Pre-Budget Memorandum 2014-15...Krishna Kumar S. Jhunjhunwala Manish P. Sampat Nandita P. Parekh Narayan K. Varma Narayan R. Pasari Pradip K. Thanawala Saurabh P. Shah Sonalee A. Godbole

Bombay Chartered Accountants’ Society 7, Jolly Bhavan No. 2, New Marine Lines, Mumbai 400 020

Tel. : 61377600 to 05 / Fax : 61377666 E-mail : [email protected]; Website : www.bcasonline.org

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Pre-Budget Memorandum 2014-15

Managing Committee

President Naushad A. Panjwani Vice President Nitin P. Shingala Hon. Secretaries Raman H. Jokhakar Mukesh G. Trivedi Hon. Treasurer Chetan M. Shah Members

Abhay R. Mehta Aliasgar Z. Kherodawala

Bharatkumar K. Oza Deepak R. Shah

Himanshu V. Vasa Jayesh M. Gandhi

Krishna Kumar S. Jhunjhunwala Manish P. Sampat

Nandita P. Parekh Narayan K. Varma

Narayan R. Pasari Pradip K. Thanawala

Saurabh P. Shah Sonalee A. Godbole

Suhas S. Paranjpe Sunil B. Gabhawalla

Suril V. Shah




Taxation Committee

Chairman Gautam S. Nayak

Co-Chairman Sanjeev R. Pandit

Ex-Officio Naushad A. Panjwani Nitin P. Shingala

Chairman Anil D. Doshi Jagdish T. Punjabi Saurabh P. Shah

Members Ameet N. Patel Anil J. Sathe

Anish B. Mehta Ankit V. Shah

Arvind H. Dalal Bhadresh K. Doshi

Bharat S. Raut Hardik D. Mehta

Hitesh D. Gajaria Kirit R. Kamdar

Kishor B. Karia Mukesh G. Trivedi

Narayan K. Varma Nihar N. Jambusaria

Nilesh M. Parekh Nina P. Kapasi

Pinakin D. Desai Pinky H. Shah

Pradip N. Kapasi Pradyumna N. Shah

Rajan R. Vora Rajeev N. Shah

Rajesh V. Shah Rutvik R. Sanghvi

Sanjeev D. Lalan Sonalee A. Godbole

Saroj V. Maniar Tilokchand P. Ostwal

Yogesh A. Thar




Pre Budget Suggestions, 2014-15

On Direct Tax Laws

Table of Contents

I. Policy / Major Issues ......................................................................................................... 6

1. Policy on Retrospective Amendments ................................................................................ 6

2. Addressing the growth and accumulation of litigation ........................................................ 7

3. Removal of Domestic Transfer Pricing Provisions ................................................................ 8

4. Accountability on the part of the Income-tax Department .................................................. 8

5. Scrutiny of the Tax Returns based on the Annual Information Return [AIR] Returns ............ 11

6. Uploading of erroneous demands on CPC databases, inaction in respect of pending

rectification applications and adjustment of erroneous demands against refunds of later

years .............................................................................................................................. 12

7. Broadening of Taxpayer base ........................................................................................... 12

II. Suggestions for Specific amendments to various sections of Income-tax Act, 1961 .............. 13

8. Suggestions regarding Domestic Transfer pricing Provisions .............................................. 13

9. Amendments required in Section 47(xiii), (xiiib) and (xiv) ..................................................17

10. Deemed speculation loss in case of Companies - Explanation to Section 73 ........................ 18

11. Provisions Relating to Gift: Section 2(24)(xv) & 56(2)(vii) .................................................. 19

12. Taxation of Share Premium – Section 56(2)(viib) ................................................................20

13. Tax on Long Term Capital Gains – Section 112(1)(c)(iii) – Clarification required ................... 21

14. Tax on Distributed Profits - Section 115-O - Effect on Non-Resident shareholder ................ 23

15. Increase in threshold limit for TDS – Section 194A ............................................................ 23

16. Tax Deduction at Source in respect of Payment to Non-residents – Section 195(7) .............. 24

17. Clarification required through an amendment to the provisions of Section 269SS & Section

269T .............................................................................................................................. 24

Bombay Chartered Accountants’ Society 6

I. Policy / Major Issues

1. Policy on Retrospective Amendments

1.1 The single most factor which has hurt or insulted the taxpayer community –

in particular, the international community – has been the spate of

retrospective amendment in 2012, and the manner in which the issue was

handled. It has resulted in uncertain revenue gain at the loss of value of

goodwill in the capital field. Unfortunately, the task of handling the

amendments was in the hands of those who were not born on 1st April 1962

when the amendments were introduced. It was an unprecedented

experience for those in the civilised economy. The interpretation is still

unequivocal to many.

1.2 As part of any statute or constitution, the retrospective amendment should

be strictly discouraged. Any such amendment should be considered as a rare

phenomenon.

1.3 Even assuming there is a retrospective amendment, it should always be

accompanied by a basket of the following:

Levy of mandatory interest to be relieved.

No penalty to be initiated.

No tax withholding default can be attributed.

No attempt can be made to disallow an expenditure on the basis of tax

withholding default.

No fictional liability should be fastened on an agent of a non-resident

under S. 163 - may be, except, if at all, when the agent is a subsidiary or

a close associate.

Grant of instalment for payment of principal amount of tax.

1.4 The least that the taxpaying community expects even today is a circular

reiterating the factors at para 1.3 above.


2. Addressing the growth and accumulation of litigation

2.1 A serious evaluation of reasons as to why India is emerging as one of the most – if

not the most – litigative countries despite the fact that the cost of litigation is

proving to be beyond the means of a number of honest taxpayers in the country.

2.2 There is an urgent need on the part of all – including the tax department – to

accept that, as a breed, the honest taxpayers do exist and that it is wrong to

presume that a taxpayer is necessarily a tax evader unless he is thoroughly

controlled. The law and administration cannot be planned on the erroneous

presumption of generalising tax paying community on the basis of a small sample

of 10 to 20% of the community.

2.3 No remedy is in sight unless there are strict norms of accountability for actions. For

example, Reversal of an addition by a higher authority – say, Tribunal or High Court

should, in itself, lead to a monitoring, questioning or investigating the causes. Such

enquiry should be the basis of further promotion or evaluation of the officials.

2.4 Self-imposed monitoring of the manner in which the subordinates function may be

far more effective than relying on the formal complaints.

2.5 One of the major reasons why a taxpayer necessarily undertakes litigation against

an addition are; linkage of tax withholding default with income assessment; and

the fear of penalty and prosecution which he may be visited with. While

prosecution may not be visible, the fear and verbal threat of prosecution are not

uncommon. The remedies may be; (i) circulars clarifying from time to time areas of

law points which are prone to bonafide interpretation – being the cases in which

penalty and prosecution may be relieved; (ii) delinking of tax withholding default

and income addition.

2.6 Of late, it has been noticed that the department has been following a ‘target

based’ approach in respect of assessment and collection of taxes. In order to

achieve the targets, in many cases it is experienced that high pitched assessments

are made, demands raised and collected. This leads to further litigation and in

most of such cases additions are not upheld by the higher appellate forums. This

causes tremendous harassment to the tax payers and a huge cost of litigation

culminating into bad image for the country as an investment destination. This

practice need serious reconsideration and should be stopped.

2.7 The institution of DRP has largely failed. It needs to be revamped, preferably, by

making it more independent together with departmental nominees and by having

permanent benches of DRP instead of senior officials having additional charges as

members of DRP.


2.8 In the area of Transfer Pricing there has been huge amount of litigation and the

same is increasing day in and day out. Safe Harbour Rules brought in with the

intention of reducing the litigation in this area have failed to work towards the

desired goal, primarily due to very high operating profit margins / Interest rates /

commission or fees prescribed in the rules. There is an urgent need to thoroughly

review the existing Safe Harbour Rules and revise the same downwards in tune

with the actual business realities and overall prevailing economic scenario.

2.9 There is a likely upsurge of litigation with the routine introduction of GAAR.

Possible remedies could be:

Defer the application by two more years and utilise the time for education.

Publish the guidelines which deal with 50 to 100 different examples by a

person of the stature of Dr. Shome.

Advance the date of grandfathering to the date of introduction of law.

GAAR may be applied where the predominant purpose is tax avoidance.

Taxpayers seeking treaty benefit may be told about the norms of substances

which are expected of them to claim the treaty benefits.

3. Removal of Domestic Transfer Pricing Provisions

Domestic Transfer Pricing provisions are more relevant and prevalent in countries like USA

and Canada, where both federal and state income-taxes separately exist. In India since

income-tax is a central tax, DTP provisions have no relevance as any adjustment due to

domestic transfer pricing provisions should, logically have offsetting effect and should have

no material revenue impact as both the assessees would be resident in India. Further, the

documentation requirements in case of transfer pricing are quite onerous, and has

increased and resulted in substantial compliance costs for domestic taxpayers. Therefore,

domestic transfer pricing provisions should be removed from the Income-tax law / statute

book.

4. Accountability on the part of the Income-tax Department

4.1 It has been our observation at all times that to bring in ‘voluntary compliance’ as

an acceptable concept in tax-payers, what is required, more than fair tax-laws, is

fair, just, tax-payer friendly tax-administration, ACCOUNTABLE to the tax-payer and

in general.

The most essential pre-requisite to bring tax administration to that goal of

ACCOUNTABILITY is to legislate some provisions for ACCOUNTABILITY in tax-

administration.


We believe that the tax-administration is no doubt a tax-gathering body but in

reality its function is to serve tax-payers and for that purpose be accountable.

The preamble to the Right to Information Act states:

“AND WHEREAS, democracy requires an informed citizenry and transparency of

information which are vital to its functioning and also to contain corruption and to

hold Government and their instrumentalities accountable to the governed …”

We are of the opinion that similar objective exists for the Income-tax law.

In the past and today accountability has been severely lacking. What is needed is

attitudinal change in the mindset of the individuals’- right from the Chairman of

CBDT down to the peons.

4.2 Government has certain expectations from taxpayers. The ‘CITIZEN’S CHARTER’

released in July 2010 lists all of them. However, no efforts are made to encourage,

motivate & assist taxpayers to enable them to meet these expectations. For

example:

Expectations include ‘to verify credits in tax-credit statement’. When a tax-payer

verifies and finds errors in the same, the department’s officials make no effort to

assist the tax-payer.

When a tax-payer has some difficulty to understand the tax-provisions or when

unjust treatment is given to him or he is facing the ‘corrupt’ official, no higher

authority is available to approach in the matter.

We believe that large number of tax-payers are honest and law abiding, more can

be brought in that category if the department becomes more accountable.

4.3 In order to make the system and the income-tax department accountable, we

make following suggestions on macro level:

In the Income-tax Act, 1961 [the Act] / Direct Tax Code, 2013 [DTC] provision needs

to be made to create and establish independent body having wide authority to

ensure accountability in the working of the department. Such body needs to be

headed by a person of eminence of retired High Court / Supreme Court judge or

senior respected professional. That body shall have members -

representatives of the profession

representatives of tax-payers

retired CCIT or CIT


In brief, we note that-

It shall monitor ‘Service Delivery Standards’ laid out in the citizen’s Charter and

ensure proper implementation of the ‘Service Quality Policy’ issued by the income-

tax Department.

All grievances of citizens not resolved by the tax authority would be handled by

this body.

The grievances of the department’s personnel and/or whistleblowers in the

department will also have this body to effectively approach. This will bring better

accountability in tax-administration.

In order that this body is independent of the tax-authority, it should report to the

Finance Secretary / Finance Minister.

More detailed constitution and other aspects for its working, functions etc. can be

provided if desired. We believe that this kind of body shall usher in accountability

into the department. Citizens will believe and so also the department’s individuals

that there is somebody to look up to if he/she has some problem with the tax

department. In short, we urge that formation of such independent well-powered

body be provided in Income-tax Act, 1961 / Direct Tax Code, 2013. It will make a

huge difference in the governance of the tax department as it shall bring in

accountability.

4.4 The provisions of Section 244A of the Act also should be changed to the following

effect:

Presently, the section grants interest on refunds due to the tax-payers @ 6% p.a.

(Against 12% p.a. charged under other sections such as section 234A/ 234B etc.)

As per the “Service Delivery Standards” laid down in the ‘CITIZEN’S Charter’ standard

is to issue refunds within 6 months to 9 months. If it is not so issued, presently

nobody is accountable. Experience shows that in thousands of cases refunds are not

issued for years and the standards (present or earlier) are not observed.

At times also unofficial instructions are given by higher authorities to assessing

officers, not to issue refunds in the last quarter of the financial year to show better

picture of the net tax collection.

If the tax-payer has to pay a price for any default, the department must also pay a

price for default.

If the tax-payer has obligations and accountability in law and has enforceable

obligations, we opine that the department also should be accountable and have

enforceable obligations.

We suggest that the following should be provided in section 244A (Section in IT Act

1961):


If the refunds due are not issued until 12 months from the end of the month in

which the return of income is furnished or appellate order is passed or due for any

other reason, rate of interest shall be enhanced to 12% p.a. for next 12 months and

18% p.a. for the period thereafter.

5. Scrutiny of the Tax Returns based on the Annual Information Return

[AIR] Returns

The intention of introduction of AIR was to obtain information relating to various prescribed

transactions of assessees from different sources and cross verify the same with the details and

documents of the assessees, in order to unearth the undisclosed income.

For this purpose, it was intended that in majority of such cases the inquiry or verification

would be limited to only AIR reported transactions and full scrutiny of the assessees would not

be done.

It has been observed that in most cases, the Assessing Officers [AOs] do not limit the inquiry /

verification to only AIR reported transactions but instead conduct the full scrutiny assessment

of the assessees leading to the harassment and inconvenience to the assessees. This is against

the guidelines of the CBDT.

In addition, it is also found that in the recent past AOs are asking for the

information/documents from the assessees in respect of various AIR reported transactions

[which in many cases are erroneously captured by the system/software of the Income-tax

department or erroneously filed by the AIR Filers] and requiring the assessees to reconcile

each and every entry of the AIR information in their possession. In case the same does not

match, for whatever reason including erroneous reporting by the AIR filers, the difference is

added to the income leading to huge, unjust and unwarranted demands and litigation in

respect of the same.

It is strongly suggested that:

i. The AOs should be strictly instructed to limit their inquiries to the information related

to the AIR only and not conduct full scrutiny assessment unless the same is picked up

by the CASS or as per CBDT guidelines.

ii. In case of mismatch of information / details, and on errors being pointed out by the

assessees, the AOs should ask the AIR filers to correct information and /or summon

and cross examine the Filers before making huge unwarranted additions to the income.


6. Uploading of erroneous demands on CPC databases, inaction in respect

of pending rectification applications and adjustment of erroneous

demands against refunds of later years

Recently, a lot of heartburn in the tax payer community has taken place due to the fact that in

many cases:

a. No action has been taken in respect of pending rectification applications u/s 154 of the

Act. Moreover, pending demands have been uploaded on the CPC database and

adjusted against the pending refunds of the assessees;

b. In cases where the rectification has been carried out and the demands have been

nullified / reduced / cancelled, the information is not updated on the CPC database

and demands are continued to be shown as pending and adjusted against the

legitimate refunds due to the assessees.

c. Refund orders have been passed but the actual refunds are not granted and there is

considerable delay in many cases.

It is strongly suggested that a proper action plan should be laid down by the CBDT and all

the field officers should be instructed to carry out the rectifications with in a time bound

manner and same should be closely monitored by the senior officials of the department.

After the rectifications, the erroneous demands uploaded on the CPC database should be

forthwith updated and refunds should be granted to assessees in all such cases at the

earliest possible.

7. Broadening of Taxpayer base

There has been a strong feeling amongst the citizenry that the honest and tax compliant

assessees are targeted [or flogged] more and more while those who are not in the tax net / tax

compliant go virtually scot-free and no visible strong action is taken against them. There is

urgent need to broaden the taxpayers’ base in the country and spare the honest taxpayers

from more and more compliance burden.

In this regard, it is suggested that:

a. In order to motivate desired behaviour among the public, the government should

introduce a system for rewarding the honest taxpayers in recognition of having met

national responsibility;

b. Strong and better use of data warehousing and analytics to identify new taxpayers;

c. Introduction of Presumptive Taxation Scheme on the lines of earlier Presumptive

Taxation Scheme of Rs. 1,400/- with suitable modification of amount to Rs. 5,000/-.


II. Suggestions for Specific amendments to various sections of Income-tax Act, 1961

8. Suggestions regarding Domestic Transfer pricing Provisions

i. Section 40A(2)(a) 8.1 The Finance Act, 1968 had introduced a new section 40A in the Income-tax Act,

1961 ('ITA’) with effect from 1 April 1968. Section 40A(2) provides that an

expenditure incurred in business or profession for which payment has been or is to

be made to the tax-payer’s relatives or associate concerns is liable to be disallowed

in computing the profits of the business or profession to the extent the

expenditure is considered to be excessive or unreasonable. The reasonableness of

any expenditure is to be judged having regard to the fair market value of the

goods, services or facilities for which the payment is made for the legitimate needs

of the business or profession or the benefit delivered by, or accruing to, the tax-

payer from the expenditure. Such portion of the expenditure which, in the opinion

of the Income-tax Officer, is excessive or unreasonable is to be disallowed in

computing the profits of the business or profession.

8.2 The Section was inserted with the object to check evasion of tax through excessive

or unreasonable payments to relative or any other specified person. The relevant

extracts of the Departmental Circular - Circular No. 6-P, Dated 6-7-1968, whereby

this Section was introduced, are as under:

“Where payment for any expenditure is found to have been made to a relative or

associate concern falling within the specified categories, it will be necessary for the

Income-tax Officer to scrutinise the reasonableness of the expenditure with

reference to the criteria mentioned in the section.

The Income-tax Officer is expected to exercise his judgment in a reasonable and fair

manner. It should be borne in mind that the provision is meant to check evasion of

tax through excessive or unreasonable payments to relatives and associate

concerns and should not be applied in a manner which will cause hardship in bona

fide cases.”

8.3 The Assessing Officer [AO] had all discretion to ensure that payment made or

expenditure incurred is based on fair market rates and hence there was no warrant

to amend the stated position.


8.4 With the recent insertion of Proviso to sub section (2)(a) of Section 40A by the

Finance Act, 2012, w.e.f. 1-4-2013, no disallowance under this clause on account of

expenditure being excessive or unreasonable having regard to the fair market value

of good, services or facilities shall be made in respect of Specified Domestic

Transaction [SDT] referred to in section 92BA, if such transaction is at arm’s length

price (‘ALP’) as defined in clause (ii) of section 92F. Hence, with the insertion of this

proviso, the section has extended the applicability of the specific concept of arm’s

length price instead of a fair market value to determine the value of domestic

related party transactions.

8.5 The principles of ALP as propagated by OECD in the context of International

Transfer Pricing are purely theoretical and far from reality. All the methods

recommended to achieve results are based on the data base available in public

domain, which does not exist and such results are used for Rent-seeking and

causes undue harassment to the taxpayers and also increases the compliance

costs on the tax payer.

8.6 The limit of payment in excess of Rs. 5 crores is absolutely unrealistic and

burdensome as such payment would include even purchase of goods.

8.7 The administration in India is not geared up to handle such matters as the law

requires reference to T.P.O. which is a specialized wing, which does not exist all

over India.

8.8 Finally, DTP provisions are introduced in various jurisdictions which are concerned

with allocation of Income-tax between Federal and State Governments. India does

not have such a system of taxation. In India, Income-tax is recovered only under an

all India enactment, administered by Central Government alone and hence there is

no allocation of taxing rights granted to various States. It is only after collection of

taxes, such collections are distributed amongst the States based on the

recommendations of Finance Commission and this has been working well. If at all

DTP provisions are required then the principle to be followed should be to ensure

that payment made by one tax payer, to another should be subject to full taxation

at maximum marginal rate and there should not be any arbitrary apportionment to

save taxes. If that is achieved, then the tax officer and tax payer should not be

overburdened with compliance of documentation requirement.


8.9 It is, therefore, strongly recommended that only the transactions of purchase and

sale of goods and services should be subject to benchmarking in accordance with

the arm’s length methods prescribed under Indian Transfer Pricing regulations.

Hence such provisions could be restricted to tax payers availing Chapter VIA

deductions or exemptions u/s 10AA but should not be extended to payments

covered by Section 40A(2) of the ITA. However, the extension of these provisions

to all expenditure incurred by tax-payer on payments to its relatives or associate

concerns leads to absurdity. One cannot determine the arm’s length price that

should have been paid on various transactions, since the payment may be based

on various factors and considerations, like the business market scenario,

competition, each individual’s experiences, intellect, etc.

8.10 A few such examples have been listed below, wherein the benchmarking of such

transactions may be impossible using arm’s length principle:

a) Managerial Remuneration and remuneration to partners

b) Services provided free of cost by tax holiday units

c) Applicability of SDT to Companies falling under Presumptive taxation

d) Allocation of expenses between the group entities, following consistent

principles and allocation keys

e) Joint Development Agreement

f) Project Management Fees

g) ESOP

h) Corporate Guarantees for the group entities

i) Maintenance and Administrative charged and shares services

Alternatively, it is also suggested:

8.11 The second proviso to Section 92C(4) permits single track adjustment and prohibits

consequential adjustment in the hands of the other party. This provision is made

applicable to SDT as well. As a result, disallowance of expenditure in the hands of

one related party does not mean that there would be co-relative reduction in the

hands of recipient. Recipient will be assessed with reference to actual income as

earned, even assuming entire expenditure is disallowed in hands of related party.

This approach of revenue will lead to unjust enrichment of the State at the cost

of the innocent taxpayer.


8.12 It is recommended that even if the above provisions continue and deduction on

account of payment to a related party is reduced by application of SDT

provisions, the related party’s income should also automatically stand reduced to

that extent.

ii. Alternatively, in respect of DTP provisions, the following points require consideration:

(a) Harmonisation of the ‘related party’ definitions

Presently, three different sections referred to in section 92BA and section 92A of the

Act have different thresholds for determination of the ‘related party’ definitions which

are as under:

(i) Substantial Interest – Not less than 20% of voting power – Explanation (b)

to Section 40A(2).

(ii) Associated Enterprises - Not less than 26% of voting power – Section

92A(2)(a) & (b).

(iii) Associated Person - Not less than 26% of voting power – Section 80A read

with section 35AD(8).

There is clearly a need for harmonisation of the different thresholds for the related

party definitions in the aforesaid sections and necessary amendments in this regard

should be carried out.

(b) Guidance in respect of benchmarking of Directors’ remuneration

Presently, there is no guidance in respect of benchmarking of the Directors’

remuneration. Since payment of directors’ remuneration is subject to DTP provisions,

necessary guidance for benchmarking in respect of the same should be provided.

(c) Arm’s Length Price vs Ordinary Profits

Section 80IA(8) deals with ‘ordinary profits’ whereas transfer pricing compliance refers

to the ‘Arm’s Length Price’ of the transactions. Conceptually, ‘price principles’ cannot

apply for benchmarking of ‘profits’.

(d) Correlative Adjustments

Presently, in the DTP provisions there is no provision relating to correlative adjustment.

It is very important that in case of any covered under the DTP provisions, if any

adjustment [upward or downward] is made, then correlative adjustment in the hands

of the other party should be invariably be made. Necessary amendment should be

made in the DTP provisions to provide for the correlative adjustments.


(e) Increase in the threshold limit of Rs. 5 crore

The threshold limit of 5 crore is too low for applicability of the Domestic Transfer

Pricing Provisions. In order to ensure that only substantial transactions are covered

under the DTP provisions, the threshold limit should be raised to Rs. 25 crore.

(f) Provisions of Advance Pricing Agreement [APA] should be made applicable to DTP

The proposed APA provisions are being made applicable to only international

transactions. The same should also be made applicable to domestic transactions

covered by DTP provisions.

(g) Exclusion of Expenditure of a Capital Nature

The term “specified domestic transaction” has been defined to mean any expenditure

in respect of which payment has been made or is to be made to a person referred to in

clause (b) of sub-section (2) of section 40A. Such expenditure would possibly include

capital expenditure made to such a related person, even though section 40A(2)(b) does

not apply to capital expenditure. It is therefore suggested that it should apply to

expenditure referred to in section 40A(2)(a), and not to payments made to persons

specified in section 40A(2)(b).

(h) Documentation Requirements

Where the volume of specified domestic transactions is below the threshold limit, the

maintenance of documentation as required for transfer pricing should not be

applicable.

9. Amendments required in Section 47(xiii), (xiiib) and (xiv)

9.1 Section 47 contains provisions in respect of Transactions not regarded as ‘transfer’

for the purposes of capital gains.

9.2 Section 47(xiii) provides that any transfer of a capital asset or intangible asset by a

firm to a company as a result of succession of the firm by a company in the

business carried on by the firm, would be an exempt transfer:

provided that the aggregate of the shareholding in the company of the partners of

the firm is not less than fifty per cent of the total voting power in the company and

their shareholding continues to be as such for a period of five years from the date

of the succession;


9.3 A similar condition regarding period of five years is provided in section 47(xiiib) and

Section 47(xiv).

9.4 It is submitted that in today’s fast changing business environment, no useful

purpose is being served by keeping a long period of five years for continuing

shareholding.

9.5 It is, therefore, strongly suggested that the period of continuing shareholding

should be reduced to 2 years from 5 years presently prescribed. This would help

the reorganisation / restructuring of small and medium enterprises without fear

of losing the exemption.

10. Deemed speculation loss in case of Companies - Explanation to

Section 73

10.1 As per the provisions of section 73 of the Act, any loss, computed in respect of a

speculation business carried on by the assessee, cannot be set off except against

profits and gains, if any, of another speculation business.

10.2 As per Explanation 2 to section 28 of the Act, where speculative transactions carried on

by an assessee are of a nature so as to constitute a business, the business (referred to as

"speculation business") shall be deemed to be distinct and separate from any other

business.

10.3 As per Section 43(5) of the Act, "speculative transaction" means a transaction in which

a contract for the purchase or sale of any commodity, including stocks and shares, is

periodically or ultimately settled otherwise than by the actual delivery or transfer of

the commodity or scrips.

10.4 Accordingly, speculative business is normally understood as business in respect of

transactions where settlement takes place without actual delivery.

10.5 However, as per Explanation to section 73 of the Act, where any part of the business of

a company (other than a company whose gross total income consists mainly of income

which is chargeable under the heads, "Interest on securities", "Income from house

property", "Capital gains" and "Income from other sources" or the company the

principal business of which is the business of banking or the granting of loans and

advances) consists in the purchase and sale of shares of other companies, such

company shall be deemed to be carrying on a speculation business to the extent to

which the business consists of the purchase and sale of such shares.


10.6 Accordingly, as per the Explanation to Section 73, in case of most companies, even

delivery based share transactions are deemed to be speculative. The present

provisions deeming even delivery based purchase and sale of shares as speculative

business discriminate between corporate and non-corporate assessees.

10.7 Automation of the trading mechanism, screen based trading, controls on reporting of

capital market transactions by share brokers, submission of AIRs, dematerialization

and other measures initiated by SEBI over the last few years have brought total

transparency in share trading, leaving little scope for manipulation of share trades by

transfer of profits/losses from one person to another. In any case, corporates are more

regulated compared to non-corporates and hence, disadvantage to companies in terms

of the discriminatory tax provision as described above can hardly be justified.

10.8 The need of the hour is to encourage corporatisation which could bring about more

transparency and healthy business practices. However, the present provisions act as a

disincentive for corporatisation.

10.9 Further, when derivatives which are in the nature of speculative transactions are not

considered as speculative transactions, there is no logic in continuing the deeming

fiction of treating the transactions in shares entered into by a company as

speculative transactions.

10.10 It is, therefore, suggested that the aforesaid Explanation to section 73 of the Act be

deleted.

11. Provisions Relating to Gift: Section 2(24)(xv) & 56(2)(vii)

11.1 As per Section 56(2)(vii) and Section 2(24)(xv), any receipt in the nature of gift, subject

to certain exceptions, is taxed as income if the aggregate receipts during the year

exceed Rs. 50,000/-. Similarly, receipt of certain specified assets without any

consideration or for consideration less than fair market value, is also taxed as income,

if the difference between the fair market value and the consideration is more than Rs.

50,000/-.

11.2 The gift related provisions were sought to be introduced twice over in the past - but

were, for valid reasons, withdrawn after due consideration.

11.3 The Government should not be shy of reconsidering the wisdom and should restore

the earlier position. Therefore, the earlier position whereby gifts were not taxed in

the hands of the donees unless the said gifts were proved to be bogus, should be

restored.


11.4 Measures of Rationalisation

In case for any reason, the provision has to remain on the statute, it should be rationalised

appropriately. The measures of rationalization suggested are as under:

A. The following receipts should be exempted from the charge:

a) Any receipt which is in the nature of damages or accident compensation or which

is received on compassionate grounds.

b) Any receipt which is in the nature of prize or reward for performance at state,

national or international level.

c) Any receipt, which is not in the nature of a gift.

d) Such other receipts as may be notified by the CBDT.

B. Further, there is an anomaly in the existing provisions in as much as a gift received by

a person from his father’s brother is exempted from tax but if the same person (i.e.

the nephew) makes a gift to his father’s brother, then the latter would have to pay

tax on the gifted amount if the aggregate gifts received by him exceed Rs. 50,000 in a

year. This anomaly needs to be removed immediately.

C. An unintended outcome of the amendment made to Section 56 by the Taxation Laws

(Amendment) Act, 2006 is that if a person receives gifts aggregating to more than Rs.

50,000 in a year from persons other than relatives then the entire amount of gifts

would be taxed as income in his hands instead of only the amount in excess of Rs.

50,000. It is suggested in order to avoid ambiguity and resulting disputes and

litigation, the section be amended to clearly lay down a basic threshold limit for

exemption of Rs. 50,000 per year.

12. Taxation of Share Premium – Section 56(2)(viib)

12.1 A new clause (viib) has been added to section 56(2) by the Finance Act, 2012, under

which the share premium received by a closely held company from a resident in excess

of the fair market value of the shares is deemed to be the income of the company. The

fair market value has to be substantiated based on the value of the assets of the

company or as per the prescribed method. Exemption has been provided to amounts

received by a venture capital undertaking from a venture capital fund or a venture

capital company.


12.2 It appears that this provision is intended to target the practice of obtaining investment

in a company at a high premium in exchange for other favours granted by the

promoters of such company, through the other positions held by them. It is submitted

that such misuse has been by only a few companies, but the remedy provided would

adversely affect a significantly large number of promising companies all over the

country.

12.3 This provision will seriously impact genuine small start-ups and other small and

medium-size companies looking to grow rapidly, particularly in the services sector,

which depend upon angel investors or private equity funds for their funding. Such

funding normally depends upon future prospects of the company, rather than the

current value of the assets of the company. This provision would completely destroy

the developing culture of angel investors and private equity funds funding promising

entrepreneurs, who have the skills, but very few assets.

12.4 There are already sufficient safeguards under section 68 to tax undisclosed income

received by companies in the form of share capital. Further, the GAAR provisions are

sufficient to check such misuse. It is therefore suggested that such a harsh provision

should be deleted.

12.5 Alternatively, an exemption should be provided for such shares allotted at a

premium, where the shares are held by the allottee for not less than 3 years from the

date of allotment.

13. Tax on Long Term Capital Gains – Section 112(1)(c)(iii) – Clarification

required

13.1 Clauses (ii) & (iii) of Section 112(1)(c) substituted by Finance Act, 2012 reads as under:

“(ii) the amount of income-tax calculated on long-term capital gains [except where such

gain arises from transfer of capital asset referred to in sub-clause (iii)] at the rate of

twenty per cent; and

(iii) the amount of income-tax on long-term capital gains arising from the transfer of a

capital asset, being unlisted securities, calculated at the rate of ten per cent on the

capital gains in respect of such asset as computed without giving effect to the first

and second proviso to section 48;”


13.2 Circular No. 3/2012, dated June 12, 2012 containing Supplementary Memorandum

Explaining the Official Amendments moved to the Finance Bill, 2012 as reflected in the

Finance Act, 2012, clarifies in this regard as under:

“Concessional rate of taxation on long term capital gain in case of non-resident

investors

Currently, under the Income-tax Act, a long term capital gain arising from sale of

unlisted securities in the case of Foreign Institutional Investors (FIIs) is taxed at the

rate of 10% without giving benefit of indexation or of currency fluctuation. In the case

of other non-resident investors, including Private Equity investors, such capital gains

are taxable at the rate of 20% with the benefit of currency fluctuation but without

indexation. In order to give parity to such non-resident investors, the Finance Act

reduces the rate of tax on long term capital gains arising from transfer of unlisted

securities from 20% to 10% on the gains computed without giving benefit of

currency fluctuations and indexation by amending section 112 of the Income-tax

Act.”

13.3 Explanation to Section 112 defines securities, listed securities and unlisted securities as

under:

“(a) the expression "securities" shall have the meaning assigned to it in clause (h) of

section 2 of the Securities Contracts (Regulation) Act, 1956 (32 of 1956);

(aa) "listed securities" means the securities which are listed on any recognised stock

exchange in India;

(ab) "unlisted securities" means securities other than listed securities;”

13.4 Section 2(h) of the Securities Contracts (Regulation) Act, 1956 [SCRA] defines

‘Securities’ as under:

(h) “securities” include -

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other

marketable securities of a like nature in or of any incorporated company or

other body corporate; …..”

13.5 Thus, the intention of the legislature, as clearly mentioned in the memorandum

explaining the aforesaid provisions, is to give parity in the case of other non-resident

investors [other than the FIIs], including Private Equity investors, where long term

capital gains are taxable at the rate of 20% with the benefit of currency fluctuation but

without indexation, by reducing the rate of tax on long term capital gains arising from

transfer of unlisted securities from 20% to 10% on the gains computed without giving

benefit of currency fluctuations and indexation by amending section 112 of the

Income-tax Act.


13.6 Based on the literal interpretation of the definition of securities as per SCRA, only

shares which are ‘marketable’ i.e. freely transferable, in the nature are covered under

the Act. Thus, since the shares of a private company normally have restrictions on the

free transferability of shares, they would fail to meet the ‘marketable’ test and hence

may not be covered within the ambit if the definition of unlisted securities and would

be liable for the higher rate of tax of 20% instead of 10%, as provided in the newly

inserted clause (iii) of section 112(1)(c).

13.7 A large number of non-resident investors including private equity investors [other than

FIIs] invest in the shares of private limited companies and the aforesaid provisions of

section 112(1)(c)(iii) should be applicable to them. However, in view of the import of

the definition of securities from SCRA and appearance of the word ‘marketable’, the

benefit of the lower rate of tax @ 10% could be denied in such cases, which is contrary

to the purpose and intention of insertion of aforesaid clause (iii).

13.8 It is therefore, strongly suggested that suitable amendments should be made to

clearly provide that even in the cases of transfer of shares of private limited

companies resulting in long term capital gains, the rate of tax applicable would be

10% and not 20%. This would avoid unnecessary and costly litigation and provide

much need clarity to the non-residents.

14. Tax on Distributed Profits - Section 115-O - Effect on Non-Resident

shareholder

Tax on distributed profits is the liability of the company. Therefore, non-resident shareholders

find it difficult to get credit of such tax in tax assessments in their respective countries

especially when there is no direct or indirect provision for such credit either in the domestic

law of their countries or in the relevant Double Tax Avoidance Agreement. In view of this,

effectively, this method of collecting tax on dividend results in a benefit to the Government of

the country of the non-resident rather than the non-resident investor. It is therefore, suggested

that appropriate specific provisions should be made in the Act to treat such DDT as tax on

dividend receipt of non-resident shareholders.

15. Increase in threshold limit for TDS – Section 194A

The threshold limits in respect of payments not subject to deduction of tax at source should be

reviewed every 3 years, and should be revised upwards taking into account the impact of

inflation. In particular, the limits of Rs. 5,000 and Rs. 10,000 under section 194A for interest

have not been revised since June 2007 though limits under other sections were increased in

July 2010. It is, therefore, suggested that these limits be revised upwards to Rs. 15,000 and Rs.

30,000 respectively.


16. Tax Deduction at Source in respect of Payment to Non-residents –

Section 195(7)

16.1 The new sub-section 195(7) inserted by Finance Act, 2012 provides as under:

“(7) Notwithstanding anything contained in sub-section (1) and sub-section (2), the

Board may, by notification in the Official Gazette, specify a class of persons or

cases, where the person responsible for paying to a non-resident, not being a

company, or to a foreign company, any sum, whether or not chargeable under the

provisions of this Act, shall make an application to the Assessing Officer to

determine, by general or special order, the appropriate proportion of sum

chargeable, and upon such determination, tax shall be deducted under sub-

section (1) on that proportion of the sum which is so chargeable.”*Emphasis

supplied]

16.2 From the language of the aforesaid sub-section, it is evident that the same is self-

contradictory and would lead to further litigation in respect of an issue which has been

very well settled by the Supreme Court that where the sum payable to a non-resident

is not chargeable to income-tax in India, there is no question of deduction of tax source

from the same, at the time of making payment to the non-resident.

16.3 It is not quite clear as to how an assessing officer can, by a general or special order,

‘determine the appropriate proportion of sum chargeable’ where the sum is ‘not

chargeable under the provisions of this Act’, as provided in the sub-section 7.

16.4 It is strongly suggested that the Board should not be empowered to notify those

cases where the sum payable to a non-resident is not chargeable to tax in India under

the Act. Otherwise, the same would lead to avoidable harassment, hardships and

would also lead to delays in payments and litigation.

17. Clarification required through an amendment to the provisions of

Section 269SS & Section 269T

17.1 The provisions of Section 269SS were introduced for deterring taxpayers from

introducing unaccounted money by way of small loans or deposits in cash in their

activities. But the Section provides that if deposits or loans are accept by a mode other

than account payee cheque or demand draft the provision shall be attracted resulting

in imposition of penalty u/s 271D. The clarification circular that was issued by CBDT

following the introduction of section 269SS had clearly stated that the provisions were

introduced to deter attempts to explain sources of cash deposits or loans or to offer an

explanation for apparently unaccounted cash found during a search.


17.2 Lately however, there is a tendency among Assessing Officers [AOs] to invoke the

provisions for payments made or settlements effected by other mode like Real Time

Gross Settlement [RTGS] National Electronic Funds Transfer [NEFT] and direct wire

transfers and to even transfer by journal entries within the sister concerns for normal

and effective business needs. The AOs take a very narrow view that such transfers are

not by way of a/c payee cheques or Demand Drafts [DDs] for various reasons overlooking

the fundamental fact that the source of the money/fund or finance involved is fully

accounted for. The AO is solely guided by the fact that the quantum of transfer is large

and he should avoid any career risk and most of the times for rent seeking.

17.3 The quantum being usually big results in a large tax/penalty demand that prompts the

AO and supervisory authorities to go for coercive recoveries. The large quantum

involved also weighs very heavy in the mind of CIT(A) as well. A number of courts and

ITAT have held the issue in favour of the taxpayer. For example, the Delhi ITAT in the

case of Ruchika Chemicals 88 TTJ 85 clearly held that Section 269SS does not apply to

transfer or journal entries. The Delhi High Court [HC] decision in Noida Toll Bridge 262

ITR 260 in this regard has been accepted by the Department and no SLP has been filed.

But this stand of the Department has not been circulated. Present day complex and

competitive business compels business entities to transfer funds, rights or liabilities

and lack of clarity compels the AO to penalize the business entity even for a genuine

business transaction.

17.4 Taxpayers are facing equally hard times in respect of the provisions of Section 269T,

that mandates mode of repayment of loans or deposits, violation of which leads to

imposition of penalty u/s 271E. If a business credit is squared off or settled by a journal

entry, AOs are interpreting it as a repayment of a loan /deposit not by the prescribed

mode and hence imposing penalty.

17.5 So common business or trade practices authorised by Accounting Standards are treated

as violations of statutory provisions, leading to imposition of penalties, affecting a

business entity very drastically. The confusion apparently has been created by incorrect

interpretation of different court decisions. In CIT v/s Noida Toll Bridge Co. Ltd., the

Delhi HC held clearly that merely because payment was settled by a book entry and

not by the mode prescribed u/s 269SS, penalty u/s 271D cannot be levied. The HC held

that this provision gets attracted only if payment is made in cash. The said decision is

accepted by the Department and no SLP has been filed. But unfortunately this has not

been brought to the notice of the officers of the department.


17.6 Subsequently the Bombay HC decided in the case CIT vs Triumph International

Finance Ltd. 345 ITR 273 in respect of Section 269T and Section 271E. The HC gave the

opinion that repayment of a loan/deposit through journal entries did violate the

provisions of Section 269T. However, if it is done for business requirement, that would

be a reasonable cause u/s 273B for not imposing penalty u/s 271E. If the AO fails to

give a finding that it was not for a business requirement, penalty cannot be levied. But

unfortunately AOs tend to come to such a conclusion without giving any finding on

facts. They are overawed by the quantum involved or the number of entries. So either

way the Tax payer is hard pressed for recovery and forced to go through various layers

of appeal, from the department point of view the entire process only leads to creation

of very high uncollectible demands, till the level of appeals before the HC.

17.7 It is therefore strongly suggested that a clarificatory circular as a sequel to the one

issued by the CBDT while introducing Section 269SS may be issued that the

provisions shall not apply to transfer or journal entries transferring funds, financial

rights or liabilities. A similar clarification in respect of repayment of loan or deposit

referred to in Section 269T also needs to be issued. The existing circular even did not

consider fund transfers by RTGS/NEFT or transfer from one account to another and

mentioned only of cheques and DDs and that perhaps has created the confusion. If

however, it is decided by the CBDT that the desired clarification can be brought about

only by an amendment of the provision, it is submitted that it should be effected at

the earliest available opportunity so that the hardship caused to business entities is

set to rest at the earliest.

***

Documents

Pre-Budget Memorandum 2014-15...Krishna Kumar S. Jhunjhunwala Manish P. Sampat Nandita P. Parekh Narayan K. Varma Narayan R. Pasari Pradip K. Thanawala Saurabh P. Shah Sonalee A. Godbole