Taxmann's Direct Taxes Law & Practice with Special Reference to Tax Planning

A few words from the authors

T

HE compendious and complex nature of our law relating to direct taxes makes the task of students and professional practitioners, who have not only to understand it but have also to develop the ability to apply it in given situations, extremely onerous and difficult. They have to acquire a familiarity with, and awareness of, the nature and scope of the main provisions of direct taxes. At the same time, they also require an up-to-date knowledge of how a statutory provision has been interpreted by different courts of law on different occasions.

As such, they need a book on direct taxes which not only is comprehensive and up-to-date on both the law and its judicial interpretations but which also explains the difficult subject lucidly and through appropriate illustrations so as to render the study of direct taxes simple and easy.

Unlike other text books available on this subject, this book makes a fresh and novel approach to the study of direct taxes keeping in view the specific requirements of the candidates appearing in CA, CS, ICWA, MCom., LLB and MBA examinations as well as those appearing in the income-tax departmental examination. The chief aim of the book is to enable the students to cut the time spent by them in preparing for the examination, while, at the same time, giving them the most precise and up-to-date information on the subject of their study.

The present edition of the book has several unparalleled features which make it distinct from other available text books. These are : u The present edition is thoroughly revised with a view to making it more

reader-friendly. u The treatment of the subject is lucid, to-the-point and the matter is painstak-

ingly arranged in paras and sub-paras with distinct numbers to save time and energy. Besides, debatable issues have been deliberated to their logical conclusion. u Theoretical discussion is suitably supplemented by illustrations (over 600 in

number and covering an exhaustive range of issues) providing solutions to the knotty problems with reference to the latest case law. u Hints are given wherever tax planning can be resorted to. u Latest circulars, notifications, amendments and the case laws (i.e., up to

December 31, 2023) are included in the discussion. All recent citations of court rulings, circulars and notifications have been highlighted. u In a nutshell, law is lucidly enumerated and its practical application is

adequately explained.

I-5

A few words from the authors

I-6

u All questions set for CA (Final) examination for last 10 years are given along

with their solutions (of theory as well as practical questions) as per law applicable for the assessment year 2024-25. Besides, questions set at various post-graduate and professional examinations are also included at the end of each chapter.

Our grateful thanks are due to Shri Rakesh Bhargava for his guidance and suggestions and for extending various facilities during the preparation of the manuscript of this book.

Readers’ views, comments and criticism relating to the present work are most welcome.

22 Deepali, Pitampura, Delhi - 110034.

Email : vks@taxmann.com Phone : 27015500, 27016686, 9810008160

VKS KS

About the Authors Dr. Vinod K. Singhania got his Ph.D. from the Delhi School of Economics in 1976.

His fields of special interest include all facets of corporate legislation and corporate economics especially the tax laws. Associated in different capacities with several professional institutes and business houses in India and abroad, Dr. Singhania is author of many popular books and software published by Taxmann. He has to his credit more than 300 research articles which have appeared in leading journals.

He has been a resource person in over 800 seminars in India and abroad. He can be reached at vks@taxmann.com.

Dr. Kapil Singhania, a Fellow of the Institute of Chartered Accountants of India and belonging to the alumni of Shri Ram College of Commerce, has completed his research work for which he has been awarded Ph.D. in 2003. His fields of involvement in research work in form of articles in various reputed journals and analytical studies span across from corporate laws to direct and indirect taxation.

He has authored a variety of acclaimed books on direct and indirect taxes published by Taxmann. Dr. Singhania is providing tax consultancy to a number of business organizations, which include multinational and public sector companies.

I-7

Contents PAGE u A few words from the authors

I-5

u About the authors

I-7

u Section-wise Index

I-25

1 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

17.

18.

19.

20.

Assessment year Previous year Person Assessee Charge of income-tax Income Gross total income Total income and tax liability Agricultural income Difference between exemption and deduction Assessment Definition of “manufacture” Capital asset Company Fair market value Capital receipts vs. Revenue receipts Capital expenditure vs. Revenue expenditure Method of accounting Definitions of amalgamation, demerger, infrastructure capital company and infrastructure capital fund Rules of interpretation

2 22.

23.

24.

25.

26.

27.

28.

29.

30.

31.

Basic concepts 1 1 5 6 6 7 17 21 30 31 31 31 31 31 31 32 38 38 39 40

Residential status and tax incidence

What is relevance of residential status Residential status - General norms Residential status of an individual Residential status of a Hindu undivided family Residential status of the firm and association of persons Residential status of a company Residential status of “every other person” Relation between residential status and incidence of tax Receipt of income Accrual of income

I-9

54 54 55 63 64 65 69 69 72 74

Contents

I-10 PAGE

32.

32A. 33.

34.

Income deemed to accrue or arise in India Fund Managers in India not to constitute business connection of offshore funds Hints for tax planning in respect of residential status Problems on residential status and tax incidence

3 38.

39.

40.

41.

42.

43.

44.

Incomes exempt from tax

Incomes exempt under section 10 Special provisions in respect of newly established undertakings in free trade zone, etc.

Special provisions in respect of newly established units in Special Economic Zone Special provisions in respect of newly established hundred per cent export-oriented undertakings Special provision in respect of export of artistic hand-made wooden articles Income exempt under section 13A Exemption to Electoral Trust

4

Essential norms of salary income Basis of charge Place of accrual of salary income Tax treatment of different forms of salary income Allowance Perquisites Valuation of perquisites Deduction from salary income Tax on salary of non-resident technicians Salaries of other foreign citizens Employees’ provident fund Approved superannuation fund Approved gratuity fund Deduction under section 80C Relief under section 89 Relief from taxation in income from retirement benefit account maintained in a notified country 62. Meaning of salary for different computations 63. Hints for tax planning 64. Problems on salary income Annex 1 : Frequently Asked Questions (FAQs) about computation of salary income

86.

87.

88.

101 135 135 140 140 140 140

Salaries

46.

47.

48.

49.

50.

51.

52.

53.

54.

55.

56.

57.

58.

59.

60.

61.

5

78 95 97 98

142 144 145 146 164 171 175 206 206 206 207 214 214 214 214 217 218 220 221 233

Income from house property

Chargeability Applicability of section 22 in certain typical situations Principle of mutuality vis-a-vis section 22

234 239 241

I-11

Contents

89.

90.

91.

92.

93.

94.

95.

App.

Property income exempt from tax Computation of income from a let out house property Computation of income from self-occupied property Special provisions when unrealised rent is realised subsequently Mode of taxation of arrears of rent in the year of receipt Hints for tax planning Problems on computation of property income Frequently Asked Questions (FAQs) about mode of computation of annual value

PAGE

6

242 242 251 260 260 260 261 271

Profits and gains of business or profession

101. Chargeability 102. General principles governing assessment of business income 103. Method of accounting 104. Scheme of deductions and allowances 105. Basic principles governing admissibility of deduction under sections 30 to 44DB 106. Deductions expressly allowed in respect of expenses/allowances 107. Rent, rates, taxes, repairs and insurance of building 108. Repairs and insurance of machinery, plant and furniture 109. Depreciation 110. Investment allowance for acquisition and installation of new plant and machinery 110A. Investment allowance in backward area in Andhra Pradesh, Bihar, Telangana or West Bengal 111. Tea/coffee/rubber development account 112. Site restoration fund 113. Reserves for shipping business 114. Expenditure on scientific research 115. Expenditure on acquisition of patent rights, copyrights, know-how 116. Expenditure for obtaining right to use spectrum for telecommunication services 117. Amortization of telecom licence fees 118. Expenditure on eligible projects or scheme 119. Deduction in respect of expenditure on specified business 120. Payment to the associations and institutions carrying out rural development programmes 120A. Deduction for expenditure incurred on agricultural extension project 120B. Deduction for expenditure for skill development 121. Amortisation of preliminary expenses 121A. Amortisation of expenditure in the case of amalgamation/demerger 121B. Amortisation of expenditure under voluntary retirement scheme 122. Amortisation of expenditure on prospecting, etc., for development of certain minerals 123. Insurance premium 124. Insurance premium paid by a federal milk co-operative society 125. Insurance premium on health of employees 126. Bonus or commission to employees 127. Interest on borrowed capital

275 288 294 295 295 297 297 298 299 342 342 343 346 348 348 359 359 360 362 362 367 368 368 369 373 373 373 376 376 376 376 377

Contents

I-12 PAGE

127A. Discount on zero coupon bonds 128. Employer’s contribution to recognised provident fund and approved superannuation fund 128A. Employer’s contribution to notified pension scheme 129. Contribution towards approved gratuity fund 130. Employees’ contribution towards staff welfare schemes 131. Write off allowance for animals 132. Bad debts 133. Provision for bad and doubtful debts relating to rural branches of commercial banks 134. Transfer to special reserve 135. Family planning expenditure 136. Contribution towards Exchange Risk Administration Fund 137. Revenue expenditure incurred by entities established under any Central, State or Provincial Act 137A. Contribution to credit guarantee trust fund 137B. Commodities transaction tax/Securities transaction tax 138. Expenditure for purchase of sugarcane by a co-operative society engaged in sugar manufacturing 138A. Marked to market loss 139. Expenditure on advertisement 140. Expenses deductible from commission earned by life insurance agents, UTI agents, post office/Government securities agents and agents of notified mutual funds 141. General deduction 142. Amounts expressly disallowed under the Act 143. Amount not deductible under section 40(a) 144. Amount not deductible in the case of partnership firm 145. Amounts not deductible in the case of an association of persons and body of individuals 146. Amount not deductible under section 40(c)/(d) 147. Payments to relative 148. Payments exceeding Rs. 10,000 paid otherwise than by account payee cheques or bank drafts 149. Expenditure on payment of salary or perquisite to employees 150. Fees for services payable to a former employee 151. Provision for payment of gratuity 152. Interest on public deposit 153. Restriction on contributions by employers to non-statutory funds 154. Disallowance of marked to market loss 155. Disallowance of unpaid liability 156. Deemed profit 157. Income from undisclosed sources 158. Maintenance of accounts by certain persons 159. Audit of accounts by certain persons 160. Special provisions consequential to changes in the rate of exchange of currency 161. Special provision for deduction in the case of trade, professional or similar associations

380 381 382 382 382 383 383 387 390 392 393 393 393 393 393 394 394

395 396 454 454 466 466 466 466 469 473 473 473 474 474 475 475 486 490 492 494 496 498

I-13

Contents PAGE

162.

163.

164.

165.

Special provisions Valuation of stock Hints for tax planning Problems on computation of income from business/profession

7

Capital gains

Chargeability Meaning of capital asset Types of capital assets Transfer of capital asset Computation of capital gain Full value of consideration Expenditure on transfer Cost of acquisition Cost of improvement Indexed cost of acquisition and indexed cost of improvement Computation of capital gain in certain special cases Reference to Valuation Officer Capital gains exempt from tax Capital gains arising from transfer of residential house Capital gains arising from the transfer of land used for agricultural purpose Capital gains on compulsory acquisition of land and buildings forming part of industrial undertaking 182. Capital gain not to be charged on investment in certain bonds 182A. Capital gain not to be charged on investment in units of a specified fund 183. Capital gains on transfer of a long-term capital asset other than a house property 184. Capital gains on transfer of assets in cases of shifting of industrial undertaking from urban area 185. Exemption of capital gains on transfer of assets in cases of shifting of industrial undertaking from urban area to any Special Economic Zone 185A. Capital gain on transfer of residential property 185B. Extension of time-limit for acquiring new asset 186. Short-term/long-term capital gains - How charged to tax 187. Hints for tax planning 188. Problems on computation of capital gains 166.

167.

168.

169.

170.

171.

172.

173.

174.

175.

176.

177.

178.

179.

180.

181.

8 191.

192.

193.

194.

195.

196.

197.

198.

499 525 530 536

545 545 549 552 566 569 570 572 585 587 591 624 625 627 634 636 637 640 641 648 651 651 652 653 669 671

Income from other sources

Basis of charge Relevance of method of accounting Dividend Winnings from lotteries, crossword puzzles, horse races and card games, etc.

Sum received from employees as their contribution towards staff welfare schemes Interest on securities Income from machinery, plant or furniture let on hire Income from composite letting of building, machinery, plant or furniture

676 679 679 688 690 690 694 694

Contents

I-14 PAGE

Money/property is received without consideration or for inadequate consideration 200. Share premium in excess of fair market value 201. Advance money received in course of negotiations for transfer of a capital asset 201A. Compensation on termination of employment or modification of terms of employment 201B. Distribution by business trusts to unitholders [Secs. 56(2)(xii) and 115UA] 201C. Sum received under a life insurance policy [Sec. 56(2)(xiii)] 202. Interest on KVP, IVP, NSC, etc.

203. Deductions 204. Other points 205. Problems on computation of income from other sources 199.

9 206.

207.

208.

209.

210.

211.

212.

213.

214.

215.

216.

217.

218.

226.

227.

228.

229.

230.

231.

232.

233.

711 712 712 716 717 719 720

Income of other persons included in assessee’s total income

Transfer of income without transfer of assets Revocable transfer of assets When an individual is assessable in respect of remuneration of spouse When an individual is assessable in respect of income from assets transferred to spouse When individual is assessable in respect of income from assets transferred to son’s wife When individual is assessable in respect of income from assets transferred to a person for the benefit of spouse When an individual is assessable in respect of income from assets transferred to a person for the benefit of son’s wife Income of minor child Conversion of self-acquired property into joint family property and subsequent partition Other profits Recovery of tax Hints for tax planning Problems explaining clubbing provisions

10

696 706 711

726 726 727 730 734 735 736 736 738 739 739 740 741

Set off and carry forward of losses

Mode of set off and carry forward - The three steps Inter-source adjustment - How made Inter-head adjustment - How made Carry forward of loss Loss of partnership firms Loss of closely held companies Carry forward and set off of loss and depreciation - When permissible in the hands of amalgamated and demerged company or co-operative bank Problems illustrating the provisions of set off and carry forward of losses

746 746 747 749 762 762 762 763

I-15

Contents PAGE

11

Deductions from gross total income and tax liability

Essential rules governing deductions Deduction in respect of life insurance premia, deferred annuity, contributions to provident fund, subscription to certain equity shares or debentures, etc.

235A. Deduction in respect of deposit under National Savings Scheme 236. Equity Linked Savings Scheme 237. Deduction in respect of pension fund 237A. Deduction in respect of contribution to a National Pension System (NPS) 237B. Deduction in respect of subscription to long-term infrastructure bonds When available under section 80CCF 237C. Deduction in respect of investment made under any equity saving scheme 237D. Deduction in respect of contribution to Agnipath Scheme [Sec. 80CCH] 238. Deduction in respect of medical insurance premia 239. Deduction in respect of maintenance including medical treatment of a dependent being a person with disability - When and to what extent available 240. Deduction in respect of medical treatment, etc.

241. Deduction in respect of payment of interest on loan taken for higher studies 241A. Deduction in respect of interest on loan taken for residential house property 241B. Deduction in respect of interest on loan taken for certain house property 241C. Deduction in respect of interest on loan taken for purchase of electric vehicle 242. Deduction in respect of donation to certain funds, charitable institutions, etc.

243. Deduction in respect of rent paid 244. Deduction in respect of certain donations for scientific research or rural development 245. Deduction in respect of contributions given by companies to political parties or electoral trust 246. Deduction in respect of contributions given by any person to political parties or electoral trust 247. Deduction in respect of profits and gains from projects outside India 248. Deduction in respect of profits and gains from housing projects aided

by World Bank 249. Tax incentives for exports 250. Deduction in respect of earnings in convertible foreign exchange 251. Deduction in respect of profit from export of computer software 252. Deduction in respect of profits and gains from export or transfer of films software 253. Deduction in respect of profits and gains from industrial undertaking or enterprises engaged in infrastructure development etc. - How to find out 253A. Deductions in respect of profits and gains by an undertaking or enterprise engaged in development of Special Economic Zone 253B. Deduction in respect of eligible start-up 254. Deduction in respect of profits and gains from certain industrial undertakings other than infrastructure development undertakings - How to avail 254A. Deduction in respect of profits from housing projects 255. Deduction in respect of profits and gains of certain undertakings in certain special category of States - How to find out 255A. Deduction in the case of hotels and convention centre in NCR 255B. Deduction in respect of certain undertakings in North-Eastern States 234.

235.

767 768 776 777 778 779 781 781 782 782 785 787 790 790 791 792 792 799 800 801 802 802 802 802 802 802 802 803 815 816 817 828 830 830 830

Contents

I-16 PAGE

256.

257.

258.

259.

260.

261.

262.

263.

264.

265.

266.

267.

268.

269.

270.

Deduction in respect of profits and gains from the business of collecting and processing of bio-degradable waste Deduction in respect of employment of new employees Deduction in respect of interest on certain securities, investments, etc.

Deduction in respect of certain income of Offshore Banking Units and International Financial Services Centre Deduction in respect of inter-corporate investment Deduction in respect of income of a co-operative society Deduction in respect of certain income of producer companies Deduction in respect of royalty income of authors Deduction in respect of remuneration or professional income from certain foreign sources Deduction in respect of royalty on patents Deduction in respect of interest on deposits in savings accounts Deduction in respect of interest on deposits in case of senior citizens Deduction in case of a person with disability Deductions from tax liability Rebate for resident individuals

12 278.

279.

280.

281.

285.

286.

287.

288.

295.

296.

297.

298.

299.

300.

301.

302.

303.

839 839 841 841 842 843 844

850 856 858 859

Typical problems on assessment of individuals

Tax incidence on individuals Taxable income - How computed Tax liability Problems on computation of taxable income

14

834 835 837 837 838

Agricultural income

Definition Income which is partly agricultural and partly from business Partially integrated taxation of non-agricultural income with income derived from agriculture Computation of net agricultural income

13

831 831 834

867 867 868 872

Tax treatment of Hindu undivided families

Meaning of Hindu undivided family Hindu coparcenary Different schools of Hindu law Jain and Sikh families Assessment as Hindu undivided family - Basic conditions Taxable income - How to compute Rates of tax Partition of a Hindu undivided family Problems on Hindu undivided families

883 883 883 884 884 885 887 887 889

I-17

Contents PAGE

15 313.

314.

315.

316.

317.

318.

319.

320.

321.

322.

323.

324.

325.

326.

327.

328.

Special provisions governing assessment of firms and association of persons

Meaning of partnership Scheme of taxation of firms When remuneration/interest is deductible What are the conditions a firm should fulfil under section 184 What are the conditions for claiming deduction of remuneration to partners under section 40(b) What are the conditions for claiming deduction of interest to partners under section 40(b) Carry forward and set-off of loss in the case of change in the constitution of firm Computation of income of firm Computation of tax of firm Assessment of partners of a firm How to compute income of an association of persons (AOP) or body of individuals (BOI) Computation of income of an AOP/BOI Computation of tax of AOP or BOI Assessment of member of AOP/BOI Hints for tax planning Problems on computation of taxable income of firms/partners and association of persons

16

339.

340.

341.

342.

898 904 905 908 910 917 920 922 922 924 929 936

Taxation of companies

333. Definitions 334. Taxable income and tax liability - How computed 335. Carry forward and set-off of losses in the cases of certain companies 336. Minimum alternate tax 337. Tax on distributed profits of domestic companies 337A. Tax on income distributed to unitholders 337B. Tax on income received from venture capital companies and venture capital funds 337C. Additional income-tax on distributed income by company for buy-back of unlisted shares 338. Problems on computation of taxable income of a corporate-assessee

17

896 896 896 897

942 944 946 948 970 971 971 971 972

Assessment of co-operative societies

Meaning of co-operative society Taxable income and tax liability - How computed Deduction in respect of income of co-operative societies Problems on computation of income of a co-operative society

996 996 997 1005

Contents

I-18 PAGE

18

Assessment of charitable and other trusts

Meaning of trust Tax exemption Charitable purpose Essential conditions for exemption How to find out exemption u/s 11 Accumulation of income Forfeiture of exemption Public charitable/religious trust - How chargeable to tax Private discretionary trust Income from property held under trust partly for religious purposes and partly for other purposes 352A. Oral trust 352B. Tax on distributed income by securitization trusts 352C. Special provisions pertaining to business trust 352D. Pass through status to Category I and Category II Alternative Investment Funds 343.

344.

345.

346.

347.

348.

349.

350.

351.

352.

19

1007 1007 1007 1012 1018 1025 1027 1037 1040 1041 1043 1043 1044 1046

Return of income and assessment

353. Voluntary return 354. Return of loss 355. Belated return 356. Revised return 357. Updated return 358. Defective or incomplete return 358A. Modified return 359. Scheme to facilitate submission of returns through Tax Return Preparers 359A. Power of Board to dispense with furnishing of documents 359B. Filing of return in electronic form 360. Return by whom to be verified 361. Permanent Account Number (PAN) 361A. Quoting of Aadhaar number 362. What is self-assessment 363. Inquiry before assessment 364. Summary assessment without calling the assessee 365. Assessment in response to notice under section 143(2) 366. Best judgment assessment 366A. Reference to dispute resolution panel 367. Income escaping assessment and re-assessments 368. Issue of notice for reassessment under section 148 369. What are the provisions regarding rectification of mistake 370. Time limit for completion of assessments/reassessments 371. Provisions of section 155 372. Problems on return of income and assessment 372A. Obligation to furnish annual information return pertaining to financial transactions

1051 1055 1055 1056 1058 1063 1065 1066 1066 1066 1066 1067 1073 1074 1076 1080 1083 1095 1096 1098 1106 1113 1118 1124 1126 1129

I-19

Contents PAGE

372B. Submission of statement by a non-resident having liaison office in India 372C. Furnishing of information or document by an Indian concern 372D. Reporting by producers of cinematograph films or persons engaged in specified activities

20 373.

374.

375.

376.

377.

378.

379.

380.

381.

382.

383.

384.

385.

386.

387.

388.

389.

390.

391.

392.

1178 1179 1180 1180

Interest

Interest payable by the assessee Interest payable to assessee Procedure to be followed in calculation of interest Waiver or reduction of interest under sections 234A, 234B and 234C Chief Commissioner/Director General (Investigation) to reduce penal interest in certain cases Power of CBDT and Settlement Commission to reduce/waive interest Writ petition Problems illustrating computation of interest

23

1133 1144 1164 1164 1169 1169 1172 1176

Advance payment of tax

Income liable for advance tax Advance tax liability - Under different situations Interest payable by the assessee or Government Problems illustrating advance tax provisions

22

1132

Penalties and prosecutions

Penalties for defaults in brief Penalty for concealment/under-reporting of Income Who can levy penalty Power of Commissioner to reduce or waive penalty Procedure for imposition of penalty Time-limit for completion of penalty proceedings Offences and prosecutions Onus of proof

21

1132 1132

1182 1198 1202 1202 1203 1204 1204 1204

Tax deduction or collection at source

404. Scheme of tax deduction at source 405. Deduction of tax from salaries 405A. Tax deduction at source from withdrawal from employees provident fund scheme 406. Deduction of tax at source from interest on securities 407. Deduction of tax at source from dividends 408. Deduction of tax at source from interest other than interest on securities 409. Deduction of tax at source from winnings from lotteries or crossword puzzles, etc.

409A. Deduction of tax at source from winnings from online games [Sec. 194BA] 410. Deduction of tax at source from winnings from horse races 411. Deduction of tax at source from payments to contractors or sub-contractors 412. Deduction of tax at source from insurance commission

1211 1214 1220 1223 1224 1225 1229 1230 1233 1233 1239

Contents

I-20 PAGE

412A. Tax deduction from payment of life insurance policy 413. Payment to non-resident sportsman or sports association 414. Deduction of tax from payments in respect of National Savings Scheme 415. Deduction of tax at source on payments on account of repurchase of units by Mutual Funds or UTI 416. Deduction of tax from commission, etc., on sale of lottery tickets 417. Deduction of tax at source from commission or brokerage 418. Deduction of tax at source from income by way of rent 418A. Tax deduction at source on purchase of immovable property 418B. Tax deduction from payment of rent by certain individuals/HUFs 418C. Tax deduction from payment under joint development agreement 419. Tax deduction at source on fees for professional or technical services, royalty or directors fees 419A. Tax deduction at source in respect of income from units 420. Tax deduction from payment of compensation in certain cases 420A. Deduction of tax at source from interest payable on infrastructure debt fund 420AA. Tax deduction from income from units of business trust 420AB. Tax deduction from income in respect of units of investment fund 420ABB. Tax deduction from income in respect of investment in Securitization fund 420B. Tax deduction by an Indian specified company or business trust from interest to a non-resident/foreign company 420C. Tax deduction at source on interest on bonds/Government securities 420D. TDS on certain payments by individual/HUF 420E. TDS on payment of certain amounts in cash 420F. TDS on payment by e-commerce operator to e-commerce participants 420G. Deduction of tax in case of specified Senior Citizen 420H. Deduction of tax at source on payment for purchase of goods 420-I. Deduction of tax on benefit/perquisite pertaining to business/profession 420-J. Deduction of tax from payment on transfer of virtual digital asset 421. Deduction of tax at source from other sums 422. Tax deduction from any income payable to non-resident unit-holders of Mutual Fund 423. Deduction of tax at source in respect of units referred to in section 115AB 424. Deduction of tax from income or long-term capital gain from foreign currency bonds/Global Depository Receipts 425. Deduction of tax from income of Foreign Institutional Investors from securities 426. Payment without tax deduction or with deduction at lower rate 427. Processing of statements of tax deducted at source 428. Other points for consideration 429. Tax collection at source

24 430.

431.

432.

433.

1240 1241 1242 1242 1242 1243 1245 1250 1250 1251 1252 1256 1256 1257 1257 1258 1258 1259 1260 1261 1262 1263 1264 1265 1268 1271 1272 1278 1278 1278 1279 1279 1283 1283 1292

Refund of excess payments

Right to claim refund - When arises Who can claim refund How to claim refund Other points

1304 1304 1304 1305

I-21

Contents PAGE

25 434.

435.

436.

437.

438.

439.

440.

441.

442.

443.

444.

Meaning of appeal Appellate hierarchy Appeal to Joint Commissioner (Appeals) Appeal to the Commissioner (Appeals) Revision by the Commissioner of Income-tax Appeal to the Appellate Tribunal Appeal to High Court Appeal to the Supreme Court Provision for avoiding repetitive appeals Procedure for appeal by revenue when an identical question of law is pending before High Court/Supreme Court Consequence of non-filing of appeal in respect of cases where the tax effect is less than the prescribed monetary limit

26 445.

446.

471.

472.

473.

474.

475.

476.

477.

478.

479.

1351

1353 1353

1356 1356 1360

Special measures in respect of transactions with persons located in notified jurisdictional area

Special measures in respect of certain transactions Notified jurisdictional area Applicability of transfer pricing provisions Disallowance of payment to financial institutions located in notified jurisdictional area Disallowance of other expenditure Amount received to be treated as income in some cases TDS at higher rate Provisions illustrated

29

1350

Settlement Commission and Dispute Resolution Committee

Settlement Commission Discontinuation of Income-tax Settlement Commission Dispute Resolution Committee

28

1307 1307 1308 1309 1322 1330 1342 1348 1349

Income-tax authorities

Tax authorities Central Board of Direct Taxes

27 457.

458.

459.

Appeals and revisions

1363 1363 1363 1364 1364 1364 1364 1364

General Anti-avoidance Rule

Applicability of general anti-avoidance rule

1367

Contents

I-22 PAGE

480.

481.

482.

483.

Impermissible avoidance arrangement When GAAR provisions are not applicable Procedure for invoking GAAR Clarifications given by Board

30

1367 1369 1369 1370

Advance ruling

485.

Constitution of the Board for Advance Ruling

1371

486.

Advance ruling

1373

487.

Procedure for filing application

1374

488.

Procedure on receipt of application

1376

489.

Applicability of advance ruling

1378

490.

Advance ruling to be void in certain circumstances

1379

491.

Powers of authority

1379

491A. Authority for advance rulings

1379

31

Search, seizure and assessment

492. Powers regarding discovery, production of evidence, etc.

493. Search and seizure 494. Requisitioning of books of account, etc.

495. Application of assets seized or requisitioned 496. Power to call for information 497. Power of survey 498. Power to collect certain information 498A. Power to call for information by prescribed income-tax authority 499. Scheme of assessment in case of search or requisition 500. Prior approval in the case of search

32

1381 1382 1390 1392 1393 1394 1396 1397 1397 1404

Transfer pricing

Taxation of international transaction Computation of the arm’s length price Arm’s length price - Computation of Computation of arm’s length price in cases where more than one price is determined under most appropriate method 510. Reference to transfer pricing officer 510A. Power of Board to make Safe Harbour Rules 511. Maintenance of books of account and furnishing of report in respect of international group 512. Report from accountant 513. Specified domestic transactions 514. Advance Pricing Agreement (APA) 514A. Secondary adjustment in certain international transactions 514B. Provisions pertaining to thin capitalisation

1405 1409 1410

514C. Important judicial rulings

1448

506.

507.

508.

509.

1417 1427 1430 1434 1439 1439 1439 1441 1445

I-23

Contents PAGE

33 515.

516.

517.

518.

519.

520.

521.

522.

523.

Restructuring business Amalgamation Demerger Conversion of sole proprietary business into company Conversion of firm into company Slump sale Transfer of assets between holding and subsidiary companies Amalgamation or demerger of co-operative banks Conversion of private company/unlisted public company into Limited Liability Partnership (LLP)

34 531.

532.

533.

534.

535.

536.

537.

538.

539.

540.

541.

542.

543.

544.

545.

546.

547.

548.

549.

550.

551.

552.

553.

554.

555.

556.

557.

558.

559.

Business restructuring 1449 1449 1458 1468 1469 1471 1477 1482 1484

Alternative tax regime

Alternative tax regime available under different sections Manufacturing domestic companies under section 115BA Tax on income of certain domestic companies Conditions and restrictions Tax rate Option MAT not applicable Case studies New manufacturing domestic companies Conditions Mode of computation of income Computation of tax liability under section 115BAB Option MAT not applicable Case study Income of individuals, HUF, AOP, BOI and artificial juridical person Rate of income-tax under the alternative tax regime Conditions and restrictions Option Case studies Tax on certain resident co-operative societies Conditions and restrictions under section 115BAD Tax rate Option New manufacturing co-operative society Conditions Mode of computation of income Computation of tax liability under section 115BAE Option

1489 1492 1493 1493 1494 1494 1494 1494 1495 1495 1496 1497 1497 1498 1498 1499 1499 1500 1502 1503 1508 1508 1509 1509 1509 1509 1510 1510 1511

Contents

I-24 PAGE

35 565.

566.

567.

568.

569.

570.

571.

Tax planning Tax planning with reference to setting up of a new business Tax planning with reference to financial management decisions Tax planning with reference to specific managerial decisions Tax planning in respect of employees’ remuneration Tax planning in respect of non-residents Tax planning in respect of amalgamation or demerger of companies or business restructuring

36 572.

573.

574.

575.

577.

578.

580.

581.

582.

583.

Tax planning 1512 1514 1516 1517 1521 1523 1528

Miscellaneous

Introduction of Tonnage Tax Securities Transaction Tax Tax clearance certificate Equalisation levy Provisions pertaining to successor entity subsequent to business reorganization Commodities transaction tax Facility for electronic communication Introduction of Document Identification Number Power to withdraw approvals Restriction on cash transactions

1529 1532 1534 1536 1540 1541 1542 1542 1542 1542

ANNEXURES 1.

Tax rates

1546

2.

Rates of depreciation

1571

3.

The Eleventh Schedule, Thirteenth Schedule, Fourteenth Schedule/ Investment ceiling in the case of small scale industrial undertaking

1578

4.

Notified backward districts

1585

5.

Questions set for CA (Final) Examination and Answers from May 2013 to May 2023

1587

1439

Advance Pricing Agreement

Para 514

Report from accountant 512. The report from an accountant which is required to be furnished under section 92E by every person who has entered into an international transaction during the previous year shall be in Form No. 3CEB and be verified in the manner indicated therein. It shall be furnished electronically before the time-limit given below – - Up to the assessment year 2019-20 - On or before the due date of submission of return of income.

- From the assessment year 2020-21 - One month prior to the due date of submission of return of income (if the due date of submission of return of income is November 30 of the assessment year, the above report should be uploaded on or before October 31 of the assessment year).

Specified domestic transactions 513. Section 92BA was inserted with effect from the assessment year 2013-14. It provides the meaning of “specified domestic transaction” with reference to which the income is to be 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 (Rs. 5 crore for the assessment years 2013-14 to 2015-16) – a. any expenditure in respect of which payment has been made or is to be made to a person referred to in section 40A(2)(b) (applicable only for the assessment years 2013-14 to 2016-17); 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 business transacted between the persons referred to in section 115BAB(6); g. any business transacted between the assessee and other person referred to in section 115BAE(4); or h. 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 discussed earlier in this chapter.

Advance Pricing Agreement (APA) [Secs. 92CC and 92CD] 514. Advance Pricing Agreement is an agreement between a 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.

Sections 92CC and 92CD provide a framework for advance pricing agreement under the Act. These provisions provide the following— ■ Board may enter into APA - Section 92CC empowers the Board (with the approval of the Central

Government) to enter into an advance pricing agreement with any person to determine the – a. arm’s length price (or specifying the manner in which arm’s length price is to be determined) in relation to an international transaction; b. (with effect from April 1, 2020) income referred to in section 9(1)(i) (or specifying the manner in which said income is to be determined) as is reasonably attributable to the operations carried out in India by (or on behalf of) a non-resident.

Para 514

Income-tax - Transfer pricing

1440

■ Purpose of APA - Such APA shall include determination of the arm’s length price or specify the manner in which arm’s length price shall be determined, in relation to an international transaction to be entered into, by that person.

■ How to compute ALP - The manner of determination of arm’s length price in such cases shall be

any method including those already provided in section 92C(1), with necessary adjustments or variations.

■ APA to supersede provisions of section 92C or 92CA - The arm’s length price of any international transaction, which is covered under such APA, shall be determined in accordance with the APA so entered into. The provisions of section 92C or 92CA which normally apply for determination of arm’s length price will be modified to this extent. As a consequence, arm’s length price shall be determined in accordance with APA. ■ Validity of APA - The APA shall be valid for such previous years as are specified in the agreement

which in no case shall exceed five consecutive previous years.

■ Roll back provisions - APA scheme is in operation in many countries. In many countries, the APA

scheme provides for “roll back” mechanism for dealing with ALP issues relating to transactions entered into during the period prior to APA. The “roll back” provisions refer to the applicability of the methodology of determination of ALP, or the ALP, to be applied to the international transactions which had already been entered into in a period prior to the period covered under an APA. However, the “roll back” relief is provided on case to case basis subject to certain conditions. In the original scheme of APA as inserted by the Finance Act, 2012, there was no provision of “roll back”. The Finance (No. 2) Act, 2014, however, amended the provisions of section 92CC (with effect from October 1, 2014) to provide roll back mechanism. The APA may, subject to such prescribed conditions‡, procedure and manner, provide for determining the arm’s length price or for specifying the manner in which arm’s length price is to be determined in relation to an international transaction entered into by a person during any period not exceeding 4 previous years preceding the first of the previous years for which the advance pricing agreement applies in respect of the international transaction to be undertaken in future.

■ Effectiveness of APA - The APA shall be binding only on the person and the Commissioner (including income-tax authorities subordinate to him) in respect of the transaction in relation to which the agreement has been entered into. The APA shall not be binding if there is any change, in law, or facts having bearing on such APA. ■ APA obtained by fraud - The Board is empowered to declare, with the approval of Central

Government, any such agreement to be void ab initio, if it finds that the agreement has been obtained by the person by fraud or misrepresentation of facts. Once an agreement is declared void ab initio, all the provisions of the Act shall apply to the person as if such APA had never been entered into.

For the purpose of computing any period of limitation under the Act, the period beginning with the date of such APA and ending on the date of order declaring the agreement void ab initio shall be excluded. However, if after the exclusion of the aforesaid period, the period of limitation referred to in any provision of the Act is less than 60 days, such remaining period shall be extended to 60 days.

■ Procedures - 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.

■ Pending proceedings - Where an application is made by a person for entering into such an APA, proceedings shall be deemed to be pending in the case of the person for the purposes of the Act like for making enquiries under section 133.

‡ See rule 10MA. *Rules 10F to 10T inserted by Notification No. 36/2012, dated August 30, 2012.

1441

Secondary adjustment in common parlance

Para 514A.1

■ Modified return within 3 months† - 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 in 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.

■ Pending assessments - Where the assessment or reassessment proceedings 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 the normal period of limitation of completion of proceedings shall be extended by 1 year.

■ Modification of completed assessment - 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, pass an order modifying the total income of the relevant assessment year determined in such assessment or reassessment, having regard to and in accordance with the APA. To such order, 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 such order is 1 year from the end of the financial year in which the modified return is furnished.

■ Case study - For the assessment year 2015-16, X Ltd. submits return of income on November 10,

2015. On November 18, 2015, it enters into an advance pricing agreement (APA) with the Board pertaining to determination of arm’s length price in connection with import of semi-finished goods from its holding company situated in the Netherlands. The agreement provides ALP for the transactions pertaining to the assessment years 2014-15 and 2015-16. The assessment of 2014-15 has already been completed but the assessment for 2015-16 is pending on the date of entering into APA. In this case, X Ltd. will have to submit a modified return for the assessment year 2014-15 (and also for the assessment year 2015-16) on or before February 28, 2016 (i.e., within 3 months from the end of the month in which APA is made).

On February 28, 2016, the assessment for the assessment year 2014-15 has already been completed.

For the assessment year 2014-15, the Assessing Officer will reassess or modify the income keeping in view the provisions of APA. This order can be completed on or before March 31, 2017 (i.e., within 1 year from the end of the financial year in which modified return is submitted).

On February 28, 2016, the assessment for the assessment year 2015-16 is pending. Normally, the assessment for the assessment year 2015-16 should be completed before April 1, 2018. In this case, the Assessing Officer can complete the assessment for the assessment year 2015-16 (keeping in view the provisions of APA) at any time before April 1, 2019.

Secondary adjustment in certain international transactions [Sec. 92CE] 514A. Section 92CE was inserted with effect from the assessment year 2018-19.

514A.1 Secondary adjustment in common parlance - Secondary adjustment means an adjustment in the books of account of the assessee and its associated enterprise to reflect that the actual allocation of profits between the assessee and its associated enterprise are consistent with the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash account and actual profit of the assessee. As per the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD transfer pricing guidelines), secondary adjustment may take the form of constructive dividends, constructive equity contributions, or constructive loans. † If the time-limit expires during March 20, 2020 and December 31, 2020, it has been extended to March 31, 2021 by virtue of the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020.

Para 514A.2

Income-tax - Transfer pricing

1442

The provisions of secondary adjustment are internationally recognised and are already part of the transfer pricing rules of many leading economies in the World (countries like Canada, France, Korea, South Africa, USA have adopted this kind of adjustment in their transfer pricing legislations).

While mode of secondary adjustments in different countries is different, yet there can be no case of secondary adjustment in the absence of primary adjustment. Deemed dividend, deemed equity contribution or deemed loan are different approaches adopted by different countries. However, the object of different approaches is to align the economic benefit of the transaction with the arm s length position.

514A.2 When section 92CE is applicable - Under section 92CE, the assessee is required to carry out secondary adjustment where the primary adjustment to transfer price has been made.

■ What is primary adjustments - Primary adjustment to a transfer price means the determination

of transfer price in accordance with the arm s length principle resulting in an increase in the total income or reduction in the loss, as the case may be, of the assessee.

■ What is secondary adjustment - Secondary adjustment means an adjustment in the books of account of the assessee and its associated enterprise to reflect that the actual allocation of profits between the assessee and its associated enterprise is consistent with the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash account and actual profit of the assessee.

■ When secondary adjustment will be applicable - Secondary adjustment will be applicable in the following situations

1. Where a primary adjustment to transfer price has been made suo motu by the assessee in his return of income.

2. Where a primary adjustment to transfer price made by the Assessing Officer has been accepted by the assessee.

3. Where a primary adjustment to transfer price is determined by an advance pricing agreement entered into by the assessee under section 92CC on or after April 1, 2017.

4. Where a primary adjustment to transfer price is made as per the safe harbour rules framed under section 92CB. 5. Where a primary adjustment to transfer price is arising as a result of resolution of an assessment by way of the mutual agreement procedure under DTAA entered into under section 90/90A. ■ Threshold limit - When secondary adjustment is not applicable - If the following two conditions are not satisfied, secondary adjustment is not required

a. the amount of primary adjustment made in the case of an assessee in any previous year does not exceed Rs. 1 crore; or b. the primary adjustment is made in respect of the assessment year 2016-17 (or any earlier assessment year).

■ Quantification of secondary adjustment - The relevant provisions are as follows

1. As a result of primary adjustment to the transfer price, there is an increase in the total income or reduction in the loss, as the case may be, of the assessee.

2. The difference between the arm’s length price determined in primary adjustment and the price at which the international transaction has actually been undertaken, is “excess money”.

3. The excess money is not repatriated to India by the associated enterprise within the prescribed time (given by rule 10CB) (in general terms, repatriation means effectively reversing the funds so that the accounts of the parties involved are in line with the economic intend of the primary adjustment). The excess money (or part thereof, which is not repatriated to India) shall be deemed to be an advance made by the assessee to such associated enterprise and the interest on such advance shall be computed as the income of the assessee in the manner as is prescribed by rule 10CB.

1443

When section 92CE is applicable

Para 514A.2

■ Prescribed time-limit as per rule 10CB - CBDT has notified rule 10CB which prescribes computation

of interest income pursuant to secondary adjustment. Rule 10CB also provides that repatriation of excess money shall be made on or before 90 days from – - Due date of filing of return, if primary adjustment to TP has been made suo motu by the assessee.

- Date of order of Assessing Officer or appellate authority, if primary adjustment determined in the order has been accepted by assessee.

- Due date of filing of return in case assessee had entered into advance pricing agreement (if the advance pricing agreement has been entered into on or before the due date of filing of return for the relevant previous year).

- The end of the month in which the advance pricing agreement has been entered into (if the said agreement has been entered into after the due date of filing of return for the relevant previous year).

- Due date of filing of return in case assessee opted for safe harbour rules.

- The date of giving effect by the Assessing Officer under rule 44H to the resolution arrived at under mutual agreement procedure (MAP), where the primary adjustment to transfer price is determined by such resolution.

The following points should be noted – 1. If the repatriation of excess money is not made within 90 days from the dates given above, interest would be chargeable from the dates given above (without excluding 90 days).

2. The time-limit of 90 days for repatriation of excess money shall begin only when the primary adjustments exceeding Rs. 1 crore made in respect of assessment year 2017-18 (or later), attains finality. Where the transfer pricing order is appealed against by the taxpayer, the time-limit for repatriation shall commence only after the appeal is finalized by the appellate authority ■ Prescribed rate of interest as per rule 10CB - With regard to the rate of interest to be computed in

the case of failure to repatriate the excess money within the prescribed time given above, rule 10CB provides for separate interest rates for international transactions denominated in Indian rupee and those denominated in foreign currency. The rate of interest is on annual basis and shall be computed as follows – At one year marginal cost of fund lending rate of SBI as on April 1 of previous year plus 325 basis points in case international transaction is denominated in Indian rupees.

- At six-month LIBOR as on September 30 of previous year plus 300 basis points in the case international transaction is denominated in foreign currency.

The rate of exchange for the calculation of the value in rupees of the international transaction denominated in foreign currency shall be the telegraphic transfer SBI buying rate of such currency on the last day of the previous year in which such international transaction was undertaken.

-

■ Additional income tax - In a case, where the excess money (or part thereof) has not been repatriated

in time, the assessee has an option (with effect from September 1, 2019) to pay additional incometax at the rate of 18 per cent on such excess money (or part thereof). It is subject to surcharge of 12 per cent and health and education cess of 4 per cent (effective tax rate : 20.9664 per cent). The following points should be noted – - If the assessee pays the additional income-tax, he is not required to make secondary adjustment or compute interest from the date of payment of such tax. However, he is required to make secondary adjustment pertaining to interest till the date of payment of additional tax.

- The tax so paid shall be the final payment of tax and no credit shall be allowed in respect of the amount of tax so paid.

- The deduction in respect of the amount on which such tax has been paid, shall not be allowed under any other provision.

514A-P1 X Ltd. is an Indian company. It renders services to Y Inc. (an American company which is an associated enterprise of X Ltd. within the parameters of section 92A). During the previous year 2021-22, X Ltd. charges 8 per cent on cost for providing services to Y Inc. However, X Ltd. would have earned a margin of 11 per cent on cost if

Para 514A.2

Income-tax - Transfer pricing

1444

similar services were provided to unconnected foreign entities. The Assessing Officer makes transfer pricing adjustments to the tune of 3 per cent which comes to an addition of Rs. 12 crore to the reported income of X Ltd. (date of assessment order : December 20, 2022). The adjustment is accepted by X Ltd. Discuss the tax consequences for different assessment years. Assume that annual taxable income (before any adjustment under section 92CE) is Rs. 2 crore and Situation 1 - X Ltd. does not want to pay additional income-tax as per section 92CE(2A).

Situation 2 - X Ltd. pays additional income-tax on the entire excess money on October 31, 2023 under section 92CE(2A).

SOLUTION:

The addition of Rs. 12 crore is known as primary adjustment. However, the primary adjustment to the income of X Ltd. does not address the benefit obtained by Y Inc. by retaining Rs. 12 crore in cash. Provisions of section 92CE on secondary adjustment seek to target such cash benefit by applying a tax charge on the excess benefit in the hands of foreign entity. Under this section, Rs. 12 crore will be considered as a separate transaction as a deemed loan (in the language of section 92CE it is known as secondary adjustment ) given by X Ltd. to Y Inc. This deemed loan would exist for tax purposes only and would not appear in the books of account of X Ltd. Arm s length value of interest on deemed loan will be calculated as per rule 10CB [i.e., where international transaction is denominated in Indian rupee: MCLR of SBI (1 year) + 3.25%]. This interest will be taxable in the hands of X Ltd. annually till Rs. 12 crore is repatriated

by Y Inc. (of America) to X Ltd. (in India). Tax consequences in this case will be as follows on the assumption that (a) MCLR (1 year) of SBI + 3.25% comes to 11.7%, and (b) Y Inc. has not repatriated Rs. 12 crore to X Ltd. Previous year 2022-23 - Date of final assessment order (no appeal by X Ltd.) is December 20, 2022. Excess money is Rs. 12 crore. Time-limit for repatriation is 90 days from the date of final order (i.e., December 20, 2022 + 90 days, last date for repatriation is March 20, 2023). Deemed interest on Rs. 12 crore will start from March 21, 2022 at the rate of 11.7%. For the previous year ending March 31, 2023, it comes to Rs. 4,23,123 [i.e., interest at the rate of 11.7% on Rs. 12 crore (i.e., primary adjustment) for 11 days commencing on March 21, 2023 and ending on March 31, 2023]. X Ltd. will pay income-tax on Rs. 4,23,123 at the applicable rate (i.e., 22% or 25% or 30% + applicable surcharge + HEC).

Previous year 2023-24 - The following calculations are given on the assumption that income of X Ltd. before the aforesaid secondary adjustment is Rs. 2 crore and applicable tax rate is 30%. Tax on secondary adjustment is calculated under two different situations : Situation 1 - X Ltd. does not pay additional income-tax as per section 92CE(2A), Situation 2 - X Ltd. pays additional income-tax on the entire excess money on October 31, 2023 under section 92CE(2A) Situation 1

Situation 2

Primary adjustment for the previous year 2022-23 Add: Secondary adjustment for the previous year 2022-23

12,00,00,000 4,23,123

12,00,00,000 4,23,123

Total (a)

12,04,23,123

12,04,23,123

Secondary adjustment for the previous year 2023-24 - In Situation 1 [i.e., interest @ 11.7% on (a) from April 1, 2023 to March 31, 2024] - In Situation 2 [i.e., interest @ 11.7% on (a) from April 1, 2023 to October 31, 2023] Other income

1,40,89,505

2,00,00,000

82,18,878 2,00,00,000

Net income

3,40,89,510

2,82,18,880

Tax @ 30% + SC : 7% + HEC : 4%

1,13,80,440

94,20,590

2,16,00,000

Additional income-tax under section 92CE(2A) Income-tax (18% of Rs. 12,00,00,000) Add: Surcharge @ 12% (always applicable, even if net income is below Rs. 1 crore)

25,92,000

Total Add: Health and education cess @ 4%

2,41,92,000 9,67,680

Additional tax under section 92CE(2A)

2,51,59,680

1445

Limitation on interest deductible

Para 514B.1

Note - If the aforesaid additional tax is not paid, secondary adjustment for the previous year 2024-25 will be notional interest [@ MCLR (1 year) of SBI + 3.25%] on (Rs. 12,04,23,123 + 1,40,89,505).

514A-P2 A Ltd. (an Indian company) gets a loan of US $ 50,00,000 from its overseas related company (B Ltd.).

A Ltd. is required to pay interest at the rate of 8 per cent per annum. However, TPO finds that interest is excessive to the extent of 3.5 per cent which is accepted by A Ltd. Consequently, primary adjustment of Rs. 1.14 crore is made by the Assessing Officer to the income of A Ltd. for the assessment year 2023-24. Prepare a report for the management of A Ltd. pinpointing tax consequences of the aforesaid excessive payment of interest. Make suitable assumptions.

SOLUTION:

Assessment year 2023-24 - Primary adjustment of Rs. 1.14 crore is made by the Assessing Officer to the income of A Ltd. for the assessment year 2023-24. The secondary adjustment will result in creating in deemed loan of Rs. 1.14 crore by A Ltd. to B Ltd. and arm s length value of interest will be taxable annually in the hands of A Ltd. till Rs. 1.14 crore is repatriated by B Ltd. to A Ltd. Assessment year 2024-25 - For the assessment year 2024-25, it is assumed that the adjustment of 3.5 per cent results in addition of Rs. 1.05 crore to the income of X Ltd. This will be primary adjustment. Interest on deemed loan of Rs. 1.05 crore (along with interest on deemed loan of 1.14 crore of the earlier year) will be treated as secondary adjustment for the assessment year 2024-25 [both will continue till Rs. 1.14 crore + Rs. 1.05 crore is repatriated to India or till additional income tax under section 92CE(2A) is paid].

Assessment year 2025-26 - For the assessment year 2025-26, it is assumed that the adjustment of 3.5 per cent results in addition of Rs. 97 lakh. This is primary adjustment. Since it is not more than Rs. 1 crore, secondary adjustment will not be applicable. However, interest on deemed loan of Rs. 1.14 crore + interest on deemed loan of Rs. 1.05 crore (pertaining to earlier years) will continue [till 1.14 crore + Rs. 1.05 crore is repatriated to India or till additional income tax under section 92CE(2A) is paid].

514A-P3 C Ltd. is an Indian subsidiary company of D Inc. (a US company). During the previous year 2023-24, C Ltd. issues shares to D Inc. at the rate of Rs. 800 per share. As per TPO, the issue price of shares should have been Rs. 1,900 per share. On this account, a transfer pricing adjustment of Rs. 5.5 crore is made by TPO to the income of C Ltd. TPO further wants to make secondary adjustment by treating Rs. 5.5 crore as deemed loan under section 92CE. Notional interest at the rate of 9 per cent on deemed loan is added as secondary adjustment by TPO. Discuss whether primary and secondary adjustment are tenable in law.

SOLUTION:

Even if it is assumed that shares are issued by C Ltd. to its associated enterprise D Inc. at less than arm s length price, the short fall of Rs. 5.5 crore would have increased the share capital of C Ltd. and not credit side of its profit and loss account. Under section 92, notional income arising from an international transaction with reference to arm s length price can be added to taxpayer s income. If an international transaction does not have any impact on the income of taxpayers, transfer pricing provisions are not applicable. No adjustment can be made under section 92. In other words, there cannot be any primary adjustment. When there is no primary adjustment, secondary adjustment is not possible under section 92CE. Therefore, both primary adjustment and secondary adjustment are legally not tenable.

Provisions pertaining to thin capitalisation 514B. A company is typically financed or capitalized through a mixture of debt and equity. The way a company is capitalized often has a significant impact on the amount of profit it reports for tax purposes as the tax legislations of countries typically allow a deduction for interest paid or payable in arriving at the profit for tax purposes while the dividend paid on equity contribution is not deductible (in some countries, dividend distribution attracts additional tax). Therefore, higher the level of debt in a company (and thus the amount of interest it pays), the lower will be its taxable profit and tax liability. For this reason, debt is often a more tax efficient method of finance than equity.

Multinational groups are often able to structure their financing arrangements to maximize these benefits. For this reason, country’s tax administrations often introduce rules that place a limit on the amount of interest that can be deducted in computing a company’s profit for tax purposes. Such rules are designed to counter cross-border shifting of profit through excessive interest payments, and, thus, aim to protect a country’s tax base.

514B.1 Limitation on interest deductible [Sec. 94B] - Section 94B was inserted with effect from the assessment year 2018-19.

Para 514B.1

Income-tax - Transfer pricing

1446

■ Conditions - Section 94B is applicable if the following conditions are satisfied

1. The assessee (i.e., borrower) is an Indian company or a permanent establishment of a foreign company in India.

2. It incurs any expenditure by way of interest (or of similar nature) in respect of any debt (or deemed debt). The debt is issued by a non-resident (being an associated enterprise of the borrower). Where the debt is issued by a lender (which is not associated with the borrower) and an associated enterprise either provides an implicit or explicit guarantee to such lender (or deposits a corresponding and matching amount of funds with the lender), such debt shall be “deemed” to have been issued by an associated enterprise. “Debt” means any loan, financial instrument, finance lease, financial derivative, or any arrangement that gives rise to interest, discounts or other finance charges that are deductible.

3. Interest is deductible while computing income chargeable under the head “Profits and gains of business or profession”.

4. For the aforesaid debt, interest (which is otherwise deductible for computing business/professional income of the borrower for the previous year) is more than Rs. 1 crore.

5. The borrower is not engaged in the business of banking or insurance or (with effect from the assessment year 2024-25) such class of non-banking financial companies as may be notified by the Central Government.

6. With effect from the assessment year 2021-22, interest is not paid in respect of a debt issued by a lender which is a PE of a non-resident (being a person engaged in the business of banking) in India.

■ Limitation on deduction of interest under section 94B - If the above conditions are satisfied, interest shall not be deductible while computing income under the head Profit and gains of business or profession to the extent it arises from excess interest . Excess interest , as per section 94B(2), is a. interest paid or payable in excess of 30 per cent of earnings (before interest, taxes, depreciation and amortization) (EBITDA) of borrower in the previous year; or b. interest paid or payable to associated enterprises for that previous year, whichever is less.

■ Carry forward of the excess interest - The excess interest of the current year (which is not allowed as deduction) shall be carried forward to the following assessment year. In the next assessment year, it shall be allowed as a deduction against business/profession income of the borrower to the extent of maximum allowable interest expenditure in accordance with section 94B(2). This carry forward is allowed for 8 assessment years (immediately succeeding the assessment year for which the excess interest was first computed).

514B-P1 X Ltd. is an Indian company. It is Indian subsidiary of A Inc. (a US company having business connections in US, Europe and Asia). X Ltd. has taken a loan from A Inc. From the data given below, find out disallowance under section 94B and net income of X Ltd. for the assessment years 2023-24 and 2024-25.

(Rs. in crore) Previous year Business income (calculated after deducting the following) - Interest to A Inc. - Interest to others in India and outside India (recipients are not associated enterprises) - Depreciation (normal and additional) under section 32 - Amount deductible under section 35

2022-23

2023-24

(a) (b) (c)

156 130 70

400 140 90

(d) (e)

30 10

20 5

1447

Limitation on interest deductible

Para 514B.1 Previous year

- Amortisation of expenses under section 35D - Investment allowance under section 32AD Transfer pricing adjustment under section 92 out of (b) made by TPO

2022-23

2023-24

(f) (g) (h)

15 25 20

15 Nil 40

(a)

156

400

(h)

20 59.7

40 Nil

(s)

235.7

9.5 430.5

(i) (c)

110 70

100 90

(j)

180

190

(k) (l)

176 110

440 100

SOLUTION:

Business income Add: Disallowance Under section 92 Under section 94B [see Note 1] Less: Adjustment of carry forward of disallowance under section 94B(4) [see Note 2] Net income Note 1 - Computation of disallowance under section 94B Interest to A Inc. (deductible under provisions other than section 94B) [(b) (h)] Interest to others Total interest (deductible under provisions other than section 94B) [(i) + (c)] Earnings before interest, tax, depreciation and amortization (EBITDA) - Business income (taxable if section 94B is ignored) [(a) + (h)] - Add: Interest to A Inc. (deductible if section 94B is ignored) [(b) (h)] - Add: Interest to others, depreciation, amortization under section 35D [(c) + (d) + (f)]

(m)

115

125

EBITDA [(k) + (l) + (m)]

(n)

401

665

30% of EBITDA Excess of interest over 30% of EBITDA [(j) (o)] Disallowance under section 94B [(p) or (i), whichever is less]

(o) (p) (q)

120.3 59.7 59.7

199.5 Nil Nil

Disallowance to be carried forward to next year [(q) (s)]

(q)

59.7

50.2

Note 2 - Adjustment of carry forward of disallowance under section 94B(4) - Amount of disallowance brought forward - 30% of EBITDA not utilised during the current year [(o) (j)] Amount deductible under section 94B(4) [(q) or (r), whichever is lower]

(q) (r) (s)

59.7 9.5 9.5

514B-P2 Y Ltd. is an Indian company. It is Indian subsidiary of B Inc. (a Japanese company having business connections in Asia and South Africa). Y Ltd. has taken a loan from Z Ltd., an Indian company, which is guaranteed

by B Inc. Find out the amount of disallowance under section 94B for the assessment year 2023-24 in the following different situations (Rs. in crore) Situation 1

Situation 2

Situation 3

Situation 4

Business income (calculated after deducting the following) - Interest to Z Ltd. - Interest to others - Depreciation deductible under section 32

500 100 10 72

2 1.1 1.2 2

300 80 120 20

300 120 80 20

Disallowance @ 30 per cent under section 40(a)(ia) [tax not deducted out of interest to Z Ltd.]

30

0.33

24

36

Para 514C

Income-tax - Transfer pricing

1448

SOLUTION:

Business income Add: Disallowance Under section 40(a)(ia) Under section 94B [see Note]

500

2

300

300

30 Nil

0.33 Nil

24 20

36 8

Net income

530

2.33

344

344

Note - Computation of disallowance under section 94B Interest to Z Ltd. (deductible under provisions other than section 94B) Interest to others

70 10

0.77 1.2

56 120

84 80

Total interest (deductible under provisions other than section 94B)

80

1.97

176

164

530

2.33

324

336

70 82

0.77 3.2

56 140

84 100

682 204.6

6.3 1.89

520 156

520 156

Nil

0.08

20

8

Nil

Nil

20

8

Earnings before interest, tax, depreciation and amortization (EBITDA) - Business income (taxable if section 94B is ignored) - Add: Interest to Z Ltd. (deductible if section 94B is ignored) - Add: Interest to others and depreciation EBITDA 30% of EBITDA Excess of interest over 30% of EBITDA Disallowance under section 94B (excess of interest over 30% of EBITDA or interest otherwise deductible which is paid to Z Ltd., whichever is lower) (section 94B not applicable in Situation 2, as interest to Z Ltd. is less than Rs. 1 crore)

Important judicial rulings 514C. One should also keep in view the following judicial rulings – ■ When same persons participate, directly or indirectly or through an intermediary, in management

or control or capital of two or more enterprises, such enterprises are required to be treated as ‘associated enterprise’. Thus, the true test of associated enterprise is control by one enterprise over other, or control of two or more associated enterprises by common interests—Diageo India (P.) Ltd. v. CIT [2011] 47 SOT 252 (Mum.).

■ Rule 10B(4) clearly states that the data to be used in analyzing the comparability of uncontrolled

transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into. Proviso to rule 10B(4) provides an exception to the effect that the data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer price in relation to transactions being compared. Thus, according to the law, the data relating to relevant financial year is only the contemporaneous data and the proviso is applicable only in some specified cases—Geodis Overseas (P.) Ltd. v. CIT [2011] 45 SOT 375 (Delhi).

■ In case of transaction of lending money in foreign currency to foreign subsidiary, London Inter

Bank Offered Rate (LIBOR) should be taken as benchmark rate for computing ALP of interest— Cotton Naturals (I) (P.) Ltd. v. CIT [2013] 32 taxmann.com 219 (Delhi).

Direct Taxes Law & Practice

with Special Reference to Tax Planning AUTHOR PUBLISHER DATE OF PUBLICATION EDITION ISBN NO NO. OF PAGES BINDING TYPE

: : : : : : :

VINOD K. SINGHANIA, KAPIL SINGHANIA TAXMANN FEBRUARY 2024 70TH EDITION 9789357787000 1776 PAPERBACK

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