Finance Bill 2017- Critical Analysis of Direct Tax Provisions

Finance Bill 2017- Critical analysis of Direct Tax Provisions

1.       Capital gains – Joint Development Property

a)      Finance Bill 2017, propose section 45(5A) which provide for the  time of taxability of capital gain arising on  transfer of land or building, contributed by an Individual or HUF, in Joint Development agreement.

b)      The salient features of Section 45(5A) are as under;-

i)                    Section 45(5A) supersede section 45(1), thus providing an exception that capital gains will not be chargeable in the year of Transfer.

ii)                   Capital gains will be taxable in the year in which property or part of the property under joint development gets completion certificate

iii)                 The sales consideration will be stamp duty value (of year in which property gets completion certificate) of share of property attributable to Individual or HUF and cash consideration if any.

iv)                 Thus transfer will take place in earlier year and computation and taxability will be in posterior years.

c)       Critical analysis – In case of Long term capital Gains, of which year Cost inflation index will be applicable i.e year of Transfer or Year of Computation, as Section 48 prescribe that for Calculating Indexed Cost, Cost Inflation index (CFI) of the year of Transfer be taken.  Exemplified as under:-

i)                    Cost of land Contributed in JDA – Rs. 10 lacs  (Acquired in year 2013-14, CFI - 939)

ii)                   Year of Transfer – 2017-18 (Stamp duty value – Rs. 30 lacs, CFI assumed - 1200)

iii)                 Year  of Computation & Taxability (property gets completion certificate) – 2020-21

iv)                 During 2017-18 and 2020-21, there is huge run up in inflation and as a result thereof property price and Cost inflation index also goes up substantially (by 50%)

v)                  Capital gain Computation in two scenarios are as under;-

Particulars	Units	Cases
		CFI - Year of Transfer	CFI - Year of Taxability
CFI	Nos	1200	1800
Consideration	Rs lacs	45	45
Cost	Rs lacs	10	10
Indexed Cost	Rs lacs	12.78	19.17
Capital gain	Rs lacs	32.22	25.83

vi)                 On parity principles, CFI should be taken of the year of which Stamp duty value is taken as sales consideration, otherwise assessee would be required to pay more taxes.

2.       Cost of Acquisition of share of developed Property under JDA

a)      Section 45(5A) provides that in JDA, the sales consideration for land/building transferred in JDA, will be aggregate of following two:-

i)                    Stamp duty value (of the year of Completion) of Individual’s share in Developed Property and

ii)                   Cash Consideration, if any.

b)      Propose section 49(7) provides for cost of acquisition of Individual share in developed property received in JDA. It read as under;-

“Where the capital gain arises from the transfer of a capital asset, being share in the project, in the form of land or building or both, referred to in sub-section (5A) of section 45, not being the capital asset referred to in the proviso to the said sub-section, the cost of acquisition of such asset, shall be the amount which is deemed as full value of consideration in that sub-section”

c)       The Cost of acquisition of share in developed property should be only stamp duty value taken as sales consideration earlier and should not include the cash consideration received.

d)      Illustrated

i)                    Cost of land Contributed in JDA – Rs. 5 lacs

ii)                   Stamp Duty Value of Individual share in Developed Property – Rs. 15 lacs

iii)                 Cash Consideration – Rs. 2 lacs

iv)                 Thus as per section 45(5A), the full consideration is Rs. 17 lacs

v)                  Further as per section 49(7), the cost of acquisition of Share in developed property is Rs. 17 lacs, which is not factually correct.

vi)                 The cost of acquisition of Share in Developed Property should be Rs. 15 lacs , taken as sale consideration earlier, rather than Rs. 17 lacs.

3.       Double Taxation – Interplay of Section Propose section 50CA and 56(2)(x)

a)      Section 50CA provides that on transfer of unquoted share of company, being capital asset, if sales consideration is less than FMV, to be be prescribed, then FMV shall be deemed as sales consideration

b)      Section 56(2)(x)- Among other things, said section provides that if person receives any property (Including unquoted shares in company) at value less than FMV, then excess of FMV over such value will be deemed as income of recipient of shares.

c)       Assuming the FMV as per section 50CA is on same basis, as prescribed for section 56(2)(x), then there will be double taxation of same amount in the hands of two assessee.

d)      Demonstrated

i)                    Mr. A sold unquoted shares to Mr. B at Rs. 1 lakh, at cost to him and the FMV being 1.7 lacs.

ii)                   As per section 50CA, Rs. 70,000 (1.7 lacs – 1.00 lacs) will be capital gains in the hands of Mr. A.

iii)                 As per Section 56(2)(x), same Rs. 70,000 will be taxable in the hands of Mr. B, as he paid less than FMV for acquiring the shares.

4.       Section 56(2)(x) – Impediment in restructuring stated in section 47.

a)      Among other things, section 56(2)(x) provides that, if a company or firm receives any Immovable property or shares & Securities (Listed or unlisted) or other specified properties (Capital asset) at value less than FMV, then excess of FMV over such value be deemed as Income of said company or firm.

b)      Section 56(2)(x) provides its non-applicability in case  of merger and demerger, however following types of restructuring is not covered in exclusion scope of section 56(2)(x)

i)                    Transfer of capital asset by Holding to Wholly owned Subsidiary or vice versa, referred to in section 47(iv) & 47(v)

ii)                   Any transfer of Capital asset by a firm to company, referred to in section 47(xiii).

iii)                 Any transfer of capital asset by Company to LLP, referred to in section 47(xiiia)

iv)                 Any transfer of Capital asset by  sole proprietorship concern to company, referred to in section 47(xiv)

v)                  Contribution of listed shares as capital by partner in Firm at less than FMV.

c)       Typified

i)                    Holding Company is having land of Rs. 5 lacs, FMV being Rs, 50 lacs

ii)                   It transferred the same to wholly owned Subsidiary at cost, with an objective to develop real estate project in separate entity.

iii)                 The holding company is not subject to capital gain, as the said transaction does not amounts to transfer u/s 47(iv) but now u/s 56(2)(x), subsidiary will be made taxable on Income of Rs. 45 lacs, the excess of FMV over consideration paid for acquiring the land.

5.       Thin Capitalization Provision

a)      Though propose section 94B, thin capitalization rules are intended to be introduced in India.

b)      Section 94B provides as under;-

i)                    An Indian company or Permanent establishment (PE) borrow money from its foreign company, being an associated enterprise

ii)                   The amount of Interest, on said borrowing, which is eligible for deduction under computing PGBP, exceeds Rs. 1 Cr.

iii)                 In above situation, the interest eligible for deduction under PGBP will be restricted to 30% of EBITDA or actual amount of Interest, whichever is less.

iv)                 The Interest not allowed as afore-said will be carried forward to next year and such carried forward is allowed upto 8^th assessment years.

c)       The thin capitalization provisions in its current propose setting may not be able to pass the test of Non-discrimination Rule under Article 24 of OECD Model Convention of DTAA.

d)      Article 24(4) of  OECD model reiterates as under:-

“Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article 11 or paragraph 4 of Article 12 apply, interest, royalties and other disbursement paid by an enterprise of a contracting state to a resident of the other contracting state shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to resident of first-mentioned state”

e)      Let analyses the provision of article 24(4)

i)                    It prohibits the discrimination against deduction of expenditure, paid to foreign enterprise , in the hands of resident enterprise, where such deduction would have been allowable, had payment being made to other resident enterprise in similar conditions

ii)                   The said discrimination is prohibited only when same is also forbidden by Article 9.

iii)                 The OECD Commentary on Article 9 permits the application of Thin Capitalization rules in domestic legislation, provided the same does not have the effect of increasing the taxable profits of relevant domestic enterprise to more than Arm’s Length Profit.

f)       Analysis of Section 94B vis-à-vis Article 24 and Article 9

i)                    Restriction of Interest expenditure upto 30% of EBITDA, paid to Foreign associated enterprise is discrimination, whereas similar expenditure to any extent is allowed when same is paid to other domestic enterprise. – Article 24(4) will prevent such discrimination

ii)                   The criterion of restricting Interest paid to foreign associated enterprise upto 30% of EBIDTA may have effect of taxing the profit of Domestic Enterprise at more than Arm’s length level profit, as comparable enterprise may have allowable interest expenditure in excess of said 30% range.- Article 9 will prevent such taxation of profit at more than Arm’s length level

iii)                 Thus Thin Capitalization Provisions u/s 94B may not have desired impact in view of non-discrimination provision of Article 24(4).

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