CA Prasanna L. Joshi

On implementation of land ceiling laws in 1960s, with division of land holdings over last 3 generations, farmers are now left with smaller land holdings. Small farmers join co- operatives to get timely capital for their farming requirements, seeds for plantation of crops and fertilisers, pesticides, weedicides, to sustain them. These co-operatives are the backbone of rural economies. Then there are co-operatives operating businesses whose raw materials are agriculture based. The milk producers’ dairy co-operatives, sugarcane producers’ sugar co-operatives and cotton producers’ spinning mills, to name a few. These are essentially promoted by farmers with the active support of State Governments. The object of all such co- operatives is to add value to farmers’ produce, to make it marketable and to sell the same with the object of giving higher returns for the farmers’ produce. This noble object of putting more money in the pockets of lakhs of small and marginal farmers was a boon to rural consumption and creation of massive rural demand. Its effect can very well be seen in the rural economies where these co-operatives operate. A fall out was, power progressively got vested in managements of these co-operatives creating leaders with political aspirations. The heady mix of political power and hold over these co-operatives led to instances of mis- management and media attention. A few PILs were filed in courts, wherein some strictures were passed on the managements. In the last few decades the holier than cow perception regarding co-operatives took a severe beating.

Taxmen and courts were not immune to these vibes which inherently played a part in the tax litigation. The noble object of co-operatives to put more money in the pockets of lakhs of small farmers was forgotten and vibes from media played a role on sugar and dairy co-operatives facing the wrath of Taxmen.

Sugar Co-operatives

Sugar and Sugarcane are governed by Essential Commodities Act. Till 2014, sugar mills were required to sell a percentage of sugar produced at a price fixed by Govt. for sale in ration shops and FCI, called “Levy” sugar. The balance “Free” sugar could be sold in the market but its quantity was limited to the monthly quota released by Govt. for each sugar mill. Restrictions on sugar imports, exports and storage were in place to curb profiteering. Through these controls, Govt. ensured that there was no runaway increase in domestic sugar prices. Sugar mills are required to pay farmers for their cane, at least a minimum support price which is annually notified by the Govt. (SMP). In this era sugar mills made healthy profits at the cost of farmers by paying SMP for their cane. From decade of 1950-60, sugar co-ops entered the scene.

When a farmer becomes a member of a sugar co-op, he commits to cultivate cane on his farms, binds himself to supply the cane grown to the sugar co-op. and agrees to a host of directions issued by the co-op on cultivation of cane. Cane, after it is cut, becomes perishable and needs to

be crushed within 24 hours. Cane cutting and transport is organized by sugar mills so that fresh cane is crushed by them. Many farmers chose not to become members of a sugar co- op and retain their choice to supply cane to any other sugar mill in the hope that they can get better returns. The farmers are required to register the cane cultivated by them with a sugar mill. With these registrations in place, the sugar mill annually applies for a license from the State Govt. to commence cane crush. The registration form of sugar co-ops inter alia provides that the farmer shall accept the price of cane as is fixed by the State Govt.

When cane is procured by sugar co-ops from farmers, its price is not fixed, barring the support price (SMP) notified by Govt. World over the price of cane paid to farmers is derived from the price realised for sugar and its by- products. In India, sugar is produced from cane crushed during November to April. Farmers have to be paid for cane supplied within a fortnight. But sugar is sold over next 16 months. To pay first advance to farmers, sugar co-ops avail bank loans upto 85% of the value of sugar stocks pledged. When sugar is sold over the months, margin locked up gets released and funds are available to pay further advances. On sale over the months, the price of sugar produced also gets progressively discovered. Closing sugar stocks are valued at rate State Govt. directs. Based on value of production and costs incurred for conversion of cane to sugar, final cane price is proposed by sugar co-ops to the State Govt. Final cane price as approved by State Govt., is accounted for and claimed by sugar co-ops as their purchase price of cane.

For many years State Govt. levied an ad-valorem Purchase Tax on final price of cane purchased by sugar mills. Income Tax authorities concurrently sought to levy income tax on part of the price of cane purchased by sugar co-ops which has already suffered State’s purchase tax. Till 1989, State of Maharashtra levied a tax on agricultural income earned in excess of Rs 36,000. Further the agricultural income earned by a farmer who pays income tax on his non-agricultural income, is clubbed for rate purposes and suffers an indirect income tax in his hands.

Taxmen held that sugar co-ops were distributing part of their profits to farmers in the guise of cane payments. Taxmen allowed SMP as the price for purchase of cane and payments in excess thereof were disallowed. In May 1968, late Shri Nani Palkhiwala convinced the Income Tax Appellate Tribunal that businesses run by co-operatives need to be assessed differently. He argued that an ordinary businessman could exploit farmers by driving them to accept to minimum support cane prices (SMP). Sugar co- ops were formed to stop exploitation of farmers. Sugar is produced and sold by sugar co-ops so as to give best possible cane price to farmers. He said Revenue did not produce any evidence as to which farmers were ready to supply their cane at SMP. He argued that Revenue has no authority to tax agricultural income of farmers in the hands sugar co-ops as their alleged non- agricultural income. Tribunal agreed that if a sugar co-op were to retain more profit by paying SMP, it would have defeated the very object for which it was established. The cane price of sugar co-ops fixed by State Govt. was allowed as a deduction. In 1973, Hon’ble Supreme Court rejected CIT’s appeals in Pravara SSK, 94 ITR 321.

In 1974, Govt. of India realised that despite growth in cane area, sugar production did not commensurately grow. On recommendation it introduced payment of “additional price” (AP) in addition to minimum support price (SMP). The AO was to be determined after end of a sugar season (October to September). AP was calculated at 50% of the difference between value of sugar produced minus cost of its production as notified by Govt.

In 1995 Taxmen re-ignited the dispute concluded in 1973. They disallowed part of cane purchases

in excess of SMP only from members of sugar co-ops u/s 40A(2) on the ground that co-op sugar mill is an AOP. First appellate authorities deleted disallowance u/s 40A(2) but held payment was not wholly exclusively for business. They held that the manner in which final price was determined by State Govt., despite of judgement in Pravara, led to distribution of profits to all farmers, including to non-members. Special Bench of the Tribunal deleted the entire addition, 91 ITD 361. Hon’ble Bombay High Court rejected CIT’s appeals, 301 ITR 191. However, in January 2010, Hon’ble Supreme Court set aside the issue back to CIT(A) with certain directions, 326 ITR 42. The CIT(A) took a representative case and held that SMP was the purchase price of cane. He also held that going by real income theory, the AP was also to be allowed as deduction. He ignored that larger bench of the Hon’ble Supreme Court in a Civil Appeal had held that though SMP was Rs 360/Mt to Rs 400/Mt the price to be paid by sugar mills to non-members for their cane was Rs 740/Mt, 1995 SCC, Supl. (3) 475. In a subsequent SLP of CIT, another bench of the Hon’ble Supreme Court referred the issue to a larger bench.

Meanwhile, in late 2009 SMP and AP were substituted by Fair and Remunerative Price (FRP) with preamble to the Bill amending Essential Commodities Act clearly stating that FRP was to be taken as cost of cane for computing “levy” sugar price. In those days levy price was Rs 18/Kg (for 20% production) whereas market price of sugar was Rs 33/Kg (for 80% production). Obviously the average sugar realization of sugar mills being much higher than levy price, corresponding derived cane price was much higher than FRP. But in assessment of sugar co-ops, Revenue authorities allowed only FRP as a deduction ignoring farmers’ agitations demanding higher cane prices. Submissions against Revenue’s point of view were not even brought on record in assessment orders. Same Revenue authorities

allowed as deduction market prices much higher than FRP paid for cane purchases by competing private sector sugar mills. Sugar co-ops got no relief before First Appellate authorities as they did not consider prevailing facts requiring sugar co-ops to pay higher cane prices but extensively quoted the order of the CIT(A) in the representative case.

This tax dispute was flagged in 2015 before the then Finance Minister. He desired to end the tax litigation and by Finance Act 2015 inserted sub- section (xvii) in section 36(1) but w.e.f. AY 2016-

17. This stipulated that cane payments less than or equal to the cane price fixed or approved by Govt. be allowed as a deduction in assessment of sugar co-ops. However, many Revenue authorities did not abide by the amendment. CBDT was forced to issue a Circular No. 18 dated 25-10-2021 clarifying that “price fixed or approved by Govt.” would include price fixation by State Govts. through any state level mechanism. This applied to AY 2016-17 and onwards, but it was the past that was haunting the sugar co-ops.

In Mar, 2019 the larger bench of Hon’ble Supreme Court, 412 ITR 420, while considering the SMP and AP regime, held that for cane supplied by members to sugar co-ops, their cane purchases were to be allowed at SMP plus expenditure to be determined by the Assessing Officer out of difference between AP and SMP. For cane purchases from non-members, AO was to make a disallowance based on 40A(2). Nothing was said about cane price paid which was more than SMP plus AP. The larger bench judgement did not consider its court’s repeated views (preamble to EC Amendment Bill 2009) that AP was a liability of sugar mills and had to be included by Govt. in the cost of cane taken for computing levy price. This view of the Hon’ble Supreme Court was the reason for substitution of SMP plus AP by FRP. That the larger bench judgement was wrongly decided is mentioned in 11th Ed. of Kanga & Palkhiwala.

On directions of the Hon’ble Supreme Court given in 2010, first the CIT(A)s and next the Tribunal without evaluation of prevailing facts applied its larger bench judgement of 2019 and set aside the disallowance out of cane purchases for all years prior to AY 2016- 17, including FRP, to the AO. There were no findings on facts of the respective years which could have a bearing on deciding whether the cane price paid was an expenditure of the sugar co-ops. Linkage between realization of sugar and its by-products with the cane prices were ignored. Report of a committee constituted by the Hon’ble Prime Minister under Dr. C. Rangarajan recommending 75% of sugar realization or 70% of sugar plus by- products realization be shared as cane price with farmers was not even considered.

In set aside assessments till AY 2015-16, original disallowances out of cane purchases were reconfirmed by AOs and huge tax demands were re-created from AY 1990-91 onwards. As sugar co-ops over last 3 decades had already paid farmers final cane prices which were much higher than SMP and AP, they had no funds to pay 20% of the tax demands, even for seeking stays. Faced with this reality that tax was levied on money already paid long back to farmers, relief from past tax arrears on account of huge disallowances from cane purchases made over last 3 decades has been proposed by the Finance Minister. Finance 2023 Bill proposes to introduce sub-section (19) in section 155 which provides for AOs to allow as deduction cane prices fixed by Govt. by amending their existing assessments. Circular No. 18 dated 25-10-2021 clarifying “price fixed or approved by Govt.” would include price fixed by State Govt. under their state level mechanisms will come in handy. This brings down curtain on a tax litigation where assessments were made on a fundamentally wrong presumption that sugar mills could purchase cane at its minimum price even when sugar prices ruled high.

Cash Withdrawals from Co-op Banks

If a person annually withdraws cash from a bank, including a co-op society engaged in the business of banking or a post office, an aggregate of more than Rs 1 crore, then cash disburser is required to deduct tax @ 2% of such cash withdrawal. This limit for co-ops is proposed to be increased to Rs 3 crores. So also if the cash recipient has not filed his income-tax returns for last 3 years within his due dates, then, the annual aggregate limit stands reduced to Rs 20 lakhs. In cases of non-filers, TDS is 2% upto Rs 1 crores and 5% in excess thereof. With substitution of Rs 3 crores for co-ops in place of Rs 1 crores, this rigour of 5% TDS for non-filer customers of co-ops would become applicable after reaching annual cash withdrawal of Rs 3 crores. This decrease in outgo of TDS will benefit agrarian folks requiring cash for their businesses like farmers, petty contractors, small vendors and self-employed artisans who rarely file income tax returns due to low non- agricultural incomes.

Primary Co-op Societies

These are co-op societies which provide credit to their members for their agricultural and incidental activities. These societies usually operate at a grass root, say at taluka level. Their dealings, which include accepting deposits and giving loans, are mainly with rural and agrarian folks who generally have low incomes. For ease of business operations by folks of low income groups, the limits of Rs 20,000 in cash for accepting deposits, giving loans and accepting repayments from members of primary agricultural credit societies and primary co-op agricultural and rural development banks are being proposed to be relaxed to Rs 2 lakhs. The rigours of sections 269SS and 269T are also felt by small vendors and self-employed persons who are not aware of these provisions and are unfortunately caught in their mischief when the entities like banks and NBFCs file their reports. The appellate mechanism to grant them relief does not take into account the situation in which these folks function and relief on a wider scale is certainly desirable to exclude small persons.

New Manufacturing Co-ops

In line with tax rate applicable to new manufacturing companies, new co-operatives setting up manufacturing activities are entitled to a lower tax rate of 15%. They have to be registered on or after 1-4-2023 and manufacture or production should commence before 31-3- 2024. Usual conditions apply, i.e. should not be formed by splitting up of business already in existence; previously used machinery should not exceed 20% of the total value of machinery or plant used. Also it should not be engaged in any business other than manufacture or production, including electricity generation. Manufacture would not include software development, mining, converting marbles to slabs, bottling gas into cylinder, printing books or producing cinema films and other notified business. In computing eligible profits, special deductions are not be considered, like those for additional depreciation in first year, or exclusion of income of new units in SEZs, or special deductions for tea, coffee or rubber development or for site restoration in oil prospecting or extraction, or payments for approved programme of scientific research, or certain pre-operative expenses or expenditure on notified agricultural extension project and chapter VI-A deductions (other than on hiring new employees). In the subsequent years, brought forward losses or unabsorbed depreciation of this business will not be set off nor carried forward. If more than ordinary profits are attributed to arise to the newly started manufacturing co-op due to arrangement of transactions with connected persons, AO can re-compute reasonable profits of new co-op’s eligible activity by also applying ALP mechanism. Profits arising in excess of reasonable amount as determine by AO are to be taxed at 30% rate. As also income which is unrelated to manufacturing business is taxed at 22%. Option to select lower tax regime of 15% is to the exercised before due date of filing first year’s regular return of income and such option exercised will continue for subsequent years without alteration. The time limit of one year to commence manufacture may have to be revisited.

Development Authorities

Difficulty arose in assessments of notified bodies, authorities, boards, trusts or commissions whose income was excluded u/s 10(46) which provides they should not be engaged in any commercial activity. Said section does not specify as to what is a commercial activity. Hon’ble Supreme Court, 449 ITR 389, held that commercial activity mentioned in section 10(46) has the same meaning as “trade, commerce, business” in section 2(15). While considering as to what would be a commercial activity, the Hon’ble court considered firstly the quantum of mark up in their revenues in relation to their cost incurred and secondly section 10(46) did not have any limit like 20% of revenues from allied activities provided in section 2(15). On the other hand Hon’ble Court felt that boards created under statutes would be exempt from tax. To get over the issue of “not engaged in any commercial activity” a new provision by way of (46A) is proposed to be inserted in section 10 to provide exclusion from income for notified bodies, authorities, boards, trusts or commissions (not being a company) established by Central or State Act for the purposes of (i) dealing with and satisfying housing accommodation; (ii) planning, development or improvement of cities, towns and villages; (iii) regulating or developing any activity for benefit of general public or for regulating any matter arising therefrom. This should put an end to tax litigation against such statutory bodies, irrespective of the charges levied by them for their services.

For sugar co-operatives this budget has ended a nightmare for last 3 decades.

Benefits to corporate taxpayers by Finance Bill, 2023

CA (LLB) Abhitan Mehta

India Inc. always has a long wish list bet always it ends up being _ a bucket list which rarely gets ticked. The sigh of relief since the last few budgets has not been any big positive announcement (on the income tax front) but, no negative announcements or retrospective levies for India Inc. Even in this Finance Bill the beneficial provisions for corporates are far and few and if one excludes the benefit linked to start-ups and public sector divestment there is hardly a benefit for India Inc. which is even worth mentioning.

The good thing is that we are moving towards a stable tax regime and not significantly tinkering tax laws in every budget, the number of amendments even this year are no less (more than 100 amendments), but the majority of amendments are in the procedural sections and do not impact the general computation of income (other than amendments in relation to taxation Charities). One key thing to be noted by the corporates is that, the time period to commence manufacturing to avail the concessional tax regime of 15% (new manufacturing company) has not been extended and therefore the manufacturing should commence on or before 31.3.2024 (Section 115BAB). Therefore, the corporates planning for expansion through a new company should adhere to the timeline – even the commencement of manufacturing for one of the units prior to 31.3.2024 should suffice.

-There is no restriction on subsequent capacity expansion.

Extension of date of incorporation for eligible start-up

Currently, Section 80-IAC provides for a profit-

linked deduction to -an eligible start-up for a period of 3 years out of 10 years. The condition inter alia require that the Company/LLP is – incorporated after 1 April 2016 but before 1 April 2023. In order to further promote the development of start-ups in India the Finance Bill proposes to extend the period of incorporation of eligible start-ups to 1st day of April 2024.

This is consecutively the third budget wherein the period has been extended by one year. However, for incorporation of start-up there is no relief vis-à-vis the other conditions for the claim of deduction like the cap on the turnover, strict deployment of funds (e.g. the start-up cannot buy a car), etc.

The key difference in Section 80-IAC and Section 115BAB is that Section 80-IAC only requires the start-up should be incorporated prior to 1.4.2024, whereas in section 115BAB requires the company to commencemece the manufacturing prior to 31.3.2024. Therefore, for a start-up even if operations are commenced after 31.3.2024, the start-up should be eligible to claim deduction u/s 80-IAC.

Startups – Carry Forward and Set Off of Losses

Section 79 of the Income Tax Act restricts the carry forward of losses of a company in which public are not substantially interested (primarily unlisted companies which are not subsidiaries of a listed company) in case of change of more than 49% of the shareholding. The comparison of the shareholding is of the shareholding on the last day of the previous year in which the loss is incurred and the shareholding on the last day of the previous year in which the loss is intended to be set off. The objective of the section is to discourage the transfer of companies with the objective of taking the benefit of carried forward losses.

In case of start-ups the growth is primarily funded through the issue of fresh equity shares to investors, which may result in change of more than 49% of the shareholding and consequently would trigger the lapse of carry forward loss. Considering the hardships faced by the start-up a concession was granted to the eligible start- ups subject to the following conditions :

All the shareholders of the company on the last day of the year of loss, continue to hold those shares on the last day of the previous year in the year of set off.
The loss should have been incurred during the period of seven years beginning from the year of incorporation.

The Finance Bill proposes to increase the time period for loss of eligible start-ups to be considered for relaxation, from seven years to ten years from the date of incorporation. The reasons specified in the explanatory memorandum is to align the period in Section 79 with the period of benfit in Section 80-IAC

Practically, it is very difficult almost impossible to expect that all the shareholders of the start- up to continue without even taking a partial exit at the time of subsequent rounds of fund raising. Also, start-ups have a practice of giving significant employee remuneration through ESOPs; to expect all the employees to whom shares have been allotted, not to liquidate at the time of subsequent funding rounds or at the time of their exit from the company is an unreal expectation. Sometimes even the investors in the subsequent funding round, would prefer cleaning up of the cap table and would like to give exit to the present minority investors.

There may be ways and means to achieve technical compliance of the section and still achieve the commercial objective of dilution for example, if the shares of the start-up company are owned through an AIF, the unit holders can change by purchasing and selling units of the AIF but the AIF (trustees of the AIF) would continue to be the shareholders of the start-up. Similarly, start-up may issue bonus shares which are then sold by the founders and investors, so that the original shares continue to be with the founders and investors as required by the section. However, in the GAAR era, a challenge from the tax authorities on any structure entailing tax benefit cannot be ruled out.

To summarise, there is no downside of the proposed amendment but one seriously doubts if there is any real upside of the so called relaxation granted to the start up. It would have been more appropriate if the condition of continuation of shareholding is applied only to the shareholding of the to the founders of the start-up instead of applying it to all the shareholders.

Amortization of preliminary expenses

Section 35D of the Income Tax Act provides for amortization of certain preliminary expenses which are incurred in connection with extension of undertaking or setting up of a new unit. This includes expenditure in connection with preparation of feasibility report, project report, market survey etc.

The section inter alia provides that the work in connection with the preparation of feasibility report or the project report or the conducting of market survey or of any other survey or the engineering services need to be carried out

Benefits to corporate taxpayers by Finance Bill, 2023 either by the assessee himself or by a concern which is approved by CBDT.

The Finance Bill proposes to remove the requirement of the said activities being done by assessee or approved concern. Instead, it is now proposed that the assessee shall furnish a statement containing the particulars of such expenditure within the prescribed period to the prescribed Income Tax Authority in the prescribed form and manner i.e. now it would be more of a reporting requirement to the tax officer for the claim of expense and the assessee would no longer be required to incur the expense through an approved concern.

It is certainly a welcome change, however, one fails to understand the need of filing a separate form, it would have been better if the requisite details are captured in the ITR and/or the tax audit report, instead of a separate reporting requirement.

Provisions related to business reorganisation

Where business reorganizations (merger or demerger) are approved with the appointed date covering the period for which income tax return is already filed and the timeline for filing revised return is elapsed, there were no enabling provisions in the Act to furnish a return of income duly giving effect to the business reorganizations.

Finance Act 2022 introduced Section 170A to provide that in case of business reorganisation, the successor shall file a modified return of income within a period of 6 months from the end of the month in which order approving the business reorganisation is issued, in respect of the period starting from the appointed date till the effective date of the order.

Finance Act 2022 did not provide for modification of return filed by the predecessor entity. Finance Bill proposes to amend the provisions of Section 170A to substitute the word “successor” with “entity” in order to enable modification of return filed by the predecessor entity.

Even now, the power to file the modified return is only with the successor and not with the predecessor. The only amendment is the successor now has the power to file a modified return for both the entities (successor and predecessor). This would work well in case of a merger as the amalgamating company would cease to exist and the successor has to file modified return for both entities.

However, in the case of a demerger, the problem would persist, as the demerged company does not have the power to file the modified return, only the resulting company (successor) has the power to file the modified return. Though the power of the successor is wide enough to file a revised return for both entities, a successor may not be comfortable in filing a revised return for the demerged company, for a host of reasons including that the successor is not aware of other operations of the demerged company and why should he take the responsibility for filing a tax return for the demerged company. Hopefully, this is a drafting issue and would be clarified.

Further, Finance Act 2022 did not provide for any procedure/ mechanism to be adopted by the Assessing for assessment/ reassessment once the modified return is submitted. Finance Bill proposes to amend of Section 170A to provide that where the assessment or reassessment proceedings for an Assessment Year relevant to a previous year to which the order in respect of the business reorganization applies:

Have been completed on date of modified return – The Assessing officer shall pass order modifying the total income basis the modified return.
Are pending as on the date of the modified return – The Assessing officer shall pass order considering the modified return.

Though the amendments help in providing further clarity on the implementation of business restructuring, couple of points which continue to remain vague are: (i) what if there is no pending proceeding (and no proceedings are completed), whether new assessment proceedings can be initiated based on return on the modified return

? (ii) What would be the power of the AO when he has to take into account the modified return, can he propose new additions/disallowances or he has to accept the modified return as is

? – this does not seem to be the intention, but

appropriate amendments would be required in the language of the proposed amendment to clarify the issues.

Facilitating strategic disinvestment

Section 72A allows carry forward and set off accumulated loss and unabsorbed depreciation allowance arising from the amalgamation or demerger. Carry forward of loss in the case of de-merger does not have any major conditions. However, carry forward of loss in case of merger has a host of conditions and is also primarily available in case of merger of industrial undertaking. To facilitate strategic divestment and without the lapse of carry forward loss, Finance Act, 2021 extended the benefit of carry forward of loss u/s 72A to the cases of strategic divestment.

The strategic divestment was defined as reduction in shareholding of Central Government and State Government below 51% with transfer of control to the buyer. The Finance Bill proposes to expand the definition of strategic divestment to cover divestment of shareholding even by public sector company.

Section 72AA deals with carry forward of loss in case of merger of banks. The scope

of the Section has been expanded to include the amalgamation of one or more banking company with any banking institution or company subsequent to strategic disinvestment provided the amalgamation is carried out within five years from the year of strategic disinvestment.

The Sections have a very niche applicability – divestments by the Government. However, one can only wonder about the disparity in taxation – we have Section 79 which restricts carry forward of loss in case of change in majority shareholding and we have provisions for strategic divestment wherein the carry forward of loss is explicitly allowed.

Closing remarks

The budget is consistent with the Governments policy to move towards away investment-linked deductions, discontinue profit linked deduction to corporates and to try and plug any tax benefit or relief granted by the courts to the taxpayers which according to them is not justified. The draconian amendment of the budget according to the author is the amendment to Section 28(iv) wherein the Supreme Court ruling in the case of Commissioner v. Mahindra And Mahindra Ltd.1 has been overruled to expand the scope of Section 28(iv) to even include a benefit or perquisite in cash which coupled with the requirement of TDS u/s 194R is a nightmare. The amendment would give rise to a host of issues – including implications on waiver of loans, write-off of bad debt, discounts (not covered by the circular) etc. One often wonders whether the zeal to tax the last dime is worth the hardship caused to genuine taxpayers in carrying out their routine business transactions.

1. [2018] 404 ITR 1 (SC)

Implications for Non-Residents under Finance Bill 2023

CA Paresh P. Shah

Introduction
In this article, we will cover the amendments proposed by Finance Bill 2023 to the Income Tax Act, 1961 (the ‘Act’ or ‘ITA’) which affect taxation of non-residents pertaining to the following:
1. Section 9(1) – Extending deeming provisions under section 9 to certain persons being not ordinarily residents (Clause 4 of the Finance Bill 2023)
2. Section 56(2)(viib) – Bringing the non- resident investors within the ambit of the section (Clause 32 of the Finance Bill 2023)
3. Section 92(D) – Reducing time provided for furnishing TP report (Clause 46 of the Finance Bill 2023)
4. Section 44BB and 44BBB – Prevention the misuse of section 44BB and 44BBB (Clauses 18 & 19 of the Finance Bill 2023)
5. Tax Incentives to International Financial Services Centre (Clauses 5, 21 & 59 of the
Finance Bill 2023)
Extending deeming provision under section 9 to gift to ‘Not-ordinarily resident’ (‘NOR’)
Under the Income Tax Act, any income that is deemed to accrue or arise in India is taxable in India. Sub-section (1) of section 9 of the Act is a deeming provision providing the types of income deemed to accrue or arise in India.

Finance (No. 2) Act, 2019 inserted clause (viii) to sub-section (1) of section 9 of the Act to provide

that the any sum of money exceeding fifty thousand rupees, received by a non-resident without consideration from a person resident in India, on or after the 5th day of July, 2019, shall be income deemed to accrue or arise in India. Sum of money is referred to in section 2(24)(xviia) of the Act
1. Extract of the relevant portion of the existing provisions:
  1. Section 9(1) provides, inter alia, that the following type of income shall be deemed to accrue or arise in India:- Section 9(1)
    (viii) – income arising outside India, being any sum of money referred to in sub-clause (xviia) of clause (24) of section 2, paid on or after the 5th day of July, 2019 by a person resident in India to a non-resident, not being a company, or to a foreign company.
  2. Section 2(24) (xviia) – any sum of money or value of property referred to in clause (x) of sub- section (2) of section 56
  3. Section 56(2)(x) – where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017,—
    1. any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;
    2. any immovable property,—
      1. without consideration, the stamp duty value of which exceeds fifty thousand rupees, the stamp duty value of such property;
      2. for a consideration, the stamp duty value of such property as exceeds such consideration, if the amount of such excess is more than the higher of the following amounts, namely:—
        
        the amount of fifty thousand rupees; and
        
        the amount equal to 70[ten] per cent of the consideration:
        Provided that where the date of agreement fixing the amount of consideration for the transfer of immovable property and the date of registration are not the same, the stamp duty value on the date of agreement may be taken for the purposes of this sub-clause
    3. any property, other than immovable property,—
      1. without consideration, the aggregate fair market value of which exceeds fifty thousand rupees, the whole of the aggregate fair market value of such property;
      2. for a consideration which is less than the aggregate fair market value of the property by an amount exceeding fifty thousand rupees, the aggregate fair market value of such property as exceeds such consideration.
  4. Non-residents are taxable in India in respect of income that accrues or arises in India or is received in India or is deemed to accrue or arise in India or is deemed to be received in India. Gift received by non-residents from residents was falling outside the purview of income accruing and arising in India and was therefore not taxed in India. However, with the insertion of subsection (viii) to Section 9(1) by the Finance Act, 2019, all the gift of money or property (as explained above) is taxed in the hands of non-resident donee, except for certain exemptions provided in clause (x) of sub-section (2) of section 56.
2. Proposed Amendment under Finance Bill 2023
  1. The existing provision was only applicable to non-residents for gifts received from residents. However, Not Ordinarily Residents (‘NORs’) were still outside the ambit of the above amendment and were receiving gifts from residents but not paying tax on it. Moreover, the definition of NOR has been widened by Finance Act 2020. Therefore, to widen the scope, this amendment is proposed in order to widen and deepen the tax base and as an anti- abuse provision.
  2. Accordingly, it is proposed that Section 9(1)
    (viii) shall be substituted as follows:
    
    “(viii) income arising outside India, being any sum of money referred to in sub-clause (xviia) of clause (24) of section 2, paid by a person resident in India ––
    1. on or after the 5th day of July, 2019 to a nonresident, not being a company, or to a foreign company;
      or
    2. on or after the 1st day of April, 2023 to a person not ordinarily resident in India within the meaning of clause
    (6) of section 6.” (Applicable from 01-04-2023)
3. Comments and Implications
  The number of people falling under the NOR category have significantly increased after the amendment to the definition of residence in India brought in by FA 2020. An NOR is also not required to pay taxes on their foreign income except for income which accrues or arises outside
  
  India from a business controlled in or a profession set up in India.
  
  Thus, an NOR had the best of both worlds,
  
  i.e. no taxation of foreign income and also no requirement to stay outside India for more than 245 days or reduce the income in India to less than INR 15 lakhs.
  
  With the increase in the number of people falling under the NOR category, it was considered necessary to put the NOR category under the provisions of Section 56(2)(X) as well to plug the leakage of tax revenue and bring NORs on par with non-residents so far as taxation of gifts from residents is concerned.
Section 56(2)(viiib) – Inclusion of non-residents within its ambit
1. Extract of current Provisions and Analysis:
  1. Section 56(2) provides, inter alia, that the following type of income shall be chargeable to income-tax under the head “Income from other sources”- Section 56(2)(viib): where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares
  2. Rule 11UA of the Income-tax Rules provides the formula for computation of the fair market value of unquoted equity shares for the purposes of the Section 56(2)(viib) of the Act where by either the Net Asset Value method (i.e. Book value method) or the Discounted Cash Flow method (based on future cash flows) may be adopted.
  3. This Section is applicable to Companies, other than those where the public are substantially interested. The term “company in which public are substantially interested” has been defined in section 2(18) of the Income Tax Act. This broadly includes
    public companies which are listed on stock exchanges, or subsidiaries of listed public companies.
  4. Equity and Preference shares both are covered under this section.
  5. The tax is payable on the amount received against issue of shares by such a Company from residents, to the extent it exceeds the fair value of the shares.
  6. Clause (viib) of sub section (2) of section 56 of the Act was inserted vide Finance Act, 2012 to prevent generation and circulation of unaccounted money through share premium received from resident investors in a closely held company in excess of its fair market value
2. Proposed Amendment and intent reflected in Memorandum
  1. In order to bring the non-resident investors within the ambit of section 56(2)(viib) and to prevent generation and circulation of unaccounted money through share premium, it is proposed to include the consideration received from a non- resident for issue of shares in excess of Fair Market Value as income under the head ‘Income from other sources’ in case of company receiving such Premium
  2. Accordingly, it is proposed by Finance Bill 2023 that Section 56(2)(viib) will read as under:
    “where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person ~~being a resident~~, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares” (Applicable from 01-04-2024)
  3. The amendment will apply to money received by a Company for issue of shares at a premium from anybody, regardless of their residential status.
3. Comments and Implications
  The proposed amendment will impact start-ups and other Small and Medium Enterprises (SMEs) looking for rapid growth as they are thinly capitalized and depend upon foreign investors for their funding. Such funding is normally at a substantial premium as the underlying assets of the startup do not support a higher fair market value. As a result, such funding normally depends on future prospects of the company rather than the current value of the assets of the company. Currently, such funding by non-residents did not involve valuation under Section 56(2)(viib) as it was not applicable to non-residents, though it could be argued that such cases were otherwise covered under Section 56(2)(x) which required fair valuation to be considered in all cases where a person receives money or property from any other person, except exempt cases as provided therein. It appears that with this proposed amendment, the regulatory loophole is being inadvertently plugged.
  
  Notwithstanding the above proposed amendment, investment by non-residents in shares of Indian companies was subject to pricing guidelines under FEMA, unless such investment was on non-repatriation basis. So, in most cases, valuation as per internationally accepted methods was required and the shares were issued at or above such computed fair value as required under FEMA. With this proposed amendment, in cases where shares are issued above the fair value to non-residents, such a difference will now be taxed whereas earlier it was not being taxed as the section applied only to subscription by residents.
  
  Further, It may be noted that Startups can take resort to the CBDT notification
  
  13/2019 dated 5th March, 2019, which exempts Startups from the applicability of the provisions of Section 56(2)(viib), provided the conditions mentioned therein are fulfilled by the Startups.
Reducing time provided for furnishing TP report – Section 92D(3)
1. Current Provisions and Analysis
  1. Section 92D(1) provides that: Every person,—
    1. who has entered into an international transaction or specified domestic transaction shall keep and maintain such information and document in respect thereof as may be prescribed;
    2. being a constituent entity of an international group, shall keep and maintain such information and document in respect of an international group as may be prescribed.
  2. Section 92D(3) provides that – The Assessing Officer or the Commissioner (Appeals) may, in the course of any proceeding under this Act, require any person referred to in clause (i) of sub-section (1) to furnish any information or document referred therein, within a period of thirty days from the date of receipt of a notice issued in this regard:
    Provided that the Assessing Officer or the Commissioner (Appeals) may, on an application made by such person, extend the period of thirty days by a further period not exceeding thirty days.
  3. Section 92D of the Act, provides that every person who has entered into an international transaction or a specified domestic transaction shall keep and maintain the information and documents as provided under rule 10D of the Income- tax Rules, 1962
2. Proposed Amendment by Finance Bill 2023
  1. It has been represented that in several instances due to limited time available for Transfer Pricing proceedings, it may not be practically possible to provide minimum 30 days for producing these information or documents which in any case is already in possession of the assessee. Accordingly, the time period allowed for submission of information or documents in respect of international transactions or a specified domestic transaction is required to be rationalised so as to provide the Assessing Officers a reasonable amount of time to examine the information / documents submitted and complete the pending proceedings.
  2. In view of the above, it is proposed to amend sub-section (3) of section 92D of the Act to provide that,-
    (i) The Assessing Officer or the Commissioner (Appeals) may, in the course of any proceeding under this Act, require any person referred to in clause (i) of sub-section (1) to furnish any information or document referred therein, within a period of ten days from the date of receipt of a notice issued in this regard:
    
    Provided that the Assessing Officer or the Commissioner (Appeals) may, on an application made by such person, extend the period of ten days by a further period not exceeding thirty days. (Applicable from 01-04-2023)
3. Comments and Implications
  The amendment is aimed at making more time available with the Assessing Officer (‘AO’) to complete the assessment within the time limits specified in Section 153 of the Act. The information that may be sought from the assessee is already likely to be available with the assessee given the fact that he is obligated to maintain the information and documents as specified in Rule 10D of the Income Tax Rules, hence
  
  reduction of period for submission may not make material difference to the assessee.
  
  As required under Section 92CA(3A), in cases where reference has been made by the AO to the Transfer Pricing Officer (‘TPO’) under Section 92CA(1) for computation of arms- length price, the TP order should be issued at least 60 days prior to the due date for completion of assessment as provided in Section 153 of the Act.
  
  Relevant extract of Section 92CA(3A) of the ITA is as follows: ……an order under sub-section (3) may be made at any time before sixty days prior to the date on which the period of limitation referred to in section 153, or as the case may be, in section 153B for making the order of assessment or reassessment or recomputation or fresh assessment, as the case may be, expires.
  
  Accordingly, the AO has a limited time period of 60 days to conclude and issue the draft Assessment Order. In case he requires any further additional information, then under the existing provision a period of 30 days is available for the assessee to submit the same which may be extended by further 30 days thereby leaving no time for the AO to conclude the assessment. In view of same, the amendment is proposed whereby the time available to the assessee for submission of the required information is reduced to 10 days with further extension of 30 days thereby enabling the AO with sufficient days to complete the assessment within the overall period specified in Section 153 of the Act.
Prevention of misuse of section 44 BB and 44 BBB- presumptive Scheme
1. Current Provisions and Analysis
  1. Section 44BB of the Act provides for presumptive scheme in the case of a non-
    resident assessee who is engaged in the business of providing services or facilities in connection with, or supplying plant and machinery on hire used, or to be used, in the prospecting for, or extraction or production of, mineral oils. Under the scheme, a sum equal to 10% of the aggregate of the amounts specified in sub- section (2) of the said section is deemed to be the profits and gains of such business chargeable to tax under the head “Profits and gains of business or profession”.
  2. Section 44BBB of the Act provides for presumptive scheme in the case of a non- resident foreign company who is engaged in the business of civil construction or the business of erection of plant or machinery or testing or commissioning thereof, in connection with a turnkey power project approved by the Central Government. Under this scheme, a sum equal to 10% of the amount paid or payable (whether in or out of India) to the said assessee or to any person on his behalf on account of such civil construction, erection, testing or commissioning is deemed to be the profits and gains of such business chargeable to tax under the head “Profits and gains of business or profession”.
  3. Both sections provide that an assessee may claim lower profits and gains than the profits and gains specified if he keeps and maintains such books of account and other documents as required under sub-section
    (2) of section 44AA of the Act and gets his accounts audited and furnishes a report of such audit as required under section 44AB of the Act.
2. Proposed Amendment by Finance Bill 2023
  1. It is seen that taxpayers opt in and opt out of presumptive scheme in order to avail benefit of both presumptive scheme income and non-presumptive income. In a year when they have loss, they claim actual loss as per the books of account
    and carry it forward. In a year when they have higher profits, they use presumptive scheme to restrict the profit to 10% and set off the brought forward losses from earlier years. Conceptually, if assessee is maintaining books of account and claiming losses as per such accounts, he should also disclose profits as per accounts. There is no justification for setting off of losses computed as per books of account with income computed on presumptive basis.
  2. To avoid such misuse, it is proposed to insert a new sub-section to section 44BB and to section 44BBB of the Act to provide that:
    Notwithstanding anything contained in subsection (2) of section 32 and sub- section (1) of section 72, where an assessee declares profits and gains of business for any previous year in accordance with the provisions of presumptive taxation, no set off of unabsorbed depreciation and brought forward loss shall be allowed to the assessee for such previous year (Applicable from 01-04-2024)
3. Comments and Implications
  The intention of law when introducing the presumption schemes of taxation under Section 44BB and Section 44BBB (which provided for lower taxation) was to pay minimum taxes after considering all the expenses on deemed basis and hence not to provide for the benefit of carry-forward and set-off of losses. However, due to the manner in which the said Sections were framed, such a loophole came into being which was exploited by the tax payers. The proposed amendment is therefore aimed at discouraging such an abuse of law.
Tax incentive to the International Financial Services Centre (IFSC)
In order to further incentivize operations from IFSCs, the following changes are proposed by the Finance Bill 2023
1. Proposed Amendments by Finance Bill 2023
  1. Section 47 (viiad) – Finance Act 2021 provided incentives in case of relocation of funds to IFSC if the relocation had taken place on or before 31 March 2023. It is proposed to extend the sunset clause in case of relocation from 31st March 2023 to 31st March 2025.
  2. Accordingly, It is proposed to amend clause
    (b) of the Explanation to clause (viiad) of section 47 of the Act to extend the date for transfer of assets of the original fund, or of its wholly owned special purpose vehicle, to a resultant fund in case of relocation to 31st March, 2025 from current limitation of 31st March, 2023.
  3. Section 10(4)(E) – Income of non-residents on transfer of Offshore Derivative Instruments (ODI) entered into with IFSC Banking unit is exempt under section 10 (4E) of the Act. Under the ODI contract, the IFSC Banking Unit (IBU) makes the investments in permissible Indian Securities. Income earned by the IBU on such investments is taxed as capital gains, interest, dividend under section 115AD of the Act. After the payment of tax, the IBU passes such income to the ODI holders. Presently, the exemption is provided only on the transfer of ODIs and not on the distribution of income to the non- resident ODI holders, hence this distributed income is taxed twice in India i.e. first when received by the IBU and second, when the same income is distributed to non-resident ODI holders.
  4. Therefore, in order to remove the double taxation, it is proposed to amend clause (4E) of section 10 of the Act, to also provide exemption to any income distributed on the offshore derivative instruments, entered into with an offshore banking unit of an International Financial Services Centre as referred to in sub-section (1A) of section 80LA, which fulfils such conditions as may be prescribed. It has also been provided that such exempted income shall include only
    that amount which has been charged to tax in the hands of the IFSC Banking Unit under section 115AD.
  5. The IFSCA (Fund Management) Regulations, 2022, went into effect on May 19, 2022. To include the reference to the said regulation in the Income Tax Act’s provisions, it is proposed to amend the definition of “Investment Fund” (as provided in Explanation 1, in clause (a) to Section 115UB) to include the reference to the IFSCA (Fund Management) Regulations, 2022
  6. The amendments referred to in paragraphs
    1. 1. and 6.3. will take effect on April 1, 2023, and will apply to assessment years 2023-24 and onwards. The amendment in paragraph
      2. will take effect on April 1, 2024, and will apply to assessment years 2024-25 and onwards.
2. Comments and Implications

Several tax breaks have been granted to units located in the International Financial Services Centre (IFSC) under the Income Tax Act in recent years in order to make it a global financial services hub. Over the years, the Government has made tremendous effort in making policies, regulatory changes and providing tax incentives that are conducive for setting up presence in IFSC. The Economic Survey 2022-2023 mentioned that GIFT IFSC is now emerging as a preferred jurisdiction for international financial services. Recognising the growing significance of IFSC, the Global Financial Centres Index, London Report (March 2022) put IFSC in GIFT City at the top, among 15 centres globally.

The amendments proposed in the Finance Bill 2023 are in continuation of the pursuit of the Government to make IFSC an attractive destination for setting up operations and attracting investments.