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Rashmin Sanghvi & Associates

Chartered Accountants

220, 2nd Floor, Arun Chambers,
Tardeo Road,
Mumbai - 400 034,
Maharashtra, India.

Tel. Nos.: (+91 22) 2351 1878, 2352 5694.

Fax : (+91 22) 2351 5275.

Email : [email protected]

 
Home Articles Taxation         Share :

Budget 2016Chapter A


Date: 10th May 2016.

Dear Reader,

Finance Bill 2016 – Income-tax

 

This Government presented its third Finance Bill on 29th February 2016. The Government has taken some concrete steps during the past two years to bring in clarity in the Income-tax Act. It appointed committees to look into controversial and difficult issues. Wherever issues were controversial, the Government has brought in circulars and given its view - in some cases, clearly in favour of tax payers.


In this finance bill also, there are measures to bring in clarity. The direction is good. We appreciate that Income-tax law is a complex legislation with several objectives. To balance the same is a difficult job. In the circumstances, we consider the direction of the finance bill good. We hope it will continue in future as well.


We have given our analysis of the important provisions in the Finance Bill 2016 relating to Income-tax. Needless to say, this is continuing exercise. As we go along, we will have more clarity.


We will glad to receive your feedback and observations.


Rashmin Sanghvi and Associates


Finance Bill 2016

This document contains our analysis of the key amendments proposed by the Finance Bill 2016. This note also considers amendments to the Finance Bill made on 29th April 2016. Finance Bill has been passed in the Lok Sabha. It has to receive President’s assent. Therefore this note refers to the Finance Bill provisions as proposals. These can be considered as final.
All these amendments apply from FY 2016-17 (AY 2017-18) unless otherwise stated.1


The section numbers given in the paragraph titles refer to sections of the Income-tax Act. In some cases, we have given reference to the clauses of Finance Bill 2016.


We have attempted to explain the provisions in non-technical language so that it is simple to understand. Many provisions have conditions to be fulfilled. There could be some issues and controversies. We have given only the important issues associated with the provisions as otherwise it will make the analysis unduly long. Before taking any decisions, professional advice should be taken. The reader should not take any decision based on this document.



1. This time quite a few provisions are made applicable from a future year and hence care needs to be taken of such amendments which become part of the Finance Act 2016.

 

Chapter A - Tax Rates, Tax reliefs & Future Scenario – Broad Policy

1. Rates of Income-tax:

1.1 In the previous Budget speech, the Finance Minister had proposed to bring down corporate tax to 25% in the next 4 years combined with removal of tax exemptions. He has made a beginning with the following measures:

i) A company set-up and registered after 1st March 2016 and engaged in business of manufacturing and production, may opt to be taxed at 25% subject to fulfillment of some conditions. [S. 115BA]. (See para 2 for more details.) If the companies do not opt for 25% tax rate, they will be taxed like any other company.

ii) Corporate rate of tax in case of domestic companies has been reduced from 30% to 29% provided total turnover or gross receipts of the company does not exceed Rs. 5 crores for the financial year 2014-15.

iii) Profit linked/weighted deductions, accelerated depreciation deductions are being phased out with dates announced in advance. The deductions having a sunset date will continue till that date. However, where no terminal date is provided, sunset date will be 31st March 2017. (see Annexure II for details).  


1.2 Tax on dividend has been introduced for shareholders who earn dividend of Rs. 10 lakhs or more from dividend declared by Indian companies. This will apply to individuals, HUFs and firms. (see para 3 for more details.)
 

1.3 The tax rates for FY 2016-17 are given in Annexure I.
 

2. Tax rate on new companies: [S. 115BA]
 

As mentioned in para 1.1 above, the Government wants to remove deductions and lower the corporate tax rates.
 

2.1 A new Indian company set up and registered on or after 1st March 2016 is eligible for a lower rate of tax of 25% (plus surcharge and education cess) instead of the 30% rate applicable for other companies. Only a company engaged in the business of manufacturing or production of any article or thing is eligible for this relief. The lower rate is applicable from Financial year 2016-17 onwards. The present lower tax rates for short term gain on some assets like equity shares and certain units, and long Term gain will continue. MAT will also continue to apply.
 

2.2 Such a company needs to compute its income as under:
 

i) The company is engaged in the business of manufacturing or production of any article or thing and research in relation to, or distribution of such article or thing manufactured or produced by the company. Other businesses like services, software, etc. are not eligible.

ii) None of the following reliefs can be claimed by the company  



a) relief for units in SEZs.

b) accelerated depreciation for new machinery.

c) deduction for new machinery cost of which exceeds Rs. 100 cr.

d) deduction for new machinery in backward areas of Andhra Pradesh, Bihar and West Bengal.

e) deduction for special bank deposits for those who are engaged in growing and manufacture of tea, coffee or rubber.

f) deduction for special bank deposits for those who are engaged in prospecting for, extraction of production of petroleum and natural gas.

g) weighted deduction for expenditure on scientific research.

h) expenditure for approved projects for social and economic welfare.

i) deduction for capital expenditure for pipelines, hotels, housing projects, etc.

k) weighted deduction for expenditure in skill development.

l) deductions under Chapter VI-A infrastructure relief, etc.

(The only deduction allowed is u/s. 80JJA for new employment. See para 7 for details.)  

iii) No loss can be carried forward from any earlier assessment year if such losses are attributable to any of the deductions referred to in clause (ii) above.

iv) Depreciation is determined in the manner as may be prescribed.  



2.3 To avail the benefit of 25% tax rate, the company needs to exercise this option before the due date of filing its first return. If it does not exercise this option in the first year, it cannot do so in subsequent years. Once the company opts to be taxed at 25%, the company cannot subsequently withdraw the option in any year.
 

It may choose not to exercise this option if it considers that going under the normal provisions may be better.
 

3. Tax on dividend: [S. 115BBDA]
 

3.1 Under the current law, dividends paid by a domestic company are subject to Dividend Distribution tax (DDT). This DDT is levied irrespective of the income of the person receiving the income. Such dividend is exempt in the hands of the shareholders.
 

3.2 It is now proposed to levy a tax @ 10 % on the dividend income earned over and above Rs. 10,00,000 by a resident individual, HUF, firm or an LLP. No expense can be claimed against the dividend income earned.
 

In effect, those who undertake business through a company, will be liable to tax at three levels – first as tax on corporate profits; second as DDT on distribution of such profits; and now third as dividend tax in the hands of shareholders receiving more than Rs. 10,00,000. While the assessees and types of incomes are different at each taxing event, the total impact is high – especially for promoters of private and closely held companies will be detrimental. (see para 3.6 for more details.)
 

The new provision will come in force from 1st April, 2017 i.e. will be applicable from F.Y. 2016-17. Many companies have decided to issue interim dividends before 31st March to spare shareholders from this additional tax burden.
 

The promoters who hold shares in business companies through their personal holding companies, will not be liable to tax as long as their personal holding companies do not declare dividend.
 

3.3 Non-residents are not liable to this tax. As discussed in para 3.2, there are three levels of tax. The non-resident will be liable to tax in his home country. This will be the 4th level of tax. While he will get credit for tax in his country, he will mostly not be entitled to credit for corporate tax and DDT paid by the Indian company. Hence the burden can be very high. It is fair that the non-resident is not taxed on dividends.
 

3.4 Impact on foreign dividends:
 

Presently, dividends declared by a foreign company in which an Indian company holds 26% or more are taxed at 15% as per S. 115BBD. Further, these dividends are allowed as a deduction from dividends paid by the Indian company if the foreign company is a subsidiary of the Indian company. This results in net tax of 15% on foreign dividends earned by Indian promoters. With the proposed levy of additional tax of 10% on dividends exceeding Rs. 10 lakhs, the effective tax will increase to 25%.
 

3.5 Businessmen prefer holding business through LLPs instead of companies. There is no tax on profits distributed by LLPs. Hence the dividend tax and now this additional tax will be a clear saving.
 

3.6 Different holding structures – through company, LLP, Indian companies and foreign companies gives rise to several permutations. One needs to carefully analyse under what structure should investments be held. Some illustrations are given below in paras 3.7 and 3.8.
 

3.7 Indian business held through Indian entities
 

- Indian Promoter does business in India.
 

- He can do business through a private company or a LLP.
 

- The holding structure is give below. The table after the chart gives tax implications.
 

Sr.

Particulars

 

Operating business entity

Indian company

Indian LLP

         

1

Business profit and tax

     

1.1

Net profit

 

1,000

1,000

         

1.2

Tax on net profit

30%

300

300

         

1.3

Profit after tax

 

700

700

         

2

Distribution of profit and tax

     

2.1

Dividend distributed by company.

LLP distributed profits

 

500

500

         

2.2

DDT paid by Indian company

15%

150

0

         

2.3

Tax payable by shareholder / partner

10%

50

0

         

3

Total tax paid (1.2+2.2+2.3)

 

500

300

 

3.8 Foreign business held through Indian entities
 

- Indian promoter does business outside India.
 

- He opens a foreign company outside India.
 

- The shares of foreign company can be held by individual, Indian company or Indian LLP.
 

- The holding structures are given below. The table after the chart gives tax implications.
 


 

 

Sr.

Particulars

 

Foreign company held under various options

Through Indian company

Through Indian LLP

Individually

           

1

Business profits and tax

       

1.1

Net profit

 

1,000

1,000

1,000

           

1.2

Foreign Tax on profit (assumed)

30%

300

300

300

           

1.3

Profit after tax

 

700

700

700

           

2

Distribution of profit and tax

       

2.1

Dividend distributed by foreign company

 

500

500

500

           

2.2

Tax on dividend in foreign country – assumed *

10%

50

50

50

           

2.3

Tax payable by shareholder in India

 

75

150

150

 

Tax rate for companies – 15%

Tax rate for LLP / individual – 30%

       
           

2.4

Less: Tax credit for foreign tax on dividend (2.2 above)

 

50

50

50

           

2.5

Net tax paid in India (2.3 - 2.4)

 

25

100

100

           

3

Funds after tax on dividend - distributed to promoter (2.1-2.3)

 

425

350

350

           

4

Tax payable by promoter **

 

43

0

0

           

5

Total tax paid (1.2+2.2+4)

 

418

450

450



* Tax on dividend in the foreign country will normally be restricted by the DTA to 10 or 15%. It will be available as a credit against Indian tax. Hence the total in India and abroad will be 15%. If tax payable in the foreign country exceeds 15%, the total tax cost will increase.
 

** On declaring dividend by Indian company to the promoter, DDT is payable. However in the above illustration, dividend received from foreign company will be set off against dividend paid by the Indian company. Hence there will be no DDT payable. However there may be some controversy. Tax payable in India will be the net tax after reducing foreign tax. Hence when the Indian company declares dividend, will credit be available for the total tax paid (i.e. 2.3 above) or tax paid in India (i.e. 2.5 above).
 

3.9 It should be appreciated that thinking on taxes keep changing every few years. Hence if the cost of changing the structure is high, the structure may be left as it is.
 

The primary conclusion which one may draw is that in case of holding Indian business, an LLP can be considered.
 

For foreign businesses, an Indian company appears to be better. Although tax cost is lower if foreign company is held through an Indian company, the regulations for companies are quite onerous. An LLP has far lesser compliances. Hence an LLP can be a good option. One may balance the same and take a decision.