Corporate Tax - Hidden agendas galore

The Finance Minister has done a creditable job of delicately balancing the objective of preserving fiscal prudence and yet continuing with the overall theme of widening tax base while sustaining moderate tax rates.

The budget is not only a reflection of the currently flourishing Indian economy but also an indication towards growth and buoyancy expected in the economy in the coming years.

On the corporate tax front, the budget has not brought about any change in rates. The FM's decision to keep personal and corporate tax rates intact seems to have stemmed from a healthier-than- anticipated fiscal situation. The government estimates its revenue deficit for 2005-06 at 2.1% of gross domestic product vis-a-vis the budgeted 2.7%.

Last year's budget witnessed the introduction of two significant taxes i.e Fringe Benefit Tax (FBT) and Banking Cash Transaction Tax (BCTT). Although it was the industry's wish that these taxes be abolished, the FM did not accede to the wish and instead made some changes in the FBT regime.

Some of the key corporate tax changes in the Finance Bill 2006 (Bill) have been discussed in the ensuing paragraphs.

Abolition of exemption may impact investments in infrastructure:

Till now, exemption was available to investors under section 10(23G) of the Income tax Act, 1961 (Act) on income by way of dividends, interest or long-term capital gains (LTCG) of infrastructure capital fund/ infrastructure capital company/ co-operative bank arising from investments made in specified infrastructure businesses including development of special economic zones (SEZs), and specified hotel, hospital and housing projects. The exemption was introduced with a view to provide cheaper capital to projects with huge capital outlay coupled with long gestation periods.

The Bill proposes to remove the exemption on the pretext that interest rates are benign. Further, given that dividend income is already exempt in the hands of recipient and LTCG from transactions which are subject to Securities Transaction Tax (STT) are also exempt under Act, it is believed that the exemption has outlived its utility.

However, the withdrawal of exemption is likely to have a dampening impact on future investments (foreign and domestic) in such businesses as the cost of funding such businesses would now rise. This proposal is also dichotomous to the accepted theme that investment in infrastructure needs a bolster if India has to achieve the goal of 10% growth.

In fact, on that note, the Bill proposes to amend section 80IA to extend the time limit for tax holiday on industrial parks to March 31, 2009 and on power generation, distribution or transmission to March 31, 2010. It should be noted that the existing exemption under section 10(23G) is not even grandfathered and all benefits, which are available as of date to approved projects, would be lost come March 31, 2006.

The deletion seems to suggest that accretion to the value of existing investments in such projects should be booked and gains claimed exempt before the sunset of March 31 this year. This proposed deletion of exemption seems even more surprising in the context of the recently enacted SEZ Act, which proposes to extend this benefit.

Amendment in Minimum Alternate Tax (MAT) provisions may bring more companies in the MAT net:

MAT had been introduced in Act with a view to bring zero tax companies into the tax net. The Bill seeks to increase the rate of MAT from existing 7.5% of book profits to 10% of book profits. It also seeks to increase period of availability of MAT credit from 5 to 7 years. The marginal increase in MAT rate, static corporate tax rates coupled with extension of period for which MAT credit can be availed reflects a pragmatic approach adopted by FM towards meeting the twin objective of achieving targeted revenue collections and maintaining stability on tax front to keep up the buoyant market sentiment.

However, what is clearly an unwarranted move is that LTCG arising on transfer of equity shares or units of equity oriented funds, on which STT is leviable, are now required to be included while calculating MAT.

For companies that, till yesterday, rejoiced the fact that their income from LTCG on sale of equity shares on the stock market or equity-oriented funds was not subject to tax, may suddenly be looking at a potential tax of 11.22% (including surcharge and cess) on the book profits.

The Bill proposes to blur the difference in tax impact on capital gains by an investment holding company on sale of its investments in a listed subsidiary whether the transaction is culminated as a long term sale over the stock exchange or long term sale outside the stock exchange or as a short term sale.

It appears that the earlier exemption of such LTCG under MAT had been made available to act as a cushion against the new levy of STT. However, now, when the market seems to have adjusted to levy of STT, the exemption from MAT on such income has been withdrawn.

Companies, at times, revalue their assets upwards and such increase is credited to a revaluation reserve. This revaluation of assets has, sometimes, been attempted with a view to claim higher depreciation and reduce book profits thereby attempting to reduce the MAT liability.

Keeping in view this potential tax abuse and to plug such leakage of revenue, FM has proposed that claim of depreciation, on account of revaluation of assets, shall be added back to book profits to nullify the effect of the same. Further, it has been proposed to provide that amount withdrawn from revaluation reserve and credited to profit and loss account to the extent it does not exceed the amount of depreciation on account of revaluation of assets (added back while computing book profits), shall be reduced from book profits.

Such a provision has been inserted with a view to avoid double taxation, which could be triggered on taxing the amount withdrawn from the revaluation reserve and credited to profit and loss account since to such extent book profits would have already been increased by depreciation on revaluation of assets. The aforesaid amendment would help block the lacuna which may have been used by certain companies for escaping payment of MAT by claiming higher depreciation on upward revaluation of assets.

Time period for serving notice by tax department

The existing provisions of section 142(1) stipulate that where a tax payer has not furnished return of income within prescribed due date, the tax officer may serve a notice requiring him to furnish the return of income. Hitherto, the time period up to which such a notice can be issued was not specifically prescribed. In a recent judgment in the case of Motorola Inc, Ericsson Radio Systems AB and Nokia Networks OY (96 TTJ 1), it was held by the Special Bench of Delhi Income Tax Appellate Tribunal that a notice after the end of relevant assessment year was invalid since the Act provided a separate provision (ie: section 148) under which a notice could be issued by a tax officer within a specified period beginning from the end of the assessment year requiring the assessee to furnish a return of income.

The Bill seeks to amend section 142(1) of Act by providing that where a person has not furnished his return before the end of relevant assessment year, the tax officer can serve a notice after the end of relevant assessment year under the said section requiring such person to furnish his return of income.

The memorandum explaining the budget states such amendment to be clarificatory in nature thereby implying that the power of the tax officer under this section extends to issuing a notice on assessee any time after the relevant assessment year till the time period prescribed for completion of assessment proceedings.

Such a provision could result in an absurdity where tax officer issues a notice under this section any time before completion of assessment proceedings which could even be a week/ day before completion of the assessment proceedings.

Expenditure relating to exempt income:

Till now, expenditure in relation to earning tax exempt income is not deductible. However, no method had been prescribed for computing such expenditure.

The Bill proposes to introduce a method for determining such expenditure and it would be mandatory for the tax officer to determine the amount of expenditure incurred in relation to exempt income in accordance with the prescribed method.

However, the tax officer shall be required to adopt the prescribed method if he is not satisfied with the correctness of claim of the assessee!

On a plain reading of the provision, application of prescribed method for determination of expenditure related to exempt income is at the discretion of the tax officer only if the tax officer is not satisfied with the correctness of claim of assessee in respect of such expenditure.

Further, even in a case where separate books of account are maintained for exempt income and expenditure, the tax officer can apply the prescribed methods.

The issue that merits attention is whether the tax officer has power to only determine the amount of expenditure (that is, only apportionment) or can he also determine whether a particular type of expenditure relates to exempt income?

This is clearly a move that seeks to enhance arbitrariness of tax assessments and should be re-examined.

Although the proposed changes do not seem to result in any major revamping of corporate tax provisions on plain reading, the real impact of the proposed amendments would emerge gradually as the amendments come into practice.

(Courtesy: Ernst & Young)