Tax on accreted Income- Section 115TD of Income Tax Act

Tax on Accreted Income- Section 115TD

1.       Objective of Section

a)      Trust or institution registered u/s 12AA enjoy tax exemption on its income

b)      If due to charging event, specified in section 115TD, income of such trust or institution is made taxable currently, then section 115TD provides for charging tax on “accreted income” (past exempted income) of such trust or institution

c)       The measurement of accreted income is FMV of assets less book value of liabilities on Specified Date

d)      Tax on accreted income is to be paid at Maximum Marginal rate (30% currently)

2.       Charging event- if any of the following event occurs, then section 115TD will be applicable and Trust/institution has to pay tax on accreted income

a)      Case- 1 – Trust/Institution is converted into any FORM, which is not eligible for grant of registration u/s 12AA. It consist of following 2 situations:-

i)                    Case 1(a) – Registration under section 12AA has been cancelled

ii)                   Case 1(b) – Trust/Institution has undertaken modification of its object, which do not confirm to conditions of registration and

·         Case 1(b)(i) – has not applied for fresh registration u/s 12AA

·         Case 1(b)(ii) – has applied for fresh registration u/s 12AA but application has been rejected

b)      Case 2 – Trust/Institute has merged with any other entity, other than entity registered u/s 12AA and has its object similar to trust/institution

c)       Case 3 – Trust/Institution has been dissolved but failed to transfer its assets and liabilities to either Trust/institution registered u/s 12AA or other institution registered u/s 10(23C)((iv)/(v)/(vi/(via), within period of 12 months from the end of the month in which dissolution take place.

3.       Previous year in which accreted income is taxable, specified date for computing accreted Income, Payment of tax on accreted income

Case	Situation	PY in which accreted Income is taxable	Specified date for computing accreted income	Date of Payment of Tax (max time)
1(a)	No appeal has been filed against cancellation order	FY in which order is passed by Commissioner cancelling the registration	Date of order of Commissioner cancelling the registration	74 (60+14) days from the date, on which order of Commissioner cancelling the registration is received
1(a)	Appeal is filed but cancellation of registration is confirmed in appellate proceedings	FY in which appellate order is received	Date of order of Commissioner cancelling the registration	14 days from the date on which appellate order is received
1(b)(i)	Has not applied for fresh registration u/s 12AA on modification of objects	FY in which modification of object is done	Date on which modification of object is done	14 days from the end of the previous year in which modification of object is done
1(b)(ii)	No appeal is filed against order rejecting application	FY in which order is passed by Commissioner rejecting the application.	Date on which modification of object is done	74 days from the date, on which order of Commissioner rejecting the application is received.
1(b)(ii)	Appeal is filed but rejection of registration in confirmed in appellate proceedings	FY in which appellate order is received	Date of order of Commissioner rejecting the application.	14 days from the date on which appellate order is received
Case 2		FY in which merge is done	Date of Merger	14 days from the date of merger
Case 3		FY in which 12 months from end of month in which dissolution take place falls	Date of dissolution	14 days from the date on which said period of 12 months expires.

4.       Examples

i.                     Example 1

a)      Registration of Trust is cancelled on 01/03/2018 and such order is received on 05/03/2018

b)      No appeal is filed against such order

PY in which accreted income is taxable	Specified Date	Date of Payment of tax
PY 17-18 (FY in which order is passed by Commissioner)	01/03/2018 (date of order cancelling registration	74 days from 05/03/2018

ii.                   Example-2

Registration of Trust is cancelled on 01/03/2018, appeal is file against said order with ITAT,ITAT confirm cancellation by an order dated 01/05/2019 and order is received on 15/05/2019. No further appeal is filed

PY in which accreted income is taxable	Specified Date	Date of Payment of tax
PY 19-20 (FY in which ITAT order is passed received)	01/03/2018 (date of order cancelling registration)	14 days from 15/05/2019

iii)                 Example- 3

a)      Modification of objects of trust is done on 1/2/2018 , which do not confirm to condition of registration u/s 12AA

b)      No application is made for fresh registration u/s 12AA

PY in which accreted income is taxable	Specified Date	Date of Payment of tax
PY 17-18 (FY in which modification of object is done)	01/02/2018 (date of modification of object)	14 days from 31/3/2018 (14 days from the end of the PY in which modification of object is done)

iv)                 Example – 4

a)      Modification of objects of trust is done on 1/2/2018 , which do not confirm to condition of registration u/s 12AA

b)      Application is made for fresh registration u/s 12AA on 1/3/2018

a)      Order is passed by commissioner rejecting the application on 30/9/18 and order is received on 4/10/2018

PY in which accreted income is taxable	Specified Date	Date of Payment of tax
PY 18-19 (FY in which application for fresh registration is rejected)	01/02/2018 (date of modification of object)	74 days from 04/10/2018.

v)                  Example- 5

c)       Modification of objects of trust is done on 1/2/2018, which do not confirm to condition of registration u/s 12AA

a)      Application for registration is rejected; appeal is filed before ITAT, which confirm rejection. ITAT passed the order on 1/6/2019 and order is received on 10/6/2019. No further appeal is filed

PY in which accreted income is taxable	Specified Date	Date of Payment of tax
PY 19-20 (FY in which ITAT order is received)	01/02/2018 (date of modification of object)	14 days from 10/06/2018.

5.       Special point relating to computation of accreted income:-

a)      Accreted income is FMV of assets and Liabilities of trust/institution as on specified date

b)      In computing FMV of assets, following assets shall not be included:-

i)                    Assets, which have been acquired directly out of agriculture income referred to in section 10(1).

ii)                   Assets which have been acquired between the period beginning from the date on which trust in created and ending on the date on which registration u/s 12AA become effective, if no benefit u/ 11 and 12 is given during said period.

iii)                 In case of dissolution of trust , the assets which have been transferred to either Trust/institution registered u/s 12AA or other institution registered u/s 10(23C)((iv)/(v)/(vi/(via), within period of 12 months from the end of the month in which dissolution take place

Thin Capitalization- Section 94B- Operational Analysis

Thin Capitalization- Section 94B- Operational Analysis

1.       Applicability to

a)       Indian Company

b)      Permanent Establishment of Foreign Company

(Referred to as Entity in subsequent discussion)

2.       Charging Provision

a)       Entity incur DEDUCTIBLE Interest expenditure in Previous Year in computing income under the head PGBP, in respect of debt (direct & Indirect) taken from Associated Enterprise.

b)      The amount of such deductible Interest expenditure exceeds Rs. 1 Cr.

c)       If afore-said conditions are satisfied, then Excess Interest will be disallowed to Entity in a previous year.

d)      When Entity borrow money from Non-AE, but Associated enterprise either provides implicit or explicit guarantee to lender (for amount lend to entity) or deposit equivalent amount with lender, then it shall be treated as indirect borrowing from AE

e)      Section 94B is not applicable where entity is engaged in banking or insurance business.

Analysis - Deductible expenditure against PGBP

i)                    If Interest expense is being disallowed u/s 40a(i), then same being not deductible expenditure in a previous year, it will not be taken into consideration in computing One Crore yardstick

ii)                   Suppose an Indian company borrow money from AE. It could not deploy the funds in business project and earn interest income by investing the borrowed funds. Since the said interest income is chargeable to tax under the head Income from other sources and Interest payable to AE is being set-off against said interest income, said Interest expense will not be considered for calculating One Crore Benchmark, as same was not deductible expenditure under PGBP.

3.       Computation of Excess Interest

The Excess Interest is lower of the following: -

i)                    Total Interest Expenditure (Payable to AE and Non-AE) Less 30% of Earning before Interest, Taxes Depreciation and amortization (EBITDA) or

ii)                   Interest paid or payable to Associated Enterprise

Analysis

i)                    EBITDA is not defined in section 94B. The point for consideration is whether EBITDA is to be computed as per books of accounts or same is to computed with by imputing provision of Income Tax Act.

ii)                   My view is that EBITDA be computed as per books of accounts. Income tax legislation used the terminology as Gross Total Income or Total income or Income under respective head and nowhere it used the words “Earning” or “Amortization”. EBITDA is term used in accounting parlance and legislator must have used the definition in the same sense only.

iii)                 Illustration of computation of Excess Interest

                

S.No	Particulars	Case 1	Case 2	Case 3
1	EBITDA	5,00,00,000	5,00,00,000	5,00,00,000
2	Interest Paid to Non-AE	30,00,000	1,50,00,000	70,00,000
3	Interest Paid to AE	1,10,00,000	1,10,00,000	1,10,00,000
4	TOTAL Interest Expenditure	1,40,00,000	2,60,00,000	1,80,00,000
5	30% of EBITDA	1,50,00,000	1,50,00,000	1,50,00,000
6	Total Interest- 30% of EBIDA	-10,00,000	1,10,00,000	30,00,000
7	Interest Paid to AE	1,10,00,000	1,10,00,000	1,10,00,000
8	Excess Interest - Lower of 5 or 6	0	1,10,00,000	30,00,000
9	Interest Allowed (4-8)	1,40,00,000	1,50,00,000	1,50,00,000
10	Excess Interest Carried Forward to Next year (8)	0	1,10,00,000	30,00,000

iv)                 The excess interest is allowed in subsequent year to the extent of limits specified in point 3 above i.e. aggregate of Interest (Current year and unabsorbed Interest) should not exceed 30% of EBITDA

4.       Treatment of Excess Interest of First Year Carried forward to next year/subsequent year.

a)      Whether carried forward Excess Interest be considered in computing benchmark of 1 Cr of subsequent year or not

i)                    Suppose Interest Payable to AE in next year is Rs. 80 lacs. Whether we need to add the excess interest (case 2) of Rs. 110 lacs to Rs. 80 lacs, to arrive at benchmark interest amount of Rs 1 Cr determining the applicability of Charging provision of section 94B.

ii)                   In my understanding, it should not be added. The reasons are two-folded:-

a.       Section 94B(1), charging section, used the words where entity “incurs any expenditure by way of Interest-----“. Thus benchmark is to be evaluated based on Interest expenditure incur in previous year

b.       Considered the case- 3 above. In this case, it is indeterminable whether excess Interest relates to AE or non-AE. Since the law does not provide the basis for evaluation of the same, it is not possible to assess the subsequent year benchmark by adding previous year excess Interest.

b)      Limit on deduction of Excess Interest in Subsequent year, if charging provision is not applicable in said subsequent year

i)                    The Itinerary of section 94B is as under: -

a.       Section 94B(1) is charging section, which disallow the excess interest, if the Interest payable to AE is in excess of Rs 1 Cr.

b.       Section 94B(2) provide for computation of Excess Interest.

c.       Section 94B(3) provides the exclusion of section 94B to Banking or Insurance Company.

d.       Section 94B(4) provides for carry forward of excess Interest and further provides for its deduction in subsequent year to the extent specified in section 94B(2). Section 94B(4) reads as under:-

“Where for any assessment year, the interest expenditure is not wholly deducted against income under the head "Profits and gains of business or profession", so much of the interest expenditure as has not been so deducted, shall be carried forward to the following assessment year or assessment years, and it shall be allowed as a deduction against the profits and gains, if any, of any business or profession carried on by it and assessable for that assessment year to the extent of maximum allowable interest expenditure in accordance with sub-section (2)” (Emphasis supplied)

ii)                   Under Section 94B(2), Maximum allowable Interest is to the extent it does not exceed Excess Interest. The Excess Interest is computed only, when charging provision as per section 94B(1) is applicable. If charging provision is not applicable, then there is no computation of excess Interest, hence no restriction on allowability of Interest. In this scenario, Excess interest of past year, should be allowed in entirety in next year, in my view.

Section 92CE-Secondary Adjustments- Finer Aspects

Section 92CE – Secondary adjustment- Deciphering Finer aspects

·         Legal enforceability of Rate of Interest prescribed u/s 92CE

Section 92CE relating to Secondary adjustment provides for following:-

a)      Deeming excess money (Excess of Arm’s length Price as a result of Primary adjustment over value of International transaction) as an advance recoverable from Associated Enterprise.

b)      Manner of computation of Interest on such an advance.

c)       Rate of Interest.

In my view, the rate of interest prescribed under rule 10CB in exercise of power u/s 92CE lacks legal enforceability enunciated as under:-

1.       Each section and each chapter of Income Tax Act is meant for specific operation/action as under;-

i)                    Section 2- Defining the meaning of word used in the Act, either extending or curtailing the dictionary or common parlance meaning of the word.

ii)                   Section 4 is charging section

iii)                 Section 5 defines the range of Income

iv)                 Section 14 qualifies the income to various head

v)                  Section 15 to 59 (Chapter IV) quantify the Income

vi)                 Chapter X - Special provisions relating to avoidance of tax - In other words, the said chapter deals with  the Specific Anti Avoidance rules (SAAR) in various scenarios, whereby it provides measures to re-adjust the taxable income quantified under substantive provisions of Chapter IV

2.       Submission as regard non-enforceability of rate of interest prescribed u/s 92CE.

a)      Is every advancement of money by assessee is taxable transaction, mandating him to compute and offer for tax interest thereon, even if no interest is charged by him?  This aspect is possible in either of the two scenarios;-

i)                    Where Interest on such advance is deemed as Income u/s 2(24) or

ii)                   Transaction of advancement of money is made part of SAAR, whereby if prescribed conditions are satisfied, assessee will be liable to offer for tax interest on such advance.

b)      Section 92CE deems that excess money (Excess of Arm’s length Price as a result of Primary adjustment over value of International transaction) is an advance recoverable from Associated Enterprise (deemed debt).

c)       Section 2(24) has not been amended to provide for interest on deemed debts as deemed income.

d)      Section 92B provides that transaction of advance between enterprise and associated enterprise is an international transaction.

e)      Section 92 provides that income arising on international transaction shall be determined as per Arm’s length principle.

f)       Thus in view of afore-said, the interest on deemed debt u/s 92CE is made taxable (i.e charged) by virtue of application of Section 92 i.e SAAR and in this scenario, Interest rate prescribed u/s 92CE has no applicability, explained as under:-

i)                    Assessee will be required to find comparable uncontrolled transaction (CUT) for deemed debt

ii)                   The Income accruing under CUT will be deemed as income from deemed debt.

iii)                 There is no requirement to visit section 92CE to compute interest on deemed debt on the rates prescribed in the section, when the same is computed under ALP mechanism.

g)      At this point, following points also merits attention

                                I.            The role of Chapter X is to prescribe benchmark/milestone/criterion to evaluate whether there is avoidance of tax in different scenarios and then provide the mechanism to recover avoided tax either through enhancement of income or disallowance of loss quantified under chapter IV and other substantive provisions.

                              II.            The quantification/computation of income is a solely domain of chapter IV.

                            III.            Even if definition of income is being amended to deem interest on deemed debt as income, its quantification can be only be provided in Chapter IV and not in Chapter-X

                            IV.            Safe harbor rules u/s 92CB also does not provide for quantification of Income. It only provides that if an income on international transaction is within the range provided under safe harbor rule, it will be deemed that same is as per ALP, even if income under comparable transaction is more than income under international transaction. In other words, safe harbor rule does not provide for quantification of income but only modifies the ALP mechanism by making section 92 subject to section 92CB.

                              V.            To illustrate, section 92B provides that Corporate Guarantee or receivable is International transaction and income/interest thereon shall be computed on ALP basis. Safe harbor rules only provide that in certain situations, if income/interest thereon, quantified under Chapter IV, is at level specified in the safe harbor rules, it shall be deemed that income/interest is at ALP. Thus law has not quantified income/interest on corporate guarantee or receivable under chapter X

                            VI.            For Secondary adjustment, section 92 has not been made subject to section 92CE, similar to safe harbor rules. Thus section 92 will operate independently of section 92CE. Further, when a section provides for chargeability of Income to Tax, then computation machinery relating to that charging section will prevail, over the other computation provision relating to that income.

Thus interest rate prescribes u/s 92CE has no applicability for following reasons:-

a)      The interest on deemed debt is made chargeable by virtue of application of provision of  section 92 and accordingly interest is to be computed as per the ALP mechanism prescribed for section 92, rather than on the basis of rate prescribed u/s 92CE

b)      Section 92 has not been made subject to the provision of section 92CE, similar to section 92CB relating to Safe harbor rules, thus providing for independent operation of section 92.

c)       Further role of Chapter X is not to provide for quantification of Income, which is sole prerogative of Chapter IV.

·         Recovery of deemed debt

1.       Section 92CE provides that till deemed debt is recovered, assessee has to charge interest on deemed debt.

2.       The point for consideration is whether deemed debt should be recovered separately in specie or if the value of International transaction in subsequent years is more than ALP, can it be taken that assessee has recovered deemed debt

3.       If deemed debt is recovered separately, then issues involved will be as under:-

a)      The deemed debt is not an actual debt in the books of assessee.

b)      If the assessee recover such deemed debt, then recovery of same will be either credited in the P&L or be taken as direct credit to reserve.

c)       In the year of recovery, if assessee  is subject to MAT, then whether assessee will be liable to MAT, if such amount is credited to P&L

d)      There is no such exception provided u/s 115JA for exclusion of the same

e)      However MAT is entire code in itself and whether exclusion of such recovery from computation of book profit will be permitted is debatable question

f)       If MAT is not applicable and recovery is credited to P&L, then under normal provision, assessee can exclude the same from Computation of Income, on the principle of double taxation of same income.

4.       If in subsequent years, value of International transaction is more than ALP, then can it be deemed that assessee has recovered deemed debt advanced to associated enterprise. Exemplified

a)      In year 1, AO made primary adjustment to the extent of Rs. 5 Cr, which assessee disputed and but lost the case before ITAT in Year 5

b)      In Year 2 & 3, the assessee facts are as under;-

Year	Income under International Transaction	Income under Comparable Uncontrolled Transaction
2	12 Cr	10 Cr
3	14 Cr	11 Cr

c)       In above case, though assesse international transaction is at ALP, can assessee take stand that since income under international transaction is in excess of income under CUT by Rs. 5 Cr in aggregate, he has recovered the deemed debt relating to Year 1 and as such there is no requirement for secondary adjustment in Year 5, when assessment proceedings for year 1 crystallized.