Pre-Budget Memorandum 2011-12 (Direct Taxes)
CORPORATE TAXATION
- Corporate Tax Rate
Corporate tax rate of 30% for resident companies, coupled with surcharge of 10%, continuing education cess of 2% and additional education cess of 1%, results in effective tax rate of 33.99%. In addition to this, enhanced dividend distribution tax and lowered depreciation rates impose a further strain on companies leading to increased out-go of taxes thus leaving inadequate funds for generation of internal resources for ploughing back for expansion, modernization, technology up-gradation, etc.
The current aggregate tax burden is, thus, significantly higher than other developing / developed countries in the Asia Pacific region. Rationalizing the tax rates and the total tax burden would encourage higher voluntary compliance and result in higher revenues.
Suggestion
It is suggested that the Government should draw up a roadmap for reduction of tax rates and the effective corporate tax rate inclusive of surcharge, cess and other levies should be lowered further to 25%.
- Dividend Distribution Tax (DDT)
As per the provisions of section 115-O, domestic company is required to pay tax on the dividends distributed @ 17% (including surcharge and education cess). The Government aims to put in place a rational and streamlined tax structure. Levying Dividend Distribution Tax results in double taxation of income which is not justified and goes against the above thinking.
Further, the provisions of Section 115-O of the Income-tax Act were amended in the Finance Act, 2008, through insertion of subsection 1A.
While the amendment u/s 115-O to some extent mitigates the cascading effect of taxation of dividend, in case of holding and subsidiary companies, it however, restricts elimination of double taxation only at one level. i.e. only in case of corporates adopting a single tier holding structure i.e. a parent and its subsidiary (Clause (c) of sub-section 1A). The second level and the further step-down subsidiary although in the same group and distributing dividend will continue to pay DDT without any relief on account of cascading effect.
Particularly, in case of infrastructure business, the projects are developed by parent company generally through its holding company which in turn develops and operates/maintains these projects through subsidiaries (Special Purpose Vehicle). Eliminating the cascading effect only partially by granting the benefit only in case of horizontal structure of holding subsidiary and not extending it to the vertical structure wherein there will be more than one step down subsidiary, would impose undue burden on such companies.
Suggestion
It is suggested that the cascading effect should be eliminated.
Further, the cascading effect should be eliminated not just partially by granting the benefit only in case of horizontal structure of holding - subsidiary but also in case of Vertical structures wherein there will be more than one step down subsidiary. Multi-tier structures are being very commonly adopted by the corporates in the new complex and competitive business environment.
It is therefore suggested that the clause (c) of sub-section 1A of Section 115-O should be deleted. This will also be on par with the earlier provisions of Section 80M under which a deduction was allowed in computing the total income of a domestic company of an amount equal to the dividends from another domestic company as did not exceed the amount of dividend distributed by the first mentioned domestic company.
- Sunset Clause in respect of Sections 10A/ 10B Undertakings
The tax benefits in respect of sections 10A/10B undertakings specially for the computer software sector will be lapsing in the current Financial Year. Capacity related investment decisions will continue to be sub-optimal because for any return on investment a minimum five year window is necessary.
Moreover, since the software sector is currently undergoing a crisis because of the worldwide economic crisis and it is also not possible for small companies to shift to Special Economic Zones, it is suggested that the same may be extended at least by another 3 years i.e. till 2014.
4.Taxation of ESOPs
The Finance Act, 2009 provided for the inclusion of ESOPs under section 17(2) to be taxed as a “perquisite”, consequent to the abolition of FBT.
The section states that ESOPs issued free of cost or at concessional rates will be taxed on the date of exercise on the difference between the “fair market value” and the amount actually paid by the employee. The “fair market value” is to be determined based on stipulated methods which have been separately prescribed by the CBDT.
This suffers from the following drawbacks :
- It seeks to tax a notional benefit at a time when the actual gain is not realised by the employee. In fact, it is possible that the actual sale of shares could result in a loss for the employee. Since the perquisite tax paid earlier cannot be set off against the capital loss, the employee suffers a double loss, namely tax outgo and loss on sale of shares. “It is important to bear in mind that if the shares allotted to the employee had no realisable sale value on the day when he exercised his option then there was no cash inflow to the employee. It was not possible for the employee to know the future value of the shares allotted to him on the day he exercises his option.” It may be borne in mind that in the Infosys case, the Supreme Court dismissed the Government’s appeal not only because the ESOP shares were not enumerated under “perquisites” in S. 17 (2), but also because it does not amount to a benefit.
- The question whether the ESOPs are granted at a concessional rate is being determined with reference to the “fair market value” on the date of exercise of the options. Technically, this is an incorrect approach. If the ESOPs are issued at the prevailing market price on the date of grant, the issue should be treated as “non concessional”. This would be in line with the guidelines issued by SEBI. Any subsequent gain accruing to the employee due to favourable market movements by the date of vesting or exercise of option cannot be treated as a “perquisite” granted by the employer.
- Since the actual sale of shares will attract capital gains tax, if applicable, it is unnecessary to subject the employee to perquisite tax.
In fact, before FBT was imposed on ESOPs, specific provisions existed in the Income Tax Act for giving concessions by way of exempting the same from perquisites and subjecting it only to capital gains tax.
It may be noted that ESOPs have emerged over the years as a critical, motivational and retention tool for companies in a highly competitive market for talent. It is a very effective instrument for encouraging employees to perform and excel and is a win-win proposition for the employers / shareholders on one hand and the employees on the other. As such, such concessional treatment was given earlier.
Suggestion
It is suggested that the fair market value should be the market price prevailing on the date of grant of ESOPs.
The earlier income tax provisions before FBT was imposed on ESOPs be brought back by way of exempting the same from perquisite tax and subjecting the subsequent market appreciation to capital gains tax or else, the “fair market value” be determined based on the market value on the date of grant of options.
5.Rate of Depreciation
The rate of depreciation for general machinery and plant has been reduced from 25% to 15%, along with the enhancement of initial depreciation rate from 15% to 20%.
Suggestion
In view of the rapid obsolescence, the lowered depreciation is not adequate to meet the requirement of replacement of the asset. It is therefore suggested that depreciation on machinery should be allowed at least at the rate of 25 percent to provide assesses with sufficient plough back of funds.
Alternatively, the additional depreciation @20% which is applicable on plant & machinery only for the manufacturing sector, on fulfilment of stipulated conditions, should be extended to all asset categories and for all industries.
6.Section 35 (2AB) - Weighted deduction for crop development
Sec 35 (2AB) of Income Tax Act permits a weighted deduction of 200% of expenditure on Scientific Research, in-house Research and development facility in specified industries.
Enhancing productivity lies at the root revitalizing Agriculture, together with effective linkages to markets – both domestic and international. In this context, effective agricultural extension services are crucial to enable effective absorption of technology and best practices at farms. In order to ensure widespread reach of effective extension services, the providers of such services and those engaged in crop development activities need to be recognized on par with Research and Development.
Suggestion
This facility should also be extended to expenditure on agri extension and crop development being done by private companies. By this, all companies engaged in extension of services/research will be encouraged to invest in the upgradation of cultivation / agri practices for improved returns to the farmers.
Also, Section 33 A of the Income Tax Act which permits Development Allowance for Tea plantations may be extended to Crop Development of other cash crops like coffee, tobacco etc. with a weighted deduction of 150%. By this, those engaged in Crop Development / extension services / research will be encouraged to invest in the upgradation of cultivation for improving returns to the farmer and enhancing export competitiveness.
Similarly, assistance given to farmers by the Industry towards modernisation of cultivation practices, e.g. Solar Barns, Seedlings, Irrigation Equipment, should be given weighted deduction in the year it is incurred.
7.Expenditure on Scientific Research {Section 35(2AB)}
As per existing provision where a company is engaged in business of manufacture or production of “or articles notified by the board” and incurred any expenditure (not being expenditure in nature of cost of any land and building or construction of any building) on in-house research and development facility as approved by prescribed authority then such R&D expenditure is allowed as a deduction of a sum equal to 2 times of the expenditure so incurred.
To boost of the research and development activity, the benefit of tax deduction should be extended on expenditure on building exclusively used for R&D.
Since in-house research and development is an integral part of business and a huge amount is incurred on building for setting up research and development facilities.
8.Suggestions Related to Hotel Industry
(i)Section 35AD - Deduction of Capital Expenditure
Section 35AD was introduced by Finance (No.2) Act, 2009 for giving deduction of capital expenditure in respect of new hotels. However, the tax deduction has been restricted to the extent of the profits under section 73A in respect of the said hotel. This has virtually resulted in non-availability of tax relief in initial years when the major capital expenditure is incurred and the new hotel may not have sufficient profits for adjustment. The hotel industry is a highly capital intensive industry. Construction of a new hotel project in 5 Star category demands massive Capital Investment ranging from Rs.300 to Rs.500 crores. The bulk of investment in a hotel is on land and building which gives return to the investors after a very long period.
To accelerate the pace of construction of more hotel rooms, the hotel industry therefore needs to be declared an infrastructure industry. It should be given full benefits of concession for infrastructurefacilities available to other sectors like airports, seaports, power projects and gas distribution networks.
Suggestion
It is thus suggested that the deductibility of capital expenditure should be allowed in full in the initial year by allowing adjustment with the profits from other hotels as well as other businesses. This could in turn not only result in doubling of foreign exchange earnings from tourism but also enlarge the employment opportunities in the country.
(ii)Section 80 IA – Definition of Infrastructure to include Hotels
Under Section 80 IA all new infrastructure projects can avail 100% deduction of their profits and gains for a period of 10 years. The hotels business is a very capital intensive business with high gestation period. An incentive like this would result in more business entities investing in the hotel sector and help in channeling huge investments of about Rs. 50,000 Crores in the tourism sector in the next 3-4 years and quickly bridge the shortfall of hotel accommodation.
Suggestion
It is thus suggested to include hotels in the definition of infrastructure facility under Section 80 IA.
(iii)Section 80 IC - Inclusion of Hotels in Schedule XIV
Section 80 IC of the Income Tax Act provides that any undertaking commencing any operation specified in Schedule XIV having undertaken substantial expansion during the period 1/1/2003 to 1/4/2012 to promote eco tourism in the special category states such as Sikkim, Assam, Tripura, Meghalaya, Mizoram, Nagaland, Manipur, Arunachal Pradesh, Uttaranchal and Himachal Pradesh are exempt from Income Tax for a period of five years for promoting eco tourism in the country.
However, Schedule XIV of the Act does not include hotels as an eligible operation for taking benefit under this provision.
Suggestion
Since the hotel sector is a strong driving force in eco tourism in the country, it is suggested that the benefit of this provision may be extended to cover hotels by including it as an eligible activity in Schedule XIV.
9.Suggestions related to Tax Deducted at Source (TDS):
(i)Applicability of Section 194C to Manufacturing / Supplying Product
In the Finance (No.2) Act, 2009, TDS was made applicable under section 194C in respect of contracts for manufacturing or supplying a product according to the requirement or specification of a customer by using material purchased from such customer. However, in a large number of instances, it is observed that the material which is purchased from the customer represents a small fraction of the total cost and this provision has created huge operating problems since the transaction may be a ‘principal to principal’ contract for purchase and sale of goods and the profit margin may be very small.
Suggestion
It is thus suggested that the provisions of section 194C be only made applicable in cases where the material purchased from the customer is substantial in nature, i.e., say it exceeds 40% of the total material cost (inclusive of raw materials and packing materials).
(ii)Enhancement of Limits for TDS u/s 194C for Payment to Contractors
Currently any payment for contract services rendered which exceeds Rs. 20000 at a time or Rs. 50000 per annum requires the persons responsible for making such payments to deduct tax at source under section 194C.
Suggestion
It is suggested that the threshold limit may be enhanced to Rs. 50,000 for single payment and Rs. 100,000 for aggregate annual limit as the limits of Rs. 20,000 and Rs. 50,000 are meager in the context of rising inflation. The deduction of tax at source on such small amounts involves deployment of relatively large amount of resources in terms of manpower, systems and other costs at the assessee’s end without any significant benefits to the revenue.
(iii) Section 206AA - Higher withholding tax for non quoting of PAN
Section 206AA has been introduced by the Finance Act 2009 provide that w.e.f. 1.4.2010 in the event of non submission of Permanent Account Number by the payee, tax will be deducted at the higher of the following rates, namely;
-Rate specified in the relevant provisions of the Act.
-Rate or rates in force.
-@ 20% whichever is higher.
In many cases one time payment to non-residents on account of technical service fees are negotiated on a net of tax basis. In other words, a non-resident in such cases receives the payment net of withholding tax. The tax in this case is borne by the Indian deductors and the same is grossed up. The payees are not interested in complying with the provisions of obtaining PAN since these are one-time transactions as also the fact that the tax is borne by the Indian payer. It is worth noting that the newly enacted provision will adversely hit the Indian payer who will be required to bear an additional tax burden merely because of the fact that the non-resident payee has not furnished PAN.
Provisions of Section 115A(5) specifically exempt foreign companies from the requirement of furnishing return if the income is derived from certain specified receipts. Such companies will not be interested in complying with the requirement of obtaining PAN. In such cases also the Indian payer will be subject to additional cost burden because of the proposed provision.
Further, the provisions Section 206AA also necessitates the quoting of PAN in case of all declarations for domestic parties under section 197A. However, this is contradictory to the provisions of section 139A which stipulates that PAN is applicable only in certain cases like those with taxable income etc.
In fact, 197A only covers the issue of declarations in respect of dividend income and interest incomes under sections 194 and 194A in Form 15G and Form 15H. Parties with exempt incomes under the various provisions of the Income Tax Law like those with agricultural income etc. are not eligible to give declarations under section 197A for receiving payments in respect of other TDS provisions like section 194C, 194J etc.
Suggestion
It is suggested that a reasonable threshold limit should be fixed upto which the mandatory condition of obtaining PAN should not be applicable to overseas service providers.
It is further suggested that requirement of PAN should be dispensed with where provisions of Section 197A(i) are applicable and parties file declarations in Forms 15G and 15H of the Rules.
Section 197A may be extended for all TDS sections so that a person with agricultural income or income below taxable limit and in receipt of any payment under section 194C etc. can give a proper declaration.
(iv)Applicability of TDS to be Determined Net of Service Tax
The CBDT has only clarified vide Circular no.4/2008 dated 28/4/2008 that the computation of TDS ‘net of service tax’ is to be done in respect of section 194-I for rental income. However, for TDS under other sections like section 194C, 194J etc. the law has not spelt out whether TDS has to be determined inclusive of service tax or net of service tax.
Suggestion
It is suggested that the provisions of Chapter XVII-B should be made applicable ‘net of service tax’ since the same represents a tax and not any income.
10.Weighted Deduction under Section 42 of the Income Tax Act
Under the provisions of the section 42, all expenditure incurred on drilling and exploration activities including capital expenditure is allowed as a deduction to the assessee beginning with the year in which commercial production commences. Any expenditure by way of infructuous or abortive exploration expenses in respect of any area surrendered prior to the beginning of commercial production is also allowed as a deduction to the assessee. The fact that capital expenditure is also otherwise allowed as a deduction beginning with the year of commercial production this provision only amounts to an accelerated deduction of the expenditure incurred and does not amount to any additional deduction or incentive being granted to the assessee.