Intensive Study Course on Income Tax
Issues Concerning Computation of business Income
4 July 2012
Jatin Kanabar
Contents
•
Computation of Business Income
‒ Incomes & Deductions
•
Analysis of current issues
•
Taxation of Limited Liability Partnerships
•
Proposed General Anti Avoidance Rules (GAAR)
2
Computation of Business
Income
3
Setting up of business (1)
•
When an activity, essential to carrying on the business is started, the business must be
said to have set up
‒ CIT v. ESPN Software India (P.) Limited (301 ITR 368) (Delhi HC)
•
All expenses incurred after the setting up of the business and before the
commencement of the business, would be permissible deductions
‒ Western India Vegetable Products Ltd. v. CIT (26 ITR 151) (Bombay HC)
•
A manufacturing concern cannot be said to have set up its business simply by installing
the machinery and giving it a trial run with a hired generator set.
‒ CIT v. Forging & Stamping (P.) Ltd. (119 ITR 616) (Bombay HC)
• Section 35D of Income Tax Act, prescribes the deduction in respect of preliminary
expenses incurred,
‒ before commencement of business or
‒ after commencement in connection with extension of undertaking or setting up of new
unit
4
Setting up of business (2)
• Under Section 35D,
‒ An amount equal to one-fifth of the specified expenditure is allowed as deduction over
five successive years
‒ The deduction is restricted to five percent of the cost of project or capital employed,
whichever is higher
• In the case of Medreich Ltd. (140 TTJ 7), Bangalore Tribunal held that the
expenditure incurred by assessee company on issue of shares to increase its capital
base did not qualify to be amortized under section 35D as business expansion and
market expansion of an existing business will not amount to extension of the
'undertaking‘
• Recently, in the case of Ashok Leyland Ltd. (ITA Nos. 1253,1254 and 1256/2005),
Madras High Court held that deduction under section 35D is allowable for expansion
of capacity of undertaking as the the word 'extension' covers not only horizontal but
also includes vertical expansion
• Under the Direct Tax Code* (DTC), date of setting up of business,
‒ For manufacturing companies, the date on which the production of the goods begins
after successful trial run of the plant
‒ For other than manufacturing companies the date on which it is ready to commence its
commercial operations
*DTC is in draft stage and it is expected to be enacted in April 2013
5
Profits and gains
• Section 28, is the charging section and provides a comprehensive list of the incomes
which shall be chargeable to income tax under the head “profit and gains of business or
profession. It inter alia includes‒ Any interest, salary, bonus, commission or remuneration, received by, a partner of a
firm
‒ Any sum, received or receivable, under an agreement for
• not carrying out any activity in relation to any business; or
• not sharing any know-how, patent, copyright, trade-mark, license, franchise or any
other business or commercial right of similar nature
• Under DTC, scope of business income is widened to include,
‒ Consideration on account of certified carbon credits
‒ Consideration in respect of transfer of any capital asset self generated in the course of
business
‒ Amounts received or accrued (as advance, deposit or otherwise) from long term
leasing or transfer of business asset
‒ The gross earning of business will include “any amount received as reimbursement of
any expenditure incurred”
6
Computation of income
• Section 29, prescribes the method of computation of business income and it requires
business income to be computed in accordance with the provisions contained in sections
30 to 43D
• Under DTC, Income from distinct and separate business to be computed independently,
if:
‒ Units processing, producing, manufacturing or trading same goods but located
physically apart
‒ Processing, producing or manufacturing same goods, but utilizing different raw
material or manufacturing process from each other
‒ Separate books of account are maintained or ‘capable’ of being maintained
‒ Business under specific tax computation i.e. Insurance, shipping, mineral oil and
natural gas, SEZ developers and business availing investment linked tax incentives
‒ Business under presumptive basis of taxation
‒ Speculative transactions in nature of business
‒ Special source income
Every undertaking will considered to be a separate business, hence the deduction of
common expenditure may be contested by revenue !!
7
Deductible expenditure (1)
•
Section 30, prescribes for the deductions in respect of rent, taxes, repair and
insurance for buildings and Section 31, prescribes for the deductions in respect of
Current repair and insurance for of machinery, plant and furniture.
•
The Apex court in the case of Saravana Spring Mills (293 ITR 201) held that for
allowability of expense under section 31,
‒ The expenditure should be on account of current repairs
‒ Current repairs means an expense incurred to preserve and maintain an existing asset
‒ Current repair implies repair in part of the machine and not replacement of entire
machine
•
Cost of repair/reconstruction of tenanted premises is revenue in nature and allowable as
deduction under section 30(a)(i)
‒ As per Explanation 1 to section 32, in respect of any capital expenditure incurred by
assessee in respect of leasehold premises used for the purpose of business or
profession, provisions of section 32 would apply as if he is the owner of such premises
and depreciation is allowable thereon.
8
Deductible expenditure (2)
•
Section 32, prescribes for the allowance in respect of depreciation on ‘Block of Assets’:
•
Prerequisites for allowance of depreciation under section 32
‒ Ownership, wholly or partly
‒ Used for business purpose
•
Registered Ownership is not necessary for the purpose of claiming depreciation
‒ Mysore Minerals (239 ITR 775) (SC)
•
Once all the rights and dominion over properties had vested with assessee, the
assessee was entitled to depreciation under section 32 irrespective of its legal title
‒ Jammu and Kashmir Tourism (120 Taxman 298) (J&K HC)
•
If the machinery is employed and kept ready for use, the depreciation is allowable even
though not actually put to use
‒ Capital Bus Service (P.) Ltd (123 ITR 404) (Delhi HC)
‒ CIT v. Premier Industries (India) Ltd (170 Taxman 407) (MP HC)
‒ However, there are certain contrary rulings as well wherein it was held that the word ‘used’
denotes actually used and not merely ready for use or mere preparations for use will not be
sufficient for claim of depreciation
•
9
•
Dineshkumar Gulabchand Agarwal (267 ITR 768) (Bom. HC)
•
Jivaji Rao Sugar Company (71 ITR 319) (MP HC)
Claim of depreciation is mandatory [w.e.f. Assessment year 2002-2003]
Deductible expenditure (3)
•
Depreciation on Intangible assets
‒ Intangible assets as contained in section 32(1)(ii) include know-how, patents,
copyrights, trademark, license, franchises or any other business or commercial rights
of similar nature. In view of section 32(1)(ii), it is vital to analyze,
•
Whether depreciation on goodwill is allowable?
‒ Amount paid for the goodwill was one for acquiring a business and commercial rights.
The same was comparable with trademark, franchise, copyright etc. and eligible for
depreciation
• B. Raveendran Pillai v. CIT (332 ITR 531) (Kerala HC)
• Hindustan Coca Cola Beverages Pvt. Ltd (ITA Nos.1391,1394,1396/2010) (Delhi
HC)
‒ Goodwill acquired does not come under the purview of any other business or
commercial rights of the nature similar to know-how, patents, copyrights, etc. or
depreciation is allowable on specified intangible assets mentioned in section 32(1)(ii)
• R. G. Keshwani (308 ITR 271) (Mum ITAT)
• Osram India (137 TTJ 749) (Delhi ITAT)
10
Deductible expenditure (4)
• Depreciation on Intangible assets
‒ Depreciation was allowable on the intangible assets, viz., business claims, business
information, skilled employees, etc., acquired under slump sale agreement though
classified as “goodwill” in the books of account of the tax payer
• Areva T & D India Ltd. and Jai Parabolic Spring Ltd.
• Whether payment made under non-compete agreement / right acquired by
assessee by payment of non-compete fee is eligible for depreciation?
‒ By making payment of non-compete fee, the assessee acquires a right in the nature of
business or a commercial right. Such rights are intangible ones and eligible for
depreciation under section 32(1)(ii)
• Serum Institute of India Ltd. (135 ITD 69) (Pune ITAT)
• Real Image Tech (P.) Ltd. (177 Taxman 80) (Chennai ITAT)
‒ Non compete fees does not have same genus to which know-how, patents, copy rights,
trademarks, licenses/franchises belong and expression 'any other business or
commercial rights of similar nature' would mean the right in the nature of know-how,
patents, copy-rights, trade-marks, licenses or franchises.
• Sharp Business Systems (133 ITD 275) (Delhi ITAT)
• Shreevatsan Surveyors (32 SOT 268) (Chennai ITAT)
11
Deductible expenditure (5)
• Section 36, prescribes following in respect of other specified deductions:
‒ Bonus or commission
• Amount paid to employees as production incentive in excess of statutory liability is
not a bonus within meaning of section 36(1)(ii). However, the same would fall for
consideration under section 37(1)
‒ Kasturi Mills Ltd (234 ITR 538) (Madras HC)
‒ Interest paid in respect of capital borrowed for the purpose of business
• As per section 2(28A), interest means interest payable in respect of money borrowed
and includes any service fees or charge in respect of such borrowings
• Proviso to section 36(1)(iii) states that, no deduction shall be allowed in respect of
interest paid for
‒ Acquisition of the asset for extension of existing business
‒ For a period beginning from the date on which the capital was borrowed till the
date on which such asset was first put to use,
• Borrowed fund advanced to a sister concern or subsidiary on account of commercial
expediency, shall be allowed as deduction under section 36(1)(iii)
‒ S.A. Builders (288 ITR 1) (SC)
‒ Tulip Star Hotels Ltd (CC 7138-7140/2012) (SC)
12
Deductible expenditure (6)
• Bad Debts
‒ Relevant factors for determining the nature of debt for allowability under section 36(1)(vii):
• Death of debtor without leaving any assets or bankruptcy of debtor
• Debt is statute barred
• Debtor is not traceable
• Negotiation efforts have failed and cost of litigation is too high
‒ The opinion of taxpayer that a debt is bad debt should suffice when there is a circumstance or
material to indicate reasonableness of the same
• Ahmedabad Electricity Co. Ltd. (262 ITR 97) (GUJ HC)
‒ With effect from 1-4.1989, it is not necessary to establish that debt has in fact become
irrecoverable, it is enough if the debt is written off as irrecoverable in the books of accounts
• TRF Ltd (323 ITR 397) (SC)
• Oman International Bank (184 Taxman 314) (BOM)
• Other Deductions- Section 37, prescribes following in respect of residual
deductions, such as:
‒ For claiming deduction under section 37, an expenditure should be:
‒ Revenue expenditure
‒ Incurred wholly and exclusively for purpose of business
‒ Incurred during the previous year
13
‒ Not of the nature described in section 30 to 36
Section 37(1) – General Positive and Negative Tests
• In view of various judicial pronouncements, general positive and negative tests for
allowance are as follows which contains, expense incurred,
Positive Tests
Negative Tests
14
•
•
•
•
•
•
•
•
Revenue in nature
For the purpose of business or to bring more profits
On account of commercial expediency
To save future losses
To ensure smooth operations and dividends
As a man of ordinary prudence
To fulfill civil obligation
With reasonability
•
•
•
•
•
•
For own philanthropic purposes
For gaining public goodwill
For illegal, immoral or corrupt purposes
To oblige a relative or for political purposes
In respect of bogus or sham transaction
For any of the purposes listed in positive tests with
personal objectives
Section 37(1) – General Deductions (1)
• Concept of ‘Commercial Expediency’ as laid down by legal precedents,
‒ Intention of the parties, the terms of agreement and surrounding circumstances are
relevant
‒ Must be judged from businessman’ s point of view and contemporary socio-economic
background
‒ Contractual obligation is not necessary
• Fundamental criteria coming from judicial decisions for distinction between capital and
revenue expenses are as follows,
Sr.No.
15
1
Particulars of Expenditure
Type of Expenditure
Bringing into existence asset or advantage of enduring
nature
Capital
2
Related to fixed capital
Capital
3
Related to circulating capital
Revenue
4
Initial business set up outlay
Capital
5
Operating or working capital
Revenue
Non-deductible expenditure (1)
• Disallowance of certain expenditure for non-deduction of tax
‒ Payment to non-residents- Section 40(a) (i)
• Non-deduction or non-payment of tax deducted at source (TDS) in respect of any
payment made on account of interest, royalty, fees for technical services or any other
sum chargeable under the act
‒ Payment to residents- Section 40(a) (ia)
• Non-deduction or non-payment of TDS in respect of any payment made on account
of interest, commission, brokerage, rent, royalty, fees for professional or technical
services and amount paid to a contractor.
• The time limit for payment of TDS has been extended up to due date for filing return
of income under section 139(1) irrespective of the month of deduction
‒ Introduced by Finance Act 2010, w.e.f. 1.4.2010
‒ Calcutta High Court in the case law of Virgin Creations (ITA No. 302/2007) held
that amendment as brought down in time limit for deposit of tax, is remedial and
clarificatory in nature, and the same could be applied retrospectively
16
Non-deductible expenditure (2)
• The amount disallowed under section 40(a)(i) or 40(a)(ia) shall be allowed during the
previous year in which the TDS has been paid
• In absence of Permanent Account Number (PAN), the TDS will be deducted at the rate
of 20% or the rates in force, whichever is higher
‒ Section 206AA (applicable from A.Y. 2010-11)
‒ Overriding to entire Income Tax Act
17
Non-deductible expenditure (3)
• Rationalising the disallowance provisions by Finance Act, 2012
‒ Payment of interest, commission, brokerage, professional fee, etc. to resident payees
is subject to TDS
• Non-deduction of tax results in disallowance of business expenditure
• Expenditure is allowed in the year in which tax is subsequently deducted and paid
‒ No disallowance will be made for non-deduction of tax if the recipient has:
• Furnished its return of income
• Taken into account such sum for computing income in the return
• Paid the tax due on income declared in the return
‒ Payer will not be deemed to be an assessee in default
• Interest payable by the payer for default in complying with TDS provisions
‒ Payer has to submit a certificate from an accountant in the prescribed form
•
18
Whether the above amendment can have retrospective application?
Non-deductible expenditure (4)
• Payment to related persons
‒ Disallowance shall be attracted in respect of payment of any expenditure to specified
persons, which is in excess of its fair market value
‒ Section has overriding effect to the other provision of the Act
‒ A proviso has been inserted to section 40A(2)(a) by Finance Act, 2012 (applicable from
1-4-2013)
• Expenditure covered within section 40A(2)(a) would be subject to rules of Specified
Domestic Transactions (SDT) as defined under section 92BA
• No disallowance if the transactions between the related parties are undertaken at
‘Arm’s Length’ price
• Thus, expenses or payments covered in section 40A(2)(a) would qualify as specified
domestic transaction (SDT) and the same would be subject to transfer pricing
provisions
‒ Definition of ‘related persons’ expanded by Finance Act, 2012
• In view of amendments, transactions between group companies would be required to
be reported
19
Non-deductible expenditure (5)
• Amendment enacted- “Specified Domestic Transactions” (SDT)
‒ SDT have been brought under the purview of Transfer Pricing Regulations with effect
from 1st April 2013 [i.e. FY 2012-13]
‒ Threshold limit for the applicability of TP Provisions to Specified Domestic Transaction
is INR 50 million
‒ SDT may be any allowance for Expense, Interest or Income
‒ Provisions relating to determination of Arm’s Length Price will be applicable to the
“Specified Domestic Transactions”
‒ Domestic transactions covered under new provision of 92 BA are :
• Which are not international transactions;
• Transactions covered under section 40A (2) (b)- Expenses/ Payment transactions
between related persons;
• Transfer of goods/ services/ business by the assessee covered under the beneficial
provisions of 80 IA or under Chapter VI A or 10 AA or 80A
‒ SDT described above will be subject to TP Compliance requirements including TP
Documentation, Certification and TP Litigation/ Penalty provisions.
20
Non-deductible expenditure (6)
• Section 43B prescribes the deduction of following expenditure only on actual payment
made on or before the due date mentioned under section 139(1):
‒ Tax, duty, cess or fee
‒ Employer contribution to the provident or superannuation or gratuity fund
‒ Bonus, commission or leave encashment paid to employees
‒ Interest payable to public/state financial institution or scheduled bank
• In respect of disallowance made under section 43B, deduction for the same will be
allowed during the previous year in which the payment has been made.
• The Calcutta high court held that Section 43B(f) on leave encashment is to be struck
down being arbitrary, unconscionable and de hors Apex Court decision in case of Bharat
Earth Movers v. CIT (245 ITR 428)
‒ Exide Industries Limited (164 Taxman 9) (Calcutta HC)
‒ However, the department has filed an SLP with the Supreme Court (SC) against the
order of Calcutta High Court
21
Profit chargeable to tax
•
Section 41, prescribes following profits chargeable to tax on account of :
‒ Any benefits accruing in respect to loss, expenditure or trading liability allowed as
deduction in the previous years
‒ Profits accruing from sale of capital assets used in in-house research facility
‒ Proceeds from debts claimed as bad debts in the previous years
•
Whether time-barred debts are covered under section 41?
‒ The liability ceases only when it has become barred by limitation and the assessee
has unequivocally expressed its intention not to honour the liability even when
demanded.
• CIT v. Chase Bright Steel Ltd. (No. 2) (177 ITR 128) (Bombay HC)
• Liquidator, Mysore Agencies (P.) Ltd. (14 ITR 853) (Karnataka HC)
Under DTC, remission of any liability is treated as income and absence of transactions
with the creditor for five years to be deemed remission
22
Analysis of current issues
23
Expenditure incurred in relation to income not
includible in total income – Section 14A
• Background and Section Summary
‒ Introduced in A.Y. 2001-02 with retrospective effect from 1st April, 1962
‒ Prior to its introduction, no taxes were paid in respect of exempt income, while
expense incurred to earn such income were claimed as deduction
• The above treatment was based on the principle that, if Income derived from various
ventures is earned in course of one and indivisible business, entire expenditure would
be permissible deduction even though part of income was exempt
‒ Rajasthan State Warehousing (242 ITR 450) (SC)
‒ Retrospective application of Section 14A is not permitted in cases of re-assessments
under section 147 or 154 pertaining to A.Y. 2001-02 or prior years
‒ Further, provisions of section 14A(2) and 14A(3) empowers the Assessing Officer to
determine the amount of expenditure incurred in relation to such income as per Rule
8D
• Rule 8D applicable with effect from A.Y. 2008-09
24
Section 14A – Principles laid down by recent judicial
pronouncements (1)
• Godrej & Boyce Mfg. Co. Ltd. (328 ITR 81) (2010) (Bom HC)
‒ Section 14A and Rule 8D are constitutionally valid
• Proximate relationship required between expenditure and exempt income to invoke
disallowance
• Rule 8D will apply from AY 2008-09. For earlier years, the tax authority has to apply
reasonable method for quantifying section 14A expenditure
• Rule 8D cannot be invoked mechanically by the Tax Authority
• The co-ordinate bench decision in Godrej & Boyce was binding on ITAT, despite IT
Department's SLP in SC.
25
Section 14A – Principles laid down by recent judicial
pronouncements (2)
• Whether disallowance u/s 14A be made for dividend earned on shares held as
stock in trade?
‒ In the case of Daga Capital (117 ITD 169) Mumbai Tribunal (SB), it was held that
disallowance under section 14A shall be made in respect of dividend income earned
on shares held as stock in trade
‒ Contrary decisions also exist wherein it was held that no such disallowance can be
made for in respect of dividend income on shares held as stock in trade
• Avshesh Mercantile Pvt Ltd (ITA No. 5779/2006) (Mum ITAT)
• CCI Ltd. V JCIT (ITA No. 359 of 2011) (Karnataka HC)
• Is it correct to apply the provisions of section 14A where assessee has sufficient
interest free funds to make investments?
‒ Where there are interest free funds available to an assessee to meet its investments
then provisions of section 14A could not be applied even if at the same time the
assessee had raised a loan on which interest payments were made
‒ Reliance Utilities and Power Limited (ITA Nos. 1389/2008) (Bombay HC)
26
Section 14A – Principles laid down by recent judicial
pronouncements (3)
• Is it correct to apply the provisions of Rule 8D without considering the claim made
by assessee in offering disallowance under section 14A?
‒ It is incorrect on the part of the Assessing Officer (AO) to proceed on the premise, as if
the disallowance as per Rule 8D is automatic, irrespective of the genuineness of the
assessee’s claim
• Auchtel Product Ltd (ITA Nos. 3183,2649,3185/ 2011) (Mum ITAT)
• Whether provisions of section 14A is applicable in respect of deductions?
‒ Disallowance u/s 14A is not applicable for deductions u/s 10AA and 80IAB as Sec
10AA is a ‘deduction’ provision and not an ‘exemption’ provision
• Meditap Specialities Pvt Ltd (ITA No.6835/2010) (Mumbai Tribunal)
• Whether provisions of section 14A is applicable in respect of loss?
‒ Section 14A of the Act is applicable in respect of 'expenditure'. Loss is different from
expenditure and hence provisions of section 14A are not applicable in respect of loss
• Navin Bharat Industries Ltd. (90 ITD 1) (Mumbai Tribunal)
• Mindtree Consulting Pvt. Ltd. (102 TTJ 691) (Bangalore Tribunal)
27
Section 14A – Principles laid down by recent judicial
pronouncements (4)
• Whether provisions of Section 14A are applicable to insurance companies?
‒ Delhi bench of ITAT held that Sec 14A was not applicable to insurance companies
‒ The income of the insurance companies had to be computed u/s 44 read with Rule 5
of the First Schedule to Income Tax Act, which requires no head-wise bifurcation of
income and it is a specific provision overriding Sec 14A
• Oriental Insurance Co. (130 TTJ 388) (Delhi ITAT)
• Whether provisions of Section 14A are applicable to shipping companies which is
subject to tonnage tax?
‒ Sec. 14A was not applicable to a shipping company which is subject to tonnage tax.
• Varun Shipping Company Ltd (134 ITD 339) (Mum ITAT)
• Whether provisions of section 14A be made applicable in respect of share of profit
from partnership firm?
‒ Sec. 14A disallowance is applicable to partners’ share in the firm’s profit, which is
exempt u/s 10(2A)
‒ ITAT held that a partnership firm is not a pass through vehicle and the firm and
partners are separately assessable to tax, despite the position of law under the
Partnership Act
• Vishnu Anant Mahajan (ITA No.3002/Ahd/2009) (Ahmedabad Tribunal)
28
Section 43A – Exchange Fluctuation
• Woodward Governor India (179 Taxman 326) (SC)
‒ Computing taxable profits based on the commercial accounting principles and
accounting method regularly followed by the assesse;
‒ The expression “expenditure” as used in section 37 of the Act covers “loss” in the
circumstances of a particular case;
‒ losses arising on account of restatement of the foreign currency liability taken on
revenue account are deductible;
‒ the provisions of section 43A of the Act as amended w.e.f. 1-4-2003 cannot be
regarded as retrospective in nature
29
Minimum Alternate Tax (MAT)
•
Provisions of MAT contained Section 115JB, introduced by Finance Act 2000 – Currently
Provides for levy of tax on book profits at 18.5% plus applicable SC and EC
•
Applicable in case of an assessee being a company
•
P&L account to be prepared in accordance with Sch.VI of Companies Act
•
Book profit to be computed after making adjustments as envisaged under explanation to
Section 115JB
•
Comparison of tax on total income with 18.5% of book profit
•
Credit in respect of MAT paid shall be allowed in the year when tax becomes payable
under normal provisions of the Act
•
Credit allowed to be carried forward for up to 10 succeeding assessment years
•
Accounting policies/ standards, depreciation rate/method adopted for statutory closing
to be followed
•
Provision for doubtful debts / diminution in value of assets
‒ By virtue of amendment by Finance Act 2009 (applicable retrospectively from 1-42001) the amount set aside as provision for bad and doubtful debt has to be added
back in computing the book profit
30
Tax Residency Certificate (TRC)
• Amendment by Finance Act, 2012
‒ Sections 90 and 90A of the Income tax Act, 1961 were amended, requiring every nonresident to produce a TRC (with effect from A.Y. 2013-2014)
‒ Certificate is necessary but not sufficient condition for benefiting from DTAAs
• Application format or particulars required for obtaining TRC
‒ Currently, the format and particulars are yet to be prescribed
‒ In this context, practice adopted in US and UK could be instructive
• Analysis on Current position
‒ Non-resident assessee would have to adopt wait and watch approach
‒ A question arises what if TRC was obtained post-transaction — will the certificate
validate the benefit of treaty?
‒ Need for clear guidelines and flexibility in the format exists
31
Scope of coverage of royalty widened
• Clarification that transfer of rights for use / right to use computer software (including
granting of a license) is in the nature of royalty
‒ In line with judgment of the Karnataka High Court in the case of Samsung
‒ Not in line with international principles
• Clarification that royalty includes consideration in respect of right, property or information,
whether or not: (1) possession is with the payer; or (2) used directly by the payer; or (3)
location is in India
• Clarification that ‘process’ includes transmission by satellite, cable, optic fibre or by any
other similar technology, whether or not such process is secret
• Retrospective amendment from 1 June 1976
‒ Attempt to overcome contrary judicial pronouncements of the Delhi High Court in the
cases of Ericsson and Asia Satellite and in other cases
Possible to argue that payments not taxable under the treaty?
32
Taxation of Limited Liability
Partnership (LLP)
33
LLP – Basics
• As the name suggests, LLP is a partnership wherein partners have limited liabilities to
the extent of contribution made by that partner
• An entity with 'hybrid' features
• LLP created either by:
‒ Registering as a new LLP; or
‒ Converting an existing partnership firm or an existing private or unlisted company
• LLP combines the features of a Company and a Partnership firm
• Taxation of LLP kept at par with 'general partnership' (firm)
• Vide Finance Act, 2011, AMT has been levied on LLPs @ 18.5% (plus cess) (Applicable
from 1 April 2011)
• Tax credit can be carried forward for 10 years
‒ To be set off to the extent of difference between regular tax and AMT
• May not qualify for tax holiday/incentive provisions which are restricted to company
‒ E.g. Section 80IA
34
LLP – Taxation
• Tax neutrality for merger /demerger, apply only when companies are parties to the
reorganization
‒ Conversion of private/ unlisted company into LLP will be tax neutral for:
• Company i.e. no capital gains on transfer of assets
• Shareholders i.e. no capital gains on transfer of shares
‒ On fulfillment of following conditions listed under section 47 (xiiib)
• Assets and liabilities before and after conversion remains the same
• Shareholders of the company become partners in LLP and profit sharing ratio is
corresponding to their previous shareholding in the company
• Shareholders of the company do not receive any consideration or benefit other than
share in LLP
• Aggregate of the profit sharing ratio of the shareholders of the company in LLP shall
not be less than fifty per cent at any time during the period of five years from the
date of conversion;
• the total sales or turnover in the business of the company in any of the three
previous years preceding the previous year in which the conversion takes place
does not exceed sixty lakh rupees; and
• no amount is paid for a period of 3 years to any partner out of balance of
accumulated profit in the accounts of the company on the date of conversion
35
LLP – Comparative Analysis
Particulars
General partnership
LLP
30.9%
30.9%
MAT (Whether applicable)
No
Yes (Effective rate of MAT
is 19.06%)
Yes (Effective rate of MAT
is 20%)
DDT (Whether
applicable)
No
No
Yes (Effective rate of DDT
is 16.22%)
Exempt
Exempt
Exempt (provided DDT is
paid on dividends)
Not Applicable
Not Applicable
Applicable
Basis of accounting
May opt for Cash Basis
May opt for Cash Basis
Only on Mercantile basis
Deemed Dividend
Loan by firm to partners
not taxable as deemed
dividend in his hands
Loan by LLP to partners
not taxable as deemed
dividend in his hands
Loan/ advanced by
company to shareholders
might be construed as
deemed dividend
Effective rate of tax
Tax treatment of
dividends/ profit share in
the hands of partners/
members
Wealth Tax
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Private Company
30.9% (Where total
income exceeds Rs 1
crore then 32.45%)
Widening of tax base – Alternate Minimum Tax (AMT)
• Amendment introduced in existing provisions of section 115JC contained in Chapter XIIBA of the Income Tax Act
• Amendment proposed to be made effective from A.Y. 2013-2014
• Scope of levy of AMT (@ 18.5%) extended to all persons other than companies (earlier
applicable only to Limited Liability Partnerships)
• AMT levy not applicable to specified persons, if Adjusted Total Income of such person
does not exceed twenty lakh rupees
• It is also provided that the credit for tax (tax credit) paid by a person on account of AMT
under Chapter XII-BA shall be allowed to the extent of the excess of the AMT paid over
the regular income-tax
• This tax credit shall be allowed to be carried forward up to the tenth assessment year
immediately succeeding the assessment year for which such credit becomes allowable
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Proposed General Anti
Avoidance Rules (GAAR)
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GAAR – Proposed Amendments
(to be applicable from 1.4.2013)
Impermissible
arrangement
Objective of obtaining
tax benefit (including
intangible benefits)
Arrangement
Creates rights and
obligations not normally
created in arm’s length
transactions
Results in direct or indirect
misuse or abuse of the
provisions
Lacks or is deemed to lack
commercial substance in
whole or part
Is not bonafide
Consequences
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Disregarding, combining
or re-characterising the
whole or part of the
arrangement
Treating the arrangement
as if it has not been
entered into
Disregarding any party or
treating parties as one and
the same person
Deeming connected
persons to be one
Reallocating any income /
receipt and expenditure /
deduction
Determining the place of
residence or situs of asset
or transaction
Disregarding any
corporate structure
Treatment of equity as
debt and vice versa
GAAR – Draft guidelines on implementation
Proposal for inclusion in guidelines on GAAR
• GAAR provisions shall apply to income accruing or arising to taxpayers on or after 1 April
2013.
• Prescribed guidelines
‒ A monetary threshold in relation to a tax benefit for invoking the GAAR
‒ To ensure principles of natural justice, statutory forms for reference by the tax
authorities for invoking GAAR have been recommended.
‒ Time limits for taking various actions under GAAR to be put in place
• Recommendations for Circular on GAAR
‒ A detailed note on GAAR
‒ GAAR would not apply to Foreign Institutional Investors (FIIs), if they do not avail of tax
treaty benefits. In any case GAAR provisions would not be invoked in the case of nonresident investors of the FII.
‒ Where a Specific Anti-Avoidance Rule (SAAR) is applicable, GAAR will not be invoked.
‒ GAAR would apply to transactions between related parties (as defined in transfer
pricing provisions) as well as transactions between relatives.
‒ Where only a part of the arrangement is impermissible, GAAR would apply to only that
part of the arrangement.
• Several examples in the draft circular has been laid out where GAAR could or could not
be invoked
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Open house …
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