Taxation law (Second Amendment) bill, 2016- Lack effectiveness

Taxing the disclosed unexplained income @ 85% may not be achieved through proposed amendments

1.       Government has proposed amendments in section 115BBE, Finance Act 2016 and proposed a new section 271AAC so as to provide the following:-

a)      Amendment in Section 115BBE- Where the total income of assessee includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D and reflected in the return of income furnished under section 139, the income tax payable on said income shall be @ 60%.

b)      Amendment in Finance Act, 2016 – The Surcharge on income chargeable to tax u/s 115BBE shall be 25%.

c)       Proposed section 271AAC – Where income determined includes any any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D, the assessee shall be liable to pay penalty @ 10% of the tax payable u/s 115BBE.

2.       The Schema of Act for computation of Income is as under;-

a)      AO will first compute the Income under various head of Income.

b)      After that , If AO found that conditions of section 68 to Section 69D are met, then amount specified in those sections may be deemed to be the income of the assessee and same will be aggregated with the income determined under clause (a)

3.       Conditions of Section 68 to 69D are CAUSE and EFFECT thereof is treating unexplained credit/expenditure/assets as income of assessee. For example, if the assessee is found to be owner of money  and

a)      such money is not recorded in the books of accounts, if any, maintain AND assessee offers no explanation about the nature and source of acquisition of money (CAUSE),

b)      then money may be deemed to be income of assessee.(EFFECT)

4.       These sections will not have any implications where CAUSE is Income and EFFECT is assessee being the owner of money.

5.       In other words, these section deals with unexplained credit/expenditure/assets and not with unexplained income. Thus if assessee himself disclose certain amount as his income in ITR, though it remain unexplained on his part, it cannot be said that income is deemed under the provisions of section 68 to 69D.

6.       Thus in the absence of disclosed unexplained income being falling under section 68 to 69D, section 115BBE will not have any implications and as a result thereof that proposed amendment in section 115BBE may not yield the desired result of taxing the unexplained income at higher rates.

7.       I think, that there should  have been separate section under Chapter XII – Determination of Tax in special cases, whereby higher tax rate maybe prescribed in the case where the assessee disclose certain income in his return but unable to explain the source thereof to the satisfaction of AO.

Draft Rule 17CB under Section 115TD of Income Tax Act - Analysis

Section 115TD -  Tax on Accreted Income of Charitable Trust & Institution.

CBDT has proposed Draft Rule (Rule 17CB) for computation of aggregate Fair Market Value of Net Assets for the purpose of quantification of Accreted Income under section 115TD.

Through below stated analysis, I am of the view that in legislation of propose draft rule 17CB under delegated legislation, the Executive Body is legislating excessively, than mandated by the objective and policy spelt out in express substantive provision of Section 115TD.

1.      Section 115TD provides for levy of Exit tax on charitable trust/institution registered u/s 12AA, when such trust/institution :-

a)      Is converted into any form which is not eligible for grant of registration u/s 12AA.

b)      Is merged with any other entity, other than trust/institution having objects similar to it and registered u/s 12AA.

c)      Upon dissolution, failed to transfer the assets to other prescribed Trust/Society within period 12 months from the end of the month in which dissolution take place.

2.      In simple terms for our analysis, section 115TD charges Exit Tax, when charitable trust/institution ceased to purse charitable activities.

3.      The base for Exit tax is accreted income on specified date and same is made taxable on maximum marginal rate.

4.      The accreted income is measured as excess of aggregate fair market value of assets over liabilities on specified date, to be computed in accordance with method of valuation as may be prescribed – Section 115TD(2)

5.      In exercise of power u/s 115TD (2), CBDT has notified the Draft Rules 17CB for computing the fair market value of assets.

6.      Among other things, the propose rule 17CB prescribed the Current market value of Assets i.e Current share price for listed securities, Current Market value for Immovable properties & so on.

7.      The question for deliberation is whether in prescribing Current market value of assets, legislation of propose Rule 17CB is within the framework of power vested under delegated legislation.

8.      Scope of Delegated legislation –Judicial Precedents

a)      Essential Legislative function consists of the determination of legislative policy and its formulation as binding force. The legislature must retain in its own hands the essential legislative function and what can be delegated is the task of sub-ordinate legislation necessary for implementing the purposes and objects of the Act – Municipal Corps. Of Delhi v Birla Cotton Spg. &  Wvg. Mills, AIR 1968 SC 1232, 1244

b)     A delegated legislation must also be read in a meaningful manner so as to give effect to the provision of statue. In selecting the true meaning of a word regard must be had to the consequences leading thereto. If two constructions are possible to adopt, a meaning which would make the provision workable and in consonance with the statutory scheme should be preferred. – Ramesh Mehta V. Sanwal Chand Sighvi (2004) 5 SCC 409, 426-427

9.      Section 115TD uses the words “Fair Market Value” In order to understand the true meaning of these words, it is necessary to evaluate the same in the context of objective of section interwoven with basic interpretation rules.

10.  Objective of Section

a)      Section 115TD intends to place in statue a mechanism to tax past income of charitable trust/institution, when it ceases to continue its charitable activities. The criterion used to measure the past income is taken as accreted income, which is defined as excess of asset over liabilities. The benchmark used is perfect as all past income gets accumulated in net worth, which is same as accreted income in accounting parlance.

b)      Memorandum Explaining Finance Bill 2016 provides that “there is a need to ensure that the benefit conferred over the years by way of exemption is not misused and to plug the gap in law that allows the charitable trusts having built up corpus/wealth through exemptions being converted into non-charitable organization with no tax consequences.”

11.  Interpretation Rules

a)      Section Placement – Section 115TD is put under chapter XII-EB. The entire series of sections under chapter XII to XIIH deals with either special rate of tax for specified income or special rate of tax for special income. Neither sections in these chapters deals with taxation of any event or transaction, which is considered as unlawful or penal in nature. Thus levy of exit tax u/s 115TD cannot be treated as any penal tax, but rather it provides a situation to impose tax on past income, when a charitable trust/institution voluntary decides to discontinue charitable activities.

b)      Real Income – Unless otherwise provided, person can be fastened with tax liability only on real income.

c)      Double taxation – Unless otherwise provided, section should be so interpreted that it does not lead to double taxation of same income in the hands of same person.

12.  Thus the words “Fair market value” should be so construed that objective of Section 115TD is achieved in collocation with accepted principles of interpretation of Real Income Theory and Prevention of Double taxation.

13.  The Propose Rule 17CB does not seems to be in consonance with above-mentioned objective & policy emanating from section 115TD, expounded as under:-

a)      Against Objective of section and Real Income Theory – The objective of section 115TD is to tax the past income of charitable trust/institution. By valuing the assets at current market price, the rules intend to tax the present unearned income i.e. rule is providing to tax imaginary unearned income, which is neither the mandate of section nor in conformity with principle of taxation of Real Income.

b)      Double taxation –

i)                    Suppose a charitable trust is having an immovable property of Rs. 1,00,000, the market value thereof is Rs. 10,00,000. If charitable trust stops charitable activities, then by virtue of section 115TD read with propose Rule 17CB, it will be made liable to pay tax of 10,00,000 @ 30%.

ii)                  Finance Act 2016, which put section 115TD on statue, nowhere provides for substitution of enhanced value in the hands of trust upon inviting section 115TD. When in future, the trust will actually sell the Immovable property, the cost will be taken as Rs. 1,00,000 as per section 48 and it will lead to double taxation of income of Rs. 10,00,000.

iii)                Thus in the absence of express provision for double taxation, operation of section 115TD along with propose rule 17CB culminate in double taxation under Income Tax Act.

14.  Propose Rule 17CB seems to be exercise of excessive delegation, as it is not supplementing, but rather supplanting section 115TD, on following counts:-

a)      The Propose Rule is in not in aligned with objective of section – to tax the past earned income. The propose rule leads to taxation of present unearned income which dehors the objective of section.

b)      The rules have taken the Words “fair market value” in literal sense by prescribing current market value of assets, leading to absurdity in working of section 115TD by introducing the double taxation.

c)      By taxing the imaginary income of charitable trust/institution, without having recourse in Income Tax Act to avoid double taxation, the propose valuation methodology place the provision of section 115TD at par with penal provision, which is also against vowed objection of section.

15.  Thus in present setting, rulemaking authority cannot advocate the current market value of assets for computing accreted income, the same needs to be confined to book value only or any suitable variant thereof.

Draft Buy-back Rules- section 115QA of Income Tax Act- Critical Analysis

Draft Buy-Back Rules under section 115QA

Critical Analysis

1.       Under Section 115QA ‘distributed Income” by company on buy- back of shares (not being listed shares) from shareholders is subject to tax 20% in the hands of Company

2.       “Distributed income” means consideration paid by company on buy-back of shares as reduced by the amount, which was received by the company for issue of shares, determined in the manner as may be prescribed.

3.       CBDT has come with draft rules to determine the amount received by company for issue of shares, in various scenarios, in the context of section 115QA, as under;-

a)      Subscription of Shares-  Paid up amount actually received including share premium shall be amount received by company for issue of shares.

b)      Past Capital Reduction – Where any sum has been returned by company in respect of shares on capital reduction, which is presently subject to buy-back, the amount so returned shall be reduced from amount received in respect of those shares and reduced amount shall be considered as amount received by company for issue of shares.

c)       Amalgamation – Upon shares being issued on amalgamation in lieu of shares in amalgamating company, the amount received by amalgamating company in respect of those shares, shall be amount received in respect of shares issued by amalgamated company.

d)      Demerger –

i)                    Resulting Company - For shares being issued by Resulting company, the amount received by resulting company on issue of shares shall be : Amount Received by Demerged company on issue of shares x Net book value of assets transferred to Resulting Company/Net worth of Demerged Company.

ii)                   Demerged Company – The amount received by demerged company in respect of original shares, shall be reduced by the amount determined at (i) above

e)      Bonus Shares – NIL Amount.

f)       Convertible Debenture/Bonds – The amount received in respect of Debenture/bonds so converted, shall be considered as amount received by company for issue of shares

g)      Residual Clause – In any other case, the face value of shares shall be considered as  amount received by company for issue of shares

Critical Analysis

1.       Consolidate Approach absent

a)      The draft rules prescribes piecemeal scenarios to determine the amount received in respect of shares issued by company,  but determination of amount received in respect of shares issued, where existing Share capital is comprise of Subscription shares, bonus shares and shares issued on amalgamation, is lacking.

b)      Consider the following case

i.                     Status of Share Capital of Company

S.No	Particulars	Nos	Rs
		Shares	Face Value	Share Premium	Amount Received as per Draft rules
1	Shares Subscribed by Shareholders	15,000	150,000	150,000	300,000
2	Bonus Shares	15,000	150,000	-	-
3	Shares Issued on Amalgamation	5,000	50,000	-	10,000
	TOTAL	35,000	350,000	150,000	310,000

ii.                   Suppose the company decides to buy-back 10% of its outstanding shares i.e 3500 shares.

iii.                  The point for consideration is how to determine the amount received in respect of 3500 shares issued. The draft rules are silent on this aspect.

iv.                 In this case, whether the residual clause will be applicable, whereby face value of 3500 shares i.e Rs. 35,000 be taken as amount received in respect of such shares?

v.                   Clarity on this aspect is required.

2.       Rule 2 – Consistency missing

a)      The Rule 2 read as under:-

“Where the company had at any time, prior to the buy-back of the share, returned any sum out of the amount received in respect of such share, determined in accordance with this rule, the amount as reduced by the sum so returned shall be the amount received by the company for issue of the share.”

b)      The strike out sentence is missing in the rule, which need to be there, explained as under:-

                                            I.            The Rule provides for deduction of amount repaid on capital reduction from amount received earlier in respect of shares. But the question is how to determine the amount received in respect of those shares originally i.e. will it be in accordance with normal parlance or will it be in accordance with methodology provided in the rules.

                                          II.            Consider the case, where company has earlier issued shares on amalgamation and carried out capital reduction:-

Particulars	Shares (Nos)	Face Value	Share Premium	TOTAL	Amount Received as per rule
Shares Issued on Amalgamation	10,000	100,000	200,000	300,000	60,000
Capital Reduction	1,000			30,000	30,000
Balance	9,000			270,000	30,000

                                        III.            The company has received assets worth Rs. 3,00,000 on amalgamation and issued shares of similar value. So company has received Rs. 3,00,000 in respect of 10,000 shares but the amount received by amalgamating company on shares, in lieu of which amalgamated company has issued 10,000 shares, was Rs. 60,000. (Assumed).

                                        IV.            To maintain consistency with Rule 3 & Rule 4, for the purpose of determining the amount received in respect of 9,000 shares, the value should be taken at Rs. 30,000 instead of 2,70,000

c)       The Rule 3, which provides for determination of amount received on shares issued by amalgamated company, explicitly states that amount received by amalgamating company in respect of shares should be determined in accordance with this rule, which is reproduced as under:-

“Where the share has been issued by a company being an amalgamated company, under a scheme of amalgamation, in lieu of the share or shares of an amalgamating company, then, the amount received by the amalgamating company in respect of such share or shares determined in accordance with this rule, shall be deemed to be the amount received by the amalgamated company in respect of the share so issued by it.”

d)      Thus to maintain parity and uniformity, it is suggested that strike out words be inserted in Rule 2

Equalization Levy

Equalization Levy

Important points relating to Equalization levy

·         Even though no TDS is required to  be deducted u/s 195 of Income Tax Act, 1961 on specified services which are subject to equalization levy, but information on said remittance to non-resident is to be furnished to Income Tax  Department in Part- D of FORM 15CA as mandated by Rule 37BB (2) of Income Tax Rules.

·         Consequences - When assessee does not deduct and deposit equalization levy on the honest belief that the services are not specified services.

Before I dealt with the issue, it is better to go through the itinerary of Chapter VIII of Finance Act, 2016 as under:-

S.No	Section	Matter covered
1.	163	Extent, Commencement & Application
2.	164	Definitions
3.	165	Charge of Equalization levy
4.	166	Collection & Recovery of Equalization Levy
5.	167	Furnishing of Annual Statement
6.	168	Processing of Annual Statement- Intimation
7.	169	Rectification of Mistake in Intimation
8.	170	Interest on delayed payment of Equalization levy
9.	171	Penalty for failure to deduct or pay equalization levy
10.	172	Penalty for failure to furnish Annual Statement
11.	173	Penalty not to be imposed in certain cases
12	174	Appeal to CIT(A)
13.	175	Appeal to ITAT
14.	176	Punishment for false statement
15.	177	Institution of Prosecution
16.	178	Application of certain provision of Income Tax Act.
17.	179	Power to make Rules
18.	180	Power to remove difficulties

ISSUES

a)      Under which section AO will pass order to conclude that services are specified services?

i)                    Under Income Tax Act 1961, if TDS is not deducted by payer on the good faith that requisite payment does not attract TDS liability, then AO has power u/s 201 to pass an order adjudging on requirement to deduct TDS on the part of assessee and treating him assessee in default for non-payment of necessary TDS amount.

ii)                   There is no pari-materia provision in Chapter VIII of Finance Act, 2016 similar to section 201.

iii)                 Section 178 of Finance Act, 2016 giving reference to various sections of Income Tax Act, 1961 to be applicable to Equalization levy, does not include section 201.

iv)                 Thus if an assessee does not deduct and deposit equalization levy on the belief that services are not specified services, Chapter VIII of Finance Act 216 does not provide specific section authorizing AO  to  pass an order adjudicating that services are specified services and  treating an assessee as assessee in default and proceed to recover the amount due.

b)      AO’s Order holding that services are specified services is NON-APPEALABLE

i)                    In case of equalization levy, consider the following situation:-

1)      Assessee makes foreign remittances to Non-resident for certain Services.

2)      No TDS was deducted u/s 195 of Income Tax Act, 1961, on the basis that said payment is not chargeable to tax in India under DTAA.

3)      Assessee is also under bona-fide belief that said services are not specified services attracting equalization levy.

ii)                   Though there is no explicit provision in Chapter VIII of Finance Act, 2016 empowering AO to order that services are specified services but assumes that AO draws power under section 166 of Finance Act, 2016 (Collection and Recovery of Equalization levy) and on the basis of information furnished in FORM 15CA conclude that services are specified services and treat assessee as assessee in default for non-payment of equalization levy.

iii)                 In above case, the order of AO holding that services are specified services requiring deduction & deposit of equalization levy is NOT APPEALABLE, as only penalty order u/s 171 of Finance Act, 2016 is appealable order u/s 174 of Finance Act, 2016.

iv)                 Thus in the first instance AO assumption of jurisdiction to pass afore-said order is itself litigative. Even if jurisdiction challenge fails, law does not provide an assessee adequate forum to address his grievances against AO’s order and only option left is take the route of writ petition. At this stage it is worth mentioning that order u/s 201 of Income Tax Act, 1961 is appealable.

v)                  As the scope of specified services, which is presently restricted to online advertisement, is bound to increase in future, clarity on ambiguities engulfing above issues are at most important.