INTRODUCTION
Finance Minister Nirmala Sitharaman presented her maiden Budget in the
backdrop of a significant economic slowdown which is now threatening to turn
into a recession. The Budget and the Finance Act passed thereafter did not
reduce the tax rates which many expected. In fact, the surcharge on individuals
was increased significantly, reversing the trend of a gradual reduction in
taxes in earlier Budgets. The increase was criticised and it was felt that the
high level of taxes would have a negative impact on the investment climate in
the country. Responding to the situation, the government issued the Taxation
Laws (Amendment) Ordinance, 2019 which seeks to give relief to corporates and a
fillip to the economy.
This article analyses the various issues in the two principal provisions
in the Ordinance. In writing this article I am using inputs from Bhadresh
Doshi, my professional colleague who spoke on the topic on the BCAS
platform a few days ago.
As I write this article, the Ordinance has been converted into a Bill. I
have considered the amendments made in the Bill while placing it before
Parliament. However, during its passage in Parliament, the said Bill may
further be amended. The article therefore should be read with this caveat.
SECTION 115BAA
The new provision 115BAA(1) provides that
(a) notwithstanding anything contained in the other provisions of the
Income-tax Act
(b) income tax payable by
(c) a domestic company
(d) for A.Y. 2020-21 onwards
(e) shall at the option of
the company
(f) be computed at the rate
of 22% if conditions set out in sub-section (2) are satisfied
The proviso to this sub-section stipulates that in the event the company
opting for the lower rate violates any condition prescribed in sub-section (2),
the option shall become invalid for that previous year in which the condition
is violated and the provisions of the Act shall apply as if the option had not
been exercised for that year as well as subsequent years.
Sub-section (2) provides the following conditions:
(i) the income of the
company is computed without deductions under sections 10AA, 32(1)(iia), 32AD,
33AB, 33ABA, 35(1)(ii)/(iia)/(iii), 35(2AA)/(2AB), 35CCC, 35CCD or any
deductions in respect of incomes set out in Part C of Chapter VIA other than a
deduction u/s 80JJAA;
(ii) the company shall not
claim a set-off of any loss or depreciation carried forward from earlier
assessment years, if such loss or depreciation is attributable to the
provisions enumerated above;
(iii) the company shall not
be entitled to set-off of any deemed unabsorbed loss or depreciation carried
forward by virtue of an amalgamation or demerger in terms of section 72A;
(iv) company shall claim depreciation u/s 32(1).
Sub-section (3) provides that the loss referred to in sub-section (2)
shall be treated as having been given effect to. The proviso, however, provides
that there would be an adjustment to the block of assets to the extent of the
depreciation that has remained unabsorbed for the years prior to assessment
year 2020-21.
Sub-section (4) provides that if the option is exercised by a company
having a unit in the International Financial Services Centre as referred to in
sub-section (1A) of section 80LA, the conditions contained in sub-section (2)
shall be modified to the extent that the deduction u/s 80LA shall be available
to such unit subject to compliance with the conditions contained in that
section.
Sub-section (5) provides that the section shall apply only if an option
is exercised by the company in the prescribed manner on or before the due date
specified under sub-section (1) of section 139 for any assessment year from
2020-21 onwards. The sub-section further provides that the option once
exercised cannot be withdrawn for the said year or future years.
The proviso provides that if an option exercised u/s 115BAB becomes
invalid on account of certain violations of the conditions set out in that
section, such a person may exercise the option under this section.
ANALYSIS
The new section grants an option to domestic companies to choose a lower
rate of tax @ 22% plus the applicable surcharge and cess and forgo the
deductions enumerated. It is fairly clear from the section that claim in an
anterior year attributable to the specified deductions which could not be
allowed on account of insufficiency of income cannot be set off in the year in
which an option under the section is exercised or future years.
The issue that may arise in this context is that except for the claim
u/s 35(1)(iv), the law does not contemplate a segregation of the business loss
into loss attributable to different sections. In fact, it is only in regard to
the loss arising on account of a capital expenditure u/s 35(1)(iv) that a
priority of set-off of losses is contemplated in section 72(2). Therefore, if
one is to give effect to section 115BAA(2), then the assessee company would
have to compute a breakup of a business loss which has been carried forward,
between various provisions to which it is attributable. Without such a
bifurcation the provision attributing loss to the enumerated deductions cannot
be given effect to. Even as far as depreciation is concerned, depreciation is
computed under sections 32(1)(i) and (iia). It is the aggregate of such depreciation
which is claimed as an allowance and a reduction from the written down value
(w.d.v.) of the block of assets. There is no specific provision requiring a
bifurcation between the two.
A harmonious interpretation would be that a company exercising the option
for the applicability of this section would have to give a breakup of the said
loss, attributing losses to the deductions referred to above and such
attribution would bind the Department, as the provisions for set-off do not
provide for an order of priority between general business loss and loss
attributable to the enumerated deductions.
The proviso
to sub-section (3) seeks to mitigate the double jeopardy to a person seeking to
exercise the option of the lower rate, namely, that set-off of unabsorbed
depreciation will not be allowed as well as the w.d.v. of the block would also
stand reduced. The proviso provides that if there is a depreciation allowance
in respect of a block of assets which has not been given full effect to, a
corresponding adjustment shall be made to the w.d.v. of the block. To
illustrate, if Rs. 1 lakh is unabsorbed depreciation in respect of a block of
assets for assessment year 2019-20, for computing the depreciation for the
block for assessment year 2020-21 the w.d.v. of the block shall stand increased
to that extent.
SECTION 115BAB
This section seeks to grant a substantial relief in terms of a reduced
tax rate to domestic manufacturing companies. The section provides that
(1) a domestic company, subject
to conditions prescribed, would at its option be charged at a tax rate of 15%
from assessment year 2020-21 onwards;
(2) it is, however, provided
that income which is neither derived from nor incidental to manufacturing or
production, and income in the nature of short-term capital gains arising from
transfer of non-depreciable assets, will be taxed at 22%. In regard to such
income, no deduction of expenditure would be allowed in computing it;
(3) the income in excess of the
arm’s length price determined u/s 115BAB(6) will be taxed at 30%;
(4) the conditions are:
(a) the company is set up
and registered on or after 1st October, 2019 and commences
manufacture or production on or before the 31st day of March, 2023;
(b) it is not formed by
splitting up or the reconstruction of a business already in existence (except
for re-establishment contemplated u/s 33B);
(c) it does not use any
machinery or plant previously used for any purpose (except imported machinery
subject to certain conditions). Other than imported machinery, the condition
will be treated as having been fulfilled if the value of previously used
machinery or part thereof does not exceed 20% of the total value of machinery;
(d) it does not use any
building previously used as a hotel or convention centre in respect of which a
deduction u/s 80-ID has been claimed and allowed;
(e) the company is not
engaged in any business other than the business of manufacture or production of
any article or thing and research in relation to or distribution of such
article or thing manufactured or produced by it;
(f) the explanation to
section 115BAB(2)(b) excludes development of computer software, mining,
conversion of multiple blocks or similar items into slabs, bottling of gas into
cylinders, printing of books or production of cinematograph film from the
definition of manufacture or production. The Central Government has also been
empowered to notify any other business in the list of excluded categories;
(g) income of the company is
computed without deductions under
sections 10AA, 32(1)(iia), 32AD, 33AB, 33ABA, 35(1)(ii)/(iia)/(iii),
35(2AA)/(2AB), 35CCC, 35CCD or any deductions in respect of incomes set out in
Part C of Chapter VIA other than a deduction u/s 80JJAA;
(h) the company shall not be
entitled to set-off of any deemed unabsorbed loss or depreciation carried
forward by virtue of an amalgamation or demerger in terms of section 72A;
(i) company shall claim
depreciation u/s 32(1).
Sub-section (3) provides that the loss referred to in sub-section (2)
shall be treated as having been given effect to.
Sub-section (4) empowers the CBDT, with the approval of the Central
Government, to remove any difficulty by prescribing guidelines in regard to the
fulfilment of the conditions regarding use of previously-used plant and
machinery or buildings, or the restrictive conditions in regard to the nature
of business.
Sub-section (5) provides that the guidelines issued shall be laid before
each House of Parliament and they shall bind the company as well as all income
tax authorities subordinate to the CBDT.
Sub-section (6) provides that if, in the opinion of the assessing
officer, on account of close connection between the company and another person,
the business is so arranged that it produces to the company more than ordinary
profits, he shall compute for the purposes of this section such profits as may
be reasonably deemed to have been derived from such business.
The proviso to the sub-section provides that if the aforesaid
arrangement involves a specified domestic transaction (SDT) as defined in
section 92BA, the profits from such transaction shall be determined having
regard to the arm’s length price as defined in section 92F.
The second proviso provides that the profits in excess of the arm’s
length price shall be deemed to be the income of the person.
Sub-section (7) provides that the section shall apply only if an option
is exercised by the company in the prescribed manner on or before the due date
specified under sub-section (1) of section 139 for any assessment year from
2020-21 onwards. The sub-section further provides that the option once
exercised cannot be withdrawn for the said year or future years.
The explanation to the section states that the expression ‘unabsorbed
depreciation’ shall have the meaning assigned to it in section 72A(7) for the
purposes of section 115BAB and 115BAA.
ANALYSIS
Unlike the provisions of section 115BAA, the provisions of this section
give rise to a number of issues, many of them arising on account of lacunae in
drafting which may be taken care of when the Taxation Laws (Amendment) Bill
becomes an Act. These are as under:
The threshold condition of eligibility is that the company is set up and
registered on or after 1st October, 2019 and commences manufacture
or production on or before the 31st day of March, 2023. It is not
clear as to whether the eligibility for the lower rate would be available to
the company after it is set up but before it commences manufacture or
production.
It needs to be pointed out that the situs of manufacturing unit
is not relevant. Therefore, manufacture outside India would also be entitled to
the lower rate of tax. Considering the tax cost in the country of manufacture,
this may not turn out to be tax effective, but such a situation is
theoretically possible.
If a company fails to meet the condition of commencement of manufacture
or production, the grant of the lower rate of tax would amount to a mistake
apparent from record amenable to a rectification u/s 154.
It is possible that in the interregnum between the setting up and
commencement of manufacture or production, the company may earn some income.
This is proposed to be taxed at 22% if it is not derived from or incidental to
manufacture or production. The term ‘incidental’ is likely to create some
controversy. While the higher rate of tax for such other income can be
understood, the condition that no deduction or expenditure would be allowed in
computing such income appears to be unjust. To illustrate, a company demolishes
an existing structure and disposes of the debris as scrap. The debris is
purchased by a person to whom it has to be transported and the company bears
the transport cost. On a literal interpretation of the section a deduction of
such expenditure will not be allowed. This aspect needs to be dealt with during
the passage of the Bill into an Act, or a suitable clarification needs to be
issued by
the CBDT.
Section 115ABA(2)(a)(i): This provides that the company is not formed by
splitting up or reconstruction of a business already in existence. As to what
constitutes splitting up or reconstruction of a business is already judicially
explained [Refer: Textile Machinery vs. CIT 107 ITR 195 (SC)].
There are several other decisions explaining the meaning of these terms. The
difference between this provision and all other incentive provisions is that in
those provisions (sections 80-I, 80-IA) this phrase was used in the context of
the business of an ’undertaking’. In this case the phrase is used in the
context of an assessee, namely, a domestic company. Therefore, an issue may
arise as to whether, after its formation, if a company acquires a business of
an existing entity (without acquiring its plant and machinery), the conditions
of this section would be vitiated. The words used are similar to those in other
incentive provisions, namely, ‘is not formed’. It therefore appears that a
subsequent acquisition of a business may not render a company ineligible for
claiming the lower rate of tax.
Section 115ABA(2)(a)(ii): This prescribes that the company does not ‘use’
any machinery or plant previously used for any purpose. While the explanation
grants some relaxation in regard to imported machinery, this condition is
extremely onerous. This is because hitherto the words used were ‘transferred to
a new business of machinery or plant’. Therefore, the undertaking had to be
entitled to some dominion and control over the old machinery for the condition
to be attracted. The provision as it is worded now will disentitle the company
to the relief if any old machinery is used. To illustrate, a company decides to
construct its own factory and the plant and machinery in the said factory is of
the value of Rs. 5 crores. During the course of construction, the company hires
for use a crane (which obviously has been used earlier), of the value of Rs. 2
crores. It would have, on a literal reading of the section, contravened one of
the eligibility conditions. It must be remembered that the condition is not
even connected with the business of manufacture but is attracted by ‘use’ of
the machinery by a company for any purpose.
Admittedly, this may not be the intention, but this condition needs to
be relaxed or amended to ensure that an overzealous tax authority does not deny
the rightful lower rate to a company which is otherwise eligible.
Section 115ABA(2)(a)(iii): This clause prescribes a condition that is even
more onerous. The company is not entitled to ‘use’ any building previously used
as a hotel or convention centre, in respect of which a deduction u/s 80-ID is
claimed. Here again the test is merely ‘user’ without there being any dominion
or control of the company over the building. Further, it is virtually
impossible for a company to ascertain whether the building in respect of which
it has obtained a right of temporary user has hitherto been used as a hotel or
convention centre, and whether deduction u/s 80-ID has been claimed by the
owner / assessee. To illustrate, a company decides to hold a one-month
exhibition of its manufactured goods and for that purpose obtains on leave and
licence 5,000 sq. ft. area in a commercial building. It holds its exhibition
and it later transpires that the said area was hitherto used as a convention
centre. On a literal reading of the section, the company would lose benefit of
the lower rate of tax. Clarity on this issue is required by way of issue of a
CBDT circular.
Section
115BAB(2)(b): The
last condition, which is distinct from the conditions prescribed in 115BAA, is
in regard to restricting the eligibility to those companies whose business is
of manufacture or production of articles and things, research in relation to
such goods as well as distribution thereof. The term manufacture is defined in
the Act in section 2(29B). The same is as follows: [(29BA) ‘manufacture’, with
its grammatical variations, means a change in a non-living physical object or
article or thing:
(a)
resulting in transformation of the object or article or thing into a new and
distinct object or article or thing having a different name, character and use;
or
(b) bringing
into existence of a new and distinct object or article or thing with a
different chemical composition or integral structure.]
These two terms have been judicially interpreted and are distinct from
each other, though the common man uses them interchangeably. Reference may be
made to the decisions of the Apex Court in CIT vs. N.C. Budharaja 204 ITR
412 (SC); CIT vs. Oracle Software India Ltd. 320 ITR 546(SC). The term
production is a wider term, while the term manufacture must ensure that there
is change in the form and substance of an article at least commercially. While
introducing the Bill, development of software in any form, mining and certain
other activities which could have fallen into the realm of manufacture or
production have been specifically excluded. Companies engaged in such business
will therefore not be entitled to the lower rate. It is also provided that the
Central Government is empowered to notify further businesses which will not be
entitled to the lower rate. It is hoped that any notification will be
prospective in nature, because if a company is registered and it incurs a cost
in setting up a manufacturing facility, a subsequent notification denying it
the lower rate will be unfair.
The
conditions prescribed in section 115BAB(2)(c) are identical to those of section
115BAA and the analysis in regard thereto will apply with equal force to this
section as well.
Sub-section (6) seeks to limit the operation of the section to income
which is derived from the business of the company computed at arm’s length. The
proviso further provides that if the arrangement between the company and the
related person (associated enterprise), involves a specified domestic
transaction, then the profits from the transaction will be computed based on
the arm’s length price as defined in 92F(ii).
Like in the case of section 115BAA, sub-section (7) provides that, in
order to avail of the benefit of the section, the company must exercise the
option on or before the due date prescribed in section 139, and once exercised
the option cannot be subsequently withdrawn for that or any previous year.
The explanation provides that the term ‘unabsorbed depreciation’ will
have the meaning assigned to it in clause (b) of sub-section (7) of section
72A. It is therefore clear that the denial of unabsorbed depreciation in
computing income will be restricted to such depreciation that is deemed to be
unabsorbed on account of an amalgamation or demerger. This appears to be in
keeping with the intent of the lawmakers.
CONCLUSION
Both the sections are clear on intent but seem to suffer from lacunae in
drafting, particularly in the case of section 115BAB. Let us hope that these
creases are ironed out before the Bill becomes an Act or if that does not
happen, then the Central Board of Direct Taxes (CBDT) issues circular/s
clarifying the legislative intent.
