In his Budget speech for FY 2015-16, the then Finance Minister, Late Shri. Arun Jaitley set the tone for phasing out of tax exemptions, deductions etc. and gradually moving to a lower and more competitive corporate tax regime to achieve higher level of investment, growth and jobs.
In line with the same, the CBDT in 2015 laid down the roadmap for phasing out of profit linked and investment linked tax deductions for both, corporate and non-corporate taxpayers. The intent of the government was translated into action by reducing the corporate tax rate from 30% to 25% over subsequent years which was subject to the turnover cap.
While a comprehensive removal of deductions and reduction in corporate tax rate was underway, on account of global headwinds and sluggish domestic growth, the Government made a series of announcements in 2019 including a new tax regime for companies with significantly reduced tax rates.
Finance Minister Nirmala Sitharaman promulgated the Taxation Laws (Amendment) Ordinance, 2019 on 20 September 2019 to further reduce the corporate tax rate for companies not availing specified tax exemptions. The Ordinance was replaced by the Taxation Laws (Amendment) Act, 2019 ('the Amendment Act') on receiving the assent of the President on 11 December 2019 effective 20 September 2019.
The new corporate tax rate regime are codified in the Income-tax Act, 1961 ('Act') itself as opposed to the past trend of prescribing the rate in the Finance Act. Accordingly, the Government will not have to prescribe the rates in the Finance Bill every year.
Section 115BAA - Concessional Tax Rate of 22% for Domestic Companies
As per section 115BAA introduced by the Amendment Act, any domestic company1 may opt for the concessional tax rate of 22% with a fixed surcharge of 10% and health and education cess of 4%. Thus, the effective tax rate for domestic companies under this section, once opted for shall be 25.17%. The reduced rate under this section is subject to the following key conditions:
• Companies would not be eligible to avail any tax deductions/exemptions2 as specified in the section
• No carry forward and set-off of unabsorbed depreciation in relation to specified tax incentives. Further, set-off of any loss or unabsorbed depreciation arising out of amalgamation u/s 72A is also not permitted where such a loss or depreciation is attributed to any of the specified tax incentives.
• Option for concessional tax rate will have to be exercised by the domestic company on or before the due date of filing of return of income under Section 139(1) of the assessment year 2020-21 or thereafter and such option once exercised, shall apply to all subsequent years.
• CBDT has clarified3 that a company opting for section 115BAA shall not be allowed to claim set-off of any brought forward depreciation on account of additional depreciation.
It may noted that the aforesaid conditions are required to be satisfied in the first year as well as each subsequent year in respect of which the benefit of reduced rate is claimed.
The provisions do not specify any limitation/condition on account of turnover, nature of business or date of incorporation for opting for the concessional tax rate. Accordingly, all existing as well as new domestic companies are eligible to avail this concessional rate of tax.
Needless to mention that the corporates are likely to be enticed to avail the benefits under this scheme and therefore deliberate and draw comparisons before making the irreversible choice of being taxed at the lower rate under this regime.
The section does not put any cap on the time period for exercising the option. Therefore, a company with substantial brought forward losses/unabsorbed depreciation relating to tax incentives not allowed under the new regime, may choose to continue to be taxed under the normal provisions of the Act and exhaust the brought forward losses/unabsorbed depreciation and opt for the concessional tax rate in future years.
Further, despite the condition of giving up certain exemptions/deductions for opting for the lower tax rate, there still remains a handful of tax deductions that a company would be entitled to under the new regime. For instance, the incentive linked with job creation i.e. deduction with respect to the cost of new employee u/s 80JJAA would still be available to such companies. The illustrative list of such other deductions/incentives is as under:
1. Section 35 - Expenditure on scientific research except for the following payments:
a. To research association or to a university, college or other institution to be used for scientific research [Section 35(1)(ii)]
b. To any Indian company for scientific research [Section 35(1)(iia)]
c. To research association or to a university, college or other institution to be used for social science and statistical research [Section 35(1)(iii)]
d. To a National Laboratory, university, IIT or specified person to be used for scientific research under a programme approved by the prescribed authority [Section 35(2AA)]
e. By way of expenditure on scientific research on in-house research and development facility by a company engaged in bio-technology business or manufacturing of products other than Eleventh Schedule [Section 35(2AB)]
In other words, revenue and capital (other than land) expenditure incurred on scientific research in relation to business of the company, can still be claimed as deduction under the new tax regime.
2. Section 35ABA - Expenditure for obtaining right to use spectrum for telecommunication services
3. Section 35ABB - Expenditure for obtaining license to operate telecommunication services
4. Section 35CCA - Expenditure by way of payment to associations and institutions for carrying out rural development programmes
5. Section 35D - Amortization of preliminary expenses on expansion of business
6. Section 35DD - Amortization of expenditure in case of amalgamation or demerger
7. Section 35DDA - Amortization of expenditure incurred under voluntary retirement scheme
8. Section 35E - Deduction for expenditure on prospecting etc. for certain minerals
Further, with the proposed abolishment of Dividend Distribution Tax ('DDT') and taxing the dividend in the hands of shareholder under the Finance Bill, 2020, it has been proposed to allow deduction under section 80M to the corporate shareholders opting for the concessional tax rate. As per section 80M, in case of inter-corporate dividends, a deduction will be provided to the recipient corporate shareholder from the dividend income to the extent dividend is distributed by it.
Prior to insertion of Section 115BAA, there were broadly two tax rates applicable to domestic companies. Domestic companies having turnover less than INR 400 crores during the FY 2017-18 were liable to pay tax @25% plus surcharge and education cess as applicable (Category I). Further, domestic companies having turnover more than INR 400 crores were liable to pay tax @30% plus surcharge and education cess as applicable (Category II).
Below table shows net tax savings for a domestic company applying the reduced rate of 22% as compared to the existing rate of 25%/30%.
|Category of taxpayer
||Tax liability under normal provisions for domestic companies having Turnover
< INR 400 crores in FY 2017-18
||Tax Liability under Section 115BAA
||Net Savings in taxes
||Tax liability under normal provisions for domestic companies having Turnover
> INR 400 crores in FY 2017-18
||Tax Liability under Section 115BAA
||Net Savings in taxes
|Income up to INR 1 crores
|Income more than INR 1 crores but up to INR 10 crores
|Income more than INR 10 crores
Category I constitutes 99.3% of total domestic companies in India. Therefore, the real gainers of the new concessional tax rate will be the companies comprising 0.7% whose turnover exceeded INR 400 crores in the FY 2017-18 i.e. Category II.
No MAT for companies opting for section 115BAA-
As mentioned above, the provisions of section 115BAA do not allow companies to claim tax incentives/exemptions thereby reducing the gap between taxable income as per normal provisions of the Act and the book profits for MAT purposes. Therefore, doing away with the applicability of MAT on such companies is a consequential amendment rather than an added incentive. However, a company earning income other than income under the head Profit and Gains from Business and Profession in respect of which reduced tax rates have been prescribed in the Act (such as long term capital gain @ 10%) would benefit, i.e. they would not be liable to pay MAT.
Since provisions of MAT are not applicable, section 115JAA which deals with MAT credit would also not be applicable for a company opting for tax regime as per section 115BAA. Consequently, MAT credit possessed by companies who paid taxes on their book profits in the past would become a dead loss if they opt for the concessional tax regime. This may give rise to a potential challenge wherein if a company violates conditions under section 115BAA resulting in non-availability of concessional tax rates, it will not be able to utilize MAT credit even though it would be liable to pay tax under normal provisions i.e. at the rate of 25% or 30%.
Section 115BAB - Domestic Manufacturing Companies
The Amendment Act introduced another special tax regime (under a new section 115BAB) for domestic companies with an objective to boost domestic manufacturing in line with the 'make in India' initiative of the Hon'ble Prime Minister.
According to this section, any company incorporated in India on or after 01 October 2019 and engaged solely in the business of manufacturing4 or production of any article or thing and research in relation to, or distribution of such article or thing manufactured or produced by it, shall have the option of paying tax at a concessional rate of 15% plus surcharge at the rate of 10% and health and education cess at the rate of 4%. Accordingly, the effective tax rate for such companies shall be 17.16%.
This benefit for lower tax rate shall be available to all domestic companies who commence manufacturing or production on or before 31 March 2023 and who do not avail any specified tax exemption/incentive (same as mentioned in section 115BAA). The domestic company has to exercise the option to be governed by this new regime before the due date of filing the first return of income for an assessment year 2020-21 or thereafter and once exercised, it shall apply to all subsequent assessment years. Further, companies would not be liable to pay MAT under this regime.
There are certain inbuilt anti-abuse conditions in the section which are mentioned hereunder-
• This benefit is available only to those domestic companies which are not formed by splitting up or reconstruction of a business already in existence;
• The companies cannot use any plant and machinery previously used for any other purpose exceeding 20% of total value of the plant and machinery of the company;
• The company is restricted from engaging in any business activity other than manufacture or production of any article or thing and research in relation to or distribution of such articles;
• A negative list with respect to activities which would not be considered as manufacture or production of any article or thing has been provided;
• In order to discourage false reporting of extraordinary profits (i.e. above the arm's length price), the section seeks to tax excess profits derived from arranged affairs at the rate of 30%.
It is interesting to note that although the section restricts a company from engaging in any business activity other than manufacture or production, it still provides for the taxation of income derived from non-manufacturing activities at the rate of 22% on gross basis. Accordingly, it is not clear if a domestic company that earns any income which is not related to manufacturing activity such as rental income, whether the company will lose the benefit available under section 115BAB to pay tax at concessional rate in entirety or such income will be taxed at the rate of 22% on gross basis and the income derived from or incidental to business would continue to be governed by the provisions of this section and be liable to tax at the rate of 15%. The Government should come out with a clarification on the same.
Further, it has been provided that short term capital gain derived on transfer of non-depreciable assets would be liable to tax at 22%. Therefore, one may take a view that short term capital gain derived from transfer of depreciable assets which is incidental to manufacturing would be taxed at the rate of 15%.
Section 115BAB provides that opting for the aforesaid regime is an irreversible decision i.e. once opted, it will apply to all subsequent years. However, it is to be noted that if the company violates any of the prescribed conditions therein, it may still choose to be governed by section 115BAA i.e. pay taxes at 22% (as against the flat rate of 30%). Accordingly, if a company engaged in the business of manufacturing, chooses to expand its business beyond manufacturing, it may still choose to pay tax @22% under section 115BAA. However, the option of computing taxes at the rate of 15% under section 115BAB would not be available again. It is relevant to point out that there is no condition under Section 115BAA that the option to pay tax is to be exercised in the first year itself. Thus, such option may be exercised in subsequent year as well.
Capital Gains taxable under Section 111A, 112 and 112A
It is relevant to point out that sub-section (1) of both Section 115BAA and Section 115BAB states that "Notwithstanding anything contained in this Act but subject to the provisions of this chapterâ€¦â€¦". It is to be noted that the total income of the company is taxable at the rate of 22% under Section 115BAA and at the rate of 15% under Section 115BAB, however, the same are subject to provisions of this chapter. Following concessional rates on capital gain fall under this chapter:
• Section 111A - Rate of 15% is prescribed in respect of STT paid short term capital gain
• Section 112 - Rate of 20% is prescribed in respect of long term capital gain tax rate after indexation
• Section 112A - Rate of 10% is prescribed on STT paid long term capital gain without indexation in respect of sale of equity/units of mutual funds post 01 April 2018
Accordingly, income by way of capital gain as mentioned above shall be chargeable at the appropriate rate prescribed under Sections 111A, 112 and 112A and not at the rate of 22% under Section 115BAA and 15% under Section 115BAB. However, tax on other short-term capital gains which is chargeable under the normal provisions and does not fall under this chapter will be governed by the provisions of Section 115BAA and Section 115BAB as the case may be.
Certain unanswered issues under section 115BAB-
• Whether the income of a manufacturing company from transfer/license of IP and entailing royalty receipts, be viewed as an activity beyond the permissible definition of business of manufacturing?
• The debate of whether an activity would constitute manufacture for the purpose of this section such as the activity of construction of a dam, laying down of pipelines after joining them together etc.
• The particular business model would require due consideration in terms of whether the business of sub-contracting arrangements/job work would be eligible for such regime?
• Categorization of interest on late payments by customers to whom it had supplied goods as income 'derived from' the main business activity i.e. manufacturing?
• Whether the decision of an existing company to set up a new manufacturing entity to avail the aforesaid scheme can be subject to challenge under the GAAR.
Despite the aforesaid issues, one cannot deny that the recent economic developments necessitated the provision of additional fiscal stimulus to attract investment and boost the economy. The new tax regimes for corporates introduced by the Amendment Act is therefore a step in right direction. The effective tax rate of 17.16% for manufacturing companies has improved India's competitiveness in South East Asia5 . While it may seem that reduction in corporate tax rate would cost the government in terms of revenue foregone, the same is likely to be offset with much expected industrial growth and employment opportunities.
CA Sujay Paul and CA Sidharth Sipani (with inputs from CA Nandita Monga). Views expressed are personal.
1. The Finance Bill, 2002, also proposes to extend the benefit of concessional tax rate to cooperative societies
2. Section 10AA, 32(1)(iia), 32AD, 33AB, 33ABA, 35(1)(ii)/(iia)/(iii), 35(2AA), 35(2AB), 35AD, 35CCC, 35CCD or chapter VI-A(C) except 80JJAA and 80M
3. circular no. 29 of 2019 dated 2 October, 2019
4. The benefit under Section 115BAB is proposed to be extended to extended to business of generation of electricity vide the Finance Bill, 2020 introduced in Lok Sabha
5. Singapore 17%, Thailand 20%, Japan 23.2%, China 25%