1 LESSON 1 (a) Tax planning, tax management, tax evasion and tax avoidance (b) Types of companies, residential status of companies and tax incidence (A) TAX PLANNING, TAX MANAGEMENT, TAX EVASION AND TAX AVOIDANCE 1. STRUCTURE 1.1 Concept of Planning 1.2 Tax Management 1.3 Objectives of Tax Planning 1.4 Importance of Tax Planning 1.5 Essential of Tax Planning 1.6 Tax Evasion and Tax Avoidance 1.7 Difference Between Tax Planning and Tax Management 1.8 Difference Between Tax Planning and ‘Tax Evasion’ 1.9 Difference Between Tax Avoidance and Tax Evasion 1.10 Definition of Company (Section 2(17) 1.11 Types of Companies 1.12 Residence of a Company (Section 6(3) 1.13 Incidence of Tax 1.14 Incomes Received or Deemed to be Received in India (Section 7) 1.15 Income Accruing or Arising in India or Deemed to be Accrued Tax payment has never been a pleasure for any tax payer. Though tax is defined as a contribution by the people to the government but it is a levy and an unpleasant burden on every assessee. Tax is defined as something which taxes your strength, your patience or your resources it uses nearly all of them so that you have great difficulty in carrying out what you are trying to do. It is a task which requires lot of mental and physical efforts. One tries to reduce tax burden by many means because tax is reduction in his disposable income which he earned from his physical and mental efforts. Therefore every tax payer tries to minimise the burden of tax by his own means. 1.1 CONCEPT OF TAX PLANNING Tax Planning is an exercise undertaken to minimise tax liability through the best use of all available allowances, deductions, exclusions, exemptions, etc., to reduce income. Tax planning can be defined as an arrangement of one's financial and business affairs by taking legitimately in full benefit of all deductions, exemptions, allowances and rebates so that tax liability reduces to minimum. In other words, all arrangements by which the tax is saved by ways and means which comply with the legal obligations and requirements and are not colourable devices or tactics to meet the letters of law but the spirit behind these, would constitute tax planning. The Hon'ble Supreme Court in McDowell & Co. v. CIT (1985) 154 ITR 148 has observed that "tax planning may be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid payment of tax by resorting to dubious methods." Tax
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(a) Tax planning, tax management, tax evasion and tax ... · ... TAX PLANNING, TAX MANAGEMENT, TAX EVASION ... All transactions in respect of tax planning ... deduction from gross
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1
LESSON 1
(a) Tax planning, tax management, tax evasion and tax avoidance
(b) Types of companies, residential status of companies and tax incidence
(A) TAX PLANNING, TAX MANAGEMENT, TAX EVASION
AND TAX AVOIDANCE
1. STRUCTURE
1.1 Concept of Planning
1.2 Tax Management
1.3 Objectives of Tax Planning
1.4 Importance of Tax Planning
1.5 Essential of Tax Planning
1.6 Tax Evasion and Tax Avoidance
1.7 Difference Between Tax Planning and Tax Management
1.8 Difference Between Tax Planning and ‘Tax Evasion’
1.9 Difference Between Tax Avoidance and Tax Evasion
1.10 Definition of Company (Section 2(17)
1.11 Types of Companies
1.12 Residence of a Company (Section 6(3)
1.13 Incidence of Tax
1.14 Incomes Received or Deemed to be Received in India (Section 7)
1.15 Income Accruing or Arising in India or Deemed to be Accrued
Tax payment has never been a pleasure for any tax payer. Though tax is defined as a
contribution by the people to the government but it is a levy and an unpleasant burden on
every assessee. Tax is defined as something which taxes your strength, your patience or your
resources it uses nearly all of them so that you have great difficulty in carrying out what you
are trying to do. It is a task which requires lot of mental and physical efforts. One tries to
reduce tax burden by many means because tax is reduction in his disposable income which he
earned from his physical and mental efforts. Therefore every tax payer tries to minimise the
burden of tax by his own means.
1.1 CONCEPT OF TAX PLANNING
Tax Planning is an exercise undertaken to minimise tax liability through the best use
of all available allowances, deductions, exclusions, exemptions, etc., to reduce income.
Tax planning can be defined as an arrangement of one's financial and business affairs
by taking legitimately in full benefit of all deductions, exemptions, allowances and rebates so
that tax liability reduces to minimum. In other words, all arrangements by which the tax is
saved by ways and means which comply with the legal obligations and requirements and are
not colourable devices or tactics to meet the letters of law but the spirit behind these, would
constitute tax planning.
The Hon'ble Supreme Court in McDowell & Co. v. CIT (1985) 154 ITR 148 has
observed that "tax planning may be legitimate provided it is within the framework of the law.
Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain
the belief that it is honourable to avoid payment of tax by resorting to dubious methods." Tax
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planning should not be done with intent to defraud the revenue; though all transactions
entered into by an assessee could be legally correct, yet on the whole these transactions may
be devised to defraud the revenue. All such devices where statute is followed in strict words
but actually spirit behind the statute is marred would be termed as colourable devices and
they do not form part of tax planning. All transactions in respect of tax planning must to be in
accordance with the true spirit of statute and should be correct in form and substance.
Various judicial pronouncements have laid down that substance and form of the
transactions shall be seen in totality to determine the net effect of a particular transaction. The
Hon'ble Supreme Court in the case of CIT v. B M Kharwar (1969) 72 ITR 603 has held that,
"The taxing authority is entitled and is indeed bound to determine the true legal relation
resulting from a transaction. If the parties have chosen to conceal by a device the legal
relation, it is open to the taxing authorities to unravel the device and to determine the true
character of relationship. But the legal effect of a transaction cannot be displaced by a
probing into substance of the transaction."
In brief tax planning may be defined as an arrangement of one's financial affairs in
such a way that without violating in any way the legal provisions of an Act, full advantages
are taken of all exemptions, deductions, rebates and reliefs permitted under the Income Tax-
act, so that the burden of the taxation on an assessee, as far as possible be the least.
Actually the exemptions, deductions, rebates and reliefs have been provided by the
legislature to achieve certain social and economic goals. For example section 80IB of the
Income Tax Act, 1961 provides deduction from gross total income in respect of profits from
newly established industrial undertakings in industrially backward State or industrially
backward district as may be notified in this behalf. The object of the tax concession is clear,
i.e., economic development of industrially backward district or State. Section 80C provides
deduction from gross total income, if an individual or H.U.F. saves the amount and invests or
deposits it in the prescribed schemes. The deduction has been provided to encourage savings
and investments for economic development of the country. Thus, if a person takes .the
advantages of the aforesaid deductions, he not only reduces his tax liability but also helps in
achieving the objective of the legislature, which is lawful, social and ethical. Thus, tax
planning is an act within the four corners of the Act and it is not a colourable device to avoid
the tax liability.
1.2 TAX MANAGEMENT
Tax planning is a broader term which requires management of affairs in such a way
that results in the reduction in minimisation of tax liability. Tax planning is not possible
without tax management. It refers to the compliance of statutory provisions of law. Some
important areas of tax management are as stated below.
(i) Deduction of tax at source u/s 194 to 196
(ii) Payment of tax and self assessment u/s 140A
(iii) Payment of tax an demand u/s 220
(iv) Maintenance of accounts u/s 44AA
(v) Audit of accounts u/s 44AB
(vi) Payment of cess, duty or fees, bonus and commission to employees etc v/s 43B
(vii) Furnishing return of income u/s 139
(viii) Documentation and maintenance of tax files etc.
(ix) Review of order received from tax Authorities.
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1.3 OBJECTIVES OF TAX PLANNING
The objective of tax planning is to minimise tax liability and to avail maximum
benefits of the taxation laws within their framework. The objectives of tax planning cannot be
regarded as offending any concept of the taxation laws and subjected to reprehension of
reducing the inflow of revenue to the Government coffers, so long as the tax planning
measures are in conformity with the statute laws and the judicial expositions thereof. The
Basic objectives of tax planning are:
(a) Reduction of tax liability
(b) Minimisation of litigation
(c) Productive investment
(d) Reduction in cost
(e) Healthy growth of economy
(f) Employment generation
(a) Reduction in tax liability: The basic objective of tax planning is to reduce the tax
liability so that enough surplus out of profits remains with the earner of it for his personal and
social needs and also for future investments in his business. This is only possible by planning
his tax affairs properly and availing the deductions, exemptions and reliefs, etc. which are
admissible under the Acts. He can succeed in doing so by updating his knowledge about the
various concessions available in the taxation laws and the conditions to be fulfilled to avail
them.
(b) Minimisation of litigation: There is always a tug-of-war between the tax payers
and the tax administrators. The tax payers try their best to pay the least tax and the tax
administrators attempt to extract the maximum. This sometimes results in prolonged
litigation. Actually the main reason of litigation lies in tax avoidance and not in tax planning.
Whenever a tax payer wants to reduce his tax liability by finding a loophole in the Act and
title tax administrator does not agree with the interpretation of the assessee under which he is
demanding exemption, deduction or relief, it results in litigation. A good tax planning is
always based on clear words of the statute or in conformity with the provisions of the taxation
laws. In such a case the chances of litigation are minimised.
(c) Productive investment: A proper tax planning brings fiscal discipline in the
functioning of a tax payer and reduces the transfer of money, from the person who has earned
it by hard labour, to the Government for waste and misuse. The amount so saved enhances
the capacity of the tax payer for expansion and growth, which in turn increases the tax
revenue of the Government.
(d) Reduction in cost: Incidence of tax (direct and indirect) forms a part of cost of
production. The reduction of tax by tax planning reduces the overall cost. It results in more
sale, more profit and more tax revenue and more investment.
(e) Healthy growth of economy: The growth of a nation's economy depends upon
the growth of its peoples. Savings through tax planning devices foster the growth of economy
while savings through tax evasion lead to generation of black money, the evils of which are
obvious. The tax planning plays an important role in the development of backward districts
and backward states and development of infrastructure facilities or in other words it takes the
economy in the intended direction.
(f) Employment generation: The amount saved by tax planning is generally invested
in commencement of new undertakings or expansion of the business. This creates new
employment opportunities in the society. Further, taxation laws are so complicated that by
and large tax payers cannot plan their affairs efficiently. Hence, such persons need services of
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chartered accountants, financial advisers and lawyers. Such persons join the business
concerns either as employees or provide their services as tax experts.
1.4 IMPORTANCE OF TAX PLANNING
Though the basic objective of the planning is to minimise the tax liability of tax payer
yet following are the some considerations which are important for tax planning-
(i) When an assessee has not claimed all the deductions and relief, before the
assessment is completed, he is not allowed to claim them at the time of appeal. It
was held in CIT u/s Gurjargravures Ltd. (1972) 84 ITR 723 that if there is no tax
planning and there are lapses on the part of the assessee, the benefit would be the
least.
(ii) Tax planning exercise is more reliable since the Companies Act, and other allied
laws narrow down the scope for tax evasion and tax avoidance techniques, driving
a taxpayer to a situation where he will be subjected to severe penal consequences.
(iii) Presently, companies are supposed to promote those activities and programmes,
which are of public interest and good for a civilised society. In order to encourage
these, the Government has provided them with incentives in the tax laws. Hence a
planner has to be well versed with the laws concerning incentives.
(iv) With increase in profits, the amount of corporate tax also increases and it
necessitates the devotion of adequate time on tax planning to minimise' tax
burden.
(v) Tax planning enables a company to bear the burden of both direct and indirect
taxation during inflation. It enables companies to make proper expense planning,
capital budgeting, sales promotion planning etc.
(vi) Repairs, renewals, modernisation and replacement of plant and machinery are
indispensable for an industry for its continuous growth. The need for capital
formation in the corporate sector cannot be ignored and heavy taxation reduces the
inflow of corporate funds. Capital formation helps in replacing the technologically
obsolete and outdated plant and machinery and enables carrying on of
manufacturing operation with a new and more sophisticated system. Any decision
of this kind would involve huge capital expenditure which is financed generally
by ploughing back the profits, utilisation of reserves and surplus along with the
availing of deductions. Availability of accumulated profits, reserves and surpluses
and claiming such expenses as revenue expenditure are possible through proper
implementation of tax planning techniques.
(vii) In current days of credit squeeze and dear money conditions, even a rupee of tax
decently saved may be taken as an interest-free loan from the Government, which
perhaps, an assessee need not repay. It is rightly said that money saved is money
earned.
Thus, any legitimate step taken by an assessee directed towards maximising tax benefits,
keeping in view the intention of law, will not only help it but also the society since it
promotes the spirit behind the legal provisions. All those assessees which practice tax
planning may have the satisfaction that they are contributing their best to the nation's broad
objectives and goals in a welfare State like ours. At the same time, the law makes the
fulfillment of certain conditions obligatory before allowing the benefits to be claimed by the
assessees. In this way, the assessees, besides helping themselves, also help in securing the
objectives, tasks and goals set before them by the country.
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1.5 ESSENTIALS OF TAX PLANNING
Successful tax planning techniques should have following attributes:
(a) It should be based on uptodate knowledge of tax laws. Not only is an uptodate
knowledge of the statute law necessary, assessee must also be aware of judgments
made various by the courts. In addition, one must keep track of the circulars,
notifications, clarifications and Administrative instructions issued by the CBDT from
time to time.
(b) The disclosure of all material information and furnishing the same to the income-tax
department is an absolute pre-requisite of tax planning as concealment in any form
would attract the penalty clauses - the penalty often ranging from 100 to 300% of the
amount of tax sought to be evaded.
(c) Whatever is planned should not simply satisfy the requirements of law by complying
with legal provisions as stated and meeting the tax obligations but also should be
within the framework of law. It means that sham transactions or make-believe
transactions or colourable devices, which are entered into just with a view to misuse
the legal provisions, must be avoided.
Every citizen is obliged to honestly pay the taxes. Therefore, only colourable devices
resorted to by the tax payers for evading a tax liability will have to be ignored by the
court. Accordingly, a tax planning within the four corners of the taxation laws is not
to be turned down only because it legitimately reduces the tax inflow to the
Government. A genuine tax-planning device, aimed at carrying out the rules of law
and courts' decisions and to overcome heavy burden of taxation, if fully valid and
ethical.
(d) A planning model must be capable of attainment of the desired objectives of a
business and be suitable to its possible future changes. Therefore, all the important
areas of corporate planning, whether related to strategic planning, project planning or
operational planning involving tax considerations for long-term or short-term
management objectives and policies should be strictly scrutinised in relative
situations. Foresight is the essence of a business. Tax planning is one of its important
attributes.
1.6 TAX EVASION AND TAX AVOIDANCE
In the context of not paying tax, there are generally two methods which are used by
the assesses. They are (1) Tax Evasion (2) Tax Avoidance.
(1) Tax Evasion: It refers to a situation where a person tries to reduce his tax liability by
deliberately suppressing the income or by inflating the expenditure showing the
income lower than the actual income and resorting to various types of deliberate
manipulations. An assessee guilty of tax evasion is punishable under the relevant
laws. Tax evasion may involve stating an untrue statement knowingly, submitting
misleading documents, suppression of facts, not maintaining proper books of accounts
of income earned (if required under the law) omission of material facts in assessments
etc. An assessee who dishonestly claims the benefit under the statute by making false
statements, would be guilty of tax evasion.
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Thus when a person reduces his total income by making false claims or by withholding the
information regarding his real income, so that his tax liability is reduced, is known as tax
evasion. Tax evasion is not only illegal but it is also immoral, anti-social and anti-national
practice. Therefore, under the direct tax laws, provisions have been made for imposition of
heavy penalty and procedure of prosecution proceedings against tax evaders.
A tax evader reduces his taxable income by one or more of the following steps :
(a) Unrecorded sales.
(b) Claiming bogus expenses, bad debts and losses etc.
(c) Charging personal expenses as business expenses, e.g., car expenses, telephone
expenses, travelling expenses, medical expenses incurred for self or family may be
shown in the account books as business expenses.
(d) Submission of bogus receipts for charitable donations for claiming deduction u/s 80G.
(e) Non-disclosure of capital gains on sale of asset.
(f) Non-disclosure of income from 'Benami transactions'.
(2) Tax Avoidance: The line of demarcation between tax planning and tax avoidance is
very thin and blurred. There could be elements of malafide motive involved in tax
avoidance also. Any planning which, though done strictly according to legal
requirements defeats the basic intention of the Legislature behind the statute could be
termed as instance of tax avoidance. It is usually done by adjusting the affairs in such
a manner that there is no infringement of taxation laws and by taking full advantage
of the loopholes therein so as to attract the least incidence of tax. Earlier tax
avoidance was considered completely legitimate, but at present it may be illegitimate
in certain situations only. In the latest judgement of the Supreme Court in McDowell's
case 1985 (154 ITR 148) SC, tax avoidance has been considered as heinous as tax
evasion and a crime against society. Most of the amendments are now aimed at
plugging loopholes and curbing practice of tax avoidance.
Per Jagadisan J. [in Aruna Group of Estates vs. State of Madras (1965) 55 ITR 642
(Mad.)], observed "Avoidance of tax is not tax evasion and it carries no ignominy
with it, for it is a sound law and; certainly, not bad morality, for anybody to so arrange
his affairs as to reduce the burnt of taxation to a minimum."
However, now the Supreme Court is of the view that the colourable devices to avoid
tax should not be encouraged and this is the duty of the court to expose the persons
who avoid tax and refuse to approve such practice because the social evils of tax
avoidance are manifold, which may be summarised as below:
(a) substantial loss of much needed public revenue, particularly in a welfare state like
India;
(b) serious disturbance caused to the economy of the country by piling up of mountains of
black money directly causing inflation;
(c) large hidden loss to the community by some of the best brains in the country being
involved in the perpetual war waged between tax avoider and his expert team of
advisers, lawyers and accountants on one side, and Tax Officer and perhaps hot so
skilful advisers on the other side;
(d) sense of injustice and inequality of those who are unwilling or unable to profit by it;
(e) Tactics of transferring the burden of tax liability to the shoulders of the guideless,
good citizens from those of artful dodgers.
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One may not agree with the issue of generating black money by avoidance of tax. In
legal tax avoidance the money neither goes out of books nor it is spent unnecessarily but it is
used for further expansion of business.
In CWT vs. Arvind Norottam [(1988) 173 ITR 479] the Supreme Court has observed,
"It is true that tax avoidance in an undeveloped country should not be encouraged on practical
as well as ideological grounds.
Recently the legislature has inserted the provisions in direct and indirect tax laws for
checking tax avoidance. But so long there are loopholes in the laws, tax avoidance cannot be
checked by the courts. The function of judiciary in India is clearly not legislative, its role lies
in interpreting the law made by the legislature.
1.7 DIFFERENCE BETWEEN TAX PLANNING' AND TAX MANAGEMENT'
Tax planning primarily aims at adopting an arrangement so as to bring about the least
incidence of tax under the four corners of law. On the other hand, tax management comprises
a wider field like compliance with the statutory provisions of law, prospective planning so as
to ease the financial constraints if any, that would arise when discharging the commitments
through payment of tax, keeping close watch and monitoring the statutory requirements of
other laws, claiming the due reliefs arising on account of double taxation avoidance
agreements or claiming unilateral relief, etc. Thus, while tax planning is the pivot which
enables the drawing up of the different incentives and keep the incidence of tax law, the tax
management is the revolving wheel, which translates the policy in terms of results. The
difference between tax planning and tax management are stated as under:
1. Tax planning is a wider-term. It includes tax management. Tax management is the
first step towards tax planning.
2. The primary aim of tax planning is minimising incidence of tax, whereas main aim of
tax management is compliance with legal formalities.
3. Tax planning is not essential for every assessee, while tax management is essential for
every person, otherwise he may be liable for penal interest, penalty and prosecution.
For example, a person may not be reducing his tax liability by claiming any
exemption, deduction, relief, etc. in computing his total income but if he is liable to
pay advance tax or responsible for deduction of tax at source, etc. he has to comply
with all legal formalities.
4. Tax planning is a guide in decision making while tax management -is a regular feature
of an undertaking.
5. In tax planning exemptions, deductions and reliefs are claimed while in tax
management the conditions are complied with to claim the exemptions, deductions
and reliefs.
6. In tax planning alternative economic activities are studied and an activity with least
incidence of tax is selected whereas tax management includes maintenance of
accounts in prescribed form, getting books audited, filing the required forms and
returns, payment of taxes, etc.
7. Tax planning essentially looks at future benefits arising out of present actions. Tax
management relates to past, present and future. In respect of appeals, revision,
rectification of mistakes, etc. it deals with the past. Maintenance of records, self-
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assessment, filing the return and other _ documents, keeping pace with the changes,
etc. are present activities. Follow-up plans, etc. are in future.
1.8 DIFFERENCE BETWEEN TAX PLANNING AND 'TAX EVASION'
1. Tax planning is an act within the four corners of the Act to achieve certain social
and economic objectives and it is not a colourable device to avoid the tax. Tax evasion is a
deliberate attempt on the part of tax-payer by misrepresentation of facts, falsification of
accounts including downright fraud.
2. Tax planning is a legal right and a social responsibility. By tax planning certain
social and economic objectives are achieved. Tax evasion is a legal offence coupled with
penalty and prosecution.
3. Tax planning requires thorough knowledge of the relevant Acts, social, economic
and political situation of the country while tax evasion requires misadventure to infringe the
law.
4. Tax planning helps in economic development of the country by providing
additional funds for investment in desired channels while tax evasion generates black money
which is generally utilised for smuggling, bribery, extravagant expenses on luxury and
unlawful activities.
5. A tax planner enjoys its fruits freely and he does not suffer from high blood
pressure, whereas a tax evader remains always in anxiety of search and seizure and suffers
from many abnormalities.
As our society has become 'money society', whatever the evils of black money may
be, it has become a part of the life of most of the people and in near future there is no hope of
Putting a check on it. There is depth of honest tax payers.
1.9 DIFFERENCE BETWEEN 'TAX AVOIDANCE' AND 'TAX EVASION'
1. Tax avoidance is legal but tax" evasion is illegal.
2. In case of tax avoidance the objects and spirit of the law are not followed while in
the case of tax evasion the provisions of the law are flouted.
3. In case of tax avoidance no penalty can be imposed while in case of tax evasion the
person is liable to penalty and prosecution.
4. In case of tax avoidance, black money is not generated, hence, it is not very
harmful to the society. In case of tax evasion, black money is generated which is mostly used
for unproductive illegal and immoral purposes.
(B) TYPES OF COMPANIES, RESIDENTIAL STATUS OF COMPANIES
AND TAX INCIDENCE
1.10 DEFINITION OF COMPANY (SEC. 2(17)
A company means:
(i) any Indian company, or
(ii) any body corporate incorporated by or under the law of a country outside India, or
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(iii) any institution, association or body which is or was assessable or was assessed as
a company for any assessment year under the Income Tax Act, 1922, or which is or was
assessable or was assessed under the Income Tax Act, 1961 as a company for any assessment
year upto 1970-71, or
(iv) any institution, association or body, whether incorporated or not and whether
Indian or non-Indian, which is declared by general or special order of the Board to be a
company provided that it will be deemed to be a. company only for the assessment years
specified in the order.
The definition of company under the Income Tax Act is much wider than the Indian
Companies Act. The Income Tax Act has empowered the Central Board of Direct Taxes to
declare any association, institution, or body to be a company for income tax purposes.
Accordingly, on a few occasions Chamber of Commerce, Club, etc., have been declared by
the Board to be a company even though these bodies do not possess the ordinary
characteristics a company.
1.11 TYPES OF COMPANIES
Under the Income Tax Act companies are classified as under:
(1) Indian Company [Sec. 2(26)]
It means a company formed and registered under the Indian Companies Act, and
includes :
(i) a company formed and registered under any law relating to companies formerly in
force in any part of India other than the State of Jammu and Kashmir and the places specified
in (v);
(ii) a corporation established by or under a Central, State or Provincial Act;
(iii) any institution, association or body which is declared by the Board to be a
company;
(iv) in the case of the State of Jammu and Kashmir, a company formed and registered
under any law for the time being in force in that state;
(v) in the case of Dadra and Nagar Haveli, Goa, Daman and Diu and Pondicherry, a
company formed and registered under any law for the time being in force in these place
places.
(2) Domestic Company
It means an Indian company, or any other company which in respect of its income
liable to tax under the Income Tax Act, has made the prescribed arrangements for the
declaration and payment within India, of the dividends (including dividends on preference
shares) payable out of such income.
In other words:
(i) All Indian companies are domestic companies. or
(ii) A foreign company which has made the prescribed arrangements for the
declaration and payment of dividends (out of taxable income in India) within India is also a
domestic company.
(3) A company in which the public are substantially interested: (section 2(18) :
As per section 2(18) such companies include:
(i) A company owned by Government or Reserve Bank of India. or
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(ii) A company having Govt. participation i.e. A company in which not less than 40%
of its shares are held by Government or the RBI or a corporation owned by the RBI. Or
(iii) Companies registered under section 25 of the Indian Companies Act, 1956:
Companies registered under section 25 of the Companies Act, 1956 are companies which are
promoted with special object such as to promote commerce, art, science, charity or religion or
any other useful object and these companies do not have profit motive. However, if at any
time these companies declare dividend they would loose the status of a company in which the
public are substantially interested. Or
(iv) A company declared by the CBDT i.e. a company without share capital and
which having regard to its object, nature and composition of its membership or other relevant
consideration is declared by the Board to be a company in which public are substantially
interested. Or
(v) A Mutual benefit finance company, where principal business of the company is
acceptance of deposits from its members and which has been declared by the Central
Government to be a Nidhi or a Mutual Benefit Society. Or
(vi) A company having co-operative society participation i.e. a company in which at
least 50% or more equity shares have been held by one or more co-operative societies.
(vii) A public limited company i.e. company is deemed to be a public limited
company if it is not a private company as defined by the Companies Act,1956 and is fulfilling
either of the following two conditions:
(a) Its equity shares were listed on a recognised stock exchange, as on the last day of
the relevant previous year; or
(b) Its equity shares carrying at least 50% of the voting power (in the case of an
industrial company the limit is 40%) were beneficially held throughout the relevant previous
year by Government, a Statutory Corporation, a Company in which the public is substantially
interested or a wholly owned subsidiary of such a company.
(4) Widely held company
It is a company in which the public are substantially interested.
(5) Closely held company
It is a company in which the public are not substantially interested.
Burden of proof: The onus is on the department to establish that the public are not
substantially interested in a company. [Jayantilal Amritlal Ltd. v CIT (1965) 55 ITR (SC)] In
other words, the onus is on the department to establish that the company was a closely-held
company. On the other hand, the Bombay High Court had earlier held that the burden of
proving that a company is one in which the public are substantially interested is on the
company. [P.M. Hutheesingh & Sons Ltd. v CIT (1946) 14 ITR 653 (Bom)].
(6) Foreign Company [Section 2(23A)]
Foreign company means a company which is not a domestic company.
(7) Investment Company
Investment company means a company whose gross total income consists mainly of
income which is chargeable under the heads Income from house property, Capital gains and
Income from other sources.
1.12 RESIDENCE OF A COMPANY [SECTION 6(3)]
A company is said to be a resident in India during the relevant previous year if: (a) it
is an Indian Company, or (b) if it is not an Indian company then, the control and the
management of its affairs is situated wholly in India on the other hand.
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A company is said to be non-resident in India if it is not an Indian company and the
control and management of its affain; is situated outside India fully or partially
Note :
As a rule, the direction, management and control, the head, seat and directing power
of a company's affairs is situated at the place where the directors meetings are held.
Consequently a company would be resident in the country if the meetings of directors
who manage and control the business are held there. It is not what the directors have
power to do, but what they actually do, that is important in determining the question
of the place where the control is exercised. (Egyptian Hotels Ltd. v. Mitchell 6 T.C.
542). In this case Lord Sumner observed.
Where the directors forbore to exercise their powers, the bare possession of those powers was
not equivalent to taking part in or controlling the trading. Control means de facto control and
not merely de jure control. The control and management of a company's affairs is not situated
at the place where the shareholders meetings are held, even if one shareholder, by reason of
his holding an absolute majority of shares, has a decisive voice in matters relating to the
company's affairs.
1.13 INCIDENCE OF TAX
The residence of a company is important to determine total income and tax liability.
As per section 5 of the Income Tax Act 1961, following are the scope of total income of a
company on the basis of residence.
I. Resident. The total income of any previous year of a person who is a "Resident'
includes all income from whatever source derived which :
(a) is received or is deemed to be received in India in such year by or on behalf of
such person; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year;
or
(c) accrues or arises to him outside India during such year.
It is important to note that under clause (c) only income accruing or arising outside
India, is included. Income deemed to accrue or arise outside India is not includible. Hence,
net dividends received from foreign companies is includible in income and not the gross
in accordance with a scheme framed by the Tea Board/Coffee Board/Rubber Board with the
previous approval of the Central Government.
4.7. DEDUCTION IN RESPECT OF PROSPECTING FOR, OR EXTRACTION OR
PRODUCTION OF PETROLEUM OR NATURAL GAS OR BOTH IN INDIA —
(SECTION 33ABA)
(A) The main provisions of this section are as under:
(i) Deduction will be allowed if the Central Government has entered into an agreement
with the assessee.
(ii) The assessee before the end of the previous year has deposited the amount:
(a) in a special account with the State Bank of India, for the specified purposes in
a scheme approved in this behalf by the Government of India.
65
(b) in an account—Site Restoration Account (S.R.A.) for the purposes specified in
a scheme framed by the Government.
(B) Quantum of deduction:
(a) a sum equal to the amount or the aggregate of the amounts so deposited; or
(b) 20% of the profits of such business (computed under the head 'Profits and
gains of business or profession' before making any deduction under the section
33ABA whichever is less.
Notes:
(i) The profits shall be computed before deducting the brought forward losses from
earlier years,
(ii) Where assessee is a firm, A.O.P., or B.O.I, the deduction shall not be allowed to
partners or members, as the case may be.
(iii) Where any deduction is respect of deposits has been allowed in any previous year, no
deduction shall be allowed in respect of such amount in any other previous year. For
example, an assessee deposits 25% of the profits of such business in S.R.A. in
previous year 2014-15. He wi 11 get the deduction of only 20% of such profits. In the
following year he cannot claim the deduction in respect of additional 5% amount
deposited.
(C) Condition for deduction. The accounts of the assessee must be audited for the
previous year in which the deduction is claimed and the audit report must be furnished
along with the return of income.
(D) Withdrawal from the deposit. The amount deposited in special account or S.R.A.
shall not be allowed to be withdrawn except for the purposes specified in the scheme or in the
circumstances specified below:
(i) closure of business
(ii) death of an assessee
(iii) partition of a H.U.F.
(iv) dissolution of a firm
(v) liquidation of a company.
(E) No deduction will be allowed in respect of any amount utilised for the purchase
of:
(a) any machinery or plant to be installed in any office premises or residential
accommodation or guest house;
(b) any office appliances (not being computers);
(c) any machinery or plant, the whole of the actual cost of which is allowed as a
deduction in computing business income of any one previous year;
(d) any new machinery or plant to be installed in an industrial undertaking for the
purposes of business of construction, manufacture or production of any article
or thing specified in the Eleventh Schedule.
(F) Chargeability on withdrawl
(a) Where the amount is withdrawn from S.R.A. on closure of business or
dissolution of a firm it will be deemed to be the income of that previous year
and chargeable to tax accordingly.
66
(b) Where the amount is withdrawn for being utilised for the purposes of such
business in accordance with the scheme, is not so utilised, wholly or partly,
within that previous year, the unutilised amount shall be deemed to be the
profits and gains of business and accordingly chargeable to tax for that
previous year.
(c) Where any asset acquired in accordance with the scheme is sold or otherwise
transferred in any previous year by the assessee to any person at any time
before the expiry of eight years from the end of previous year in which it was
acquired, such part of cost of such asset as it relatable to the deduction shall be
deemed to be the profits and gains of business of the previous year in which
the asset is sold or otherwise transferred. However, this provision shall not
apply in the following cases:
(i) where the asset is sold or transferred to Government, a local authority, a corporation
established by or under a Central, State or Provincial Act or a Government Company.
(ii) where the sale or transfer of the asset is made in connection with the succession of a
firm by a company and the Scheme continues to apply to the company inthe same
manner applicableto the firm.
(G) No deduction for expenses out of special account or S.R.A.: Where the amount is
withdrawn and utilised for such business in accordance with the scheme, such expenditure
shall not be allowed as a deduction in computing the income under the head 'Profits and gains
of business or profession.
(H) Withdrawal of deduction. The Central Government may, by notification, withdraw
the deduction after such date as may be specified in the notification.
4.8 EXPENDITURE FOR OBTAINING LICENCE TO OPERATE
TELECOMMUNICATION SERVICES [SECTION 35ABB]
Where any capital expenditure is incurred by the assessee for acquiring any right to
operate telecommunication services either before the commencement of the business to
operate telecommunication service or thereafter any time during any previous year and for
which payment has actually been made a deduction will be allowed in equal instalments over
the period for which the license remains in force, subject to the following conditions:
(a) If the fee is paid for acquiring any right to operate telecommunication services before
the commencement of such business, the deduction shall be allowed for the previous
years beginning with the previous year in which such business commenced.
(b) If the fee is paid for acquiring such rights after the commencement of such business
the deduction shall be allowed for the previous years beginning with the previous year
in which the license fee is actually paid.
Notes:
(i) Where a deduction for any previous year has been claimed and allowed under this
section, no depreciation shall be allowed under section 32(1) for the same or any
subsequent year.
(ii) Payment has actually been made" means the actual payment of expenditure
irrespective of the previous year in which the liability for the expenditure was
incurred according to the method of accounting regularly employed by the assessee.
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Example 4: Z. Ltd. obtained a licence to operate telecommunication services from
Department of Telecommunication on 1.7.2012 for a period of 11 years i.e. till 30.6.2023 for
a sum of Rs. 13,20,000. Calculate the amount of deduction available to the company under
section 35ABB for the various previous years assuming:—
(a) The payment of the entire licence fee was made on the date of acquisition of the
licence;
(b) Rs. 4,00,000 was paid on the date of acquisition, Rs. 2,60,000 was paid on 15.10.2012
and balance Rs. 6,60,000 will be paid in two equal instalments of Rs. 3,30,000 each
during previous year 2013-14 and 2014-15.
Solution: (a) Since the entire licence fee has been paid during the previous year 2012-13, the
deduction under section 35ABB shall be allowed for 12 relevant previous year in
equal amount of Rs. 1,10,000 each year starting from previous year 2012-13.
(b) Amount to be allowed as deduction
in previous year 2012-13 Rs.660000
12= 55,000
Amount to be allowed as deduction
in previous year 2013-14
55,000 (1/12th the amount paid in 2012-13
30,000 (3,30,000/11 i.e. amount paid in 2013-14
unexpired period of licence i.e. Rs. 85,000
Amount to be allowed as deduction in previous year 2014-15
Rs. 85,000 + 33,000 (3,30,000/10)
i.e. Rs. 118000
Previous years 2015-16 to 2013-24 Rs. 1,18,000
(A) Sale of licence
(a) Where the entire licence is transferred: (i) If the sale proceeds is less than the written down value of the licence, such deficiency shall
be allowed as deduction in the year in which the licence is transferred.
(ii) If the sale proceeds exceeds the written down value of the licence then such excess shall
be taxable as under:
(a) Where the sale proceeds does not exceed the original cost of the licence Sale
proceeds — Written down value of the licence shall be business income
taxable under this section.
(b) Where sale proceeds exceeds the original cost of licences
Original cost — WDV of the licence shall be business income taxable under this section and
Sale proceeds — Original cost (indexed cost in case the assets are held for more than 36
months) shall be short-term or long-term capital gain of the previous year in which such
assets are sold.
(b) Where only a part of the licence is transferred: (i) Where a part of the licence is transferred for a sum less than the written down
value of the total licence, the balance amount not yet written off shall be allowed as
deduction in the balance number of years in equal instalments.
(ii) If part of the licence is transferred for a sum exceeding the written down value of
the licence, then such excess shall be taxable as under:
68
Where the sale proceeds does not exceed the original cost of the licence Sale proceeds —
WDV of the entire licence shall be business income taxable under this section.
Where sale proceeds exceeds the original cost of licences
(i) Original cost — WDV of the entire licence shall be business income taxable
under this section.
(ii) Sale proceeds — Original cost of entire licence (indexed cost in case the assets
held for more than 36 months) shall be short-term or long-term capital gain of
the previous year in which such asset is sold.
Notes:
(a) Amalgamation demerger the; amalgamated! company or the resulting company, as the
case may be, shall be allowed to write off the balance amount of licence which was
not written off by the amalgamating company or demerged company in the same
manner as was allowed to the amalgamating company or demerged company as the
case may be.
(b) Where a deduction for any previous year u/s 35ABB(1) is claimed and allowed in
respect of any expenditure referred to in that sub-section, no deduction shall be
allowed on account of depreciation u/s 32(1) in the same previous year or any
subsequent previous year.
4.9 EXPENDITURE ON ELIGIBLE PROJECTS OR SCHEMES [SECTION
35AC]
Where an assessee incurs any expenditure by way of payment of any sum to a public
sector company or a local authority or to an association or institution approved by the
National Committee for carrying out any eligible project or scheme for promoting the social
and economic welfare of or the uplift of the public as the Central Government may specify,
the amount so paid, shall be allowed as deduction provided a certificate in Form No. 58A is
obtained from the said institution and furnished alongwith the return of income.
However, in the case of a company assessee, the deduction of such expenditure can be
allowed as under:
(a) Expenditure by way of payment to aforesaid institutions for specified purpose: The expenditure incurred by the company by way of payment of any sum to a public
sector company or to a local authority, or to an approved institution/association as
specified above. The deduction shall not be allowed unless the assessee furnishes,
alongwith a return of income, a certificate from such public sector company or local
authority or association in Form No. 58A.
(b) Direct expenditure: The expenditure incurred directly by the company on the
eligible project or scheme undertaken by it. The deduction shall not be allowed to the
assessee unless it furnishes, alongwith the return of income, a certificate from a
Chartered Accountant in Form No. 58B.
Notes:
(i) All assessees other than companies are allowed deduction only for payments made to
outside agencies whereas the companies may either make the payment to outside
agencies or incur the expenditure themselves.
69
(ii) If deduction is claimed under this provision, it shall not be allowed under any other
provision of the Act for the same or any other assessment year.
4.10 DEDUCTION IN RESPECT OF EXPENDITURE ON SPECIFIED BUSINESS
[SECTION 35AD]
(A) Eligibility: Deduction under section 35AD shall be allowed to the assessee who is
carrying on any of the following specified business:
(i) Setting up and operating a cold chain facility;
(ii) Setting up and operating a warehousing facility for storage of agricultural produce
(iii) laying and operating a cross-country natural gas or crude or petroleum oil pipeline
network for distribution, including storage facilities being an integral part of such
network
(iv) The business of building and operating anywhere in India, a hotel of two-star or above
category, as classified by the Central Government;
(v) Building and operating, anywhere in India, a hospital with at least 100 beds for
patients;
(vi) Developing and building a housing project under a scheme for slum redevelopment or
rehabilitation framed by the Central Government or a State Government, as the case
may be, and notified by the Board in this behalf in accordance with the guidelines as
may be prescribed;
(vii) Developing and building a housing project under a scheme for affordable housing
framed by the Central Government or a State Government, as the case may be, and
notified by the Board in this behalf in accordance with the guidelines as may be
prescribed;
(viii) Production of fertiliser in India;
(ix) Setting up and operating an Inland Container Depot or Container Freight Station
notified and approved under the Customs Act, 1962;
(x) Bee-keeping and production of honey and beeswax; and
(xi) Setting up and operating a warehousing facility for storage of sugar.
(B) Nature and amount of deduction: 100% deduction shall be allowed on account of
any expenditure of capital nature incurred wholly and exclusively for the purpose of the
above specified business carried on by such assessee during the previous year in which such
expenditure in incurred by him. However, in case any of the following business has
commenced its operation on or after 1-4-2012, the deduction allowed shall be 150% of such
capital expenditure incurred instead of 100%. The deduction is allowed for:
(a) Setting up and operating a cold chain facility.
(b) Setting up and operating a warehouse for storage of agricultural produce.
(c) Building and operating, anywhere in India, a hospital with atleast one hundred beds
for patients.
(d) Developing and building a housing project under a scheme for affordeable housing
framed by the Central Government or State Government and notified by the Board in
accordance with guidelines as prescribed.
(e) Production of fertilizer in India.
(C) Expenditure incurred prior to commencement of operation to be allowed in the
year of commencement of operation: The expenditure incurred, wholly and exclusively, for
the purposes of any specified business, shall be allowed as deduction during the previous year
in which he commences operations of his specified business, if—
70
(a) the expenditure is incurred prior to the commencement of its operations; and
(b) the amount is capitalized in the books of account of the assessee on the date of
commencement of its operations.
(D) Conditions: This section is applicable to the specified business which fulfils all the
following conditions:
(i) it is not set up by splitting up, or the reconstruction, of a business already in existence;
(ii) it is not set up by the transfer to the specified business of machinery or plant
previously used for any purpose;
(iii) where the business is of laying and operating a cross country natural gas or crude or
petroleum oil pipelines network it should satisfy the following conditions also:
(a) it is owned by an Indian or by a consortium of such companies or by an
authority or a board or a corporation established or constituted under any
Central or State Act;
(b) it has been approved by the Notified Petroleum and Natural Gas Regulatory
Board;
(c) it has made such proportion of its total pipeline capacity available; for use on
common carrier basis by any person other than the assessee or an associated
person as prescribed' by the Petroleum and Natural Gas Regulatory Board;
(d) any other condition as may be prescribed.
Notes:
(A) "Cold chain facility" means a chain of facilities for storage or transportation of
agricultural and forest produce, meat and meat products, poultry, marine and dairy
products, products of horticulture and apiculture and processed food items under
scientifically controlled conditions including refrigeration and other facilities
necessary for the preservation of such produce.
(B) Any expenditure of capital nature shall not include any expenditure incurred on the
acquisition of any land or goodwill or financial instrument.
(C) Where a deduction under section 35AD is claimed and allowed for any assessment
year, no deduction shall be allowed section 80-IA to 80RRB for the same.
Example 5: P.Ltd. constructed a building and started operating a hotel of 3 star category
w.e.f. 1.4.2015. The assessee incurred following expenditure in this connection.
1. Capital expenditure (including cost of land Rs. 50 lakhs)
incurred during December, 2014 to March 2015 which
were capitalized in the books of account 31.3.2015 Rs. 1,10,00,000
2. Capital expenditure incurred during previous year 2015-16
(it includes Rs. 20 lakhs paid for Goodwill) Rs. 1,40,00,000
(a) Compute the deduction available under section 35AD in the
assessment year
2016-17
(b) What will be your answer if such building was constructed
for operating a hospital of 100 beds.
Solution: Rs.
(a)
Capital expenditure incurred before commencement but capitalized
in books of account 1,10,00,000
Less: Cost of land not eligible for deduction under section 35AD 50,00,000
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60,00,000
Capital expenditure incurred during previous year 2015-16
exclusive of value of goodwill 1,20,00,000
Deduction allowable under section 35AD 1,80,00,000
(b) Deduction shall be 150% of Rs. 1,80,00,000.
4.11 WEIGHTED DEDUCTION OF 150% FOR EXPENDITURE INCURRED ON
1. When can a company claim exemption regarding capital gains on distribution of assets
at the time of its liquidation?
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LESSON 9
Double Taxation Relief, Provisions Regulating Transfer Pricing
9. STRUCTURE
9.1 Introduction of International Taxation
9.2 Double Tax Avoidance
9.3 Double Taxation Relief
9.4 Bilateral Relief
9.5 Bilateral Relief may be Granted by one of the following two Methods
9.6 Unilateral Relief u/s 91
9.7 Transfer Pricing
9.8 Transfer Pricing Provisions in India
9.9 Arm’s Length Price (ALP)
9.10 Associated Enterprises (Section 92 A)
9.11 Deemed Associated Enterprises
9.12 Conditions for Applicability of Arm’s Length Price in the International Transaction
9.13 Specified Domestic Transactions
9.14 Methods of Determination of ALP
9.15 Reference to Transfer Pricing Offer
9.16 Determination of Arm’s Length Price by Transfer Pricing Officer
9.17 Procedure of Computation of Arm’s Length Price by Transfer Pricing Officer (TPO)
9.18 Rectification of Arm’s Length Price Order by Transfer Pricing Officer
9.19 Maintenance, Keeping of Informations and Documents by Persons Entering into
International Transatcions
9.20 Advance Pricing Agreement (APA) [Section 92CC and 92 CCD]
9.21 Calculation of Arm’s Length Price Under Advance Pricing Agreement
9.22 Validity of Advance Pricing Agreement
9.23 Parties Bound by Advance Pricing Agreement
9.24 Void Advance Pricing Agreement
9.25 Effect of Void Agreement
9.26 Procedure of APA
9.27 Modified Return
9.28 Asessment under APA
Double Taxation Relief
9.1 INTRODUCTION OF INTERNATIONAL TAXATION.
After the liberalization of Indian economy and easing of restrictions on the entry of foreign
entities, cross border business transactions have increased. With the ratification of WTO by
the Government of India, our economy has become robust and an atmosphere has sprang up
where FII investments in India have increased tremendously. All these economic activities
has ramifications for tax laws of the country. Issues like tax havens, transfer pricing, double
taxation, WTO, F, etc. are required to be taken care of and have become part and parcel of
international taxation regime.
With the acceptance of the WTO regime India has embarked on the policy of market reforms
and merging with the international business community by providing market access to the
overseas investor with zero or qualitatively lesser restrictions.
136
In the context of international taxations, including cross border-investments, eliminated
double taxation become an important consideration in doing business in India and abroad
specially with the double taxation aspect became omnipresent in relations to transitions
involving cross border investments with those foreign entities belonging to those countries
with which India doesn't have double taxation avoidance agreements.
To overcome difficulties faced by investors from countries, India in recent years entered into
Double Taxation Avoidance Agreement (DTAA) with many countries. Section 91 of the
Income Tax Act deals with unilateral relief given to the concerned persons of the foreign
countries with whom India does not have DTAA under section 90 of the Act deals with
general aspect concerning bilateral relief,
Another way of resolving dispute relating to taxes involving international transaction is
through Mutual Agreement Procedure (MAP) in regard to those categories of disputes 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) to deal with the problems of tax
evasion. There are nil tax haven destinations as well as low tax haven destinations.
In cases of double taxation the parties can get relief either through unilateral measures or
bilateral measures or under adjudication by judiciary or through commercial arbitration.
Section 90 of the Income Tax Act, 1961 deals with agreements entered by Government of
India with Government of other countries. Section 91 deals with provisions relating to those
issues for which India does not have any formal agreements with Government of other
countries, regarding avoidance of double taxation. Section 90A relates to granting to
permissions to 'specified association'-through official Gazette notification to enter into
agreement with foreign Government in regard to giving of relief for double taxation.
9.2 DOUBLE TAX AVOIDANCE
The situation of double taxation will arise where the income gets taxed in two or more than
two countries whether due to residence or source principle as the case may be. The problem
of double taxation arises if the income of a person is taxed in one country on the basis of
residence and on the basis of source in another country or on the basis of both. To mitigate
the double taxation of income the provisions of double taxation relief were made. The double
taxation relief is available in two ways one in unilateral relief and other is bilateral relief.
Government of India can enter into agreement with a foreign government vide Entry 14 of
the Union List regarding any matter provided Parliament verifies it. Double Tax Avoidance
Agreement is a kind of bilateral treaty or agreement, between Government of India and any
other foreign country or specified territory outside India. Such treaty or agreement or
agreement is permissible in terms of Article 253 of the Constitution of India.
In pursuance of Section 90, agreements for grant of relief on double taxation and agreement
for avoidance of double taxation are executed by the Government of India from time to time
Some of the countries with which such agreements are in force are: Canada, Korea, New
Zealand, Hungary, Czechoslovakia, Belgium, Sri Lanka, Swiss Federal Council, Sweden,
Denmark, Finland, Great Britain, Norway, Japan, The Federal Republic 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.
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9.3 Double Taxation Relief
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 are two main
rules of income taxation i.e. (a) Source of income rule and (b) residence rule.
As per source of income rule, the income may be subject to tax in the country where the
source of such income exists (i.e. where the business establishment is situated or where the
asset/property is located) whether the income earner is a resident in that country or not. On
the other hand, residence rule stipulates that power to tax should rest with that country in
which tax payer resides. In other words, the income earner may be taxed on the basis of his
residential status in that country. For example if a person is resident of a country, he may
have to pay tax on any income earned outside that country as well.
Thus problem of double taxation arises if a person is taxed in respect of any income on the
basis of source of income rule in one country and on the basis of residence in another 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 residential status of
the assessee during the previous year. In case the assessee is resident in India, he also has to
pay tax on the income which accrues or arises outside India, and also received outside India.
The position in many other countries may be broadly similar, it frequently happens that a
person may be found to be a resident in more than one country or that the same item of his
income may be treated as accruing, arising or received in more than one country with the
result that the same item becomes liable to tax in more than one country.
Relief against such happening can be provided mainly by two methods (a) Bilateral relief, (b)
Unilateral relief.
9.4 Bilateral relief
The Government of two countries can enter into Double Taxation Avoidance Agreement
(DTAA's) so that the same income may not be taxed twice. DTAA's lay down the rule of
taxation of the income by the source country and the residence country. Such rules are laid
for various categories of income, for example interest, dividend, royalties, capital gains,
business income, salary income etc. Each such category is dealt with by separate article in
DTAA.
Thus DTAA's are entered into to provide relief against such Double Taxation, worked out 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 as to the basis of the
relief to be granted by either of them.
9.5 BILATERAL RELIEF MAY BE GRANTED BY ONE OF THE FOLLOWING
TWO METHODS-
(a) Exemption method: Where two countries agree that income from various specified
sources which are likely to be taxed in both the countries should either be taxed only
in one of them or that each of the two countries should tax only a particular specified
portion of the income so that there is no overlapping. Such an agreement will result in
a complete avoidance of double taxation of the same income in the two countries.
This is known as exemption method of relief.
138
(b) Tax credit method: This method does not evolve any such scheme of single
taxability 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
assessee is liable to have his income taxed in both countries but is given a deduction,
from the tax payable by him in the country of residence, of a part of the taxes paid
by him thereon, in the source country usually the lower of the two taxes paid. This is
known as tax credit method of relief.
9.6 UNILATERAL RELIEF U/S 91:
Section 91 provides for the grant of unilateral relief in the case of resident taxpayers on
income which has suffered tax in India as well as in the country with which there is no
DTAA agreement.
The following requirement have to be satisfied order that an assessee is entitled to claim
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 outside India ;
(c) In respect of that income which accrued or arose outside India, he must have paid by
deduction or otherwise tax under the law in force in the foreign country.
The relief will be worked out as under:
1. First, ascertain the amount of doubly taxed income. It consists such income which has
accrued or arisen to the taxpayer in a foreign country and has been subjected to
income-tax in that country as well as in India. It however, does not include income
which is deemed to have accrued or arisen to the taxpayer in India, even though it has
been charged to income-tax in a foreign country.
2. On the amount of that doubly taxed income so ascertained, income-tax calculated at
the Indian rate of tax and the rate of tax of the foreign country. The foreign tax rate
has to be calculate separately for each county.
3. Relief is granted by allowing to the taxpayer a deduction from the tax liability of an
amount equal to the tax calculated at the average Indian rate of tax or the amount of
tax 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 be
entitled to the double taxation relief under section 91 only in respect of Rs. 440000
which has been subject to income-tax India.
Therefore we can say that double taxable relief in the case of no agreement with the foreign
country is allowed unilaterally u/s 91. If a person has earned income outs India in a country
haring no agreement under Section 90 for the relief or avoidance of double taxation and he
proves that he has paid income tax by way of deduction or otherwise under the law in force in
that country in respect of the income so included he shall be entitled to a deduction from the
India income tax payable by him of a sum calculate on such taxed income so included at the
average Indian income tax rate or the average foreign tax rate whichever is lower or at the
Indian rate of tax it both the rates are equal.
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Example:
Mr. Rajeev an individual, resident of India in the previous year receive professional fees of
Rs. 1,70,000 on 7th August 2015 and Rs. 2,55,000 on 15th March 2016 for rendering services
in Pakistan on Which TDS of Rs. 30,000 and Rs. 45,000 had been deducted respectively. He
incurred Rs. 2,60,000 as expenditure for earning this fees. He paid Rs. 90,000 towards PPF.
His Income from other sources in India is Rs. 2,60,000. Compute Tax liability & relief under
section 91.
Solution:
Computation of Relief section 91 of Mr. Rajeev
For the Assessment Year 2016-17
1. Computation of tax liability of Mr. Rajeev as per the Income Tax Act, 1961
Rs. Rs.
Income under the head business & profession: 5,00,000
Less: Expenditure incurred 2,60,000 2,40,000
Income from other sources 2,60,000
Gross Total income 5,00,000
Less: Deduction u/s 80C: PPF 90,000,
Total Income 4,10,000
Tax on Rs. 4,10,000 16,000
Less: Rebate under section 87A1 (2,000)
Net Tax 14,000
Net Tax including cess 14,420
Less: Relief u/s 91 (8,441)
Tax Payable (rounded off) 5980
Computation of relief u/s 91
Double Taxed Income = Rs. 2,40,000
Total Income in India = Rs. 4,10,000
Tax on total income in India = Rs. 14,420
Tax paid in foreign country = Rs. 75,000
Total income assessed in foreign country = Rs. 5,00,000
(a) Tax in India on such doubly taxed income in foreign country: 14,420×2,40,000
4,10,000 × = Rs. 8,441
(b) Tax on such doubly taxed income in foreign country: Rs. 75000
Relief u/s 91 will be lower of (a) or (b) above i.e. Rs. 8,441
Example:
Mr. Ram, a resident of India, provides you the following particulars of his income for the
assessment year 2016-17
Rs.
(1) Interest on Government Securities 25,000
(2) Income form House Property (Computed) 45,000
(3) Business Income 4,40,000
(4) Income from a foreign country with which no agreement
for relief or avoidance of double taxation exists
1,00,000
(5) Income tax paid on foreign income Compute the amount
of income tax payable in India.
20,000
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Solution:
Computation of Total Income
for the Assessment Year 2016-17
Rs.
Interest on securities 25,000
Income from House Property 45,000
Business income 4,40,000
Foreign income 1,00,000
Gross Total Income 6,10,000
Deduction Nil
Total Income 610000
Computation of Tax Payable
for the assessment year 2016-17
Rs.
Income tax on Rs. 6,10,000 47,000
Add : Surcharge Nil
47,000
Add : Education cess @ 3% 1,410
Total
Less Relief on foreign income at Indian rate of tax or
foreign rate of tax, whichever is lower 48,410×1,00,000
6,10,000i.e., Rs. 7,936 or Rs. 20,000, whichever is less
Tax Payable
48410
7,936
40,747
9.7 TRANSFER PRICING
In the present age of globalization, diversification and expansion, most of the companies are
working under the umbrella of group in diversified fields/sectors leading to large number of
transactions between related parties. Related party transaction means the transaction between/
among the parties which are associated by reason of common control, common ownership or
other common interest.
The mechanism for accounting, the pricing for these related transactions is called Transfer
pricing.
Transfer Price refers to the price of goods/service which is used in accounting for transfer of
goods or services from one responsibility centre to another or from one company to another
associated company. Transfer price affects the revenue of transferring division and cost of
receiving division. As a result, the profitability, return on investment and managerial
performance evaluation of both divisions are also affected.
Example
Hero & Companies is a group Companies engaged in diversified business. One of its
units i.e. Unit X is engaged in manufacturing of automotive batteries. Another Unit Y is
engaged in manufacturing of Trucks. Unit X is supplying automotive batteries to Unit Y.
In such cases transfer price mechanism can be used to account for the transfer of
automotive batteries.
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9.8 TRANSFER PRICING PROVISIONS IN INDIA
Increasing participation of multi-national groups in economic activities in India has given rise
to new and complex issues emerging from transactions entered into between two or more
enterprises belonging to the same group. Hence, there was a need to introduce a uniform and
internationally accepted mechanism of determining reasonable, fair and equitable profits and
taxes in India. Accordingly, the Finance Ac, 2001 introduced law of transfer pricing in India
through Sections 92 to 92F of the Income Tax Act, 1961 which guides computation of the
transfer price and suggests detailed documentation procedures. Year 2012 brought a big
change in transfer pricing regulations in India whereby government extended the applicability
of transfer pricing regulations to specified domestic transactions which are enumerated in
Section 92BA. This would help in curbing the practice of transferring profit from a taxable
domestic zone to tax free domestic zone. The fundamental of transfer pricing provision is that
transfer price should represent the arm's length price of goods transferred and services
rendered from one unit to another unit.
9.9 ARM'S LENGTH PRICE (ALP)
In general arm's length price means fair price of goods transferred or services rendered. In
other words, the Arm's Lenth price should represent the price which could be charged from
an independent party in uncontrolled conditions. Arm's length price calculation is very
important for a company. In case the transfer price is not at arm's length, it may have
following consequences.
(a) Wrong performance evaluation
(b) Wrong pricing of final product (In case where the goods/services are used in the
manufacturing of final product)
(c) Non compliances of applicable laws and thus attraction of penalty provisions.
The same may be explained with the following three examples.
Company A and Company B is working under the common umbrella of AB & Company.
Company A manufactures a product which is raw material for Company B.
Case Criteria Effect on Company A Effect on Company B
1. Company A
charges price
more than the
Arm's length
price from
Company B
The revenue of
company A will
increase.
The total cost of company B will
increase. The will result into
wrong pricing of its product
which may further lead to non-
competitiveness of its product
2. Company A
charges price
less than the
Arm's from
company B
The revenue of
company parent
company A will
decrease and may
close the company A
treating it as loss
making entity.
The total cost of company B will
decrease. Therefore, the company
B may charge lower price which
may lead to loss.
3. Company A
charges Arm's
Length price
from Company
The revenue of
company A will be
representing true and
fair view of its
Company B will be paying the
price as equivalent to market
price of Company A product and
its cost will be correct. On the
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B operation basis of the cost arrived after
considering the arm's length price
of company A product, company
B will be able to take correct
price decision.
9.10 ASSOCIATED ENTERPRISES (SECTION 92 A)
"The concept of associated enterprises and international transaction are very important
"Associated enterprise", (AE) in relation to another enterprise, means an enterprise-
(a) Which participates, directly or indirectly, in the management or control or capital of
the other enterprise; or
(b) In respect of which one or more person who participate, directly or indirectly, in the
management or control or capital of the other enterprise. Thus, from above definition
we may understand that the basic criterion to determine an Associated enterprise is
the participation in management, control or capital (ownership) of one enterprise by
another enterprise whereby the participation may be direct or indirect or through one
or more intermediaries.
9.11 DEEMED ASSOCIATED ENTERPRISES
As per Section 92A(2), two enterprises shall be deemed to be associated enterprises if, at any
time during the previous year-
(a) One enterprise holds, directly or indirectly, shares carrying not less than twenty-six
per cent of the voting powers in the enterprise; or
(b) Any person or enterprise holds, directly or indirectly, shares carrying not less than
twenty-six per cent of the of the voting power in each of such enterprise; or
(c) A loan advanced by one enterprise to the other enterprise constitutes not less than
fifty-one per cent of the book value of the total assets of the other enterprise; or
(d) One enterprise guarantees not less than ten per cent of the total borrowings of the
other enterprise; or
(e) More than half of the board directors or executive members of the governing board, or
one or more executive directors or executive member of the governing board of one
enterprise, are appointed by the other enterprise; or
(f) More than half of the directors or members of the governing board, or one or more
executive directors or members of the governing board, of each of the two enterprises
are appointed by the same person or persons; or
(g) The manufacture or processing of goods or articles or business carried out by one
enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-
marks, licences, franchises or any other business or commercial rights of similar
nature, or any data, documentation, drawing or specification relating to any patent,
invention, model, design, secret formula or process, of which the other enterprise is
the owner or in respect or which the other enterprise has exclusive rights; or
(h) Ninety per cent or more of the raw materials and consumables required for the
manufacture or processing of goods or articles carried out by one enterprise, are
supplied by the other enterprise, or by persons specified by the other enterprise, and
the prices and other conditions relating to the supply are influenced by such other
enterprise: or
(i) The goods or articles manufactured or processed by one enterprise, are sold to the
other enterprise or to persons specified by the other enterprise, and the price and other
conditions relating thereto are influenced by such other enterprise; or
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(j) Where one enterprise is controlled by an individual, the enterprise is also controlled
by such individual or jointly by such individual and relative of such individual; or
(k) Where one enterprise is controlled by a Hindu undivided family, the other enterprise
is controlled by a member of such Hindu undivided family or by a relative of a
member of such Hindu undivided family or jointly by such member and relative of
such individual; or
(l) Where one enterprise is a firm, association of persons or body of individual, the other
enterprise holds not less than ten per cent interest in such firm, association of persons
or body of individuals; or
(m) There exists between the two enterprises, any relationship of mutual interest, as may
be prescribed.
In Brief, two enterprises will be deemed as Associated Enterprises as per fallowing criteria:
Quantum of Interest Criteria applied for Associated Enterprises
26% or more Shareholding with voting power either direct
or indirect
51% or more Advancement of loan by one entity to other
constituting percentage of the book value of
the total assets of the other entity.
51% or more The board of directors appointed in the
governing board of the entity in the other
90% or more The quantum of supply of raw materials and
consumables by one entity to the other.
10% or more Total borrowing guarantee by one enterprises
for other
10% or more Interest by a firm or Association of Person
(AOP) or by a Body of individuals (BOI) in
other firm AOP or BOI
9.12 CONDITIONS FOR APPLICABILITY OF ARM'S LENGTH PRICE IN THE
INTERNATIONAL TRANSACTION
The provisions under sections 92 to 92F have been enacted with an intention to provide
statutory framework which can lead to computation of reasonable, fair and equitable profit
and tax in India so that the profits chargeable to tax in India do not get diverted elsewhere by
altering the prices charged and paid in intra-group transactions leading to erosion of Indian
tax revenue. Any income arising from an international transactions shall be computed with
regard to arm's length price.
With effect from the assessment year 2013-14, section 92BA has been inserted to extend
transfer pricing provisions to a domestic transactions also.
The following conditions need to be satisfied for the applicability of the arm's length price in
the international transaction-
1. International transaction is subject to the arm's length price only in case of transaction
between two entities called associated enterprise. An enterprise would be regarded as
an associated enterprise of another enterprise, if-it participates, directly or indirectly,
or through one or more intermediaries, in the management or control or capital of the
other enterprise; or in respect of it one or more persons who participate, directly or
indirectly, or through one or more intermediaries, in its management or control or
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capital, are the same persons who participate, directly or indirectly, or through one or
more intermediaries, in the management or control or capital of the other enterprise.
2. Two enterprises shall be deemed to be associated enterprises if the two enterprises
fall, at any time during the previous year, in any of the prescribed conditions stated
above. In addition, these provisions are applicable if there is complete dependency of
one enterprise on the other enterprise.
3. An international transaction should be carried out by the associated enterprise.
4. The transactions between an enterprise and another person is deemed as transactions
entered into between two associated enterprises if either there is a prior agreement in
relation to the relevant transaction between such other person and the associated
enterprise or the terms of the relevant transaction are determined in substance between
such other person and the associated enterprise.
9.13 SPECIFIED DOMESTIC TRANSACTIONS
Section 92BA has been inserted by finance act 2012 with effect from the assessment year
2013-14. It provides meaning of "specified domestic transaction" with reference to which the
income is computed under section 92 having regard to arm's length price. The following
transactions are covered within the meaning of "specified domestic transactions" if the
aggregate of these transactions entered into by the assessee in a previous year exceeds Rs. 20
crore.
(a) any expenditure in respect of which payment has been made or is to be made to be
made to a person 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 in section
80-IA(10);
(e) any transaction referred to in any other section under Chapter VI-A or section 10AA,
to which provisions of section 80-IA(8)/(10) are applicable; or
(f) any other transaction as may be prescribed.
Any allowance for an expenditure or interest or allocation of any cost or expense or any
income in relation to the above domestic transactions shall be computed having regard to the
arm's length price. For this purpose, arm's length price shall be determined within the
parameters of sections 92 to 92F
9.14 METHODS OF DETERMINATION OF ALP.
Arm's length price can be computed by any the following methods:
(a) comparable uncontrolled price method; (CUPM)
(b) resale price method; (RPM)
(c) cost plus method; (CPM)
(d) profit split method; (PSM)
(e) Transactional and Net margin Method; (TNMM)
(f) such other method as may be prescribed by the (CBDT)
A. Comparable uncontrolled price method (CUP) – Under this method following
Procedure is adopted:
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(a) The price charged or paid for property transferred or services provided in a
comparable uncontrolled transaction, (i,e., a transaction between enterprises other
than associated enterprises whether resident or non-resident) or a number of such
transactions, is identified;
(b) Such price is adjusted to account for differences, if any, between the international
transaction and the comparable uncontrolled transactions or between the enterprises
entering entering into such transactions, which could materially affect the price in the
open market;
(c) The adjusted price arrived at under (b) is taken to be an arm's length price in respect
or the property transferred or services provided in the international transaction.
CUPM is applied when a price is charged for a product or service. This is essentially
comparison of prices charged for the property or services transferred in a controlled
transaction to a price charged for property or services transferred in a comparable
uncontrolled transaction. The essence of this method is the identification of an identical
transaction, in a situation where a price is charged for product or services between unrelated
parties.
B- Resale price method (RPM) is: The essence of this method.
(a) The price at which property purchased or services obtained by the enterprise from an
associated enterprise is resold or are provided to an unrelated enterprise, is identified;
(b) Such resale price is reduced by the amount of a normal gross profit margin accruing
to the enterprise or to an unrelated enterprise from the purchase and resale of the same
or similar property or from obtaining and providing the same or similar services, in a
comparable uncontrolled transaction, or a number of such transactions;
(c) The price so arrived at is further reduced by the expenses incurred by the enterprise in
connection with the purchase of property or obtaining of services;
(d) The price so arrive at is adjusted to take into account the functional and other
differences, including differences in accounting practices, if any, between the
international transaction and the comparable uncontrolled transactions, or between the
enterprises entering into such transaction which could materially affect the amount of
gross profit margin in the open market;
(e) The adjusted price arrived at under (d) above is taken to be an arm's length price in
respect of the purchase of the property or obtaining of the services by the enterprise
from the associated enterprise.
Example: A sold a machine to B (Associated enterprise) and in turn B sold the same machinery
to C (an independent party) at sale margin of 30% for Rs. 2,10,000 but without
making any additional expenses and change. Here arm's length price would be
calculated as
Sales price to C = Rs. 2,10,000
Gross Margin = 2,10,000 × 30% = Rs. 63,000
Arm's Lenth Prce = Rs. 1,47,000
Example:
A sold a machine to B (Associate enterprise) and in turn B sold the same machinery to
C (an independent party) at sale margin of 30% for Rs. 4,00,000 but B has incurred
Rs. 4000 in sending the machine to C. Here Arm's length price would be calculated as
Sales price to C = Rs. 4.00.000
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Gross Margin = Rs. 4,00,000 × 30% Rs. 1, 20,000
Balance = Rs. 2,80,000
Less : Expenses incurred by B : = Rs. 4,000
Arm's length price = Rs. 2,76,000
C- Cost Plus Method (CPM) – The essence of this method is:
(a) The direct and indirect costs of production incurred by the enterprise in respect of
property transferred or services provided to an associated enterprise, are determined;
(b) The amount of a normal gross profit mark-up to such costs (computed according to
the same accounting norms) arising from the transfer or provision of the same or
similar property of services by the enterprise, or by an unrelated enterprise, in a
comparable uncontrolled transaction, or a number of such transaction, or between, is
determined;
(c) The normal gross profit mark-up referred to in clause (b) is adjusted to take into
account the functional and other differences, if any, between the international
transaction and the comparable uncontrolled transactions, or between the enterprises
entering into such transaction, which could materially affect such profit mark-up in
the open market;
(d) The costs referred to in clause (a) increased by the adjusted profit mark-up arrived at
under clause (c)
(e) The sum so arrived at is taken to be an arm's length price in relation to the supply of
the property or provision of services by the enterprise.
This method is ordinarily used where some semi-finished goods are sold between related
parties or similar situations or in respect of joint facility agreements long-term buy and
supply arrangements of provisions of services, etc.
D- Profit Split Method (PSM) – This method is applicable mainly in international
transactions involving transfer of unique intangible or in multiple international transactions
which are so interrelated that they cannot be evaluated separately for the purpose of
determining the arm's length price of any one transaction. As per profit split method
following step are taken :
(a) The combined net profit of the associated enterprises from the international
transaction in which they are engaged, is determined;
(b) The relative contribution made by each of the associated enterprises to the earning of
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 the
basis of reliable external market data which indicates how such contribution would
be evaluated by unrelated enterprises performing comparable functions in similar
circumstances;
(c) The combined net profit is then split amongst the enterprises in proportion to their
relative contributions, as evaluated under clause (b)
(d) Profit thus apportioned to the assessee is taken into account to arrive at an arm's
length price in relation to the international transition.
E- Transactional Net Margin Method (TNMM)- According to transactional net margin
method following steps are taken to calculate ALP :
(a) The net profit margin realised by the enterprise from an international transaction
entered into with an associated enterprise is computed in relation to costs incurred or
147
sales effected or assets employed or to be employed by the enterprise or having regard
to any other relevant base;
(b) The net profit margin realised by the enterprise or by an unrelated enterprise from a
comparable uncontrolled transaction or a number of such transactions is computer
having regard to the same base;
(c) The net profit margin referred to in (b) above arising in comparable uncontrolled
transactions is adjusted to take into account the differences, if any, between the
international transaction and the comparable uncontrolled transactions, or between the
enterprises entering into such transitions, which could materially affect the amount to
net profit margin in the open market;
(d) the net profit margin realised by the enterprise and referred to in clause (a) is
established to be the same as the net profit margin referred to in (c) above;
(e) The net profit margin thus established is then taken into account to arrive at an arm's
length price in relation to the international transaction.
Selection of Appropriate Method :
In selecting a most appropriate method, the following factors shall be taken into account as
per Rule 10C of Indian Income Tax Rules 1962;
(a) The nature and class of the international transaction.
(b) The class or classes of Associated Enterprises entering into the transaction and the
functions performed by them taking into account assets employed or to be employed
and risks assumed by such enterprises.
(c) The availability, coverage and reliability of data necessary for application of the
method.
(d) The degree of comparability existing between the international transaction and the
uncontrolled transaction and between the enterprises entering into such transaction.
(e) The extent to which to which reliable and accurate adjustments can be made to
account for differences, if any, between the international transaction and the
comparable uncontrolled transactions or between the enterprises entering into such
transactions.
(f) The nature, extent and reliability of assumptions required to be made in the
application of a method.
The starting point to select the most appropriate method is the functional analysis which is
necessary regardless of what transfer pricing method is selected. Each method may require a
deeper analysis focusing on aspects relating to various methods. The functions analysis helps
in the following.
I. To identify and understand the intra-group transactions;
II. To have a basis for comparability
III. To determine any necessary adjustments to the comparables;
IV. To check the accuracy of the method selected; and
V. To consider adaptation of the policy it the functions, risks or assets have been
modified.
There is no universally accepted method or model which describes the technique for choosing
a transfer pricing method. Traditionally comparable Uncontrolled Pricing Method, Profit
Split Method, Resale Price Methods are being used in transfer pricing. Other method as
TNMM may also be used after the functional analysis and global practices analysis.
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9.15 REFERENCE TO TRANSFER PRICING OFFICER
Section 92CA of Income Tax Act Deals Reference to the Transfer Pricing Officer by the
Assessing Officer. It provides that Assessing Officer with prior approval of the Principal
Commissioner or Commissioner may refer the computation of Arm's Length Price in an
International Transaction to transfer Pricing Officer if he considers it necessary or expedient
to do so. On reference by Assessing officer, Transfer Pricing officer (TPO) shall serve a
notice to the Assessee requiring him to produce the evidence in support of computation made
by him of Arm's Length Price in relation to an international transaction.
9.16 DETERMINATION OF ARM'S LENGTH PRICE BY TRANSFER PRICING
OFFICER
Transfer Pricing officer after hearing the evidences, information or documents as produced
by assessee and after considering such evidence as he may require on any specified points
and after taking into account all relevant materials which he has gathered, shall, by order in
writing, determine the arm's length price in relation to the international transaction/specified
transaction and send a copy of his order to the Assessing Officer and to the assessee.
On receipt of the order from Transfer Pricing officer, the Assessing officer shall proceed to
compute the total income of the assessee in conformity with the arm's length price as
determined by the Transfer Pricing Officer.
9.17 PROCEDURE OF COMPUTATION OF ARM'S LENGTH PRICE BY
TRANSFER PRICING OFFICER (TPO)
As per selection 92 (CA) the A.O. may refer the computation of arm's length price, with the
previous approval of the Commissioner, to the TPO. TPO means a Joint Commissioner or
Deputy Commissioner or Assistant Commissioner, authorised by the Board to perform all or
any of the functions of an A.O. specified in Secs. 92C and 92D in respect of any person or
class of persons.
Where a reference is made, the TPO shall serve a notice on the assessee to produce on a date
specified therein, any evidence on which the assessee may rely in support of the computation
made by him of the arm's Length price in relation to the international transaction. Keep the
TPO shall following in mind:
i. the evidence as the assessee may produce;
ii. any information or documents referred to in Sec. 92D()3;
iii. all relevant materials which he has gathered.
He will send a copy of the order to the A.O. and the assessee.
The TPO shall pass an order at least 60 days before the period of limitation referred to in Sec.
153/153B, for making the order of assessment or reassessment or recompilation or fresh
assessment, expires. The TPO shall determine the arm's length price keeping in view the
following:
On receipt of the order the A.O. will proceed to compute the total income of the assessee (u/s
92C(4)) in conformity with the arm's length price determined by the TPO. The TPO may
amend an order passed by him with a view to rectifying any apparent mistake keeping in
view the provisions of Sec. 154. Where an amendment is made by the TPO in his order, he
will send a copy of it to the A.O. who will thereafter proceed to amend the order of
assessment accordingly.
Penalty. Where an assessee enters into an international transaction (defined in Sec. 92B), any
amount is added or disallowed in computing the total income, then, the amount so added or
disallowed shall be deemed to represent the income in respect of which particulars have been
149
concealed or inaccurate particulars have been furnished. A minimum 100% as maximum
300% penalty may be imposed of the amount of tax evaded.
9.18 RECTIFICATION OF ARM'S LENGTH PRICE ORDER BY TRANSFER
PRICING OFFICER
If any mistake is observed which is apparent from record, the Transfer Pricing Officer may
amend any order passed by him and the provisions of Section 154 for rectification of mistake
shall apply accordingly. Where any amendment is made by the Transfer Pricing Officer, he
shall send a copy of his order to the Assessing Officer who shall thereafter proceed to amend
the order of assessment in conformity with such order of the Transfer Pricing Officer.
9.19 MAINTENANCE, KEEPING OF INFORMATIONS AND DOCUMENTS BY
PERSONS ENTERING INTO INTERNATIONAL TRANSACTIONS
(1) Every person who has entered into an international transactions shall keep and
maintain such informations and documents in respect thereof, as may be prescribed.
(2) The informations and documents shall be kept and maintained for a period of eight
years from the end of the relevant assessment year.
Penalty. If a person fails to keep and maintain any such information and document as
required (u/s 92D (1) or (2) the Assessing Officer or Commissioner (Appeals) may impose a
penalty, a sum equal to two percent of the value to each international transaction entered into
by him.
(3) The Assessing Officer or the Commissioner (Appeals) may, in the course of any
proceeding under this Act, require any person who has entered into an international
transaction to furnish any information or document in respect thereof, as may be
prescribed, within a period of thirty days from the date of receipt of a notice issued in
this regard:
However, the Assessing Officer or the Commissioner (Appeals) may, on an application made
by such person, extend the period of thirty days by a further period not exceeding thirty days.
Penalty. If a person, who has entered into an international transaction, fails to furnish any
such information or document as required (u/s 92D(3) the Assessing Officer or the
Commissioner (Appeals) may impose a penalty on him, a sum equal to two per cent of the
value of the international transaction for each such failure.
Report form an accountant to be furnished by persons entering into international
transaction. Every person who has entered into an international transaction during a previous
year shall obtain a report from an accountant and furnish such report on or before the due
date of furnishing the return in the prescribed form (Form No. 3CEB) duly signed and
verified in the prescribed manner by such accountant and setting forth such particulars as may
be prescribed.
Penalty. If a person fails to furnish a report from an accountant relating to his international
transactions, the Assessing Officer may impose a penalty on him of Rs. 1,00,000
Note: No penalty shall be levied under aforesaid sections if the assessee proves that there was
reasonable cause for the said failure.
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Example 1:
A Ltd., an Indian company, sells computer monitor to its 100 per cent subsidiary X Ltd. in
United States @ $ 50 per piece. A Ltd. also sells its computer monitor to another company Y
Ltd. in United States @ $ 80 per piece. Total income of A Ltd. for the assessment year 2015-
16 is Rs. 12,00,000 which includes sales made for 100 computer monitors @ $ 50 to X Ltd.
Compute the arm's length price and taxable income of A Ltd. The rate of one dollar may be
assumed to the equivalent to Rs. 60
Solution
Computation of Arm's Length Price and
Taxable Income of A Ltd.
Arm's length price : 100×80×60 = Rs. 4,80,000
Rs.
Total Income 12,00,000
Add: Arm's length price 4,80,000
Less : Price charged 100×50×60 3,00,000
Taxable Income 13,80,000
9.20 ADVANCE PRICING AGREEMENT (APA) SEC. 92CC AND 92CCD
Advance Pricing Agreement is an agreement between taxpayer and a taxing authority on an
appropriate transfer pricing methodology for a set of transactions over a fixed period of time
in future. The APA offers better assurance on transfer pricing methods and are conducive in
providing certainty and unanimity of approach. Section 92CC and 92CD have been inserted
by the Finance Act, 2012 with effect from July 1,2012 to provide a framework for advance
pricing agreement under the Act. Section 92CC empowers the Board (with the approval of
the central Government) to enter into an advance pricing agreement, in relation to an
international transaction to be entered into by that person.
9.21 CALCULATION OF ARMS'S LENGTH PRICE UNDER ADVANCE PRICING
AGREEMENT
Arm's Length Price under Advance Pricing Agreement shall be calculated as per method
enumerated in section 92C (1) or any other method with such adjustment and variation as
may be necessary and expedient so to do.
Section 92 C (1) of Income Tax Act prescribes that the arm's length price in relation to an
international transaction shall by determined by any of the following methods, being the most
appropriate method, having regard to the nature of transaction or class of transaction or class
of associated persons or functions performed by such persons or such other relevant factors as
the Board may prescribe (see rule 10B) namely:-
(a) Comparable uncontrolled price method;
(b) Resale price method;
(c) Cost plus method;
(d) Profit split method;
(e) Transactional net margin method;
(f) Such other method as may be prescribed by the Board.
Notwithstanding anything contained in Section 92C or Section 92CA, if the Advance Pricing
Agreement has been entered between an assessee and Board in respect of one international
transaction, the arm's length price will be calculated as per the provisions of Advance Pricing
Agreement.
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9.22 VALIDITY OF ADVANCE PRICING AGREEMENT
The Advance Pricing Agreement shall be valid for a period as specified in the Advance
Pricing Agreement. However, this period will not be more than 5 consecutive years.
9.23 PARTIES BOUND BY ADVANCE PRICING AGREEMENT
Advance Pricing Agreement shall be binding on:
(a) the person in whose case, and in respect of the transaction in relation to which, the
agreement has been entered into; and
(b) on the Principal Commissioner or Commissioner, and the income-tax authorities
subordinate to him, in respect of the said person and the said transaction.
However the advance pricing agreement shall not be binding if there is a change in law or
facts having bearing on the agreement so entered.
9.24 VOID ADVANCE PRICING AGREEMENT
If an agreement has been obtained by fraud or misrepresentation or false documents it may be
declared void ab initio:
9.25 EFFECT OF VOID AGREEMENTS:
If an agreement in declared void;
(a) All the provisions of the Act shall apply of the person as if such agreement had never
been entered into; and
(b) Notwithstanding anything contained in the Act, for the purpose of computing any
period of limitation under this Act, the period beginning with the date of such
agreement and ending on the date of order for declaring an Advance Pricing
Agreement void ab initio shall be excluded. Provided that where immediately after the
exclusion of the aforesaid period, the period of limitation, referred to in any provision
of this Act, is less than sixty days, such period shall be extended to sixty days and the
aforesaid period limitation shall be deemed to be extended accordingly.
9.26 PROCEDURE OF APA
The Board is empowered to prescribe a scheme providing for the manner, form, procedure
and any other matter generally in respect of the advance pricing agreement.
9.27 MODIFIED RETURN
The person entering into such APA shall necessarily have to furnish a modified return within
a period of 3 months from the end of the month in which the said APA was entered into
respect of the return of income already filed for a previous year to which the APA applies.
The modified return has to reflect modification to the income only in respect of the issues
arising from the APA and in accordance with it.
9.28 ASSESSMENT UNDER APA
Where the assessment or reassessment proceeding for an assessment year relevant to the
previous year to which the agreement applies are pending on the date of filing of a modified
return, the Assessing Officer shall proceed to complete the assessment or reassessment
proceedings in accordance with the agreement, taking into consideration the modified return
so filed and normal period of limitation of completion of proceeding shall be extended by one
year.
152
If the assessment or reassessment proceedings for an assessment year relevant to a previous
year to which the agreement applies has been completed before the expiry of period allowed
for furnishing of modified return, the Assessing Officer shall, in a case where modified return
is filed, proceed to assess or reassess or recomputed the total income of the relevant
assessment year having regard to and in accordance with the APA. To such assessment, all
the provisions relating to assessment shall apply as if the modified return is a return furnished
under section 139. The period of limitation for completion of such assessment or
reassessment is one year from the end of the financial year in which the modified return is
furnished.
Questions:
1. What is double taxation avoidance agreement? Discuss in the context of India.
2. Disuses the steps for calculating unilateral tax relief.
3. What are the condition for claiming double taxation relief?
4. Rakesh is a magician deriving income from shows performed outside India amounting
Rs. 2,50,000. Tax of Rs. 37,500 was deducted at source in the country where the
concerts were given. India does not have any agreement with that country for
avoidance of double taxation. Assuming that the Indian income of Rakesh is Rs.
5,00,000, what is the relief due to him under Section 91 for assessment year 2016-17.
Ans. Rs. 25750
5. An individual, resident of India has the following incomes during P.Y. 2015-16
Rs.
1. Business income in India 7,20,000
2. Business income in a foreign country with
which India does not have Double
Taxation avoidance agreement
3. Tax an income mentioned in 2 by foreign
country deposited in Public Provident Fund
Compute his tax liability
2,40,000
48,000
40,000
Ans. Rs. 83087
6. Discuss method under. Which arm's length price relating to an international
transaction determined.
7. When an enterprise is treated an associated enterprise under income tax act? Discuss
deemed associated enterprises.
8. Write notes on advance pricing agreement.
9. Distinguish between resale price method and cost plus method.
10. From the following information determined the 'Arm's' length price' and taxable
income of S. Ltd. a 100% Indian subsidiary company of a foreign Company F Ltd. :
a. F Ltd. sold 1,000 mobile phones to S. Ltd. @ $ 40 per unit.
b. F Ltd. sold 2,000 mobile phones to other Indian companies @ $ 50 per unit.
c. Total income of S Ltd. for the year Rs. 15,00,000
d. Assume the rate of a dollar = Rs. 65
Ans. ALP Rs. 3250000 income – Rs. 2150000
153
LESSON 10
(a) Special Provisions Relating to Non-Residents
(b) Advance Ruling
(a) NON-RESIDENTS
According to section 2(30), “Non-resident” means a person who is not a resident in India.
However in the following cases, it also includes a person who is not ordinarily resident in
India:
1. Section 92 : relating to computation of income from international transactions
having regard to arm’s length price;
2. Section 93 : avoidance of income tax by transactions resulting in transfer of
income to non-residents;
3. Section 168 : executors.
TYPES OF NON-RESIDENTS IN INDIA
Under Income-tax Act, non-resident in India can be of two types:
1. Non-resident Indian:
“Non-resident Indian” means an individual, being a citizen of India or a person of Indian
origin who is not a resident.
2. Any other non-resident person:
Foreign nationals (other than individuals of Indian origin) or foreign companies or Overseas
financial organizations (Offshore funds) or foreign institutional investors, etc.
EXEMPTED INCOMES
1. Any income by way of interest on notified securities or bonds (including income by
way of premium on the redemption of such bonds) or any income by way of interest
on moneys standing to a non-resident individual’s credit in a Non-Resident (External)
Account in any bank in India in accordance with the relevant rules [Sec. 10(4)].
2. A foreign company deriving income by way of royalty or fees for technical services
received from Government or an Indian concern in pursuance of an agreement made
by the foreign company with Government or the Indian concern after the 31st day of
March, 1976 but before the 1st day of June, 2002 [Sec. 10(6A)].
3. A non-resident (not being a company) or a foreign company deriving income (not
being salary, royalty or fees for technical services) from Government or an Indian
concern in pursuance of an agreement entered into before the 1st day of June, 2002 by
the Central Government with the Government of a foreign State or an international
organisation, the tax on such income is payable by Government or the Indian concern
to the Central Government under the terms of that agreement or any other related
agreement approved before that date by the Central Government [Sec. 10(6B)].
4. Any income arising to notified foreign companies by way of royalty or fees for
technical services received in pursuance of an agreement entered into with that
Government for providing services in or outside India in projects connected with
security of India [Sec. 10(6C)].
5. Any payment made, by an Indian company engaged in the business of operation of
aircraft, to acquire an aircraft or an aircraft engine (other than a payment for providing
spares, facilities or services in connection with the operation of leased aircraft) on
lease from the Government of a foreign State or a foreign enterprise under an
agreement, not being an agreement entered into between the 1st day of April, 1997
and the 31st day of March, 1999,] and approved by the Central Government [Sec.
10(15A)].
154
COMPUTATION OF CERTAIN INCOME OF NON-RESIDENTS
1. Profits and gains of shipping business [Sec. 44B]:
This section is applicable if the assessee is a non-resident in India and engaged in the
business of operation of ships.
Income shall be calculated @ 7.5% of the aggregate of the following:
a. the amount paid or payable (whether in or out of India) to the assessee on account of
carriage of passengers, livestock, mail or goods shipped at any Indian port; and
b. the amount received or deemed to be received in India by the assessee on account of
the carriage of passengers, livestock, mail or goods shipped at any port outside India.
The amount paid or payable or received or deemed to be received also include the amount
received by way of demurrage charges or handling charges or any other amount of similar
nature.
The provisions of section 44B are applicable to a ship which is engaged in regular business in
India and provisions of section 172 are applicable to a ship which occasionally visits the
Indian ports. However, assessees applying section 172 can opt for being governed by the
provisions of section 44B, and accordingly, in such cases taxes paid under section 172 shall
be adjusted in light of the tax liability computed under section 44B.
Section 172 Section 44B
Tax liability 7.5% of amount received on account
of carriage of goods, passengers, etc.,
is taxable at the rate applicable to a
foreign company [if not opted for
regular assessment]
7.5% of such collection is taken as
business income; other provisions
will be applicable to find out taxable
income which will be taxable at the
rate applicable to a non-resident.
Overriding
effect
It overrides all other provisions of the
Act subject to availing the facility of
regular assessment
It overrides sections 28 to 43A
2. Profits and gains of business of exploration etc. of mineral oils [Sec. 44BB]:
This section is applicable if the assessee is non-resident and engaged in the business of
providing services and facilities in connection with, or supplying plant and machinery on
hire, used or to be used in the exploration for, and exploitation of, minerals oils.
Income is calculated @ 10% of the amounts given below:
a. amount paid or payable to the assessee (whether in or out of India) for the aforesaid
services or facilities or supplying plant and machinery for the aforesaid purposes; and
b. amount received or deemed to be received in India for the aforesaid services or
facilities or supply of plant and machinery.
For this purpose, "plant" includes ships, aircraft, vehicles, drilling units, scientific apparatus
and equipment, used for the purposes of the said business.
The provisions of sections 28 to 41, 43 and 43A are not applicable.
3. Profits and gains of the business of operation of aircraft [Sec. 44BBA]:
This section is applicable in the case of a non-resident engaged in the operation of aircraft.
Income from such business is calculated @ 5% of the following:
155
a. the amount received (whether in or out of India) by the assessee on account of
carriage of passenger, livestock, mail or goods from any place in India; and
b. the amount received or deemed to be received in India by the assessee on account of
carriage of passenger, livestock, mail or goods from any place outside India.
4. Profits and gains of business of civil construction etc. in certain turnkey power
projects [Sec. 44BBB]:
This section is applicable in the case of a foreign company engaged in the business of civil
construction or the business of erection of plant or machinery or testing or commissioning
thereof, in connection with a turnkey power project approved by the Central Government.
Income @ 10% of the amount paid or payable (whether in India or out of India) to the said
assessee (or to any person on his behalf) on account of such civil construction, erection,
testing or commissioning, shall be deemed to be the profits and gains of such business
chargeable to tax under the head “Profits and gains of business or profession”.
In such a case, provisions of sections 28 to 44AA are not applicable.
5. Head office expenditure in the case of non-resident [Sec. 44C]: Deduction in respect of head office expenditure is restricted to the least of the following:
a. an amount equal to 5% of the “adjusted total income”, or in the case of loss, 5% of
“average adjusted total income”; or
b. the actual amount of head office expenditure attributable to the business or profession
in India;
The term “adjusted total income” means the total income without giving effect to unabsorbed
depreciation, allowance under section 44C, capital expenditure in respect of promoting
family planning amongst its employees, business loss brought forward, speculation loss
brought forward, loss under the head “capital gains” or any deduction under sections 80C to
80U.
The term “average adjusted total income” means one-third of the aggregated amount of
adjusted total income in respect of three previous years preceding the relevant assessment
year. If the assessee has assessable income for less than three years out of the preceding three
years, the average will be based upon those lesser number of years only, i.e., in case of two
years, the aggregate of two years will be divided by two and in case of one year only the
actual amount of adjusted total income will be the average also.
The term “Head office expenditure” means executive and general administration expenditure
incurred by the assessee outside India, including expenditure incurred in respect of:
a. rent, rates, taxes, repairs or insurance of any premises outside India used for the
purposes of the business or profession;
b. salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or
profits in lieu of or in addition to salary, whether paid or allowed to any employee or
other person employed in, or managing the affairs of any office outside India;
c. travelling by any employee or other person employed in, or managing the affairs of
any office outside India; and
d. such other matters connected with executive and general administration as may be
prescribed.
156
6. Royalties and fees for technical services [Sec. 44D]: Provisions of section 44D are divided into two categories:
a. In case of a foreign company, the deduction that would be admissible in computing its
income by way of royalty or fees for technical services received from Government or
an Indian concern in pursuance of an agreement made by it with them before April 01,
1976 will be limited to 20 percent of the gross amount of such income, as reduced by
the amount, if any, of so much of the royalty income as consists of lump sum
consideration for the transfer outside India of, or the imparting of information outside
India in respect of, any data, documentation, drawing or specification relating to a
patent, invention, model, design, secret formula or process or trademark or similar
property.
The aforesaid ceiling is applicable in relation to all royalties and fees for technical services
received by foreign companies from Indian concerns, irrespective of whether such royalties
or fees for technical services are received under agreements which have been approved by the
Central Government or not.
b. In case, the agreement is made after March 31, 1976 but before April 01, 2003, no
deductions under sections 28 to 44C shall be allowed to foreign companies having
income by way of royalty or fees for technical services received from Government or
an Indian concern (applicable whether the agreement is approved by the Central
Government or not).
7. Royalties and fees for technical services in case the agreement is made after
March 31, 2003 [Sec. 44DA]:
The income by way of royalty or fees for technical services received from Government or an
Indian concern in pursuance of an agreement made after March 31, 2003 by a non-resident
non-corporate assessee or a foreign company with the aforesaid person shall be computed
under the head “Profit and gains of business or profession” if the following conditions are
satisfied:
1. The assessee carries on business in India through a permanent establishment (PE)
situated in India, or performs professional services from a fixed place of profession
situated in India.
2. The right, property or contract in respect of which the royalties or fees for technical
services are paid to the taxpayer is effectively connected with such permanent
establishment or fixed place of profession.
In computing the income for this purpose, the following expenses shall not be allowed:
a. Any expenditure or allowance which is not wholly and exclusively incurred for the
business of such permanent establishment or fixed place of profession in India.
b. Any amount paid (otherwise than towards reimbursement of actual expenses) by the
permanent establishment to its head office or to any of its other offices.
Deductions under sections 28 to 44D and 57 are allowed from such incomes.
DETERMINATION OF TAX IN CERTAIN SPECIAL CASES (CHAPTER XII):
Section 110 to 115BBE relates to computation of tax as special cases. For example, section
111A tax income from STCG @ 15%, section 112 tax income from LTCG @ 20%, section
115BB tax lottery income @ 30%, etc. But we will discuss only those special tax rates which
are applicable to non-residents.
157
Tax on dividends, royalty and fees for technical services [Sec. 115A]: This section is applicable for non-resident non-corporate assessee or a foreign company.
Incomes covered under section 115A are divided into two categories:
1. Following incomes are covered:
a. Dividend (not being dividend covered under section 115-O); and
b. Interest received from Government or an Indian concern on moneys borrowed or
debt incurred by Government or Indian concern in foreign currency; and
c. Income received in respect of units, purchased in foreign currency, of a Mutual
Fund specified under section 10(23D) or of UTI
2. Four different cases of royalties and fees for technical services received under an
agreement made on or after April 01, 1976 (not being covered by section 44DA):
a. Where such agreement is with the Government of India; or
b. Where such agreement is with an Indian concern, the agreement is approved by
the Central Government; or
c. Where such agreement relates to a matter included in the industrial policy, for the
time being in force, of the Government of India, the agreement is in accordance
with that policy; or
d. Where such royalty is in consideration for the transfer of all or any rights
(including the granting of a licence) in respect of copyright in any book to an
Indian concern or in respect of any computer software to a person resident in
India.
No deduction under sections 28 to 44C and section 57 is allowed from such incomes.
Tax rates on incomes covered under section 115A are given in table 2.
Table 1: Collective impact of sections 44D, 44DA and 115A:
Royalty or fees for technical services received by a
foreign company or a non-resident non-corporate
assessee from Government or an Indian concern
Deductions
under
sections 28 to
44C and 572
Deductions
under
sections 80C
to 80U
Tax rate
(%)3
Such royalty or technical fee is received under an
agreement made after March 31, 1976 but before
April 01, 2003:
a. Where such agreement is with Government
b. Where such agreement is with an Indian
company, the agreement is approved by the
Central Government
c. Where such agreement relates to a matter
included in the industrial policy, for the time
being in force, of the Government of India, the
agreement is in accordance with that policy
d. Where such royalty is in consideration for the
transfer of all or any rights (including the
granting of a licence) in respect of copyright in
any book to an Indian concern or in respect of
No deduction
No deduction
No deduction
No deduction
Deduction
available
Deduction
available
Deduction
available
Deduction
available
10
10
10
10
2 Section 57 relates to deductions under the head “Income from other sources”. 3 Plus surcharge (if applicable) plus education cess plus secondary and higher education cess.
158
computer software to a person resident in India
e. In any other case
Foreign
company
cannot claim
any deduction,
non-resident
non-corporate
assessee can
claim
deduction
Deduction
available
Applicable
rate
Such royalty or technical fee is received under an
agreement made after March 31, 2003:
a. Where royalty or technical fee is effectively
connected to Permanent Establishment (PE) in
India
b. Where PE is absent but the case is covered by
section 115A(1) [i.e., a to d (supra)]
c. In any other case (means except a and b)
Deduction
available
No deduction
Deduction
available
Deduction
available
Deduction
available
Deduction
available
Applicable
rate
10
Applicable
rate
Table 2: Summary of provisions of sections having special rates of tax:
Sections Nature of income Deductions
under
sections 28
to 44C and
574
Deductions
under
sections 80C
to 80U
Tax rate
(%)5
115A
Following incomes in the case of a non-
resident non-corporate assessee or a foreign
company:
1. Dividend (not being dividend
covered under section 115-O)
2. Interest received from Government
or an Indian concern on moneys
borrowed or debt incurred by
Government or Indian concern in
foreign currency
3. Income received in respect of units,
purchased in foreign currency, of a
Mutual Fund specified under section
10(23D) or of UTI
Not available
Not available
Not available
Not available
Not available
Not available
20
20
20
Royalty or technical fees of a non-resident
non-corporate assessee or a foreign company
See the provisions given in table 1
115AC
Following incomes of a non-resident:
a. Income by way of interest or
dividends (not being covered by
section 115O), on notified bonds/
Global Depository Receipts (GDRs)
of an Indian Company or public
sector company, sold by the
Government and purchased by him
Not available
Not available
10
4 Section 57 relates to deductions under the head “Income from other sources”. 5 Plus surcharge (if applicable) plus education cess plus secondary and higher education cess.
159
Sections Nature of income Deductions
under
sections 28
to 44C and
574
Deductions
under
sections 80C
to 80U
Tax rate
(%)5
in foreign currency; or
b. Income by way of LTCG arising
from the transfer of aforesaid bonds
or GDRs
[in this case (b), first and second proviso to
section 486 are not applicable]
----
Not available
10
115BBA
Following income of a non-resident
sportsman (including an athlete) who is a
foreign citizen:
1. Participation in India in any game
(other than the game of winnings
wherefrom the income is taxable
under section 115BB) or sport; or
2. Advertisement; or
3. Contribution of articles relating to
any game or sport in India in
newspapers, magazines or journals
Not available
Not available
Not available
Not available
Not available
Not available
20
20
20
Any amount guaranteed to be paid or
payable to a non-resident sports association
or institution in relation to any game (not
being a game referred to in section 115BB)
or sports played in India
Not available Not available 20
Income of a non-resident foreign citizen
entertainer
Not available Not available 20
115D7
Following incomes of a non-resident Indian:
1. Investment income from foreign
exchange assets
2. LTCG on transfer of foreign
exchange assets
[in this point (2), first proviso to section 48 is
applicable but second proviso is not
applicable]
No deduction
under any
provision
----
Not available
Not available
20
10
SPECIAL PROVISIONS [Sec. 115C to 115I] [Chapter XIIA] The provisions under section 115C to 115I are applicable only in respect of the following
incomes derived by a non-resident Indian:
a. Investment income derived from “foreign exchange assets”; and
b. Long-term capital gains on sale or transfer of “foreign exchange assets”.
Foreign exchange assets:
6 First proviso to section 48 relates to computing capital gains by converting selling price (in Indian currency)
into foreign currency which the assessee had brought to invest in bonds etc. Second proviso to section 48 states
that benefit of indexation is not available.
7 Covered under chapter XIIA in detail.
160
It means any “specified asset” acquired, purchased or subscribed to, by the non-resident
Indian in foreign currency in accordance with the Foreign Exchange Regulation Act, 1973/
Foreign Exchange Management Act, 1999.
Specified assets:
Following are the “specified assets” for this purpose:
a. Shares in an Indian company;
b. Debentures of an Indian public limited company;
c. Deposits with an Indian public limited company;
d. Securities of the Central Government; and
e. Any other asset which the Central Government may by notification in the Official
Gazette specify in this behalf.
Computation of investment income:
In computing the investment income for the above purpose, no deduction shall be allowed in
respect of any expenditure or allowance under any provision of the Act. Further, no deduction
under sections 80C to 80U shall be allowed in respect of investment income for the above
purpose.
Computation of long-term capital gain:
Long-term capital gain on sale or transfer of foreign exchange assets shall be calculated
subject to the following points:
1. The benefit of indexation is not available in respect of sale or transfer of foreign
exchange assets.
2. No deduction is permissible in respect of long-term capital gain under sections 80C to
80U.
3. By investing sale consideration in another asset, the non-resident Indian can claim
exemption under section 115F.
Computation of tax:
Investment income is taxable @ 20% and LTCG is taxable @ 10%.
Section 115F:
If the following conditions are satisfied, one can take the benefit of section 115F:
1. The taxpayer is a non-resident Indian at the time of sale of capital asset.
2. He has transferred a capital asset [i.e., shares in an Indian company, debentures of an
Indian public limited company, deposits with an Indian public limited company, or
securities of the Central Government (hereinafter referred to as “original asset”)]
which has been acquired or purchased with, or subscribed to in, convertible foreign
exchange.
3. Such asset is a long-term capital asset.
4. Within 6 months of the transfer of original asset, the taxpayer has invested the whole
or any part of net sale consideration (i.e. sale minus expenses on sale) in any of the
following assets (hereinafter referred to as “new asset”):
a. Shares in an Indian company;
b. Debentures of an Indian public limited company;
c. Deposits with an Indian public limited company; or
d. Securities of the Central Government;
161
5. If the above given conditions are satisfied, exemption under section 115F is equal to 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛𝑠
𝑁𝑒𝑡 𝑠𝑎𝑙𝑒 𝑐𝑜𝑛𝑠𝑖𝑑𝑒𝑟𝑎𝑡𝑖𝑜𝑛* Amount invested in new asset
In case the new asset, is transferred or converted (otherwise than by transfer) into money
within 3 years from the date of its acquisition, the capital gains arising from the transfer of
original asset exempted from tax on the basis of acquisition of new asset will be deemed to be
income by way of long-term capital gains of the previous year in which such new asset is so
transferred or converted into money.
Return of income not to be filed in certain cases [Sec. 115G]:
In cases where a non-resident Indian has income only from a foreign exchange asset or
income by way of long-term capital gains arising on transfer of a foreign exchange asset, or
both, and tax deductible at source from such income has been deducted, he is not required to
file the return of income under section 139(1).
The income from foreign exchange assets and long-term capital gains arising on transfer of
such assets would be treated as a separate block and charged to tax at a flat rate as explained
above. If the non-resident Indian has other income in India, such other income is treated as an
altogether separate block and charged to tax in accordance with other provisions of the Act.
Applicability of this benefit in certain cases even after assessee becomes resident [Sec.
115H]:
Where a person, who is a non-resident Indian in any previous year, becomes assessable as
resident in India in any subsequent year, he may furnish to the Assessing Officer a
declaration in writing (along with his return of income under section 139 for the assessment
year for which he is so assessable) to the effect that the special provisions shall continue to
apply to him in relation to the investment income derived from any foreign exchange asset
being debentures and deposit with an Indian public limited company and Central Government
securities. If he does so, the special provisions shall continue to apply to him in relation to
such income for that assessment year until the transfer or conversion (otherwise than by
transfer) into money of such assets.
Non-applicability of this special provision [Sec. 115I]:
A non-resident Indian may opt that the special provisions relating to taxation of the
investment income and long term capital gains at flat rate should not apply to him. This
option will be exercisable by the assessee making a declaration to that effect in his return of
income for the relevant assessment year. In cases where such an option is exercised by a non-
resident Indian, the whole of his total income (including income from foreign exchange assets
and long-term capital gains arising on transfer of a foreign exchange asset) is charged to tax
under the general provisions of the Act.
FIRST PROVISION TO SECTION 48
To avail the benefit of this provision, the following conditions should be satisfied:
1. The taxpayer is a non-resident (may be an Indian or foreign citizen, or a corporate-
assessee or a non-corporate assessee but not being an assessee covered by sections
115AC and 115AD) at the time of sale of capital asset.
162
2. He acquires shares8 in (or debentures of) an Indian company (may be public limited or
private limited) by utilizing foreign currency.
3. The asset may be short-term or long-term.
Rule of computation under this section:
If the aforesaid conditions are satisfied, then the following procedure shall be adopted to
determine capital gain (it may be noted that the procedure given below is applicable without
any exception whenever the above conditions are satisfied):
1. Capital gain shall be computed in the same foreign currency which was initially
utilized in acquiring shares or debentures.
2. Capital gain so calculated in the foreign currency shall be reconverted into Indian
currency.
3. The benefit of indexation shall not be available but the option of taking fair market
value on April 01, 1981 is available.
4. The aforesaid manner of computation of capital gain shall be applicable in respect of
capital gain accruing or arising from every re-investment thereafter in (and sale of)
shares in (or debentures of) an Indian company.
5. Average exchange rate:
It is the average of the telegraphic transfer buying rate and telegraphic transfer selling
rate of the foreign currency initially utilized in the purchase of the said asset.For this
purpose, telegraphic transfer buying/ selling rate in relation to a foreign currency is
rate of exchange adopted by the SBI for purchasing or selling such currency where
such currency is made available by that bank through telegraphic transfer.
6. Buying rate:
It is the telegraphic transfer buying rate of such currency.
7. The aforesaid provision is applicable even in the case of short-term capital gain.
Steps to be followed to compute capital gain under this section:
Following steps are to be applied whether the gain is short-term or long-term:
Step 1: Find out sale consideration in Indian currency and convert it into foreign currency at
“average exchange rate” on the date of transfer.
Step 2: Find out the expenditure on transfer in Indian currency and convert it into foreign
currency at “average exchange rate” on the date of transfer (and not on the date on
which expenditure is incurred).
Step 3: Find out the cost of acquisition in Indian currency and convert it into foreign currency
at “average exchange rate” on the date of acquisition.
Step 4: Capital gain (1 – 2 – 3) will be reconverted in to Indian currency at “buying rate” on
the date of transfer.
8 In some cases, capital gain on transfer of equity shares is not chargeable to tax under section 10(38).
163
TRANSACTIONS NOT TREATED AS TRANSFER [Sec. 47] The following transfers by a foreign company/ non-resident are not regarded as transfer,
hence, the capital gains arising out of the transaction is not liable to tax:
1. Any transfer of shares held in an Indian company, by the amalgamating foreign
company to amalgamated foreign company, in a scheme of amalgamation, if:
a. At least 25% of the shareholders of the amalgamating foreign company continue
to remain shareholders of the amalgamated foreign company; and
b. Such transfer does not attract tax on capital gains in the country in which the
amalgamating company is incorporated.
2. Any transfer of shares held in an Indian company by the demerged foreign company
to resulting foreign company, in a scheme of demerger, if:
a. Shareholders holding not less than 75% in value of shares of the demerged foreign
company continue to remain shareholders of the resulting foreign company; and
b. Such transfer does not attract tax on capital gains in the country in which the
demerged foreign company is incorporated.
3. Any transfer of bonds or Global Depository Receipts purchased in foreign currency
held by a non-resident to another non-resident, where the transfer is made outside
India.
TRANSFER OF SHARES OR UNITS IN A RECOGNIZED STOCK EXCHANGE IN
INDIA [Sec. 111A or 10(38)]
Whenever, equity shares or units of equity oriented mutual fund are transferred in a
recognized stock exchange in India on or after October 1, 2004, the transaction is chargeable
to securities transaction tax*.
In such cases, long-term capital gain is exempt from tax under section 10(38). However, if
the capital asset is short-term capital asset, then short-term capital gain is taxable under
section 111A @ 15%9. Such short-term capital gain is calculated without considering
securities transaction tax paid by the assessee.
Deductions under sections 80C to 80U is not allowed from LTCG or STCG (covered under
section 111A).
Normal LTCG is taxable at a flat rate of 20% + Surcharge (if any) + EC and SHEC @ 3%.
TAX INCIDENCE ON TRANSFER OF LISTED SECURITIES (and units of mutual
fund whether listed or not):
Listed securities include shares, bonds, debentures and Government Securities.
In this case, tax on LTCG can be computed under two options and the taxpayer has an option
to pay tax under option I or option II, whichever is lower.
Option I:
Compute LTCG after applying indexation and compute tax @ 20% + surcharge (if any) + EC
and SHEC (3%)
Option II:
9 Plus surcharge (if applicable) plus education cess plus secondary and higher education cess.
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Compute LTCG without applying indexation and compute tax @ 10% + surcharge (if any) +
EC and SHEC (3%)
Example 1:
Mr. X, a non-resident Indian, furnishes the following information to you for the previous year
2015-16: Rs.
a. Income from property (Net) 1,12,000
b. Income from consultancy derived during his visits to India 80,000
c. Income from other sources 1,10,000
d. Capital gains on sale of shares in an Indian Company:
Cost in 1989-90 Rs. 1,90,000
Sale price in 2015-16 Rs. 4,80,000 2,90,000
CII for 1989-90 is 172 and 2015-16 is 1081.
Your advice is sought on his tax liability in India for the assessment year 2016-17 assuming
that the shares of the Indian Company were purchased in convertible foreign exchange. Can
the tax on capital gains be saved?
Solution:
Tax payable under sections 115C to 115I:
Amount (Rs.)
Income from property 1,12,000
Income from consultancy 80,000
Income from other sources 1,10,000
3,02,000
Long term capital gains on sale of shares 2,90,000
Net Taxable Income 5,92,000
Tax on Rs. 2,90,000 @ 10% 29,000
Tax on remaining income of Rs. 3,02,000
[10% of (3,02,000 – 2,50,000)] 5,200
34,200
Add: Surcharge Nil
34,200
Add: Cess @3% 1,026
Tax payable (Rounded off) 35,230
Tax payable under other provisions of the Act:
Amount (Rs.)
Income excluding LTCG 3,02,000
Long term capital gains:
Sale consideration 4,80,000
Less: Indexed cost of acquisition
(1,90,000/172*1081) 11,94,128 (7,14,128)*
Tax on Rs. 3,02,000 (i.e., income excluding LTCG) 5,200
Add: Surcharge Nil
5,200
Add: Cess @ 3% 156
Tax payable (Rounded off) 5,360
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Conclusion: Mr. X should pay tax under other provisions of the Act.
The capital gains arising on the sale of foreign exchange asset can be saved by investment in
specified assets. If the cost of asset is not less than the net consideration in respect of the
original asset, the whole of the capital gains will not be charged to tax. Otherwise, the capital
gains will be exempt proportionately as given below:
Capital gain/ Net sale consideration* Cost of investment
Example 2:
The total income of a non-resident Indian includes: Rs.
a. Investment income (net after TDS) 40,000
b. Long-term capital gains 25,000
c. Other income 2,85,000
Total income 3,50,000
What will be the tax payable by him in respect of assessment year 2016-17 on the above
income under Chapter XIIA (Sections 115C to 115I) of the Income-tax Act? In what manner
can the tax liability be reduced in this case?
Solution:
It has been assumed that the investment income and long-term capital gains are from foreign
exchange assets.
The tax liability of a non-resident Indian shall be computed under chapter XIIA:
Amount (Rs.)
Investment income (40,000/80*100) = 50,000*20% 10,000
LTCG (25,000*10%) 2,500
Remaining Other income (2,85,000 – 2,50,000)*10% 3,500
16,000
Add: Surcharge Nil
16,000
Add: Cess @ 3% 480
16,480
Less: TDS 10,000
Net tax payable by the assessee 6,480
As far as reduction of tax liability is concerned, the tax liability on LTCG can be saved if the
assessee invests the net consideration on sale of original specified assets in specified assets
within 6 months from the date of transfer of original asset.
Example 3:
Mahesh, a non-resident Indian, has the following income from investments in foreign
exchange assets and other income: Rs.
a. Interest on Central Government Securities 50,000
b. Interest on debentures of public limited company 1,00,000
He spent on collection of above incomes 3,000
c. Long-term capital gains on transfer of debentures mentioned
in point (b) above [computed under section 48 (proviso)] 2,00,000
d. Other income 2,90,000
Determine his tax liability for the assessment year 2016-17 under sections 115C to 115H of
the Income-tax Act. How can ‘X’ reduce his tax liability?
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Solution:
Tax payable under sections 115C to 115H:
Income from foreign exchange assets:
Amount (Rs.)
Interest on Central Government Securities 50,000
Interest on debentures of public limited companies 1,00,000
LTCG on transfer of debentures mentioned above 2,00,000
3,50,000
Add: Income from other sources 2,90,000
6,40,000
Tax on interest income (1,50,000*20%) [115D] 30,000
Tax on LTCG (2,00,000*10%) [115D] 20,000
Tax on Rs. 2,90,000 [10% of (2,90,000 – 2,50,000)] 4,000
54,000
Add: Surcharge Nil
54,000
Add: Cess @ 3% 1,620
Tax payable 55,620
Tax payable under other provisions of the Act:
Amount (Rs.)
Interest on debt in foreign currency:
a. Interest on Central Government Securities 50,000
b. Interest on debentures 1,00,000
LTCG 2,00,000
Income from other sources 2,90,000
6,40,000
Tax on debt in foreign currency (1,50,000*20%) [Sec. 115A] 30,000
Tax on LTCG (2,00,000*20%) [Sec. 112] 40,000
Tax on Rs. 2,90,000 (2,90,000 – 2,50,000)*10% 4,000
74,000
Add: Surcharge Nil
74,000
Add: Cess @ 3% 2,220
Tax payable 76,220
Conclusion: Mahesh should pay tax under the provisions of section 115C to 115H.
Example 4:
‘X’, a member of the New Zealand Cricket team, received a sum of Rs. 5 lakh for
participation in matches in India. He also received a sum of Rs. 1 lakh in India for endorsing
a product on T.V. He contributed articles in an Indian newspaper for which he received Rs.
10,000. During the tour of India, he won a prize of Rs. 10,000 in horse race. What will be his
tax liability for the assessment year 2016-17?
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Solution:
Under section 115BBA, ‘X’ has to pay tax @20% on the following incomes:
Amount (Rs.)
Income from participation in matches 5,00,000
Articles in newspapers 10,000
Advertisement on TV 1,00,000
6,10,000
Tax on Rs. 6,10,000 @ 20% 1,22,000
Tax on Rs. 10,000 @ 30%
(Income from horse races is Rs. 10,000) 3,000
Total tax (1,22,000 + 3,000) 1,25,000
Add: Surcharge Nil
1,25,000
Add: Cess @ 3% 3,750
1,28,750
Example 5:
A non-resident company is engaged in the business of operation of ships. From the following
information compute its business income assessable in India under section 44B and tax
liability for the assessment year 2016-17:
Amount (Rs.)
1. Goods shipped in Bangladesh:
a. Freight paid in Bangladesh 1,00,000
b. Freight paid in India by the consignees 40,000
2. Goods shipped in India:
a. Freight paid in India 70,000
b. Freight paid in Pakistan by the consignees 40,000
c. One party delayed the goods, hence, the company
charged demurrage 20,000
Solution:
Computation of business income in India of non-resident shipping company for the
assessment year 2016-17:
Particulars Amount (Rs.)
Income received in India:
Freight paid in India by consignees of goods shipped in Bangladesh 40,000
Freight paid in India regarding goods shipped in India 70,000
Demurrage charges 20,000
Income accrues in India:
Freight paid in Pakistan by the consignees of goods shipped in India 40,000
Total receipts 1,70,000
Therefore, assessable income under section 44B = 7.5% of Rs. 1,70,000 = Rs. 12,750
Tax liability is Rs. 5,250 after rounding off [Rs. 12,750*41.20%]
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(b) Advance Rulings
In order to avoid needless litigation and promote better relations with a non-resident, a
system of ‘advance rulings’ [Chapter XIX-B] has been incorporated under the Income Tax
Law by the Finance Act, 1993.
Meaning of advance ruling [Sec. 245N(a)] Advance ruling means:
1. A determination, by the Authority in relation to a transaction which has been
undertaken or proposed to be undertaken by a non-resident applicant and such
determination shall include the determination of any question of law or of fact
specified in the application; or
2. A determination by the Authority in relation to the tax liability of a non- resident
arising out of a transaction which has been undertaken or is proposed to be undertaken
by a resident applicant with such non-resident and such determination shall include
the determination of any question of law or of fact specified in the application; or
3. A determination by the Authority in relation to the tax liability of a resident applicant,
arising out of a transaction which has been undertaken or is proposed to be undertaken
by such applicant and such determination shall include the determination of any
question of law or of fact specified in the application; or
4. A determination or decision by the Authority in respect of an issue relating to
computation of total income which is pending before I.T. Authority or the Tribunal
and such determination or decision shall include the determination or decision of any
question of law or of fact relating to such computation of total income specified in the
application; or
5. A determination or decision by the Authority whether an arrangement, which is
proposed to be undertaken by any person being a resident or a non-resident, is an
impermissible avoidance arrangement as referred to in Chapter X-A or not.
Meaning of applicant [Sec. 245N(b)] Applicant means any person, who:
1. is a non-resident mentioned in point (1); or
2. a resident mentioned in point (2); or
3. is a resident mentioned in point (3) falling within any such class or category of
persons as the Central Government may, by notification, specify;
For this purpose, a resident, in relation to his tax liability arising out of one or more
transactions valuing Rs. 100 crore or more in total which has been undertaken or
proposed to be undertaken, has been notified by the Central Government.
4. is a resident falling within any such class or category of persons as the Central
Government may, by notification, specify in this behalf;
For this purpose, a public sector company has been notified by the Central
Government.
5. is referred in point (5) above; or
6. in makes an application under section 245Q(1).
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Authority for Advance Rulings [Sec. 245-O]
1. The Authority shall consist of a Chairman and such number of Vice-chairmen,
revenue Members and law Members as the Central Government may, by notification,
appoint.
2. A person shall be qualified for appointment as—
a. Chairman, who has been a Judge of the Supreme Court;
b. Vice-chairman, who has been Judge of a High Court;
c. a revenue Member from the Indian Revenue Service, who is a Principal Chief
Commissioner or Principal Director General or Chief Commissioner or
Director General;
d. a law Member from the Indian Legal Service, who is, or is qualified to be, an
Additional Secretary to the Government of India.
3. The Central Government shall provide to the Authority with such officers and
employees, as may be necessary, for the efficient discharge of the functions of the
Authority under this Act.
4. The powers and functions of the Authority may be discharged by its Benches as may
be constituted by the Chairman from amongst the Members thereof.
5. A Bench shall consist of the Chairman or the Vice-chairman and one revenue
Member and one law Member.
6. The Authority shall be located in the National Capital Territory of Delhi and its
Benches shall be located at such places as the Central Government may, by
notification specify.
Vacancies, etc., not to invalidate proceedings [Sec. 245P]
No proceeding before, or pronouncement of advance ruling by, the Authority shall be
questioned or shall be invalid on the ground merely of the existence of any vacancy or defect
in the constitution of the Authority.
Application for advance ruling [Sec. 245Q]
1. An applicant desirous of obtaining an advance ruling may make an application in
prescribed forms and in prescribed manner, stating the question on which the advance
ruling is sought.
2. The application shall be made in quadruplicate (four copies) and be accompanied by a
fee of Rs. 10,000 or prescribed fee in this behalf, whichever is higher.
3. An applicant may withdraw an application within 30 days from the date of the
application.
The prescribed forms are:
a. Form 34C in respect of a non-resident applicant referred in point (1) section 245N(a);
b. Form 34D in respect of a resident applicant referred in point (2) of section 245N(a);
c. Form 34DA in respect of a resident applicant referred in point (3) of section 245N(a);
d. Form 34E in respect of a resident referred in point (4) of section 245N(a); and
e. Form 34EA, in respect of an applicant referred in point (5) of section 245N of the Act.
Procedure on receipt of application [Sec. 245R]
1. On receipt of an application, the Authority shall cause a copy thereof to be forwarded
to the Principal Commissioner (or Commissioner) and, if necessary, call upon him to
furnish the relevant records.
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2. The Authority may, after examining the application and the records called for, by
order, either allow or reject the application. However, no application shall be rejected
unless an opportunity has been given to the applicant of being heard. Further, where
the application is rejected, reasons for such rejection shall be given in the order.
3. However, the Authority shall not allow the application where the question raised in
the application –
a. is already pending before any income-tax authority or Appellate Tribunal [except
in the case of a resident applicant mentioned in point (4) of section 245N(b)] or
any court;
b. involves determination of fair market value of any property;
4. relates to a transaction or issue which is designed prima facie for the avoidance of
income-tax [except in the case of a resident applicant mentioned in point (4) of
section 245N(b) or in the case of an applicant mentioned in point (5) of section
245N(b)].
Where an application is allowed, the Authority shall, after examining such further
material as may be placed before it by the applicant or obtained by the Authority,
pronounce its advance ruling on the question specified in the application.
5. On a request received from the applicant, the Authority shall, before pronouncing its
advance ruling, provide an opportunity to the applicant of being heard, either in
person or through a duly authorised representative.
6. A copy of every order shall be sent to the applicant and to the Principal Commissioner
(or Commissioner).
7. The Authority shall pronounce its advance ruling in writing within six months of the
receipt of application.
8. A copy of the advance ruling pronounced by the Authority, duly signed by the
Members and certified in the prescribed manner shall be sent to the applicant and to
the Principal Commissioner (or Commissioner), as soon as may be, after such
pronouncement.
9. No income-tax authority or the Appellate Tribunal shall proceed to decide any issue
in respect to which an application has been made by a resident applicant.
Applicability of advance ruling [Sec. 245S]
The advance ruling pronounced by the Authority under section 245R shall be binding only on
the applicant who had sought it and that too, in respect of the transaction in relation to which
the ruling had been sought. It is also binding on the Principal Commissioner (or
Commissioner), and the income-tax authorities subordinate to him, in respect of the applicant
and the said transaction.
The advance ruling shall be binding as aforesaid unless there is a change in law or facts on
the basis of which the advance ruling has been pronounced.
Advance Ruling to be void in certain circumstances [Sec. 245T]:
Where an authority finds (on a representation made to it by the Commissioner or otherwise)
that an advance ruling pronounced by it has been obtained by the applicant by fraud or
misrepresentation of facts, it may (by order) declare such ruling to be void ab-initio and
thereupon all the provisions of the Act shall apply (after excluding the period beginning with
the date of such advance ruling and ending with the date of order declaring such ruling as
void), to the applicant as if such advance ruling had never been made. However, on receipt of
such representation, a notice shall be issued to the applicant along with a copy of the
representation for rebuttal and reasonable opportunity shall be allowed to the applicant and
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the Commissioner for being heard before passing order declaring the advance ruling to be
void.
Powers of Authority [Sec. 245U]:
The Authority will have all the powers of a Civil Court in respect of discovery and
inspection, enforcing the attendance of any person including any officer of a banking
company and examining him on oath, issuing commissions and compelling the production of
books of account and other records. It will also have the power to regulate its own procedure
in all matters arising out of the exercise of its powers under the Act. The Authority would be
deemed to be a Civil Court for the purposes of section 195 of the Code of Criminal
Procedure, 1973, and every proceeding before the Authority shall be deemed to be a judicial
proceeding under certain provisions of the Indian Penal Code.
Questions
1. Explain briefly the amount of deduction allowed on account of head office
expenditure in the case of non-residents.
2. How the following incomes of a non-resident are determined:
a. profits of shipping business;
b. business of operation of aircraft;
c. business of civil construction in certain turnkey power project.
3. Mr. X is an individual of Indian origin through his residential status is non-resident.
During the previous year 2015-16, his income from investments in Foreign Exchange
Assets in India is as follows:
Amount (Rs.)
Interest on deposits with Public Limited Company 40,000
Interest on Central Government Securities 50,000
Dividend from an Indian Company 30,000
Determine the tax liability for the assessment year 2016-17 under sections 115C to
115H. [Ans. Rs. 18,540]
4. ‘A’, a member of the West Indian Cricket team, received a sum of Rs. 10 lakh for
participation in matches in India. He also received a sum of Rs. 2 lakh in India for
endorsing a product on T.V. He contributed articles in an Indian newspaper for which
he received Rs. 20,000. During the tour of India, he won a prize of Rs. 10,000 in
horse race. What will be his tax liability for the assessment year 2016-17?
[Ans. Rs. 2,54,410]
Questions:
1. Discuss the scheme of advance ruling briefly.
2. What is ‘Advance Ruling’? When does a ruling become void?
3. State the circumstances under which application for advance ruling shall not be
allowed by the Authority for Advance Ruling.
4. Mr. ‘A’ is a non-resident. The appeal pertaining to the assessment year 2015-16 is
pending before the Appellate Tribunal, the issue involved being computation of
income from house property. The same issue persists for the assessment year 2016-17
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also. A’s friend has obtained an advance ruling under chapter XIX B from the
Authority for Advance Ruling on an identical point. Mr. ‘A’ proposes to use the said
ruling for his assessment pertaining to the assessment year 2016-17. Advise ‘A’
suitably.
[Ans. Keeping in view the provisions of section 245S, A cannot use the ruling
obtained by his friend for his assessment.]
5. What is advance ruling as per section 245N(a). Who can be the applicant for advance
ruling under section 245N(b). Under what circumstances the authority shall reject the
application for advance ruling.
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LESSON -11
Tax Planning with Reference to Business Restructuring
11. STRUCTURE
11.1 Meaning of Amalgamation
11.2 Exceptions
11.3 Tax Incentives for Amalgamation
11.4 Accumulated Non-Speculative Business Losses and Unabsorbed Depreciation
11.5 Tax Liability of Amalgamated Company
11.6 Amalgamation of Banking Company
11.7 Tax Planning
11.8 Meaning of Demerger [Section 2(19AA)]
11.9 Important Points for Consideration for Demerger
11.10 Meaning of demerged Company [Section 2(19AAA)]
11.11 Meaning of Resulting Company [Section 2(41A)]
11.12 Tax Concession/Incentives in Case of Demerger
11.13 Tax Concession to the Resulting Company
11.14 Other Important Points
11.15 Distinction Between Amalgamation and Demerger
11.16 Slump Sale
11.17 Coversion of Sole Proprietary Concern/Partnership Firm into Company
11.18 Coversion of a Private Company or an Unlisted Public Company into a Limited
Liability Parternship (LLP)
11.19 Transfer of Assets between Holding and Subsidiary Companies
11.1 MEANING OF AMALGAMATION
Amalgamation is a merger of two or more existing undertakings into one undertaking. The
shareholders of each company become substantially the shareholders in the company which is
to carry on the business of merged undertakings. There may be 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 either merger of
one or more companies with another company or the merger of two or more companies to
form one new company. The definition of amalgamation under section 2(1B) covers the
following cases.
Merger of A Ltd. with B Ltd. A Ltd. goes out of existence.
Merger of A Ltd. and B Ltd. with C Ltd. A Ltd. and B Ltd. go out of existence.
Merger of A Ltd. and B Ltd. into a newly incorporated company C Ltd. A Ltd. and B
Ltd. go out of existence.
Merger of A Ltd., B Ltd. and C Ltd., into a newly incorporated company D Ltd. In the
case, A Ltd., B Ltd. and C Ltd. are amalgamating companies, while D Ltd. is an
amalgamated company.
For a merger to qualify as an "amalgamation" for the purpose of the Income-tax Act, it has to
satisfy the following three conditions—
174
1. All the properties of the amalgamating company immediately before the
amalgamation should become the property of the amalgamated company by virtue of
the amalgamation
2. All liabilities of the amalgamating company immediately before the amalgamation
should become the liabilities of the amalgamated company by virtue of the amalgam-
ation
3. Shareholders holding not less than three-fourths shares in the amalgamating company
should become shareholders of the amalgamated company by virtue of 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 Ltd., the
above-mentioned condition 3 will be satisfied if shareholders holding not less than 3/4 (in
value) of the remaining 80 per cent of the shares in A Ltd., ie., 60 per cent thereof (3/4 C 80),
become shareholders of B Ltd., by virtue of the amalgamation. Where, however, the whole
share capital is held by another company, the merger of two companies will as an
amalgamation within section 2(1B), if the other two conditions are fulfilled.
For the purpose of condition (3), "shareholders" may be equity shareholders or preference
shareholders. Consequently, persons holding at least 75 per cent of the equity and preference
shares (in value) in the amalgamating company should become shareholders (by holding
equity or preference shares or both) in the amalgamated company.
11.2 EXCEPTIONS
Section 2(1B) specifically provides that in the following two cases there is no "amalgam-
ation" for the purpose of the Income-tax Act, though the element of merger exists:
(i) where the property of the company which merges is sold to the other company and the
merger is actually a result of sale
(ii) where the company which merges is wound up in liquidation and the liquidator
distributes its proceeds to the other company.
11.3 TAX INCENTIVES FOR AMALGAMATION
Some tax incentives have been provided for amalgamation of a company under income tax
Act to the:
1. amalgamating company;
2. shareholders of the amalgamating company; and
3. amalgamated company.
1. Tax incentives to Amalgamating Company (a) Exemption from Capital gains tax. There shall be no liability for capital gains tax on the
transfer of capital assets by the amalgamating company if the amalgamated company is
an Indian company. [Sec. 47(vi)]
(b) Tax Concession to foreign Company: There shall be no liability for capital gains tax on
the transfer of shares of an Indian company by a foreign company to another foreign
company in a scheme of amalgamation between the two foreign companies, if
(i) at least 25% of the shareholders of the amalgamating foreign company continue to
remain shareholders of the amalgamated foreign company;
(ii) such transfer does not attract tax on capital gains in the country in which the
amalgamating company is incorporated. [Sec. 47(via)]
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(c) Exemption from tax liability on transfer of licence to operate telecommunication
services etc: There shall be no tax liability on transfer of a licence to operate
telecommunication services (u/s 35ABB) or on transfer of a business of prospecting for or
extraction or production of petroleum and natural gas (u/s 42) by the amalgamating
company if the amalgamated company is an Indian company.
2. Tax incentives to Shareholders of Amalgamating Company (a) Period of holding of shares of the amalgamated company: Where shares in an Indian
Company, which become the property of the assessee in consideration of shares transferred in
case of amalgamation, it shall be included the period for which the shares in the
amalgamating company were held by the assessee. [Sec. 2(42A)(C)]
(b) Exemption from tax on exchange of shares. The shareholders of the amalgamating
company are not liable to capital gains tax, when they are allotted shares by the Indian
amalgamated company in lieu of shares held by them in the amalgamating company.
[Sec. 47(vii)]
3. Tax incentives to Amalgamated Company (a) Capital expenditure on scientific research: Where a company is amalgamated before
claiming full deduction in respect of capital expenditure on scientific research, the
amalgamated company (being an Indian company) is entitled to claim deduction of such
unabsorbed amount. [Sec. 35(5)]
(b) Expenditure incurred to obtain licence to operate telecommunication services. Where a company is amalgamated before claiming full deduction in respect of expenditure to
obtain licence to operate telecommunication services, the amalgamated company (being an
Indian company) is entitled to claim deduction in respect of remaining instalments of such
expenditure. [Sec. 35ABB]
(c) Preliminary expenses. Where an Indian company is amalgamated before claiming full
deduction in respect of certain preliminary expenses, the amalgamated company (being an
Indian company) is entitled to claim deduction in respect of remaining instalments of such
expenses. [Sec. 35D(5)]
(d) Expenses on amalgamation. Where an Indian company incurs expenditure wholly and
exclusively for the purposes of amalgamation, it shall be allowed a deduction @ 20% of such
expenditure for each of five successive previous years beginning with the previous year in
which amalgamation tookes place. (Sec. 35DD)
(e) Expenses incurred under voluntary retirement scheme. Where an Indian company is
amalgamated before claiming full deduction in respect of expenses incurred under voluntary
retirement scheme the amalgamated company (being an Indian company) is entitled to claim
deduction in respect of remaining instalments of such expenses.
[Sec. 35DDA(2)]
(f) Expenses on prospecting etc. of certain minerals. Where an Indian company is
amalgamated before claiming full deduction in respect of expenditure incurred on
prospecting for, or extraction or production of certain minerals, the amalgamated company
(being an Indian company) is entitled to claim deduction in respect of remaining instalments
and unabsorbed amount of such instalments. [Sec. 35E(7)]
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(g) Capital expenditure on family planning. Where a company is amalgamated before
claiming full deduction in respect of capital expenditure incurred for the purpose of
promoting family planning amongst its employees, the amalgamated company (being an
Indian company) is entitled to claim deduction in respect of remaining instalments and
unabsorbed amount of such instalments. [Sec. 36(l)(ix)]
(h) Expenses on prospecting etc. of petroleum and natural gas. Where a company is
amalgamated before claiming full deduction in respect of expenditure incurred on
prospecting for or extraction or production of petroleum and natural gas, the amalgamated
company (being an Indian company) is entitled to claim deduction in respect of such
expenditure. (Sec. 42)
(i) Bad debts. Where a part of debts taken over by the amalgamated company from the
amalgamating company becomes bad subsequently, such bad debts are allowed as a
deduction in computing the income of the amalgamated company.
(j) Actual cost of an asset. Where, in a scheme of amalgamation, any capital asset is
transferred by the amalgamating company to amalgamated company and the amalgamated
company is an Indian company the actual cost of the transferred capital asset to the
amalgamated company shall be taken to be the same as it would have been if the
amalgamating company had continued to hold the capital asset for the purpose of its own
business. [Sec. 43(1)]
(k) Actual Cost of depreciable assets. Where in any previous year, any block of assets is
transferred by an amalgamating company to the amalgamated company in a scheme of
amalgamation, and the amalgamated company is an Indian Company, then the actual cost of
the block of assets transferred to the amalgamated company shall be the book value of the
assets to the amalgamating company in the immediately preceding previous year as reduced
by the amount of depreciation actually allowed in relation to the said preceding previous
year, [Sec. 43(6)]
(l) Deduction in respect of profits from undertaking engaged in infrastructure
development or other than infrastructure development. Certain deductions are allowed
from gross total income under sections 80IA 80-IAB or 80-IB or 80-IC or 80-IE on fulfilment
of certain conditions. If the amalgamated company fulfils those conditions it is entitled to
these deductions resulting in reduction of its tax liability zione is transferred to another unit.
(m) Special Economic Zone. Where an unit of SEZ is transfered to another unit in a scheme
of amalgamation, the exemption shall be allowed to the other unit for the unexpired period.
[Sec. 10AA(5)]b
(n) Tonnage Scheme. Where there has been an amalgamation of a qualifying company with
another company, the provisions relating to the tonnage tax scheme shall apply to the
amalgamated company if it is a qualifying company.
However where the amalgamated company is not a tonnage tax company, it can exercise an
option for tonnage tax scheme within three months from the date of the approval of the
scheme of amalgamation. (Sec. 115VY)
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11.4 ACCUMULATED NON-SPECULATIVE BUSINESS LOSSES AND
UNABSORBED DEPRECIATION:
Where a company owning an industrial undertaking or ship or hotel amalgamates with
another company, or a banking company amalgamates with a specified bank, or one or more
public sector company or companies engaged in the business of operation of aircraft
amalgamates with one or more public sector company or companies engaged in similar
business, the accumulated loss and the unabsorbed depreciation of the amalgamating
company shall be deemed to be the loss or unabsorbed depreciation of the amalgamated
company of the previous year in which the amalgamation. Thus, the amalgamated company
will be entitled to carry-forward and set-off the loss and unabsorbed depreciation of the
amalgamating company as if these were the losses or unabsorbed depreciation of the
amalgamated company itself. It is important to note thatthe amalgamated company has the
right to carry-forward and set-off the balance of business loss for a period of eight assessment
years immediately succeeding the assessment year relevant to the previous year in which the
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 occurred or
depreciation remains unabsorbed, for three or more years.
(b) It has held continuously as on the date of amalgamation at least three-fourth of the book-
value of fixed assets held by it two years prior to the date of amalgamation.
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 five years from the
effective date of amalgamation.
(b) The amalgamated company continues the business of the amalgamating company 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 amalgamating
company by way of amalgamation, shall achieve the level of production of at least fifty
percent of the installed capacity of the said undertaking before the end of four years from the
date of amalgamation and continue to maintain the said minimum level of production till the
end of five pears from the effective date of amalgamation.
However, the, Central Government, on an application made by the amalgamated company,
may relax the condition of achieving the level of production or period of production or both
having regard to the genuine efforts made by the amalgamated company to attain the
prescribed level of production and the circumstances preventing such efforts from achieving
the same.
(b) The amalgamated company shall furnish to the Assessing Officer a certificate in Form
No. 62, duly verified by a Chartered Accountant, with reference to the books of accounts and
other documents showing particulars of production, along with the return of income for the
assessment year relevant to the previous year during which the prescribed level of production
is achieved and for subsequent assessment years relevant to the previous years falling within
five years from the date of amalgamation. For the purposes of this rule 'Installed capacity'
means the capacity of production existing on the date of amalgamation.
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Non-fulfillment of conditions. If the above specified conditions are not fulfilled that part of
carry forward loss and unabsorbed depreciation remaining to be utilised by the amalgamated
company shall lapse, and such loss or depreciation as has been set-off shall be treated as the
income of the year in which the failure to fulfill the conditions occurs.
11.5 TAX LIABILITY OF AMALGAMATED COMPANY
1. Where an allowance or deduction has been made in respect of loss, expenditure or liability
to the amalgamating company and subsequently during any previous year the amalgamated
company has obtained any amount (in cash or otherwise) in respect of aforesaid loss or
expenditure or some benefit in respect of trading liability by way of remission 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
amalgamating company in respect of income for the previous year in which the succession
took place up to the date of succession and for the previous year preceding that year can be
recovered from the amalgamated company if it cannot be recovered from the amalgamating
company. [Sec. 170(3)] Hence, the tax liability for the aforesaid period of the amalgamating
company should carefully be ascertained.
11.6 AMALGAMATION OF BANKING COMPANY : (SEC. 72AA)
(Sec.72AA) Provides carry forward and set-off of accumulated loss and unabsorbed
depreciation allowance of a banking company against the profits of a banking institution
under a scheme of amalgamation sanctioned by the Central Government. [Section 72AA]
Conditions:
1. There is an amalgamation of a "banking company" with any other "banking institution".
Banking company for this purpose means a company which transacts the business of banking
in India. A manufacturing or trading company which accepts deposits of money from the
public merely for the purpose of financing its business shall not be deemed to transact the
business of banking. A banking institution for this purpose means any banking company and
includes State Bank of India or other scheduled banks.
2. The amalgamation is sanctioned and brought into force by the Central Government under
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 depreciation of the
amalgamating banking company shall be deemed to be the loss or the allowance for
depreciation of the banking institution for the previous year in which the scheme of
amalgamation is brought into force.
For this purpose, "accumulated loss" means so much of the loss of the amalgamating banking
company under the head "Profits and gains of business or profession" which such
amalgamating banking company, would have been entitled to carry forward and set off under
the provision of section 72 if the amalgamation had not taken place. It does not, however,
include speculative business Losses. Unabsorbed depreciation" means so much of the
depreciation of the amalgamating banking company which remains to be allowed and which
would have been allowed to such banking company if amalgamation had not taken place.
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11.7 TAX PLANNING:
1. Where some assets or liabilities are not proposed be taken over by the amalgamated
company, the same may be disposed of or paid-off by the amalgamating company before the
scheme of amalgamation effected.
2.'Where shareholders holding more than 25% shares of the amalgamating company are not
willing to become shareholders of the amalgamated company, the shares of some of the
dissenting shareholders may be purchased by the other shareholders or amalgamated
company before amalgamation, so that the condition shareholders holding at least 75% of the
shares of the amalgamating company become shareholders of 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 are not 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. It would help in continuing to carry-
forward and set-off the unabsorbed depreciation and losses against the profits derived from
the business of the profit-making company.
4. The amalgamated company should not give composite consideration (shares and
debentures or shares and cash) to the shareholders of the amalgamating company in lieu of
shares held by them in the amalgamating company. They should be given only shares in lieu
of share held by them in amalgamating company. In case of composite consideration the tax
incentive u/s 47(vii) will not be available.
Example 1. From the following information determine whether there is an amalgamation for income tax
purposes :
(i) All the assets and liabilities of company 'A' are transferred to company 'B';
(ii) The position of shareholders is as under :
(a) 40% shares in value of company 'A' are held by company B';,
(b) 60% shares in value of company 'A' are held by other shareholders.
The other shareholders holding 40% shares in value of company 'A become the shareholders
of company 'B'.
Solution: Following conditions should be fulfilled order to constitute a valid amalgamation for income
tax purposes.
(i) All the assets and all the liabilities of amalgamating company must be transferred to the
amalgamated company; (ii) Shareholder holding at least 75% value of the amalgamating
company (excluding shares held by the amalgamated company or its nominee or its
subsidiary company) become the shareholders of the amalgamated company.
In the given case first condition is satisfied but the second condition is not satisfied, i.e.,
shareholders holding 75% shares of 60% shares i.e. 45% shares in company A do not become
the shareholders of company 'B'. Hence, there is no amalgamation.
Example 2.
Company A is proposed to be merged with company B in 2017. The following are the
particulars of the company A.
(i) unabsorbed depreciation Rs. 50 lakh
(ii) unabsorbed business loss Rs. 30 lakh
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(iii) unexpired period for deduction under section 80IB 3 years
Consider which of the benefits can be availed by company B if:
(a) the merger is not 'amalgamation'
(b) the merger is 'amalgamation' but does not satisfy conditions of Sec. 72A;
(c) the merger satisfies conditions of amalgamation as well as Sec. 72A.
Solution: (a) When merger of company A is not an amalgamation u/s 2(1B);
(i) Company B cannot carry-forward and set-off the unabsorbed depreciation and
unabsorbed business loss of company A;
(ii) Company B cannot avail deduction u/s 80IB for unexpired period of three years.
[Sec. 80IB(12)]
(b) When merger of company A is amalgamation u/s 2(1B) but does not satisfy conditions of
Sec. 72A, company B can claim deduction u/s,80IB for unexpired period of three years.
However, company B cannot carry forward and set-off the unabsorbed depreciation and
unabsorbed business loss of company A.
(c) When merger of company A is amalgamation u/s 2(1B) and it satisfies the conditions of
Sec. 72A as well, company B can :
(i) claim the deduction u/s '80IB for unexpired period of three years;
(ii) set of and carry-forward and set-off business loss against its business income within
8 years from the end of previous year in which amalgamation takes place;
(iii) set off or carry-forward and set-off unabsorbed depreciation against any income till
it is fully absorbed.
11.8 MEANING OF DEMERGER [SECTION 2(19AA)]:
"Demerger", in relation to companies, means the transfer, pursuant to a scheme or
arrangement under sections 391 " to 394 of the Companies Act, 1956 by a demerged
company of its one or more undertakings to any resulting company in such a manner that—
(i) all the property of the undertaking, being transferred by the demerged company,
immediately before the demerger, becomes the property of the resulting company by
virtue of the demerger;
(ii) all the liabilities relatable to the undertaking, being transferred by the demerged
company, immediately before the demerger, becomes the liabilities of the resulting
company by virtue of the demerger;
(iii) the property and the liabilities of the undertaking or undertakings being transferred by
the demerged company are transferred at values appearing in its books of account
immediately before the demerger.
(iv) the resulting company issues, in consideration of the demerger, its shares to the
shareholders of the demerged company on a proportionate basis;
(v) the shareholders holding not less than three-fourths in value of the shares in the
demerged company (other than shares already held therein immediately before the
demerger, or by a nominee for, the resulting company or, its subsidiary) become
shareholders of the resulting company or companies by virtue of the demerger,
otherwise than as a result of the acquisition of the property or assets of the demerged
company or any undertaking thereof by the resulting company;
(vi) the transfer of the undertaking is on a going concern basis;
(vii) the demerger is in accordance with the conditions, if any, notified under subsection
(5) of section 72 A by the Central Government in this behalf.
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11.9 IMPORTANT POINTS FOR CONSIDERATION FOR DEMERGER
(a) Meaning of undertaking being transferred [Explanation to Section 2(19AA)]: For the
purposes of this clause, "undertaking" shall include any part of an undertaking, or a unit or
division of an undertaking or a business activity taken as a whole, but does not include
individual assets or liabilities or any combination thereof not constituting a business activity.
(b) Meaning of liabilities referred to in sub-clause (ii) of section 2(19AA): For the
purposes of this clause, the liabilities referred to in sub-clause (ii), shall include—
(i) the liabilities which arise out of the activities or operations of the undertaking;
(ii) the specific loans or borrowings raised, incurred and utilised solely for the activities
or operations of the undertakings; and
(iii) in cases, other than those referred to in clause (a) or clause (b), above so much of the
amounts of general or multipurpose borrowings, if any, of the demerged company as
stand in the same proportion which the value of the assets transferred in a demerger
bears to the total value of the assets of such demerged company immediately before
the demerger.
(c) Value of the property of the undertaking being transferred: Section 2(19AA)
specifies that the value of the property and the liabilities of the undertaking being transferred
by the demerged company should be at book value appearing in books immediately before
demerger. This is also required that any change in the value of assets consequent to
revaluation shall be ignored.
(d) Benefit of demerger also available to certain authorities or Boards: For the purposes
of this clause, the splitting up or the reconstruction of any authority or a body constituted or
established under a Central, State or Provincial Act, or a local authority or a public sector
company, into separate authorities or bodies or local authorities or companies, as the case
may be, shall be deemed to be a demerger if such split up or reconstruction is as per the
conditions, if any, specified by the Central Government.
(e) Shares to be issued on a proporttoriate basis: Under the provision of section 2(19AA)
the resulting company should issue shares on a proportionate basis to the shareholders of
demerged company.
11.10 MEANING OF DEMERGED COMPANY [SECTION 2(19AAA)|:
"Demerged company" means the company whose undertaking is transferred, pursuant to a
demerger, to a resulting company.
11.11 MEANING OF RESULTING COMPANY [SECTION 2(41A)]:
"Resulting company" means one or more companies (including a wholly owned subsidiary
thereof) to which the undertaking of the demerged company is transferred in a scheme of
demerger and, the resulting company in consideration of such transfer of undertaking, issues
shares to the shareholders of the demerged company and includes any authority or body or
local authority or public sector company or a company established, constituted or formed as a
result of demerger.
Example 3. ‘A’. Ltd., transferred its fertilizer business to a new company 'B' Ltd., by way of
demerger with effect from appointed date of 1.4.2015 after satisfying the conditions of
demerger. Further information are also given.
(a) Book Value of the entire block of plant and machinery held by 'A' Ltd. as on 1.4.2015 is
Rs. 100 crores;
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(b) Out of the above (a), WDV of block of plant and machinery of fertilizer division is 70
crores;
(c) 'A' Ltd. has unabsorbed depreciation of Rs.50 lakhs as at 31.3.2015; On the basis of above
facts:
(i) You are required to explain the provisions of the income-tax as to the allow ability of
depreciation, in the hands of' 'A' Ltd. and 'B' Ltd. on at 31.3.2016. (ii) State how the
unabsorbed depreciation has to be dealt with for the assessment year 2016-17.
Solution:
(A) As the conditions laid down in section 2(19AA), have been satisfied the depreciation
claim will be subject to the following provisions:
1. Where there is a demerger of a company the resulting company will be entitled to
depreciation on the written down value of the block of assets transferred to it, which will be
the written down value of the transferred assets of the demerged company .immediately
before the demerger [Explanation 2B to section 43(6)].
2. Where there is a demerger of a company the written down value of the block of assets in
the hands of the demerged company shall be the written down value of the block of assets of
the demerged company for the immediately preceding previous year as reduced by the
written down value of the assets transferred to the resulting company pursuant to the
demerger. [Explanation 2A to section 43(6)].
3. Depreciation on plant and machinery in the hands of 'A' Ltd. and 'B' Ltd. will be computed
as under:
WD V of plant and machinery 'A" Ltd. 'B' Ltd.
Rs. (in crores) Rs. (Crores)
As at 1-4-2015 " 30.00 70.00
Less: Depreciation® 15% 4.50 10.50
WDV as at 31-3-2016 25.50 59.50
(ii) Set-off of unabsorbed depreciation:
In case of demerger section 72A(4) provides as under:
(a) the unabsorbed depreciation directly relatable to the resulting company is allowed to
be carried forward and set off in the hands of the resulting company.
(b) where such unabsorbed depreciation is not directly relatable to the undertaking
transferred to the resulting company, it has to be apportioned between the demerged
company and the resulting company in the same proportion in which the assets of the
undertakings have been retained by the demerged company and transferred to the
resulting company.
(c) the demerged company and the resulting company would be allowed to carry toward
and set-off their respective share of unabsorbed depreciation, as calculated above, for
indefinite period as per section 32(2). However, brought forward business loss can be
carried forward for the unexpired period of 8 years only.
11.12 TAX CONCESSION/INCENTIVES IN CASE OF DEMERGER:
If any demerger takes place within the meaning of section 2(19AA) of the Income-tax Act,
the following tax concession shall be available to various parties:
(A) Tax concessions to demerged company.
(B) Tax concessions to shareholders of demerged company.
(C) Tax concessions to resulting company.
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These concessions are on similar lines as are available in case of amalgamation discussed
earlier. However some concessions available in case of amalgamation are not available in
case of demerger of companis.
1. Tax concession to demerged company:
(i) Exemption from Capital gain Tax: According to section 47(vib) where there is a transfer
of any capital asset in a scheme of demerger by the demerged company to the resulting
company, such transfer will not be regarded as a transfer for the purpose of capital gain
provided the resulting company is an Indian company.
(ii) Tax concession to a foreign demerged company [Section 47(vic)]: Where a foreign
company holds any shares in an Indian company and transfers the same, in a scheme of
demerger, to another resulting foreign company, such transaction will not be regarded as
transfer for the purpose of capital gain under section 45 if the following conditions are
satisfied:
(a) at least seventy-five per cent of the shareholders of the demerged foreign company
continue to remain shareholders of the resulting foreign company; and
(b) such transfer does not attract tax on capital gains in that country, in which the
demerged foreign company was incorporated.
(iii) Reserves for shipping business: Where a ship acquired out of the reserve is transferred
in a scheme of demerger, even within the period of eight years of acquisition there will be no
deemed profits to the demerged company.
2. Tax concessions to the shareholders of the demerged company [Section 47] Any
transfer or issue of shares by the resulting company, in a scheme of demerger to the
shareholders of the demerged company shall not be regarded as a transfer if the transfer or
issue is made in consideration of demerger of the undertaking.
Existing shareholders: the existing shareholder of the demerged company will now hold:
shares in resulting company; and shares in demerged company, and in case the shareholders
transfers any of the above shares subsequent to the demerger, the cost of such shares shall be
calculated as given below:—
Cost of acquisition of shares in the resulting company [Section 49(2C). It shall be; he
amount which bears to the cost of acquisition of shares held by the assessee in the demerged
company the same proportion as me net book value of the assets transferred in a demerger
bears to the net worth of the demerged company immediately before such demerger.
In other words Cost of acquisition of the shares in the resulting company = cost of acquisition
of share held by the assessee in the demerged company × Net book value of the assets
transferred to resulting company Net worth of the demerged company immediately before
demerger.
Cost of acquisition of shares in the demerged company [Section 49(2 D)]: The cost of
acquisition of the original shares held by the shareholder in the demerged company shall be
deemed to have been reduced by the amount as so arrived at under section 49(2C) above.
For the above purpose net-worth means the aggregate of the paid up share capital and general
reserves as appearing in the books of account of the demerged company immediately before
the demerger.
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3. Period of holding of shares of the resulting company: [Section 2(42A)(g)]: In the case
of a capital asset, being a share or shares in an Indian company, which becomes the property
of the assessee in consideration of a demerger, there shall be included the period for which
the share or shares held in the demerged, company by the assessee.
11.13 TAX CONCESSION TO THE RESULTING COMPANY:
The resulting company shall be eligible for tax concessions only if the following two
conditions are satisfied:
(i) The demerger satisfies all the conditions laid down in section 2(19AA); and
(ii) The resulting company is an Indian company.
The following concessions are available to the resulting company in a scheme of demerger:
1. Expenditure for obtaining licence to operate telecommunication services [Section
35ABB(7)]: Where in a scheme of demerger, the demerged company sells or otherwise
transfers its licence to the resulting company (being an Indian company), the provisions of
section 35ABB which were applicable-to the demerged company shall become applicable in
the same manner to the resulting company, therefore:
(i) The expenditure on acquisition of licence, not yet written off, shall be allowed to the
resulting company in the same number of balance instalments.
(ii) Where such licence is sold by the resulting company, the treatment will be same as would
have been in the case of demerged company.
2. Treatment of preliminary expenses [Section 35D(5A)]: Where the undertaking of an
Indian company which is entitled to deduction of preliminary expenses in transferred before
the expiry of deduction period to another company in a scheme of demerger, the preliminary
expenses of such undertaking which are not yet written off shall be allowed as deduction to
the resulting company in the same manner as would have been allowed to the demerged
company. The demerged company will not be entitled to the deduction thereafter.
3. Treatment of expenditure on prospecting, etc. of certain minerals [Section 35E(7A)]\
Where the undertaking of an Indian company which is entitled to deduction on account of
prospecting of minerals, is transferred before the expiry of period of 10 years to another
company in a scheme of demerger, such expenditure of prospecting, etc. which is not yet
written off shall be allowed as deduction to the resulting company in the same manner as
would have been allowed to the demerged company. The demerged company will not be
entitled to the deduction thereafter.
4. Treatment of bad debts [Section 36(l)(vii)]: Where due to demerger the debts of the
demerged company have been taken over by the resulting company and subsequently any
such debt or part of debt becomes bad such bad debt will be allowed as a deduction to the
resulting company. This is based upon the decision of the Supreme Court in the case of K.
Koteswara Rao & Co. (1985) 155 1TR 152 (SC) which was decided in the case of
amalgamation of companies.
5. Amortisation of expenditure in case of demerger [Section 35DD}: (1) Where an
assessee, being an Indian company, incurs any expenditure, on or after 1-4-1999, wholly and
exclusively for the purposes of demerger of an undertaking, the assessee shall be allowed a
deduction of an amount equal to one-fifth of such expenditure for each of the five successive
previous years beginning with the previous year in which the demerger took place.
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6. Carry forward and set off of business losses and unabsorbed depreciation of the
emerged company [Section 72A(4) & (5)]: The accumulated loss and unabsorbed
depreciation in a demerger, should be allowed to be carried forward by the resulting company
if these are directly relatable to the undertaking proposed to be transferred. More it is not
possible to relate these to the undertaking, such loss and depreciation shall be apportioned
between the demerged company and the resulting company in proportion of the assets
coming to the share of each company as a result of demerger.
7. Deduction available under section 80-1AB or 80-IB or 80-IC or 80-IE: Where an
idertaking which is entitled to deduction under section 80-IAB/80-IB/80-IC/80-IE is
ansferred in the scheme of demerger before the expiry of the period of deduction under action
80-IAB or 80-IB or 80-IC or 80-IE, then—
(i) no deduction under section 80-IAB/80-IB/80-IC/80-IE shall be available to the demerged
company for the previous year in which amalgamation takes place; and
(ii) the provisions of section 80-IAB/80-IB/80-IC/80-IE shall apply to the resulting company
in such manner in which they would have applied to the demerged company.
11.14 OTHER IMPORTANT POINTS
1. "Actual cost" of assets to the resulting company: Where, in a merger, any capital asset
is transferred by the demerged company to the resulting company and the resulting company
is an Indian company, the actual cost of the is transferred capital asset to the resulting
company shall be taken to be the same as it would have been if the demerged company had
continued to hold the capital asset for the pose of its own business.
2. "Written down value" of assets to the resulting company. Where in previous year, any
asset forming part of a block of assets is transferred by a demerged company to the resulting
company, then, the written down value of the block of assets in the case of the resulting
company shall be the written down value of the transferred assets as appearing in the books
of account of the demerged company immediately before the demerger.
3. "Written down value" of assets to the demerged company: Where in any previous year,
any asset forming part of a block of assets is transferred by a demerged company to the
resulting company, then, the written down value of the block of assets of the demerged
company for the immediately preceding previous year shall be reduced by the written down
value of the assets transferred to the resulting company pursuant to the demerger.
4. Apportionment of depreciation between the demerged company and resulting
company [Proviso 5 to section 32] If in any previous year there is any demerger then for the
purpose of computing depreciation for that previous year it will be first assumed as if no
demerger had taken place and thereafter depreciation so computed shall be apportioned
between the demerged company and the resulting company in the ratio of the number of days
for which the assets were used by them.
5. Recovery of any allowance/deduction earlier allowed to the demerged company [Section 41(1)\: Where a demerged company was earlier allowed any allowance/deduction in
respect of loss, expenditure, or trading liability and subsequently the resulting company has
obtained/recovered whether in cash or in any other manner any amount in respect of which
any allowance/deduction was allowed to the demerged company, such amount shall be
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deemed to be the profits and gains of business or profession of the resulting company of the
previous year in which it is recovered.
11.15 DISTINCTION BETWEEN AMALGAMATION AND DEMERGER
(i) An amalgamation has a reference to a company as a whole whereas a demerger has a
reference to an undertaking of the company.
(ii) The amalgamating company will lose its identity in amalgamation whereas the demerged
company may continue to exist after demerger.
(iii) Demerger stipulates a transfer under sections 391 to 394, whereas there is no such
requirement in case of amalgamation.
(iv) Demerger requires transfer of undertaking on going-concern basis whereas there is no
such explicit requirement in case of amalgamation.
11.16 SLUMP SALE
'Slump Sale'. [Sec. 2(42C)] It means transfer of one or more undertakings as a result of the
sale for a lump-sum consideration without values being assigned to the individual assets and
liabilities in such slump sales.
Explanation-1. 'Undertaking' shall include any part of an undertaking or a unit or division of
an undertaking or a business activity taken as a whole, but does not include individual assets
or liabilities or any combination thereof not constituting a business activity.
Explanation-2. The determination of the value of an asset or liability for the sole purpose of
payment of stamp duty, registration fees or other similar taxes or fees shall not be regarded as
assignment of values to individual assets or liabilities.
1. Computation of Capital Gains in case of Slump Sale (Sec. 50B)
Any gains arising from the slump sale effected in the previous year shall be chargeable as
long-term capital gains of the previous year in which the transfer took place.
However, gains on slump sale of capital asset being one or more undertakings owned and
held by the assessee for not more than 36 months immediately preceding the date of its
transfer shall be deemed to be short-term capital gains.
2. Cost of acquisition and cost of improvement in case of slump sale The net worth' of an undertaking or division transferred by way of slump sale shall be
deemed to be the cost of acquisition and improvement for purposes of sections 48 and 49. It
is to be noted that indexed cost of acquisition of long-term capital asset shall not be
considered in slump sale.
The assessee shall furnish in the prescribed form along with the return of income, a report of
Chartered Accountant, indicating the computation of net worth of the undertaking or division
and certifying that the net worth has been correctly arrived at in accordance with the
provisions of this section.
Explanation-1. Net worth shall be the aggregate value of total assets of the undertaking or
division as reduced by its liabilities as appearing in books of account. However, any change
in the value of the assets on account of revaluation of assets shall be ignored for computing
the net worth.
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Explanation-2. For computing net worth, the aggregate value of total assets will be
computed as under:
(a) in the case of depreciable assets, the written down value of the block of assets as
determined u/s 43(6)(c)(i)(C)];
(b) in the case of capital assets in respect of which the whole of the expenditure has been
allowed or is allowable as a deduction u/s 35AD, nil; and
(c) in the case of other assets, the book value of such assets.
3. Determination of Written down value for slump sale [Sec. 43(6)(c)(i)(C)]
Actual cost of the asset shall be reduced by :
(a) the amount of depreciation actually allowed to the assessee upto assessment year 1987-88;
and
(b) the amount of depreciation that would have been allowable to the assessee for any
assessment year commencing on or after 1st day of April, 1988 as if the asset was the only
asset in the relevant block of assets.
11.17 CONVERSION OF SOLE PROPRIETARY CONCERN/ PARTNERSHIP FIRM
INTO COMPANY
1. Conversion of Partnership Firm into a Company
[Sec. 47(xiii)]
Where a firm is succeeded by a company in the business carried on by it as a result of which
the firm sells or otherwise transfers any tangible asset or intangible asset to the company it is
not regarded as a transfer and capital gains, if any, are not chargeable to tax. The exemption
will be allowed if the following conditions are satisfied :
(a) All the assets and liabilities of the firm relating to the business immediately before
succession become the assets and liabilities of the company.
(b) All the partners of the firm immediately before succession become shareholders of the
company in the same proportion in which their capital accounts stood in the books of the firm
on the date of succession.
(c) The partners of the firm do not receive any consideration or benefit, directly or indirectly,
in any form or manner, other than by way of allotment of shares in the company.
(d) The aggregate of the shareholding in the company of the partners is not less than 50% of
total voting power in the company for at least five years from the date of succession.
2. Conversion of Sole Proprietary Concern into a Company [Sec. 47(xiv)]
Where a sole proprietary concern is succeeded by a company in the business carried on by
him as a result of which the concern sells or otherwise transfers any tangible asset or
intangible asset to the company it is not regarded as a transfer and capital gains, if any, are
not chargeable to tax. The exemption will be available if the following conditions are
satisfied:
(a) All the assets and liabilities of the concern relating to the business immediately before
succession become the assets and liabilities of the company.
(b) The shareholding of the proprietor in the company is not less than 50% of the total voting
power in the company for at least five years from the date of succession.
(c) The proprietor does not receive any consideration or benefit, directly or indirectly, in any
form or manner, other than by way of allotment of shares in the company.
Important Notes:-
(1) The above exemption is available in case of business and not in case of profession.
188
(2) The exemption is available in case of transfer of capital assets. Stock-in-trade is not a
capital asset, hence, gains on its transfer shall be business profits and liable to tax.
(3) Regarding cost of acquisition of the assets for the .company nothing has been given
specifically. Hence, the cost of acquisition of the assets shall be the price at which the assets
have been transferred to the company by the firm/sole proprietor.
(4) Where the aggregate of the shareholding of the partners or the shareholding of the sole
proprietor, as the case may be, in the company does not remain 50% of the total voting power
at any time during a period of five years from the date of succession, the capital gains
exempted at the time of succession shall be chargeable to tax in the hands of successor
company for the previous year in which such requirement is not complied with.
3. Carry forward and set-off of accumulated loss and unabsorbed depreciation in case
of succession. [Sec. 72A(6), (7)(a)(b)] Where a sole proprietary concern or firm is succeeded by a company which fulfils the
conditions laid down in sec. 47(xiii/47(xiv), the accumulated loss and unabsorbed
depreciation of predecessor firm/proprietary concern shall be deemed to be the loss and
unabsorbed depreciation of the successor company for the previous year in which business
reorganisation was effected. The provisions of the Act relating to set-off and carry-forward
loss and unabsorbed depreciation shall apply accordingly.
If any of the conditions laid down in sec. 47(xiii)/47(xiv) are not complied with, the set-off of
loss or allowance of depreciation made in any previous year in the hands of the successor
company, shall be deemed to be the income of the company chargeable to tax in the year in
which such conditions are not complied with.
'Accumulated loss' means so much of the loss of the predecessor firm/proprietary concern
under the head 'Profits and Gains of Business or Profession' (not being speculative loss)
which the predecessor would have been entitled to carry forward and set-off u/s 72 if the
reorganisation of business had not taken place.
'Unabsorbed depreciation' means so much of the depreciation allowance of the predecessor
firm/proprietary concern which remains to be allowed and which would have been allowed to
the predecessor under this Act, if the reorganisation of business had not taken place.
Example 4: The following is the Balance Sheet of a firm as on 31.3.2016 :
Liabilities Rs. Assets Rs.
Capital Accounts Land at cost (Acquired on
A 6,00,000 10.6.2009) 4,00,000
B 3,00,000 Building W.D.V. 6,00,000
C 3,00,000 Plant W.D.V. 3,00,000
Creditors 4,00,000 Debtors 2,00,000
Other liabilities 2,00,000 Stock 3,00,000
18,00.000 18,00.000
The partners share profit/loss in the ratio of 2:1:1,
The firm wants to convert into a company on 1.4.2016. Discuss what steps the firm and
company should take to avoid the tax on capital gains.
The firm revalued its assets as under for transfer to the company:
Rs.
Land 15,00,000
Building 9,00,000
Plant & Machinery 4,00,000
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Debtors 2,00,000
Stock 4,00,000
The liabilities will be transferred at the book value
Solution:
All the partners (A, B and C) should become shareholders of the company in the same
proportion in which their capital accounts stood in the books of the firm on the date of
succession. The capital accounts will be :
Other Stock
Assets Rs. Rs.
Transfer price 30,00,000 4,00,000
Less : Book-value 15,00,000 3,00,000
Profit on transfer 15.00.000 1.00.000'
Partners' Capital Accounts after succession:
A B C
Rs. Rs. Rs.
Capital 6,00,000 3,00,000 3,00,000
Add: Profit in 2:1:1 8,00,000 4,00,000 4,00,000
Capital on the date of succession 14.00.000 7.00.000 7.00.000
4. The company should allot shares worth Rs. 28,00,000 to A, B and C in the capital ratio. No
consideration should be paid by the company in any form or manner except allotment of
shares.
5. The voting power of partners should not be less than 50% of the total voting power of the
company.
6. The partners should hold in aggregate at least 50% of total voting power in the company
for at least five years from the date of successions.
11.18 CONVERSION OF A PRIVATE COMPANY OR AN UNLISTED PUBLIC
COMPANY INTO A LIMITED LIABILITY PARTNERSHIP (LLP)
Exemption of Capital Gains Where capital assets or intangible assets are transferred by a private company or an unlisted
public company (company) to a LLP or shareholder transfers shares held in such company, it
will not be regarded as transfer [u/s 47 (xiii b)] for the purposes of capital gains (u/s 45) the
following conditions should be satisfied :
(a) All assets and liabilities of the company become the assets and liabilities of the LLP.
(b) All the shareholders of the company become partners of the LLP in the same proportion
as their share-holding in the company.
(c) The total sales, turnover or gross receipts in business of the company do not exceed sixty
lakh rupees in any of the three preceding previous years.
(d) No consideration other than share in profit in the LLP arises to partners.
(e) The shareholders of the company continue to be entitled to receive at least 50% of the
profit of the LLP for a period of five years from the date of conversion.
(f) No amount is paid, directly or indirectly, to any partner out of accumulated profits of the
company for a period of three years from the date of conversion.
1 Taxation of Capital Gains. If the above mentioned conditions are not complied with, the
benefit of exemption of capital gains availed by the company shall be deemed to be the
capital gains of the LLP and chargeable to tax for the previous year in which the
conditions are not complied with.
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2 Carry forward and set-off of Losses and unabsorbed depreciation Where a private/unlisted company is succeeded by a LLP, which fulfils the above
mentioned conditions, the accumulated Losses and unabsorbed depreciation of predecessor
company shall be deemed to be the Losses and unabsorbed depreciation of the successor
LLP for the previous year in which business reorganisation was effected. The provisions of
the Income Tax Act relating to set-off and cany-forward Losses and unabsorbed
depreciation shall apply accordingly.
If any of the conditions mentioned above are not complied with, set-off of Losses or
unabsorbed depreciation made in any previous year in the hands of the successor LLP,
shall be deemed to be the income of the LLP chargeable to tax in the year in which such
conditions are not complied with.
3 Actual cost, (i) Actual cost of the assets to the LLP shall be the WDV of the block of
assets of the predecessor company on the date of conversion.
(ii) The cost of acquisition of the asset for the successor LLP shall be deemed to be the
cost for which the predecessor company acquired it.
Cost of acquisition of Capital asset being rights of a partner in the Limited Liability
Partnership [Sec 49(2AAA)] Where a private company or unlisted public company is converted into a limited liability
partnership, the cost of acquisition of above mentioned capital asset to the partner shall be
deemed to be the cost of acquisition of shares in the company immediately before its
conversion.
No Tax Credit to LLP. The tax credit, (u/s 115 JAA) available to a company regarding
minimum tax paid (u/s 115 JB) shall not be allowed to the successor LLP.
11.19 TRANSFER OF ASSETS BETWEEN HOLDING AND SUBSIDIARY
COMPANIES
Transfer of assets between holding and subsidiary companies:
1. Transfer of assets from holding company to subsidiary company [Sec. 47(iv)]:
Any transfer of capital asset by a company to its subsidiary company is not regarded
as transfer, if:
a. The parent company or its nominees hold the whole of the share capital of the
subsidiary company, and
b. The subsidiary company is an Indian Company.
2. Transfer of assets from subsidiary company to holding company [Sec. 47(v)]:
Any transfer of capital asset by a subsidiary company to Holding Company is not
regarded as transfer, if:
a. The whole of the share capital of the subsidiary company is held by the holding
company, and
b. The holding company is an Indian Company.
Notes –
1. Exception:
Any transfer of a capital asset covered in sections 47(iv) and 47(v) shall be treated as
transfer if the transfer is made after February 29, 1988, as stock in trade.
2. Withdrawal of exemption [Sec. 47A]:
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If at any time before the expiry of 8 years from the date of transfer of a capital asset
referred to in sections 47(iv) and 47(v):
a. Such capital asset is converted by the transferee company into, or is treated by it as
stock in trade of its business, or
b. The parent company (or its nominee) or the holding company ceases to hold the
whole of the share capital of the subsidiary company,
then, the amount of capital gain exempted from tax shall be deemed to be the income of
transferor company chargeable under the head ‘capital gains’ of the year in which such
transfer took place.
3. Amendment of assessment order [Sec. 155(7B)]:
Where the profits or gains arising from the transfer of a capital asset are not charged to
tax under section 45 [by virtue of section 47(iv) or (v)] but such profits or gains are
deemed under section 47A to be income chargeable under the head ‘Capital Gains’ the
Assessing Officer may, make an order of amendment at any time before the expiry of 4
years from the end of the previous year in which the relevant capital asset was
converted in to, or treated as, stock in trade or, as the case may be, the parent company
ceased to hold the entire share capital of subsidiary company.
4. Cost of acquisition of an asset where capital gains are exempt:
Where a capital asset has been transferred between holding and subsidiary companies,
the cost of acquisition of the asset shall be the aggregate of the following:
a. the cost for which the previous owner of the property acquired it, and
b. the cost of any improvement of the asset incurred by the previous owner or the
assessee, as the case may be.
5. Cost of acquisition of an asset where capital gains are chargeable under section 47A:
The cost of acquisition of such asset to the transferee company shall be the cost for
which such asset was acquired by it.
6. Period for which the capital asset is held by the assessee:
Where the capital asset becomes the property of the assessee there shall be included the
period for which the asset was held by the previous owner.
Other points –
1. The provisions of indexation and adoption of market value as on 01-04-1981 were
made effective only w.e.f. assessment year 1993-94.
2. From the assessment year 1985-86 onwards, the conversion of capital asset into stock-
in-trade of a business carried on by the taxpayer (it may be a new business or an
existing business) is treated as a transfer within the meaning of section 2(47).
3. However, section 45(2) provides that although such a conversion of capital asset into
stock-in-trade will be treated as a transfer of the previous year in which the asset is so
converted, but the notional capital gain will not arise in the previous year in which the
asset is converted; it will arise in the previous year in which such converted asset is
sold or otherwise transferred.
4. Indexation of cost of acquisition and improvement, if required, will be done till the
previous year in which such conversion took place. Further, the fair market value of
the capital asset, as on the date of such conversion, shall be deemed to be full value of
the consideration of the asset.
5. The sale price minus market value as on the date of conversion shall be treated as
business income and taxed under the head “Profits and gains of business or
profession”.
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Example 5:
S Ltd. is a wholly-owned subsidiary of A Ltd. Both are Indian companies and maintain books
of account on the basis of financial year. On April 10, 1984 (relevant to the assessment year
1985-86), S Ltd. transfers a capital asset (i.e., shares) to A Ltd. (acquired on April 6, 1981 for
Rs. 50,000) for Rs. 1,50,000. A Ltd. sells the asset on May 10, 2015 for Rs. 6,40,000.
Determine the assessable profits of A Ltd. and S Ltd. under the following situations:
a. Before the sale of asset, A Ltd. has not converted it into stock-in-trade and it does not
cease to hold entire share capital of S Ltd.
b. A Ltd. has converted the capital asset into stock-in-trade before its sale on May 10,
2015 (date of conversion: June 10, 1987, fair market value: Rs. 3,10,000).
c. Though A Ltd. does not convert capital asset into stock-in-trade, it ceases to hold
entire share capital of S Ltd. on June 10, 1988 when 5% shareholding in S Ltd. is
transferred by way of sale to the public.
The CII for 1984-85 is 125, for 1987-88 is 150, for 1988-89 is 161 and for 2015-16 is 1081.
Solution:
Situation 1:
S Ltd.:
Transfer between A Ltd. and S Ltd. will not be treated as transfer under section 47(v).
Consequently, nothing will be taxable in the hands of S Ltd. in the assessment year 1985-86.
A Ltd.:
A Ltd. will, however, be taxable in respect of capital gain for the assessment year 2016-17
computed as under:
Amount (Rs.)
Sale consideration 6,40,000
Less: Indexed cost of acquisition
(50,000/100*1081) 5,40,500
LTCG 99,500
Cost inflation index of 1981-82 i.e., 100 has been taken because it is the year in which the
asset was acquired by the previous owner.
Situation 2:
S Ltd.:
Since A Ltd. has converted the capital asset into stock-in-trade within 8 years from April 10,
1984, exemption granted by section 47(v) will not be available and, consequently, Rs.
1,00,000* (i.e., Rs. 1,50,000 – Rs. 50,000) will be treated as long-term capital gain (by virtue
of section 47A) of S Ltd. for the assessment year 1985-86 86 and taxed according to the
provisions applicable at that time..
* It is to be noted the provisions of indexation of cost and adoption of market value as on 1-4-
1981 were made effective only w.e.f. the assessment year 1993-94.
A Ltd.:
Capital gain for the assessment year 2016-17 will be determined as under:
Amount
(Rs.)
Full value of consideration received [Fair market value on the date
of conversion of capital asset into stock-in-trade under section 45(2)] 3,10,000
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Less: Indexed cost of acquisition (1,50,000/125*150) 1,80,000
Long-term capital gain (notional) 1,30,000
1987-88 (CII: 150) is the year in which capital asset ceased to exist.
Besides, Rs. 3,30,000 (i.e., Rs. 6,40,000 – Rs. 3,10,000) will be chargeable to tax under
section 28(i) as business profits for the assessment year 2016-17.
Situation 3:
S Ltd.:
Since A Ltd. has transferred the shareholding in S Ltd. before the expiry of 8 years from
April 10, 1984, the exemption granted by section 47(v) will not be available and,
consequently, Rs. 1,00,000* (i.e., Rs. 1,50,000 – Rs. 50,000) will be treated as long-term
capital gain (by virtue of section 47A) of S Ltd. for the assessment year 1985-86 and taxed
according to the provisions applicable at that time.
* It is to be noted the provisions of indexation of cost and adoption of market value as on 1-4-
1981 were made effective only w.e.f. the assessment year 1993-94.
A Ltd.:
Capital gain for the assessment year 2016-17 will be determined as under:
Amount (Rs.)
Sale consideration 6,40,000
Less: Indexed cost of acquisition (1,50,000/125*1081) 12,97,200
Long-term capital gain (6,57,200)
Other than the income of capital gains in assessment year 2016-17, there will be no other
income in the year in which it ceases to be wholly owned subsidiary company.
Example 6:
S Ltd. is a wholly owned subsidiary of H Ltd. Both companies are Indian companies. H Ltd.
purchased a piece of land in May 2006 at Rs. 3,00,000. In June 2009, H Ltd. transferred the
land to S Ltd. at Rs. 5,62,000. In August 2015, S Ltd. sold the land at Rs. 12,00,000.
Compute capital gain/business profit in the following cases:
a. Before the sale of land by S Ltd., neither H Ltd. ceases to hold 100% shares of S Ltd.
nor does S Ltd. convert land into stock-in-trade.
b. In July 2015, S Ltd. converted the land into stock-in-trade, when the fair market value
of land was Rs. 7,50,000.
c. In May 2015, H Ltd. sold 10% shares of S Ltd. to the public.
The CII in 2006-07, 2009-10, 2012-13 and 2015-16 were 519, 632, 852 and 1081
respectively.
Solution:
Situation 1:
H Ltd.:
Transfer between H Ltd. and S Ltd. will not be treated as transfer under section 47(iv).
Consequently, nothing would be taxable in the hands of H Ltd.
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S Ltd.:
S Ltd. will, however, be taxable in respect of capital gain for the assessment year 2016-17
computed as under:
Amount (Rs.)
Sale consideration 12,00,000
Less: Indexed cost of acquisition
(3,00,000/519*1081) 6,24,855
LTCG 5,75,144
Cost inflation index of 2006-07 i.e., 519 has been taken because it is the year in which the
asset was acquired by the previous owner.
Situation 2:
H Ltd.:
Since the land has been converted into stock-in-trade in July 2015, which falls within 8 years
of the original transfer date (i.e., June 2009), there will be capital gains to H Ltd. and its
assessment of assessment year 2010-11 (i.e., previous year 2009-10) will be rectified under
section 155 as under:
Amount (Rs.)
Consideration price 5,62,000
Less: Indexed cost of acquisition (3,00,000/519*632) 3,65,318
LTCG 1,96,682
The long-term capital gain of Rs. 1,96,682 will be included in the total income for the
assessment year 2010-11 and taxed according to the provisions applicable at that time.
S Ltd.:
Although the land was converted into stock-in-trade in July 2015, which will be regarded as
transfer, but capital gain on such a transfer will be taxable in the previous year in which such
converted asset is sold. Indexation of cost, will, however, be done till the year of conversion.
The cost of acquisition in this case will be the value at which the asset was transferred to it.
Capital gain for the assessment year 2016-17 will be determined as under:
Amount
(Rs.)
Full value of consideration received [Fair market value on the date
of conversion of capital asset into stock-in-trade under section 45(2)] 7,50,000
Less: Indexed cost of acquisition (5,62,000/632*1081) 9,61,269
Long-term capital gain (notional) (2,11,269)
Besides, business income for the assessment year 2016-17:
Amount (Rs.)
Sale price 12,00,000
Less: Market value on the sale of conversion 7,50,000
Business income 4,50,000
Situation 3:
H Ltd.:
Since holding company ceases to hold 100% share capital of subsidiary company before the
expiry of 8 years from the date of transfer of the asset, there will be capital gains to H Ltd.
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and its assessment of assessment year 2010-11 (i.e., previous year 2009-10) will be rectified
under section 155 as under:
Amount (Rs.)
Consideration price 5,62,000
Less: Indexed cost of acquisition (3,00,000/519*632) 3,65,318
LTCG 1,96,682
The long-term capital gain of Rs. 1,96,682 will be included in the total income for the
assessment year 2010-11 and taxed according to the provisions applicable at that time.
S Ltd.:
There will be no income in the year in which it ceases to be wholly owned subsidiary
company. Since the asset has been sold in August 2015, there will be capital gain to S Ltd. on
such a transfer for the assessment year 2016-17.
Capital gain for the assessment year 2016-17 will be determined as under:
Amount (Rs.)
Sale consideration 12,00,000
Less: Indexed cost of acquisition (5,62,000/632*1081) 9,61,269
Long-term capital gain 2,38,731
Example 7:
S Ltd. is a wholly owned subsidiary of H Ltd. Both companies are Indian companies. H Ltd.
purchased a piece of land in May 2001 for Rs. 6,00,000. In June 2007, H Ltd. transferred the
land to S Ltd. at Rs. 12,00,000. In August 2015, S Ltd. sold the land at Rs. 20,00,000.
Compute capital gain/business profit in the following cases:
a. Before the sale of land by S Ltd., neither H Ltd. ceases to hold 100% shares of S Ltd.
nor does S Ltd. convert land into stock-in-trade.
b. In July 2014, S Ltd. converted the land into stock-in-trade, when the fair market value
of land was Rs. 16,00,000.
c. In May 2015, H Ltd. sold 10% shares of S Ltd. to the public.
The CII in 2001-02, 2007-08, 2014-15 and 2015-16 were 426, 551, 1024 and 1081
respectively.
Solution:
Situation 1:
H Ltd.:
Transfer between H Ltd. and S Ltd. will not be treated as transfer under section 47(iv).
Consequently, nothing would be taxable in the hands of H Ltd.
S Ltd.:
S Ltd. will, however, be taxable in respect of capital gain for the assessment year 2016-17
computed as under:
Amount (Rs.)
Sale consideration 20,00,000
Less: Indexed cost of acquisition
(6,00,000/426*1081) 15,22,535
LTCG 4,77,465
Cost inflation index of 2001-02 i.e., 426 has been taken because it is the year in which the
asset was acquired by the previous owner.
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Situation 2:
H Ltd.:
Since the land has been converted into stock-in-trade in July 2014, which falls within 8 years
of the original transfer date (i.e., June 2007), there will be capital gains to H Ltd. and its
assessment of assessment year 2008-09 (i.e., previous year 2007-08) will be rectified under
section 155 as under:
Amount (Rs.)
Consideration price 12,00,000
Less: Indexed cost of acquisition (6,00,000/426*551) 7,76,056
LTCG 4,23,944
The long-term capital gain of Rs. 4,23,944 will be included in the total income for the
assessment year 2008-09 and taxed according to the provisions applicable at that time.
S Ltd.:
Although the land was converted into stock-in-trade in July 2014, which will be regarded as
transfer, but capital gain on such a transfer will be taxable in the previous year in which such
converted asset is sold. Indexation of cost, will, however, be done till the year of conversion.
The cost of acquisition in this case will be the value at which the asset was transferred to it.
Capital gain for the assessment year 2016-17 will be determined as under:
Amount
(Rs.)
Full value of consideration received [Fair market value on the date
of conversion of capital asset into stock-in-trade under section 45(2)] 16,00,000
Less: Indexed cost of acquisition (12,00,000/551*1024) 22,30,127
Long-term capital gain (notional) (6,30,127)
2014-15 (CII: 1024) is the year in which capital asset ceased to exist.
Besides, business income for the assessment year 2016-17:
Amount (Rs.)
Sale price 20,00,000
Less: Market value on the sale of conversion 16,00,000
Business income 4,00,000
Situation 3:
H Ltd.:
Since holding company ceases to hold 100% share capital of subsidiary company before the
expiry of 8 years from the date of transfer of the asset, there will be capital gains to H Ltd.
and its assessment of assessment year 2008-09 (i.e., previous year 2007-08) will be rectified
under section 155 as under:
Amount (Rs.)
Consideration price 12,00,000
Less: Indexed cost of acquisition (6,00,000/426*551) 7,76,056
LTCG 4,23,944
The long-term capital gain of Rs. 4,23,944 will be included in the total income for the
assessment year 2008-09 and taxed according to the provisions applicable at that time.
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S Ltd.:
There will be no income in the year in which it ceases to be wholly owned subsidiary
company. Since the asset has been sold in August 2015, there will be capital gain to S Ltd. on
such a transfer for the assessment year 2016-17.
Capital gain for the assessment year 2016-17 will be determined as under:
Amount (Rs.)
Sale consideration 20,00,000
Less: Indexed cost of acquisition (12,00,000/551*1081) 23,54,265
Long-term capital gain (3,54,265)
Questions
1. What do you mean by amalgamation? What are various modes of amalgamation.
2. Discuss the provisions u/s 72AA regarding carry forward and set off of accumulated
loss and unabsorbed depreciation of a banking company.
3. What are tax incentive to an amalgamated company.
4. Define demerger as per Income Tax Act and discuss process of demerger.
5. What are the conditions for exemption of capital gain in the case of conversion of sole
proprietorship into private limited company or LLP.
6. Write note on slump sale and determination of capital gains in the case of slump sale.
7. Discuss the tax implications to a resulting company in the scheme of demerger.
8. Explain in the conditions which should be satisfied to claim exemption of capital
gains in the case of conversion of a firm into a private limited company.
9. Define the status of transfer of assets between holding and subsidiary company. What
are the cases when profits and gains arising from such transfer will be charged to
capital gains tax?
10. Discuss the tax implications in case of transfer of assets between holding and
subsidiary companies. When are profits and gains from such transactions chargeable