As noted in an earlier post, the Direct Taxes Code Bill has been introduced in Parliament. If enacted, it will come into force from 2012. Below is a comparative chart discussing the differences in the provisions in the current Act and in the Code Bill. The changes below are not exhaustive, and we will be discussing other aspects of the Code in subsequent posts.
Current Treatment under the Income Tax Act, 1961, as amended up to the Finance Act, 2010
Proposed Treatment under the Direct Taxes Code, 2010
Residence of companies
U/s 6(3), a company is treated as a resident, if it is an Indian company, or if its control and management is situated 'wholly' in India.
Under cl. 4(3) of the Bill, a company is treated as resident if it is an Indian company, or if its place of 'effective management' at any time of the year is in India. The test for determining residence has been altered and made broader. 'Place of effective management' is defined under cl. 314(192) to mean either the place where the Board/executive directors of a company make their decisions or, in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform
U/s 2(26), an Indian company is one which is formed and registered under the Companies Act, 1956 or established by or under a Central or State Act. A Proviso requires the registered/principal office to be in India.
Under cl. 314(132), an Indian company is a body corporate which is registered or established or constituted by or under the Companies Act, 1956 or another State or Central Act. The requirement of the proviso is separately included. The change in language seems clarificatory.
Residence of other legal persons
U/s 6(4), other legal persons are treated as residents in India in any previous year in every case, except where the control and management of his affairs is situated wholly outside India.
Under cl. 4(4), every other legal person is to be treated as a resident in any financial year, if the place of control and management of its affairs, at any time in the year, is situated wholly, or partly, in India. The language seems to have changed, but the test seems same – if any part of management is carried out in India, the person is a resident.
Scope of total income
Residents are taxed on worldwide income; non-residents on a source-based model
Essentially the same model, but 'source' has been widened. In particular, please refer to the discussions on deemed accrual below.
In addition, cl. 3(3) provides that any income which accrues to a resident or is received by a resident outside India during the year shall be included in the total income of the resident, whether or not such income has been charged to tax outside India.
Deemed accrual in India
Section 9(1)(i): Through or from any business connection, property, or asset/source in India, or through the transfer of a capital asset situate in India. Where operations are not carried on entirely in India, only that income which is reasonably attributed to operations in India is deemed to accrue in India.
Cl. 5(1): The same four categories apply – it is clarified that income arising 'through or from' all the 4 would be covered (as opposed to the present Section, where 'through or from' qualifies the other 3 categories but the provision only read 'through' the transfer of a capital asset. Business connection has been defined in cl. 314(40) to include a permanent establishment. PE is defined under cl. 314(183) to mean a fixed place of business through which the business of a non-resident is wholly or partly carried out – the general clause. The definition of PE then goes on to give a list of activities/installations/ structures which are included in the general clause; and then lists certain other elements which are deemed to be included.
Deemed accrual of income from interest, royalties and fees for technical services
Section 9(1)(v), (vi) and (vii): The income is deemed to accrue in India if it is: (a) payable by the Government;
(b) payable by a resident except where it is payable in respect of any debt/right/property/information/ services utilised for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India
(c) payable by a non-resident where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India
Cl. 5(2): The interest income is deemed to accrue or arise in India if it is:
(a) According to cl. 5(2)(d)/(f)/(h), accrued from or payable by the Government or any resident;
(b) According to cl. 5(2)(e)/(g)/(i), accrued from or payable by a non-resident if it is in respect of / for the purposes of a business carried on in India or for the purpose of earning any income in India.
The royalty provision has been broadened. Any royalty payable by a resident is now covered, even if that royalty was entirely in respect of a business carried out outside India. To my mind, this looks as if nexus requirements have been removed in respect of taxing a non-resident.
There is an exception under cl.5(4), where the income is not to be treated as accruing "in India under sub-section (1)" if it is in respect of a business carried on by a resident outside India or for the purpose of earning any income outside India. Curiously, the provisions on interest, royalty and FTS are under cl. 5(2), while the exception is only in respect of income under cl. 5(1). This is either a drafting error (and the notes on clauses indicate that this is the case), or a case of giving with one hand and taking away with the other. Interestingly, clause 5(2) is specifically stated to be without prejudice to cl. 5(1).
Additionally, it is provided under cl. 5(5), that income under clause 5(2)(c) to (k) shall be deemed to accrue or arise in India whether or not the payment is made in India, the services are rendered in India, the non-resident has a place of business/business connection in India, and irrespective of the actual place of accrual. This is probably to ensure that the 'render+utilize' debate does not arise again.
Calculation of income in case of indirect transfers
It is arguable that when there is a transfer of a share / interest outside India, there is no transfer of a capital asset in India; and no part of the consideration whatsoever is chargeable in India.
Cl. 5(6) provides that where the income of a non-resident, in respect of transfer, outside India, of any share or interest in a foreign company, is deemed to accrue in India under the 'transfer of a capital asset situate in India' provision [thereby implying that such an accrual is possible under the wordings of the Bill], the income shall be calculated by the formula Income = 'A' multiplied by 'B' divided by 'C', where:
A = Income from the transfer computed in accordance with
provisions of this Code as if the transfer was effected in
B = fair market value of the assets in India, owned, directly
or indirectly, by the company;
C = fair market value of all assets owned by the company.
Under cl. 5(4)(g), the fair market value of the assets in India, owned, directly or indirectly, by the company, must represent at least 50% of the fair market value of all assets owned by the company, in order for the same to be taxable in India.
Definition of 'fees from technical services'
Explanation II to Section 9(1)(vii) specifies that FTS means consideration for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head "Salaries".]
Cl. 314(97) defines FTS to mean any consideration:
i. for the rendering of any managerial, technical or consultancy services
ii. for provision of services of technical or other personnel.
The exclusion is available. The difference is that point (ii) is included separately, as opposed to the current act where it is included within managerial, technical or consultancy services. Now, on its plain reading, the clause is quite broad – FTS includes consideration… for the provision of services… of other personnel. The word 'other' in the second sub-clause should, it seems, be read in conjunction with 'technical' as opposed to all other personnel.
Definition of Royalty
U/s 9(1)(6), Explanation 2, royalty was defined to mean consideration for, inter alia, the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property.
Under cl. 314(220), royalty is defined to mean consideration for, inter alia, transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, trade mark, secret formula, process, or similar property. The change in the language is relevant – for example, there is debate in current law (see the Tribunal decisions such as New Skies and PanAmSat) as to whether the word 'secret' qualifies only 'formula' or both 'formula ' and 'process'. The Bill, by inserting the comma in place of the 'or' clarifies that the word 'secret' does not qualify process. This clarifies the existing provision – interestingly a Special bench of the Tribunal had come to the same conclusion in any case on the existing wording.
The other clauses seem to be similar to the existing definition, except for the change noticed above.
Treaty and Act interplay
Under Section 90(2), a tax treaty will override and the act will apply only to the extent it is more beneficial.
The principle remains the same. However, the wording of cl. 291(8) states that the principle applies "Where the Central Government has entered into an agreement under sub-section
(1) or sub-section (2), or has adopted an agreement entered into by the specified association under sub-section (4)…"
What about treaties which are entered into under Section 90(1) of the existing Act, as opposed to cl. 291(1), (2) or (4) of the Bill? Can the Revenue tomorrow argue that the treaty was actually not entered under this clause, but under Section 90; and hence, the Act will override in all cases? There was some amount of controversy in the first draft of the DTC regarding this; if there has been a rethink by the Government, there should be a specific mention of Section 90 as well to forestall the Revenue argument.
The treaty benefits are further restricted under cl. 291(9); according to which notwithstanding anything in sub-section (8), the provisions of this Code relating to (a) General Anti-Avoidance Rule (cl. 123), levy of Branch Profit Tax (cl. 111), or (c) Control Foreign Company Rules referred to in the Twentieth Schedule, shall apply to the assessee.
General Anti Avoidance Rule
There is no GAAR in the current Act.
Cl. 123 proposes a GAAR which is extremely wide. "Any arrangement" may be declared as an impermissible avoidance arrangement. Separately, in cl. 124(15), "impermissible avoidance arrangement" is defined to mean a step in, or a part or whole of, an arrangement, whose main purpose is to obtain a tax benefit and it:
(a) creates rights, or obligations, which would not normally be created between persons dealing at arm's length;
(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Code;
(c) lacks commercial substance, in whole or in part; or
(d) is entered into, or carried out, by means, or in a manner, which would not normally be employed for bona fide purposes.
Cl. 125 contains a presumption of purpose.
Cl. (3) states that the provisions of the GAAR shall apply subject to such conditions and in the manner as may be prescribed. It remains to be seen as to what these conditions will be.
There are serious concerns to my mind about the constitutional validity of the GAAR provisions; and it is submitted that if enacted, the provisions should be either read down severely, or struck down. This aspect will require a fuller discussion; and we will discuss constitutionality-related aspects after enactment of the Bill.
Best judgment assessment
U/s 144, a best judgment assessment is allowed in cases where there is a failure to file a return/failure to comply with the terms of certain notices etc.
Under cl. 156, in addition to the existing requirements, a best-judgment assessment can also be made if the fails to regularly follow the prescribed method of accounting, or if the AO is not satisfied about the correctness or completeness of the accounts of the assessee.