The Finance Bill, [2018] 401 ITR (St.) 36, has been analysed by various Senior Advocates and Chartered Accountants. Some of the important amendments, points, and the views of the speakers have been summarised for the benefit of tax professionals and readers, as under:

Clause 3 & Clause 38 : Section 2(22) & Section 115-O : Deemed Dividend and Tax on distributed profits of Domestic Companies :

S. E. Dastur, Senior Advocate :

With regard to S.2(22)(e) which treats as dividend any loan or advance made by a company to a shareholder who beneficially holds 10% of the share capital of the company. Up till now such amount which was regarded as dividend was assessable in the hands of the recipient. And the company who advanced the loan did not have to pay DDT in respect of that. It had to pay DDT for all other dividends but not this. Now for some reason, it is provided that the individual will not have to pay tax on this amount but the company must pay DDT on it @ 30%. So even if you advanced a loan of 5L, the company will have to pay tax @30%. Leave aside equities about it. Now as I said earlier, this provision would come into play if the loan is given to a person who holds 10% of the beneficially holds 10% of the share capital of the closely held company. Now Mr. A is a shareholder, B, C and D who are also shareholders are his benamidars and assuming that it is permitted under the benami act, it does not fall foul of it. Now if A, B, C and D hold more than 10% then the company will have to deduct tax from that. But how will the company know whether B, C and D are nominees of A? The company is to pay tax when a loan is given to a person who beneficially holds 10%. But there is no mechanism for the company to know that B, C and D are nominees. So the company would say I am not at fault, how do I deduct tax if I don’t know that A does not hold 10% but holds 8% but B, C and D hold 8 % each, so in effect, he holds 32%. How will the company know whether it is a nominee. If the company does not know, even the declaration under the companies act will not apply, so if the company does not know this, then you can’t hold the company responsible. The individual shareholder will say, now I am no longer responsible for paying tax on dividend u/s 2(22)(e). So you may end up with a situation where the individual is not liable and the company pleads correctly that is no way in which I can implement this so you cannot penalise me. Now this again shows how provision is made from imposing liability @30% without having regard to the implementation of the provision. So this provision which is there, it is overenthusiastic provision. The amendment has been made and this is what the provision says, how do they justify it in the explanatory memorandum that it has been made to bring clarity and certainty. What is the clarity? In fact you are introducing uncertainty. So what is the certainty that you are bringing. So words are being used to justify in being rational, in being, to make it apparent, transparent, etc, etc. nut words must have some meaning, and if they don’t, and you don’t adhere to such meaning, it makes no sense.

Saurabh N. Soparkar, Senior Advocate :

Now, the proposal is, the liability to pay tax would be shifted from the recipient from the dividend to the distributor of the dividend in the form of loans & advance namely the company. So like all other dividend distribution tax- regular dividend distribution tax u/s 115O – saying that this provision would not apply to deemed dividend u/s 2(22)(e) now, that exception is withdrawn & therefore whenever a company gives loans or advance which is to be treated as deemed dividend u/s 2(22)(e) the proposal is company shall pay tax before distributing the amount of loan or advance @ 30% flat. So now there is no differing rate there is a flat rate @ 30%. Only thing differentiation is normal dividend distribution is 15% which continues to be @ 15% & normal dividend distribution tax on being given @ 15% is to be grossed up in the hands of the company and this 30% is not required to be grossed up. So loans and advances not to be taxed on the hands of the recipient shareholder but in the hands of giver company @ 30% flat without grossing up but at net basis.

Further, dividend that is received from equity oriented mutual fund now before such mutual fund will distribute dividend that such mutual fund will also have to deduct that tax @ 10% so now the mutual fund is taxable now, not in the hand of the shareholder. Taxable at the hand at the mutual fund & will have to pay tax @ 10%, sec 115R is appropriately being amended. These are the amendments in the field of dividend.

Bansi S. Mehta, Chartered Accountant :

There is an extended division of dividend u/s 2(22). It’s inclusive of a lot of things like amount capital deduction, distribution of dividends, advancing of loans but all of these are governed by one common factor this is accumulated profits. Now if there is no accumulated profits the deemed dividend does not apply. There is a provision if there is an amalgamation, the profits of the amalgamating company will also be considered for finding out what are the accumulated profits of the merged entity. The first thing is that to incorporate the effect of merger, in incorporating the effect of the merger the guidance note which Mr. Malegham prepared, treatment of reserves in amalgamation which is now incorporated in an Accounting Standard. However in many cases the reserves lose their identity because of the losses of the transferee company (cause you set off, one against another) however according to a famous legal term: once a mortgage always a mortgage, similarly if you say that there are profits then those profits must be considered even though there are no physically no profits continuing. As far as amalgamation is concerned, if you think someone is doing an aggressive tax planning, you have the NCLT. NCLT has to keep an open mind and give effect to it. This is what Gujarat High Court held in Wood Polymer Ltd., In re [1977] 109 ITR 177 (Guj.) (HC), “if a court is satisfied, that the amalgamation sold or dominant objective was to gain a tax advantage then it is the duty of the court to reject this case” to say that no we will take the amalgamating companies accumulated profits is not workable. It is true as explanatory statement states that they have noticed that somebody devised the scheme which you first converted the reserves into share capital through amalgamation thereafter the loan was given & the tribunal in the case of ACIT v. Gautam Sarabhai Trust No. 23 [2002] 81 ITD 677 (Ahmadabad), upheld the SC contention that there are no accumulated profits because they are all being converted into share capital & the attempt of the proposed amendment is to do away with this tribunal decision.

However, there are several problems with that to give effect to an amalgamation you have to follow the accounting principles, & sometimes even the scheme itself provides the manner of treating the assets, liabilities, reserves etc. so you’re giving effect to a judicial order. Now how will you able to keep track after 5 years and 6 years what are the profits of the amalgamating company. There is an amendment to this effect.

Dr. Girish Ahuja, Chartered Accountant :

S.2(22)(e) i.e. deemed dividend is known by all. Taxable in the hands of the Assessee. A notice was also sent to the company for non-deduction of TDS. Now, an amendment has been brought i.e. if any advance or loan has been given by a closely held company, to a shareholder holding more than 10% voting power, or to a concern in which such shareholder holds 20% or more voting power, then the amount of loan or advance would be treated as deemed dividend and the company would have to pay the tax. The rate of tax is 30% without grossing. DDT is around 20.3% but in this case, a tax of 30% has to be given by the company. The day on which the dividend has been distributed, the DDT has to be paid within a period of 14 days from the date of distribution of such dividend u/s. 115O. A circular has also been released that if such loan or advance is proved to be a business advance or a business loan then such deeming provision would not take effect i.e. no tax @30% needs to be paid. The difficulty which would arise is, in Form 3CD under item no. 36, a declaration has to be given as to details w.r.t. 115-O, how much dividend has been deposited and what is the time limit. Now the dispute would be whether such a loan or advance would be a business loan or business advance? Even though there is a ruling of the Supreme Court that tax must be paid, the question would arise that how can a company pay the tax since it cannot be considered as a shareholder. Now everyone is caught in this net. I suggest and advice that no closely held company should try to give any loan or advance, even if such loan or advance is being repaid the next day, it shall still be treated as deemed dividend. Even if interest is charged, even that will be considered as deemed dividend. Now no closely held company can give any loan or advance. Only those companies may be able to give a loan or an advance, which does not have any accumulated profit at all. If there exists accumulated profits, then the loan or advance to the extent of the Accumulated profits exclusive of the capitalised profit, will be liable for DDT at the rate of 30%. Alternatives could be, show a loan first and as a repayment of loan, such payment can be made or some money is already due and payment is against such due, then there should not be a problem. But if there is nothing outstanding, then even one rupee of a loan, can be considered as a deemed dividend to the extent of the Accumulated Profits and tax could be levied.

Clause 4 : Section 9 : Income Deemed to Accrue or Arise in India :

S. E. Dastur, Senior Advocate:

Presently, income from business connection is deemed to accrue in India if the business connection springs from an activity carried on by a non-resident through a person who has authority and habitually exercises authority in India to control contracts on behalf of the non-resident. Unless such activity is confined to purchase of goods in India. That is the scope of business in India. Now it is widened. Even if the person doesn’t have such authority, but habitually controls contracts on behalf of the non-resident or even habitually plays a principal’s role leading to the conclusion of the contracts by the non-residents, it would be regarded as business connection. So, one looks at whether a person has habitually exercised this right, not whether he has the power to exercise such power or not. And provided of course, the contracts are in the name of the Non-resident or for the transfer of ownership of Goods or property belonging to the non-resident or for the grant of the right to use the property which the non-resident has the right to use. For example, the non-resident has tenancy in India and it gives the right to use the property to someone else, it may be regarded as giving a right to use the property of which the non-resident is possessed of. A contract of performance of services by the non-resident, even though the services are performed from outside India is also taken into the scope of business connection. The exception that there would be no business connection where goods are purchased for export or to promote purchase in India is removed. So therefore now, even if goods are purchased in India for a non-resident, it may result in a business connection and a liability in the hands of the non-resident. Not only the action but significant economic presence of the non-resident in India now results in the non-resident having a business connection. What is meant by significance economic presence? It is defined as including transactions in respect of goods, services to property carried out by the non-resident if the aggregate claimant arising therefrom exceeds a limit which is to be prescribed. So that will be regarded as significance presence of the non-resident. Further the transaction in question would include provision of download of data or software in India. Significant economic presence also includes systematic and continuous soliciting of business or engaging in interaction with such number of users as through digital means, as may be prescribed. Now, how will you determine the number of persons who have been contacted through digital means, I don’t know but this is what is stated in the Act. And how it cannot be disputed. Is it so that you will summon that person, I have never contacted him. So therefore I think persons who draft there amendments should also take into account the consequence and what it will result into. It is extremely vague and litigation prone, which is of course to the benefit of all of you and all lawyers. The first proviso says that a non-resident can have significant economic presence in India even though he does not have a residence or place of business in India. Obviously, if he has a place of business in India, he would have presence in India and he would have been chargeable, but, this is what is provided. These amendment have been made, the reason which has been provided is important. Reason – To bring in line the provision of the Act with the widening scope now prevailing under the DTAA as per BEPS Plan 7 and Multilateral conventions to implement tax treaty related measures. So, you are trying to bring the Act, bring into the Act, the provision of DTAA which are against the assessee. Here thereto the philosophy has always been that the act is paramount and DTYAA is subsidiary. S.90(2) brings that up that nothing in the DTAA, which is contrary, shall affect the Act. Now you are amending it, that is the Act, to make it compliant with DTAA requirements overlooking that the DTAA requirements may not apply if the other party, if the country of the other party has not accepted this. So therefore, it may be you are introducing an amendment in the Act which will affect the assessee even though, the DTAA, which you are following, may not be applicable in third case because the other party in Singapore or Mauritius has not accepted that amendment. So, I think, it’s a bit topsy tervy, as to, what is paramount, the Act or the DTAA? I would think it has to be the Act and the DTAA has to be tuned to be in line with the Act if at all and give some concessions but not the other way round. “Jack’s greed knows no limits, and that is the only reason I can give for this but Jack’s greed sometimes overlook the consequence of greed is indigestive”. So again I think, incorporating into the act what is in the DTAA, adverse to an assessee, is not the best philosophy.

Saurabh N. Soparkar, Senior Advocate :

If there is a foreign company, or a foreign partnership firm, which has some business in India, now how do you conduct a business-if you conduct it through an agent, who is an independent agent, & there is no permanent establishment over here, there is no need to pay any tax. You have to pay tax only if you are doing a business through a dependant agent. And in that your dependant agent will be your P.E, depending upon the services rendered through that dependant agent, the foreign entity will have to pay tax.

This provision is in the model double taxation avoidance treaty under which there is a definition of P.E. (Permanent Establishment) & this model is followed by all the countries, the provision is- a foreign country has a P.E in another country if & only if the agent over there is an dependant agent. A dependent agent who is carrying out negotiation for & in the name of non- resident principal & he has authority to conclude contract on behalf of the non-resident. In other words, taking a situation, tomorrow a U.S company, wants to set up something in India, it appoints Mr. X as an agent if Mr. x only has only a right to discuss, find out & explore the possibilities & report back to the principal about the scenario, then there is no P.E in India, and there is no income attributable to that foreign entity. But if that local agent has the right to do business in the name of that foreign entity, right to conclude & negotiate business, it will be assumed that the foreign entity has a P. E in India & tax will have to be paid by that foreign entity on that part of the income which is attributable to Indian operations.

Internationally, it was found that this definition of dependent agent was being misused because dependant agent is defined to recollect as a person who has authority to negotiate, conclude contract. What was being found was that companies were internationally appointing agents in other countries, the rights would have the right to negotiate, & just before the negotiation is going to result into conclusion of contract, the agent will walk out. He will not be there for the purpose of concluding the contract. The person negotiation and the person concluding the contract would be 2 different people. It was found that by splitting the activity more than once, they were able to get out of the definition of P.E internationally. To this, the Org. of all countries, gave a serious thought to it, & in its Base Erosion & profit shifting (BEPS) action plan No. 7, it recommended modification of Article 5, Para 5, so as to expand the scope whereby it was proposed, that if a person is appointed by a foreign entity as an agent in another country, who habitually either concludes contract or who habitually plays principal role relating to conclusion of contract, , he may not conclude but he may play a principal role in the matter of conclusion of contracts in the name of non- resident. Then even that agent who is not concluding the contract, who is playing primary /preliminary part for the purpose of concluding the contract even that part is considered P.E of that non-resident & income would be to the extent to his services taxable in the source country. Looking @ the BEPS recommendation there is a multilateral convention to implement tax treaties related measures, a policy document signed by all governments, that if we make a change in this policy document, the said change will be applicable to all mutually accepting countries, India is a party to it, by signing the document as a result which under international law as applicable by the treaty by signing the document, the treaty automatically gets modified. We all know that between treaty &domestic law whatever is more beneficial to the assessee’s is to be preferred. Here is the situation where, treaties with various countries by virtue of this indirect method, are amended & not only an agent that actually concludes the contract but even an agent who principally takes part of the conclusion, in the earlier stages is also considered as P.E. that is the provision under treaty. under domestic law we still have the old law. In order to bring domestic law in par with international law, domestic law is being narrowed against the assessee or broadened in favour of revenue. Now the amendment is in the same lines of which treaty are being amended namely if you have an agent of foreign entity sitting in India who may have no right to conclude negotiations to enter into contract but who plays principal role in the matter of negotiation which would result into conclusion of contract then a foreign entity has a P.E. in India, the tax would have to be paid in India. Question would arise what is the principal role? That is all matter of facts of each case to be interpreted, it’ll be decided by the courts of law. Whether the role is principal or supplementary or major or minor. One thing What’s proposed is, to expand the scope of levy of tax or the persons connected with foreign entities, either it may have not been a P.E but now it will be regarded as a P.E of a foreign country.

Dr. Girish Ahuja, Chartered Accountant:

An inclusive definition in S.9 has been given for business connection. Till now, if you have a business connection in India, it would be taxable in India. It says, if a person has and habitually exercises the authority to conclude contracts on behalf of Non-resident, it will be treated as having PE in India or having business connection India. Now what has been changed is, if he has or habitually has the authority to exercise a concluded contract and concludes contract and plays an important role which leads to conclusion of contract on behalf of the non-resident. So even if he plays an important role, which leads to conclusion of contract, it will lead to permanent establishment in India. According to him, this tinkering in the section has been rightly done since people are concluding the contracts but they are showing that they are not concluding contracts. It is being shown that they are concluding the contracts by the non-residents there and they are not paying the taxes here. But if you play a vital role or an important role in the conclusion of the contracts which leads to the conclusion of the contracts, that will also be treated as a Business Connection in India. The last time, e-commerce had been introduced, saying that we had introduced an equalization levy on electronic advertisement. Now here, we have a concept of e-commerce where people are doing business but their location is not known. A lot of business is being provided but the person who is providing, their location is not known not their place of residence and how to tax such a person. A similar concept had also been brought into BEPS i.e. Base Erosion Profit Shifting, where this concept of e-commerce was taken. This time, they have inserted an explanation saying that if there is economic presence in India to a certain in India to a certain amount, a certain economic physical presence in India, that will also be considered as economic physical presence. We are not talking about Actual Physical presence, but only economic physical presence exceeding a certain amount to be specified, then it will also be considered as business connection in India which means it would be taxed in India.

Clause 5(b)(ii) : Section 10(23C) : Exemption from tax in respect of certain funds :

S.E. Dastur, Senior Advocate :

S. 10(23C) grants exemption from tax in respect of certain funds universities, hospitals, etc. The proviso lays down conditions to be fulfilled to avail of the exemption. For example; the prescribed portion of the income has to be applied for the purposes for which the fund is formed. Now it is provided that if a payment has been made in cash for achieving the objects of more than 10,000 on a day, that will not be regarded as an application. Similarly, if you have to determine the prescribed percentage has been made, disallows 30% of the sum paid to a resident if tax is not deducted at source. So therefore, say if a hospital or an educational institution pays to a doctor or to a teacher an amount without deducting at source, and that will not be regarded as application of income. But only 70% of income will be regarded as application of income. So if you spend 100, only 70 will be regarded as application, if you do not fulfil the requirement of application, you may not get exemption u/s. 10(23C). Now what happens is, the fund makes a payment to a doctor or to a teacher without deducting tax, pays 100, only 70 will be regarded as application. Now if you are aware, if you omit to deduct tax at source, the revenue can demand that amount from u, if the recipient has not paid tax. So, supposing the doctor does not pay tax and the revenue demands that amount from u, you will again have to pay and question will arise, will that payment be regarded as application for the purposes of the fund or will they say, no no, this is not application for the purposes of your fund, this is to make good the default in non-deducting taxes. So therefore, even though ultimately, you pay 70 today, you pay 100, don’t deduct tax, only 70 will be regarded as application, if subsequently you pay the 30, you will not get the benefit of application. Now this has to be thought through that can you impose something like that. It’s very good to say that I will collect more money, but you have to be realistic. You have to consider, what are the other possibilities which may arise and whether it will because unnecessary hardships to the assessee. Then it is provided that in the section that provisions of 41A and 43 will be applied mutatis mutandis. Now I think it would be much better if you specify exactly what you mean because it is again very vague and may raise several issues which will have to be decided. The new provision speaks of provisions of S.40 applying mutatis mutandis done will be better now.

Clause 6 : Section 11(1) : Income from property held for Charitable or Religious purposes :

S. E. Dastur, Senior Advocate :

An amendment similar to that of 10(23C) also applies in the case of exemptions claimed by a charitable trust because u/s. 11, application for charitable purposes has to be at least 85% of the income unless you accumulate for future application following the prescribed procedure. Then an interesting point which arises in connection with the provision for S.11 application. S.80 of the income tax act says that if you have, you are a charitable trust, if you incur, if you want to set off any capital loss in the future you will have to file the return of income in time and the loss will have to be determined. Now what happens, you file a return disclosing your professional income and a capital loss. The officer accepts your income, does not determine the loss. The section requires, S.80, that the loss must be determined. Does it mean, it is impliedly determined by not upsetting something in the return or do you then have to file an appeal and the only ground being, direct the officer to determine the loss. Or make an application for mistake apparent from the record. So again here in 80, using the word determined, nobody has raised this issue until now, but using the word determined, may prevent an assessee from giving credit for losses which is already incurred.

Saurabh N. Soparkar, Senior Advocate :

Income Registered u/s 10(23C) or Sec. 11 is not required to pay tax under normal provisions of law , essentially paying tax on receipt versus payment, all payments are taxable as well as deductible. In relation to payments, no restriction as to what kind of payments was allowed. The Government found that a large number of charitable trusts & 10(23C) institutions, are either making payment in cash in excess of 20,000 or they are not deducting tax in source before making the payment. These trusts are brought at par with a businessman who would attract disallowance u/s. 40A(3) & 40(a)(ia) respectively. So now it will be regarded as not being applied at charitable purposes, unless you fall in that 15% criteria on that amount you will have to pay tax.

Bansi S. Mehta, Chartered Accountant :

Unfortunately, if you see or analyse, what are the amendments, S.11 will win hand thumb. Almost in every financial year, an amendment has been made in Section 11. Now there are 2 broad comments that every time you make an amendment concerning a charity trust, you are affecting to the trusties, you are affecting those who benefit from the charity trust, so you are affecting the community. But I can understand that there was something which was, let’s say, in terms of equity, wrong, or Govt. is entitled to modify. But what they have done is something very curious. Basic Point: They are 3 different occasions/tiers – First is when the income is earned, second is when the income is applied and the third is when the income is accumulated. There are 3 stages. Now the law provides that if the charity trust applies on the objects of the trust and accumulates upto 15%, then it will enjoy exemption. In simple language, that the provision of S.11. Now , somehow or the other, the FM believes that he would like to incorporate disallowance provision of the income tax act in computing the charity trust income. Disallowance provisions by 2 grounds i.e. one is when payment is not made via account payee cheque and the other is that no tax is deducted at source. Now I am not able to understand that how this amendment will be made applicable. Now as I said, o1st stage is income. There are several judgements and board’s circulars which state, that income much be income as commercially understood. It is not computed under Income tax act, but it is computed under commercial principles. The second is applied. Now application something like in corporate entity like appropriation. Something which is applied on the objects of the trust is called as application. The third is the net result which is accumulated. Now which is the stage in which there could be some relevance for examining whether an expense is allowable or not allowable. On the first, there is no relevance, because, income has to be understood in the commercial sense, it’s not total income, the boards own instruction says that it would be commercial income. There is not stage for allowing or disallowing, it can only be at the time of application, that is when income is applied, first is if tax is not deducted or not deducted, if tax is deductible. The second thing is when it is paid otherwise in my payee’s account cheque, according to the amendment, it would be disallowed. Disallowed from being considered as Application. We use charities to supplement what the government has done or what it’s not done & it’s best to leave charities open. If it’s found that somebody is misusing the charitable funds for purposes which are not covered by the objects by all means hang them up. But you cannot affect charity trust because you want to collect some taxes. Historically, both under the Income tax act 1922 & 1961, charity has been exempted because they are doing something itself what the government wants to do, to do public good. But there is a provision, a proposal- unsure about how it will work- because only at the stage of application. The limit for cash payment is 10,000 (eg- somebody has to make a payment to a person who has to make a payment to the hospital- without which he will not receive a discharge. & it comes up to 1,50,000. The law says that have to pay by payees Account check. – your diluting charity. Not enhancing it.

Suppose a person is poor- and has to pay for his son’s education – charity trust gives an amount it’s not taxable and there is no concept of deducting taxes. What they are mixing up is- when you pay salary to your staff and your not deducted it will not be considered. But that is not in application its computing commercial problem the amendment is confines to Application. So to that extent the amendment can be reviewed. – if the govt wants to make sure that expenses can be disallowed or tax is not deducted then they can do that. But the wider point is that who are you affecting? Your affecting the public. I am not suggesting that charity trusts that are set up for purposes other than public good should get away with what they are doing or not doing –that is not the point. The point is like this is mob firing, where your affecting people who need all the help. As far the earlier coalition was concerned, they claimed that they were secular. However this government has no claim to be secular, infact they insist, so many trusts including religious trusts will be affected this. For nobody’s benefit this has been made. There is not even a reference in the finance ministers speech to this amendment. All charity trusts will be prejudicially affected by this.

The finance bill as far as possible spend money through payees account cheque and not by cash. From the govt. point of view it’s a very good objective. But as my previous example of medical examination. Now charity trusts as far as Gujarat and Maharashtra is concerned will have to comply with this requirement. Don’t know if an amount like 20,000 to a small time charitable trust in godra, will be workable.

Dr. Girish Ahuja, Chartered Accountant :

S.11 is a section where charitable trust or institution or a religious trust can get exemption. We have a S.40(a)(ia), where if no tax has been deducted, then 30% would be disallowed, or if not deposited to the Govt. and also mentioned that if the tax is deposited in any other previous year, such deduction would be allowable then, but that is only for business. We have another section i.e. S.40A(3), where the payment for a transaction exceeds ₹ 10,000, it should be paid by way of an account payee cheque or account payee draft or an electronic clearing system, otherwise such expense would be disallowed. Both the sections are for business assessees. Charitable Trusts of religious trusts do not do business but they are also supposed to deduct TDS, they are also making payment exceeding 10000 but they may be making the payment in cash, to cut short that, a proviso has been inserted u/s. 10(23C) and secondly, an explanation has been inserted under s.11(1) explanation 3. The explanation says : For the purpose of determination of the amount of application of the fund i.e. applied for the fund for claiming the deductions, the provisions of S.40(a)(ia) and S.40A(3) shall mutatis mutandis also apply as they are applicable for computing the profit or gain from business or profession. Hence from now onwards, if any payment exceeding 10000 is paid in cash or no taxes has been deducted where it was required to be deducted, such payment will not be regarded as payment for the purposes of application of funds. 30% shall be disallowed of the application amount.

A question arose that if 90% of the funds are applied, and after application of 90%, u/s 40A(3) and 40(a)(ia) – 5% is disallowed, but even then, I get the total exemption since 15%-5% would be 10%, which I have already claimed, then would there be an issue? Doctor says, s.11 states that an exemption up to 15% is available for the amount which is set apart for accumulation, which means, the exemption is available only for such amount which is set aside for accumulation. Now in the present example, only 10% is set aside and the rest of 90% is used or applied for charitable purposes. Since the exemption is only 10%, the disallowance will also be from such 10%. S.164(2) states, if there is an income which is not exempt under s.11(1), then such income shall be taxable.

Clause 7 & Clause 8 : Section 16 & Section 17 : Deduction and Definition:

S. E. Dastur, Senior Advocate :

Then, one comes to another, all these are provisions adverse to the assessee. Then there are certain provision, you will be surprised, are also in favour of the assessee. For example, a salaried employee gets a flat deduction of ₹ 40,000. Flat deduction was done away with from the AY 2006-07. At that time, it was provided that the flat deduction will be ₹ 30,000. Now it is ₹ 40,000. But, everything is not chocolates and sweets. Simultaneously, it is provided that the exemption up to ₹ 15,000 which is available where the employer reimburses the medical cost to the employee, will no longer be available. Further, the benefit of conveyance/transport allowance, which today is ₹ 19,200 per year will also not be available. So though, you get a flat deduction of ₹ 40,000, you are at the same time deprived of deduction of ₹ 15,000 and ₹ 19,200, which means if my mathematics is correct, that you get an advantage only of ₹ 5,800. Now in the speech, it is emphasised, look we have done so much for the employees, but what
about the hidden costs which the employee has to bear?

Dr. Girish Ahuja, Chartered Accountant :

S.16 : Abolished 2006-07 : Standard Deduction : 33.5% of salary subject to maximum of
₹ 30,000/- was the deduction earlier till 2006-07. Now it has been reintroduced. The amount of salary or the amount of ₹ 40,000/-, whichever is less, would be allowed for deduction. However, many have raised the contention that the transport allowance of ₹ 19,200/- and the medical reimbursements of ₹ 15,000/- paid by employer have now been withdrawn. Therefore ₹ 34,200/- was taken away and the net benefit was only ₹ 5,800/-, so nothing substantial has been done by the government. Let me tell you, the major beneficiaries would be, 1) retired officers or persons above 60 years, since salary includes pension, and the retired persons don’t get and transportation allowance. 2) For small employers, the employees are given ESI i.e. Employee State Insurance, they don’t get any reimbursement of medical employee since they are anyway receiving state insurance. Maybe, they don’t even receive any sort of conveyance allowance. And the last 3) Everyone else, has definitely benefitted by at least
₹ 5,800/-, and also, they may not be required to now produce false medical bills to claim the medical reimbursement deduction. So definitely, a benefit exists.

Clause 9 : Section 28 : Insertion of Clause e : Profits and Gains of Business or Profession :

S. E. Dastur, Senior Advocate :

Compensation received by any person by whatever name called in connection with the termination or modification of the terms and conditions of any contract relating to his business is to be assesses as Profits or gains of business, which means the above becomes a revenue receipts if it’s in case of termination of contract relating to business. Now this goes counter to all concepts of what is when is compensation can be regarded as a capital receipt and when as a revenue receipt. If the compensation puts an end to a contract then that is certainly not a revenue receipt but a receipt on capital account. This has been laid down by several decisions. One of the decisions being, the decision of Khanna & Annadhanam v. CIT [2013] 351 ITR 110 (Del.), where they held that a receipt for termination of a particular assignment would be a receipt from capital account. This follows that the compensation is to be regarded as income and it is to be regarded as income from other sources. Again I think this sought of an amendment as well as the next one I am going to refer to, really shows how a distinguishment between a capital receipt and a revenue receipt is now a being almost extinguished because S.2(24) has been amended which defines income, innumerable number of times to tax the income, what is not income under any concept of law. The other compensation of this type is, where one receives compensation of a salaried employee, receives compensation on account of the alteration of the terms and conditions of his employment or in the termination of his employment, this is to be assessed as Income from other sources. Now it is overlooked that presently s.17(3)(i) provides the profit in lieu of salary is an accountable as income. So we now have 2 provisions dealing with the same subject and providing that it is to be regarded as income. One is 17(3)(i) and the other is S. 56(2)(xi). Obviously there is a conflict and the [person w2ho drafted this amendment in 56(2)(xi) was not conscious that there is already a [provision in S.17(3)(i) to this effect.

Dr. Girish Ahuja, Chartered Accountant :

Till now – when there was an agreement entered into and there was termination of such contract thereafter or modification of the terms of conditions, due to which, any amount is received as compensations, there has always been a dispute with regard to it that it could either be a capital receipt or mesne profit, etc, which is not taxable, or a revenue receipt and taxable. Now the government has cleared such ambiguity, by now including such amount received as compensation under the ambit of business income i.e. revenue receipt.

Clause 9 : Section 28 : Insertion of Sub-Clause (via) : Conversion of Inventory into Capital Asset :

S.E. Dastur, Senior Advocate :

Hitherto this subject is not dealt with in the Act. A conversion of a capital asset into stock in trade is dealt with. It is stated that this can be regarded as a transfer u/s. 2(47) but Capital against tax can only e recovered when that asset is sold and not before that. Now insofar as conversion of an inventory into a capital asset is concerned, it is provided that the fair market value of the inventories as on the date of conversion will be treated as profits and gains from business. So, it would follow that not the entire value of the fair market value on conversion is to be income but obviously it is to be taken into account under the head profit and gains and one will get deductions of the cost for acquiring that stock in trade. It is also provided that when the capital asset is sold, stock in trade converted into capital asset, this capital asset is sold then the capital gain will be the sale price minus the fair market value of the inventory as on the date of conversion because that difference has already been assessed and further more indexation has to be allowed only from the date of conversion, not from the date on which the stock in trade was acquired, It is also been made clear that in determining what is a short term capital gain, you will have regard to the holding from the date on which the conversion takes place. So after converting, if it is sold within one year, it will be regarded as a short term capital gain.

Saurabh N. Soparkar, Senior Advocate :

If I have shares which are my capital asset and convert them into stock in trade. SC in CIT v. Bai Shirinbai K. Kooka [1962] 46 ITR 86 (SC), said no tax is payable & therefore Sec.45(3) was introduced. However even prior to this SC case way back in the matter of Sir Kikabhai Premchand v. CIT [1953] 24 ITR 506 (SC), said that if I am withdrawing stock in trade from the business & make it a capital asset there is no taxing given. SC took an interesting example that if a grain merchant for the purpose of making rice at home, takes some grain from his shop or godown, he is not selling to himself & therefore law is well settled that conversion of stock in trade into capital asset was not taxable. Now the proposal is that the year in which you convert stock in trade into capital asset the difference between the cost & the value on the date of conversion would be taken to be your business income, eventually when you will sell the capital asset in the market, the value at which you have converted would be allowed to you as a cost & the period during which you have held the capital asset as capital asset would be as the period of holding u/s 2(42A). Situation – I have a stock in trade worth ₹ 20,00,000., market value is worth ₹ 50,00,000 today. I convert my stock in trade into capital asset on the difference between 50 & 20. On the basis of ₹ 30,00,000 I will have to pay business tax. I retain this capital asset for a period of 2 years, it’ll be a short term capital gain, but if I hold it for more than 3 years from date of conversion then it will be considered as a long term capital asset. So the 2 things required to be stated are 1. The tax will be levied on the hidden income on the year of conversion. Mark u/s 45(3) when you convert from capital asset to stock in trade, hidden income is to be taxed only when the asset is sold or transferred. In a reverse situation, the gain is subjected to tax in the very year of conversion. The holding period, there was confusion – if I so convert, do I take holding from period of date of original holding or date of conversion. They’ve made it very clear, from the date of conversion.

Dr. Girish Ahuja, Chartered Accountant :

S.2(41) states that conversation of a capital asset into stock in trade is a transfer. S.45(2) states that where there is a capital asset converted into stock in trade, it will be regarded as a transfer, but the capital gain will arise, not in the year of conversion but in the previous year in which such converted asset is sold or otherwise transferred. If a Share is converted into Stock in trade, then, up to the date of conversion, whatever profit arose, when we sell, was taxed as capital gain and thereafter was treated as business income. But no clarity was provided with a vice-versa situation i.e. what will happen when the stock in trade into a capital asset? Now, in S.28, clause b(ia) has been inserted, which states that, fair market value of the asset on the date of conversion or treatment of such asset into capital asset, shall be treated as income. So now, when the inventory is converted into capital asset, the day when such conversion takes place, the fair market value of such asset as on that day, would be treated as the business income of the assessee, irrespective of whether such converted asset has been sold or not.

Example : If there are shares of a company bought at the rate of ₹ 500 per share, which, after a while were converted when he fair market value of such a share was ₹ 900/-. The amount treated as business income on conversion would be ₹ 900/- and not ₹ 500/-. Now a question would arise that whether the amount of ₹ 500/- paid for the acquisition of the share would be deductible which calculating the amount of income. The answer is, no, the cost of acquisition i.e. ₹ 500/- would not be considered and the total amount of ₹ 900/- would be taken. The reason for this is, the opening value on the date of conversion would be ₹ 900/- however, there would be no closing stock since the share is now converted. The calculation states that amount to be taxed is Op. Stock plus purchases minus Cl.stock. In the present scenario, there is no cl.stock, hence the entire amount of ₹ 900/- would be taxable. Now one more question would arise with respect to how to calculate the capital gain on sale of such converted asset. What would be the cost of acquisition and what would be the period of holding? In S.49, sub-section 9 has been inserted which states that the fair market value as on the date of conversion of such stock in trade into capital asset, i.e. ₹ 900/- is the present case, would be treated as the cost of acquisition for the capital asset. Under S.2(42A), the amendment states that the period of holding would be the period starting from the date of conversion of the stock in trade into the Capital Asset.

Hence it is advisable that the stock in trade is not converted into Capital asset otherwise, the entire fair market value would be treated as business income without considering the cost of acquisition.

Clause 10 & Clause 11 : Section 36 & Section 40A : Deductions : Income Computation and Disclosure Standards:

Saurabh N. Soparkar, Senior Advocate :

S. 145(A) prescribes that Assessee must follow a particular method of accounting. It also says that, the ICDS issued by the Income tax department which are 10 in number, sec. 145A(2) stated that wherever the ICDS has been issued then the income will have to be taxed in accordance with the notification prescribing ICDS. The problem arose that some of the ICDS was conflicting with the existing law, but if they are contradicting, then law will prevail. This created lot of confusion, ICDSR to be made effective from April 15th extended to April 17th. This ICDS was challenged by the Delhi high court by the chamber of tax consultant in a judgement reported in 87 taxman.com pg 92. Delhi high court has examined each of ICDS in great detail & it found that some of the clauses of ICDS are patently illegal. ICDS were issued a notification. Notification is a subordinate legislation. Subordinate legislation cannot go beyond the parent legislation according to the Income tax Act. So the Delhi high court took the view that these ICDS parts are invalid., because they were not according to the provisions of the Income tax act but by the notification issued u/s 145(2). Sec 145A itself is being amended & wherever the government wanted to bring changes in the accounting not withstanding what the Delhi high court has said those areas now amendments are proposed by statutory provision. In one area where govt is agreeable to what Delhi high court has to say. ICDS which was not a part of statute but it was a notification under statute now is being recognized as part of a statute, so the fundamental ground as per what Delhi high court held that ICDS cannot go beyond the statute now that fundamental ground itself will go away, because ICDS itself is a statute and an statute always overrides to override any judgement of any court.

ICDS from notification is now a part of statute.

Dr. Girish Ahuja, Chartered Accountant :

A Delhi High Court in the case of Chamber of Tax Consultants v. Union of India [2018] 400 ITR 178 (Del.) (HC), had stayed the application of ICDS stating that one cannot overrule the judicial decisions since it was mentioned in it that it would overrule the judicial decisions. To overcome such a stay, the government has changed the law itself. Now all the ICDS have been incorporated into the income tax act. First in S.36(1), it was inserted that mark to market loss will be allowed to you, but then they have inserted in S.40A that Mark to market loss which are not specified will not be allowed to you. Then S.43AA has been inserted with respect to foreign income currency computation as per Income Computation Disclosure Standard. Then 43C has also been inserted in which the ICDS i.e. Percentage Completion Method will be followed and not completed method, which has already been inserted under section 43C . It has also been mentioned that Retention money will not be considered as income as per the ICDS. S.145A and 145D have not now been introduced in place of the old section 145. S.145A talks about Inventory Valuation and 145D about grants and interest on enhancement of cost, etc of the ICDS, all have been included in the Income Tax Act now. They are applicable for A.Y. 2017-18. Hence all ICDS have to be followed now. Now one has to be careful that all sections i.e. 145A, 145B, 36(1), 40A(3), 43AA, etc have to be followed since all are included under the income tax act.

Clause 19 : Section 50C : Full Value of Consideration in certain cases :

S. E. Dastur, Senior Advocate :

Now, under the Act today, the stamp duty value has to be taken in certain circumstances, for eg: u/s 50C, if a capital asset is transferred but the fair market value as per the stamp duty authorities exceeds the fair market value disclosed, then the stamp duty amount will be regarded as the fair market value and capital gain computed accordingly. Similarly under 43CA which is inserted in the AY 14-15, where there is a transfer of a land or building or both, which are held as stock in trade, and there is this differential between the stamp duty value and the value disclosed, again the stamp duty value will be taken. Further, under 56(2)(10), which was inserted last year, stamp duty value has to be substituted in the hands of the recipient, when he received the property from another person and if the difference between the value as disclosed, and the stamp duty value, the stamp duty value will be taken. Now it is provided that, one will take the stamp duty value which is also known as the circle rate value only if a play of 5% is not satisfied. So therefore, if you show a consideration of 100, but the stamp duty value is not more than 105, it will not be applied. It is for consideration whether, just a 5% adjustment with the stamp duty value is sufficient. But what you have really to think is, when the stamp duty value was made compulsory, did not the FM think that you can’t have such a provision, because there may be several reasons why a stamp duty value in an area may not be comparable to the property you are dealing with. Because stamp duty in an area is on a uniform basis, your building may be dilapidated, the stamp duty value will be the same. You can appeal to the stamp duty authorities but should not in income tax a larger play be allowed. And why was in the first place, a provision introduced without any play.

Saurabh N. Soparkar, Senior Advocate :

If I sell land or building or both held by me as a capital asset or stock in trade at a price below the jantri price. Difference between the jantri price and the sale price is deemed to be my income. Correspondingly in the hands of the purchaser u/s 56(2)(x) difference between the purchase price & the jantri price is taken to be as his income.

Govt. has accepted that there could be variety of reason as to why an assessee may not have possibility of realising the full jantri price, so now there is a small window, the window says if you receive up to 5% of the jantri price then there will be no addition. Eg: jantri price is
₹ 1 crore, I sell for ₹ 95,00,000 then I don’t have to pay tax nor the purchaser has to pay tax on ₹ 5,00,000. But mark, this is not a standard deduction, so if I sell for ₹ 94,00,000 I as well as the purchaser will have to pay tax on a difference of 6,00,000. So this being not a standard deduction, so either you are within 5% no addition or your beyond 5% addition of a whole.

Dr. Girish Ahuja, Chartered Accountant :

Now , we have S.43CA, 50C and S. 56(2)(x). S.50C states that where the consideration accruing from the transfer of any capital asset being land or building, is less than the consideration price already received, then for the purpose of computing the capital gain, the consideration price will be deemed to be the stamp duty price. The difference between the value of the property and the stamp duty value, tax has to be paid on that irrespective of whether it is a business asset u/s 43CA or a capital asset as considered under section 50C. S.56(2)(x) states that the difference between the stamp duty value and the purchase price will be treated as income under income from other sources. Now what new has been brought in is, only 5% variation has been allowed. The wordings are as under: Provided that f the Stamp duty value assessed or assessable, does not exceed 105% of the actual consideration, then the consideration price may be taken as the actual consideration. Even u/s 56(2) also it is inserted that if the difference between the Stamp Duty value and the purchase price is in excess of the higher of the following two i.e. stamp duty value and 105%.

Clause 20 : Section 54EC : Capital Gain not to be charged on Investment in Certain Bonds :

S. E. Dastur, Senior Advocate :

Then there are various provisions for exemption from payment of capital gains tax if an investment is made in certain specified assets. S.54 and 54F deal with the case of sale of residential accommodation. That has not been disturbed but other provisions are no longer applicable i.e. 54A, 54E, 54EA, 54EB, 54ED, etc because they all dealt with certain transactions before a particular date which have not elapsed. So there are only two provisions now which are applicable i.e. 54EC and 54EE. 54EC provides for investment of the capital gain in bonds, redeemable after 3 years and not earlier which are issued by the national highway authority or the rural electrification corporation. 54EC will apply from AY 2019-20 only in respect of capital gain arising from transfer of long term capital assets being land or buildings or both. That is not from gains from the transfer of any other asset. And further that investment is to be in the bonds is to be redeemable after 5 years. So the 3 year period is now extended to 5 years. S.54EE is interesting. It was inserted last year and provides from exemption from tax on all long term gains where investment is made in units issued before 1/4/19 by notified funds. I have not been able to find any funds having been notified as such up till now. So therefore 54EE, though more than an year has elapsed, is still a non-starter. Further, both in 54EC and EE investment is to be made within 6 months of the transfer and you cannot get exemption for more than 50 Lakhs invested. So if we invest 60 Lakhs, the exemption will be confined only to 50 Lakhs. This is dubbed here in the explanatory memorandum and are also capital gains from transfer of only land and buildings. Now these amendments have been done as rationalisations. What does one mean by rationalisation? There is a section which you have not made effective and there is another section in which you have imposed further terms, what is rationalisation in that? I understand that therefore now if nothing is prescribed under 54EE by 1/4/2019, which is just about 14 months away, 54EE will be a dead letter for all time to come.

Saurabh N. Soparkar, Senior Advocate :

If I sell a long term capital asset & have long term capital gain and I do not want to pay long term capital gain in tax I have a right to invest up to 50,00,000 in the bonds under sect. 54EC irrespective of the asset I have sold. Proposal now is, govt. is very keen to recover that 10% tax on shares. Only if you sell land, or building or both & you have long term capital gain & if you invest in such long term capital gain, only then this section would be beneficial. Also, these bonds
will have to held by you for a period of 5 years.

Dr. Girish Ahuja, Chartered Accountant :

54EC : It states that any long term capital gain arising to any assessee from the transfer of any capital asset shall be exempt to the extent such capital gain is invested in the specified bond within a period of 6 months from the date of transfer and the exemption is limited to
₹ 50,00,000/-. Now it has been amended. Now it states the long term capital asset should arise to any assessee from the transfer of any land or building or both and not from any capital asset. Now it is also mentioned that the lock in period for holding the bond will be 5 years and not 3 years. If the benefit of 3 years is desired, then such investment in bonds should be done before 31st march, 2018. But if the investment is done after 31st March 2018, then the lock in period would be 5 years.

Clause 22 : Section 79 : Carry forward and set off of losses in case of certain Companies :

S.E. Dastur, Senior Advocate :

Under section 79, if there is a change in shareholding, you do not get the benefit of carry forward. This is now amended to provide, that if the change in the shareholding is on account of a plan framed under the bankruptcy code whereby there would be a change in shareholding, that will not affect the right of carry forward.

Saurabh N. Soparkar, Senior Advocate :

3 changes are being proposed.-

Restructuring schemes would suggest that shares of the company held by the promoter should be handed to the new promoter whose resolution plan will be accepted by the NCLT.

States sec. 79 of the Income-tax Act. This was creating a complication, people were not willing to give a resolution plan when they were not getting the benefit of carry forward loss. Now the first proposal is, that if a company is undergoing insolvency resolution plan, approved by NCLT then sect. 79 will not be implemented. Provided reasonable opportunities given to jurisdiction principles Cit in the proceeding in front of the NCLT.

Confusion being what is reasonable opportunities, which will later because confusion.

On a large number of cases as a part of restructuring, banks were required to take a hit, would have to waive principal amount, they may have to waive interest amount, creditors will have to give up money all of this will be regarded as income as per sect. 41. Suddenly companies will have to pay tax, companies that have losses and that will not be able to sustain on its own, because of restructuring plan, and it can be revived.

While working out restructuring packages, insolvency professionals were asking banks to take more cut, so the additional tax will go in payment of taxes. Those bodies represented to the government, so “mat” provision is to be amended. Provision of “mat” is that carry forward loss or depreciation whichever is lower, as per books is to be allowed. The proposal is: carry forward loss and depreciation both to be allowed, and the words “as per books” are no longer there. Which say that you are entitled tax laws and tax depreciation collectively for the purpose of computing the net liability for the purpose of such companies.

Who would file return of income for such companies, BOD gets displaced as soon as resolution profession is appointed. Provision is the company before the NCLT the obligation to file return of income is on the resolution professional.

Dr. Girish Ahuja, Chartered Accountant :

S.79 : Carry forward and set off of losses in case of certain companies : It’s for a closely held company : This section states that where there is a business loss in respect of a closely held company, this business loss will not be allowed to be carried forward unless the shareholder carrying 50% of the voting power as on the date when the loss was incurred and also as on the date when the loss is set off, should be same. That is, only if 51% of the shareholders are the same as on the date when the loss was incurred and as on the date when the loss is sought to be set off, for the purpose of claiming the benefit of carry forwarding the loss.

Now, in case of insolvency where the adjudicating authority has admitted the application, now different shareholders will come. So now when the shares will be purchased by the new shareholders, then how the loss would be carried forward? Now the law has made it clear u/s 79 that S.79 would not be applicable, once the application has been admitted by the adjudicating authority. Then Business loss can be carried forward even if 51% shareholders are not the same. Also u/s. 115JB : When we compute the book profit, then brought forward loss or unabsorbed depreciation, whichever is lesser, would be deducted, but in case of insolvency as referred above, both the brought forward loss and the unabsorbed depreciation, both will be deductible.

The benefit of 115JB has been given to the insolvency cases along with the S.79 benefit, it is a good proposal, since, if the losses are not going to be set off or even on the losses we are going to pay MAT, then no one would opt for it, hence such an amendment has taken place.

Clause 23 : Section 80AC : Deduction not to be allowed unless Return furnished :

S. E. Dastur, Senior Advocate :

As per section 80AC, deduction was not admissible under 6 provisions unless the return was filed in time. 80IA, 80IAB, 80IB, 80IC, etc etc,. Now it is stated that unless the return of Income is filed within the time prescribed in 139(1), no deduction under chapter VIA part C, no deduction will be available. And part C covers section 80H to 80TTA. So, the requirement may now, of course, 23 is to file the return and now presently the provision applies only for 6 types. Now for the entire provisions, the return is to be filed in tie and there is no exception permitted. An individual has fallen sick and he could not file the return in time, he will not get carry forward, he will not get a certain deduction he is entitled to. Should there not be some provision for unforeseen contingencies to be taken into account. They say that equity and tax are strangers but do they have to be enemies?

Dr. Girish Ahuja, Chartered Accountant :

S.80AC : Till date, deduction was not allowed u/s 80-IA, 80IAB, 80IB, 80IC, 80ID or 80IE, shall not be allowable unless return is furnished within the due date u/s 139(1). There are 4 chapters. First chapter talks about miscellaneous, second chapter talks about expenditures which are deductible which come under 80C to 80GGC. The third chapter talks about the Incomes which are deductible which start from 80IA to 80RRB. And the Fourth chapter starts with 80TTA to 80U. Now, with the new amendment, the total chapter C i.e. from 80IA to 80RRB, the deduction shall not be allowable if the return has not been filed within the due date.

Clause 24 : Section 80D : Deduction in respect of Health Insurance Premia :

Dr. Girish Ahuja, Chartered Accountant :

S.80D : For senior Citizens : “i can call it a senior citizen budget”: There were 2 concepts i.e. senior citizen and very senior citizen. Senior citizen would be more than 60 and very senior citizen would be above 80. It was told that, since insurance may not be taken by the very super senior citizens, they were allowed a deduction on the actual amount of medical expenditure up to a maximum of ₹ 30,000/-. Now, what has been changed is the term ‘VERY’ i.e. the word very from very senior citizen has been removed and it has been made applicable to both the senior citizens and the super senior citizens. Also, the limit of ₹ 30,000/- has been increased to ₹ 50,000/-.

Clause 25 : Section 80DDB : Deduction in respect of Medical Treatment, etc :

Dr. Girish Ahuja, Chartered Accountant :

S. 80DDB : Expenditure incurred on any specified ailment or disease for yourself or dependent on you. If not senior citizen, then deduction up to ₹ 40,000 and if senior citizen, then deduction up to ₹ 60,000/-. Very senior citizen – ₹ 80,000/-. Now, with the new amendment, the term ‘Very” has been removed and only senior citizen is retained i.e. now, to every senior citizen, a deduction is allowed up to ₹ 1,00,000/-. And all this is in addition to 80D.

Clause 26 : Section 80IAC : Special Provision in respect of Specified Business :

Saurabh N. Soparkar, Senior Advocate :

New start-up’s section i.e. S.80IAC- the extension has become 2021, but you have to ensure that you remain small. The moment your turnover extends 25 crores you will lose the benefit. So you have to be good but you don’t have to be so good that you grow.

Dr. Girish Ahuja, Chartered Accountant :

S.80IAC : Small change : Initially 80IAC had come into existence for Start up specified businesses, where 100% deduction for 3 years is available, provided the profit does not exceed 100 crore. 3 consecutive years from 7 years. Now, the definition of eligible business has been enlarged. Further, the commencement of such business was supposed to be between 1-4-2016 and 31-3-2019, and now the time
limit has been extended by 2 years i.e. till 31-3-2021. It has also been mentioned that such deduction of 100% for 3 years would be applicable provided the turnover of the company does not exceed 25 crores for a period of 7 years.

Clause 27 : Section 80JJAA : Deduction in respect of Employment of New Employees :

Dr. Girish Ahuja, Chartered Accountant :

S. 80JJAA : A good Deduction : It mentions that employ workmen with a pay not more than ₹ 25,000/-. The additional cost of the additional employment, shall be allowed deduction at the rate of 30% for a period of 3 years if the pay is not more than ₹ 25,000/- and they have been employed for at least 240 days. But some industries are seasonal, like the apparel industry and hence, the term has been reduced to 150 days for them. Now the change brought is, along with the apparel industry, the leather and footwear industry has also been brought under lesser term of 150 days employment. Now it has also amended, for good, that in case an employee has been employed for less than 240 days or 150 days as the case maybe, due to year ending before completion of the number of days as required, even then, if the employee is continued in employment in the subsequent year, and completes the stipulated number of days, the deduction shall be allowable. Which means, whenever the person is employed, deduction shall be allowed, if not in the current year, at least in the subsequent year.

Clause 30 : Section 80TTB : Deduction in respect of Interest on deposits of Senior Citizens :

Dr. Girish Ahuja, Chartered Accountant :

S.80TTB : A beneficial and good section for senior citizens : “Mr. Modi has done a brilliant job by inserting this provision” : Interest on account of deposits in savings account for senior citizen. Deduction up to ₹ 50,000/- with a banking company, co-operative bank or a post office.

It is praise-worthy that so many deductions are provided to the senior citizens. ₹ 50,000 is provided under this section, then ₹ 50,000 is given under the medical benefit and ₹ 40,000 is given to the pensioners. In total, a number of benefits have been provided to the Senior Citizens.

Clause 31 : Section 112A : Tax on Long Term Capital Gains in certain cases :

S. E. Dastur, Senior Advocate :

What the president referred to about long term capital gains and transfer of equity shares. Today, there is complete exemption in respect of shares sold on the stock exchange or units of a equity fund or units of a business fund provided STT has been paid, both at the time of purchase and at the time of sale where the purchase take place after October 2004, when the STT provisions came into force. If therefore it is felt I presume, that capital gain, first assessees get undue advantage on account of the exemption from charge of capital gains. And it is said even in the explanatory memorandum, that the reason for making this changes is that S.10(38) inherently biased against manufacturing and has encouraged diversion of investment in financial assets. What does that mean? Does it mean that today, an individual who invests in financial assets will now go into manufacturing because he does not get this exemption. You may use words to justify that we are doing this very worthwhile thing but does it make sense. And does the explanatory memorandum think, probably members of parliament don’t read the explanatory memorandum, but does the framer think that anybody who reads it will not look at it rationally, whether it serves any purpose. It is better not to justify an assessee unfriendly amendment rather than given= such reasons which do not really stand scrutiny. It is also stated that the exemption of capital gains has led to abusive use of tax arbitrage opportunities. Assuming that it is correct, what have you framed GAAR for? Apply GAAR. If all that could come within GAAR and you could challenge it is not made intersection itself, then where will GAAR come into play. So if you think some unfair advantage has been taken and it is not according to the intention is, apply GAAR. But you don’t need to make these amendments. Then in certain circumstances, I do not know, I think, you gentlemen and ladies are more adapt at determining it, whether it would be advantageous for an assessee to claim application of section 112 as existing at the moment and which still continuous rather than to go under 112A. He may be better off by not selling on the stock exchange, I think that is feasible. If I think, what I feel is right, then you think that it may give raise now, to people advertising that they will purchase shares at a rate which is given. So the person who wants to sell shares will get advantage of 112. The person who buys the shares will buy it at lesser than the market price, so he will gain also. They have not yet said so, but they could have said, that this will be the result and this could result in greater employment. Because greater employment flouted all over the explanatory memorandum, but they have not said it probably because they have not thought of it.

Saurabh N. Soparkar, Senior Advocate :

If you have long term capital asset in the form of equity shares or units of equity oriented mutual funds, if you hold them for than 1 year & if you sell on the floor stock exchange & pay security transaction tax, you are not required to pay any long term capital gain tax. Therefore, these transactions are completely exempt. The government has to say only those who have shares get the benefit the rest don’t & Govt. also needs money. They expect that ₹ 40,000/- crores gets raised by virtue of elimination or removal of this exemption. Even thought the exemption is removed. The transaction is not taxable.

Capital gain up to 31st January, 2018, is to be held tax-free. Proposal is if I have long term capital asset in the form of equity shares, which I was holding prior to 31st January. If I sell prior to 31st march,2018 the law continues what it is. The new law comes into force only from 1st April. If I sell after 1st April, supposedly my cost is ₹ 2,00,000/-, market value as on 31st January 2018 is ₹ 9,00,000/- & I sell the share at ₹ 10,00,000/- then I have the right to claim from the sale price of ₹ 10,00,000/- as cost. My actual cost of ₹ 2,00,000/- or market value as on 31st Jan 2018, whichever is higher. In other words, my capital gain up to 31stjan, is protected & made exempt.

Another example- my cost is ₹ 2,00,000, market value as on 31st January 2018 is ₹ 9,00,000 & I sell the share at ₹ 8,00,000. As compared to my original cost I have made a gain at ₹ 6,00,000 but as compared to market value as on 31st January, I have made a loss at ₹ 1,00,000. Government doesn’t want to take advantage of this notional loss. Proposal is, if you sell shares hereafter, 31st of March against consideration original cost or market value of the 2 whichever is higher to be allowed. But if the consideration is lower than the market value as on 31st Jan, then market value will not be allowed, the gain will be exempt.

Find out the market value as on 31st Jan,2018, of the script your selling. Find out @ the price your selling. If the price is higher pay the difference @ 10%, if the price is lower, you don’t have to pay any tax. If the price is so low to go below your actual cost, then you’re entitled to the capital loss. Otherwise there is no requirement to pay any tax. The only issue will be, those companies that are highly profitable , that have huge reserves, but they are not listed as on today, if they take listing hereafter, they will have no such protection. If they would have said, like units, in case of unlisted companies also the NAV or rule 11UA value as on 31st January would be allowed as the deduction probably would have been a better situation. Therefore, this amendment as to sec. 10(38) r/w sec.112A effectively sticks to levy long term capital gains on sale of shares, equity shares & units but to a very limited extent. This section also says that you have to pay security transaction tax at the end of purchase also if you acquire them on October 4th. We had a similar provision under the old regime also, where govt. had come with a notification significantly relaxing the requirement in today’s FAQ, they’ve said they are going to retain the same parameters. So if you have received the shares as bonus shares, as right share etc. then you may not have to worry about the fact that estate is not paid. 2 more things. i. normally when a tax is being levied at a flat rate, deduction under chapter VIA are not to be allowed or sec. 87A are not to be allowed, that’s a normal situation . In the present case, they have expressly stated, that on such capital gain, the deduction under chapter VIA will be allowed & rebate u/s 87A would also be allowed. So it is not as if there is a flat rate of 10% irrespective of deduction & the rebate. This is so far as sec 10(38) is concerned.

Bansi S. Mehta, Chartered Accountant :

The amendment made/proposed to be made, should have been discussed first amongst the general public and the effect of such amendment so that it is understood and absorbed. I feel, the persons who have framed this amendment, have not understood the philosophy behind Mr. Chidambaram’s budget years ago, by which he exempted Long term Capital Gains tax on stock market provided security transaction tax is paid. So he made an amendment that 10(23B) that this will be exempt provided STT is paid and STT is charged automatically on the stock exchange when the transactions are electronically conducted and recorded. In fact the government has got a lot of revenue from the levy of Security Transaction tax. But now, there is an amendment proposed to remove the Capital Gain tax exemption, however, by some curious process of reasoning, they say we’ll retain the STT. You have STT which was introduced to make good the loss on account of Capital Gain Tax, that plus LTCG tax would be chargeable. The amendment is not very difficult to understand, they wanted to remove the exemption. However, what is now happening is that a bulk of investment in India comes from FIIs. Now, there are broadly 2 kinds of FII investment. One is which comes from a Double Tax Treaty jurisdiction and the others come from other jurisdiction. Now those who come from the DTAA jurisdiction and there is a provision for exemption of capital gain tax, then this amendment has no effect. However, most of the treaties in which capital gains tax was exempted, Cyprus, Mauritius, etc, Govt. of India has renegotiated the treaties and said that Capital Gain tax will be charged. However, there is one country, with which the govt. either has not been able to or not negotiated i.e. Netherlands. One country, where under the treaty, capital gain exemption tax is there. Now what is the effect of this? Effect is, FIIs who are short term players in the market, may not now invest since they will have to pay both i.e. STT and Capital Gain tax. Purely on Academic ground, the FM is right, i.e. somebody who worked by his own effort, is fully taxed and somebody who just takes advantage of the market, does not pay tax. But I think, inequities, imbalance, and something with which we, even today, why is CG taxed @ 10% under this budget whereas professional tax is paid @ 30% or more. So there is inevitably a distinction and this is so not because you want to favour someone, but because some other activity needs to be incentivised. So I personally don’t think that there is anything wrong with the old section 10(23) by which the exemption was given for LTCG tax. Provided there is one lacuna, the finance bill has required or has provided that STT should’ve been paid both at the time of purchase and at the time of sale. That was the position. However, there is a question and answer which has come today, I went through it. It said, even if no STT was paid at the time of purchase, because it was not payable, that should not disqualify. There is one doubt in my mind which has been resolved.

Dr. Girish Ahuja, Chartered Accountant :

S.112A : Important and Dangerous Provision : Long Term Capital Gain is not taxable. Rumours are that even though LTCG tax has been levied, STT should have been withdrawn. Such a rate of 10% has been chosen due to the presentation of wrong facts. It was told that there has been a Long Term Capital Gain of ₹ 3,47,000 crore. And revenue through tax can be generated from here. Without appreciating that many companies would have also incurred a loss, and such loss may not have been set off against this figure of gain. Without doing so, tax has been levied. S.112A now states that, not withstanding anything contained in S.112, where gross total income of an assessee shall be taxable as per sub-section 2 of S.112A if there is a capital gain and the capital gain is on account of transfer of shares on which the securities transaction tax has been paid at the time of its acquisition as well as at the time of its transfer and if it is a mutual fund, STT should have been paid at the time of transfer. Also, it should be a long term capital gain. The amount of tax would be 10% on an amount exceeding ₹ 1,00,000/- i.e. only on the amount over and above ₹ 1,00,000/-. It has also been mentioned, that if the total income of an Individual or an HUF from other sources is less than the exemption limit, then, so much of the capital gain will be shifted to other income to claim full exemption of ₹ 2,50,000 or ₹ 3,00,000 or ₹ 5,00,000 as the case may be.

It would be advisable that such gain may now be earned in the name of the senior or very senior citizens so that it is profitable, in
case they do not have any other source of income.

Sub-section 4 states that a notification will be issued to notify as to which transactions, even if the STT is not paid, there would not be a problem.

Sub-section 5 is adverse to the assessee where the benefit of indexation has not been provided to the assessee and if a non-resident, the no benefit of Proviso 1 as well. For eg: I have listed shares. If I sell it off-market, I have an option to pay, either a rate of 20% after taking the benefit of indexation or to pay a rate of tax @10% without taking the benefit of indexation. But if I have listed shares and I sell it on the stock exchange, then I will have to pay tax @10% and I will not even have the benefit of Indexation. But yes, in Sub-section 6, a grand-fathering clause has been inserted, which is very interesting. It has been mentioned that till 31st January, 2018, whatever appreciation in the value of the share has taken place, such amount shall not be considered for the purpose of taxation, if it is long term in nature, up to 31st January, 2018. The benefit is, no tax need to be paid on the profit and if there is a loss then the entire loss will be allowed. Eg: Cost of acquisition minus consideration will give us the Capital gain. How do we compute the cost of acquisition? Take A and B. A is the Actual cost of acquisition. B will be lower of the two i.e. fair market value on 31st January, 2018 and sale price. Now compare this amount with that of A and the higher of the two will have to be taken. For eg: share is taken at ₹ 100, sold at 150, the grandfathered value is 120, then only the difference between ₹ 120 and ₹ 150 would be taxed @30%. But assuming there is a loss i.e. the share is sold at 90, then the loss i.e. difference between 120 and 90, would be allowed. Loss is allowed to be set off from Capital Gains. Further, S.10(38) is still available till 31/3/2018, hence if there is any Long term capital asset and there could be a possible gain, it is advisable to sell the same so that nothing is taxable as Long Term Capital Gain. And even if not sold, even then, gains till 31th January 2018 will not be taxable anyways.

It has also been clarified that no deduction is allowed under chapter VIA from such profit. Further no rebate u/s 87A is also permitted.

A FEW OTHER EXPLANATIONS BY THE EXPERTS:

Clause 10 : Section 36(1) : Marked to Market Losses :

S.E. Dastur, Senior Advocate :

Then deduction is allowable for mark to market or other expected loss computed in accordance with the income computation and disclosure standards. I for my part, am at a loss to understand how you can compute this according to the standards and also say that not only mark to market but any other expected loss. Now how can you show this is an expected loss and I should get deduction and supposing the expected loss does not fructify, what happens?

Saurabh N. Soparkar, Senior Advocate :

On account of foreign exchange fluctuation etc. we have to bring down the foreign currency valuation mark to market was an acceptable way of recording this transaction, SC had made certain observations, court had accepted that. Yet, ICDS stated that mark to market losses would not be allowed as a loss. This is being corrected and the amendment u/s 36(1)(viii) is that now it is expressly being provided effectively from assessment year 17-18. It is now being expressly stated that mark to market loss would be allowed as deductible expenditure, but it’s also been stated by 40A still be allowed only if its computed in accordance with ICDS not beyond that. On principal ICDS is to be allowed but otherwise computation is to be left on ICDS method of calculation.

Clause 15 : Section 43CB : Computation of Income from Construction and Service Contracts : Percentage Completion Method :

S. E. Dastur, Senior Advocate :

Another amendment introduced is Percentage completion method has to be followed in construction contracts.

You cannot say that I will follow the completion method just so that I have presumed the first 30 or 40 % has not been regarded. But after you have considered the first 40 %, you will be chargeable to tax. This may mean that you are chargeable to tax in year 1, 2 and 3 but if your expectations don’t come true, in year 4 you may have a loss on the actual completion of the contract. This against pre-pones the time of charging the profit to tax. The same provision also applies in respect of service contracts. They have to be also on the basis of proportionate completion. But one exception, if the contract is not to last more than 90 days, but if it is to last for 91 days, you must apply the proportion completion method. Now again it is for consideration whether, by expediting the time of paying tax, is much achieved, because in the overall limit, you are not increasing the quantum of tax you will collect. The Bom HC has stated more than once, that we don’t see since in provisions, which impose a tax liability, in year 1, which could have as well been accounted in year 3. But then as I say, when you are in the fourth year of your government and are not really conscious as to whether you will be there after 5 years, you want to collect it as soon as possible.

Saurabh N. Soparkar, Senior Advocate :

Being introduced from 1st April, 17, this section is in relation to method of accounting to be adopted for construction contract or for contract for providing services. ICDS has stated that you have to have only percentage of project completion method & you are not permitted to adopt project completion method. Delhi high court(supra) struck down this part of ICDS by holding that the only permissible method is not percentage completion method even project completion method is acceptable. In order to now nullify the judgement the Sect. says that now you will have to follow only percentage completion method in accordance with ICDS, so what was held to be impermissible by Delhi high court like phoenix it’s being revived by being a part of the statute.

Even in relations to services contract, it will have to be on a percentage completion method, only exception is if the service is for less than 90 days, you can go by project completion method. If you are rendering multiple services, under 1 contract & it is not possible to find out what price is pertinent to what service then it will be spread over on a proportionate bases without applying of mind if important services rendered or yet to be rendered. This is a mandatory provision. But there is also a provision under sect. 145(1) an assessee in a given case can have cash or mercantile method of accounting. So if an assessee is rendering services like law, CA, architect etc. he is having cash method of accounting, but 43CB states you have to record profit only on percentage of completion method.

In ICDS (3) while computing income of a contractor whether the retention money will be taxed or not was an issue. Delhi high court states that retention money is not your income until the project is complete. & till the warranty period is over till then it will not be have offered to tax. There is again an amendment, for the purpose of computing revenue from a contract retention money will be taken as an income in the year in which it is received. Therefore Delhi high court judgement is held to be invalid.

Clause 44 : Section 143 : Assessment :

S. E. Dastur, Senior Advocate :

I would like to draw your attention to one amendment and that is section 143(3): It is stated that the central government may frame a scheme to make assessments under 143(3) for, please hold your breaths, eliminating interface between the assessee and the AO so as to impart greater efficiency, transparency, accountability, optimising utilisation of resources through economies of scale and functional specialisation, introducing team based assessment, I do not know what team based assessment means, one officer will assess your capital gains, another officer will assess your income from other sources, with dynamic jurisdictional scheme and by notification, may direct, that provisions of the Act shall not apply or will apply with prescribed modifications, additions as specified in rules to be placed before the parliament. So therefore by rules, you can overcome whatever is the provision in the Act. Is that constitutional? And what is meant by team based assessment? What is meant by Dynamic Jurisdiction? It is a good example of what Thomas Shandell observed 400 years ago, ” Words may be false and full of art if you don’t want to go back that long then you may quote Eliza Doolittle in my fair lady where she chunks ‘words, words, words, I am sick of words’…”. It is considered that eliminating face to face reaction with the officer is something good, but it only means that you have not confidence in your officers, because you think, face to face means corruption, but what about the honest assessee who wants to put forward his claim to an AO across the table. There are several things you cannot explain in writing, you may point to him, look at this I have done, how do you assess this? Which you cannot do when you write. Further, he makes an assessment, this all knowing CPU-central processing unit and you find some objection, they are supposed to give you a notice, you file an objection, who will it go before? Because there is a team of AOs. If you are objecting to Capital Gains, it will go to Mr. Nail, if you are objecting to IFOS, it will go to Mr. Patel, I don’t know. Further, you, what does he write, because he is supposed to peruse your response. I Have seen cases where the officer in rejecting your response says,, he repeats what he initially has dons and says, I have considered your response if any. Because the section says, he will consider the response if any. So if he is not sure that I have filed a response, how is he going to consider it? As is say, this is frustrating. One wants to pay tax honestly but doesn’t want to be cheated.

Then, Clause 6 of the proviso to 143(1), today says that, in making an intimation an addition cannot now be made under 143(1) for additional income appearing in form 26AS, form 16 or Form 16A. Does it mean that, he cannot make an intimation, but he can make an assessment invoking this? Now this, the real problem, with regard to these magical forces that you must have experienced, credit is not allowed for tax deducted, admittedly deducted, at source because the from filed by the payer who is the officer’s agent, not mine, he is deducting tax as the agent of the officer, not as my agent, the form filed does not reveal so much tax deducted at source, but there will be several reasons, but this is so. He may treat it as income of year one but the Assessee treats it as year 2 or the other way round. Then this action is contrary to decisions of all the HCs including the Bom HC in Yashpal Sahni v. Rekha Hajarnavis, ACIT [2007] 293 ITR 539 (Bombay) (HC) as well as the decisions Asstt. CIT v. Om Prakash Gattani [2000] 242 ITR 638(Gauhati), Smt. Anusuya Alva v. Dy. CIT [2005] 278 ITR 206(Karn.), etc, which are to the effect that, ‘once tax is deducted at source, the person from whose income tax is deducted does not have to do anything further and the revenue has to give him credit for the tax which is deducted. The CPU in not granting proper credit, acts not only contrary to these decision, contrary to the provisions of 205 but also contrary to the circulars which the board has itself issued. And the board takes no action in the matter. You issue a circular to satisfy a person to show, that look, I have issued this. But do you implement it? Also the Delhi HC has laid down certain rules in the case of Court On Its Own Motion v. CIT [2013] 352 ITR 273 (Delhi)(HC). These are also flouted and what remedy do you have?

Saurabh N. Soparkar, Senior Advocate :

Now it’s being proposed that, that sec. 143(1) adjustments would not cover adjustments on account of discrepancy of return on income & form 26AS, 16A, or form 16.

Policy amendment, for greater efficiency transparency and accountability, we may not have assessments being carried out at same geographical location at which assessee’s situated. So if I file my assessee in Ahmadabad it can go anywhere in India, not only that they intend to break up the return, on I assume some logical basis & then these people will interact with me only through email. The idea is that there is no interface between the assessee and the officers secondly they also want to bring specialization in the matter of assessment. But disadvantage is that in large number of cases personal hearing is necessary to communicate effectively, because a lot of times after communicating multiple times the assessee officer does not understand or does not want to understand. Because you need great communicating skills, even though there are great language barriers throughout in India. The proposal is by 31st March, 2020 they will lay down the schemes, they have only taken the power to formulate the scheme but it’s not formulated yet. That it will happen first in the house of parliament and after the approval it will be implemented.

Clause 50 : Section 253 : Appeals to the Appellate Tribunal :

S.E. Dastur, Senior Advocate :

271J provides for imposition of penalty on an accountant, a merchant banker or a registered valuer who was furnished incorrect information in a report or certificate, a penalty of 10000 per default can be charged. Now penalty is charged by either the AO or the commissioner. It is provided that by amending S.253, that where the penalty is charged by the commissioner, an appeal will lie to the tribunal, but there is no provision, that when there is a penalty would be charged by the AO, an appeal will lie to the commissioner. So if the AO imposes this penalty on an accountant, he has no recourse, but if the commissioner imposes it, he can file an appeal. So, again as I said, total irrationality.

Rate of Tax for Companies : W. E. F. A.Y. 2019-20 :

S. E. Dastur, Senior Advocate :

A new era of tax rates have come into being. Its seeds were sown in 2017. I refer to the rate of 25% which will be applicable to the predominate % of companies. Where the turnover does not exceed 250 crores. If the turnover exceeds 250 crores then tax will be payable @ 30%. Apparently only 7000 companies have turnover in excess of 25 crores. And this is a very small percentage of the total number of companies registered.

Dr. Girish Ahuja, Chartered Accountant :

Promise of reducing the tax for domestic companies has been done i.e. from 30% to 25%. Last time an attempt had been made i.e. A.Y. 2015-16 that who had a turnover of over 250 crore, would be paying a tax of 25%. This time , turnover of 250 crore or less, the rate has been reduced from 30% to 25%. There are 8,91,000/- whichever under this. Only 1% companies i.e. 9000 companies have turnover over 250 crores. Therefore 99% of the companies practically now will be paying tax @25%. Why not for partnership or LLP. Answer is they don’t stand on the same footing. In case of a company, after tax of 25%, cess and surcharge if any, they also have to pay Dividend Distribution Tax. DDT is around 20%. Therefore in effect it is 25% along with 20%. However, for LLP and partnership, such tax is not there. In case of partnership, one more thing is allowed i.e. interest on capital. May be 12%, but it is available. There is no question of deduction of interest of share capital. So the answer is very obvious why the companies and partnerships and LLPs stand on a different footing. For a company, some relaxation had to be given because of the reason of the high Dividend Distribution tax also.

Acknowledgments Sources: Bombay Chartered Accountants Society, Institute of Chartered Accountants of India, Ahmedabad Branch of WIRC of ICAI lecture meetings on Finance Bill, 2018

[For reference – Link available on itatonline.org]

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Section 15 of the Income Tax Act, 1961 [hereinafter referred to as ‘the Act’] provides for incomes chargeable under the head ‘Salaries’ such as any salary due from an employer or former employer in the previous year whether paid or not, any salary paid or allowed in the previous year by or on behalf of the employer or a former employer, though not due or before it became due and any arrears of salary paid or allowed in the previous year by or on behalf of an employer or a former employer, if not charged to income tax for an earlier previous year shall be treated as salary income. The income mentioned in section 15 of the Act is chargeable to tax under the head “Salaries” subject to certain deductions/allowances mentioned in section 16 and section 17 of the Act.

Budget Speech on Relief to salaried taxpayer

Before dealing with the proposed amendment to the provisions of sections 16 and 17 dealing with the computation of income from salaries, the relevant excerpts of speech of Hon’ble Finance Minister Shri Arun Jaitley is reproduced as under:

“Relief to salaried taxpayers 151

The Government had made many positive changes in the personal income-tax rate applicable to individuals in the last three years. Therefore, I do not propose to make any further change in the structure of the income tax rates for individuals. There is a general perception in the society that individual business persons have better income as compared to salaried class. However, income tax data analysis suggests that major portion of personal income-tax collection comes from the salaried class. For assessment year 2016-17, 1.89 crore salaried individuals have filed their returns and have paid total tax of ₹ 1.44 lakh crore which works out to average tax payment of ₹ 76,306/- per individual salaried taxpayer. As against this, ₹ 1.88 crore individual business taxpayers including professionals, who filed their returns for the same assessment year paid total tax of ₹ 48,000 crore which works out to an average tax payment of ₹ 25,753/- per individual business taxpayer. In order to provide relief to salaried taxpayers, I propose to allow a standard deduction of ₹ 40,000/- in lieu of the present exemption in respect of transport allowance and reimbursement of miscellaneous medical expenses. However, the transport allowance at enhanced rate shall continue to be available to differently-abled persons. Also other medical reimbursement benefits in case of hospitalisation etc., for all employees shall continue. Apart from reducing paper work and compliance, this will help middle class employees even more in terms of reduction in their tax liability. This decision to allow standard deduction shall significantly benefit the pensioners also, who normally do not enjoy any allowance on account of transport and medical expenses. The revenue cost of this decision is approximately ₹ 8,000 crore. The total number of salaried employees and pensioners who will benefit from this decision is around ₹ 2.5 crore.”

Amendment of Section 16 of the Act

Existing Provisions

Under the existing provisions of section 16, the income chargeable under the head Salaries shall be computed after considering certain deductions specified therein.

Proposed amendment

Clause 7 of Finance Bill, 2018 seeks to amend section 16 of the Act relating to computation of income from salary.

The Finance Bill, 2018 proposes to insert a new clause (ia) after clause (i) of section 16 of the Act so as to provide standard deduction of ₹ 40,000/- or the amount of salary whichever is less while computing the income chargeable under the head Income from Salaries.

Reason for amendment

Under the existing provisions of clause (ii) of section 16 only Government employees are entitled to a deduction of entertainment allowance of a sum equal to one-fifth of the salary or ₹ 5,000/-, whichever is less. Further, a deduction of any sum paid on account a tax on employment within the meaning of clause (2) of Article 276 of the Constitution, leviable by or under any law is also allowable to all the salaried employees.

The proposed clause aims at providing a standard deduction to all the assessees who are declaring income under the head Salaries an amount of ₹ 40,000/- or the amount of salary whichever is less. This amendment will take effect from 1st of April, 2019. Thus, the same is applicable for the assessment years 2019-20 onwards.

Amendment of section 17 of the Act

Existing provisions

The existing provisions of sub-clause (2) Section 17 defines the term perquisite which is chargeable in the hands of the assessee under the head income from salary. However, as per the proviso appended to the above sections certain payments or amounts received by the employee from his employer shall not be treated as perquisite under section 17 of the Act. The existing clause (v) of the proviso occurring after sub-clause (viii) of section 17(2) of the Act provides that any sum paid by the employer in respect of any expenditure actually incurred by the employee on his medical treatment or treatment of any member of his family not exceeding fifteen thousand rupees in the previous year shall not be treated as perquisite in the hand of the employee. Thus, under the existing provisions an assessee declaring salary income is entitled to claim deduction of ₹ 15,000/- incurred towards medical purposes for himself or towards his family.

Proposed amendment

Clause 8 of Finance Bill, 2018 proposed to omit clause (v) of the proviso occurring after sub-clause (viii) in clause 2 of section 17 of the Act. Thus, the Finance Bill, 2018 withdrew the expenditure of ₹ 15,000/- deductible from his employer on account of medical expenses incurred during the year on the treatment of employee or his family while computing the income from salaries.

Further, as mentioned in the memorandum explaining the provisions in the Finance Bill, 2018 the exemption in respect of Transport Allowance (except in case of differently abled person) is also stands withdrawn. Thus, the transport allowance of ₹ 19,200/- earlier allowed to the assessee’s while computing the income from salaries is also withdrawn by the Finance Bill, 2018.

Reasons for amendment

The reason for the amendment is clear from the Budget Speech of Hon’ble Finance Minister Shri Arun Jaitley wherein he has said that the proposed amendment will help the middle class employees in reducing their tax liability. Further, as per the earlier provisions, the employees claiming the benefit of section 17 has to furnish relevant papers of medical bills, whereas now the standard deduction of ₹ 40,000/- is available to all class of employees without requirement of maintaining any paper work. The proposed amendment is also helpful to the pensioners, who normally do not enjoy any benefit of allowance on account of transport and medical expenses.

Analysis of the proposed amendment

The present amendment is likely to benefit the individual assessee by giving them a standard deductions of ₹ 40,000/- while computing the income from salary. However, at the same time, the proposed amendment will take away the benefit of deduction on account of medical expenses amounting to ₹ 15,000/- and travel allowance of ₹ 19,200/- (i.e. ₹ 1,600/- per month) aggregating to ₹ 34,200/-. Thus, the benefit given through the proposed amendment is only ₹ 5,800/-. When we take an example of an individual having salary income of ₹ 5 lakh per annum, the total benefit available to him under the proposed amendment is only ₹ 290/- (i.e. 5% of ₹ 5,800/-) and if the salary income is ₹ 10 lacs, he will get the benefit of ₹ 1,160/- (i.e. 20% of ₹ 5,800/-) only.

Further, the proposed amendment will be available to all class of salaried individual and it is not required to maintain any documents to claim the benefit. The proposed amendment is also beneficial to the pensioners who are not claiming any benefit of medical allowance or travel allowance.

Effective date

This amendment will take effect from 1st April, 2019 and will, accordingly, apply in relation to the assessment year 2019-20 and subsequent years.

Introduction

In backdrop of the decision of Hon’ble Delhi High Court in case of “Chamber of Tax Consultants versus Union of India” (87 taxmann.com 92), the Government in the recent budget, 2018 proposes to incorporate certain amendments in the Income Tax Act, 1961 (“the Act”) to overcome the observations of Hon’ble Delhi High Court and provide legal backing to some of the Income Computation and Disclosure Standards (“ICDS”). The said decision of Hon’ble Delhi High Court rendered various parts of the said ICDS unconstitutional in light of the well settled proposition of the law that a delegated legislation (i.e. the “ICDS” notified by the Central Government under section 145(2) of the Act) cannot override binding judicial precedents and provisions of the Act. In the budget speech, the Hon’ble Finance minister expressed the clear intention behind introduction of certain provisions relating to the ICDS which reads as under:

“In order to provide statutory backing and certainty to Income Computation and Disclosure Standards (ICDS), it is proposed to amend the provisions of chapter IV-D of the Act relating to computation of business income and Chapter XIV of the Act.” (Para 28 of Annexure V to Part B of Budget speech)

This article deals with section 145A and Section 145B which have been proposed to water down the decision referred to above.

At the outset, it is important to note that proposed section 145A and section 145B will substitute existing section 145A of the Act. The proposed sections incorporate the existing provisions of section 145A and in addition thereto, provide statutory backing to certain provisions of the ICDS.

Applicability

Clause 45 of the Finance Bill, 2018 provides that existing section 145A of the Act shall be substituted and shall be deemed to have been substituted with effect from the 1st day of April, 2017. It means both the sections are applicable from 1st April, 2017. (i.e. applicable from the assessment year 2017-18). One may wonder that how these provisions are proposed to be made effective from 1st April, 2017 and the reason for the same is explained in the memorandum reads as under:

“Recent judicial pronouncements have raised doubts on the legitimacy of the notified ICDS. However, a large number of taxpayers have already complied with the provisions of ICDS for computing income for assessment year 2017-18. In order to regularise the compliance with the notified ICDS by large number of taxpayers so as to prevent any further inconvenience to them, it is proposed to bring the amendments retrospectively with effect from 1st April, 2017 i.e. the date on which the ICDS was made effective and will, accordingly, apply in relation to assessment year 2017-18 and subsequent assessment years.”

No doubt it is definitely a welcome move to protect taxpayers who had already gone ahead and complied with the said “ICDS” while furnishing their income tax returns for the assessment year 2017-18. However at the same time a question arises what will happen to other taxpayers who have filed their Income Tax returns by taking a stand which was in consonance with the law as it then stood. In this entire process, protracted litigation on various issues may arise.

Now we proceed to discuss proposed section 145A of the Act as under:

Provisions of section 145A

“‘145A. For the purpose of determining the income chargeable under the head “Profits and Gains of business or profession”,––

(i) the valuation of inventory shall be made at lower of actual cost or net realisable value computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145;

(ii) the valuation of purchase and sale of goods or services and of inventory shall be adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods or services to the place of its location and condition as on the date of valuation;

(iii) the inventory being securities not listed on a recognised stock exchange, or listed but not quoted on a recognised stock exchange with regularity from time to time, shall be valued at actual cost initially recognised in accordance with the income computation and disclosure standards

(iv) the inventory being securities other than those referred to in clause (iii), shall be valued at lower of actual cost or net realisable value in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145:

Provided that the comparison of actual cost and net realisable value of securities shall be made category-wise.

Explanation 1.–For the purposes of this section, any tax, duty, cess or fee (by whatever name called ) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment.

Explanation 2. –For the purposes of this section, “recognised stock exchange” shall have the meaning assigned to it in clause (ii) of Explanation 1 to clause (5) of section 43.”

Overview of section 145A

Proposed section 145A has limited application to the extent of “determination” of income under the head “Profit and gains from business or profession”. It means the proposed section neither affects maintainance of books of accounts nor method of accounting regularly employed under section 145 of the Act. Further the said section has applicability while determining the income under the head “profit and gains from business or profession” meaning thereby the said section cannot be pressed into service while dealing with other heads of income. The said section contains four clauses out of which three clauses other than clause (ii) refer to the ICDS. Clause (ii) of the proposed section is similar to existing section 145A(a) of the Act. The said section is divided into four parts and each part is discussed at length as under:

Analysis of clause (i) of section 145A

From the plain reading of the aforesaid clause, following points emerge:

1) The clause has applicability for valuation of inventory.

Though the entire focus of the said clause is to value “Inventory”, the definition of the same is nowhere provided in the Act. In absence of any precise definition of the same in the Act, some issues may arise. However, at the same time, it must be borne in mind that the said term “inventory is defined in ICDS II at paragraph 2(1)(a) which is as under:

a. Held for sale in ordinary course of business

b. In the process of production for such sale

c. In the form of materials for supplies to be consumed in the production process on in the rendering of services.

In view of the same, it will be advisable to adopt the definition of “inventory” which has already been given in ICDS II to avoid unnecessary litigation.

2) It uses the verb “shall” and means that valuation of the inventory at lower of actual cost or net realisable value is mandatory and not optional.

From the plain reading, it emerges that there is no option given to assessees to value the inventory at their own discretion and valuation of inventory at lower of actual cost or net realisable value is mandatory.

3) Valuation of inventory shall be at lower of cost or net realisable value computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145.

Though valuation of inventory was never provided on the statute book before, judicial forums including Hon’ble Apex Court on various occasions have accepted the principle to value the inventory at lower of cost or net realisable value based on commercial accounting principles and accounting standard – 2 dealing with valuation of inventory issued by the Institute of Chartered Accountants of India. The distinction is that the clause categorically uses the phrase “in accordance with” the income computation and disclosure standards notified under sub-section (2) of section 145 meaning thereby cost or net realisable value is required to be computed in accordance with the ICDS notified under section 145(2) of the Act which deals with valuation of inventories.

Analysis of clause (ii) of section 145A

Clause (ii) of proposed section 145A read with explanation 1 is similar to existing section 145A(a) of the Act. However, it is pertinent to note that the proposed provision also covers valuation of purchases or sale of services which in not currently covered by existing section 145A of the Act. As per the proposed amendment, while valuing purchases and sales of services, items enumerated in section 145A(ii) are required to be included henceforth. Since the said clause is similar to existing section 145A(a) of the Act, a detailed analysis of interpretation of terms such as tax, duty, cess or fees or any other phrase as appearing in the section is not made in this article and one may refer to decisions on the subject matter as and when required.

At this juncture, it is extremely important to deal with a major difference between existing section 145A(a) and section 145A(ii). It is pertinent to note that existing section 145A appearing on the statute clearly overrides section 145 of the Act. It means a method of accounting regularly employed by an assessee is not a relevant factor for applicability of section 145A(a) of the Act and in view of the same, all assessees irrespective of their system of accounting are required to adhere to section 145A(a) of the Act for arriving at valuation of purchases, sales of goods and of inventory while determining income chargeable under the head profit and gains from business or profession.

Now if one comes to proposed section 145A(ii), the said section does not override section 145 of the Act in the first place meaning thereby a system of accounting regularly employed by an assessee under section 145 of the Act still holds field and is relevant while dealing with section 145A(ii). It means both sections will operative simultaneously and conflict with each other. Keeping the same in mind, a question arises for consideration whether a method of accounting will make a difference for applicability of the said clause in absence of an overriding effect. That is to say an assessee computing his business profits as per the cash system of accounting can take a shelter and say that he is not under obligation to adjust any tax, duty, cess or fee as mentioned in section 145A(ii) while determining valuation of sales, purchases of goods, services or inventory unless such tax, duty, cess or fee are actually paid or received.

There is another interesting issue that crops up while interpretation of the proposed section along with section 145 of the Act. As mentioned earlier, existing section 145A which overrides section 145 of the Act is mainly divided into proposed section 145A(ii) and section 145B(1). It is interesting to note that though both the proposed provisions are substantially extracted from existing section 145A of the Act, it appears that an overriding effect of existing section 145A is restricted only to section 145B (1) and not extended to section 145A(ii). It means section 145 of the Act will operative in toto and will not get overridden by proposed section 145A(ii). In view of the same, a question arises for consideration whether it is possible to contend that in absence of an overriding effect to the provision of section 145 of the Act, profits and gains from business or profession computed as per chapter IV-D read with section 145 of the Act without giving any effect to section 145A(ii) are correct profits which cannot be disturbed. This aggressive interpretation seems to be possible. Needless to say, it may invite litigation.

Analysis of clauses (iii) and (iv) of section 145A

Since both the clauses deal with valuation of securities held as inventory, the same are analysed together and two major differences with regard to the same are tabulated as under:

Differences between clauses (iii) and (iv) of section 145A

Particulars Section 145A(iii) Section 145A(iv)
Types of securities The said clause deals with following two types of securities: 1) Securities not listed on recognised stock exchange. 2) Securities listed but not quoted on a recognised stock exchange with regularity from time-to-time. The said clause is residuary in nature. It covers all securities which are not covered in clause (iii)
Valuation It is to be valued at actual cost initially recognised in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145. It is to be valued at lower of actual cost or net realisable value in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145. Provided that the comparison of actual cost and net realisable value of securities shall be made category-wise.

Common points applicable to both the clauses

For both the clauses, the term “securities” is not defined in the said section. However, one may refer to the definition given in ICDS-VIII dealing with ”Securities” for the same. From both the clauses, it is apparent that valuation of securities is mandatory and not optional. Further it is worth noting that both the clauses categorically mention that “actual cost” and “net realisable value “, as the case may be, are required to be determined only “in accordance with” the income computation and disclosure standards notified under sub-section (2) of section 145. Though the said clauses do not give specific reference to any ICDS, it is implied that ICDS-VIII which deals with “securities” has application for determination of “actual cost” or “net realisable value” for valuation of securities.

Special points applicable to clause (iii) of section 145A

It is pertinent to note that clause (iii) contains the term “recognised stock exchange” which is mentioned in explanation 2 of the said section. Further one of the types of securities covered in the said clause is “Securities listed but not quoted on a recognised stock exchange with regularity from time-to-ime”. In view of the same, how the term regularity is to be interpreted will be a main question while interpreting the said clause.

Special points applicable to clause (iv) of section 145A

The proviso to section 145A(iv) states that while comparing actual cost or net realisable value of securities, the comparison is to be done category wise. It is worth noting that the said proviso is similar to para 10 of ICDS VIII. However, the proviso does not mention how securities are required to be classified under different categories which is provided in the said ICDS. In view of the same, it is advisable to classify securities as mentioned in ICDS-VIII.

Now we proceed to discuss section 145B at this juncture. Broadly, section 145B contains three sub-sections:

Provision of section 145B(1)

“(1) Notwithstanding anything to the contrary contained in section 145, the interest received by an assessee on any compensation or on enhanced compensation, as the case may be, shall be deemed to be the income of the previous year in which it is received.”

Analysis of Section 145B(1)

Section 145B(1) is a replica of existing section 145A(b) of the Act which deals with interest on compensation or enhanced compensation. The section provides that the interest on compensation or enhanced compensation shall be deemed to be the income of the previous year in which it is received. It is pertinent to note that since the existing provision of section 145A from which section 145B (1) is extracted overrides section 145 of the Act to the extent it is contrary, proposed section 145B(1) also overrides section 145 of the Act in the same manner and starts with the phrase “Notwithstanding anything to the contrary contained in section 145”. It is necessary to appreciate that the application of proposed section 145B(1) is exactly identical to that of existing section 145A(b) of the Act. Keeping the said aspect in mind, it may not be out of place to mention that all judicial propositions rendered in the context of Section 145A(b) till date will hold the field and squarely apply to section 145B(1). As mentioned above, since proposed section 145B (1) is placed on the same lines of existing section 145A(b) of the Act, the detailed analysis of the proposed section is not done in this article.

Provision of section 145B (2)

“(2) Any claim for escalation of price in a contract or export incentives shall be deemed to be the income of the previous year in which reasonable certainty of its realisation is achieved.”

Analysis of Section 145B(2)

The above-mentioned section deals with two types of income:

1. Any claim for escalation of price in a contract

2. Export incentives

The section provides for year of chargeability with regard to certain types of income (i.e. escalation claim in a contract and export incentives) mentioned therein. As per the proposed amendment, the – two incomes would be chargeable to tax only in the year in which reasonable certainty of its realisation is achieved. Though the said section may appear simple on the statute book, its application in reality will be the toughest task for taxpayers as well as the department. Determination of a particular year in which reasonable certainty of collection is achieved, is a factual aspect and litigation may arise in that regard.

With regard to inclusion of export incentives in the said section, It is appears that the said provision is proposed to be inserted to overrule the observation of Hon’ble Delhi High Court in the decision referred to above in which Hon’ble High Court while dealing with para 5 of ICDS IV which deals with Revenue recognition concluded that the said paragraph is contrary to the decision of Hon’ble Apex Court in “CIT versus Excel Industries Ltd” 358 ITR 295 and is therefore held ultra vires.

Now as per the proposed amendment, an assessee is required to ffer export incentives as income of the year in which reasonable certainty of its collection is achieved.

Looking at the types of incomes specified in the proposed section, it is certain that both the types relate to business and the same would fall under the head “profit and gains from business or profession” It is equally important to note that as per section 145 of the Act, the income under the heads “profit and gains from business or profession and income from other sources” shall subject to provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by an assessee. From plain language of section 145B(2) and section 145 of the Act, it appears that there is a conflict regarding recognition of the same for assessees who maintain their accounts on cash system as per section 145 of the Act. A close look between section 145B(1) and section 145B(2) clarifies that unlike section 145B(1), section 145B(2) does not override section 145 of the Act. In view of the same, a question arises for consideration whether the aforesaid section that creates a deeming fiction has any applicability for assessees who determine their business income on cash system of accounting as per section 145 of the Act because the well settled proposition demands that a person opting for the cash system of accounting is not under any obligation to recognise any income or expense unless the same is followed by actual cash inflows/outflows. There appears to be a great conflict between section 145 and section 145B(2) which does not appear to have been considered. If the said conflict is not resolved properly, litigation may arise.

Provision of section 145B(3)

“(3) The income referred to in sub-clause (xviii) of clause (24) of section 2 shall be deemed to be the income of the previous year in which it is received, if not charged to income-tax in any earlier previous year.”

Analysis of Section 145B(3)

The above-mentioned provision is proposed to overrule the observation of Hon’ble Delhi High Court in regard to para 4(2) of ICDS VII which deals with Government grants. The said para enumerated that “recognition of Government grant shall not be postponed beyond the date of actual receipt. “While dealing with the said paragraph, Hon’ble High court observed that it is contrary to the well-settled principle of accrual system of accounting and held the same as same ultra vires.

In response to the same, the section is proposed to be inserted. The said section covers the income referred to in section 2(24)(XViii) of the Act and brings the same as deemed income of the previous year in which it is received. However to avoid double taxation of the same income, the said section provides an exception and brings the same to tax in the year of receipt only if such income is not charged to tax in any earlier previous year.

Conclusion

The intention behind proposed sections 145A and 145B is to provide clarity in computing income under the head “profits and gains from business or profession” and achieve certainty with regard to the same. However the manner in which the provisions have been drafted may lead to a fresh round of litigation defeating the purpose.

Introduction

1. An assessee may withdraw/convert/treat his stock in trade and hold it as a capital asset if there are changes in facts and circumstances necessitating such conversion.

2. Conversion of stock-in-trade to capital asset may also result into advantage of lower taxes since capital gains are taxed at a lower rate compared to business income and there is also an advantage of indexation. Therefore, many a times we see builders convert their stock-in-trade i.e. land into a capital asset or a share trader converts his stock-in-trade of shares into investment. Such conversion was
usually not treated as taxable by the
taxpayer and consequently on sale of such investment, taxes as applicable to capital gains were paid.

3. However, the Income tax department disputed the veracity of such conversion in the year of sale and taxed the income arising on sale of investment as a business income. For example, in many cases it was seen that a share trader converted his stock of shares as on 31-3-2004 into investment as from AY 05-06, LTCG was tax free and STCG was taxed at a lower rate. Thus when the shares were sold after one year of conversion, assessee would claim income on sale as income arising on sale of investment and consequently claim LTCG as exempt. However, the A.O. would treat such gains as business income.

4. Thus, when an inventory is converted into a capital asset, several issues regarding taxability of said transaction arise. Some of the issues are as under:

(i) Whether conversion of inventory into a capital asset is permitted by law?

(ii) Whether AO can dispute such conversion?

(iii) Whether such conversion gives rise to a taxable event?

(iv) If there is a taxable event upon conversion, then what is the sale consideration and when is the tax to be paid i.e., in the year in which there is sale of capital asset or in the year of conversion itself?

(v) What should be taken as the cost of acquisition of the capital asset post conversion and what will be the period of holding of the capital asset?

5. The above issues on conversion have arisen from a very long time and different assessees have given different treatments upon such conversion. However, unlike Section 45(2) which provides for taxability in the case of conversion of a capital asset into stock-in-trade, there were no specific provisions dealing with a reverse situation i.e taxability arising on conversion of Inventory into Capital Assets.

Proposed Amendment

6. The Finance Bill, 2018 proposes to make amendments to following provisions:

(i) Section 28, by inserting clause (via) so as to provide that the fair market value of inventory as on the date on which it is converted into, or treated as a capital asset determined in the prescribed manner shall be charged to tax as business income.

(ii) Section 2(24), by inserting clause (xiia) so as to include such fair market value in the definition of income;

(iii) Section 49, by inserting Sub-Section (9) so as to provide that for the purposes of computation of capital gains arising on transfer of such capital assets, the fair market value on the date of conversion shall be the cost of acquisition;

(iv) Clause (42A) of section 2, by inserting clause (ba) in Explanation 1 clause(i), so as to provide that the period of holding of such capital asset shall be reckoned from the date of conversion or treatment.

Reason for proposed amendments

7. As per the Memorandum explaining the provisions, the reason for proposed amendment are two fold as under :

(i) To provide symmetrical treatment like treatment provided for conversion of capital asset into stock-in-trade u/s. 45(2).

(ii) To discourage the practice of deferring the tax payment by converting the inventory into capital asset.

Effective date of proposed amendments

8. These amendments will take effect from 1st April, 2019 and will, accordingly, apply in relation to the assessment year 2019-20 and subsequent assessment years.

Analysis

9. It is important to analyse the pre-amended law to know the difference between the pre-amended law and post-amended law. Further, the conversions which have taken place prior to the proposed amendments would be governed by the pre-amended law.

10. The pre-amended law is essentially derived from judicial precedents. Some of the important decisions and the legal principles laid down by them are as under:

A. NO TAXABLE EVENT ON CONVERSION OF INVENTORY INTO CAPITAL ASSET

Sir Kikabhai Premchand v CIT (1953) 24 ITR 506 (SC).

This a landmark decision which forms the fulcrum of various subsequent decisions on the issue of conversion of stock-in-trade into capital asset. This was a Judgment rendered by a Full Bench (5 Judges) and the verdict was a split in the ratio of 4:1. The judgment deals with the tax treatment in the year of conversion. In this case, assessee a trader in silver bars and shares was valuing the stock at cost. During the relevant previous year the assessee withdrew from the business certain shares and silver bars and settled then or certain trusts at cost. The AO assessed the profit at the difference between the cost price of the said shares and silver bars and the market value thereof at the date of their withdrawal from the business. The High Court confirmed the action of the AO. Reversing the decision of the High Court, the Supreme court held, speaking through Bose, J. for the majority view :

(i) A man cannot be compelled to make a profit out of any particular transaction.

(ii) It is wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent.

(iii) The position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the face of it is not only absurd but against all canons of mercantile and income-tax law.

(iv) Under the Income-tax Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains made in the relevant accounting year.

Thus, as per this decision there is no taxable event arising on conversion of inventory into Capital Asset.

At this juncture, it will be very important to consider the dissenting view of Bhagwati, J who held as under :

(i) So far as the business is concerned the asset ceases to be a part of the stock-in-trade whether it is realised or is withdrawn from the stock-in-trade. It makes not the slightest difference whether an asset is realised in the course of the business or is withdrawn from the stock-in-trade of the business.

(ii) So far as the business is concerned it is entitled to credit in its goods account the price of that asset as has been realised by the sale thereof or the market value of that asset as at the date of its withdrawal.

Thus, as per the dissenting view there is a taxable event arising on conversion of inventory into capital asset and market value of the stock-in-trade shall be the sale consideration.

Interestingly one can see that the minority view is now the proposed amended law and the majority view is set at naught by the Parliament.

In CIT v. Dhanuka & Sons [1980] 124 ITR 24 (Cal.)(HC) while dealing with the assessment in the year of conversion, on considering Sir Kikabhai Premchand’s case (supra) and several other judgments had expressed as under:–

“14. Further, in our view, there cannot be any actual profit or loss in such transfers where no third party is involved and the items are kept in a different account of the assessee himself. The question of gain or loss would arise in the facts of the instant case only in future when the stocks transferred to the investment account might be dealt with by the assessee. If such shares be disposed of at a value other than the value at which it was transferred from the business stock, the question of capital loss or capital gain would arise.”

Thus, conversion did not result into any taxable event and taxable event takes place only upon subsequent sale of capital asset giving rise to capital gains tax only.

In ACIT v. Bright Star Investment (P.) Ltd. [2009] 120 TTJ 498 (Mum)(Trib) assessee had converted some shares from stock-in-trade to investment as on 1-4-1998 at its book value. Thereafter, the assessee sold some of the shares out of the above shares and offered profit earned as long-term capital gain. The Assessing Officer opined that in view of the provisions laid down under section 45(2) the income of the assessee would be computed separately as business income till the date of conversion of the shares from the stock to investment and thereafter as long-term capital gain. The Assessing Officer, therefore, took the highest market rate of the said shares on date of conversion and computed the business income, being the difference in the value at which the said shares were converted into investment and the market value of the said shares on the date of conversion, i.e., 1-4-1998 and, further computed the long-term capital gain at ₹ 4,57,62,262 being the difference between the market value and the actual sale value of the shares. The Hon’ble ITAT held as under :

(i) While incorporating sub-section (2) to section 45, the Legislature has not visualised the situation in other way round, where the stock-in-trade is to be converted into the investment and later on the investment is sold on profit. In the absence of a specific provision to deal with this type of situation, a rational formula should be worked out to determine the profits and gains on transfer of the asset.

(ii) The formula which was adopted by the assessees i.e., the difference between the sale price of the shares and the cost of acquisition of share, which is the book value on the date of conversion with indexation from the date of conversion, should be computed as a capital gain was to be accepted.

It is to be noted that no appeal against the above decision was filed by the Department. However the Income Tax Department filed an appeal before the Bombay High Court in the case of
Synchem Chemicals (I) Ltd. reported in CIT-10 v. Synchem Chemicals (I) Ltd. [2016] 384 ITR 498 (Bom.)(HC) wherein the ITAT had followed the decision of
ACIT v. Bright Star Investment (P.) Ltd. (supra). The Department appeal was dismissed by the High Court.

B. COST OF ACQUISITION AND INDEXATION

In the case of Kalyani Exports & Investment (P.) Ltd./Jannhavi Investment (P.) Ltd./Rajgad Trading (P.) Ltd. v. Dy. CIT [2001] 78 ITD 95 (Pune) (TM) assessee acquired certain shares in the year 1977. On the original holding they received bonus shares in the financial year 1981-82 and additional bonus shares in the financial year 1989-90. All the shares were held as stock-in-trade till 6-11-1987. On the sale of the shares, while working out capital gain, assessee computed fair market price as on
1-4-1981. Indexation was also claimed by taking base year as AY 1981-82. The Assessing Officer held that since the assessee was holding the shares as stock-in-trade up to 2-11-1987 and as the said shares were not capital assets as on 1-4-1981, the option adopted as fair market price as on 1-4-1981 was not available to the assessee and indexation should be allowed from the year of conversion. The Tribunal held as under :

(i) There can be only one acquisition of an asset and that when the assessee acquires it for the first time, irrespective of its character at that point of time. It was therefore, held that what is relevant for the purpose of capital gains is the cost of acquisition and not the date at which the asset became a capital asset. Thus, FMV as on 1-4-1981 was to be taken as cost as acquisition.

(ii) Indexation has to be taken from the Base Year 1981-82.

The above decision of the ITAT has been confirmed by the Bombay High Court in CIT v. Jannhavi Investment Pvt. Ltd. [2008] 304 ITR 276 (Bom)(HC) The High Court held as under :

“In our view, there is no substance in the contention of the Revenue. The amendment of 1993 referred to hereinabove does not in any way nullify or dilute the ratio as laid down in the case of
Keshavji Karsondas v. CIT reported in [1994] 207 ITR 737 (Bom.) The cost of acquisition can only be the cost on the date of the actual acquisition. In the present case, there was no acquisition of the shares on November 6, 1987, when the same were converted from stock-in-trade to a capital asset.”

C. PERIOD OF HOLDING

In Splendor Constructions (P.) Ltd. v. ITO [2009] 27 SOT 39 (Del.)(Trib.) and Deensons Trading Pvt. Co. Ltd. v. ITO [2017] 81 taxmann.com 71 (Chennai – Trib.) it was held that holding period was to be counted from the date of conversion and not from the date of acquisition. The decisions also held that the Third Member decision of ITAT in the case of Jahannvi Investment Pvt. Ltd. (supra) related to cost of acquisition and not period of holding.

D. DISPUTING THE VERACITY OF CONVERSION

In CIT-Delhi v. Abhinandan Investment Ltd. [2016] 282 CTR 466 (Delhi) the year of conversion of stock-in-trade into investment and the year of sale of investment was the same. The conversion was not accepted by the Court. It was held as under :

(i) The exercise of conversion was seen as sham to reduce tax incidence and consequently the conversion was not recognised.

(ii) The period of holding is to be computed from date of conversion

(iii) The Court gave a prima facie view that on sale of investment/converted stock-in-trade, cost of acquisition could be the market value as on the date of conversion. Further, in the year of sale of investment, difference between market value and book value as on date of conversion should be assessed as business income and balance as capital gains. However, it is to be noted that the Court did not finally decide the issue and left the question open to be decided in an appropriate case.

Similarly the Mumbai ITAT in Mr Kenneth D’Souza v. Addl. CIT ITA No 865/M/2012 A.Y. 2008-09 dtd. 6-2-2015 (Mum)(Trib.)
also did not uphold the validity of conversion of stock-in-trade of shares into investments on the ground that Assessee had not shown any material change in facts justifying such conversion. The decision of ITAT was confirmed by the Bombay High Court in Kenneth D’Souza v. Addln CIT ITA No 770/M/15 dtd 24-1-2018(Bom.)(HC).

However, in Deeplok Financial Services Ltd. v. CIT [2017] 393 ITR 395 (Cal)(HC) the claim of assessee regarding conversion of stock in trade into investment in earlier year and return of capital gains in year of sale of converted stock-in-trade was accepted. It was held as under :

(i) Section 45(2) of the Act provides for conversion by the owner of a capital asset into or its treatment by him as stock-in-trade of a business carried on by him as chargeable to income-tax . The Act however does not provide for the conversion of stock-in-trade into capital asset.

(ii) Conversion of stock-in-trade into Investment is permissible even though the Income-tax Act does not provide for the same.

It appears that the above decision has acted as a trigger for the proposed amendment.

11. Thus the pre-amended position can be summed up as under:

a) Though conversion is permissible in law, veracity of such conversion can be disputed by the AO.

b) Conversion does not give rise to any taxable event.

c) Taxable event arises only upon subsequent sale of capital asset and the gains will be taxable as capital gains. It is to be noted that the observation of
Delhi HC in CIT-Delhi v. Abhinandan Investment Ltd. (supra) was only a prima facie view and not a conclusive decision.

d) The cost of acquisition shall be the actual cost of acquiring the asset. However, in
ACIT v. Bright Star Investment (P.) Ltd. (supra) the ITAT accepted the Book Value of stock- in-trade as on the date of conversion as cost of acquisition.

e) For classifying gains as short term capital gains or Long Term capital gains, period of holding is to be computed from date of conversion.

12. Having analysed the pre-amended law, I will now proceed to analyse the post-amended law as under :

A. CONVERSION OF INVENTORY INTO STOCK IN TRADE RESULTS IN A TAXABLE EVENT

By virtue of amending Section 28 by inserting clause (via) it is provided that the fair market value of inventory as on the date on which it is converted into, or treated as a capital asset shall be charged to tax as business income. Consequently Section 2(24) is amended by inserting clause (xiia) so as to include such fair market value in the definition of income. Thus, FMV as on the date of conversion will be taken as income u/s. 28.

B. YEAR OF TAXABILITY SHALL BE THE YEAR OF CONVERSION

The year of taxability shall be the year of conversion itself. The reason for same is as under :

(i) The amendment is in accordance with the principle laid down by the minority view in Sir Kikabhai Premchand v. CIT (Supra) according to which there is a taxable event upon conversion. The minority view did not consider the principle of trading with oneself as applicable to the situation of conversion of stock-in-trade into capital asset. Hence, there is no merit in the argument that the business income arising on conversion is to taxed in the year of sale of capital asset.

(ii) Section 45(2) specifically provides that gain on conversion is to be taxed the year of sale of stock-in-trade. No such provision is incorporated w.r.t. conversion of stock-in- trade into investment.

(iii) The memorandum explaining the provisions clearly state the one of the objectives of the proposed amendments is to discourage the practice of deferring the tax payment
by converting the inventory into capital asset.

(iv) The FMV as on date of conversion is itself income as per Section 2(24). Hence, there is no reason for deferring the incidence of tax to the year of sale of Capital Asset.

C. FAIR MARKET VALUE

The FMV as on the date of conversion/treatment as capital asset shall be taken into consideration. Definition of FMV in relation to ‘capital asset’ has been provided in clause (22B) of Section 2 to be a value which it can fetch in the open market. However the same will not apply in this case as this clause requires FMV in relation to ‘Inventory’ and further in this clause it is provided that FMV of inventory shall be determined in the prescribed manner. It is to be noted that under the Income- tax Act FMV is not always the value which an asset can fetch in the open market. For instance under Rules 11U and UA, FMV is not always the value which can be fetched in the open market. Thus, one will have to wait for the CBDT to prescribe the valuation rules.

D. INCOME

The amount to be taken as income is the entire FMV. This is because the difference between the FMV and the Book Value of opening stock will be adjusted in the trading account itself. For example, In AY 19-20 stock in trade being one share is purchased for ₹ 100. The closing stock is valued at ₹ 90. Hence, a loss of ₹ 10 will be booked in AY 2019-20. The share is converted to investment in the middle of AY 20-21. The FMV as on date of conversion was ₹ 200. For computation of income under Section 28(via) ₹ 200 will have to be taken and not ₹ 200-90. This is because the difference of ₹ 110 will be adjusted in the trading and P/L A/C itself.

E. COST OF ACQUISITION ON SUBSEQUENT SALE OF CAPITAL ASSET

Section 49(9) provides that for the purposes of computation of capital gains arising on transfer of such capital assets, the fair market value on the date of conversion shall be the cost of acquisition.

F. PERIOD OF HOLDING

Clause (42A) of section 2, by inserting clause (ba) in Explanation 1 clause (i), provides that the period of holding of such capital asset shall be reckoned from the date of conversion or treatment.

G. CERTAIN ISSUES

(i) The conversion of stock-in-trade into investment has now been given a statutory mandate. Suppose, there is a claim of loss on account of conversion of certain stock- in-trade which is adjusted against business profits and according to AO the conversion is done for the purpose of reducing profits. Though ultimately the amount of profit which will be brought to tax may not change but there is a deference. Can the AO dispute the conversion? According to me, AO can no longer dispute the conversions which take place after the proposed amendments are brought into effect as conversion of stock-in-trade into investment is statutorily recognised and there is no provision putting any pre-conditions for conversion.

(ii) A situation may arise where no tax is paid upon conversion. The converted stock-in-trade is sold after 10 years. There is no way the gain of conversion can be taxed after 10 years. The issue will arise regarding adoption of cost of acquisition i.e., whether FMV as on date of conversion can be adopted. The proposed provision of Section 49(9) states that FMV as on the date of conversion will be the cost of acquisition. It does not state that FMV will be cost of acquisition only if gains on conversion are offered to tax.

Conclusion

13 As pointed out above, the proposed amendments completely disregard the fundamental principles of Income Tax Act such as “no man can trade with himself” or that “no one can profit from oneself” . It was on these principles that the Supreme Court in
Sir Kikabhai Premchand v CIT (Supra) held that there is no taxable event upon conversion. It further held that State has no power to tax potential profits. This amendment is a part and parcel of the recent trend to tax
deemed/ notional income instead of taxing real income.

14 From the analysis of the pre-amended law, it can be seen that almost all issues arising on conversion were no longer res-integra and were perhaps settled after years of litigation. The situation is similar to introducing penalty provisions u/s. 270A though the law on penalty u/s. 271(1)(c) was almost settled after several years of litigation.

15 The Supreme Court in Sir Kikabhai’s case also highlighted the freedom of businessman to deal with his business in the manner he likes by way of an illustration. It appears that such freedom now stands impinged. I would conclude by reproducing the said illustration which would aptly manifest the contrast between the pre-amended law and post-amended law :

“A man trades in rice and also uses rice for his family consumption. The bags are all stored in one godown and he draws upon his stock as and when he finds it necessary to do so, now for his business, now for his own use. What he keeps for his own personal use cannot be taxed however much the market rises; nor can he be taxed on what he gives away from his own personal stock, nor, so far as his shop is concerned, can he be compelled to sell at a profit. If he keeps two sets of books and enters in one all the bags which go into his personal godown and in the other the rice which is withdrawn from the godown into his shop, rice just sufficient to meet the day-to-day demands of his customers so that only a negligible quantity is left over in the shop after each day’s sales, his private and personal dealings with the bags in his personal godown could not be taxed unless he sells them at profit. What he chooses to do with the rice in his godown is no concern of the Income-tax department provided always that he does not sell it or otherwise make a profit out of it. He can consume it, or give it away, or just let it rot. Why should it make a difference if instead of keeping two sets of books he keeps only one? How can he be said to have made an income personally or his business a profit, because he uses ten bags out of his godown for a feast for the marriage of his daughter? How can it make any difference whether the bags are shifted directly from the godown to the kitchen or from the godown to the shop and from the shop to the kitchen, or from the shop back to the godown and from there to the kitchen? And yet, when the reasoning of the learned Attorney-General is pushed to its logical conclusion, the form of the transaction is of its essence and it is taxable or not according to the route the rice takes from the godown to the wedding feast. In our opinion, it would make no difference if the man instead of giving the feast himself hands over the rice to his daughter as a gift for the marriage festivities of her son.”

I. Introduction

1) Since the Union Budget for the fiscal year 2012-13 presented on 16th March 2012, and all budgets thereafter, we have seen the direct tax proposals being assiduously organised into various heads. While some of these heads represent the disposition of Government’s policies such as
Ease of doing business, Make in India and Swachchh Bharat, some other heads denote the transient and ad hoc nature of yearly budgetary exercise such as
Rationalisation measures and Tax incentives and reliefs. But there is one head – Widening of tax base – which has figured in some form or the other in direct tax proposals for most budgets during the years 2012 till 2018.

2) The focus of the Government in the recent years has been to boost socio-economic growth, improve investment climate, promote affordable housing and provide fillip to digital economy. All these laudable objectives require funds and one way to generate funds is through tax revenues. To fund them, the Government has been broadening the tax base by bringing in more and more types of transactions within the tax net and also mobilising additional resources to generate higher tax revenues. As a result, the growth rate of direct taxes in the financial years 2016-17 and 2017-18 has been significant at 12.6% and 18.7% (till 15th January 2018) respectively. The number of effective taxpayer base has increased from ₹ 6.47 crores at the beginning of financial year 2014-15 to ₹ 8.27 crores at the end of financial year 16-171.

3) One such measure aimed at widening the tax base proposed in the Budget for the year 2018-19 is amendment to provisions relating to dividends under Section 2(22) of the Income-tax Act, 1961 (the “Act”) and to Dividend Distribution Tax (“DDT”) under Sections 115-O and 115R.

II. Taxation of dividends – Existing scheme

4) As per Section 8 of the Act, any dividend declared by a company or distributed/ paid by it within the meaning of sub-clauses (a) to (e) of Section 2(22) is includible in assessee’s total income. As per Section 2(22), dividend includes:

i. distribution by a company of accumulated profits if such distribution entails the release of company’s assets [Clause (a)];

ii. distribution by a company to shareholders of debentures, debenture-stock, or deposit certificates and any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits [Clause (b)];

iii. distribution to shareholders on liquidation of company [Clause (c)];

iv. distribution to shareholders on reduction of share capital [Clause (d)];

v. advance or loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or payment for such shareholder’s individual benefit [Clause (e)].

5) Except for dividends referred to in sub-clause (e) of Section 2(22), DDT is payable by the company @ 15% on the amount of dividends declared/distributed. Consequently, dividend is exempt in the hands of the recipient by virtue of Section 10(34) of the Act, subject to provisions of Section 115BBDA as per which the amount of dividend in excess of ₹ 10 lakhs in a year received by a resident individual, Hindu undivided family or a firm is taxable @ 10%.

6) Under the existing scheme, deemed dividend referred to in sub-clause (e) of Section 2(22) is taxable in the hands of the shareholder/recipient and DDT is not payable thereon by the payer-company.

III. Proposed amendments and analysis

A. Expansion of scope of “accumulated profits”

III(A)(i) Amendment in brief

7) The dividend referred to in the clauses of Section 2(22) intends to cover distribution/payment to the extent of accumulated profits of the company, whether capitalized or not. The scope of “accumulated profits” is set out in Explanation 1 and Explanation 2 below Section 2(22). As per Explanation 2, the expression “accumulated profits” in sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in sub-clause (c) shall include all profits of the company up to the date of liquidation, but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place.

8) Explanation 2A is proposed to be added after Explanation 2 to expand the scope of “accumulated profits” to provide that in case of an amalgamated company, the accumulated profits, whether capitalised or not, or loss, as the case may be, shall be increased by the accumulated profits, whether capitalised or not, of the amalgamating company on the date of amalgamation.

9) The expanded scope will apply to distributions/ payments made on or after 1st April, 2018.

III(A)(ii) Analysis of amendment

10) The expansive scope of the term “accumulated profits” would mean that not only the profits of the company in question are to be considered for determining accumulated profits but even profits of a company which gets amalgamated into the company in question should be considered. E.g. X Limited merges into Y Limited. The accumulated profits of X Limited as on date of amalgamation is ₹ 100 and that of Y Limited as on date of distribution is ₹ 500. Y Limited distributes dividend of nature referable to any of the clauses in Section 2(22) to its shareholders. The accumulated profits of Y Limited for the purpose of computing the amount of “dividend” shall be ₹ 600.

11) The reason for expanding the scope of “accumulated profits”, as stated in the Memorandum explaining provisions of Finance Bill, 2018 (the “Memorandum”), is to get over abusive arrangements whereby a company with large accumulated profits amalgamate into a company with less accumulated profits and the amalgamated company would distribute/ pay dividend out of the accumulated profits of the amalgamating company. In this fashion, the amalgamated company would circumvent the provisions as the accumulated profits would be less. In the case of ACIT v. Gautam Sarabhai Trust No. 23 reported in [2002] 81 ITD 677 (Ahd.), the Ahmedabad Bench of the Income-tax Appellate Tribunal (the “Tribunal”) had the occasion to deal with one such case. In this case, the Tribunal held that profits in balance sheet of amalgamating company could not be treated as accumulated profits of amalgamated company and surplus realised by amalgamating company and capitalised by issue of paid-up capital would not be covered under the expression “accumulated profits”.

12) Though the Memorandum does not make reference to this judgment of the Tribunal, the amendment intends to get over arrangements such as the one in that case i.e., of reverse mergers (where large/ profit making company gets amalgamated into a smaller/ loss making company).

13) The intention behind the amendment is to prevent abusive arrangements and not to extend any benefit in the form of reduction of losses of the amalgamating company from profits of amalgamated company. Therefore, the language of Explanation 2A has been carefully worded and refers to “accumulated profits, whether capitalised or not, or loss” of the amalgamated company but refers only to “accumulated profits, whether capitalised or not” of the amalgamating company. The absence of the words “or loss” when referring to amalgamating company makes the intention of the legislature clear that no benefit of losses of amalgamating company would be available to the amalgamated company for reduction from the latter’s accumulated profits for computing the amount of dividend. Though for income-tax purposes, it is settled that “profits” would include “loss”2, such a contention may not be possible to reduce losses of amalgamating company from accumulated profits of the amalgamated company for the purpose of Section 2(22) due to the conspicuous absence of the words “or loss” in one place and their mention in another as stated above.

III(A)(iii) Whether the amendment was necessary and its consequences?

14) The General Anti-Avoidance Rule (“GAAR”) contained in Chapter X-A of the Act is in force. These provisions are intended to tackle abusive arrangements. Therefore, one may say that adequate safeguards already exist to tackle abusive arrangements such as the ones intended to be prevented by this amendment. While giving its views on applicability and implementation of GAAR, the Central Board of Direct Taxes, in Circular No. 7 of 2017, justified the need for GAAR by stating that specific anti-avoidance provisions (commonly known as SAAR) may not address all situations of abuse, and there was need for GAAR. Now even with GAAR, the legislature has come up with a specific amendment to tackle abusive arrangements. Of course, GAAR is applicable only where the tax benefit from an impermissible avoidance arrangement is exceeds ₹ 3 crores3; the effect of this amendment would be that even amalgamations which are not intended to misuse or abuse the provisions of the Act but are driven by expediency and commercial considerations would get covered.

15) By bringing in SAAR to prevent abuse through amalgamations, the legislature has done away with the need to take approvals necessary for invoking GAAR and possibly the consequent litigation arising therefrom.

16) This will lead to significant tax impact on schemes of restructuring, rearrangements and takeovers and may become a disincentive to genuine schemes of restructuring, rearrangements and takeovers where any tax benefit is only incidental. Thus, this measure to widen the tax base is likely to impede the Ease of Doing Business.

B. DDT on dividend under sub-clause (e) of Section 2(22)

III(B)(i) Amendment in brief

17) The Explanation to Chapter XII-D of the Act pertaining to DDT provisions which provides that DDT is not payable by the company on dividend under sub-clause (e) of Section 2(22) is proposed to be deleted. As a consequence of this deletion, companies shall become liable to pay DDT on the advance or loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or payment for such shareholder’s individual benefit.

18) Furthermore, the rate of DDT in such cases is sought to be fixed at 30% as against the usual rate of 15% by inserting a proviso in sub-section (1) of Section 115-O and making sub-section (1B) inapplicable. The Memorandum states that DDT will be chargeable in such cases @ 30% without grossing up and consequently, the grossing-up provision in Section 115-O(1B) is made inapplicable.

19) The amendment will apply to transactions undertaken i.e., payments made on or after 1st April, 2018.

III(B)(ii) Analysis of amendment

20) Explanation below Chapter XII-D provided that for the purpose of DDT provisions, “dividend” would not include advance or loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or payment for such shareholder’s individual benefit [i.e. Section 2(22)(e)].

21) With the deletion of this Explanation, DDT provisions would become applicable to such transactions also and the company would have to pay DDT when it gives loan to a 10% or higher shareholder or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest or pays any amount for such shareholder’s individual benefit. The rate of DDT would be flat 30% by virtue of insertion of proviso to Section 115-O(1) and no benefit of slab rate etc., would be available. As a consequence of this amendment, the amount which was earlier includible in the hands of the shareholders would become exempt by virtue of Section 10(34) of the Act. The effect of this amendment is shifting of incidence of tax from the shareholder/ recipient to the payer-company and denial of slab rates (if applicable) to the recipient.

22) For instance, in the existing scheme, when a closely held company, Z Private Limited, would lend a sum of ₹ 100 to its shareholder (holding more than 10% shares), the shareholder would have to pay tax on ₹ 100 received by him at the marginal rates applicable to him. The benefit of slab rates and minimum exemption limit would be available to the shareholder. After the proposed amendment is incorporated, if Z Private Limited has ₹ 100 for being loaned to the shareholder and discharge tax liability thereon from such ₹ 100, it would have to set aside an amount @ 30% (plus surcharge and cess) from the amount to be actually loaned to discharge DDT liability. In such case, Z Private Limited would be able to lend only ₹ 76.92 and the balance ₹ 23.08 (i.e., 30% of the amount loaned, excluding surcharge and cess) would have to be paid as DDT by it.

III(B)(iii) Whether the amendment serves Government’s intention?

23) The rationale of this amendment, as stated in the Memorandum, is to bring clarity and certainty in the taxation of deemed dividends and prevent camouflaging dividend in the form of loans and advances. It is important to note that the charging provision for taxing loans and advances to a shareholder or to its concern or for its benefit is sub-clause (e) of Section 2(22). There is no amendment in this sub-clause or its exceptions in sub-clauses (ii). Litigation on applicability of this provision majorly revolves around the following points:

i. Whether the giving of the loan or advance constitutes ordinary course of its business for the company;

ii. Whether money lending is a substantial part of the company’s business;

iii. Interpretation of beneficial owner vis-à-vis registered owner;

iv. Whether benefit of loan/ advance has been derived or not;

v. Whether recipient is shareholder in the payer company or not;

vi. Whether the advance was in the course of a commercial transaction;

vii. Material time when shareholding must be seen i.e., at the time of giving of loan/ advance or as at the year end;

viii. Applicability to inter-corporate deposits;

ix. Applicability to loan or advance due to business expediency;

x. Applicability to advances made to director to make purchases on behalf of the company;

xi. Applicability to shareholder’s running account in company’s books and credit balances therein;

xii. Applicability when amounts paid under family arrangements;

xiii. Controversies regarding computation of accumulated profits; etc.

24) None of the abovementioned issues would get resolved by the present amendment. Therefore, it is unlikely that the proposed amendment would help to bring in “clarity” in taxation of deemed dividends as sought to be achieved by the present amendment. The Memorandum also states that the provision of Section 2(22)(e) has been subject matter of extensive litigation. However, without any change in the substantive law, litigation also may not reduce.

25) The amendment may bring in “certainty” in collection of tax and may overcome the problem of the collection of the tax. However, it needs to be considered that the amendment only seeks to shift the point of taxation from the shareholder/ recipient to the company. This, per se, may not overcome the problem in collecting taxes. This is because a closely held company may contest action of the Assessing Officers in imposing DDT. A company which can give a loan or an advance to a shareholder or to its concern or for its benefit would even contest imposition of DDT which would ultimately benefit such shareholder. On the whole, the amendment does not seem to be well-thought through and is unlikely to serve the purposes for which it is intended.

C. DDT on dividend payouts to unit holders in an equity oriented fund

III(C)(i) Amendment in brief

26) One more proposal to widen the tax base made by the Government is introduction of DDT on income distributed to a unit holder of equity oriented funds. An amendment has been proposed in Section 115R(2) of the Act to provide that DDT shall be charged @ 10% of the amount of income distributed by a mutual fund. The DDT is liable to be paid by the mutual fund effectively reducing the income in the hands of the unit holder.

27) Clause (b) in second proviso in Section 115R(2) which guards income distributed by equity oriented funds from levy of DDT is proposed to be deleted.

28) The above amendment will apply from 1st April 2018 and would apply from distributions made on or after this date.

III(C)(ii) Analysis of amendment

29) The rationale behind the proposed amendment is to provide a level playing field between growth-oriented funds and dividend distributing funds. The Budget 2018 also proposes to introduce capital gains tax on transfer of long term equity-oriented mutual fund units which have been exempt since the year 2004 upon introduction of Securities Transaction Tax. With introduction of capital gains tax on transfer of long term equity-oriented mutual fund units @ 10%, the Government has proposed to introduce DDT @ 10% on dividend paid by equity oriented fund in order to obviate disadvantage to unit holders of growth schemes vis-à-vis unit holders of dividend schemes of equity oriented funds.

30) The DDT to be payable on dividends distributed must be done on gross basis as per Section 115R(2) of the Act and as a result of this amendment, the amount of dividends actually received by unit holders of mutual funds would be lesser. The amount received by the unit holders as dividend would continue to remain exempt under Section 10(35) of the Act.

IV. To sum-up

31) One of the expectations of the Industry from Budget 2018 was abolition of DDT as its abolition was thought to be an aid in
Ease of doing business. Contrary to expectations, the Government has sought to widen its ambit. The above amendments to DDT provisions only suggest that DDT is here to stay as DDT is perceived to facilitate easy collection of taxes. Ease of collecting taxes, though not a separate head for organizing tax proposals in a Budget, after all, is one of the inherent policies in tax collecting exercise for any Government.

 

1. Paras 144 and 145 of 2018-19 Budget Speech.

2. CIT v. Harprasad & Co. (P.) Limited [1975] 99 ITR 118 (SC)

3. Rule 10U(1)(a) of Income-tax Rules, 1962.

Vide Finance Bill, 2018 the Finance Minister has proposed certain amendments in regard to scheme of taxation of long term capital gains arising on transfer of equity shares and units of mutual funds. Proposed amendments and their implications are being discussed hereunder with reference to present provisions of the Act.

Present provision

As per section 10(38) of the Income-tax Act any income arising from transfer of long term capital asset being an equity share in a company or a unit of Equity Oriented Fund or a unit of Business Trust is exempt from tax provided Security Transaction Tax (STT) has been paid on transfer of the shares or units.

By way of insertion of a proviso vide Finance Act, 2017 w.e.f. 1-4-2018 i.e. A.Y. 2018-19 it was provided that exemption in respect of income arising on transfer of equity shares in a company will not be available in case STT was not paid in respect of transaction for acquisition of shares except in the cases of acquisition as may be notified by the Central Government. The Central Government
vide Notification No. SO 1789(E) dated 5-6-2017 has notified certain cases of acquisition of shares pursuant to aforesaid proviso wherein exemption will be available for income on transfer of shares even if STT at the time of acquisition has not been paid. Such transfers are generally those transactions which represent allotment of shares on preferential basis or shares allotted as per the scheme approved by the Government etc.

Further, proviso to Section 10(38) of the Income-tax Act provides that such capital gain, notwithstanding it will be exempt, will be considered for the purpose of book profit for the purpose of payment of tax under Section 115 JB of the Act. It has also been provided that income arising on transactions undertaken on a recognised stock exchange located in any International Financial Services Centre and where the consideration is paid or payable in foreign currency will also be exempt notwithstanding that STT in respect thereof has not been paid.

In conclusion, it is stated that in terms of Section 10(38) of the Income-tax Act capital gains arising on transfer of shares or units of mutual funds held for a period of 12 months will be exempt from tax.

In respect of transfer of shares or units held for long term, other than referred to in Section 10(38) of the Act, tax is payable in terms of provisions of Section 112 of the Income-tax Act. In respect of such transfers, tax is payable @ 20% after taking indexation as per the second proviso to Section 48 of the Income-tax Act. The aforesaid Section also provides an option to an assessee that tax can be paid by him on capital gains @ 10% without taking indexation.

Amendments proposed

Provisions of Section 10(38) are proposed to be made inapplicable in respect of transfer of shares or units after 1-4-2018. Accordingly, no exemption from capital gains arising on transfer of shares or units even held for long term will be available in accordance with present provisions of Section 10(38) of the Income-tax Act.

A new Section 112A is proposed to be inserted in the Act. The aforesaid section provides that notwithstanding provisions of Section 112, tax will be payable by an assessee in respect of capital gains arising from transfer of long term asset being equity shares in a company or units of an equity oriented fund or units of business trust on the amount exceeding ₹ one lakh @ 10%. Further, it has been provided that in respect of equity shares STT has been paid on acquisition as well as on transfer of shares. It has, however, been provided in sub-section (4) that Central Government may by notification specify nature of acquisition in respect of which condition of payment of STT will not be applicable. In regard to capital gains arising on transfer of units of oriented fund or units of business trust condition of payment of STT is applicable only at the time of transfer of such units.

Tax liability payable by an assessee in terms of sub-section (2) is to be determined on the basis that tax will be payable @ 10% of amount of capital gain exceeding ₹ one lakh and tax will be payable on remaining income considering the same to be the total income. By way of proviso it has further been provided that in case of an individual or Hindu Undivided Family total income other than the capital gains is less than the maximum amount not chargeable to tax, amount of capital gains to the extent of such amount will be reduced and accordingly tax on long term capital gain @ 10% is to be calculated on the remaining amount of long term capital gains.

Sub-section (3) exempts the transactions from taxability of transfer undertaken on a recognised stock exchange located in any International Financial Services Centre as at present.

Sub-section (5) provides that benefit of indexation will not be available to the assessees.

Sub-section (6) provides that for the purpose of determination of long term capital gains which will be chargeable as per Section 112A of the Income-tax Act fair market as on 1-2-2018 will be cost of acquisition in case same is higher. Provisions of Sub-Sections (7) & (8) provide that no deduction in any of the Sections under Chapter VIA will be available and no tax rebate available under Section 87A will also be allowable to the assesses from amount of long term capital gain and tax payable thereon.

Comments

In regard to proposed provisions of Section 112A of the Income Tax Act following comments are being made:-

1. The proposed amendments are against the concept introduced in the Income Tax Act for granting exemption from long term capital gain along with levy of STT w.e.f 1-4-2004. The Finance Minister in his speech at that time had stated that it will be win-win situation. The assessee will be able to get exemption in respect of long term capital gain arising on transactions on which STT has been paid and the Government will also be able to get its due tax by way of STT. The amendment in the Scheme is contrary to the purpose and intention with which exemption was introduced in Section 10(38) of the Income Tax Act.

2. It may be stated that provisions of Section 112A, like other sections in Chapter XII provides for ‘Determination of Tax in Certain Special Cases’. These sections are not the charging sections but same provides for special rates in respect of particular nature of the income. Charging sections of the Income Tax Act in relation to capital gain are Sections 45 to 55. Section 48, which provides for indexation is part of the charging sections. Accordingly, an issue arises whether an assessee is required to compute the income under the head “Capital Gain” as per above referred charging sections or total income under the head “Capital Gain” needs to be calculated taking into consideration provisions of Section 112A of the Income Tax Act. In case we refer to provisions of Section 112 of the Act same provides for payment of tax @ 20% on long term capital gain, which is determined as per the charging sections including the provision for indexation. Thereafter a Proviso has been provided therein to the effect that in case tax payable @ 20% exceeds the tax payable @ 10% of the amount of capital gain without taking indexation then such excess amount of tax is to be ignored. Accordingly, the aforesaid Proviso in Section 112 do not modify the computation of taxable income but only grant a relief in the computation of tax payable. Section 112A, however, provides that long term capital gain shall be determined without taking indexation. Hence, an issue arises that how an assessee has to compute his income under the head “Capital Gain”. This may lead to litigation unless clarified by way of suitable amendment in the charging sections.

3. As per the present provisions of Section 112 of the Act an assessee has an option to pay tax @ 20% after availing benefits of indexation or @ 10% without availing benefits of indexation. In the proposed provisions of section 112A of the Act tax is payable in all cases @ 10% without taking benefit of indexation. It is incongruous with provisions of taxation of long term capital gain. An assessee may be in a disadvantageous position while making payment of tax @ 10% without availing benefit of indexation. An option should be available to an assessee to pay tax after indexation @ 20% or without indexation @ 10% as is available in section 112 of the Act.

4. It is stated that in the cases of individuals having total income other than capital gain of less than the maximum limit of income not chargeable to tax and an amount of capital gain along with other income is less than Rs. Five Lacs, tax liability in terms of provisions of Section 112A of the Income Tax Act will works out to be more than the tax liability which otherwise would be in such cases. This position is being shown by way of following example:-

Amount (Rs.)

Income other than long term capital gain 2,00,000/-

Long term capital gain on transfer of shares 3,00,000/-

Total Income 5,00,000/-

A. Tax payable considering long term capital gain as part of normal taxable income.

– Tax payable on Rs. 2,50,000/- Nil

– Tax payable on balance of Rs. 2,50,000/- @ 5% 12,500/-

Total Tax payable 12,500/-

Less rebate available u/s. 87A of the Act 5,000/-

Net amount of tax payable. 7,500/-

B. Tax payable by the assessee in terms of Section 112A of the Act

Long term capital gain 3,00,000/-

Less :Amount representing difference between other income and exempt Income not chargeable to tax. 50,000/-

Balance long term capital gain 2,50,000/-

Less : Exemption available u/s. 112A 1,00,000/-

Balance long term capital gain chargeable to tax 1,50,000/-

Tax payable on above @ 10% 15,000/-

Tax payable on other income Nil
_________________________
Total Tax Payable. 15,000/-
_________________________

It is suggested that an option should be provided to an assessee to calculate the tax considering the long term capital gain as part of its income and pay the tax thereon accordingly or avail the concession provides for of specified rate in Section 112A of the Act.

5. There was also a doubt in regard to the position whether loss can be set off against any other long term capital gain and wether same can be carried over to subsequent year for the purpose of set off against long term capital gain. This position has been clarified by CBDT vide Notification dated 4-2-2018 wherein it has been stated that long term capital loss can be set off and carried forward in accordance with existing provisions of the Act and, therefore, it can be set off against any other long term capital gains and unabsorbed loss can be carried forward to subsequent 8 years for set off against long term capital gains.

6. There appears to be anomaly while reading Sub-section (4) of Section 112A of the Income Tax Act with reference to provisions of Sub-section (1) of Section 112A of the Act. Sub-Section (1)(iii)(a) provides for a condition for payment of STT on acquisition as well as on transfer of equity shares. Sub-section (4) provides that Central Government may by notification specify the nature of acquisition in respect of which provisions of Sub-clause (a) of Clause (iii) of Sub-section (1) shall not apply. The reading of above Sub-section gives an interpretation that in respect of cases specified by the Central Government with reference to condition of STT on acquisition above clause will not be applicable at all and resulting thereby condition for payment of STT will not apply. This appears to be an unintended position.

Suggestion

It is suggested that provisions should provide for computation of long term capital gain in respect of equity shares and units referred to in section 112A of the Act in the normal course as per provisions of sections 45 – 55 of the Act including indexation in terms of proviso to section 48 of the Act. As regards cost of acquisition to be taken at fair market value as on 31-1-2018 necessary amendment should be made in section 49 of the Act. Provisions of section 112 should be applicable to these shares and units also and an option should be available to an assessee to pay the tax at 20% after taking indexation or @ 10% after determining the long term capital gain without indexation. In case of individual assesses an option should be provided to determine the tax liability considering the income in the normal course or availing benefit of concessional rate of tax as provided in this regard. These amendments are necessary since provisions as proposed will be disadvantageous to certain assesses and may also lead to litigation.

 

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