On 20 September 2019, the Government announced fiscal stimulus in the form of Taxation Laws (Amendment) Ordinance, 2019 (Ordinance) by reducing the income-tax rates of domestic companies, to attract investment, generate employment opportunities and boost the economy of the country. The Ordinance proposed various amendments to the Income-tax Act, 1961 (Act) and the Finance Act (No. 2) of 2019, which are effective from Assessment Year (AY) 2020-21.
The Ordinance, amongst others, provided domestic companies with an option to pay tax at a lower rate of 22%, if they do not claim certain specified deductions/ incentives. Further, to attract fresh investment in the manufacturing sector, it provided domestic manufacturing companies with an option to pay tax at a lower rate of 15%. This brings India at par with some other manufacturing hubs across the globe, such as China, Thailand, Indonesia, Vietnam, Singapore and Hong Kong.
On November 25, 2019, the Government introduced the Taxation Laws (Amendment) Bill, 2019 to replace the Ordinance. The Bill incorporated the amendments made vide the Ordinance and has further provided clarification on certain aspects, which lacked clarity in the Ordinance. Subsequently, the Bill received the Parliament's approval and the Presidential assent and the Taxation Laws (Amendment) Act, 2019 (the Act) was published in the Official Gazette of India on December 12, 2019.
While the language of the Act is mostly unambiguous, there remains room for interpretation on some issues, especially the benefit extended to manufacturing concerns. This article highlights some interpretational/ practical issues that companies might encounter while opting for the concessional tax regime.
Consequences of invalid exercise of option under section 115BAA
Section 115BAA provides that in case a company fails to satisfy the specified conditions in any previous year (PY), the option shall become invalid for the AY relevant to that PY and subsequent AYs, and the other provisions of the Act shall apply as if the option had not been exercised for that AY and subsequent AYs.
Assume a scenario in which a company exercises the option under section 115BAA and computes its total income without setting-off of brought forward losses or depreciation and Minimum Alternate Tax (MAT) credit. It may happen that during the course of scrutiny proceedings, the revenue authorities may deny the claim by alleging that certain specified conditions are not fulfilled and there is no valid exercise of option. In such a scenario, it would be imperative to understand whether a company could restore the brought forward losses or depreciation and MAT credit and claim it while paying taxes at the rate of 30%/ 25%, as per the normal provisions of the Act. While the brought forward losses or depreciation and MAT credit should be allowed to be restored as denial of claim under 115BAA would tantamount to option not being exercised at all, a formal clarification on this would certainly help.
Consequences of non-fulfilment of specified conditions under section 115BAB
Section 115BAB provides that if a company fails to satisfy the specified conditions in any PY, the option shall become invalid for the AY relevant to that PY and subsequent AYs, and the other provisions of the Act shall apply as if the option had not been exercised for that AY and subsequent AYs. Further, in the event of breach of conditions pertaining to use of old plant and machinery or building or nature of business activity, an option is given to companies to avail the beneficial tax rate under section 115BAA at the rate of 22%. However, no such option is available to companies in case of breach of formative conditions (i.e. splitting up and reconstruction of business already in existence).
Accordingly, if the formative conditions are not satisfied, the company would lose the benefit of the concessional tax rate of 15% and 22%. Therefore, companies should attain certainty on the fulfilment of the formative conditions through expert opinions, view of Counsel, etc. (in case of any doubt/ uncertainty on the position) before exercising the option under section 115BAB.
Splitting up and reconstruction of business already in existence
Section 115BAB provides that the company should not be formed by splitting up or reconstruction of a business already in existence. In a scenario where a manufacturing plant in the capital work in progress (CWIP) stage is transferred from an existing company to a new company and the new company makes a substantial investment prior to 31 March 2023, it would be interesting to evaluate if the condition of splitting up or reconstruction is vitiated. Various jurisprudence, in the context of other sections with similar provisions, have laid down certain criteria to be fulfilled to treat a unit as a new one. For example, investment of substantial fresh capital in the new unit, manufacture or production of articles in the new unit, earning profits clearly attributable to the new unit and a separate and distinct identity of the new unit set up. Based on the satisfaction of such criteria, companies may take a view that transfer of CWIP from one company to another should not be constituted as "splitting up or reconstruction of a business already in existence." However, this is a fact-based exercise, and a conclusion should be drawn after mapping the facts of each case with the principle/ guidance emanating from various jurisprudence on this issue. Additionally, it is necessary to consider this aspect from the GAAR perspective.
Practical application of option allowed to avail beneficial tax rate under section 115BAA in the event of breach of certain specified conditions
While companies have the option to opt for the beneficial tax rate under section 115BAA in the event of breach of certain specified conditions, clarity is necessary on the modus operandi of opting for such beneficial tax rate.
From a practical standpoint, the benefit availed by the companies under section 115BAB would be tested at the time of scrutiny proceedings by the revenue authorities. Assuming a company exercises option under section 115BAB in Year 1. The scrutiny proceedings would be carried out for that AY in Year 2 or 3. In case the benefit of Year 1 is denied by the revenue authorities due to non-fulfilment of conditions relating to usage of old plant and machinery or building or the nature of business activity, it would not be practically possible for companies to exercise the option under section 115BAA. This is because this option needs to be exercised before the due date of filing of return of income for that PY. In addition, companies might be litigating the denial of benefit of 15% tax rate due to non-fulfilment of conditions to keep the issue alive. In such a scenario, a prudent approach for the companies would be to make a protective claim during appellate proceedings on the beneficial tax rate of 22% under section 115BAA.
Conditions for use of plant and machinery â€“ To be satisfied every year or only in the year of formation
While section 115BAB imposes a condition that the company will not use any plant or machinery previously used for any purpose, it does not expressly mention whether these conditions have to be satisfied on a year-on-year basis or only at the time of formation of the company. Similar conditions exist in certain tax holiday sections, where one of the eligibility conditions for claiming benefit/ deduction is that the new unit should not form by the transfer of machinery or plant previously used for any purpose. Various jurisprudence in the context of such sections, have held that this condition relates to the formation of the unit, and hence, need not be satisfied subsequent to the formation of the unit. However, considering that section 115BAB uses the words, "does not use machinery or plant previously used for any purpose" as against "formed by transfer to a new business of machinery or plant previously used for any purpose" used in some other tax holiday sections, a better interpretation would be that the conditions need to be satisfied on a year-on-year basis. In addition, considering that the benefit has been introduced with the intent of providing continuous impetus to the manufacturing sector, restricting the test to only the first year might result in planning around it.
Taxability of short-term capital gains arising from depreciable assets
The proviso to section 115BAB provides that where the total income of a company includes income that has neither been derived from nor is incidental to manufacturing or production of an article or thing and in respect of which no specific rate of tax is provided under Chapter XII, such income shall be taxed at the rate of 22%. Further, no deduction or allowance on any expenditure shall be allowed in computing such income. Additionally, the section prescribes a rate of 22% for short-term capital gains arising from non-depreciable assets (other than short term capital gains covered under section 111A).
The section does not expressly specify any tax rate for short-term capital gains arising from depreciable assets, which results in uncertainty if it would be taxable at 30%/ 25% as per the normal provisions of the Act or at 22%, as per the proviso to section 115BAB. In case a position is taken to tax it at 22%, as per the proviso to section 115BAB, the cost of acquisition may not be allowed, as no deduction/ allowance would be allowed in computing such income. Given the ambiguity, a clarification on this aspect would be welcome.
Some other open issues that warrant consideration are as follows:
• Value to be considered for determining the threshold for used plant and machinery; whether it refers to cost or fair market value or written down value.
• Whether a company engaged in "contract manufacturing" and "job work" is eligible for the concessional tax regime under section 115BAB.
The concessional tax rates for domestic companies are certainly a radical reform to enhance the competitiveness of Indian industry in global markets. In addition, the timing of this reform is appropriate, given the trade conflict between the USA and China, forcing foreign multinationals to explore other Asian countries to establish their units. This will result in the establishment of units in India; thereby, increasing FDI. However, it would be critical for them to evaluate the eligibility criteria, considering these highlighted aspects.
In addition, it would be interesting to see how a combination of reduced headline tax rates along with the recent international developments, such as Digital taxation, MLI and Profit attribution would yield the desired results for India.
Views expressed are personal
By Pallavi Singhal, Partner and Akhil Kedia - Associate Director â€“ Corporate and International Tax, PwC India
Cr Abhinaya also contributed to this article.