JANUARY 10, 2017

By Pallav Gupta, Head-Taxation, ITC Limited

1. TAX RATES:

Corporate Tax Rates:

In the context of the worldwide economic problems and its consequent effect in India, it is suggested that the corporate tax rate be brought down to 25% within the next 2 - 3 years and surcharge and education cess be removed in respect of corporates. This will result in generating more surpluses in the hands of companies with consequential boost to investment and growth and accelerate the GDP growth in India.

2. INCOME COMPUTATION DISCLOSURE STANDARDS (ICDS):

Various Accounting Standards like Ind AS are becoming applicable for companies alongwith the provisions of the new Companies Act. 2013.

The Government is now propagating the 'Make in India' concept for bringing about buoyancy and growth in the Indian economy. For the purpose, it is necessary to ensure that "doing business in India" is easy and hassle free.

In this context, the introduction of Tax Accounting Standards, termed as 'ICDS' is a retrograde step since it introduces difficulties and complications by necessitating the maintenance of a parallel set of Books for tax purposes over and above the prescribed Books maintained under the Company Law. Also, it will result in disputes and litigation by changing the basic accounting principles and standards for which the legal positions have been established over the years and which will no longer be valid. In fact, this will create uncertainty and deterrence in the conduct of business in India.

Therefore, it is suggested that ICDS should be withdrawn.

3. CORPORATE SOCIAL RESPONSIBILITY COSTS :

Section 135 of the Companies Act 2013 and The Companies (Corporate Social Responsibility Policy) Rules, 2014 (CSR Rules) as notified make CSR expenditure a statutory requirement for all practical purposes (as per the spirit of the law), in respect of companies falling under the ambit of such regulations. In this connection, it may also be noted that the CSR expenditure under law is in effect calibrated to the average Pre-tax profits (as computed under Section 198 of the Companies Act 2013, akin to managerial remuneration) earned during the preceding three years and is therefore a charge on profits (just like managerial remuneration) and not an appropriation thereof (which is a shareholder prerogative).

In the Finance (No.2) Act, 2014 it was mentioned that under section 37(1) Explanation 2, all CSR expenditure shall not be deemed to be an expenditure for the purpose of business on the rationale that it is an application of income.

It may be noted that every expenditure represents application of income and not an appropriation, if the charge/debit is made before determination of the PBT. In that context, CSR is an item of expenditure similar to any other standard item like rent, repairs and insurance. Moreover, such expenditure which is to be incurred under the new Companies Act and determined @2% of the pre-tax profits, is automatically an expenditure for business purpose even though it may not be incurred in the normal course of business. Also, statutorily sharing the burden with the Government "in providing social services" under law cannot be termed as getting subsidy from the Government through the said deduction since it is a statutory expenditure and is not in the nature of any tax or dividend.

In fact, the alternative argument of it not being an expenditure for tax computation purposes is itself not sustainable since it then becomes a "tax" which cannot be introduced under the Companies Act.

The industry therefore expects that such CSR expenditure would be allowed as a deduction under the Income Tax Act and Rules and all the more so, as certain elements of eligible CSR expenditure such as those covered under sections 30 to 36 are fully deductible even under the present tax laws, as explained in the Memorandum.

In fact, the High Level Committee on CSR formed by the Ministry of Corporate Affairs had observed that certain items of CSR are allowable under the Income Tax Act, whereas other items are not allowable and this has resulted in inconsistencies and lack of uniformity in the treatment for tax purposes and this has to be corrected.

It is therefore recommended that the amendment made under section 37(1), Explanation 2 be dropped and the Income Tax Act expressly stipulate that all expenditure incurred by companies in accordance with Section 135 of the Companies Act 2013 and the CSR Rules be allowed as a deduction under law so as to bring about fairness and uniformity in tax treatment and eliminate potential disputes & litigation that would otherwise arise in this regard.

4. SECTION 80IA BENEFIT - POWER GENERATION :

Under Section 80 IA of the Income Tax Act, deduction in respect of profits and gains from power undertakings (including for captive power generation plants) is available for any ten consecutive assessment years out of fifteen years beginning from the year in which the undertaking generates power. This benefit is available provided the power undertaking begins to generate power at any time before 31st March, 2017.

In the current scenario, new power undertakings in the area of solar and other renewable energy sources are becoming critical, especially in the context of protection of the global environment.

Therefore, the provisions of section 80IA, should be extended till 31 st March, 2020, specially in respect of generation of power from renewable sources like solar, wind etc..

Sub-section 12A to section 80IA imposes a restriction on any merged or demerged undertaking for not allowing the benefit of deduction from taxable income after such restructuring. In fact, this benefit is not passed on to the successor of business for the unexpired period after the said restructuring. This is extremely unfair and should be deleted, since it adversely affects a lot of corporate restructuring decisions.

5. DEDUCTION IN RESPECT OF EXPENDITURE ON BRAND BUILDING :

In India, there is an over abundance of foreign brands. These range from run-of- the- mill to high-end luxury products. Even for items of daily consumption, the brands consumed by millions of household are predominantly owned by overseas enterprises. Be it baby food, home care, personal care products, tooth pastes, shaving creams, breakfast cereals, tea, coffee, ice creams, confectionary, chocolates, washing machines, laptops, personal computers, refrigerators, mobile phones, televisions, air conditioners, motor cars, etc., the leading brands in the Indian market are the property of foreign enterprises. Every time these products are consumed, value flows out of the country to pay for trademarks used, licenses provided, services consumed and so on.

Until December 16, 2009, the Government had imposed a cap on royalty payments for technological collaboration which was 5% on domestic sales and 8% on exports. Lumpsum royalty payments were capped at US $ 2 million. For use of a brand name, royalty could be paid at upto 1% of sales and 2% of exports. Beyond these levels, approval of the Foreign Investment Promotion Board (FIPB) was required. However, royalty payments have increased sharply since December 2009, when the caps were withdrawn and everything was put under the automatic route. In 2009-10, about US $ 4.44 billion was paid as royalty by Indian companies which was 13% of the Foreign Direct Investment (FDI) inflow into India that year. In 2012-13, Indian companies royalty payments increased to US $ 6.99 billion or 18% of India's FDI inflows that year. These pay-outs have increased 57.43% in the space of four years.

This unenviable situation is indeed a disheartening reflection of the competitive capabilities of India's home grown brands which are few and far between. However, instead of bemoaning the huge outgo in terms of royalty and other payments, it is much more important to align national and corporate energies to create world class Indian brands. World class brands lend a huge intangible value to products and services enabling them to command a premium and loyalty from consumers. Moreover, successful brands reflect the innovative capacity of their countries and they enrich their national economies. For example, the net sales of Samsung is equivalent to 20% of GDP of South Korea. In fact, a successful global brand is a sustained source of wealth creation. Also, world class brands can contribute increasingly to import substitution, value added exports as well as larger value capture from global markets. In fact, this can transform the country from one dominated by foreign brands to a player of substance in the global arena.

The creation of world class brands demands tremendous staying power with substantial investment commitments over the long run. It requires deep consumer insight, continuous nurturing of R & D, differentiated product development capacity, brand building capability, cutting edge manufacturing and an extensive trade marketing and distribution network. This will also result in job creation and retention of value in the country.

Therefore, it is vital that the policy environment incentivises the creation of Indian brands. For example, since foreign brands entail a royalty outflow, a similar percentage (say 5%) of turnover of Indian brands should also be admissible as a "standard deduction" for income tax purposes. Moreover, a larger deduction of say 10% of turnover should be admissible for new brands for the first 10-15 years of their commercial launch. Alternatively, a weighted deduction of 200% of the relevant expenditure on brand building should be allowed as a deduction. This will create a level playing field for domestic enterprises. Moreover, this will help in making the Indian brands globally competitive and thereby control the current account deficit problem on a sustainable basis.

6. "MAKE IN INDIA" : ENCOURAGING INNOVATION TO DELIVER CORPORATE INITIATIVES FOR LARGER SOCIETAL VALUE CREATION :

- In line with the Hon'ble Prime Minister's call for qualitative and sustainable industrial growth in the form of "Make in India: Zero Defect and Zero Effect", there is a strong need to encourage and incentivise the immense transformational capacity of corporates in innovating business models that can synergistically deliver economic and social value simultaneously.

- Sustainability in Business Development in its truest sense can only take place when economic growth fosters social equity. Growth must translate into the creation of sustainable livelihoods and replenishment of scarce environmental resources. Limits to future growth will be defined more by vulnerabilities flowing from social inequities, environmental degradation, and climate change than by any other economic factor.

- Government can support the development of a Responsible Business "Trustmark" Rating System that could be used to convey to the consumer a company's environmental and social performance. An enterprise could be awarded credits by way of "Trustmark Rating", based on an objective evaluation of its triple bottom line performance. An accumulation of such credits could earn the enterprise Trustmark Ratings on a progressive scale. These Ratings could then be displayed on products and services of the company to help consumers make an informed choice.

- Government must consider the provision of a differentiated and preferential set of incentives, fiscal or financial, to companies that demonstrate leadership in sustainability performance. Companies with high "Trustmark" ratings should be provided with incentives like priority fast track clearances, purchase preferences, lower levies of central excise duty for manufacture of "green", eco-friendly products, weighted deduction for the expenditure under the Income Tax Law and so on. This would spur powerful market drivers that will incentivise innovation for larger triple bottom line impact.

- Banks and Financial Institutions could also factor in the Trustmark Ratings in their lending operations providing benefits to more responsible corporations. Going forward, it may even be possible to trade in these "Trustmarks", if a system similar to carbon credits or energy efficiency certificates can be developed so that organisations with surplus credits are able to monetise their efforts.

7. LIMITLESS ROYALTY PAYMENTS - A DRAIN ON THE ECONOMY :

- India is now a global market with free competition by international players in most areas of economic activity.

- International companies are in India to exploit this global market and compete with other international and domestic players.

- To compete effectively, they bring their brands, know how, technology and other intellectual property in their own self-interest.

- Hence, incentives in the form of royalty pay-outs by their Indian subsidiaries are neither justified nor required.

- Payment of royalty by Indian subsidiaries to their overseas parent entities is extremely illogical and injurious to India's current account balance, government exchequer and minority shareholders. In the year 2012-13, the pay-out was US$ 7 billion representing 20% of India's annual FDI inflows, and is growing exponentially in the subsequent years. It is therefore recommended that such royalty payments should not be permitted. Otherwise, the Income Tax Law should provide for higher quantum of withholding tax.

- Indian players seeking access to intellectual property to compete effectively with the international players in the Indian global market should continue to be allowed to pay royalty to unrelated parties on an arm's length basis, without government intervention.

8. TAXABILITY OF EXPORT COMMISSION PAID TO NON-RESIDENT EXPORT AGENTS :

a. A non-resident export agent renders export promotion and marketing services outside India and also receives payment for such services outside India. Generally, the services rendered by an export commission agent would restrict to soliciting customers in the foreign location, liaising with the customers, coordination, negotiation and procuring the export orders etc. They do not render any technical services and the payment is only towards the functions and responsibilities that a commission agent is expected to discharge.

b. Accordingly, the export commission paid to such non-resident export agents does not accrue or arise/ be received or deemed to accrue or to be received in India and thus are not taxable in India as per Section 5 of the Income Tax Act, 1961 (the Act). Further, the said export commission to non-resident agents cannot be deemed to arise from any business connection in India, as the entire service is carried out outside India and hence it not taxable in India as per Section 9(1)(i) of the Act. Accordingly, no withholding tax u/s 195 applies to such export commission paid to non-resident agents.

c. Reliance is also placed on several Court rulings wherein it has been held that export commission paid to non-resident agents for services rendered by the agent outside India are not taxable in India:

- In CIT vs Toshoku Ltd., Guntur and Ors - 2002-TII-03-SC-INTL The Supreme Court has held that since non-resident taxpayer did not carry on any business operations in India, amounts earned for services rendered outside India could not be deemed to be incomes which had either accrued or arisen in India.

- In CIT vs Eon Technology (P) Ltd - 2011-TII-41-HC-DEL-INTL - The Delhi High Court has held that when an agent was not rendering any service or performing any activity in India itself, commission income cannot be said to have accrued, arisen to or received by agent in India.

- In the case of Panalfa Autolektrik Ltd - 2014-TII-51-HC-DEL-INTL - The Delhi High Court has held that services rendered by the non-resident cannot be said to be in the nature of 'managerial', 'technical' or 'consultancy' services and hence, the commission cannot be treated as 'fees for technical services'. Thus, the export commission was not taxable in India.

There are various other judicial precedents wherein it has been held that commission paid to export agents outside India would not be taxable in India and accordingly, no withholding tax would apply on such payments made by Indian assesses:

•  Armayesh Global vs ACIT, - 2012-TII-85-ITAT-MUM-INTL

•  Gujarat Reclaim and Rubber Products Ltd vs Add.CIT - 2013-TIOL-635-ITAT-MUM

•  ITO vs Trident Exports - 2014-TII-212-ITAT-MAD-INTL

•  DCIT vs Divi's Laboratories Ltd - 2011-TII-182-ITAT-HYD-INTL

•  DCIT vs Transformers & Electricals Kerala Ltd. - 2014-TII-138-ITAT-COCHIN-INTL

•  DCIT vs Sandoz (P) Ltd - 2013-TII-20-ITAT-MUM-INTL

•  ACIT vs Farida Shoes (P) Ltd - 2013-TII-239-ITAT-MAD-INTL

•  ACIT vs Model Exims - 2014-TII-46-ITAT-LKW-INTL

•  IVAX Paper Chemicals Ltd vs Additional CIT - 2014-TIOL-1086-ITAT-HYD

Legal issue Involved :

d.   The CBDT had issued Circular No 23 dated 23 July 1969 and Circular No. 786 dated 7 February 2000 wherein it was clarified that where the non-resident agent operates outside the country, no part of his income arises in India. Further, since the payment would be remitted directly abroad it cannot be held to have been received by or on behalf of the agent in India. Such payments were therefore held to be not taxable in India.

e. However, CBDT vide Circular No. 7/2009 dated 22.10.2009, withdrew their earlier Circular No 23 dated 23.07.1969 along with Circular No. 786 dated 07.02.2000.

f. This withdrawal of the circular have led some Assessing Officers to erroneously believe that export commission paid to non-resident export agents are taxable in India and they are arbitrarily disallowing all the export commission expenditures under section 40(a)(i) during assessments on the pretext of non-deduction of tax at source on such export commission, which are legally not taxable in India.

This has led to unnecessary harassment of the assessees and has needlessly increased the litigation cost of the assesses.

g. It may be worthwhile to point out that the Circular No 23/1969 was introduced after a Supreme Court ruling in the case of CIT v. R.D. Aggarwal & Co. - 2002-TII-15-SC-LB-INTL, as explained in Para 2 of the said circular. Thus, the position stated in Circular No 23/1969 or Circular No. 786 dated 07.02.2000 were mere clarifications regarding applicability of the provisions of Section 9 of the Act, and are in no way any alteration to the principals laid down in Section 9 of the Act. Thus, withdrawal of this Circular by the CBDT will not change the provisions of the law which clearly expounds that export commission paid to non-resident are not taxable in India since the export agents have rendered all services outside India (no income accrues or is deemed to accrue in India) and payments have been received by them in their foreign bank accounts (no income is received or is deemed to be received in India).

Recommendation:

CBDT should come out with a clear clarification that export commission payments to non-resident agents are not taxable in India, in case:

- They render the services entirely outside India

- They receive the payment abroad i.e. do not receive the payment in India.

9. TAX ADMINISTRATIVE REFORMS :

- The Government had announced that the focus should be on 'Ease of doing Business'. In the context of the same, the Tax Administrative Reforms Commission (TARC) was set up under Dr Parthasarathi Shome.

- The Shome Committee has already submitted its report to the Government, which amongst various things, has suggested that there should be a very strong "customer focus" to ensure that tax payer services receive maximum priority. Also, it has suggested various other measures like merger of CBDT and CBEC, research based analysis of policy, bottoms up approach for fixation of revenue targets, impact assessment studies for various tax policy measures and bifurcation of the administrative functions from that of law making. However, no feedback is currently available on the implementation of the said committee's recommendations till date. It is suggested that the various aspects of the Shome Committee's recommendations be examined at the earliest and given effect to for the ones which are accepted. This by itself will help in improving the Revenue Department's role and alignment of various tax policy measures in line with global practices.

10. CAPITAL GAINS ON DEBT ORIENTED MUTUAL FUNDS:

More than 6.7 million retail investors (Report in Business Standard, Mumbai, 15th July 2014), in addition to a significantly large number of institutional investors have been impacted adversely by the proposals in the last Budget for increasing the tenure of debt-oriented Mutual Funds from 12 months to 36 months for availing long term capital gains benefit and increasing the capital gains tax rate on such funds to 20%.

The debt market is critical to the growth of a developing economy like India where large amount of capital is required for achieving industrial and infrastructure growth. A robust debt market enables (i) efficient mobilisation and allocation of resources in the economy (ii) greater funding avenues to the Government as well as public-sector and private sector projects at a competitive cost of borrowing (iii) unlocking of illiquid retail investments, e.g., gold, and (iv) deepening of the Corporate Bond market.

Currently, in case of equity shares held in a company or any other security (including debentures / bonds) listed in a recognised stock exchange in India or a unit of the Unit Trust of India or a unit of a Mutual Fund or a zero coupon bond, the period of holding for qualifying as a short term capital asset is not more than 12 months.

Debt-oriented mutual funds invest in debt securities a majority of which are listed and exposed to interest rate risk as reflected in daily price changes. Such risk is fully borne by the investor as Mutual Funds are pass-through structures. However, the Budget proposals will result in differential tax treatment for Mutual Fund Units and listed Securities, though both are subject to market risk in terms of price change. By doing so, investment in debt-oriented mutual funds are being equated to other asset classes like real estate and gold despite performing an altogether different role for the Indian Economy. Such a policy stance may not be appropriate.

Further, mutual funds are active and key participants in the Corporate Bond market and meet the funding requirements of many sectors of the economy at highly competitive rates particularly in the case of NBFCs. Also, mutual funds are counter parties to 35% of the secondary trades that take place in Bonds. Hence, to support and deepen the Corporate Bond market, it is essential to strengthen the Mutual Fund industry which plays the role of aggregating savings in the economy.

The existing tax provisions on debt-oriented funds provide:

•  A viable investment opportunity to investors who have a low to medium risk appetite and a short to medium term investment horizon.

•  An opportunity to Corporates to access funds at a competitive borrowing cost for investments in infrastructure and technology.

It is apprehended that the said change would weaken the mutual fund industry which in turn would negatively impact the Corporate Bond market. This would, inter alia, result in higher interest rates/yields for borrowers as the market loses depth in the absence of support from mutual funds. Further, the opportunity of a viable return to investors, including the almost 7 million retail investors will get undermined. More so since investments in alternate avenues like Bank Fixed Deposits have been rendered sub-optimal in the scenario of high inflation.

In view of the above, it is recommended that the earlier provision in the Income Tax Law in respect of period of holding of not less than 12 months for debt-oriented mutual funds for the purpose of determining long term capital gain along with the currently applicable rate of long term capital gains tax be continued.

11. DIVIDEND DISTRIBUTION TAX (DDT) :

The Finance Act 2014 has changed the methodology of determination of tax payable on dividend distribution by a domestic company and mutual funds. While the DDT rate has been left unchanged, the DDT computation will have to be done after grossing up the dividend with the DDT tax rate. As a consequence of this, the situation of a "tax on tax" is getting further aggravated.

Dividend is paid out of post-tax profits, which itself is currently under severe pressure on account of the global economic downturn. Therefore, the above grossing up, which will result in increasing the DDT tax, will impact the dividend pay-out to shareholders and mutual fund subscribers. This reduction in net dividends will bring down the attractiveness of investing in Indian equities and in turn will impact the stock markets. Also, this will have an adverse impact on the divestment plan of the Government and reduce the ability to draw foreign investments that are crucial in financing the deficit. The mutual fund industry will also be impacted due to the lower dividend payouts and future flow of funds will be affected.

Therefore, it is suggested that the earlier methodology of calculation of the DDT based on the net dividend pay-out be continued.

12. TAXING OF ESOPS IN THE HAND OF THE EMPLOYEES:

The current Income Tax Law, provides for the inclusion of ESOPs under section 17(2) to be taxed as a "perquisite", consequent to the abolition of FBT.

The section states that ESOPs issued free of cost or at concessional rates will be taxed on the date of exercise on the difference between the "fair market value" and the amount actually paid by the employee. The "fair market value" is to be determined based on stipulated methods which have been separately prescribed by the CBDT.

This suffers from the following drawbacks :

(a) It seeks to tax a notional benefit at a time when the actual gain is not realised by the employee. In fact, it is possible that the actual sale of shares could result in a loss for the employee. Since the perquisite tax paid earlier cannot be set off against the capital loss, the employee suffers a double loss, namely tax outgo and loss on sale of shares.

(b) The question whether the ESOPs are granted at a concessional rate is being determined with reference to the "fair market value" on the date of exercise of the options. Technically, this is an incorrect approach. If the ESOPs are issued at the prevailing market price on the date of grant, the issue should be treated as "non concessional". This would be in line with the guidelines issued by SEBI. Any subsequent gain accruing to the employee due to favourable market movements by the date of vesting or exercise of option cannot be treated as a "perquisite" granted by the employer.

(c) Further, if such subsequent gains are a perquisite in the hands of employers, it would stand to reason that the value equivalent of such a perquisite should have been a deductible expenditure in the hands of the company issuing the ESOP. Since the tax law does not contemplate such a deduction, the taxation of the perquisite would result in double taxation.

(d) Also, from the strictly legal angle, there are a number of differences between ordinary shares and ESOP shares. Therefore, they are not comparable. The taxation principles currently existing, result in discrimination. The market value is also strictly not applicable since there are lock-in periods applicable. A detailed note on these aspects is enclosed (Annexure 1).

Since the actual sale of shares will attract capital gains tax, if applicable, it is unnecessary to subject the employee to perquisite tax. In fact, before FBT was imposed on ESOPs, specific provisions existed in the Income Tax Act for exempting the same from perquisites and subjecting it only to capital gains tax

It may be noted that ESOPs have emerged over the years as a critical, motivational and retention tool for companies in a highly competitive market for talent. It is a very effective instrument for encouraging employees to perform and excel and is a win-win proposition for the employers / shareholders on one hand and the employees on the other.

It is suggested that the taxation of ESOPs as perquisite at the time of allotment / exercise should be avoided for the reasons explained above. If at all it is taxed, it should be based on the fair market value i.e. the market price prevailing on the date of grant. Any subsequent appreciation should only be taxed at the time of realization / sale as capital gains.

13. TAXING OF CONTRIBUTION TO SUPERANNUATION FUND BEYOND SPECIFIED MONETARY LIMITS (CURRENTLY IN EXCESS OF RS.1.50 LAKH) - IN VIOLATION OF SUPREME COURT JUDGEMENT :

The Finance Act, 2009 had imposed tax on employees in respect of the company's contribution to Superannuation Fund in excess of Rs.1 lac and this limit was increased by the Finance Act. 2016 to Rs.1.50 lakh.

It may be noted that there are various types of superannuation funds. In case of the new pension scheme and similar superannuation funds, the contributions made by the employer vests with the employee and he can transfer it from one employer to another. However, in other cases, contributions made by the employer to a Superannuation Fund do not accrue to the benefit of the employee till such time he retires upon superannuation, when the Fund is used to purchase annuities and/or to pay the commuted pension to the retired employee. Such contributions may or may not result in superannuation benefits to the employees since there are various conditions to be fulfilled by the employees like serving a stipulated number of years, reaching a certain age etc. Therefore, this should not be taxed as perquisite as per the ratio of decision laid down by the Hon'ble Supreme Court in CIT vs. L W Russel - 2002-TIOL-686-SC-IT. Further, the pension payments are subjected to tax at the time of actual receipt by the employee.

As such, it is suggested that contribution to superannuation fund should not be taxed as perquisite.

14. VALUATION OF COMPANY OWNED ACCOMODATION PROVIDED TO EMPLOYEES :

As per the current Income Tax Law, company owned accommodation provided to employees is taxable @ 15% of salary in cities having population exceeding 25 lakhs. In other cases, it is taxable @ 10% of salary in cities having population between 10 lakhs and 25 lakhs and 7.5% of salary in other places.

In case of leased / rented accommodation, value of the accommodation is taken at the stipulated percentages or lease rent, whichever is lower.

However, the above method of determination of the perquisite suffers from various inequities. For example, for the same employee staying in the same company owned accommodation, the perquisite will increase with any salary increase.

Again, for the same company owned accommodation, different employees with different salaries will have different perquisite value.

Also, irrespective of the size/quality of company owned accommodation, the perquisite for a particular employee will be determined as a percentage of salary.

Therefore, it is suggested that in case of company owned accommodation the concept of fair value should be introduced to ensure that the right amount of perquisite is determined for income tax purposes.

15. SCIENTIFIC RESEARCH EXPENDITURE:

The income tax law provides for certain tax benefits in respect of scientific research expenditure. In-house R&D is separately incentivized under section 35(2AB) of the Income Tax Act 1961. This specifically requires that the in-house research and development facility be approved by the Department of Scientific & Industrial Research (DSIR). The deduction is available @ 200% till FY 2020-21 and thereafter @100% for the following expenditures -

1) Revenue expenditure, and

2) Capital expenditure (not being expenditure in the nature of cost of land and building)

For claiming deduction, there are certain conditions laid down in the Section and in DSIR Guidelines that are required to be fulfilled.

The current issues include the following :

a) Negative list of articles/ things specified in the Eleventh Schedule of the Income Tax Act - should be deleted

Section 35(2AB) specifically lays down that weighted deduction is NOT available for the articles/ things specified in the Eleventh Schedule. Eleventh Schedule, inter-alia, among other things contains various products like beer, wine and other alcoholic spirits, Tobacco and tobacco preparations (such as cigar and cheroots, cigarettes, biris, smoking mixtures for pipes and cigarettes, chewing tobacco and snuff), Confectionery and chocolates, Cosmetics and toilet preparations, Tooth paste, dental cream, tooth powder and soap etc.

It is highly discriminatory that weighted deduction is not available in respect of the in-house research and development carried out for the above articles/ things. India is a developing market and the need for quality and internationally competitive products cannot be undermined. In fact, in the absence of quality in-house R & D in India, significant expenses are incurred in respect of royalty payments for use of imported technology, packaging/technical specifications etc. Such forex remittances on account of royalty and technical knowhow are putting serious strain on the Current Account Deficit and this needs to be addressed on an urgent basis. Moreover, the menace of contraband products also becomes another area of concern in the country which is a direct fallout of the above problem.

Therefore, companies which are in the business of manufacture/ production of the above products and are incurring expenditure in carrying out in-house research and development should not be denied the benefit of weighted claim, which otherwise would result in excessive payments in foreign exchange for royalty / technical knowhow and poor quality/contraband products flooding the market as explained in the earlier para. In fact, domestic production of international quality products can help not only in saving precious foreign exchange, but also in bringing foreign exchange into the country through exports and royalty earnings. Further, to boost domestic production and empower the domestic companies against big foreign players, it has become imperative to extend the benefit of weighted claim to all manufacturers. Therefore, it is suggested that the negative list as given in the Eleventh Schedule be removed in the context of section 35(2AB).

b) Revenue expenses eligible for weighted claim - scope of expenses to be enlarged :

DSIR Guidelines (last updated May 2010) has identified various revenue expenses which are not eligible for weighted claim. However, i t is the need of hour that the exclusion list be stream-lined and narrowed down. There is no doubt that weighted deduction is intended to be made available only for in-house R&D activities carried out. However, it cannot be denied that there are certain activities, which though forming part of the overall R&D activities, are carried out outside the approved R&D facility. Weighted claim should be available for these activities also. Also, considering the increasing complexities in R&D, there may be foreign consultants involved. However, there is no reason why foreign consultancy expenditure should not be eligible for claim. It is therefore recommended that to encourage greater in-house R&D activity, the ambit of eligible revenue expenses be increased to include -

•  Expenditure on outsourced R&D activities

•  Lease rent paid for research farms or research labs

•  Foreign consultancy expenditure

•  Building maintenance, municipal taxes and rental charges

•  Clinical trial activities carried out outside the approved facilities

•  Contract research expenses

(c) DSIR Guidelines - Excessively Restrictive

Among various other conditions, the DSIR Guidelines specifically lay down that -

(i) The manufacturers who wants to lodge weighted claim should enter into an agreement with the DSIR for 'co-operation' in such research and development facility.

The word 'co-operation' shall, inter-alia, mean that the company shall be willing to undertake projects of national importance, as may be assigned to it by the DSIR, on its own, or in association with laboratories of CSIR, ICAR, ICMR, DRDO; DBT, MCIT, M/O Environment, DOD, DAE, Department of Space, Universities, Colleges or any other public funded institution(s). The company would be free to exploit the results of such R&D projects, subject however, to any conditions which may be imposed by Government of India, in view of national security or in public interest.

(ii) Assets acquired and products, if any emanating out of R&D work done in approved facility, shall not be disposed of without approval of the DSIR.

It cannot be denied that such conditions, as above, are very restrictive in nature and instead of promoting in-house R&D, hamper the willingness of corporates to carry out in-house R&D. There is already a condition that the in-house R&D facility should be approved by DSIR. Once the R&D facilities are DSIR approved, there should not be any requirement for entering into a separate agreement with DSIR. In fact, such requirements would do nothing except burdening the corporates with administrative hassles. There is an urgent need to relax these stipulations so that in-house R&D activities are encouraged and in-house scientific research gets the necessary tax benefits. This will result in incentivising R & D expenditure for promoting "Make in India" manufacturing.

16. DISALLOWANCE OF EXPENSES RELATING TO EXEMPT INCOME UNDER SECTION 14A:

As per section 14A of the Income Tax Act, 1961, no deduction is allowed in respect of expenditure incurred in relation to exempt income. In the context of the same, the Government has prescribed rule 8D (amended vide notification no.43/2016 dated 2nd June 2016) as per which the disallowance will be determined as below :

(i) The amount of expenditure directly relating to exempt income.

(ii) 1% of the annual average of the monthly averages of the opening and closing value of investments.

The stipulation regarding the disallowance of 1% of the monthly averages of the value of investment is very harsh since it has no relationship with the earning of exempt income. In fact, this could result in adhoc and excessive disallowance and in some instances, there could be cases of the disallowance exceeding the total exempt income. This is even worse when investments are made at the end of the accounting year, say on 31st March. Also, as per current accounting systems, corporates are not required to do any book closing on a monthly basis and therefore this would result in additional work for the sole purpose of determination of disallowance. Moreover, in respect of exempt income from dividends arising out of investment in companies and mutual funds, the payers also pay the dividend distribution tax. Therefore, technically this could not be termed as tax free income in the hands of the recipient and the above disallowance results in double taxation.

Therefore, it is suggested that rule 8D be amended and should be restricted to the following:

•  Exempt income to exclude dividend income on which dividend distribution tax has already been paid.

•  Expenditure directly attributable to earning of exempt income be disallowed.

•  Interest expenditure to be disallowed in line with the existing law based on the proportion of average value investments to total assets after excluding the interest expenditure specifically related to the business of the company.

•  The disallowance for administrative expenditure should be made by estimating the time of the personal and resources involved for undertaking the activities which result in earning of the exempt income. The aforesaid estimation to be done on a reasonable basis after considering the facts of each case and this should be certified by the Tax Auditor. In case this is not feasible, then the disallowance be restricted to 0.5% of the exempt income.

•  The disallowance should not be made for strategic investments which are incurred for gaining a controlling stake in another company/subsidiaries, JVs and associates.

Annexure-1

ESOP shares vis-à-vis Market Shares

They are not comparable

1. ESOP shares are "issued" by the employer and "subscribed" to by the employee, whereas the shares acquired in the market ("market shares") are "transferred" from one shareholder to another. Consequently, while the market shares are goods, the ESOP shares do not become goods until they are allotted in favour of the subscribing employee.

2. It follows that the ESOP shares are not comparable with the shares that are already being traded. Therefore, it is incorrect to quantify any benefit to the employee with reference to the already trading shares or their so-called market value.

3. Even after allotment of the ESOP shares, the employee is prevented by law or the terms of the grant, from selling the shares during a lock-in period, whereas the shares bought in the market can be sold immediately without any restraint. The legal ability of disposition being one of the essential attributes of "property", the ESOP shares, unlike the market shares, are not property in the hands of the employee even after allotment.

4. When on the date of exercise the shares are subject to a lock-in condition, they cannot be considered to be a benefit; and if it is a not a benefit, it ought not to be fictionally treated as benefit and brought under "perquisites". In CIT v. Infosys Technologies Ltd., at page 277 = 2008-TIOL-01-SC-IT, the Supreme Court held as follows:

"During the said period, the said shares had no realisable value, hence, there was no cash inflow to the employees on account of mere exercise of options. On the date when the options were exercised, it was not possible for the employees to foresee the future market value of the shares. Therefore, in our view, the benefit, if any, which arose on the date when the option stood exercised was only a notional benefit whose value was unascertainable. Therefore, in our view, the Department had erred in treating Rs.165 crores as perquisite value being the difference in the market value of shares on the date of exercise of option and the total amount paid by the employees consequent upon exercise of the said options."

The Court further, at page 279, held:

"It is important to bear in mind that if the shares allotted to the employee had no realisable sale value on the day when he exercised his option then there was no cash inflow to the employee. It was not possible for the employee to know the future value of the shares allotted to him on the day he exercises his option."

It may be borne in mind that in the Infosys case, the Supreme Court dismissed the Government's appeal not only because the ESOP shares were not enumerated under "perquisites" in S. 17 (2), but also because it does not amount to a benefit.

5. For this reason also the ESOP shares and the market shares are not comparable, and the latter cannot afford any basis for determining any benefit that may have accrued to the employee on account of the ESOP shares.

Discrimination

6. When a listed company issues IPO or rights shares at a price less than the market value (or bonus shares), the difference between the issue price and the market price is not taxed. If in such a case the difference does not take the character of income, it cannot be income in the case of ESOP shares too.

7. And, if such difference (in the case of IPO/rights/bonus) does take the character of income, then taxing ESOP share alone lacks any intelligible differentia that can validly explain this classification.

8. If a distinction is suggested on the ground that in the case of ESOP shares the benefit takes the character of income from salaries (which is apparent from treating it as "perquisite") which is not so in the case of market shares, it would be incorrect because such income, especially in the nature of salaries, would flow to the employee only when he realizes a gain upon the sale of the shares and not by mere allotment. Therefore, this is not a meaningful distinction.

Valuation

9. The "market value" is taken as on the date of exercise. But the ESOP shares are allotted after a lapse of time, when the market value may not be the same.

10. Even the market value on the date of allotment would not be relevant because the employee would not be able to realize that "value", being prevented from selling the ESOP shares during the lock-in period.

11. Further, the issue of ESOP shares results in expanding the capital base, and a consequent reduction in the intrinsic value of the existing shares. For this reason also, the alleged benefit flowing from ESOP shares cannot be reckoned with reference to the current value of the already existing market shares.