The Government introduced section 115BAB in the Income-tax Act, 1961 (the Act) to boost the investment and provide impetus to the Make-in-India initiative. This new section provides an option to new domestic manufacturing companies i.e. companies set up and registered on or after 1 October 2019 and which commence manufacture and production activities on or before 31 Mach 2023, to avail the reduced corporate tax rate (CTR) of 15%. The benefits of reduced CTR can be availed provided the company do not claim specified tax incentives/deductions and fulfill other eligibility conditions laid down in the section. As a major relief, Minimum Alternate Tax (MAT) would not be applicable to such companies.
This section was initially introduced through the Taxation Laws (Amendment) Ordinance, 2019 ('the Ordinance') on 20 September 2019. The Bill to replace the Ordinance was placed before the Parliament on 25 November 2019 and received the Hon'ble President's assent on 11December 2019. This provision is applicable from Financial Year 2019-20.
Though, while introducing the Bill in the Parliament, the government took into account and addressed several concerns and anomalies of the Ordinance, however, the fact remains that there are still certain areas where some clarity would be really desirable. Some such issues, emanating from the section are discussed below:
Meaning of the term "manufacture"
Section 115BAB does not contain the definition of the term "manufacture", which is however defined in section 2(29BA) of the Act. A plain reading of this definition suggests that it is a very widely worded and it captures the crux of various Apex Court decisions on this issue.
There are several other sections in the Act where the term manufacture has been used and there are plethora of judgements which explain whether an activity could be considered as manufacture. Since some of these provisions also source the definition of manufacture from other Acts such as the SEZ Act, many judgements have interpreted the term 'manufacture' while examining definitions contained in other Acts. Further, there are several activities and sectors, where there have always been differing judicial views e.g. food industry, processing, generation of power.
Hence, it is desirable that to cut down prospective litigation and interpretational issues, just as negative list has been rolled by the Government, a positive list may also be considered. This will provide surety to sectors where there has been litigation in past as regards the view that the government proposes to take.
Income not derived from manufacture
The section stipulates that where the income earned is neither derived from nor incidental to manufacturing or production, such income would be taxed @ 22%. This would be done on gross basis i.e. without permitting any deduction or allowance for any expense incurred to earn such income.
Notably, the section does not disallow any expenses incurred to earn such income and therefore such expenses continue to be claimed as deduction from income which would be taxed at the reduced CTR of 15% under the new regime. It is recommended that keeping the matching principle concept in mind, the expenses incurred to earn such income should be allowed as a deductible expense for earning that income itself so that the actual income is taxed at higher rates.
It is also desirable to list out incomes that would be considered derived from/not derived from manufacture to reduce litigation in future.
Splitting up and Reconstruction
Another condition laid down in the section is that if any company is claiming the benefit under this section, its business should not be formed by splitting-up or reconstruction of a business already in existence. The expression splitting up and reconstruction has been used in several other provisions of the Act and subjected to long drawn litigation.
There is also litigation on the term "formed", which has led to creative tax planning by taxpayers in the past. As most of these judicial precedents deal with "undertaking formed by splitting up or reconstruction" there may be another set of litigation on the difference between "undertaking formed by split-up and reconstruction" and "business formed by split-up and reconstruction". Hence, at this juncture, it may be useful to issue guidance to deal with situations such as conversion of LLP to company, slump sale, demerger and amalgamation etc.
Business other than manufacturing
The benefit under this section is only available to a company which is not engaged in any business other than the business of manufacture or production of article or thing and research in relation thereto, or distribution of articles or goods manufactured by it. If the company violates these conditions, it shall be prohibited from availing the lower CTR benefit.
Consider a situation where a company invests in its subsidiary by infusing share capital, or a company uses surplus funds to buy and sell securities, would they be considered to have violated the basic condition and the benefit be denied to them. In the case of investment in subsidiary it may be argued that it is merely an investment activity, however, in case of buying and selling of securities, since the company is carrying on a systematic activity, it could be impacted.
It is desirable that some guidance is rolled out in form of FAQs depicting the government's intent .Clarity on the subject matter is necessary especially in the view of the fact that where the company is denied the benefit on the said account, it would end up being subjected to higher CTR.
Provisions of section 115BAB are silent on the issue of sub-contracting. In the recent past, the government had liberalized the FDI regime, where it permitted 100% FDI in contract manufacturing. The intent was to provide boost to "Make in India" initiative. The issue being the applicability of section 115BAB in such cases. There have been judicial precedents in the past which have held that outsourcing is part and parcel of manufacturing process and merely because some part of manufacturing is outsourced to an outside entity or job worker, a person does not cease to be a manufacturer.
In this context the issue would be, could the rationale behind the FDI policy be used to interpret tax laws or as they operate in different spheres this is not desirable. It is important to note that intent of both the policies is the same to boost "Make in India" initiative.
A company may outsource part of its activity to a sub-contractor/job worker on principal to principal or principal to agent basis. The question arises on the eligibility to claim the benefit of lower CTR by the manufacturer and sub-contractor. What would be the factors that would be considered relevant to arrive at a conclusion. Would it be supervision and control of manufacturing operations, bearing of business risk, quality check, final dealing with customers and funding of manufacturing set up etc. Who can claim the reduced CTR, the principal, or the agent or both? Numerous permutations and combinations could be possible. It may be highlighted that for any company who claims benefit under this section, this would be just the first step in meeting eligibility condition contained in section 115BAB, other conditions laid down in section also are required to be met.
Previously used Plant & machinery
The section permits use of any machinery or plant previously used for any purpose, provided the total value of such machinery or plant does not exceed twenty per cent of the total value of the machinery or plant used by the company. There is lack of clarity as to whether the term "total value" means written down value as per books, written down value as per the Income-tax provisions, actual cost or fair market value of the asset.
Denial of benefit
Where a new manufacturing company fails to comply with certain conditions stipulated in the section 115BAB, it would not be able to avail lower CTR of 15%. In such cases, law gives the company an option to opt for lower tax rate of 22% under section 115BAA of the Act. However, in order to do so, the option has to be exercised in the prescribed manner on or before the due date of filing the return of income under section 139(1).
In a situation where during the course of assessment. proceedings benefit of CTR of 15% is denied to the company by a tax officer, would such company be forced to pay taxes @ 25% or 30% as the case may be, merely because option was not exercised in due time. This issue needs to be addressed so that taxpayers are not penalized.
Manner of computing Depreciation
The section stipulates the depreciation would be computed in a manner as may be prescribed. This methodology is yet to be rolled out. In a manufacturing set-up the quantum of depreciation may be a sizable amount, hence a company opting for this provision needs to analyze and compare it with the other options available under law at the planning stage itself. It is hence important that this methodology be prescribed soon. It would enable taxpayer to take informed decisions.
To conclude, the reduction in CTR is a laudable step to boost economic activity in India and has made India an attractive and competitive destination for manufacturing companies. Perhaps taking cue from avoidance arrangements witnessed by the government in past, the anti-avoidance provisions codified in this section are more stringent as compared to several other provisions in the Act, which contained incentives for manufacturing sector.
However, it is desirable that keeping in mind the interpretational issues involved in this section, which have a massive potential to fuel litigation, detailed clarifications in form of FAQs are issued at the earliest. More so, because unlike some other mature tax jurisdictions, currently Indian tax regime does not provide taxpayers much avenue to consult the tax department at a planning stage.
Contributed by CA Richa Sawhney (with inputs from CA Sameer Shah)