OECD BEPS Framework: Recent Development

Addressing tax issues arising in the digital economy has been a priority of the international community since past several years. It aims to deliver a consensus-based solution and ensure Multinational Enterprises (MNEs) pay a fair share of tax in the jurisdiction they operate. After years of intensive negotiations, the Organization for Export Co-operation and Development (OECD) / G20 has recently introduced a major reform in the international tax framework for taxing the Digital Economy.

The OECD / G20 inclusive framework on Base Erosion and Profit Shifting (BEPS) [“IF”] has issued a Statement, on 8th October 2021, agreeing on a two pillar-solution to address the tax challenges arising from the digitalization of the economy. There are 136 countries, including India, out of a total of 140 countries, representing more than 90% of the global GDP, that have agreed to this Statement. All members of the OECD countries have joined in this initiative and there are four G20 country members  (i.e. Kenya, Nigeria, Pakistan & Sri Lanka) who have not yet joined. The broad framework of the two-pillar approach as per the Statement is as follows:

 

Pillar One

 

Introduction and applicability:

  • Pillar One focuses on fairer distribution of revenue and allocation of taxing rights between the market jurisdictions (where the users are located), based on a ‘’special purpose nexus’’ rule, using a revenue-based allocation.
  • Applicable to large MNEs with a global turnover in excess of  Euro 20 Billion and profitability above 10% (i.e. profit before tax)[1]. This revenue threshold is expected to be reduced to Euro 10 Billion, upon successful review, after 7 years of the IF coming into force.
  • The regulated financial services sector and extractive industries are kept out of the scope of Pillar One.

 

Calculation Methodology:

  • Such allocation will help determine the ‘’Amount A’’ under Pillar one.
  • The special-purpose nexus rule will apply solely to determine whether a jurisdiction qualifies for Amount A allocation based on which 25% of residual profits, defined as profit in excess of 10% of revenue, would be allocated to the market jurisdictions using a revenue-based allocation key.
  • Allocation vis-à-vis nexus rule will be provided for market jurisdictions in which the MNE derives at least Euro 1 Million  of revenue  [Euro 250,000  for smaller jurisdictions (i.e. jurisdiction having  GDP lower than Euro 40 Billion )]
  • Profits will be based on financial accounting income, subject to:
    • Minimal adjustments; and
    • Carry forward of losses
  • Detailed revenue sourcing rules for specific categories of transactions shall be developed to ensure that revenues are sourced to end market jurisdiction, where goods or services are consumed.
  • Safe harbour rules will be separately notified, so as to cap the allocation of baseline marketing and distribution profits of the MNE, which may otherwise already be taxed in the market jurisdiction.

 

Tax Certainty:

  • Rules will be developed to ensure that no double taxation of profits gets allocated to the market jurisdiction, by using either the exemption or the credit method.
  • Commitment has been provided to have mandatory and binding dispute prevention and resolution mechanisms to eliminate double taxation of Amount A and also resolve issues w.r.t transfer pricing and business profits disputes.
  • An elective binding dispute resolution mechanism for issues related to Amount A will be available only for developing economies, in certain cases. The eligibility of jurisdiction for this elective mechanism will be reviewed regularly.

 

Implementation:

  • Amount A will be implemented through a Multilateral Convention (MLC), which will be developed to introduce a multilateral framework for all the jurisdictions that join the IF.
  • The IF has mandated the Task Force on the Digital Economy (TFDE) to define and clarify the features of Amount A (e.g. elimination of double taxation, Marketing and Distribution Profits Safe Harbour), develop the MLC, and negotiate its content so that all jurisdictions that have committed to the Statement will be able to participate.
  • MLC will be developed and is expected to be open for signature in the year 2022, with Amount A expected to come into effect in the year 2023.
  • IF members may need to make changes to domestic law to implement the new taxing rights over Amount A. To facilitate consistency in the approach taken by jurisdictions and to support domestic implementation consistent with the agreed timelines and their domestic legislative procedures, the IF has mandated the TFDE to develop model rules for domestic legislation by early 2022 to give effect to Amount A.
  • The tax compliance will be streamlined allowing in-scope MNEs to manage the process through a single entity.

 

Unilateral Measures:

  • The MLC will require all parties to remove all digital service tax (DST) and other similar taxes (eg: Equalisation levy from India perspective) with respect to all companies and to commit not to introduce such measures in the future.
  • No newly enacted DST or other relevant similar measures will be imposed on any company from 8 October 2021 and until earlier than 31 December 2023 or coming into force of the MLC.

 

Pillar Two

 

Introduction:

 

  • Pillar Two consists of Global anti-Base Erosion Rules (GloBE) to ensure large MNEs pay a minimum level of tax thereby removing the tax arbitrage benefit which arises by artificially shifting the base from high tax jurisdiction to low tax jurisdiction with no economic substance.
  • Pillar Two is a mix of several rules, viz. (i) Income Inclusion Rule (IIR); (ii) Undertaxed Payment Rule (UTPR); and (iii) Subject to Tax Rule (STTR).
  • IIR imposes a top-up tax on parent entity in respect of low taxed income of a constituent entity
  • UTPR denies deductions or requires an equivalent adjustment to the extent low tax income of a constituent entity is not subject to tax under an IIR.
  • STTR is a treaty-based rule which allows source jurisdiction to impose limited source taxation on certain related-party payments subject to tax below a minimum rate. The STTR will be creditable as a covered tax under the GloBE rules.
  • There would be a 10-year transition period for exclusion of a certain percentage of the income of intangibles and payroll which will be reduced on year on year basis
  • GloBE provides de minimis exclusion where the MNE has revenue of less than Euro 10 Million and profit of less than Euro 1 Million and also provides exclusion of income from international shipping.

 

Calculation Methodology:

 

  • Pillar Two introduces a minimum effective tax rate (ETR) of 15% on companies for the purpose of IIR and UTPR and would apply to MNEs reporting a global turnover above Euro 750 Million under country-by-country report.
  • The IIR allocates top-up tax based on a top-down approach, subject to a split-ownership rule for shareholdings below 80%. The UTPR allocates top-up tax from low-tax constituent entities, including those located in the Ultimate Parent Entities (UPE) jurisdiction. However, MNEs that have a maximum of EUR 50 million tangible assets abroad and that operate in no more than 5 other jurisdictions, would be excluded from the UTPR GloBE rules in the initial phase of their international activity.
  • IF members recognize that STTR is an integral part of Pillar Two for developing countries and applies to payments like interest, royalties, and a defined set of other payments. The minimum rate for STTR will be 9%, however, the tax rights will be limited to the difference between the minimum rate and tax rate on payment.
  • GloBE rules would not be applicable to Government entities, international organizations, non-profit organizations, pension funds or investment funds that are UPE of an MNE Group or any holding vehicle used by such entities, organizations, or funds.

 

Implementation:

  • Model rules to give effect to the GloBE rules are expected to be developed by the end of November 2021. These model rules will define the scope and set out the mechanics of the GloBE rules. They will include the rules for determining the ETR on a jurisdictional basis and the relevant exclusions, such as the formulaic substance-based carve-out.
  • An implementation framework that facilitates the coordinated implementation of the GloBE rules is proposed to be developed by the end of 2022. This implementation framework will cover agreed administrative procedures (e.g. detailed filing obligations, multilateral review processes) and safe-harbors to facilitate both compliance by MNEs and administration by tax authorities.
  • Pillar Two is proposed to be effective in the year 2023, with the UTPR coming into effect in the year 2024.

 

FM Comments :

 

With the introduction of the OECD/G20 inclusive framework on BEPS, OECD expects revenues of developing countries to go up by 1.5-2% and increase in overall reallocation of profits to developing countries of about USD 125 Billion. India, being a huge market to large MNEs, has always endorsed this global tax deal. However, with the introduction of this framework, India will have to abolish all unilateral measures, such as equalization levy tax and Significant Economic Presence (digital permanent establishment) provisions. MNEs will also have to re-visit their structure to ring-fence their tax positions based on the revised digital tax norms.  This Statement lays down a road map for a robust international tax framework w.r.t taxing of the digital economy,  not restricted to online digital transactions.

References

[1] Calculated, using an “averaging mechanism”, details of which are awaited.

Image Credits: Photo by Nataliya Vaitkevich from Pexels

With the introduction of the OECD/G20 inclusive framework on BEPS, OECD expects revenues of developing countries to go up by 1.5-2% and increase in overall reallocation of profits to developing countries of about USD 125 Billion. India, being a huge market to large MNEs, has always endorsed this global tax deal.

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Taxation (Amendment) Bill, 2021: Regaining Investor Confidence

The retrospective clarificatory amendment regarding taxability of indirect transfers and consequent demand raised in a few cases, had created doubts and serious concerns for potential investors in our country and had also tarnished India’s image in the international community. The country today stands at a juncture when quick recovery of the economy after the COVID-19 pandemic, is the need of the hour and foreign investment has an important role to play in promoting faster economic growth and employment.  With this objective in mind, the Hon. Finance Minister of India has proposed this Taxation Laws (Amendment) Bill 2021 (“the Bill’), to put an end to the protracted litigation on this subject matter.

 

The issue regarding taxability of indirect transfer of assets located within the country, by transferring shares of an intermediary foreign company, was first analyzed in the case of Vodafone International Holdings (‘Vodafone’). In that case, Vodafone had acquired 100 percent shares of a Cayman Island based subsidiary company, from Hutchison Telecommunication International Ltd. (‘HTIL’), which was holding 67 percent controlling interest in Hutchison Essar Limited (‘HEL’), an Indian Joint venture company. Through this transaction, Vodafone had indirectly acquired a controlling interest of 67% in HEL, without triggering any taxable event in India. However, the Indian Revenue authorities had served a notice on Vodafone for not withholding tax under section 195 of the Indian Income Tax Act, 1961 (‘the Act’) on the consideration that was paid by it to HTIL.

The controversy was finally settled by the Hon’ble Supreme Court (‘SC’) in 2012 in favour of Vodafone[1]. The SC had ruled that the word “through” in section 9 of the Act does not mean “in consequence of” and “sale of share in question to Vodafone, did not amount to transfer of capital asset within the meaning of section 2(14) of the Act”. Accordingly, an indirect transfer of Indian assets by transferring shares in a foreign company was not chargeable to tax in India and therefore was not liable to any withholding tax.

Retrospective Amendment in Finance Act, 2012:

In order to override the SC decision and tax such Indirect transfer transactions, the Central Board of Direct Taxes (CBDT) had introduced an amendment under section 9(1) of the Act, which was made effective retrospectively from 01 April 1962. The Finance Act, 2012 had inserted a clarificatory Explanation 4 and Explanation 5 to section 9(1)(i), as under:

“Explanation 4— For the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of”, “in consequence of” or “by reason of”.

Explanation 5— For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India”

The above retrospective amendments created doubts in the minds of the stakeholders regarding the stability of India’s tax laws and also invited huge criticism and embarrassment at the international level.

Pursuant to this retrospective amendment, income tax demand had been raised in seventeen cases by the Revenue authorities. In four cases, the aggrieved taxpayers had preferred arbitration under India’s Bilateral Investment Protection Treaty with the United Kingdom and the Netherlands, respectively. Recently, the respective Arbitration Tribunals have, in the case of Vodafone International Holding BV vs. The Republic of India as well as in Cairn Energy PLC vs. The Republic of India, ruled in favour of the assessee and against the Government of India. The government of India has challenged both this arbitration award.

Proposed Amendment:

The Bill [2] proposes to amend the Act and abolish the retrospective tax on indirect transfer of Indian assets, if the transaction was undertaken before 28 May 2012 [3].

The amendment proposes to insert three provisos (fourth, fifth and sixth) under Explanation 5 to section 9(1)(i), thereby nullifying:

  • any pending or concluded assessment or reassessment; or
  • any order enhancing the demand / reducing the refund; or
  • any order deeming a person to be an “assessee in default” for non-withholding of tax; or
  • any order imposing a penalty

with respect to any income accruing or arising from the transfer of an Indian asset pursuant to the transfer of shares in a foreign company.

Therefore, all assessments or rectification applications (pending/ concluded) before the Revenue authorities, to the extent it relates to the computation of income from any indirect transfer of assets, shall be deemed to have concluded/ have never been passed without any additions.

Specified Conditions:

Relief under the proposed amendment would be available only to assessees fulfilling the following specified conditions:

  • The assessee shall either withdraw or submit an undertaking to withdraw any appeal filed before the Tribunal, High Court or Supreme Court with respect to the indirect transfer, in such form and manner as may be prescribed [4];
  • The assessee shall either withdraw or submit an undertaking to withdraw any proceeding for arbitration, conciliation or mediation, with respect to the indirect transfer, in such form and manner as may be prescribed [3];
  • The assessee shall furnish an undertaking waiving his right, whether direct or indirect, to seek or pursue any remedy or any claim in relation to indirect transfer in such form and manner as may be prescribed [3].

Pursuant to fulfillment of the specified conditions, where any amount becomes refundable to the person referred to in the fifth proviso, then, such amount shall be refunded to such person, without any interest on such refund under section 244A of the Act.

FM Comments:

The amendment is a proactive step aimed at neutralizing the criticism and embarrassment caused by retrospective amendment and regaining the stakeholder’s confidence in Indian judicial system. Such measures from the Government will certainly create a positive sentiment and a sense of tax certainty amongst the investors and hopefully, help in attracting incremental foreign investment into the country, which will play an important role in promoting faster economic growth and development.

 

References:

[1] Vodafone International Holdings B.V. vs. UOI (2012) 341 ITR 1 (SC)

[2] President is yet to give his assent on the said Amendment Bill

[3] Date on which Finance Bill, 2012 received assent of the President

[4] Form for submitting undertaking is yet to be prescribed

 

Image Credits: Photo by Michael Longmire on Unsplash

Such measures from the Government will certainly create a positive sentiment and a sense of tax certainty amongst the investors and hopefully, help in attracting incremental foreign investment into the country, that will play an important role in promoting faster economic growth and development.

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Tax Alert: Latest COVID-19 Related Relaxations and Exemptions Issued by the Government

In view of the prevailing COVID-19 pandemic situation in the country, resulting in hardship and difficulty vis-à-vis complying with various due dates under the Indian Income tax Act, 1961 (‘the Act’) and causing severe impact on the cash flows, the Central Board of Direct Taxes (‘CBDT’) has time and again issued relevant Notifications, Circulars and Press Releases extending the due date w.r.t  various direct tax compliances.

 

Updated as on 13th July 2021

 

In the table below, we have summarized the key Notifications and Circulars issued by the CBDT, which has extended the due dates of various direct tax compliances under the Act:

Sr No

Compliance Particulars

Original Due Date

Extended Due Date[1]

1

Objections to Dispute Resolution Panel (DRP) and Assessing officer under section 144C

01 June 2021

31 August 2021 (note 1)

2

Statement of Deduction of Tax for the last quarter of the Financial Year 2020-21

31 May 2021

15 July 2021

3

Certificate of Tax Deducted at Source in Form 16

15 June 2021

31 July 2021

4

Statement of income paid or credited in Form 64D by Investment Fund to its unit holders for Financial Year 2020-2021

15 June 2021

15 July 2021

5

Statement of income paid or credited in Form 64C by Investment Fund to its unit holders for Financial Year 2020-2021

30 June 2021

31 July 2021

6

The application under Section 10(23C), 12AB, 35(1)(i i)/(iia)/(iii) and 80G of the Act in Form No. 10Af Form No.10AB. for registration/ provisional registration/ intimation/ approval/ provisional approval of Trusts/ Institutions/ Research Associations

30 June 2021

31 August 2021

7

Compliances for claiming exemption under provisions contained in sections 54 to 54GB

01 April 2021 to 29 September 2021

01 April 2021 to 30 September 2021

8

Quarterly Statement in Form 15CC to be furnished by Authorized Dealer in respect of foreign remittances made for quarter ended 30th June 2021

15 July 2021

31 July 2021

9

Equalization Levy Statement in Form 1 for Financial Year 2020-21

30 June 2021

31 July 2021

10

Time Limit for processing Equalization Levy return

–

30 September 2021

11

Annual Statement in Form 3CEK to be furnished under section 9A(5) by Eligible Investment Fund

29 June 2021

31 July 2021

12

Uploading declaration received from recipients in Form No 15G / 15H for quarter ended 30th June 2021

15 July 2021

31 August 2021

13

Exercising of option under section 245M(1) in Form No. 34BB for withdrawing application before Settlement Commission

27 June 2021

31 July 2021

14

Last date of linking of Aadhar with PAN under section 139AA

31 March 2021

30 September 2021

15

Last date of payment under Vivad se Vishwas (without additional amount)

–

31 August 2021

16

Last date of payment under Vivad se Vishwas (with additional amount)

–

31 October 2021

17

Time Limit for passing assessment / reassessment order

31 March 2021

30 September 2021

18

Time Limit for passing penalty order

–

30 September 2021

19

Due date for furnishing Return of Income – Non Audit Case

31 July 2021

30 September 2021

20

Due date for furnishing Tax Audit Report

30 September 2021

31 October 2021

21

Due date for furnishing Transfer Pricing Audit

31 October 2021

30 November 2021

22

Due date for furnishing Return of Income – Audit case

31 October 2021

30 November 2021

23

Due date for furnishing Return of Income where Transfer Pricing is applicable

30 November 2021

31 December 2021

24

Belated / Revised return for Assessment Year 2021-22

31 December 2021

31 January 2022

Note:

1) If the last date allowed u/s. 144C is later than 31 August 2021 then such a later date shall prevail.

 

References:

[1] Notification No 74/2021 & 75/2021 and Circular No 9/2021 dated 20 May 2021 and 12/2021 dated 25 June 2021

Image Credits: Photo by Nataliya Vaitkevich from Pexels

We have summarized the key notifications and circulars issued by the CBDT, extending the due dates of various direct tax compliances under the Act.

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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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'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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