M.Com (C.No. M.Com-112) 1st Sem..pdf - Directorate Of ...

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SELF LEARNING MATERIALFor

M.Com Semester - ITAXATION OF FINANCIAL SERVICES

Unit I to IVCourse No. : M.Com-C112 Lesson : 1 - 20

Co-ordinator M.ComProf. Sandeep Kour TandonRoom No. 111, 1st Floor, DDE

University of Jammu

• All rights reserved. No part of this work may be reproduced in any form, bymimeograph or any other means, without permission in writing from theDDE, University of Jammu.

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© Directorate of Distance Education, University of Jammu, 2021

Written by :Mr. Sunil Kumar

Astt. ProfessorPG Deptt. of Commerce

University of Jammu

M.Com Semester - I

DIRECTORATE OF DISTANCE EDUCTION

UNIVERSITY OF JAMMU

M.COM FIRST SEMESTER (NCBCS)

TAXATION OF FINANCIAL SERVICES

Course No. M.Com-C112 Maximum Marks : 100

Credit : 4 External : 80 Marks

Time : 3 Hours Internal : 20 Marks

OBJECTIVES: To impart knowledge about tax provisions related to financialservices and international taxation to students.

Page No.

UNIT - I: FINANCIAL SERVICES 1-113

Financial services - Concept, evolution, importance, types, recent trends;Lease financing - Kinds of lease, tax considerations related to own orlease decision; Dividend policy - Tax considerations related to dividenddecisions; Tax considerations in respect of amalgamation - foramalgamating company, amalgamated company, shareholders ofamalgamating company, amalgamation of banking company; Taxconsiderations related to debt and equity.

UNIT- II : TRANSFER PRICING AND INTERNATIONAL TAXATION 114-196

International transactions; Conditions for applicability of arm’s lengthprice (ALP) in international transactions; Computation of the arm’s lengthprice- Method of computing arm’s lengh price, comparability of

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transactions, most appropriate method, determination of ALP by AssessingOfficer in certain cases; Reference to Transfer Pricing Officer; Maintenanceof books of account - Report from accountant, specified domestictransactions, advance pricing agreements, secondary adjustment in certaininternational transactions; Double taxation relief - Relief of doubletaxation, ADT agreements, unilateral relief; Tax considerations in respectof foreign collaboration agreements.

UNIT- III : TAX DEDUCTION AT SOURCE 197-297

Deduction of tax at source from - interest on securities, dividends, interestother than interest on securities; Insurance commission, payment of lifeinsurance policy national savings scheme, mutual funds of UTI; UnitsCommission or brokerage, rent, professional or technical services,infrastrucutre debt fund; Units of business trust, units of investment fund,investment in securitisation fund, bonds/government securities; Deductionfrom gross total income-deduction under section 80C, 80CCD, 80CCG,80D, 80DDG, 80E, 80EE, 80G, 80GG, 80LA, 80TTA, 80U; Advancepayment of tax - Liability to pay advance tax, due dates of payment ofadvance tax, payment of advance tax under different situations, interest.

UNIT: IV : GST ON FINANCIAL SERVICES 298-397

GST-Concept, need, relevant, definitions, advantages; GST on loantransactions; GST on securitization tranactions; GST on factoringtransactions; GST on stock-broking business; Impact of GST on housingfinance; Impact of GST on transactions in securities; Impact of GST onBanks and Banking services; Impact of GST on Mutual funds; GSTimplication ons sale of repossessed assets; GST implication with respectto Guarantees; GST implications on alternative investment funds; Leasetransactions under GST.

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RECOMMENDED BOOKS

1. Financial Services - M.Y. Khan, Tata McGraw Hill Education.

2. Direct Taxes Law & Practice - Dr. Vinod K. Singhania and Dr. Kapil Singhania,Taxman’s Publishing.

3. Corporate Tax Planning & Business Tax Procedures - Dr. Vinod K. Singhaniaand Dr. Monica Singhania, Taxmann’s Publishing.

4. GST on Financial Services - Vinod Kothari, Taxman’s Publishing.

5. GST Base Act.

6. Basics of GST - Nitya Tax Associates, Taxman’s Publishing.

MODE OF EXAMINATION :

The paper consists of two sections. Each section will cover the whole of the syllabuswithout repeating the question in the entire paper.

Section A: It will consist of eight short answer questions, selectingtwo from each unit. A candidate has to attempt any sixand answer to each question shall be within 200 words.Each question carries four marks and total weightage tothis section shall be 24 marks.

Section B: It will consist of six essay type questions with answer toeach question within 800 words. One question will be setatleast from each unit and the candidate has to attemptfour . Each question will carry 14 marks and totalweightage shall be 56 marks.

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M.Com. 1st Sem. Unit-ILesson No. 1

FINANCIAL SERVICES-CONCEPT, EVOLUTION,IMPORTANCE, TYPES, RECENT TRENDS

Structure

1.1 Introduction

1.2 Objectives

1.3 Concept

1.4 Evolution

1.5 Importance

1.6 Types

1.7 Recent Trends

1.8 Summary

1.9 Glossary

1.10 Self Assessment Questions

1.11 Lesson End Exercises

1.12 Suggested Readings

1.1 INTRODUCTION

The Financial services sector in India is blooming and has become one of thelucrative areas to professionalism. The sector has undergone change since 1990.

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Indian economy got liberalized during 1991 and the financial sector was kept openfor private and foreign players. During the late eighties, the financial services industryin India was dominated by commercial banks and other financial institutions governedby the Central Government. The economic liberalization has brought in a completetransformation in the Indian financial services industry.

Prior to the economic liberalisation, the Indian financial service sector wascharacterised by various other factors, which was related to the growth of this sector.Some of the factors of significance are as follows:

• Too much of control and regulation by the apex bodies in the form of interestrates, money rates etc.

• Controller of capital issues used to regulate the prices of securities

• Absence of independent credit rating and credit research agencies.

• Strict regulation of the foreign exchange market

• Restrictions on foreign investment and foreign equity

• Non-availability of debt instruments on a large scale.

However, after the economic liberalisation the entire financial sector hasundergone a see-saw change and now new financial instruments are entering thecapital market on a daily basis. The present scenario in the Indian Capital market ischaracterized by financial innovation and financial creativity.

Financial services basically mean all those kinds of services provided in financialor monetary terms, where the essential commodity is money. These services include;Leasing, Hire purchase, venture capital, Merchant banking, Insurance, housing finance,Mutual funds, factoring, stock broking and many others.

1.2 OBJECTIVES :

After going through this lesson, you should be able to understand

• the concept of financial services

• the evolution, importance and types of financial services

• the recent trends in financial services industry

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1.3 CONCEPT

The Term financial services in its broader sense refers to “mobilizing andallocation of savings”. It is identified as all those activities involved in the process ofconverting savings into investment. Financial services also include financialintermediaries such as Merchant Bankers, Venture capitalists, Commercial banks,Insurance Companies etc. The financial services comprise of the following majorconstituents in the financial system. They are:

a) Financial instruments

b) Market players

c) Specialised Institutions

d) Regulatory bodies

a) Financial Instruments:

It includes equity, debt and hybrid. These instruments are written evidencesof ownership and they give the holders the right to demand and receive property notin their possession.

The ownership of a corporation is divided into various units and each unit iscalled as a share. A shareholders interest is evidenced by a stock certificate, whichstates the name of the shareholder, the class of stock and the number of shares owned.

Debenture is a certificate issued by the company under its common sealacknowledging the debt to be repayable with interest. Hybrid instrument is thecombination of both equity and debt instruments.

b) Market players:

The players in the market include:

i. Commercial banks

ii. Financing companies

iii. Stock brokers

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iv. Consultants

v. Underwriters

vi. Market makers

i. Commercial Banks:

The commercial banking in the developed countries provide term loans tocorporate sector by participating in the capital and equipment finance. The commercialbanking has undergone a number of structural and functional changes in the developingcountries. The Indian banks have recently commenced hire purchasing finance, leasing,factoring and other services.

ii. Financing companies:

The participation of finance organizations can stimulate the economic growth.They inject new blood to the corporate sector. All these reflections made for theevolution of a vibrant, competitive and dynamic financial system, the Non-BankingFinance Corporations sector has recorded marked growth in the recent past.

iii. Stock Brokers:

Stock Brokers play an important role in the stock market. They involve inbuying and selling of securities in a recognized stock exchange. If anyone wants towork as a broker, a certificate of registration from the SEBI is mandatory aftersatisfying all the terms and conditions. SEBI will grant the registration to the brokers.The membership in the stock exchange can be granted as individual membership andcorporate membership.

iv. Consultants:

Consultants are the professionals in the area of Finance can be providing bestsolutions to the problems faced by the corporate sector. They are pioneer in theirfield and render the quality service with high integrity and standards. A financialconsultant occupy a key role in problem solving solution like in all areas of functionalmanagement such as production, finance, marketing and human resources. Theirservices are intangible and show greater impact on the functioning of the company.

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They provide customised solution to all the problems irrespective of any area.

v. Underwriters:

Underwriters are the intermediaries in the primary market. They provideassurance to the companies, which approach the capital market for raising the financialresources. They render valuable services to the newly started companies, which requirebelievable advice. Underwriters assure the company full subscriptions for acommission.

vi. Market makers:

Market makers are associated with the stock exchanges. The market makingsystem is very much popular in London, New York and Chicago stock exchanges.Their basic function is to provide the needed liquidity to a particular scrip. They helpin eliminating the temporary disparity between the supply and demand of scrip. Theyhelp in maintaining a fair and orderly market.

c) Specialised Institutions:

Financial services area meant for providing solution to various problems facedby the corporate sector. The provider of financial services remains in constant touchwith the dynamic market. The financial markets are required to develop specialisedinstitutions to solve the financial problems of the corporate sector. These specialisedinstitutions include acceptance houses, Discount houses, Factors, Depositories, Creditrating agencies, Venture capital. These institutions provide solutions to the financialproblems of the corporate sector.

d) Regulatory Bodies:

Regulations are the most important factor in any area of financial system. TheFinancial markets are highly volatile and need a close observation by the Government.The government of India watches the market affairs on daily basis through its nomineeSEBI. The government regulates the financial system through various legal organs ofthe administration. The banking affairs are monitored by the RBI. The corporateaffairs are regulated by the company law board and board for industrial and financialreconstruction.

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1.4 EVOLUTION

Financial services sector is blooming in India and it has passed through variousphases as mentioned below:

i) Initial phase (1960-80)

ii) Second phase (1980-90)

iii) Third phase (1990-2002)

i) Initial phase:

Financial services at the initial phase introduced many innovative servicessuch as merchant banking, Insurance and leasing finance. The term merchant bankingwas not known till 1960. It was used as an umbrella function. Its activities start fromproject appraisal to mobilization of finance from suppliers. They also underwrote thepublic issues and helped in getting the shares listed in the stock exchange. LIC, GICand UTI initiated to enter into this segment during this period. Leasing activities wasstarted in the year 1970. Initially leasing companies were engaged in equipment leasefinancing. Afterwards they have undertaken different kinds of leasing such as financiallease, operating lease and sale and lease back leasing.

ii) Second phase:

Financial services entered the second stage and it covered the period of 10years approximately. In this phase it introduced many innovative value added servicessuch as over the counter share transfers, pledging of shares, mutual funds, factoring,discounting, venture capital and credit rating. Mutual funds provide major fund tothe industry anywhere in the developed countries. Credit rating reduces malpracticesin the capital market and this rating is applied only to debt instruments only. Now thisrating is mandatory for commercial papers and fixed deposits.

iii) Third phase:

This phase in financial services include the setting up of new institutions andinstruments. This period started after post liberalisation. The depositories, the stocklending schemes, online trading, paperless trading, dematerialisation, book buildings

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are the contemporary issues of this phase. This phase has initiated to popularize bookbuilding to help both investors and fund mobilises. In this phase government hastaken initiatives to allow foreign institutional investors into the capital market. Thegovernment of India is revamping Companies act, Income tax act, CCI etc, fordelivering effective financial services.

PRESENT SCENARIO:

i) Conservatism to dynamism:

At present, the financial system in India is in a process of rapid transformation,after the liberalization of financial sector. The main objective of the financial sectorreforms is to promote an efficient, competitive and diversified financial system in thecountry. Now the Indian financial services sector is very dynamic and it is adoptingitself to the changing needs.

ii) Emergence of Primary Equity Market:

Primary market in India is now very active. India is now witnessing theemergence of many private sector financial services. Capital market is one of themajor places to raise finance. The aggregate funds raised in the Indian capital markethave doubled over a decade.

iii) Concept of Credit Rating: The facility of credit rating helps the investors infinding a profitable and safe debt capital. It rates the debt issues and instructs theinvestors not to invest in the debt capital of the firms that are badly rated. The regulatorsof the Indian capital market are contemplating on introducing Equity grading, whichhelps the investors to prudently invest their savings.

iv) Process of Globalisation:

Globalization has given way for the entry of innovative and sophisticatedfinancial products into our country. Government of India is very keen in removing allthe obstacles in the financial sector. Indian capital market has high potential for theintroduction of innovative financial products.

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v) Process of liberalisation:

Government of India has initiated many steps to reform the financial servicesindustry. The interest rates have been deregulated. The private sector has beenpermitted to participate in banking and mutual fund sectors. The Finance Act ofGovernment of India is bringing various amendments every year to keep the financialsector very flexible.

1.5 IMPORTANCE

Financial services are a part of financial system that provides different types of financethrough various types of credit instruments, financial products and services.

• Financial instruments- cheques, bills, promissory notes, letter of credit

• Financial products- different types of mutual funds, investment opportunities

• Financial services- leasing, factoring, hire purchase finance etc.

It is the presence of financial services that enables a country to improve itseconomic conditions leading to economic growth. However its main importance ishighlighted below:

(i) Promoting investment: The presence of financial services creates moredemand for products so the producer in order to meet the demand of the consumergoes for more investment.

(ii) Promoting Savings: Financial services such as mutual funds provide ampleopportunity for different types of saving. In fact different types of investment optionsare available for investors with different needs so that they can be assured of areasonable return on investment without much risk.

(iii) Minimising the risk: Insurance not only offers protection from the fluctuatingbusiness conditions but also from risks caused by natural calamities. Insurance alsoleads to savings.

(iv) Maximizing the returns: The presence of financial services makes the creditavailable to businessmen at a reasonable rate. Producers can avail various types of

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credit facilities for acquiring assets. They can even avail the facility of leasing whichreduces initial financial burden. Thus maximizing the returns.

(v) Ensures greater yield: The financial services enable the producer to notonly earn more profit but also maximise the wealth. The stock market and differenttype of derivative market provides enormous opportunities to get a higher yield forthe investment made.

(vi) Economic growth : The presence of financial institutions ensures that theyprovide equitable services to all the sectors of economy so that balance growth canbe ensured for the economy.

(vii) Economic development : Financial services enable the consumers to obtaindifferent types of products and services by which they can improve their stand ofliving. Thus giving an indication towards economic development of the country.

(viii) Benefit to Government : A healthy financial system provides greater strengthto the economic conditions of the nation as it ensures proper flow of money to theprospective investors and reduces burden on the government. As availability of differentservices from the different financial institutions enables the government to focus onmore specific activities for the growth of the nation.

(ix) Expands activities of financial institutions : Financial institutionsare not performing only traditional functions but the range of activities undertakenhave increased in the past few decades which is an indication that opportunities forthe financial institution have increased.

(x) Capital market : One of the barometers of any economy is the presence of avibrant capital market. If there is hectic activity in the capital market, then it is anindication of the presence of positive economic conditions. The financial servicesensures that all the companies are able to acquire funds to boost production and toreap more profits eventually. In the absence of financial services, there will be paucityof funds which will adversely affect the working of companies and will only result ina negative growth of the capital market. When the capital market is more active,funds from foreign countries also flow in. Hence, the changes in capital market aremainly due to the availability of financial services.

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(xi) Promotion of Domestic and Foreign Trade: Financial services ensurepromotion of domestic as well as foreign trade. The presence of factoring and forfeitingcompanies ensures increasing sale of goods in the domestic market and export ofgoods in the foreign market. Banking and insurance services further contribute tostep up such promotional activities.

(xii) Balanced Regional Development: The government monitors the growth ofeconomy and regions that remain backward economically are given fiscal and monetarybenefits through tax and cheaper credit by which more investment is promoted. Thisgenerates more production, employment, income, demand and ultimately increase inprices. The producer will earn more profits and can expand their activities further.So, the presence of financial services backward regions to develop and catch up withthe rest of the country that has developed already.

1.6 TYPES

LEASING:

The term leasing refers to a contract under which the owner of an asset allowsanother person or party to use the asset in return for some rent. The persons involvedare lessor and lessee. Lessor is the owner of the asset and the lessee is the persongetting the benefit of asset taken on lease.

Steps involved in Leasing:

A contract of lease provides a person an opportunity to use an asset, whichbelongs to another person. The following steps are involved in a leasing transaction:

i) At the first instance the lessee has to take a decision regarding the requiredasset. Then he has to select a supplier before selecting the type of machine.

ii) The lessee then enters into a lease agreement with lessor. The lease agreementcontains the terms and conditions of the lease such as, lease period, rentalpayments, details regarding renewal of lease period, cost of repair andmaintenance, insurance and any other expenses.

iii) After the lease agreement is signed the lessor consents the manufacturer andrequests him to supply the asset to lessee.

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MERCHANT BANKING:

Merchant banks are financial institutions providing specialist services thatgenerally include the acceptance of bills of exchange, corporate finance, portfoliomanagement and other banking services.

Services of merchant banks:

A merchant banker helps in the process of issue management and his servicesare broadly categorized as pre-issue management and post issue management. Thepre-issue management involves the following:

• Printing prospectus

• Pricing of issues

• Marketing the issue

• Underwriting

• Listing of securities in stock exchange Post issue management includes the following:

• Collection of application forms

• Screening the applications

• Deciding allotment procedure

• Mailing of letter of allotment

• Issue of share certificates

• Refund of application money to non-allotters.

A merchant banker acts as a liasoning officer at the event of mergers andacquisitions. He helps the company in managing its portfolio.

A merchant banker help their clients in off shore financing such as long termforeign currency loans, joint ventures abroad, licensing and franchising, financingexports and imports, foreign collaboration arrangements etc.

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The services of Merchant bankers also include investment advisory to Non-ResidentIndians in terms of identification of investment opportunities, selection of securities,investment management etc. They also take care of the operational details like purchaseand sale of securities, securing necessary clearance from RBI.

MUTUAL FUND:

A mutual fund is a corporation, trust or partnership that combines the assetsof all its shareholders or partners into one common investment account for the purposeof providing diversification and professional management. ?A mutual fund meanspooling the investments of a number of investors by way of investment in units ofequal size'. The concept of Mutual funds was started with unit schemes of Unit Trustof India in 1964 in India. The term mutual funds came into prominence only in 1987when leading public sector banks like SBI, Canara bank set up their mutual funds,followed by LIC of India in 1989. From the year 1993 the mutual funds were allowedto start under private sector also. At present in India there are 40 mutual fundcompanies in India.

ORGANISATION OF MUTUAL FUND COMPANIES IN INDIA:

The organization of mutual funds involves five constituents or special bodies.

They are:

a) The sponsor/s

b) The board or trustees

c) The asset management company (AMC)

d) The custodian and

e) The unit holders.

A mutual fund is set up in the form of a trust, which has sponsor, trustees,Asset Management Company and custodian. The trust is established by a sponsor ormore than one sponsor who is like a promoter of a company. The trustees of themutual fund hold its property for the benefit of the unit holders. AMC approved by

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SEBI manages the fund by making investments in various types of securities. Custodianwho is registered with SEBI holds the securities of various schemes of the fund in itscustody. The trustees are vested with the general power of superintendence anddirection over AMC. They monitor the performance and compliance of SEBIregulations by the mutual fund.

CLASSIFICATION OF MUTUAL FUNDS:

• A Mutual fund scheme can be classified into open-ended or closed ended schemesdepending on its maturity period.

• An open-ended scheme is one that is available for subscription and repurchase ona continuous basis. These schemes do not have a fixed maturity period.

• A closed ended scheme has a stipulated maturity period e.g. 5-7 years. The fund isopen for subscription only during a specified period at the time of launch of thescheme. Investors can invest in the scheme at the time of initial public issue andthereafter they can buy or sell the units of the scheme on the stock exchanges wherethe units are listed.

• The schemes can also be classified as Growth funds, income funds and balancedfunds.

i) Growth funds:

The growth funds aim to provide capital appreciation over the medium tolong term. Such schemes normally invest a major part of their corpus in equities.Such funds have comparatively high risks. These schemes provide different optionsto the investors like dividend; capital appreciation etc. and the investors can choosean option depending on their preferences.

ii) Income funds:

These funds aim to provide regular and steady income to investors. Suchschemes generally invest in fixed income securities such as bonds, corporatedebentures, government securities and money market instruments. These funds arenot affected by the market fluctuations.

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iii) Balanced funds:

These funds provide both growth and regular income as such schemes invest both inequities and fixed income securities. These are appropriate for investors looking formoderate growth. They generally invest 40-60% in equity and debt instruments. Thesefunds are also affected by fluctuations in share prices in the stock market.

• The other schemes are as follows: Money market mutual funds, Indexed funds,Sector schemes, Tax saving schemes, load fund, no load fund etc.

iv) Money market mutual funds:

These are income funds and their aim is to provide easy liquidity, preservation ofcapital and moderate income. These schemes invest exclusively in safer short terminstruments such as treasury bills, certificates of deposit, commercial paper and interbank call money, government securities etc.

v) Indexed funds:

These funds invest exclusively in the government securities. Government securitieshave no default risk. Net asset values of these schemes also fluctuate due to changein interest rates and other economic factors as in the case of income or debt orientedschemes.

vi) Sector schemes:

These are the funds, which invest in the securities of only those sectors or industriesas specified in the offer documents. E.g. Soft ware industries, pharmaceuticals,FMCGS etc. The returns in these funds are dependent on the performance of therespective sector. While these funds may give higher returns, they are more risky ascompared to diversified funds. Investors need to keep a watch on the performance ofthese sectors and must exit at an appropriate time besides seeking expert advice.

vii) Tax saving schemes:

These schemes offer tax rebates to the investors under specific provisions ofthe income tax act of 1961, as the government offers tax incentives for investment inspecified avenues. EG. Equity linked saving schemes, pension schemes etc.

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viii) Load fund:

A load fund is one that charges a percentage of Net asset value for entry orexit. Each time one buys or sells units in the fund, a charge will be payable. Thischarge is used by the mutual fund for marketing and distributing expenses.

ix) No-load fund:

This fund is one that does not charge for entry or exit. It means the investorscan enter the fund at Net asset value and no additional charges are payable on purchaseor sale of units. The price a unit holder is charged while investing in an open-endedscheme is called sales price.

CREDIT RATING:

Credit rating is an assessment, by an independent agency of the capacity of anissuer of debt security to service the debt and repay the principal as per the terms ofissue of debt. A rating agency collects the qualitative as well as the quantitative datafrom a company, which has to be rated, and assesses the relative strengths and capabilityof company to honour its obligations contained in the debt instrument throughoutthe duration of the debt instrument. The rating given is based on an objective judgmentof a team of experts from the rating agency involved in credit rating.

OBJECTIVES OF CREDIT RATING:

The objectives of credit Rating are mentioned below :

• It imposes a financial discipline on the borrowers

• It helps the financial intermediary in discharging the functions relating to the debtissues.

• It guides the investor regarding the commitment towards a particular debtinstrument for better returns.

• It facilitates the formulation of the public guidelines on the institutional investment.

• It may provide adequate funds for the high rated companies at a low rate of interest.

• It lends greater credibility to the financial and other representatives.

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• It encourages transparency of information and better accounting standards.

CREDIT RATING PROCESS:

A) The issuing company approaches the rating agencies.

B) On the basis of client needs, rating agency appoints a team of experts to appraisethe financial position of the company.

C) The experts team makes report to the agency appoints a team of experts toappraise the financial positions.

D) Credit rating agency submits its observations about the quality of debt instrumentthrough symbols.

VENTURE CAPITAL:

It is a form of financing, designed for funding high technology, high risk and perceivedhigh reward projects. A venture capitalist provides funds to entrepreneurs andenterprises pursuing in the new and unexplored avenues. Venture capitalist helps thepromoter to actualize the project and attain commercialization.

Features of venture capital:

i. Venture capital is usually will be in the form of equity participation.

ii. The investment is made only in high tech projects having high growth potential.

iii. Venture capitalist joins the firm as a co-partner and shares the risk and reward ofthe enterprise.

iv. Once the started venture reaches the full potential and starts earning profit, theventure capitalist will withdraw his investments.

v. This type of investment is generally made in small and medium scale businesshouses.

vi. Venture capital is available only for commercialization of new ideas and it is notavailable for the firms engaged in trading, financial services, research anddevelopment etc.,

FACTORING: It may be defined as a continuing arrangement between thefinancial institutions or banks and a business concern selling goods or providing services

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on credit, wherein the factor undertakes the task of recording, collecting, controllingand protecting the book debts and also purchasing the bills receivables of the suppliers.

Factoring involves the following functions:

a) Purchase and collection of debts

b) Management of sales ledger

c) Credit investigation

d) Provision of finance against debt

e) Rendering consultancy services

LOAN SYNDICATION:

This is also referred as consortium financing. This work is taken up by theMerchant banker and he arranges loans to the customers by accumulating moneyfrom various sources. If a single bank cannot provide a huge sum of loan, a numberof banks join together and form a syndicate. It enables the members of the syndicateto share the credit risk associated with a particular loan among themselves.

1.7 RECENT TRENDS

Insurance Sector

• New distribution channels such as bank assurance, online distribution and NBFCshave widened the reach and reduced operational costs

• The life insurance sector has witnessed the launch of innovative products suchas Unit Linked Insurance Plans (ULIPs)

• Most general insurance public companies are planning to expand beyond Indianmarkets, especially in South- East Asia and the Middle East

• Insurance industry in India is expected to reach US$ 280 billion by 2020

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Mobile Wallets

• As the Reserve Bank of India (RBI) allows more features such as unlimited fundtransfers between wallets and bank accounts, mobile wallets will become strong playersin the financial ecosystem,

• India's mobile wallet industry is estimated to grow at a compound annual growthrate (CAGR) of 148 per cent to reach US$ 4.4 billion by 2022.

Digital Transactions

• Indian companies are strengthening their footprint on foreign shores, enhancinggeographical exposure. Digital transactions reached an all-time high of 1.11 billion inJanuary 2018. India's digital payments are estimated to increase to US$ 1 trillion by2023, backed by global technology majors boosting infrastructure as aggregators forretail payments.

• India has been ranked 28th out of 73 countries in 2018, in adoption of e-paymentsby the government.

NBFCs

• NBFCs have served the unbanked customers by pioneering into retail asset-backedlending, lending against securities and microfinance. NBFCs aspire to emerge as aone-stop shop for all financial services

• Non-Banking Financial Companies are expected to raise their share to 19-20 percent by 2020 through recapitalisation program for public sector

• New RBI guidelines on NBFCs with regard to capital requirements, provisioningnorms and enhanced disclosure requirements are expected to benefit the sector in thelong run

STRATEGIES ADOPTED

Innovation

• In insurance industry, several new and existing players have introduced innovativeinsurance-based products, value add-ons and services. Few foreign companies have

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also entered the domain, including Tokio Marine, Aviva, Allianz, Lombard General,AMP, New York Life, Standard Life AIG and Sun Life.

• HDFC Capital Advisors Ltd has raised US$ 550 million for its second affordablehousing fund, HDFC Capital Affordable Real Estate Fund-2 (H-CARE-2), whichwill invest in affordable and mid-income and residential projects in 15 cities acrossIndia.

Mergers and Acquistions

• As of December 2018, Warburg Pincus LLC acquired minority stake in FusionMicrofinance for Rs 520 crore (US$ 75 million).

• In October 11, 2018, MobiKwik forayed into the wealth management businesswith acquisition of Clearfunds.

• In 2018, 74 deals of acquisition took place in financial sector. The total value ofsuch transactions was US$ 4.166 billion.

Stepped up IT Expenditure

The explosion of mobile phones, uptake of technologies such as cloud computingand rising pace of convergence and interconnectivity have led companies in the financialservices industry to ramp up investment in Information Technology (IT) to betterserve their end-customers

Expanding Geographical presence

Indian companies are strengthening their footprint on foreign shores, enhancinggeographical exposure.

GROWTH DRIVERS IN FINANCIAL SECTOR

Government Initiatives

• In September 2018, SEBI asked for recommendations to strengthen rules whichwill enhance the overall governance standards for issuers, intermediaries orinfrastructure providers in the financial market.

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• In December 2018, Securities and Exchange Board of India (SEBI) proposeddirect overseas listing of Indian companies and other regulatory changes. It hasprovided companies with a broader investor base, better valuation, increasedawareness, analyst coverage and visibility.

• In November 2018, India's leading stock exchange BSE has created a new sub-segment within its existing small to medium (SME) segment to list start-up companiesin India.

Shift to Financial Asset Class

• Financial sector growth can be attributed to rise in equity markets and improvementin corporate earnings.

• In FY17, individual wealth in India expanded to Rs 344 lakh crore (US$ 5,337.47billion) from Rs 310 lakh crore (US$ 4,620.66 billion) in FY16.It increased growthrate from 10.91 per cent in FY17 to 8.50 per cent in FY16.

• By 2022, India's personal wealth is forecasted to reach US$ 5 trillion at a CAGR of13 per cent. It stood at US$ 3 trillion in 2017.

• As of November 2018, outlook of global brokerages Morgan Stanley and CreditSuisse are turning upbeat towards Indian equities.

• Investments by Foreign Portfolio Investors (FPIs) in Indian capital markets havereached Rs 6,310 crore (US$ 899.12 million) up to November 22, 2018.

1.8 SUMMARY

The Financial services sector in India is blooming and has become one of thelucrative areas to professionalism. The sector has undergone change since 1990.Indian economy got liberalised during 1991 and the financial sector was kept openfor private and foreign players. During the late eighties, the financial services industryin India was dominated by commercial banks and other financial institutions governedby the Central Government. The economic liberalisation has brought in a completetransformation in the Indian financial services industry.

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1.9 GLOSSARY

HNWIs: High-Net-Worth Individuals

IRDA: Insurance Regulatory and Development Authority

LIC: Life Insurance Corporation

NBFCs: Non Banking Financial Company

1.10 SELF ASSESSMENT QUESTIONS

1. Define financial services.

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2. What do you understand by loan syndication?

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1.11 LESSON END EXERCISES/EXAM ORIENTED QUESTIONS

1. What are the advantages of financial services?

2. Highlight recent trends in financial services industry.

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3. Explain the types of financial services.

4. Discuss the evolution of financial services.

1.12 SUGGESTED READINGS

1. Financial Services - By Thummuluri Siddaiah

2. Management of Financial Services- By V.K. Bhalla

3. Indian Financial System- By Vasant Desai

4. www.ibef.org

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LEASE FINANCING- KINDS OF LEASE, TAXCONSIDERATIONS RELATED TO OWN OR LEASE

DECISION

STRUCTURE

2.1 Introduction

2.2 Objectives

2.3 Meaning of Lease Financing

2.4 Kinds of Lease

2.5 Tax considerations related to own or lease decision

2.6 Summary

2.7 Glossary




2.1 INTRODUCTION

Lease financing is one of the popular and common methods of assets based finance,which is the alternative to the loan finance. Lease is a contract. A contract underwhich one party, the leaser (owner) of an asset agrees to grant the use of that asset to

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another leaser, in exchange for periodic rental payments. Lease is contractualagreement between the owner of the assets and user of the assets for a specific periodby a periodical rent.

2.2 OBJECTIVES

After going through lesson you should be able to understand

• the meaning of lease financing

• the types of lease

• the tax consideration related to own or lease decisions

2.3 MEANING OF LEASE FINANCING

Lease financing is one of the popular and common methods of assets based finance,which is the alternative to the loan finance. Lease is a contract. A contract underwhich one party, the leaser (owner) of an asset agrees to grant the use of that asset toanother leaser, in exchange for periodic rental payments. Lease is contractualagreement between the owner of the assets and user of the assets for a specific periodby a periodical rent.

2.4 KINDS OF LEASE

Leasing, as a financing concept, is an arrangement between two parties for a specifiedperiod. Leasing may be classified into different types according to the nature of theagreement. The following are the major types of leasing as follows:

(A) Lease based on the term of lease

1. Finance Lease

2. Operating Lease

(B) Lease based on the method of lease

3. Sale and lease back

4. Direct lease

(C) Lease based in the parties involved

5. Single investor lease

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6. Leveraged lease

(D) Lease based in the area

7. Domestic lease

8. International lease

1. Financing lease

Financing lease is also called as full payout lease. It is one of the long-term leases andcannot be cancelable before the expiry of the agreement. It means a lease for termsthat approach the economic life of the asset, the total payments over the term of thelease are greater than the leasers initial cost of the leased asset. For example: Hiringa factory, or building for a long period. It includes all expenditures related tomaintenance.

2. Operating lease

Operating lease is also called as service lease. Operating lease is one of the short-term and cancelable leases. It means a lease for a time shorter than the economic lifeof the assets, generally the payments over the term of the lease are less than theleaser's initial cost of the leased asset. For example: Hiring a car for a particulartravel. It includes all expenses such as driver salary, maintenance, fuels, repairs etc.

3. Sale and lease back

Sale and lease back is a lease under which the lesee sells an asset for cash to aprospective leaser and then leases back the same asset, making fixed periodic paymentsfor its use. It may be in the firm of operating leasing or financial leasing. It is one ofthe convenient methods of leasing which facilitates the financial liquidity of thecompany.

4. Direct lease

When the lease belongs to the owner of the assets and users of the assets with directrelationship it is called as direct lease. Direct lease may be Dipartite lease (two partiesin the lease) or Tripartite lease. (Three parties in the lease)

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5. Single investor lease

When the lease belongs to only two parties namely leaser and it is called as singleinvestor lease. It consists of only one investor (owner). Normally all types of leasingsuch as operating, financially, sale and lease back and direct lease are coming underthis category.

6. Leveraged lease

This type of lease is used to acquire the high level capital cost of assets and equipments.Under this lease, there are three parties involved; the leaser, the lender and the lessee.Under the leverage lease, the leaser acts as equity participant supplying a fraction ofthe total cost of the assets while the lender supplies the major part.

7. Domestic lease

In the lease transaction, if both the parties belong to the domicile of the same countryit is called as domestic leasing.

8. International lease

If the lease transaction and the leasing parties belong to the domicile of differentcountries, it is called as international leasing.

2.5 TAX CONSIDERATIONS RELATED TO OWN OR LEASE DECISION

Now a days, if a business house/company wants to acquire an asset (Plant, machinery,land, building and furniture etc.), it has the following two options:

(1) To own/purchase the asset

(2) To take the asset on lease. -

(1) Owning/Purchasing the asset. The owning or buying of an asset has the followingeffects:-

(i) The buyer becomes the legal owner of the asset;

(ii) The buyer has to pay the purchase price either in lump sum or in installmentstogether with interest;

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(iii) The purchased asset can be offered as security to outsiders;

(iv)The risk of asset becoming obsolete lies with the buyer;

(v)The buyer can claim depreciation on the asset.

(vi)The asset can be sold or disposed off by the buyer as and when/desired.

Owning an asset with owned Capital or borrowed Capital

Now the asset can be purchased by using either

(i) Owned capital [Equity share capital, Preference share capital etc.]

or

(ii) Borrowed capital [Taking loan or by issuing debentures]

As we know that the debt is a cheaper source of finance as compared to ownedcapital because interest on debt is 100% tax deductible and helps in saving incometax.

Thus in case of profit earning business houses, it is always better to own the assetwith borrowed capital.

(2) Taking Asset on lease. Leasing is an arrangement that provides a business housean opportunity to use and control an asset without buying and owning the same.Lease is a contract between the owner of the asset and the user of the asset wherebythe owner gives the right to use the asset to other party for an agreed period of timein consideration of regular pre-decided lease rentals.

The owner of the asset is called the lessor while the other party that uses the asset isknown as the lessee. The terms and conditions of lease agreement are specified in thelease contract which is also called 'Lease Deed.'

ACQUIRING ASSET ON LEASE MADE POSSIBLE BY A LEASINGCOMPANY

Leasing Companies are a particular class of companies which are engaged in investingin assets required by the users/industries and provide these assets to them (users) for

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a consideration called

'Lease rentals'. Leasing an owned asset to other is a very good business these days.The income of such companies is taxable 'under the head Business'. These leasingcompanies are professionally managed companies operating in private sector as wellas public sector.

Leasing companies-an addition to traditional source of finance

Following are, by & large, the main sources of finance resorted to by corporatehouses:-

(1) Share Capital: - Under this source of finance, companies raise finance by issuingequity shares and preference shares. Corporate houses having good track record,generally do not face any problem in raising finance through this source.

However for new companies and companies with average or bad track record, it isnot an easy source of finance. Also, the cost of issuing shares such as advertisementcost and underwriting commission etc is high.

(2) Debentures or Bonds:- Under this source, a company issues debentures or bondsas debt instrument with fixed rate of interest. These debentures carry a floating chargeover the assets of the company.

(3) Public Deposits:- Subject to restrictions imposed by Companies Act 1956.

(4) Term loans from Banks and financial institutions for expansion andmodernisation.

(5) Bank Loans for working capital requirement:-

As far as, raising of finance from Banks and financial institutions is concerned, thecredit policy of the Government plays an important role. The existence of strict creditnorms leads to low availability of finance thus causing a great deal of hardship tocorporate houses.

Leasing as a source of finance:-

Leasing companies (Lessors), though not a direct source, is considered as a sourceof finance to industries or corporate houses.

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Although these companies do not provide cash/finance to industries directly yet bymaking available assets required bythem (Industries), these leasing companies reducethe dependence of industries/corporate houses on traditional sources of finance asdiscussed earlier.

Leasing, as a source of finance, is gaining popularity all over the world.

LIMITATIONS OF LEASING

Following are the limitation of leasing :

(1) Asset taken on lease does not provide ownership rights to lessee.

(2) Assets taken n lease cannot be offered as a security to outsiders like Bankers andother financial institutions

(3) Since asset taken on lease is to be returned to lessor at the end of the lease period,thus Business house/lessee is required to make fresh arrangements for its acquisition.

Financial factors affecting own or lease Decisions

(1) Liquidity position / Availability of cash.

(2) Earning position of company

(3) Rate of technological obsolescence

(4) Residual value at end

(5) Reliability of lessor.

(6) Tax treatment of lease rentals (i.e. Tax Considerations)

(7) Availability of credit.

TAX EFECTS IN OWN OR LEASE

The buy or lease decision should be taken after analysing the tax effects of both theoptions.

(1) Tax effects for buyer in case of buying an asset

(i) The - buy can claim depreciation at prescribed rate as an expense while calculatingbusiness income for income tax purposes.

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(ii) The buyer can also charge expenses incurred on repairs, maintenance etc. of theasset.

(iii) If asset is purchased by taking loan then interest on loan can also be claimed as'expense while calculating business income.

(2) Tax implications for lessee (In case of both financial and operating lease) /

The lessee can claim lease rentals as expense while calculating business income forincome tax purposes.

Note. The lessee cannot claim depreciation as expense on asset taken on lease.

However, it is the lessor who can claim depreciation on assets leased by him whilecalculating his income from leasing business.

OWN OR LEASE-HOW TO CHOOSE?

For making a decision; the present value of total post-tax cash outflows in both theoptions should be compared and the option having lesser present value of cash outflows should be exercised.

(A) Calculation of present value(of cash out flows in case of owning an asset withborrowing

Step I. Calculate cash out flows

Cash out flows = Loan repayment + Interest on loan

Step II. Tax saving on account of depreciation and interest on loan

Since both depreciation (at prescribed rate) and interest on loan are tax deductiblewhile calculating business income, therefore there will be saving in payment of incometax.

Tax saving = (Interest + Depreciation) x Tax rate applicable to buyer

Note :- The above tax saving will occur year after year.

Step III. Calculate Post-tax Cash out flows

Post-tax Cash out flows = Out flows in step I - Tax saving as per step II

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Step IV. 'Since post-tax cash outflows are to occur at different points of time therefore,these are to be discounted at a specified rate of return by applying the followingformula :- Post-tax cash outflows x Present value factor of Re. 1 at specified rate

(B) Calculation of Present value of post-tax cash outflows in case of lease

Step I. Calculate cash outflows related to asset taken on lease

Here cash outflows = Annual lease rent + Other charges to be paid

Step II. Tax saving on account of lease rent

Since lease rent is an allowable expense while calculating business income for incometax purposes therefore there will be saving in payment of income tax.

Thus tax saving = Annual lease rent etc. x Tax rate applicable to lessee

Step III. Calculate Post-tax cash outflows

Post-tax cash outflows = Cash outflows in step I -Tax saving in step II

Step IV. Since post tax cash outflows are to occur at different points of time therefore,these are to be discounted at a specified rate of return by applying the followingformula:

Post tax cash outflows X P.V.F. of Re 1 at specified rate.

ILLUSTRATION 1. Silver Star Ltd. wants to acquire an industrial equipment costing' 20 lakhs. There are two alternatives available:

(a) To buy the equipment by taking a loan of 20 lakhs repayable in 5 equal year endinstallments together with interest @ 14% per annum.

(b) To take it on lease for a period of 5 years at annual lease rent of 5,00,000 payableat each year end.

Other Information:

(i) The tax rate applicable to company is 30%. (Ignore Surcharge & Education Cess)

(ii) The normal rate of depreciation applicable to industrial equipment is 15%.

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additional depreciation @ 20% of actual cost of equipment is also available in thefirst year of acquisition.

The company has a policy of evaluating capital budgeting proposals at 13% discountrate.

Present value factor for Re. 1 at 13%

I II III IV V

0.885 0.783 0.693 0.613 0.543

(v) The life of asset is 5 years and at the end of life there will be no scrap realisation.

As a Tax Consultant, you are asked to suggest that which of the above two optionsshould be exercised?

SOLUTION

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It is important to note that additional depreciation is available only in the first year inwhich asset is acquired and put to use. It is available @ 20% of actual cost of asset ifthe asset is used for 180 days or more during the year of acquisition. However if theasset is used for less than 180 days in the year of acquisition then additional depreciationis available at half of the normal rate of depreciation. In future years, only normaldepreciation will be available.

SOLUTION

The Industrial Equipment should be taken on lease.

ILLUSTRATION 2. Alpha Ltd. wants to acquire a plant and machinery worth5,00,000. The company requires it for 5 years. It has following two options:

Option I: To acquire the machinery by taking a loan of 5,00,000 repayable in 5installments of 1,00,000 together with interest @ 13%. Life of the asset is 5 yearsand at the end of 5 years it will fetch an amount equal to it book value on that date.The loan payment is to start from the end of first year.

Option II : To take it on lease basis for 5 years at an annual lease rent of 1,60,000which is payable at each year end.

Other Information:

(i) Tax rate applicable to company is 30%

(ii) The company discounts cash flows at 13% p.a.

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(iii) The normal rate of depreciation applicable to machinery is 15% on W.D.V. basis.

Additional depreciation @ 20% of actual cost is also available in the first year ofacquisition.

(iv) Present value factor at 13%:

Year I II III IV V

.885 .785 .693 .613 .543

You are required to suggest the better alternative.

SOLUTION

It is important to note that additional depreciation is available only in the first year inwhich asset is acquired and put to use. It is available @ 20% of actual cost of asset ifthe asset is used for 180 days or more during the year of acquisition. However if theasset is used for less than 180 days in the year of acquisition then additional depreciationis available at half of the normal rate of depreciation. In future years, only normaldepreciation will be available.

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Since the Present value of cash outflows is less in Option I, therefore, the companyshould acquire plant and machinery with borrowing.

ILLUSTRATION 3. Star Ltd. wants to acquire an equipment for its sales officecosting 20 lakhs. There are two alternatives available: - -

(a) To buy the equipment by taking a loan of 20 lakhs repayable in 5 equal year endinstallments together with interest @ 15% per annum.

(b) To take it on lease basic for a period of 5 years at annual lease rent of 5,00,000payable at each year end.

Other information -

(i) Star Ltd is in 30% tax bracket.

(ii) Rate of depreciation applicable to equipment is 15%.

(iii) The company has a policy of evaluating the capital budgeting proposals at 16%discount rate.

(iv) Present Value Factor for Re 1 at 16%

Year I II III IV V

.862 .743 .641 .552 .476

As a Tax Consultant, you are asked to suggest which of the above two options shouldbe adopted?

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• Asset should be taken on lease.

ILLUSTRATION 4. SABU Ltd. wants to acquire a second hand automatic machinecosting ' 12,00,000 for its manufacturing division and is considering the followingtwo options :-

Option I. To buy the machine by taking a loan of 12 lakhs repayable in 6 installmentsof 2,00,000 each together with interest @ 15% per annum.

Option II. To take it on lease for 6 years at an annual lease rent of 3,00,000 payableat each year end. The lessor will charge 1% of cost of machine as file charges payablealong with the lease rent of 1st year.

Other Information :-

(i) Tax rate applicable to company 30%.

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(ii) After-tax cost of capital 14%.

(iii) Rate of depreciation applicable to machine 15% on W.D.V. basis [ depreciationis not available].

(iv) Present value Factor for Re. 1 @ 14%

At the end of Year I II III IV V VI

.877.770 .675 .592 .519 .456

Suggest which option company should accept?

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Since the present value of total post-tax cash outflows is less in case of leasing optionthan buying with borrowing.

The company should acquire the machine on lease basis.

ILLUSTRATION 5. 'MAGA Ltd.' wants to acquire an asset worth 5,00,000. TheCo. requires it for 5 years. It has following two options: - Option I. To acquire theasset by taking a loan of 5,00,000 repayable in five installments of 1,00,000 togetherwith interest @ 14%. Life of the asset is 5 years and at the end of 5 years it will fetchan amount equal to its book value on that date. The loan repayment is to start from,the end of 1st year. -

Option II. To take the asset on lease basis for 5 yrs at an annual lease rent of! 1,60,000which is payable at each year end.

Other Information :-

(i) Tax Rate applicable to company is 30%

(ii) The Co. discounts its cash flows at 16%

(iii) The rate of depreciation on assets under Income tax Act is 25% on WDV basis.

Yearend I II Ill IV V VI

P.V. at 16%. 0.862 0.743 0.641 0.552 0.476 0.410

You are required to suggest the better alternative.

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Since the present value of cash outflows in case of Option I is less, so, the Co. shouldbuy the asset with borrowing.

Tax Planning in respect of own or lease decision

(1) Leasing and Non-depreciable assets: With due consideration to various factorsso far as applicable, affecting own or lease decision, it is preferable to acquire non-depreciable assets like land etc. on lease basis. It will help in reducing cash out flowson account of saving in income tax payment because lease rent is allowed as deductionwhile calculating income for income tax purposes.

(2) Bargaining on Pattern of Lease rentals. While taking/acquiring assets on lease,corporate houses/users are advised to bargain the pattern of lease rentals accordingto their expected profitability. If a business house expects higher profits in initial

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years then higher lease rentals should be paid in initial years followed by lower leaserent in subsequent years or vice-versa.

It is interesting to note that now a days, leasing companies are coming forward withflexible schemes as demanded by business houses requiring assets on lease

(3) Consideration to Tax holidays. Leasing (i.e. taking asset on lease) in oftenbeneficial for undertakings eligible to claim exemption u/s 1OAA or u/s lOB. Duringthe continuance of tax holiday period, such undertakings can very easily adjust thelease rentals according to the available tax holiday period. For example, if tax holidayperiod is 5 years i.e. 100% tax exemption for 5 years then these undertakings cannegotiate lower lease rentals during 5 years followed by higher lease rentals in nextyears.

4. Owning Business premises is beneficial: Often, it is beneficial to purchase businesspremises rather than taking it on lease basis because of the following positive pointsof owning a business premises:

(i) owned business premises provides a sense of pride and goodwill to business.

(ii) owned business premises can be offered as security to lender for raising loan.

(iii) Value of premises generally increases with passage of time.

(iv) Notional rent of owned business premises is not taxable in the hands of owner.

(v) Allowability of following expenditure

(a) Depreciation on premises at prescribed rates.

(b) Expenditure on current repairs.

(c) Interest on loan if premises are acquired with borrowed funds.

These positive aspects of owning a business premises overweigh the positive aspectsof taking it on lease. Hence, it is advised that, if possible, business premises should bepurchased rather than taking on lease. -

(5) Assets required for short duration

Such assets should be taken on lease especially if such assets are required for a period

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of less than 12 months. It is so because, if any asset is sold in the same previous yearin which it is acquired then no depreciation can be charged on such asset in thatprevious year.

For example X Ltd. purchased a specific purpose machine costing 1,00,000 on 1-4-2016. The machine has been used in business upto 31st January 2017 X Ltd. sold themachine on 1st February 2016 for 80000.

In this case 20,000 shall be treated as short term capital loss but X Ltd. cannot chargeany depreciation in respect of above machine although it has used the machine forbusiness purposes for 10 months.

SALE OF ASSETS OF SCIENTIFIC RESEARCH

Before discussing the tax treatment of sale of asset used for scientific research, it isimportant to recall the provisions relating to allowability of capital expenditure incurred(i.e. asset purchased) for scientific research.

Tax treatment of capital expenditure incurred on scientific research

Any capital expenditure incurred on purchase of asset for scientific research is allowedas deduction in full in the year in which such expenditure is incurred if the research isrelated to the business of the assessee.

For example. A Ltd. is engaged in the business of manufacturing computer parts. Ithas also established its 'Research and Development' department for undertakingscientific research related to its business. For this purpose the company purchased atesting machine for 5,00,000. Now this 5,00,000 will be allowed as deduction in theyear in which such expenditure is incurred.

Note: - On such assets, no depreciation shall be charged U/s 32

Capital expenditure on acquisition of land not allowed

No deduction shall be admissible in respect of any expense incurred on the acquisitionof land whether the land is acquired as such or part of any property after 29th day ofFebruary 1984.

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Capital expenditure incurred before the commencement of business

The aggregate of capital expenditure incurred within 3 years immediately precedingthe commencement of business shall be deemed to have been incurred in the previousyear of commencement of business and hence deduction shall be available in respectof such expenditure for the previous year in which the business is commenced.

Tax treatment on sale of such asset

It is possible that an asset purchased for scientific research may not remain useful forscientific research at a later stage. Thus business house stops using such asset forscientific research. There can be two alternatives before the business: -

Alternative I. To dispose off / sell the asset immediately without using it for otherbusiness purposes simply because the asset cannot be used for any other businesspurpose.

Alternative II. To start using the asset for other purpose of the business. In such acase, the asset will be sold later on when it does not remain useful for other businesspurposes also.

In both the above alternatives, tax treatment on sale of such asset is different andhence can be explained in following two cases : -

Case I. Where such asset is sold without having been used for any other purposes.

Case II. Where such asset is sold after using it for other purposes of business.

Case I. Where such asset is sold without having been used for any other purposes

(i) In such a case, the sale price to the extent it is equal to the amount of deductionallowed u/s 35 is treated as the taxable business income u/s 41 (3) of the previousyear in which such asset is sold.

Note : - The above provision will be applicable even if the business is not in existencein the year of sale of such asset. [Explanation to Sec. 41 (3)]

(ii) The capital gain or loss arising on transfer of above capital asset shall be calculatedas follows:- Capital gain or loss = Sales consideration - Cost/Indexed cost of acquisition

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This calculation is to be made because after all the assets sold is a capital asset andthe case falls u/s 45 for chargeability of any capital gain or loss.

Section 35 does not restrict in any way the calculation of capital gain or loss in abovecase.

2.6 SUMMARY

This lesson outlines the meaning and types of lease and also describes the factorsaffecting lease decisions. Tax considerations related to own or lease decisions havealso been discussed in this lesson. In the end various measures of tax planning arealso described.

2.7 GLOSSARY

Sec 10AA- Special provisions in respect of new established undertakings in SpecialEconomic Zone

Sec 10B- Provisions for 100% Export Oriented Undertaking

Sec 32- Depreciation

Sec 35- Expenditure on scientific research


1. Explain the financial factors affecting own or lease decisions.

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2. What are the limitations of leasing?

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2.9 LESSON END EXERCISES

1. Explain the tax effects of leasing for lessor and lessee.

2. Discuss the kinds of lease.

3. What is the treatment of capital expenditure incurred on scientific research?

4. Discuss the tax considerations related to own or lease decisions.


1. Corporate Tax Planning & Business Tax Procedures with Case Studies- By Dr.Vinod K. Singhania and Dr. Monica Singhania.

2. Corporate Tax Planning and Management- By Rajeev Puri and Puja Gaur.

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DIVIDEND POLICY - TAX CONSIDERATIONS RELATEDTO DIVIDEND DECISIONS

STRUCTURE

3.1 Introduction

3.2 Objectives

3.3 Meaning of dividend

3.4 Factors Affecting dividend policy

3.5 Tax considerations related to dividend decisions

3.6 Summary

3.7 Glossary




3.1 INTRODUCTION

When a Company distributes its profits among shareholders (equity or preference), itis called distribution of 'dividend'. Dividend represents cost of share capital. It is thereturn expected by shareholders who invest their money in the purchase of shares

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(equity or preference).

'Dividend Policy' of a company implies the decision regarding distribution of dividendand is affected by a number of factors as discussed below. It reflects management'sdecision as to what portion of accumulated earnings will be distributed to shareholdersand what portion will be retained for reinvestment in the company. Generally, theentire earnings of a company are not distributed among shareholders. A part of thetotal earnings is reinvested in the business by transferring such earnings to variousreserves such as general reserve etc. When a company does so, it is referred to asploughing back of profits. The retained earnings represent the amount of financingthat the company can utilise without having to compete against other companies inthe capital market and is an important source of capital for the company.

The decision regarding the quantum of dividend is the most complex decision for afinance manager. If the company decides to distribute more dividend, it will implyless retained earnings and vice-versa, if a company does not distribute dividends, theprice of its equity shares will rise proportionally with earnings. However, the investorwho requires some earnings from their investment in shares may sell their shares inthe market to obtain a "home made dividend." On the other hand, if a companydistributes dividend the price of its equity shares will fall in proportion to the dividendpayout.

3.2 OBJECTIVES :


• Meaning and factors affecting dividend policy

• The tax considerations related to dividend decisions

3.3 MEANING OF DIVIDEND

In common language 'dividend' means the profits distributed by a company to itsshareholders. Apart from that, i.e., dividend paid by a company to its shareholders,section 2(22)(e) gives the definition of deemed dividend. Hence, under the Income-tax Act, dividend includes deemed dividend. As per section 2(22), "dividend" includesfollowing payments or distribution to the extent of accumulated profits of the company[i.e. whether capitalised profit or not for section 2(22)(a) to (d) and capitalised profit

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in case of section 2(22)(e)] :

(a) any distribution if such distribution entails the release of all or any part of theassets of the company ;

(b) any distribution of debentures, debenture-stock, or deposit certificates in anyform, whether with or without interest, and any distribution to its preferenceshareholders of bonus shares ;

(c) any distribution made on liquidation of a company except where the shareholderis not entitled to participate in the surplus asset in the event of liquidation andshares were issued to him for full cash consideration.

(d) any distribution on the reduction of capital of a company except where theshareholder is not entitled to participate in the surplus asset in the event ofliquidation and shares were issued to him for full cash consideration.

(e) Any payments in the form of loans or advances made by a closely-held company(i.e. a company in which public are not substantially interested) to its shareholderwho is the beneficial owner of shares holding not less than 10% of voting powerin such company or to any concern in which such shareholder is a member or apartner and which he has a substantial interest or any payment made by on behalfof such shareholder for his/her individual benefit. However, such payment wouldnot amount to dividend, if such payment is made in the ordinary course of businessand money lending is substantial part of the company's business.

However, "dividend" does not include-

(i) any payment made by a company on purchase of its own shares from a shareholderin accordance with the provisions of section 77A of the Companies Act, 1956;

(ii) any distribution of shares made in accordance with the scheme of demerger bythe resulting company to the shareholders of the demerged company whether ornot there is a reduction of capital in the demerged company.

(iii) any dividend paid by a company which is set off by the company against thewhole or any part of any sum previously paid by it and treated as a dividendwithin the meaning of sub-clause (e), to the extent to which it is so set off.

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3.4 FACTORS AFFECTING DIVIDEND POLICY

(1) Liquidity position of the Company- If profits of the company are adequatelyrepresented by cash reserves then company can declare more dividends. On the otherhand, if profits are not represented by liquid resources then a company may find itdifficult to declare more amount of dividend.

(2) Requirement of funds for expansion etc:- If company requires funds for variousexpansion programmes to be undertaken in future then dividend payout is reducedotherwise the Company can decide to pay more dividend.

(3) Availability of funds from market:- Where on account of any reason, it is notpossible to raise finance from market then such a company pays less dividend. In areverse situation, dividend payment is more.

(4) Expectations of investors (shareholders):- If, majority of shareholders are infavour of declaring more dividend them company usually bowes to their wish &consequently dividend payout is more.

3.5 TAX CONSIDERATIONS RELATED TO DIVIDEND DECISIONS

As a prudent finance manager, dividend policy should always be prepared keeping inview the tax effects also. t is so because Income tax Act 1961 contains some provisionswhich are required to be complied with by the company declaring or distributingdividend for e.g. TDS u/s 194. The Income tax Act has also imposed a special 'dividendtax u/s 115-0 on domestic companies. This tax is in addition to normal income taxpaid or payable by the company. The payment of 'dividend tax' will reduce the amountavailable for distributing dividend among shareholders.

Thus thorough knowledge of following topics is a must while chalking out dividendpolicy:

A. Meaning of 'dividend' under income tax Act, 1961.

B. Tax implications for company u/s 115-0 and u/s 194 (if any)

C. Tax implications for shareholders.

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A. Meaning of dividend under Income tax Act

The term dividend has been defined in an inclusive manner under section 2 (22). Thedefinition is divided in sub-clauses (a) to (e) and contains these explanations.

(a) Any distribution by a company to its shareholders of accumulated profitentailing release of company's assets. This provision relates to bonus shares.The two conditions which must be fulfilled for including a particular distributionof profits by a company as dividend are: (i) it must be out of accumulatedprofits, and (ii) it must entail the release of the assets of the company. [2(22)(a)]

ILLUSTRATION 1. A Ltd. purchased the shares in B Ltd. in 2001-02 at a cost of15,00,000 (i.e. 1,50,000 shares @ 10 per share). It has been shown as investment inthe balance sheet of A Ltd. On September 15,2016 (i.e.during P.Y. 2016-17), A Ltd.distributed 1,00,000 shares (out of above invesments) in specie to its shareholders.The market price per share on the date was ' 11. The company possessed accumulatedprofits of 18,00,000 at the time of above distribution. Discuss tax treatment in thehands of A Ltd.

SOLUTION

As per section 2(22)(a), any distribution by a company of its accumulated profits,whether capitalised or not, to its shareholders entailing release of company's asset,shall be treated as dividend distributed by the company.

In the above case,

Accumulated profit of A Ltd. = ' 18,00,000

(on the date of distribution of its investment)

Value of investments which have been distributed = 11,00,000

Date of distribution of dividend = September 15, 2016.

Thus, 11,00,000 shall be treated as deemed dividend in the hands of shareholders ofA Ltd.. A Ltd. shall be liable to pay 'dividend tax' on this distribution of 11,00,000 U/s 115-0 @ 20.35765% [ 17.64706% + S.C @ 12% + Edu. cess @ 2% + SHEC @1%]

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The issue of bonus shares out of capitalised accumulated profits does not entail therelease of any asset and as such the bonus shares are not dividend when they areissued to holders of equity or ordinary shares. But the position will be entirely differentif the company, instead of issuing its own shares, purchases the shares of anothercompany out of its accumulated profits and then issues them to its shareholders asdividend because it will amount to release of assets, i.e., shares of another company,and it shall be treated as dividend distributed by company.

Sometimes company offers two options-either to take bonus share or their cash value,If the shareholders opt for bonus shares then it shall not be treated as dividend but ifthey opt for cash, the amount will be treated as dividend. When the redeemablepreference shares are issued as bonus shares out of accumulated profits and they arepaid off, the amount so received by an assessee will be treated as dividend undersection 2 (22), sub-clause (a).

(b) Any distribution by company of

debentures, debenture-stock, deposit certificates in any form, whether with orwithout interest to its shareholders, and

-any distribution of bonus shares to its preference shareholders,

-to the extent to which company possesses accumulated profits, whethercapitalised or not [ 2(22) (b]

Analysis.. Thus where a company issues debentures etc. to its shareholders (equity orpreference) free of cost then it shall be treated as dividend distributed by the companyto the extent to which the company possesses accumulated profits.

Similarly, if a company distributes bonus shares to its preference shareholders, it shallalso be treated as dividend distributed by the company to the extent to which thecompany possesses accumulated profits.

Important. The above distribution mentioned in clause (b) shall be treated as dividendalthough there is no release of assets of the company.

(c) Any distribution made to the shareholders on the liquidation of the company.Any distribution made by a company to its shareholders on its liquidation to

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the extent the company possessed accumulated profits before its liquidationshall amount to dividend. It is immaterial whether such accumulated profitsare capitalised or not[2(22)(c)]

Analysis. Thus, any distribution made out of profits of the company after the date ofliquidation shall not be deemed as dividend.

Exceptions (a). Dividend shall not include any distribution made on liquidation inrespect of any share issued for full cash consideration, where the holder of the shareis not entitled to participate in the surplus assets. In other words, the above distributionmade, to non participating preference shares shall not be treated as dividend. However,in case, the distribution is made to participating preference shares, then it shall betreated as dividend. It is important to note that preference shares are always non-participating unless specifically stated to be participating preference shares.

(b) Dividend shall not include any distribution which is attributable to the capitalisedprofits of the company representing bonus shares allotted to its equity shareholdersduring 1-04-64 to 31-3-65.

(d) Any distribution by a company to its shareholders on the reduction of itscapital, to the extent to which the company possesses accumulated profitswhether capitalised or not. [2(22)(d)]

Analysis. Thus, if at any time, it is felt that the company is over capitalised and hasaccumulated profits and the capital of such company is reduced by way of repaymentto shareholders, then such distribution to shareholders shall be treated as dividend tothe extent of accumulated profits possessed by the company on the date of distribution.

Exceptions. (a) Dividend shall not include any distribution made on reduction ofcapital in respect of any share issued for full cash consideration where the holder ofthe share is not entitled to participate in the surplus assets. in other words, the abovedistribution made to preference shares shall not be treated as dividend as preferenceshareholders are not entitled to participate in the surplus assets.

(b) Dividend shall not include any distribution which is attributable to the capitalisedprofits of the company representing bonus shares allotted to its equity shareholdersduring 1-04-64 to 31-3-65.

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(e) Any payment by a closely held company, of any sum, by may ofadvance or loan to

- a shareholder who is the beneficial owner of not less than 10% of sharescarrying voting power, or

- any concern in which the above shareholder is a member or a partnerhaving substantial interest or

-any person on behalf of or for the individual benefit of above shareholder tothe extent to which the company possesses accumulated profits.

Meaning of Concern [3(a)]: Concern means a Hindu undivided family, or a firm oran association of persons or a body of individuals or a company.

Meaning of Substantial interest in Concern [3 (b)]. A person shall be deemed tohave a substantial interest in a concern, other than a company, if he is, at any timeduring the previous year, beneficially entitled to not less than 20% of the income ofsuch concern.

Note. Thus, where a closely held company grants loan to preference shareholdersholding 10% or more of shares, it shall not be treated as dividend as per Sec 2(22)(e).

Exceptions. (a) if any payment is made to a shareholder/concern/any person as perSec 2(22) (e) by a company in the ordinary course of its business, where the lendingof money is substantial part of the business of the company, it shall not be treated asdividend.

(b) Dividend shall not include any dividend paid by a company which is set off by thecompany against the whole or any part of any sum previously paid by it and treated asa dividend within the meaning of above sub-clause (e), to the extent to which it is setoff.

MEANING OF ACCUMULATED PROFITS

1. Accumulated profits for Sec 2(22) (a), (b), (d) and (e). For these 4 sub-clauses,accumulated profits shall include all profits of the company upto the date of distributionor payment.

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2. Accumulated profits for Sec 2(22) (c). Accumulated profits shall include all profitsof the company upto the date of liquidation.

However, where the company is liquidated due to its compulsory acquisition by thegovernment or a corporation owned or controlled by the government under any law,then any profits of the company prior to three successive previous years immediatelypreceeding the previous year in which such acquisition took place, shall not be includedin accumulated profits.

Note. For all the sub-clauses (a) to (e), the Expression "accumulated profits" shallnot include capital gains arising before 1st April 1946 or between 1-4-1948 to 31-3-1956.

Other distributions which are not treated as dividend u/s 2(22) (a) to 2(22)(e).The following payments/distributions are also not treated as dividend as per section2(22) (a) to 2(22) (e):

(1) any payment made by a company on purchase of its own shares from a shareholderin accordance with the provisions of section 77A of the Companies Act, 1956.

(2) any distribution of shares pursuant to a demerger by the resulting company to theshareholders of the demerged company (whether or not there is a reduction of capitalin the demerged company.

ILLUSTRATION 2. 'B' is a holder of 5,000 equity shares of 100 each (fully paid) in'M' & Co, Ltd. On 1-1-2017 the company decided to issue to its equity shareholdersbonus shares out of the balance in the General Reserve Account at the rate of onebonus share of 100 each (fully paid) for every five shares held by them. On 31stMarch, 2017 'B' received 1,000 bonus shares from the company, the market value ofthe bonus share on that date being 120 per share. Discuss 'B's liability to tax in respectof the bonus shares received by him. Would your answer be any different if 'B' hadreceived the bonus shares as a holder of company's preference shares?

SOLUTION

The issue of bonus shares out of capitalised accumulated profits does not entail therelease of any asset and as such bonus shares are not dividend when they are issued to

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holders of equity and ordinary shares. Two conditions must be fulfilled to include thecase, issue of bonus shares in category of dividend in the hands of the recipientshareholder. These conditions are:

(a) Dividend must have been issued out of accumulated profit of the company and

(b) It must entail the release of the assets of the company. Since in the above case,issue of bonus shares to equity shareholders does not entail the release of the assetsof the company, so this does not constitute dividend in the hands of the shareholder.

But bonus shares distributed amongst the preference shareholders will amount todividend.

ILLUSTRATION 3. Mr. D holds 2,000 preference shares of 100 each in a company.Company had reserves worth 50,00,000. Out of these reserves it issued bonus sharesin the ratio of 1: 4. Market value of these shares amounts to 116 per share. How willthey be treated in the hands of D?

SOLUTION

In the present case bonus shares have been issued to the preference shareholders.Under Section 2(22) (b), any distribution of bonus shares to preference shareholdersshall be deemed as dividend to the extent company possesses accumulated profits,whether capitalised or not.

As such, market value of 500 shares issued by the company (500 x 116 per share) i.e.58,000 shall be deemed as dividend.

Name (% holding)Sanjay 35%Amit 20%Nitin 15%Tapan 12%Umesh 10%Rahul 8%

100%

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ILLUSTRATION 4. Santur Chemicals Ltd. is a private limited company. Thecompany has following 6 shareholders who are very good friends.

During the previous year 2016-17 the company gave following loans to itsshareholders:

(i) a loan of 2,00,000 given to Sanjay on 15, September 2016. Sanjay didn't repay anyamount upto 31-3-17.

(ii) a loan of 1,00,000 given to Amit on 31st December 2016, out of which 30,000was repaid by him on 25 march 2017.

(iii) A loan of 40,000 given to Umesh on 25th February 2017.

(iv) a loan of 20,000 given to Rahul on 15 March 2017

(v) a loan of 10,000 given to M/s Kambli and Sons in which Tapan is a partner having25% share in profits.

Discuss which of the above payments by the company shall be treated as dividend u/s 2(22)(e) if the accumulated profit of the company are 15,00,000.

SOLUTION

Accumulated profits = 15,00,000

The accumulated profits, cover the various loans given by the company to itsshareholders.

(i) Sanjay holds 35% equity shares

Loan = 2,00,000

It shall be regarded as dividend distributed to Sanjay

(ii) Amit holds 20% Equity shares

Amount of Loan = 1,00,000 [ 31-12-2016]

Loan repaid by Amit = 30,000 [ 25-3-2017]

The loan of '1,00,000 shall be treated as dividend distributed by the company to Amit

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on 31-12- 2016. The repayment of loan does not make Sec 2(22) (e) non-operational.

(iii) Umesh holds 10% equity shares

Loan = 40,000

It shall be treated as dividend to Umesh u/s 2(22)(e)

(iv) Rahul holds 8% equity shares [ less than 10%]

Loan amount = 20,000

Since Rahul holds less than 10% equity shares of Santur Ltd., hence it shall not beregarded as dividend distributed to Rahul.

(v) Loan given to M/s Kambli and Sons. (a partnership firm) Total amount of loansadvanced by company = 3,50,000 Tapan, a shareholder (holding 12% equity sharesof the company) is a partner in the said firm having 25% share in firm as Income.

Hence the above distribution shall be regarded as dividend distributed to Tapan.

Amount of loan = 10,000

B. Tax implications for company distributing dividend

Case I: - If company distributing dividend is a domestic company

1. Tax on distributed profits of companies [115-0] (1)

In addition to income tax chargeable on the total income of a domestic company,where such company has declared, distributed or paid some amount by way ofdividends [ interim or final] on or after 1-64997 but before 1.4.2002 and again from1.4.2003 onwards whether out of current or accumulated profits, it had to payadditional income tax at the on amount of dividend so declared, distributed or paid.Such tax shall be known as tax on distributed profits.

2. Dividend Covered u/s 115-0: All dividends except dividend covered u/s 2(22)(e).

3. Treatment of dividend received by a domestic company from its domesticsubsidiary company [115-0 (IA) (i)(a)]

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Any dividend received by a domestic company from its subsidiary company shall bereduced from the amount of dividend declared, distributed or paid by such domesticcompany during the year if:

(a) Such dividend is received from its subsidiary:

(b) Such subsidiary is a domestic company; and

(c) The subsidiary company has paid tax which is payable under section 115-0 onsuch dividend.

4. Treatment of dividend received by Indian company from Foreign Subsidiary[Section 115-O(1A)(B)] [1-6-2013] where Indian holding company has paid tax ondividend received from the foreign subsidiary u/s 115BBD, any dividend distributedby the holding company in the same year to the extent of such dividend, shall not besubject to Dividend Distribution Tax u/s 115-0.

Notes:

(i) The same amount of dividend shall not be taken into account for reduction morethan once. For the purpose of section 115-0 (1A)(ii).

(ii) A company shall be a subsidiary of another company, if such other company holdsmore than half in nominal value of the equity share capital of the company. [Explanationto Section 115- 0(1A)].

(iii) w.e.f. A.Y. 2013-14, for the purpose of computing tax on distributed profits, anydividend received by a domestic holding company from any subsidiary company shallbe reduced from the dividend distributed by such holding company whether suchholding company itself is a subsidiary of another company or not.

5. Treatment of dividend paid under Pension System Trust [115-0 (IA) (ii)]. Anydividend paid by a domestic company to any person for, or on behalf of the NewPension System Trust referred to in section 10(44) shall also be reduced from theamount of dividend declared, distributed or paid by such domestic company duringthe previous year. In other words, w.e.f. assessment year 2010- 11, any dividend paidunder New Pension System Trust shall be exempt from corporate dividend tax.

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6. Rates of Tax u/s 115-0 [ 115-0(1)]

* For the purpose of corporate dividend tax, Surcharge is applicable whether thetotal Income of the company exceeds one crore or not.

Note. Asessment Rate of SurchargeUpto A.Y. 2010-11 10%For A.Y. 2011-12 7.5%

For A.Y. 2012-13 & AY 2013-14 5%For A.Y. 2014-15 & A-Y-2015-16 10%For A.Y. 2016-17 & A.Y. 2017-18 12%

* * Education cess of 3% includes:

(a) Education cess @ 2% of tax & surcharge

(b) Secondary & Higher Education cess (SHEC) @ 1% of tax & surcharge

7. Tax on distributed profit of a domestic company to be levied on 'gross dividend'(w.e.f. 1.10.2014) [115-O(1B)] Tax on distributed profit of a domestic companyshall be levied on gross amount of dividend and not on net amount of dividenddistributed. The new methodology is complex.. To put it simply, w.e.f. 01-4-20 15,

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the DDT rate with regards to dividend distributed shall be 20.35765%.

8. Dividend tax payable even if no income-tax is payable by a domestic company[115-0(2)]. The tax on distributed profits under section 115-0(1) shall be payable bydomestic company even if no income-tax is payable by such a company on its totalincome computed in accordance with the provisions of this Act.

9. Responsibility to deposit tax [115-0(3)]

The principal officer of such domestic company shall be liable to deposit tax ondistributed profits to the credit of Central Government within 14 days of the date ofdeclaration or distribution or payment of dividend, which ever is earlier.

10. Final payment [115-0(4)]

The amount of tax on distributed Profits deposited as per above shall be consideredas final and no further credit shall be claimed by such domestic company or any otherperson in respect of the amount of tax so paid.

11. No deduction [115-0(5)]

The company or any shareholder of such company shall not have any right to claimany deduction for the amount of tax paid under this section.

12. No 'Dividend Tax' on distributed profits by an undertaking or enterpriseengaged in developing, operating and maintaining a special economic zone [115-0 (6)] [Applicable upto A.Y. 2011-12]

Notwithstanding anything contained in this section, no tax on distributed profits shallbe chargeable in respect of the total income of an undertaking or enterprise engagedin developing or developing and operating or developing, operating and maintaininga Special Economic Zone for any assessment year on any amount declared, distributedor paid by such Developer or Enterprise, by way of dividends (whether interim orotherwise) on or after 1-4-2005 out of its current income either in the hands of theDeveloper or Enterprise of the person receiving such dividend not falling under clause(23G) of section 10.

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13.Applicability of 'Dividend Distribution Tax' on SEZ developers [Proviso toSection 115- 0(6) w.e.f. A.Y. 2012-13]

w.e.f. assessment year 2012-13, SEZ developer shall be liable to pay 'DividendDistribution Tax' on the amount of dividend declared, distributed or paid on or after1-6-2011.

14. NO 'Dividend tax' on dividend distributed by a specified domestic companyto a business trust [ 115-0(7)] [w.e.f 1-06-2016]

No tax on distributed profits shall be chargeable under this section in respect of anyamount declared, distributed or paid by the specified domestic company by way ofdividends (whether interim or otherwise) to a business trust out of its current incomeon or after the specified date:

Provided that nothing contained in this sub-section shall apply in respect of any amountdeclared, distributed or paid, at any time, by the specified dome company by way ofdividends (whether interim or otherwise) out of its accumulated profits and currentprofits up to the specified date

(a) Meaning of specified domestic company: "specified domestic company" means a

domestic company in which a business trust has become the holder of whole of thenominal value of equity share capital of the company (excluding the equity sharecapital required to be held mandatorily by any other person in accordance with anylaw for the time being in force or any directions of Government or any regulatoryauthority, or equity share capital held by any Government or Government body).

(b) Meaning of specified date: "specified date" means the date of acquisition by thebusiness trust of such holding as is referred to in clause (a).

15. NO 'Dividend Tax' on dividend distributed by a unit of an InternationalFinancial Services Centre deriving income solely in convertible foreign exchange[ 115-0(8)] w.e.f. 1-04-2017]

Notwithstanding anything contained in this section, no tax on distributed profits shallbe chargeable in respect of the total income of a company, being a unit of anInternational Financial Services Centre, deriving income solely in convertible foreign

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exchange, for any assessment year on any amount declared, distributed or paid bysuch company, by way of dividends (whether interim or otherwise) on or after the 1-04-2017, out of its current income, either in the hands of the company or the personreceiving such dividend.

(a) Meaning of International Financial Services Centre: "International FinancialServices Centre" shall have the same meaning as assigned to it in section 2(q) of theSpecial Economic Zones Act, 2005.

(b) Meaning of Unit: "Unit" means a unit established in an International FinancialServices Centre, on or after the 1-o4-2016.

(c) Meaning of convertible foreign exchange: "Convertible foreign exchange" meansforeign exchange which is for the time being treated by the Reserve Bank of India asconvertible foreign exchange for the purposes of the Foreign Exchange ManagementAct, 1999 and the rules made there under.

16. Interest payable for nonpayment of tax by domestic companies [115P]

If the Principal Officer of the company or the company fails to pay the tax under theabove provisions, such person or company shall have to pay interest @ 1% p.m. ofthe tax due for the period from the last date on which tax was payable till the date ofactual payment.

17. Assessee in default: [115Q]

In case the Principal Officer of the company or the company fails to pay the tax underthe above provisions such person or company shall be deemed as an assessee indefault and the provisions relating to the recovery of tax shall become applicable.

18. Penalty for nonpayment of 'dividend distribution tax' [271C]

If any person fails to pay 'dividend distribution tax' as required as per section 115-0(2), the shall be liability to pay as penalty a sum equal to the amount to tax whichsuch person has failed to pay. However, no penalty shall be levied if the assesseeproves that there was reasonable cause for failure.

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19. Prosecution for nonpayment of 'dividend distribution tax' [276B]

If a person fails to pay to the credit of the central government the tax payable by himas per section 115-0(2), he shall be punishable with rigorous imprisonment for a termwhich shall not be less than three months but which may extend to seven years withfine. However, no prosecution proceeding shall be undertaken if the assessee provesthat there was reasonable cause for failure.

20. Dividend covered u/s 115-0 not taxable for recipient

Any dividend distributed by a domestic company which is subject to dividenddistribution tax shall be exempt in the hands of the recipient under section 10(34).

21. Various forms of dividend covered u/s 115-0

(i) Normal dividend/final dividend

(ii) Interim Dividend

(iii) Deemed dividend as mentioned u/s 2(22) (a) to Sec 2(22) (d)

Note:- No dividend tax u/s 115-0 is payable by domestic company if the dividenddistributed/paid is of the nature referred to in clause (e) of section 2 (22)

22. T.D.S. Liability is respect of dividend u/s 2(22) (e)

A domestic company is required to deduct tax at source u/s 194 only if it distributesdividend of the nature referred to u/s 2 (22) (e) to a shareholder who is resident inIndia. If in the above case, shareholder is non resident then company will deduct taxat source u/s 195.

23. No TDS in following cases

(i) Incase of individual shareholder:- If the following conditions are fulfilled:

(a) the dividend is paid by the company by an account payee cheque; and

(b) the aggregate amount of such dividend distributed or paid or likely to be paid bythe company to the shareholder during the previous year, does not exceed! 2500

(ii) If receipient is life insurance corporation;

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(iii) If receipient is General Insurance Corporation

(iv) Incase of any other insurer in repect of any shares owned by it or in which it hasfull beneficial interest.

Case II. Distribution of dividend by a non domestic company

1. No Application of Sec 115-0:- A non-domestic company is not required to paytax on distributed profits.

2. No Liability of TDS:- A non-domestic company is not required to deduct any taxat source before making payment of dividend under income tax Act 1961.

C. TAX IMPLICATIONS FOR SHAREHOLDERS

Before discussing tax treatment of dividend, in the hands of shareholders , it isimportant to understand the year of taxability/chargeability of dividend.

(a) Normal dividend/Final Dividend:- Such dividend is chargeable /relatable totax for the previous year during which it is declared by the company.

(b) Interim dividend:- It is chargeable to tax in the year in which it is received bythe shareholder.

(c) Deemed dividend:- u/s 2(22) (a) to (e) is taxable in the year in which suchdividend is distributed among shareholders.

Case I. If distributed, declared or paid by domestic company

1. Dividend Covered u/s 115-0 i.e. u/s 2(22)(a) to (d)

(i) During the period 1-6-97 to 31-3-02 Any dividend except covered u/s 2 (22) (e),shall be fully exempt in the hands of shareholder because on such dividend companyin liable to pay dividend tax u/s 115-0.

Note:- A shareholder cannot get any credit/benefit of dividend tax paid by companyin respect of his share of dividend under any circumstance. .

(ii) During the period 1-4-02 to 31-3-03 - Such dividend shall be fully taxable as'ncome from other source of the receipient. If net amount received by the shareholder (after TDS) is given then it is to be grossed up as shown above.

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(iii) on or after 1-4-03:- Any dividend except covered u/s 2 (22) (e), shall be fullyexempt in the hands of shareholder because on such dividend company is liable topay dividend tax u/s 115-0.

Note:- A shareholder cannot claim any credit/benefit of dividend tax paid by companyin respect of his share of dividend under any circumstance

Dividend from domestic company made taxable for certain shareholders[115BBDA] [ by the Finance Act, 2016 w.e.f. A.Y. 2017-18] . .

1. Shareholders for whom dividend is taxable? : Resident individual, ResidentHUF or Resident firm.

2. Payer of dividend: Dividend declared, distributed or paid by a. domestic company.

3. Nature of dividend: Dividend covered u/s 1 15-0 i.e. dividend covered u/s 2(22)(a)to (d).

4. How much dividend is taxable?: The amount of dividend in aggregate, in excessof Rs. 10 lakh from a domestic company or companies.

5. No deduction allowed: No deduction in respect of any expenditure or allowanceor set off of loss shall be allowed in computing the income by way of dividend. Thus,the amount of dividend in excess of Rs. 10 lakh shall be taxable on gross basis.

6. Rate of tax: 10%

It is important to note that for above mentioned shareholders the income-tax payableshall be aggregate of-

(a) the amount of income-tax calculated on the income by way of dividends inaggregate

exceeding ten lakh rupees, at the rate of 10%.; and

(b) the amount of income-tax with which the assessee would have been chargeablehad the total income of the assessee been reduced by the amount of income by way ofdividends. Section 115BBDA(1)]

2. Treatment of dividend covered u/s 2 (22) (e) i.e. Dividend not covered u/s115,-0

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Such dividend shall be taxable as income from other source of the shareholder. If netamount received by the shareholder is given then it is to be grossed up as follows:-

Net dividend received x 100100 - Rate of TDS

ILLUSTRATION 5. X Ltd is an Indian closely held company in which Mr. Param isa shareholder who is holding 17% of the equity shares. The accumulated profits ofthe company as on 31-3-2016 amounted to 6,00,000. The company has given a loanof 1,00,000 to Param by an account payee cheque on 15-09-2016. The companydoes not have the business of advancing loans. Param.repaid the loan to the companyby an account payee cheque on 25-3-2017. Discuss the tax treatment of the aboveloan and its repayment in the hands of Param for assessment year 2017-18.

SOLUTION

As per section 2(22)(e), any payment by a closely held company by way of advanceor loan to a shareholder who is the beneficial owner of shares holding not less than10% of the voting power, shall be treated as dividend to the extent to which thecompany possesses accumulated profits.

In the above case, X.Ltd is a closely held Indian Company i.e: a company in whichpublic are

substantially interested. The accumulated profits of the company as per last balancesheet i.e. as on 31- 3-16 amounted to 6,00,000.

Now

Date of granting loan to Param 15-9-16

Amount of loan = 11,00,000

Accumulated profits on 15-9-16 = 6,00,000

(Assumed to be equal to accumulated profits on 31-3-16)

Param is a shareholder holding 17% of the equity shares of the company & it isassumed that the equity shares carry proportionate voting rights. Y Ltd. does not

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have the business of money lending and hence the loan has not been advanced in theordinary course of its business.

Hence, the above loan of 1,00,000 to Param shall be treated as dividend distributedby the company to him during the previous year 2016-17 & it shall be included in thetotal income of Param under the heading 'Income from other source' for the previousyear 2016-17.

Further, it is given that Param has repaid the loan to company on 25-3-17 (i.e. duringthe same previous year). It is to be noted that the repayment of loan by such shareholderdoes not relax, in any way, the application of section 2(22)(e). In other words, therepayment of above loan will not affect the taxability of dividend income of 1,00,000in the hands of Param. .

Case II. If distributed, declared or paid by non- domestic company

Any dividend received, from non-domestic company (i.e. foreign company) shall befully taxable in the hands of shareholders and shall be treated as his income fromother sources. A foreign company is not required to deduct tax at source. u/s 194 inrespect of dividend distributed by it.

SPECIAL TAX PROVISIONS FOR SHAREHOLDERS

(A) Rules Regarding Bond Washing Transactions

Meaning of Bond Washing Transaction. A bond washing transaction implies saleof securities just before the due of interest and again purchasing same or similarsecurities after due date of interest. By doing so, a high income group security holdertries to reduce or avoid his income arising from such securities and ultimately he isable to reduce or avoid his tax liability. This is so because income from securities istaxable in the hands of person who holds the securities on the due date of income i.e.interest.

To curb such practices section 94, provides certain provisions which nullify the effectof such bond washing transactions.

Provisions of Section 94. (Anti Bond Washing Provisions)

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1. In case a person sells his securities to another person a few days before the accrualof interest and purchases them back after, the date of accrual, and Assessing officer issatisfied that the transaction has been made with the intention of avoiding tax, suchinterest shall be deemed as income of. the transferor and not transferee. [94(1)].

2. In case a person has any beneficial interest in any securities and as a result of somearrangement either no Income is received by such person or the income received byhim is lower than the amount which would have received, the interest, which wouldhave accrued on such securities had there been no such arrangement, would be includedin, the Income of person making such arrangements [ 94(2)].

3. The above provisions will not be applicable, if such person proves to the satisfactionof the Assessing officer that the transaction has not resulted into any avoidance of taxor if at all there was some avoidance it was exceptional as there had not been anyavoidance of tax in any of'three preceding previous years [ 94(3)].

4. In case of dealer of securities, if there is a transaction of sale or purchase ofsecurities and as a result the interest becomes receivable by him but is not deemed tobe his income due to the above provisions, no account shall be taken of the transactionin computing profits arising from or loss sustained in the business. [ 94(4)].

5. The Assessing officer may direct any person to furnish a detail of securities held byhim by serving upon him a notice for not less than 28 days [ 94(5)].

Applicability of section 94 to shareholders

1. For the purpose of section 94, "securities" include stock and shares. and

2. Hence, "Interest" includes dividend.

Implication: Thus, it is clear from the above that Bond washing transactions inrespect of shares are also covered under section 94.

Thus:

1. In case a person sells his share's to another person a few days before the accrual ofdividend & purchases them back after that, and Assessing officer is satisfied that thetransaction has been made with the intention of avoiding tax, such dividend shall be

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deemed as income of the transferor & not of transferee [ 94(1)].

2. In case a person has beneficial interest in any shares and as a result of somearrangements either no income is received by such person or the income received byhim is lower than the amount which he would have received, the dividend, whichwould have accrued on such shares, had there been no arrangement, would be includedin the income of person making such arrangements. [ 94(2)].

3. The above provisions will not be applicable, if such person proves to the satisficationof the Assessing officer that the transaction has not resulted into any avoidance of taxor if at all there was some avoidance it was exceptional as there had not been anyavoidance of tax in any of three preceding previous years [ 94(3)].

4. In case of dealer of shares, if there is a transaction of sale or purchase oi shares andas a result the dividend becomes receivable by him but is not deemed to be his incomedue to the above provisions, no account shall be taken of the transaction in computingprofits arising from or loss sustained in the business. [ 94(4)}.

5. The Assessing officer may direct any person on to furnish a detail of shares held byhim by serving upon him a notice for not less than 28 days [ 94(5)].

Advice to shareholders. In the light of above provisions, the shareholders are advisednot to adopt such bond washing practices. However, in case of dividend income fromdomestic company (dividend covered under section 115-0), a shareholder is notrequired to resort to above practice because cf exemption of such dividend in thehands of shareholders.

(B) Impact of section 94(7) on Dividend Stripping practices of shareholders

Dividend stripping is a process under which an investor (shareholder) buys securities(including stocks and shares) shortly before record date & sells them after the recorddate at a lower price. It involves getting in and out of Equity market or equity basedschemes (Since their dividend is exempt), in quick succession after availing tax freedividend income. Such exercise would result in short term capital loss to the investorwhich he can set off against other capital gains and can also carry forward for set offin future year as per law. By resorting to such a practice, the investor is benefitted in

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two ways :-

(i) Enjoyment of tax free dividend income and

(ii) Set off of. short term capital loss on sale of such securities against other capitalgain (STCG/LTCG).

Thus, the Finance Act 2001, introduced section 94(7) (w.e.f. assessment year 2002-03) restricting the set off of such short capital loss by certain amount.

Provisions of Section 94(7) : where

(a) Any person buys or acquires any securities or unit within a period of three monthsprior to the record date.

(b) Such person sells or transfer

(i) Such securities within a period of three months after such date; or

(ii) Such unit within a period of nine months after such date.

(c) the dividend or income on such securities or unit received or receivable by suchperson is exempt. then, the loss, if any, arising to him on account of such purchaseand sale of securities or unit to the extent such loss does not exceed the amount ofdividend or income received or receivable on such securities or unit, shall be ignoredfor the purpose of computing his income chargeable to tax.

Explanation:

(1) "Record date" means such date as may be fixed by:

(a) a company for the purposes of entitlement of the holders of the securities toreceive dividends; or

(b) a mutual fund or the administrator of the specified undertaking or the specifiedcompany, for the purpose of entitlement of the holder of the units to receive income.

(ii) "Securities" includes stocks and shares;

(iii) "Units" means a mutual fund specified under section 10(23D) or units of unit

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trust of India.

Important Notes:

(i) As Discussed Earlier, dividend from shares of a domestic company is exempt inthe hands of shareholders under section 10(34), if such dividend is covered undersection (115.0).

(ii) Under section 10(35), the following dividends income are exempted in the handsof shareholders.

(a) Income received in respect of units of Mutual Fund specified under clause (23D);or

(b) Income received in respect of units from the Administrator of the specifiedundertaking or

(c) Income received in respect of units from the specified company.

Meaning of Administrator:

"Administrator" means the administrator as referred to in section 2(a) of Unit Trustof India (Transfer of undertaking and repeal) Act, 2002.

Meaning of Specified Company: -

"Specified Company" means a company as referred to section 2(h) of unit Trust ofIndia (Transfer of undertaking and Repeal) Act, 2002.

INTER CORPORATE DIVIDEND

Introduction-According to Sec. 186 of the Companies Act 2013, a company canacquire the shares or securities of any other body corporate i.e. company upto aspecified extent. Thus A Ltd. can purchase the shares of B Ltd.

Limits on Inter Company Loans, Inter Company Investment in Shares

Sec. 186 of the Companies Act provides an overall limit on inter-corporate loans,guarantee or security and inter-corporate investment in shares. The said section readsas follows:

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"No company shall directly or indirectly -

(a) make any loan to any other body corporate;

(b) give any guarantee, or provide security, in connection with a loan made by anyother person to any other person by, any-body corporate; and

(c) acquire by way of subscription, purchase or otherwise the securities of any otherbody corporate.

Exceeding sixty percent of its paid up share capital and free reserves, or one hundredper cent of its free reserves, whichever is more ….

However, investment in excess of aforesaid limits can be made by passing a specialresolution in the general meeting of the company.

INTER CORPORATE DIVIDEND) :- The Concept of 'Inter corporate Dividend' isthe result of the above provisions which authorise a company to purchase shares ofanother company. When a company receives or is entitled to receive dividend fromanother company, it is called 'Inter corporate dividend' received.

Meaning of dividend under Income Tax Act, 1961

'Dividend Implies':-

(a) Normal dividend (which is declared at A.G.M.);

(b) Interim dividend; and

(c) Deemed dividend u/s 2(22)

Thus, if A Ltd. purchases shares of B Ltd. then it is but natural that A Ltd. shall alsoreceive dividend from B Ltd, no doubt, subject to dividend distribution policy of BLtd. Such dividend received /receivable by A Ltd. is called inter-corporate dividend.

Tax treatment of inter-corporate dividend received/receivable

Tax treatment of inter corporate dividend in the hands of recipient company is nothingbut tax treatment in the hands of share-holder. In case of inter corporate dividend,the recipient, i.e the share holder is a company. The tax treatment of inter corporate

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dividend for recipient depends upon the status of the paying company.i.e. whetherthe paying company is a domestic company or non domestic company. It also dependson the form of dividend.

Important Note:

In this topic, the tax treatment of inter corporate dividend has been discussed inrespect of dividend declared, distributed or paid during the following periods:

(a) on or after 1-6-97 but before 1-4-02 (b) on or after 1-4-03

Students may kindly note that, it is only the tax treatment of inter-corporate dividendreceived/ receivable during the previous year 2016-17 is relevant for current assessmentyear (i.e. A.Y: 2017- 18). However, since the tax treatment of dividend declared/distributed/paid during the period 1-6-97 to 31-3-02, was also same, hence, the abovetwo periods (a) and (b) have been cited together

Case I. If dividend is received/receivable from a domestic company.

Any such dividend received or receivable is fully exempt in the hands of recipientcompany if it is distributed or declared or paid (as the case may be) by the payingcompany on or after 1-6-97 but before 1-4-02 and again from 1-4-03 on words. Suchdividend may be:

(a) Normal dividend

(b) Interim dividend

(c) Deemed dividend as per Sec. 2(22) (a) to Sec. 2(22) (d)

As such recipient company is not required to include such dividend in its total income.

The exemption of above dividend is enjoyed by the recipient company because ofapplication of Sec. 115-0 on the paying company.

On dividend of the above nature, distributed or paid during above stated periods, thepaying company is liable to pay 'Dividend tax' u/s 115-0. This tax is in addition tonormal income tax applicable to paying company.

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EXAMPLE 1:- If XYZ Ltd. receives interim dividend from another domesticcompany named PQR Ltd. during previous year 20 16-17 then such dividend shall beexempt in the hands of XYZ Ltd. for assessment year 2017-18.

EXAMPLE 2:- XYZ Ltd. holds shares in PQR Ltd.(a domestic Co.). During theprevious year 2016-17 (on 15 sept. 2016), PQR, Ltd. declared dividend. The dividendis actually paid to XYZ Ltd. on 15-4-17. Discuss the tax treatment of dividend forXYZ Ltd. Also state the relevant A.Y. for which this tax treatment shall be relatable.

SOLUTION

In this question, the paying company (PQR Ltd.) is a domestic company. The companyhas declared dividend during previous year 2016-17 which has been actually paid toXYZ Ltd. during previous year 2017-18.

Under Income Tax Act 1961, declared dividend is treated as income of the recipientfor the previous year in which it is declared.

Since PQR Ltd. is liable to pay dividend tax u/s 115-0 on such dividend, hence thisdividend will be exempt in the hands of XYZ for previous year 2016-17 (i.e. A.Y.2017-18).

Treatment of the dividend covered u/s 2(22) (e)

If recipient company receives dividend of the nature referred to u/s 2 (22) (e) then itshall not be exempt in the hands of recipient company. Such distribution receivedshall be treated as income U/H other source for the recipient company clause (e) ofSec. 2 (22) reads as follows:

Any payment by a company, not being a company in which the public are substantiallyinterested, of any sum (whether as representing a part of the assets of the company orotherwise) 4 after the 31st day of May, 1987, by way of advance or loan to ashareholder, being a person who is the beneficial owner of shares (not being sharesentitled to a fixed rate of dividend whether with or without a right to participate inprofits) holding not less than ten percent of the voting power, or to any concern, inwhich such share-holder is a member or a partner and in which he has a substantialinterest (hereafter in this clause referred to as the said concern)] or any payment by

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any such company on behalf, or for the individual benefit, of any such shareholder, tothe extent to which the company in either case possesses accumulated profits:

Example to illustrate above point

XYZ Ltd. holds 25% equity shares in PQR Ltd. which is a closely held company andis engaged in manufacturing business. During the previous year PQR Ltd. advanceda loan to XYZ Ltd. to the extent of 5,00,000. PQR Ltd. possesses accumulatedreserves to the extent 8,00,000.

Now the entire amount of loan i.e. 500,000 shall be treated as dividend income ofXYZ Ltd.

This dividend will not be exempt in the hands of XYZ Ltd. However, PQR Ltd. isliable to deduct tax at source u/s 194.

Important Note: Section 115BBDA dealing with taxability of dividend in excess of10,00,000 received from a domestic company, is not applicable on dividend receivingcompany.

Case II. If dividend is received or receivable from a non-domestic company

Any such dividend declared, distributed or paid by any non-domestic company, (i.e.foreign Co. shall be fully taxable in the hands of recipient company such income shallbe chargeable to tax u/h 'Income from other sources'. The company paying dividendshall not deduct any tax at source under Income Tax Act 1961 (i.e. u/s 194)

TAX PLANNING IN RESPECT OF BONUS SHARES

Introduction.

The concept of Bonus shares has emerged as a result of Ploughing back of profitspolicy often adopted by companies. These shares are issued by a company to itsexisting shareholders in the process of conversion of reserves & surpluses into capital.These shares are issued out of accumulated profits of the company & are given toexisting shareholders in proportion of their existing shareholding in the company.Since nothing goes out of the pocket of shareholders in getting these shares, theseare populary called 'Free Shares' or 'Bonus Shares'.

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The process of conversion of reserves & surpluses into share capital is also called"Capitalisation of Reserves & Surpluses" and has following two effects:

(i) It reduces accumulated Reserves & Surpluses (i.e. Profits) of the company and

(ii) There is a corresponding increase in the paid-up share capital of the company.

Generally prosperous companies often issue Bonus shares and are seen with respectfuleyes in the corporate sector. The issue of bonus shares enables a company to bringthe amount of its paid-up capital in line with the real capital employed so as to showreal earning capacity of the company and brings down the apparent abnormal highrate of dividend.

Brief Provisions of the Companies Act 1956 in respect of Bonus Shares

(1) The Companies Act 2013 prohibits a company to issue bonus shares in lieu ofdividend by providing that no dividend can be paid except in cash.

(2) The bonus shares can be issued out of the following reserves :-

(i) General Reserve

(ii) Balance in P & LA/c or P & L Appropriation A/c

(iii) Reserve fund

(iv) Capital reserve or Profit realised in cash

(v) Balance in Sinking fund created for redemption of debentures after the debentureshave been redeemed.

(vi) Dividend equalisation fund

(vii) Capital Redemption Reserves (CRR)

(viii) Security Premium received in cash

(3) Bonus shares cannot be issued out of :-

(a) Reserves created for some specific purposes.

(b) Capital Reserve appearing as a result of revaluation of assets and liabilities.

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In addition to above, a company is also required to follow the guidelines issued bySEBI from time to time regarding issue of bonus shares.

"Tax Aspects of Bonus Shares"

The tax aspects of Bonus shares can be studied from the following two angles:

(A) Tax aspects for company issuing bonus shares.

(B) Tax aspects for shareholders receiving bonus shares.

(A) Company issuing Bonus Shares

The issue of bonus shares in not regarded as distribution of dividend by the company.This inference has been drawn from clause (a) of sec. 2 (22) which defines the term'dividend'. The said clause reads as follows :-

"Dividend includes any distribution by a company to its shareholders to the extent ofaccumulated profits whether capitalised or not resulting in the release of all or anypart of the assets of the company."

Since the issue of bonus shares does not involve the release of any asset of the company,hence it is not treated as distribution of dividend by company.

However' clause (b) of Sec. 2(22) specifically provides that distribution of bonusshares to preference shareholders will be treated as distribution of dividend by companyeven though it does not involve release of any asset of the company.

• The market value of bonus shares oil the date of distribution will be treated asamount of dividend received by shareholders.

Conclusion from Clause (a) & (b) of Sec. 2(22) :- It can be concluded that the issueof bonus shares to only equity shareholders is not regarded as dividend distributed bycompany.

Thus, for issuing company, tax implication of bonus shares issued, depends upon thenature of shareholders i.e. whether, the bonus shares have been issued to equityshareholders or preference shareholders.

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A-I. If bonus shares are issued to equity shareholders

There are four occasions which necessitate the understanding of tax implications forissuing company These are:

1. At the time of Issue:- Since issue of bonus shares to equity shareholders does notamount to dividend, hence, the company is saved from paying dividend tax u/s 115-0 in the year of distribution of such bonus shares.

2. At the time of redemption:- When such bonus shares are redeemed it is treatedas dividend distributed by the company to the extent of Accumlated profits, u/s 2(22) (a) because there is release of assets from the company. In case, such bonusshares have been redeemed during the period

(i) On or after 1-6-97 to 31-3-02

(ii) on or after 1-4-03, the company will be required to pay dividend tax u/s 115-0 atprescribed rates

* For the purpose of corporate dividend tax, Surcharge is applicable whether thetotal Income of the company exceeds one crore or not.

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Note Assessment year Rate of SurchargeUpto A.Y. 2010-11 10%For A.Y. 2011-12 7.5%

For A.Y. 2012-13 & A.Y. 2013-14 5%For A.Y. 2014-15 & A.Y. 2015-16 10%

For A.Y. 2016-17 and 2017-18

* * Education cess of 3% includes:

(a) Education cess @ 2% of tax & surcharge.

(b) Secondary & Higher Education Cess (SHEC) @ 1% of tax & surcharge.

Tax on distributed profit of a domestic company to be levied on 'gross dividend'.[Section 115-O(1B)] [ 1.10.2014]. Tax on distributed profit of a domestic companyshall be levied on gross amount of dividend and not on net amount of dividenddistributed. The new methodology is complex.

To put it simply, w.e.f. 1-04-2015, the DDT rate with regards to dividend distributedshall be 20.35765%.

3. At the time of liquidation of issuing Co.:- On such Occasion any distributionmade to equity shareholders, to the extent of accumulated profits, shall be treated asdistribution of dividend u/s 2(22) (c). Then, any sum distributed to equity shareholdersagainst bonus shares as well as other shares, (to the extent of accumulated profits)shall be treated as distribution of dividend u/s 2 (22) (e).

If any such distribution made during the period

(a) on or after 1-6-97 but on or before 3 1-3-02

(b) on or after 1-4-03, the company is required to pay dividend tax u/s 115-0.

(4) If shareholders sells bonus shares:- Then it does not involve any tax liability oncompany issuing bonus shares.

A-Il. : If Bonus shares are issued to preference share-holders

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(1) At the time of issue:- Clause (b) of sec. 2 (22) specifically provides thatdistribution of bonus shares to preference share-holders shall be treated as distributionof dividend by the company. In case, such bonus shares have been issued during theperiod

(i) on or after 1-6-97 to 31-3-02 and

(ii) on or after 1-4-03, the company shall be required to pay dividend tax u/s 115-0.The rate of dividend tax u/s 115-0 have already been shown earlier.

(2) At the time of redemption :- No tax liability

(3) At the time of liquidation of Co. :- No tax liability

(4) If shareholders sells bonus share :- Then it does not involve any tax liability oncompany.

A-Ill. Treatment of expenditure on issue of bonus shares

The decision to issue bonus shares often, necessitates the incurring of certain expensesby the company. These expenses may be

(i) expenses incurred for increasing the authorised capital of the company.

(ii) other expenses related to bonus issue such as printing, postage, fees etc.

A-Ill(a) Treatment of Expenses incurred for increasing the authorised capital

As we know that the issue of bonus share implies the issue of fresh shares (out ofunissued shares) to the shareholders free of cost. Thus, if an existing company hasalready exhausted its authorised share capital by issuing to the shareholders in thepast, then it will have to increase its authorised share capital. For this purpose, companymay have to incurr certain expenses. It is important to note that such expenses shallbe treated as capital expenditure in view of the authoritative pronouncements by theSupreme Court in the case of Punjab State Industrial Development Corporation Vs.CIT 225 ITR 792 and Brooke Bond India Ltd. Vs. CIT 225 1TR 798.

A-lII(b) Treatment of other expenses such as printing & stationery, postage,fees etc. -

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For a long time, the treatment of these expenses remained a subject matter of judicialcontroversies due to conflicting judgments by various courts. However, thiscontroversy has been put to rest by the Supreme Court's Judgment dated September25, 2006, in the case of CIT Vs. General Insurance Corporation (2006) 205 CTR280, wherein it has been held that these expenses incurred on issue of bonus shares isrevenue expenditure.

B. Tax treatment in the hands of shareholders

B-I : In the hands of equity shareholders

1. At the time of receipt:- Since the receipt of bonus shares by equity shareholders-does not amount to receipt of dividend, therefore the shareholder is not required totreat the values of bonus shares as his income from other source.

2. At the time-of redemption:- When bonus shares held by equity shareholders areredeemed by the company at a later stage, it is treated as receipt of dividend byshareholders. If shares are redeemed during the period.

(a) on or after 1-6-97 to 31-3-02 and

(b) on or after 1-4-03, then, any such amount shall be fully exempt in hands ofshareholders and as such equity shareholder will not be required to include the amountso received in his income from other source.

3. At the time of liquidation of company:- Amount received by shareholders onbonus shares as well as on other shares (to the extent of accumulated profits) istreated as receipts of dividend. On Such occassion, occuring during the period (a) onor after 1-6-97 to 31-3-02 and; (b) on or after 1-4- 03, any amount received shall befully exempt in the hands of shareholder.

(4) At the Time of Sale

On sale of bonus shares, a shareholder is required to pay tax on any gain arisingtherefrom. Such gain will be long term or short term depending upon the period ofholding of such bonus shares. The period of holding shall be counted from the date ofissue of the bonus shares.

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For calculating capital gain., the cost of acquisition of bonus shares shall be taken asfollows:-

(i) If bonus shares were received before 1-4-81 : In such a case the market value ofbonus shares as on 1-4-8 1 shall be treated as cost of acquisition.

(ii) If bonus shares were received on or after 1-4-81 : In such a case, the cost ofacquisition of bonus shares shall be taken as 'nil' and entire amount received on saleshall be chargeable to capital gain tax.

ILLUSTRATION I. Assessee A is the investor in shares and held 1,000 shares of! 10each in a company. On 31st March, 2016 he was allotted 1,000 Bonus Shares of theface value of! 10 each. The cost of acquisition of original shares was! 12 each. Duringthe previous year ending 31st March, 2017 assessee sold 500 shares out of his Bonusshares @! 14 per share. Compute the capital gain for the assessment year 2017-18 ifcost inflation index for 2015-16 is 1081 and 2016-17 is 1125.

B-Il. Tax treatment in the hands of preference shareholders

1. At the time of receipt:- When bonus shares are received by preference shareholdersthen it is treated as dividend received by them. If bonus shares are received during theperiods (a) on or after 1- 6-97 to 31-3-02 and (b) on or after 1-4-03, then suchdistribution shall be fully exempt in the hands or preference shareholders.

If bonus shares were received during P.Y. 2002-03 then preference shareholders arerequired to include the market value of bonus shares in their individual income asincome under the head other sources

2. At the time of redemption:- It shall not be treated as dividend in the hands ofpreference shareholders because the market value of said bonus shares, when issuedto them, was treated as dividend received by them.

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3. At the time of liquidation of company:- It shall also not be treated as dividend inthe hands of preference shareholders.

4. At the time of sale: - Same as discussed for equity shareholders.

3.6 SUMMARY

This lesson highlights the meaning of dividend and factors affecting it as decisionsrelated to dividend policy are crucial for business organisations. It has also discussedthe tax considerations related to dividend policy. The lesson also stresses the need forissue of bonus shares as measure of tax planning in case of dividend policy.

3.7 GLOSSARY

Sec 94- Anti Bond Washing Provisisons

Sec 115-O- Dividend Distribution Tax

Sec 194- Tax Deduction at Source from Dividends


1. Define dividend.

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2. Explain the various factors affecting dividend decisions.

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3.9 LESSON END EXERCISES/EXAM ORIENTED QUESTIONS

1. Explain the various tax considerations relating to dividend decisions.

2. Discuss the tax treatment on 'Inter-corporate dividend' received by domesticcompany.

3. Describe the anti-bond washing transactions contained in Income Tax Act,1961.


1. Corporate Tax Planning & Business Tax Procedures with Case Studies- ByDr. Vinod K. Singhania and Dr. Monica Singhania.


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TAX CONSIDERATIONS IN RESPECT OF AMALGAMATIONFOR AMALGAMATING COMPANY, AMALGAMATING

COMPANY, SHAREHOLDERS OF AMALGAMATINGCOMPANY, AMALGAMATION OF BANKING COMPANY

Structure

4.1 Introduction

4.2 Objectives

4.3 Meaning of Amalgamation

4.4 Conditions of Amalgamation

4.5 Tax considerations in respect of amalgamation

4.5.1 for amalgamating company

4.5.2 for amalgamated company

4.5.3 for shareholders of amalgamating company

4.6 Amalgamation of banking company

4.7 Summary

4.8 Glossary

4.9 Self assessment questions

4.10 Lesson end exercises

11 Suggested readings

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4.1 INTRODUCTION

Amalgamation is a merger of two or more existing undertakings into oneundertaking. The shareholders of each company become substantially the shareholdersin the company which is to carry on the business of merged undertakings. There maybe amalgamation either by the transfer of two or more undertakings to a new company,or by the transfer of one or more undertakings to an existing company.

For the purpose of the Income-tax Act, amalgamation of companies means eithermerger of one or more companies with another company or the merger of two ormore companies to form one new company. The definition of amalgamation undersection 2(1B) covers the following cases.

(a) Merger of A Ltd. with B Ltd. A Ltd. goes out of existence.

(b) Merger of A Ltd. and B Ltd. with C Ltd. A Ltd. and B Ltd. go out of existence.

(c) Merger of A Ltd. and B Ltd. into a newly incorporated company C Ltd. ALtd. and B Ltd. go out of existence.

(d) Merger of A Ltd., B Ltd. and C Ltd., into a newly incorporated company DLtd. In the case, A Ltd., B Ltd. and C Ltd. are amalgamating companies,while D Ltd. is an amalgamated company.

4.2 OBJECTIVES :


• The meaning of amalgamation

• The conditions of amalgamation

• Tax considerations in respect of amalgamation

• Provisions related to amalgamation of banking company

4.3 MEANING OF AMALGAMATION

` Amalgamation is a merger of two or more existing undertakings into oneundertaking. The shareholders of each company become substantially the shareholders

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in the company which is to carry on the business of merged undertakings. There maybe amalgamation either by the transfer of two or more undertakings to a new company,or by the transfer of one or more undertakings to an existing company.

For the purpose of the Income-tax Act, amalgamation of companies means eithermerger of one or more companies with another company or the merger of two ormore companies to form one new company. The definition of amalgamation undersection 2(1B) covers the following cases.

(a) Merger of A Ltd. with B Ltd. A Ltd. goes out of existence.

(b) Merger of A Ltd. and B Ltd. with C Ltd. A Ltd. and B Ltd. go out of existence.

(c) Merger of A Ltd. and B Ltd. into a newly incorporated company C Ltd. ALtd. and B Ltd. go out of existence.

(d) Merger of A Ltd., B Ltd. and C Ltd., into a newly incorporated company DLtd. In the case, A Ltd., B Ltd. and C Ltd. are amalgamating companies, while D Ltd.is an amalgamated company.

4.4 CONDITIONS OF AMALGAMATION

For a merger to qualify as an "amalgamation" for the purpose of the Income-tax Act, it has to satisfy the following three conditions-

1. All the properties of the amalgamating company immediately before theamalgamation should become the property of the amalgamated company byvirtue of the amalgamation

2. All liabilities of the amalgamating company immediately before theamalgamation should become the liabilities of the amalgamated company byvirtue of the amalgamation.

3. Shareholders holding not less than three-fourths shares in the amalgamatingcompany should become shareholders of the amalgamated company by virtueof the amalgamation.

For example where A Ltd. merges with B Ltd., in a scheme of amalgamation,and immediately before the amalgamation, B Ltd. held 20 per cent of the shares in A

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Ltd., the above-mentioned condition 3 will be satisfied if shareholders holding notless than 3/4 (in value) of the remaining 80 per cent of the shares in A Ltd., ie., 60 percent thereof (3/4 of 80), become shareholders of B Ltd., by virtue of the amalgamation.Where, however, the whole share capital is held by another company, the merger oftwo companies will as an amalgamation within section 2(1B), if the other twoconditions are fulfilled.

For the purpose of condition (3), "shareholders" may be equity shareholders orpreference shareholders. Consequently, persons holding at least 75 per cent of theequity and preference shares (in value) in the amalgamating company should becomeshareholders (by holding equity or preference shares or both) in the amalgamatedcompany.

4.5 TAX CONSIDERATIONS IN RESPECT OF AMALGAMATION

Some tax incentives have been provided for amalgamation of a companyunder income tax Act to the:

1. amalgamating company;

2. shareholders of the amalgamating company; and

3. amalgamated company

4.5.1 FOR AMALGAMATING COMPANY

(a) Exemption from Capital gains tax. There shall be no liability for capital gainstax on the transfer of capital assets by the amalgamating company if the amalgamatedcompany is an Indian company. [Sec. 47(vi)]

(b) Tax Concession to foreign Company: There shall be no liability for capitalgains tax on the transfer of shares of an Indian company by a foreign company toanother foreign company in a scheme of amalgamation between the two foreigncompanies, if

(i) at least 25% of the shareholders of the amalgamating foreign company continueto remain shareholders of the amalgamated foreign company;

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(ii) such transfer does not attract tax on capital gains in the country in which theamalgamating company is incorporated. [Sec. 47(via)]

(c) Exemption from tax liability on transfer of licence to operatetelecommunication services etc: There shall be no tax liability on transfer of a licenceto operate telecommunication services (u/s 35ABB) or on transfer of a business ofprospecting for or extraction or production of petroleum and natural gas (u/s 42) bythe amalgamating company if the amalgamated company is an Indian company.

4.5.2 FOR AMALGAMATED COMPANY

1. Capital expenditure on scientific research: Where a company is amalgamatedbefore claiming full deduction in respect of capital expenditure on scientific research,the amalgamated company (being an Indian company) is entitled to claim deductionof such unabsorbed amount. [Sec. 35(5)].

2. Expenditure incurred to obtain licence to operate telecommunication services.Where a company is amalgamated before claiming full deduction in respect ofexpenditure to obtain licence to operate telecommunication services, the amalgamatedcompany (being an Indian company) is entitled to claim deduction in respect ofremaining installments of such expenditure. [Sec. 35ABB]

3. Preliminary expenses. Where an Indian company is amalgamated before claimingfull deduction in respect of certain preliminary expenses, the amalgamated company(being an Indian company) is entitled to claim deduction in respect of remaininginstallments of such expenses. [Sec. 35D(5)]

4. Expenses on amalgamation. Where an Indian company incurs expenditure whollyand exclusively for the purposes of amalgamation, it shall be allowed a deduction @20% of such expenditure for each of five successive previous years beginning withthe previous year in which amalgamation takes place. (Sec. 35DD)

5. Expenses incurred under voluntary retirement scheme. Where an Indiancompany is amalgamated before claiming full deduction in respect of expenses incurredunder voluntary retirement scheme the amalgamated company (being an Indiancompany) is entitled to claim deduction in respect of remaining installments of suchexpenses. [Sec. 35DDA(2)]

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6. Expenses on prospecting etc. of certain minerals. Where an Indian company isamalgamated before claiming full deduction in respect of expenditure incurred onprospecting for, or extraction or production of certain minerals, the amalgamatedcompany (being an Indian company) is entitled to claim deduction in respect ofremaining installments and unabsorbed amount of such installments. [Sec. 35E(7)]

7. Capital expenditure on family planning. Where a company is amalgamatedbefore claiming full deduction in respect of capital expenditure incurred for the purposeof promoting family planning amongst its employees, the amalgamated company (beingan Indian company) is entitled to claim deduction in respect of remaining installmentsand unabsorbed amount of such installments. [Sec. 36(l)(ix)]

8. Expenses on prospecting etc. of petroleum and natural gas. Where a companyis amalgamated before claiming full deduction in respect of expenditure incurred onprospecting for or extraction or production of petroleum and natural gas, theamalgamated company (being an Indian company) is entitled to claim deduction inrespect of such expenditure. (Sec. 42)

9. Bad debts. Where a part of debts taken over by the amalgamated company fromthe amalgamating company becomes bad subsequently, such bad debts are allowedas a deduction in computing the income of the amalgamated company.

10. Actual cost of an asset. Where, in a scheme of amalgamation, any capital assetis transferred by the amalgamating company to amalgamated company and theamalgamated company is an Indian company the actual cost of the transferred capitalasset to the amalgamated company shall be taken to be the same as it would havebeen if the amalgamating company had continued to hold the capital asset for thepurpose of its own business. [Sec. 43(1)]

11. Actual Cost of depreciable assets. Where in any previous year, any block ofassets is transferred by an amalgamating company to the amalgamated company in ascheme of amalgamation, and the amalgamated company is an Indian Company, thenthe actual cost of the block of assets transferred to the amalgamated company shallbe the book value of the assets to the amalgamating company in the immediatelypreceding previous year as reduced by the amount of depreciation actually allowed

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in relation to the said preceding previous year, [Sec. 43(6)]

12. Deduction in respect of profits from undertaking engaged in infrastructuredevelopment or other than infrastructure development. Certain deductions areallowed from gross total income under sections 80IA 80-IAB or 80-IB or 80-IC or80-IE on fulfillment of certain conditions. If the amalgamated company fulfils thoseconditions it is entitled to these deductions resulting in reduction of its tax liabilityzone is transferred to another unit.

13. Special Economic Zone. Where an unit of SEZ is transferred to another unit ina scheme of amalgamation, the exemption shall be allowed to the other unit for theunexpired period. [Sec. 10AA(5)]

14. Tonnage Scheme. Where there has been an amalgamation of a qualifying companywith another company, the provisions relating to the tonnage tax scheme shall applyto the amalgamated company if it is a qualifying company.

However where the amalgamated company is not a tonnage tax company, itcan exercise an option for tonnage tax scheme within three months from the date ofthe approval of the scheme of amalgamation. (Sec. 115VY)

4.5.3 FOR SHARE HOLDERS OF AMALGAMATING COMPANY

1. Period of holding of shares of the amalgamated company: Where shares in anIndian Company, which become the property of the assessee in consideration of sharestransferred in case of amalgamation, it shall be included the period for which theshares in the amalgamating company were held by the assessee. [Sec. 2(42A)(C)].

2. Exemption from tax on exchange of shares. The shareholders of the amalgamatingcompany are not liable to capital gains tax, when they are allotted shares by theIndian amalgamated company in lieu of shares held by them in the amalgamatingcompany.[Sec. 47(vii)].

Accumulated Non-speculative Business Losses and Unabsorbed Depreciation:

Where a company owning an industrial undertaking or ship or hotelamalgamates with another company, or a banking company amalgamates with aspecified bank, or one or more public sector company or companies engaged in the

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business of operation of aircraft amalgamates with one or more public sector companyor companies engaged in similar business, the accumulated loss and the unabsorbeddepreciation of the amalgamating company shall be deemed to be the loss orunabsorbed depreciation of the amalgamated company of the previous year in whichthe amalgamation. Thus, the amalgamated company will be entitled to carry-forwardand set-off the loss and unabsorbed depreciation of the amalgamating company as ifthese were the losses or unabsorbed depreciation of the amalgamated company itself.It is important to note that the amalgamated company has the right to carry-forwardand set-off the balance of business loss for a period of eight assessment yearsimmediately succeeding the assessment year relevant to the previous year in whichthe amalgamation was effected and unabsorbed depreciation till it is fully absorbed.(Sec. 72A)

Conditions:

(1) For amalgamating company:

(a) It has been engaged in the business, in which the accumulated loss occurredor depreciation remains unabsorbed, for three or more years.

(b) It has held continuously as on the date of amalgamation at least three-fourthof the book-value of fixed assets held by it two years prior to the date ofamalgamation.

(2) For amalgamated company:

(a) The amalgamated company holds at least 75% of book value of fixed assets,of the amalgamating company acquired as a result of amalgamation, for fiveyears from the effective date of amalgamation.

(b) The amalgamated company continues the business of the amalgamatingcompany for at least five years from the effective date of amalgamation.

(c) The Central Government may notify such other conditions as may be necessary.

3. Conditions prescribed by the Government:

(a) The amalgamated company, owning an industrial undertaking of the

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amalgamating company by way of amalgamation, shall achieve the level of productionof at least fifty percent of the installed capacity of the said undertaking before the endof four years from the date of amalgamation and continue to maintain the said minimumlevel of production till the end of five pears from the effective date of amalgamation.

However, the, Central Government, on an application made by theamalgamated company, may relax the condition of achieving the level of productionor period of production or both having regard to the genuine efforts made by theamalgamated company to attain the prescribed level of production and thecircumstances preventing such efforts from achieving the same.

The amalgamated company shall furnish to the Assessing Officer a certificatein Form No. 62, duly verified by a Chartered Accountant, with reference to the booksof accounts and other documents showing particulars of production, along with thereturn of income for the assessment year relevant to the previous year during whichthe prescribed level of production is achieved and for subsequent assessment yearsrelevant to the previous year's falling within five years from the date of amalgamation.For the purposes of this rule 'Installed capacity' means the capacity of productionexisting on the date of amalgamation.

Non-fulfillment of conditions. If the above specified conditions are not fulfilledthat part of carry forward loss and unabsorbed depreciation remaining to be utilisedby the amalgamated company shall lapse, and such loss or depreciation as has beenset-off shall be treated as the income of the year in which the failure to fulfill theconditions occurs.

Tax liability of amalgamated company

1. Where an allowance or deduction has been made in respect of loss, expenditure orliability to the amalgamating company and subsequently during any previous year theamalgamated company has obtained any amount (in cash or otherwise) in respect ofaforesaid loss or expenditure or some benefit in respect of trading liability by way ofremission or cessation thereof, it is taxed in the hands of the amalgamated company.[Sec.41(1)]

2. Amalgamation is treated as a case of succession to business. The tax liability of the

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amalgamating company in respect of income for the previous year in which thesuccession took place up to the date of succession and for the previous year precedingthat year can be recovered from the amalgamated company if it cannot be recoveredfrom the amalgamating company. [Sec. 170(3)] Hence, the tax liability for the aforesaidperiod of the amalgamating company should carefully be ascertained.

4.6 AMALGAMATION OF BANKING COMPANY (Sec. 72AA)

(Sec.72AA) Provides carry forward and set-off of accumulated loss and unabsorbeddepreciation allowance of a banking company against the profits of a banking institutionunder a scheme of amalgamation sanctioned by the Central Government.

Conditions

1. There is an amalgamation of a "banking company" with any other "bankinginstitution". Banking company for this purpose means a company which transacts thebusiness of banking in India. A manufacturing or trading company which acceptsdeposits of money from the public merely for the purpose of financing its businessshall not be deemed to transact the business of banking. A banking institution for thispurpose means any banking company and includes State Bank of India or otherscheduled banks.

2. The amalgamation is sanctioned and brought into force by the Central Governmentunder section 45(7) of the Banking Regulation Act, 1949.

Consequences if the above conditions are satisfied-

If the above conditions are satisfied, the accumulated loss and unabsorbed depreciationof the amalgamating banking company shall be deemed to be the loss or the allowancefor depreciation of the banking institution for the previous year in which the schemeof amalgamation is brought into force.

For this purpose, "accumulated loss" means so much of the loss of the amalgamatingbanking company under the head "Profits and gains of business or profession" whichsuch amalgamating banking company, would have been entitled to carry forward andset off under the provision of section 72 if the amalgamation had not taken place. Itdoes not, however, include speculative business Losses. Unabsorbed depreciation"

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means so much of the depreciation of the amalgamating banking company whichremains to be allowed and which would have been allowed to such banking companyif amalgamation had not taken place.

Tax Planning

1. Where some assets or liabilities are not proposed be taken over by the amalgamatedcompany, the same may be disposed of or paid-off by the amalgamating companybefore the scheme of amalgamation effected.

2. 'Where shareholders holding more than 25% shares of the amalgamating companyare not willing to become shareholders of the amalgamated company, the shares ofsome of the dissenting shareholders may be purchased by the other shareholders oramalgamated company before amalgamation, so that the condition shareholdersholding at least 75% of the shares of the amalgamating company become shareholdersof amalgamated company is fulfilled.

3. Where the amalgamation does not satisfy the conditions laid down in section 72A,the benefit of set-off unabsorbed depreciation and carry forward business losses arenot available to the amalgamated company. In such a case it is better that a profit-making company merges with the loss incurring company rather than vice-versa. Itwould help in continuing to carry-forward and set-off the unabsorbed depreciationand losses against the profits derived from the business of the profit-making company.

4. The amalgamated company should not give composite consideration (shares anddebentures or shares and cash) to the shareholders of the amalgamating company inlieu of shares held by them in the amalgamating company. They should be given onlyshares in lieu of share held by them in amalgamating company. In case of compositeconsideration the tax incentive u/s 47(vii) will not be available.

4.7 SUMMARY

This lesson broadly outlined the meaning of amalgamation, conditionsnecessary for amalgamation. Apart from this tax incentives for amalgamated company,for amalgamating company and shareholder of amalgamating company are alsodiscussed. This lesson also discusses the provisions related to amalgamation of bankingcompanies and tax planning under Income tax Act.

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4.8 GLOSSARY

Sec. 35DD- Expenses on Amalgamation

Sec. 35D- Preliminary Expenses

Sec.35 (5) - Capital Expenditure on Scientific Research

Sec.72AA- Amalgamation of Banking Company


1. What are the conditions necessary for amalgamation?

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2. Discuss the tax incentives available for shareholders for amalgamatingcompany.

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4.10 LESSON END EXERCISES QUESTIONS

1. Discuss the provisions u/s 72AA regarding carry forward and set off ofaccumulated loss and unabsorbed depreciation of a banking company.

2. What are the tax incentives available to amalgamating company?

3. Define amalgamation. What are the modes of amalgamation?

4. How would you determine tax liability of amalgamated company?


1. Direct Taxes Law & Practice- Dr. Vinod K. Singhania and Dr. Kapil Singhania,Tax mann's Publishing.

2. Corporate Tax Planning & Business Tax Procedures- Dr. Vinod K. SinghaniaDr. Monica Singhania, Taxmann's Publishing.

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TAX CONSIDERATIONS RELATED TO DEBT AND EQUITY

Structure

5.1 Introduction

5.2 Objectives

5.3 Factors affecting debt and equity decision

5.4 Tax considerations related to debt and equity

5.5 Summary

5.6 Glossary

5.7 Self-assessment questions


5.9 Suggested readings

5.1 INTRODUCTION

Before commencing a new project a vital management decision regarding selectingright type of capital structure has to be taken. An optimum capital structure is onewhich maximises shareholder's return. The advantages of having an optimum capitalstructure are twofold. It maximises the value of the assets of the company and wealthof its owner and minimises the cost of capital which, in turn, raises its ability to findinbuilt additional investment opportunities. Problem of planning capital structure isof crucial importance and has long term implications. The tax planner should properly

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balance risk, cost, control and tax consideration. In capital structure decisions, thecost of capital is an important consideration along with risk factor. One of the mainreasons for raising finance through borrowing (as against issue of equity shares) is toincrease earning on equity share capital. But excessive use of debt capital increasesthe financial risk of the company.

5.2 OBJECTIVES

After going through this lesson, you should be able to understand factors affectingand the tax considerations related to debt and equity decisions.

5.3 FACTORS AFFECTING DEBT AND EQUITY DECISION

(1) Nature of business: - Businesses prone to more risks and unstable income shouldprefer equity shares as source of finance whereas business houses with lower risk &stable income will find it beneficial to use debentures & preference along with equityshares. For e.g public utility concerns.

(2) Purpose of finance: - If funds are required for investing in new projects withlong gestation period then equity shares capital is advised. However, debentures andpreference shares can be used where invested funds will start generating immediatereturn.

(3) Period of finance:

For very long term Equity Shares

For medium term, Preference Shares

For Short term Debentures

(4) Risk factor:- The excessive use of loans and debts increases the financial risk.The debt burden can cause death of a business. It is said that it is easy to take a loanbut it is difficult to service it. In the initial stages of business the interest burdencripples the unit and the business finds it very difficult to survive.

(5) Trends in capital market:- In case of favourable capital market conditions wheresupply of finance is in abundance, the business house can issue different types ofsecurities such as equity shares, preference shares and debentures etc. However, in

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case of depressed capital market, the retained earnings are the best source of finance.

(6) Miscellaneous factor:- Attitude of Management, rate of return expected frominvestment, control etc.

5.4 TAX CONSIDERATIONS RELATED TO DEBT AND EQUITY

Tax aspects should also be given due care while deciding the capital structure i.e. thevarious types of securities to be issued.

From taxation angle, the following should be considered:

(A) Cost of capital and its tax treatment

(B) Floatation cost and its tax treatment

(C) Effect of corporate tax rate

(D) Tax treatment in the hands of investors.

(A) COST OF CAPITAL AND ITS TAX TREATMENT

Case I : Loan, Debentures etc.

(1) Cost of capital:- The cost of capital for loans & debentures refers to the rate ofinterest payable to lender or debenture holder.

(2) Meaning of Interest under Income Tax Act. [2(28A)]. According, to Section2(28A) of Income Tax Act 1961, the 'Interest' means interest payable in any mannerin respect of any money borrowed or debt incurred (including a deposit, claim orother similar right or obligation) and includes any service fee or other or other chargein respect of the money borrowed or debt incurred or in respect of any credit facilitywhich has not been utilised.

(3) Tax treatment of interest:- Interest on loans /debts/ debentures is 100% taxdeductible while calculating business income. The allowability of interest can be ondue basis or on paid basis depending upon the method of accounting adopted bybusiness house. Thus, if accounts are prepared on accrual basis then interest can beclaimed as deduction on due basis even though it has not been paid during the previousyear.

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Allowability of interest on actual payment basis in certain cases (Sec.43 B)

In the following cases, the interest will be allowed as deduction only if it is either paidduring the previous year itself or if not during the previous year. then it must be paidon or before the due date of furnishing of return of income :-

(i) Interest on any loan or borrowing from a public financial institution like IDBI,ICICI, State financial corporation, State Industrial Investment Corporation Etc.

(ii) Interest on any term loan, loan or advance taken from a scheduled bank includingco operative bank.

The proof of the payment has to be attached along with the return of income.

Note 1. If, in both the above cases, any interest is converted into a loan or borrowingor advance then such interest shall not be deemed to have been actually paid and shallnot be allowed as deduction during the previous year in which such interest is convertedinto loan/Advance/borrowing. [ 3C & 3D to Sec 43B inserted by Finance Act, 2006]

Note 2. If interest of a particular P.Y. is not paid before the due date of furnishing ofreturn of income of that P.Y. also & is actually paid afterwards then deduction can beclaimed in the previous year in which it is paid.

Note 3. Explanation 4 to Section 43 B provides the meaning of certain terms asfollows:

(a) Public Financial Institution. It shall have the following meaning assigned to it insection 4A of the Companies Act, 1956.

(1) Each of the financial institutions specified in this sub-section shall be regarded,for the purposes of this Act, as a public financial institution, namely:

(i) the Industrial credit and Investment Corporation of India Limited, a companyformed and registered under the Indian Companies Act, 1913 (7 of 1913);

(ii) the Industrial Finance Corporation of India, established under section 3 of theIndustrial Finance Corporation Act, 1948 (15 of 1948);

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(iii) the Industrial Development Bank of India, established under section 3 of theIndustrial Development Bank of India Act, 1964 (18 of 1964);

(iv) the Life Insurance Corporation of India, established under section 3 of the LifeInsurance Corporation Act, 1956 (31 of 1956);

(v) the Infrastructure Development finance Company Limited, a company formedand registered under this Act.

(2) Subject to the provisions of sub-section (1), the Central Government may, bynotification in the Official Gazette, specify such other institution as it may think fit tobe a public financial institution Provided that no institution shall be so specified unless,

(i) it has been established or constituted by or under any Central Act, or

(ü) not less than fifty-one per cent of the paid-up share capital of such institution isheld or controlled by the Central Government.

(b) Scheduled Bank. It shall have the meaning assigned to it in the Explanation toclause (iii) of sub-section (5) of section 11. As per the above said clause, "Scheduledbank" means the State Bank of India Constituted under the State Bank of India Act,1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (SubsidiaryBanks) Act, 1959 (38 of 1959), a corresponding new bank constituted under section3 of the Banking Companies (Acquisition and Transfer of Undertakings Act, 1970 (5of 1970), or under section 3 of the Banking Companies (Acquisition and Transfer ofUndertakings) Act, 1980 (40 of 1980), or any other bank being a bank included in theSecond Schedule to the Reserve Bank of India Act, 1934 (2 of 1934);

(c) "State financial corporation." It means a financial corporation established undersection 3 or section 3A or an institution notified under section 46 of the State FinancialCorporations Act, 1951 (63 of 1951);

(d) "State industrial investment corporation." It means a Government company withinthe meaning of section 617 of the Companies Act, 1956 (1 of 1956), engaged in thebusiness of providing long-term finance for industrial project3 and approved by the 2for deduction] under clause (viii) of sub section (1) of section 36.]

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ILLUSTRATION 1. X Ltd. borrowed 50,00,000 for 1DB! on April 1, 2016, at 12%p.a. The company paid the interest of 6,00,000 for the period April 1, 2016 to March31, 2017, on November 15, 2017. The company prepares its accounts as per accrualsystem of accounting. Discuss the allowability of interest as business expenditure.

SOLUTION

Period of Interest = April 1, 2016 to March 31, 2017 i.e. P.Y. 2016-17

Amount of interest = 6,00,000

Here, the loan has been taken from IDBI (a public financial institution).

The interest on this loan can be claimed as deduction subject to the provisions of sec.43B.

As per sec. 43B, this interest can be claimed as deduction for any P.Y. only if it is paideither during the P.Y. or on or before the due date of furnishing of return of incomefor that P.Y.

Interest due for the P.Y. 2016-17 has been paid on November 15, 2017 (P.Y. 2017-18) i.e. neither during the P.Y. 2016-17 nor upto September 30, 2017 (Due date offiling return for P.Y. 2016-17).

Hence, this interest shall be allowed as deduction in the P.Y. 2017-18 (i.e. A.Y. 2018-19).

When interest is to be capitalised & then written off:-

Interest on loan taken before commencement of business, is treated as preliminaryexpenditure and is written off 1/5th every year. In case loan is taken to acquire theasset, the interest on loan from the date of taking loan till the date asset is put into useis treated as capital expenditure and is added to the cost of asset for depreciationpurposes.

ILLUSTRATION 2. Nishit Ltd. took a loan of 10,00,000 (on 1-10-16) from a privatefinance company for the purchase of an imported machine for its manufacturingdivision. The company got the possession of machine on February 28, 2017. However,the company started using the machine w.e.f. 1-04-17. The loan carries interest @14%p.a.

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Discuss the Tax Treatment of interest for assessment years 2017-18 and 2018-19.

SOLUTION

Tax treatment of Interest forAY. 201 7-18

Period of Interest = 6 months (i.e. for 1-06-16 to 31-3-17)

Amt. of Interest = 10,00,000 × 14% ×= 70,000

612

The above interest of 70,000 shall not be allowed as deduction while calculatingincome under the head profits and gains because the company did not use the assetduring the previous year 2014- 15. This interest shall be capitalised hence shall beadded to the cost of machine for depreciation purposes.

Tax treatment of Interest for A.Y. 201 8-19

Asset was put into use on 1-04-17Loan outstanding = 10,00,000 (assuming to repayment)Rate of Interest = 14% p.a.Period of a Interest = 12 Month (i.e. from 1-04-17 to 31-3-18)Amount of Interest = - 14% of 10,00,000

= 1,40,000

The above interest shall be allowed as deduction while calculating income under thehead profits and gains.

Case II: Owned capital (Equity shares & Preference shares)

1. Cost of Capital:- 'Dividend signifies the cost of capital of owned capital. In caseof equity, shares capital, dividend may fluctuate from year to year but in case ofpreference share capital, the dividend is fixed subject to availability of profits.

2. Meaning of Dividend under Income Tax Act:

In common parlance 'dividend' means the profits distributed by a company to itsshareholders. Apart from that, i.e., dividend paid by a company to its shareholders,

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section 2(22)(e) gives the definition of deemed dividend. Hence, under the Income-tax Act, dividend includes deemed dividend. As per section 2(22), "dividend" includesfollowing payments or distribution to the extent of accumulated profits of the company[i.e. whether capitalised profit or not for section 2(22)(a) to (d) and capitalised profitin case of section 2(22)(e)] :

(a) any distribution if such distribution entails the release of all or any part of theassets of the company ;

(b) any distribution of debentures, debenture-stock, or deposit certificates in anyform, whether with or without interest, and any distribution to its preferenceshareholders of bonus shares ;

(c) any distribution made on liquidation of a company except where theshareholder is not entitled to participate in the surplus asset in the event of liquidationand shares were issued to him for full cash consideration.

(d) any distribution on the reduction of capital of a company except where theshareholder is not entitled to participate in the surplus asset in the event of liquidationand shares were issued to him for full cash consideration.

(e)Any payments in the form of loans or advances made by a closely-held company(i.e. a company in which public are not substantially interested) to its shareholderwho is the beneficial owner of shares holding not less than 10% of voting power insuch company or to any concern in which such shareholder is a member or a partnerand which he has a substantial interest or any payment made by on behalf of suchshareholder for his/her individual benefit. However, such payment would not amountto dividend, if such payment is made in the ordinary course of business and moneylending is substantial part of the company's business.

3. Tax treatment of dividend

(i) Whether allowable as business expenditure:- The dividend paid to shareholder isnot a deductible business expenditure. It has to be paid out of after tax profits.

(ii) Payment of dividend tax u/s 115-0

A company is also required to pay dividend tax u/s 115-0 at prescribed rates, if

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dividend is distributed etc during the following periods :-

(i) On or after 1-6-97 to 31-3-02

(ii) On or after 1-4-03.

(B) Floatation cost and its tax treatment

Floatation cost includes expenses like printing of promotional material, applicationforms, underwriting commission to brokers, bankers and Advertisment etc. Thefloatation cost related to each source of capital should be duly considered whiledesigning the capital structure.

Tax treatment: Indian company or any other resident non-corporate assessee canclaim deduction in respect of above expenses as preliminary expenses u/s 35D as perrules prescribed therein. However, the maximum qualifying amount of such expenditurehas been restricted to 5% of project cost/Capital employed.

Amount of deduction = 1/5th of qualifying amount during 5 consecutive assessmentyears

Note:- The above provisions are applicable in respect of floatation cost of both debtand share capital)

(C) Effect of Corporate Tax rate

(i) In case of debt:- Since interest on debt is 100% tax deductible subject to on thebasis of payment in certain cases, as a result of it, the cost of debt shall be reducedfurther. So, if corporate income tax rate is high then it will reduce further the cost ofdebt to a considerable extent. However, in case of low corporate tax, the cost of debtwill not fall much.

(ii) In case of share capital:- No such benefit is available in respect of dividend paidon share capital.

(D) Tax treatment in the hands of investors

(i) If investor is a lender:- Any interest received received by the lender in respect ofloan giver to company or debentures purchased, shall be taxable in his hands as

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follows:

(i) if investing in debentures etc. or giving loan is his business then interest shall betaxable as business income.

(ii) Otherwise, the interest shall be taxable as income from other source.

(ii) If investor is share holder

For tax treatment of dividend in the hands of shareholder, see topic 'dividend policy'.ILLUSTRATION 3. D.B. Ltd. is an existing company and needs capital for itsexpansion. It has two options

(a) To have equity capital of 40,00,000 and loaned capital of 20,00,000 @ 15% p.a.

(b) To have equity capital of ' 20,00,000 and loaned capital of ' 40,00,000 @ 15%p.a. The expected rate of return is 22% and company had been distributing dividendof 20% p.a. for last several years. Rate of tax is 30% + surcharge @ 5% of tax.Education cess is @3% of tax and surcharge Suggest the better option assuming thatcompany has decided to plough back its entire profits.

Note: The Surcharge @ 7% is applicable only if the total income of the companyexceeds 1 crore but does not exceed 10 crore.

SOLUTION

In this case it will be better for the company to go in for option-lI as rate of return isbetter in this option as compared to first option. Tax liability is also less in this option.

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Working Note.

Calculation of Income tax

ILLUSTRATION 4 Shree Ltd. requires 75,00,000 to finance its expansionprogrammes. It has the following three options

The Expected rate of return before interest and tax is 25% for the past few years thecompany has been declaring a dividend of 16%. The tax rate applicable to companyis 30% + surcharge @ 7% + Education cess @2% + SHEC @ 1%.

Which is the best alternative for the Company?

Note. (i) The Board of directors have decided not to distribute any dividend as thecompany has to plough back the entire profits.

(ii) The Surcharge @ 7% is applicable only if the total income of the company exceeds1 crore but does not exceed 10 crores.

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SOLUTION

From above, it is clear that alternative III gives maximum rate of return on EquityCapital, therefore, the Co. should opt for alternative III.Working Note

ILLUSTRATION 5. Chirag Ltd. (incorporated in 2000-01), requires ! 50,00,000 tofinance an expansion project. The expected rate of return before interest and tax is30% of the investment in project. The debt can be raised by issuing 11% debentures.The corn Dany has following 3 options.

The tax rate applicable to company is 30% plus 7% surcharge [ Total Income > 1crore but does not exceed 10 crore] and 3% education cess (2% + 1% SIIEC).

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The company has decided to distribute the entire earnings as dividend. The rate ofcorporate dividend tax on amount of dividend distributed is 17.64706 (after grossing)+ 12% surcharge + 3% Education cess (2% + 1% SHEC).

Suggest the best option out of the three options.

SOLUTION

From above, it is clear that option III gives maximum rate of return on equity capital,therefore, the company should opt for alternative III.

Working Note 1. Calculation of Income Tax

Working Note 2. Calculation of dividend tax u/s 115-0

The Co. has decided to distribute the entire earnings after tax as dividend subject topayment of dividend tax.

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TAX PLANNING AND MANAGEMENT

1. When to use debt in capital structure?. The companies are advised to use moreand more of debt in its capital structure if the expected rate of return on investmentis higher than the cost of debt i.e. rate of interest payable on debt. The use of debt insuch a case, shall increase the return available to equity shareholders due to theoperation of favourable financial leverage.

• Further, interest on debt is 100% tax deductible, hence, it will reduce the taxablebusiness income of the company which will lead to saving in tax. As a result of this,the effective cost of debt will reduce further.

• How if the expected rate of return on investment is less than cost of debt then acompany should not use debt in its capital structure.

Words of Caution. As a matter of fact, tax planning shall always imply the use ofmore and more of debt in the capital structure. But in the course of tax planning, acompany should not raise too much debt as a proportion to its owned capital becausesuch a company shall be exposed to more financial risk.

2. In Case of Projects Having Long Gestation Period. If a Company needs moneyfor a project having long gestation period then as far as possible the company shouldraise money through equity share capital or preference share capital. It is so because,

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during the gestation period, the company will have either no earnings or earnings lessthan cost of debt. If in such a case, a company raises money from borrowings then itwill have to pay interest out of its capital which will ultimately increase the businessloss to be carried forward. As there is a limitation on carry forward of business loss(maximum 8 assessment years), so, it is possible that company may not be able to setoff such heavy losses in future.

3. Borrow long term Finances from Financial Institutions. In India, both, CentralGovernment & State Governments have established financial institutions for providinglong term finances to industries for investment in fixed assets etc. These institutionsprovide easy loan of high amount at Government administered rates of interest whichare often concessional in nature. So as far as possible, Long term financial should beraised from these 'public financial institutions.'

4. Use 'Ploughing back of Profit Policy'. As far as possible, a company shouldresort to ploughing back of profits. This will help a company to save expenses relatingto issue of fresh capital from market. If a company plough back its profits then it canalso save dividend tax u/s 115-0 to be paid in respect of dividend distributed/declared.

5. Claim not only interest but also service fee etc. In respect of debts taken, acompany can claim not only the interest as business expense but also the service feeor any other charge. So, any such service fee/charge in respect of the moneys borrowedshall also be claimed along with interest, as business expense.

6. Treatment of Cost of Raising Share Capital. In case, long term finance is raisedby issuing shares, equity or preference, the cost associated with raising of such sharecapital is treated as capital expenditure and is not allowed as deduction as revenuebusiness expenditure while calculating business income. However, if such cost inclaimed as preliminary expenses as per the provisions of section 35D, such expenditurecan be claimed as deduction over a period of 5 years subject to overall limit on suchexpenditure [ 5% of project cost or capital employed}

7. Companies to Deduct Tax at Source in Respect of Interest Payment

(a) If the debt is raised by way of issuing securities, then while making payment ofinterest to resident payees, the Co. should deduct tax at source as per section 193.

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(b) If the debt is raised otherwise than by way of issuing securities, then, while makingpayment of interest to resident payees, the company should deduct tax at source asper section 194 A..

(c) If in the above cases (a) and (b) the payee is a non-resident or a foreign Company,then the while making payment of interest the Company should deduct tax at sourceas per section 195.

8. Companies to pay 'Dividend Tax' as per See 115-0

The companies are required to pay dividend tax in respect of dividend distributed inany of the ways mentioned u/s 2(22) (a) to 2(22) (d). So, the managing directorshould ensure that dividend tax is paid duly.

9. Care regarding payment of interest. If the loan is raised from public financialinstitutions, scheduled banks or cooperative banks then company in order to claim itas an expenses, should ensure that the above interest is paid either during the previousyear on or before the due date of filing of return of that previous year. Otherwise, theabove interest shall be allowed as deduction in the year in which, it is paid. (SeeIllustration 1)

However, interest on other loans can be claimed as deduction even on due basis.

5.5 SUMMARY

In capital structure decisions, the cost of capital is an important consideration alongwith risk factor. One of the main reasons for raising finance through borrowing (asagainst issue of equity shares) is to increase earning on equity share capital. Butexcessive use of debt capital increases the financial risk of the company.

5.6 GLOSSARY

Sec.35D- Amortisation of Preliminary expenses

Sec. 193- Tax deduction at source from interest on securities

Sec 194A- Tax deduction at source from interest other than interest on securities

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1. Explain the factors affecting debt and equity decisions.

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2. Define floatation cost and its tax treatment.

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5.8 LESSON END EXERCISES/ EXAM ORIENTED QUESTIONS

1. As a tax expert what tax planning measures would advise to reduce tax liabilitywith regard to debt and equity decisions?

2. Describe cost of capital and its tax treatment.




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M.Com. 1st Sem. Unit-IILesson No. 6

TRANSFER PRICING & INTERNATIONAL TAXATION

Structure

6.1 Introduction

6.2 Objectives

6.3 International transactions

6.4 Conditions for applicability of arm's length price (ALP) in internationaltransactions

6.5 Computation of the arm's length price

6.6 Method of computing arm's length price

6.6.1 Comparable uncontrolled price method

6. 6.2 Resale Price Method

6.6.3 Cost plus method

6.6.4 Profit split method

6.6.5 Transactional net margin method

6.7 Summary

6.8 Glossary



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6.1 INTRODUCTION

The provisions under sections 92 to 92F have been enacted with a view toprovide a statutory framework which can lead to computation of reasonable, fair andequitable profit and tax n India so that the profits chargeable to tax in India do not getdiverted, elsewhere by altering the prices charged and paid intra-group transactionsleading to erosion of Indian tax revenue Any income arising from an internationaltransaction shall be computed having regard to arm's length price

• With effect from the assessment year 2013-14, section 92BA has been inserted toextend transfer pricing provisions to a few domestic transactions.

• Income arising from an international transaction is a pre-condition for applicationof transfer pricing provisions. Further, the Act defines the term income in an inclusivemanner. Income, in its normal meaning will not include capital receipts unlessspecifically provided The amounts received on issue of share capital including thepremium are on capital account The activity of issue of shares by a subsidiary companyto its overseas holding company at a price which is below the fair market value doesnot give rise to any income and transfer pricing provisions are not applicable on it Insuch a case what is sought to be taxed is capital forgone i.e not received from a nonresident in the form of short premium.

6.2 OBJECTIVES :


• The concept of International transactions

• The conditions for applicability of arm's length price

• The various methods of computing arm's length price

6.3 INTERNATIONAL TRANSACTIONS

The provisions under sections 92 to 92F have been enacted with a view to

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provide a statutory framework which can lead to computation of reasonable, fair andequitable profit and tax in India so that the profits chargeable to tax in India do notget diverted, elsewhere by altering the prices charged and paid intra-group transactionsleading to erosion of Indian tax revenue Any income arising from an internationaltransaction shall be computed having regard to arm's length price

• With effect from the assessment year 2013-14, section 92BA has been inserted toextend transfer pricing provisions to a few domestic transactions.

• Income arising from an international transaction is a pre-condition for applicationof transfer pricing provisions. Further, the Act defines the term income in an inclusivemanner. Income, in its normal meaning will not include capital receipts unlessspecifically provided The amounts received on issue of share capital including thepremium are on capital account The activity of issue of shares by a subsidiary companyto its overseas holding company at a price which is below the fair market value doesnot give rise to any income and transfer pricing provisions are not applicable on it Insuch a case what is sought to be taxed is capital forgone i.e not received from a nonresident in the form of short premium.

6.4 CONDITIONS FOR APPLICABILITY OF ARM'S LENGTH PRICE(ALP) IN INTERNATIONAL TRANSACTIONS

The following conditions need to be satisfied for the applicability of the arm'ss length price in the international transaction-

CONDITION 1- TWO OR MORE ENTERPRISES- International transaction issubjected to the arm's length price only in case of transaction between two entitiescalled associate enterprises.

ENTERPRISES MEANING OF [Sec. 92F (iii)] Enterprise means a person whoengages or has been engaged or proposed to engage m the following activities:

a. any activity relating to the production storage supply distribution acquisition orcontrol of .articles or goods;

b. how patents copyrights trademarks licenses franchises or any other business orcommercial rights of similar nature or any data, documentation, drawing or

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specification relating to any patent invention model design secret formula or processof which the other enterprise is the owner or in respect of which the other enterprisehas exclusive rights;

c. any activity relating to the provision of services of any kind

d. carrying out any work m pursuance of a contract (e g construction contract)

e. investment activity;

f. activity relating to provision of loan;

g. business of acquiring, holding, underwriting or dealing with shares, debenture orother securities of anybody corporate.

o A person would be an enterprise if it carries on the specified activity/business directlyor through one or more of its units or divisions of subsidiaries.

CONDITION 2 ENTERPRISES SHOULD BE REGARDED AS ASSOCIATEENTERPRISES (SEC 92A(1)- The provisions regarding taxation of internationaltransactions [ 92 to 92F] apply in case the two enterprises are associated enterprises.

An enterprise would be regarded as an associated enterprise of another enterprise, if-

a. it participates, directly or indirectly, or through one or more intermediaries, in themanagement or control or capital of the other enterprise; or

b. in respect of it one or more persons who participate, directly or indirectly, orthrough one or more intermediaries, in its management or control or capital, are thesame persons who participate, directly or indirectly, or through one or moreintermediaries, in the management or control or capital of the other enterprise.

• Clause (a) of section 92A(1) is about participation by one enterprise into otherenterprise While clause (b) of the said section is about participation by a third enterpriseinto both the enterprises.

• Clause (a) of section 92A(1) provides that the enterprise which participates inmanagement, control or capital is an associated-enterprise for the 'other enterprise'.

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The language of the provision should be construed harmoniously such that both theparticipating enterprise and other enterprise are regarded as associated enterprises

i The word control is of a wider ambit than the word management and therefore evenif a person is not managing the other but only able to control him, then he will fallwithin the ambit of phrase control or management

DEEMED ASSOCIATED ENTERPRISES [ 92A(2)] Mere fact of participation byone enterprise m the management or control or capital of the other enterprise or theparticipation of one or more persons in the management or control or capital of boththe enterprises shall not make them associated enterprises unless the criteria specifiedm section 92A(2) are fulfilled. For instance, where one enterprise is holding preferenceshares (not carrying voting rights) in other enterprise then they shall not be regardedas associated enterprises because though one is participating m the capital of otherenterprises but still they are not satisfying any of the thirteen categories mentioned insection 92A(2).

Section 92A(2) provides that two enterprises shall be deemed to be associatedenterprises if for the purpose of section 92A(l) the two enterprises satisfy at any timeduring the previous year any of the following conditions:

Thirteen categories [ 92A(2)] - Two enterprises shall be deemed to be associated.enterprises for the purpose of section 92A(l) if at any time during the previous year -

i. one enterprise holds (directly or indirectly) shares carrying not less than twenty sixper cent of the voting power m the other enterprise [ clause a] or

ii. any person or enterprise holds (directly or indirectly) shares carrying not less thantwenty-six per cent of the voting power in each of such enterprises [ clause b]; or

iii. a loan advanced by one enterprise to the other enterprise constitutes not less thanfifty-one per cent of the book value of the total assets of the other enterprise [clausec]; or

iv. one enterprise guarantees not less than ten per cent of the total borrowings of theother enterprise [clause d]; or -

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v. more than half of the board of directors or members of the governing board, or oneOr more executive directors or executive members of the governing board of oneenterprise, -are appointed by the other enterprise [clause e]; or

vi more than half of the directors or members of the governing board, or one or moreof the executive directors or members of the governing board, of each of the twoenterprises are appointed by the same person or persons [clause f]; or

vii the manufacture or processing of goods or articles or business carried out by oneenterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any .other business or commercial rights of similarnature, or any data, documentation drawing or specification relating to any patentinvention model design secret formula or process, of which the other enterprise is theowner or in respect of which the other enterprise has exclusive rights [ clause g]; or

viii. ninety per cent or more of the raw materials and consumables required for themanufacture or processing of goods or articles carried out by one enterprise, aresupplied by the other enterprise, or by persons specified by the other enterprise, andthe prices and other conditions relating to the supply are influenced by such otherenterprise [clause h] or

ix. the goods or articles rnanufactured or processed by one enterprise, are sold to theother enterprise or to persons specified by the other enterprise, and the prices andother conditions relating thereto are influenced by such other enterprise [clause i]; or

x. where one enterprise is controlled by an individual, the other enterprise is alsocontrolled by such individual or his relative or jointly by such individual and relativeof such individual[clause j]; or

xi. where one enterprise is controlled by a Hindu undivided family, the other enterpriseis controlled by a member of such Hindu undivided family, or by a relative of amember of such Hindu undivided family, or jointly by such and his relative [clause k],or

xii. where one enterprise is a firm, association of persons or body of individuals, theother enterprise holds not less than ten per cent interest in such firm, association of

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persons or body of individuals [clause l]; or

xiii. there exists between the two enterprises, any relationship of mutual interest, asmay be prescribed [clause m]

• Raw material Supply of According to clause (h) of section 92A(2) two enterprisesshall be deemed to be associated enterprises only if one of the enterprise or anypersons specified by it -

a. supplies 90 per cent or more of raw materials and consumables required by theother and

b. the price and other conditions relating to the supply are influenced by such enterprise.

Here, limit-of 90 per cent is to be applied on the 'value' of raw material andconsumables.

• Directly or indirectly - Only clauses (a) and (b) of section 92A(2) speaks of thephrase 'directly or indirectly Thus construing the deeming provisions of section 92A(2)strictly it appears that clause (c)of 92A(2) comprehends a direct relationship betweenthe associated enterprises

Book value - Clause (c) of section 92A(2) does not provide for the ingredients ofthe 'book value'. Hence increase m value on account of revaluation of assets will notbe ignored here

• Appointment of directors- Clause (c) of section 92A(2) contemplates actualappointment of director for application of the deeming provisions of associatedenterprises Thus a power to appoint directors in the absence of actual appointmentof directors will not attract the aforesaid provisions.

Wholly dependent on intangible assets- Clause (g) of section 92A(2) provides thattwo enterprises shall be deemed to be associated enterprises if at any time during theprevious year the manufacture or processing of goods or articles or business carriedout by one enterprise is wholly dependent upon the use of know-how, patents,copyrights, trade-marks, licenses, etc;, of which the other enterprise is the owner orhas exclusive rights

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The aforesaid provisions are applicable if there is complete dependency of oneenterprise on the other enterprise In other words m case of partial dependency thetwo enterprises will not be deemed to be associated enterprises. -

CONDITION 3-INTERNATIONAL TRANSACTION SHOULD BE CARRIEDOUT BYTHEASSOCIATED ENTERPRISES -

An international transaction should be carried out by-the associated enterprises. Toconstitute an international transaction, it should be: -

1. A transaction between two or more associated enterprises (either or both are non-residents) in nature of (a) purchase, sale or lease of intangible property, or (b) provisionof services, or (c) lending or borrowing money.

2. A transaction between two or more associated enterprises (either or both are non-residents) having a bearing on the profits, income, losses or assets of such associatedenterprises

3. Mutual agreement or arrangement between two or more associated enterprises for(a) allocation or apportionment of, or (b) contributing to, any cost or expense incurred(or to be incurred) regarding a benefit service or facility provided (or to be provided)to any one or more of such associated enterprise.

DEEMED INTERNATIONAL TRANSACTION - Section 92B (2) provides thattransactions between an enterprise and a person other than associated enterprise(hereinafter referred to as "other person") is deemed as international transactionsentered into between two associated enterprises if the following conditions are satisfied

• Condition 1-There is a prior agreement in relation to the relevant transaction betweensuch other person and the associated enterprise. Alternatively, the terms of the relevanttransaction are determined in substance between such other person and the associatedenterprise.

• Condition 2 - The enterprise or the associated enterprise or both of them are non-resident, irrespective of whether such other person is non-resident or not.

Section 92F provides an inclusive definition. According to section 92F, the transaction

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includes an arrangement, understanding or action in concert, whether or not sucharrangement, understanding or action is formal or in writing; or is intended to beenforceable by legal proceeding.

Thus, not only the word 'transaction' includes those things which are included insection 92F(l), but it also includes such things which the term signifies according toits general and natural meaning.

• Section 92B has been amended with retrospective effect from the assessment year2002-03 to clarify that "international transaction" shall include -

a. the purchase, sale, transfer, lease or use of tangible property including building,transportation vehicle, machinery, equipment; tools, plant, furniture, commodity orany other article, product or thing;

b. the purchase, sale, transfer, lease or use of intangible property, including the transferof ownership or the provision of use of rights regarding land use, copyrights, patents,trademarks, licences, franchises, customer list, marketing channel, brand, commercialsecret, know-how, industrial property right, exterior design or practical and newdesign or any other business or commercial rights of similar nature;

c. capital financing including any type of long term or short term borrowing lendingor guarantee purchase or sale of marketable securities or any type of advance paymentsor deferred payment or receivable or any other debt arising during the course ofbusiness;

d. provision of services, including provision of market research, market development,marketing management administration technical service repairs design consultationagency scientific research legal or accounting service;

e. a transaction of business restructuring or reorganisation entered into by an enterprisewith an associated enterprise, irrespective of the fact that it has bearing on the profit,income, losses or assets of such enterprises at the time of the transaction or at anyfuture date.

• Further the expression "intangible property shall include (with retrospective effectfrom the assessment year (2002-03) for the aforesaid purpose the following -

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a. marketing related intangible assets, such as, trademarks, trade names, brand names,logos;

b. technology related intangible assets, such as, process patents, patent applications,technical documentation such as laboratory notebooks, technical know-how;

c artistic related intangible assets such as literary works and copyrights musicalcompositions copyrights, maps, engravings;

d.. data processing related intangible assets, such as, proprietary computer software,software copyrights, automated databases, and integrated circuit masks and masters;

e. engineering related intangible assets, such as, industrial design, product patents,trade secrets, engineering drawing and schematics, blueprints, proprietarydocumentation;

f. customer related intangible assets, such as, customer lists, customer contracts,customer relationship, open purchase orders;

g. contract related intangible assets, such as, favourable supplier, contracts, licenceagreements, franchise agreements, non-compete agreements;

h. human capital related intangible assets, such as, trained and organised work force,employment agreements, union contracts;

i. location related intangible assets, such as, leasehold interest, mineral exploitationrights, easements, air rights, water rights;

j. goodwill related intangible assets such as institutional goodwill professional practicegoodwill personal goodwill of professional, celebrity goodwill, general business goingconcern value;

k. methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts,estimates, customer lists, or technical data;

l. any other similar item that derives its value from its intellectual content rather thanits physical attributes.

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6.5 COMPUTATION OF THE ARM'S LENGTH PRICE

If conditions mentioned above are satisfied, then arm's length price shall be computed.

Arm's length price - Meaning of - Arm's length price as per section 92F is the priceapplied proposed to be applied when two unrelated persons enter into a transactionin uncontrolled conditions.

UNRELATED PERSONS - Persons are said to be unrelated if they are ot associatedor deemed to be associated enterprise according to section 92A.

UNCONTROLLED CONDITIONS - Conditions which are not controlledsuppressed or moulded or achievement of pre-determined results are said to beuncontrolled conditions. If a buyer is related to a seller or where prices are governed bythe Government policy then transaction is said to be taking place under controlledconditions.

Therefore to constitute arm's length price:

the price should be applied or proposed to be applied in a transaction;

b. the transaction is between unrelated persons; and

c the transaction is taking place in uncontrolled conditions

POINTS TO BE KEPT IN MIND- In computing such income allowance for anyexpense or interest shall also be determined having regard to arm's length price. Ithas been classified by insertion of explanation in section 92(1) that even whereinternational transaction comprises of only an outgoing the allowance for such expensesor interest arising from the international transaction shall also be determined havingregard to the arm's length price, and that the provision would not be applicable in acase where the application of arm's length price results in a downward revision in theincome chargeable to tax in India.

The following points should also be kept in mind while computing arm's length price:

INCOME - WHETHER INCLUDES 'INCOME NET OF EXPENSES' - This sectionprovides that the allowance for any expense is also to be determined in computingincome under section 92. Income includes losses also and the word 'income' as referred

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to in section 92 will constitute 'income net of expenses'

DOES SECTION 92 OVERRIDE SECTIONS 5 AND 9-. According to section 5, anon-resident is liable to tax in respect of income which is received or deemed to bereceived in India by him or on his behalf or which accrues or arises or is deemed toaccrue or arise in India during the previous year.

Similarly, section 9 provides for income which is deemed to accrue or arise in India.

Section 5 reads as follows : "Subject to the provisions of this Act, the total income ofany previous year of a person

Use of the phrase "Subject to other provisions of Act' imply that in considering whatis total income under section 5 one has to exclude such income as is excluded fromthe scope of total income by reason of any other provisions of the Income-tax Actand not that the other provisions of the Income- tax Act override the provisions ofsection5.

Therefore, section 92 does not override section 5. In other words, the AssessingOfficer is authorised to tax that income only which is taxable in India as per theprovisions of sections 5 and 9. In other words, non-residents whose income is nottaxable as per sections 5 and 9 do not fall within the ambit' of section 92.

'HAVING REGARD TO' - MEANING OF - According to section 92, income frominternational transaction is to be computed "having regard to' arm s length price -

The use of the words having regard to denotes that it is not incumbent upon theAssessing Officer to compute the arm s length price for each and every internationaltransactions In other words income of the assessee need not compulsorily be computedby replacing contracted price by arm s length price m the international transactionTherefore factors other than arm s length price hike restrictions imposed by theGovernment policy on free market play should also be taken into account along withthe arm s length price

INTENT TO DECEIT REVENUE OR MALA FIDE MOTIVE TO AVOID/REDUCE TAX IN INTERNATIONAL TRANSACTION

Section 92 has to be applied in every such case where an international transaction has

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taken place and the price agreed to between the two enterprises is different from thearm's length price, whether or not there is a mala fide motive According to OECDguidelines the need to make adjustments to approximate arm's length dealings arisesirrespective of any contractual obligation undertaken by the parties to pay a particularprice or of any intention of the parties to minimum tax. Thus, a tax adjustment underthe arm's length principle would not affect the underlying contractual obligations.

RESTRICTIONS IMPOSED BY GOVERNMENT ON FREE MARKET PLAY -If certain Government policies hinder the free market play by restricting, for instance,payment of interest or the rate charged thereupon, then the arm length price shall becomputed by taking into account such restrictions of Government policies.

Arm's length price - Computation of [Sec. 92C]

The arms length price shall be determined by any of the method specified in thissection being the most appropriate method an assessee has entered into various typesof international transactions with associated enterprises arm's length price should bedetermined on a transaction by transaction basis and not on an aggregate basis.

6.6 METHOD OF COMPUTING ARM'S LENGTH PRICE

Arm's length price can be computed by the following methods:

1. comparable uncontrolled price method;

2. resale price method;

3. cost plus method;

4. profit split method;

5. transactional net margin method;

6.6.1 COMPARABLE UNCONTROLLED PRICE METHOD

COMPARABLE UNCONTROLLED PRICE METHOD (CUP) - Under this method,

a the price charged or paid for property transferred or services provided in a comparableuncontrolled transaction,) (i.e.. a transaction between enterprises other than associated

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enter prices whether resident or non-resident) or a number of such transactions, isidentified;

b. such price is adjusted to account for differences, if any, between the internationaltransaction and the comparable uncontrolled transactions or between the enterprisesentering into such transactions, which could materially affect the price in the openmarket;

c. the adjusted price arrived at under (b) supra is taken to be an arm's length price inrespect of the property transferred or services provided in the international transaction.

• CUP is applied when a price is charged for a product or service. This is essentiallycomparison of prices charged for the property or services transferred in a controlledtransaction to a price charged for property or services transferred in a comparableuncontrolled transaction. The bedrock of this method is the identification of an identicaltransaction in a situation where a price is charged for products or services betweenunrelated parties.

• While applying CUP, the comparability between controlled and uncontrolledtransactions should not be only judged from the point of product comparability; butshould also take into consideration, the effect on price of other broader businessfunctions. Even minor differences in contractual terms or economic conditions,geographical areas, risks assumed, functions assumed, etc., could affect the amountcharged in an uncontrolled transaction. Comparability under this method depends onclose similarities with respect to various factors. -

• The CUP can be internal or external. The internal CUP is the price that the assesseehas paid/ charged in a comparable uncontrolled transaction with an independent partywhen compared to the price paid/charged in a controlled transaction. External CUPis a price charged in comparable uncontrolled transactions between third parties when,compared to the price of a controlled transaction. However where CUP method is tobe applied on the basis of public data it is provided in regulation 1.482 3(b)(5) of USRegulations that following requirements must be met

1. The data is widely and routinely used in ordinary course of business in the industryto negotiate prices for uncontrolled sales

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2. The data is used to set prices m the controlled transaction in the same way that itis used by uncontrolled taxpayers in the industry; and

3. The amount charged in the controlled transaction is adjusted to reflect productand service variations.

The US regulations further warn that data from public exchanges quotation mediashould not be used m extraordinary situations such as war period economic depressionnatural calamities period etc. The above principles are of universal application andthere is no good reason why they should not be applied in transfer pricing determinationm India

• The CUP method may be applicable in the following situations

a. The taxpayer or any other member of the group sells similar goods, in similarquantities and under similar terms to an independent enterprise in a similar market(an internal comparable).

b. An independent enterprise sells the particular product m similar quantities andunder similar terms to any other independent enterprise in similar market (an externalcomparable).

c. The taxpayer or another member of the group buys similar goods, in similar quantitiesand under similar terms from an independent enterprise in a similar market (an internalcomparable).

d. An independent enterprise buys similar goods in similar quantities and under similarterms from other independent enterprise in a similar market (an external comparable).

• Under the CUP method, the properties of a product and accompanying circumstancesand' conditions have to be evaluated for comparison and even a minor change in theproperties of the products, circumstances of trade (billing period, amount of credittherein, etc.) may have a significant effect on the price. Product comparability isabsolutely a key, in particular physical features such as size, weight, appearance alongwith volume, reliability/storage requirements, regulatory requirements, etc. Pricingof a product is a very subjective exercise and its true value, as received by the receiver,

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can differ from that received by others in the market place. Thus, CUP method requiresa high degree of comparability along the following dimensions:

i quality of the product or service;

iii level of market, ie., wholesale, retail, etc.;

ii contractual terms (example, scope and terms of warranties provided, sale or purchasevolumes, credit terms, transportation terms, etc.;

iv. geographical market in which the transaction takes place;

v. intangible property associated with the sale;

vi. foreign currency receipt; and -

vii. alternatives realistically available with the buyer and the seller

• For purpose of application of CUP method there should be similarity of transactionsto be compared. This method is not suitable if there are material product differencesor substantial adjustments. Under CUP method TPO should compare price declaredby the assessee with custom tariff rate at port of destination as it stood on day ofcontract of sale entered into between the assessee and its AE Where transaction is oflending in foreign -currencies to the assessees foreign subsidiaries, CUP method ismost appropriate method. Where the assessee cannot produce details about qualityof diamond mentioned with reference to invoices, CUP method is not applicable.

6.6.2 RESALE PRICE METHOD

RESALE PRICE METHOD (RPM) - Under this method,

a. the price at which property purchased or services obtained by the enterprise froman associated enterprise is resold to an unrelated enterprise/ is identified

b. such resale price is reduced by the amount of a normal gross profit margin accruingto the enterprise or to an unrelated enterprise from the purchase and resale of thesame or similar property from obtaining and providing the same or similar services,(ina comparable uncontrolled transaction)or a number of such transactions;

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c. the price so arrived at is further reduced by the expenses incurred by the enterprisein connection with the purchase of property or obtaining of services;

d. the price so arrived at is adjusted to take into account the functional and otherdifferences including differences in accounting practices if any between the internationaltransaction and the comparable uncontrolled transactions or between the enterprisesentering into such transactions which could materially affect the amount of grossprofit margin in the open market

e. the adjusted price arrived at under (d) (supra) is taken to be an arm's length pricein respect of the purchase of the property or obtaining of the services by the enterprise,from the associated enterprise.

The RPM is to-be--applied when a property purchased or service obtained from anassociated enterprise is resold to an unrelated enterprise. The RPM is based on theprice at which a product that has been purchased from an associated enterprise isresold to an independent enterprise. The resale price is reduced by resale price marginfor arriving at the ALP. The resale price of good is reduced by the direct expenditureand the normal gross profit margin that would have been earned by an unrelatedenterprise in a similar- transaction. The price is further adjusted onaccount of differentaccounting practices and other differences between the transactions. There may bean internal RPM or external RPM as in the case of a CUP. Benchmarking of themargins is critical in this process RPM could be reasonable method to apply totransactions involving resale of tangible property or in cases where the services areresold without value addition. This method -is particularly suitable in cases wheregoods are sold within a short period of purchases and influence of other factors isfound to be minimal.

6.6.3 COST PLUS METHOD

COST PLUS METHOD (CPM) - Under this method,

a. the direct and indirect costs of production incurred by the enterprise m respect ofproperty transferred or services provided to an associated enterprise, are determined;

b. the amount of a normal gross profit mark-up to such costs (computed accordingto the same accounting norms) arising from the transfer or provision of the same or

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similar property or services by the enterprise or by an unrelated enterprise m acomparable uncontrolled transaction or a number of such transactions is determined

c the normal gross profit mark up referred to in (b) supra is adjusted to take intoaccount the functional and other differences,- if any, between the internationaltransaction and the comparable uncontrolled transactions or between the enterprisesentering into such transactions which could materially affect such profit mark up mthe open market

d. the costs referred to in (a) supra are increased by the-adjusted profit mark-uparrived at under (c)supra;

e the sum so arrived at is taken to be an arm s length price in relation to the supply ofthe property or provision of services by the enterprise.

This method is ordinarily used where some semi-finished goods are sold betweenrelated parties or similar situations or in respect of joint facility agreements long termbuy and supply arrangements of provisions of services, etc,)

This is a method which uses the costs incurred by the supplier of the property orservices in a controlled transaction. Here also as in the case of RPM, benchmarkingof normal gross profit margins is necessary. The cost plus markup of the supplier in acontrolled transaction should ideally be established by reference to the cost plusmark up with the supplies of functional similarity earned in a comparable uncontrolledtransaction.

Cost Plus Method is adopted in situations where comparable transactions are offunctional similarity with that of controlled transactions. In other words under costPlus Method there is no necessity to benchmark with such product which is 100 percent identical Products functionally comparable, are good enough for benchmarkingunder Cost Plus Method. Even in this regard, FAR analysis is critical in identifyingfunctionally similar comparable transactions.

As in other methods, the assets employed, the functions performed, the risk assumed,-the contractual terms and other differences have to be taken into account. The markup must be measured consistently between the associated enterprises, and independententerprises.

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• Where there are various differences in-export segment and domestic segment suchas market functions, geographic difference, volume difference, credit risk, relatedparty transactions, etc.; TPO is not justified in adopting CPM as most appropriatemethod.

• CPM is most appropriate method in case of contract manufacturers but that wouldbe subject to satisfaction of parameters laid down in rule 1OC.

6.6.4 PROFIT SPLIT METHOD

PROFIT SPLIT METHOD (PSM) - This method is applicable mainly in internationaltransactions involving transfer of unique intangibles or in multiple internationaltransactions which are so interrelated that they cannot be evaluated separately for thepurpose of determining the arm's length price of any one transaction. As per profitsplit method, which

a. the combined net profit of the associated enterprises arising from the internationaltransaction in which they are engaged is determined.

b. the relative contribution made by each of the associated enterprises to the earningof such combined net profit, is then evaluated on the basis of the functions performed,assets employed or to be employed and risks assumed by each enterprise and on thebasis of reliable external market data which indicates how such contribution wouldbe evaluated by unrelated enterprises performing comparable functions in similarcircumstances;

c. the combined net profit is then split amongst the enterprises in proportion to theirrelative contributions, as evaluated under (b) (supra);

d. the profit thus apportioned to the assessee is taken into account to arrive at anarm's length price in relation to the international transaction:

However, the combined net profit referred to in (a) supra may, in the first instance, bepartially allocated to each enterprise so as to provide it with a basic return appropriatefor the type of international transaction m which it is engaged with reference tomarket returns achieved for similar types of transactions by independent enterprises,

( 133 )

and thereafter, the residual net profit remaining after such allocation may be splitamongst the enterprises in proportion to their relative contribution in the mannerspecified under (b) and (c) supra and m such a case the aggregate of the net profitallocated to the enterprise in the first instance together with the residual net profitapportioned to that enterprise on the basis of its relative contribution shall be takento be the net profit arising to that enterprise from the international transaction.

This method may be applicable in cases where transactions involved transfer of unique,intangible or any multiple interrelated international transactions, which cannot beevaluated separately for determining the ALP of any one transaction.

The profit split method first identifies the profit to be split for the associated enterprisefrom the controlled transactions in which the associated enterprises are engaged. Itthen splits those profits between the associated enterprises on an economically validbasis that approximates the division of profits that would have been anticipated andreflected hi an agreement made at arm's length price. The combined profit may be thetotal profit from the transactions or a residual profit intended to represent the profitthat cannot readily be assigned to one of the parties, such as the profit arising fromhigh value, sometimes unique, intangibles.

The contribution of each enterprise is based upon a functional analysis and valued tothe extent possible by any available reliable external market data. The functionalanalysis is an analysis of the functions performed (taking into account assets usedand risks assumed) by each enterprise. The external market criteria may include, forexample, profit split percentages or returns, observed among independent enterpriseswith comparable functions.

6.6.5 TRANSACTIONAL NET MARGIN METHOD

TRANSACTIONAL NET MARGIN METHOD (TNMM) - According totransactional net margin method- a. the net profit margin realised by the enterprisefrom an international transaction entered into with an associated enterprise is computedin relation to costs incurred or sales effected or assets employed or to be employedby the enterprise or having regard to any other relevant base;

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b. the net profit margin realised by the enterprise or by an unrelated enterprise froma comparable uncontrolled transaction or a number of such transactions is computedhaving regard to the same base; -

c. the net profit margin referred to in (b) (supra) arising in comparable uncontrolledtransactions is adjusted to take into account the differences, if any, between theinternational transaction and the comparable uncontrolled transactions, or betweenthe enterprises entering into such transactions, which could materially affect the amountof net profit margin in the open market;

d. the net profit margin realised by the enterprise and referred to in (a) (supra) isestablished to be the same as the net profit margin referred to in (c) (supra)

e. the net profit margin thus established is then taken into account to arrive at anarm's length price in relation to the international transaction.

The TNMM requires establishing comparability at a broad functional level. It requirescomparison between net margins derived from the operation of the uncontrolledparties and net margin derived by an associated enterprise similar operation.

• Under this method, the net profit margin realized by an associated enterprise froman international transaction is computed in relation to a particular factor such ascosts incurred sales assets utilized etc The net profit margin realized by an associatedenterprise is compared with net profit margin of the uncontrolled transactions toarrive at the ALP. The TNMM is similar to RPM and CPM to the extent that itinvolves comparison of margin earned in a controlled situation with margins earnedfrom comparable uncontrolled situation. The only difference is that in the RPM andCPM methods, comparison is of margins of gross profits whereas in TNMM thecomparison is of margins of net profit.

• The TNMM requires comparison of net profit margins realized by an enterprisefrom an international transaction (or an aggregate of international transactions) andnot comparisons of operating margins of enterprises.

• One cannot determine arms length price under TNMM by relying upon multipleyear's data, where current year's data of comparable companies are available in publicdomain.

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• There is no warrant for substituting "net operating profit with "cash profits mdetermining ALP under TNMM and thereby excluding depreciation from totaloperating cost. If, however, items of non-operating incomes are excluded fromcomputation of operating profit under TNMM, then items of non- operating expensesshould also be excluded while determining ALP.

6.7 SUMMARY

The provisions under sections 92 to 92F have been enacted with a view toprovide a statutory framework which can lead to computation of reasonable, fair andequitable profit and tax in India so that the profits chargeable to tax in India do notget diverted, elsewhere by altering the prices charged and paid intra-group transactionsleading to erosion of Indian tax revenue Any income arising from an internationaltransaction shall be computed having regard to arm's length price.

6.8 GLOSSARY

CUP- Comparable Uncontrolled Price Method

CPM- Cost Plus Method

PSM- Profit Split Method

TNMM- Transactional Net Margin Method


1. What are deemed associated enterprises?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

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2. Explain Transactional Net Margin Method.

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

6.10 LESSON END EXERCISES.

1. Discuss deemed international transactions.

2. Explain the conditions for applicability of arm's length price (alp) ininternational transactions.

3. Describe the various methods of computation of arm's length price.


1. Direct Taxes Law & Practice- By Dr. Vinod K. Singhania & Dr. Kapil Singhania

2. Simplified Approach to Corporate Tax Planning & Management- By Dr.Girish Ahuja & Dr. Ravi Gupta

--------

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COMPARABILITY OF TRANSACTION, MOSTAPPROPRIATE METHOD, DETERMINATION OF ALP BY

ASSESSING OFFICER IN CERTAIN CASES

Structure

7.1 Introduction

7.2 Objectives

7.3 Comparability of transaction

7.4 Most Appropriate Method

7.5 Determination of ALP by Assessing Officer in certain cases

7.6 Summary

7.7 Glossary




7.1 INTRODUCTION

The comparability of one transaction with another shall be judged withreference to the following, namely-.

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a. the specific characteristics of the property or services transferred in either transaction;

b. the functions performed, taking into account assets employed or to be employedand the risks assumed, by the respective parties to the transactions;

c. the contractual terms (whether or not such terms are formal or in writing) of thetransactions which lay down explicitly or implicitly how the responsibilities risks andbenefits are to be divided the respective parties to the transactions; '

d. conditions prevailing in the markets in which the respective parties to the transactionsoperate, including the geographical location and size of the markets costs of labourand capital m the markets, overall economic development and level of competitionand whether the markets are wholesale or retail.

WHEN TWO TRANSACTIONS ARE DEEMED TO BE COMPARABLE- Anuncontrolled transaction shall be comparable to an international transactions if-

a. none of the differences (if any) between the transactions being compared or betweenthe enterprises entering into such transaction, are likely to materially affect the priceor cost charged or paid in, or the profit arising from, such transactions in the openmarket; or

b reasonably accurate adjustments can be made to eliminate the material effects ofsuch differences

• The data to be used in analysing the comparability of an uncontrolled transactionwith an international transaction shall be the data relating to the financial year inwhich the international transaction has been entered into. However the data relatingto a period (not being more than two years prior to such financial year) may also beconsidered if such data reveals facts which could have an influence on the determinationof transfer prices in relation to the transactions being compared

• Decisive factors for determining inclusion or exclusion of any case in/from list ofcomparables are specific characteristics of services provided, assets employed, risksassumed, contractual terms and conditions prevailing including geographical locationand size of markets costs of labour and capital in markets etc Nowhere higher orlower profit rate has been prescribed as determinative factor to make a case

( 139 )

incomparable, because profit is not a factor in itself, but consequence of effect ofvarious factors; only if higher or lower profit rate results on account of effect offactors given in rule 1OB(2), read with sub-rule (3), that such case shall merit omission.However, if extreme profit rate is achieved because of factors other than those givenin rule, then such case would continue to find its place in list of comparables

• Merely because a comparable is making loss, it cannot be excluded from the list ofcomparables for the purpose of computation of arm's length price. However, in acase where the functional area of a comparable is different, it has a negative networth and its turnover is very low as-compared to the assessee-company, such acomparable has to be excluded from the list of comparables while determining arm'slength price.

For instance, if turnover of the assessee is Rs. 32 crore, it cannot be compared withthe case of a company in the similar business but having turnover of only Rs. 92 lakh.Likewise, territory of business is a material factor in deciding comparability of casesand where the assessee has rendered services in USA whereas the comparable companyrendered services in India, this fact is sufficient to exclude such a comparable intransfer pricing.

7.2 OBJECTIVES :


• Comparability of transactions

• Most appropriate method for calculating arm's length price

• Determination of ALP by assessing officer

7.3 COMPARABILITY OF TRANSACTION- The comparability of onetransaction with another shall be judged with reference to the following, namely-.

a. the specific characteristics of the property Or services transferred in eithertransaction;


( 140 )



WHEN TWO TRANSACTIONS ARE DEEMED TO BE COMPARABLE- Anuncontrolled transaction shall be comparable to an international transactions if-

a. none of the differences (if any) between the transactions being compared or betweenthe enterprises entering into such transaction, are likely to materially affect the priceor cost charged or paid in, or the profit arising from, such transactions in the openmarket; or

b reasonably accurate adjustments can be made to eliminate the material effects ofsuch differences

• The data to be used in analysing the comparability of an uncontrolled transactionwith an international transaction shall be the data relating to the financial year inwhich the international transaction has been entered into. However the data relatingto a period (not being more than two years prior to such financial year) may also beconsidered if such data reveals facts which could have an influence on the determinationof transfer prices in relation to the transactions being compared

• Decisive factors for determining inclusion or exclusion of any case in/from list ofcomparables are specific characteristics of services provided, assets employed, risksassumed, contractual terms and conditions prevailing including geographical locationand size of markets costs of labour and capital in markets etc Nowhere higher orlower profit rate has been prescribed as determinative factor to make a caseincomparable, because profit is not a factor in itself, but consequence of effect ofvarious factors; only if higher or lower profit rate results on account of effect offactors given in rule 1OB(2), read with sub-rule (3), that such case shall merit omission.However, if extreme profit rate is achieved because of factors other than those given

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in rule, then such case would continue to find its place in list of comparables

• Merely because a comparable is making loss, it cannot be excluded from the list ofcomparables for the purpose of computation of arm's length price. However, in a casewhere the functional area of a comparable is different, it has a negative net worth andits turnover is very low as-compared to the assessee-company, such a comparable hasto be excluded from the list of comparables while determining arm's length price.

For instance, if turnover of the assessee is Rs. 32 crore, it cannot be compared withthe case of a company in the similar business but having turnover of only Rs. 92 lakh.Likewise, territory of business is a material factor in deciding comparability of casesand where the assessee has rendered services in USA whereas the comparable companyrendered services in India, this fact is sufficient to exclude such a comparable intransfer pricing.

7.4 MOST APPROPRIATE METHOD- According to section 92C (1), the arm'slength price shall be - determined having regard to the most appropriate method. Themost appropriate method shall be the method which is best suited to the facts andcircumstances of each particular transaction, and which provides the most reliablemeasure of an arm's length price in relation to an international transaction.

The most appropriate method shall be selected having regard to the following, namely:-

i. the nature and class of the international transaction;

ii. the class or classes of associated enterprises entering into the transaction and thefunctions performed by them- taking into consideration assets employed or riskassumed;

iii. the availability, coverage and reliability of data necessary for application of themethod;

iv. the degree of comparability existing between the international transaction and theuncontrolled transaction and between the enterprises entering into such transactions:-

v. the extent to which reliable and accurate adjustments can be made to account fordifferences, if any, between the transactions being compared and the enterprisesentering into such transactions;

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vi. the nature, extent and reliability of assumptions required to be made in applicationof a method.

• In a case where the factors referred to above indicate more than one method as themost appropriate method, the method providing a result consistent with the resultobtainable by application of a method other than such methods may be taken as themost appropriate method. However, in a given situation, and to the extent possible,the comparable uncontrolled price method, or the resale price method or the costplus method shall be considered to be more appropriate than the profit split methodor the transactional net margin method. -

If the assessee wants to adopt a particular method to demonstrate that the internationaltransaction in question is at arm's length, then it is its duty to maintain and furnishadequate required data. When the burden of proving that a particular method is themost appropriate method is initially on the assessee, it is for the assessee to demonstratethe same by furnishing adequate records and data, irrespective of the fact whetherthey are statutorily required or not.

• There is no particular order or priority of methods which the assessee must follow.No method can invariably be considered to be more reliable than others. However,transactional profit methods (i.e. Transactional Net Margin Method and Profit SplitMethod) are treated as methods of last resort which are pressed into service onlywhen the other methods cannot be- reasonably applied. The OECD Guidelines alsorecognize this approach.

ARITHMETIC MEAN - Where more than one price is determined by the mostappropriate method, the arm's length price shall be taken to be the arithmetical meanof such prices.

'TOLERANCE TAG OR TOLERANCE RANGE - If the variation between thearm's length price so determined and price at which the international transaction orspecified domestic transaction has actually been undertaken does not exceed suchnotified percentage (which, from the assessment year 2013-14, cannot be more than3 per cent) of the latter, the price at which the international transaction or specifieddomestic transaction has actually been undertaken shall be deemed to be the arm'slength price.

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AMENDMENT MADE BY THE FINANCE (NO.2) ACT, 2014 - The aboveprovisions have been amended with effect from the assessment year 2015-16. Theamended version provides that where more than one price is determined by the mostappropriate method, ALP in relation to above transaction undertaken on or afterApril l, 2014, shall be computed in such manner as may be prescribed.

Illustration 1X Ltd., on Indian company, is a subsidiary company of Y Inc., a company registeredin the Netherlands. It purchased raw materials from Y Inc. Purchase prices of rawmaterial determined by the most appropriate method ore Rs. 9,950 and Rs. 10,000per unit. X Ltd., however, paid to Y Inc. Rs. 10,400 (Situation 1), Rs. 10,500 (Situation2), Rs. 10,600 (Situation 3), Rs. 9,400 (Situation 4), Rs. 9,500 (Situation 5) ond Rs.9,600 (Situation 6). Determine the arm's length price in the six situations. Assumethat the assessment year is 2012-13 and tolerance range notified by the Governmentis 5 per cent.

SOLUTIONSituation

1Rs.

Situation2Rs.

Situation3Rs.

Situation4Rs.

Situation5Rs.

Situation6Rs.

Arithmetic mean of price determined underthe most appropriate methods [(Rs .10,000+Rs. 9,950) ÷ 2] (a)

Price of which raw material is purchasedfrom associate enterprise under internationaltransaction (b)

Difference between arithmetic mean andtransaction price [(a) - (b) or (a)] (c)

5% of transaction price [i.e., 5% of (b) ] (d)Whether difference exceeds 5% oftransaction price [or (c) is more than (d)] (e)

Arm’s length price [if difference is more than5% of transaction price, then arithmeticmean is taken arm’s length price; otherwiseno adjustment would be required]

Under section 92 (3), by adopting arm’slength price taxable income cannot bereduced (whether adopting arm’s length pricewill reduce taxable income)

Purchase price of raw material to be takeninto consideration for calculating taxableincome of X Ltd. after applying provisions ofsection 92

9,975

10,400

425

520

No

10,400

NA

10,400

9,975

10,500

525

525

No

10,500

NA

10,500

9,975

10,600

625

530

Yes

9,975

No

9,975

9,975

9,400

575

470

Yes

9,975

Yes

9,4-00

9,975

9,500

475

475

No

9,500

NA

9,500

9,975

9,600

375

480

No

9,600

NA

9,600

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Computation of arm's length price

Illustration II. A Inc. is an American company situated in New Jersey. It has threesubsidiary companies - X Ltd. (an Indian company), Y Ltd. (a South African company)and Z Ltd. (a Nigerian company). X Ltd. has a manufacturing plant in Andhra Pradesh.Raw material is imported from Y Ltd. And Z Ltd. Approximately 90 percent of themanufactured goods are exported to A Inc. Remaining goods are sold in domesticmarket. The profit and loss account of X Ltd. for the year ending March 31, 2013 isgiven below-

Import of raw material from Y Ltd. 100Import of raw material from Z Ltd. 180Other expenses 90Net Profit 70

340

(Rupees in crore)Export to A Inc. 280Domestic sale 60

340

Net profit is Rs. 70 crore over total cost of Rs. 340 crore (which comes to 20.59 percent margin over cost). Since the assessment year 20 11-12, the assessment of X Ltd.is completed by adopting the Transaction Net Margin Method (TNMM). Discuss theapplicability of arm's length range (5 per cent variation) in this case.

SOLUTION

Calculation of profit margin after applying 5% variation

Import form YLtd.Import from ZLtd.Other expensesNet profit

100809070

340

65

——

95769093

354

Export to A Inc.Domestic sale

Amountbefore 5%variation

5%variation

Amountafter5%variation

Amountbefore 5%variation

5%variation

Amount after5% variation

28060

340

14—

29460

354

(Rupees in crore)

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Net profit after 5% adjustment will be Rs. 93 crore over total cost of Rs. 354 crore(which comes to 26.27% margin over cost). If profit margin according to TNMMmethod is equal to or less than 26.27%, the aforesaid transaction would be consideredto be at arm's length and no adjustment would be required. Conversely, however, ifprofit margin according to TNMM is more than 26.27%, the aforesaid transactionwill not be considered to be at arm's length and necessary adjustment would berequired.

7.5 DETERMINATION OF ALP BY ASSESSING OFFICER IN CERTAINCASES [SEC. 92C (3)] - The Assessing Officer may determine the arm's lengthprice, if the following conditions are satisfied:

1. There is a proceeding for assessment of income.

2. The Assessing Officer has material or information or document in his possession.

3. On the basis of such material or information or document, the Assessing Officer isof the 'opinion' that the-

a. arm's length price charged or paid in an international transaction has not beendetermined in accordance with sub-section (1) or (2) of section 92C; or

b. assessee has not kept the prescribed information and document relating to aninternational transaction; or

c. information or data used for consulting the arm's length price is not reliable orcorrect; or

d. assessee has failed to furnish, within the time specified any information or documentwhich was required to be furnished by the Assessing Officer.

On satisfaction of the aforesaid conditions, the Assessing Officer may proceed todetermine the arm's length price.

WHEN ACTION SHOULD BE TAKEN BY THE ASSESSING OFFICER - Itshould be made clear to the concerned Assessing Officers that where an internationaltransaction has been put to a scrutiny, the Assessing Officer can have recourse tosub-section (3) of section 92C only under the circumstances enumerated in clauses

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(a) to, (d) of that sub-section and in the event of material information or document inhis possession on the basis of which an opinion can be formed that any suchcircumstance exists. In all other cases, the value of the international transaction shouldbe accepted without further scrutiny-Circular No. 12/2001, dated August 23, 2001.

MATERIAL OR INFORMATION OR DOCUMENT IN POSSESSION - Theinformation must be something more than mere rumour or gossip or hunch. Theopinion must be based on the material which is available and it should not be formedon the basis of extraneous or irrelevant material. The formation of opinion shall haverational connection and bearing to the reasons for such opinion. The formation ofopinion should be based on active application of mind and be bona fide and not beaccentuated by mala fide, bias or based on extraneous or irrelevant material. Thebelief must be bona fide and cogently supported-Prabhubhai Vastabhai Patel v. R.P.Meena [1997] 226 ITR 781 (Guj.). The words 'information in his possession' shouldbe construed as some valid, definite information m possession and not any imaginaryor invalid information The information should be credible and if there is some suchinformation the court cannot go into the sufficiency of the information-Kusum Latav. CIT 180 ITR 365 (Raj.).

The expression 'material or information or document' should be construed as somevalid and definite material information or document and not any imaginary or invalidmaterial information or document. The material information or document should notbe vague and far fetched.

OPPORTUNITY OF BEING HEARD - According to proviso to section 92C(3) anopportunity shall be given by the Assessing Officer by serving a notice calling uponthe assessee to show cause, why the arm's length price should not be so determinedon the basis of material or information or document in the possession of the AssessingOfficer.

In other words, an assessee should be given an opportunity of being heard and a rightto question the correctness or the relevancy of the materials on the basis of which theAssessing Officer proposes to make the best judgment assessment

SERVICE OF NOTICE - The issue and service of a notice is not a mere procedural

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formality. The assessment would be invalidated on account of failure to provide areasonable opportunity to the assessee of being heard.

DISCLOSURE TO ASSESSEE - The Assessing Officer has to provide an opportunityto the assessee to show cause as to, why the arm's length price should not be determinedon the basis of material or information or documents m the Assessing Officer spossession It is only when the information or document on the basis of which showcause notice is issued is made available to the assessee that the assessee will be ableto rightfully represent himself and be able to show cause as to why the arm s lengthprice should not be so determined as proposed by the Assessing Officer.

COMPUTATION BY ASSESSING OFFICER NOT MANDATORY - Section92C(3) provides that if the Assessing Officer is, on the basis of material or informationor document in his possession, of the opinion that the price charged or paid in aninternational transaction has not been determined in accordance with provisions ofsection, he may proceed to determine the arm's length price.

As the word 'may' has been used, it can be said that there is no stringent rule that inevery case where the price charged/paid is not in accordance with section 92C(1)and (2), the arm's length price must be determined under section 92C(3) by theAssessing Officer.

BURDEN OF PROOF - A dispassionate study of provisions of various countries onburden of proof, would show the following fundamental features:

1. That the burden to establish that international transaction is carried at ALP, is onthe taxpayer who is to disclose all the relevant information and documents relating toprices charged and profit earned with related and unrelated customer.

2. If the Assessing Officer has determined an ALP, other than the price declared bythe assessee, the Assessing Officer has to prove that the price determined by him isreliable and reasonable and confirms the statutory requirement unless the case iscovered by situation No. (3) below.

3. In case of failure on the part of the taxpayer to comply with the statutory provisions,the tax authorities would have to determine the ALP. Tn such a situation, burden ofproof on tax authorities is much reduced.

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Determination of total income after computing arm's length price [ 92C(4)]-The Assessing Officer may compute the total income of the assessee having regard toarm s length price determined under section 92C(3).

The Assessing Officer is empowered to recompute the total income of the assesseehaving regard to the arm s length price If the total income is enhanced no deductionunder sections 10A, 10AA, 10B, or under Chapter VIA shall be allowed in respect ofthe increased quantum of income.

• Speaking order - The Assessing Officer is required to provide the assessee with acopy of reasons supporting the inference drawn while computing the arm's lengthprice for the transaction.

Income chargeable under the Act should not decrease on applying arm's lengthprice [Sec.92(3) and second proviso to sec. 92C(4)]- The following two provisionsshould be noted-

1. The provisions of transfer pricing shall not be applicable in a case where theapplication of arm's length price results in a downward revision in the incomechargeable to tax m India computed on the basis of entries made in the books ofaccount of the previous year in which the international transaction was entered.

2. According to the second proviso to section 92C(4), total income of the recipientassociated enterprise will not be recomputed if (a) total income of payer (associatedenterprise) is recomputed by the Assessing Officer on determination of arm s lengthprice [ upon determination of arm s length price (which is less than contracted priceof the international transaction) the Assessing Officer (of payer associate enterprise)increases the taxable income and reduces the allowable expenditure], and (b) tax hasbeen deducted or deductible at source by the payer enterprise.

In other words this proviso provides that while on determination of arm s lengthprice (if arm s length price is less than the contracted price) the income of the payerenterprise will increase on account of decrease m the amount of allowable expenditurebut the income of the recipient enterprise cannot be accordingly reduced by suchamount of contracted price winch is in excess of the amount of arm s length price

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Illustration I X Ltd., a company incorporated in US, sells laser printer cartridge to its100 per cent Indian subsidiary A Ltd. @ $50 per cartridge. X Ltd. also sells its laserprinter cartridge to another company Y Ltd. in India @ $80 per piece. Total incomeof A Ltd. for the assessment year 2015-16 is Rs. 12,00,000 after making payment for100 cartridges @ $50 (1 $=Rs. 49). A Ltd. has deducted tax at source while makingpayments to X Ltd. In this case, sale to unrelated party Y Ltd. is @ $80. Compute thearm's length price and taxable income of X Ltd. and A Ltd. The rate of one dollar maybe assumed to be equivalent to Rs. 49 in all transactions for the sake of simplicity.

SOLUTION : Arm's length price - Arm's length price of laser printer cartridge, whichis sold to A Ltd. will be $80 per cartridge by comparable uncontrolled price method

Income of A Ltd It will be computed as under-

Income as per books of account 12,00,000Add : Amount charged by X Ltd. [$50 × 100 × Rs. 49] (+) 2,45,000Less : Arm’s length price [$80 × 100 x 49] (-) 3,92,000Income (after applying arm’s length price) 10,53,000

By virtue of section 92(3), one cannot reduce taxable income by applying arm'slength price. Therefore, income of A Ltd. will be Rs. 12,00,000.

Income of X Ltd.- If the transactions are actually on a principal-to-principal basisand are at arm's length and the subsidiary company functions and carries on businesson its own, instead of functioning as an agent of the parent company, the mere factthat the Indian company is a subsidiary of the non-resident company will not beconsidered a valid ground for invoking section 9 for assessing the non-resident.

If the aforesaid conditions are satisfied, then X Ltd. is not chargeable to tax in India.

Conversely, if the aforesaid conditions are not satisfied, X Ltd. will be chargeable totax in India in respect of income which arises on sale of goods to A Ltd. However, theadoptation of arm's length price by the Assessing Officer will not affect the computationof taxable income of X Ltd. [ as per second provis to section 92C(4) when tax isdeducted/ deductible, the income of recipient enterprise will not be recomputed ifarm's length price is adopted in the case of payer-enterprise].

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Illustration II A Ltd., an Indian company, sells computer monitor to its 100 per centsubsidiary X Ltd. in United States @ $50 per piece. A Ltd. also sells its computermonitor to another company Y Ltd. in United States @ $80 per piece. Total incomeof A Ltd: for the assessmentyear20 15-16 is Rs: 12,00,000 which includes sales madefor 100 computer monitor @ $50 to X Ltd. Compute the arm's length price andtaxable income of A Ltd. The rate of one dollar may be assumed to be equivalent toRs. 49 for the sake of simplicity.

As no income is deemed to accrue or arise in India, nothing is taxable in the hands ofX Ltd.

Use of foreign trade mark/logo on domestic products - If a domestic entity (whichis an associate enterprise of a foreign entity within meaning of section 92A) uses theforeign entity's trademark and/or logo on its products (or on containers, packaging,etc.), manufactured and/or sold in India, no payment by the foreign entity on accountof such user is necessary in case the use of foreign trademark and/or logo isdiscretionary for the domestic entity. If, however, such domestic entity is mandatorilyrequired to use the foreign trademark and/or logo on its products (and/or containers,packaging, etc.), appropriate payment in this regard should be made by the foreignentity to domestic entity, on account of benefit it derives in form of marketingintangibles obtained by it from such mandatory use of its trademark and/or logo indomestic market.

Judicial rulings - One should keep in view the following rulings -

1. Where the assessee receives an amount towards reimbursement of expenditureincurred by it on behalf of its associated enterprises, it will be excluded for the purposeof computing adjustment under section 92C only if it is actually reimbursement-

Rs.Arm’s length price ($80 × 100 × Rs. 49) 3,92,000Income of A Ltd.Income as per books of account 12,00,000Less : Sale consideration 100 monitor sold to X Ltd. (recorded price) (-) 2,45,000Add : Sale consideration of arm’s length price (+) 3,92,000Taxable income 13,47,000Income of X Ltd.

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Mylan Laboratories Ltd. v. CIT [ 4] 46 taxmann.com 76 (Hyd.).

2. A company cannot be compared to a company which has 50 times high turnover ascompared to the assessee company and which also has big brand value-HyundaiMotors India Engineering (P) Ltd v CIT[2014] 49 taxmann.com 290 (Hyd) Likewisea company with turnover of Rs 13 000 crore cannot be comparable to the companywith turnover of Rs. 32crore-Cordys R&D (India) (P.) Ltd. v. CIT [2014] 149 ITD587 (Hyd.).

3. Supernormal profit companies must be excluded for determination of ALP-AvineonIndia (P.) Ltd. v. CIT [2014] 150 ITD 543 (Hyd.).

4. In course of determining ALP, preference should be given to internal uncontrolledcomparables over external uncontrolled comparables. However, if nature of transactionwith associated enterprise (AE) is different from that with non-AE or data in respectof two segments is either not workable or not reliable, then assistance from suchinternally comparable uncontrolled transactions should be avoided-LummusTechnology Heat Transfer B. V. v. DIT [2014] 146 ITD 775 (Delhi).

5. Extraordinary events like merger and demerger have an effect on profitability of acompany in the financial year in which such event takes place. A company which isundergoing such events cannot be considered as comparable-Hyundai Motors IndiaEngineering (P.) Ltd. v. ITO [2015] ITD 112 (Hyd.).

7.6 SUMMARY

The comparability of one transaction with another shall be judged with reference tothe following, namely-.

a. the specific characteristics of the property or services transferred in eithertransaction;



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7.7 GLOSSARY

OECD- Organisation For Economic Co-operation and Development

Most Appropriate Method- According to section 92C (1), the arm's length priceshall be - determined having regard to the most appropriate method. The mostappropriate method shall be the method which is best suited to the facts andcircumstances of each particular transaction, and which provides the most reliablemeasure of an arm's length price in relation to an international transaction.

Tolerance Tag or Tolerance Range- If the variation between the arm's length priceso determined and price at which the international transaction or specified domestictransaction has actually been undertaken does not exceed such notified percentage(which, from the assessment year 2013-14, cannot be more than 3 per cent) of thelatter, the price at which the international transaction or specified domestic transactionhas actually been undertaken shall be deemed to be the arm's length price.


1. What is comparability of transactions?

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2. Under what conditions determination of ALP is done by assessing officer?

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1. Describe the most appropriate method.

2. Explain the manner in which ALP is determined by the assessing officer.


1. Simplified Approach to Corporate Tax Planning & Management- By Dr. GirishAbuja & Dr. Ravi Gupta

2. Corporate Tax Planning & Management- Dr. H.C. Mehrotra & Dr. S.P. Goyal


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REFERENCE TO TRANSFER PRICING OFFICER,MAINTENANCE OF BOOKS OF ACCOUNT-REPORT FROMACCOUNTANT, SPECIFIED DOMESTIC TRANSACTIONS,

ADVANCE PRICING AGREEMENTS, SECONDARYADJUSTMENT IN CERTAIN INTERNATIONAL

TRANSACTIONS

Structure

8.1 Introduction

8.2 Objectives

8.3 Reference to Transfer Pricing Officer

8.4 Maintenance of books of account

8.4.1 Report from Accountant

8.5 Specified domestic transactions

8.6 Advance pricing agreements

8.7 Secondary adjustment in certain international transactions

8.8 Summary

8.9 Glossary

8.10 Self assessment questions

8.11 Lesson end exercises questions


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8.1 INTRODUCTION

The Assessing Officer may refer the computation of arm's length price undersection 92C to the Transfer Pricing Officer (TPO) if he considers it necessary andexpedient and an approval of the Commissioner has been obtained. "Transfer PricingOfficer" means a Joint Commissioner or Deputy Commissioner or AssistantCommissioner authorised by the Board to perform all or any of the functions of anAssessing Officer specified in sections 92C and 92D in respect of any person or classof persons.

8.2 OBJECTIVES :


• Conditions under which the matter is referred to Transfer Pricing Officer

• Maintenance of books of accounts in case of ALP

• Specified domestic transactions

• Advance pricing agreements

• Secondary adjustments in certain international transactions

8.3 REFERENCE TO TRANSFER PRICING OFFICER [SEC. 92CA]

The Assessing Officer may refer the computation of arm's length price undersection 92C to the Transfer Pricing Officer (TPO) if he considers it necessary andexpedient and an approval of the Commissioner has been obtained. "Transfer PricingOfficer" means a Joint Commissioner or Deputy Commissioner or AssistantCommissioner authorised by the Board to perform all or any of the functions of anAssessing Officer specified m sections 92C and 92D in respect of any person or classof persons

Necessary or expedient- Meaning - According to the Shorter Oxford EnglishDictionary the word "necessary" means indispensable, requisite, needful. Similarly,the word "expedient" means advantageous; fit, proper, or suitable to the circumstancesof the case; those which help forward or conduces to an end a means to an endTherefore where Assessing Officer thinks it indispensable and advantageous to help

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forward in the case then he may refer the computation of the arm's length price to theTransfer Pricing Officer. It should be noted that here in section 92CA the words"necessary or expedient" has not been qualified with a requirement unlike section143(2) where it has been qualified. Section 143(2) provides that where AssessingOfficer considers it necessary or expedient to ensure that the assessee has notunderstated the income or has not computed excessive loss In section 143(2), thewords "necessary Or expedient" has been qualified with a responsibility of ensuringthat assessee has not understated his income. However, in section 92CA there is nosuch overriding requirements and hence it has a broader scope.

It cannot be held that avoidance of tax is a condition precedent for invoking theprovisions of section 92C/92CA .There is no requirement of establishment of taxevasion before initiations of proceedings for determination of ALP.

Opportunity of hearing to assessee- Transfer Pricing Officer shall serve a notice tothe assessee requiring him to produce (or cause to be produced) on a specified dateany evidence which the assessee may rely in support of the computation made by himof the arm s length price in relation to the international transaction However theAssessing Officer referring the case to the Transfer Pricing Officer is not required toprovide any reasons or basis for referring the case to the assessee,

Passing of the order- After hearing the assessee the evidence produced by him andafter considering the evidence as the Transfer Pricing Officer may require on anyspecified points and after taking into account all relevant materials which he hasgathered the Transfer Pricing Officer shall by order in writing determine the arm'slength price in relation to the international transaction in accordance with provisionsof section 92C(3) and send a copy of his order to the Assessing Officer and to theassessee

• Can the Transfer Pricing Officer determine arms length price in other cases whichare not referred by the Assessing Officer- In the case of 3i Infotech Ltd. v CIT AppealNo 2831 of 2007 July 30 2010], the Tribunal held that the Transfer Pricing Officer(TPO) cannot under section 92CA(3) determine the arm's length price (ALP) inrelation to an international transaction not referred to him by the Assessing Officer

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under section 92CA(1). A similar ruling is given by the Delhi Tribunal in the case ofAmadeus India (P.) Ltd. v. CIT [2011] 10 taxmann.com 88.

To supersede the aforesaid rulings sub-section (2A) has been inserted in section 92CAby the Finance Act, 2011 with effect from June 1, 2011 to specifically provide thatthe jurisdiction Of the TPO shall extend to the determination of the ALP in respect ofother international transactions, which are noticed by him, subsequently, in the courseof proceedings before him. These international transactions would be in addition tothe international transactions referred to the TPO by the Assessing Officer.

• Can the Transfer Pricing Officer determine arm's length price in a case where reportis not submitted by the assessee under section 92E - Under section 92E, there isreporting requirement on the taxpayer and the taxpayer is under an obligation to filean audit report in Form No. 3CEB before the Assessing Officer containing details ofall international transactions undertaken by the taxpayer during the year.

This audit report is the primary document with the Assessing Officer, which containsthe details of international transactions undertaken by the taxpayer. If the assesseedoes not report such a transaction in Form No. 3CEB, then the Assessing Officerwould normally not be aware of such an international transaction so as to make areference to the Transfer Pricing Officer (TPO). TPO may notice such a transactionsubsequently during the course of proceeding before him. In absence of specific power,the determination of arm's length price by the TPO would be open to challenge, eventhough the basis of such an action is non-reporting of transaction by the taxpayer atthe first instance.

Keeping in view the aforesaid situation, section 92CA has been amended by theFinance Act, 2012 (with retrospective effect from June 1, 2002) to empower TPO todetermine arm's length price of an international transaction noticed by him in thecourse of proceedings before him, even if the said transaction was not referred to himby the Assessing Officer, provided that such international transaction was not reportedby the taxpayer as per the requirement cast upon him under section 92E. However,this retrospective amendment will not empower the Assessing Officer either to assessor reassess under section 147 or pass an order enhancing the assessment or reducing

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a refund already made or otherwise increasing the liability of the assessee undersection 154, for any assessment year, proceedings for which have been completedbefore July 1, 2012.

• Can the Transfer Pricing Officer conduct survey - Section 92CA(7) provides thatfor the purpose of determining the ALP, the TPO can exercise powers available to anAssessing Officer under section 131(1)/(6). These are the powers of summoning orcalling for details for the purpose of inquiry, or investigation into the matter. In orderto enable the TPO to conduct on-the-spot enquiry and verification, section 92CA(7)has been amended with effect from June 1, 2011 by the Finance Act, 2011 SO as toenable the TPO to also exercise the power of survey conferred upon an income-taxauthority under section 133A.

• What time limit for passing order- From June 1,2007, an order under section 92CA(3)by a Transfer Pricing Officer for determination of arm's length price of internationaltransactions shall be made at least 2 months before the period of limitation referredto in section 153 or 153B, for making the order of assessment or reassessment orrecomputation, or fresh assessment expires. This provision shall also be applicable incases where a reference was made to the Transfer Pricing Officer before June 1, 2007for determining arm's length price of an international transaction but an order has notbeen passed by him before the said date.

• Should TPO rely on orders of TPO of preceding years -TPO should apply his mindafresh every year and should not rely on orders of TPO for preceding years whilecomputing arm's length price.

• Can TPO examine validity of reference - TPO cannot judge validity of a reference.Nor can he deliberate on a question as to whether there has been any internationaltransaction during period under consideration.

• Whether reference to TPO is valid if case is not taken up in scrutiny and referenceto TPO is made after expiry of time-limit for issuing section 143(2) notice- Scrutinynotice under section 143(2) is not issued. After the expiry of time-limit (i.e., afterSeptember 30), if reference is made to TPO, it is not valid.

Computation of income by Assessing Officer - On receipt of the order, the Assessing

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Officer shall proceed to compute the total income of the assessee under section 92C(3)having regard to the arm's length price determined by the Transfer Pricing Officer.The use of the words 'having regard to' denotes that it is not incumbent upon theAssessing Officer to compute the arm's length price as per the computation made bythe Transfer Pricing Officer for each and every international transactions.

From June 1, 2007, the above provision has been amended so as to provide that, onreceipt of the order of the Transfer Pricing Officer, the Assessing Officer shall proceedto compute the total income of the assessee in conformity with the arm's length pricedetermined by the Transfer Pricing Officer.

Mistakes apparent from records - Transfer Pricing Officer may amend any orderpassed by him with a view to rectify any mistake apparent from the record andprovisions of section 154 shall apply accordingly. Thereafter Transfer Pricing Officershall send the copy of such order to the Assessing Officer and on the basis of suchorder the Assessing Officer shall amend his order accordingly

Action can be taken with a view to rectifying any mistake apparent from the record.It does not enable an order to be reversed by revision or by review, but permits onlysome error which is apparent on the face of the record to be corrected. Where anerror is far from self-evident, it ceases to be an apparent error.

Powers under section 131 or 133 - The Transfer Pricing Officer may for the purposeof determining the arm's length price under section 92CA exercise all or any of thepowers specified in clauses (a) to (d) of section 131(1) or section 133(6).

8.4 MAINTENANCE OF BOOKS OF ACCOUNT [SEC. 92D]

Every person who has entered into an international transaction shall keep and maintainthe following information and documents, namely-

a. a description of the ownership structure of the assessee enterprise with details ofshares or other ownership interest held by other enterprises;

b. a profile of the multinational group of which the assessee enterprise is a part alongwith the name, address, legal status and country of tax residence of each of theenterprises comprised in the group with whom international transactions have been

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entered into by the assessee, and ownership linkages among them;

c. a broad description of the business of the assessee and the industry in which theassessee operates, and of the business of the associated enterprises with whom theassessee has transacted;

d. the nature and terms (including prices) of international transactions entered intowith each associated enterprise, details of property transferred or services providedand the quantum and the value of each such transaction or class of such transaction;

e. a description of the functions performed, risks assumed and assets employed or tobe employed by the assessee and by the associated enterprises involved in theinternational transaction;

f. a record of the economic and market analyses, forecasts, budgets or any otherfinancial estimates prepared by the assessee for the business as a whole and for eachdivision or product separately, which may have a bearing on the internationaltransactions entered into by the assessee;

g. a record of uncontrolled transactions taken into account for analysing theircomparability with the international transactions entered into, including a record ofthe nature, terms and conditions relating to any uncontrolled transaction with thirdparties which may be of relevance to the pricing of the international transactions;

h a record of the analysis performed to evaluate comparability of uncontrolledtransactions with- the relevant international transaction; -

i. a description of the methods considered for determining the arm's length price inrelation to each international transaction or class of transaction, the method selectedas the most appropriate method along with explanations as to why such method wasso selected, and how such method was applied in each case;

j. a record of the actual working carried out for determining the arm's length price,including details-of the comparable data and financial information used in applyingthe most appropriate method, and adjustments, if any, which were made to accountfor differences between the international transaction and the comparable uncontrolledtransactions, or between the enterprises entering into such transactions;

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k the assumptions, policies and price negotiations, if any, which have critically affectedthe determination of the arm's length price;

l. details of the adjustments, if any, made to transfer prices to align them with arm'slength prices determined under these rules and consequent adjustment made to thetotal income for tax purposes;

m. any other information, data or document, including information or data relating tothe associated enterprise, which may be relevant for determination of the arm's lengthprice.

The information specified above should be available by the due date of submission ofreturn of income. In a case where the aggregate value of international transactionsentered into by the assessee does not exceed Rs. 1 crore, the information anddocuments specified above may not be maintained.

However, such assessee shall be required to substantiate, on the basis of materialavailable with him, that income arising from international transactions entered intoby him has been computed in accordance with section 92.

Support by authentic documentation - The information specified above shall besupported by authentic documentation, which may include the following

a. official publications, reports, studies and data bases from the Government of thecountry of residence of the associated enterprise or of any other country;

b. reports of market research studies carried out by recognized institutions;

c. price publications including stock exchange and commodity market quotations;

d. published accounts and financial statements relating to the business affairs of theassociated enterprise;

e. agreements and contracts entered into with associated enterprises or with unrelatedenterprises, in respect of transactions similar the international transactions;

f. letters and other correspondence documenting any terms negotiated between the

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assessee and the associated enterprise;

g. documents normally issued in connection with various transactions.

The information specified above should by available by the due date of submission ofreturn of income.

Continuity of international transaction for more than a year - Where aninternational transaction continues to have effect over more than one previous year,fresh documentation need not be maintained separately in respect of each previousyear, unless there is any significant change in the nature or terms of the internationaltransaction in the assumption made or in any other factor and in case of such significantchange, fresh documentation as maybe necessary shall be maintained detailing theimpact of the change on pricing of the international transaction.

Period for which Information should be maintained - The information anddocuments specified shall be kept and maintained for a period of 8 years from the endof the relevant assessment year.

Furnishing information about international transaction - The Assessing Officeror Com missioner (Appeals) may in the course of any proceeding under this Actrequire any person who has entered into an international transaction to furnish anyinformation or document in respect thereof.

It may be noted that Assessing Officer or Commissioner (Appeals) can require theassessee to furnish information only during continuation of any proceeding underIncome-tax Act) at the relevant time.

The Assessing Officer may require information or documents regarding existingproceeding but no information about future proceeding could be asked to be furnished.

This provision cannot be regarded as permitting to make roving or unnecessary enquiryand obtaining information or documents which are unrelated to an existing pendingproceeding merely in order to enable the Assessing Officer to decide whether or notto institute the proceedings.

Thus, (a) there should be a pending proceeding in existence, and (b) information

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sought to be furnished must be of a nature which is relevant and fruitful for suchpending proceedings.

• This information or document will have to be furnished within a period of 30 daysfrom the date of receipt of notice in this regard. The Assessing Officer or theCommissioner (Appeals) may grant an extension of not more than 30 further days tofurnish the said information or document.

8.4.1 REPORT FROM ACCOUNTANT

The report from an accountant which is required to be furnished under section 92Eby every person who has entered into an international transaction during the previousyear shall be in Form No. 3CEB and be verified in the manner indicated therein. Itshall be furnished before the due date of submission of return of income.

8.5 SPECIFIED DOMESTIC TRANSACTIONS

Section 92BA has been inserted with effect from the assessment year 2013-14. Itprovides the meaning of "specified domestic transaction' with reference to which theincome is to be computed under section 92, having regard to arm's length price. Thefollowing transactions are covered within the meaning of "specified domestictransactions" if the aggregate of these transactions entered into by the assessee in aprevious year exceeds Rs. 5 crore (Rs. 20 crore from the assessment year 2016-17)-

a. any expenditure in respect of which payment has been made or is to be made to aperson referred to in section 40A(2)(b);

b. any transaction referred to in section 80A;

c. any transfer of goods or services referred to in section 80-IA(8);

d. any business transacted between the assessee and other person as referred to insection 80-IA(10);

e. any transaction, referred to in any other section under Chapter VI-A or section10AA, to which provisions of section 80-IA(8)/(10) are applicable; or

f. any other transaction as may be prescribed.

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Any allowance for an expenditure or interest or allocation of any cost or expense orany income in relation to the above domestic transactions shall be computed havingregard to the arm's length price For this purpose arm's length price shall be determinedwithin the parameters of sections 92 to 92F.

Provisions illustrated - X Ltd. is a manufacturing company it owns two industrialunits- Unit A (eligible for 80-lB deduction) and Unit B (not eligible for any deduction)Manufacturing activity of Unit B depends upon goods produced in Unit A. On July 1,2014, 1,00,000 units manufactured by Unit A are transferred to Unit B at the rate ofRs. 30 per unit. On January 1,2015, X Ltd. gives a technical consultancy assignmentto Y Ltd. (one of the directors of X Ltd. holds 21 per cent equity in Y Ltd. duringApril 6, 2014 and May 1, 2014). On completion of the project on March 1 7, 2015,X Ltd. pays the agreed fees of Rs. 2.9 crore (after deduction of tax at source).

In this case the transfer from Unit A to Unit B is covered by section 80 IB(1 3) readwith section 80 IA(8) Technical consultancy payment to Y Ltd. is covered by section40A(2). The aggregate value of these two transactions exceeds Rs. 5 crore.Consequently, these transactions are "specified domestic transactions". Value for thesetransactions shall be calculated having regard to the arm's length price for calculatingincome of X Ltd. Provisions of sections 92 to 92F will be applicable in determiningthe arm's length price.

8.6 ADVANCE PRICING AGREEMENTS

Advance Pricing Agreement is an agreement between a taxpayer and a taxing authorityon an appropriate transfer pricing methodology for a set of transactions over a fixedperiod of time in future. The APA offers better assurance on transfer pricing methodsand are conducive in providing certainty and unanimity of approach.

Sections 92CC and 92CD have been inserted by the Finance Act, 2012 with effectfrom July 1,2012 to provide a framework for advance pricing agreement under theAct. These provisions provide the following-

• Board may enter into APA Section 92CC empowers the Board (with the approvalof the Central Government) to enter into an advance pricing agreement with anyperson.

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• Purpose of APA - Such APA shall include determination of the arm's length price orspecify the manner in which arm's length price shall be determined, in relation to aninternational transaction to be entered into, by that person.

• How to compute ALP - The manner of determination of arm's length price in suchcases shall be any method including those already provided in section 92C(1), withnecessary adjustments or variations.

• APA to supersede provisions of section 92C or 92CA - The arm's length price ofany international transaction, which is covered under such APA, shall be determinedin accordance with the APA so entered into. The provisions of section 92C or 92CAwhich normally apply for determination of arm's length price will be modified to thisextent. As a consequence, arm's length price shall be determined in accordance with APA.

• Validity of APA - The APA shall be valid for such previous years as are specified inthe agreement which in no case shall exceed five consecutive previous years.

• Roll back provisions - APA scheme is in operation in many countries. In manycountries, the APA scheme provides for 'roll back" mechanism for dealing with ALPissues relating to transactions entered into during the period prior to APA. The 'rollback" provisions refer to the applicability of the methodology of determination ofALP, or the ALP, to be applied to the international transactions which had alreadybeen entered into in a period prior to the period covered under an APA. However, the'roll back" relief is provided on case to case basis subject to certain conditions In theoriginal scheme of APA as inserted by the Finance Act, 2012, there was no provisionof "roll back'. The Finance (No. 2) Act, 2014, however, amended the provisions ofsection 92CC (with. effect from October 1, 2014) to provide roll back mechanism.The APA may, subject to such prescribed conditions, procedure and manner, providefor determining the arm's length price or for specifying the manner in which arm'slength price is to be determined in relation to an international transaction entered intoby a person during any period not exceeding 4 previous years preceding the first ofthe previous years for which the advance pricing agreement applies in respect of theinternational transaction to be undertaken in future.

• Effectiveness of APA - The APA shall be binding only on the person and the

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Commissioner (including income tax authorities subordinate to him) in respect of thetransaction m relation to which the agreement has been entered into. The APA shallnot be binding if there is any change, in law, or facts having bearing on such APA.

• APA obtained by fraud - The Board is empowered to declare, with the approvalof Central Government, any such agreement to be void ab initio, if it finds that theagreement has been obtained by the person by fraud or misrepresentation of facts.Once an agreement is declared void ab initio, all the provisions of the Act shall applyto the person as if such APA had never been entered into.

For the purpose of computing any period of limitation under the Act, the periodbeginning with the date of such APA and ending on the date of order declaring theagreement void ab initio shall be excluded. However, if after the exclusion of theaforesaid period, the period of limitation referred to in any provision of the Act is lessthan 60 days, such remaining period shall be extended to 60 days.

• Procedures - The Board is empowered to prescribe" a scheme providing for themanner, form, procedure and any other matter generally in respect of the advancepricing agreement.

• Pending proceedings - Where an application is made by a person for entering intosuch an APA, proceedings shall be deemed to be pending in the case of the person forthe purposes of the Act like for making enquiries under section 133.

• Modified return within 3 months- The person entering into such APA shallnecessarily have to furnish a modified return within a period of 3 months from theend of the month in which the said APA was entered into m respect of the return ofincome already filed for a previous year to which the APA applies The modifiedreturn has to reflect modification to the income only in respect of the issues arisingfrom the APA arid in accordance with it.

• Pending assessments - Where the assessment or reassessment proceedings for anassessment year relevant to the previous year to which the agreement applies arepending on the date of filing of a modified return, the Assessing Officer shall proceedto complete the assessment or reassessment proceedings in accordance with theagreement, taking into consideration the modified return so filed and the normal

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period of limitation of completion of proceedings shall be extended by 1 year.

• Reassessment of completed assessment - If the assessment or reassessmentproceedings for an assessment year relevant to a previous year to which the agreementapplies has been completed before the expiry of period allowed for furnishing ofmodified return, the Assessing Officer shall, in a case where modified return is filed,proceed to assess or reassess or recompute the total income of the relevant assessmentyear having regard to and in accordance with the APA. To such assessment, all theprovisions relating to assessment shall apply as if the modified return is a returnfurnished under section 139. The period of limitation for completion of such assessmentor reassessment is 1 year from the end of the financial year in which the modifiedreturn is furnished.

• Case study - For the assessment year 2015-16, X Ltd. submits return of income onNovember 10, 2015. On November 18, 2015, it enters into an advance pricingagreement (APA) with the Board pertaining to determination of arm's length price inconnection with import of semi-finished goods from its holding company situated inthe Netherlands. The agreement provides ALP for the transactions pertaining to theassessment years 2014-15 and 2015-16. The assessment of 2014- 15 has alreadybeen completed but the assessment for 2015-16 is pending on the date of enteringinto APA.

In this case, X Ltd. will have to submit a modified return for the assessment year2014-15 (and also for the assessment year 2015-16)011 or before February 28,2016(i.e., within 3 months from the end of the month in which APA is made).

On February 28, 2016, the assessment for the assessment year 20 14-15 has alreadybeen completed. For the assessment year 2014-15, the Assessing Officer will reassessthe income keeping in view the provisions of APA. This assessment can be completedon or before March 31, 2017 (i.e., within 1 year from the end of the financial year inwhich modified return is submitted).

On February 28, 2016, the assessment for the assessment year 2015-16 is pending.Normally, the assessment for the assessment year 20 15-16 should be completedbefore April 1, 2018. In this case, the Assessing Officer can complete the assessment

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for the assessment year 2015-16 (keeping in view the provisions of APA) at any timebefore April 1, 2019.

8.7 SECONDARY ADJUSTMENT IN CERTAIN INTERNATIONALTRANSACTIONS [SEC. 92CE]

Section 92CE has been inserted with effect from the assessment year 2018-19."Secondary adjustment" means an adjustment in the books of account of the assesseeand its associated enterprise to reflect that the actual allocation of profits betweenthe assessee and its associated enterprise are consistent with the transfer pricedetermined as a result of primary adjustment, thereby removing the imbalance betweencash account and actual profit of the assessee. As per the OECD's Transfer PricingGuidelines for Multinational Enterprises and Tax Administrations (OECD transferpricing guidelines), secondary adjustment may take the form of constructive dividends,constructive equity contributions, or constructive loans.

The provisions of secondary adjustment are internationally recognised and are alreadypart of the transfer pricing rules of many leading economies in the World (countrieslike Canada, France, Korea, South Africa, USA have adopted this kind of adjustmentin their transfer pricing legislations). While mode of secondary adjustments in differentcountries is different, yet there can be no case of secondary adjustment in the absenceof primary adjustment. Deemed dividend, deemed equity contribution or deemedloan are different approaches adopted by different countries. However, the object ofdifferent approaches is to align the economic benefit of the transaction with the arm'slength position.

When section 92CE is applicable

Under section 92CE, the assessee is required to carry out secondary adjustmentwhere the primary adjustment to transfer price has been made.

• What is primary adjustments - "Primary adjustment" to a transfer price means thedetermination of transfer price in accordance with the arm's length principle resultingin an increase in the total income or reduction in the loss, as the case may be, of theassessee.

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• What is secondary adjustment - "Secondary adjustment" means an adjustment inthe books of account of the assessee and its associated enterprise to reflect that theactual allocation of profits between the assessee and its associated enterprise isconsistent with the transfer price determined as a result of primary adjustment, therebyremoving the imbalance between cash account and actual profit of the assessee.

8.8 SUMMARY

The Assessing Officer may refer the computation of arm's length price under section92C to the Transfer Pricing Officer (TPO) if he considers it necessary and expedientand an approval of the Commissioner has been obtained. "Transfer Pricing Officer"means a Joint Commissioner or Deputy Commissioner or Assistant Commissionerauthorised by the Board to perform all or any of the functions of an Assessing Officerspecified m sections 92C and 92D in respect of any person or class of persons. Onreceipt of the order, the Assessing Officer shall proceed to compute the total incomeof the assessee under section 92C(3) having regard to the arm's length price determinedby the Transfer Pricing Officer. The use of the words 'having regard to' denotes thatit is not incumbent upon the Assessing Officer to compute the arm's length price asper the computation made by the Transfer Pricing Officer for each and everyinternational transactions.

8.9 GLOSSARY

APA- Advance Pricing Agreements

TPO- Transfer Pricing Officer

Primary Adjustments-Primary adjustment to a transfer price means the determinationof transfer price in accordance with the arm's length principle resulting in an increasein the total income or reduction in the loss, as the case may be, of the assessee.


1. Explain secondary adjustment.

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2. What are specified domestic transactions?

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8.11 LESSON END EXERCISES/EXAM ORIENTED EXAMINATIONS

1. Write a note on maintenance of books of account.

2. Explain advance pricing agreements.

3. Describe reference to transfer in case of international transactions.





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DOUBLE TAXATION-RELIEF FOR DOUBLE TAXATION,ADT AGREEMENTS AND UNILATERAL RELIEF

Structure

9.1 Introduction

9.2 Objectives

9.3 Relief for double taxation

9.4 ADT agreements

9.5 Unilateral Relief

9.6 Summary

9.7 Glossary




9.1 INTRODUCTION

The situation of double taxation will arise where the income gets taxed in two ormore than two countries whether due to residence or source principle as the casemay be. The problem of double taxation arises if the income of a person is taxed inone country on the basis of residence and on the basis of source in another country or

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on the basis of both. To mitigate the double taxation of income the provisions ofdouble taxation relief were made. The double taxation relief is available in two waysone in unilateral relief and other is bilateral relief.

Government of India can enter into agreement with a foreign government vide Entry14 of the Union List regarding any matter provided Parliament verifies it. DoubleTax Avoidance Agreement is a kind of bilateral treaty or agreement, betweenGovernment of India and any other foreign country or specified territory outsideIndia. Such treaty or agreement or agreement is permissible in terms of Article 253 ofthe Constitution of India.

In pursuance of Section 90, agreements for grant of relief on double taxation andagreement for avoidance of double taxation are executed by the Government of Indiafrom time to time Some of the countries with which such agreements are in force are:Canada, Korea, New Zealand, Hungary, Czechoslovakia, Belgium, Sri Lanka, SwissFederal

Council, Sweden, Denmark, Finland, Great Britain, Norway, Japan, The FederalRepublic of Germany, Republic of Austria, Greece, Romania, Republic of Lebanon,United Arab Republic, French Republic, Iran, Libya, Malaysia, Singapore, Tanzania,Zambia, Australia, Bulgaria, Ethiopia, Italy, Kuwait, USA, USSR etc.

9.2 OBJECTIVES

After going through this lesson you should be able understand the kinds of reliefavailable under double taxation avoidance agreements.

9.3 RELIEF FOR DOUBLE TAXATION

Double taxation means taxation of same income of a person in more than one country.This results due to countries following different rules for income taxation. There aretwo main rules of income taxation i.e. (a) Source of income rule and (b) residencerule.

As per source of income rule, the income may be subject to tax in the country wherethe source of such income exists (i.e. where the business establishment is situated orwhere the asset/property is located) whether the income earner is a resident in that

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country or not. On the other hand, residence rule stipulates that power to tax shouldrest with that country in which tax payer resides. In other words, the income earnermay be taxed on the basis of his residential status in that country. For example if aperson is resident of a country, he may have to pay tax on any income earned outsidethat country as well.

Thus problem of double taxation arises if a person is taxed in respect of any incomeon the basis of source of income rule in one country and on the basis of residence inanother country or on the basis of mixture of above two rules.

In India, the liability under the Income-tax Act arises on the basis of the residentialstatus of the assessee during the previous year. In case the assessee is resident inIndia, he also has to pay tax on the income which accrues or arises outside India, andalso received outside India. The position in many other countries may be broadlysimilar, it frequently happens that a person may be found to be a resident in more thanone country or that the same item of his income may be treated as accruing, arising orreceived in more than one country with the result that the same item becomes liableto tax in more than one country. Relief against such happening can be providedmainly by two methods (a) Bilateral relief, (b) Unilateral relief.

Bilateral relief

The Government of two countries can enter into Double Taxation AvoidanceAgreement (DTAA's) so that the same income may not be taxed twice. DTAA's laydown the rule of taxation of the income by the source country and the residencecountry. Such rules are laid for various categories of income, for example interest,dividend, royalties, capital gains, business income, salary income etc. Each suchcategory is dealt with by separate article in DTAA.

Thus DTAA's are entered into to provide relief against such Double Taxation, workedout on the basis of mutual agreement between the two concerned sovereign countries.This may be called a scheme of 'bilateral relief' as both concerned countries agree asto the basis of the relief to be granted by either of them. The Central Governmentmay enter into agreement with foreign countries:

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(a) for granting relief in respect of income on which tax have been paid bothincome tax under this Act and income tax in that country, or

(b) for the avoidance of double taxation of income under this Act and thecorresponding law in force in that country, or

(c) for exchange of information for the prevention of evasion or avoidance ofincome tax chargeable under this Act or under the corresponding law in forcein that country, or investigation of cases of such evasion or avoidance, or

(d) for recovery of income tax under this Act and under the corresponding law inforce in that country

The Central Government has so far entered into agreements for relief against oravoidance of double taxation with many countries and these agreements are inoperation.

These agreements may be classified into two parts:

(a) Agreement for relief from double taxation

(b) Agreement for avoidance of Double Taxation(i.e. Double Taxation AvoidanceAgreement)

Bilateral relief may be granted by one of the following two methods-

(a)Exemption method: Where two countries agree that income from various specifiedsources which are likely to be taxed in both the countries should either be taxed onlyin one of them or that each of the two countries should tax only a particular specifiedportion of the income so that there is no overlapping. Such an agreement will resultin a complete avoidance of double taxation of the same income in the two countries.This is known as exemption method of relief.

(b)Tax credit method: This method does not evolve any such scheme of singletaxability but merely provides that, if any item of income is taxed in both the countries,the assessee should get relief in a particular manner. Under this method, the assesseeis liable to have his income taxed in both countries but is given a deduction, from thetax payable by him in the country of residence, of a part of the taxes paid by him

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thereon, in the source country usually the lower of the two taxes paid. This is knownas tax credit method of relief.

Double Taxation Relief in case specified associations

Section 90A provides as under -

• There is a specified association in India

• It enters into an agreement with any specified association in a specified territoryoutside India.

• The Central Government may, by notification in the Official Gazette, makethe necessary provisions for adopting and implementing such agreement-

a. for grant of double taxation relief, for avoidance of double taxation

b. for exchange of information for the prevention of evasion or avoidance ofincome-tax;

c. for recovery of income-tax.

9.4 ADT AGREEMENTS

The government of India has entered into comprehensive agreements for avoidanceof double taxation with different countries. Besides, the government of India hasentered into agreements which cover limited areas of activity like aircraft and shippingbusiness. The effect of an ADT agreement is as follows-

(a) if no tax liability is imposed under the Act, the question of resorting to theagreement would not arise, no provision of the agreement can possibly fastena tax liability where the liability is not imposed by the Act;

(b) if a tax liability is imposed by the Act, the agreement may be resorted to fornegativating or reducing it;

(c) in case of difference between the provisions of the Act and of the agreement,the provisions of the agreement prevail over the provisions of the Act andcan be enforced by the appellate authorities and the court.

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Provisions of DTAAs override the provisions of the Act, to the extent these agreementsare more favourable to the assessee.

9.5 UNILATERAL RELIEF

Section 91 provides for the grant of unilateral relief in the case of resident taxpayerson income which has suffered tax in India as well as in the country with which thereis no DTAA agreement.

The following requirements have to be satisfied order that an assessee is entitled toclaim deduction on the doubly taxed income:

(a) The assessee must have been resident in India in the relevant previous year ;

(b) Income must have accrued or arisen to him during that previous year outsideIndia ;

(c) In respect of that income which accrued or arose outside India, he must havepaid by deduction or otherwise tax under the law in force in the foreigncountry.

The relief will be worked out as under:

1. First, ascertain the amount of doubly taxed income. It consists such incomewhich has accrued or arisen to the taxpayer in a foreign country and has been subjectedto income-tax in that country as well as in India. It however, does not include incomewhich is deemed to have accrued or arisen to the taxpayer in India, even though it hasbeen charged to income-tax in a foreign country.

2. On the amount of that doubly taxed income so ascertained, income-taxcalculated at the Indian rate of tax and the rate of tax of the foreign country. Theforeign tax rate has to be calculated separately for each county.

3. Relief is granted by allowing to the taxpayer a deduction from the tax liability of anamount equal to the tax calculated at the average Indian rate of tax or the amount oftax calculated at the rate of tax of the foreign country on the doubly taxed income,whichever is lower. For example, if out of income of Rs. 4,80,000 deduction of Rs.40,000 is allowed under section 80 in computing the total income, the assessee will

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be entitled to the double taxation relief under section 91 only in respect of Rs. 440000which has been subject to income-tax India.

Therefore we can say that double taxable relief in the case of no agreement with theforeign country is allowed unilaterally u/s 91. If a person has earned income outsIndia in a country haring no agreement under Section 90 for the relief or avoidanceof double taxation and he proves that he has paid income tax by way of deduction orotherwise under the law in force in that country in respect of the income so includedhe shall be entitled to a deduction from the India income tax payable by him of a sumcalculate on such taxed income so included at the average Indian income tax rate orthe average foreign tax rate whichever is lower or at the Indian rate of tax it both therates are equal.

What is Indian rate- The Indian rate of tax means the rate determined by dividing theamount of Indian income -tax after deduction of any relief due under the provisionsof the Act, but before deduction of any relief due under section 90 and 91 by the totalincome.

What is foreign rate- The rate of tax of the foreign country means income tax andsuper-tax actually paid in that country in accordance with the corresponding laws inforce thereafter deduction of all relief due, divided by the whole amount of theincome as assessed in that country.

Calculation of Unilateral Relief can be understood with the help of the followingillustration.

Illustration I. X (62 years) is a musician deriving income from concerts performedoutside India of Rs. 7,50,000. Tax of Rs. 1,50,000 was deducted at source in thecountry where the concerts were given and remaining Rs. 6,00,000 is remitted toIndia. India does not have any agreement with that country for avoidance of doubletaxation. Assuming that the Indian income of X is a Rs. 4,00,000, what is the reliefdue to him under section 91 for assessment year 2017-18, assuming that X is residentin India and has deposited Rs 22,000 in the public provident fund account.

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Solution

Rs.

Indian Income 4,00,000

Foreign Income 7,50,000

Gross Total Income 11,50,000

Less: Deduction under section 80 C 22,000

Net Income 11,28,000

Tax on Net Income 1,58,000

Add: Surcharge Nil

Tax and Surcharge 1,58,400

Add: Education cess(2% of tax) 3,168

Add: Secondary and higher education cess (1% of cess) 1,584

Tax liability in India 1,63,152

Rate of tax in India [ i.e. Rs. 1,63,152/ Rs. 11,28,000] 14.46%

Rate of tax in foreign country [i.e. Rs. 1,50,000/ Rs. 7,50,000] 20%

Doubly taxed income 7,50,000

Rebate under section 91 on Rs. 7,50,000 @ 14.46% 1,08,749

Tax payable in India [Rs. 1,63,152- Rs. 1,08.479] (rounded off) 54,760

Illustration II. X (46 years), an individual, is resident and ordinarily in India. Duringthe previous year 2016-17, he has the following income---

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Find out the tax liability of X for the assessment year 2017-18.

Solution

Rs.

Business Income (i.e. Business A: Rs. 8,00,000+ Business B: Rs. 7,15,000- BusinessLoss: Rs. 1,60,000) 13,55,000

Income from other sources 40,000

Gross Total Income 13,95,000

Less: Deductions 80,000

Net income 13,15,000

Tax on net Income

Income Tax 2,19,500

Add: Education Cess 4,390

Add: Secondary and Higher Education Cess 2,195

Tax liability 2,26,085

Average rate of tax in India (i.e. Rs. 2,26,085/ Rs. 13,15,000): 17.19%

Rs.

Income from Business A situated in India 8,00,000

Income from Business B situated in foreign country (India does not have ADT

agreement) (tax levied in the foreign country: Rs 2,80,000)

7,15,000

Loss from Business C situated in another foreign country (India does not have

ADT agreement)

(-) 1,60,000

Income from other sources in India 40,000

Amount deductible under sections 80C and 80D 80,000

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Foreign rate tax (Rs. 2,80,000/ Rs. 7,15,000): 39.16%

Doubly taxed Income: Rs. 7,15,000

Rate of relief on doubly taxed income 17.19%

Relief under section 91 (i.e. 17.19% of Rs. 7,15,000) 1,22,928

Tax Liability( rounded off) 1,03,160

9.6 SUMMARY

After the liberalisation of Indian economy and easing of restrictions on the entry offoreign entities, cross border business transactions have increased. With the ratificationof WTO by the Government of India, our economy has become robust and anatmosphere has sprang up where FII investments in India have increased tremendously.All these economic activities has ramifications for tax laws of the country. Issues liketax havens, transfer pricing, double taxation, WTO, FII, etc. are required to be takencare of and have become part and parcel of international taxation regime. With theacceptance of the WTO regime India has embarked on the policy of market reformsand merging with the international business community by providing market accessto the overseas investor with zero or qualitatively lesser restrictions.

In the context of international taxations, including cross border-investments, eliminateddouble taxation become an important consideration in doing business in India andabroad specially with the double taxation aspect became omnipresent in relations totransitions involving cross border investments with those foreign entities belongingto those countries with which India doesn't have double taxation avoidance agreements.

To overcome difficulties faced by investors from countries, India in recent yearsentered into Double Taxation Avoidance Agreement (DTAA) with many countries.Section 91 of the Income Tax Act deals with unilateral relief given to the concernedpersons of the foreign countries with whom India does not have DTAA under section90 of the Act deals with general aspect concerning bilateral relief.

Another way of resolving dispute relating to taxes involving international transaction

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is through Mutual Agreement Procedure (MAP) in regard to those categories ofdisputes where there are no DTAA. In order to reduce the misuse of tax havens,some countries have started the concept of CFC (controlled foreign corporations) todeal with the problems of tax evasion. There are nil tax haven destinations as well aslow tax haven destinations. In cases of double taxation the parties can get reliefeither through unilateral measures or bilateral measures or under adjudication byjudiciary or through commercial arbitration. Section 90 of the Income Tax Act, 1961deals with agreements entered by Government of India with Government of othercountries. Section 91 deals with provisions relating to those issues for which Indiadoes not have any formal agreements with Government of other countries, regardingavoidance of double taxation. Section 90A relates to granting to permissions to'specified association'-through official Gazette notification to enter into agreementwith foreign Government in regard to giving of relief for double taxation.

9.7 GLOSSARY

Sec. 90- Bilateral Relief

Sec 91- Unilateral relief

Sec 90A- Specified Associations

MAP- Mutual Agreement Procedure

CFC- Controlled Foreign Corporations

WTO- World Trade Organisation


1. What is bilateral relief?

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2. What do you understand by ADT agreements?

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1. What are the methods for providing bilateral relief?

2. Explain the procedure for calculating unilateral relief.

3. Discuss the purpose of double taxation agreements.

4. What are the conditions for claiming double taxation relief?

5. Describe the provisions related to specified associations.




3. Corporate Tax Planning & Business Tax Procedures with Case Studies- ByDr. Vinod K. Singhania & Dr. Monica Singhania

4. Income Tax Law & Practice- By V.P. Gaur, D.B. Narang, Puja Gaur & RajeevPuri

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TAX CONSIDERATION IN RESPECT OF FOREIGNCOLLABORATION AGREEMENTS

Structure

10.1 Introduction

10.2 Objectives

10.3 Tax considerations in respect of foreign collaboration agreements

10.4 Summary

10.5 Glossary



10.1 INTRODUCTION

The income tax incidence involved in transactions between Indians andforeigners is always an important consideration while entering into agreements orcontracts between them. Thus foreign collaboration agreements are drafted not merelywith a view to ensure the supply of technical services or technical information to theassessees in India but also with a view to having the least incidence of income tax forthe foreign collaborator. In a developing country like our's rapid and planned growthis not possible without technical assistance. Foreign collaboration is a means to imparttechnology for economic development. Keeping in the view the key importance offoreign collaboration the Government of India has set up a foreign country cell/department under Ministry of Industries.

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10.2 OBJECTIVES

After going through this lesson, students should be able to understand

• The meaning of foreign collaboration

• The various tax considerations related to foreign collaboration agreements

10.3 TAX CONSIDERATIONS IN RESPECT OF FOREIGNCOLLABORATION AGREEMENTS

The income tax incidence involved in transactions between Indians andforeigners is always an important consideration while entering into agreements orcontracts between them. Thus foreign collaboration agreements are drafted not merelywith a view to ensure the supply of technical services or technical information to theassessees in India but also with a view to having the least incidence of income tax forthe foreign collaborator. In a developing country like our's rapid and planned growthis not possible without technical assistance. Foreign collaboration is a means to imparttechnology for economic development. Keeping in the view the key importance offoreign collaboration the Government of India has set up a foreign country cell/department under Ministry of Industries. Foreign collaboration are generally of twotypes:

(a) Equity participation

(b) Technical Participation

Mere financial assistance collaboration without technical assistance has not beenconsidered desirable by the Government. Accordingly such ventures have not beenmuch promoted, technical collaboration may be required for a new project/ undertakingor for an already existing project/undertaking.

Tax planning in Foreign Collaboration

1. Residential Status: Incidence of tax varies according to residential status.Foreign party should avoid becoming resident in India.

2. Salary income of foreign technician visiting India: Where foreign technician

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visit India to train employees(of the Indian concern) in installation/erection of Plant& Machinery imported from abroad or to advise them on other technical matter,salary earned by them in India is to be taxable as it is deemed to have accrued orarose in India.

But sec. 10(6)(vi) exempts such salary provide that following conditions are satisfied:

• The foreign enterprise is not engaged in any trade or business in India

• Stay of foreign technicians in India should not exceed 90 days in previousyear

• Such remuneration is not liable to be deducted from the income of Indiancounterpart chargeable under this Act.

If the above conditions are satisfied, the foreign technicians would not be liable topay tax on salary earned in India. However, this would go against the Indian employercounterpart because the salary so pad by him to foreign technician is not allowed asdeductible expenditure. Keeping in view the interest of Indian labour and foreigntechnician, it is advisable to arrange the foreign technicians from the country withwhich India has double taxation avoidance agreements.

3. Avoiding business connection in India: All income accruing or arisingwhether directly or indirectly through or from any business connection in India. Thuseven if the foreign collaborator is a non-resident in India, he is taxable on such incomeas it would be deemed to accrue or arise to him from business connection in India.So, an effort should be made that no business connection should be established betweenthe foreign collaborator and Indian concerned to avoid application of deemedprovisions.

4. Royalty : Royalty has been defined in Explanation 2 to section 9(1)(vi) tomean the consideration (including any lump sum consideration but excluding anyconsideration which would be the income of the recipient chargeable under the head'capital gains') for:

(i) the transfer of all or any rights (including the granting of a licence) in respectof a patent, invention, model, design, secret formula or process or trade mark or

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similar property;

(ii) the imparting of any information concerning the working of or the use ofpatent, invention, model, design, secret formula or process or trade mark or similarproperty;

(iii) the use of any patent, invention, model, secret formula or process or trademark or similar property;

(iv) the use or right to use any industrial, commercial or scientific equipment butnot including the amounts referred to in section 44BB;

(v) the imparting of any information concerning technical, industrial, commercialor scientific knowledge, experience or skill;

(vi) the transfer of all or any rights including the granting of a licence in respect ofany copyright, literary, artistic or scientific work including films or video tapes foruse in connection with television or tapes for use in connection with radio broadcastingbut not including consideration for the sale, distribution or exhibition ofcinematographic films; or

(vii) the rendering of any service in connection with the activities referred to in (I)to (v) above. Further, CBDT Circular No. 202 dated 5.7.1976 has clarified that 'royalty'would include both industrial royalties and copyright royalties.

Section 9(1)(vi) deems income by way of royalty as accruing or arising in India in thefollowing three cases:

(i) Royalty payable by the Central Government or any State Government mustbe deemed to accrue in India regardless of who is the payee and what is the amountof royalty and also irrespective of the purpose of the payment;

(ii) Royalty payable by any resident taxpayer to any person, whether resident ornon- resident, would be deemed to accrue in India in every case except where thepayment is relatable to a business or profession carried on by the resident outsideIndia or for the purpose of making or earning any income from any other sourceoutside India; and

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(iii) Royalty payable even by a non-resident would be deemed to accrue in Indiain cases where the payment is relatable to any business or profession carried on bythe non- resident in India or to any other sources of the non-resident's income in India.

However, the definition excludes any income which might otherwise be chargeableas capital gains. Thus, a receipt of a capital nature for the total change in ownershipof the patents, invention, model, design, drawings, specifications, trade mark, secretformula or process, data, documentation, etc. representing technical know-howprovided by foreign collaborators to Indian taxpayers would not give rise to incomeby way of royalty while the authority given under the collaboration agreement to theIndian taxpayer to use for the purpose of his business the drawings, designs, patents,etc., representing technical know-how which would continue to belong to the foreigncollaborator would come within the purview of royalty for purposes of deeming thesame accruing in India, thus, making the non-resident liable to tax under this provision.For this purpose, it is immaterial whether the royalty is paid as a lump sum or as arecurring payment; it is also immaterial whether the royalty is described as suchunder the collaboration agreement or is known as licence fees, copyright charges orby any other name.

Under section 115A(1)(b)(A), royalty income is taxable in the hands of non-corporatenon- residents and foreign companies at the rate of 10% if it is received in pursuanceof an agreement made after 31st May, 2005, 20% if it is received in pursuance of anagreement made after 31st May, 1997 but before 1st June, 2005, and at the rate of30% if such agreement is made on or before 31st May, 1997. The conditions attachedto this provision are as follows:

(i) The recipient of the royalty should be a foreign company or a non-corporatenon-resident.

(ii) The royalty may be received from the Government or an Indian concern.

(iii) The royalty should be received in pursuance of an agreement made by theforeign company with the Government or the Indian concern after 31st March, 1976.

(iv) Where the agreement is with an Indian concern, it should be approved by theCentral Government.

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(v) Where the agreement relates to a matter included in the industrial policy(prevailing at that time) of the Central Government, the agreement should be inaccordance with that policy.

(vi) The conditions (iv) and (v) shall not apply where the royalty is received inconsideration for the transfer to an Indian concern, all or any rights in respect ofcopyright in any book, or for the transfer to a person resident in India, any computersoftware.

(viii) In computing the royalty income, no deduction shall be allowed under sections28 to 44C and section 57.

It is to be noted that section 115A is not applicable in respect of royalty incomecovered under section 44DA (1).

Source Rule for "royalty" - section 9 (1) (vi) [CBDT Circular 202, dated May 7,1976]

A non-resident taxpayer is chargeable to tax in India in respect of income by way ofroyalty which is received or is deemed to be received in India or which accrues orarises or is deemed to accrue or arise in India. The Income-tax Act, however, doesnot contain any definition of the term "royalty" nor is there any clear cut source rulespecifying the circumstances in which royalty income can be regarded as accruing orarising in India. Further, lump sum payments made for the supply of know-how arenot chargeable to tax where such know-how is supplied from abroad and the paymenttherefore is made outside India even though the know-how is used in India, if no partthereof is attributable to any services rendered in India.

The Finance Act, 1976 has inserted a new clause (vi) in section 9(1) clearly specifyingthe circumstances in which the royalty income will be deemed to accrue or arise inIndia and also defining the term "royalty".

Under the new provision, royalty income of the following types will be deemed toaccrue or arise in India:

(a) royalty payable by the Central Government or any State Government;

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(b) royalty payable by a resident, except where the payment is relatable to abusiness or profession carried on by him outside India or to any other source of hisincome outside India; and

(c) royalty payable by a non-resident if the payment is relatable to a business orprofession carried on by him in India or to any other source of his income in India.

In view of the aforesaid amendment royalty income consisting of lump sumconsideration for the transfer outside India of, or the imparting of information outsideIndia in respect of, any data, documentation, drawings or specifications relating toany patent, invention, model, design, secret formula or process or trade mark orsimilar property, will ordinarily become chargeable to tax in India. In order, however,to ensure that foreign suppliers of technical know-how who had entered intoagreements or had finalised proposals for the receipt of such lump sum royalties withthe approval of the Central Government on the understanding that such paymentswould be exempt from income-tax, it has been provided that such lump sum paymentsreceived under approved agreements made before 1-4-1976 will not be deemed toaccrue or arise in India, and for this purpose, an agreement made on or after 1-4-1976 will be deemed to have been made before that date if the following conditionsare fulfilled:

(i) In the case of a taxpayer other than a foreign company, if the agreement ismade in accordance with proposals approved by the Central Government before thatdate.

(ii) In the case of a foreign company, if the condition referred to in (a) above issatisfied, and the foreign company exercises an option by furnishing a declaration inwriting to the Income-tax Officer that the agreement may be regarded as having beenmade before 1-4-1976. The option in this behalf will have to be exercised before theexpiry of the time allowed under section 139(1) or section 139(2) (whether fixedoriginally or on extension) for furnishing the return of income for the assessmentyear 1977-78 or the assessment year in which the royalty income first becamechargeable to tax, whichever assessment year is later. The option so exercised will befinal not only for the assessment year in relation to which it is made but also for everysubsequent year.

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[The intention of giving an option to foreign companies to claim that agreementsmade on or after 1-4-1976 may be regarded as agreements made before that date isthat where exemption from income-tax in respect of lump sum royalty is allowed, thebalance of the royalty income should be charged to tax at the rates applicable in thecase of such income derived under approved agreements made before that date. Inother words, taxpayers exercising the option will be placed on a par with taxpayersderiving royalty income under approved agreements made before 1-4-1976 in allrespects. This aspect has been explained in detail in paragraph 36.1 of the circular.]

For the purposes of the aforesaid source rule, "royalty" has been defined in Explanation2 to section 9(1)(vi). It will be seen that the definition is wide enough to cover bothindustrial royalties as well as copyright royalties.

Further, the definition specifically excludes income which would be chargeable to taxunder the head "Capital gains" and, accordingly, such income will be charged to taxas capital gains on a net basis under the relevant provisions of the law. The amendmentsreferred to in this paragraph have come into force with effect from 1-6-1976, and willapply in relation to the assessment year 1977-78 and subsequent years. [Section 4(b)(Part) of the Finance Act]

5.Fee for technical services: Section 9(1)(vii) defines 'fees for technical services' asany consideration (including lump sum consideration) for the rendering of anymanagerial, technical or consultancy services (including the provision of services oftechnical or other personnel) but does not include consideration for any construction,assembly, mining or like project undertaken by the recipient. Further, any income ofthe recipient chargeable under the head "salaries" will also not form part of fees fortechnical services.

The taxability of fees received for technical services is on similar lines as royaltyincome. Under section 115A(1)(b)(B), income-tax shall be charged at 10% if thetechnical fees has been received in pursuance of an agreement made after 31st May,2005, at 20% if such fees are received in pursuance of an agreement made after 31stMay, 1997 but before 1st June, 2005, and at 30% if the said agreement was made onor before 31st May 1997. No deduction shall be allowed under sections 28 to 44Cand section 57 in respect of any expenditure or allowance, for the purpose of computing

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the aforesaid income. In this regard, the following issues are relevant. Section 115A,however, does not apply in respect of fees for technical services covered under section44DA (1).

Source Rule for 'fees for technical services' - section 9(1)(vii) [CBDT Circular 202,dated May 7, 1976]

As in the case of royalty, the Finance Act, 1976 has amended the Income-tax Actclearly specifying the circumstances in which income by way of "fees for technicalservices" will be deemed to accrue or arise in India and also defining the expression"fees for technical services". For this purpose, a new clause (vii) has been inserted insection 9(1).

Under the new provision, income by way of "fees for technical services" of thefollowing types will be deemed to accrue or arise in India:

(a) fees for technical services payable by the Central Government or any StateGovernment;

(b) fees for technical services payable by a resident, except where the payment isrelatable to a business or profession carried on by him outside India or to any othersource of his income outside India; and

(c) fees for technical services payable by a non-resident if the payment is relatableto a business or profession carried on by him in India or to any other source of hisincome in India.

The expression "fees for technical services" has been defined to mean any consideration(including any lump sum consideration) for the rendering of managerial, technical orconsultancy services, including the provision of services of technical or other personnel.It, however, does not include fees of the following types, namely:

(i) Any consideration received for any construction, assembly, mining or like projectundertaken by the recipient. Such consideration has been excluded from the definitionon the ground that such activities virtually amount to carrying on business in Indiafor which considerable expenditure will have to be incurred by a non-resident andaccordingly, it will not be fair to tax such consideration in the hands of a foreign

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company on gross basis or to restrict the expenditure incurred for earning the sameto 20 per cent of the gross amount as provided in new section 44D. Consideration forany construction, assembly, mining or like project will, therefore, be chargeable totax on net basis, i.e., after allowing deduction in respect of costs and expenditureincurred for earning the same and charged to tax at the rates applicable to the ordinaryincome of non-resident as specified in the relevant Finance Act.

(ii) Consideration which will be chargeable to tax in the hands of the recipient underthe head "Salaries".

The aforesaid amendment has come into force with effect from 1-6-1976, and willapply in relation to the assessment year 1977-78 and subsequent years.

6. Consideration for the sale of technical now-how: Technical know-how providedby the foreign collaborator to India concern is the result of research and experienceof collaborator outside India. Technical know-how covers the supply of technicaldata, maps, blueprints, layouts, design secret processes, and other technical literature.Foreign collaborator should prefer an outright sale of technical know-how for lumpsum consideration outside India to avoid any tax liability in India.

7. Sale of Capital goods: The foreign collaborator is advised to supply capitalequipments to Indian employer on FOB basis through letter of credit to avoid taxliability in India under CIF contracts.

Also the transaction of sale and purchase between the foreign collaborator and Indianimporter should be on principle to principle basis to avoid any tax liability of theforeign collaborator.

8. Separate contracts for every job: Foreign collaborator should not take a singlecontract for all jobs, instead separate contracts are made for each job undertaken, ifa single contract is taken for all jobs, the entire profits would be deemed to accrue orarise in India even if a part of contract would include in the tax liability of the foreigncollaborator, if the whole contract is broken into several sub contracts i.e. separatecontract for each job undertaken, it is possible to avoid tax liability in India, if thecontract is made outside India, is performed outside India and payment is made outsideIndia.

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9. Export of goods from India by non-residents: In the case of every non-resident,no income should be regarded as being deemed to accrue or arise to him in Indiathrough or from operations which are confined to the purchase of goods in India forthe purpose of export. Thus, even in cases where the non-resident has an agency oroffice in India but the agent or branch office in India does nothing more than thepurchase of the goods for their export, there would be no question of income accruingto the non-resident under the deeming provisions although in effect the non-residentmay derive income outside India from the goods so exported ultimately on their saleoutside India and the profits arising from such export are traceable to the businessconnection in India through the agency, branch or office. The exemption is, however,subject to the non-resident taking precaution to ensure that even a negligible part ofthe goods purchased are not sold in India and the whole of the goods purchased areonly exported. The country to which the export is made is immaterial for the purpose.Of course, care should be taken in every case to secure that no part of the saleproceeds for the goods exported is received directly or indirectly, in cash or in kind inIndia by or on behalf of the non-resident. In view of this benefit of total exemptionfrom income-tax without any monetary or other limits and conditions, every possibleexport should be made by foreign collaborators and their Indian counterparts tosecure that the benefit of exemption under clause (b) of the Explanation to section9(1)(i) is obtained, wherever practicable.

10. Tax treatment of payments made for expenses etc.: The carrying on of abusiness in India by different categories of taxpayers involves a variety of expensesbeing incurred by them both in India and outside. The nature and amount of theexpenses would, however, depend on the nature of the business, the purpose ofincurring the expenditure and the stage at which it is incurred.

In general, a substantial portion of the expenditure is incurred after the business ofthe taxpayer in India is actually set up. The expenses incurred prior to the setting upof the business do not qualify for any allowance or deduction in computing the taxableprofits of the business in India since the previous year of the business cannot beregarded as having commenced until the business is actually set up. Therefore, expenseswhich are incurred prior to the setting up of business and which are directly related tothe acquisition of capital assets including their installation, whichever necessary, have

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to be capitalised and the assessee would become entitled to claim depreciationallowance and investment allowance (where applicable) in respect thereof from thetime the business commences its normal operations by virtue of the commercialproduction being started.

11. Special provisions for computing profits and gains of shipping business incase of non-residents: Sec. 44B of Income Tax Act provides that in case of non-residents engaged in the business of operation of ships, 7.5% of the amount paid orpayable to the assessee, or to any person on his behalf on account of carriage ofpassengers, livestocks, mail or goods shipped at any part of India or the amountreceived or deemed to be received for such carriage of goods etc. shipped at any partoutside India would be deemed to be the taxable profits of such business.

12. Special provisions for computing profits and gains of business of exploration,etc. of mineral oils: Section 44BB contains special provisions for computation oftaxable income of a non resident assessee engaged in the business of providing servicesor facilities in connection with, or supplying plant and machinery on hire, used or tobe used, in the prospecting for, or extraction or production of, mineral oils. It providesthat 10% of the amount paid or payable to, or the amount received or receivable by,the assessee for provision of such services or facilities or supply of plant and machineryshall be deemed to be the taxable income of such non-resident assessee.

13. Special provision for computing profits and gains of business of operationof aircraft in the case of non-residents: Section 44BBA contains special provisionsfor computing profits and gains of the business of operation of aircraft of non-residents.It provides for determination of the income of non-resident taxpayers on presumptivebasis at a flat rate of 5% of the amount received or receivable for carriage of persons,livestock, mail or goods from any place in India or the amount received or deemed tobe received within India on account of such carriage from any place outside India.

10.4 SUMMARY

To conclude we can say that the income tax incidence involved in transactions betweenIndians and foreigners is always an important consideration while entering into

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agreements or contracts between them. Thus foreign collaboration agreements aredrafted not merely with a view to ensure the supply of technical services or technicalinformation to the assessees in India but also with a view to having the least incidenceof income tax for the foreign collaborator. In a developing country like our's rapidand planned growth is not possible without technical assistance. Foreign collaborationis a means to impart technology for economic development.

10.5 GLOSSARY

Sec. 44B: Special provisions for computing profits and gains of shipping business incase of non-residents

Sec.44BB: Special provisions for computing profits and gains of business ofexploration, etc. of mineral oils

Sec. 44BBA: Special provision for computing profits and gains of business ofoperation of aircraft in the case of non-residents


1. What do you understand by foreign collaboration?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. Explain the provision related to income from royalty.

____________________________________________________________

____________________________________________________________

____________________________________________________________

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____________________________________________________________

____________________________________________________________

____________________________________________________________


1. Explain the tax treatment of fees for technical services.

2. Discuss the special provision in case of computation of profits and gains ofthe business of operation of aircraft in case of non-residents.





4. www.icaiknowledgegateway.org

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M.Com. 1st Sem. Unit-IIILesson No. 11

TAX DEDUCTION AT SOURCE FROM INTEREST ONSECURITIES, DIVIDENDS AND INTEREST OTHER THAN

INTEREST ON SECURITIES

Structure

11.1 Introduction

11.2 Objectives

11.3 TDS from Interest on securities

11.4 TDS from Dividends

11.5 TDS from Interest other than interest on securities

11.6 Summary

11.7 Glossary




11.1 INTRODUCTION

Under scheme of tax deduction at source (TDS), persons responsible for makingpayment of income, covered by the scheme, are responsible to deduct tax source anddeposit the same to the Government's treasury within the stipulated time. The recipientof income- though he gets only the net amount (after deduction of tax at source)- is

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liable to tax on gross amount and the amount deducted at source is adjusted againsthis final tax liability. TDS scheme covers payments like salary (to resident/non-resident), payment other than salary to residents (namely, interest, dividend, rent,commission/brokerage, lottery winnings, winnings of races, technical/professionalfees, royalty, compensation, etc.) and payments to non-residents/ foreign companies.

11.2 OBJECTIVES :


• Provisions of TDS related to interest on securities

• TDS provisions in case of Dividends

• TDS on interest other than interest on securities

11.3 TDS FROM INTEREST ON SECURITIES [SEC. 193]

The provisions of section 193 are given below-Who is the payerWho is the recipientPayment coveredAt what time tax has to be deducted at source

Maximum amount which can be paid without taxdeductionRate of tax deduction at source

When the provisions are not applicable

Is it possible to get the payment without tax deductionor with lower tax deduction

Payer of interest on securitiesA resident person holding securitiesInterest on securitiesAt the time of payment or at the time of credit, which-ever is earlier--

10%Interest on Central/State Government securities

Yes

Securities interest which is not subject to tax deduction

No tax is deductible at source from the amount of interest payable on the following:

a. debentures issued by any co-operative society (including a co-operative landmortgage bank or a co-operative land development bank) or any other institution orauthority or a public sector company notified by the Central Government;

b. any security of the Central/State Governments [ from June 1, 2007, interest exceed

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ing Rs. 10,000 payable during a financial year on 8 per cent Savings (Taxable) Bonds,2003 will be subject to tax deduction at source irrespective of date of investment];and

c. securities beneficially owned by the Life Insurance Corporation of India or theGeneral Insurance Corporation of India or to any of the four companies formed byvirtue of the schemes framed under section 16(1) of the General Insurance Business(Nationalisation) Act, 1972 or any other insurer.

d. any listed Demat security.

Time of tax deduction

Tax has to be deducted at source at the time of payment or at the time of credit to theaccount of payee or transfer to interest payable account or suspense account, whichevercomes earlier. However, tax cannot be deducted until identity of the person in whosehands it is includible as income can be ascertained.

When tax is not deductible at regular rates

In the following cases tax is not deducted at regular rates:

• Application to Assessing Officer in Form No. 13 - Provisions of Sec. 197 areapplicable.

Sec. 197 of the Income Tax Act

The Income-tax laws permit certain taxpayers to get relief from TDS at a lower or nilrate under Section 197 of the Income Tax Act. Normally, TDS is deducted fromsalary and various other payments by Deductor and remitted with the Government.In case excess TDS is deducted, the taxpayer is allowed to apply and obtain anincome tax refund by filing income tax return for the excess TDS deducted. AnAssessing Officer can grant relief from TDS provisions, if the Officer is satisfied thatthe existing and estimated tax liability of a person will be lower than the amount ofTDS deducted and provide sufficient grounds for the same. This article is a briefaccount on Section 197 of the Income Tax Act, which deals with this provision.

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Certificate for deduction at lower rate.

(1) [Subject to rules made under sub-section (2A), where, in the case of any incomeof any person [or sum payable to any person, income-tax is required to be deductedat the time of credit or, as the case may be, at the time of payment at the rates in forceunder the provisions of sections 192, 193, 194, 194A, 194C, 194D, 194G, 194H,194-I, 194J, 194K, 194LA and 195, the Assessing Officer is satisfied that the totalincome of the recipient justifies the deduction of income-tax at any lower rates or nodeduction of income-tax, as the case may be, the Assessing Officer shall, on anapplication made by the assessee in this behalf, give to him such certificate as may beappropriate.

(2) Where any such certificate is given, the person responsible for paying the incomeshall, until such certificate is cancelled by the Assessing Officer, deduct income-tax atthe rates specified in such certificate or deduct no tax, as the case may be.

(2A) The Board may, having regard to the convenience of assessees and the interestsof revenue, by notification in the Official Gazette, make rules specifying the cases inwhich, and the circumstances under which, an application may be made for the grantof a certificate under sub-section (1) and the conditions subject to which such certificatemay be granted and providing for all other matters connected therewith.

Areas of Consideration

The eligibility of an assessee to claim the benefits of this rule is determined by theAssessing Officer by assessing his/her existing and estimated liability, which isdetermined by considering the following:

• Tax payable on estimated income of the previous year relevant to theassessment year.

• Tax payable on the assessed or returned income of the preceding three tears.

• Existing liability under the Income-tax Act, 1961 and Wealth-tax Act, 1957.

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• Payment of advance tax for the assessment year relevant to the previous yearuntil the date of making the relevant application.

• Tax deducted at source for the assessment year relevant to the previous yearuntil the date of making the relevant application.

• Tax collected at source for the assessment year relevant to the previous yearuntil the date of making the relevant application.

NIL TDS Certificate - Form 13

If the assessee wishes to avail nil or low deduction of TDS, he/she must make anapplication in Form 13 to the Income Tax Officer. After assessing the application, theAssessing Officer will grant a certificate on being satisfied that such a deduction isjustified. On making an application for exemption from TDS provisions in Form 13,the Assessing Officer must dispose the application within a time period of 30 daysfrom the end of the month, in which the completed application is received in allrespects. The certificate approving deduction under Section 197 will be valid for theassessment year specified in the certificate or until cancelled by the Assessing Officer.

• Declaration to the payer in form No. 15G - If a declaration is submitted undersection 197A by the receipient to the payer, then no tax is deductible in a few cases.The provisions of section 197A as are given in the table

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• Debenture interest up to Rs. 5,000 - It is not necessary to deduct tax at source fromany interest on debentures paid to a resident individual or a resident Hindu undividedfamily, if the following conditions are fulfilled:

a. the debentures have been issued by a company in which the public are substantiallyinterested;

b. the interest is paid by the company by an account payee cheque; and

c. the aggregate amount of interest paid or likely to be paid by the company to theholder of the debentures during the financial year does not exceed Rs. 5,000.

Taxable pre-

mature

withdrawal

from

provident

fund [Sec.

192 A]

Interest[Sec.193

and 194A] or

rent[ Sec. 194-I

with effect from

June 1, 2016] or

insurance

commission[

Sec. 194D, with

effect from

June1, 2017]

Dividend

[Sec.194]

Payment in

respect of

life

insurance

policy [Sec.

194DA]

National

Savings

Scheme

[Sec.

194EE]

Condition 1- Who is

receipient

Individual Other than a

company or

firm

Resident

Individual

Other than

a company

or firm

Resident

Individual

Condition 2- What is

tax on total income

of the previous year

Nil Nil Nil Nil Nil

Condition 3- How

much is total of

income covered by

section 192A, 193,

194, 194A, 194D,

194DA, 194-I and

194EE

Not exceeding the maximum amount not chargeable to tax

( 203 )

• Regimental fund - The matter with regard to regimental fund or non-public fundestablished by Armed Forces has been examined in the Board. Since the income ofthese organisations is exempt under section 10(23AA), it has been decided that notax may be deducted at source under sections 193 and 194-I from the income of suchFund-Circular No. 735, dated January 30, 1996.

• Deep discount bonds - Tax is deductible at the time of redemption-Circular No. 4/2004, dated May 13, 2004. If the recipient has paid tax on interest on accrual basis,he can take relief under section 197 or 197A.

11.4 TDS FROM DIVIDENDS [SEC.194]

The provisions of section 194 are given below-

In the following cases, tax is not deducted at source or deducted at the lower rates:

• Dividends covered by section 115-0 - No tax is deductible from June 1, 1997 toMarch 31, 2002 and from April 1, 2003 in the case of dividend referred to in section115-0.

• Application in Form No. 13- The Income-tax laws permit certain taxpayers to getrelief from TDS at a lower or nil rate under Section 197 of the Income Tax Act.Normally, TDS is deducted from salary and various other payments by Deductor andremitted with the Government. In case excess TDS is deducted, the taxpayer is allowedto apply and obtain an income tax refund by filing income tax return for the excessTDS deducted. An Assessing Officer can grant relief from TDS provisions, if theOfficer is satisfied that the existing and estimated tax liability of a person will be

Who is the payerWho is the recipientPayment coveredAt what time tax has to be deducted at sourceMaximum amount which can be paid without taxdeductionRate of tax deduction at sourceWhen the provisions are not applicableIs it possible to get the payment without tax deductionor with lower tax deduction

Domestic companyResident shareholderDeemed dividend under section 2(22) (e)At the time of payment----

10%Dividends covored by section 115-OYes

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lower than the amount of TDS deducted and provide sufficient grounds for the same.This article is a brief account on Section 197 of the Income Tax Act, which deals withthis provision.









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• Tax collected at source for the assessment year relevant to the previous yearuntil the date of making the relevant application



• Declaration to the payer in Form No. 15G - If a declaration is submitted undersection 197A by the receipient to the payer, then no tax is deductible in a few cases.The provisions of section 197A as are given in the table

11.5 TDS FROM INTEREST OTHER THAN INTEREST ON SECURITIES[SEC.194A]

The provisions of section 194A are given below-

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In the cases given below interest is not subject to tax deduction or tax deduction atlower rate:

• Interest not subject to tax deduction - By virtue of sections 194A(3) and 197(1D),tax is not deductible in the following cases-

a. where the aggregate amount of interest credited or paid or likely to be credited orpaid during a financial year does not exceed the limit given below;

b. where interest is credited or paid to any banking company, co-operative bank,public financial institutions, the Life Insurance Corporation, the Unit Trust of India,

Taxable pre-

mature

withdrawal

from

provident

fund [Sec.

192 A]

Interest[Sec.193

and 194A] or

rent[ Sec. 194-I

with effect from

June 1, 2016] or

insurance

commission[

Sec. 194D, with

effect from

June1, 2017]

Dividend

[Sec.194]

Payment in

respect of

life

insurance

policy [Sec.

194DA]

National

Savings

Scheme

[Sec.

194EE]

Condition 1- Who is

receipient


company or

firm

Resident

Individual

Other than

a company

or firm

Resident

Individual


tax on total income


Nil Nil Nil Nil Nil

Condition 3- How

much is total of

income covered by

section 192A, 193,

194, 194A, 194D,

194DA, 194-I and

194EE


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an insurance company or a co-operative society carrying on the business of insurance,or notified institutions [ Taxmann's Direct Taxes Circulars, Vol. 2, 2009 edition];

c. where interest is credited or paid by the firm to its partner(s);

d. where interest is credited or paid by a co-operative society (other than a co-operativebank) to its members [ it covers interest on time deposits/other deposits to membersholding at least one share-Circular No. 9/2002, dated September 11, 2002] or to anyother co-operative society;

e. where interest is credited or paid in respect of deposits under the schemes of PostOffice (Time Deposits), Post Office (Recurring Deposits), Post Office Monthly IncomeAccount, Kisan Vikas Patra, National Savings Certificates VIII Issue, and IndiraVikas Patra;

f. where interest is credited or paid in respect of deposits (other than time depositmade on or after July 1, 1995) with a banking company or (interest to non-memberson deposit) with a co operative bank;

g. where interest is credited or paid in respect of deposit (by non-members) with aprimary agricultural society, or primary credit society or co-operative land mortgagebank or co operative land development bank;

h. where interest is credited or paid by the Central Government under differentprovisions of the direct taxes;

i. where the interest is paid (or, up to May 31, 2015, credited) on compensationawarded by the Motor Accidents Claims Tribunal if the amount of payment or theaggregate amount of such payment does not exceed Rs. 50,000;

j. income paid/payable by an infrastructure capital/fund or public sector company inrelation to zero coupon bonds issued on or after June 1, 2005;

k. where interest is paid or payable by an offshore banking unit on deposits (orborrowings) made on or after April 1, 2005 by a person who is resident but notordinarily resident in India; and

l. interest referred to in section 10(23FC).

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• No tax deduction if interest does not exceed a specified amount - Tax under section1 94A is not deductible where the aggregate amount of interest credited or paid (orlikely to be credited or paid) during a financial year does not exceed the amountgiven below-

Notes -

1. The aforesaid limits shall be computed with reference to the income credited orpaid; by branch of the banking company or the co-operative society, as the casemaybe. However, branch wise computation system is discontinued from June 1,2015From June 1,2015, section 194A h been amended to provide that for computingthreshold limit (given above) interest credited paid by the banking company/co-operative bank which has adopted core banking solution (CBS), shall be considered.

2 The expression time deposits" has been defined to mean deposits excluding recurringdeposits repayable on the expiry of fixed period. The scope of TDS provisions hasbeen extended (with effect from June 1, 2015) to cover interest on recurring depositswithin its scope for the purposes of deduction of tax under section 194A.

3. The interest on time deposits made with a primary agricultural credit society or aprimary credit- society or a co-operative land mortgage bank or a co-operative landdevelopment bank, will not be subject to the requirement of deduction of income-taxat source.

• Declaration to the payer in Form No. 15G or 15H - If a declaration is submittedunder section 197A by the receipient to the payer, then no tax is deductible in a fewcases. The provisions of section 197A as are given in the table

Where the payer is banking company and interest is paid or payable on timedeposit

Where the payer is a co-operative society engaged in carrying on the bankingbusiness and interest is paid or payable on time deposit.

Where the payer is post office and interest is paid payable on notified depositscheme with post office (i.e., Senior Citizen Savings Scheme, 2004)

Where the payer is any other person

10,000

10,000

10,000

5,0000

Front June 1, 2007Rs.

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• Application to the assessing officer in Form No. 13- . The Income-tax laws permitcertain taxpayers to get relief from TDS at a lower or nil rate under Section 197 ofthe Income Tax Act. Normally, TDS is deducted from salary and various otherpayments by Deductor and remitted with the Government. In case excess TDS isdeducted, the taxpayer is allowed to apply and obtain an income tax refund by filingincome tax return for the excess TDS deducted. An Assessing Officer can grant relieffrom TDS provisions, if the Officer is satisfied that the existing and estimated taxliability of a person will be lower than the amount of TDS deducted and providesufficient grounds for the same. This article is a brief account on Section 197 of theIncome Tax Act, which deals with this provision.

Taxable pre-

mature

withdrawal

from

provident

fund [Sec.

192 A]

Interest[Sec.193

and 194A] or

rent[ Sec. 194-I

with effect from

June 1, 2016] or

insurance

commission[

Sec. 194D, with

effect from

June1, 2017]

Dividend

[Sec.194]

Payment in

respect of

life

insurance

policy [Sec.

194DA]

National

Savings

Scheme

[Sec.

194EE]

Condition 1- Who is

receipient


company or

firm

Resident

Individual

Other than

a company

or firm

Resident

Individual


tax on total income


Nil Nil Nil Nil Nil

Condition 3- How

much is total of

income covered by

section 192A, 193,

194, 194A, 194D,

194DA, 194-I and

194EE


( 210 )











( 211 )





Adjustment in the case of short deduction

The person responsible for making the payment at the time of making any deductionmay increase or reduce the amount to be deducted under section 1 94A for the purposeof adjusting any excess or deficiency arising out of any previous deduction or failureto deduct during the - financial year.

Payment under a hire purchase agreement

When a part of purchase installment is paid by a hirer to the owner under a higherpurchase contract, the provisions of section 194A are not attracted-Instruction No.1425, dated November 16, 1981.

11.6 SUMMARY

Under scheme of tax deduction at source (TDS), persons responsible for makingpayment of income, covered by the scheme, are responsible to deduct tax source anddeposit the same to the Government's treasury within the stipulated time. The recipientof income- though he gets only the net amount (after deduction of tax at source)- isliable to tax on gross amount and the amount deducted at source is adjusted against

( 212 )

his final tax liability. TDS scheme covers payments like salary (to resident/non-resident), payment other than salary to residents (namely, interest, dividend, rent,commission/brokerage, lottery winnings, winnings of races, technical/professionalfees, royalty, compensation, etc.) and payments to non-residents/ foreign companies.

11.7 GLOSSARY

Sec. 193-TDS from Interest on securities

Sec. 194-TDS from Dividends

Sec. 194A-TDS from Interest other than interest on securities

Sec. 197- Obtaining certificate of lower rate from the Assessing officer


1. What are the cases in which securities interest is not subject to tax deductionat source?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. Explain the provisions related to availing certificate in Form No. 13 for lowor nil TDS.

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

( 213 )

____________________________________________________________

____________________________________________________________


1. Explain the TDS provisions related to interest on securities.

2. Discuss the TDS provisions related to dividends.

3. Describe the provisions concerning interest other than interest on securities.




3. Income Tax Law and Practice- By V.P. Gaur, D.B. Narang, Puja Gaur andRajeev Puri

------

( 214 )


TAX DEDUCTION AT SOURCE FROM INSURANCECOMMISSION, PAYMENT OF LIFE INSURANCE POLICY,NATIONAL SAVINGS SCHEME, MUTUAL FUNDS OR UTI

Structure

12.1 Introduction

12.2 Objectives

12.3 TDS from Insurance commission

12.4 TDS from Payment of life insurance policy

12.5 TDS from payments in respect of National Savings Scheme

12.6 TDS from payments on account of repurchase of units of Mutual Funds orUTI

12.7 Summary

12.8 Glossary




12.1 INTRODUCTION

Considering tendency of taxpayers to adopt tax evasion measures, Income tax

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provisions provide for deduction of tax at source / collection of tax source. Tax ratesfor such deduction are provided under Section 192, Section 194 and 195(non-residents). Person responsible for making the payment is entrusted with theresponsibility of deducting the tax at specified rates either at the time of credit in thebooks or payment to the recipient, whichever is earlier and only pay the balanceamount to the recipient. This ensures tax is collected in advance, checks tax evasionand also helps track income of recipients in the future.

However, this scheme of deducting tax at source itself may create hardship to fewtaxpayers who may not be have a taxable income at all. Such scenarios could arisewhere:

• Taxpayer has incurred a loss for the current year;

• Taxpayer has carried forward losses of previous years available for set off inthe current year;

• Taxpayer is eligible to claim certain exemptions or deductions during theyear;

The above could result in the taxpayer not having any taxable income at all for theyear. While TDS rates are determined in general considering larger income populationas a whole and income category, it might lead to undue difficulties to certain taxpayersas above who would not have any taxable income yet tax gets deducted at source forthem which they end up claiming as refund. No doubt these taxpayers are eligible foran interest on such refund, funds unnecessarily get blocked till refund is received.Moreover, they have to go through the process of filing their return to claim it (in acase where it was not otherwise mandatory for them to file it under law).

12.2 OBJECTIVES

After going through this lesson you should be able to understand the provisionsrelated to tax deduction at source with regard to Insurance commission, payment oflife insurance policy, national savings scheme and mutual funds or UTI.

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12.3 TDS FROM INSURANCE COMMISSION [SEC. 194D]

The provisions of section 194D are given below-Who is the payer

Who is the recipientPayment coveredAt what time tax has to be deducted at source

Maximum amount which can be paid withouttax deduction

Rate of tax deduction at source

When the provisions are not applicableIs it possible to get the payment without taxdeduction or with lower tax deduction

Any person paying insurance commissionA resident personInsurance commissionAt the time of payment or at the time of credit, whichever isearlierAny amount which is Rs. 15,000 or less (to be calculated onaggregate basis for the entire financial year)

5% (if recipient is a person other than company) 10% (if recipientis a company)----The recipient can make an application in Form No. 13 to theAssessing Officer to get a certificate of lower tax deduction or notax deduction

Adjustment not possible

At the time of deducting tax from the insurance commission credited to an agent'saccount adjustment for any debits made in his account in respect of excess commissioncredited or pal to him earlier is not permissible and income-tax must be deductedfrom the full amount of commission credited to this account-Circular No. 277, datedJuly 21, 1980.

When tax is not deductible or deductible at lower rate

In the cases given below, tax is not deductible or deductible at lower rate-

1. No tax is required to be deducted at source if the insurance commission creditedor paid (or likely to be credited or paid) during the financial year does not exceed Rs.15,000.

2. The person receiving insurance commission can make an application in Form No.13- Provisions of Sec. 197 are applicable.


The Income-tax laws permit certain taxpayers to get relief from TDS at a lower or nilrate under Section 197 of the Income Tax Act. Normally, TDS is deducted fromsalary and various other payments by Deductor and remitted with the Government.

( 217 )

In case excess TDS is deducted, the taxpayer is allowed to apply and obtain anincome tax refund by filing income tax return for the excess TDS deducted. AnAssessing Officer can grant relief from TDS provisions, if the Officer is satisfied thatthe existing and estimated tax liability of a person will be lower than the amount ofTDS deducted and provide sufficient grounds for the same. This article is a briefaccount on Section 197 of the Income Tax Act, which deals with this provision.








( 218 )








Reinsurance not covered by section 194D

Reinsurance differs from insurance in a number of ways and the most important isthat there is no contractual relationship between the direct insured and the reinsurer.There are separate contracts involved - one between the insured and the insurer andanother between the insurer and the reinsurer. Insurer has to pay all valid claims tothe insured, irrespective of whether the insurer can recover the same from his reinsurer.

When a reinsurance company gets business from insurance company at premium lesscommission", the "commission" is not subject to TDS under section 194D, as it is notpayable to an agent for procuring insurance business. Similarly, when "profitcommission" is payable by an reinsurance to an insurance company, after the expiryof the term of insurance, in respect of such cases where there is no claim during theoperation of the reinsurance treaty, TDS under section 194D is not required - GeneralInsurance Corpn. of India v. CIT 28 SOT 453 (Mum.).

( 219 )

12.4 TDS FROM PAYMENT OF LIFE INSURANCE POLICY [SEC. 194DA]

The provisions of section 194DA are given below -

Who is payer

Who is recipient

Payment covered

At what time tax has to be deducted

Maximum amount which can be paid without taxdeductionRate of tax deduction


It is possible to get the payment without tax deductionor with lower tax deduction

Any person responsible for paying to a resident any sum undera life insurance policy (including bonus)A resident personAny payment pertaining to life insurance policy (whether atthe time of maturity or otherwise)

At the time of paymentAny amount which is less than Rs. 1,00,000 (to be calculatedon aggregate basis for the entire financial year)

2% (1% from June 1,2016)If the payment is exempt in the hands of recipient under section10 (10D)

If the recipient submits Form No. 15G/ 15H under section197A, tax is not deductible.

• Exemption under section 10(10D) - If exemption is available to the recipient undersection l0(10D), then the above TDS provisions are not applicable. Consequently, inthe following cases TDS provisions of section 194DA are applicable -

a. any payment under a keyman insurance policy;

b. b. any payment under section 8ODD(3) or section 8ODDA(3);

c. any payment under insurance policy issued during April 1, 2003 to March 31, 2012where annual insurance premium is more than 20 per cent of capital sum assured;

d. any payment under insurance policy issued after March 31, 2012 where annualinsurance premium is more than 10 per cent of capital sum assured; or

e. any payment under insurance policy issued after March 31, 2013 to a person coveredunder section 80U or 8ODDB where annual insurance premium is more than 15 percent of capital sum assured.

( 220 )

In cases covered by (c), (d) or (e) (supra) , tax is not deductible if the payment ismade on the death of a person.

Any payment under a policy [being a keyman insurance policy or a policy coveredunder section 8ODD(3) or section 8ODDA(3)] issued prior to April 1, 2003, will notbe subject to TDS provisions of section I94DA.

TDS provisions of section 194DA will be applicable whether payment is made at thetime of maturity or otherwise. Suppose an insurance company gives a loan of Rs.l,00,000 (or more) to a policyholder against an insurance policy (which was issuedon or after April 1, 2003 and annual insurance premium is more than 20 per cent ofsum assured), TDS provisions of section 194DA would be applicable at the time ofrelease of loan amount to policyholder. Taxable pre-

mature

withdrawal

from

provident

fund [Sec.

192 A]

Interest[Sec.193

and 194A] or

rent[ Sec. 194-I

with effect from

June 1, 2016] or

insurance

commission[

Sec. 194D, with

effect from

June1, 2017]

Dividend

[Sec.194]

Payment in

respect of

life

insurance

policy [Sec.

194DA]

National

Savings

Scheme

[Sec.

194EE]

Condition 1- Who is

receipient


company or

firm

Resident

Individual

Other than

a company

or firm

Resident

Individual


tax on total income


Nil Nil Nil Nil Nil

Condition 3- How

much is total of

income covered by

section 192A, 193,

194, 194A, 194D,

194DA, 194-I and

194EE


( 221 )

Possibility of getting payment without tax deduction or with lower tax deduction-Declaration to the payer in Form No. 15G or 15H

12.5 TDS FROM PAYMENTS IN RESPECT OF NATIONAL SAVINGSSCHEME [SEC. 194EE]

The provisions of section 194EE are given below-

The person responsible for paying any amount (i.e., principal and interest) out ofNational Savings Scheme, 1987 should deduct tax at source. It may be noted that thepayment out of National Savings Scheme, 1992 (which was eligible for the benefit ofsections 80L and 88) is not subject to tax deduction at source.

When tax is not deductible

No tax deduction shall be made in the following cases-

• Payment below Rs. 2,500-Where the amount of payment or the aggregate amountof payments in a financial year is less than two thousand five hundred rupees no taxis deducted at source

• Payment to heirs - Where the payment is made to the heirs of the deceased assessee(depositor), no tax is deducted at source.

Who is the payer

Who is the recipientPayment covered

At what time tax has to be deducted at source




Is it possible to get the payment without taxdeduction or with lower tax deduction

Post officeAny personPayment (principal + interest) out of National Saving Scheme,1987)

At the time of paymentIf the amount of payment is Rs. 2,500 cr less than Rs. 2,500

20% (10% from June 1, 2016)

The payment is made to legal heirs of the deceased depositor

Yes

( 222 )

• Declaration to the payer in Form No. 15G or 15H-

Taxable pre-

mature

withdrawal

from

provident

fund [Sec.

192 A]

Interest[Sec.193

and 194A] or

rent[ Sec. 194-I

with effect from

June 1, 2016] or

insurance

commission[

Sec. 194D, with

effect from

June1, 2017]

Dividend

[Sec.194]

Payment in

respect of

life

insurance

policy [Sec.

194DA]

National

Savings

Scheme

[Sec.

194EE]

Condition 1- Who is

receipient


company or

firm

Resident

Individual

Other than

a company

or firm

Resident

Individual


tax on total income


Nil Nil Nil Nil Nil

Condition 3- How

much is total of

income covered by

section 192A, 193,

194, 194A, 194D,

194DA, 194-I and

194EE


( 223 )

12.6 TDS FROM PAYMENTS ON ACCOUNT OF REPURCHASE OF UNITSOF MUTUAL FUNDS OR UTI [SEC. 194F]

The provisions of section 194F are given below-

It may be noted that section 8OCCB is applicable if investment was made during theprevious year's 1990-91 and 1991-92 in the notified units of Equity Linked SavingScheme of UTI or a mutual fund.

12.7 SUMMARY

Considering tendency of taxpayers to adopt tax evasion measures, Income taxprovisions provide for deduction of tax at source / collection of tax source. Tax ratesfor such deduction are provided under Section 192, Section 194 and 195(non-residents). Person responsible for making the payment is entrusted with theresponsibility of deducting the tax at specified rates either at the time of credit in thebooks or payment to the recipient, whichever is earlier and only pay the balanceamount to the recipient. This ensures tax is collected in advance, checks tax evasionand also helps track income of recipients in the future.

12.8 GLOSSARY

Sec. 194D- TDS from Insurance commission

Sec. 194DA- TDS from Payment of life insurance policy

Sec. 194EE- TDS from payments in respect of National Savings Scheme

Who is the payer





When the provisions are not applicableIs it possible to get the payment without taxdeduction or with lower tax deduction

Mutual fund or UTIUnit holder under section, 80CCBPayment on account of repurchase of units referred to in section80CCBAt the time of payment---

20%

---

No provision

( 224 )

Sec. 194F- TDS from payments on account of repurchase of units of Mutual Fundsor UTI


1. State the concept of TDS.

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. What are the TDS provisions related to payments on account of repurchaseof units of mutual funds or UTI?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________


1. Discuss the TDS provisions with respect to Insurance commission.

2. Explain the TDS measures with respect to National Savings Scheme.

( 225 )

3. Highlight the TDS provisions for payment of life insurance policy.




3. Income Tax Law and Practice- By V.P. Gaur, D.B. Narang, Puja Gaur andRajeev Puri.

-------

( 226 )


TAX DEDUCTION AT SOURCE FROM COMMISSION ORBROKERAGE, RENT, PROFESSIONAL OR TECHNICALSERVICES, INFRASTRUCTURE DEBT FUND, UNITS OF

BUSINESS TRUST, UNITS OF INVESTMENT FUND,INVESTMENT IN SECURITIZATION FUND, INTEREST ON

BONDS/GOVERNMENT SECURITIES

Structure

13.1 Introduction

13.2 Objectives

13.3 TDS from Commission or brokerage

13.4 TDS from Rent

13.5 TDS on fees for professional and technical services

13.6 TDS from interest payable on infrastructure debt fund

13.7 TDS from Income from units of business trust

13.8 TDS from income in respect of units of investment fund

13.9 TDS from income in respect of investment in securitization fund

13.10 TDS from interest on bonds/government securities

13.11 Summary

13.12 Glossary

( 227 )




13.1 INTRODUCTION

TDS stands for tax deducted at source. As per the Income Tax Act, any company orperson making a payment is required to deduct tax at source if the payment exceedscertain threshold limits. TDS has to be deducted at the rates prescribed by the taxdepartment. The company or person that makes the payment after deducting TDS iscalled a deductor and the company or person receiving the payment is called thedeductee. It is the deductor's responsibility to deduct TDS before making the paymentand deposit the same with the government. TDS is deducted irrespective of the modeof payment-cash, cheque or credit-and is linked to the PAN of the deductor anddeducted.

TDS is deducted on the following types of payments:

• Commission or brokerage

• Income from business trust

• Commission payments

• Rent payments

• Consultation fees

• Professional fees

However, individuals are not required to deduct TDS when they make rent paymentsor pay fees to professionals like lawyers and doctors.

TDS is one kind of advance tax. It is tax that is to be deposited with the governmentperiodically and the onus of the doing the same on time lies with the deductor. Forthe deductee, the deducted TDS can be claimed in the form of a tax refund after theyfile their ITR.

( 228 )

13.2 OBJECTIVESAfter going through lesson you should be able to understand the provision of TDSrelated to commission or brokerage, rent, professional or technical services,infrastructure debt fund, units of business trust, units of investment fund, investmentin securitisation fund,bonds/government securities.

13.3 TDS FROM COMMISSION OR BROKERAGE [SEC. 194H]

The provisions of section 194H are given below-

When tax has to be deducted ?

Tax shall be deducted at the time of credit of such income to the account of thepayee or at the time of payment of such income in cash or by the issue of a cheque ordraft or by any other mode, whichever is earlier. Where any income is credited to anyaccount, whether called "Suspense account" or by any other name, in the books ofaccount of the person liable to pay such income, such crediting shall be deemed to becredit of such income to the account of the payee.

"Commission or brokerage" for the purpose of section 194H includes any paymentwhich satisfies the following conditions-

Who is the payer

Who is the recipient

Payment covered


Maximum amount which can be paid without taxdeduction




Any person paying commission or brokerage (not being anindividual or Hindu undivided family whose books ofaccount are not required to be audited under section 44ABin the immediately preceding financial year)

Any resident person

Commission or brokerage (not being insurancecommission)

At the time of payment or at the time of credit, whichever isearlier

If the amount of payment is Rs. 5,000 (Rs. 15,000 from June1, 2016) or less

10% (5% from June 2, 2016)

---

The recipient can make an application in Form No. 13 tothe Assessing Officer to get a certificate of lower taxdeduction or no tax deduction

Payment is received or receivable by a person acting on behalf of the payer.The aforesaid payment is received for services rendered (not being professional services) or for anyservice in the course of buying / selling of goods or in relation to any transaction relating to any asset,valuable article or thing, not being securities.The above payment may be received or receiable directly on indirectly.The above payment is not insurance commission covered by section 194D.

Condition 1Condition 2

Condition 3Condition 4

( 229 )

The expression "professional services" means services rendered by a person in thecourse of carrying on a legal, medical, engineering or architectural profession or theprofession of accountancy or technical consultancy or interior decoration or suchother profession as is notified by the Board for the purposes of section 44AA (i.e.,authorised representative, film artist, 'company secretary and information technology).

A question may arise whether there would be deduction of tax under section 194Hwhere commission' or brokerage is retained by the consignee/agent and not remittedto the consignor/ principal while remitting the sale consideration. Since the retentionof commission by the consignee/agent amounts to constructive payment of the sameto him by the consignor/ principal, deduction of tax at source is required to be madefrom the amount of commission. Therefore, the consignor/principal will have to depositthe tax deductible on the amount of commission income-Circular No. 619, datedDecember 4, 1991.

Tax is not deductible in respect of commission or brokerage paid or payable byBSNL/ MTNL to their PCO franchises.

13.4 TDS FROM RENT [SEC. 194-I]

The provisions of section 194-I are given below-

Who is the payer


Payment covered




Any person paying rent (not being an individual or Hinduundivided family whose books of account are not requiredto be audited under section 44AB in the immediatelypreceding financial year)

Any resident person

Rent

At the time of payment or at the time of credit, whichever isearlier

If the amount of payment during a financial year is Rs.1,80,000 or less than Rs. 1,80,000

The recipient can make an application in Form No. 13 toAssessing Officer to obtain lower TDS certificate.Alternatively, recipient (can submit Form No. 15G/ 15H tothe payer of income

( 230 )

Rate of TDS

Tax is deductible at source under section 194-I at the rates given below-

• Service tax or GST- Tax is deductible in respect of payment/credit of rent (excludingservice tax or GST) - Circular No. 4/2008, dated April 28,2008, Circular No. 23/2017, dated July 19,2017.

Time for Deduction of tax at source

The person responsible for paying rent should deduct tax at source. Tax is to bededucted at source either:

a at the time of credit of such income to the account of payee; or

b. at the time of payment thereof in cash or by issue of a cheque or draft or by anyother mode, whichever is earlier:

Where any income by way of rent is credited to any account (whether called "Suspenseaccount" or by any other name) in the books of account of the person liable to paysuch rent, such crediting shall be deemed to be credit of such income to the accountof the payee.

Rent as defined in section 194-I

The salient features of "rent" are as follows-

1. Payment is made under any lease, sub-lease, tenancy or any other agreement orarrangement.

2. Payment is made for use of land, building (including factory building), landappurtenant to a building, machinery, plant, equipment, furniture or fittings.

3. It is immaterial whether or not such building is owned by the person to whom rentis paid.

For the use of any machinery or plant or equipment 2%

For the use of any land or building or furniture or fittings for all persons. 10%

( 231 )

Provisions of TDS is not applicable in the following cases:

No tax deduction if payee is Government/local authorities

There is no requirement to deduct income-tax at source on income by way of 'rent' ifthe payee is the Government. In the case of the local authorities and the statutoryauthorities referred to in section 10(20A)/ 10(20), there will be no requirement todeduct income-tax at source from income by way of rent if the person responsible forpaying it is satisfied about their tax-exempt status under clause (20) or (20A) ofsection 10 on the basis of a certificate to this effect given by the said authorities-Circular No. 699, dated January 30, 1995.

No tax deduction when rent is paid/ credited to real estate investment trust

With effect from June 1, 2015, no tax deduction shall be made under section 194-Iwhere the income by way of rent is credited or paid to a business trust, being a realestate investment trust, in respect of any real estate asset, referred to in section10(23FCA), owned directly by such business trust.

Payment with no tax deduction or lower tax deduction- Provisions of Sec. 197are applicable.




(1) [Subject to rules made under sub-section (2A), where, in the case of any incomeof any person [or sum payable to any person, income-tax is required to be deducted

( 232 )

at the time of credit or, as the case may be, at the time of payment at the rates in forceunder the provisions of sections 192, 193, 194, 194A, 194C, 194D, 194G, 194H,194-I, 194J, 194K, 194LA and 195, the Assessing Officer is satisfied that the totalincome of the recipient justifies the deduction of income-tax at any lower rates or nodeduction of income-tax, as the case may be, the Assessing Officer shall, on anapplication made by the assessee in this behalf, give to him such certificate as may beappropriate.











( 233 )



• Declaration to the payer in form No. 15G - If a declaration is submitted undersection 197A by the receipient to the payer, then no tax is deductible in a few cases.The provisions of section 197A as are given in the table

Taxable pre-

mature

withdrawal

from

provident

fund [Sec.

192 A]

Interest[Sec.193

and 194A] or

rent[ Sec. 194-I

with effect from

June 1, 2016] or

insurance

commission[

Sec. 194D, with

effect from

June1, 2017]

Dividend

[Sec.194]

Payment in

respect of

life

insurance

policy [Sec.

194DA]

National

Savings

Scheme

[Sec.

194EE]

Condition 1- Who is

receipient


company or

firm

Resident

Individual

Other than

a company

or firm

Resident

Individual


tax on total income


Nil Nil Nil Nil Nil

Condition 3- How

much is total of

income covered by

section 192A, 193,

194, 194A, 194D,

194DA, 194-I and

194EE


( 234 )

13.5 TDS ON FEES FOR PROFESSIONAL AND TECHNICAL SERVICES[SEC. 194J]

The provisions of section 194J are given below-

When tax is deductible at lower rate- Provisions of Sec. 197 are applicable.



Who is the payer


Payment covered






Any person (not being an individual /HUF) who pays/ credit fees forprofessional/technical service/royalty or director’s fees, is responsiblefor tax deduction.However, an invidual/HUF is responsibsle for tax deduction only ifbooks of account of the payer is subject to audit under section 44ABin the immediately preceding year and payment/ credit is ofprofessional fees (not for personal purposes) or technical fees)

A resident personFees for professional/technical services/royalty (excluding service tax,if service tax is shown separately in invoice).At the time of payment or at the time of credit, whichever is earlier

If the amount of profession fees during a financial year is Rs. 30,000or less than Rs. 30,000. Similarly, the amount of technical fees duringa financial year is Rs. 30,000 or less. Further if the amount of royaltyduring a financial year is Rs. 30,000 or less Rs. 30,000 in case ofany sum referred to in section 28 (va). No threshold limit is providedin the case of director’s fees.

10% (with effect from June 1, 2017, it is 2% if the recipient is engagedonly in the business of operation of call centre)--

The recipient can make an application in Form No. 13

( 235 )











( 236 )





The expression "professional services" has been defined to mean services renderedby a person in the course of carrying on legal, medical, engineering or architecturalprofession or the profession of accountancy or technical consultancy or interiordecoration or advertising (i.e., models, artists, photographers, providing services toan advertising agency) or such other profession as is notified by the Board for thepurposes of section 44AA [ authorised representative, film artist or company secretaryor information technology] or of this section4 The expression "fees for the technicalservices" has been given the same meaning as in Explanation 2 below clause (viz) ofsub-section (1) of section 9.

• Amount paid by non-resident- Any fees paid through regular banking channels toany chartered accountant, lawyer, advocate or solicitor who is resident in India bythe non-resident who do not have any agent or business connection or permanentestablishment in India may not be subject to the provisions of tax deduction at sourceunder section 194J- Circular No. 726, dated October16, 1995.

• Can payment for services provided by machines be taken as royalty -After theamendment made 'by the Finance Act, 2012 in section 9, consideration for servicesprovided by machines will become "royalty" and will be subject to the provisions ofsection 194J.

( 237 )

13.6 TDS FROM INTEREST PAYABLE ON INFRASTRUCTURE DEBTFUND [SEC. 194LB]

Section 194LB provides for tax deduction at source as follows-

13.7 TDS FROM INCOME FROM UNITS OF BUSINESS TRUST [SEC.194LBA]

The provisions of section 194LBA applicable from October 1, 2014 are given below-

• Time of tax deduction - Tax deduction is applicable if a business trust distributesany income referred to in section 115UA [being of the nature referred to in sectionl0(23FC)(a) or section 10(23FCA)] to its unit holder. Taxis deductible at the time ofcredit of such payment to the account of the payee or at the time of payment thereofin cash or by the issue of a cheque or draft or by any other mode, whichever is earlier.

• Rate of TDS - Tax is deductible at the following rates - -

If the recipient is resident - If the recipient unit holder is resident in India, tax isdeductible at the rate of 10 per cent. -

If the recipient is non-resident - if the recipient unit holder is a non-resident or aforeign company, tax is deductible at the rate of 5 per cent. If, however, rental income(received by a real estate investment trust) is distributed to unit holders, tax shall bededucted at rate in force as applicable for deduction of tax on payment to the non-resident of any sum chargeable to tax (applicable from June 1, 2015).

Who is the payer/deductor




Rate of tax deductionIs it possible to get the payment without TDS or withlower TDS

Any person responsible for paying income by way orinterest by an infrastructure debt fund referred to in section10(47)

A non-resident or a foreign company

Interest on infrastructure debt fund

At the time of credit of such income to the account ofrecipient or at the time of payment thereof in cash or bycheque/draft/any other mode, whichever is earlier

No threshold limit

5% (+SC+EC+SHEC)

Section 197 is not applicable

( 238 )

If the recipient does not have PAN, tax is deductible at the rate of 20 per cent.Provisions of section 197 or section 197A are not applicable.

13.8 TDS FROM INCOME IN RESPECT OF UNITS OF INVESTMENT FUND[SEC. 194LBB]

Section 194LBB has been inserted with effect from June 1, 2015. Provisions of thissection are given below -

• Time of tax deduction - Tax deduction is applicable if a business trust distributesany income referred to in section 115UB [not being business income of the naturereferred to in section 10(23FB) to its unit holder. Tax is deductible at the time ofcredit of such payment to the account of the payee or at the time of payment thereofin cash or by the issue of a cheque or draft or by any other mode, whichever is earlier.

• Rate of TDS - Tax is deductible at the rate of 10 per cent. If the recipient does nothave PAN, tax is deductible at the rate of 20 per cent.

• Lower TDS certificate - Provisions of section 197 or section 197A are not applicable.

13.9 TDS FROM INCOME IN RESPECT OF INVESTMENT INSECURITIZATION FUND [SEC. 194LBC]

Section 194LBC has been inserted with effect from June 1, 2016. Provisions of thissection are given -

• Time of tax deduction - Tax deduction is applicable if income is payable to aninvestor respect of an investment in a securitization trust. Tax is deductible at thetime of credit of such payment to the account of the payee or at the time of paymentthereof in cash or by the issue of a cheque or draft or by any other mode, whicheveris earlier.

• Rate of TDS - Tax is deductible at the rates given below -

a. 25 per cent (where the payee is a resident individual/HUF);

b. 30 per cent (where the payee is a resident but other than an individual/HUF);

( 239 )

c. 40 per cent (+SC+EC+SHEC) (where the payee is a foreign company);

d. 30 per cent (+SC+EC+SHEC) (where the payee is a non-resident, not being aforeign company).

o Lower TDS certificate - Provisions of section 197 are applicable. However, section197A is not applicable.

13.10 TDS FROM INTEREST ON BONDS/GOVERNMENT SECURITIES[SEC.194LD]

Section 194LD provides as under -

Who is deductor - Any person who is responsible to for making payment (as givenbelow) should deduct tax at source.

Who is deductee- A foreign institutional investor or a qualified foreign investor.

Payment covered by section 194LD-Interest on a rupee denominated bond of anIndian company (interest not to exceed notified rate of interest) or Government securitywhich is payable after May 31, 2013 but before July 1, 2020.

Time of tax deduction - At the time of payment or at the time giving credit to therecipient, whichever is earlier.

Rate of TDS -5 per cent (+SC+EC+SHEC). If recipient does not have PAN, tax isdeductible at the rate of 20 per cent.

Lower TDS certificate under section 197- Not possible.

13.11 SUMMARY

TDS stands for tax deducted at source. As per the Income Tax Act, any company orperson making a payment is required to deduct tax at source if the payment exceedscertain threshold limits. TDS has to be deducted at the rates prescribed by the taxdepartment. The company or person that makes the payment after deducting TDS iscalled a deductor and the company or person receiving the payment is called thedeductee. It is the deductor's responsibility to deduct TDS before making the paymentand deposit the same with the government. TDS is deducted irrespective of the mode

( 240 )

of payment-cash, cheque or credit-and is linked to the PAN of the deductor anddeducted.

13.12 GLOSSARY

Sec. 194H- TDS from Commission or brokerage

Sec. 194I- TDS from Rent

Sec. 194J- TDS on fees for professional and technical services

Sec. 194LB- TDS from interest payable on infrastructure debt fund

Sec. 194LBA- TDS from Income from units of business trust

Sec. 194LBB TDS from income in respect of units of investment fund

Sec. 194LBC TDS from income in respect of investment in securitization fund

Sec. 194LD- TDS from interest on bonds/government securities


1. What do you understand by professional services?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. Explain the provisions of Sec. 197 of the Income Tax Act.

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

( 241 )

____________________________________________________________

____________________________________________________________


1. Explain the TDS provisions related to interest payable on infrastructure debtfund.

2. What is the rate of TDS applicable to payment of rent?

3. Describe the TDS provisions with respect to income in respect of units ofinvestment fund.

4. Discuss the TDS provisions for interest on bonds/government securities.




3. Income Tax Law and Practice- By V.P. Gaur, D.B. Narang, Puja Gaur andRajeev Puri

-----

( 242 )


DEDUCTION FROM GROSS TOTAL INCOME UNDER SECTION80C, 80CCD, 80CCG, 80D, 80DD, 80DDB, 80E, 80EE, 80G, 80GG,

80LA, 80TTA, 80U

Structure

14.1 Introduction

14.2 Objectives

14.3 Deduction in respect of life insurance premia, contributions to provident fundetc.(80C)

14.4 Deduction in respect of contribution to a National Pension System (NPS)(80CCD)

14.5 Deduction in respect of investment made under any equity saving scheme(80CCG)

14.6 Deduction in respect of medical insurance premia (80D)

14.7 Deduction in respect of maintenance including medical treatment of adependent being a person with disability (80DD)

14.8 Deduction in respect of medical treatment etc. (80DDB)

14.9 Deduction in respect of payment of interest on loan taken for higher studies(80E)

( 243 )

14.10 Deduction in respect of interest on loan taken for residential house property(80EE)

14.11 Deduction in respect of donation to certain funds, charitable institutions, etc.(80G)

14.12 Deduction in respect of rent paid (80GG)

14.13 Deduction in respect of certain income of Offshore Banking Units andInternational Financial Services centre (80 LA)

14.14 Deduction in respect of interest on deposits in savings accounts (80TTA)

14.15 Deduction in case of a person with disability (80U)

14.16 Summary

14.17 Glossary




14.1 INTRODUCTION

In computing the total taxable income of an assessee, certain deductions under section80C to 80U are allowed from his Gross Total Income. It means, firstly, that theincome of the assessee shall be calculated under five specific heads of income andincomes from all heads are put together and then from this total, certain deductionsare made and after making deductions whatever remains shall be the total income ortotal taxable income. The deductions to be allowed from the Gross Total Income areto be distinguished from the deductions which are made while computing incomeunder different heads. The deductions made from the gross total income are eitherincentive to save for future or a kind of relief to the assessee in certain cases. On theother hand, the deductions made while computing income under different heads are

( 244 )

allowed to meet the expenses which are necessary, wholly, totally and exclusivelyincurred in earning under these heads of income.

14.2 OBJECTIVES :


This lesson aims at providing students with knowledge about deductions from grosstotal income available to different assessees under Income Tax Act 1961.

14.3 DEDUCTION IN RESPECT OF LIFE INSURANCE PREMIA,CONTRIBUTIONS TO PROVIDENT FUND ETC.(80C)

• Deduction under section 80C is available only to an individual or a Hindu undividedfamily.

• Deduction is available on the basis of specified qualifying investments/contributions/deposits/payments (hereinafter referred to as "gross qualifying amount") made bythe taxpayer during the previous year. Such investment, deposit, etc., can be madeout of taxable income or otherwise.

• Amount deductible under section 80C cannot be more than Rs. 1, 50,000.

• The maximum amount deductible under sections 80C, 80CCC and 8OCCD (1)cannot exceed Rs. 1, 50,000".

Qualifying Investment

1. Life insurance premium [ to a maximum of 20 per cent of sum assured (if policy isissued before April 1, 2012) or 10 per cent of sum assured (if policy is issued on orafter April 1, 2012)**]

2. Payment in respect of non-commutable deferred annuity

3. Any sum deducted from salary payable to a Government employee for the purposeof securing him a deferred annuity (subject to a maximum of 20% of salary)

4. Contribution (not being repayment of loan) towards statutory provident fund andrecognized provident fund

( 245 )

5. Contribution (not being repayment of loan) towards 15-year public provident fund[the public provident fund scheme, the maximum contribution is Rs. 1,50,000.

6. Contribution towards an approved superannuation fund

7. Subscription to National Savings Certificates (VIII Issue and IX Issue) and depositin Sukanya Samriddhi Account.

8. Contribution for participating in the Unit-Linked Insurance Plan (ULIP) of UnitTrust of India

9. Contribution for participating in Unit-Linked Insurance Plan (ULIP) of LIC MutualFund

10. Payment for notified annuity plan of LIC or any other insurer.

11. Subscription towards notified units of Mutual Fund or UTI

12. Contribution to notified pension fund set up by Mutual Fund or UTI (i.e.,Retirement Benefit Pension Fund of UTI)

13. Any sum paid (including accrued interest) as subscription to Home Loan AccountScheme of the National Housing Bank or contribution to any notified pension fundset up by the National Housing Bank.

14 Any sum paid as subscription to any scheme of-

a. public sector company engaged in providing long-term finance for purchase/construction of residential houses in India (i.e., public deposit scheme of HUDCO)

b. housing board constituted in India for the purpose of planning, development orimprovement of cities/towns

15. Any sum paid as tuition fees (not including any payment towards developmentfees/donation/payment of similar nature) whether at the time of admission or otherwiseto any university/college/educational institution in India for full time education ofany two children of an individual.

16. Any installment or part payment towards the cost of purchase/construction of aresidential property to a housing board or co-operative society (or repayment of

( 246 )

housing loan taken from Government, bank, cooperative bank, LIC, National HousingBank, assessee's employer where such employer is public company/public sectorcompany/university/co-operative society).

17. Amount invest in approved debentures of, and equity shares in, a public companyengaged in infrastructure including power sector or units of a mutual fund proceedsof which are utilized for the developing, maintaining, etc., of a new infrastructurefacility.

18. Amount deposited as term deposit for a period of 5 years or more in accordancewith a scheme framed by the Government.

19. Subscription to any notified bonds of National Bank for Agriculture and RuralDevelopment (NABARD).

20. Amount deposited under Senior Citizens Saving Scheme.

21. Amount deposited in five-year time deposit scheme in post office.

Notes-

I. Interest on NSC will be chargeable to tax on the basis of annual accrual. Moreover,the accrued interest for any year (except last year) is deemed as re-investment andthe same is entitled for deduction under section 80C.

II. Investment/deposits are qualified on payment basis.

14.4 DEDUCTION IN RESPECT OF CONTRIBUTION TO A NATIONALPENSION SYSTEM (NPS) (80CCD)

Under section 8OCCD(1) - Employee's contribution to National Pension System(NPS) (Le., New Pension Scheme and Atal Pension Yojna) or 10 per cent of salary,whichever is lower, is deductible under section 8OCCD(1). In case of a person otherthan employee, amount deductible under section 8OCCD(l) is contribution by suchperson or 10 per cent (20 per cent from the assessment year 2018-19) of gross totalincome, whichever is lower.

• Under section 8OCCD(2) - Employer's contribution to NPS is first included insalary income and then it is deducted under section 8OCCD(2). However, deduction

( 247 )

under section 8OCCD(2) cannot exceed 10 per cent of salary of the employee.

• Under section 80CCD(1B) - From the assessment year 2016-17, an employee (orany other person) can contribute to NPS and claim (up to Rs. 50,000) additionaldeduction under section

Cumulative ceiling under section 80CCE - The aggregate amount of deduction undersections 80C, 8OCCC and 8OCCD(1) cannot exceed Rs. 1,50,000. This ceiling isnot applicable on amount deductible under section 8OCCD(1B) and 8OCCD(2).

Amount taxable at the time of receipt - Taxable as follows -

•Meaning of salary - "Salary" includes dearness allowance, if the terms of employmentso provide. It also includes commission if commission is payable at a percentageturnover achieved by him. But it excludes all other allowances and perquisites.

14.5 DEDUCTION IN RESPECT OF INVESTMENT MADE UNDER ANYEQUITY SAVING SCHEME (80CCG)

A resident individual (not having gross total income exceeding Rs. 12 lakh) can claimdeduction under section 8OCCG if he is a new retail investor as specified in a schemenotified by the Government and has acquired shares in accordance with the notifiedscheme. Such investment is locked-in for a period of 3 years.

Amount of deduction is 50 per cent of investment or Rs. 25,000, whichever is less(available up to the assessment year 2017-18, subject to a few exceptions).

Provisions applicable -From the

AY 2018-19For the

AY 2017-18

1. Partial withdrawal form NPS (to the extent it does not exceed25% of an employee’s contribution)2. Amount received by the assessee on closure of account or on hisopting out of the NPS Scheme3. In (2), amount is received by a nominee on the death of the assessee4. Pension received out of NPS5. Amount received in (2), (3), (4) is utilized for purchasing anannuity plan in the same previous year6. Pension received out of annuity plan purchased in (5)

Exempt

60% taxable

ExemptTaxable

ExemptTaxable

Taxable

60% taxable

ExemptTaxable

ExemptTaxable

( 248 )

14.6 DEDUCTION IN RESPECT OF MEDICAL INSURANCE PREMIA (80D)

The salient features of the provisions of section 80D are given below:

1. The taxpayer is an individual (maybe resident/non-resident or Indian citizen/foreigncitizen) or a Hindu undivided family (maybe resident or non-resident).

2. Mediclaim insurance is paid by the individual or Hindu undivided family In thecase of individual payment can also be made to the Central Government Health Schemeand/or on account of preventive health check-up.

3. Payment should be made out of income chargeable to tax

4. Payment should be made by any mode other than cash. However payment onaccount of preventive health check-up can be made by any mode (including cash).

An individual/HUF can claim deduction under section 80D if payment is made out ofincome chargeable to tax. The table given below highlights provisions of section 80Dapplicable from the assessment year 2016-17 onwards -

Deduction in thecase of individual

Deduction inthe case of HUF

Family Parents Any memberof HUF

For whose benefit payment can be made

A. a. Medi-claim insurance premiumb. Contribution to CGHS/notified schemec. Preventive health check-up payment

EligibleEligibleEligible

Eligible–Eligible

Eligible––

Maximum deduction -- General deduction [applicable in respect

of (a), (b) and (c)]- Additional deduction [applicable only in

case of (a) when medi-claim policy intaken on the life of a senior citizen]

Rs. 25,000

Rs. 5,000

Rs. 25,000

Rs. 5,000

Rs. 25,000

Rs. 5,000

Medical expenditure on the health of a personwho is a super senior citizen if mediclaiminsurance is not paid on the health of such person

Maximum deduction in respect of (B)

Maximum deduction in respect of (A) and (B)

B.

C.

Eligible Eligible Eligible

Rs. 30,000 Rs. 30,000 Rs. 30,000Rs. 30,000 Rs. 30,000 Rs. 30,000

Notes -

1. Family includes individual, spouse of the individual and dependent children of theindividual.

( 249 )

2. Parents include father and mother (dependent or otherwise). Father-in-law andmother-in-law are not included.

3. The aggregate payment on account of preventive health check-up of self, spouse,dependent children, father and mother cannot exceed Rs. 5,000.

4. The above payments [given under (A) and (B)] should be made by any mode otherthan cash.

However, payment on account of preventive health check-up can be made by anymode (including cash).

5. "Senior citizen" is a resident individual who is at least 60 years of age at any timeduring the previous year.

6. "Super senior citizen" is a resident individual who is at least 80 years of age at anytime during the previous year.

14.7 DEDUCTION IN RESPECT OF MAINTENANCE INCLUDINGMEDICAL TREATMENT OF A DEPENDENT BEING A PERSON WITHDISABILITY (80DD)

The provisions of section 8ODD are given below:

Conditions- The following conditions should be satisfied-

1. The taxpayer is resident in India (maybe ordinarily resident or not ordinarilyresident)

2. The resident taxpayer is an individual (maybe an Indian citizen or foreign citizen)or a Hindu undivided family.

3. The taxpayer has opted for any (or both) of the following options-

Option 1 Option 2

The taxpayer has incurred an expenditure for themedical treatment (including nursing), training andrehabilitation of a dependent (being a person withdisability)

The taxpayer has paid or deposited under anyscheme framed in this behalf by the Life InsuranceCorporation or any other insurer, or theadministrator1 or specified company2 and apporovedby the Board in this behalf, for maintenance ofdependent (being a person with disability)

( 250 )

4. For the above purpose a "dependent being a person with disability' is a person whosatisfies the following points-

a. in the case of an individual, dependent means the spouse, children, parents, brothersand sisters of the individual or any of them;

b. in the case of a Hindu undivided family; "dependent" means a member of a Hinduundivided family;

c. such person is wholly or mainly dependent upon such individual or Hindu undividedfamily for support and maintenance;

d. such person has not claimed any deduction under section 80U in computing histotal income for the assessment year relating to the previous year;

e "disability" shall have the meaning assigned to it in section 2(i) of the Persons withDisabilities (Equal Opportunities Protection of Rights and Full Participation) Act1995;

f. "person with disability" means a person having any "disability' stated above of notless than 40 per cent.

Autism Cerebral Palsy and Multiple Disability - The meaning of the expression"disability' has been enlarged from the assessment year 2005-06 to include "autism',"cerebral palsy' arid "multiple disability' referred to in clauses (a), (c) and(h) of section2 of the National Trust for Welfare of Persons with Autism Cerebral Palsy MentalRetardation and Multiple Disabilities Act, 1999. A similar amendment has been madein the definition of medical authority' "person with disability' and "person with severedisability'.

5. Under option 2 the scheme provides for payment of an annuity or a lump sumamount for the benefit of dependent, being a person with disability, in the event of thedeath of the individual or the member of the Hindu undivided family in whose namesubscription to the scheme has been made.

6. Under option 2, the assessee nominates either the dependent (being a person withdisability) or any other person or a trust to receive the payment on his behalf, for thebenefit of such dependent.

( 251 )

7. For claiming the deduction, the assessee shall have to furnish a copy of the certificateissued by the medical authority along with the return of income [certificate shall be inForm No. 10-IA where the person is suffering from autism, cerebral palsy or multipledisability or in the form prescribed under Persons with Disabilities Act in any othercase]. Where the condition of disability requires reassessment, a fresh certificate fromthe medical authority shall have to be obtained after the expiry of the period mentionedon the original certificate in order to continue to claim the deduction. Amount of deduction - The amount deductible is a fixed deduction of Rs. 50,000(Rs. 75,000 from the assessment year 2016-17) whenever the conditions specifiedabove are satisfied irrespective of the amount incurred or deposited under Option 1and/or Option 2

A higher deduction of Rs. 1,00,000 (Rs. 1,25,000 from the assessment year 2016-17)shall be allowed, where such dependant is a person with severe disability havingdisability of 80 per cent or more.

If dependent predeceases the taxpayer - If the dependent with disability predeceasesthe individual or the member of the Hindu undivided family referred to above, anamount equal to the amount paid or deposited as stated above shall be deemed to bethe income of the assessee of the previous year in which such amount is received bythe assessee and shall accordingly be chargeable to tax as the income of that previousyear.

14.8 DEDUCTION IN RESPECT OF MEDICAL TREATMENT ETC. (80DDB)

The provisions of section 80DDB are given below-

Conditions - One has to satisfy the following conditions-

1. The taxpayer is resident in India (maybe ordinarily resident or not ordinarily resident).

2 The taxpayer is an individual (maybe an Indian citizen or a foreign citizen) or aHindu undivided family.

3. The taxpayer has actually paid any amount for the medical treatment of a specifieddisease or ailment as prescribed by the Board under rule 11DD.

( 252 )

4. The expenditure is actually incurred for medical treatment of the assessee himselfor wholly/mainly dependent husband/wife, children, parents, brothers and sisters ofthe taxpayer. If the taxpayer is a Hindu undivided family the expenditure is actuallyincurred for the medical treatment of any member of the family who is wholly/mainlydependent upon the family.5. The assessee shall have to submit a certificate in the prescribed form [Form No. l0-I] from a neurologist, an oncologist, a urologist a hematologist, an immunologist orsuch other specialist as may be prescribed working in a Government hospital. Fromthe assessment year 2016 17 the assessee is required to obtain a prescription from aspecialist doctor for the purpose of availing this deduction. Amount of deduction- If all the aforesaid conditions are satisfied the amount ofdeduction is Rs 40000 or the expenditure actually incurred whichever is lower.• Where the expenditure incurred is in respect of the assessee or his dependant or anymember of a Hindu undivided family of the assessee and who is a senior citizen [i.e.an individual who is resident in India and who is at least 60 years of age at any timeduring the previous-year], then Rs. 60,000 or actual expenditure, whichever is lower,is deductible. From the assessment year, 2016-17 the amount of deduction will beRs. 80,000 or actual expenditure, whichever is lower, in the case of medical treatmentof a super senior citizen (i.e., a resident individual who is at least 80 years of age atany time during the previous year)• Deduction under this section shall be reduced by the amount received, if any, underinsurance from an insurer, or reimbursed by an employer, for the medical treatmentof the person referred to above. Other points - The following points shall be noted-1. For this purpose "Government hospital" includes a departmental dispensary (whetherfull-time or part-time) established and run by a department of the Government foremployees, a hospital maintained by a local authority and any other hospital withwhich arrangements have been made by the Government for the treatment ofGovernment servants.2. The requirement is only of working in a Government hospital. It does not requireemployment in a Government hospital on regular basis. A surgeon rendering honoraryservice at a Government hospital is as such a surgeon working in a Governmenthospital.

( 253 )

Illustration I X (35 years) is a resident individual. During the previous year, he incurs the following

expenditure—Actual

expenditure

Name of the taxpayer

Amount re-imbursed by

Insurancecompany

Rs.

Amountreimbursed byemployer of

XRs.

30,000

14,300

Nil

3,000

28,000

6,000

Medical treatment (specified disase) of X in aGovernment hospitalMedical treatment (specified disease) of Mrs. X in ahospital recognised by Chief CommissionerSalary of X is Rs. 4,00,000. In the two cases, disease is specified in the rules made by the Board. Findout the net income of X for the assessment year 2015-16SOLUTION :

Rs.Salary 4,00,000Perquisite in respect of medical treatment of X and his spouse NilGross salary 4,00,000Less : Standard deduction —Salary 4,00,000Any other income NilGross otal income 4,00,000Less : Deduction under section 80DDB [see Note] 3,000Net Income 3,97,000

Note - The amount deductible is as follows —a. actual expenditure (i.e., Rs. 30,000 + Rs. 14,000); orb. Rs. 40,000 (Rs. 60,000 in the case of senior citizen),whichever is less.Rs. 40,000 is deductible if nothing is recovered from the insurance company or employer. From the amountdeduction (i.e., Rs. 40,000 in this case), the amount received from insurance company as well as employershall be deducted. Therefore, Rs. 40,000 – Rs. 3,000 – Rs. 28,000 – Rs. 6,000, i.e., Rs. 3,000 is deductible.Find out the amount of deduction under section 80DDB in the followin g cases for the assessment year2015-16

X Y Z A BResidential status of the taxpayer

Expenditure incurred on medical treatment of dependent mother in a hospitalrecognised by the Chief Commissioner(amount in rupees)Age of motherResidential status of dependent mother

Resident Resident Resident Resident Non-resident

50,00059 yearsResident

26,00059 years

Non-resident


1,00,00063 years

Non-resident


( 254 )

Note - The perquisite in respect of reimbursement of medical expenditure by employer is notchargeable to tax.Suppose in problem, the expenditure is incurred on medical treatment of dependent grandmother.SOLUTION :

Deduction under section 80DDB is not available from the assessment year 2005-06. Moreover,the perquisite in respect medical treatment reimbursement of medical expenditure is taxable(even deduction of Rs. 15,000 is not available).

14.9 DEDUCTION IN RESPECT OF PAYMENT OF INTEREST ON LOANTAKEN FOR HIGHER STUDIES (80E)

Deduction under section 80E is available if the following conditions are satisfied

Amount of deduction under section80DDB

XRs.

YRs.

ZRs.

ARs.

BRs.

Deduction under section 80DDB if nomoney is recovered from insurancecompany and employerLess : Amount received from insurancecompany and employerAmount of deduction under section 80DDB

40,000

6,00034,000

26,000

17,0009,000

60,000

74,000Nil

40,000

35,0005,000

Nil

23,000Nil

Name of the taxpayer X Y Z A BWhether the disease is specified underrule 11DD made by the BoardAmount received from insurancecompany (amount in rupees)Amount received from the employer ofthe taxpayer (amount in rupees

Yes Yes Yes Yes Yes

4,000

2,000

14,000

3,000

70,000

4,000

15,000

20,000

7,000

16,000

SOLUTION :

Condition 1

Condition 2

Condition 3

Condition 4

Condition 5

Condition 6

The assessee is an individual

He had taken loan from any bank, financial institution [i.e., a banking company or notified financialinstitution*] or an approved charitable institution [i.e., an institution approved for the purpose ofsection 10 (23C) or 80G (2) (a).

The loan was taken for the purpose of purshing higher education [i.e., all fields of studies (includingvocational studies) pursued after passing the Senior Secondary Examination or its equivalent fromany school, board or university recognised by the Central Government or State Government orlocal authority or by any other authority authorized by the Central Government or State Governmentor local authority to do so].

The loan was taken by taxpayer for the purpose of pursuing his own higher education or for thepurpose of higher education of his relatives, i.e., spouse/ any child/ / (with effect from the assessmentyear 2010-11) the student for whom the taxpayer is the legal guardian.

Amount is paid by the individual during the previous year by way of interest on such loan.

Such amount is paid out of his income chargeable to tax.

( 255 )

Amount deductible - If the above conditions are satisfied, the entire amount paid by wayof interest is deductible under section 80E. However, the following points should be noted-1. The above deduction is allowed in computing the taxable income of the initialassessment year (i.e. the assessment year relevant to the previous year in which theassessee starts paying the interest on the loan) and 7 immediately succeedingassessment years (or until the above interest is paid in full, whichever is earlier).2. From the assessment year 2006-07, no deduction will be available under section80E in respect of repayment of principal amount.14.10 DEDUCTION IN RESPECT OF INTEREST ON LOAN TAKEN FORRESIDENTIAL HOUSE PROPERTY (80EE)Deduction under section 8OEE is, available if the following conditions are satisfied1. The assessee is an individual.2. He has taken a loan from a financial institution. Financial institution is a bank orhouse finance company (i.e. an Indian public limited company formed with the mainobject of carrying on the business of providing long-term finance for construction orpurchase of residential houses in India).3. The loan has been sanctioned by the financial institution during the financial year2016-17.4. The amount of loan sanctioned for acquisition of the residential house propertydoes not exceed Rs. 35 lakh.5. The value of residential house property does not exceed Rs. 50 lakh.6. The assessee does not own any residential house property on the date of sanctionof loan. Amount of deduction - If the above conditions are satisfied, interest payable for theprevious year 2013-14 on the aforesaid loan shall be deductible for the assessmentyear 20l4-15 (up to a maximum of Rs. 1 lakh). If, however, interest payable duringthe previous year 2013-14 is less than Rs 1 lakh the balance amount shall be allowedas deduction in the assessment year 2015-16. Now the deduction is allowed for up toRs 50,000 per year, starting from financial year 2016-17 and subsequent years untilthe loan is repaid. If interest is allowed as deduction under' section 80EE, the sameinterest is not deductible under any other provision of the Act for the same or anyother assessment year.14.11 DEDUCTION IN RESPECT OF DONATION TO CERTAIN FUNDS,CHARITABLE INSTITUTIONS, ETC. (80G)

Any taxpayer can claim this deduction. Donation to the following is deductible fromgross total income (the amount of deduction is given in the last column)-

( 256 )

Donee Maximumlimit

Deduction(as % of net

qualifying amount)

a. National Defence Fund

b. Jawaharlal Nehru Memorial Fund

c. Prime Minister’s Dought Relief Fund

d. Prime Minister’s National Relief Fund

e. Prime Minister’s Armenia Earthquake Relief Fund

f. Africa (Public Contributions - India) Fund

g. National Children’s Fund

h. Indira Gandhi Memorial Trust

i. Rajiv Gandhi Foundation

j. National Foundation for Communal Harmony

k. An approved university/ educational institution

l. Maharashtra Chief Minister’s Relief Fund

m. Any fund set up by the Government of Gujarat for providing reliefto victims of earthquake in Gujarat

n. Zila Saksharta Samiti

o. National Blood Transfusion Council and State Council for BloodTransfusion

p. Fund set up by a State Government for the medical relief to thepoor

q. Central Welfare Fund of the Army and Air Force and the IndianNaval Benevolent Fund

r. Andhra Pradesh Chief Minister’s Cyclone Relief Fund

s. National Illness Assistance Fund

t. Chief Minister’s Relief Fund or Lieutenant Governor’s Relief Fund

u. National Sports Fund or National Cultural Fund or Fund forTechnology Development and Application

v. Any other fund or any institution which satisfies conditionsmentioned in section 80G(5)

w. Government or any local authority to be utilised for any charitablepurpose other than the purpose of promoting family planning

x. Any authority constituted in India by (or under) any law enactedeither for the purpose of dealing with and satisfying the need forhousing accomodation or for the purpose of planning, developmentor improvement of cities, towns and villages, or for both

y. Any corporation specified in section 10 (26BB) for promotinginterest of minority community

(1) (2) (3)

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

NA

As given below

As given below

As given below

As given below

100

50

50

100

100

100

100

50

50

100

100

100

100

100

100

100

100

100

100

100

50

50

50

50

50

( 257 )

Maximum amount- Where the aggregate of the sums mentioned in (v), (w), (x), (y),(z), (za), or (zb) supra exceeds 10 per cent of the adjusted gross total income, thenthe amount in excess of 10 per cent of the adjusted gross total income will be ignoredwhile computing the aggregate of the sums in respect of which deduction is to beallowed.

Mode of payment - Donation can be given in cash or by cheque or draft. However, nodeduction shall be allowed under section 80G in respect of donation in cash of anamount exceeding Rs. 10,000 (for the assessment years 2013-14 to 2017-18) or Rs.2,000 (from the assessment year 2018-19 onwards).

Gross total income minus the following is adjusted gross total income-

a. amount deductible under sections 80C to 80U (but not section 80G);

b. such incomes on which income-tax is not payable;

c. long-term capital gains;

Donee Maximumlimit

Deduction(as % of net

qualifying amount)

z. Government or any approved local authority, institution orassociation to be utilised for the purpose of promoting familyplanning

za. Any notified temple, mosque, gurdwara, church o other place (forrenovation or repair)

zb. Indian Olympic Association or to an institute notified by the CentralGovernment for the development of infrastructure for sports andgames in India; or the sponsorship of sports and games in India(only donation by a company)

zc. Any trust, institution or fund to which section 80G(5C) applies forproviding relief for victims of earthquake in Gujarat

zd. National Trust for Welfare of Persons with Autism, Cerebral Palsy,Mental Retardation and Mutiple Disabilities

ze. Swachh Bharat Kosh

zf. Clean Ganga Fund (amount donated by residents only)

zg. National Fund for Control of Drug Abuse (from the assessmentyear 2016-17)

(1) (2) (3)

As given below

As given below

As given below

NA

NA

NA

NA

100

50

100

100

100

100

100

( 258 )

d. short term capital gain which is taxable under section 111A at the rate of 15 percent; and

e. incomes referred to in section 115A, 115AB, 115AC or 115AD

14.12 DEDUCTION IN RESPECT OF RENT PAID (80GG)

1. The taxpayer is an individual.

2. The taxpayer is a self-employed person. Alternatively, the taxpayer is an employeebut he does not get house rent allowance from the employer at any time during theprevious year.

3. The following persons should not own any residential accommodation at the placewhere the taxpayer resides, performs the duties of his office, or employment or carrieson his business or profession-

a. the taxpayer;

b. his/her spouse;

c. his/her minor child (including minor step child and minor adopted child); and

d the Hindu undivided family of which the taxpayer is a member.

4. If the taxpayer owns a residential accommodation at a place other than the placenoted above, then in respect of that house the concession in respect of self-occupiedproperty is not claimed by him.

5. The taxpayer files, online declaration in Form No. 10BA regarding the expenditureincurred by him towards payment of rent.

Amount of deduction

The amount deductible under section 8OGG is the least of the following-

a. Rs. 5,000 per month;

b. 25 per cent of "total income'; or

c. the excess of actual rent paid over 10 per cent of "total income'.

"Total income' for this purpose is gross total income minus long-term capital gains,short-term capital gains under section 111A, deductions under sections 80C to 80U(not being section 8OGG) and income under section 115A.

( 259 )

14.13 DEDUCTION IN RESPECT OF CERTAIN INCOME OF OFFSHOREBANKING UNITS AND INTERNATIONAL FINANCIAL SERVICESCENTRE (80 LA)

The following conditions should be satisfied-

1. The assessee is-

a. a scheduled bank and having an offshore banking unit in a special economic zone;or

b a foreign bank and having an offshore banking unit in a special economic zone or c.a unit of International Financial Services Centre.

2 The gross total income of the assessee includes (a) any income from the offshorebanking unit in a Special Economic Zone; (b) from the business referred to in section6(1) of the Banking Regulation Act, with an undertaking located in Special EconomicZone or any other undertaking which develops, develops and operates or operatesand maintains a Special Economic Zone; (c) from any unit of the International FinancialServices Centre from its business for which it has been approved for setting up insuch a centre in a Special Economic Zone

3. The report from a Chartered Accountant in Form No. 10CCF certifying that thededuction has been correctly claimed in accordance with the provisions of this sectionshould be submitted along with the return of income.

4 Deduction under section 8OLA is not available unless it is claimed m the return ofincome (applicable from the assessment year 2003-04 onwards)

5. A copy of permission obtained under section 23(1)(a) of Banking Regulation Actshould be submitted along with the return of income

Amount of deduction: If the above conditions are satisfied then 100 per cent of theaforesaid income is deductible for 5 consecutive assessment years beginning with theassessment year relevant to the previous year iii which the permission as stated inpoint No 4 (supra) or permission of SEBI or under any other law is obtained. For thenext 5 years 50 per cent of such income would be deductible.

( 260 )

14.14 DEDUCTION IN RESPECT OF INTEREST ON DEPOSITS INSAVINGS ACCOUNTS (80TTA)

Section 8OTTA has been inserted with effect from the assessment year 2013-14. Itprovides a deduction up to Rs. 10,000 in aggregate to an assessee (being an individualor a Hindu undivided family) in respect of any income by way of interest on deposits(not being time deposits) in a savings account with -

a. a banking company;

b. a co-operative society engaged in carrying on the business of banking (including aco-operative land mortgage bank or a co-operative land development bank); or

c. a post office.

However, where the aforesaid income is derived from any deposit in a saving accountheld by, or on behalf of a firm, an association of persons or a body of individuals, nodeduction shall be allowed in respect of such income in computing-the total incomeof any partner of the firm or any member oft-he association or body.

• Post office savings bank, interest exemption under section 1O(15)(i) - Post officesavings bank interest is exempt up to Rs 3,500 (in an individual account) and Rs7000 (in a joint account) under section 10(15)(i) by virtue of Notification No 32/2011 dated June 3 2011, read with Notification No. GSR 607, dated June 9, 1989.The cumulative impact of sections 10(15)(i) and 8OTTA is as follows-

Up to the assessmentyear 2011-12

Rs.

Up to the assessmentyear 2012-13

Rs.

From the assessmentyear 2013-14

Interest on Post OfficeSavings Bank [exemptionunder section 10(15)(i)]

Interest on savings accountwith a bank co-operativebank and Post Office(deduction under section80TTA)

Full exemption, nothingis taxable

No deduction

Exemption upto Rs. 3,500in a single account and Rs.7,000 in a joint account

No deduction

Exemption up to Rs. 3,500in a single account and Rs.7,000 in a joint account

Deduction up toRs. 10,000

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14.15 DEDUCTION IN CASE OF A PERSON WITH DISABILITY (80U)

The provisions of section 80U are given below-

Conditions- Deduction is available if the following conditions are satisfied-

INDIVIDUAL - The taxpayer is an individual (may be a citizen of India or foreigncountry).

RESIDENT IN INDIA - He is resident in India (maybe ordinarily resident or notordinarily resident). Deduction under this section is not available if he is non-residentin India for the relevant assessment year.

PERSON WITH DISABILI1Y - The taxpayers suffers 40 per cent or more than 40per cent of any disability given below-

i. blindness;

ii. low vision;

iii leprosy-cured;

iv. hearing impairment;

v. locomotor disability;

vi mental retardation;

vii. mental illness

"Blindness - "Blindness" refers to a condition where a person suffers from any of thefollowing conditions, namely:-

i. total absence of sight; or . - ,

ii,. visual acuity not exceeding 6/60 or 20/200 (snellen) in the better eye with correctinglenses; or

iii. limitation of the field of vision subtending an angle of 20 degree or worse

• Low vision "Person with low vision" means a person with impairment of visualfunctioning even after treatment or standard refractive correction but who uses or is

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potentially capable of using vision for the planning or execution of a task withappropriate assistive device.

• Leprosy cured person - "Leprosy cured person" means any person who has beencured of leprosy but is suffering from- '

i. loss of sensation in hands or feet-as well as loss of sensation and paresis in the eyeeye-lid but with no manifest deformity;

ii. manifest deformity and paresis but having sufficient mobility in their hands and feetto enable them to engage in normal economic activity;

iii. extreme physical deformity as well as advanced age which prevents him fromundertaking any gainful occupation.

• Hearing impairment - "Hearing impairment' means loss of sixty decibels or more inthe better ear in the conversational range of frequencies.

• Locomotor disability - "Locomotor disability" means disability of the bones, jointsor muscles leading to substantial restriction of the movement of the limbs or anyform of cerebral palsy.

• Mental retardation - "Mental retardation' means a condition of arrested or incompletedevelopment of mind of a person, which is specially characterised by subnormality ofintelligence.

• Mental illness - "Mental illness" means any mental disorder other than mentalretardation.

• Autism, cerebral palsy and multiple disabilities. From the assessment year 2005 06autism cerebral palsy and multiple disability have been included in the expression"person with disability".

CERTIFIED BY MEDICAL AUTHORITY - The taxpayer shall have to furnish acopy of the certificate [ Form No. 10-IA where the person is suffering from autism,cerebral palsy or in the notified form under Persons with Disabilities Act, 1995 in anyother case] issued by the medical authority--along with the return of income. Wherethe condition of disability requires reassessment, - a fresh certificate from the medical

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authority shall have tobe obtained after the expiry of the period mentioned on theoriginal certificate in order to continue to claim the deduction.

"Medical authority' for this purpose means any hospital or institution specified bynotification, by the appropriate Government for the purpose of the Persons withDisabilities (Equal Opportunities, Protections of Rights and Full Participation) Act,1995. -

Amount of deduction - If the aforesaid conditions are satisfied, then a fixed deductionof Rs. 50,000 (Rs. 75,000 from the assessment year 2016-17) is available.-A higherdeduction of Rs. 1,00,000 (Rs. 1,25,000 from the assessment year 2016-17) is allowedin respect of a person with severe disability (ie., having any disability of 80 per centor above).

14.16 SUMMARY

In computing the total taxable income of an assessee, certain deductions under section80C to 80U are allowed from his Gross Total Income. It means, firstly, that theincome of the assessee shall be calculated under five specific heads of income andincomes from all heads are put together and then from this total, certain deductionsare made and after making deductions whatever remains shall be the total income ortotal taxable income.

14.17 GLOSSARY

Sec. 80CCG- Deduction in respect of investment made under any equity savingscheme

Sec. 80E- Deduction in respect of payment of interest on loan taken for higher studies

Sec. 80GG- Deduction in respect of rent paid

Sec. 80U- Deduction in case of a person with disability


1. Explain the necessary conditions for availing deduction under Sec. 80EE.

____________________________________________________________

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____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. What the different avenues of investment for which deduction under Sec. 80C can be availed?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________


1. Explain the provisions of sec. 80D and 80 DD.

2. How is the amount of deduction calculated for sec. 80G?

3. What is amount of deduction available under section 80GG, 80LA, 80TTA?



2. Law & Practice of Income Tax- By Bhagwati Prasad.

------------

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ADVANCE PAYMENT OF TAX- LIABILTY TO PAY ADVANCETAX, DUE DATES OF PAYMENT OF ADVANCE TAX, PAYMENT

OF ADVANCE TAX UNDER DIFFERENT SITUATIONS, INTEREST

Structure

15.1 Introduction

15.2 Objectives

15.3 Liability to pay advance tax

15.4 Due dates of payment of advance tax

15.5 Payment of advance tax under different situations

15.6 Interest

15.7 Summary

15.8 Glossary




15.1 INTRODUCTION

Under the scheme of advance payment of tax, every income (including capital gains,winnings from lotteries, crossword puzzles, etc.) is liable for payment of advance

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tax. It is obligatory to pay advance tax in every case where the advance tax payableis Rs. 10,000 or more. A senior citizen (i.e., a resident individual who is at least 60years of age at any time during the financial year) not having any income from business/profession is not liable to pay advance tax.

15.2 OBJECTIVES


• The provisions of advance payment of tax

• The chargeability of interest in case of non-payment/late payment of advance tax

15.3 LIABILITY TO PAY ADVANCE TAX

Under the scheme of advance payment of tax, every income (including capital gains,winnings from lotteries, crossword puzzles, etc.) is liable for payment of advancetax. It is obligatory to pay advance tax in every case where the advance tax payableis Rs. 10,000 or more. A senior citizen (i.e., a resident individual who is at least 60years of age at any time during the financial year) not having any income from business/profession is not liable to pay advance tax.

15.4 DUE DATES OF PAYMENT OF ADVANCE TAX

Advance tax due dates applicable from the assessment year 2017-18 are given below-

• An assessee who has opted for the scheme of computing business income undersection 44AD on presumptive basis at the rate of 8 per cent of turnover is exemptedfrom payment of advance tax related to such business for the assessment years 2011-12 to 2016-17.

Due date of payment of advance tax For any assessee (except an eligibleassessee given in column 3)

An eligible assessee in respect of aneligible business referred to in

section 44AD or 44 ADAOn or before June 15 of the previousyearOn or before September 15 of theprevious yearOn or before December 15 of theprevious year

On or before March 15 of the previousyear

Up to 15 per cent of advance taxpayableUp to 45 per cent of advance taxpayableUp to 75 per cent of advance taxpayable

Up to 100 per cent of advance taxpayable

–

–

–

Up to 100 per cent of advance taxpayable

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• Any payment of advance tax made on or before March 31 shall also be treated asadvance tax paid during the financial year.

• If the last day for payment of any installment of advance tax is a day on which thereceiving bank is closed, the assessee can make the payment on the next immediatelyfollowing working day, and in such cases, the mandatory interest leviable under sections234B and 234C would not be charged.

• After March 31, 2008, all corporate assessees and other assessees (who are subjectto compulsory audit under section 44AB) will have to make electronic payment oftax through internet banking facility offered by authorised banks. Alternatively, thesetaxpayers can make electronic payment of tax through internet by way of credit ordebit cards. It is not necessary for the assessee to make payment of taxes from hisown account in an authorized bank. An assessee can make electronic payment oftaxes also from the account of any other person. However, the challan for makingsuch payment must clearly indicate the Permanent Account Number (PAN) of theassessee on whose behalf the payment is made-Circular No. 5/2008, dated July 17,2008.

15.5 PAYMENT OF ADVANCE TAX UNDER DIFFERENT SITUATIONSAdvance tax liability can be computed as follows:

Payment of advance tax by the assessee of his own account [Sec. 210] An assessee who is liable to pay advance tax is required to estimate his currentincome and pay advance tax thereon without having to submit any estimate orstatement of income to the assessing authorities.

Revision of second and subsequent installment -After making payment of first/secondinstallment of advance tax, an assessee can revise the remaining installment(s) ofadvance tax in accordance with his revised estimate of current income and pay taxaccordingly, without any requirement of filing the revised estimate of advance tax.

Computation of Tax

Tax can be computed on the current income (estimated by the taxpayer) at the ratesin force during the financial year. From the tax so computed, tax deducted* or collected'at source will be deducted. Calculation can be made on similar lines in the case ofupward/downward revision of current income.

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Payment of advance tax in pursuance of order of Assessing officer [Sec. 210]

The Provisions are given below-

1. The taxpayer is one who had earlier been assessed to income-tax.

2. Inspite of the legal obligation, he has not paid advance tax.

3. The Assessing Officer may pass an order under section 210(3) requiring him to payadvance tax on his current year's income

4. The order must specify the different installments in which the advance tax shouldbe paid

5. Such order may be passed during the previous year but not later than last day ofFebruary.

• Lower estimate by assessee- On receipt of the notice from the Assessing Officer topay advance tax the assessee can submit his own estimate of lower current income/advance tax and pay tax accordingly. In such a case he has to send an intimation mForm No 28A to the Assessing Officer. An estimate furnished by assessee in FormNo. 28A cannot be rejected by departmental authorities--Punjab Tractors Ltd v. CIT[2004] 137 Taxman 211 (Punj. & Har.). However care must be exercised by assesseesin every such case to file such estimate in Form No. 28A (by the due date of makingpayment of advance tax) for any failure in this regard will prompt the AssessingOfficer to make legally permissible coercive recovery under the law.

• Higher estimate by the assessee - Alternatively, if the advance tax on current incomeas per own estimate of the assessee is likely to be higher than the amount estimatedby the Assessing Officer the assessee shall pay higher tax in accordance with his owncalculation. In such case, m intimation to the Assessing Officer is required.

Computation of Tax by Assessing Officer

The provisions are given below-

• First of all the Assessing Officer will have to find out income of the current year.Current year's income would be calculated on the following basis-

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a. total income of the latest previous year in respect of which the assessee has beenassessed h way of regular assessment; or

b. the total income returned by the assessee for any subsequent year, whichever ishigher.

• Tax liability on the income of the current year would be calculated according to therate applicable. Tax deducted/collected at source will be deducted.

• Calculation can be made on the similar lines when the assessee wants to makeupward/downward revision of current income. -

Payment of Advance tax in Pursuance of revised order of Assessing Officer

The provisions are given below:

1. The order passed by the Assessing Officer under section 210(3) can be revised byhim under section 210(4).

2. Such revision is possible if subsequent to passing an order under section 210(3)but before March 1 of the relevant financial year, the assessee had furnished a returnof income for a later year or any assessment for a later year has been completed at ahigher figure.

3. On receipt of revised order, the assessee will have to pay advance tax accordingly.

• Lower estimate by the assessee - The assessee can submit his own estimate of lowercurrent income/advance tax and pay tax accordingly. In such a case he has to sendintimation in Form No. 28A to the Assessing Officer.

• Higher estimate by the assessee -If alternatively, the advance tax on current incomeas per own estimate is likely to be higher than the amount re-estimated by the AssessingOfficer, the assessee shall pay higher tax in accordance with his own calculation. Insuch a case intimation to the Assessing Officer is not required.

The total income declared in the return furnished by the assessee for the later previousyear or total income in respect of which the regular assessment is made after passingan order by the Assessing Officer but before March 1, shall be taken and income-laxthereon shall be calculated at the rates in force in the financial year. From the tax sodetermined, tax deducted or collected at source will be deducted.

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Case Study

The following are the particulars submitted by different taxpayers for the assessmentyear 2017-18:

X (anindividual

Rs.

Y (a Hinduundivided

family)Rs.

Z (a firm)

Rs.

A Ltd. (acompany)

Rs.

2 3 4 51

SalariesIncome from house propertyProfits and gains of business or professionCapital gains (short-term)Income from other sourcesGross total incomeLess : Deduction under sections 80C to 80UUnder section 80CUnder Section 80GNet incomeTax liabilityLess : Rebate under section 87A (100% of taxor Rs. 5,000, whichever is less, applicableonly in the case of a resident individual if netincome does not exceed Rs. 5,00,000)BalanceAdd : Surcharge (not applicable)Tax and surchargeAdd : Education CessAdd : Secondary and higher education cessTotalLess : Tax deducted or collected atsourceBalance (a)

4,50,0003,000

—16,00013,000

4,82,000

26,0002,000

4,54,00020,400

5,00015,400

Nil15,400

308154

15,862

5,8639,999

—87,000

(-) 13,000—

2,88,0003,62,000

45,003,000

3,54,50010,450

Nil10,450

Nil10,450

209105

10,764

21010,554

—36,000

2,98,84024,00043,000

4,01,840

—2,000

3,99,8401,99,952

Nil1,19,962

Nil1,19,952

2,3991,200

1,23,551

27,85395,698

—(-) 14,0005,50,000

67,00038,000

6,41,000

—3,000

6,38,0001,91,400

Nil1,19,400

Nil1,91,400

3,8281,914

1,97,142

51,1921,45,950

Determine the amount of advance tax payable during the financial year 2016-17.Advance tax payable for the financial year 2015-16 will be as under :

*Since in the case of X, amount of tax as shown at (a) is less than Rs. 10,000, it is not necessaryto pay advance tax.

Advance tax payable on or before June 15, 2016Advance tax payable after June 15, 2016but on or before September 16, 2016)Advance tax payable after September 16, 2016but on or before December 15, 2016Advance tax payable after 15, 2016but on or before March 15, 2017

XRs.

YRs.

ZRs.

A Ltd.Rs.

—

—*

—*

—*

1,583

3,166

3,166

2,639

14,355

28,709

28,709

23,925

21,893

43,785

43,758

36,487

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Illustration X Ltd is a company in which the public are not substantially interested. Itwas assessed for the first time in 1977. It does not pay any advance tax during April1, 2016 and September 15, 2016. The concerned Assessing Officer (vide order datedSeptember20, 2016 in Form No.28) requires the company to pay tax of Rs. 22,170on current income of Rs. 71,740 as advance tax (Rs.16,630 on or beforeDecember,2Ol6 and Rs. 5,540 on or before March 2017).. What are the differentalternatives before the company?

On receipt of the demand notice the company has the following three alternatives:

Alternative 1 - It can pay advance tax as demanded by the Assessing Officer.

Alternative 2 If it thinks that current income is lower than the income estimated bythe Assessing Officer it can intimate it to the concerned officer in Form No. 28A andpay tax accordingly. Suppose, as per the expectation of the company, the currentincome is Rs. 40,000, it can pay advance tax of Rs. 12,360 (i.e., Rs. 9,270 on orbefore December 15, 2016 and Rs. 3,090 on or before March 15, 2017).

The company can revise advance tax liability even after payment of installment onDecember 15, 2016.

Suppose, the company pays Rs. 16,630, as per order of the Assessing Officer onDecember 15, 2016, and later on (say during January2017) it suffers a loss of Rs.10,000 (loss is unexpected and was not considered by the Assessing Officer), it canrevise the advance tax payable on March 15,2017 (after sending intimation in FormNo. 28A to the Assessing Officer) as follows:

Current income (i.e., Rs. 71,740-loss of Rs. 10,000) 61,740

Tax 19,078

Less: Advance tax paid on December 15, 2016 16,630

Advance tax payable on March 15, 2017 2,450

Alternative 3: Under the third alternative, the company can make upward revision ofthe tax liability estimated by the Assessing Officer (if as per calculation of the company,

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tax on current income is higher) and pay tax accordingly. No intimation isrequired to be given to the Assessing Officer. Suppose, the company pays Rs.16,630 on December 15, 2016 (as per order of the Assessing Officer).It getsunexpected profit of Rs. 45,000 due to a strike in the factory of a competitor. Itcan revise the tax payable on March 15, 2017 as follows:

Rs

Current income (Rs. 71,740 + Rs. 45,000) 1,16,740

Tax 36,073

Less: Tax paid on December 15, 2016 16,630

Tax payable on March 15, 2017 19,440

15.6 INTEREST

When interest becomes payable by assessee

Interest is payable by the assessee under the Income-tax Act in the circumstancesenumerated below:

if the return of income is furnished after the due date or is not furnished, the assesseeis liable to pay interest under section 234A.

Interest is calculated as under:1. Rate of interest

2. Period for which interest is payable.

3. Amount on which interest is payable.

1 percent per month or part of month (simple interest).

Commencing on the date immediately following the due date for fillingthe return of income and ending on–

a. the date of furnishing the return (where return has been filed after thedue date); or

b. the date of completion of assessment under section 144 (where noreturn has been furnished).

It is calculated as under :

1. Find out the tax on total income as determined under section 143(1)or on assessment under section 143(3) or section 147 or 153A (if theassessment is made for the first time under section 147 or 153A)1.

2. From the tax so determined, advance tax paid*, tax deducted orcollected at source, relief under section 90/90A/91, MAT credit undersection 115JAA and alternate minimum tax credit under section 115JD(but not tax paid under section 140A) shall be deducted.

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The following points shall also be kept in view:

In case of CIT vs. Pranoy Roy [2009] 179 Taxman 53, the Apex Court held that -

a. if self-assessment tax is paid before the due date of submission of return of incomeand return is submitted after the due date, interest under section 234A is not applicable[case (a)] and

b. if self-assessment tax is paid after the due date of submission of return of income,interest under section 234A is applicable[case (b)]

However, the Court's ruling is silent on the point whether in Case (b), interest ispayable till the date of payment of self-assessment tax or till the date of submission ofreturn of income. The Court's ruling gives consideration to the fact that when self-assessment tax is paid before submitting return of income [ Case (a)] interest shouldnot be payable after the deposit of self- assessment tax (there being no loss to therevenue). A similar view should be taken in Case (b) as well. if self-assessment tax ispaid after the due date of submission of return of income (assume date of payment isDecember 20, 2017) and return is submitted belatedly after payment of tax (say,return is submitted on January 20, 2018 for the assessment year 2017-18), interestunder section 234A should be payable up to date of payment of self-assessment tax(i.e., up to December 20, 2017).

A belated return cannot be submitted after the expiry of one year from the end of theassessment year. if an assessment is made for the first time under section 147, thenthe assessee cannot be made liable to pay interest for the period during which it wasnot possible on the part of the assessee to file return (i.e., after one year from the endof the assessment year) till issuance of notice under section 148

Section 234A(3) is applicable if return of income is not submitted or submittedbelatedly in the course of reassessment proceedings. Interest in such a case is payableby the assessee at the rate of 1 per cent per month (for part thereof) for the period ofdefault. The period of default commences on the date immediately following theexpiry of time given by notice under section 148 or 153A and ends on the date offurnishing of return (or on the date of completion of reassessment under section 147

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or 1 53A where no return has been furnished). Interest is payable on the amount bywhich the tax on the total income as reassessed exceeds the tax on the total incomedetermined on the basis of the earlier assessment if as a result of an order undersections 154, 155,250,254,260,262,263,264 and 245D(4), the interest payable isincreased or reduced, as the case may be, the interest shall be increased/ reducedaccordingly.

There is no provision for reduction or waiver of interest,

Interest should not be charged where delay in filing return is due to strike of personnelof Income-tax Department

The liability to pay interest under sections 234A, 234B and 234C is automatic andthe question of granting opportunity of being heard does not arise

While charging interest under section 234A, 234B or 234C, the Assessing Officer isrequired to pass a specific order to this effect in its assessment order. When theassessment order is silent, as to whether any interest is leviable, the notice of demandunder section 156 cannot be beyond the assessment order and the assessee cannot beserved with any such notice demanding the interest. Interest cannot be charged bymere observation like charge interest as per law.

During the period when the books of account are in the custody of the concernedincome- tax authorities, it is not possible for the taxpayer, to submit the return ofincome. Consequently, he cannot be saddled with liability to pay penal interest undersection 234A for that period

Vide Notification No.275/ 12/2007-IT(B), dated April 26,2007, interest chargeableunder section 234A and section 234B for assessment year 2007-08 shall be waivedfor the period up to the date of filing the return of income or up to March 31, 2009,whichever is earlier, in respect of the migrant-assessees of Kashmir Valley and assesseeswho reside in, or have their principal place of business in, the Kashmir Valley. TheBoard gave a similar concession for the earlier assessment years.

Case Study

Determine the amount of interest under section 234A in the following cases:

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Failure to deduct or collect and pay tax at source

The provisions are given below-

• Default - Interest is payable in respect of any of the following defaults-

1. If the person responsible for deducting/collecting tax at source does not deduct/collect tax at source, wholly or partly, under sections 192 to 196C and 206C.

2. After deducting/collecting tax, he falls to pay the same as required by the Act.

• Interest- In the above two cases, the person responsible for deducting/collectingtax is liable to pay interest, Interest is calculated at the rate of 1 per cent per month(or part thereof). However, in the case of short deduction/non-deduction of tax atsource, interest is payable as follows-

X (32Years)

Y (62 years) X (P) Ltd. X (HUF)

Date of filing returnDate of payment of entire self-assessment tax

Date of completion of assessment

Income declaredIncome assessedAdvance tax paid during 2016-17Tax deducted or collected at source•Interest will be determined under :Period of default (a part of month is taken asfull month)Income assessedTaxAdd : SurchargeTax and surchargeAdd : Education cessAdd : Secondary and higher education cessTax payable on assessed incomeLess : Advance tax paid and tax deducted orcollected at sourceShortfall (tax paid under section 140A is notconsidered)Shortfall (rounded off) (c)Interst on (c) at the rate of 1% per month

Not filedNot paid

September 4,2017

September 1,2017

March 10,2018

January 3,2018

December 17,2017

November 20,2017

January 7,2018

Rs.—

7,07,54026,400

220

September 4,2017

Rs.9,80,0709,82,600

26,500300

April 15,2018

Rs.3,50,1003,61,500

95,0001,100

December 17,2018

Rs.21,87,17021,95,000

1,000500

6 monthsRs.

7,07,54061,508

Nil61,508

1,230615

63,35326,62036,733

36,7002,202

2 monthsRs.

9,82,6001,16,520

Nil1,16,520

2,3301,165

1,20,01526,80093,215

93,2001,864

4 monthsRs.

3,61,5601,08,468

Nil1,08,468

2,1691,085

1,11,72296,10015,622

15,600624

2 monthsRs.

21,95,0004,83,500

Nil4,83,500

96704,835

4,96,5051,500

4,96,505

4,96,5009,930

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Interest is payable on short payment or non-payment. It is payable from the date onwhich such tax was deductible/collectible to the date on which the tax is actuallypaid.

• Quarterly return cannot be submitted before payment of interest - Quarterly returnof TDS/TCS cannot be submitted before payment of interest for late deposit taxdeducted or collected at source.

Provisions applicable from July 1,2012 - The Finance Act, 2012, amended the aforesaidprovisions with effect from July 1, 2012. After this amendment, the payer shall not bedeemed to be an assessee in default if -

a. the resident recipient has included such income in the return submitted under section139 and the recipient has paid tax on such income; and

b. the payer uploads a certificate to this effect in Form No. 26A from a charteredaccountant. In such a case, interest shall be payable at the rate of 1 per cent from thedate on which tax was deductible to the date of furnishing of return of income by theresident recipient.

Similar rule is applicable from July 1, 2012 in the case of non-collection of tax atsource. The aforesaid relaxation given by the Finance Act, 2012 is applicable onlywhen the recipient is resident and the default pertains to the period commencing onor after July 1,2012. if the recipient is a non-resident (or if the recipient is a residentbut default pertains to the period prior to July 1,2012), the amendment made by theFinance Act, 2012 is not applicable. In such a case, one can take shelter of judicialrulings where the Courts held that interest cannot be recovered for non- deduction orshort-deduction from the payer for any period which falls after the date of paymentof tax by the recipient.

• Meaning of "month "-For calculating interest under section 201(1A), term "month"

Rate of interest (per month or part) Period of which interest is payable

1 percent

1.5 percent

From the date on which tax was deductible to the date on which tax isactually deducted

From the date on which tax was atcually deducted to the date on whichtax is actually paid

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must be ordinary meaning of term of 30 days period and not British calendar month-Navayuga Quazigund Expressway (B) Ltd v. CIT[2015] 64 taxmann.com 212 (Hyd.).Consider this example-i.. Date of tax deduction: July 12, 2016, due date of deposit:August 7, 2016, actual date of deposit: August 10, 2016, interest of only one monthcan be charged under section 201(1A).

For default in payment of Advance Tax [Sec 234B]

Under section 234B(1), interest is payable as follows:

One should keep in view the following points-

• Assessed tax - Meaning of - "Assessed tax" means the tax on total income determinedon the basis of summary assessment under section 143(1) or regular assessment asreduced by tax deducted' or collected at source or relief under section 90/90A/91 orMAT credit on any income which is taken into account in computing such total income.If interest under section 234B is to be calculated for the purpose of self-assessmentunder section 140A, then "assessed tax' means tax on returned income.

• Adjustment when tax is paid before regular assessment under section 140A - Ifbefore the date of determination of total income under section 143(1) or completionof a regular assessment, tax is paid on the basis of self-assessment under section140A, the interest shall be calculated a under:

a. up to the date of payment of tax under section 140A, interest will be calculated asmentioned in the table above; and

b. from the date of payment of tax under section 140A, interest will be calculated on

When interest is payable

An assesse who is liable topay advance tax, has failedto pay such tax

Amount on whichinterest is payable

Rate of interest Period for which interest is payable

Interest is payable onassessed tax

Simple interest @ 1percent for every monthor part of month

From April 1 of the assessment yearto the date of determination ofincome under section 143(1) orwhere regular assessment is madeto the date of regular assessment

An assessee who has paidadvance tax but the amountof advance tax paid by himis less than 90 percent ofassessed tax‡

Assessed tax minusadvance tax

Simple interest @ 1percent for every monthor part of month

From April 1 of the assessment yearto the date of determination ofincome under section 143(1) orwhere regular assessment is madeto the date of regular assessment

( 278 )

the amount by which advance tax and tax paid under section 140A falls short ofassessed tax.

From the amount of interest computed above, amount paid under section 140A towardsinterest chargeable under section 234B shall be deducted.

• Reassessment/re-computation - if as a result of reassessment/re-computation undersection 147 or 153A, the amount on which interest was initially payable is increased,the taxpayer will be liable to pay additional interest at the rate of 1 per cent per month(or pa of month). This additional interest is payable for the following period -

- Up to May 31, 2015 - For the period starting from the date of determination of totalincome under section 143(1) or regular assessment and ending on the date ofreassessment/re- computation.

- From June 1, 2015 - For the period commencing on the first day of the assessmentyear and ending on the date of reassessment/ re-computation.

• Where an application for settlement is made under section 245C (1) 234B (2A) J-Sub-section (2A) has been inserted with effect from June 1, 2015. It provides thatwhere an application for settlement is made under section 245C (l), the assessee shallbe liable to pay simple interest at the rate of 1 per cent for every month (or part of amonth) comprised in the period commencing on the first day of April of suchassessment year and ending on the date of making such application, on the additionalamount of income-tax. Further, where as a result of an order of the SettlementCommission under section 245D(4) for any assessment year, the amount of totalincome disclosed in the application under section 245C(1) is increased, the assesseeshall be liable to pay simple interest at the rate of 1 per cent for every month (or partof a month) comprised in the period commencing on the first day of April of suchassessment year and ending on the date of such order, on the amount by which thetax on the total income determined on the basis of such order exceeds the tax on thetotal income disclosed in the application filed under section 245C(l). Where, as aresult of a rectification order under section 245D(6B), the amount on which interestwas payable under the above provisions has been increased or reduced, as the casemay be, the interest shall be increased or reduced accordingly.

( 279 )

• Shipping business of non-residents - The Board is of the opinion that non-residentassessees engaged in the business of carriage by shipping of passengers and goods,etc., shall be liable to pay interest under sections 234B and 234C or entitled to interestunder section 244A in respect of their income attributable to the business of suchcarriage of passengers and goods, etc.-Circular No. 9/2001, dated July 9, 2001.

• Shortfall because of interpretation of law - if short payment of advance tax is mainlybecause of a bona fide dispute regarding the interpretation of law, interest undersection 234B is not applicable.

For deferment of advance tax

Interest is payable under section 234C if an assessee has not paid advance tax or underestimatedinstallments of advance tax. Interest is to be computed on the following basis:

This category covers the following assessees-

Notes:

a. Tax on the total income declared in the return filed by the assessee.

b. Tax deducted or collected at source, relief under section 90/90A/91 and MAT/AMT credit under section 115JAAor 115JD.

c. Amount of advance tax paid on or before June 15 of the financial year immediatelypreceding the relevant assessment year.

• A corporate assessee.• A non-corporate assessee [but not being an eligible assessee covered by section 44AD or 44ADA and discussedin para 296.4-2]

If advance tax paid on or beforeJune 15 is less than 12% (a–b)

If advance tax paid on or beforeSeptember 15 is less than 36%(a–b)

Simple interest @ 1 per centper month

Simple interest @ 1 per centper month

3 months

3months

15% (a–b) – c

45% (a–b) – d

When interest is payableunder section 234C

Rate of Interest Period of interest Amount on whichinterest is payable

(1) (2) (3) (4)

( 280 )

d. Amount of advance tax paid on or before September 15 of the financial yearimmediately preceding the relevant assessment year.

e. Amount of advance tax paid on or before December 15 of the financial yearimmediately preceding the relevant assessment year.

f. Amount of advance tax paid on or before March 15 of the financial year immediatelypreceding the relevant assessment year.

This category covers the following assessees-

In the case of an eligible assessee (covered under section 44AD), interest undersection 234C is payable (in respect of non-payment or short payment of advance taxpertaining to eligible business) as follows-

Notes :

a. Tax on the total income declared in the return filed by the assessee.

b. Total of (1) tax deducted/collected at source on any income which is subject tosuch deduction or collection and which is taken into account in computing such totalincome, (it) relief/deduction of tax claimed under section 90 or 91 on account of taxpaid in a country outside India, (iii) relief of tax claimed under section 90A on accountof tax paid in any specified territory outside India; and (iv) tax credit under section115JD.

c. Amount of advance tax paid on or before March 15 of the financial year immediatelypreceding the relevant assessment year.

No interest will be levied in respect of any shortfall in the payment of advance taxdue on the returned income if-

• An eligible assessee covered by section 44AD or 44ADA.

If advance tax paid on or beforeMarch 15 is less than 100% (a–b)

Simple interest @ 1 percent — 100% (a — b) — c

When interest is payableunder section 234C

Rate of Interest Period of interest Amount on whichinterest is payable

( 281 )

a. the shortfall is on account of an underestimate or failure to estimate the amount ofcapital gains or income of the nature referred to in section 2(24)(ix) (i.e., lotteryincome, gambling income, etc.) or (with effect from June 1, 2016) income from anew business/profession or dividend income; and

b. the assessee has paid the whole of the amount of tax payable in respect of suchincome, as part of the remaining installments of advance tax which are immediatelydue (after accrual of such income), or if no is due, then such tax is paid before the endof the financial year.

Case Studies

During the financial year 2016-17, X (36 years) pays the following installments ofadvance tax

Rs.First instalment on June 15, 2016 52,000Second instalment on September 15, 2016 1,02,000Third instalment on December 10, 2016 1,60,000Fourth instalment on March 13, 2017 30,000Fifth instalment on March 20, 2017 20,000

The regular assessment for the assessment year 2017-18 is completed on January 10,2018 and income determined by the Assessing Officer is Rs. 20,02,720 (income asper income-tax return :Rs. 19,90,000, addition made by the Assessing Officer: Rs.12,720). He is also entitled to tax credit of Rs. 2,800 on account of tax deducted atsource.

Self assessment tax is not paid. Is he liable for interest under section 234B or 234C?

Interest liability under section 234B:

( 282 )

Rs.Income computed by the Assessing Officer 20,02,720Tax on Rs. 20,02,720 [for rates, see Annex 1] 4,38,590Less : Tax deducted at source 2,800Assessed tax 4,35,79090% of assessed tax 3,92,211Advance tax paid during the financial year 2016-17 (Rs. 52,000+Rs, 1,02,000+Rs. 1,60,000+ Rs. 30,000 + Rs. 20,000) 3,64,000Since advance tax paid during the financial year is less than 90% of assessed tax, X isliable to pay interest under section 234B as follows –Assessed tax 4,35,790Less : Advance tax paid during the financial year 2016-17 3,64,000Short fall 71,790Short fall (rounded off) 71,700Period for which interest is payable (from April 1, 2017 to January 10, 2018) 9 months(and a few days Period for which intesest if payable (rounded off) 10 monthsRate of interest 1% per monthAmount of interest under section 234B (Rs. 71,700 X 1% X10) 7,170Interest liability under section 234 C–Income as per return of income 19,90,000Tax on Rs. 19,90,000 (for rates, see Appendix 1) 4,34,600Less : Tax deducted at source 2,800Assessed tax 4,31,860First instalment (due date : June 15, 2016)15% of assessed tax 64,77912% of assessed tax 51,823Advance tax actually paid up to June 15, 2016 52,000Since advance tax paid is not less than 12% of assessed tax, interest is not payablefor short payment of first installment of advance tax.Second instalment (due date : September 15, 2016)45% of assessed tax 1,94,33736% of assessed tax 1,55,470Advance tax actually paid to September 15, 2016 (Rs. 52,000 + Rs. 1,02,000) 1,54,000Since advance tax paid is less than 36% of assessed tax, interest is payable for shortpayment of second instalment of advance taax.Short fall (45% of assessed tax : Rs. 1,94,337 - advance tax paid to September 15, 2016 :Rs. 1,54,000) 40,337Short fall (rounded off) 40,300Interest for short payment of second instalment (Rs. 40,300 X 1% X 3 months) 1,209Third instalment (due date : December 15, 2016)75% of assessed tax 3,23,895Advance tax actually paid up to December 15, 2016 (Rs. 52,000 + Rs. 1,02,000 + 1,60,000) 3,14,000Since advance tax paid is less than 75% of assessed tax, interest is payable for short paymentof third instalment of advance tax.Short fall (75% of assessed tax : Rs. 3,23,895 - advance tax paid up to December 15, 2016:Rs. 3,14,000) 9,895Short fall (rounded off) 9,800Interest for short payment of second instalment (Rs. 9,800 X 1% X 3 months) 294

( 283 )

Rs.Fourth instalment (due date : March 15, 2017)100% of assessed tax 4,31,860Advance tax actually paid upto March 15, 2017 (Rs. 52,000 + Rs. 1,02,000 + Rs. 1,60,000+ Rs. 30,000) 3,44,000Since advance tax paid is less than 100% of assessed tax, interest is payable for shortpayment of fourth instalment of advance tax.Shot fall (100% of assessed tax : Rs. 4,31,860 - advance tax paid up to March 15, 2017 :Rs. 3,14,000) 87,860Short fall (rounded off) 87,800Interest for short payment of second instalment (Rs. 87,800 X 1%) 878Interest payable under section 234C (Rs. 1,209 + Rs. 294 + Rs. 878) 2,381296.4-P2 X Ltd, an Indian company, files return of income on December 10, 2017, through the due date is September30, 2017 for the assessment year 2017-18. On the same day, it deposits Rs. 2,69,300 (being self-assessment tax) undersection 140A computed as follows –

Rs.Tax on income of Rs. 12,00,000 declared in the return 3,70,800Less :Advance tax paid during 2016-17 1,23,600Tax deducted at source 16,572Balance 2,30,628Add : InterestUnder section 234A for late submission of return [@ 1% per month on Rs. 2,30,600 for 3 months] 6,918Under section 234B for short deposit of advance tax [on Rs. 2,30,600 from April 1, 2017 toDecember 10, 2017 @ 1% per month] 20,754Under section 234C [Rs. 11,000 is correctly computed under section 234C] 11,000Toal 2,69,300Assessment is completed under section 143(3) on April 20, 2018 on income of Rs 12,20,000. Find out the amount oftax payable.•Interest liability under section 234A December 10, 2017Date of filing return September 30, 2017Due date of return 3 monthsPeriod of default (a part of month is taken as full month) Rs.Income 12,20,000Tax on income [i.e., 30% of Rs. 12,20,000 plus 3% education cess] 3,76,980Less : Advance payment of tax 1,23,600Less : Tax deducted at source 16,572Assessed tax 2,36,808Interest under section 234A on assessed tax (i.e., Rs. 2,36,800) @ 1% per month for 7,1043 months Interest liability under section 234 B:Assessed tax (i.e., tax minus tax deducted at source; as computed above) 3,60,40890% of assessed tax 3,24,367Advance tax paid during 2016-17 1,23,600It is liable to pay interest under section 234B as advance tax paid is shorter than Rs. 2,24,367Shortfall from April 1, 2017 to December 10, 2017 2,36,808Period of default (April 1, 2017 to December 10, 2017) 9 monthsInterest @ 1% per month for 9 months 21,312Shortfall from December 10, 2017 to April 20, 2018 [i.e., Rs. 2,36,808 — Rs. 2,30,628 (self-assessment tax under section 140A paid on December 10, 2017 — see Note 1)] 6,180Period of default January 1, 2018 to April 20, 2018 (in the shortfall of 9 months periodupto to December 31, 2017 is included) 4 monthsInterest on Rs. 6,100 for 4 months @ 1% per month 244Interest under section 234B 21,556

( 284 )

Notes:

1. In this example, X Ltd. has paid Rs. 2,69,300 on December 10,2017 under section140A. As per calculation given in the problem, Rs. 38,672 is adjusted towards paymentof interest and the balance Rs. 2,30,628 is adjusted towards tax payable. If tax paidunder section 140A (Le self-assessment tax) is less than Rs. 2,69,300, then the amountpaid under section 140A, shall be first adjusted towards interest payable and thebalance if any, shall be adjusted towards tax payable.

Rs.2. Net tax and interest payable is to be computed as under : 3,76,980Tax on Rs. 12, 20,000Add : InterestUnder section 234A 7,104Under section 234B 21,556Under section 234C 11,000Total 4,16,640Less : Prepaid taxTax deduction at source 16,572Advance tax 1,23,600Self-assessment tax under section 140A 2,69,300Balance payable (rounded off) 7,170

Calculate the amount of interest payable under section 234C.•Interest under section 234C for short payment of first instalment of advance tax (i.e., on or before June 15,2016)- For this purpose, long-term capital gain generated June 15, 2016 and new business started from June15, 2016 shall not be considered. Short fall will be calculated as follows -

Rs.

Income from brokerage and commission (business was established in 1982)Long-term capital gain on sale of gold on September 18, 2016Income from commission agency business (new business started on November 4, 2016

Amount deposited in PPF on March 20, 2017

14,300,0003,00,0006,78,000

1,50,000Prepaid tax -TDS/TCSAdvance tax paid on -- June 13, 2016- September 15, 2016- December 14, 2016- March 15, 2017

23,400

21,00049,000

1,50,0002,00,000

X (50 years) is business person. For the previous year 2016-17, he reports the following transactions in his return ofincome-

( 285 )

Interest under section 234C for short payment of second installment of advance tax(Le., on or before September15, 2016)- For this purpose, long-term capital gaingenerated after September 15,2016 and new business started after September 15,2016 shall not be considered. Short fall will be calculated as follows -

Rs.Income from brokerage and commissionAny other incomeGross total incomeLess : Deduction under section 80CNet IncomeTax (Including education cess)Less : TDS/TCSAssessed tax15% of assessed tax12% of assessed taxAdvance tax paid up to June 15, 2016

14,30,000Nil

14,30,0001,50,000

12,80,0002,15,270

23,4001,91,870

28,78123,02521,000

Short fall (for short payment of first instalment of advance tax, interest under section 234C is notapplicable if advance tax paid up to June 15, 2016 is not less than 12% of assessed tax. In thiscase, X has paid advance tax of Rs. 21,000 which is less than 12% of assessed tax of Rs. 23,025.In such a case, interest is payable under section 234C. Short fall will be calcualted as thedifference between 15% of assessed tax and advance tax paid up to June 15, 2016, i.e., Rs.28,781 - Rs. 21,000. It comes to Rs. 7,781) (rounded off)Interest under section 234C for short payment of first instalment of advance tax (interest on Rs.7,700 @ 1% per month for 3 months)

7,700

231

Rs.Assessed tax45% of assessed tax36% of assessed taxAdvance tax paid upto September 15, 2016 (Rs. 21,000 + Rs. 49,000)

1,91,87086,34269,07470,000

Short fall (for short payment of first instalment of advance tax, interest under section 234C is notapplicable if advance tax paid up to September 15, 2016 is not less than 36% of assessed tax. In thiscase, X has paid advance tax of Rs. 70,000 which is less than 36% of assessed tax of Rs. 69,074. Ifadvance tax paid up to September 16, 2016 is shorter than Rs. 69.074, short fall will be calculatedby taking the difference between 45% of assessed tax and advance tax paid upt to September 15,2016)Interest under section 234C for short payment of second instalment of advance tax

Nil

Nil

Interest under section 234C for short payment of third instalment of advance tax(i.e., on or before December 15, 2016) - Short fall will be calculated as follows -

( 286 )

Rs.Income from brokerage and commissionIncome from business newly set-up on November 4, 2016Long-term capital gainGross total incomeLess : Deduction under section 80CNet IncomeTax (including education cess)Less : TDS/TCSAssessed tax75% of assessed taxAdvance tax paid up to December 15, 2016 (Rs. 21,000+Rs. 49,000 + Rs. 1,50,000)Short fall (rounded off)Interest under section 234C for short payment of third instalment of advance tax (Interest on Rs.1,27,300 @1% per month for 3 months)

14,30,0006,78,0003,00,000

24,08,0001,50,000

22,58,0004,86,572

23,4004,63,1723,47,3792,20,0001,27,300

3,819

Interest under section 234C for short payment of fourth instalment of advance tax (i.e., on or beforeMarch 15, 2017) - Short fall will be calculated as follows -

Rs.Assessed taxAdvance tax paid up to March 15, 2017 (Rs. 21,000 + Rs. 49,000 + Rs. 1,50,000+Rs. 2,00,000)Short fall (rounded off)Interest under section 234C for short payment of fourth instalment of advance tax (interest on Rs.43,100 @ 1%)

4,63,172

4,20,00043,100

431

Interest payable under section 234C : Rs. 4,481

X (40 years) owns a manufacturing business. Turnover of the business for the previous year 2016-17 is Rs.1,70,00,000. He does not maintain books of account. The following transactions are noted from his return ofincome (which he will upload in ITR-4S) for the assessment year 2017-18-

Rs.Business income under section 44AD (8% of Rs. 1,70,00,000 (TDS/ TCS : Rs. 9,000)Rental income from a commercial property purchased on December 18, 2016 (let out @ Rs. 3,00,000per month from January 1, 2017, municipal tax : nil, interest : nil, tax deducted by tennat : Rs.90,000 @ 10 per cent)Interest on bank FD (tax deducted by bank : Rs. 4,00,000

PPF deposit on March 20, 2017

13,60,000

9,00,00040,00,000

1,50,000

Rs.Advance tax paid on -- June 14, 2106- June 15, 2016- July 15, 2016- December 15, 2016- March 15, 2017- March 31, 2017

92,0001,78,0002,70,0004,00,0003,00,000

( 287 )

Rs.Income from house property (Rs. 9,00,000 - deduction under section 24 @ 30%)Business income under section 44ADBank interestGross and incomeLess : Deduction under section 80CNet IncomeTax on net income

6,30,00013,60,00040,00,00059,90,000

1,50,00058,40,00016,24,310

Calculate the amount of interest payable under section 234 C.•

Section 234C does not provide method of calculating tax separately on business income (covered by section44AD) and other incomes. In this case business income is Rs. 13,60,000 and gross total income is Rs. 59,90,000.Tax pertaining to business income may calculated on the basis of these figures which comes to Rs. 3,68,792(i.e., Rs. 16,24,310X Rs. 13,60,000 ÷ Rs. 59,90,000).

Tax pertaining to -

Tax on incomeLess : TDS / TCSAssessed tax15% of assessed tax (12% of assessed tax : Rs. 91,863)45% of assessed tax (36% of assessed tax : Rs. 2,75,586)75% of assessed tax100% of assessed tax

Income u/s 44AD Other incomes

Rs. Rs.

3,68,7929,000

3,59,792---

3,59,792

12,55,5184,90,0007,65,5181,14,8283,44,4835,74,1397,65,518

Computation of interest under secion 234C –Rs.

First instalment (advance tax paid up to June 15, 2016 is not less than 12% of assessed tax, interestunder section 234C is not applicable for short payment of first instalment (advance tax paid up toSeptember 15, 2016 is less than 36% of assessed interest under section 234C is applicable) (short-fall : Rs. 3,44,483 – Rs. 92,000 - Rs. 1,78,000 = Rs. 74,483) (Rs. 74,400 X 0.01 X 3 months)Third instalment (short-fall : Rs. 5,74,139 - Rs. 92,000 – Rs. 92,000 – Rs. 1,78,000 - Rs. 2,70,000= Rs. 34,139 (Rs. 34,100 X 0.01 X 3 months)Fourth instalment (short-fall : Rs. 3,59,792 + Rs. 7,65,518 - Rs. 92,000 - Rs. 1,78,000 - Rs. 2,70,000- Rs. 4,00,000 = Rs. 1,85,310) (Rs. 1,85,300 X 0.01)

Total

Nil

2,232

1,023

1,853

5,108

X (28 years) (a businessman whose turnover is Rs. 30 lakh) pays Rs. 1 0,000 as advance tax on March15,2017 (no installment of advance tax is paid on September 15,2016 and December 15,2016). Hefurther paid advance tax of Rs. 12,000 on March 31, 2017. He files his return of income on November10,2017 (income declared: Rs. 5,67,500). On November 10, 2017, he pays Rs. 10,600 (Rs. 8,600 by wayof tax and Rs. 2,000 by way of interest for not paying advance tax in time and for late filing of return ofincome). His assessment for the year 2017-18 is completed on March 14, 2018 (income assessed: Rs.5,82,500). He is also entitled for tax credit of Rs. 5,230 on account of tax deducted at source. Is he liablefor interest under sections 234A, 234B and 234C?

( 288 )

As perreturn ofincome

As perassessment

order

Due date of returnDate of filling of returnPeriod of default (a part of month is taken as full month)

IncomeTax on incomeAdd : SurchargeTaxAdd : Education cessAdd : Secondary and higher education cessTax payableLess : Advance paymenttaxTax deducted at sourceAssessed taxAssessed tax (rounded off)Interest on assessed tax @ 1% per month for 4 monthsInterest liability under section 234BAssessed tax (as computed above)90% of assessed taxAdvance tax paid during 2016-17Shortfall from April 1, 2017 to November 10, 2017Shortfall (rounded off)Period of default (April 1, 2017 to November 10, 2017)Interest @ 1% per month for 8 months on shortfallShortfall from November 10, 2017 to March 14, 2018 [i.e., Rs. 37,515-Rs. 22,000 (advance tax) – Rs. 7,479, self-assessment tax under section140A paid on November 10, 2017 — see Note 1]Shortfall (rounded off)Period of default (December 1, 2017 to March 14, 2018 in theshortfall of 8 months period up to Noveber 30, 2017 is included)Interest on Rs. 8,000 for 4 months @ 1% per monthInterest under section 234BInterest liability under section 234CIncome as per returnTax on Rs. 5,67,500 (a)Less : Tax deducted at source (b)Assessed tax (a—b)Advance tax paid on or before June 15, 2016(c)Advance tax paid on or before September 16, 2016 (d)Advance tax paid on or before December 15, 2016 (e)Advance tax paid or or before March 15, 2017 (f)Interest on 15% (a–b)—(c) [i.e., Rs. 15,491 @1% per month for 3 months(Rs. 51,400 X 3 X 1/ 100]Interest on 45% (a–b)—(c) [i.e., Rs. 25,819 @1% per month for 3 months(Rs. 15,400 X 3 X 1/ 100]Interest on 75% (a–b)—(c) [i.e., Rs. 5,164 @1% per month for 3 months(Rs. 25,800 X 3 X 1/ 100]Interest on (a–b—f) (i.e., Rs. 24,425) @1% (Rs. 24,400 X 1/100)

Total

Interet liability under section 234A

July, 31, 2017November10, 20174 months

Rs.5,67,500

38,500—

38,500770385

39,65522,000

5,23012,42512,300

496

34,425—

22,00012,42512,400

8 months992

——

———

5,67,70039,655

5,23034,425

NilNilNil

10,000

153

462

774244

1,633

July, 31, 2017November10, 20174 months

Rs.5,82,500

41,500—

41,500830415

42,74522,000

5,23015,51515,500

620

37,51533,76422,00015,51515,500

8 months12,40

8,0368,000

4 months320

1,560

*Surcharge is not applicable as income does not exceed Rs. 1 crore.

( 289 )

Notes:

1. In this example, X has paid Rs. 10,600 on November 10,2017 under section l40A.Out of Rs. 10,600, Rs. 2,000 is paid towards interest under sections 234A, 234B and234C. As per calculation given below, interest liability comes to Rs. 3,121. Hence, asper explanation to section 140A(1), Rs. 3,121 shall be adjusted towards payment ofinterest and the balance Rs. 7,479 (Le., Rs. 10,600- Rs. 3,121) is to be adjustedtowards the tax payable.

Section 234D is applicable to charge interest on excess refund granted at the timeof summary assessment.

• Interest under section 234D(1) - In any of the following two cases, interest isattracted under section 234D(l)- Case one - If any refund is granted under section143(1) but no refund is due on regular assessment.

Case two -If any refund is granted to the assessee under section 143(1) and therefund so granted exceeds the amount refundable on regular assessment.

For the aforesaid purpose, regular assessment means assessment under section 143(3)or 144. If an assessment is made for the first time under section 147 or section 153A,the assessment so made shall be regarded as a regular assessment.

Computation of interest - In any of the above two cases interest is payable undersection 234D(1) as follows-

Rs.Interest under section 234A as per return of income up to November 10, 2017 496,Interest under section 234B as per return of income up to November 10, 2017 992Interest under section 234C 1,633Total interest as per return of income 3,1212. Net tax and interest payable is to be computed as under :Tax on Rs. 5,82,500 42,745Add : Interest• Under section 234A 620• Under section 234B 1,560• Under section 234C 1,633Total 46,558Less : Prepaid tax• Tax deduction at source 5,230• Advance tax 22,000• Self-assessment to tax under section 140A 10,600Balance payable (rounded off) 8,730

( 290 )

• Adjustment under section 234D(2) - Where, as a result of an order under section154 or 155 or 250 or 254 or 260 or 262 or 263 or 264 or an order of the SettlementCommission under section 254D(4) the amount of refund granted under section 143(1)is held to be correctly allowed, either in whole or in part, as the case may be, then theinterest chargeable under section 234D(1), shall be reduced accordingly.

For the assessment year 2017-18, X files return of income on September30, 2017(income declared in the return Rs. 4,55,000, advance tax: Rs. 4Z940). The AssessingOfficer refunds under section 143(1) the excess tax paid by X on July 20, 2018 asfollows-

Rate of interestPeriod for which interest is payable

Amount on which interest is payable

0.5 per cent per month or part of a monthThe period commencing from the date of grant of refund under section143(1) to date of regular assessment.In Case One on whole of the amount refunded; in Case Two on theexcess of amount refunded under section 143(1) over the amountrefundable on regular assessment.

The Assessing Officer issues notice under section 143(2) on August 16, 2018. Theassessment is completed under section 143(3) on March 26, 2019. Income assessedis (a) Rs. 4,55,000, (b) Rs. 4,80,000; or (c) Rs. 7,85,000. Assume that interest undersection 234C etc., is (a) Rs. 3,500, (b) Rs. 3,630 or (c) Rs. 6,550, respectively in thethree cases, find out interest under section 234D.

Rs.Tax on Rs. 4,55,000 (after rebate under section 87A) 15,500Add : Education cess 310Add : Secondary and higher education cess 155Tax 15,965Add : Interest under section 234C 3,500Total 19,465

Rs.Less : Prepaid tax 47,940Refund 28,475Add : Interest under section 244A 2,272Amount refunded (rounded off) 30,750

( 291 )

If any assessee fails to pay any tax (other than advance tax) specified in a demandnotice within 30 days of the service of notice of demand, he is liable to pay interest atthe rate of 1 per cent for every month or part of month from the expiry of 30 days ofthe service of demand notice.

Section 234E is applicable in respect of quarterly TDS/TCS return which is to besubmitted on or after July 1, 2012. Under this section, if a person fails to deliver (orcause to be delivered) a quarterly TDS/TCS return within the time prescribed insection 200(3) or the proviso to section 206C(3), he shall be liable to pay, by way offee, a sum of Rs. 200 for everyday during which the failure continues.

This fee will be in addition to other consequences under the Act. However, the feesshall not exceed the amount of tax deductible/collectible. After July 1,2012, it willnot be possible to submit belated quarterly TDS/TCS returns without payment offees under section 234E.

If assessed income is

Rs. 4.55 lakhRs

Income-tax on assessed income (after rebateunder section 87AAdd : SurchargeTax and surchargeAdd : Education cessAdd : Secondary and higher education cessTax payableAdd : Interest under section 234CTotalLess : Prepaid taxTax refund dueAdd : Interest under section 244ARefund (rounded off)Amount refunded under section 143(1) onJuly 20, 2018 (a)Amount of tax or refund as per assessment order undersection 143(3) dated March 26, 2019 (b)Excess refund given earlier [a - b]Rounded offPeriod from July 20, 2018 to March 26, 2019Interest @ 0.5 percent per month under section 234D

Rs. 4.8 lakhRs

Rs. 7.85 lakhRs

15,500—

15,500310155

15,9653,500

19,46547,94028,475

2,27230,750

30,750

30,750––––

18,000—

18,000360180

18,5403,630

22,17047,94025,660

2,05627,830

30,750

27,8302,9202,900

9 months130.50

82,000—

82,0001,640

82084,460

6,55091,01047,940

---

30,750

30,75030,700

2,9009 months1,381.50

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A fee for delay in furnishing of return shall be levied for assessment year 2018- l9under section 234F where the return is not filed within the due dates given undersection 139(1). The amount of fee und section 234F is as follows -

1. A fee of Rs. 5,000 shall be payable, if the return is furnished after the due date buton or before December 31 of the assessment year.

2. A fee of Rs. 10,000 shall be payable in any other case.

3. However, in a case where the total income does not exceed Rs. 5 lakh, the feeamount shall not exceed Rs. 1,000.

Interest payable to assessee [Sec.244A]

Interest is payable where any refund arises due to any excess payment of tax. Thereis no need for making claim for refund.

Interest is payable by the Government as follows-

The above mode of computation of interest under section 244A has been modifiedwith effect from June 1, 2016 on the following lines -

• Category 1-Refund out of TDS, TCS and advance tax - Where refund arises out ofTDS, TCS or advance tax paid during the financial year immediately prior to theassessment year, interest shall be calculated at the rate of 0.5 per cent per month (orpart thereof) for the following period- Situation 1 [ return of income is submitted onor before the due date of submission of return of income given under section 139(1)]- In this case, interest is payable from the first day of the assessment year to the dateon which refund is granted.

Refund of advance income tax, taxdeducted or collected at source,

advance fringe benefit tax

Whether any applicationfor obtaining refund isrequiredRate of interest

Period

No

0.5 percent per month (or part of month)From the first day of the assessmentyear to the date of grant of refund (i.e.,the date of signing of the refund order)

Refund in any other case

(1) (2) (3)

No

0.5 percent per month (or part of month)From the date of payment of tax to thedate of grant of refund (i.e., the date ofsigning of the refund order)

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Situation 2 [in any other case] -In this case, interest is payable from the date offurnishing of return of income to the date on which refund is granted.

• Category 2- Refund out of self-assessment tax paid under section 140A - Wherethe refund is out of self-assessment tax paid under section 140A, such interest shallbe calculated at the rate of 0.5 per cent per month (or part thereof) from the date offurnishing of return of income or the date of payment of self-assessment tax, whicheveris later, to the date on which the refund is granted.

• Category 3-Refund which arises out of appeal effect - Where a refund arises out ofappeal effect being delayed beyond the time prescribed under section 153(5) (Le., 3months from the end of the month in which appellate order is received by CIT), theassessee shall be entitled to receive an additional interest (over and above interestgiven under Category 1 or Category 2). Additional interest on such refund shall becalculated at the rate of 3 per cent per annum, for the period beginning from the datefollowing the date of expiry of the time allowed under section 153(5) to the date onwhich the refund is granted. Where extension is granted by the Principal CIT/CIT byinvoking proviso to section 153(5), the period of additional interest, if any, shallbegin from the expiry of such extended period.

• Category 4- Refund of TDS to deductor (applicable from April 1, 2017)- Section244A( 1B) has been inserted from April 1, 2017. It provides that where refund of anyamount becomes due to the deductor such person shall be entitled to receive, maddition to the refund simple interest on such refund Interest will be calculated at therate of 05 per cent per month (or part of a month) Interest will be available from thedate on which claim for refund is made in the prescribed form to the date on whichthe refund is granted. Where refund arises on account of giving effect to an appellateorder under section 250/254/260/262, interest will be available from the date of depositof TDS to the date on which refund is granted. However, interest shall not be allowedfor the period for which the delay (in the proceedings resulting in the refund) isattributable to the deductor.

One should also keep in view the following points-

• No interest on excess payment of advance tax/TDS/TCS/advance fringe benefit tax

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in some cases - In the case of refund of advance income-tax/fringe benefit tax, taxdeduction/collection at source no interest is payable if the excess payment is less than10 per cent of tax determined under section 143(1) or on regular assessment.

• When assessee is responsible for delay in refund - if the proceedings (resulting inthe refund) are delayed for reasons attributable to the assessee (whether wholly or inpart), the period of the delay so attributable to him shall be excluded from the periodfor which interest is payable.

•When assessment is reframed- if as a result of an order under section 115W(l),143(1), 143(3), 147, 154, 155, 250, 254, 260, 262, 263, 264 or 245D(4), the amounton which interest was payable has been increased/reduced, the interest shall beincreased/reduced accordingly if interest is reduced, the Assessing Officer will senda notice of demand in the prescribed form specifying the amount of the excess interestpaid and requiring him to pay such amount.

• Interest with refund is a must- Vide Instruction No. 2/2007, dated March 28, 2007,the Board has reminded all Assessing Officers that while granting refund to theassessees, care should be taken to ensure that any interest payable under section244A on the amount of refund due should be granted simultaneously with the grantof refund and there should, in no case, be any omission or delay in the grant of suchinterest. Failure to do so will be viewed adversely and the officer concerned will beheld personally accountable, inviting appropriate action.

In calculating interest payable by the assessee or interest payable by the CentralGovernment to the assessee, the amount of tax, penalty or other sum in respect ofwhich interest is to be calculated will be rounded off to the nearest multiple of Rs.100 ignoring any fraction of Rs. 100.

• Where interest is to be calculated on annual basis, the period for which such interestis to be calculated shall be rounded off to a whole month/months and for this purposeany fraction of a month shall be ignored. Where, however, the interest is to be calculatedfor every month or part of a month comprised in a period, any fraction of a monthshall be deemed to be a full month.

Where as a result of any order of a Court, statutory authority or of the Government

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(other than an order of assessment, appeal, reference or revision passed under theprovisions of the Income-tax Act) passed after the close of the said previous year(such income and the order hereinafter referred to as the "relevant income" and the"relevant order", respectively) interest under sections 234A, 234B and 234C shall bereduced or waived by the Chief Commissioner/ Director-General subject to certainconditions.

The following conditions shall be satisfied-

a. the interest computed for the period mentioned in above with reference to the taxon the total income inclusive of the relevant income; and

b. the interest computed for the same period with reference to the tax on the totalincome as reduced by the relevant income.

15.7 SUMMARY

This lesson provides an in depth understanding about the meaning and due dates forpayment of advance tax. It also discusses the provisions related to payment of advancetax on the basis of his own account, in pursuance of order of Assessing officer and inpursuance of revised order of the assessing officer. This lesson also elaborates on theprovisions related to the payment of interest under different situations in case ofadvance payment of tax.

Condition 1 The relevant income is disclosed in a return of income furnished for the saidprevious year or is otherwise disclosed to the Assessing Officer.

Condition 2 The tax attributable to such income has been paid.

Section Period in respect of which reduction or waiver is allowed

Section 234A

Section 234B

Section 234C

From the date immediately following the due date for furnishing the return of incomefor the relevant assessment year till the end of the month in which the relevant ordergiving rise to the relevant income is passed.

From the first day of April of the relevant assessment year till the end of the month inwhich the relevant order giving rise to the relevant income is passed.

For the period mentioned in that section.

Reduction/waiver of interest is given in respect of the following period-

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15.8 GLOSSARY

Sec. 44AD- Computing business profits on presumptive basis

Sec. 139(1)- Time for filing return of income

Sec. 234A- Default in furnishing return of income

Sec.234B- Default in payment of advance tax

Sec. 234C- Deferment of advance tax

Sec. 244A-Interest payable to assessee


1. Under what conditions interest is payable to the assessee?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. What are the due dates for payment of advance tax?

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________


1. Explain the different situation for payment of advance tax.

2. What are the provisions related to default in payment of Advance Tax?

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---------------

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M.Com. 1st Sem. Unit-IVLesson No. 16

GST ON FINANCIAL SERVICES - CONCEPT, NEED,RELEVANT DEFINITIONS, ADVANTAGES, GST ON LOAN

AND SECURITIZATION TRANSACTIONS

Structure

16.1 Introduction

16.2 Objectives

16.3 Concept

16.4 Need

16.5 Relevant definitions

16.6 Advantages

16.7 GST on Loan Transactions

16.8 GST on Securitization Transactions

16.9 Summary

16.10 Glossary

16.11 Self-assessment question



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16.1 INTRODUCTION

Whether it was uniformity of taxation and consequent free interior trade orpossession of 'the jewel in the crown' at the root of prosperity of Britain is debatable,nonetheless the words of father of modern economics on the benefits of uniformity ofsystem of taxation cannot be taken too lightly. Before implementation of Goods andService Tax (GST), Indian taxation system was a farrago of central, state and localarea levies. By subsuming more than a score of taxes under GST, road to a harmonizedsystem of indirect tax has been paved making India an economic union.

16.2 OBJECTIVES


• The concept, need and advantages of GST

• The impact of GST on loan transactions

• The impact of GST on securitisation transactions

16.3 CONCEPT

GST is an Indirect Tax which has replaced many Indirect Taxes in India. TheGoods and Service Tax Act was passed in the Parliament on 29th March 2017. TheAct came into effect on 1st July 2017; Goods & Services Tax Law in India is acomprehensive, multi-stage, destination-based tax that is levied on every valueaddition. In simple words, Goods and Service Tax (GST) is an indirect tax levied onthe supply of goods and services. This law has replaced many indirect tax laws thatpreviously existed in India. GST is one indirect tax for the entire country.

16.4 NEED

The introduction of CENVAT removed to a great extent cascading burden byexpanding the coverage of credit for all inputs, including capital goods. CENVATscheme later also allowed credit of services and the basket of inputs, capital goodsand input services could be used for payment of both central excise duty and servicetax. Similarly, the introduction of VAT in the States has removed the cascading effectby giving set-off for tax paid on inputs as well as tax paid on previous purchases and

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has again been an improvement over the previous sales tax regime.

But both the CENVAT and the State VAT have certain incompleteness. Theincompleteness in CENVAT is that it has yet not been extended to include chain ofvalue addition in the distributive trade below the stage of production. Similarly, in theState-level VAT, CENVAT load on the goods has not yet been removed and thecascading effect of that part of tax burden has remained unrelieved. Moreover, thereare several taxes in the States, such as, Luxury Tax, Entertainment Tax, etc. whichhave still not been subsumed in the VAT. Further, there has also not been any integrationof VAT on goods with tax on services at the State level with removal of cascadingeffect of service tax.

CST was another source of distortion in terms of its cascading nature. It wasalso against one of the basic principles of consumption taxes that tax should accrueto the jurisdiction where consumption takes place. Despite remarkable harmonizationin VAT regimes under the auspices of the EC, the national market was fragmentedwith too many obstacles in free movement of goods necessitated by proceduralrequirement under VAT and CST.

In the constitutional scheme, taxation powers on goods was with CentralGovernment but it was limited upto the stage of manufacture and production whileStates have powers to tax sale and purchase of goods. Centre had powers to taxservices and States also had powers to tax certain services specified in clause (29A)of Article 366 of the Constitution. This sort of division of taxing powers created agrey zone which led to legal disputes. Determination of what constitutes a goods orservice is difficult because in modern complex system of production, a product isnormally a mixture of goods and services.

As can be seen from the previous paragraphs, India moved towards valueadded taxation both at Central and State level, and this process was complete by2005. Integration of Central VAT and State VAT therefore is nothing but an inevitableconsequence of the reform process. The Constitution of India envisages a federalnature of power bestowed upon both Union and States in the Constitution itself. Asa natural corollary of this, any unification of the taxation system required a dual GST,levied and collected both by the Union and the States.

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16.5 RELEVANT DEFINITIONS

Business- The term "business" includes--

(a) any trade, commerce, manufacture, profession, vocation, adventure, wager orany other similar activity, whether or not it is for a pecuniary benefit;

(b) any activity or transaction in connection with or incidental or ancillary to sub-clause (a);

(c) any activity or transaction in the nature of sub-clause (a), whether or not there isvolume, frequency, continuity or regularity of such transaction;

(d) supply or acquisition of goods including capital goods and services in connectionwith commencement or closure of business;

(e) provision by a club, association, society, or any such body (for a subscription orany other consideration) of the facilities or benefits to its members;

(f) admission, for a consideration, of persons to any premises;

(g) services supplied by a person as the holder of an office which has been acceptedby him in the course or furtherance of his trade, profession or vocation;

(h) services provided by a race club by way of totalisator or a licence to book makerin such club ; and

(i) any activity or transaction undertaken by the Central Government, a StateGovernment or any local authority in which they are engaged as public authorities;

Business Vertical- "business vertical" means a distinguishable component of anenterprise that is engaged in the supply of individual goods or services or a group ofrelated goods or services which is subject to risks and returns that are different fromthose of the other business verticals.

Capital Goods- "capital goods" means goods, the value of which is capitalised in thebooks of account of the person claiming the input tax credit and which are used orintended to be used in the course or furtherance of business.

Composite Supply-"composite supply" means a supply made by a taxable person to

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a recipient consisting of two or more taxable supplies of goods or services or both, orany combination thereof, which are naturally bundled and supplied in conjunctionwith each other in the ordinary course of business, one of which is a principal supply.

Consideration- "consideration" in relation to the supply of goods or services orboth includes--

(a) any payment made or to be made, whether in money or otherwise, in respect of,in response to, or for the inducement of, the supply of goods or services or both,whether by the recipient or by any other person but shall not include any subsidygiven by the Central Government or a State Government;

(b) the monetary value of any act or forbearance, in respect of, in response to, or forthe inducement of, the supply of goods or services or both, whether by the recipientor by any other person but shall not include any subsidy given by the CentralGovernment or a State Government:

Provided that a deposit given in respect of the supply of goods or services or bothshall not be considered as payment made for such supply unless the supplier appliessuch deposit as consideration for the said supply.

Mixed Supply- "mixed supply" means two or more individual supplies of goods orservices, or any combination thereof, made in conjunction with each other by a taxableperson for a single price where such supply does not constitute a composite supply.

Money- "money" means the Indian legal tender or any foreign currency, cheque,promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque,money order, postal or electronic remittance or any other instrument recognised bythe Reserve Bank of India when used as a consideration to settle an obligation orexchange with Indian legal tender of another denomination but shall not include anycurrency that is held for its numismatic value.

Person- "person" includes-

(a) an individual;

(b) a Hindu Undivided Family;

(c) a company;

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(d) a firm;

(e) a Limited Liability Partnership;

(f) an association of persons or a body of individuals, whether incorporated or not, inIndia or outside India;

(g) any corporation established by or under any Central Act, State Act or ProvincialAct or a Government company as defined in clause (45) of section 2 of the CompaniesAct, 2013;

(h) anybody corporate incorporated by or under the laws of a country outside India;

(i) a co-operative society registered under any law relating to co-operative societies;

(j) a local authority;

(k) Central Government or a State Government;

(l) society as defined under the Societies Registration Act, 1860;

(m) trust; and

(n) every artificial juridical person, not falling within any of the above

Supplier-"supplier" in relation to any goods or services or both, shall mean the personsupplying the said goods or services or both and shall include an agent acting as suchon behalf of such supplier in relation to the goods or services or both supplied.

Fixed Establishment-"fixed establishment" means a place (other than the registeredplace of business) which is characterised by a sufficient degree of permanence andsuitable structure in terms of human and technical resources to supply services, or toreceive and use services for its own needs.

Inward Supply-"inward supply" in relation to a person, shall mean receipt of goodsor services or both whether by purchase, acquisition or any other means with orwithout consideration.

Market Value-"market value" shall mean the full amount which a recipient of asupply is required to pay in order to obtain the goods or services or both of like kindand quality at or about the same time and at the same commercial level where the

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recipient and the supplier are not related.

Mixed Supply-"mixed supply" means two or more individual supplies of goods orservices, or any combination thereof, made in conjunction with each other by a taxableperson for a single price where such supply does not constitute a composite supply.

16.6 ADVANTAGES

1. Benefits to the exporters: The subsuming of major Central and State taxes inGST, complete and comprehensive setoff of input goods and services and phasingout of Central Sales Tax (CST) would reduce the cost of locally manufactured goodsand services. This will increase the competitiveness of Indian goods and services inthe international market and give boost to Indian exports. The uniformity in tax ratesand procedures across the country will also go a long way in reducing the compliancecost.

2. Benefits to small traders and entrepreneurs: GST has increased the thresholdfor GST registration for small businesses. Those units having aggregate annual turnovermore than Rs 20 lakhs (10 lakh in case of North Eastern States) have be registeredunder GST. Unlike multiple registrations under different tax regimes earlier, a singleregistration is needed under GST in one State. An additional benefit under Compositionscheme has also been provided for businesses with aggregate annual turnover uptoRs 1.5 Cr. With the creation of a seamless national market across the country, smallenterprises will have an opportunity to expand their national footprint with minimalinvestment.

3. Benefits to agriculture and Industry: GST will give more relief to industry,trade and agriculture through a more comprehensive and wider coverage of input taxset-off and service tax set-off, subsuming of several Central and State taxes in theGST and phasing out of CST. The transparent and complete chain of set-offs whichwill result in widening of tax base and better tax compliance may also lead to loweringof tax burden on an average dealer in industry, trade and agriculture.

4. Benefits for common consumers: With the introduction of GST, the cascadingeffects of CENVAT, State VAT and service tax will be more comprehensively removedwith a continuous chain of set-off from the producer's point to the retailer's point

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than what was possible under the prevailing CENVAT and VAT regime. Certain majorCentral and State taxes will also be subsumed in GST and CST will be phased out.Other things remaining the same, the burden of tax on goods would, in general, fallunder GST and that would benefit the consumers.

5. Promote "Make in India": GST will help to create a unified common nationalmarket for India, giving a boost to foreign investment and "Make in India" campaign.It will prevent cascading of taxes and make products cheaper, thus boosting aggregatedemand. It will result in harmonization of laws, procedures and rates of tax. It willboost export and manufacturing activity, generate more employment and thus increaseGDP with gainful employment leading to substantive economic growth. Ultimately itwill help in poverty eradication by generating more employment and more financialresources. More efficient neutralization of taxes especially for exports thereby makingour products more competitive in the international market and give boost to IndianExports. It will also improve the overall investment climate in the country which willnaturally benefit the development in the states. Uniform CGST & SGST and IGSTrates will reduce the incentive for evasion by eliminating rate arbitrage betweenneighboring States and that between intra and inter-State supplies. Average tax burdenon companies is likely to come down which is expected to reduce prices and lowerprices mean more consumption, which in turn means more production thereby helpingin the growth of the industries. This will create India as a "Manufacturing hub".

6. Ease of Doing Business: Simpler tax regime with fewer exemptions along withreduction in multiplicity of taxes that are at present governing our indirect tax systemwill lead to simplification and uniformity. Reduction in compliance costs as multiplerecord-keeping for a variety of taxes will not be needed, therefore, lesser investmentof resources and manpower in maintaining records. It will result in simplified andautomated procedures for various processes such as registration, returns, refunds,tax payments. All interaction shall be through the common GSTN portal, therefore,less public interface between the taxpayer and the tax administration. It will improveenvironment of compliance as all returns to be filed online, input credits to be verifiedonline, encouraging more paper trail of transactions. Common procedures forregistration of taxpayers, refund of taxes, uniform formats of tax return, common taxbase, common system of classification of goods and services will lend greater certainty

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to taxation system.

16.7 GST ON LOAN TRANSACTIONS

Financial transactions are at the very center of economic activity, as investmentin assets, goods and productive activity is funded by financial transactions. Thesetransactions take various forms - from equity, to loans, to investment in various typesof securities. Besides primary financing transactions, there are numerous secondarymarket transactions - including trades in securities, assignment and- securitization ofloans, etc.

The introduction of GST is, admittedly, one of the most outstanding tax reformssince Independence, and therefore, it is very important to unravel the implications ofGST on financial transactions. This chapter is limited to GST on basic financial-transactions, excluding insurance, stock broking services, etc.

GST ON LENDING TRANSACTIONS

One of the primary facts one should note while evaluating the applicability ofGST is the nearly-all-pervasive nature of the levy. The charging section [9 of theCGST Act] imposes the tax on any "supply". Exclusions are items like non-taxablesupplies [for example, alcohol for human consumption], or exempt supplies, or supplieswhich are zero-rated. Hence, the focus shifts to the ambit of the word "supply",which consists of all forms of supply of goods and services [sec.7(1) of CGST Act].Since the word is intrinsically connected with the words "goods" and "services" oneneeds to examine the meaning of those terms.

"Goods" are defined in sec. 2(52) to include any movable property, otherthan money and securities. "Services" are defined in sec. 2(102) to mean "anythingother than goods, money and securities but includes activities relating to the use ofmoney or its conversion by cash or by any other mode, from one form, currency ordenomination, to another form, currency or denomination for which a separateconsideration is charged."

Mere money is excluded from both "goods" as well as "services". When readwith the word "supply" supply of money is neither a supply of goods, nor a supply of

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services. However, sec. 2(102) includes, in the definition of "service", any activityrelating to use of money, even though supply of money itself is not a service. Meresupply of money could be settlement of a transaction - for instance, making a paymentfor goods and services. It could not have been argued that the person making thepayment itself is making a supply. Therefore, the intent of the law excluding supply ofmoney, but including any activity pertaining to the use of money becomes intriguing.This conundrum was faced by the Delhi High Court in Delhi Chit Fund Associationvs Union of India while interpreting similar expression used in sec. 65B(44) of theFinance Act, 1994 - the High Court expressed its perplexity in the following words:The Explanation, therefore, seems to offer a clue to the problem which appears to usto be a creation of the very confounding manner in which the definition is found tohave been drafted. However, we have to make sense of what we have".

Can it therefore be argued that lending of money is an activity pertaining touse of money? If the settlement of a supply in form- of a monetary payment cannotitself be taken to be a supply, then what else could be the exclusion of monetarytransactions in both the definition of "goods" as well as "services", except lending ordeposit of money?

The discussion may seem academic because the list of exempted services[item 8- extending deposits, loans or advances in so far as the consideration isrepresented by way of interest or discount (other than interest involved in credit cardservices)]. That is to say, there is a clear exemption for extending of deposits, loansor advances, insofar as the consideration is interest or discount. Therefore, it doesnot practically matter whether lending of money is a supply of services or not. However,the question becomes crucial from at least 2 viewpoints:

• Lending of money is a supply of services, but an exempt service in terms of Item 8of Exemption list;

• Interest involved in credit cards is not a fully exempt service.

The essence of the Delhi High Court ruling in Delhi Chit Fund Association was thatexempting something that was not even included in the ambit of the law does nothave much meaning. However, the question whether money lending is itself a supplyof service at all will continue to engage courts for some time to come.

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The exemption for financial transactions in India is quite narrow - it is only the interest/discount earned or paid for loans, deposits or advances. Therefore, if the transactiondeviates from a plain vanilla structure and therefore, fails the test of being a "loan","deposit" or "advance", or the consideration is not an interest or discount, theexemption is lost. As a result:

• All earnings and charges other than interest or discount will be chargeable to GST.This includes any upfront or regular charges such as processing fees, documentationcharges, service charges, collection charges, inspection charges, repossession charges,foreclosure or prepayment charges and so on.

• If the transaction does not fit into the meaning of "loan", "deposit" or "advance",even if the transaction is intrinsically a financial transaction, it does not seem that thesupply will be exempt from GST. Thus, if an inventory repurchase transaction or afinancial lease transaction may have the substance of a financial transaction, but itwill be difficult to contend that they avail the exemption given in Item 8 of theExemption list.

• Nevertheless, if the transaction is a loan transaction, there is no question of GST onthe recovery of principal lent, as the tax can only be on the consideration, and not forprincipal recovery.

REGISTRATION REQUIREMENTS

Loan transactions are currently originated, besides banks, by thousands ofnon-banking financial entities, thousands of money-lenders and entities occasionallyengaged in lending activities. Therefore, a pertinent question is -- is registration underGST law relevant for an entity, even though the entity may be earning income by wayof interest?

Notably, interest on loans is exempt as per the exemption discussed above; however,the registration requirement is based on (a) aggregate turnover in a financial yearexceeding 20 lacs; and (b) the supplier making a taxable supply. The term "aggregateturnover" as defined in sec. 2(6) includes value of all exempt supplies as well. Thus,while there is no GST on interest on loans, but the same is still captured in whilecomputing aggregate turnover. Thus:

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• If the aggregate amount of turnover (note that this is all-India turn over), includinginterest, in a year exceeds ? 20 lacs; and

• The entity has received any consideration other than interest (any amount whatsoever)or made any other taxable supply (for example, even sale of scrap in the office), theentity will require registration.

As may be well-known, GST law requires registration in every state where a taxablesupply is being offered from. In context of lending activities, a pertinent question is -what is the place from where the supplier is rendering the service? There is an elaboratedefinition of "location of supplier of services" in sec. 2(71) of the CGST Act, but thedefinition does not address the crucial question of the place from where the supply isbeing made. The determination of the place at which the supply is made, that place ofsupply, is done as per principles laid in the IGST Act, that Act does not provideguidance in fixing the place of the supplier.

Section 2(71) refers to a fixed establishment or the establishment most directlyconcerned with the provision of the supply. In case of a lending transaction, there arevarious facets - sourcing of the loan, servicing of the loan, legal documentation,refinancing of the loan, etc. Each of these may be done from different places - therefore,lenders will continue to ask which is the place from where the lending service is beingprovided?

One wonders why did the law leave such a crucial question open to interpretation?One potential answer is that eventually; GST law is destination-based, and therefore,the benefit of the levy will anyway travel to the state where the recipient of theservice is registered. However, it will be too optimistic to expect that the States willcare about whether the eventual benefit has been passed on to the state by way ofinter-State transfer of credits, if the transaction otherwise falls in their primary taxingjurisdiction.

In terms of practical advice, if the lender has a "fixed establishment" [defined in sec.2(50) with reference to "sufficient degree of permanence and suitable structure interms of human and technical resources to supply services"], it should generally beadvisable for the lender to get registration in that state. Notably, the draft of the law

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is inspired, to quite an extent, by the EU VAT regime, and the rulings under EU VATDirective seem to favour the above interpretation.

AVAILING INPUT TAX CREDIT

One of the most critical issues for lenders will be the manner of seeking inputtax credits. As a general rule, the credit for input services is allowed, if such inputsare used in course of or in furtherance of the business of the supplier [sec. 16 ofCGST Act]. Sec. 17(1) puts a restriction to the aforesaid general rule, stating that ifthe inputs are used partly for business purposes, and partly for other purposes, thenthe input credit will be restricted to so much input tax as is attributable to businesspurpose. Sec. 17(2) makes a similar rule for use of inputs for making exempt supplies,providing that the claims for input tax credit will be restricted to so much of the inputtax as it used for making taxable and zero-rated supplies.

In case of banks and financial institutions, the output is mostly in form ofloans, which is exempt. So, there will only be a small fraction of taxable output. Asregards inputs, once again, large part of the inputs are in form of interest, or manpowercost - most of which are non-taxable. Hence, there is an option, in sec. 17(4), tobanks, financial institutions and NBFCs, to take a thumb rule of 50% set-off - that is,on a monthly basis, 50% of the available input tax credits are set-off against outputtax liability.

Many lenders often have activities or business segments which have distinctlytaxable outputs. For example, agency functions, brokerages, leasing, etc have taxableoutputs. Therefore, a lender may like to evaluate whether to put for the segment orbusiness-silo computation, or to opt for the 50% set off. In case of the former option,Rule 42 of the Central Goods and Services Tax Rules, 2017 provides the detailedmanner of apportionment of inputs to the respective silos. The inputs explicitlyattributable to the taxable outputs are taken off, after deducting the explicitlydisallowable inputs [ non-business use, those specifically attributable to exemptturnover, and those which are blocked credits under sec. 17(5)], and the remainingcredits are apportioned on the basis of the contribution of exempt turnover to totalturnover.

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If a lender has a business segment which can be regarded as a "business vertical"in terms of the definition given in sec. 2(18), on considerations of risks and returns,the lender may also elect to register the business vertical as a "distinct person", thatis, a separate GST entity, though within the same legal and income-tax entity.Therefore, there are as many as 4 options with lenders: (a) opt for 50% set-off undersec. 17(4); (b) make a segment-wise computation by identifying inputs explicitlyattributable to exempt and taxable turnover respectively and appropriating the rest ofthe inputs in proportion of turnover; (c) opting for a separate vertical registration forthe taxable activity, though within the same legal entity; and (d) option for a separatelegal entity for the taxable activity.

Sec. 17(2) - silo-wisecomputation

Extent of set-off available

Sec. 17(4) -50% set-off

Separate businessvertical

Separate legalentity

Inputs directly attributableto taxable output to beallowed fully; remaininginputs to be splitproportionately based onturnover

50% of theinputs on amonthly basis

Inputs used in the taxablevertical to be allowed fully;inputs used for the othervertical may be subject to50% set-off u/s 17(4)

Two separateenti t ies-hence,same as forseparate vertical

GST registrations One for each relevant state One for eachrelevant state

Two for each relevant statewhere separate verticaloption exercised

Two for eachrelevant state

Legal and income-taxentities

One One One Two

Cross-offset of excess ofinput taxes over outputtaxes betweeen differentsilos

Possible, after re-strictingand apportioning theinputs

Question doesnot arise

Not possible Not possible

Compliance burden since segment-wiseattribution of input taxes tobe done

Minimal not only segment-wiseattribution, but twodistinct persons for GSTpurposes

two separatec o r p o r a t i o nentities-leading toduplication of allcorporate, legaland GSTcompliances

Flexibility of the option Option opted once will bevalid for the financial year

Opting out will amount tode-registation for GSTpurposes.

Opting out willrequire corporatemerger formalitiesas well

Option optedonce will bevalid for thefinancial year

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The selection of one, out of the 4 options above is a tricky choice, as thereare numerous factors to be considered. Table 1 compares the 4 options. In practice,the choice is based on a mix of quantitative factors (numerical impact based on thesize of the taxable activity), as well as qualitative factors.

16.8 GST on Securitisation transactions

Transitioning into GST, assessing its impact on business and taking appropriatemeasures to bring about tax neutrality/efficiency are the prime concern for all andsundry. GST therefore also has an impact on the securitisation transactions in Indiawhich now happens to be 85,000 crores odd industry. In this Chapter we are broadlytrying to deal with GST impact on securitisation of standard as well as non-performingassets and its various facets.

In India, securitisation is undertaken through the PTC route (issuance ofpass-through certificates or direct assignments. The distinction is not relevant whenwe talk about securitisation of non-performing assets through asset reconstructioncompanies.

GST IMPLICATIONS ON PTCs TRANSACTIONS

A securitisation transaction will have the following facets:

a. Assignment of receivables by the originator to an SPV

b. SPV acquiring receivables on discount

c. SPV issuing PTCs to investors and servicing PTCs over the term

c Originator receives servicing fees for collections/recovery of receivables

e. Originator receives excess interest spread (US) in the transaction after servicing ofthe investors with the receivables collected.

There is one more issue of whether the SPV will be considered as a related person asdefined under the CGST Act.

Before we delve into each of these it is pertinent to understand the colour of receivablesunder GST.

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Actionable Claims

Section 2(52) of the CGST Act, defines "goods" to include actionable claim, thedefinition is as below:

'(52) "goods "means every kind of movable property other than money and securitiesbut includes actionable claim, growing crops, grass and things attached to or formingpart of the land which are agreed to be severed before supply or under a contract ofsupply;'

Under the CGST Act, "actionable claims" have been included in the list of activitiesor transactions which shall be treated neither as supply of goods nor as supply ofservices. Relevant extracts from the CGST Act have been reproduced below:

"SCHEDULE III

[Section 7]

ACTIVITIES OR TRANSACTIONS WHICH SHALL BE TREATED NEITHERAS A SUPPLY OF GOODS NOR A SUPPLY OF SERVICES

Actionable claims, other than lottery, betting and gambling.

The term "actionable claims" has been defined in the CGST Act in the followingmanner:

2. In this Act, unless the context otherwise requires, -

(1) "actionable claim" shall have the same meaning as assigned to it in section 3 of theTransfer of Property Act, 1882;'

Section 3 of the Transfer of Property Act, 1882 defines "actionable claims" in thefollowing manner -

"actionable claim" means a claim to any debt, other than a debt secured by mortgageof immovable property or by hypothecation or pledge of movable property, or to anybeneficial interest in movable property not in the possession, either actual orconstructive, of the claimant, which the civil courts recognise as affording groundsfor relief, whether such debt or beneficial interest be existent, accruing; conditionalor contingent;

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The definitions put together can be summarised in the following way:

a. Goods include actionable claims.

b. Actionable claims falls into the exclusion of taxable supply (of goods or services),that is, it falls under activities or transactions that are exempt from applicability oftax.

c. The definition of taxable claim is a claim to debt other than secured debt, thismeans, that secured debt shall be included in the list of taxable supply.

d. In financial transactions, actionable claim is claim to money, that is to say, whethersecured or unsecured the objective is recovery of money. Money however is excludedfrom the definition of goods and a money for money transaction also does not fallunder taxable supply.

If one was to extrapolate the above, the understanding that emerges is, unsecureddebt clearly is excluded from taxable supply, secured debt is excluded from definitionof actionable claim and therefore, two exclusions would make an inclusion seemingly.

If one was to consider further, it would be clear that in a secured debt the primaryconcern is recovery of money. Even if there was a case of default, the security/collateralwould be used to repay the debt due. Any additional amount recovered throughenforcement of security interest would not belong to the lender and would rightfullygo to the borrower. Therefore in case of a secured debt, the collateral is a mere caseof recovery of debt due.

Therefore, it would be not be a caricature to say that whether secured or unsecureddebt, the objective is to get repaid on financial transaction and that both, secured orunsecured debt are money for money transaction, which, anyway falls into theexemption list from taxable supply.

Therefore, the understanding that emerges is that in case of transactions in actionableclaims, including such of assignment of receivables, there would be no tax applicableunder the GST regime as well.

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Servicing Fees

Typical to a securitisation transaction is that the originator continues to do thecollection of receivables from the obligors for and on behalf of the SPV. The originatortherefore acts as a servicing agent and charges a servicing fee.

Under the current tax regime, servicing fees was subject to 15% service tax, chargedby the originator to the SPV. The SPV would typically not be able to claim set off andthis would be a sunk cost.

This cost under the GST regime goes up to 18%. Therefore if the servicing fee is 50basis points, the increase in cost is 9 basis points. Since SPV cannot claim the set off,the GST is a dead loss.

In India, the typical servicing fee charged is 25 basis points. Whether or not theconsideration for taxable supply of service is reasonable would depend upon the typeof a pool. For instance, if the pool is a microfinance pool or a granular pool, it maynot seem reasonable to charge a servicing of 25 bps as against a car loan pool.Therefore; where the servicing fee does not seem at arm's-length, it may be challengedthat servicing fees is not adequate consideration or the only consideration for collectionof receivables.

Further, if it was to be contested that the SPV is a related person to the originator asdefined under the CGST Act, then the servicing fees charged could be subject tovaluation rules which will subject the servicing fees to reasonable determination ofvalue of such supply of service by the assessing officer.

SPV a related person?

One of the issues during securitisation transaction structuring is to ensure that anSPy is a distinct entity from legal and accounting perspective. It would be relevant tohave independence established of the SPV from tax perspective as well.

The definition of related persons under CGST is as follows:

'For the purposes of this Act,-

(a) persons shall be deemed to be are persons" if-

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(i) such persons are officers or directors of one another's businesses;

(ii) such persons are legally recognised partners in business;

(iii) such persons are employer and employee;

(iv) any person directly or indirectly owns, controls or holds twenty-five per cent ormore of the outstanding voting stock or shares of both of them;

(v) one of them directly or indirectly controls the other;

(vi) both of them are directly or indirectly controlled by a third person;

(vii) together they directly or indirectly control a third person; or

(viii) they are members of the same family;

(b) the term 'person "also includes legal persons;

(c) persons who are associated in the business of one another in that one is the soleagent or sole distributor or sole concessionaire, howsoever described, of the other,shall be deemed to be related.'

One of the ways of establishing that the SPV and the originator are related persons,is by establishing control by the originator. The term control has not been definedunder CGST and therefore, one may have to rely on accounting tests for control.

As per the accounting standards, if the originator is controlling the SPV, it wouldlead to consolidation thereby frustrating the purpose of doing securitisation itself.

So, to avoid consolidation it is pertinent to avoid control by the originator over theSPV. If there is no control, the other parameters for falling into related person definitioncould be meandered.

However, if the transaction structure was such that control could be established thenthe transaction is subject to arm's length test and valuation rules.

Treatment of EIS component

Another critical issue in structuring securitisation transactions is how the excess interestspread or EIS will be swept by the originator from the transaction. Typically,

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transactions are devised to give residuary sweep to the originator after servicing thePTCs. Therefore there could be a challenge that EIS is al of servicing fees orconsideration for acting as a .servicing agent. The meaning of consideration underthe CGST Act is consideration in any form and the nomenclature supports the intentof the transaction.

Since, the originator gets excess spread question may arise, if excess spread is in thenature of interest. Therefore it is important to structure excess spread as IO strip.

Going forward it would be rather recommendable that the sweep of excess spread isstructured as IO strip. Since it is interest only.

Servicing of PTCs

Another facet of securitisation transaction that needs attention from GST perspectiveis taxability of servicing of coupon and repayment of PTCs. PTCs being securities,servicing of securities is exempt from applicability of GST.

GST implications on Direct Assignment transactions

In case of direct assignment, as in case of PTCs transaction, the assignment ofreceivables will be tax exempt (going by the same rationale).

The servicing fees charged to the buyer, would be subject to GST. The only reprievehere being that the buyer would be a bank or an NBFC and would be able to claim setoff on the GST levied.

GST implications on sale of Non-Performing Loans (NPLs)

In case of sale of NPLs to an asset reconstruction company (ARC), the receivablesare acquired by a trust floated by an ARC. The receivables usually are not on thebooks of the ARC directly.

In case of ARCs, it would be a very strong contention that the trust of the ARC is arelated person to the ARC and therefore the management fees, the carry amount etc.charged by the managers would be subject to valuation rules.

With regard to security receipts issued by the ARCs, the taxability of such SRs would bethe same as in case of PTCs, as both are securities and therefore not falling undertaxable supply.

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16.9 SUMMARY

GST law marks a major change. Financial transactions are catalysts for economicactivity and the exemption in India for financial transactions is very narrow - intereston loans and purchase/sale and servicing of securities. It is, therefore, imperative thattransactions are structured carefully to avoid unhappy results.

The securitisation industry as gone through several rounds of regulatory changes -some favourable and some not. From change in the regulatory guidelines of RBI todistribution tax applicability and subsequent roll-over. There have been several seasonsof changes to come to some momentum as on date.

16.10 GLOSSARY

EIS: Excess interest spread

PTC: Pass through certificates

NPL: Non-Performing loans

ARC: Asset Reconstruction Company

SPV: Special Purpose Vehicle

16.11 SELF ASSESSMENT QUESTION

1. State the concept of GST.

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

____________________________________________________________

2. What are the advantages of GST?

____________________________________________________________

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1. Discuss the impact of GST on loan transactions.

2. Explain the need for GST in India.

3. How GST affects securitisation transactions?

4. Describe the provisions related to availing of input tax credit.


1. GST on Financial Services- By Vinod Kothari Consultants (P.) Ltd.

2. Guide to GST on Services- By Rakesh Garg & Sandeep Garg

3. Goods and Service Tax- By Dr. H.C. Mehrotra & Prof. V.P. Agarwal

4. GST Bare Act

5. www.cbic.gov.in

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GST ON FACTORING TRANSACTIONS, GST ON STOCK-BROKING BUSINESS, IMPACT OF GST ON

HOUSING FINANCE

Structure

17.1 Introduction

17.2 Objectives

17.3 GST on factoring transactions

17.4 GST on stock-broking business

17.5 Impact of GST on housing finance

17.6 Summary

17.7 Glossary




17.1 INTRODUCTION

Factoring is a very popular product mode of working capital funding acrossthe globe. In factoring transaction, the seller sells receivables of a debtor to a factoringcompany. The receivables are sold at a discount. Once the receivables are sold the

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factoring company enters into the share of seller and carries out all the activities thatthe seller should have done.

17.2 OBJECTIVES :


• The impact of GST on factoring transactions

• The impact of GST on stock-broking business

• Impact of GST on housing finance

17.3 GST ON FACTORING TRANSACTIONS

As we know that Factoring is a very popular product mode of working capital fundingacross the globe. In India, however, the picture is not quite rosy for factoringcompanies. Nevertheless, like every other thing in the country, factoring transactionswill also be affected by the introduction of GST in India.

In a factoring transaction, the seller sells receivables of a debtor to a factoring company.The receivables are sold at a discount. Once the receivables are sold, the factoringcompany enters into the shoe of seller and carries out all the activities that the sellershould have done. In fact, the servicing of the receivables is also done by the factoringcompany. A graphical representation of a typical factoring transaction is providedbelow:

Seller Debtor

2. Sale ofreceivables

3. Purchaseconsideration

1. Sale of goods

4. Servicingof receivables

5. Payment

FactoringCompany

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Implications of GST

Under GST regime, a transaction becomes chargeable only where it qualifies to be ataxable supply. Supplies can be either in the nature of supply of goods or supply ofservices and each of them are treated differently. So in order to understand the taximplications on factoring transactions, we will have to first understand the whether itwill qualify to be a supply of service or supply of goods.

A factoring transaction has several components attached to it and each of suchcomponents are to be examined individually to see if they are attracting the provisionsof GST. The components of a factoring transaction are -

1. Sale of receivables - First, there is a sale of receivables from the seller to thefactoring company, for which the seller receives a consideration. The consideration isarrived at after discounting the receivables at a discounting rate.

2. Processing of transaction - Second, there is a fee that is normally charged bythe factoring company for processing the transaction.

3. Factoring charges - Next, there is an amount charged by the factoring companyto the borrower towards the charges incurred for registration of factoring transactionswith the Central Registry of Securitisation Asset Reconstruction and Security Interestof India (CERSAI).

4. Servicing of receivables - Once the receivables are sold to the factoringcompany, the servicing and collections are carried out by the factoring companyonly. This is an additional service that is provided by the factoring company and theconsideration for the same is adjusted with the discounting rate that is fixed fordiscounting the receivables.

Let us now analyse the impact of GST on each of the above components.

1. Sale of receivables

Receivables are actionable claims and transactions in actionable claims are dealt inthe following manner under the GST regime.

The term "goods" has been defined under section 2(52) of the Central Goods and

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Service Tax Act, 2017 in the following manner:

(52) "goods" means every kind of movable property other than money and securitiesbut includes actionable claim, growing crops, grass and things attached to or formingpart of the land which are agreed to be severed before supply or under a contract ofsupply;

The definition includes actionable claims within its purview, however, Schedule IIIcasts an exemption on actionable claims. Schedule III states transactions in actionableclaims shall neither be treated as a supply of service nor as a supply of goods. Further,the law also provides the definition of "actionable claims" under section 2(1) of theCGST Act in the following manner:

• "actionable claim" shall have the same meaning as assigned to it in section 3 of theTransfer of Property Act, 1882;

Section 3 of the Transfer of Property Act, 1882 defines the term "actionable claims"in the following manner:

"actionable claim" means a claim to any debt, other than a debt secured by mortgageof immovable property or by hypothecation or pledge of movable property, or to anybeneficial interest in movable property not in the possession, either actual orconstructive, of the claimant, which the civil courts recognise as affording groundsfor relief, whether such debt or beneficial interest be existent, accruing, conditionalor contingent;

On reading of the above text of law it can be inferred that only such claims to debtwhich are not secured by mortgage, hypothecation or pledge shall be considered asactionable claims.

Therefore, on reading of the above text of law, on the face of it might look thattransactions in only unsecured debts shall be exempted from GST and the transactionin secured receivables will still be covered under the GST law.

But as we do a closer reading of the definition of "goods" we understand that goodsexclude money; a secured debt is primarily nothing but a claim for money, the collateralis just an additional cushion for the lender which can be utilised to recover the money

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in case there is a default. Therefore, even secured debts should be considered asnothing more than money to money transactions.

Therefore, it can be concluded that transfer of receivables shall not be taxable underGST.

2. Processing of transaction

The CGST Act defines the term "services" in the following manner:

(102) "services" means anything other than goods, money and securities but includesactivities relating to the use of money or its conversion by cash or by any other mode,from one form, currency or denomination, to another form, currency or denominationfor which a separate consideration is charged;

As is evident from the above, services exclude any money to money transaction butincludes activities relating to the use of money. In a factoring transaction, processingfee is charged by a factoring company for processing the transaction, which fallswithin the meaning of activities relating to use of money. Therefore, processing feescharged will be charged to GST as supply of service.

3. Factoring charges

Factoring charges are charged by factoring companies towards the charges incurredfor registration of factoring transactions with CERSAI. As provided in the definitionof services, anything other than supply of goods, money and securities shall be treatedas services and this represents nothing among the three, therefore, the transactionwould qualify to be a supply of services and shall be subject to GST accordingly.

4. Servicing of receivables

As stated earlier in this document, once the receivables are transferred, the servicingis done by the factoring company, therefore, there is a service component involvedhere and ideally it should be charged to GST. The factoring company adjusts thecompensation for servicing and collection with the discounting rate. Therefore, thediscounting rate has two components attached to it, first, compensation towards thecredit risk and next towards the servicing and collection, while the former one isexempted from GST and the latter one is subject to GST, therefore, making the

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transaction a mixed supply.

In a mixed supply, GST is charged on the transaction at rate at which the supplycarrying the highest rate is charged.

Therefore, in the present case, the discount charged by the factoring company shallbe chargeable to GST at the rate which is applicable to the supply of collectionservices.

17.4 GST ON STOCK-BROKING BUSINESS

The implementation of GST has an impact on all sorts of businesses, transactions andacross entities. One of the financial intermediaries important to the capital markets instock brokers and this chapter is to understand the impact of GST on stock brokingbusiness, if any.

SHARE BROKING BUSINESS

A stock broker in India needs to be registered with SEBI. A "Stock-broker" is definedas per the Securities and Exchange Board of India (Stock-Brokers and Sub-Brokers)Regulations, 1992 as a person having trading rights in any recognised stock exchangeand includes a trading member Such a person, has to either make an application forregistration or register as a stock broker, in accordance with Section 3 ofaforementioned Regulation. Share broking services are those services which areprovided by registered broking firms, entities, individuals that are responsible forhelping the investors put their money in the stock market. These stock brokers act asmediators or middlemen to connect the buyers and sellers to facilitate their transactions.They act as an agent of customers in purchasing any selling securities in return for acommission commonly known as brokerage. These brokerage firms provides ancillaryservices like advising the client on their decision of buying/selling transactions andcharge commissions for the same.

A role of a stock broker typically is of the following type:

a. Underwriting and marketing new issuances;

b. Render advisory/consultancy on investment in stocks;

c. Trading in stocks for clients.

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Considering that the stock brokers render advisory on trading/investment in stocksancillary functions include research on stocks and capital markets, maintaining tradeaccounts for the clients, issuing research publication for general public (also a meansto marketing about the services and abilities). GST is chargeable on the servicesrendered by a stock broker.

ANALYSING THE IMPACT OF GST ON SERVICES

GST Act does not make any separate provisions for taxability of broking services. Inthe existing Service tax era, the service tax was imposed on the broking services, andthe commission received by the brokers was taxable. The basic principal of levyingGST is supply of goods/services. The services rendered by the stock broker will beconsidered as supply of services and will be taxed accordingly.

(1) Registration Requirements of Stock Broker

Section 22 of the CGST Act dictates the registration need for any person. The stockbrokers would not be liable to register itself unless the aggregate turnover (earnedthrough the commission/brokerage charges) exceeds the threshold limit of twentylakhs or is rendering inter-state supplies, which would most likely be the case for allstock brokers.

Section 24 of the CGST Act provides for mandatory registration of the personsmaking inter-State supplies. However, the Government of India, after exercising thepowers conferred upon it under section 2 3(2), exempted suppliers making inter-State supply of taxable services but having aggregate turnover of less than ' 20 lakhs,in States other special category States, or 10 lakhs in special category States, exceptJammu and Kashmir.

Based on the above understanding, even if the stock brokers provide inter-statesupplies, they will not have to obtain registration unless the turnover requirementsare met.

(2) Value of Services

The services are always provided in return for a consideration and could be in thenature of commission, remuneration, brokerage, factorage which are taxable to Goods

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and Service Tax. The brokerage/commission charged is often a percentage of securitiestransacted and considered as taxable value for levy. It is often argued whether thevalue of shares is included in the taxable value computed for the purpose of levy oftax.

The definitions of goods and services outlined in CGST Act exclude any transactionin securities, thereby, making the supply outside the purview of taxation. Further, thebroker embeds various charges while issuing a contract note like Securities TransactionTax (STT), SEBI Turnover fee, transaction charges stamp duty etc. Here we notethat SEBI Turnover fees and STT being a tax on securities, charged by the broker isactually a reimbursement for the expense incurred by him while facilitating thetransaction. These charges are ultimately paid to the government and any such servicesare exempted from levy of GST, likewise for stamp duty as well.

Therefore, it can be safely concluded that the value of supply or the amount on whichthe GST would be levied, would include the brokerage commission and transactioncharges mentioned in the contract note issued by the broker and would not includevalue of securities bought or sold by the broker.

(3) Rate Applicable

The services rendered under GST are taxable at the rate of 18% as against a rate of15% levied in case of service tax levied under the earlier tax regime. The additionalcost of 3% would increase the cost of trading for the customers, definitely having animpact on the volumes of the transactions.

17.5 IMPACT OF GST ON HOUSING FINANCE

GST is likely to impact almost all the transactions in the country and housing financeis no different. Given the importance of the role that housing finance sector plays inthe development of the country, it becomes imperative to analyse the impact of GSTon these transactions. Therefore, in this write up we intend to discuss the likelyimpact that GST would have on the housing finance business.

VARIOUS FACETS OF A HOUSING LOAN TRANSACTION

Under GST regime, a transaction becomes chargeable only when it qualifies to be a

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taxable supply. Supplies can be either in the nature of supply of goods or supply ofservices and each of them are treated differently. So, in order to understand theimplications of GST on housing loans, we will have to first understand whether it isa supply of goods or services.

There are several facets to a housing loan transaction, from the point of view of alender, and each of them has to be examined separately to see if they are gettingcovered under GST:

1. Lending of money - First, there is a loan that flows from the lender to the borrowerwhich is repaid along with the interest on the loan amount in installments.

2. Processing of loan transaction - Next, there is a fee that is normally charged by thelender for processing the transaction. This typically includes the charges fordocumentation as well.

3. Collections and recovery - Next, once the loan is granted there has to be recoveryand collections of the installments as well. This is done either by the lender's in-houseteam or through hired servicing agents.

4. Sourcing of business through agents - Often the housing finance providers engagethird parties for sourcing of business.

Let us now analyse the impact of GST on each of these.

1. Lending of money - Section 9 of the CGST Act levies GST on every supply,subject to the exceptions of non-taxable supplies, exempted supplies or zero-ratedsupplies. Supply can be either of goods or services. Therefore, it becomes importantto understand the meaning of "goods" and "services".

The term "goods" have been defined in the following manner:

'(52) "goods "means every kind of movable property other than money and securitiesbut includes actionable claim, growing crops, grass and things attached to or formingpart of the land which are agreed to be severed before supply or under a contract ofsupply;'

The term "services" have been defined in the following manner:

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'(102) "services" means anything other than goods, money and securities but includesactivities relating to the use of money or its conversion by cash or by any other mode,from one form, currency or denomination, to another form, currency or denominationfor which a separate consideration is charged;'

Neither "goods" nor "services" include money; therefore, supply of money shall notbe subject to the GST. Loan transactions are nothing but supply of money, therefore,are exempted from the scope of GST. This becomes more evident on reading of item8 of the list of exempted services under GST, which is -

"Services by way of-

(i) extending deposits, loans or advances insofar as the consideration is representedby way of interest or discount (other than interest involved in credit card services);"

Therefore, extending deposits, loans or advances shall remain exempted under GSTif the consideration is represented by way of interest or discount. In a housing loan,the consideration paid by the borrower is interest; therefore, the same shall not besubject to GST.

2. Processing of loan transaction

The CGST Act defines the term "services" in the following manner:

'(102) "services" means anything other than goods, money and securities but includesactivities relating to the use of money or its conversion by cash or by any other mode,from one form, currency or denomination, to another form, currency or denominationfor which a separate consideration is charged;'

As is evident from the above, services exclude any transaction in money but includesactivities relating to the use of money. In a loan transaction, processing fee is chargedby a lender for processing the transaction, which falls within the meaning of activitiesrelating to use of money. Therefore, processing fees charged will be charged to GSTas supply of services.

3. Collections and recovery

Some of the lenders engage servicing or collection agents for collecting the installments

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due, in such a case, the transaction between the agent and the lender shall be subjectto the GST. Here it is pertinent to take a note of the notification issued by the GSTCouncil for listing down the services to be charged on reverse charge basis includesservices supplied by recovery agents to a banking company or a financial institutionor a non-banking financial company are subject, which means the tax has to be paidand deposited by the lender instead of the servicing agent and the lender will be ableto claim credit of the same.

4. Sourcing of business through sourcing agents -

It is a very common practice for the housing finance companies to engage thirdparties for carrying out business sourcing for them. Services provided. by sourcingagents will be taxable under GST. However, it is important to note that if services areprocured from unregistered sourcing agents, the entity will have to pay tax underreverse charge mechanism.

REGISTRATION REQUIREMENTS

The registration requirements under GST law have been laid down under the ChapterVI of the CGST Act. As per section 22 of the CGST Act, every supplier shall be liableto be registered in the State/UT from where it makes a taxable supply of goods orservices or both, if the aggregate turnover in a financial year exceeds 20 lakhs/ 10laths (in case of special category states).

Each of the highlighted words has been defined under the CGST Act and warrantsdiscussion here.

The term "supplier" has been defined to mean:

'(105) "supplier" in relation to any goods or services or both, shall mean the personsupplying the said goods or services or both and shall include an agent acting as suchon behalf of such supplier in relation to the goods or services or both supplied,'

Therefore, anyone who supplies goods or services or both is a supplier. Next thing tounderstand is the meaning of taxable supply. The term has been defined in the followingmanner:

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'(108) "taxable supply" means a supply of goods or services or both which is leviableto tax under this Act;'

Therefore, only if a supplier makes taxable supplies, it would require registration. Asthe term suggests, taxable supplies mean such supplies which are taxable under thelaw, therefore, the supplies must not be any of the following:

• List of supplies mentioned under Schedule III of the CGST Act;

• Non-taxable supplies;

• Exempted supplies.

Last but not the least, a supplier, making taxable supplies, must have an aggregateturnover of 20 lakhs/ 10 lakhs, as the case may be. The term aggregate turnover hasbeen defined in section 2(6) of the CGST Act in the following manner:

"aggregate turnover" means the aggregate value of all taxable supplies (excludingthe value of inward supplies on which tax is payable by a person on reverse chargebasis), exempt supplies, exports of goods or services or both and inter-State suppliesof persons having the same Permanent Account Number, to be computed on all Indiabasis but excludes central tax, State tax, Union territory tax, integrated tax and cess;'

Breaking down the various components of aggregate turnover:

• Value of all taxable supply

• Value of exempt supply

• Value of exports of goods or services or both

• Inter-state supplies between persons having same PAN

Therefore, an entity will have to get itself registered on its aggregate turnover reachingthe specified mark, even if the turnover from the taxable supplies still remains withinthe limit.

In case of housing finance companies, the major portion of the aggregate turnoverwill represent interest from loans extended, which is exempt from GST, and thetaxable component of the business, that is represented processing fees, documentation

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charges etc., will represent a small part of the aggregate turnover.

So, if the aggregate turnover of a housing finance company exceeds the specifiedlimit, even if the taxable component represent only a fraction of the total pie, it willhave to register itself with the authority. Further, the entity will have to obtainregistration in each of such state/UT in which it intends to carry on the business, asthe language of section 22(1) suggests so.

INVOICING AND BILLS OF SUPPLY

Under the GST regime, a supplier has to issue a tax invoice for every taxable supplyand a bill of supply for every exempted supply. Therefore, going forward, the housingfinance companies will have to issue tax invoice for charges like processing fees,documentation charges and for interest charged on loan transactions, bill of supplywill have to be issued. This will be a new thing for the housing finance companies,because, the payment of installments happened based on the payment scheduled signedbetween the parties and no invoice was raised, but going forward, every month a billof supply will have to be raised.

INPUT TAX CREDIT

There are two ways in which housing finance companies can claim input tax credit(ITC) under GST law - either under section 17(2) or under section 17(4) of theCGST Act.

Section 17(2) states a registered person can claim credit on inputs to the extent it isused for making taxable supplies, this also called the silo approach. Section 17(4) isa special provision for banks or financial institutions including non-banking financialcompanies, and it states that these classes of entities can claim credit to the extent of50% of the taxes paid on total inputs acquired.

For a housing finance company, substantial portion of the outward supplies will beloans and advances which are non-taxable, and only a minor portion of the outwardsupplies will comprise of taxable supplies, i.e., to the extent the entity chargesprocessing fees, documentation charges etc.

In such a situation, if the entity opts to claim ITC as per section 17(2), substantial

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portion will be disallowed. However, if it decides to opt for the other option, it willbe able to claim ITC at a flat rate of 50%, which will be better.

17.6 SUMMARY

GST Act does not make any separate provisions for taxability of broking services. Inthe existing Service tax era, the service tax was imposed on the broking services, andthe commission received by the brokers was taxable. The basic principal of levyingGST is supply of goods/services. The services rendered by the stock broker will beconsidered as supply of services and will be taxed accordingly.

There is no doubt that GST is going to change the way businesses were conducted inIndia all these years. Each and every business structure, be it large or small, will haveto be reviewed and housing finance businesses will be no different and will require adetailed review.

17.7 GLOSSARY

ITC: Input Tax Credit

STT: Securities Transaction tax

SEBI: Securities and Exchange Board of India

CERSAI: Central Registry of Securitisation Asset Reconstruction and SecurityInterest of India

17.8b SELF ASSESSMENT QUESTIONS

1. Explain the concept of factoring.

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2. What is bill of supply?

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1. Explain the various facets of housing loan transactions.

2. Examine the impact of GST on stock-broking business.



2. GST on Financial Services- By Aditya Singhania


4. GST Bare Act

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IMPACT OF GST ON TRANSACTIONS IN SECURITIES,IMPACT OF GST ON BANKS AND BANKING SERVICES

Structure

18.1 Introduction

18.2 Objectives

18.3 Impact of GST on transactions in securities

18.4 Impact of GST on Banks and Banking services

18.5 Summary

18.6 Glossary




18.1 INTRODUCTION

Finance which is correctly termed as "life blood" of the economy has variedsources. One significant source among them happens to be the capital markets.Company issues instrument such as share, debt instrument, etc. Subsequently theyget listed in stock exchanges, investors subscribe them and capital market comes intoplay. The whole idea of having a secondary market is to have liquidity at any given

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point. Thus finance can said to be highly available at any point of time for investors;of course one may argue this to be far from truth.

18.2 OBJECTIVES :


• GST provisions related to transaction in securities

• The impact of GST on banks and banking services

18.3 IMPACT OF GST ON TRANSACTIONS IN SECURITIES

Finance which is correctly termed as "life blood" of the economy has variedsources. One significant source among them happens to be the capital markets.Company issues instrument such as share, debt instrument, etc. Subsequently theyget listed in stock exchanges, investors subscribe them and capital market comes intoplay. The whole idea of having a secondary market is to have liquidity at any givenpoint. Thus finance can said to be highly available at any point of time for investors;of course one may argue this to be far from truth.

In India,' capital markets enjoy a special attention. Capital marketintermediaries form a significant part of the financial world. Therefore, it is pertinentto understand various nuances and intricacies with regard to tax implications in relationto capital market transactions. Investment activity happens to be mostly under thepurview of direct taxes whereby specific provisions have been placed to capture thegains and have tax paid on it while it is also interesting to note that the same activity,having suffered tax, is also taxed under indirect tax regime. However, it is a wellestablished principle that direct and indirect taxes are mutually exclusive and do notcoincide and provisions of the two do not overlap. So an investor is required toprovide due consideration to both the provisions of direct and indirect tax to getbetter benefits out of the transaction in form of returns.

OLD TAX REGIME

The indirect tax regime in India has always excluded securities for indirecttax purposes whether it was the provisions of Service Tax Act or VAT Act(s). TheIndirect tax regime works on fundamental principle that it shall be levied on

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consumption and not on income as direct tax do. The tax is levied on the valueadded/extra consideration charged. Therefore applying the principle above,transactions in securities i.e. sale/purchase of securities being investment and notconsumption were never charged to tax. The position regarding to transaction insecurities was fairly clear in the old tax regime while they are still clear under GST.But it is interesting to note how the same pans out in the GST regime.

Provisions under Service tax

Service tax was always charged on the provision of service. The word "service"was defined in section 65B(44) of the Service Tax Act, 1994 to mean "any activityfor consideration carried out by one person for another and includes a declaredservice". The definition by itself had exclusions which were not considered as servicethough they represented an activity for a consideration. Of such exclusion was "anyactivity which constitutes transfer in title of goods''. That is to say if there was sale/purchase of goods then it did not constitute service and service tax was not chargedon such sale/purchase. Further goods were defined to include securities. In effectactivities in nature of only transfer of title by way of sale, redemption, purchase onprincipal to principal basis was excluded from the definition. Thus on a comprehensivereading of the above, the investment activity was getting out of the definition ofservice itself and no service tax was payable on transaction in security.

However one needs to pay heed to the point that only activity in nature of sale/purchase/redemption was out of ambit of service tax. Any activity relating to suchsale/purchase was never out of the ambit. This was the reason that services providedby the dealers, brokers or agents in relation to such activity was always charged toservice tax.

Provisions under VAT

VAT being an indirect tax was always charged on sale of goods when made incourse of business. Therefore for a transaction attract there was a need to all thethree conditions, namely

(a) There must be a "sale".

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(b) Sale must be a sale of "goods".

(c) Sale must take place in course of business.

The word "goods" were defined in the VAT Act(s) to exclude stocks and shares.Therefore in case of transaction in securities VAT was not being charged, as securitieswere not qualifying as goods. Hence in the present regime transaction in securitieswas out of ambit of indirect tax.

PROVISIONS UNDER GST REGIME

As per section 9 of the CGST Act, 2017 ("CGST Act"), GST would be chargedon all supplies. This thus means that if transaction qualifies to be a supply then thesame would be subject to GST. The word supply has been defined in section 764 ofCGST Act to include all forms of supply which includes sale, transfer, barter, exchange,licence, rental, lease or disposal made in course or furtherance of the business.Therefore looking at the inclusive definition which is very broad, transaction insecurities are getting covered by the term supply and on first thought it seemstransaction in securities will be chargeable to tax. However it will be too early toform such an opinion.

Since GST is tax on supply of goods or services or both, therefore the wordsupply is required to be read in conjunction with the word goods/services. Thus weneed to refer to the definitions of goods/services for coming to conclusion on theleviability. Goods as defined in section 2(52) of the CGST Act means "every kindother than money and security" while services have been defined in section 2(102) ofthe CGST Act to mean "anything other than goods, securities is charged".

Therefore securities are neither treated as goods nor as services because ofspecific exclusions in the definitions. For this reason, the transaction in securities isgetting included in the meaning of non-taxable supply and in turn happens to be anexempt supply under the GST regime.

The exemption has been given to securities and at this stage it is pertinent tounderstand the meaning of securities. Securities have been defined in section 2(101)

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of CGST Act and derive its meaning from the Securities Contracts (Regulation) Act,1956. The term securities as defined in clause

(h) of the said Act and is as follows-

'securities' includes -

• Shares, scrips, stocks, bonds, debentures, debenture stock or other marketablesecurities of a like nature in or of any incorporated company or other body corporate.

• Derivative.

• Security receipt as defined in clause (zg) of section 2 of the Securitisation andReconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

• Units or any other such instrument issued to the investors under any mutual fundscheme.

• Any certificate or instrument (by whichever name called), issued to any investor byany issuer being a special purpose distinct entity which possesses any debt or receivable,including mortgage debt, assigned to such entity, and acknowledging beneficial interestof such investor in such debt or receivable, including mortgage debt, as the case maybe.

• Government securities.

• Such other instruments as may be declared by the Central Government to be securities.

• Rights or interest in securities.

Now, a question arises that whether transaction facilitating transaction insecurity is also exempt. In this regard we need to understand that what is exempt isonly the transaction which takes place on principal to principal basis i.e. activitiesthat are in the nature of only transfer of title by way of sale, redemption, purchase oracquisition of securities. Any transaction which facilitates transaction in securities isnot exempt. This can be borrowed from the fact that exclusion is of securities and notany transaction relating to securities. In essence we can say that unless specifically

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mentioned anywhere reference to a main service does not include reference to aservice which is used to provide main services. This can be understood through anexample below:

Suppose a broker is providing services to a seller/purchase to sell/purchasesecurities for which the broker is charging brokerage of x% on the value of thetransaction. The seller/purchaser in this case is not required to pay GST on sale/purchase price but on the consideration charged by the broker for facilitating thetransaction. Here the main service happens to be sale/purchase of securities and theauxiliary service happens to be that of broker. The main service is exempt as understoodabove but service provided by the broker has nowhere been exempted and wouldthus be chargeable to tax.

In light of the above, it can be said that any charges for facilitating transaction will bechargeable to GST. The same can be summarized below

18.4 IMPACT OF GST ON BANKS AND BANKING SERVICES

An economy without a robust banking sector is incomplete. Banks these daysnot only resort to traditional products like lending and accepting deposits, but alsoextend several other ancillary services. Re-iterating, GST has created an impact oneach and every sector of the Indian economy and the banking sector is no different.While the traditional products of banks, i.e., loans and deposits, have been exemptedunder the GST regime but the other services have not been exempted from GST.This gives rise to several questions - Whether GST will be beneficial for the customers

Buying and selling of mutualfunds or debenturesBrokerage charges

No, buying/ selling happens to be transaction in securitie andnot chargeable to tax.Yes. The consideration would be charged @ 18%

Transaction Taxability

Entry and Exit load on units

Issuance/ Redemption ofdebentures

Yes, the considertion is for documentation, initial expenses,asset management fees and etc.No, being transaction in securities as it involves transfer oftitle.

Transaction Taxability

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or will it make the situation worse? Is it going to make the work of banks easier ordifficult? These are some of the questions we are going to discuss in this chapter.

IMPACT OF GST ON BANKS

Registration

Under the existing service tax regime, some of the services provided by thebanks were subject to service tax; therefore, they had to obtain registration. Theprovisions relating to registration of service providers were laid down in the ServiceTax Rules, 1994. As per rule 4(1) read with rule 4(2), where a person, liable forpaying service tax on a taxable service:

i provided such service from more than one premises or offices; or

ii received such service in more than one premises or offices; or

iii. had more than one premises or offices, which were engaged in relation to suchservice in any other manner, making such person liable for paying service tax, andhad centralized billing system or centralized accounting system in respect of suchservice, and such centralized billing or centralized accounting systems were locatedin one or more premises, the person had the option of registering such premises oroffices from where centralized billing or centralized accounting systems were done.

Therefore, the banks and financial institutions opted for this and obtained asingle registration under the erstwhile regime. But under GST, things have changeddrastically.

As required under section 22 of the CGST Act, every person has to get itselfregistered in each state/UT where it intends to provide taxable services. Therefore,unlike before, the banks will have to go for decentralized registration, which means ifa bank operates in 29 states; it will have to obtain 29 separate registrations. Onceregistered, each of the branches will be treated as separate independent entities forthe purpose of GST.

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Place of supply

The concept of place of supply of services is of utmost importance fordetermining the taxability of a transaction under GST. Under GST, a transaction istreated to be in course of inter-State trade or commerce if the location of supplier ofservices and the place of supply are located in two different states/UTs; otherwise thetransaction is treated to an intra State transaction. Therefore, a detailed discussionabout place of supply of services by banks is warranted.

These days' banks allow their customers to avail their services from multiplelocations through internet, say for instance a customer having an account with abranch at Chennai avails service from Delhi, here it is important to understand placeof supply in order to determine the taxability of transaction. In the present case, it isvery clear that the place of supply is Delhi and therefore, IGST should be charged onthe transaction by the branch at Chennai. But given, the volume of transactions,tracking each and every transaction will not only be a cumbersome task for the banksbut will also increase the operational costs of the bank.

Considering the problems that could arise in the banking and financing industry inthis regard, special provisions were inserted in the GST to law to counter this potentialproblem. The IGST Act contains a special provision for determining the place ofsupply of services provided by banking companies. Section 12(12) of the IGST Actstates -

(12) The place of supply of banking and other financial services, including stockbroking services to any person shall be the location of the recipient of services on therecords of the supplier of services:

Provided that if the location of recipient of services is not on the records of thesupplier, the place of supply shall be the location of the supplier of services. In mostof the cases, the customers of different branches of the banks are locally domiciled,therefore, in most of the cases, the services provided by banking companies shall beintra-State transactions, even if they are availed from other states/UTs through internetbanking.

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Input Tax Credit

Under GST law, there are two ways in which a bank can claim ITC:

a. Claim credit under section 17(2) of the CGST Act - Claim credit of taxes oninputs to the extent they are used for making taxable supplies; or

b. Claim credit under section 17(4) of the CGST Act - Claim credit to the extentof 50% of taxes paid on all inputs of the entity. Since the major portion of suppliesmade by banks are non-taxable in nature, if the first option is chosen, the entity willend up losing significant portion of credit on taxes paid on inputs. Whereas, if thesecond option is opted for then credit to the extent of 50% will still be available.

Distribution of ITC

As stated earlier, under GST regime, banks will have to obtain separateregistration, therefore, each of the branches with distinct registrations will be treatedas separate persons under GST. Unlike as under the erstwhile regime, the banksfaced no problem in claiming ITC on common inputs since they followed centralisedregistration model, under the GST regime, the decentralised registration model cancreate problems relating distribution and utilisation of credits.

These shortcomings may be tackled by getting one of its branches registeredas Input Service Distributor (ISD). This ISD would accumulate the credit of taxespaid on common inputs and distribute among the various locations in the proportionof their turnover.

Impact of the GST on various services provided banks

In addition to the traditional services provided by the banks, i.e. acceptanceof deposits, giving loans and advances etc. banks these days provide other services aswell. Let us understand the impact of GST on such services.

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Service offered Whether taxable or not

Locker service

Rate of tax

Banks offer safety lockers forrent to the customers and therelationship between a bankand its customer is that of alessor and lessee. But thequestion, will this be treated asa rent of movable property oran immovable property.Lockers are typicaly fixed to thewall and it cannot be removedwithout causing substantialdamage to the property,therefore, undoubtedly theseare immovable property. Paraof renting of immovableproperty shall be treated assupply of services under GST.Therefore, renting of safetykeeping lockers shall be subjectto tax under GST.

18%

Facilitating ATMwithdrawals

Banks facilitates its accountholders to withdraw cash fromATMs. Normally, a certainnumber of withdrawals formATMs are free of any chargeand banks start charging onATM withdrawals as soon asthe number of the withdrawalsexceed the specified limit.These charge will be subject toGST. In addition to the above,banks also charge an annual orbi-annual fee from all thecustomers for making the ATMfacilities available to them.Providing ATM facility to thecustomers would get coveredunder the definition of supply,therefore, all these charges willbe subject to GST.

18%

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Service offered Whether taxable or not

Facilitating internetbanking

Rate of tax

Just like in case of the ATMwithdrawals, banks charge feefor providing internet bankingfacilities. Based on similarlogic, these charges would besubject to GST.

18%

Drawing of demanddrafts

Bank charge a fee for drawingdemand drafts. Drawing ofdemand drafts being in thenature of services, would getcovered under the definition ofsupply.Therefore, the fee so chargedshall be subject to GST.

18%

Agency services Banks operating on standinginstructions by its customers isa very common sight thesedays. Based on the standinginstructions, banks operate asagents of the customers toexecute several functions likemaking payments, collectingdividends, transacting insecurities etc., for which itcharges fees or agencycommission.These services are very wellcovered within the ambit of“supply”, therefore, thesecharges are subjected to GST.

18%

Acting as Executor,Trustees, Attorneyetc.

Banks act as executors of will,trustees, attorneys andadministrators. As an executorit preserves the “Wills” of thecustomers and executes themafter their death. As a trustee,it takes care of the funds of thecustomers. As an attorney, itsigns transfer forms anddocuments on behalf of thecustomer.

18%

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INVOICING UNDER GST REGIME

The new regime has increased the amount of the paperwork substantially.Under GST regime, one has to raise invoice or similar documents on the re irrespectiveof whether it is providing taxable supplies or exempted supplies. Loans and advanceswere exempted from service tax regime and is exempt under GST as well earlierthere was no requirement of raising invoice for interest charged by bank were madebased on the payment schedule signed between the parties, but under GST regime, abank will have to raise bill of supply for each installment, where the amount chargedtherein is exempt from GST.

Service offered Whether taxable or not Rate of tax

Any amount charged for theaforesaid services would besubject to GST.

Foreign currencyexchange

Banks often facilitate foreigncurrency exchanges. Thesewould be subject to GST andthere are specific provisionsgiven under law to covertaxability of such.

Rule 32(2) (b) of the CGST Rules providefor taxability of such transactions in thefollowing manner.

Bank guarantee Banks often extend guaranteesagainst which it chargesguarantee commission. Givingof guarantee is a type of supply,therefore, GST will have to becharged on guaranteecommission as well.

18%

Value of currencyexchanged

GST Rate

Upto Rs. 1,00,000 1% of Gross Amountsubject to minimum of Rs.250

Rs. 100001-Rs. 1000000

Rs. 1,000+0.5% of theGross amount excedingRs. 1,00,000 and upto10,00,0000

AboveRs. 10,00,000

Rs. 5,000+0.10% of theGross amount exceedingRs. 10,00,000 subject toMaximum amount of Rs.60,000

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While bill of supply will have to be issued for exempted supplies, invoice willhave to be issued for taxable supplies in the manner prescribed under GST law. Inaddition to it, if a bank makes any payment on tax on reverse charge basis, it will haveto issue a self-invoice.

18.5 SUMMARY

In India, capital markets enjoy a special attention. Capital market intermediaries forma significant part of the financial world. Therefore, it is pertinent to understand variousnuances and intricacies with regard to tax implications in relation to capital markettransactions. Investment activity happens to be mostly under the purview of directtaxes whereby specific provisions have been placed to capture the gains and have taxpaid on it while it is also interesting to note that the same activity, having suffered tax,is also taxed under indirect tax regime. As per section 9 of the CGST Act, 2017("CGST Act"), GST would be charged on all supplies. This thus means that iftransaction qualifies to be a supply then the same would be subject to GST Thereforesecurities are neither treated as goods nor as services because of specific exclusionsin the definitions. For this reason, the transaction in securities is getting included inthe meaning of non-taxable supply and in turn happens to be an exempt supply underthe GST regime.

Banks these days not only resort to traditional products like lending and acceptingdeposits, but also extend several other ancillary services. Re-iterating, GST has createdan impact on each and every sector of the Indian economy and the banking sector isno different. While the traditional products of banks, i.e., loans and deposits, havebeen exempted under the GST regime but the other services have not been exemptedfrom GST.

18.6 GLOSSARY

Place of supply: The place of supply of banking and other financial services, includingstock broking services to any person shall be the location of the recipient of serviceson the records of the supplier of services.

Bill of supply: It is issued for exempted supplies.

ISD: Input Service Distributor

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1. What is the rate of GST on various banking services?

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2. What do you understand by place of supply?

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1. Explain the registration requirements for banks under GST.

2. Discuss the impact of GST on transactions in securities.





4. Goods & Services Tax (GST) in India- By B. Viswanathan

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IMPACT OF GST ON MUTUAL FUNDS AND GSTIMPLICATION ON SALE OF REPOSSESED ASSETS

Structure

19.1 Introduction

19.2 Objectives

19.3 Impact of GST on Mutual funds

19.4 GST implication on sale of repossessed assets

19.5 Summary

19.6 Glossary


19.8 Lesson end exercises/exam oriented examinations


19.1 INTRODUCTION

A mutual fund is an investment vehicle, which pools money from variousinvestors, typically retail investors to be invested in the capital market. A mutual fundwould be floated by a sponsor, who would act as an anchor to the fund. The mutualfund would then float several investment schemes which describe the investmentobjective, which could be investment in equities, debt securities, hybrid, or investmentin gold etc. Based on the risk appetite and matching with the return expectations,

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investors would invest in a typical mutual fund scheme. The pooled-in money fromthe investors would be invested based on the scheme objectives by the investmentmanager. The investment manager would be professionals equipped with theknowledge and wherewithal of investments and are entrusted with the funds.

19.2 OBJECTIVES :


• Impact of GST on mutual funds

• GST implication on sale of repossessed asset

19.3 IMPACT OF GST ON MUTUAL FUNDS

A mutual fund is an investment vehicle, which pools money from various investors,typically retail investors to be invested in the capital market. A mutual fund would befloated by a sponsor, who would act as an anchor to the fund. The mutual fund wouldthen float several investment schemes which describe the investment objective, whichcould be investment in equities, debt securities, hybrid, or investment in gold etc.Based on the risk appetite and matching with the return expectations, investors wouldinvest in a typical mutual fund scheme. The pooled-in money from the investorswould be invested based on the scheme objectives by the investment manager. Theinvestment manager would be professionals equipped with the knowledge andwherewithal of investments and are entrusted with the funds.

Typically a trustee is appointed to be able to monitor the investments, activities of thefund manager to protect the interest of the investors. A custodian is appointed tocarry out custodial services for the scheme. Therefore the parties involved in a mutualfund are:

a. Fund Manager;

b. Trustees;

c. Custodian;

d. Sponsor;

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e. Investors or unit holders.

As was the case under the service tax regime, GST would be charged on variousexpenses borne by investors or the fund for the services rendered by various entitiestowards the functioning of the fund. Prima facie, the impact of GST could be analysedfrom the following perspective:

(1) Working of Mutual Fund

(2) Charges paid by unit holders

(3) Expenses incurred by mutual fund

We would delve into each of the above to understand the implication of GST on eachof the facets.

(1) Working of fund

The principle of GST tax rests on "supply of goods and services' GST is levied ontransactions where there is a "supply" of "goods" and/ or "services". Therefore, belowwe discuss the functioning of the fund to understand the implication of GST on thefund.

A typical mutual fund company works in following manner:

(i) Investors pool their money

The investors pool in the funds to be deployed for a proposed investment objective.The investments made the investors are represented by the unit held by them signifyingproportional share in the fund. Investment in the fund is use of money, deployed in aninvestment objective. It is similar to a capital contribution. 'Money' is excluded fromthe definition of both goods and services under GST. A mere transfer of money to thetrust shall not be attracted by GST.

Units hasn't been defined under the GST law, however, the term 'securities' underSection 2 of the CGST Act reads as follows:

(101) "securities" shall have the same meaning as assigned to it in clause (h) of section2 of the Securities Contracts (Regulation) Act, 1956;

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Now we come to the definition under Securities Contracts (Regulation) Act, 1956,relevant extract of which is:

(h) "securities" include-

"units or any other such instrument issued to the investors under any mutual fundscheme",

Securities are specifically excluded from the definition of both goods and services.By virtue of the above definition of 'securities', it shall also include units as issued bythe fund. And therefore, issue of such units shall not subject to GST.

(ii) Mutual fund invests the amount in Securities

As discussed earlier, the definition of goods under Section 2(52) and services undersection 2(102) specifically excludes securities, result thereto, acquisition or sale ofsecurities shall not be subject to GST.

(iii) Generates return on the fund and distributed to unit holders

The fund earns returns out of the investments made and such returns are undividedinterest of the investors/unit holders in the income earned by the fund and are eventuallydistributed among the investors. The returns earned by the fund are not subject toGST.

The investors of mutual fund generally earn return in the form of dividend payout orthe capital appreciation of their units. The dividend pay-outs, as discussed earlier isexempt, and the capital appreciation results when there is a sale of mutual fund unitor in its maturity which is outside the purview of GST. Distribution of returns to theunit holders is in a form of sharing/appropriating the profit by different name. Thereis no intent to provide services and hence, represents only a transaction in money.GST would, therefore, not be imposed on such distribution.

(2) Charges paid by unit holders/investors

(a) Entry or Front End Loads

Entry load means fees charged from the investor at the time of making investment ina mutual fund. This fee is eventually paid to the brokers or distributors. SEBI has

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barred mutual funds from applying any entry load fees to the investors thus the conceptis not relevant any more from GST perspective.

(b) Exit or Back End Loads

Exit loads are the charges which are liable to be paid in case an investor exits a fundbefore a specified time frame. Similar to entry loads, they are charged at a smallpercentage of the investment. In the service tax regime, service tax was paid by thefund on the amount received as exit load, and the balance was credited back to thescheme. This was highlighted in the Para 2.6.10 of the CBEC Service Tax EducationGuide which stated:

"Entry or exit loads are in the nature of consideration for documentation, coveringinitial expenses, asset management etc. Hence service tax would be leviable on suchentry and exit loads"

In line with that, GST laws excludes transaction in money but "activities relating tothe use of money" are under its purview, so GST would be charged on the exit loads.

(c) Transaction fees

A fixed nominal amount is charged from the investor at the time of investment inschemes of the company. AMFI has issued a clarification on the same.

Transaction charges are collected from investors and paid to the distributors. Forexample, if INR 100 are collected from investors, INR 10 is paid to the distributorsand INR 90 is invested in the fund. From MF perspective, the said deduction is aregulatory compliance under the SEBI Laws. The said amount is collected as adeduction in the NAV of the unit holder. There would be no GST implication on theMF. However, the distributor would be required to pay GST on such transactioncharges. Where the distributor is unregistered, MF has to discharge the GST on suchtransaction charges under reverse charge.

(d) Exchange fees

Exchange fees is incurred when an investor transfers to some other funds within thesame portfolio. Since these are extra charges rep resenting the documentation work

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and further processing of unit holders request, they would be leviable to GST.

(e) Account Fee

Fees are sometimes charged from investors in connection with the maintenance ofaccounts. Most funds ignore collecting these amounts from investors, and GST wouldbe levied only when separate charges are collected on account of maintenance of theaccounts as it is a service rendered by the fund to its investors.

(f) Investment Advisory

Sometimes investment advisory services are rendered by the fund company to theinvestors; GST would be applicable on the value of consideration received.

(g) Fund Management Fees

Management fees are collected by the fund houses for operating a mutual fund. Thisfees is backed by various expense incurred by firm in managing the fund and otheradministrative expenses incurred by them. This represents a percentage on theinvestment made and the tax amount is embedded in the percentage fees so collected.

(3) Expenses incurred by mutual fund

The mutual fund has to incur numerous expenses in running the fund and the sameincludes:

(a) Commission to Distributors

The commission is paid to the various distributors who operate on behalf of thecompany to bring investors and take part on the funds schemes. The commissionpaid is charged to the GST which is paid by the broker after collecting from the assetmanagement company. The above tax would be paid by the company under reversecharge if the so mentioned distributors are not registered.

It would be interesting to understand whether the distributors are liable to registerunder the GST laws for the commission received by them. Referring to the thresholdlimit of twenty lakhs/ten lakhs mentioned in Section 22 of the CGST Act forregistration, it gets evident that if their turnover received in the form of commissions

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exceeds the threshold limit, registration would become mandatory. The distributorsrender their service to the Head office of the Mutual fund Company, so if the registeredoffice of the company is situated in a state different to that of distributors, the supplywould be classified as "inter-state? Further, if they are providing service inter-state,the provisions of mandatory registration stated in Section 24 of the CGST Act wouldattract and require compulsory registration.

(b) Payouts to Registrar and Transfer Agent

They are institutions which register and maintain detailed records of the transactionsof investors for the convenience. GST would be levied on such service provided bythem by the RTA.

(c) Custodian Expenses

Custodian is responsible for keeping as well as safeguarding the investments andsecurities on behalf of the fund. Custodian services availed by the fund would beliable to GST at the rate of 18%.

(d) Trustee Payouts

The trustee oversees the management and operations of the fund on the behalf of unitholders. They oversee the performance of the fund, approve the rules and regulationsunder which it performs, approve the fee paid to the asset management company(AMC) for its services, and oversee the fund's compliance program. Therefore, suchservices are return for consideration, therefore, chargeable to GST.

(e) Audit expense, marketing & selling and other operating expense

GST is charged on supply of all those services covered in the ambit of its definitionunder Sec. 2(102), therefore services of auditor, marketing companies would have todischarged with the tax liability charged by the supplier.

Therefore it could be concluded that an increase in rate of GST would impact thevarious expense charged by the funds from the investors. Combined with an increase

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in tax, the fund itself has to incur on the various services availed, would result inlower returns from the investors.

19.4 GST IMPLICATION ON SALE OF REPOSSESSED ASSETS

Lending is always to good borrowers, but often, the good borrowers become badborrowers, either circumstantially or intentionally. Thus, the business of lending bringswith it the necessary element of enforcement of security interests as well. Therepossession of the collateral asset and eventual sale for recovery of the losses due todefault are a common phenomenon in lending business. This chapter deals with theGST implications for sale of repossessed assets.

ROLE IN REPO SALE

Under the existing tax regime, there has been art inevitable question of whether saleof repossessed assets will attract sales tax? Whether the lender, selling the repossessedassets is doing so as an agent of the borrower? There have been several rulingsdiscussing these issues.

To be able address the questions, one needs to understand a few things on sale ofrepossessed assets. There needs to be ownership of assets before there can be sale.The lender is not the owner of the repossessed assets, the borrower is. Therefore, thelender causing sale of repossessed assets is merely doing it with the objective ofeffectuating recovery of losses after default. The lender also does not do it as anagent to the borrower, since the lender is acting in its own capacity, by virtue of thepowers vested under law and the contract entered into between the borrower and thelender. The lender makes sale of a repossessed asset on the strength of thehypothecation agreement, and not as a factor or agent. The matter was discussed ina Calcutta High Court ruling of Tata Motors Finance vs Asstt. Commissioner ofSales tax.

While there have been rulings qualifying the position of the lender, there have beenother rulings stating that the title ownership of the assets does not determine the taxliability in case of sale of repossessed goods.

Most lenders eventually end up paying sales tax on sale of repossessed goods.

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REPO SALES OF MOVABLE PROPERTY

Under GST law, taxability of repo sales seems beyond doubt. If one reads the provisionsof rule 32(5) of the Valuation Rules the position will come clear. The Rule states asfollows:

"(5) Where a taxable supply is provided by a person dealing in buying and selling ofsecond hand goods i.e. used goods as such or after such minor processing whichdoes not change the nature of the goods and where no input tax credit has beenavailed on purchase of such goods the value of supply shall be the difference betweenthe selling price and purchase price and where the value of such supply is negative itshall be ignored:

Provided that the purchase value of goods repossessed from a defaulting borrower,who is not registered, for the purpose of recovery of a loan or debt shall be deemedto be the purchase price of such goods by the defaulting borrower reduced by fivepercentage points for every quarter or part thereof, between the date of purchase andthe date of disposal by the person making such repossession."

Provision specifically made in proviso to rule 32(5) to provide a deemed input taxcredit benefit by taxing only the difference between the actual sale price and depreciatedvalue. The combined effect of the sub-rule (5) and its proviso is that in case of sale ofrepossessed goods, the tax is not on the full price, but full price minus the deemedpurchase price. Deemed purchase price is the depreciated value, taking a 20% annualdepreciation.

For instance, if you sell an excavator which is 3 years old, originally bought at Rs. 10lacs, is now repossessed and sold at a price of Rs. 7 lacs, the GST treatment will be:

Selling price = Rs. 7 lacs

Deemed purchase price as per proviso (10 - 3*20%) = 4 lacs

Taxable value = Rs. 3 lacs

If the value is negative, it shall be ignored.

Some pertinent questions on the issue

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Note that Rule 32(5) is applicable only in case of repossession from a defaultingborrower, who is not registered. Does it mean, in case of registered dealer, there is areversal of input tax credit in the hands of the borrower, and therefore, a proper GSTclaim in the hands of the lender?

The intent of the law in keeping the proviso limited to unregistered dealers could nothave been to restrict the benefit. It will be a purely unintelligible discrimination tomake a law that favours repo from unregistered dealers, but not favour one fromregistered dealer.

Section 18 of the CGST Act states that -

"(6) In case of supply of capital goods or plant and machinery, on which input taxcredit has been taken, the registered person shall pay an amount equal to the inputtax credit taken on the said capital goods or plant and machinery reduced by suchpercentage points as may be prescribed or the tax on the transaction value of suchcapital goods or plant and machinery determined under section 15, whichever ishigher:

Provided that where refractory bricks, moulds and dies, jigs and fixtures are suppliedas scrap, the taxable person may pay tax on the transaction value of such goodsdetermined under section 15."

The section states that if capital goods on which ITC has been claimed are "supplied",there will be a reversal of ITC based on higher of the contractual value and depreciatedvalue.

Is repossession a case of supply?

Repossession can be of two types - first, protective, i.e., for safeguarding the assetand the lender gets to no right to exploit the asset; and second, exploitative, i.e., byrepossessing the asset the lender would get the right to exploit the asset in any mannerwhatsoever. By being a party to the first one, borrower does not lose its control orrights over the assets, therefore, such act of repossession cannot be treated as disposalof assets in the hands of the Borrower. However, second one is leading to transfer theeffective control over the asset from the hands of the Borrower to the hands of the

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Lender, therefore, resulting in disposal.

Further, free consensus of the both the parties is not mandatory for effecting a transfer,as was held in the Supreme Court ruling of ONGC vs State of Bihar. Therefore,involuntary transfers may not be sales, however, certainly is a case of "transfer" evenif there is no transfer of title and supply includes transfer as well as disposal.

In case of sale of repossessed assets, there is disposal of assets. Whether the disposalis from the borrower to the financier or from the financier to the purchaser is notrelevant; what is relevant is that there is a title transfer in the hands of the buyer.Whether title is conferred by way of a trail that travels from the borrower via thefinancier to the buyer or not, there is surely a transfer.

Therefore assuming a case that repo sales is a transfer. What is the contractual valueof such sale? Ideally the contractual value of such sales should be the credit financiergives in his post repo account statement.

The sale should be booked as a case of reversal of input tax credit. There is no reasonfor a borrower to continue to claim ITC for the capital goods which have beendispossessed from his.

REPO SALES OF IMMOVABLE PROPERTY

Immovable property itself is not covered by GST, however, the law says if the propertyis sold before completion certificate, it is covered by GST. Hence, if the lender hasprovided loan against property to a developer and enforcement happens beforecompletion of the project, it is likely that there is a component of GST. In case ofsuch sales, the value of land should be excluded from the computation.

REPO SALES OF SECURITIES

Securities such as shares etc. are exempt from the definition of goods and thereforeare exempt from being a taxable supply. Hence in case pledge is invoked on securities,there seems no issue under GST laws.

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REPO SALES OF STOCK-IN-TRADE

In case stock is repossessed and sold, the Rule discussed above shall apply. If thestock is repossessed and held, then it does not lead to supply and question of GSTdoes not arise. If the stock repossessed is self-supplied, then there will be a questionof tax being applicable.

POSITION OF REPO SALES UNDER GST

The position that emerges is as follows:

a. In case of repo sale of movable assets and stock, there will be GST applicablewhether to a third party buyer or in case of self-supply.

b. In case of repo sale of immovable assets, there is no question of GST being applicablehowever, if the repo happened prior to completion of the project (as in case of LAPloans), then GST will be applicable.

c. In case of repo sales of securities, there is no GST applicable as it is not a taxablesupply.

d In case repo assets is not sold/supplied and held in stock, there is no GST applicable.

19.5 SUMMARY

A mutual fund is an investment vehicle, which pools money from various investors,typically retail investors to be invested in the capital market. A mutual fund would befloated by a sponsor, who would act as an anchor to the fund. The mutual fund wouldthen float several investment schemes which describe the investment objective, whichcould be investment in equities, debt securities, hybrid, or investment in gold etc.Based on the risk appetite and matching with the return expectations, investors wouldinvest in a typical mutual fund scheme. The pooled-in money from the investorswould be invested based on the scheme objectives by the investment manager. Theinvestment manager would be professionals equipped with the knowledge andwherewithal of investments and are entrusted with the funds.

Under the existing tax regime, there has been art inevitable question of whether saleof repossessed assets will attract sales tax? Whether the lender, selling the repossessed

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assets is doing so as an agent of the borrower? Therefore, the lender causing sale ofrepossessed assets is merely doing it with the objective of effectuating recovery oflosses after default. The lender also does not do it as an agent to the borrower, sincethe lender is acting in its own capacity, by virtue of the powers vested under law andthe contract entered into between the borrower and the lender. The lender makes saleof a repossessed asset on the strength of the hypothecation agreement, and not as afactor or agent.

19.6 GLOSSARY

Entry Load: Entry load means fees charged from the investor at the time of makinginvestment in a mutual fund.

Exit Load: Exit loads are the charges which are liable to be paid in case an investorexits a fund before a specified time frame.

Exchange Fee: Exchange fees is incurred when an investor transfers to some otherfunds within the same portfolio.

Account Fee: Fees charged from investors in connection with the maintenance ofaccounts.

Repo sales of Securities: Securities such as shares etc. are exempt from the definitionof goods and therefore are exempt from being a taxable supply. Hence in case pledgeis invoked on securities, there seems no issue under GST laws.


1. What is transaction fee?

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2. What is a repo sale?

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1. Describe the parties involved in mutual fund.

2. Discuss the GST implications on sale of repossessed asset.





4. Good & Simple Tax- GST for you- By CMA Bhogavalli Mallikarjuna Gupta

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GST IMPLICATIONS WITH RESPECT TO GUARANTEES,GST IMPLICATIONS ON ALTERNATIVE INVESTMENT

FUND AND LEASE TRANSACTIONS UNDER GST

Structure

20.1 Introduction

20.2 Objectives

20.3 GST implication with respect to Guarantees

20.4 GST implications on alternative investment fund

20.5 Lease transactions under GST

20.6 Summary

20.7 Glossary


20.9 Lesson end exercises questions


20.1 INTRODUCTION

Related party transactions always follow the presumption of not being at arm's lengthand therefore tax provisions prescribe that the transactions should be undertaken atmarket value and be based on usual commercial terms, as if done with a third party.

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Transactions with related parties are always subject to scrutiny and are required todemonstrate that the transactions are driven by commercial understanding. The GSTregime also prescribes for definition of related persons and applicability of valuationrules, as prescribed in case of transactions with related persons. The lesson intends tohighlight some of the issues that the GST switch-over will bring about in case ofguarantee provided by related parties.

20.2 OBJECTIVES : After going through this lesson, students should be able tounderstand

• The GST implications with respect to Guarantees

• The GST implications on Alternate investment funds

• Discuss lease transactions under GST

20.3 GST IMPLICATION WITH RESPECT TO GUARANTEES

Related party transactions always follow the presumption of not being at arm's lengthand therefore tax provisions prescribe that the transactions should be undertaken atmarket value and be based on usual commercial terms, as if done with a third party.Transactions with related parties are always subject to scrutiny and are required todemonstrate that the transactions are driven by commercial understanding. The GSTregime also prescribes for definition of related persons and applicability of valuationrules, as prescribed in case of transactions with related persons. The lesson intends tohighlight some of the issues that the GST switch-over will bring about in case ofguarantee provided by related parties.

Section 15 of the GST Act states that the value of supply of goods or services shall beconsidered to be the actual price paid or payable for the purpose of taxation, wherethe transactions is not between related persons and price is the sole consideration forsupply. In case the supply of goods or services is between related persons then thevalue of such supplies shall be determined by the valuation rules prescribed in thisregard.

Who are related persons?

Explanation to Section 15 of the Central GST Act explains that

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a. persons shall be deemed to be related person if

(i) such persons are officers or directors of one another's businesses;

(ii) such persons are legally recognised partners in business;

(iii) such persons are employer and employee;

(iv) any person directly or indirectly owns, controls or holds twenty-five percent ormore of the outstanding voting stock or shares of both of them;

(v) one of them directly or indirectly controls the other;

(vi) both of them are directly or indirectly controlled by a third person;

(vii) together they directly or indirectly control a third person; or

(viii) they are members of the same family;

b. the term "person "also includes legal persons;

c. persons who are associated in the business of one another in that one is the soleagent or sole distributor or sole concessionaire, howsoever described, of the other,shall be deemed to be related.

Therefore holding and subsidiary, associates, fellow subsidiaries shall be taken to berelated persons.

Identifying issues in guarantee transactions

Rule 28 of the CGST Rules provides for determining the value of supply of goodsand/or services between distinct or related persons, other than through agent. Therule prescribes that the value of the supply between related persons shall be:

a. the open market value of such supply;

b. where open market value of such supply is not available, it shall be the value ofsupply of like kind and quality;

c. and where the value cannot be determined by the mechanisms stated in (a) and (b)above, it shall be determined by application of Rule 30 or Rule 31 of the aforesaidrules..

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Guarantees provided by holding to a subsidiary or transactions alike between relatedpersons will be considered to be a supply of service for the purpose of GST andusually, there is no guarantee commission charged.

So in case of guarantees provided by related person, the valuation rules shall apply.Also there is no market for guarantee commissions or service of like nature.

Proviso to Rule 28 states that:

"Provided that where goods are intended for further supply as such by the recipient,the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the sup-ply of goods of like kind and quality by therecipient to his customer not being a related person:

Provided further that where the recipient is eligible for full input tax credit, the valuedeclared in the invoice shall be deemed to be the open market value of goods orservices."

The provisos creates a carve out, (a) where there is regular supply of such goods or(b) where the recipient is eligible for full input tax credit, the value of the supply shallbe based on the invoice value for the purpose of taxability.

In case of guarantee the relevant proviso is where the recipient is a full input taxcredit eligible entity. In case it is not, then one will have to look at Rule 30 and Rule31 of the CGST Rules to conclude on the value of supply.

Rule 30 and Rule 31

Rule 30 states that- "Where the value of a supply of goods or services or both is notdeter minable by any of the preceding rules, the value shall be one hundred and tenper cent of the cost of production or manufacture or cost of acquisition of suchgoods or cost of provision of such services."

In case of guarantees there cannot be a computation of costs. Therefore the rule isnot relevant.

Rule 31 is the residual method of valuation and states that -

"Where the value of supply of goods or services or both cannot be determined under

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rules 27 to 30, the same shall be determined using reasonable means consistent withthe principles and general provisions of section 15 and these rules:"

Rule 31 exposes the determination of value of supply to the discretion of the taxofficer. The officer can apply any methodology to arrive at the value of guarantee forthe purpose of tax. The definition of related persons and the rationale for valuation isin lines with the World Trade Organisation Customs Valuation Agreement.

20.4 GST IMPLICATIONS ON ALTERNATIVE INVESTMENT FUND

An Alternative Investment Funds ("AIF") is an arrangement whereby funds are pooledtogether, and invested in different securities and markets. A typical AIF consists offollowing entities:

1. The Fund - Primarily, a fund is set up, which may be in the nature of a trust, acompany, an LLP or a body corporate (for ease of understanding, in further discussionwe assume that it is setup as a trust and referred to as trust). The trust is set up toexclusively pool the investments made by numerous investors

2. Sponsor - A sponsor is the person, who decides to float the fund and his role issimilar to that of a promoter of a company. He is the anchor to the fund and continuesto have skin-in-the-game at all times. The investors make the decision to invest lookingat who the sponsor of the fund is.

3. Investors - Investors are the persons that invest in the units of the AIF. Theinvestments made by the investors are pooled together.

4. Fund Manager - Fund Manager is the person who facilitates pooling of investmentsand is professionally equipped to deploy the pooled investments of the AIF based onthe objectives of investment of the fund. The investors typically look at the-fundmanager's ability to manage the funds to make investments.

5. Trustee - The fund also appoints a trustee to ensure that the interest of the investorsis protected at all times and that the fund is in compliance with its objectives. The roleof the trustee is to monitor activities of the fund with the objective of ensuring thatthe interest of investors is not jeopardized. The trustee also charges a fee for renderinghis services.

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6. Custodian- Some funds may also appoint a custodian to manage the property/assets held by the fund. The objective again is to ensure that the interest of the investorsin the assets of the funds is protected at all times. The custodian also charges acustodian fees for the services rendered.

A standard structure of an AIF is enumerated underneath:

TRANSACTION STRUCTURE

Functioning of a fund has series of transactions undertaken between the parties to thefund. The summation of these transactions leads to running of a fund. From GSTperspective therefore, we will be assessing these transactions.

1. Between investor and Fund

An investor contributes funds in the trust, in return, the investor is issued unitsrepresenting proportional interest in the fund and its assets.

The fund manager further invests these funds. Any dividend or income arising fromsuch investments is distributed among the investor in the proportion of units held bythem. On disposal of any security, income/gain if any is also transferred to the investorin the proportion of unit held by them.

2. Between Fund and fund manager

The fund managers charge fees for managing the fund. The fees structure will have

Invest in the unitsissued by the funds

The funds pools theinvestment made bynumerous investors

Trustee ensuresthat the interestof the investors isprotected

Appoints fund manager for development andmanagement of pooledfunds

Fund Manager

AIF (Fund/trust)Investors

Trustee

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fixed and a variable component. The variable component becomes applicable if thethreshold return (also called the hurdle rate) is met. The variable component is ashare in the profits earned by the fund. The variable component is called "carry".

3. Between the fund manager, trustee and custodian

The trustee and the custodian work towards protecting the interest of the investorsin the fund. They charge a fees for the services rendered, which is a cost to the fund.

GST IMPLICATIONS

On contribution to fund and units issued

'Money' is excluded from the definition of both goods and services under GST. Amere transfer of money to the trust shall not be attracted by GST.

Units hasn't been defined under the GST law, however, the term 'securities' underSection 2 of the CGST Act reads as follows:

(101) "securities" shall have the same meaning as assigned to it in clause (h) of section2 of the Securities Contracts (Regulation)Act, 1956;

Now we come to the definition under Securities Contracts (Regulation) Act, 1956,relevant extract of which is:

(h) "securities" include-

(id) units or any other such instrument issued to the investors under any mutual fundscheme;

Securities are specifically excluded from the definition of both goods and services.By virtue of the above definition of 'securities', it shall also include units as issued byAIF and therefore, issue of such units shall not subject to GST.

On receipt of any interest/dividend

As a return from the investments, income accrues in the form of interests in case ofdebt securities and dividend in case of shares. As per exemption list of services interestis exempted under serial No. 27, hence the same will not be liable to GST. Dividendis the consideration received by the investor for investing their funds in securities.

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Receipt of dividend does not involve any element of rendering of services to theinvestor, it is a transaction in money and hence the same is not liable to GST.

On fund manager fees and other charges

A fee charged by a fund manager is against the services of management of the fundand using professional expertise to manage the funds. Such fees and other chargesfor services shall be taxable under GST.

On fund managers 'carry' component

A construct of a typical fund is where the manager charges a fixed fees and a variablecomponent called "carry" as explained above. Before we delve into the question ofwhether GST is to be levied on such "carry" component, we will briefly discuss onthe nature of the carry.

The fund promises a return to the investors. The investors look at the investmentobjectives of the fund, the sponsors of the fund and their credibility, the manager'sexperience in the sector in which the fund intends to invest and the return expectationprovided by the fund.

The return expectation offered to the investor therefore becomes the hurdle rate thatthe managers need to cross while making investment decision.

Once the hurdle rate is crossed, the manager takes a share of the profits earned by thefund on the excess return earned above the hurdle rate. The carry explains that thelarger share of the profits will go to the manager and a smaller share to the investors(the market convention is an 80:20 carry, where 80% of the excess return goes to themanager).

Therefore, we need to understand whether 'carry' is in nature of fees charged by themanager for services rendered based on the efficiency of the manager to generatesufficient returns or is it a share of profit. This brings us to the question of whetheraca is a charge against profit or is it appropriation of profit.

For answering the question, we can draw an analogy from the generally acceptedprinciples for treatment of commission paid to the directors for the services rendered

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to the company. The commission is calculated as a percentage of profits earned bythe company and the same is a charge on the profits and not appropriation of theprofits. The question was discussed in an ITAT ruling of Hyderabad, in the matter ofM/s Swarnandhra Ijmi Integrated Township Development Company P Ltd vs. DeputyCIT Circle 3(3) Hyderabad where ITAT held that -

With regard to the question as to whether a payment is an expenditure allowable incomputing the profits of the business or whether it is a distribution of profit dependson the real nature of disbursement and on a true construction of the contract betweenthe It was further held in the said ruling that where the commission payable is computedas a percentage of net profits, the same will not affect the allowability of expenses inthe hands of the assessee. The relevant extracts of the ruling has been reproduced asunder:

He relied on the judgment in the case of CIT v. Parikh (C) & Co. (India) Ltd. [ 661(SC), where the managing agents' commission was payable as a percentage of netprofits, it was held that commission so paid was eligible for deduction in computingthe profits chargeable to tax. The fact that the commission payable had to be computedas a percentage of net profits was held not relevant in determining whether the sameis eligible for deduction. Nizam Sugar Factory v. C Ag. IT [(1964) 52 ITR 939 (AP)]

According to the AR, the Income-tax is a tax on the real income, i.e., the profitsarrived at on commercial principles subject to the pro visions of the Income-tax ActThe real profit can be ascertained only by making the permissible deductions. Thereis a clear-cut distinction between deductions made for ascertaining the profits anddistributions made out of profits. In a given case whether the outgoings fall in one orthe other is a question of fact to be found on the relevant circumstances, havingregard to business principles. This was the view of the Supreme Court in PoonaElectric Supply M/s. Swarnandhra IJMII Integrated Township Development CompanyPvt. Ltd"

From the above we can conclude that "carry" is a charge against the profit and in thenature of variable fees and hence subject to GST. The documentation of the fundshould also make it amply clear that the carry is an additional fees, variable in nature,payable subject to returns crossing the hurdle rate and therefore be subject to GST.

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Rate of tax

As per Central Tax Rate notification No. 11/2017 dated 28th June, 2016, the aforesaidservices of fund manager will be classified under heading No. 9971 - Financial andrelated services and subject to GST at the rate of 18%.

20.5 LEASE TRANSACTIONS UNDER GST

Lease as a mode of financing is used widely world-over and has over the years becomeone of the significant ways of asset-backed lending. It is not uncommon to see businesshouses or individuals acquiring and using assets on right to use basis. In fact, the useof leases is quite common.

Acquiring an asset on right to use basis entails lot of benefits vis-a-vis borrowing.One of the significant benefits from lease happens to be that leasing provides a wayto use the asset without being stuck with them and thus businesses remain asset light.Leases also enable users to spread their cash outlays over the years as against theoption of outright purchase where the whole cash outlay is done at day zero. Thedeductibility of the lease rental expense also allows tax shelter to the users and thusleases becomes quite attractive because of the aforesaid reasons.

The business of leasing has shot up over the years because of the above mentionedreasons and more so because of the clarity in the regulatory regime. India has witnessedhuge change in terms of regulatory structure in recent times, be it implementation ofIFRS converged Accounting Standard or implementation of GST. The changes havegreatly altered the economics of the businesses. Therefore, it is imperative on thepart of the beneficiaries and stakeholders in the leasing industry to take a note of thechanges and understand its implications. Thus, in this chapter we shall be studyingthe impact of GST on leases and how GST affects various facets of the transaction.

APPLICABILITY OF GST ON LEASES

The first question that comes to our mind when we refer to applicability of GST is,are lease transactions subject to GST? In the pre-GST regime, leases were subject toboth VAT and Service Tax (though only in case of financial lease). Leases will bechargeable to tax in the GST regime as well. Article 265 of the Constitution provides

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a mandate that no tax shall be levied or collected except by authority of law. Theauthority comes from the statute, from what is called the charging section.

The charging section of GST provides that tax shall be levied GST on all supply ofgoods and/or services. Therefore the taxability event for the purpose of GST is-

(a) Supply, and

(b) Supply should be of goods and/or services.

In other words, for determining the applicability of GST, primarily, one has to seewhether the transaction is a supply or not. The word supply is all pervasive andencompassing subject to relevant carve out which have been given in the scope ofsupply itself. The scope of supply has been dealt within section 7 of the CGST Act,2017. The generic meaning of supply happens to be that it includes all forms ofsupply (whether of goods/services) and includes supplies agreed to be made for aconsideration in the course or furtherance of the business. It specifically includessale, transfer, barter, exchange, license, rental, lease or disposal. The definition is aninclusive one. There can be other circumstances when it may be said to be a supplyprovided that the other conditions such as consideration etc. are fulfilled. Further,taxability does not only depend on the word supply, it has to be supply of goods and/or services. GST takes into account supply of goods and/or services for a transactionto be taxable. Therefore, the definition of goods/services becomes important forapplicability of GST. It is equally relevant to understand the inclusions and exclusionsto the definitions, exemptions provided under statute to determine what would be ataxable supply of goods/services.

The CGST Act contains a negative list, whereby the transaction though being supplyof goods or services are neither considered to be supply of goods nor supply ofservices. Schedule III of the CGST Act provides the list of such transactions. Forexample, actionable claims other than lottery, betting and gambling will not beconsidered as taxable supply even though it happens to be included in the definitionof goods and this is because of the deeming provisions of Schedule III. Furthermorethe Board has also provided exemptions with regard to certain transactions and thosetransactions would also not be charged to tax.

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So, we can visualize the above circumstances as trigger points. If all the circumstancesare triggered then only the transaction will be charged to tax. Accordingly to summarizewe can say, GST would be chargeable if all the following points get triggered-

1. There is a supply of goods and/or services

2 It is for a consideration and m course or for furtherance of business

3. It is not listed in Schedule III

4. It is not exempt services or goods as per the Notification issued by the Board.

The discussion has been elaborated by the graphic description below-

Now in light of above discussion, for determining the applicability of GST one hasto go by the flow explained above. Consequently, lease happens to be a supply as thedefinition specifically includes leases. It is classified as supply of services by virtue of

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the entry 5(f) in Schedule II. Schedule III does not contain any entry relating to theleases and therefore it happens to be taxable supply. The Board has not exemptedleases from applicability of taxes. However, there are certain exemptions provided bythe Board namely, entry 45 of the exemption list which exempts leasing of assets (rollingstock assets including wagons, coaches, locos) by Indian- Railway Finance Corporationto Indian Railways -and entry 57 of the exemption list which exempts leasing of agromachineries. Therefore, tractors, tilling equipments or other agricultural machinery,used directly in agricultural operations, may be regarded as agriculture machinery andtherefore leasing of such machines may be exempt from GST. Thus, we can concludethat leases other than those listed entries above will be subject to GST.

SUPPLY OF GOODS VS. SUPPLY OF SERVICES

In the section above, we have discussed about leases being services in the GST regime.But a question remains as to why are we classifying it as a service when in pre GSTregime it was held to be deemed sale by virtue of Article 366(29A) of the Constitution.The answer to the question lies in the entry of the Schedule II of the CGST Act.Schedule II lays down the list of activities that are treated as supply of goods andsupply of services.

Clause 1 of Schedule II states that -

"1. Transfer

(a) any transfer of the title in goods is a supply of goods;

(b) any transfer of right in goods or of undivided share in goods without the transferof title thereof, is a supply of services;

(c) any transfer of title in goods under an agreement which stipulates that property ingoods shall pass at a future date upon payment of full consideration as agree4 is asupply of goods."

A lease transaction usually does not by itself result into a transfer of title. A hirepurchase transaction contains an option to buy the asset with the hirer - however, thecited definition of Transfer of goods" in Schedule II refers to a transaction positively

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resulting into a transfer. This is clear from use of the expression "property shall pass".A mere option to buy does not seem to be captured by the definition above. Therefore,it seems to cover conditional sales, and not hire purchase contracts, particularly thosewhich explicitly provide an option to return the goods. However, the notion of theDepartment seems to be that hire purchase is a supply of goods as stated in the FAQsof the CBEC On the contrary, in all lease transactions there is a transfer of right touse the asset. Therefore, based on the above understanding it can be concluded thatlease transactions shall be treated as "supply of services" for the purpose of GST.

However, if the financial lease involves an automatic transfer of asset after a periodof time to the Lessee, the same shall be treated as "supply of goods".

The distinction on whether a transaction is a supply of goods or supply of services isan important distinction from GST perspective. We need to understand that theprovisions relating to invoicing, time of supply, place of supply; etc. is different forsupply of goods and supply of services. Therefore, in order to be compliant with theprovisions of GST, we need to understand whether a particular supply is that ofgoods or services.

While lease transactions are admittedly included as "supply of services", the dichotomyinherent in applying the rate applicable to a supply of goods, to a transaction which istreated as supply of services, will continue to surface. The provisions of GST law asapplicable in case of services apply to lease transactions; however, a lease is a putativeequivalent of a supply of goods.

While the distinction between supply of goods or services is an important one toidentify under GST, from leases perspective, GST does not distinguish betweenfinancial lease and operating lease. As per Schedule II, any transfer of right in goodsamounts to supply of services. In case of both, operating leases and financial leases,there is a transfer of right to use to the goods from the Lessor to the Lessee. FromGST perspective, 'a lease is a lease, irrespective of the accounting classification.

However, here it is important to understand that the nature of a financial lease isadmittedly a financial assistance and is akin to loan transactions. There have beenseveral judicial pronouncements where it has been substantiated that financial leases

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are akin to loan. In the case of Association of Leasing Financial Services Company v/s Union of India, paragraphs 20 and 21 of the judgment c1ear out the fact that financialleasing and-hire-purchase are a mode of long term funding. In case of Asea BrownBaveri Ltd v/s Industrial Finance Corporation of India the judgment brings fore thefact that financial lease is nothing but loans in disguise.

Currently, loan transactions, are outside the purview of taxable supply (since neither"goods" nor "services" include money). By that argument, since a financial lease isadmittedly a monetary transaction, it stands to logic that the interest inherent in financiallease should be exempt. However, currently, the taxation regime under GST lawseems to have opted to go by the legal form of the contract rather than economicsubstance. Hence, financial leases shall be taxed as supply of services

Chargeability of GST and its ambit in respect of leases

Rate of GST in ease of leases

By chargeability, we mean what would be the rate of GST chargeable on the leasetransactions. The, rate of tax has a direct bearing on the transaction and directlyalters the economics. We know that GST is a system whereby the taxable person hasto self-assess his liability and pay to the government and in case there is either wrongpayment or short payment on part of the supplier, there will be monetary fines inform of interest and penalty. Section 73 of the CGST Act corresponds with the samewhich clearly states that interest with penalty would be levied on the person's m anevent where the taxes have been short levied or not levied. Therefore it becomesnecessary on the part of supplier to correctly classify his product and levy correctrate of taxes.

Leases have been classified as supply of services and as per entry in the Schedule ofGST rates (rate of GST on services) for services approved by GST council, transferof the right to use any goods for any purpose (whether or not for a specified period)for cash, deferred payment or other valuable consideration (supply of service) toattract the same GST rate and compensation cess as applicable on supply of similargoods which involves any transfer of title m goods (supply of goods)

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Therefore, though leasing will qualify to be supply of service under GST regime, itwill attract rates which are assigned to assets that are being leased out. For instance,if a person takes a car on lease, such a transaction would be subjected to the GSTrate that is applicable for car i.e. 28% plus the additional cess imposed out of 15%(depending on the category of the car). The words "same GST rate and compensationcess as applicable on supply of similar goods" distinctly consider the rate which isapplicable for the supply of goods. So, the same rate of leased goods would apply onthe value of consideration applicable for leasing.

For example, if motor car is acquired for Rs. 10 lakhs and duty is paid at the rate of28% on it i.e. Rs. 2.8 lakhs that does not necessarily mean that when leased out, thetotal taxes to be collected under the lease facility shall also amount to Rs. 2.8 lakhs.There is also an inherent interest component in case of lease transactions, GST willbe charged on the interest component as well. Therefore, the tax collected on leasetransactions shall not be the same as that paid for the acquisition of the assets.

Therefore, it can be concluded that only the rate of tax is same and not the base oftaxation. The value of a taxable supply is the price actually paid or payable for thesupply [Sec. 15 of CGST Act]. Accordingly, lease rentals will be taxable over theperiod of time over which the same accrue.

Here it is important to take a note that the Government has offered several relaxationsto the leasing companies engaged in the business of leasing of motor vehicles withrespect to the lease of vehicles purchase before the date of implementation of GST,i.e., 1st July, 2017 vide its notification number 37/2017-Central Tax (Rate) dated13th October, 2017. Such transactions shall be charged to tax at 65% of the applicableGST + Cess rate. This reduced rate would be applicable for a period of 3 years witheffect from lst July 2017.

Further, the vehicles covered by the above leases (i.e. leases of vehicles purchasedand leased prior to 1-7 2017), when disposed of/sold shall also be taxed at 65% ofthe applicable GST + Cess rate. This reduced rate will apply for a period of 3 yearswith effect from 1st July 2017.

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Similar relief has been granted to suppliers of vehicles who had procured the vehiclebefore 1st July, 2017 but not claimed credit of taxes paid on the inputs. Supply ofsuch vehicles after the said date will attract tax at the rate of 65% of the applicableGST rate + cess. This reduced rate would be applicable for a period of 3 years witheffect from 1st July 2017.

Inter-state vs. Intra-state supplies

The rules for determination of inter-state supply and intra-state supply come fromsections 7 and 8 of the IGST Act and have to be read with sections 10 and 12 of thesaid Act. The rules are different in case of supply of goods, and supply of services, Incase of supply of goods, the determination is based on the movement of goods [sec.l0(1)(a)], or the deemed delivery of goods [10(1)(b)], or the situs of goods [ 10(l)(c)]or the place of assembly of goods [ l0(1)(d)] In case of services, the determination isbased on the place of location of the recipient of the services, except in case ofspecific services for which specific rules apply. The rules have been discussed atlength in an earlier chapter.

A lease is admittedly a case of supply of service Therefore, where the place of thesupply and the location of the supplier are m different states/union territories, it is aninter-state supply of services. The meaning of place of supply of service has to bederived from section 12(2) of the IGST Act, which states -

"(2) The place of supply of services, except the services specified in sub-sections (3)to (14),-

(a) made to a registered person shall be the location of such person;

(b) made to any person other than a registered person shall be,-

(i) the location of the recipient where the address on record exists; and

(ii) the location of the supplier of services in other cases.

We have discussed earlier the meaning of the location of the supplier of services - asthe fixed establishment from where the service of leasing is most directly provided.

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Unless otherwise clear, in our view, the place from where the sourcing and servicingof the client is being done should be that place.

In practice, it may be quite difficult for parties to identify the location of the lessorfrom where the leasing service is being provided. A general guidance is as follows:

(a)As far as practical, the order for procurement of goods may be given by the lessorwith the GSTN of the lessee state. Hence, if the goods are coming from a differentstate, this will have the impact of making the purchase an inter-State transaction, byvirtue of sec. 10(1)(a) or sec. 10(l)(b). Subsequent lease of the goods is effected withthe GSTN of the lessee state, to the lessee in the same state, thereby exposing thetransaction to CGST-SGST. This seems the most natural transaction, as the transactionof lease gets localised in the state where the lessee has registration.

(b) If the lessor does not have GST registration of the state where the lessee issituated, the lessor may place order for the goods from any registered location. Thereby,applying sec. 10(1)(b), there will be a deemed delivery to the lessor. If the supplierlocation and the lessor location are in two different states, the purchase will be IGSTtransaction; the lease will also be an IGST transaction from the lessor state to thelessee state.

(c) Sometimes, the lessee may, subsequent to the lease transaction, move the goodshimself to a different location. Does the taxability of the lease transaction change? Inour view, the tax is on the transfer of right to use goods, and not on the exercise ofthe right to use. Therefore, subsequent movements by the lessee are on the lessee'sown account, and should not concern the lessor at all. Self movement, if done, isdone by the lessee

Applying the logic above, the conclusion will be as follows:

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Further, one may ask if there could be any tax incidence or tax efficiency on accountof leases being inter-state or intra-state. Unlike the old CST/VAT regime where CSTwas not allowed to be set-off, IGST is fully' off-settable. Of course, there is a priorityorder of set off (first -IGST, next CGST, finally SGST). However, since the rates forCGST and SGST are the same as IGST rates, and IGST is fully off settable againstCGST and SGST liability, there is no impact on account of inter-state versus intra-state supplies. lii essence, there is no tax inefficiency in acquiring goods on inter-statebasis.

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Ambit of GST with respect to lease transactions

It is pertinent to understand the ambit of GST on lease transactions, i.e., is all typesof leases covered by the GST regime? The table below provides a summary ofapplicability of GST on different types of leasing transactions, and may be relevant inview of marked difference from the position prevailing before the advent of GST:

Particulars Chareability

By type of leases as per Accounting standard

Opeating lease

Finance lease

By type of property

Lease of immovable properly being land and building

Lease of immovable property other than land andbuildings

Lease of movable property

By type of consumer of the transaction

B2B transactions

B2C transactions

C2C transactions

Yes

Yes

Yes, as renting of immovable property

Yes, as renting of immovable propery

Yes

Yes

Yes

May not be a “taxable person” or “casual taxable person”

Bye cross border movement

Cross border leases into India

Cross border leases out of India to a place outsideIndia

Lease in course of import or high seas transactions

Yes. IGST would be applicable

No. Provided goods never came to territorial waters ofIndia.No. The concept does not remain.

The table above provides a bird's eye view of different types of circumstances! leasesand its chargeability. As we have discussed GST is a pervasive tax and virtually coversevery transaction-as the taxability event has a very wide connotation. Now, one thingto note is the concept of High seas transactions at this point. High-seas transactionshave lost their relevance in the GST era. The concepts of high-seas sale or sale incourse of import were the product of a system where there was no set off acrosstaxes (CVD/SAD could not have been set off against VAT payable on a local sale).The introduction of GST makes unification of CVD/SAD and VAT. Therefore, the

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whole concept of high-seas sale/sale in course of import, to integrate an import andthe first sale made immediately after import, does not remain valid under GST regime.

While, therefore, there will no motive in structuring a high seas sale, there is, however,still a relevance of the concept, as discussed below:

(a) "India" is defined to include territorial waters [ 2(56) of CGST Act]. "Import ofgoods" is defined [ 2(10) of IGST Act] as bringing goods from out of India intoIndia.

(b) Therefore, if a sale occurs between an overseas supplier (X) to an Indian importer(Ml), who sells the goods to another Indian buyer (M2), such that the sale from Ml toM2 happens on high seas basis before the goods have entered territorial waters OfIndia, the sale from X to Ml is sale happening completely outside India, and hencenot taxable. The sale/supply from Ml to M2 is taxable as IGST sale.

(c) Since the IGST is payable upfront, there may not be any strong motivation forstructuring high-seas transactions any more.

APPLICABILITY OF GST ON VARIOUS FEE CHARGED BY LESSORAND SECURITY DEPOSIT

In a lease transaction, the lessor is not only rewarded with the lease rentals but withother kinds of charges as well. The lessor does so to compensate himself of the costthat he incurs towards documentation charges, management expenses, legal charges,etc. These charges were liable to tax in the extent regime as well and the situationcontinues to be the same under the GST era as well. In this section we-have discussedtax implications of the all the charges that is typically received in course of lease.

Processing fee

There is no doubt that processing fee is chargeable to tax. However, we need toconsider carefully the rate at which each of these are chargeable. As discussed before,in case of a transfer of right to use, the rate applicable is that same as the rate onsupply of the relevant goods. Can it be argued that the processing fee is also aconsideration for transfer of right to use goods, and is chargeable at the same rate asthat for goods, or will it be-chargeable at the rate of 18%? It seems plausible to argue

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that the consideration for the transfer of right to use is the rental, and the processingfee is a fee charged for the processing of the application and its consummation, anddoes not have to do with the asset in question being leased. If the asset in questionwas not leased, the fee might have been chargeable, or for that matter, if the asset inquestion was not a car but a computer, arguably, the fee would have been the same.Hence, the processing fee will attract the residuary rate.

Lease management fee

As regards management fee, this very often is just a convenient way of splitting thelease rentals. The lease, after all, is of the asset in question, and the management feeis for managing the same. The component pertains to the lease of the specific asset.Therefore, appropriately the rate of tax for the management fee ought to be the sameas the rate of tax on asset itself

Residual value

As regards residual value, this is not a case of supply of service, but a case of supplyof goods. The goods in question is the asset - hence, whatever is the rate applicableon the supply of the asset in question applies here.

Additional rentals

Additional lease rentals, due to variation of a base rate, are nothing but rentals. Hence,the additional rental will be chargeable to GST at the same rate as applicable for thesupply of goods in question.

Cancellation Penalty

Cancellation penalty is a fee imposed by the lessor in contemplation of early revocationof the agreement. Since, lease itself is a taxable supply, any amount received towardsit shall also be taxable under GST.

Security deposit

Reference maybe made to the definition of "consideration" in sec 2(31) of CGSTAct. The same provides:

"Provided that a deposit given in respect of the supply of goods or services or both

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shall not be considered as payment made for such supply unless the supplier appliessuch deposit as consideration for the said supply"

The natural meaning of the above is that if the deposit is explicitly taken as appropriatedagainst a consideration, hi that case, it may be said to be a part of the considerationimmediately upon receipt; else it will become a part of consideration only when it isappropriated as such. Prima facie, a deposit is against a future obligation to pay. Ifthe obligations are met as contractually agreed, the deposit gets refunded. If theobligations are not met, the deposit is put into service to meet up the obligation.Looking at the language of sec. 2(31), it does not seem that a refundable depositshould be taken as a part of taxable consideration.

FORMALITIES UNDER GST

Registration requirements

In this part we will restrict our discussion on the issues pertaining to leasing companiesonly. So with advent of GST, the concept of centralized registration gets subsided sowhat would be happen if a leasing entity has offices in more than one state. Will theentity be required to take registration in every state?

The Answer to the question happens to be affirmative. Section 22 of the CGST Actstates -

"Every supplier shall be liable to be registered under this Act in the State or Unionterritory, other than special category States, from where he makes a taxable supplyof goods or services or both, if his aggregate turnover in a financial year exceedstwenty lakh rupees".

This makes it clear that GST law does not permit centralized registration.

Since a lease transaction is a supply of service, the relevant consideration for theregistration requirement is - what is the place of business from where the service ofleasing is being offered?

Location of a supplier of services is defined in sec. 2(71) as follows:

'(71) "location of the supplier of services" means,-

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(a) where a supply is made from a place of business for which the registration hasbeen obtained the location of such place of business;

(b) where a supply is made from a place other than the place of business for whichregistration has been obtained(a fixed establishment elsewhere), the location of suchfixed establishment;

(c) where a supply is made from more than one establishment, whether the place ofbusiness or fixed establishment, the location of the establishment most directlyconcerned with the provisions of the supply; and

(d) in absence of such places, the location of the usual place of residence of thesupplier.'

The pertinent question is - what is the place from where the supply, that is, the leasingof the goods has been made? There may be several potential places:

• Place of signing of the lease document

• Place from where the order for leased goods was placed

• Place at which the lessee resides or is registered

• Place from where the lease transaction was sourced

• Place at which payments are regularly collected from the lessee.

Can the place of signing the lease, agreement be said to be the place from where thesupply was done? If the supply is the transfer of right to use is it proper to say that theexecution of the lease agreement resulted into the transfer of the right to use, andtherefore, that place becomes the place of transfer of the right? In Supreme Courtruling in the case of 20th Century Finance Corporation stress was made on the placeof execution of the lease agreement, but this was subject to the other indicators givenin section 3 of the CST Act

Section 2(71) provides several alternative tests to determine the location of the supplier,and logically, where there are several alternative meanings to a term, the reader mustread the clauses serially down. Logically, the place which is most directly concerned

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with the rendering of the leasing service is the one where the client is being serviced.Client servicing, in case of lease transactions, may mean regular interface with theclient, including collections.

Business vertical concept' in respect of leasing transactions

This is a new concept introduced by the GST regime where a company can tag aparticular business having separate risk and reward as a separate business but underthe same PAN of the company. So it holds huge relevance with respect to leasingbusiness. Leasing is majorly done by financial companies and the product portfolio ofthe financial companies contain loan as well. Therefore it can be advantageous on thepart of, the companies to go for a separate business vertical. Of course a personbefore choosing to opt for a separate business vertical will have to analyze otherprovisions as well. So a question arises whether leasing business is eligible for separatebusiness vertical registration The answer to the question is yes In view of the definitionof ab vertical" m sec 2(18), there is a strong case for treating operating leasing as aseparate business vertical. There is a regulatory distinction between leasing and lending.The risks and returns are different. However, in case of financial lease, we are of theview that it maybe difficult to regard the same as a separate business vertical. Sowhat would happen in case there is a supply from one business vertical to the othervertical of the same company within the state? The answer to the question is a straightyes. The two verticals of a same company are considered to be distinct person fromthe eyes of the law. If a company has 3 separate verticals in a state then all the threeare different persons for the GST purpose. All the three would be distinctly registeredand would be filing separate returns, in essence would be assessed separately for thepurpose

Section 8 of the IGST Act lays down the meaning of intra-state supply of goods. Asper point iii under Explanation to section 8, where a person has an establishment ina state or Union Territory and any other establishment being a business registeredwithin that state, or Union Territory, then such establishments shall be treated asestablishments of distinct persons. Hence any supply made from one business verticalto other of a company located in same state or Union Territory will attract GST.

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Invoicing and Point of taxation

Leases are classified as supply of services as per Schedule II of the CGST Act andtherefore all the provisions as applicable in case of supply of services will have to becomplied with. Accordingly tax will be levied on supply of services at the time ofsupply. As per the provisions of section 13 of the CGST Act, time of supply of servicesshall be earliest of the following dates:

a. the date of issue of invoice by the supplier, if the invoice is issued within the periodprescribed under sub-section (2) of section 31 or the date of receipt of paymentswhichever is earlier; or

b. the date of provision of service, if the invoice is not issued within the periodprescribed under sub-section (2) of section 31 or the date of receipt of payment,whichever is earlier; or

c. the date on which the recipient shows the receipt of services in his books of account,in a case where the provisions of clause (a) or clause (b) do not apply.

A lease transaction may, appropriately fall in the category of "continuous service" asdefined in sec. 2(33). This is a case where there are continuous payment obligationsunder a contract that stretches to more than 3 months. In such a case, the point oftime for the supply is the due date as per the contract, that is, the date of invoicing.

TRANSFER OF RIGHT TO USE AND PROVISION OF RIGHT TO USE: ISTHERE ANY DISTINCTION IN GST LAW?

The distinction between the transfer of right to use (lease contracts) and the provisionof right to use (license contracts) was highlighted in the case of AP High Court rulingin Rashtriya Ispat Nigam STC 182, and later, expounded by several rulings includingthat of the Supreme Court in Bharat Sanchar Nigam Limited 2006 (2) STR 161.While admittedly, a license contract is also included in the definition of "supply" insection 7, the issue is that the rate notification imposing the commodity-specific ratecontinues to refer to the words "transfer of right to use". Since the distinction betweenprovision of right and transfer of right has been well accepted by the courts GST ratenotification may leave a scope for confusion by continuing to refer to transfer of

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right, even though the rate notification says -with or without the operator. Thecontention may be that since a provision of right to use has not been specificallycovered by the rate notification, a transaction where the right to use has not beentransferred, but where the right is retained by the lessor who uses the asset for thebenefit of the beneficiary, the transaction is not specifically covered by the rate schedule,and hence the residuary rate of 18% is chargeable.

One must note two counter-arguments to this-first, the rate schedule mentions, atseveral places - with or without the operator. Therefore, if one way of distinguishingbetween a lease and license is the provision of operator by the lessor, the same seemscaptured by the rate schedule Secondly, the concept of a mixed supply may be broughtm, to say that if the transfer of right to use is combined with some other elements ofservice, the higher of the two rates will be applicable.

LEASE OF TRADE FIXTURES

Another important topic that deserves discussion here is the impact of GST on leaseof trade fixtures. Before we delve into impact of GST on such transactions, we needto understand the concept of trade fixtures first.

What are 'fixtures'?

Things embedded or fastened or attached to an immovable property in such a waythat they cannot be detached without causing detrimental loss to the property whichit is attached to and thus on their affixation, become part of the reality.

What are 'trade fixtures'?

Fixtures that are affixed so, not for the purpose of the immovable property it isattached to but for the purpose of trade or business and for effective usability of itselfin conduct of the trade or business. Following are some significant attributes thatgive 'trade fixtures' its meaning:

• The term is most often associated with commercial leases.

• Trade fixtures are things that are attached to rented property (real property) by atenant.

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• These are used in the conduct of business or trade by the tenant.

• They may be removed before or after the' term of lease or rental agreement. However,trade fixtures are attached in such a way that removal of the same from the embeddedproperty shall cause a material damage for the owner. In order to cover the damagecaused, it is generally repaired or paid by the tenant in form of compensation orotherwise.

• Examples: telecommunication towers, plant and machinery for conducting anybusiness activity.

Irrespective of the fact that GST law has come to clarify few vexed questions of law,it has still not able to give a clear way out for concepts like trade fixtures. The termhas not been defined under the Act and there still remains a long-need to bring somelucidity with respect to fixtures under the law.

Principles for classification as 'fixtures'

Three important principles were laid down in a prominent judgment given by OhioSupreme Court in Perez Bar& Grill vs. Schneider, 2012-Ohio-5820, dated onDecember 10,201 2 The court quoted,' that in order to be classified as a 'fixture', theitem must stand true to the following essential elements:

1. actual annexation to the realty, or something appurtenant thereto,

2. appropriation to the use or purpose of that part of the realty with which it isconnected, and

3. the intention of the party making the annexation to make the article a permanentaccession to the freehold.

Consequentially, an item fulfilling the test above shall be considered as a fixture.Object of annexation is significant to determine the nature of the annexation.

Classification of trade fixtures as 'immovable property'

GST law was expected to pave way for clarification on unexplained points in law,however unfortunately there is still not illumination on the treatment of trade fixtures

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under the new tax regime. A crucial point of discussion that arises every time fordiscussion is the classification of trade fixtures as movable or immovable property.The classification will thereon decide the fate of the items for, taxation purposes.

What is 'immovable property'?

Understanding the meaning of immovable property is undeniably important for thepurpose of interpretation of provisions under the GST law. For example, Section17(5) lists out the items/points where the input tax credit (ITC') shall not be available.Clauses (c) and (d) states as follows:

"(c) works contract services when supplied for construction of an immovable property(other than plant and machinery) except where it is an input service for furthersupply of works contract service

(d) goods or services or both received by a taxable person for construction of animmovable property (other than plant or machinery) on his own account includingwhen such goods or services or both are used in the course or furtherance of business."

Unfortunately, immovable property is not defined under GST law. We shall have torely on the customary definitions under other Indian laws to interpret the meaning ofthese words.

Definition under the General Clauses Act, 1897

"Immovable property" shall include land, benefits to arise out of land, and thingsattached to the earth, or permanently fastened to anything' attached to the earth.'

The above definition has two key inclusions:

1. things attached to the earth .

2. things permanently fastened to anything attached to the earth

The former is defined under the Transfer of Property. Act, 1882.

"attached to the earth" means - (a) rooted in the earth, as in the case of trees and

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shrubs; (b) imbedded in the earth, as in the case of walls or buildings; or (c) attachedto what is so embedded for the permanent beneficial enjoyment of that to which it isattached;

Other than as illustrated in clause (a) above, attached means 'imbedded' or attachedto something which is imbedded.

However, an exception to the immovable property has been made in the provision for'plant and machinery'. The words 'plant and machinery' have been specifically definedfor respective purposes. Accordingly, the expression "plant and machinery" meansapparatus, equipment, and machinery fixed to earth by foundation or structuralsupport that are used for making outward supply of goods or services or both andincludes such foundation and structural supports but excludes-

(1) land, building or any other civil structures;

(ii) telecommunication towers; and

(iii) pipelines laid outside the factory premises.

If one is talking about building or civil structures, they are not excluded from thepurview of immovable property and hence would make the taxable person ineligibleto claim ITC with respect to construction of any of such structures

Though not defined, 'immovable property' has a certain exception to it and this leadsus to give it an apparent but conclusive definition to the expression. Thus immovableproperty shall include land benefits to arise out of land and things attached to theearth, or permanently fastened to anything attached to the earth but shall not includeany plant and machinery except any land, building or any other civil structures;telecommunication towers; and pipelines laid outside the factory premises.

However, the above definition has only limited implications as far as GST law isconcerned.

The aforementioned interpretation is pertinent in order to explicate the treatment oftrade fixtures either as movable or immovable property under GST, which will furtherdecide the fate of availability and claim of ITC thereon.

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Classification of plant and machinery embedded in earth as 'immovableproperty'

The Hon'ble Supreme Court of India ruled in the case of Duncans Industries Limitedv. The State of UP paved way for deciding on whether plant and machinery attachedto earth will amount to movable or immovable property. Plant and. machineryembedded in the earth with the intention to embed for operational efficiency of themachine and to support the running of the factory and not to remove it anytimesooner cannot be a. movable property.. Such plant and machinery is an immovableproperty.

However, whether a plant and machinery attached or annexed to the earth, b or anyother immovable property will be treated as an immovable property shall be subjectto the circumstances in each case and based on the intention of the parties embeddingor attaching such plant and machinery.

According to the court, machinery which is soembeddethn earth will qualify asimmovable property or not will depend on the facts and circumstances of each case.Two elements have been put forth as pertinent to classify plant and machinery asimmovable property:

i. Intention of the parties, and

ii. Purpose of the embedment or attachment, etc.

The purpose for which the machinery is attached is additionally important to understandthe scope of classification. Where it was permanently affixed to the ground to run thefactory, it is to be con as an immovable property. ..

Structure made out of steel (such as a factory shed)

A building in layman's vocabulary would mean a structure for protection from forcesof nature, habituated by people or, for the purpose of storage of goods.

In the case of United Taxi Operators (Urban) Thrift & Credit Society Ltd. v. MCD [2 (1996) DLT 281], the Division Bench of the Delhi High Court negated the opinionthat to be a building, it has to be habitable and it was held that putting together sheetsof steel to install an underground cellar was a building.

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A similar question had arisen before the High Court of Bombay in Bharti Tele-VenturesLimited v. State of Maharashtra. The challenge was to the Notification under theMaharashtra Regional and Town Planning Act, 1966 authorizing and/or requiringthe various Municipal Corporations in the State to charge retrospective premium atthe rate of land value for the area occupied by the cabin, the tower height premiumetc. for granting permission for installation of semi structures, cabins on top of thebuildings for housing Base Station/Telephone Connector to set up Cellular Mobilesystem in pursuance to the licenses granted under the Telegraph Act. The DivisionBench held such installation to b a building under the Maharashtra Act (BombayProvincial Municipal Corporations Act, 1949) which is similar to the Act in Delhi.

In the case of Elecon Engineering Co. Ltd. v. Collector of Central Excise on 20 May, 1992Customs, Excise and Gold Tribunal, the Ld. Bench stated, "Whether or not 'the positionremains the same irrespective of whether it is simple erection/construction process or acomplicated one and whether it involves fabrication of some structures and/or some carpentryor smithy work at site. Undoubtedly, technical skill is required for construction of house andone may have to employ mistries, architects, engineers and skilled labourers and in case ofsome ultra-modern buildings, sophisticated and complicated processes/techniques may beemployed. But all that does not alter the basic fact that what is involved is creation of immovableproperty and not goods. As already noted in. the instant case all that has happened is that withthe help of various articles of iron and steel sheds have been erected on site. Hence irrespectiveof the fact-whether it involved a process of fabrication of structurals or not the basic activityremains an activity of construction and erection and the result-of all that effort, labour andskill has been creation or coming into existence of immovable property and not goods orproducts." It was highlighted that construction of sheds made up of iron or steel erected on aconstruction site requires effort and labour in a way similar to any other structure such as abuilding. Hence, it should be appropriate to considered as immovable property: As taken aview that construction on site does not amount to manufacture of goods.

GST implications in case of lease of trade fixtures

Trade fixtures such as plant, machinery attached to a real property are for the purposeof use in business. They do not or cannot serve the purpose until they are installedand/attached the way required. In spite of their capacity to serve otherwise, such

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fixtures become useful only when they are so attached to the property and hence asbeing part of immovable property as such cannot be considered as movable. Moreover,an act of detachment of such items from the real estate would cause considerabledamage to the items themselves and the property which they were attached to.Consequentially, such items cannot be removed without causing a certain loss. -

Therefore, trade fixtures can either be treated as movable properties or immovableproperties. If the assets are treated as movable in nature, then the same shall betreated as transfer of right to use goods and shall be charged to GST at the rate atwhich the asset itself is charged to tax. If the asset is treated as immovable in nature,then the same shall be treated as renting of immovable property and shall be chargedto tax at the rate of 18%.

One more thing that deserves discussion here is the availability of credit of taxes paidon construction of the trade fixtures. If the assets are treated as movable propertiesthen there is no problem with respect to availability of ITC for construction of suchassets. However, the problem arises where the assets in question are immovable innature.

As per clause (d) of Section 17(5) of the CGST Act (supra), taxes paid on workscontract availed for construction of immovable property, other than plant aridmachinery, cannot be claimed as credit.

As discussed above, trade fixtures, in most of the cases, would satisfy the definitionof plant and machinery under section 17 and therefore, the Lessor might be able toclaim the benefit of ITC on works contract for construction of assets.

20.6 SUMMARY

Transactions with related parties are always subject to scrutiny and are required todemonstrate that the transactions are driven by commercial understanding. The GSTregime also prescribes for definition of related persons and applicability of valuationrules, as prescribed in case of transactions with related persons. The lesson intends tohighlight some of the issues that the GST switch-over will bring about in case ofguarantee provided by related parties. Section 15 of the GST Act states that thevalue of supply of goods or services shall be considered to be the actual price paid or

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payable for the purpose of taxation, where the transactions is not between relatedpersons and price is the sole consideration for supply.

The business of leasing has shot up over the years because of the above mentionedreasons and more so because of the clarity in the regulatory regime. India has witnessedhuge change in terms of regulatory structure in recent times, be it implementation ofIFRS converged Accounting Standard or implementation of GST. The changes havegreatly altered the economics of the businesses. Therefore, it is imperative on thepart of the beneficiaries and stakeholders in the leasing industry to take a note of thechanges and understand its implications.

20.7 GLOSSARY

Sponsor - A sponsor is the person, who decides to float the fund and his role issimilar to that of a promoter of a company. He is the anchor to the fund and continuesto have skin-in-the-game at all times. The investors make the decision to invest lookingat who the sponsor of the fund is.

Fund Manager - Fund Manager is the person who facilitates pooling of investmentsand is professionally equipped to deploy the pooled investments of the AIF based onthe objectives of investment of the fund. The investors typically look at the-fundmanager's ability to manage the funds to make investments.

Trustee - The fund also appoints a trustee to ensure that the interest of the investorsis protected at all times and that the fund is in compliance with its objectives. The roleof the trustee is to monitor activities of the fund with the objective of ensuring thatthe interest of investors is not jeopardized. The trustee also charges a fee for renderinghis services.

Custodian- Some funds may also appoint a custodian to manage the property/assetsheld by the fund. The objective again is to ensure that the interest of the investors inthe assets of the funds is protected at all times. The custodian also charges a custodianfees for the services rendered.

Fixtures- Things embedded or fastened or attached to an immovable property insuch a way that they cannot be detached without causing detrimental loss to the propertywhich it is attached to and thus on their affixation, become part of the reality.

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1. What is an Alternative Investment Fund?

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2. What are trade fixtures?

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1. Explain the applicability of GST on leases.

2. Discuss the GST implications with respect to Guarantees.

3. Describe the working of an Alternative Investment Fund.





4. Goods & Services Tax (GST) in India- By B. Viswanathan

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