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Tax Alert: New Rules for Determining Taxability on Reconstitution of Firms

The Central Board of Direct Taxes (CBDT), vide notification[1] dated 2nd July 2021, has inserted a new sub-rule 5 under Rule 8AA of the Income-tax Rules, 1962 (Rules) which deals with the characterisation of capital gains under section 45(4) of the Act. The CBDT has also notified Rule 8AB, which deals with the attribution of income taxable under section 45(4) of the Act to the capital assets remaining with the specified entity. Additionally, the CBDT, vide circular[2] dated 2nd July 2021, has also issued guidelines for practical application of provisions under section 9B and section 45(4) of the Act.
Background
Finance Act, 2021 had inserted a new section 9B under the Income-tax Act, 1961 (Act) which provides that where a specified person[3] receives any capital asset or stock in trade or both from a specified entity [4] on dissolution or reconstitution of such specified entity, then such specified entity shall be deemed to have transferred such capital asset or stock in trade, or both, in the year in which such capital asset or stock in trade or both are received by the specified person and shall be chargeable to tax as income of the specified entity in that year, under the head “Profits and gains of business or profession” or under the head “Capital gains”, as the case may be. It is also provided that fair market value (FMV) of such capital asset or stock in trade, shall be deemed to be the full value of consideration as a result of such deemed transfer. Further, Finance Act, 2021 had also substituted the provisions of section 45(4) of the Act, which now provides that where a specified person receives any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from such receipt by the specified person shall be chargeable to tax as income of the specified entity under the head “Capital gains” in that year. The amount chargeable to tax under section 45(4) of the Act shall be calculated as per the below-mentioned formula. A = B + C – D where, A = Income chargeable to tax under section 45(4) of the Act B = Value of any money received by the specified person C = Amount of FMV of the capital asset received by the specified person D = Amount of balance in the capital account [represented in any manner (excluding increase due to revaluation of any asset or due to self-generated goodwill or any other self-generated asset)] of the specified person in the books of account of the specified entity at the time of reconstitution. It is also clarified that the provisions of section 45(4) shall operate in addition to the provisions of section 9B and accordingly the taxation under these provisions need to be worked out independently. The Finance Act, 2021 has also inserted a new clause (iii) under section 48 of the Act (deduction from the full value of consideration) which provides that the amount of income chargeable to tax under section 45(4) which is attributable to the capital asset being transferred by the specified entity shall be calculated in the prescribed manner. It may be noted that the above-mentioned provisions are applicable w.r.e.f 1 April 2021 i.e. from the tax year 2020-21 onwards.
Notification/Circular
The Central Board of Direct Taxes (CBDT), vide notification[1] dated 2nd July 2021, has inserted a new sub-rule 5 under Rule 8AA of the Income-tax Rules, 1962 (Rules) which deals with the characterisation of capital gains under section 45(4) of the Act. The CBDT has also notified Rule 8AB, which deals with the attribution of income taxable under section 45(4) of the Act to the capital assets remaining with the specified entity. Additionally, the CBDT, vide circular[2] dated 2nd July 2021, has also issued guidelines for practical application of provisions under section 9B and section 45(4) of the Act. This tax alert summarizes the notification and guidelines issued by the CBDT as under: In order to avoid double taxation of the same amount, the provisions of section 45(4) r.w.s 48(iii) of the Act requires that the amount taxed under section 45(4) of the Act should be attributed to the remaining capital asset(s) of the specified entity, such that when these capital asset(s) get transferred in the future, the amount attributed to such capital asset(s) gets reduced from the full value of consideration.
Capital Gains Charged under Section 45(4)

It is further clarified that the revaluation of an asset or valuation of self-generated asset or goodwill does not entitle the specified entity for deprecation on such increased value. 

The specified entity is required to furnish, electronically, the details of the amount attributed to the capital asset remaining with the specified entity in Form No 5C on or before the due date as prescribed under section 139(1) of the Act.

 
Applicability of Attribution Rule (Rule 8AB) to Capital Assets Forming Part of Block of Assets

 

It was observed that the current provisions provide attribution of capital gains under section 45(4) of the Act only for the purpose of section 48 of the Act. It may be noted that provisions of section 48 apply to capital assets that do not form part of block of assets.

Accordingly, in order to provide clarity and remove the difficulty, the CBDT has stated that the attribution rule i.e. Rule 8AB of the Rules shall also apply in relation to capital assets forming part of the block of assets.

It is further clarified that the amount attributed under Rule 8AB of the Rules shall be reduced from the full value of the consideration received or accruing as a result of the subsequent transfer and accordingly net consideration shall be reduced from the written-down value (WDV) of the block of assets under section 43(6)(c) of the Act or for the purpose of calculating capital gains under section 50 of the Act.

 
Characterization of capital gains under section 45(4) of the Act

 

The CBDT has notified Rule 8AA(5) under the Rules which provides for characterization of the nature of capital gains (i.e. long term or short term) under section 45(4) of the Act. It provides that where the amount of capital gains chargeable under section 45(4) is attributed to short term capital asset, capital asset forming part of a block of assets or capital asset, being self-generated asset or goodwill, then the capital gains under section 45(4) shall be deemed to be from the transfer of short-term capital asset; otherwise, it shall be deemed to be transferred from long term capital asset.

 
Examples under the Guidelines

 

In order to better understand the provisions, few examples have been given in the guidelines:

 
Example 1

 

Facts

There are three equal partners A, B and C in a Firm ‘FR’ having a capital balance of INR 10 lacs each. The details of capital assets held by the firm are as under.

Partner ‘A’ wishes to exit and accordingly the firm decides to give him INR 11 lacs of money and Land ‘U’ to settle his capital balance.

 

Tax Implications

A. Under section 9B of the Act

It shall be deemed that the Firm ‘FR’ has transferred the Land ‘U’ to Partner ‘A’ and accordingly an amount of INR 35 lakhs (50 – 15) shall be chargeable to tax in the hands of ‘FR’ under the head capital gains as long-term capital gains and a tax liability of INR 7 lakhs (assuming no surcharge or cess) shall be payable.

For Partner ‘A’, the cost of acquisition Land ‘U’ would thus be INR 50 lakhs.

B. Accounting in the books of Firm ‘FR’

The net book profit after tax of INR 33 lakhs (computed as amount of capital gains without indexation INR 40 lakhs less tax of INR 7 lakhs) shall be credited to each Partner’s capital account i.e. INR 11 lakhs each.

Pursuant to the above, the capital balance of Partner ‘A’ would increase to INR 21 lakhs (10+11).

C. Under section 45(4) of the Act

Capital gains in the hands of the firm shall be calculated as per the afore-mentioned formula.

Capital Gains under Section 45(4)

The capital gains of INR 40 lakhs shall be chargeable to tax in the hands of Firm ‘FR’ in addition to INR 35 lakhs chargeable under section 9B of the Act.

D. Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

Characterization of capital gains under section 45(4) of the Act

Subsequently, when the Land ‘S’ or Land ‘T’ would be transferred by the Firm ‘FR’, the amount of attribution would get reduced from the full value of consideration as per the provisions of section 48(iii) of the Act.

E. Characterization of capital gains

Since the amount of INR 40 lakhs charged to tax under section 45(4) of the Act has been attributed to Land ‘S’ and Land ‘T’, being long term capital assets, such amount shall be chargeable as long term capital gains as per Rule 8AA(5) of the Rules.

 

Example 2

 

Facts

The facts of Example 2 are the same as in Example 1 with a modification that the Firm ‘FR’ sells the Land ‘U’ at FMV of INR 50 lakhs to an outsider and on the exit of Partner ‘A’, the Firm decides to give him INR 61 lakhs to settle his capital balance.

 

Tax Implications

A. Under section 9B and section 45 of the Act

Since neither ‘capital asset’ nor ‘stock in trade’ have been distributed to Partner ‘A’, the provisions of section 9B of the Act do not get triggered. However, the Firm would be liable to normal capital gains tax on the sale of Land ‘U’. Accordingly, an amount of INR 35 lakhs (50 – 15) shall be chargeable to tax in the hands of ‘FR’ under the head capital gains as long-term capital gains and tax liability of INR 7 lakhs (assuming no surcharge or cess) shall be payable.

B. Under section 45(4) of the Act

Capital gains in the hands of the firm shall be calculated as per the afore-mentioned formula.

Characterization of capital gains under section 45(4) of the Act

The capital gains of INR 40 lakhs shall be chargeable to tax in the hands of Firm ‘FR’ under section 45(4) of the Act.

C. Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

Characterization of capital gains under section 45(4) of the Act

Subsequently, when the Land ‘S’ or Land ‘T’ would be transferred by the Firm ‘FR’, the amount of attribution would get reduced from full value of consideration as per the provisions of section 48(iii) of the Act.

D. Characterization of capital gains

Since the amount of INR 40 lakhs charged to tax under section 45(4) of the Act has been attributed to Land ‘S’ and Land ‘T’, being long term capital assets, such amount shall be chargeable as long term capital gains as per Rule 8AA(5) of the Rules.

In effect, the final result in both Example 1 and 2 would be same due to operation of section 9B of the Act.

 

Example 3

 

Facts

There are three equal partners A, B and C in a Firm ‘FR’ having capital balance of INR 100 lacs each. The details of capital assets held by the firm are as under.

Characterization of capital gains under section 45(4) of the Act

Partner ‘A’ wishes to exit and accordingly the firm decides to give him INR 75 lacs in money and Land ‘S’ to settle his capital balance.

 

Tax Implications

A. Under section 9B of the Act

It shall be deemed that the Firm ‘FR’ has transferred the Land ‘S’ to Partner ‘A’. However, since the full value of consideration is equal to indexed cost of acquisition, there would be no capital gain tax in the hands of the Firm.

For Partner ‘A’, the cost of acquisition would be INR 45 lakhs.

B. Accounting in the books of Firm ‘FR’

The net book profit after tax of INR 15 lakhs (computed as amount of capital gains without indexation) shall be credited to each Partners capital account i.e. INR 5 lakhs each.

Pursuant to above, the capital balance of Partner ‘A’ would increase to INR 105 lakhs (100+5).

C. Under section 45(4) of the Act

Capital gains in the hands of the firm shall be calculated as per afore-mentioned formula.

Characterization of Capital Gain - Circular No. 14 of 2021 - Tax Circular - CBDT

The capital gains of INR 15 lakhs shall be chargeable to tax in the hands of Firm ‘FR’. 

D. Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

d) Attribution of capital gains as per Rule 8AB of the Rules to the remaining capital assets

Subsequently, when the Firm transfers ‘Patent’ or ‘Goodwill’, the amount of attribution would get reduced from full value of consideration as per the provisions of section 48(iii) or section 43(6)(c) or section 50 of the Act, as the case may be.

It may also be noted that for the purpose of computing depreciation under section 32 of the Act, the WDV of the block of asset of which ‘Patent’ is a part, shall remain INR 45 lakhs only and should not be increased to INR 60 Lakhs. Similarly, no depreciation would be allowed on self-generated ‘Goodwill’.

E. Characterization of capital gains

Since the amount of INR 15 lakhs charged to tax under section 45(4) of the Act has been attributed to asset forming block of asset i.e. Patent and to self-generated Goodwill, such amount shall be chargeable as short term capital gains as per Rule 8AA(5) of the Rules.

 
FM Comments

 

The detailed guidelines and notification issued by the CBDT is indeed a welcome move and shall certainly help in addressing various concerns of the taxpayers. However, beyond the 3 specific Examples illustrated, in our view, there would be certain other issues which may require similar deliberation and clarification.

It is pertinent to note that the substituted provisions 45(4) and section 9B of the Act are applicable w.r.e.f. 1 April 2021 (i.e. from tax year 2020-21 onwards), whereas the rules for attribution of income and its characterization have been notified on 2 July 2021. The notification is silent with respect to the date of its applicability.

Generally, such notifications come into force on the date of its publication in the Official Gazette, unless the effective date of its applicability is already provided in the notification itself. CBDT, while notifying Rule 8AA(5) and Rule 8AB, has not provided any ‘effective applicable date’ for the same and accordingly it may be inferred that such Rules are to be made effective from 2 July 2021. Thus, the question which may arise is whether Rule 8AA(5) and Rule 8AB would be applicable to the reconstitution of specified entities that have already been undertaken between 1 April 2020 to 1 July 2021.

It may further be noted that the earlier provisions of section 45(4) provided that the transfer of a capital asset on the dissolution of a firm was made chargeable to tax as the income of the firm. But the distribution of money on dissolution was neither chargeable to tax in the hands of the firm nor in the hands of the recipient Partner.

However, the new provisions of section 45(4) state that distribution of money or capital asset exceeding the balance in the capital account of Partner would now be chargeable to tax under the head “capital gains”. Accordingly, the new provisions create a charge of capital tax on the distribution of money. It may be noted that, generally, ‘money’ or ‘currency’ is not considered as a ‘capital asset’ and accordingly the issue which may arise is that whether the distribution of money could be taxed under the head ‘capital gains’ as there is no transfer of capital asset.

It is also pertinent to note that the attribution rules under Rule 8AB of the Rules would lead to a premature collection of the taxes by the Government, the benefit of which may or may not be obtained by the specified entity.

The specified entity would get the benefit of attribution only when they transfer the remaining capital assets subsequently, which is a contingent event, that may or may not happen. Further, in a case where the excess payment chargeable to tax under section 45(4) of the Act, relates to the valuation of self-generated goodwill, then the entity may not be able to claim the benefit of attribution unless the entity hives off its business undertaking, which is highly unlikely. Another interesting question that would arise is how the specified entity would be eligible to claim the benefit of attribution where remaining capital assets are transferred under tax-neutral arrangements.

Moreover, in a scenario, where the aggregate value of money received by the specified person exceeds the balance in his capital account and it does not relate to the revaluation of any capital assets, then the following issues may arise:

  • Characterization of capital gains as ‘Short-term’ or Long-term’ as no attribution of income would be made by the specified entity to the remaining capital assets under Rule 8AB.
  • Such excess payment may have been made by a specified entity due to other business reasons such as payment for non-compete, etc. Accordingly, the deductibility of such excess amount while computing the taxable income of the specified person, would be a challenge.

Going forward, it would be imperative for specified entities to carefully assess the impact of the above provisions while carrying out any reconstitution activity in order to avoid double taxation.

References: [1] “specified person” means a person, who is a partner of a firm or member of other association of persons or body of individuals (not being a company or a co-operative society) in any previous year. [2] “specified entity” means a firm or other association of persons or body of individuals (not being a company or a co-operative society). [3] Notification No. 76/2021 [4] Circular No. 14 of 2021 Image Credits: Photo by Nataliya Vaitkevich from Pexels

It is pertinent to note that the substituted provisions 45(4) and section 9B of the Act are applicable w.r.e.f. 1 April 2021 (i.e. from tax year 2020-21 onwards), whereas the rules for attribution of income and its characterization have been notified on 2 July 2021. The notification is silent with respect to the date of its applicability.

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Tax Alert: Clarifications on Section 194Q-TDS on Purchase of Goods

The Central Board of Direct Taxes (CBDT) introduced a new Section 194Q in Finance Act, 2021, which is effective from 01st July 2021, for withholding tax at source on payments made for the purchase of goods.

The provision of Section 194Q states that:

  • Any person, being a Buyer, having a turnover or gross receipts exceeding INR 10 crores during the preceding financial year;
  • While making payment of any sum to any resident (Seller) for purchase of any goods of the value, where the aggregate of such value exceeds INR 50 lakhs in the previous year
  • Shall at the time of credit of such sum to the account of the Seller or at the time of payment, whichever is earlier, deduct an amount equal to 0.1% percent as income tax.

The above provision is not applicable, where:

  • Tax is deductible under any other provision of the Act; or
  • Tax is collectible under the provision of section 206C of the Act, other than transactions covered u/s. 206C(1H) therein.

The CBDT has received several representations with respect to practical challenges that may arise in the implementation of section 194Q. To address the difficulties that may arise, the CBDT has issued Circular No 13[1] of 2021 providing various clarifications regarding section 194Q.

194Q is not applicable in the following situations:

As per the Circular, ambiguity is removed on the applicability of section 194Q in a number of cases. CBDT has clarified that section 194Q is not applicable in the following situations:

  • Transactions relating to securities and commodities, which are carried through recognized stock exchanges, including exchanges that are located in the International Financial Service Centre.
  • Transactions in electricity, renewable energy certificates, or energy certificates traded through registered power exchanges.
  • Payments by non-resident Buyers unless if the purchase of goods is not effectively connected with the Permanent Establishment / fixed place of business of such non-resident in India.
  • On purchase of goods from a Seller whose income is exempt from tax. Similarly, it is clarified that tax collection at source (TCS) provisions under section 206C (1H) of the Act would not be applicable if the Buyer’s income is exempt from tax. However, these exemptions would not be applicable if only part of the Seller’s/Buyer’s income is exempt.
  • In the year of incorporation of the Buyer, the threshold of INR 10 crore would not be satisfied.
  • Transactions, where either payment or credit for the transaction happened before 1st July 2021.
  • TDS would not be applicable on the GST amount if the GST amount is separately indicated in the invoice. However, in the case of advance payments, the TDS under section 194Q will have to be discharged on the entire amount, as it is not possible to identify the GST component.

Calculation related clarifications

  • It has been clarified that for calculating the threshold of INR 50 lakhs in respect of a particular Seller, the transaction for the whole FY 2021-22 shall be considered, starting from 1st April 2021 and not from 1st July 2021.
  • For computing threshold of INR 10 crore in respect of the Buyer, only business turnover or gross receipts from business activities is to be considered. As such, turnover or gross receipts from non-business activities would not require to be taken into consideration.
  • In case of purchase returns, the TDS deducted on such purchases under section 194Q shall need to be adjusted against subsequent purchases from the same Seller, if the money is refunded by the Seller to the Buyer. However, no adjustment will be required in cases where the purchase return is replaced by goods by the Seller.

The interplay between sections 194O, 194Q, and 206C(1H) of the Act:

  • If Section 194O is applicable on any particular transaction, then Section 194Q shall not be applicable;
  • If both section 194O and section 194Q are applicable, then section 194O will prevail;
  • Section 206C(1H) is not applicable if TDS is deductible u/s. 194O or Sec 194Q;
  • If both sections 194O and 206C(1H) are applicable, then 194O shall prevail. Even if TCS is collected by the Seller still tax deduction responsibility of the E-commerce operator under section 194O cannot be condoned; this is because the prescribed tax rate under section 194O is higher than the prescribed tax rate u/s. 206C(1H);
  • If both sections 194Q and 206C(1H) are applicable, then section 194Q shall prevail. However, for ease of business, if TCS under section 206C(1H) has already been collected by the Seller then section 194Q would not be applicable; this is because the prescribed tax rate for deduction under section 194O and the prescribed tax rate for collection under section 206C(1H) are the same.

Comments:

This Circular is an extremely welcome one and has several important clarifications that have been issued by the CBDT before the enactment of the provisions of sections 194Q and 206C(1H). The Circular provides clarity vis-à-vis the scope of the relevant provisions, calculation of thresholds, interplay between overlapping provisions etc.

However, there are still some niggling doubts that prevail, requiring further clarity. For instance, while calculating the threshold of turnover or gross receipts of INR 10 crore w.r.t the Buyer, whether the amount considered should include or exclude the GST component.  

Also, it would help if it is prescribed for the Seller to obtain a “no deduction” declaration from the Buyer w.r.t TDS under section 194Q, in a situation where both sections 194Q and section 206C(1H) are jointly applicable on the same transaction and tax has already been collected and paid under section 206C(1H) by the Seller.

References

[1] Circular No 13 of 2021 dated 30th June 2021 (F No. 370142/26/2021 – TPL

 

Image Credits: Photo by Kelly Sikkema on Unsplash

This Circular is an extremely welcome one and has several important clarifications that have been issued by the CBDT before the enactment of the provisions of sections 194Q and 206C(1H). The Circular provides clarity vis-à-vis the scope of the relevant provisions, calculation of thresholds, interplay between overlapping provisions etc.

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CBDT notifies thresholds for determining ‘Significant Economic Presence’ in India

The concept of Significant Economic Presence (SEP) was introduced under Income-tax Act, 1961 (“the Act”) vide Finance Act, 2018, by way of insertion of Explanation 2A to section 9 of the Act, to expand the scope of the term ‘Business Connection’ and includes:

 

  • transaction in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or
  • systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India, as may be prescribed.

It was further provided that the transactions or activities shall constitute significant economic presence in India, whether:

 

  • the agreement for such transactions or activities is entered in India; or
  • the non-resident has a residence or place of business in India; or
  • the non-resident renders services in India.

The above-mentioned Explanation was inserted primarily for establishing Business Connection in India for Multinational entities carrying out business operations through digital means, without having any physical presence in India. However, its enforceability was deferred time and again as the discussion on this issue was ongoing under G20 – OECD BEPS project. 

Notification No 41/2021/F. No. 370142/11/2018-TPL on Significant Economic Presence in India:

 

The Central Board of Direct Taxes (CBDT), vide its notification dated 3 May 2021[1] has stipulated Rule 11UD to prescribe the ‘revenue’ and ‘users’ threshold for the purpose of determining Significant Economic Presence (SEP) of a non-resident entity in India. It has come into force with effect from 1 April 2022 (i.e., Financial Year 2021-22 or Assessment Year 2022-23 onwards).

The threshold limit notified by CBDT for the purpose of SEP has been tabulated as under:

Sr. No.NatureThreshold Limit
1

Revenue threshold –

Transaction in respect of any goods, services or property carried out by a non-resident with any person in India including provision of download of data or software in India.

INR 2 crores
2

Number of users threshold –

Systematic and continuous soliciting of business activities or engaging in interaction with users in India

3 lakhs users

If either one of the above-mentioned thresholds is met by a non-resident entity, then such entity shall be deemed to have a business connection in India and accordingly would be liable to pay tax on income attributable to transactions or activities mentioned above, subject to the beneficial provisions of tax treaties, as may be applicable.

 

FM Comments:

It may be noted that this Explanation was inserted primarily with an intention to tax digital transactions which otherwise escapes tax net due to absence of physical presence in India. However, on careful reading of the provisions, it is possible to infer that SEP provisions may even cover the transactions which are carried out through non-digital means (i.e., even on ‘physical’ buying and selling of goods and services).

At this juncture, it is also imperative to mention that UN tax committee has recently approved Article 12B (Income from automated digital services) in the UN Model Tax Convention. It would be interesting to watch whether India renegotiates its tax treaties to include this Article in its tax treaties and its interplay with the SEP provisions.

Further, from a practical perspective, this provision may not have much impact on non-resident entities based out of countries with whom India has executed tax treaties, due to existence of the conventional Permanent Establishment (PE) provisions in the tax treaty, where PE exists based on the physical presence in India. It would be worthwhile to note that the provisions of section 9 of the Act does not override the provisions of tax treaty and hence unless the tax treaty is renegotiated to include provisions that are like SEP, it would not have any impact on entities based out of tax treaty countries.

Having said the above, SEP provisions could have major impact on non-resident entities based out of non-tax treaty countries as well as tax treaty countries to whom benefit under the covered tax treaty may get denied, pursuant to application of, inter alia, Article 7 – Prevention of treaty abuse of Multilateral Instrument (MLI); considering the lower threshold prescribed by CBDT, such entities may then become liable to SEP provisions and may also have to pay incremental tax in India. Additionally, those entities may then also be under obligation to undertake various tax compliances in India (such as withholding tax, filing of return of income, etc.).

The non-resident entities may face various practical challenges in determining the “revenue” and “user” thresholds and in cases where existence of Business Connection is determined based on SEP, the challenges would be in relation to attribution of profits that would be chargeable to tax in India. Accordingly, it is of paramount importance that CBDT provides adequate guidance to determine the thresholds on how the profit would be attributed to such SEP activities in India.

Last but not the least, it would be interesting to examine the interplay and co-existence or otherwise of Equalization Levy (EQL) vis-à-vis the SEP provisions. For instance, in cases where the transaction falls specifically under the EQL provisions, then such income should be exempt from tax under the provisions of the Act and accordingly the expanded scope of business connection should not apply.

The non-resident entities may face various practical challenges in determining the “revenue” and “user” thresholds and in cases where existence of Business Connection is determined based on SEP, the challenges would be in relation to attribution of profits that would be chargeable to tax in India. Accordingly, it is of paramount importance that CBDT provides adequate guidance to determine the thresholds on how the profit would be attributed to such SEP activities in India.

References

[1] Notification No 41/2021/F. No. 370142/11/2018-TPL

Image Credits: Photo by Markus Winkler from Pexels

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Income Tax Returns for AY 2020-21: Ready Referencer

With the extended time limit for filing of Income Tax Return (for AY 2020-21), u/s. 139(1), without late fees, for Non-Audit cases and for Non-Corporate assessees of 31st December 2020 fast approaching, given below is a quick guide for ready reference of some key changes that have been made in the respective Income tax return forms for this year.

Further, the conditions and features for eligibility of forms that are applicable for filing the correct income tax returns are also specified as follows:

Key Procedural Changes:

  • ITR 1 to ITR 4 can be filed using PAN or Aadhar by Individuals.
  • The submitted ITR forms display the ITR-V with a watermark ‘Not Verified’ until the same is verified either electronically by EVC or by sending the same via post after manual signing.
  • The unverified form ITR-V will not contain any income, deduction and tax details. The unverified form will only contain basic information, E-filing Acknowledgement Number and Verification part.
  • The unverified acknowledgement is titled as ‘INDIAN INCOME TAX RETURN VERIFICATION FORM’ & final ITR-V is titled as ‘INDIAN INCOME TAX RETURN ACKNOWLEDGEMENT’.
  • Return filed in response to notice u/s. 139(9), 142(1), 148, 153A, and 153C must have DIN.
  • There is a separate disclosure for Bank accounts in case of Non-Residents who are claiming income tax refund and not having a bank account in India.

COVID related Changes:

  • The Government had extended the time limit for claiming tax deduction u/CH VIA to 31st July 2020, and the details of the same need to be reported in Schedule DI (details of Investment).
  • The time limit for investing the proceeds or capital gains in other eligible assets, so as to claim exemptions u/s 54/ 54B/ 54F/ 54EC, had been extended to 30th September 2020.
  • Penal interest u/s. 234A @ 1% p.m., where the payments were due between 20-03-20 to 29-06-20 and such amounts were paid on or before 30-06-20, had been reduced to 75%, vide ordinance dated 31-03-20.
  • Period of forceful stay in India, beginning from quarantine date or 22-03-20 in any other case up to 31-03-20, is to be excluded, for the purpose of determining residential status in India.[1]

Consequences of Late filing of Return of Income:

  • Late Fees u/s. 234F of INR. 5,000 up to 31.12.20 and INR. 10,000 up to 31.03.21. In case of total income up to 5 Lacs, the penalty is INR. 1,000.
  • Penal Interest u/s. 234A @ 1% per month
  • Reduced to 75%. vide Ordinance dated 31.03.20, where the payments were due between 20.03.20 to 29.06.20, and such amounts were paid on or before 30.06.20.
  • Vide CBDT Notification dt 24.06.2020, no interest u/s 234A if Self-Assessment tax liability is less than 1 Lac and the same has been paid before the original due date.
  • In case of a belated return, loss under any head of Income (except unabsorbed depreciation) cannot be carried forwarded.
  • Deduction claims u/s. 10A, 10B, 80-IA, 80-IB, etc would not be allowed.

Consequences of Late filing of Return of Income:

  • Late Fees u/s. 234F of INR. 5,000 up to 31.12.20 and INR. 10,000 up to 31.03.21. In case of total income up to 5 Lacs, the penalty is INR. 1,000.
  • Penal Interest u/s. 234A @ 1% per month
  • Reduced to 75%. vide Ordinance dated 31.03.20, where the payments were due between 20.03.20 to 29.06.20, and such amounts were paid on or before 30.06.20.
  • Vide CBDT Notification dt 24.06.2020, no interest u/s 234A if Self-Assessment tax liability is less than 1 Lac and the same has been paid before the original due date.
  • In case of a belated return, loss under any head of Income (except unabsorbed depreciation) cannot be carried forwarded.
  • Deduction claims u/s. 10A, 10B, 80-IA, 80-IB, etc would not be allowed.

Vide CBDT Notification dt 24.06.2020, no interest u/s 234A if Self-Assessment tax liability is less than 1 Lac and the same has been paid before the original due date.

  1. Section 5A: Apportionment of income between spouses governed by the Portuguese Civil Code.
  2.  115BBDA: Tax on dividend from companies exceeding Rs. 10 Lakhs; 115BBE: Tax on unexplained credits, investment, money, etc. u/s. 68 or 69 or 69A or 69B or 69C or 69D.
  3. Inserted in sec 139(1) by Act No. 23 of 2019, w.e.f. 1-4-2020:

Provided also that a person referred to in clause (b), who is not required to furnish a return under this sub-section, and who during the previous year:

  • has deposited an amount or aggregate of the amounts exceeding one crore rupees in one or more current accounts maintained with a banking company or a co-operative bank; or
  • has incurred expenditure of an amount or aggregate of the amounts exceeding two lakh rupees for himself or any other person for travel to a foreign country; or
  • has incurred expenditure of an amount or aggregate of the amounts exceeding one lakh rupees towards consumption of electricity; or
  • fulfils such other conditions as may be prescribed,

Shall furnish a return of his income on or before the due date in such form and verified in such manner and setting forth such other particulars, as may be prescribed.

4. Section 57: Deduction against income chargeable under the head “Income from other sources”.

5. Schedule DI: Investment eligible for deduction against income (Ch VIA deductions) to be bifurcated between paid in F.Y.19-20 and during the period 01-04-20 to 31-07-20.

6.High-value Transaction: Annual Cash deposit exceeding Rs. 1 crore or Foreign travel expenditure exceeding Rs. 2 Lakhs, Annual electricity expenditure exceeding Rs. 1 Lakh.
7.Schedule 112A: From the sale of equity share in a company or unit of equity- oriented fund or unit of a business trust on which STT is paid under Section 112A.

8. 115AD(1)(iii) proviso: for Non-Residents – from the sale of equity share in a company or unit of equity-oriented fund or unit of a business trust on which STT is paid under Section 112A.
9. Section 40(ba): any payment of interest, salary, bonus, commission or remuneration paid to a member in case of Association of Person (AOP) or Body of Individual (BOI).

10. Section 90 & 90A: Foreign tax credit in cases where there is a bilateral agreement; Section 91: Foreign tax credit in cases of no agreement between the countries.

[1] Circular No 11 of 2020 dated 08th May 2020.

References

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Guide to Income Tax Deduction from Salaries for the F.Y. 2020-21

Circular No 20/2020 (“the Circular”) was issued on 3rd December 2020 to provide procedures to be followed by employers for deducting Income tax (TDS) from the salary income of the Employee for Financial Year (F.Y.) 2020-21 relevant to Assessment Year (A.Y.) 2021-22 under section 192 of the Income tax Act, 1961 (“the Act”).

 

The guidelines/instructions laid down in the Circular are not exhaustive and in case of any doubt, reference may be made to the relevant provisions of the Act or the Income tax Rules 1962 (“the Rules”).

Here is a summary of the detailed Circular:

Rate of Tax:

The Circular notifies the rate of tax to be applied (depending upon the age of the Employee) to calculate Income tax of an individual on the income chargeable under the head “Salaries”. The tax so calculated is increased by applicable surcharges, if any, and Health and Education Cess. The tax on income under the head “Salaries” is to be calculated at the applicable rate or 20%, whichever is higher, as prescribed u/s. 206AA, in case of non-furnishing of Permanent Account Number (PAN) or Aadhar by the Employee. The Circular reiterates the allowability of Aadhar instead of PAN, in line with the Budget 2020 announcements, as valid compliance for the purpose of Section 206AA of the Act.

Finance Act 2020 had prescribed the choice of two alternate rates of tax i.e., old tax regime and the new tax regime for Individuals, as per their discretion. As such, an Individual / Assessee has the option to choose between the Old Regime i.e., Normal rate of tax or New regime i.e., Concessional rate of tax prescribed u/s. 115BAC of the Act, whichever is more beneficial to them.

Section 115BAC is an optional provision applicable to Individual and HUF, providing a concessional rate of tax, subject to the condition that the total income of the assessee shall be computed without specified exemptions or deductions, set off a loss or additional depreciation.

Further, in case of a person having income from business and profession, he would be required to exercise the option in the prescribed manner on or before the due date specified u/s. 139(1) of the Act. Such an option, once exercised, shall be applicable to all subsequent assessment years. However, the option once exercised can be withdrawn only once and such person shall never be eligible to exercise the option again unless such person ceases to have income from business and profession.

CBDT Circular No C1/2020, dated April 13, 2020 required an employee to intimate to his employer about the option he wishes to exercise between the old and the new tax regime, during each previous year and accordingly the Employer was required to calculate tax on the income of the employee. However, if no such intimation was given by the employee, the employer would have to make the TDS deduction without considering provisions of Section 115BAC. The intimation so made shall be only for the purposes of TDS during the previous year and cannot be modified during the year.

Method of Tax Calculation on Salary and Perquisite:

The Circular requires an employer to determine the estimated annual income under the head “Salaries” and calculate income tax on the same, by applying the applicable tax rate, based on the option chosen by the employee, as discussed above. The tax is to be then deducted at the applicable rate at the time of payment of salary to the employee.

No tax is to be deducted if the estimated salary income, including perquisite, does not exceed the basic exemption limit as provided by the Finance Act, 2020.

Also, the employer has been given an option to pay tax on the non-monetary perquisites given to the employee. To calculate tax on non-monetary perquisites, the Circular directs the employer to calculate the ‘average rate of tax’ and apply the said rate on the non-monetary perquisites to calculate tax on the same. The tax so paid by the employer based on the said calculation would be deemed as the TDS made from the salary of the employee.

As per Section 192(1C), an ‘eligible start-up’ as referred to in section 80-IAC, responsible for paying any income in the nature of perquisite u/s. 17(2)(vi) [Employee stock option plan or sweat equity shares] relevant to A.Y. 2021-22 or thereafter, is required to deduct or pay tax on such income within 14 days –

  1. After the expiry of 48 months from the end of the relevant A.Y.; or
  2. From the date of sale of specified security or sweat equity share by the assessee; or
  3. From the date of the assessee ceasing to be an employee,

whichever is the earliest, based on rates in force for the financial year in which the said specified security or sweat equity share is allotted or transferred.

More than one Employer:

In the case of more than one employer, the Circular requires the employer to deduct TDS on the aggregate income, including the salary received from former/another employer. The current employer is under the obligation to obtain details of income under the head “Salaries” due or received from former/other employer and deduct tax on the aggregate of such amount. The current employer is required to obtain such detail from the employee in writing and duly verified by the former/other employer.

Salary paid in Advance or Arrears:

In case of Salary paid in Advance or Arrears, the employee is entitled to claim relief u/s. 89 of the Act. The employee is required to furnish such particulars in Form No. 10E, duly verified by him, to the person responsible for deducting TDS and upon receipt of such information, the Employer is required to compute the said relief.

Income from other head:

The employer is required to consider the details of any other income submitted by the employee for the purpose of calculating the tax on salary. However, in case of loss, only loss under the head “Income from House Property” up to a maximum of Rs. 200,000 in a year can be considered and any other loss is to be ignored.

The employee is required to submit information regarding the computation of income and evidence of payment of interest under the head “Income from House Property” in Form 12BB.

(Notification No 36/2019 dated April 12, 2019, allows an employer to report only Income under the head “Income from House Property” and “Income from other sources”. Hence, any income under the head “Income from Business and Profession” and “Capital Gains” has to be ignored for the purpose of calculating TDS under the head “Salaries”)

Adjustment for excess or shortfall of deduction:

Section 192(3) of the Act allows the employer to adjust the shortfall or excess of tax deducted for any month in the subsequent months of the same financial year. There is no compulsion to deduct tax equally over the 12 months period.

Salary Paid in Foreign Currency:

In case of salary paid in foreign currency, the value of salary must be calculated by applying the “Telegraphic transfer buying rate”, prevailing on the date on which tax is required to be deducted at source, for the conversion of such currency and tax is to be calculated on the said converted value.

Person Responsible for deducting tax and their duties:

The Circular reiterates the provisions regarding the responsibility of the employer to deduct tax from the salary and emphasizes on timely deposit of TDS with the Central Government, furnishing of TDS return and the issue of Form 16, within the due dates as tabulated below:

Month Original Due Date Extended Due Date
April to June 31st July 2020 31st March 2021
July to September 31st October 2020 31st March 2021
October to December 31st January 2021 31st January 2021
January to March 31st May 2021 31st May 2021

The Circular also reminds about the penal consequences in cases of failure in payment of TDS, filing of TDS return, issuing certificate, or furnishing incorrect information, as prescribed in the Act.

  • TDS deducted for the month is to be deposited by the 7th of the subsequent month and 30th April of the subsequent financial year for the month of March in case of Non-Government Employer.

  • Interest @ 1% p.m. or part of the month is payable for non-deduction of TDS, from the date of which such tax was deductible up to the date of actual deduction.

  • Interest @ 1.5% p.m. or part of the month is payable for delayed payment of TDS from the date on which tax is deducted up to the actual date of payment of tax.

  • Delay in filing TDS return attracts penalty of Rs. 200 per day u/s. 234E, up to a maximum of the amount of TDS for the relevant quarter.

  • Penalty of Rs, 10,000 which may extend to Rs. 1,00,000 u/s. 271H for failure in furnishing statements or furnishing incorrect statements.

In case the employee has submitted a lower deduction certificate obtained from the income tax authorities, the employer is directed to deduct TDS at the rate mentioned in the certificate or deduct no TDS in the case of NIL rate, instead of the applicable tax rates.

TDS on Income from Pension:

In the case of pensioners who receive a pension from nationalized banks, not being family pension paid to the spouse, the instruction contained in this Circular would apply in a similar manner as they apply to salary income and TDS will be computed in the same manner as applicable in case of salary income. Further, all branches of the banks are bound u/s. 203 to issue a certificate of TDS in form 16 to the pensioners.

Refund of TDS in case of Non-Residents where TDS is borne by Employer:

Salary payment to non-residents for services rendered in India is regarded as income earned in India and is accordingly taxable in India. In cases where the non-resident is tax equalised and Indian taxes are borne by the employer, if any refund becomes due to the employee after he has already left India, by way of any order and the employee has no bank account in India, then the refund can be issued to the employer as the tax has been borne by it (Circular No 707 dated 11-07-1995).

On a separate note, in the case of non-residents, the rest period or leave period which is preceded and succeeded by services rendered in India and forms part of the service contract of employment, is to be regarded as income earned in India.

Computation of Income under the head “Salaries”:

Whereas the first half of the Circular deals with clarifications regarding tax calculation, procedural requirements and penal consequences, the latter part explains the computation mechanism provided under the provisions of the Act. The Circular reiterates the definition of Salary, Perquisite and Profit in Lieu of Salary. It also explains the computation methodology for determining the value of perquisite and to tax the same.

Perquisite on Motor car provided by Employer:

The perquisite valuation in case of motor car provided by employee is tabulated below:

The Circular has reproduced the valuation mechanism for various other perquisites apart from the few mentioned above. The details of the same along with the relevant para reference is tabulated below for easy reference:

Incomes not included under the head salaries:

Para 5.3 of the Circular lists down the incomes which are exempted or is not included under the head “Salaries”. The list of such income is tabulated below for ready reference.

Para 5.3.16 of the Circular states that in the case of assessee opting for concessional tax regime under section 115BAC the assessee shall be entitled to exemption only in respect of the following allowances:

  • Transport allowance granted to an employee who is blind or deaf or dumb or orthopaedically handicapped;
  • Allowance granted to meet the cost of travel on tour or on transfer;
  • Allowance granted on tour or period of a journey to meet ordinary daily wages incurred by an employee on account of absence from his normal place of duty;
  • Conveyance allowance in the performance of duties.

Proof of Deduction and Proof of Claim for LTA Exemption:

The Circular re-emphasizes that any deduction shall be allowed only after obtaining the necessary proof or evidence of investment and expenditure as claimed by the employee in Form 12BB.

The Circular also reiterates the position that the employer shall be obliged to obtain evidence in respect of the claim of exemption for leave travel concession (LTC) before allowing the said exemption. All the relevant details along with proof shall be obtained in Form 12BB.

Due to the ongoing pandemic and nationwide lockdown resulting in disruption in transport services, employees have been unable to avail LTC. In view of this and with an intent to boost consumer demand the Government has, vide Press Release dated 29th October 2020 announced a relief package both for Government and private sector employees to avail LTC exemption. The said relief expands the scope of LTC exemption to include the purchase of specified goods/services (during the period 12th October 2020 to 31st March 2021) worth three times the fare for availing the one time leave.

HRA Exemption and Rent Payment:

The employer shall ensure to collect the PAN / Aadhar of the Landlord before allowing the claim for HRA exemption in cases where the rent exceeds Rs. 1,00,000 during the year.

In the case of an 80GG deduction claimed by the employee, the employer must obtain relevant information as required in Form 10BA, irrespective of the aggregate, before allowing the deduction.

Deduction U/CH VIA:

The Circular has reproduced all the exemptions and deduction under CH-VIA which are available to an employee and that needs to be considered while calculating TDS under the head “Salaries”.

With respect to deduction u/s. 80TTA and 80TTB, the same would be allowed only to the extent of income reported by the employer in Form 12BB, subject to the prescribed limit specified in the relevant section.

We have tried to provide a summary of the key provisions in the Circular. For detailed reading, Click here: Circular No 20/2020 dated 03-12-2020.

Section 115BAC is an optional provision applicable to Individual and HUF, providing a concessional rate of tax, subject to the condition that the total income of the assessee shall be computed without specified exemptions or deductions, set off a loss or additional depreciation.

References

Image Credits: Bru-nO on pixabay.com

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SC: Consideration Paid for Purchase of Computer Software, Not Royalty, No Obligation on Buyers to Deduct Tax at Source

IN BRIEF:

The Hon’ble Supreme Court of India (SC) has at long last, put to rest the two-decade old controversy in relation to taxability of the consideration paid for purchase of computer software from a non-resident distributor/ manufacturer. The controversy revolved around whether the consideration paid for purchase of the computer software would constitute ‘Royalty’ as per the provisions of section 9(1)(vi) of the Act, read with relevant Double Taxation Avoidance Agreement (‘DTAA’). There were divergent views of some High Courts as well as of the Authority for Advance Rulings on this issue, which, thankfully, has now been settled by the Hon’ble SC, against the Revenue and in favour of the taxpayers.

In the case of Engineering Analysis Centre of Excellence Private Limited1 and others (Appellants), the Hon’ble SC has held that the consideration paid for purchase of an off-the- shelf software from a non-resident seller does not tantamount to ‘Royalty’ as per Article 12 of the DTAA and hence there is no obligation on the Indian buyer to deduct tax at source under section 195 of the Income-tax Act, 1961 (‘the Act’), as the distribution agreements/ End-User Licence Agreements (EULAs) do not create any interest or right in such distributors/ end-users which would tantamount to the use of or right to use any copyright.

FACTS OF THE CASE:

The Appellants had imported/ acquired shrink wrapped computer software from non-residents distributor/ manufacturers. While making payment to those non-residents, the Appellants did not deduct tax at source under section 195 of the Act, on the premise that such amounts do not constitute ‘Royalty’; hence are not taxable in India as per the relevant DTAA and accordingly, there could not be any obligation on them to deduct tax at source under section 195 of the Act.

QUESTION BEFORE THE SC:

The key question before the Hon’ble SC was whether there would be any obligation on a resident buyer, acquiring computer software from a non-resident distributor/ manufacturer, to deduct tax at source, under section 195 of the Act, by classifying the consideration paid as ‘Royalty’ under section 9(1)(vi) of the Act, read with Article 12 of the relevant DTAA.

There were various appeals/ questions raised before the Hon’ble SC, which were grouped into four categories:

a) Computer software purchased directly by resident end-users from non-resident suppliers or manufacturers.
b) Resident distributors or resellers purchasing computer software from non-resident suppliers or manufacturers and then reselling the same to resident Indian end-users.
c) Non-resident distributors reselling the computer software to resident Indian distributors or end-users.
d) Computer software embedded into hardware and sold as an integrated unit/equipment by non-resident suppliers to resident Indian distributors or end-users.

APPELLANT’S CONTENTIONS:

The Appellant’s contentions have been summarized below:

  •  Computer software that is imported for onward sale constitutes ‘Goods’.
  • Definition of Royalty as per DTAA did not extend to a derivative product of the copyright. For example, a book or a music CD or software products.
  • Retrospective amendment to section 9(1)(vi) by Finance Act 2012 could not be applied to assessment years under consideration, as the law cannot compel one to do the impossible.
  • Provisions of DTAA would prevail over the provisions of the Act to the extent they are more beneficial to the deductor of tax under section 195 of the Act.
  • Distinguishment can be made between the sale of a copyrighted article v/s. the sale of copyright itself. As per section 14(b) of the Copyright Act, 1957 Act (“CA Act”), ‘Computer Program’ and a ‘copy of Computer Program’ are two distinct subject matters. In the instant case, no copyright was transferred, as the end-user only received a limited license to use the product by itself with no right to reproduce, sub-licence, lease, make copies, etc.
  • It was also contended that explanation 4 to section 9(1)(vi) of the Act would apply only to section 9(1)(vi)(b) of the Act and would not expand the definition of Royalty as contained in explanation 2 to section 9(1)(vi) of the Act. Further, reference was made to Circular No. 10/2002 issued by Central Board of Direct Taxes (CBDT), wherein, ‘remittance for royalties’ and ‘supply for computer software’ were addressed as separate distinct payments, the former attracting the ‘royalty’ provision and the latter taxable as business profits.
  • Based on the doctrine of first sale/ principle of exhaustion, it was argued that the foreign supplier’s distribution rights would not extend to sale of copies of the work to other persons beyond the first sale.

REVENUE’S CONTENTION:

The Revenue’s contentions have been summarized below:

  • The primary contention of the Revenue was that what was transferred in the transaction between the parties was copyright and accordingly the payment would constitute Royalty and Indian user/ importer would be required to deduct tax at source.
  • It was argued that explanation 2(v) to section 9(1)(vi) of the Act applies to payments to a non-resident by way of royalty for the use of or the right to use any copyright. Reliance was placed on the language of explanation 2(v) and it was stressed that the words “in respect of” have to be given a wide meaning.
  • The Revenue further contended that since adaptation of software could be made, albeit for installation and use on a particular computer, copyright was parted with by the original owner.
  • It was further pointed out that the Indian Government has expressed its reservations on the OECD Commentary dealing with the parting of copyright and royalty.
  • It was argued that in some of the EULAs, it was clearly stated that what was licensed to the distributor/end-user by the non-resident would not amount to a sale, thereby making it clear that what was transferred was not goods.
  • It was further argued that explanation 4 of section 9(1)(vi) of the Act existed with retrospective effect from 1976 and accordingly the Appellants ought to have deducted the tax at source even prior to the year 2012.
  • The Revenue placed reliance on the ruling of PILCOM v. CIT, West Bengal- VII, 2020 SCC Online SC 426 [“PILCOM”]2, which dealt with section 194E of the Act, for the proposition that tax has to be deducted at source irrespective of whether tax is otherwise payable by the non-resident assessee.
  • With respect to the doctrine of first sale/principle of exhaustion, it was argued that it would have no application since it is not statutorily recognised in section 14(b)(ii) of the CA Act. Accordingly, it was contended that when distributors of copyrighted software ‘license’ or ‘sell’ such computer software to end-users, there would be a parting of a right or interest in copyright; in as much as, such “license” or sale would be hit by section 14(b)(ii) of the CA Act.

THE RULING:

  • Provisions of CA Act

The Hon’ble SC placed reliance on the provisions of the CA Act and observed as under:

The expression ‘copyright’ means the “exclusive right” to do or authorise the doing of certain acts “in respect of a work”. In the case of a computer program, section 14(b) read with section 14(a) of the CA Act prescribes certain acts as to how the exclusive rights with the owner of the copyright may be parted with. Thus, the nature of rights prescribed under section 14(a) and section 14(b) of the CA Act would be referred to as “copyright”, which would include the right to reproduce the work in any material form, issue copies of the work to the public, perform the work in public, or make translations or adaptations of the work.

Section 16 of the CA Act states that no person shall be entitled to copyright otherwise than under the provisions of the CA Act or any other law for the time being in force. Accordingly, it is held that the expression ‘copyright’ has to be understood only as is stated in section 14 of the CA Act.

On perusal of the distribution agreements, the Hon’ble SC observed that what is granted to the distributor is only a non-exclusive, non-transferable licence to resell computer software and it was expressly stipulated that no copyright and no right to reproduce the computer program, in any manner, is transferred either to the distributor or to the ultimate end user.

It further observed that the ‘license’ that is granted under EULA, conferring no proprietary interest on the licensee, is not a licence that transfers an interest in all or any of the rights contained in sections 14(a) and 14(b) of the CA Act. The SC held that there must be a transfer by way of license or otherwise, of all or any rights mentioned in section 14(b) read with section 14(a) of the CA Act.

  • Sale of Goods

The SC further observed that what is ‘licenced’ by the non-resident supplier/ distributor is in fact a sale of a physical object, which contains an embedded computer program and thereby held the same as “sale of goods” by placing reliance on the ruling of Hon’ble SC in the case of Tata Consultancy Services v. State of A.P., 2005 (1) SCC 308.3

  • Royalty in the DTAA vs the Act

It was observed that DTAA provides an exhaustive definition of ‘Royalty’ as it uses the expression “means” whereas the definition of ‘Royalty’ contained in the Act is wider in nature. Accordingly, Article 12 of the DTAA defining the term ‘Royalty’ would be relevant to determine taxability under DTAA, as it is more beneficial to the assessee as compared to section 9(1)(vi) of the Act.

It was further observed that explanation 4 to section 9(1)(vi) of the Act (retrospectively introduced vide Finance Act, 2012) is not clarificatory of the position as of 1 June 1976, but it expands the existing position and hence it does not clarify the legal position as it always stood.

The SC relied on two legal maxims, lex non-cogit ad impossibilia, i.e., the law does not demand the impossible and impotentia excusat legem, i.e., when there is a disability that makes it impossible to obey the law and further relied on various judicial precedents and held that any ‘person’ cannot be expected to do the impossible and accordingly the expanded definition of Royalty inserted by explanation 4 to section 9(1)(vi) of the Act cannot apply retrospectively, as such explanation was not actually and factually in the statute.

  • PILCOM Ruling

It was observed that the PICLOM ruling was in respect of section194E of the Act which deals with a different set of TDS provisions, without any reference to chargeability to tax under the Act. As already held in GE Technology4, deduction of tax under section 195 can be made only if the non-resident assessee is liable to pay tax under the provisions of the Act and accordingly it had no application to the present facts of the case.

  • Doctrine of First Sale/ Principle of Exhaustion

The SC relied on various judicial precedents to explain the concept of the doctrine of first sale/ principal of exhaustion, which enables free trade in material objects on which copies of protected works have been fixed and put into circulation, with the right holder’s consent. The said principle was introduced in the CA Act, vide amendment made in the year 1999.

Based on the above principle, it is held that the distribution rights subsist with the owner of the copyright, to the extent such copies are not already in circulation. Thus, it is the exclusive right of the owner to sell or to give on commercial rental or offer for sale or for commercial rental, ‘any copy of computer program’. The distributor who resells the computer program to the end-user cannot fall within its scope.

  • Interpretation of treaties and OECD Commentary

India has reserved its right under the OECD Commentary with respect to taxation of royalties and fees for technical services. However, in this regard, the SC has noted that, after India took such positions, no bilateral amendment was made by India and the other Contracting States to change the definition of royalties. Accordingly, the OECD commentary would only have persuasive value with respect to the interpretation of the term ‘Royalties.

  • CBDT Circular No. 10/2202 dated 9 October 2002

The SC further referred to the above-mentioned Circular, wherein the Revenue itself has made a distinction between royalties and remittance for the supply of computer software (which is treated as business profits and taxability depends upon the existence of permanent establishment in India).

  • Ruling

In light of the aforementioned reasoning, the Hon’ble SC held that the consideration paid for the purchase of an ‘off-the-shelf’ software from a non-resident seller did not amount to ‘Royalty’ as per Article 12 of DTAA, as the distribution agreements/ EULAs did not create any interest or right in such distributors/ end-users, which tantamounted to the use of or right to use any copyright. Since the amount was not chargeable to tax in India, there was no obligation on the Indian resident buyer to deduct tax at source under section 195 of the Act.

FM COMMENTS:

The taxation of royalty has always been a vexed issue in the Indian context. There have been conflicting rulings on the issue relating to the characterization of payments towards the purchase of computer software. This is indeed a welcome ruling, which has finally put to rest a long litigation.

However, it is pertinent to note that the Finance Act, 2020 has introduced the provisions of ‘equalisation levy’ leviable on a non-resident e-commerce operator from e-commerce supply of services. These transactions are exempted from Income-tax under section 10(50) of the Act.

Further, vide, Finance Bill 2021, it has been clarified that exemption under section 10(50) will not apply to royalty or fees for technical services, that are taxable under the Act read with the DTAA. Hence, as a corollary, it may be deduced that, based on this SC ruling, if a non-resident takes shelter under the DTAA, for payments that are made to it for purchase of computer software, the non-resident could still be liable to pay equalisation levy on the satisfaction of certain prescribed conditions. It is therefore advised that going forward, such issues are analysed carefully and separately, before arriving at any conclusion on the effective taxability that arises. Additionally, in cases where the payments are being made to parties residing in non-DTAA countries, suitable arguments would require to be made, on a case-to-case basis using this decision as a persuasive tool.

1 Civil Appeal Nos 8733 – 8734 of 2018
2 [2020] 271 Taxman 200 (SC)
3 [2004] 271 ITR 401
4 [2010] 327 ITR 456
This article expounds a recent decision regarding tax liability on the purchase of computer software from a non-resident distributor/ manufacturer.

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Income-tax Residency Circular - Circular No 2 of 2021

For Financial Year 2019-2020 – Circular 11 of 2020

Considering the exceptional circumstances caused by pandemic, Central Board of Direct Taxes (‘CBDT’) had issued Circular No 11 of 2020 dated 8th May 2020 to address the genuine hardship faced by stranded Individual during the F.Y. 2019-20. In this Circular, the CBDT had clarified that the forced stay in India due to Covid-19 between 22nd March 2020 to 31st March 2020 or due to quarantine will not be considered for the purpose of determining the residential status of an Individual in India.
For Financial Year 2020-2021 – Circular 2 of 2021 Similarly, based on several representations received by the CBDT for relaxation in determination of residential status for the Previous Year (P.Y) 2020-21, the matter was examined by the Board and a Circular has now been issued with following observations / explanations:
  •  CBDT has observed that as per the domestic tax laws, an individual needs to satisfy a minimum number of days stay in India in order to qualify as an Indian resident. Generally, an individual becomes a resident in India only if he/she has stayed in India for 182 days or more and hence any forced short stay will not result in Indian residency. Further, even in exceptional case if an individual becomes resident, he/she will most likely become “not ordinarily resident” and hence his/her foreign income shall not be taxable unless it is derived from business controlled in or profession set up in India.
  • CBDT has observed that most of the countries have the condition of stay of 182 days or more for determining residency. If a general relaxation of 182 days is provided, there may be possibilities of double non-residency and eventually the individual might end up not paying tax in any country.
  • Similar condition of stay in India, generally 182 days or more, is also present in Double tax Avoidance Agreement (DTAA) under the employment Article, in order to tax income from Salaries, where the said employment is exercised in India. CBDT has highlighted that even if an Individual qualifies as a resident of two countries, he/she can still avail the DTAA benefit by applying “Tie-breaker rule”. In the event of non-applicability of Tie-breaker rule, the individual can apply for Mutual Agreement Procedure benefit to resolve the residency issue.
  • CBDT has also highlighted that even in a case of Double taxation, a resident Indian is also entitled to claim credit of taxes paid in other country, in accordance with Rule 128 of the Income tax Rules, 1962.
  • CBDT has also observed that a similar view has been adopted by the Organisation for Economic Co-operation and Development (OECD) that DTAAs contain the necessary provisions to deal with the cases of dual residency arising due to COVID – 19 cases. Also, globally, there have been very few countries that have provided relief in this regard.

Hence, after detailed examination and explanation as provided above, CBDT has endorsed the view taken by OECD and most other countries that in light of the domestic tax law read with relevant DTAA’s, there does not appear a possibility of double taxation of Income.

Accordingly, if any individual even after considering DTAA relief faces Double taxation issues, then such individuals can apply electronically to the Principal Chief Commissioner of Income tax (PCIT) in Form – NR up to 31st March 2021, which can then be examined by the CBDT on a case-to-case basis.

Our Comments:
This Circular is rather academic in its entire narrative and provides limited relief as it is deals only with respect to a generic kind of residency situations. The Circular does not per se attempt to address specific issues such as non-treaty country situation taxability. Similarly, the taxability of employees who became Indian residents due to their evacuation to home country from no-tax jurisdictions (eg. UAE etc) during the pandemic, thus making their foreign income exposed to tax in India. The Circular is also silent on the risk of exposures vis-à-vis “Permanent Establishment (PE)” or “Place of Effective Management (POEM)” that may be triggered in India due to presence of Key personnel of Multinational Companies (MNC) exercising their duties during the pandemic months, while being forced to be present in India.

It would help if the CBDT were to bring out a more detailed Frequently Asked Questions (FAQ) quickly to deal with the unanswered questions/situations.
This article provides a summary of the Circular addressing the issue of residential status in light of travel restrictions due to COVID.

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Income Tax Relief for Developers and Residential Home Buyers To Boost Real Estate Sector

In a bid to provide an additional boost to the economy, as well as the home buyers, the Union Finance Minister – Nirmala Sitharaman, has announced a new stimulus package under Atma Nirbhar Bharat 3.0, on November 12, 2020.  As per the announcement, the acceptable difference between the ‘circle rate’ and the ‘agreement value’ for residential properties has been hiked from the existing 10% to 20%. The tax sop announced is expected to provide relief both to Developers as well as to Buyers, on the notional gains on which income tax is paid by them. The relief, which has been made effective from November 12, 2020, and will be applicable until June 30, 2021, is applicable only on the primary purchase of residential unit of value up to Rs. 2 crores.

What is Circle Rate?

 

Circle rate is the minimum rate per square foot for land or property fixed by the Government. State governments publish area-wise rates of properties, on a yearly basis, known as ‘Circle Rates’ or ‘Ready Reckoner’ rates or ‘Guideline Values’. Any difference between the Circle rate and the Agreement value beyond the acceptable rate [i.e. 10%, now increased to 20%], is taxed as “income from other sources” u/s. 56(2)(x) of the Income-tax Act 1961 (“the Act”). Accordingly, a Buyer of such property would be required to pay tax on the difference, at the applicable slab rates. Further, in the case of a Developer, under the provisions of section 43CA of the Act, the ‘sale consideration’ of such a property is deemed to be the Circle rate for the purposes of computing profits & gains.

 

 

How this will benefit?

Assume that a Buyer is buying a residential property from a Developer for a sum of Rs. 1 crore. The Circle rate value of the property is Rs. 1.2 crore. Prior to the relaxation, as the difference between the Circle rate value and Agreement value exceeded 10%, the Developer was required to consider Rs. 1.2 crore as his Sale consideration u/s. 43CA of the Act for the purpose of calculating his Profit & Gains from Business & Profession.

 

Similarly, since the difference between the Circle rate value and Agreement value exceeded 10%, the Buyer was required to show the difference between the Circle rate value and Sale consideration of Rs. 20 lacs (1.2 crore Less 1 crore) as deemed income under the head “Income from other sources” u/s. 56(2)(x) of the Act and pay tax on the same at the applicable rate.

 

The stimulus package announced provides relief by increasing the acceptable difference between the Circle rate and Agreement value from 10 % to 20 %, providing much-needed relief, both to the Buyer as well as to the Developer, during the current pandemic times.

 

The above tax sop is available only on purchase of new residential property from the Developer of value up to Rs. 2 crores and is not applicable on the resale of property. Also, the said benefit is not extended to the sale of commercial property. Nevertheless, the stimulus is expected to help Developers to clear unsold stock and generate liquidity for their other projects.

Image Credits: Nataliya Vaitkevich from Pexels

The stimulus package announced provides relief by increasing the acceptable difference between the Circle rate and Agreement value from 10 % to 20 %, providing much-needed relief, both to the Buyer as well as to the Developer, during the current pandemic times.

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'Honoring the Honest'- A Perspective on Transparent Taxation

The administration of a country makes headway with fiscal reforms when the revenue framework starts hindering effectiveness. Further, the redesigning of tax administration is done to widen the tax base and to achieve budgetary objectives.

Over the years, policymakers have understood the need for having a balance between innovation and compliance systems. The Tax Administration Reform Strategy that has been adopted, therefore, entails a simplified compliance system. At the innovation front, it has prompted the introduction of E-assessments; revamping of the E-filling portal and strengthening of Central Processing Centers (CPCs) for processing the ITRs. 

In addition, mandating the need for computer-generated Unique Document Identification Number (DIN) followed by the announcement by the Finance Minister of Faceless Assessment Scheme in her Budget Speech on July 5th, 2019, has sequentially nourished the Tax administration with a unique technological advancement, the “Transparent Taxation System”. 

Now India has embraced its policy reforms by introducing a scheme to “Honour the Honest” and to balance automation with compliance. By adopting a system of process simplification, India has become the first on an International platform to set a unique practice of “Faceless Assessment Scheme.” 

 

 

Need for Transparent Taxation 

 

The policymakers widely felt that the current tax system had components of arbitrary use of power, and direly needed to have fair play and transparency. The human interface and the multiplicity of visits to tax offices were prejudicial to the spirit of an honest taxpayer paving the way for corruption and favoritism.  

The tax system was called for and the Government also recognized the need for having an administrative mechanism with a minimal interface between a Tax-officer and a Taxpayer.  

The complications in efficiency and effectiveness demanded a transparent taxation system. Thus, the Government presented before us a Faceless Assessment Scheme and a scheme of Faceless Appeals at the level of Commissioner of Income Tax (Appeals).  

Towards the Transparent Taxation regime, the Hon’ble Prime Minister on August 13th, 2020, on behalf of the Central Board of Direct Taxes launched a new platform to meet the requirements of the 21st-century Taxation system. The New facilities launched are a part of the Government’s initiative to provide “Maximum Governance with Minimum Government”. 

The platform, apart from being faceless, is also aimed at boosting the confidence of the Taxpayer and making him/her fearless. It aims to make the tax system indefectible, faceless and painless for the Assessee. After Banking the Unbanked, Securing the Unsecured and Funding the Unfunded”, the “Honoring the Honest” initiative by the Tax Department has given the Indian Tax system, global recognition. 

 

 

Elements & Features of Faceless Assessment 

 

In respect of the features of the scheme, it enumerates the selection of a case for scrutiny through Data Analytics and Artificial Intelligence. The approach is to abolish Territorial Jurisdiction for assessment proceedings. It prescribes automated and random allocation of cases where notices, when served, will have Document Identification No. (DIN).  

The scheme provides for team-based assessments and team-based review whereby draft assessment orders from one city will undergo review in a different City and finally be issued by the Nodal Agency located in Delhi. The Government has made the facility of Faceless Appeal available from September 25th, 2020, and it will randomly allot such Appeals to any Tax officer in the country. The identity of officers deciding an appeal will remain unknown, and the appellate decisions will be team-based and reviewed.  

Most importantly, the scheme of both the Faceless Assessment and Faceless Appeal, curbs the practice of physical interface. Therefore, from now, there is no need for an assessee to visit the Income Tax Office. 

In respect of efficiency and effectiveness, the scheme intends to benefit the Taxpayer through the ease of compliance, functional specialization, improved quality of assessments, and most notably expeditious disposal of cases.  

 

 

Implementation and Execution

 

The scheme prescribes the constitution of the National E-assessment Centre (NeAC) & Regional E-assessment Centres (ReAc). The NeAC will function as a nodal agency in coordination with the ReACs located at different places supported by Assessment Units (AUs), Verification Units (VUs), Review Units (RUs), and Technical Units (TUs). Towards the completion of the Assessment, NeAc will pass and issue final orders.  

In respect of the operational perspective of the scheme, the new set-up formulated under the Faceless Assessment Scheme will administer all assessment proceedings u/s 143, 144, 148 read with 143(2)/ 142(1) of the Income-Tax Act 1961. 

However, the scheme holds exceptions as well. It would not apply to cases assigned to Central Circles, matters related to International Taxation, and facts constituting offenses under the Black Money Act and the Benami Property Act.  

Henceforth two-third of the department officers will be deputed to perform the functions of faceless assessments. The balance one third will perform residual functions enumerated under the Act including rectification proceedings, statutory powers u/s 263/264 of the Act, handling of grievances, demand management, recovery, collection, prosecution, and compounding and administrative/HRD matters. The Officers of the Directorate of Investigation and TDS units will exercise power to conduct survey u/s 133A of the Act. 

Within the folds of the new system lies the roots of the Tax Charter, which addresses the expectations of both the Revenue Department and the Assessee. The Revenue Department by way of the Charter assures fair, courteous and rational behaviour towards the Assessee. The Charter holds statutory backing with a binding character anticipating a commitment from the Assessee to fulfill the expectations of the Income Tax Department.  

 

 

Incidental Tools, towards Transparency 

 

Alongside the reforms pertaining to tax administration, the Government also revived the existing framework in terms of disclosure and reporting of transactions.  

Accordingly, Income Tax Return will now seek details of House ownership, Passport number and details of Cash deposit exceeding prescribed limits. An Assessee must now also disclose expenditure incurred on foreign travel if it exceeds INR 2 lakh and even aspects of spending on electricity bills exceeding INR 1 lakh during a Financial Year.  

Under the newly developed Tax Regime, Form 26AS (Form) will now be a complete profile of the taxpayer w.e.f. June 1st, 2020. It will cover under its scope “Specified financial transactions” covering transactions of purchase/ sale of goods, property, services, works contract, investment, expenditure, taking or accepting any loan or deposits.  

Furthermore, the Form will include information about income tax demand, refunds, pending proceedings, and proceedings completed under section 148,153A 153C of the Act. 

Revision to an assessment and details of an appeal will also be shared under the new format of the Form and it will not be a one-time affair anymore, it will be live and updated quarterly. The Form will also address information received by the Tax Department from any other country under a Tax Treaty/Tax Information Exchange Agreements. 

The Government has also proposed to expand the scope of Section 285BA of the Act for reporting of Specified Financial Transactions following which the Revenue Department may have on record the payment towards educational fee/donation and purchase of jewelry and paintings exceeding a value of INR 1 lakh.  

Thus, in a nutshell, the consumption and investment patterns of the Taxpayer will fall under the tax radar. It will now be difficult for any taxpayer to hide any transaction with a vendor, Bank/Financial Institution, etc. notified under the Income Tax Law.  

 

 

Conclusion  

 

On the face of it, the initiative is promising. Keeping in view, the intended simplicity and structure of the new administrative regime introduced for inducing better tax compliance in the Country. The question is how effectively it will overcome the challenges of and meet the intended objectives of the policymakers. The answer would depend on how seamlessly is the plan executed.   

Image Credits: Photo by Samantha Borges on Unsplash

On the face of it, the initiative is promising. Keeping in view, the intended simplicity and structure of the new administrative regime introduced for inducing better tax compliance in the Country. The question is how effectively it will overcome the challenges of and meet the intended objectives of the policymakers.

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The Ghost of Buy-Back Tax Continues to Haunt Corporates

The government has introduced a slew of tax measures in the union budget 2019 directed at taxing rich individuals and entities. One of these measures was the proposal to levy a tax on listed companies when they buy back shares from the shareholders. The imposition of 20% tax on share buyback which was earlier applicable only to unlisted companies drew in a lot of flak and concerns from corporate giants.

The stipulation was brought in as an anti-abuse provision to discourage buyback of shares and encourage dividend distribution to shareholders in case of surplus earnings by a company. There was a feeling that listed companies took to the buy-back route to avoid paying the dividend distribution tax (DDT) pegged at an effective rate of 20.5576%. Therefore, it was deemed essential to plug this loophole that corporates were exploring to evade taxes. However, it is unfair to look at the corporate action of share buyback from such a narrow perspective. Apart from being a tax saving option, buyback also increases earnings per share of the company, avail positive debt-equity ratio and facilitates an exit route to shareholders. On that account, the government needs to issue a clarification regarding the applicability of the announcement to existing buyback proposals and other legal implications of the same.

 

What Constitutes Buyback?

 

The corporate action of a share buyback is a route for companies to return the extra income earned to the shareholders while potentially boosting their earning per share and value of the share over a long term. In a share buyback a company will extinguish the shares bought back or treated as treasury stock as permitted under IND AS.

 

Section 115QA of the Income-Tax Act, 1961 which provides for the imposition of tax on distributed income of a domestic company for buy-back of unlisted shares would now be amended to include shares listed on a recognized stock exchange. As a consequence, over and above the tax on income chargeable in respect of the total income of a domestic company for any assessment year, any amount of distributed income by all corporates on buy-back of shares from a shareholders is to face an additional tax at 20% on the distributed income.

 

The Tax Impact

 

Prior to the Budget announcement, a listed company had to pay corporate tax at 30% plus applicable surcharge and cess and the profits after tax when distributed among shareholders in the form of dividend attracted an additional effective tax rate of 20.56% in at the hands of the company. In addition, a specified assessee is required to pay income tax of 10 % when the amount of dividend received by him exceeded 10 lakh rupees as provided u/s 115BBDA of the Income Tax Act.

 

So the option for listed companies was to go for buyback of share which would not attract any additional tax apart from the corporate tax so that it could benefit the shareholders most.

 

Whereas now, in case of buyback of shares, entities will have to pay 20% on the difference of the initial value of the share and the buyback tender offer. Here it is pertinent to note that shareholders were exempted from capital gains tax arising in case of buyback of unlisted shares by companies u/s 10(34A).  Now the budget amendment has extended similar exemption to shareholders of a listed shares of companies u/s 10(34A).

 

Further, questions such as what happens when there is a market-based buyback and not a tender offer buyback needs to be clarified. Also, what would be the status if there is a capital loss in the hands of the shareholder and not a gain? Whether the capital loss would be allowed to be set off in subsequent years needs to be addressed.

 

 

Application of the proposal

 

As per the Union Budget, 2019 any Buyback implemented post-July 5th, 2019 by listed Companies is subject to an additional tax @20%.  Therefore, another relevant question that needs to be addressed immediately is whether the intention is to offer prospective or retrospective tax levy. A lack of clarity on this has pushed KPR Mill Limited, a prominent player among listed companies, to withdraw its offer to buy back its securities. Another listed entity facing the dilemma, SKP Securities, has brought its concern regarding the same to the attention of the market regulator and has also enquired whether it could withdraw its call for a buyback. Therefore, whether a Corporate can withdraw its offer to buy back while the scheme is announced and open needs to be elucidated. It is vital to comprehend and evaluate what the regulator and the governing laws offer to address this dilemma. 

 

Governing Statute

 

Corporates listed in the Secondary market are governed by the SEBI (Buy-back of Securities) Regulation 2018. The regulations in this regard unambiguously state that once a corporate submits the offer letter pertinent to the scheme with the regulator, or in this regard, a public announcement is made, the Corporate cannot withdraw the said scheme.

 

It is worth noting that in this regard, the Companies law also offers similar provisions by way of Companies (Share Capital and Debentures) Rules 2014. The rules are clear: Post the announcement of an offer to its shareholders, one cannot withdraw the scheme. 

 

Consequently, KPR mills could only withdraw after citing difficulties in getting shareholder approval for the enhanced disbursement and the legal impediment in availing funds to cover it.

 

 

Conclusion

 

Although it seems that another objective that the government sought to achieve through this measure was to ensure investment by listed companies in furtherance of its business or diversification of its operation which would lead to job opportunities and boost the economy. Also, taxing rich corporates would supplement the government’s financial requirements which would help in running welfare schemes and achieving the goal of the 5 trillion USD economy that we hope to achieve by the year 2024. Rather than taxing individuals, this route would help tax corporates that have the means to pay for it. Also, it gives a level playing field to unlisted and listed companies.

 

However, the measure drives one to question whether it is possible to achieve an effective tax administration in the presence of such loopholes and grey areas in the tax system.  In addition, the announcement flouts the well-known “Canons of Taxation, “ which prescribe Canon of Certainty and Canon of Convenience among the other prescribed canons. Till the regulator or the government addresses the afore-mentioned dilemmas, it seems that the said proposal is contrary to the world-known principles of taxation.

 

 

 

 

Image Credits: Photo by rawpixel from Pixabay 

the measure drives one to question whether it is possible to achieve an effective tax administration in the presence of such loopholes and grey areas in the tax system.  In addition, the announcement flouts the well-known “Canons of Taxation, “ which prescribe Canon of Certainty and Canon of Convenience among the other prescribed canons. Till the regulator or the government addresses the afore-mentioned dilemmas, it seems that the said proposal is contrary to the world-known principles of taxation.

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