Critical Analysis of Issues in Taxation Laws (Amendment) Bill, 2019

Introduction

The Taxation Laws (Amendment) Bill, 2019 (the "Bill") which has been passed by the Parliament will replace the Taxation Laws (Amendment) Ordinance, 2019 (the "Ordinance") promulgated by the President on 20th September 2019 to reduce corporate tax rates and enhanced surcharge on certain incomes by amending the Income Tax Act 1961 and Finance (No. 2) Act, 2019. These amendments are effective from AY 2020-21.

The reduction in the corporate income tax rate is not made compulsory or mandatory but is optional to a domestic company. For this purpose, the Bill has introduced two new sections - section 115BAA and section 115BAB.

Both sections require certain conditions to be satisfied before exercising the option for the lower rate of income tax. Once the options are exercised, one cannot come out of the scheme and therefore it is very crucial to analyze all the legal issues with caution to avoid any unintended consequences. Although the provisions are simple to read, there are many ambiguous issues that need thorough and in-depth analysis.

Some of the issues emerging on a reading of the provisions of the Bill are discussed below.

Rollback of enhanced Surcharge on income tax

The Bill has reduced the enhanced surcharge on income-tax which was introduced by the Finance (No. 2) Act, 2019 which is named as 'super-rich' tax.

However, the manner in which the surcharge is reduced, it has made the computation of surcharge on income-tax more complicated.

The reduction in surcharge is made only in respect of certain categories of income chargeable under section 111A, section 112A and section 115AD(1)(b). The surcharge on these incomes cannot exceed 15 percent. In other words, only in respect of these incomes, the maximum cap of 15 percent surcharge is provided in the Bill. Other income shall continue to attract a surcharge of 25 percent or 37 percent as the case may be.

One should be careful in applying the surcharge on the income tax since it is now dependent on the composition of incomes. If the total income does not include income chargeable under section 11A or section 112A then the new reduced surcharge rates are not applicable. Further, if the total income does not exceed Rs. 2 crore, then also the new reduced surcharge rates are not applicable.

The new surcharge rates will apply only when total income exceeds Rs. 2 crore and includes income chargeable under section 111A or section 112A. Further, the new reduced rate of surcharge on income-tax is applicable for Individuals, Hindu Undivided Family (HUF), Association of Persons and Body of Individuals whether incorporated or not.

The new amended rate of the surcharge shall not apply to companies because the surcharge rates were increased in the Union Budget 2019 only for these categories of taxpayers.

New Surcharge on Companies

Presently, in case of a domestic company, the surcharge on corporate tax rates are based on the total income of the company and are as follows-

Thus, if the total income does not exceed Rs. 1.0 crore, then no surcharge is applicable.

However, in case of a domestic company exercising option under section 115BAA or section 115BAB, a flat rate of surcharge of 10 percent is required to be paid irrespective of the total income of such company.

If the total income of a domestic company is even Rs. 10 Lakh, a flat surcharge on income-tax @ 10 percent is payable if the company has opted either section 115BAA or section 115BAB.

It may be noted that the total income of a domestic company exercising option under the new provisions shall be required to be computed without considering certain deductions.

Further, it is not linked to any turnover or income criteria to become eligible for exercising the option under the new schemes.

These new schemes are only available to a domestic company. A 'domestic company' is defined in section 2(22A) of the Act. Thus, a foreign company is excluded. Other than company forms of business are also excluded viz., sole proprietor, partnership firms, LLPs, etc. from these new schemes. A domestic company may be a listed company or an unlisted company.

Exercise of option for lower corporate income-tax rate

Though the new provisions - section 115BAA and section 115BAB are made applicable from AY 2020-21, it may be noted that it is not mandatory for a domestic to pay tax under the new scheme.

A domestic company is given an option either to opt or not to opt for new schemes of taxation in the AY 2020-21 itself. For example, an existing domestic company may wish to defer to exercise the option under section 115BAA even after AY 2020-21.

Since under the new section, total income will be computed without any specified deductions and set-off of certain brought forward losses and MAT credit under section 115JAA, it may defer the exercise of the option to a later year after exhausting all the existing benefits and deductions. For example, an existing domestic company may choose to exercise the option, say, in AY 2023-24 if it so wishes; instead of AY 2020-21.

However, this is not the case in the case of section 115BAB. It is provided that an eligible company shall exercise the option before furnishing the first return on income.

What does the 'first return of income' mean is not clarified. Is it the first return that the company will file after incorporation or it refers to the first return which the company will file for the first time after the company starts commercial production.

Any wrong choice of first-year may render the option invalid forever.

No MAT credit under beneficial schemes

It is clarified in the Bill that a domestic company exercising option under section 115BAA is not eligible to take the MAT credit against tax liability determined under the new provision. For this purpose, an amendment is carried out in section 115JAA.

The 'statement of objects and reasons' does not mention the reasons for denying the benefit of MAT credit, however, a circular issued by the CBDT after the promulgation of the Ordinance clarified that since the provisions of section 115JB or MAT is not under the new scheme hence the benefit of MAT credit shall not be available to such companies exercising option under section 115BAA.

Under section 115JAA a company is eligible for utilization of MAT credit paid under section 115JB in any earlier year(s) against the tax liability under the normal provisions of the Income Tax Act, 1961.

MAT credit is thus akin to advance tax and in accounting terms, an asset. After the exercise of the option under section 115BAA, this asset will become a worthless asset that needs to be written off.

No option to exit voluntarily

It is provided that once an option is exercised either under section 115BAA or section 115BAB the option shall be required to be continued in subsequent years also. One cannot revert to the old scheme of taxation once the option is exercised.

However, the Bill has provided that if in any assessment year if any of the condition(s) specified in either section 115BAA(2) or section 115BAB(2) is violated then the new scheme shall become invalid and all other provisions of the Act will apply as if no option is exercised for that assessment year and all the subsequent assessment years.

It may be noted that if a company wishes to exit from the scheme but have no chance to violate any of the mentioned conditions in either section 115BAA(2) or section 115BAB(2), then such a company can never exit from the scheme after the exercise of the option.

It is easier to violate the conditions in section 115BAB(2) than section 115BAA(2). Hence the option must be exercised with caution and after proper study.

Switching from section 115BAB to section 115BAA

It is provided in section 115BAA [proviso to sub-section (5)] that if a person fails to comply with the conditions specified in section 115BAB(2), then such a person may exercise option under section 115BAA.

It is an option given to such a company. In other words, a company violates any of the conditions of section 115BAB(2) then such a company may opt for section 115BAA or may switch to normal provisions of the Act.

The option can be switched to section 115BAA only on violation of specified conditions in section 115BAB(2). It cannot be switched voluntarily as per the wish of the company.

If it wishes to switch to section 115BAA then it has to exercise the option in accordance with the exercise rule provided in section 115BAA(5). The said section provides that the option shall be exercised in the prescribed manner on or before the due date of filing of return of income under section 139(1).

The problem will arise when in the assessment proceedings the option exercised under section 115BAB is declared invalid and in that case, the company cannot switch to section 115BAA because by that time the time-limit for the filing of return has already been expired.

Reversal of loss and depreciation benefit and MAT credit when the option is invalid

It is provided that if a company fails to satisfy the conditions specified in sub-section (2) of section 115BAA and section 115BAB then the option shall become invalid in respect of that assessment year and all subsequent assessment years and other provisions of the Act shall apply as if the option had not been exercised for that assessment year and subsequent assessment years.

Now a question may arise whether the brought forward loss or additional depreciation which was not allowed to be set-off in the year(s) when the option under the new beneficial option was exercised in the year of violation.

The answer is "No". This is because sub-section (3) expressly provides that such loss or depreciation shall be deemed to have been given full effect to and no further deduction shall be given for such loss or depreciation in any subsequent assessment year.

Hence, if in the period when the exercise of the option was valid, the loss or depreciation so forgone shall not be allowed in the year of violation since the benefit of such loss or depreciation is deemed to have been given.

But this is not the case for MAT credit under section 115JAA. This is because the restriction on the use of MAT credit is not contained in section 115BAA, but it is provided in section 115JAA itself. The amended section 115JAA simply provides that the provisions of section 115JAA shall not apply to a person who has exercised the option under section 115BAA.

In the year of violation, the person is not exercising the option under section 115BAA and thus MAT credit under section 115jAA is available if otherwise the same is eligible.

Overriding effect of the provisions

Both the section 115BAA and section 115BAB begins with the non-obstante clause 'Notwithstanding anything contained in this Act...".

This means these provisions override other provisions of the Act except Chapter-XII. In other words, these new provisions do not override Chapter-XII of the Act.

Does it mean the other provisions of the Act viz., the provisions relating to advance tax, interest, assessment, appeals, etc will not apply in these cases.

The overriding effect to these provisions is given only to a limited extent for computing the income tax liability on the total income. Firstly, the total income shall be determined in the normal manner and then the adjustments need to be carried out for exercising the beneficial provision. On the computed income, income tax at the concessional rate shall apply. All other provisions of the Act shall continue to apply.

What shall be the rate of tax in case of short term capital gains, long term capital gains, income from undisclosed sources, etc.? Will these be taxed at 22 percent/ 15 percent or other concessional or higher rates?

It is already stated that these new beneficial provisions do not override the Chapter-XII of the Act. The Chapter-XII contains income tax rate of certain income and those rates of income-tax shall continue to apply.

The income under section 111A is chargeable to tax @ 15 percent and the same will apply even to a company that exercised option under section 115BAA or section 115BAB.

The income under section 112A is chargeable to tax @ 10 percent and the same will apply even to a company that exercised option under section 115BAA or section 115BAB.

If a company that exercised option under section 115BAA or section 115BAB and if any income is assessed under section 68/69/69A/69B/69C/69D, then the income-tax rate of 60 percent shall apply on these incomes under section 115BBE and not the concessional rate of 22 percent or 15 percent, as the case may be, which the company is otherwise liable to pay on its total income.

The reason is that section 111A or section 112A or section 115BBE is contained in the Chapter-XII of the Income Tax Act,1961 and section 115BAA or section 115BAB does not override Chapter-XII.

Hence, incomes that are specially mentioned in the Chapter-XII of the Act shall continue to be taxed at the income-tax rates specified for those incomes.

Section 115BAB itself provides income tax rates for certain incomes apart from the 15 percent tax rate. The tax rate for such incomes shall prevail over other provisions for a company that has exercised option under section 115BAB.

The income-tax rate for such other incomes are listed below-

A list of incomes specified in the Chapter-XII is given below-

Manner of claiming depreciation for computation of total income

Though additional depreciation is not allowed in the new schemes, it is imperative to know that normal depreciation is allowed under the new provisions in the prescribed manner. It means new depreciation rules will be notified for section 115BAA and section 115BAB.

Till now at the time of writing this article, no rules are yet notified. However, if we take a clue from section 115BA we find that the same normal rate of depreciation was kept except the fact that the maximum rate of depreciation was capped at 40 percent.

Recently CBDT has issued a new depreciation rule (Notification No. 69/2019) on motor cars and allowed for a higher rate of depreciation on certain cases. It is to be seen whether such higher rates of depreciation will be allowed to the companies exercising options under the new schemes.

How to exercise the option

To avail the benefit of lower tax concession under the new schemes, it should be remembered the provisions are optional and not mandatory. If an existing domestic company does not wish to avail the concessional rate of income-tax immediately can opt to do so once applicable incentives and exemptions have expired.

However, there is a restriction on exercising the option and the only restriction is that the same shall be exercised on or before the due date for filing of return u/s 139(1) and in the prescribed manner. It appears that CBDT will prescribe the rules for exercising the option under section 115BAA(5) and section 115BAB(5).

Till the time of writing this article, no rules are yet notified. However, if we take a clue from section 115BA we find that a new rule - Rule 21AD and Form 10-IB was prescribed (Notification No. 36/2017 dated 22.05.2017) for exercising the option under section 115BA(4). Therefore, a new form may be introduced for exercising the option under section 115BAA(5) and section 115BAB(5).

It should be remembered that the option shall be exercised every year before the due date of filing of return of income u/s 139(1). The actual return of income may be filed belatedly. An option once exercised cannot be changed by filing a revised return because a revised return only replaces the original return. The consequence of not exercising the option with the 'due date' is unknown.

Once the option becomes invalid no second chance to exercise the option

If the option exercised under the new provisions becomes invalid due to violation of the conditions specified in sub-section (2) of section 115BAA or section 115BAB then the exercise of the option shall become invalid and other normal provisions of the Act shall apply for that as well as subsequent assessment years.

Hence, there is no scope of re-exercising the option under the new provisions in any subsequent year(s).

Stringent Conditions for section 115BAB

1. Other Income not deriving from manufacturing activity

In the case of a company that has opted section 115BAB, it is provided that if such a company earns any income that is -

• neither derived from nor is incidental to manufacturing activity, and
• not included in Chapter-XII
• then such income shall be chargeable to tax @22 percent.

Further, such income shall be taxed on a 'gross basis' and no deduction or allowance will be allowed from such income.

For example, if a company earns lottery income, such income from lottery winnings shall be taxed @30 percent because lottery income is included in Chapter-XII under section 115BB.

On the other hand, if such a company earns rental income, which is chargeable under the head 'Income from House Property', then the gross amount of rental income shall be taxed at 22 percent.

Remember, the company cannot claim any deduction for municipal taxes paid or interest on borrowings used for the creation of such assets and the standard deduction of 30 percent.

2. Taxation of Short Term Capital Gains (STCG)

It is provided in section 115BAB that STCG deriving from non-depreciable assets shall be taxed at 22 percent.

If such a company derives STCG income from transfer of land (a non-depreciable asset) then such income shall be taxed at 22 percent.

But if such a company earns STCG income from the sale of shares of a listed company after payment of STT, then such income cannot be taxed at 22 percent but shall be taxed at 15 percent u/s 111A even though shares are non-depreciable assets. This is because section 115BAB does not override Chapter-XII of the Act and section 111A is included in Chapter-XII.

Short Term Capital Gains arising from the depreciable assets shall be taxed at 15 percent.

3. Incorporation of a new domestic company

It is mandatory to form a new domestic company on or after 1st October 2019. It must commence the manufacturing activities by 31st March 2023. Here, commencement of production means commercial commencement of production and not trial production.

4. In-depth analysis of manufacturing activities

Further, the clause has referred to certain words such as manufacture, production, article, and thing. Out of these, only the word 'manufacture' is defined in the Act in section 2(29BA).

Before opting for this scheme, it is very important to analyze whether the business that the company will carry would amount to manufacture or production of any article or thing.

The company itself should be the manufacturer else this scheme will not be available to it. for eg., if the company sends the raw materials to a job worker and the job worker makes the article and then sends it back to the company, then the job worker will qualify as a manufacturer and not the company. hence, the company cannot exercise the scheme.

The activity carried on by the company must amount to manufacture or production. There are many cases where the courts have held that certain activities are not manufacturing or production and vice-versa. What constitutes manufacture or production and what does not constitute manufacture or production is a contentious issue. One should carefully examine and analyze the same before the option is exercised to avoid any future harassment.

The Bill has defined certain activities shall not be considered as manufacture or production of any article or thing which are as follows-

(i) development of computer software in any form or in any media;

(ii) mining;

(iii) conversion of marble blocks or similar items into slabs;

(iv) bottling of gas into cylinder;

(v) printing of books or production of cinematograph film; or

(vi) any other business as may be notified by the Central Government in this behalf.

Remember, all the above exclusions are based on various court rulings in different cases.

The most important clause is the clause (vi) which empowers the government to notify whether an activity will be considered as manufacture or not.

An unanswered question. What will happen if a company carrying on a manufacturing business exercise option under section 115BAB and later on the same activity is notified as a non-manufacturing activity?

The list of exclusion excludes the development of software from manufacturing activity which is a deterrent to IT industry.

5. Manufacturing and other business

One of the pre-condition to exercise the option under this scheme is that the company shall not engage in any other business except the business of manufacturing or production of any article or thing.

It has far-reaching implications. Such a company is prohibited from carrying on any other business. It implies that such a manufacturing company cannot do, say, money lending business.

If such a company has excess funds and if such funds are given on interest to other person as a separate business then such a company will lose the benefit under this provision.

Another example is that such a manufacturing company, say a mobile phone manufacturer, can manufacture and sell the mobile phones it manufactures but cannot engage itself in the trading business of any other mobile phone manufacturer.

However, it does not include certain ancillary manufacturing activities like selling of by-products or wastes produced during manufacturing activities.

Similarly, if a company parks certain money in banks as Fixed Deposit under business compulsions like for margin money or bank guarantee then also the same will not be treated as a separate business.

6. Manufacturing and research or distribution

It is not enough that the new domestic company is engaged in the manufacturing business. It should also engage in the research of the product which it manufactures. If it is not possible to engage in the research then it should engage in the business of distribution of the product it manufactures or produces.

Therefore, the equation is like that-

• Manufacture + Research Or
• Manufacture + Distribution

Let us take the example of the job work cited above. the job-worker is manufacturing the products and sending back the same to the company i.e. not engaged in the business of distribution of the product. The company is distributing the product in the market but not manufacturing the product. So neither the job-worker nor the company can claim the benefit under section 115BAB. Therefore, it is imperative that the manufacturer should also be engaged in the business of distribution.

7. Previously used plant and machinery

The section prohibits the installation of previously used plant and machinery in India in order to avail the benefit of concessional rate of income-tax. In other words, the provision requires the use of brand-new plant and machinery. However, in the case of imported plant and machinery, the same will be considered as new plant and machinery if the same was not previously used in India.

However, an exception is provided that previously used plant and machinery can be used up to 20 percent of the total value of plant and machinery. Any plant or machinery shall be treated as previously used in India if the same was used earlier by any person whether for business or for non-business purposes. It covers personal use also. The plant and machinery is a very wide concept in the Income Tax Act and covers computers, motor cars, etc. under it. A question arises whether computers or motor cars for office personnel or directors shall also be acquired new. There are two views. One view is that since the condition is related to the manufacturing or production activity of the company, the condition as to the acquisition of new plant and machinery shall be limited to those plant and machinery which will be used in the manufacturing or production activity. Another view is that the provision is applicable to the company and the Explanation 2 of the provision also refers to the plant and machinery put to use by the company, hence, the condition shall cover the whole plant and machinery block of the company. A clarification from the CBDT in this regards is highly appreciated. Further, in the case of plant and machinery taken on lease, it shall become very important to do due-diligence whether the asset was previously used or not.

8. Buildings

In case the company wishes to acquire and use a building then it should ensure that the building was never used as a hotel or a convention center, and on which deduction under section 80-ID was claimed and allowed.

Such a hotel or convention center is wholly restricted from use under section 115BAB. Any other hotel or a convention center is allowed and can be used by the company. It may be noted that no restriction on previously used assets is put on for the Furniture and Fixtures.

9. Split-up and reconstruction of existing business

The term 'split-up' or 'reconstruction' is not defined in the Income Tax Act. In general, it means, merger, demerger, conversion of business type, and others.

It is a very vast and contentious topic that requires in-depth analysis so that the formation of the new company does not fall under or christened as the reconstruction of an existing business.

For example, if an existing company forms a subsidiary company substantially financed by it and managed by the same personnel of the holding company may be categorized as an extension of an existing business.

Conclusion

There are many issues that may require critical and in-depth analysis before the option under section 115BAA or section 115BAB is exercised. Any wrong decision may lead to undesired consequences in the future and the whole planning or exercise may go in vain. It is very important to understand the nuances of the issues in the Bill. The implications must be thoroughly examined before the option is exercised. This is because one can enter into the provision but cannot exit easily from the provisions once entered.

An effort is put in to bring the issues that arise from the Taxation Laws (Amendment) Bill, 2019. However, comments or suggestions from the esteemed readers are most welcome for further improvement.

Tags Income Tax