FEBRUARY 20, 2015

By Rishabh Kumar Sawansukha

Serial No. 1

ISSUE involved -

Section 37(1) -Permitting deductibility of CSR expenditure

Existing law

Explanation 4 to Section 37(1) has been inserted vide Finance Act, 2014 stating that Corporate Social Expenditure incurred by corporates in accordance with the provisions of Companies Act, 2013 shall not be a deductible expenditure.

Argument in support of the proposal

Vide Finance Act, 2014 deduction for CSR expenditure has been denied by introducing Explanation 4 to Section 37(1) of Income-tax Act on the following grounds:

++ Objective of CSR is to share burden of the Government in providing social services by companies having net worth / turnover / profit above a threshold

++ If such expenses are allowed as a tax deduction, this would result in subsidizing around one-third of such expenses by Government by way of tax expenditure

++ CSR expenditure is an application of income which cannot be allowed as a deduction for computing taxable income;

On one hand, Government acknowledges the fact that by mandatory social welfare spending as provided under Companies Act 2013, which is primary responsibility of the Government, Corporates are sharing Government's burden and on the other hand for such mandatory spends Corporates are penalized as no deduction shall henceforth be eligible.

Courts in the past have conferred deduction for expenditure voluntarily incurred by Corporates on social initiatives outside the realm of its business holding the same as incurred wholly and exclusively for the purposes of business.

CSR expenditure can by no stretch of imagination be held as an application of income. The concept of application of income is applied to tax an income stream in the hands of a taxpayer irrespective of the fact that the income stream has been applied / utilized in a particular manner voluntarily. Furthermore, an application of income takes color of appropriation of profits and is reported below the line in the financial statements like dividend payout or transfer to reserves. Characterizing CSR expenditure, which sits above the line i.e. as an expenditure, as an application of income is like equating the same with dividend or transfer of reserves which seems erroneous. Even Courts in the past have never held CSR expenditure as application of income.

It would not be fair on part of the Government to force Corporates to share its burden on social welfare spends and at the same time penalize them by denying tax deductibility of such spends to garner more tax revenues.

Prayer

To usher into a new era of tax friendly policies which harmonizes other legislation within the framework of which a Corporate functions, it is imperative that CSR spends shall be allowed as a deductible expenditure. This kind gesture shall go long way in Corporates whole-heartedly contributing towards various social initiatives of the Government or otherwise without being stifled by a mandatory spend as per Companies Act, 2013 on one hand and loose fiscal incentives on the other.

Serial No. 2

Issue involved

Restraining adhoc disallowance by Assessing Officer during the course of assessment proceedings

Existing law

There is no specific mandate under the existing provisions empowering an Assessing Officer to make an adhoc disallowance purely on surmises and conjectures.

Argument in support of the proposal

Irrespective of the fact that there is no specific mandate under the law permitting adhoc disallowances, the same does not preclude an Assessing Officer to make adhoc disallowances without any reason whatsoever and without testing the same on touchstone of law. To make matters worse, the same continues to be blindly followed year on year resulting in un-necessary litigation which basis past experience suggests that Tax Department invariable loses.

It shall be noted that a taxpayer gets his accounts audited under the provision of Companies Act wherein a statutory auditor examines the entire books of account and comments on the true and fair view of the state of affairs. The statutory auditor examines the books of account with reference to records maintained by the taxpayer and certifies the same. Over and above the statutory audit, the taxpayer is obligated to get a tax audit report from an accountant enabling the taxpayer to prepare his return of income. The same also acts as an aid to the Assessing Officer to complete the assessment.

If an accountant furnishing the tax audit report has certified amounts to be reported under various clauses of the tax audit report, the same needs to be honored by the Assessing Officer. Instead the Assessing Officers resort to full-fledged audit during the course of assessment proceedings questioning the amounts certified in the tax audit report resulting in significant waste of time and efforts on part of both the taxpayer as well as the Assessing Officer. If the intent of the tax audit report is to aid the Assessing Officer in completion of assessment, the aforesaid principle should be respected by the Assessing Officer.

No gain is obtained if the Assessing Officer still questions a taxpayer on the amounts reported in the tax audit report which renders the entire exercise of obtaining tax audit report redundant. If the Assessing Officer is empowered to question all transactions reported in the audited accounts, then the obligation to obtain tax audit report should be done away with which results in involvement of significant time, efforts and resources by the taxpayer.

To conduct a meaningful assessment, recourse should rather be made to adjudicate issues involving legal principles / interpretation than resorting to adhoc disallowances of expenses / adhoc additions to income which have no legal standing of its own.

Prayer

Suitable amendment should be made in the law laying down that the Assessing Officer cannot resort to adhoc disallowances and has to respect the statutory audit and tax audit furnished by a taxpayer unless the situation warrants so.

Even if disallowances are to be made, the same needs to be made only with reference to the provisions of the law without resorting to mere adhoc disallowances.

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Serial No. 3

Issue involved -

Section 68 -Not to apply on receipt of share premium in excess of fair market value to which Section 56(2)(viib) applies

Existing law

Section 68 of the Act provides for taxability of unaccounted / unexplained money i.e. where nature and source of funds remained unexplained in respect of credit entries recorded in the books of account. Section 68 as amended w.e.f. April 1, 2013, also provides that in addition to the recipient, the person contributing to the share capital of a private or an unlisted company also has to explain the nature and source of funds.

On the other hand, Section 56(2)(viib) of the Act provides that share premium received by an unlisted company upon issue of shares in excess of the fair market value shall be treated as income in the hands of such company and subject to tax accordingly. This law is applicable w.e.f. AY 2013-14.

Argument in support of the proposal

Recent newspaper reports suggest that Tax Authorities are seeking to invoke the provisions of Section 68 to transactions prior to April 1, 2013 by bringing the excessive premium to tax.

Section 68 can be invoked in a situation wherein nature and source of funds remain unexplained by the recipient and the contributor. If the nature and source of funds stands explained, tax department could then have recourse under Section 56(2)(viib) only in situations where difference in technical aspect of valuation exist. However, the converse may not be true i.e. if Section 56(2)(viib) is invoked to tax the difference in technical aspect of valuation, the test of nature and source of funds stand automatically satisfied. The rigours of Section 68 should stop with the investigation into nature and source of funds and not extend to cater to the technical aspect of valuation dealt specifically under section 56(2)(viib) as the Legislature may not have intended to provide two sections i.e. Section 56(2)(viib) and Section 68 to be used interchangeably. Section 68 also cannot be invoked in cases of genuine issue of shares by a company to joint venture partners or financial investors i.e. private equity, venture capital funds etc.

Prayer

The provisions of Section 56(2)(viib) and Section 68 of the Act be suitably amended to provide safeguard against its invocation interchangeably. Only if the tests laid down under Section 68 do not stand to be fulfilled, section 68 can be invoked. Furthermore, once 56(2)(viib) has been invoked, then the test of Section 68 should be considered as automatically satisfied. The provisions of law should not be allowed to be used interchangeably.

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Serial No. 4

Issue involved

Minimum Alternate Tax -Set-off of both book loss and depreciation

Existing law

Clause (iii) to Explanation 2 below sub-section (2) to Section 115JB of the Income-tax Act provides for reduction of loss brought forward or unabsorbed depreciation, whichever is less as per books as a reduction from net profits while computing book profits. The Explanation further states that if loss brought forward or unabsorbed depreciation is nil, no amount shall be reduced.

Argument in support of the proposal

Tax on book profits is a tax on notional income and was introduced to levy tax in case of companies which though earning net profits and declaring handsome dividends do not pay taxes under normal provisions of the Act on account of various incentives / deductions.

The law currently provides reduction of book loss or unabsorbed depreciation, whichever is lower. Vide Finance Act, 2002, by way of an Explanation it was clarified that if one of the elements is nil, no reduction shall be allowed. However, no reason was provided in the Memorandum for such clarification. Prior to such amendment, benefit for entire book loss and depreciation continued to be provided by Legislature.

For the purposes of discussing the economic argument behind availability of aforesaid provision, companies should be dissected in two baskets i.e. one set of companies would be companies earning net profits year on year but not paying taxes under normal provisions of Income-tax Act and the other being companies historically making net loss but subsequently turning into making net profits.

It may be noted that a company is said to make profits only if it has wiped off all the past losses, both book loss and unabsorbed depreciation and earned net profits during a particular year. To consider set-off of only one element i.e. either book loss or unabsorbed depreciation while computing book profits, usually the latter, would only be a half-hearted relief while taxing a company notionally on its net profits.

The provision of Companies Act also allows a company to freely distribute profits to shareholders post set-off of all past losses. In such a situation, taxing a company on its net profits for a year, that too notional, without reduction of past book losses would not be fair. The very intent behind introduction of minimum alternate tax to tax companies earning net profits and declaring dividends but not paying taxes seems to be defeated in the instant case.

The Legislature should on the contrary incentivize historically loss making company turning into net profits by allowing reduction for entire book loss and depreciation before subjecting them to MAT. This shall enable a company to recoup all its past losses, stabilize for next few years and then be on a growth trajectory.

Prayer

Clause (iii) should be suitably amended to provide that book loss and unabsorbed depreciation shall be allowed as a reduction from net profits even if one of the element is nil.

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Serial No. 5

Issue involved -

Minimum Alternate Tax -Extension of period for availability of MAT credit to 15 years from 10 years

Existing law

Section 115JAA of the Income-tax Act provides a threshold period of 10 years to claim credit for taxes paid under MAT.

Argument in support of the proposal

Tax on book profits is a tax on notional income and was introduced to levy tax in case of companies which though earning net profits do not pay taxes under normal provisions of the Act on account of various incentives / deductions. To offset the impact of taxes paid on notional income, the Legislature in its wisdom provided credit for taxes paid under MAT, subject to conditions, to be available as set-off against tax on profits computed in accordance with the normal provisions of the Income-tax Act. The threshold period for claiming such credit under the existing provisions of the Income-tax Act is 10 years beyond which any unutilized credit shall lapse.

The period for which credit is available was extended to 15 years under Direct Taxes Code. Presumably, the Legislature was seized of the hardships faced by companies in failing to claim complete credit for MAT taxes over a period of 10 years more so when the credit is available only to the extent of difference between taxes on normal profits and tax on book profits of a year.

The aforesaid situation worsens in case of second set of companies mentioned above as these companies would indeed take some years to recoup its past losses, stabilize for next few years and then be on a growth trajectory. In such cases, the period of 10 years is a very short time to claim credit for notional taxes paid on book profits and the period of 15 years proposed under Direct taxes Code was indeed a welcome change.

The Legislature could have extended the benefit in perpetuity but in its wisdom provided additional window for 5 years to enable companies on one hand to be efficient in its operations and on the other hand not loose credit for taxes paid under MAT within a defined time frame.

Another argument in support of the proposal is that though being a notional tax on profit, credit allowed to be carried forward is limited to the extent of the tax on normal profits and tax on book profits. Furthermore, offset also is allowed only to the extent of difference between the two in the relevant year. If the Legislature further restricts the time limit for set-off, the same amounts to benefitting from notional taxes paid by a company which was intended to offset the impact of minimum alternate tax. The aforesaid situation worsens in case of a historically loss making company which does not have any taxable income under other provisions of the Act but still is liable to pay MAT in accordance with the provisions of Section 115JB. In such case, entire taxes paid under MAT is available as a credit which due to limited time of 10 years may not be available as a set-off against tax on income under other provisions of the Act.

Prayer

As Direct Taxes Code is under review and has been postponed, the proposal in so far as availability of MAT credit for a period of 15 years should be introduced under Section 115JAA of the Income-tax Act supporting the economic rationale as well as intent of the Legislature as stated above.

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Serial No. 6

Issue involved -

Section 142(2A) -Volume of the accounts and doubt about the correctness of the account not to be a criteria for reference to special audit

Existing law

Section 142(2A) of the Income-tax Act has been amended vide Finance Act, 2013 to provide that volume of the account or doubt about the correctness of the account could also be one of the reasons for which the Assessing Officer may make a reference for a special audit by an accountant.

Argument in support of the proposal

Courts in the past have held that an Assessing Officer should form an opinion about the nature of accounts of a taxpayer is complex and the opinion should be formed objectively after an honest attempt has been made to understand the accounts. The contention that Assessing Officer is a layman and has no experience in dealing with accounts cannot be accepted. Only if the records are produced and accounts are examined, the complexity of the accounts can be ascertained.

The guiding principle, therefore, for reference to a special audit was hinged on objectivity and complexity of accounts and not left at the subjectivity of the Assessing Officer. With the amendment brought vide Finance Act, 2013 the aforesaid principles seems to have been obliterated and left to the subjectivity of the Assessing Officer.

Reference to special audit merely on the basis of volume of accounts would make the provisions applicable to almost all large corporates as no definition / threshold has been provided to construe what constitutes volume. Any manufacturing organization with 3-4 manufacturing locations or more would have voluminous nature of operations and shall attract the rigors of amended provisions of Section 142(2A). This would result in creation of fear psychosis in the mind of all large corporate groups as virtually all of them would be subject to special audit under the amended provisions if the Assessing Officer decides so.

Moreover, due to the subjectivity element involved, it would be like providing free hand to Assessing Officers to shirk their responsibility in favour of the accountant seeking assistance in completion of assessment. Resultantly, the taxpayer would be burdened by committing additional time, efforts and resources to get the accounts audited over and above multiplicity of audits conducted under various Legislations i.e. Companies Act, Excise, Service tax etc. It would not be fair to burden the taxpayer with one additional audit because of the subjectivity of the Assessing Officer.

Prayer

Criteria linking reference to special audit merely on the basis of volume of accounts should be removed. Moreover, subjectivity element involved in doubt on the correctness of accounts should be suitably safeguarded by introducing factors / circumstances resulting in doubt on the correctness of the accounts.

Serial No. 7

Issue involved -

Section 244A -Specifying time limit for grant of refund alongwith interest

Existing law

Section 244A of the Income-tax Act provides for interest @ 0.5% p.m. on refund due from first day of April / date of payment till the date of grant of refund.

However, no time limit has been provided within which an authority shall grant refund to a taxpayer resulting in inordinate delays extending to more than 5-10 years in many cases.

Argument in support of the proposal

Refunds legitimately due to taxpayers are withheld illegitimately by either not passing an order / order effect or not actioned upon after passing an order. In many cases, the inordinate delay ranges from 5 to 10 years or even more. This results in exchequer bearing the interest burden u/s 244A for inaction by tax authorities. To add, the rate of interest is a measly 0.5% p.m. which does not even take into account the inflation and time value of money lost by a taxpayer in the process.

Inspite of CBDT advising tax authorities by way of Circular or Citizen Charter to pass order effect / grant refunds within a minimum time frame of 1 month / 6 months respectively, such Circulars / Charter remains only on paper and never followed in practice.

On the contrary, when there is a demand pending to be paid by the taxpayer, the same tax authority swings into action and resorts to all options available under the sun, whether within the rule book or otherwise, including coercive measures to collect tax promptly.

To make matters worse, failure on part of a taxpayer to pay a demand attracts interest @ 1% p.m. whereas if the amount is due by a taxpayer, the rate of interest is 0.5% p.m. This amounts to unjust enrichment by the exchequer at the behest of hapless taxpayers who are stuck in the administrative delays and inaction by tax authorities.

Section 234D enables the tax authorities to collect interest @ 0.5% p.m. if a refund made to an assessee turns into a demand subsequently. Therefore, there is no loss to the exchequer by granting timely refund to the taxpayers. If the intention was not to grant refund alongwith interest timely or grant the same only after passing an order / order effect, then the provisions of Section 234D are rendered otiose and shall be struck down from the Act.

Prayer

To ensure transparency and adhere to Citizen Charter in practice, the relevant provisions of the Act be suitably amended to provide for a mandatory time limit of 1 month within which the tax authorities are obligated to pass an order effect suo-moto without the taxpayer making an application in this behalf.

Furthermore, Section 244A should be amended to provide that refund alongwith interest, as may be applicable shall be granted within a mandatory period of 6 months from the date when they become due.

The aforesaid shall result in huge savings to the exchequer in form of interest which are generally payable due to inaction and administrative delays on part of tax authorities without any moral obligation / being held responsible for the same.

(The author is National Head, Taxation, HCCB)