12 November, 2019
Introduction
September 20, 2019 will be remembered as a historic date in the Indian corporate sector. With the introduction of a munificent reduction in basic corporate tax rate for Indian companies from 30 per cent to 22 per cent under The Taxation Laws (Amendment) Ordinance, 2019 dated September 20, 2019 (ordinance), the government sent a very strong and clear signal to the Indian corporate sector towards rationalization of high corporate tax rates. Post addition of surcharge and cess, the effective corporate tax would be 25.17 per cent. An existing Indian company has an option to opt for this beneficial basic corporate tax rate (beneficial rate) of 22 per cent. Further, a fresh category of ‘new manufacturing companies’ (NMC) was introduced that would be eligible to opt for a separate beneficial rate of 15 per cent.
The reformation of Indian income tax regime (ITR) through reduction in existing corporate tax rates was a welcome move cheered vehemently by Indian corporates and especially the stock markets, which function on a forward multiple. To incentivize new entrants and boost domestic manufacturing, the beneficial rate of 15 per cent or NMC was also looked at very favourably.
While the existing scheme of basic corporate tax rate of 30 per cent would also continue in parallel, an Indian company (existing or NMC) would now have the option of electing the aforementioned rates. Once the option is exercised to avail the beneficial rate of 22 per cent/15 per cent, it cannot be reversed by the said Indian company. The ordinance has introduced a specific provision in ITR (Provision) that would govern the eligibility of Indian companies for availing beneficial rate.
The key perspective
While on the face of it, beneficial rate appears extremely generous and innocuous, one may need to analyze the entire framework within which the option of beneficial rate is available.
An Indian company needs to calculate its total taxable income in the manner prescribed under ITR and then apply the existing basic corporate tax rate of 30 per cent. While arriving at total taxable income, the company is entitled to avail of exemptions/incentives under ITR which will effectively reduce the quantum of taxable income, thereby in effect, reducing the total taxable income on which the basic corporate tax rate of 30 per cent would be applied.
With the advent of beneficial rate, existing Indian companies can opt for the aforesaid beneficial rate of 22 per cent subject to them not availing any exemptions/tax incentives/ tax holidays available to them under ITR. Thus, an existing Indian company would need to evaluate whether the effective tax payout is lower in the existing scenario (i.e. 30 per cent on reduced total taxable income after exemptions/incentives under ITR) or the proposed scenario (i.e. beneficial rate of 22 per cent on effectively higher total taxable income arrived at without availing any tax exemptions/benefits under ITR). Similarly, NMC eligible to avail tax incentives under ITR would also have to make a choice between the existing basic corporate tax rate of 30 per cent and the beneficial rate of 15 per cent.
The details
The Provision states that once exercised, the option for beneficial rate cannot be subsequently withdrawn by the Indian company. NMC should have been set up and registered on or after October 1, 2019. Further, NMC shall (a) not be formed by splitting up or reconstruction of existing business, and it shall (b) not be engaged in any business other than manufacture of any article or research or distribution thereof.
Key issues
Definition of the term “manufacture”
For NMC, the definition of “manufacture” under ITR envisages change in non-living physical object or article or thing resulting in either transformation of same into a new and distinct article with distinct character or bringing into existence a new and distinct object with different chemical composition or integral structure. This definition may lead to certain infirmities such as whether the term “manufacture” would include industries such as licensing of software products or development of pure software (as it is ‘intangible’ in nature while the definition envisages ‘tangibility’) or any service oriented industries such as specialized warehousing, logistics, cold storage facilities, etc. (because such an activity may not necessarily create a ‘new or distinct product’ as envisaged by the definition).
Similarly, while movable objects are envisaged in the definition of “manufacture”, would the development of immovable objects such as immovable property/real estate also get covered under the term “manufacture”?
Fixation of claim for beneficial rate
In case of a toll contractor in charge of developing and maintaining any infrastructure facility, who will qualify for beneficial rate – toll contractor or owner of property? Here, in order to decide such entitlement to claim beneficial rate, one may need to place more importance on entity bearing risk and exercising control or supervision over the activity. Mere ownership of assets may not be the sole criterion for deciding such eligibility.
Previously used plant and machinery
NMC shall not use previously used plant and machinery. However, if such previously used machinery is ‘put to use’ by NMC and value thereof does not exceed 20 per cent of total plant and machinery used by NMC, this condition shall not be deemed to have been violated. Here, one would wonder whether this threshold of 20 per cent would need to be tested in only in the initial year or every successive year?
Disqualification and recourse
The option for beneficial rate once exercised cannot be retracted. If in a given year, the conditions under the Provision are not met then that would automatically disqualify the Indian company from being eligible to claim the beneficial rate for that year. Would that mean a default recourse to original taxation structure i.e. 30 per cent regime with all exemptions and incentives for that year and all prospective years?
Accounting irregularities
Deferred tax is an accounting concept. It denotes the tax impact on account of differences between incomes computed as per accounting standards and ITR for any given financial year. A deferred tax asset is an asset on a company's balance sheet that may be used to reduce its taxable income in future. For instance, in case of carry-over of losses, if a business incurs a loss in a financial year, it is usually entitled to use that loss in order to lower its taxable income in the following years. In that sense, the loss is an asset. With the option for beneficial rate being exercised, the Indian company would have to essentially forfeit all its past losses which it may not be able to set off in future on account of the beneficial rate regime. This may lead to write-down of the deferred tax asset created on such carry forward of losses.
Nevertheless, being a landmark step in its own merit, the move has been hailed as bold and courageous. However, as stated above, it needs to be seen whether the bulk of Indian companies will decide to exercise the option for availing the simplified beneficial rate or prefer to continue under the current regime of claiming exemptions.
Since the simplified tax regime would be based on normal taxable income without taking into account any tax incentives or holidays, it ought to reduce potential tax litigation generated on account of claim of such tax incentives.
For further information, please contact:
Souvik Ganguly, Partner, Acuity Law
al@acuitylaw.co.in
