsequently in the course of the proceedings under this section.

The present time limits for the re-opening are specified under section 149 as follows:

• Upto 4 years from the end of the relevant assessment year in all cases other than cases mentioned below;
• Upto 6 years from the end of the relevant assessment year if the income chargeable to tax which has escaped assessment amounts to Rs. 1,00,000 or more for that year;
• Upto 16 years from the end of the relevant assessment year if the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment.

Under the proposed provision, the time limit for re-assessment has been reduced to 3 years from the end of the relevant assessment year except in cases where income escaping assessment is Rs. 50,00,000 or more (in which case the time limit would be 10 years from the end of the relevant assessment year).

Time Limit for Re-opening of Assessments in case of Foreign Assets (including Financial Interest) Reduced

The existing time limit of 16 years for re-opening of case where any income chargeable to tax in relation to any asset (including financial interest in any entity) located outside India which has escaped assessment is proposed to be reduced to 10 years. The period for reopening would be 3 years from the end of the assessment year, if the income escaping assessment is less than Rs. 50 lakhs.

Basis for Re-opening

Under the new procedure, a re-assessment / re-computation can be conducted only in cases where there is information with the Assessing Officer which suggests that the income chargeable to tax has escaped assessment and the Assessing Officer has obtained prior approval of the specified authority. Specified authority shall be (i) Principal Commissioner or Principal Director or Commissioner or Director, if 3 years or less have elapsed from the end of the relevant assessment year; and (ii) Principal Chief Commissioner or Principal Director General or where there is no Principal Chief Commissioner or Principal Director General, Chief Commissioner or Director General, if more than 3 years have elapsed from the end of the relevant assessment year. This would ensure that the approvals are obtained from senior most officers and hence, would have adequate safeguards.

Further, such information may be flagged by an automated system or any final objection raised by the Comptroller and Auditor General of India in relation to any assessment. The proposed mechanism based on data analytics and random selection or CAG objections seems to be more objective.

Safeguards Proposed under section 148A which specifies the Procedure before Issuing any Notice for Assessment / Re-assessment / Re-computation

A new section 148A is proposed which prescribes the procedure before issuing any notice for assessment / re-assessment / re-computation:

• The Assessing Officer should conduct an enquiry, if required, with respect to the information which suggests that the income chargeable to tax has escaped assessment;
• Such enquiry should be made with the prior approval of specified authority;
• Provide an opportunity of being heard to the assessee;
• Decide on the basis of material available on record including reply of the assessee, whether or not it is a fit case to issue a notice for assessment / re-assessment / re-computation.
• This process of enquiry shall not apply to any issues which comes to the notice of the Assessing Officer subsequently in the course of proceedings under section 147.

No Extended Time Period of 10 Years wherein the Period for Reopening has already Expired

A grandfathering provision has also been proposed to state that the notice for assessment / re-assessment / re-computation cannot be issued at any time for the assessment year beginning on or before 1 April 2021, if such notice could not have been issued at that time on account of it being beyond the time limit prescribed under the existing provisions of the Act. For instance, where the period for re-opening for AY 2013-14, say 6 years from the end of the assessment year, has already expired, the tax authorities cannot re-open the case for the said AY 2013-14 now under the new provisions.

Search or Survey Cases under the New Provisions

It is proposed that sections 153A and 153C of the Act in relation to search or requisition cases shall not apply to search initiated or requisition cases after 31 March 2021. The assessment / re-assessment / re-computation in case of search initiated or books of accounts or any other assets requisitioned or survey conducted on or after 1 April 2021 shall be done under the new procedure discussed above.

In such cases, the Assessing Officer shall be deemed to have information which suggests that the income chargeable to tax has escaped assessment in the case of the assessee or any other person for 3 assessment years immediately preceding the relevant assessment year in which the search or survey was conducted. The procedure for making an enquiry proposed under section 148A before the issuance of notice of assessment / re-assessment / re-computation, shall not apply in case of search or requisition of books of accounts or any other assets.

As per the existing provisions of the Act, the Assessing Officer is mandatorily required to do an assessment or re-assessment in search cases in respect of 6 preceding assessment years. This will now be reduced to only 3 preceding assessment years under the new procedure, whereas in case of survey proceedings, it seems that the preceding 3 years would also come within the purview of the new section on income escapement.

Concluding Remarks

The new procedure for re-assessment is a welcome step and provides finality to tax assessments as well as greater transparency. This along with the drive to go faceless carried out by the Government will also build greater trust between the taxpayers and the tax administration. Hopefully, the hanging sword of tax re-opening will be put to rest and taken out only in deserving cases.

Reassessments 2.0: Another Arrow in the Quiver to Simplify Litigation

This article has been co-authored by Viraj Kurani (Senior Manager) and Harshula Khatri (Deputy Manager), Deloitte Haskins and Sells LLP.

Though the year 2020 had witnessed multiple amendments in the Income-tax provisions in terms of tax reliefs, introduction of faceless appeals and assessments, introduction of new levies, etc., the government’s focus seems to have been improving the administrative processes with large impetus on digitalisation of such processes. Digitalisation has helped in reducing the assessment life cycle of a taxpayer, a glimpse of which also appears in the Budget 2021. 

In addition to reducing the assessment life cycle, the Budget has also showcased efforts towards significantly reducing the litigation through appropriate redressal mechanisms (such as the Board for Advance Rulings, Dispute Resolution Committee for small tax payers etc.), wherein the tax authorities and taxpayers in India have been embroiled in a judicial theatre of war.

In line with the above theme, the Finance Ministry has further proposed a complete revamp of the reassessment proceedings which clearly shows its intention of reducing litigation and providing much needed certainty to the taxpayers. In this article, we shall deliberate on the current and proposed reassessment proceedings.

Existing provisions:

Under the extant provisions, as per section 147 of the Income-tax Act, 1961 (‘the Act’), if an Assessing Officer (‘AO’) has a reason to believe basis information available with him suggesting that any income chargeable to tax has escaped assessment for any assessment year (‘AY’), he may issue a reassessment notice under section 148 of the Act.

However, notice under section 148 of the Act may only be issued within the prescribed time limits[1]:

• within four years from end of relevant AY;
• within six years from end of relevant AY in cases where income chargeable to tax escaping assessment amounts to more than INR one lakh and the taxpayer failed to disclose material facts;
• within sixteen years from end of relevant AY in cases of income, in relation to any asset located outside India, has escaped assessment.

Further, currently there are no specific timelines outlined under the Act for the reassessment procedure and the taxpayers majorly relied upon the procedures / timelines laid down by various Courts.

Proposed provisions - Budget 2021

As stated earlier, the Budget has completely revamped the reassessment procedure and the current elements of the traditional reassessment proceedings such as reasons to believe, failure to disclose material facts to invoke reassessment beyond 4 years, etc. have been done away with.

The proposed time limits to issue reassessment notice are:

Further, in search, survey or requisition cases initiated after 1 April 2021, it shall be deemed that the AO has information which suggests that income chargeable to tax has escaped assessment for the three AYs immediately preceding the relevant AY and reassessment proceedings would be carried out under the new procedure.

The said amendments with regard to reassessment procedure are proposed to take effect from 1 April 2021 and would be applicable for all the reassessments initiated after 1 April 2021.

Highlights of the proposed reassessment provisions

• Requirement of “reason to believe” done away with and “information available with AO” restricted

The proposals have restricted the scope of “information” basis which the AO may initiate reassessment proceedings, to only mean:

1. information flagged in the taxpayer’s case in accordance with the ‘risk management strategy’ formulated by the Board from time to time, or
2. any final objection raised by the Comptroller and Auditor General of India to the effect that the assessment has not been made in accordance with the provisions of the Act. 

• Requirement to conduct enquiries before issuance of notice under section 148 of the Act

The taxpayers and tax authorities have, over the years, diligently followed the procedure and timelines prescribed under certain judicial precedents for reassessment proceedings.

The government has now introduced a new section 148A, whereby before issuing a notice under section 148 itself, the AO will now be required to provide an opportunity to the taxpayer and pass an order on whether it’s a fit case for issuance of notice under section 148 of the Act within the stipulated timelines. Further, this would also require an approval from the higher ranked tax authorities.

• Reopening assessment of relevant AY beyond 3 years and upto 10 years with stringent conditions

• The AO needs to be in possession of books of accounts or other documents or evidence which reveals that the income chargeable to tax has escaped assessment; and
• The said income must have been represented in the form of an asset, which amounts to or is likely to amount to INR fifty lakhs or more for that relevant year.

Accordingly, here the income escaping assessment is intended to include only such income which is represented in the form of an asset.

• Transition provisions

The transition provision states that, notice for initiation of reassessment proceedings may not be issued for the years for which timelines for initiation of reassessment have already expired, considering the extension from six to ten years.

Points to ponder

• Although reassessment procedure seems to have been simplified, a literal interpretation of the proposed provisions suggests that the requirement to conduct enquiries may not be mandatory for every case;
• It is still unclear as to whether the taxpayer can appeal / file a writ against the order stating the its case is fit for reopening under the proposed provisions of section 148A;
• The proposed provisions retain the AO’s power to reassess any other income which comes to his notice subsequently during the course of reassessment proceedings, even if the process under section 148A may not be followed for such income;
• Instances covered in the scenario where the timeframe of ten years from the end of the relevant AY is invoked needs to be provided. Further, the term asset also needs to be elaborated / defined to provide certainty and clarity on revenue’s intention.

Our comments

Although the proposed provisions raise certain open issues, it also brings out the intention of the Finance Ministry towards reduction of litigation and providing certainty to the taxpayers.

Measures like introduction of enquiry before issuing reassessment notice, strict deadlines for various steps involved, approvals of higher ranked authorities, seems to be adequate for simplifying reassessment procedures and preempts unnecessary litigation. However, as highlighted above there are certain points which may need appropriate clarification(s).

Information for the editor for reference purposes only

Dividend Income – Withholding Tax Relief for FPI’s

This article has been co-authored by Rahul Chheda (Senior Manager), Sudit K Parekh & Co. LLP.

Budget 2020 abolished Dividend Distribution Tax (DDT) and dividend taxation was shifted on shareholders. Resident Shareholders were liable to pay tax on dividend as per the tax rates applicable to them. Similarly, for non-resident and Foreign Portfolio Investors (FPI’s), the dividend is taxable as per the provisions of Income Tax Act or rates provided under the relevant Tax Treaty.

However, this was not the case for FPI’s, as under Indian domestic tax law (IDTL), there was a specific provision for withholding tax (Section 196D of Income Tax Act, 1961) pertaining to withholding tax on income of FPI’s, which provided for withholding tax at 20% (plus applicable surcharge and education cess) and did not provide option to apply lower tax rate provided under Tax Treaty. This position of non-eligibility of treaty rates for specified sections was also upheld by Supreme Court in case of PILCOM vs. CIT West Bengal (Civil Appeal No. 5749 of 2012). While this decision of Supreme Court was not in context of the said section but was very much applicable.

Accordingly, even though FPI’s were eligible to claim the tax treaty benefit while filing the tax return, the withholding tax on dividend payment received by them was applied under the IDTL at 20% (plus applicable surcharge and cess). This resulted in blockage of funds for FPI’s as many tax treaties provides for tax rates ranging from 5% to 15%.

With an intention to resolve the anomaly, an amendment have been introduced in this budget to extend the benefits of tax treaties to FPI’s shareholders while applying the withholding tax on Dividend. This is a favourable change for FPI’s and would certainly have positive impact on cash flows of FPI’s.

Relaxation from inclusion of dividend income while computing Advance Tax Computation

Another issue in relation to dividend income was on interest payment for delay in payment of advance tax. Given that declaration and payment of dividend by Indian Companies is uncertain and dependent on various factors, it was really difficult for a shareholder to estimate the dividend income, which has resulted in excess/short payment of Advance tax liability. Accordingly, the taxpayer was either in a tax refund situation or they were liable to pay additional interest on shortfall of advance tax liability. In either case, there was blockage of fund or payment of interest.

In order to remove the above difficulty, amendments have been made wherein taxpayer would be liable to pay the advance tax on the dividend income in the quarter in which the same is being declared by the company.

Impact and Analysis

While providing of tax treaty benefit to FPI’s at a withholding tax level is a welcome change but it may increase compliance and documentation burden on the Indian companies. In order to grant tax treaty benefit, the Indian payer company would have to collect the relevant declaration/documents like Tax Residency Certificate (i.e. TRC), Form 10F & No PE declaration, etc. Almost all the tax treaties provide that beneficial tax rates for dividend would be available only if the recipient of the income is a beneficial owner of the dividend income. Given that determination of beneficial ownership would be a factual exercise, Indian payer would not be able to verify the same and would have to rely on declarations. Also companies need to be mindful of the Multilateral Instrument (MLI) provisions before granting the tax treaty benefits.

While the above changes are a welcome move, in our view other issues like withholding tax on shares held by Investor Education and Protection Fund (IEPF) – Government fund, compliance requirement for NRI shareholders having Indian bank account ought to be clarified.

Will the Revamped Advance Ruling System Bring Certainty to the Non-Residents?

This article has been co-authored by Shankey Agrawal (Principal Associate) and Saurabh Nandy (Associate), BMR Legal.

1. Introduction

Advance tax rulings are a common feature of any mature tax system. Advance Ruling allows a foreign investor to obtain an advance tax ruling before commencing a business and it is a common feature in nearly all OECD member countries. Increasingly, many non-OECD countries are also offering advance tax rulings, which provides much needed clarity and consistency regarding the application of the tax law for both taxpayers and the tax authority[1].

In a bid to reform existing Advance Ruling mechanism, Finance Bill, 2021 proposes significant proposals relating to revamp of Authority of Advance Rulings (AAR). Finance Bill proposes to constitute a Board for Advanced Rulings (hereinafter referred to as ‘BAR’) in place of the existing AAR to ensure faster disposal of Advance Ruling Applications, which are lingering for past few years. The objective behind constituting a Board is clearly to look for an alternative method of providing advance rulings that can efficiently give the taxpayers’ timely rulings.

2. Historical background & Constitution of Existing AAR

After the liberalization of the Indian economy in 1991, Foreign Direct Investment (FDI) had been significantly relaxed, which resulted in a much greater inflow of FDI. During this period, due to the complex nature of Indian taxation laws and the likelihood that the disposal of complex tax cases would take a considerable number of years for disposal, it was found pertinent to constitute an AAR. AAR was tasked to resolve foreign investors' interests at the outset and settle well in advance, the tax burden for specific transactions.

AAR was set up as a statutory quasi-judicial authority under the Income Tax Act. 1961(Act) by the Finance Act, 1993, with effect from June 1st, 1993. It was mandated that the Chairman of the Authority was a former judge of the Supreme Court (SC) and High Court (HC) of India. Similarly, the Vice-Chairman of the Authority was a Retired High Court Judge. Further, AAR's revenue and law members were appointed from senior functionaries of the government’s tax administration service and legal service respectively. It is also important to highlight that there was no Appellate Mechanism under the Act against the decision of the AAR under the Statute.

3. Shortcomings of the Existing AAR

As noted above, the existing the AAR was setup to provide certainty and advance clarifications to the non-resident investors. However, the said Authority despite its’ initial promise has substantially failed to serve the purpose for which the same was created. The fact that the posts of Chairman and Vice-Chairman have remained vacant for a long time due to non-availability of eligible persons has seriously hampered the working of AAR leading to large number of pending cases and inordinate delays. In this regard, the following may be noted:

• Constant Delay in pronouncement of rulings

In the past, practical experience of applicants has been exorbitant delays due to lack of requisite quorum for the Authority. It has been noted that there was a substantive delay in appointment of Chairmen and vice-chairman of the Authority. This may also be due to the non-availability of suitable candidates. It is noteworthy that, after the incumbent chairman’s retirement, there was a two-year period (August 2016 - July 2018) wherein the AAR had to operate without a chairman as no appointment was made. In fact, taxpayers took up this issue through a public interest litigation before the High Court as the AAR was unable to issue any ruling in the absence of a chairman.[2] As an interim measure, the court directed one of the members to carry out the functions as the in-charge chairman so that the AAR could function without a break.[3] Thus, vacancy of chairman and vice-chairman has remained a primary challenge to the efficacy and efficiency of AAR..

The Supreme Court, in the case of National Co-operative Development Corporation[4] , noticed that the ground level situation is that this methodology has proved to be illusionary because there is an increasing number of applications pending before the AAR due to its low disposal rate and contrary to the expectation that a ruling would be given in six months (as per Section 245R(6) of the Act), the average time taken for disposal was reaching around four years. Further, referring to the international scenario where there has been an incremental shift towards mature tax regimes adopting advance ruling mechanisms, the bench noticed that the increase in global trade puts the rulings system at the centre-stage of a robust international tax cooperation regime. Interestingly, The Organisation for Economic Cooperation and Development (OECD) lists advance rulings as one of the indicators to assess trade facilitation policies, making it an aspirational international best practice standard.

• No Appeal against AAR

Given the primary emphasis on avoiding long drawn litigation, AAR rulings were made binding on both the taxpayer and the tax administration without being provided a statutory appeal against the ruling. Numerous rulings of the AAR were challenged with taxpayers filing writ petitions and special leave petitions before the High Courts and Supreme Court respectively on the grounds of irreparable loss and injury ensuing from an infringement of their rights under the provisions of the Indian Constitution.[5] Supreme Court in the judgment of Columbia Sportswear Company[6] clarified the ambiguity in the procedural laws by stating that the ruling of an AAR can be challenged before a High Court by filing a writ petition under Articles 226/227 of the Constitution. Accordingly, the only option to any person aggrieved by the Judgment of AAR was to approach the High Court by invoking the Extraordinary jurisdiction of the High Court, which is available only in limited cases. Accordingly, absence of a statutory remedy against the Ruling pronounced by AAR eroded the confidence in the Authority.

4. Ingredients for the success of revamped Advance Ruling Mechanism

In view of the above a need was felt by the Government to reform the AAR for quick resolution of Applications and restore the confidence in the Advance Ruling Process. Accordingly, Finance Bill, 2021 proposes to revamp the Authority by Constituting BAR and also providing a statutory appeal against the Order of the BAR. In our opinion, the following ingredients would be essential to ensure the success of the BAR:

Independence of the presiding members

The Government's decision to constitute a Board for Advance Rulings (BAR) which is presided by two members, each being an officer not below the rank of Chief Commissioner brings up the question of independence. It has been experienced in the past that these authorities are influenced by revenue considerations. A similar experience has been noted in relation to AARs constituted under the Central Goods and Services Tax Act, 2017 (CGST Act), which are presided only by Revenue Officers from the Central and State Governments respectively. It is observed that majority of the Rulings are pronounced in favour of the Revenue Department, which raises a question on the independence of the Authority. Thus, it is of paramount importance that the independence of members of BAR is ensured. The judgment in R. Gandhi[7] and Madras Bar Association case[8] contains directions to preserve the independence and directed that 'the administrative support for all Tribunals should be from the Ministry of Law & Justice. Neither the Tribunals nor its members shall seek or be provided with facilities from the respective sponsoring or parent Ministries or concerned Department,’ Also, it is important to highlight that the Bombay High Court in Chamber of Tax Consultants[9] held that CBDT cannot issue any instructions or directions to any income tax authority to make a particular assessment or to dispose of a case in a particular manner. Hence, portion of Central Action Plan prepared by CBDT which gave higher weightage for disposal of appeals by orders favouring revenue was to be set aside.

It is suggested that to generate confidence amongst taxpayers, the Board must include judicial members in their composition, as otherwise, the Board will clearly lack the oversight of Supreme Court/ High Court Judges. This has also been proved in the past, post the constitution of AAR, which was indeed considered a glorious period, when Justice S. Ranganathan headed it. The adopted approach was entirely fair and equitable and without any bias towards the assessee or to the revenue. At that point of time, the initial confidence generated by the AAR made it popular amongst various non-resident investors who could approach the AAR to understand their tax liability. Alternatively, roping in the retired members of the Income-tax Appellate Tribunal (ITAT) for presiding over the Board of Advance Rulings can also be a suitable option as against the option of commissioners heading the Board.

Time Bound Disposal of Applications

Section 245R of the Act provides that the Authority shall pronounce the Ruling within a period of 6 months. However, the said provision has not been followed by the Existing Authority due to the reasons discussed above. Steps may be taken such that the newly formulated BAR strictly adheres to the statutory timelines. 

Consistency in Advance Rulings

There is also a need to ensure that consistency in rulings is maintained between the different benches of BAR. Different benches must be consistent in the approach and must follow the Orders passed by the co-ordinate benches. An inconsistent approach by different benches of AAR would hamper the faith in the Authority and may also lead to bench shopping by the Applicants. 

Effective Appellate Mechanism

As noted above, no statutory appeal was provided against the Order of the AAR order could only be made under the High Court's writ jurisdiction. It is proposed that a new Section 245W. would be added which provides for an appeal to the High Court against the order passed or ruling pronounced by the BAR. This effectively would mean that the applicant will have a statutory remedy and can approach High Court without invoking the Writ Jurisdiction of the High Court.

However, equally important consideration is added burden on the High Courts. It is important to note that High Courts across the country are already burdened with huge pendency and hence the Appeals from different benches of BAR would only lead to additional burden. Further, the presently the High Courts were only entertaining appeals under the Act, where substantial question of law was involved. However, in case of appeal from BAR, no such requirement is prescribed and hence this move is likely to additional burden on the High Courts.

Scheme for eliminating the interface

Another proposal in Union Budget is to formulate a scheme to eliminating the interface with the taxpayers i.e. faceless functioning of the BAR. At this stage, this proposal may not be implemented. This is for the reason that faceless determination of application without effective hearing may lead to erroneous determination. In this regard, it may be relevant to note the observations of the Madras High Court in the case of Salem Sree Ramavilas Chit Company,[10] wherein the court held that though the steps taken by the Income Tax Department to pave way for an assessment without human interaction was laudable, such proceedings could lead to erroneous assessments if the Assessing officers are not able to understand the facts due to the lack of a personal hearing. Therefore, before introducing the faceless scheme in the field of advance rulings, substantive experience and perfection is required to be attained in the e-assessments and e-appeal schemes.

5. Conclusion

Overall, reorganisation of AAR is a good step towards the right direction which will boost investor confidence provided the advance ruling process is conducted in a time-bound manner. BAR should be treated as a facilitator to attract foreign investments rather than using it to oppose every application on the ground of tax avoidance as it has been seen in the past. Further creating multiple benches of Board of Advance Rulings with retired HC judges, experiences tax professionals or retired members of the ITAT would help the Board immensely in achieving its desired objective.

Union Budget 2021 on ‘GST/Indirect Tax’ - Hits and Misses

The Central Government introduced the Budget for FY 2021-22 with an underlying theme to boost the economic growth amidst the COVID-19 pandemic. While on the tax front, the Hon’ble Finance Minister’s speech focused largely on digitalization and ease of doing business for the taxpayers, an analysis of the Finance Bill 2021 indicates that there is more to it than that meets the eye.
While it is given that the Government could not accommodate all the industry expectations from indirect tax standpoint, we look at some of the hits and misses vis-à-vis this year’s Budget announcements.

Hits

• The proposals, in essence, are aimed at aligning the parent enactment with the provisions introduced in the CGST Rules, thereby putting an end to some of the ongoing litigation as well as mitigating the possibility of undue disputes in the future. For example, the conditions to claim Input Tax Credit under the CGST Act have been amended to allow credit only once the details of the invoice or debit note have been furnished by the supplier / vendor his GSTR-1 and the same are communicated to the recipient. This, in substance, is now in sync with the restriction prescribed in Rule 36 of CGST Rules (albeit an amendment will be required to do away with the additional 5% allowance under the Rules).

Similarly, in case of goods, the requirement of export realisation within time limit stipulated under FEMA 1999, which hitherto flowed only from Rule 96B of CGST Rules, has now also been inserted in the CGST Act.

• The levy of interest on delayed payment of tax has been a subject matter of concern for the taxpayers considering the inconsistencies in the stand adopted by the Government as well as by the High Courts. While the provision for interest on ‘net tax liability’ was inserted in the GST law through the Finance Act, 2019, the same was brought into effect only from 1 September 2020, that too prospectively, although the GST Council had recommended otherwise. However, the CBIC, by way of a Press Release, had quickly assured that recoveries will not be made for the past period. Despite such assurance, questions were raised regarding the legal validity of Press Releases and hence, the retrospective amendment through Finance Bill 2021 has come at an opportune time.
• The requirement of filing Annual Return along with a Chartered / Cost Accountant certified Reconciliation Statement in Form GSTR-9C was proving to be a huge compliance burden with multiple representations being made for extension of timelines, especially during the pandemic. As a surprise to all, the requirement of such third-party certification is proposed to be dispensed with and instead, a self-certified reconciliation statement may be uploaded along with Annual Return, reconciling the values of supplies with audited financial statements. This would be a relief to the tax payers as they don’t have to appoint an auditors, who typically asked for more information, clarifications and evidences to get satisfied with the reconciliation between financials and GST returns. However, this would also mean a flurry of enquiries, notices, data from tax office for conducting scrutiny of the reconciliation statements filed. Hence, from effort point of view all the back up documents supporting the reconciliation statement of GSTR 9C should anyway be kep ready.
• The ambiguities surrounding the qualification of supplies to SEZs as “zero-rated supplies” have been addressed with a clarificatory amendment to the IGST Act to provide that they shall be considered only if they are made for the purpose of authorized operations of such SEZ.
• As a move towards digitalization of compliances and paperless processing of documents, the Finance Bill, 2021 has proposed to grant powers to the CBIC to notify ‘Common Customs Electronic Portal’ for facilitating registration, filing and amendment of Bills of Entry (BoEs), shipping bills, other documents and forms, payment of customs duty and issuance of notices, orders / decisions. While there already exists the ICEGATE portal which caters to the trade, carriers and other stakeholders, it has some inherent limitations which the Government now wants to address. The new common portal should serve the dual purpose of easing the documentation processes, including amendments, and reducing the time lag in communication with Customs administration thereby expediting assessments, investigations, audits etc. under the Customs law.

Let us now turn towards the ‘misses’ in this Budget.

Misses

• The manufacturing sector plays a crucial role in promoting the vision of the present Government, viz. “Aatmanirbhar Bharat” and “Make in India”. However, in present times, this sector (especially the electronics, chemicals, textiles and automobile industries) has been burdened with the issue of inverted duty structure, where the inputs are taxed at higher rates than the final product thereby leading to accumulation of input tax credit. Though such accumulated input tax credit is refunded back to the taxpayers, it may be noted that such remission is only to the extent of taxes paid on ‘inputs’, and not ‘input services’ / ‘capital goods’. This ultimately results in increase in the selling price of final product and in some cases, absorption of costs which impact the profit margin.

Moreover, the differing views of the High Courts have only added to the taxpayers’ woes and we will now have to wait for the Apex Court to finally settle this issue. While the Hon’ble Finance Minister, during her speech, assured the House that the Council will remove the anomalies such as the inverted duty structure, only time will tell as to when the manufacturing sector will breathe a huge sigh of relief.

• The Government could have addressed the concerns of the healthcare sector, where owing to the present GST exemption on various healthcare services, the tax paid on inward supplies becomes a cost. This is because under the law, input tax credit is reversible / inadmissible against exempt supplies. In order to make healthcare affordable to the public at large, proposals could have been introduced to tax such services at Nil or concessional rate of 5% or 12% with eligibility to input tax credit.
• In an unexpected move, the Government has decided to notify the class of persons as well as goods and / or services who shall be allowed to export on payment of IGST. While the intent seems to curb fraudulent encashment of input tax credit against fake invoices through refunds, the amendment would hamper the genuine and bona-fide exporters, who would now have to resort to exports against LUT and claim refund of unutilized input tax credit which is limited to ‘inputs’ and ‘input services’. This will certainly have an impact on the liquidity of such taxpayers.
• In line with the amnesty schemes under erstwhile Indirect tax laws, the Government could have announced a scheme under the Customs as well as GST laws, giving an opportunity to bona-fide defaulters to resolve the pending disputes.
• Besides the above, the Budget proposals could have addressed some of the contentious issues plaguing the industry at large, such as dispensing with interest on reversal of input tax credit owing to non-payment to supplier within 180 days (which was also recommended by the GST Council), clarity on taxability of intermediary services, acceptance of Foreign Inward Remittance Advice (FIRA) in lieu of FIRC for the purpose of refunds, entitlement to credit on CSR expenses etc.
• Clarification on some of these matters would have provided an additional impetus to the GST collections and only helped in reviving the economy.

It would be interesting to see the manner in which some of these measures are put in place over the next one year, and how the GST Council tackles the unresolved issues of the industry. 

Depreciation on Goodwill - A Critique

Resolving controversies and providing certainties has been one of the underlying theme of the budget. One such area which received the grace is ‘Goodwill’ – although we aren’t sure whether it was merciful or merciless. Both the elements – whether its vis-a-vis the Claim of Tax Depreciation or whether it pertains to payment to Partners on their retirement - have been proposed by Financial Bill 2021 (“FB2021”) to go a sea-through change. In this write up, we will be discussing the former.

Current provisions:

The current provisions of Income Tax Act, 1961 is defined as ITA doesn’t specifically define the term ‘Goodwill’.

The Apex Court in CIT v. B.C. Srinivasa Setty, [TS-2-SC-1981], in context of Goodwill explained “A variety of elements goes into its making, and its composition varies in different trades and in different businesses in the same trade, and while one element may preponderate in one business, another may dominate in another business. And yet because of its intangible nature, it remains in substantial in form and nebulous in character…… Its value may fluctuate from one moment to another depending on changes in the reputation of the business it is affected by everything relating to the business, the personality and business rectitude of the owners the nature and character of the business, its name and reputation, its location, its impact on the contemporary market, the prevailing socio-economic ecology, introduction to old customers and agreed absence of competition. There can be no account in value of the factors producing it. It is also impossible' to predicate the moment of its birth. It comes silently into the world, unheralded and, unproclaimed and its impact may not be visibly felt for an undefined period. Imperceptible at birth it exists enwrapped in a concept, growing or fluctuating with the numerous imponderables pouring into, and affecting, the business. Undoubtedly, it is an asset of the business, but is it an asset contemplated by section 45.”

An analysis of the above explains that there are various components and a variety of elements under an umbrella that together accounts for and gives rise to Goodwill.

S. 32 deals with depreciation related provisions under the ITA. Explanation 3 to S. 32(1) defines intangible asset as “intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature.”

On analysing the above definition, it can be seen that there is no express mention of the term goodwill. Thus, a question arose as to whether Goodwill can fall under the residuary category of “any other business or commercial rights of similar nature”. Essentially, it was a matter of interpretation testing the applicability of principle of ejusdem generis ; nosctius a sociis etc. There were decisions towards both end – supporting claim of depreciation on goodwill as well as rejecting the claim of depreciation on goodwill. Few of those decisions are referred as under:

• Cases wherein Depreciation on Goodwill was denied:
  • Guruji Entertainment Network Ltd v. ACIT, (2007) [TS-5141-ITAT-2007(DELHI)-O]
  • R.G. Keswani v. ACIT, (2009) [TS-5152-ITAT-2008(MUMBAI)-O]
  • KEC International Ltd. v. ACIT, (2010) [TS-5520-ITAT-2010(MUMBAI)-O]

• Cases wherein Depreciation on Goodwill was allowed:
  • Kotak Forex Brokerage Ltd. v. ACIT, (2009) [TS-5448-ITAT-2009(MUMBAI)-O]
  • Skyline Caterers (P.) Ltd. v. ITO, (2008) [TS-59-ITAT-2007(MUM)-O]
  • B. Ravindran Pillai v. CIT, (2011) [TS-5705-HC-2010(KERALA)-O]

The Supreme Court in CIT v. Smifs Securities Ltd, [TS-639-SC-2012] held that Goodwill would fall in the category of intangible asset and thus, shall be entitled for tax depreciation.

A Goodwill recorded by any taxpayer in their books largely emanates out of two counts – (a) Purchased Goodwill (viz., Goodwill acquired by paying a specific price/premium while acquiring business; and (b) Goodwill arising consequent to reorganisation/revaluation.

The decision of Apex Court in Smifs Securities (supra) ended the controversy around ‘Purchased Goodwill’. 

The decision further went to hold that Goodwill arising consequent to a merger (“Merger Goodwill”) is also tax depreciable. Merger goodwill is generally the balance accounting effect for recording the excess merger consideration paid over the book value of the Assets acquired under a merger.

It may be noted that Explanation 2 of S. 43(6) clarifies the following vis-à-vis tax basis in case of Depreciable Assets acquired in a Merger. The same is reproduced as under:

While holding this position on Merger Goodwill, the Apex Court did not specifically factor the provisions of S. 43 of the ITA which requires the tax WDV of Transferee for any assets acquired under a merger to remain the same as existed in the hands of the Transferor.

Hence, despite the Apex Court’s judgement, the Merger Goodwill continued to remain a controversial issue with the Tax Authorities.

Subsequent to SMIFs’ judgement(supra), there were few other cases where Appellate Authorities accepted Goodwill on Mergers, slump sale - being tax-depreciable – viz.:

• ThyssenKrupp Elevator (India) (P.)Ltd v. ACIT, [TS-558-ITAT-2014 (Del)]
• PCIT v. Zydus Wellness Ltd., [Tax Appeal No. 779 of 2017, dated 3 October, 2017] [TS-6160-HC-2017(GUJARAT)-O]
• Mylan Laboratories Ltd v. DCIT, [TS-691-ITAT-2019(HYD)]
• Demag Delaval Industries Turbomachinery (P.) Ltd v. ACIT, [TS-489-ITAT-2020(Mum)]
• Urmin Marketing (P.) Ltd. v. DCIT, [TS-546-ITAT-2020(Ahd)]

Proposed Amendment by FB2021:

The FB2021 seeks to amend the provision of S. 2(11) of ITA, which deals with the definition of the term ‘Block of Assets’. It is proposed that from the definition of ‘Block of Assets’ itself, ‘Goodwill from business or profession’ should be excluded.

On similar lines, it is also proposed to specifically exclude ‘Goodwill’, under S. 32. These amendments are being proposed to be made retroactively from the current tax year – viz., FY20-21.

In cases where depreciation have been claimed till 31 March 2020, it is proposed that Income from sale of such Goodwill forming part of the block of assets as on 31-Mar-20 will be taxed as short term capital gain @ 30% (S. 50).

Further, Mechanism to determine the ‘cost of acquisition’ of goodwill forming part of the Block for computing the capital gains will be separately notified by CBDT (S. 55)

Our Analysis:

Henceforth, goodwill will not be taxed under S. 50, but will be taxed under S. 45, in case of any transfer.

In case of existing block, the quantum of Goodwill within the block of intangible assets might be difficult to be ascertained and we would hope that the CBDT guidelines would address this aspect.

Allowing Tax Depreciation on Purchased Goodwill has been well-established global practice, being followed in various countries. The intent of allowing such depreciation being that the taxpayer had incurred a cost for the purpose of his business, and hence, should be given the benefit to atleast tax depreciate/amortize it over a period. The memorandum to FB2021 incidentally mentions the following:

“However, in some other cases (like that of acquisition of goodwill by purchase) there could be valid claim of depreciation on goodwill in accordance with the decision of Hon’ble Supreme Court holding goodwill of a business or profession as a depreciable asset.”

After this, however, the Memorandum puts up a contradictory explanation that the need of allowing tax depreciation on tax goodwill is not as justified as that allowable on other intangible assets/plant & machinery, as Goodwill in general, is not a depreciable asset and may see appreciation or otherwise depending upon how a business runs. We would believe that irrespective of whichever way Business runs, tax depreciation on Purchased Goodwill should be allowable. This is because such deduction claim by the Buyer is not basis the way business performs subsequently, but because there is a cost which has been incurred in relation to that business, which as per established tax principles should qualify for a deduction. We would hope that the Government recognizes this and make changes in the final amendment so as to continue allow tax depreciation on Purchased Goodwill.

If this doesn’t happen then Business Acquisitions will become more expensive, and that’s not good for a economy having an ambitious growth agenda where M&A is one of the commonly-followed strategy by organizations to pursue business growth.

Lastly, any proposal with retroactive amendment to levy taxes (like the one on Goodwill) brings additional share of hardship on a taxpayer, which is against the pledge taken by the Government. This is especially not good for our country’s image in terms of ‘ease of business’ and especially in a difficult year like the current, where our economy and businesses are surviving an unprecedented COVID impact. If the proposal is retained as it is, then:

• Buyers will need to rework their advance tax computations and pay additional taxes with interest where they had earlier claimed tax depreciation on Goodwill acquired through M&A Transactions closed during the current year; and
• For unclosed transactions, the Parties will need to renegotiate the transaction that were envisaged to be closed assuming availability of tax depreciation on Goodwill.

We would hope that the lawmakers pay due attention to this in the final enactment and only make it (if they need to do) prospectively. 

With contribution from CA Chirag Wadhwa.

Depreciation on Goodwill - Supreme Court Proposes, Government Disposes

The government has announced Budget 2021, with a view to simplify the tax administration, ease compliance, and reduce litigation. However, there are few amendments which may unsettle the law settled by the Supreme Court and one of such amendments is with respect to denial of depreciation on goodwill.

It has been proposed that goodwill of a business or profession will not be considered as a depreciable asset and therefore no depreciation will be available on goodwill of a business or profession in any situation.

Though, it is now well settled, until the law as it stood prior to the amendment, depreciation was not be allowed on self-generated goodwill, claim of depreciation being only allowed on acquired goodwill. Various Courts/ Tribunal while dealing with the claim of depreciation on acquired goodwill have dealt on the issue of whether goodwill is of a similar nature as other depreciable intangible assets viz. know-how, patents, copy rights, trademarks, licenses or franchises, which are specifically covered as an asset for the purpose of deprecation under Section 32 of the Income-tax Act, 1961 (the Act).

The Supreme Court in the case of Smifs Securities Ltd.[1], while interpreting Clause (b) of Explanation 3 to Section 32(1) applied the principle of ejusdem generis and observed that a reading of the words ‘any other business or commercial right of similar nature’ indicates that goodwill would fall under the said expression.

Another issue that may warrant a mention here is that in case of a bundle of rights which include trademarks, franchises, etc. along with goodwill, it may be difficult to substantiate the claim of those genuine intangible assets which would otherwise be eligible for a genuine depreciation claim and one may have to demonstrate the claim by way of effective documentation and substance.

The Memorandum to the Finance Bill, 2021 states that in certain cases of business reorganization, applying the relevant provisions[2] of the Act, there could be no depreciation on goodwill on account of the actual cost being zero and the written down value of those assets in the hands of predecessor / amalgamating company being zero. It further states that that goodwill, in general, is not a depreciable asset and in fact depending upon how the business runs; goodwill may see appreciation or in the alternative no depreciation to its value. Therefore, there may not be a justification of depreciation on goodwill in the manner there is a need to provide for depreciation in case of other intangible assets or plant & machinery.

While in case of genuine acquisitions of a business purchase where the acquirer of a business pays a sum which is more than the net asset values of the business, the excess is nothing but goodwill and the amendment may now result in denying the allowability of a depreciation claim even in case of such genuine transactions of acquired goodwill and would impact the merger and acquisition transactions in the country.

While the Memorandum makes a reference to no depreciation to its value, one set of argument that may be put forth is that pursuant to transfer of business when goodwill is acquired, if a business is not run well or not operational at all due to existing business/economic dynamics for whatever reasons, one may also witness a reduction in the business i.e. reduction of the customers, patronage etc. In such circumstances, can one still contend that goodwill paid can then not see depreciation in its value?

Further, it has also been proposed to amend Section 50 of the Act to provide that in a case where goodwill of a business or profession which forms part of a ‘block of asset’ and depreciation has been obtained by the taxpayer under the Act, the written down value of that ‘block of asset’ and short term capital gain, if any, shall be determined in the prescribed manner. It would be interesting to see the manner of computing the ‘block of asset’ in case of goodwill which is part of block which consist of other assets in the same block being ‘intangibles’.

The Memorandum clarifies that the amendments in the context of allowability of depreciation on goodwill will take effect from 1 April 2021 and will apply from Assessment Year (AY) 2021-22. In substance, this is a substantial amendment which comes into effect from current fiscal year where taxpayers may have already concluded their transactions/structuring.

The amendment will apply from AY 2021-22 and this in effect means that it would apply to a financial year, most part of which has already lapsed and that would trigger another topic of debate in regard to the retroactive applicability of the said amendment. This may also have further consequences of an incorrect calculation of advance tax on auto calculation of the interest computation in the pre-filled Income Tax Return which may lead to some uncertainty in regard to the levy of interest under S.234B and 234C of the Act though Court[3] has held that no interest could be charged on shortfall of advance tax if liability arose due to retrospective amendment. This is still a proposal and whether the same become a legal provision or not will be decided after some time when it will be passed by the parliament followed by the President’s assent.

Whether the amendment could have been applicable prospectively is another point which may be looked into considering government’s agenda of fair tax administration and its commitment to a non-adversarial tax regime. One will have to wait and see if there is some change in regard to the applicability of the AY when the Finance Bill becomes an Act.

The amendment in the context of denying deprecation on goodwill is one of the most discussed amendment of the Finance Bill, 2021 and though a rationale has been given in the Memorandum on why this amendment was introduced, certain genuine transactions which involve an element of acquired goodwill will now not be able to claim depreciation and may also be a reason for litigation. The position of the allowability of depreciation on goodwill which was blessed by the Supreme Court has been proposed to be reversed by a legislative amendment.

New Law on Re-assessment – Critical to Define “Information"

Indian Budgets are full of surprises, some good, some stringent and some clarificatory in nature. Going with this trend, Budget 2021 has brought in various measures and relaxations while keeping the tax rates unchanged, which was well received by various stakeholders. As the saying goes, substance is more important than form, and the fine print of the Finance Bill, 2021 certainly holds some surprises. One of them was the re-introduction of the law relating to re-assessments (i.e. income escaping assessments). The modified provisions pertaining to re-assessments have been proposed to be introduced on the back of more sophisticated technology,  where the Income-tax Department (ITD) will be able to collate information from various sources. Though the ultimate intent of these newly introduced provisions is to minimise litigation, there are various   issues surrounding the new provisions.

To get an overall background, it is first important to understand the provisions proposed by the Finance Bill, 2021:

• The Assessing Officer (AO) may assess or re-assess or re-compute any income escaping assessment for any assessment year, subject to issuance of a notice.
• A notice can be issued when there is information with the AO which suggests that the income chargeable to tax has escaped assessment in case of an assessee.
• The term “information” means:
  • which has been flagged in the case of an assessee by the risk management strategy (RMS) formulated by the Central Board of Direct Taxes (CBDT).
  • a final objection raised by the Comptroller and Auditor General of India (CAG) to the effect that the assessment in the case of the assessee has not been in accordance with the provisions of the Income-tax Act, 1961 (IT Act).
• The process to be followed before issuance of notice has also been provided, wherein an opportunity of hearing and passing of order by AO is mandated.
• New time limits have been proposed (3 years in normal cases and 10 years in case of serious tax evasion with evidence of concealment of income of INR 50 lakh or more in a year).

Thus, the emphasis for initiation of re-assessment proceedings is on “information” available with the AO suggesting escapement of income. At the outset, it is interesting to note that this was the same concept which was prevalent prior to the law being amended in 1987. The erstwhile Section 147(b) provided that: “…notwithstanding that there has been no omission or failure as mentioned in clause (a) on the part of the assessee, the [Assessing] Officer has in consequence of information in his possession reason to believe that income chargeable to tax has escaped assessment for any assessment year”. Under this provision, the AO typically treated the objections raised by the internal audit of ITD or issues raised by CAG as possession of ‘information’, to initiate reassessment proceedings.   

At this juncture, it would be pertinent to understand the meaning of “information” as explained judicially. The Hon’ble Supreme Court while dealing with an issue regarding eligibility of such ‘information’ for initiating re-assessment proceedings in the case of Indian & Eastern Newspaper Society v. CIT [1979] [TS-5019-SC-1979-O] (SC), had held that the opinion of an internal audit party of ITD on a point of law cannot be regarded as ‘information’ within the meaning of Section 147(b), and consequently, the re-assessment proceedings ought to be quashed. On the role played by the internal audit committee, the Hon’ble Court observed that: “Whether it is the internal audit party of the Income-tax Department or an audit party of the Comptroller and Auditor-General, they perform essentially administrative or executive functions, and cannot be attributed the power of judicial supervision over the quasi-judicial acts of income-tax authorities”. The Hon’ble Court further distinguished between pronouncing the law and its communication and observed that “an audit party does not possess the power to so pronounce on the law, it nevertheless may draw the attention of the ITO to it. Law is one thing, and its communication another”. Thus, the internal audit committee can only communicate the law and cannot opine on the position of law, which would be beyond their role and jurisdiction. Relying on the above, the Hon’ble Bombay High Court in Bachhraj Factories Ltd. vs. ITO [1985] [TS-5889-ITAT-1984(BOMBAY)-O] (BOM.) had held that where the audit party had brought to the notice of AO a judicial precedent, the same can be termed as “information” and can form the basis of re-assessment.

With the Finance Bill, 2021 bringing back the concept of “information”, it is important to understand what would constitute “information” under the proposed provision. With reference to CAG, Explanation 1 to Section 148 of the IT Act provides that a final objection raised by it to the effect that the assessment in case of an assessee has not been in accordance with the provisions of the IT Act shall also be considered as ‘information’. This raises the issue of whether the scope of the phrase “not been in accordance with the provisions of the IT Act” would  not ultimately come down to a “change of opinion”, since the AO would have already applied his mind to that particular issue.

In effect, the proposed law may provide a backdoor avenue for re-assessment proceedings to be sought to be initiated even on a change of opinion, which has been judicially held not to be a valid reason. An alternative reading is that the expression would be restricted to only communication of law and not an interpretation of the provisions under the IT Act.  

Similarly, for RMS,  Explanation 1 to Section 148 of the IT Act states that ‘information’ for this purpose means any information which has been flagged by them in the case of an assessee. With no further explanation having been provided, the issue of whether RMS can opine on any provision of law or is restricted to communication of law, or alternatively, is restricted only to information pertaining to factual aspects, remains open.

The proposed amendment does not provide any clarity on the issues raised above and in the absence thereof, more discretionary power will be granted to the ITD. As a matter of fact, on account of introduction of faceless assessments, the chance of escapement of income is reduced, and technically, the scope of re-assessment should have been restricted, but it appears that the scope of re-assessment has instead been expanded. In this backdrop, it would be prudent to issue clarifications to the effect that the jurisdiction of RMS as well as CAG will be restricted to the communication of law and not interpretation of law, for the purposes of initiating re-assessment. 

Although the proposed amendment is aimed at rationalization and providing clarity to taxpayers, it  may lead to interpretational issues and complicate re-assessment proceedings for the taxpayers. On a separate note, bringing in the procedure for providing an opportunity of hearing to the assessee before issuance of notice under Section 148, following the decision of Hon’ble Supreme Court in GKN Driveshafts (India) Ltd [TS-4-SC-2002-O] ), is certainly a welcome move and will reduce litigation. All in all, if the term “information” is clarified to be restricted to factual information, or at the most, to the communication of law, the amendment pertaining to re-assessment will certainly reduce litigation.

Disclaimer: The authors views are personal and do not reflect the views of the firm.

Budget 2021-22: Moving towards Atmanirbharta in Mobile and Electronics Industry

This article has been co-authored by Lucky Ahuja (Senior Manager), Indirect Tax – Nexdigm (SKP).

The most anticipated union budget of the recent times i.e., the Union Budget 2021-22 was finally announced on 01 February 21. With the Union Government facing daunting challenges in the wake of COVID-19 pandemic and the emerging chaos on the geo-political as well as the local front; it was to be seen what path is adopted to steer the economy out of these doldrums.

‘Chaos is a ladder’:

While COVID-19 induced chaos has forced the countries/corporations world over to look into re-alignment of their global supply chains, only a handful countries have been able to capitalize upon the opportunity offered by this chaos. India, seems to be one of those countries which marketed itself aggressively during the pandemic and was able to capitalize upon the opportunities that presented in some sectors namely mobile manufacturing and electronics. As a result we witnessed shifting of manufacturing/assembly related to some global premium mobile brands into the Indian mobile manufacture/assembly arena.

The Government has actively supported the mobile and electronics manufacturing industry through introduction of schemes like Production Linked Incentive (PLI) scheme wherein it is granted a benefit of 4% to 6% on incremental sales of goods manufactured in India to eligible companies, for a period of five years subsequent to the base year (FY2019-20). Further, passive support is being extended to this initiative by strategy of ‘Import Substitution’ wherein import duties on the mobiles, its spare parts and certain other electronic components are being increased gradually in a phased manner.

Firstly, there has been a steady increase in the Basic Customs Duty (BCD) rates on cellular phones imported as is, since a past few years to nudge the mobile manufacturers towards import of knocked down kits and local assembly (for e.g., BCD rates on import of ‘telephones for cellular network’ falling under Chapter heading 8517 of the Customs tariff has been increased from 10% as on 30 June 2017 to 20% currently).

Now, to consolidate its local manufacturing base and continue to build upon the success of the local manufacturing the Government, through this Budget, has introduced a slew of amendments to rationalize BCD rates chargeable on components used in manufacture of mobile phone and parts of accessories supplied along with them. The aim being making the local manufacture of components more attractive rather than importing them.

A similar strategy is being adopted/executed in other sectors as well, notable amongst them being solar energy operated equipment and its components as well as electronic toy industry. The solar industry was struggling due to skewed tariffs on solar cells and downstream distributable utilities (e.g., solar inverter). Budget 2020 contained enabling provisions for raising the tariff rates on solar cells and modules by up to 20%. Now, it was expected that duties applicable to other accessories would be rationalized. Similarly, the toy industry too was suffering from cheap price of imported goods vis-à-vis the locally manufactured ones.      

The below table gives an indication of the existing custom duty rates and the proposed rates that would be chargeable on certain imports:

   The data presented in the above table makes the following things very clear:

1. The Government is very keen in moving towards a progressive taxation regime which aims at incentivizing local manufacture and indigenization of a supply ecosystem relating to certain products/industry.
2. The manner in which the amendments are being planned and bought into effect point towards a definite vision of achieving Atmnirbharta/self-reliance in local manufacture in key sectors.
3. Capitalize upon the chaos generated and consolidate position as preferred manufacturing and supply chain hub in case of some emerging as well as established sectors.

To summarize the above, the vision of Atmanirbhar Bharat is not going to be realized unless sustained efforts are made at the policy level to work on a two-pronged ‘Carrots and Sticks’ strategy i.e.,

1. Creating an environment conducive to growth of local manufacture and extension of benefit under PLI schemes to other emerging sectors – The ‘carrots’ approach and
2. Along with the above penalize/disincentivize imports – the ‘sticks’ approach.

The BCD rate increments highlighted above is a representative of ‘sticks approach’. Along with this, dangling carrots like PLI incentives would go a long way in attracting investment in the manufacturing sector. There may be international restrictions on ‘sticks’ approach as other countries may retaliate by levying duties on imports from India. Hence, the Government would have to do the balancing act of incentivizing local manufacturing and imposing tariff and non-tariff restrictions on imports selectively. This seems to be the direction in this Budget.   

Budget 2021: Significant Curtailment of Export-Linked Benefits Proposed under GST and Impact

This article has been co-authored by Onkar Sharma (Principal Associate), Khaitan & Co.

Introduction

Incentivising exports is a cornerstone of economic/trade policy for any mature economy. India has had several export-linked incentive schemes historically which even led to trouble at the WTO dispute settlement body recently.

However, several changes in the last twelve months have incrementally curtailed benefits under various export-linked incentives culminating in the biggest such proposed curtailment recently through the Union Budget 2021 proposals on IGST.

The proposed amendment

Clause 114 of the Finance Bill seeks to amend section 16 of the Integrated Goods and Services Tax Act, 2017 (the IGST Act) so as to restrict the benefit of refund of IGST in cases of zero rated supplies (which includes exports) upon payment of integrated tax only to a specified class of taxpayers or specified supplies of goods or services (to be notified).

Currently, the IGST Act provides for two options for suppliers of zero-rated supplies including exports:

1. Export/undertake zero-rated supply without payment of IGST under a bond of letter of undertaking (LUT) as per section 54 of the Central Goods and Services Tax Act, 2017 (the CGST Act) and claim refund of unutilised input tax credit on the input side supply of goods or services or both. Through the formula for calculation of refund amounts under CGST Rules, such refund claims are linked to the input tax credit availed on inputs and input services during the relevant period
2. Export/undertake zero-rated supply after payment of IGST and claim refund of the said IGST paid on the supplies. Since payment of IGST on exports/ zero-rated supplies could be made by utilizing credit which has transitioned from the pre-GST regime to GST, refund under this option, unlike option (i), was not necessarily a function of the input tax credit availed on inputs and input services during the relevant period.

More often than not, this option was exercised by exporters who had transitioned a large amount of credit from the pre-GST regime to GST.

It is pertinent to highlight that this two-option structure is not a new concept under GST; under central excise laws prior to introduction of GST, Rules 18 and 19 of the Central Excise Rules, 2002 also provided a similar two-option construct for incentivizing export of goods.

The proposed amendment in Budget 2021 effectively takes away option (ii) completely with an enabling provision to restore the same for a specified class of taxpayers or specified supplies of goods or services in an indeterminate future.

Backdrop to the proposed amendment – the disputes surrounding Rule 96(10) of CGST Rules

It is important to understand that this is not the first attempt by the Government to whittle down the benefit of option (ii) above – this proposed amendment has to be seen as a continuation of the earlier steps taken by the Government vide several amendments to Rule 96(10) of the CGST Rules. Rule 96 (10) underwent multiple amendments within a period of few months and is a subject matter of challenge before various High Courts on grounds of constitutional validity – this has been briefly discussed below.

At the time of implementation of GST, Section 16 of the IGST Act provided the two-option construct (discussed above) for exports:

• “….subject to such conditions, safeguards and procedure as may be prescribed….” and
• “….in accordance with the provisions of section 54 of the Central Goods and Services Tax Act or the rules made thereunder….”

There were no independent conditions/safeguards prescribed under the IGST Rules. Thus, conditions / safeguards were to be gleaned from Section 54 of the CGST Act and CGST Rules – that is where, Rule 96 comes into play.

Interestingly, Section 54 merely envisages prescribing the ‘form and manner’ for claiming refunds and not ‘conditions, safeguards’, relevant portions of Section 54 are excerpted below. No amendment has been proposed in Budget 2021 in this section.

“54. (1) Any person claiming refund of any tax and interest, if any, paid on such tax or any other amount paid by him, may make an application before the expiry of two years from the relevant date in such form and manner as may be prescribed:

Explanation— for the purposes of this section,––

(1) “refund” includes refund of tax paid on zero-rated supplies of goods or services or both or on inputs or input services used in making such zero-rated supplies, or refund of tax on the supply of goods regarded as deemed exports, or refund of unutilized input tax credit as provided under sub-section (3).…”

At the time of implementation of GST, Rule 96 was worded in a simple manner merely prescribing the form and manner in which the refund has to be claimed. Given the widely worded refund provisions at that time (in July to December 2017), many exporter-assesses availed the option of transitioning their available pre-GST input tax credits into GST since Section 16 of IGST Act read with 54 of CGST Act and Rule 96 of CGST Rules did not provide any fetters on the usage of such transitioned credit for payment of the IGST on exports and claiming refund of such IGST thereafter.

However, upon expiry of the period for transitioning of the pre-GST input credits, on 29 December 2017, sub-rule 9 was inserted in Rule 96, placing certain restrictions on the right to claim refund as guaranteed by Section 54 of the CGST Act. Rule 9 prescribed that the refund of IGST paid on export of goods or services was not available if the exporter had received supplies from a supplier who had availed the benefits under the three specified notifications. This was given retrospective effect from 23 October 2017.

Subsequently, the aforesaid sub-rule 9 was substituted by sub-rule 9 and 10 vide Notification No. 3/ 2018 dated 23 January 2018, which too was given effect from 23 October 2017. Vide the said amendment, two more notifications, although issued under Customs Act, 1962 (the Customs Act) were added to the list of benefits which, if availed by the supplier of the exporter, would lead to denial of refund of IGST paid on exports.

Rule 96(10) was amended multiple times thereafter to further refine/restrict the benefit of refund of IGST paid on exports.

As a result, assesses/exporters who had transitioned their pre-GST input credits on the legitimate expectation that they may utilize it to pay IGST on their exports and claim refund thereof were severely impacted. That led to Rule 96(10) being challenged across various High Courts on two key grounds, amongst others:

• Section 54 of the CGST Act empowers the authorities to only prescribe the form and manner in which the refund of tax and interest can be claimed by any person. However, Rule 96(10) goes beyond the given mandate/ power and prescribes specific restrictions on the right to refund guaranteed by the CGST Act.
• The retrospective amendment to Rule 96(10) took away a vested right of rebate in an unfair manner for no discernible policy objective – thus the same is arbitrary and manifestly unfair.

The proposed amendment to Section 16 of the IGST Act in Budget 2021 seeks to overcome these legal arguments by curtailing the benefit at the source itself - section 16 of the IGST Act.

This proposed amendment to section 16 of IGST Act is likely to be challenged in courts once brought into force and, like Rule 96(10), may be tested on the constitutional touchstones of reasonableness, legitimate expectation and vested rights.

Concluding thoughts: the larger context of curtailment of export incentives and need for correction

As stated at the beginning of this article, this proposed amendment is a culmination of several developments over the last twelve to fifteen months which have adversely affected Indian exporters.

These have been highlighted at length in the press release[1] dated 10 February 2021 by the Federation of Indian Export Organizations (FIEO), some key points are set out below:

• A large number of exporters have not received their claims for 2019-20 and 2020-21 (upto December 2020) both in respect of Merchandise Exports India Scheme (MEIS) and Services Exports India Scheme (SEIS).
• The RoDTEP Scheme was announced w.e.f 1 January 2021 but no rates thereunder have been announced yet. Exporters are thus unable to finalize their export contract prices.
• The e- Wallet scheme which was recommended by the GST Council in October 2017 has not been introduced yet. This would have provided much needed cash flow relief to the exporters in as much as their money would not get blocked in payment of taxes while procuring inputs for exports.
• The proposed amendment to Section 16 of IGST as discussed in this article.

Given how strongly the Government has been emphasizing the policy objectives of ‘Make in India’ and ‘Atmanirbhar Bharat’, it is surprising to see these developments adversely affecting the exporting community.

While misuse/frauds apropos export-linked benefits have probably been a driver behind such successive curtailment of benefits, one hopes that the Government will pay heed to the difficulties highlighted in the representation and press release by FIEO and arrive at a middle-ground balancing export incentivisation and anti-abuse provisions.

Section 16 amendment by Budget 2021 | Analysis and Impact

This article has been co-authored by Anoop Kalavath (Partner), Deloitte India.

Recently, the government has been successful in busting the rackets of input tax credit (‘ITC’) on fake invoices through the use of artificial intelligence which has been one of the reasons for highest collection of GST in the month of January 2021. With the economy recovering from the impact of the COVID-19 pandemic, all eyes were set on the new policies to be introduced in Budget 2021. Budget 2021 has been certainly ambitious in terms of spending without putting much additional burden in the form of new taxes or cesses on the common man. However, there have been certain amendments proposed in GST law, which ought to impact the industry. We have focused on one such amendment in section 16 of the Central Goods and Service Tax, 2017 (‘CGST Act’).

The process of ITC availment for a taxpayer has always been cumbersome. The challenges in terms of reconciliation of ITC with GSTR-2A have been imposed by Rule 36(4) of the Central Goods and Service Tax Rules, 2017 (‘CGST Rules’). Rule 36(4) of CGST Rules mandates registered person to reconcile the ITC to be availed with GSTR-2A and allows availment of additional 5% (w.e.f. 1 January 2021) of the eligible credit appearing in GSTR-2A. There have been various petitions filed before the High Court challenging the constitutionality of Rule 36(4). It has been argued by the petitioners that Rule 36(4) is ultra vires the CGST Act and imposes additional burden on the buyer contrary to the scheme of the CGST Act. In order to overcome this lacuna, the government has proposed amendment in section 16(2) of the CGST Act vide Finance Bill, 2021.

Clause 100 of the Finance Bill, 2021 has proposed insertion of clause (aa) in section 16(2) of the CGST Act as under:

“(aa) the details of the invoice or debit note referred to in clause (a) has been furnished by the supplier in the statement of outward supplies and such details have been communicated to the recipient of such invoice or debit note in the manner specified under section 37”

As per the above clause, the ITC eligibility shall be restricted to the credit reflected in GSTR-2A. The ITC will be reflected in GSTR-2A of the recipient once supplier files GSTR-1 return under section 37 of the CGST Act. The introduction of clause (aa) in section 16(2) has the following implications:

1.  The additional ITC of 5% available as per Rule 36(4) should be discontinued from the date clause (aa) in section 16(2) is sought to be notified.

2.  Clause (aa) in section 16(2) is applicable prospectively and is not in the nature of clarification. Thus, a view can be taken that Rule 36(4) is ultra vires up to the date clause (aa) in section 16(2) is notified.

3.  The government has provided an option to the taxpayers, having aggregate turnover of less than INR 5 crores to file GSTR-1 return quarterly. In case goods or services are availed from such taxpayers, it results in delay of ITC availment as the details will be reflected in GSTR-2A of the receiver after 3 months. Thus, it results in outlay of cash for payment of GST liability as ITC cannot be availed while determining monthly GST liability. This results in blocking of working capital, affecting the small taxpayers. As the average credit period in case of supply of goods or services for small taxpayers is around 3 months, almost entire profit margin of the taxpayer is spent in payment of GST liability (which is to be paid monthly).

4.  Clause (aa) in section 16(2) casts onus on the recipient to ensure that the supplier has filed their GST returns under section 37(1) which is impossible. There is no enforcement mechanism in the hands of the recipient to enforce the supplier to file the returns whereas, the department has all the machinery at its disposal to effect recovery from the defaulting suppliers. One such case is pending before the Delhi High Court in the matter of Bharti Telemedia Ltd. vs Union of India W.P.(C) 6293/2019 & C.M. No. 26893/201 on the issue of denial of ITC due to supplier’s default. The proposed clause (aa) also does not comply with the maxim lex non cogitate ad impossible (the law does not compel the doing of impossibilities) and therefore its constitutionality can be challenged.

It would be interesting to see the interpretation of the High Courts once the proposed amendment in section 16(2) is notified by the government. The GST authorities should be given the power under the CGST Act to consider exceptional cases, where the recipient can prove eligibility of ITC which has been rejected due to default not attributable to the recipient. Further, rectification of GSTR-1 return should be allowed up to the due date of filing the annual returns as it will provide sufficient time period to the assessee. This should reduce the litigation and further simplify the compliance process. Such loss of ITC results in increase in cost, which is ultimately passed on the consumer in the form of increased prices. Therefore, it is relevant to introduce mechanisms to prevent loss of such eligible ITC.

Slump Exchange in Going Concern – An Analysis

This article has been co-authored by Sonali Valanju.

In the era where many traditional businesses are facing problems for their survival because of the COVID -19 pandemic, consolidation of multiple entities under family run setup are key concern from the point of view of compliance and finance. Further, mergers & acquisition are also taking place rapidly for attaining synergy in business, diversification of risk, economies of scale, etc. Under these circumstances, Slump Sale is the most preferred way of carrying out mergers and acquisition deal due with least complex and well-defined tax implications under Income Tax and GST as well as procedures under Companies Act, that are simple and time efficient than the other types of mergers and acquisition strategies. Slump Sale is an effective strategy for transferring assets and liabilities due to the following reasons:

• The transferee/buyer would like to strategically expand its existing business or looking to diversify in a new business altogether by acquiring business undertaking through slump sale.
• The transferor/seller would like to segregate their core operation from the non-core operations.
• In the case of non-corporate entities, where the transfer is not possible through a merger or a demerger, slump sale can be one of the options that can be taken for the transfer of business undertaking.

Expanded scope of slump sale by Finance Bill,2021:

With the effect from 1st April 2021, it is proposed to widen the definition of Slump Sale u/s 2(42C) of the Income Tax Act, 1961 to include the transfer of one or more undertakings 'by any means' for lump sum consideration without value being assigned to individual assets and liabilities in such cases. Post amendment, all types of transfer of an undertaking whether by slump sale (consideration received in cash) or slump exchange (exchange of shares, debentures etc) are sought to be covered by the provisions of slump sale under Section 50B and resulting gain shall be subject to capital gain implication.

Rationale of proposed amendment:

Reproducing the relevant para of Memorandum Explaining the Finance Bill, 2021:

While discussing transfer as a result of sale it needs to be kept in mind that it is the substance of transaction that is more important than the name given to it by the parties to the transaction. For example, a transaction of ―sale may be disguised as ―exchange by the parties to the transaction, but such transactions may already be covered under the definition of slump sale as it exists today on the basis that it is transfer by way of sale and not by way of exchange.

Currently, the definition of slump sale includes only those transfer of business/ undertaking which are transferred in lieu of cash. In other words, if the transfer takes place in exchange of shares, debentures, bonds they were outside the purview of section 50B of Income Tax Act, 1961. However, series of precedents pronounced in last few years created ambiguity regarding taxability of business transfer for barter or share exchange.

Challenges of ‘slump exchange’ inclusion in ‘slump sale’ defined u/s 2(42C) of the Income Tax Act,1961

By proposing amendment, Government opens pandora’s box on taxation of business transfer where no clarification has been provided with respect to provisions of section 47 of the Income Tax Act dealing with transfer of business on going concern basis. Section 47 is one of the sections where transfer of asset and liabilities of business on going concern takes place and capital gain tax is not applicable subject to conditions laid down in respective sections:

Let’s understand the implication of transfer of business in light of existing provision of the Act and proposed amendment where there may be some litigation from taxman as anticipated.

Case study:

Facts

Mr. A (Age 65 years) a proprietor, owns manufacturing facility - textile processing unit at Gujarat in the name of ‘A & Co.’ and exporting good quality dye and processed fabric to European Markets since 35 years which comprises of 90% of the total business.

Due to old age and no successor in the family, Mr. A decides to transfer the business but was emotionally attached to the business so he wants to transfer the business with core values which he live by over the years through hard work and integrity to the person who can continue the legacy and principles on which he operated so far.

Mr. A wants to exit the business in a phased manner. B & family, one of his Indian customers since 1991, approached him for business transfer as they were interested in backward integration of their business.

As a matter of understanding, they decide as under:

• Mr. B & family would form Private Ltd Company named AB Pvt Ltd to demonstrate the collaboration of A & B.
• Mr. A will run the business with Mr. B & Family for next 5 years where he will handover all technical know-how and other commercial rights, customer networks, all orders to Mr. B and family.
• B & Family will buy the business for 175 crores whereby Mr A is allotted shares as per mutual understanding and balance were settled in cash for his daily maintenance.
• Mr. A will work as mentor on board for next 5 years for which no remuneration will be received to Mr. A as he will be receiving consideration in form of shares and cash up front. And the shares will be transferred by Mr A at the end of 5th year by giving first time right refusal to B & family or any private investor as suggested by Mr B & family.

Mr A wants to know what will be the tax implication on above said transaction and he always wants to explore any other option to optimise tax? From the available information, following options can be explored by Mr. A related to tax. They are as follows:

Option 1

As per said conditions if transaction of business transfer on going concern is settled partly in cash and partly in shares then the said transaction will be subject to long term capital gain tax under section 50B @ 20% + surcharge + cess (Relied upon CIT v. Bharat Bijlee Ltd [2014] [TS-270-HC-2014(BOM)-O] (Bom))

Option 2

Since the facts are not completely given about comfort of B & family in restructuring business but if options are explored further then A & B may decide to collaborate whereby:

I. A’s business is taken over by new entity with condition that A will get consideration only in the form of shares and he would support the new entity’s business for next 5 years as mentor to the new management then he can legitimately avoid tax on total consideration by complying with the following conditions as prescribed u/s 47(xiv) (conversion of sole proprietorship into Company).

• All the asset and liabilities of A & Co. would become the asset and liabilities of the AB Pvt. Ltd. and business should run as a going concern.
• Shareholding of A should get at least 50% voting power in AB Pvt. Ltd. entity which he shall continue for 5 years from the date of conversion.
• Mr. A does not receive any consideration or benefit directly or indirectly in any other form or manner other than by way of allotment of shares in the AB Pvt. Ltd.

II. Mr A can receive remuneration for period of 5 years towards his labour and efforts to maintain profitability and business of AB Pvt. Ltd. However, remuneration shall not be part of consideration receivable by Mr. A on account of business transfer.

If aforesaid conditions are satisfied, then entire capital gain will not be taxed at the time of transfer of business on going concern. However, whenever Mr A sell his shares it will subject to capital gain tax.

Although, section 50B is widened enough to cover slump exchange as taxable event but by relying on judgement pronounced in case of CIT v. Areva T & D India Pvt td [2020], transfer of business on going concern basis in form of shares only and if conditions of section 47(xiv) are compiled then transaction can attract no taxation.

Scenario 1 - When there is a change in business line:

Assuming Mr. A & B agrees on option 2 and decide to convert sole proprietorship into Private Limited Company by complying the condition as per provisions of section 47(xiv). What will be the tax implication if line of business is changed, traditional practice is changed, and new technology is been incorporated in business after conversion?

Points to be noted:

Change of business line is subject to various internal and external factors. If change in line of business is due to obsolescence of old technology and adoption of new technology, then the change in line of business is not intentional for taking benefits of tax exemption under section 47 and conditions stated in section 47(xiv) would not be violated provided the condition of shareholding of A of at least 50% voting power in AB Pvt. Ltd. which he shall continue for 5 years from the date of conversion should not change.

The conditions laid down in section 47 needs to be satisfied at the time of conversion of sole proprietorship into Privat Limited Company. However, if the intention of parties of changing the line of business is apparent on the date of conversion and after conversion if the line of business is changed then conditions of Section 47(xiv) can be challenged by invoking GAAR provisions and the transaction may be subject to tax in the hands of Mr. A. 

Scenario 2 – On death of transferor within 5 years:

What if post conversion Mr. A died and shares of A in AB Private Ltd is transferred to his legal representative, his wife. Will it attract taxation in the hands of Mr. A/ legal representative of Mr. A?

Points to be noted:

Transfer of shares in the event of death of Mr. A is by the way of transmission or not by transfer of shares in true sense. Therefore, conditions of section 47(xiv) are not violated provided that legal representative of Mr A continues to hold shares in AB Private Ltd for uninterrupted period for 5 years.

Scenario 3– Acquisition by Third Party:

What if after conversion AB Private Ltd gets acquired by MNC Z Inc having Indian subsidiary Z Ltd on-going concern basis by court process whereby shareholders of AB Pvt. Ltd. continues to gets the share of other company. What will be the tax implication in the hands of Mr. A?

Points to be noted:

AB private Limited company gets acquired by Z Ltd post compliance of regulatory processes then transfer of assets and liabilities will not be subject to tax under section 47(vi) provided:

1. Z Ltd is an Indian Company
2. All assets and liabilities of AB Pvt Ltd are transferred on going concern basis to Z Ltd.

Also as stated in CIT v. Bharat Bijlee Ltd [2014] that merger took place by court process, it is the case of transfer and not sale, therefore, provisions related to slump sale would not applicable.

Pros & Cons of Slump exchange:

Pros

• Slump exchange is one of the effective methods for business synergy, for cash strapped companies who are facing issues of liquidity post COVID-19 period.
• Slump exchange can enable seller to unlock values with future performance of business.
• It is cash-less form of transfer of business undertaking with minimum time required for procedure to complete and very effective form to Small and Medium enterprises.
• No restriction for adherence to FMV of the assets from seller and buyer perspective.
• Slump exchange in form of any of the schemes laid down in section 47 can result into exempt status (as discussed supra).

Cons

• Slump exchange would attract tax outflow in the year of exchange.
• Slum Exchange in transfer of business on going concern basis may result into litigation in coming years due to overruling of various favourable pronouncements due to amendment.
• W.e.f AY 2021-22 the buyer will not get depreciation on goodwill if the acquiring value exceed net asset of the undertaking. This would result into disruption in commercial deals. Following rulings were overruled by the proposed amendment:

1. CIT v Smifs Securities Ltd [2012] [TS-639-SC-2012-O] (SC)
2. PCIT v Zydus Wellness Ltd. [2020] [TS-5014-SC-2020-O] (SC)

Key concerns:

• Applicability of deeming provisions of section 50 in case of sale of depreciable asset on which no depreciation was charged since last many years due to closure of business or otherwise.
• In case of lump sum sale consideration for sale of land & building, plant & machinery furniture along with net current assets thereon, apportionment of the same towards various assets require consideration of fair value of individual assets in the hands of buyer. Any price paid more than net assets shall be considered as Goodwill. Therefore, it is the duty of buyer to get valuation report from independent valuer for proper price allocation. With the effect from AY 2021-22 depreciation on goodwill is not permissible. The issue needs to be examined in future as it is not free from litigation.

• No clarity on reversal of GST credit claimed in past years as slump sale on going concern is exempt due to notification 12/2017-Central Tax.

Considering the above issues considering proposed amendment, it can be concluded that all business transfer / undertaking exchanged by any means would attract the provisions of section 50B of the Income Tax Act 1961 unless they are covered under section 47 of the Income Tax Act. But the issue needs to be examined in future as it is not free from litigation.

(The authors extend special thanks to CA Meet Thakkar for valuable suggestions.)

Treaty relief on TDS for FIIs – other non-resident payees?

This article has been co-authored by Natasha Carvalho (Chartered Accountant).

The Finance Bill, 2021, proposes to specifically allow application of a beneficial tax rate under the applicable treaty for tax deduction at source from payments to a Foreign Institutional Investor (FII) under section 196D of the Act[1].

It is important to understand the context in which this amendment is proposed, its implication on the past payments, as also, other payments to non-residents that are covered under the tax deduction provisions similar to section 196D.

Section 196D – current provisions

Presently, section 196D specifies a tax deduction rate of 20% (plus applicable surcharge and cess) for the specified payments made to an FII. 

Unlike section 195 or section 192, section 196D does not expressly restrict itself to any sum or income which is chargeable to tax under the Act. Also, there is no express provision in section 196D for application of the treaty rate, if it is beneficial to the FII.

Proposed amendment

The Finance Bill, 2021, proposes to insert a proviso to section 196D(1), with effect from 1 April 2021. The text of the proviso is reproduced below:

“Provided that where an agreement referred to in subsection (1) of section 90 or sub-section (1) of section 90A applies to the payee and if the payee has furnished a certificate referred to in sub-section (4) of section 90 or sub-section (4) of section 90A, as the case may be, then, income-tax thereon shall be deducted at the rate of twenty per cent. or at the rate or rates of income-tax provided in such agreement for such income, whichever is lower.”

Context behind the Amendment

Prior to the proposed amendment, in cases where the income of the FII was not chargeable to tax or chargeable to tax at a lower rate under the applicable tax treaty, the issue prevailed as to whether tax should be deducted at the rate as per section 196D or as per the treaty.

Settled position for sections 192 and 195 – whether applicable to section 196D?

The law was settled by the Supreme Court decisions in case of CIT v. Eli Lilly & Co. (India) P. Ltd[2] and GE India Technology Centre P. Ltd. v. CIT[3] with respect to payments to non-residents under sections 195 and 192. It is clear that the payments which fall under these sections are not liable to tax deduction if they are not chargeable to tax under the Act or the applicable tax treaty. If they are liable for tax deduction, the beneficial rate of tax, as per the Act or the applicable treaty, applies.

The Supreme Court, while dealing with those sections in the above decisions, had observed that if the payment being made to a non-resident is not chargeable to tax as per the applicable tax treaty, the tax deduction provisions under the Act should not apply to such a payment.

As per one school of thought, the observations of the Supreme Court in the above decisions also applied to payments covered under section 196D and other similar sections, such as sections 194E, 194LB, 194LC and 194LD, which specify a fixed tax deduction rate.

Supreme Court decision in the case of PILCOM - effect

In the context of section 194E (which specifies a fixed tax deduction rate), in the case of PILCOM v. CIT[4], the Supreme Court observed that the taxability under the applicable tax treaty is not relevant in determining the tax deduction obligation of the payer. Thus, it was held that irrespective of the taxability under the treaty, the payer is required to deduct tax at source at the rate specified in section 194E.

This decision squarely applies to payments covered under similar provisions, including section 196D. Hence, based on this decision, the payments covered under section 196D are liable for tax deduction at the rate specified therein, irrespective of their chargeability or a beneficial tax rate under the applicable treaty.

The deduction of tax, without giving regard to the treaty would have caused undue hardship to the FIIs receiving payments covered under section 196D. The result was blocking of funds for the FIIs until they receive refund from the income tax authorities.

Particularly, since dividends became taxable under the Act from FY 2020-21 onwards, this issue gathered more prominence.

Effect of the Proposed Amendment

With the proposed amendment to section 196D, the tax deduction from the payments to FIIs would be at the beneficial rate under the Act or the applicable treaty. Thus, the FIIs are relieved of the hardship that could have resulted from tax deduction at a higher rate, where the treaty either exempts the relevant income or specifies a lower tax rate for such income.

Position upto FY 2020-21 – section 196D

The proposed amendment to section 196D(1) applies to payments from 1 April 2021.

A question could arise for the payments made prior to that date, as to whether the taxability under the treaty could be taken into account.

Payments not chargeable to tax under the treaty

In cases where the payments are not chargeable to tax under the tax treaty, it is well settled that section 4(1) of the Act does not apply. Hence, as per one school of thought, for such payments, based on the Supreme Court decisions in case of Eli Lilly (supra) and GE Technology (supra), the tax deduction provisions, as governed by section 4(2) of the Act also do not apply. Based on this thought process, section 196D provisions would not apply to such payments which are not chargeable to tax under the treaty.

However, with the Supreme Court decision in case of PILCOM, there remains no room for the above contentions with respect to the payments made prior to the applicability of the proposed amendment. If at all, such a contention, would take its course again for a resolution at the Apex Court.

Payments chargeable to tax at a lower rate under the treaty

For payments to which a lower tax rate applied as per the applicable tax treaty, making the above contentions relating to applicability of section 4(2) appear to be more challenging and disputable.

However, the Pune bench of the Tribunal, in the case of DDIT v. Serum Institute of India Limited[5] and the Hyderabad Special Bench of the Tribunal, in Nagarjuna Fertilizers & Chemicals Ltd. v. ACIT[6], in the context of section 206AA, held that wherever the treaty specifies a lower rate, tax deduction at the higher rate in section 206AA is not justified.

However, as stated above, with the Supreme Court decision in the case of PILCOM, there does not appear to be any room for the contention to apply the lower rate under the treaty for payments made prior to the applicability of the proposed amendment. 

Thus, all payments covered under section 196D, made prior to 1 April 2021, should be liable for tax deduction at the rate specified in the section, based on the decision in the case of PILCOM.

Position under other similar sections

The proposed amendment by the Finance Bill, 2021, allowing the beneficial rate under the treaty is only in section 196D(1). There is no similar amendment proposed in the other sections which also specify a fixed rate for deduction of tax at source from payments to non-residents. Some of the key sections are listed below:

194E - Payments to non-resident sportsmen or sports associations

194LB - Income by way of interest from infrastructure debt fund

194LBA - Certain income from units of a business trust

194LC - Income by way of interest from Indian company

194LD - Income by way of interest on certain bonds and Government securities

196A - Income in respect of units of non-residents

196B - Income from units payable to an Offshore Fund

196C - Income from foreign currency bonds or shares of Indian company

In the absence of an amendment similar to section 196D, the position for tax deduction under section 196D for the years prior to the proposed amendment should also apply to the above sections.

Thus, based on the decision in the case of PILCOM, the payments to which the above sections apply, are liable for tax deduction at the rates specified therein.

Parting thoughts

The proposed amendment to section 196D is a welcome move by the Legislature. It is one of the positive measures taken by the Government to make India a preferred investor-friendly jurisdiction in terms of compliances.

Having said so, yeh dil maange more! The non-resident payees to whom the tax deduction sections similar to section 196D (specifying a fixed tax deduction rate) apply, are still waiting to get their share of the relief. 

Reassessment Regime - New Wine in an Old Bottle!

This article has been co-authored by Palak B. Mehta (Chartered Accountant) and Ashna Poojari (Chartered Accountant).

In the Income-tax Act (‘ITA’), in order to assess the income of the Taxpayer, the assessment procedure has been prescribed; and at the same time if some income has escaped assessment, the procedure has been laid down to reassess the income of the Taxpayer. The provision to reassess the income of Taxpayer which has escaped assessment was initially part of Income Tax Act, 1922 and after various amendments from time to time, the same has been in present form, before being substituted by new provisions in Finance Bill, 2021.

The existing provisions relating to reassessment in the Income-tax Act,1961  provide that if the Assessing Officer (‘AO’) has “reason to believe” that any income chargeable to tax has escaped assessment for any assessment year, he may assess or reassess or re-compute the total income for such year. The Memorandum explaining Finance Bill, 2021, mentions the intention of Parliament to introduce new provisions for reassessment wherein it is stated that due to advancement of technology, the department is now collecting all relevant information related to transactions of taxpayers from third parties under section 285BA of the ITA (statement of financial transaction or reportable account). Similarly, information is also received from other law enforcement agencies. Thus, in order to empower Tax Authority to reopen the assessment in such a situation, amid the new provisions, the Tax Authority has been allowed to reopen the assessment on the basis of the information so collected by the Tax Authority.

Accordingly, the Finance Bill 2021 has proposed to completely reform the system of reassessment and the assessment of search related cases.

In view of the above, in this article, we would like to discuss some of the important facets of the old and new provisions of reassessment proceedings and also the comparative analysis between old and new provisions of reassessment proceedings as under:

I.  Pre amended regime of Reassessment Proceedings (Old regime) [Section 147 to Section 153 of ITA]

1. The old regime related to the reassessment provided that if the AO had ‘reason to believe’ that income chargeable to tax had escaped assessment, he may assess or reassess the same under Section 147 of ITA by issuing notice under section 148 of the ITA subject to time limits prescribed under Section 149 of ITA after obtaining sanction from prescribed authority as under section 151 of ITA.

A. Period of Limitation

• Four years (in general cases)
• Six years (Escaped income more than Rs.1 Lac)
• Sixteen years (Undisclosed foreign asset or income cases) (Introduced by Finance Act 2012, with effect from 1 July 2012 and also applicable for any AY beginning on or before 1 April 2012)
• Agent of Non-Resident: Six years (Introduced by Finance Act 2012 and also applicable for any AY beginning on or before 1 April 2012)

B. Settled concepts in old regime

2. In the old regime there were various issues subject to litigation in the reassessment proceedings and have been settled by Apex Court and various other Courts and some of the relevant ones are as under:

1. The essential element of old regime clearly postulated that AO should have ‘reason to believe’ that certain income has escaped assessment. [introduced vide Direct Tax Laws (Amendment) Act, 1989]:
   • Change of opinion cannot be considered as ‘reason to believe’ [Kelvinator of India (2010)([TS-5005-SC-2010-O])(SC)];
   • Reopening should be based on ‘tangible material’;
   • Comptroller and Auditor General (‘C&AG’) opinion does not constitute ‘reason to believe’’
   • Presence of ‘live linkage’ with the reason to believe that income has escaped assessment;
   • Reopening on the basis of assumptions or surmise was considered as bad in law [Coca-Cola Export Corporation (1990) ([TS-5033-SC-1998-O]) (SC)].
2. No reassessment can be initiated beyond 4 years if original assessment was under section 143(3) of the ITA and there was” full and true disclosure of all material facts”. [Lakhmani Mewal Das ([TS-3-SC-1976-O])(SC)] [introduced vide Direct Tax Laws (Amendment) Act, 1989]
3. Notice issued under section 148 of the ITA issued shall be issued with approval of superior authorities as per section 151 of the ITA and they should be satisfied with reasons recorded by AO (applicable for cases reopened after expiry of 4 years). Mechanical approval without application of mind by superior authority invalidates reassessment proceedings [German Remedies Ltd ([TS-5884-HC-2005(BOMBAY)-O]) (Bombay HC)]
4. Tax Authority shall record reason before issuing notice [Vide Direct Tax Laws (Amendment) Act, 1989] and Taxpayer can seek reasons recorded and Tax Authority is bound to provide the same and objections could be raised by Taxpayer and Tax Authority is required to dispose of such objections by passing speaking order. [Procedure  to be followed was laid down by Supreme Court in case of GKN ruling Driveshafts (2002)([TS-4-SC-2002-O])(SC)],
5. Judicial conflict on AO’s ability to make additions on new issues if no additions were made on primary issues. Explanation 3 to Section 147 of the ITA (Introduced by Finance Act, 2009 with retrospective effect from 1 April 1989). However, the judicial conflict continued on this issue even after introduction of Explanation 3 to Section 147 with retrospective effect. Some of the favourable and against ruling on the same are as under:
   • Favourable Ruling: Hon’ble Bombay High Court in case of Jet Airways (2011) ([TS-160-HC-2010(BOM)-O])
   • Favourable Ruling: Hon’ble Bombay High Court in case of Black & Veatch Prichard Inc. (2016) (SLP granted)
   • Against Ruling: Hon’ble Punjab & Haryana High Court in case of Majinder Singh Kang ([TS-5671-HC-2010(PUNJAB & HARYANA)-O])(2012) (SLP dismissed)
   • Delhi High Court referred to Full Bench in case of Jakhotia Plastics (P.) Ltd. [TS-5188-HC-2018(DELHI)-O] (Delhi HC)(However, the Assessee had filed SLP against the reference to Full Bench which was dismissed by SC. However, the decision on issue in dispute is still pending before Full Bench)

3. The law which was settled from last 60+ years has been proposed to be  done away and vide Finance Bill 2021 a new procedure has been introduced to substitute in place of , existing provisions relating to reassessment of income, with the following intention:

• To reduce litigation
• Ease of doing business to Taxpayer due to reduced time limit for reassessment
• Safeguard to the taxpayer as Approval of Specified Authority required at various stages
• Opportunity of being heard to Taxpayer even before proceeding with reopening

4. In backdrop of erstwhile provisions, let us now discuss the new provisions of reassessment, which are summarized as under:

II. Post Amendment Regime (New Regime) (Section 147 to 153 of ITA) (introduced vide Finance Bill 2021)

A. Revised Time Limit for issuance of notice under section 149 of ITA

• 3 years (in general Cases)
• 10 years where Assessing Officer has books/documents/evidence in possession which reveal taxable income,
  • Which is represented in form of asset;
  • Income escaping assessment is more than Rs. 50 lacs (Threshold to be seen annually and not in aggregate for all AYs)

The aforesaid time limit is for issuance of notice and not for completion of reassessment. Time limit for completion of reassessment is governed by provisions of Section 153(2) of the ITA (i.e. 12 months from end of FY in which notice was served).

     Exception:

• Revised time limits would not apply where notice under Section 153A and 153C of the ITA is required to be issued on or before 31 March 21;
• Provisions of Section 153A/153C of the ITA will not apply in case of search initiated on or after 1 April 2021. Thereupon, the assessment would be governed in terms of new regime.

While determining period of limitation, following period is to be excluded:

• Time allowed to taxpayer to reply to show cause notice (SCN) under section 148A of the ITA;
• Time period for which section 148A of the ITA proceedings are stayed by a court order/ injunction.

B. Conditions for Reassessment

6. The new regime states that the Tax Authority can reassess the escaped income only if the Tax Authority has “information” which “suggests” escapement of income. In this regard, the two essential conditions which postulates that information suggests escapement of income are as under:

• Information flagged in taxpayer’s case for relevant AY in accordance with risk management strategy formulated by CBDT from time to time. However, following points need to be considered:
  • • Information should have linkage with actual escapement of income as held in old regime;
    • Covers “any” information and hence the scope of information may be litigation prone;
    • Emphasis on “information” is still a pre-requisite;
    • Risk Management strategy:
      • being internal document of department, it would be difficult of taxpayer to understand the criteria basis which the information is flagged;
      • may change on year on year basis thereby would lack uniformity/consistency.
• Any final objection raised by C&AG about taxpayer’s assessment not being made in accordance with provisions of ITA.
  • • Prior assessment is mandatory and some issue not been visited by AO during original assessment proceedings and C&AG feels same leads to escapement of income;
    • However, exact scope of ‘final objection’ is not very clear ;
    • Under old regime, objection of C&AG is not considered valid basis for forming reassessment opinion [Jyoti Ltd ([TS-5256-HC-1977(GUJARAT)-O]) (Guj HC)]; 

7. Thus, now the “reason to believe” has shifted to possession of “Information which suggests that income has escaped assessment”

C. New Faceless Procedure under Section 148A of the ITA

8. In the new regime, the Tax Authority will have to follow the new procedure as per section 148A of the ITA which is explained in the flowchart below:

9. In the above procedure, there is no remedy available with Taxpayer in the ITA to contest the order under section 148A(d) of ITA. Thus, the Taxpayer has an option to file writ against the said order before High Court.

10. Further, even in the new regime, the approval by specified authority must be after application of mind and it should not be mechanical approval as it was settled in the old regime.

D. Grandfathering provision

12. Under first proviso to proposed Section 149(1) of the ITA, issuance of notice under Section 148 of ITA for reassessment of AY 2021-22 and prior AYs under the new regime possible only if time limit for issue of notice under section 148 of ITA under old regime [6 years as per Section 149(1)(b)] has not already expired on date of issuance of notice. In other words, proceeding may be commenced in new regime even for such past years, the limitation period may however be ascertained on the date of issuance of notice basis the old regime. Accordingly, in case of AY 2021-22 and prior AYs, if the same could not have been reopened as on 1 April 2021, as it was beyond 6 years time limit, then the same cannot be reopened even under new regime.
13. However, it is pertinent to note that similar amendment has not been proposed for cases of 4 years [Section 149(1)(a)] and 16 years [Section 149(1)(c)] under old regime. Thus, in absence of saving provision, it is possible for Dept to take view that  since it is  procedural provision, hence  limitation period will apply as per new regime ;as generally the provisions relating to time limit are part of procedural law.

III. Comparison of old regime and new regime

14. For the sake of clarity, we have summarised the comparison between old and new provisions of reassessment proceedings as under:

IV Conclusion

15. Thus, it can be noted from the above provisions that though the government has introduced new regime to reduce litigation, settle old controversies and provide ease of doing business to the taxpayers, but at the same time, new regime brings out a whole new set of controversies which are completely new and unsettled and would open a new gateway of litigation in future. It took almost 60+ years  to somehow settle the existing law on reassessment and even till today the litigation on procedure of reassessment was challenged by Taxpayer before various Court/Tribunals basis settled law on reassessment and now the same saga will continue from this year onwards on the newly inserted section on reassessment.

Depreciation on Goodwill – Part II – Synthesis or Metamorphosis?

This article has been co-authored by Zeel Jambuwala and Jay Shah.

The amendments proposed by the Finance Bill, 2021 in relation to depreciation on goodwill are likely to have a far-reaching impact on M&A transactions. In Part I, we had discussed the jurisprudence on depreciation on goodwill under the provisions of the Income-tax Act, 1961 (‘the Act’) focusing on the pre-Budget scenario. This part contains our analysis of the proposed Budget 2021 amendments along with their potential implications.

1. Proposed amendments in Finance Bill, 2021

The Finance Bill, 2021 has proposed the following amendments in the Act with respect to depreciation on goodwill w.e.f. AY 2021-22.

1.1 Amendment to section 2(11) – Block of Asset

1.1.1 Currently, the term ‘block of assets’ is defined under section 2(11) of the Act as under –

"block of assets" means a group of assets falling within a class of assets comprising—

(a) tangible assets, being buildings, machinery, plant or furniture ;

(b) intangible assets, being know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature,

in respect of which the same percentage of depreciation is prescribed;

1.1.2  The definition of ‘block of asset’ provided in section 2(11) of the Act is proposed to be amended to expressly provide that ‘block of asset’ shall not include goodwill of a business or profession.

1.2 Amendment to section 32 of the Act – Depreciation

1.2.1 Section 32 of the Act provides that depreciation on specified tangible and intangible assets shall be allowed as deduction at specified percentage of written down value (‘WDV’) of block of assets.

• Clause (ii) of section 32(1) of the Act lists the intangible assets eligible for depreciation which essentially includes the same assets as provided in the aforementioned definition of block of assets under section 2(11) of the Act.
• Further, Explanation 3 to section 32(1) of the Act defines the term ‘assets’ to mean specified tangible and intangible assets. This list of assets is also same as contained in section 2(11) and section 32(1)(ii) of the Act.

Section 32(1)(ii) and Explanation to section 32(1) of the Act are proposed to be amended by the Finance Bill, 2021 to provide that goodwill of a business or profession shall not be considered as an asset for the purpose of these provisions.

1.3 Amendment to section 50 of the Act – Special provision for computation of capital gains in case of depreciable assets   

1.3.1 Section 50 of the Act contains special provisions that are applicable for computing capital gains in case of depreciable assets. Sub-section (2) of section 50 of the Act currently reads as under –

“Where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.”

1.3.2 Finance Bill, 2021 proposes to insert a proviso to section 50(2) of the Act as under –

“Provided that in a case where goodwill of a business or profession forms part of a block of asset for the assessment year beginning on the 1st day of April, 2020 and depreciation thereon has been obtained by the assessee under the Act, the written down value of that block of asset and short term capital gain, if any, shall be determined in such manner as may be prescribed.”

1.4 Amendment to section 55 of the Act – Meaning of cost of acquisition of capital asset

1.4.1 Section 55 of the Act inter alia stipulates the cost of acquisition under specific scenarios and for specific assets. Section 55 is now proposed to be amended by substituting clause (a) of sub-section (2) to provide that cost of acquisition in relation to a capital asset, being goodwill of a business or profession, or a trademark or brand name associated with a business or profession, or a right to manufacture, produce or process any article or thing, or right to carry on any business or profession, or tenancy rights, or stage carriage permits, or loom hours, -

a) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price;

b) in the case falling under sub-clause (i) to (iv) of section 49(1) and where such asset was acquired by the previous owner (as defined in that section) by purchase, means the amount of the purchase price for such previous owner;

c) in any other case, shall be taken to be nil.

1.4.2 Further, a proviso is proposed to be inserted to clause (a) of section 55(2) to provide that in case of goodwill of business or profession acquired by the assessee by way of purchase from a previous owner [either directly or through modes specified under sub-clause (i) to (iv) of section 49(1)] and any deduction on account of depreciation under section 32 of the Act has been obtained by the assessee in previous year 2019-20 or earlier, then the cost of acquisition will be the purchase price as reduced by the depreciation so obtained by the assessee in previous year 2019-20 or earlier.

1.5 The above amendments are proposed to take effect from assessment year 2021-22 (financial year 2020-21) onwards.

2. Impact of proposed amendments   

2.1 Permissibility of depreciation on goodwill from FY 2020-21 (AY 2021-22) onwards   

2.1.1 Finance Bill, 2021 proposes to amend the Act to provide that goodwill will not be considered as a depreciable asset and depreciation will not be allowed on goodwill.   

2.1.2 The proposed amendment seeks to nullify the decision of Supreme Court in case of Smifs Securities Ltd[1] wherein it was held that goodwill would fall under the expression 'any other business or commercial right of a similar nature' in section 32 of the Act and depreciation was held to be allowable on goodwill under section 32 of the Act.   

2.1.3 Further, the amendments neither provide for any distinction between goodwill recognized in the course of tax neutral reorganizations (merger, demerger) versus goodwill recognized in the course of a taxable transaction (slump sale); nor does it provide for any differential treatment for transactions between related parties and unrelated parties. It is proposed under the Finance Bill, 2021 that depreciation shall not be allowed on goodwill in any scenario. 

2.1.4 Considering the proposed amendment, where an assessee acquires goodwill in FY 2020-21 or in subsequent financial year, such goodwill will not be regarded as a depreciable asset and the assessee will not be allowed any depreciation thereon. This would impact the acquisitions that have taken place in the current financial year where the acquirer would have factored depreciation on goodwill as an eligible tax break. Where such acquisition has already been concluded, the acquirer would need to consider interest liability on account of non-payment / short payment of advance tax in earlier quarters due to depreciation on goodwill not being eligible as a deduction w.e.f. FY 2020-21. For instance, a taxpayer has acquired a business in the first quarter of FY 2020-21 and also paid for goodwill for such acquisition. It may have considered such goodwill to be eligible for depreciation under section 32 of the Act by placing reliance on Supreme Court decision in case of Smifs Securities (supra) and may have accordingly computed its advance tax liability for the first three quarters. In light of the proposed amendment, the taxpayer’s advance tax liability for the first three quarters would increase resulting in interest liability under section 234C. 

2.1.5 It has been held in certain judicial precedents[2] that interest under section 234B / 234C of the Act should not apply due to advance tax liability arising due to retrospective amendment. Courts have held that an assessee should not be fastened with interest liability on additions made on the basis of subsequent amendment, since the assessee could not have foreseen the liability, at the time of estimating his income for the purpose of payment of advance tax. 

2.1.6 It would be interesting to test the contention of non-applicability of interest liability under section 234C of the Act by resorting to these judgments, by taking a plea that while making payment of advance tax in the first three quarters, the taxpayer could not have pre-empted such amendments and hence it could not have foreseen the consequent tax liability at the time of payment of instalments of advance tax.   

2.1.7 Further, where the acquisitions have not been concluded, the acquirer may need to revisit the acquisition modalities, purchase price allocation and the valuation / acquisition price with the acquisition becoming expensive due to denial of tax break for depreciation on goodwill.

2.2 Allowability of depreciation on goodwill claimed in years prior to FY 2020-21   

2.2.1 Considering that the amendments proposed by Finance Bill, 2021 are slated to take effect from FY 2020-21, depreciation on goodwill legitimately claimed in earlier years should not be impacted by the amendment. The ratio of judgment of Supreme Court in case of Smifs Securities should continue to apply to such depreciation claimed in earlier years.   

2.2.2 However, the Memorandum to the Finance Bill, 2021 explaining the amendments with respect to depreciation claim on goodwill appear to imply that the depreciation on goodwill arising out of tax neutral business acquisitions in any case was always impermissible. As per the settled legal position, the Budget Speech of the Finance Minister, Notes on Clauses, circulars, etc. are only secondary aids to interpretation. and cannot be considered to be binding. They can neither be referred to for the purpose of construing the provision when the words used in the provision are clear and unambiguous; nor can they be used for cutting down the plain meaning of the words in the provision.[3] Thus, to the extent the Memorandum appears to imply a position that depreciation on goodwill arising on tax neutral re-organisations was never admissible, the said observation seems to be incorrect and also irrelevant, since it should have no impact on the overall legal position. Depreciation already claimed in years prior to AY 2021-22 should be tested applying the ratio of the decision of Hon’ble Supreme Court in the case of Smifs Securities (supra) without any reference to the Memorandum to the Finance Bill, 2021 or the proposed amendments which are effective from AY 2021-22.

2.3 Depreciation on goodwill for FY 2020-21 and subsequent years when goodwill is already forming part of block of assets of intangible assets as on 1 April 2020

2.3.1 As mentioned above, the amendments relating to depreciation on goodwill are proposed to come into effect from FY 2020-21 onwards. An issue that arises for consideration is whether the amendment would impact only new goodwill that is acquired in FY 2020-21 or in subsequent years or does it also seek to impact goodwill that was acquired in earlier years and already forms part of block of assets as on 1 April 2020. In other words, one needs to evaluate whether goodwill which is already forming part of block of assets as on 1 April 2020 would be eligible for depreciation in FY 2020-21 and in subsequent years.

2.3.2 Section 32 of the Act provides that depreciation in case of block of assets shall be allowed as a certain percentage of WDV of such block of assets. WDV in case of block of assets is defined under section 43(6)(c) of the Act as WDV of block of assets in the immediately preceding previous year as reduced by the depreciation actually allowed in respect of that block of assets in relation to the said preceding previous year and adjusted by the following

a.  Increase by the actual cost of any asset falling within that block, acquired during the previous year; and

b  Reduction of the moneys payable in respect of any asset falling within that block, which is sold or discarded or demolished or destroyed during that previous year together with the amount of the scrap value, if any.   

2.3.3 The term WDV is thus expressly defined under the Act and is to be computed in a specified manner. The Finance Bill, 2021 does not propose any amendment to the definition of WDV under section 43(6)(c) of the Act. It is a well-established proposition that an asset loses its individual identity, once it enters the block[4]. In absence of change in definition of WDV, one may argue that on a literal application of the provisions of section 43(6)(c) of the Act, the entire block of assets for intangible assets (including goodwill already forming part of such block as on 1 April 2020) should continue to be entitled for depreciation. While section 2(11) of the Act defining ‘block of assets’ is sought to be amended to provide that it shall not include goodwill, no mechanism is proposed to carve out the non-depreciated portion of goodwill from WDV of block of assets under section 43(6(c), while computing depreciation under section 32 of the Act. 

2.3.4 Section 50(2) of the Act is proposed to be amended to provide that in case goodwill formed part of block of assets and the said block of assets ceases to exist, WDV of block of asset shall be determined in prescribed manner. However, section 50(2) would apply in limited cases involving a scenario where the block of asset ceases to exist due to the reason that all the assets in that block are transferred during the previous year. Also, the application of section 50 is for the specific purposes of computing short term capital gains on sale of depreciable assets and the said section does not deal with allowability of depreciation in any manner. Unlike section 50(2), there is no amendment proposed to provide that WDV, in case of block of assets containing goodwill, for the purpose of section 43(6)(c) of the Act shall be computed in the prescribed manner.   

2.3.5 Further, section 55(2)(a) of the Act is proposed to be amended to provide that in case of goodwill in respect of which deduction on account of depreciation has been obtained during or prior to financial year 2019-20, then for the purposes of determining cost of acquisition of goodwill in the hands of the assessee, the total amount of such depreciation shall be reduced from the amount of purchase price of goodwill. It is important to note that the proposed adjustment in purchase price is relevant for the purposes of computing capital gains under section 45 read with section 48 and 49 of the Act. This would cover a scenario where goodwill is sold separately and capital gains thereon is proposed to be computed under the said provisions, rather than the provisions of section 50. The only scenario where the proposed amendments under section 55(2)(a) would become operative is a case of goodwill which was earlier subject to tax depreciation and from FY 2020-21, the said goodwill has ceased to remain a depreciable asset and part of block of assets thereby directing all capital gains on sale of said goodwill to be computed under section 45 read with section 48 and 49 (rather than computing capital gains under section 50). But such a scenario is based on an assumption that goodwill which was depreciable prior to FY 2020-21 has ceased to be eligible to depreciation from FY 2020-21 onwards. If one looks at the interplay between the proposed amendments under section 50 and 55 closely, it may suggest that the legislative intent seems to be to restrict depreciation claim even on goodwill forming part of block of assets as on 1 April 2020. However, in the absence of a specific amendment under the provisions of section 43(6)(c) of the Act relating to the definition of WDV, the taxpayer may continue to argue that the portion of goodwill merged into the block of assets cannot be extracted out and depreciation should continue to be available on the WDV of the block of assets pertaining to intangible assets as on April 2020 and thereafter.     

2.3.6 As mentioned above, courts have consistently held that once an asset forms part of block of assets, it loses its individual identity. Relying on such decisions, where goodwill already forms part of block of assets as on 1 April 2020, it appears fairly possible to contend the claim of depreciation for subsequent years basis the proposition that goodwill has lost its individual identity once it has entered the block of assets, depreciation should be allowed on the WDV of block of assets pertaining to intangible assets without any adjustment. This is because depreciation in such case is sought to be claimed on block of assets relating to intangible assets and not on goodwill, being an individual asset. The issue which the courts may like to review in detail is the validity of such proposition in case where goodwill is the only asset in the block of assets pertaining to intangibles.

2.4 Impact on unabsorbed depreciation brought forward in FY 2020-21   

2.4.1 Section 32(2) of the Act provides that where full effect cannot be given to allowance for depreciation under section 32(1) in any previous year, owing to there being no profits or gains chargeable for that previous year, or owing to the profits or gains chargeable being less than the allowance, then, subject to the provisions of section 72(2) and 73(3) of the Act, the allowance or the part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the succeeding financial year and deemed to be part of that allowance, or if there is no such allowance for the said financial year, be deemed to be the allowance for that financial year, and so on for the succeeding financial years.   

2.4.2 It is likely that an assessee had claimed depreciation on goodwill in earlier years which he was not able to set-off against the profits in its entirety. This would result in unabsorbed depreciation being available to the assessee as on 1 April 2020 for set-off in FY 2020-21 and subsequent years. The proposed amendments are silent on the treatment for such unabsorbed depreciation and do not specify whether the same would be eligible for set-off against the profits or not.   

2.4.3 The tax department can contend that since unabsorbed depreciation is deemed to be depreciation of current year, unabsorbed depreciation pertaining to goodwill should not be allowed as deduction since goodwill per se is not treated as depreciable asset from FY 2020-21.  

2.4.4 This proposition could be more strictly applied in cases where unabsorbed depreciation is solely due to depreciation on goodwill. This is of course subject to the debate regarding impact on depreciation claim in case of goodwill forming part of block of assets as on 1 April 2020 as discussed above.   However, it could be very well argued that unabsorbed depreciation of earlier years should be allowed to be set-off against profits of current year even though depreciation on goodwill is not allowable from FY 2020-21. The High Court of Gauhati in Singh Transport Co.[5] has held that section 32(2) of the Act is a complete code in itself and that unabsorbed depreciation allowance never loses its nature or character as depreciation allowance and is always required to be set off and carried forward by virtue of provisions of section 32(2) of the Act itself.     

2.4.5 Further, it can be contended that in absence of any specific restriction for disallowing depreciation pertaining to goodwill from the quantum of unabsorbed depreciation, the amount of unabsorbed depreciation need not be disturbed and should be allowed to be set-off in full subject to the amount of profits during current year (balance amount being eligible for carry forward to subsequent years). In the context of section 115BAA and 115BAB of the Act, the legislature has specifically provided that unabsorbed depreciation pertaining to specified deductions / incentives shall not be allowed to be carried forward. No such similar treatment is proposed to be provided for carving out depreciation on goodwill out of unabsorbed depreciation.   

2.4.6 The High Court of Bombay in Shri Laxmi Printing & Dyeing Works (P.) Ltd.[6] has held that the only qualification for unabsorbed depreciation to be treated as an allowance for the current year is that it must have been properly allowed in earlier years and by reason of its not being absorbed, must have been allowed to be carried forward to the subsequent year. The qualification of it being allowable on the basis of the machinery in respect of which it was claimed being in use was properly satisfied when the depreciation was allowed. There was nothing in clause (b) of the proviso to section 10(2)(vi) of the Indian Income-tax Act, 1922 (corresponding to section 32(2) of the 1961 Act) which required the qualification to be satisfied again, viz., that the machinery in respect of which it had been claimed in past years was in use in the assessment year also. Going by this premise, it could be argued that unabsorbed depreciation once properly allowed in earlier years should be allowed to be carried forward and set-off in current year even though such unabsorbed depreciation relates to goodwill.

2.5 Importance of purchase price allocation in case of new acquisition   

2.5.1 The Finance Bill, 2021 proposes to restrict the scope of intangible assets by excluding goodwill from its purview for the purpose of allowing depreciation. However, depreciation on know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature (not being goodwill) acquired by an assessee would still continue to be available.   

2.5.2 The High Court of Delhi in case of Areva T&D India Ltd[7] held that intangible assets such as business claims; business information; business records; contracts; employees and know-how acquired under slump sale agreement were in the nature of 'business or commercial rights of similar nature' specified in section 32(1)(ii) and were accordingly eligible for depreciation. Relying on the decision of Supreme Court in Smifs Securities (supra), the High Court of Bombay in Birla Global Asset Finance Co. Ltd.[8] allowed depreciation on business and commercial brand equity under section 32 of the Act.   

2.5.3 Traditionally, any amount of consideration being in excess of net value of the assets was being recorded as goodwill without clearly bifurcating between various intangibles and commercial rights. The taxpayers may now consider undertaking a detailed purchase price allocation exercise in order to attribute excess of such consideration paid over net assets acquired towards spectrum of intangible assets in nature of business or commercial rights instead of outrightly treating such difference as goodwill. This should be substantiated with a valuation report justifying the payment for acquisition of such intangible assets. Para B31 of Indian Accounting Standard 103 on Business Combinations also requires an acquirer to recognize, separately from goodwill, the identifiable intangible assets acquired in a business combination. Valuation would thus become an important factor while undertaking any business acquisition. Further, what constitutes goodwill is not defined under the Act. It is commonly understood as the balance, unrecognizable and un-allocable component of the excess of purchase price distinct from the clearly identifiable intangibles. While, the legislation clearly still permits depreciation on other business and commercial rights, it needs to be seen how the tax department deals with the proposed amendment - whether it would permit such a claim and contest the valuation or would persist the same to be a component of goodwill and deny the claim all together. 

2.6 Goodwill of profession also covered under section 55(2)(a)   

2.6.1 Section 55(2)(a) of the Act provides that cost of acquisition in case of specified self-generated capital assets is to be considered as Nil. Section 55(2)(a) of the Act was amended by Finance Act, 1987 to provide cost of goodwill of business as Nil. Other assets specified in section 55(2)(a) of the Act are trademark, brand name associated with a business or a right to manufacture, produce or process any article or thing or right to carry on any business or profession, tenancy rights, stage carriage permits and loom hours. Thus, while goodwill of business is expressly covered; currently, goodwill of profession is not covered under section 55(2)(a) of the Act. It has been held that the terms “business‟ and “profession‟ are separate and distinct, and business does not include profession[9]. In absence of deeming fiction under section 55(2)(a) providing for cost of acquisition of goodwill of profession as Nil, relying on the decision of Supreme Court in B. C. Srinivasa Setty[10], one could plausibly argue that in absence of computation mechanism under the Act, capital gains tax would not be payable in case of transfer of goodwill of profession. This is also supported by CBDT Circular explaining the amendments introduced by Finance Act, 1987 (which had provided for cost of acquisition of self-generated goodwill as Nil) which provides that the new provisions will not apply to professional firms. 

2.6.2 The Finance Bill, 2021 proposes to include even goodwill of profession expressly within the purview of section 55(2)(a) of the Act. In view of the proposed amendment, the argument of cost not being ascertained in case of goodwill of profession would thus no longer be available.

The proposed amendments under the Finance Bill, 2021, will have an overarching impact on any acquisition going forward. The post COVID era is likely to witness more traction in M&A space due to consolidation in many sectors and increase in acquisitions of stressed entities by leveraging on attractive valuations. Denial of tax break on the goodwill component would increase the cost of such acquisitions significantly. While conventionally a share acquisition and a subsequent consolidation by merger was the most common acquisition mode, M&A transactions going forward would also witness business acquisitions and non-tax neutral consolidations being resorted to. Proposal to make amended provisions applicable from FY 2020-21 has caught India Inc unaware, especially in case of deals that have already been concluded in current financial year. In such cases, one may now consider re-looking at their valuation report to undertake a more comprehensive purchase price allocation thereby recording clearly identifiable intangibles as against parking everything as goodwill. While the proposed amendment extends clarity by seeking to bring closure to a highly litigated issue, however, including goodwill arising pursuant to non-tax neutral acquisitions impermissible for depreciation, is quite a dampener and needs reconsideration.

Equalisation Levy - Another Year of Ambiguity?

The announcement made on 23^rd February, 2021 on the amendments to the provisions of the Finance Bill, 2021, has left the industrial fraternity quite disheartened in the context of equalisation levy (EL), as the industry at large was expecting necessary clarifications to be introduced on several ambiguities remaining latent within the legislation around EL, which unfortunately have not been addressed or answered. 

This article deals with a major ambiguity/ uncertainty in this regard, namely apprehensions faced by several foreign companies, who sell/ supply tangible goods and services to customers in India on an offshore basis, without the same being effectively connected to any permanent establishment (PE) in India, on being subject to EL, merely on the ground of correspondences for sale and purchase of goods/ services having taken place between sellers and customers over e-mails.

Chapter VIII of the Finance Act, 2016 had introduced equalisation levy (EL) @ 6% on the amount of consideration paid to non-residents for specified services in the form of online advertisement and provision of digital advertising space or other services related to online advertisement. The Memorandum explaining the provisions in the Finance Bill, 2016 clarified that EL was introduced in order to address the challenges of taxation of transactions under the evolving digital economy. Incidentally, it is common knowledge that EL is an interim measure introduced by the Indian Government for addressing taxation of transactions under the digital economy, pending amendments to bilateral tax treaties in line with the recommendations of the OCED/ G-20 BEPS Action 1, as and when the same would be finalised.

Though not tabled as part of the initial proposals of the Union Budget 2020-21 in the form of the Finance Bill, 2020, yet while enactment of the same by the Parliament, the scope of chargeability of EL was extended to non-resident e-commerce operators, engaged in the business of online sale of goods and services @ 2% on the value of such online sale of goods and services, through Part VI of the Finance Act, 2020, by making necessary amendments to Chapter VIII of the Finance Act, 2016 with effect from 1^st April, 2020.

The scheme of EL operates in a manner so as to apply in a scenario where the online supply of goods or services are not effectively connected with any PE of the non-resident supplier in India. Further, where the consideration for online sale of goods or services would be subject to EL, the same shall be exempt from income tax in India in the hands of the non-resident enterprise under section 10(50) of the Income-tax Act, 1961 (I T Act).

The manner in which the legislation around EL has been drafted, it gives an essence that EL is charged not merely on supply of goods and services through downloading using digital means, however, also to the supply of tangible goods and services by a foreign enterprise in favour of a customer in India, where the same are not effectively connected with any PE of the foreign enterprise in India, merely on the basis of correspondences between the foreign supplier and the Indian buyer having taken place over e-mails or other digital means, as would be evident from the following recitals of the relevant legislation : 

1.   The exact language used in the Finance Act, 2020 in this regard, vis-à-vis fastening of EL, is interalia the activity of “e-commerce supply or services” [section 163(3) of the Finance Act, 2016, read with the amendment introduced by section 153(i) of the Finance Act, 2020]. 

2.    The term, “e-commerce supply or services” has been defined to interalia mean online sale of goods or provision of services owned or facilitated by an “e-commerce operator” [section 164(cb) of the Finance Act, 2016, as inserted by section 153(ii)(A) of the Finance Act, 2020]. It is common knowledge that facilitation in the context of online supply of goods or services refers to an entity operating a marketplace.

3.      The term, “e-commerce operator” has been defined to interalia mean a non-resident, who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services [section 164(ca)(i) of the Finance Act, 2016, as inserted by section 153(ii)(A) of the Finance Act, 2020].

4.     The term, “online”, has been defined to mean “a facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network” [section 164(f) of the Finance Act, 2016].

5.        The above definitions were already inserted in the regulations around EL by the Finance Act, 2020, read with Finance Act, 2016.

6.        Finance Bill, 2021 proposed to interalia further clarify the terms, “online sale of goods” and “online provision of services”, in a manner so as to cover any one or more of the following online activities [Explanation to section 164(cb) of the Finance Act, 2016, as proposed to be introduced by section 159(a)(ii) of the Finance Bill, 2021] :

a.        Acceptance of offer for sale; or 

b.        Placing of purchase order; or

c.         Acceptance of purchase order; or

d.        Payment of consideration; or

e.        Supply of goods or provision of services, partly or wholly.

7.        A conjoint reading of the aforesaid paragraphs lends the view that for being subject to EL, the supply of goods or provision of services may even be in the form of physical importation of tangible goods or services, albeit any one or more of the activities referred to in sub-paragraphs (a) to (d) above, need to take place in an “online” manner, vis-à-vis an “e-commerce operator”. Incidentally, it appears that supply of goods or provision of services, referred to in sub-paragraph (e) above, is in the context of goods, which may be downloaded online, e.g. software, music, books, etc.

8.      Thus, in the context of a foreign enterprise, for being subject to EL with respect to supply of tangible goods or services to customers in India, the following twin conditions need to be satisfied, namely that the foreign enterprise must – (i) qualify as an “e-commerce operator”; and (ii) supply goods or services by involving any one or more of the activities, effectuated online, as referred to in sub-paragraphs (a) to (d) of paragraph (6) above.

9.       Given the manner in which the term, “online”, has been defined, as referred to above, it appears that its scope or ambit is very wide, so as to cover even communication over internet or any other form of digital or telecommunication network, meaning that correspondences or communications over emails, fax-machines and even telephones may be covered. 

10.  However, the scope of online activity interalia with respect to sale of goods or provision of services, for the purposes of levy of EL, needs to be understood in the context of an “e-commerce operator”, since unless a foreign enterprise is an “e-commerce operator”, it shall not fall within the net or ambit of EL. 

11.  As stated above, an “e-commerce operator” in the context of online sale of goods or provision of services, has been defined to mean a foreign enterprise, which owns, operates or manages digital or electronic facility or platform for online sale of goods or provision of services.

12.  A harmonious reading of the relevant provisions relating to EL, as laid out above, reflects that any online activity in the context of sale of tangible goods or services to a customer in India, namely – (a) acceptance of offer for sale; or (b) placing of purchase order; or (c) acceptance of purchase order; or (d) payment of consideration, would need to be effectuated on a digital or electronic facility or platform, which is owned or operated or maintained by the foreign enterprise supplying the goods or services.

13.  Now, the term, “digital or electronic facility of platform”, has not been defined in the provisions relating to EL. While the term, “platform”, may refer to any portal, the term, “digital or electronic facility” appears to be wide enough to cover internet facility as well, as a result of which, any foreign enterprise, owing, operating or managing even an internet facility interalia for online sale of goods or provision of services, may qualify as an “e-commerce operator” for the purposes of EL. 

14.  The said inference flows from the expansive clarification of the concept of online sale of goods or provision of services, as proposed to be inserted by Finance Bill, 2021, as referred to above. 

Thus, a very pertinent question arises, namely does the Government actually intend to charge EL on foreign enterprises who sell/ supply tangible goods and services to customers in India on an offshore basis, merely on the ground of correspondences for sale and purchase of goods/ services having taken place between sellers and customers over e-mails ? 

Incidentally, as stated earlier, since the extension of EL on e-commerce operators was not a part of the Finance Bill, 2020; and the same was only inserted as part of the legislation around EL at the time of enactment of the Finance Act, 2020, the actual intent of the Government in this regard is not manifest in the Memorandum explaining the provisions in the Finance Bill, 2020. Further, in the last one year, the Government has also not issued any circular or clarification in this regard, barring the one introduced as part of the Finance Bill, 2021, as referred to above, which actually lends support to the concern that foreign companies, who sell/ supply tangible goods and services to customers in India on an offshore basis may be subject to EL, merely on the ground of correspondences for sale and purchase of goods/ services having taken place between sellers and customers over e-mails. 

Whether or not charging of EL even on offshore supply of tangible goods and services merely on the ground that correspondences for sale and purchase of goods/ services have taken place between sellers and customers over e-mails, is fair on the part of the Government, is a different matter altogether. The unfortunate part of the matter is that with the fiscal year 2020-21 about to come to an end, foreign enterprises falling in the aforesaid category are still not sure as to whether or not they are actually liable to pay EL on such supply of tangible goods and services. The Government needs to clarify the ambiguity at the earliest, as otherwise foreign enterprises would be seriously inconvenienced in this regard. 

The question of fairness, as referred to above, actually stares hard on the face of the Government, particularly when even the United Nations, in the recent proposals around digital taxation, in the form of introduction of a new Article in its model convention, namely Article 12B, has sought to restrict the scope of digital tax only to services provided through digital means; and not on supply of tangible goods and services. 

I had authored an article in Taxsutra before the tabling of the Finance Bill, 2021 on the fitment of the legislation around EL in the framework of the Constitution of India, as the industry at large had been seeking necessary explanations from the Government in this regard. 

In light of the ambiguity prevailing on the applicability of EL on the supply of tangible goods and services, the doubts on the constitutional aspect of the impugned legislation intensify manifolds, thus meriting a deliberation on the above topic in the current article as well. It would be helpful if the Government may please dispel all the doubts and ambiguities through necessary guidelines and/ or discussions in the Parliament. 

The report issued by the Committee set up by the Central Board of Direct Taxes (CBDT) in February, 2016, for conceptualising the theme of EL, which incidentally got introduced by the Finance Act, 2016, as mentioned above, states that EL was conceived of not as an income tax, but as a tax or levy falling within the purview of Entry 92C and/ or Entry 97 of List I of the Seventh Schedule of the Constitution. 

Tax on income, other than agricultural income, is levied by the Parliament under Entry 82 of List I of the Seventh Schedule of the Constitution. Entry 92C of List I of the Seventh Schedule of the Constitution, which was introduced by the Constitution (88^th Amendment) Act, 2003, though never enforced; and finally omitted by the Constitution (101^st Amendment) Act, 2016, enabled the Parliament to enact taxes on services. Incidentally, service tax, before its merger within the overall scheme of integrated goods and services tax (IGST), was legislated by the Parliament under Entry 97 of List I of the Seventh Schedule of the Constitution. Thus, with the omission of Entry 92C from List I of the Seventh Schedule of the Constitution in 2016, though the same never came into force in the first instance, EL can at best, be said to fall only within the ambit of Entry 97 of List I of the Seventh Schedule of the Constitution, as also claimed by the Committee set up by the CBDT in its report on EL published in February, 2016, as referred to above. 

It is elementary that the manner of legislation of EL, both at the time of its initial introduction in 2016; and its enlargement vide the Finance Act, 2020, is an attempt on the part of the Central Government to override international tax treaties through a unilateral act, since there is no doubt whatsoever that the incomes, which are subject to EL, constitute “business profits” in the hands of non-resident enterprises under international tax treaties, which unless attributable to PEs of the recipients, cannot be taxed in India. Thus, unless an amendment was made in this regard in the various tax treaties signed by India, any attempt to levy any income tax on such incomes under the domestic tax laws of India, by expressly stating that the levy of such tax would not be obstructed by any tax treaty, would have been a clear and direct attempt on the part of the Indian Government to breach tax treaties through legislation in domestic tax laws, which was best avoided. 

Now, though the Parliament had intended to enact EL not in the form of income tax, yet inadequate drafting of the legislation actually bestows the said EL with the character of income tax, as would be evident from the following discussions : 

1.      The incomes, which are subject to EL, are exempt from income tax in the hands of the non-resident recipients under section 10(50) of the I T Act, thus preventing such non-resident recipients to invoke the provision of tax treaties signed by India with their respective countries of residence. 

2.      The term, “EL”, has been defined in section 164(d) of Chapter VIII of the Finance Act, 2016 to mean tax leviable on consideration received for the relevant sales/ services.

3.       Now, the term, “tax” has not been defined in Chapter VIII of the Finance Act, 2016, read with the amendments introduced therein by Part VI of the Finance Act, 2020.

4.       Section 164(j) of Chapter VIII of the Finance Act, 2016 provides that words used but not defined in the said Chapter would have the meaning assigned to them, if any, in the I T Act.

5.      Section 2(43) of the I T Act defines the term, “tax” to mean income tax, chargeable under the said Act. Therefore, given the manner in which “EL” has been legislated, the same appears to be nothing else but income tax, which the Parliament is otherwise competent to levy on income under the powers conferred upon it by Articles 245 and 246 of the Constitution, read with Entry 82 of List I of the Seventh Schedule of the Constitution. 

Thus, the exemption from income tax separately granted on the impugned incomes in the hands of the non-resident recipients, appears to be an empty piece of legislation, as nothing else but income tax is actually charged on the relevant incomes through EL. In this process, the non-resident recipients of incomes are prevented from invoking the favourable provisions of the relevant tax treaties. Thus, the legislation around EL in its current form is probably an unintended express unilateral breach of international tax treaties through amendments made in the domestic tax laws. 

Assuming that the Parliament takes necessary curative measures to remove the insignia or character of income tax from the texture of EL, though not done since its introduction in 2016, such that EL can no longer be equated with income tax, which perhaps was not intended by the Government, as per the report of the Committee set up by the CBDT, as referred to above, then one would need to understand the exact nature of the impugned levy, vis-à-vis its setting within Entry 97 of List I of the Seventh Schedule of the Constitution. 

Entry 97 of List I of the Seventh Schedule of the Constitution, enables the Parliament to enact laws on any other matter, including taxation, not enumerated in List II, i.e. the State List; or List III, i.e. the Concurrent List, of the Seventh Schedule of the Constitution.

The Honn’ble Supreme Court has held that once it is established that the taxing power claimed by the Parliament under Entry 97 is not covered by any Entry in List II or List III of the Seventh Schedule of the Constitution, it is competent for the Parliament to combine its powers under Entry 97 with some other powers, which legitimately belong to the Parliament exclusively under some other Entry of List I [refer International Tourist Corporation vs. State of Haryana – AIR 1981 SC 774]. 

Thus, in case any other Entry of List I of the Seventh Schedule of the Constitution provides for legislation by the Parliament for imposing taxes, duties, etc., similar to that of EL, then the Parliament may still otherwise be permitted to enact EL under Entry 97 of the Seventh Schedule of the Constitution. However, the debate is elsewhere, as explained below.

In so far as a non-resident enterprise may sell goods or services for consumption by customers in India, without such sale of goods or services being effectively connected with any PE of the non-resident enterprise in India, there already exist legislations for imposing taxes or duties on the value of such goods or services. Offshore sale of goods by a non-resident enterprise, amounting to importation thereof by the purchaser in India, attracts customs duty levied by the Parliament under Entry 83 of List I of the Seventh Schedule of the Constitution. Similarly, supply of services by a non-resident enterprise on an offshore basis, which are consumed in India, attracts IGST levied by the Parliament under Article 246-A of the Constitution, as per the reverse charge mechanism.

It is important to note that such customs duty and IGST are levied irrespective of whether or not the goods or services, as the case may be, are sold or provided by the non-resident enterprise through traditional or digital manner of correspondences between the supplier and purchaser.

Thus, while the Parliament is otherwise competent to enact EL on offshore supply of tangible goods or services by a non-resident enterprise per se under Entry 97 of List I of the Seventh Schedule of the Constitution, in the form of an indirect tax and not income tax, as also claimed by the Committee set up by the CBDT, the question arises that since such events of offshore supply of tangible goods or services by a non-resident enterprise are already subject to indirect taxes in the form of customs duty or IGST, as the case may be, what then is the real character of EL, namely what event/ activity triggers such levy; and further, what purpose does it intend to serve, except for dispensing with the levy of income tax on the amount of income embedded therein under the provisions of Entry 82 of List I of the Seventh Schedule of the Constitution, so that the non-resident enterprise may be prevented from obtaining relief from such income tax by resorting to the favourable provisions of international tax treaties ?

Therefore, when the underlying supply of goods and services by foreign enterprises are already subject to indirect taxes, namely customs duty and IGST respectively, levied by the Parliament under Entry 83 of List I of the Seventh Schedule; and Article 246-A respectively, of the Constitution, it appears that EL, in reality, is an additional indirect tax levied on the same goods and services merely with reference to the manner of correspondence between the foreign sellers and local buyers, namely whether through traditional modes of writing letters or through e-mails/ portals. A question therefore arises, namely is EL an indirect tax or levy merely with respect to the manner of communication between the seller and the buyer ? That is where the question relating to the fitment of the legislation around EL within the Constitution of India arises, vis-à-vis the issue of reasonable classification.

Finance Bill, 2021 - More Amendments in the Budgeted Time!

The Finance Bill, 2021, was moved in the Lok Sabha yesterday with certain amendments and the Bill with the amendments was passed by the Lok Sabha.  This is now the second year in succession where the Finance Minister has proposed important amendments to Bill as presented on the Budget day.

As we all know, the Equalization levy on non-resident e-commerce operators on consideration received from e-commerce supply or services, was introduced with effect from April 01, 2020. E-commerce supply or service is defined to include within its ambit ‘online sale of goods’ and ‘online provision of services’. An explanation was proposed to be introduced to include any of the following activities within the ambit of the above phrases – acceptance of offer for sale, placing of purchase order, acceptance of purchase order, payment of consideration, supply of goods or provision of services. An amendment was also proposed to include consideration received or receivable from e-commerce supply or services irrespective of whether the e-commerce operator owns the goods.

The Finance Minister yesterday, clarified that the intention was to treat everyone who is operating in India equally. The levy would not be applicable on consideration of sale of goods or services which are owned by persons resident in India or by a permanent establishment of a non-resident in India [both for goods and services]. One of the proposed amendments to the Bill is to give effect to this clarification. 

While this clarification is a welcome move, however, there are other aspects on which there is still no clarity – this includes applicability of levy on inter company transactions where only one aspect of the transaction is carried out online say on an internal ERP platform, and the wide ambit of the levy which almost brings in a lot of payments which are outside strict e-commerce trade.

Another amendment proposed in the Union Budget, was that, on or after April 1, 2021, interest accrued/ received on employee contribution to recognized provident fund during a financial year to the extent it relates to contribution exceeding INR 250,000 would be taxable in the hands of the employee. The manner of computation of such interest is to be prescribed under rules (yet to be notified). A proviso has now been proposed in the amendments moved yesterday to provide that if the contribution by an employee is in such a fund where there is no contribution by the employer, then in such cases the limit of INR 2,50,000 would stand increased to INR 5,00,000.

Further with respect to goodwill, an amendment in the Union Budget was proposed to the term ‘block of assets’, to exclude goodwill as an intangible asset. Correspondingly, depreciation cannot be claimed on intangibles in the nature of goodwill. Pursuant to this amendment, an amendment has been proposed in section 43(6) to provide that any increase or decrease of items specified in clause (i) on account of goodwill shall not be adjusted in the written down value of the asset and any depreciation which has already been allowed or would have been allowed shall be reduced from block of asset to arrive at the written down value. This provides much needed clarity on how one needs to compute the written down value in case of goodwill.

Further, an amendment was proposed to increase the threshold limit to undergo a tax audit from INR 5 crores to INR 10 crores, subject to conditions specified for cash transactions. A proviso is now proposed to be introduced to provide that any cheque payment which is not through an account payee cheque will be deemed in cash. 

Another significant and important amendment has been proposed in section 50B, with respect to slump sale to provide that consideration for transfer of an undertaking shall be at fair market value [in a prescribed manner]. Further, with respect to determining the net worth of the assets, in case of self-generated goodwill, the value shall be NIL. With this amendment slump sale transactions will now have to be carried at fair market value and cannot be carried out at book value.   

The provisions relating to taxability of receipt of capital assets or stock in trade at the time of reconstitution or dissolution of partnership firms which was proposed in the original Bill has been recast totally.  The amendment proposed include introduction of a new section 9B to the income-tax Act. The new section brings to tax the transfer of any capital asset or stock in trade which has been received by partner in connection with dissolution or reconstitution in the hands of the firm/AOP.BOI and such entity would be taxable on FMV either as capital gains or profits and gains of business or profession.

There are a few changes in relation to other aspects relating to the definition of the term ‘liable to tax’  provisions relating to taxability of income from aircraft leasing from IFSCs which would now include interest income in addition to royalty, etc.

The amendments with respect to equalization levy and slump sale will have a significant impact. Further, given that both these amendments are effective April 01, 2020, one will have to analyse the impact in detail even in respect of those transactions which have been undertaken in the FY 2020-21.

Board for Advance Rulings - Will it Achieve the Intended Purpose?

This article has been co-authored by Hirali Desai (Chartered Accountant) and Kiresh Shivkar (Chartered Accountant).

Since the liberalisation of Foreign Direct Investment policies started in the early 1990s, the Indian economy has welcomed many multi-national corporations to invest and was ascertained to receive large foreign investments in the future.

With the inflow of substantial foreign investments in India, the Government of India found it necessary to establish a specialised forum that could determine the taxability of transactions involving non-residents. Accordingly, based on the recommendations made by the Wanchoo Committee, with the twin objective of providing certainty and predictability in tax matters, the Finance Act, 1993, introduced a new Chapter XIX‑B (section 245N to section 245V) in the Income-tax Act, 1961 (Act) for setting up an independent forum, the Authority for Advance Rulings (AAR).

 Scheme and Object of AAR

The aforesaid chapter is a code in itself and provides the entire mechanism to obtain an advance ruling in respect of a transaction undertaken or proposed to be undertaken. The scheme was initially made available for
non-resident taxpayers only, and subsequently, was expanded to resident taxpayers.

The AAR is an independent adjudicatory body, which issues binding rulings in relation to civil tax disputes. What distinguished AAR from other traditional forums of dispute resolution was that even a potential dispute could be resorted to and resolved and a balanced and independent constitution of three members from diverse backgrounds heard the applications. The most important aspect was that the ruling of the AAR was binding on both on the taxpayer and the Department and it could be challenged only under a writ jurisdiction.

These features of the AAR sought the popularity and faith of the non-residents in the Indian dispute resolution system. The fact that, currently, more than 450 applications are pending disposal before the AAR substantiates this point. 

However, as the memorandum to the Finance Bill, 2021, suggests, since the past few years, the AAR has remained non-functioning due to vacancies in the posts of Chairman/ Vice-Chairman, which has seriously hampered the disposal of pending applications.

The Finance Bill, 2021, has sought to deal with this situation by forming another forum called the Board of Advance Rulings (BAR) in place of the existing AAR. The Finance Bill, 2021 further proposes that the said BAR shall be constituted by only two Members – both being Department Officers. The rulings of the BAR are appealable before the High Court, thereby, taking away their binding status.

This article, in the ensuing paragraphs, seeks to indicate how the aforesaid major amendments proposed by the Finance Bill, 2021, do not align with the very objective of setting up the AAR per se, and even otherwise, sound unfair to taxpayers.

• Intention was to determine ‘final’ tax liability

The whole objective of setting up the AAR was to give certainty to taxpayers on matters relating to their tax liability, and this intention probably reflects in the definition of the term ‘advance ruling’, under section 245N(a)
per se.

The term ‘advance ruling’ under sub-clauses (i) to (iv) to section 245N(a) of the Act is exclusively defined to mean the ‘determination’ of tax liability in relation to a transaction that has been undertaken or proposed to be undertaken by the Applicant.

As per the Oxford Dictionary, the word 'determine' means 'ending of a controversy or suit by the decision of a Judge or arbitrator; judicial or authoritative decision or settlement of the matter at issues; the settlement of a question by reasoning or argumentation'. As per Black’s law Dictionary, the word ‘determine’ means ‘to come to an end; to bring to an end; to bring to a conclusion, to settle by authoritative sentence, to decide’.

The Hon’ble Supreme Court in the case of Jawanta Sugar Mills Ltd v. Laxmichand , while construing the expression 'determination' occurring in Article 136 of the Constitution of India, held,

"... in the context in which it occurs in article 136 signifies an effective expression of opinion which ends a controversial dispute by some authorities to whom it is submitted under a valid law for disposal...."

The aforesaid clearly indicates that the use of the expression ‘determination’, symbolises the closure or end of a controversy or dispute, which is presumably why the Legislature used the words ‘determination’ rather than ‘adjudication’ of tax liability, while defining an ‘advance ruling’.

As the Finance Bill, 2021, proposes to make the rulings of the BAR appealable to the High Court, and thereby, non-binding on the parties, it certainly nullifies the objective of setting up such a forum to determine tax disputes in advance, and clearly does not match the definition of the term ‘advance ruling’. 

• Imbalance in the constitution of BAR

The current constitution of AAR, as provided in section 245-O of the Act, consists of three Members with distinct qualities and background. Such a constitution of Members from three different fields provides a mix of expertise, and thus, imparts a balance, which is essential. It consists of a mix that reflects a blend of judicial mind and wisdom (retired Supreme Court/ High Court judge), legal expertise (Law Member) and commercial/ accounting knowledge (Revenue Member), which helps to maintain a judicial balance that ensures a fair and just disposal of the case.

The Finance Bill, 2021, proposes that the bench of the BAR shall consist of only two members, both being Departmental Officers.

The Hon’ble Supreme Court, in the case of Columbia Sportswear Company v. DIT (2012) [TS-549-SC-2012-O], has held that the AAR is a body exercising judicial power and functions, and is a Tribunal for Articles 136 and 227 of the Constitution.

Further, Article 50 of the Constitution of India requires that the State shall take steps to separate the judiciary from the executive in the public services of the States. Simply stated, it means that there shall be a separate judicial service free from executive control.

Like a Tribunal, the hearings before the AAR are based on an adversarial system. The system suggests that there are two opposing parties who present their case before a judge or jury, who act as neutral referee from both sides. This is why, until now, the AAR constitution was independent of the parties representing before it.

With the exercise of judicial functions by income-tax officers at the Board of Advance Rulings, where one of the parties is the income-tax department, not only encroaches the judiciary’s domain but also is unjust and unfair to the taxpayer. It is also important to ponder that, when the responsibility for the settlement of a tax dispute is entrusted to a Revenue Officer who is subject to the same supervisory authority as the Assessing Officer (AO), how can the taxpayer be ensured of a fair trial?

Travelling back in time, when we look back at the date when the Income-tax Appellate Tribunal was set up on 25 January 1941, it may be seen that initially, the Finance Department of the Government of India (Central Board of Revenue) was in charge of the Tribunal. However, on opposition in public opinion, from 30 May 1942, the Tribunal was put in charge of the Legislative Department, which is the predecessor of the present Ministry of Law and Justice of the Government of India. This resulted in the Tribunal functioning as an independent authority without any interference by any Ministry or Department of the Government of India in the discharge of the functions entrusted to it by law.

Even the provisions relating to the General Anti-Avoidance Rules (GAAR) under the Act provide that the constitution of the ‘Approving Panel’ of GAAR shall be of three Members from distinct backgrounds with the Chairperson being a person who is or has been a judge of a High Court.

Further, under the Prevention of Money Laundering Act (PMLA), 2002, where the administrative control of the PMLA Tribunal is with the Ministry of Finance and not with the Ministry of Law and Justice, a writ petition challenging the same apprehending bias against the litigant is pending before the Rajasthan High Court.[1]

Under indirect tax law, where the constitution of the GST Appellate Tribunal consisted of one Judicial Member and two Technical Members (being Departmental Officers), the Hon’ble Madras High Court, in Revenue Bar Association v. Union of India [2019] (Madras)/ [2019] , has held that a justice delivery system has to be independent and impartial. The GST Appellate Tribunal, which primarily decides the disputes between State and citizens, cannot be run by a majority of non-judicial members.

“64. The submissions made by Mr. Arvind P. Datar, learned senior counsel that even tribunals, which are not constituted under Article 323-B of the Constitution of India, there cannot be any difference in matters of appointment of members. All the tribunals regardless of the fact that they are tribunals constituted under Article 323-A, 323-B or under any statute, are a part of justice delivery system and for effective justice delivery system, there is a need of an independent impartial tribunal. As stated earlier all the cases coming before the CGSTAT or TNGSTAT deals with adjudication of cases against the State. In such circumstances to have more number of members who are expert members (not Judges) will raise a reasonable apprehension in the minds of the assessee that they might not get fair justice and that the decision making, might be more oriented towards the State.

65. The Hon'ble Supreme Court of India, in R.K.Jain Vs. Union of India, reported in 1993 (4) SCC 119, Union of India Vs. R.Gandhi reported in 2010(11) SCC 1 and Madras Bar Association Vs. Union of India, reported in 2014 (10) SCC 1, more or less echoed the same feelings.

66. Mr.Arvind Datar is correct in his submissions that the GSTAT, is replacing the CESTAT, Sales Tax / VAT Tribunals. The composition of GSTAT therefore, has to be on the same lines. In fact, Article 50 of the Constitution of India which provides for separation of the judiciary from the executive, must be interpreted in such a way that the dominance of the departmental / technical members, cannot overwhelmingly outweigh the judicial members.

67. The Court can take judicial notice of the fact that now the tribunals are taking over the subjects which were initially being dealt with / adjudicated by Courts. These subjects were adjudicated by Judicial Officers. Viewed in this angle, tribunals which primarily decide disputes between State and citizens cannot be run by a majority consisting of non-judicial members.”

(emphasis supplied)

The aforesaid decision of the Hon’ble High Court, in the context of tax matters, emphasises the need for an impartial party, a judicial member to ensure fair justice and decision making.

Even the Hon’ble Supreme Court decision of UOI v. R. Gandhi [2010]  has echoed a similar proposition holding that the independence of members discharging judicial functions in a Tribunal cannot be diluted.

Even under the GST law, where the composition of AAR[2] is similar to the constitution proposed for the BAR; alarmingly, a slew of writ petitions[3] have been filed before various High Courts. These writ petitions challenge the constitutional validity of the provisions under the GST regulations to the extent they prescribe for the constitution of AAR consisting only of members from amongst the officers of the Central and State tax.

While the BAR comprising of only income-tax officers may lead to the timely disposal of applications – will it result in an effective disposal?

• Parallel proceedings

As per the existing provisions of section 245S of the Act, the ruling of the AAR is binding on both, the taxpayer as well as the Department. The said section, as proposed in the Finance Bill, 2021, will not apply in respect of rulings pronounced by the BAR. This implies that, the rulings of the BAR will henceforth, be non-binding and therefore, appealable before the High Court by both the parties to the ruling.

Given the proposed amendment, it is very likely that in most cases, the aggrieved party, either the taxpayer or the Revenue may file an appeal before the High Court. In such cases, especially where the ruling is in favour of the taxpayer and the Department has filed an appeal, the AO may not apply the ruling at all while making the assessment, the issue being sub-judice.

In such cases, the taxpayer will pursue the normal appeal remedy whereas the Department will pursue the High Court appeal leading to duplicity of proceedings on the same issue.  

Even in a scenario where the ruling is in favour of the Department and the taxpayer is in appeal, the taxpayer will have to pursue both the appeals, one under the normal appeal process against the assessment order and the second, before the High Court.

A scenario where the High Court overturns the decisions of the AAR will only lead to further complexity.

In either case, the non-binding nature of BAR rulings will lead to multiplicity of proceedings and thereby, increase litigation. This was certainly not the objective of setting up a forum such as the AAR.

• Substantive rights affected on change of forum

The Finance Bill, 2021, proposes to transfer all pending applications, as on the notified date, before the AAR to the BAR.

The aforesaid amendment will entail a change in forum for taxpayers who have already filed an application under the existing advance ruling scheme. While it is a settled principle that amendments leading to a change in forum are merely procedural in nature, and therefore, apply retrospectively; where an amendment affects the vested rights of the parties, it should be construed as a substantive amendment to be made applicable only prospectively.

The Hon’ble Supreme Court, in Hitendra Vishnu Thakur v. State of Maharashtra (1994) [TS-5034-SC-1994-O] , has held that a statute that not only changes the procedure but also creates new rights and liabilities shall have to be construed to be prospective in operation.

The constitution of the BAR, comprising only Departmental Officers and its ruling not being binding anymore, certainly affects the rights of the taxpayers who on the assurance of the Government of India that their potential tax issues will be dealt fairly and of certainty qua their tax liability in India, have made substantial investments in India. Certainly, such taxpayers cannot be subject to a disadvantage for no fault of theirs, by transferring their pending applications to the BAR. Accordingly, atleast for the applications already filed by the taxpayers before the AAR should continue with the same Authority.

Parting thoughts

The rulings of the AAR have the capacity to impact both the commercial and fiscal fortunes of the taxpayer community.

The proposed amendments qua the provisions relating to the determination of advance rulings are clearly not in harmony with the primary objective of providing certainty and predictability to taxpayers by constituting an independent adjudicating authority. With the sudden change in the fundamental framework under which an authority for advance ruling functioned certainly undermines the faith reposed in the Indian Government and causes disruption, especially for non-resident investors.

This article is also contributed by Karan Mehta

Sections 206AB and 206CCA – Thorn in the Flesh for Taxpayers?

The Finance Act, 2021 has proposed insertion of two new sections – 206AB and 206CCA with effect from July 1, 2021.

The proposed sections require persons deducting (206AB)/collecting (206CCA) tax at source, to do so at higher of 5% or twice the rates, specified or in force, while deducting/collecting tax at source from persons who have:

a)      not filed tax returns for two immediate previous years; and

b)      subjected to tax deduction/collection at source in aggregate amounting to INR 50 thousand or more in each of such two immediate previous years

It appears that that intention of the Indian government to introduce these sections is with a view to increase (notoriously low) tax regulations compliant population base in India.

However, it could cause genuine hardship to taxpayers and particularly for small taxpayers and micro, small and medium businesses/enterprises, who are likely to be most affected by these regulations.

Equally so, for the tax deductors/collectors who may be subjected to additional litigation, if they are unable to be sufficiently demonstrate compliance with these regulations. 

Some Potential issues

Documents to be submitted/collected – Would an Affidavit suffice? Or ITR V (proof of filing) and Form 26AS? (proof of tax deduction/collection)? Authenticity of such documents? Acceptance of such documents by Income tax authorities, during assessment?

Confidential information – ITR V and Form 26AS contain confidential business information (profitability/ pricing/customers etc.)

Delayed/Reduced receipts – Impact on cash flows detrimental for survival of small taxpayers and micro, small and medium businesses/enterprises and consequential interest implications for tax deductors for delayed payments, if any to such persons 

Probable solution 

Since Income Tax Authorities have the data readily available, notify a PAN linked standardized form which taxpayer can apply for and generate from the tax filing portal, as evidence of compliance.

To further reduce bureaucracy, Income Tax Authorities can auto-generate the standardized form which taxpayer can receive on email/download from tax filing portal (similar to Gold/Silver/Bronze certificates being issued by Income Tax Authorities).

Provide facility for tax deductor/collector to independently verify the authenticity of such form (similar to existing facility for Form 16/Form 16A).

Taxation of a ‘Goan’ Governed under Portuguese Civil Code – Steps towards Removal of Difficulty

This article has been co-authored by Satyaprakash Kamath (Chartered Accountant).

Brief background

Goa was liberated from Portuguese regime after 450 years of Portuguese rule on December 19,1961 and became part of India; 14 years after the rest of India got its independence. However, Goa continued to enjoy a distinct identity over the rest of India by virtue of it following the Portuguese Civil Code.  The Portuguese Civil Code is still prevalent in the state of Goa in relation to marriage, inheritance, property and other personal matters and is applicable to only Goans. Goan refers to every person who or either of whose parents or any of whose grandparents was born before December 20th, 1961 in Goa. 

From 19th December 1961 onwards the people of Goa by virtue of being Indian Citizen are liable to be taxed under the provisions of Income Tax Act,1961 because it is deemed that the said Act is extended to the territory which is newly annexed to the Union of India. Till Section 5A was specifically introduced in Finance Act 1994 effective from 1st April, 1994, the Income Tax Act had not specifically recognised the community of the property which is especially applicable to Goan governed under the Portuguese Civil Code for the purpose of assessment of Income Tax and therefore there were a number of litigations on the said issue.

Under the provisions of the Income Tax Act 1961, income is taxable in the hands of the person who earns it irrespective of the nature of the income. The exception to this rule is provided by section 5A applicable only to Goans. Income Tax Act 1961 contains specific section 5A which was inserted by Finance Act, 1994 effective retrospectively from 1st April,1963. This section governs the apportionment of income between spouses governed by Portuguese civil code as applicable in the State of Goa and reads as under:

5A (1) “Where the husband and wife are governed by the system of Community of Property (known under the Portuguese Civil Code of 1860 as “COMMUNIAO DOS BENS “) in force in the State of Goa and in the Union territories of Dadra and Nagar Haveli and Daman and Diu, the income of the husband and of the wife under any head of income shall not be assessed as that of such Community of Property (whether treated as an association of persons or a body of individuals), but such income of the husband and of the wife under each head of income (other than under the head “Salaries”) shall be apportioned equally between the husband and the wife and the income so apportioned shall be included separately in the total income of the husband and of the wife respectively, and the remaining provisions of this Act shall apply accordingly”.(Section 5A(1), Income Tax Act, 1961)

5A (2) “Where the husband or, as the case may be, the wife governed by the aforesaid system of Community of Property has any income under the head “Salaries”, such income shall be included in the total income of the spouse who has actually earned it”. (Section 5A (2), Income Tax Act, 1961)

The implications of this section on an individual, governed under the Portuguese Civil Code of 1860 as applicable in Goa, is that income from any source earned by either spouse, not being salary, is to be clubbed together, summed up and equally divided in the hands of each spouse. The said income could be in the nature of professional income, business income, income from capital gains from sale of property or financial instruments, rental income from house property, income from interest on bank deposits, interest on bank savings accounts, dividend income or any income from financial instruments. However, salary income will not be apportioned equally between both the spouses and will be taxed in the hands of the spouse who earns it.

The concept of Community of Property was first tested in a court of law in 1974 when the Bombay High Court held that a house property which yielded income became the property of the communion of the husband and wife and they were not liable to be assessed as a ‘Body of Individuals’(BOI) but they were entitled to be assessed in their individual and separate capacity under the Income Tax Act. (CIT V Purushotam Gangadhar Bhende [1977] [TS-5504-HC-1974(BOMBAY)-O] . BOI is a separate taxable entity under the Income tax Act. Under this status the entire income instead of being equally divided between both the spouse was clubbed together and taxed as a separate entity/person.

Upholding the same view, the Bombay High Court in 1983 held that Income from business run by the communion of the husband and wife married as per the custom of Goa should be assessed separately in equal share to each of them and not in the hands of the Body of individual of the communion. (Addl. CIT V. Valentino F. Pinto [1984] [TS-5444-HC-1983(BOMBAY)-O] ). The above two decisions in respect of income from house property and income from business reinforced and recognised the system prevailing in the State of Goa in the Community of Property between the spouses. However, subsequently Bombay High Court in 1994 took a different stand with respect to income from salary. It was held that income from salary should be assessed and taxed on such individual who draws the salary and as such the share of income on the basis of the principal of Community of Property need not be adhered to. The Court also held that the income from business, share of income from partnership firm and interest earned on bank accounts has to be assessed in the hands of the Body of Individual consisting of husband and wife and not separately in the hands of each spouse. (CIT V. Modu Timblo (individual) [1994] [TS-5315-HC-1993(BOMBAY)-O] ).

In conclusion, the Court in the said case stated that the communion of husband and wife married under the custom of Goa and governed by the Portuguese Civil Code constitutes a Body of Individual for the purpose of the Income Tax Act and it will have to be decided in respect of each head of income whether the income has accrued or arisen to the Body of Individual as such or to its members individually. In view of the above decision, for a taxpayer domiciled in Goa and who opted for the Portuguese Civil Code it became impossible for him to apply the principal of community of the property in the matter of income tax assessment and became disentitled to claim the benefit of sharing the income between both the spouses and thus of the assessment individually. They all became liable for assessment as Body of Individual which created harshness and resentment amongst the people of Goa since applying the concept of Body of Individual resulted in higher tax outgrow and as such even small businesses had to pay tax. On behalf of Goan assesses this issue was taken up by a core group of Chartered Accountants from Goa before the Finance Ministry.

The Finance Minister after grasping the uniqueness of the problem acted to obviate this difficulty by introducing Section 5A in the Income Tax Act in Finance Act, 1994 which came into force on 1st April, 1994. Retrospectivity was given to this section from 1st April,1963. The Finance Minister while presenting the Annual Finance budget for 1994-95 made the following statement in his speech which throws more light on the issue. It states as under: “The system of Community of Property (Communiao Dos Bens) is peculiar to the people living in Goa, Daman, Diu Dadra & Nagar Haveli. Recently, certain judicial decision has been handed down according to which business income of a Goanese family becomes taxable entirely in the hands of a single entity. The decisions affect the time honoured method of dividing such income equally and assessing such income separately in the hands of the husband and wife. This I understand has given rise to unnecessary tensions and anxiety amongst Goan couples. To set at rest all controversies in this area, I proposed to make suitable amendments in Income Tax act to ensure that expecting for salaries to any other income arising to the citizens governed by the system of Community of Property in Goa, will be divided equally and assessed separately in the hands of the husband and wife”. (Finance Budget,1994-95 Sec(1994)206 ITR(st.)5,30). Thus, 5A reduced the rigours of the judgement in case of Modu Timblo.

Hardships faced by Goan assessee

This provision being unique to Goa and the said union territories and since the income tax forms and procedures are common for entire India, the special reporting requirements of the assessee covered under Section 5A was not taken into consideration. Till the times return filing was manual and returns were processed manually by the local jurisdictional officers, the process of assessment, processing and refunds did not cause any issues. Even in the case of processing errors, the rectification process was simple since one could approach the jurisdictional officer in Goa, who being familiar with the implications of provision 5A, would provide a speedy resolution and bring the case to conclusion.

The issues started when the income tax returns were required to be filed electronically and were processed centrally at the Central Processing Centre (CPC) with the processing being done using higher technology solutions and minimal manual intervention. Since the logic of Section 5A was not taken into account, the processing resulted in wrongly determining returns as defective and incorrect demands on account of non-apportionment of TDS due to matching with Form 26AS. After representations by the Goa Branch of ICAI, the Income Tax Department took this matter into consideration and implemented the declaration of being covered under Section 5A in Part A – Gen and Schedule 5A wherein the assessee is required to declare details of spouse and income shared in the income tax return from the Assessment Year 2013-14.

Issue addressed in current budget

The current budget proposal identifies and seeks to address another hardship faced by Goan assessees. The due dates for persons covered under tax audit is 31st October as against 31st July in case of other persons. In case of an assessee covered under Section 5A, if the spouse is a partner in a firm covered under tax audit, the due date for filing is 31st October but benefit of the extended due date is not available to the assessee. The practical issue is that the income of the assessee not covered under tax audit cannot be determined till that of the spouse is determined after completion of tax audit of the firm in which the spouse is a partner. To address this issue the current budget proposes to amend Section 139 of the Income tax Act as follows:

”Amendment of section 139.

32. In section 139 of the Income-tax Act,–– (a) in sub-section (1), in Explanation 2,––

(i) in clause (a), in sub-clause (iii), after the words “any other law for the time being in force”, the words, figure and letter “or the spouse of such partner if the provisions of section 5A applies to such spouse” shall be inserted;”

As stated in the Budget Memorandum:

“Since the total income of a partner can be determined after the books of accounts of such firm have been finalised, the due dates of partners are already aligned with the due date of the firm. Thus, the due date for filing of original return of income of such partner is 31st October of the assessment year. However, this relaxation is not there for spouse of such partner to whom section 5A of the Act applies. Therefore, it is proposed that the due date for the filing of original return of income be extended to 31st October of the assessment year in case of spouse of a partner of a firm whose accounts are required to be audited under this Act or under any other law for the time being in force, if the provisions of section 5A applies to them."

From the Asst. Year 2018-19, the Income tax Act implemented Section 234F for late fees for delayed filing of returns. This late fee is computed at the time of filing the income tax returns by the utilities or softwares by considering the due date based on whether the person is covered under Section 44AB or whether the person is a partner in a firm which is covered under Section 44AB. As of now, there is provision in the ITR form for an assessee to declare being partner in a firm covered under tax audit, but there is no provision to declare that the spouse is a partner in a form covered under tax audit. Unless such provision is made in the form, it is probable that the return may be considered as belated and late fees may be levied thereon.

Other hardships and possible solutions

Despite these improvements, the assessees continued to face hardship on account of non-apportionment of TDS in line with apportionment of income since the TDS matching logic is PAN based. After representations were made by Chartered Accountants, the Income Tax Department made modifications to Schedule TDS to capture details of TDS of spouse and apportionment thereof. The effectiveness of processing of returns after this modification will be clear after processing of returns of AY 2020-21.

The other major issue affecting the Goan assessees subsequent to introduction of e-filing and automated central processing is that there is no provision in the form to declare income of each individual, add the income of spouse and then reduce half thereof to arrive at income as per requirements of Section 5A. For the lack of a better alternative, assessees would directly declare half income but would receive notice for adjustment under Section 143(1)(a) for mismatch between income and deduction as compared to Form 26AS. Certain assessees in order to avoid mismatch of the income with Form 26AS would show the total income of both assessees and then show half amount as deduction. These assessees received enquiries for claiming high deductions since the only possible field in which this amount could be reduced was “any other deduction”. This issue remains unresolved.

Suggested options based on practice followed:

Option 1: The earning spouse enters the total balance sheet and profit and loss account in ITR 3. The Schedule BP provides for a separate deduction on account of Section 5A wherein the system computes 50% of the income from BP after adjustments. Similar option to be provided under other heads of income. The earning spouse claims 50% of TDS available in Form 26AS against the PAN.

In case of the non-earning spouse, a separate line item be shown in Schedule BP as half share of income of spouse under Section 5A. 50% credit of TDS is shared to the non-earning spouse. The return of the non-earning spouse should be processed as a non-accounts case and should not be marked as defective on account of no P&L and Balance Sheet entered. No tax audit report be made applicable to the non-earning spouse.

Option 2:  Husband and wife covered under Section 5A enter 50% of all Balance Sheet items and 50% of Profit and Loss Account items in ITR 3. The earning spouse claims only 50% of the TDS credit available in Form 26AS against the PAN. The non-earning spouse claims 50% of the TDS credit available in Form 26AS against the PAN of the earning spouse.

Conclusion

The current budget proposal to extend the due date for spouse of an individual covered under Section 5A being a partner in a firm covered under tax audit is a welcome move and it is encouraging to see that the Income Tax Department is proactively addressing the hardships faced by Goan assessees at the time of processing of income tax returns. Given the other changes in the income tax forms and schema for AY 2020-21 and changes expected in the forthcoming assessment years, it appears that the accuracy of processing and speed of refunds will be seamlessly implemented.

Equalisation Levy 2.0 – Does Finance Bill, 2021 Make the Levy All-Encompassing?

This article has been co-authored by Anita Nair (Senior Manager, Deloitte Haskins and Sells LLP).

The new levy got enacted as law soon after but left taxpayers in a conundrum of sorts as it brought forth too many issues that begged for clarity. In the absence of a supporting Explanatory Memorandum or public consultation, there was no document to rely on so as to gather intent regarding the new provisions.

While certain taxpayers chose to be compliant in the face of uncertainty, many others adopted a wait and watch approach for issue of clarifications from the government. The recent section 301 United States Trade Representative (‘USTR 301’) proceedings against India also cited lack of certainty in respect of the new levy, as one of the causes for initiating proceedings against India alleging discriminatory levy.

Needless to say, for all the above reasons, all eyes were on Budget 2021 for clarity. The Budget did that and threw light on certain critical issues related to the levy.

Carve-out for payments taxable as royalties/ fees for technical services

On payment of equalisation levy, an exemption is available from payment of income tax. However, this exemption was to come into effect only from 1 April 2021. This anomaly has now been rectified making the exemption operative from 1 April 2020 itself, i.e. from the date of applicability of EQL. However, in the interim, due to non-availability of exemption from income tax even on payment of EQL, those taxpayers with payments in the nature of royalties/ fees for technical services (‘FTS’) which also fell within the ambit of EQL, ended up paying both taxes. The good news is that now there is clarity on this issue as Finance Bill 2021 (‘FB 2021’) has carved out payments in the nature of royalties/ fees for technical services (‘FTS’) from the ambit of EQL. Resultantly, taxpayers would now need to seek refund of EQL already paid in such cases. Further, going forward, characterisation of a payment as royalties/ FTS becomes all the more important. If the payment is taxable as royalties/ FTS, it is liable to income-tax and the taxpayer may claim foreign tax credit in their home jurisdiction. If the payment is not in the nature of royalties/ FTS, EQL would have to be paid on the same. Notable impact would be on businesses engaged in selling software, cloud hosting services, common shared services within a group, subscription services etc. A close reading of the fine print also reveals that this carve-out of royalties/ FTS also applies to online advertising which are subject to 6% EQL. This merits a closer examination of these services as well, especially in light of the amendments in the royalties’ definition introduced by Finance Act 2012.

It is also interesting to note that the exclusion from EQL is available if a service is taxable as royalty/ FTS under the Act, read with the relevant tax treaty. Therefore, if a payment is taxable as royalty/ FTS under the Act, but treaty benefit is available, the taxpayer will may still need to pay EQL.

Definition of the expression ‘online sale of goods/ online provision of services’

Although purported to be a levy on non-resident e-commerce operators, since EQL was imposed on ‘online sale of goods/ online provision of services’ by non-resident e-commerce operators, at the outset itself the levy sought to cover not just marketplaces but all non-residents whose business models used digital means to provide goods and services to Indian customers. However, in the absence of a precise definition, varied interpretations were possible on whether ‘sale/ providing service’ would only include cases where the sale was concluded online i.e. including the delivery leg, or either conclusion of the sales contract or delivery or both were to be conducted online or even stages precedent to contract conclusion. FB 2021 has now clearly provided that conducting any one or more of the following activities would result in sale/ service being considered as provided online:

(a)      Acceptance of offer for sale

(b)      Placing of purchase order

(c)      Acceptance of purchase order

(d)      Payment of consideration

(e)      Supply or service, wholly or partly online

As can be observed, almost all steps in the sales lifecycle have been sought to be covered above, other than possibly mere sales enquiries or display of products and prices on a digital facility by a non-resident e-commerce operator. This amendment has undoubtedly expanded the scope of the levy far beyond what may have been typically expected to fall as an ‘in scope activity’ for EQL.

No change has been made to the definition of the term ‘e-commerce operator’ who is a non-resident, who owns, operates or manages a digital or electronic facility or platform. Considering that the origin of equalisation levy can be traced to BEPS Action Plan 1 ‘Tax Challenges arising from Digitalisation’, which referred to digitized business that used platforms in the nature of mediums of mass communication, it remains to be explored whether this feature of digitized businesses can be used to some degree to contain the impact of the wide reach of the term ‘online sale of goods/ services’ as amended by FB 2021.

It is also striking that in its response to initiation of investigation of Digital Services Taxes under section 301 of US Trade Act, India purportedly stated that EQL is sought to be applied to tax businesses that have close nexus with the Indian market through their digital operations. However, fragmenting the entire sales lifecycle and applying the levy even if any of the activities leading up to sale are conducted online using a digital facility by all businesses appears to be running contrary to India’s own statements in the aforesaid response. It is quite likely therefore that taxpayers may challenge the wide ambit of the levy on these grounds which is a matter best left for the courts to decide.

Consideration to be reckoned for an e-commerce operator irrespective of ownership of goods/ services

There were also divergent views on the base amount on which EQL should apply in cases where the consideration was received by payment collection agents or marketplaces and not the foreign vendor himself. The issue was whether the consideration for sale of goods/ services received by the collection agents or marketplaces ought to be liable to EQL in their hands or not; whether EQL should apply on the gross consideration or only on the fee charged by such marketplace/ agent for their service. FB 2021 now clarifies that consideration for sale of goods/ services is taxable even if the e-commerce operator is not the owner of goods/ services. Therefore, if payment gateways/ marketplaces were hitherto offering only the net consideration to EQL, it is time to revisit the amounts exigible to the levy.

Since these clarifications are operative from 1 April 2020, and the net has been cast very wide, it is imperative for businesses to revisit their exposure to the levy so as to enable them to obtain Indian tax registration to pay the levy or in cases where the levy has been deposited for earlier quarters, to true up the levy in the last quarter payment due on 31 March. As a taxpayer friendly measure, an earnest appeal would be that these clarifications if provided at the time of introduction of the levy would provide sufficient time to taxpayers to evaluate their positions and comply with the levy.

Information for the editor for reference purposes only