New Tax Rate: Facts required to be considered.

1.   The Taxation Laws (Ordinance), 2019 has been promulgated by the President of India to amend the Income-tax Act, 1961 and the Finance (No. 2) Act, 2019. The Ordinance has introduced two new corporate tax rates, i.e., at 15% and 25% for the domestic companies. However, the benefit of reduced tax rate shall be available only when total income of the company is computed without claiming specified deductions, incentives, exemptions and additional depreciation available under the  Income-tax  Act.  

The  Ordinance  has  also  relaxed  the  provisions  related  to  Minimum  Alternate  Tax (MAT).   The   rate   of   MAT   has   been   reduced   from   18.5%   to   15%.   Further,   the companies,  which  have  opted  for  concessional  tax  regime,  are  exempted  from  MAT provisions.  So,  the  Ordinance  has  provided  significant  benefits  to  the  domestic companies.

It must be noted that the Ordinance has given tax benefits only to a domestic  companies and it is not extended to other form of business entities, i.e., Individual, Partnership Firm, Limited Liability Partnership (LLP), etc.

Considering the significant tax benefits available to a domestic company, many  business houses are looking for conversion of their legal status  into  Companies  in order to get the tax perks. In this article we have discussed on the implications if an assessee (other than a domestic company) converts into a domestic company.

New tax regimes for companies:

2.     The Ordinance has introduced two new taxation regimes for the domestic companies - Section 115BAA and Section 115BAB.

As  per  Section  115BAA,  domestic  companies  will  have  an  option  to  pay  tax  at  the reduced rate of 22%. The Income-tax rate shall be further increased by surcharge of 10% and health and education cess of 4%. Hence, the effective tax rate under Section 115BAA becomes 25.17%.

On   the   other   hands,   section   115BAB   provides   for   reduced   tax   rate   of   15%   for manufacturing companies incorporated in India on or after 01-10-2019. The Income- tax  rate  shall  be  further  increased  by  a  surcharge  of  10%  and  health  and  education cess of 4%. Hence, the effective tax rate under section 115BAB shall be 17.16%.

The benefit of concessional tax regime shall be available to companies only when the total income is computed without claiming specified deductions, incentives,  exemptions and additional depreciation available under the Income-tax Act.

If a company doesn't want to give away such specified deductions or exemptions, then  it may continue which the pre-amended rate structure.

Tax structure of non-corporates assesses:

3.  In India constitution of business varies with number of people involved in business. Each type of constitution requires certain number of people. Business can be constituted in any of the following forms:

(a)      Sole proprietorship

(b)      Association of persons (AOP)

(c)      Body of Individuals (BOI)

(d)      Limited Liability Partnership (LLP)

(e)      Partnership Firm

(f)      Company

The tax structure of all of the above mentioned business entities is different. A firm & LLP is taxable at flat rate of 30 per cent irrespective of amount income. Similarly, in case of sole proprietor, AOP & BOI, though they are taxable as per slab rate but the higher tax rate on income exceeding Rs. 10 lakhs is 30%.

Further, the surcharge is levied at rate of 12% in case of firm/LLP, if the total income exceeds Rs. 1 crore and it levied in the range of 10% to 37% in case of others if their total income exceeds specified limits.

Benefit of corporate structure:

4.   For the Assessment Year 2020-21, a domestic company is chargeable to tax at the rate of 25%, if its turnover or gross receipt does not exceed Rs. 400 crore during the financial year 2017-18 or if it opts for Section 115BA. In all other cases a domestic company is chargeable to tax at the rate of 30%. If the domestic company opts for concessional tax regime available under sections 115BAA or 115BAB, the rate of tax   gets further reduced to 25.17% and 17.16% respectively.

Further,  the  provisions  of  MAT  aren't  applicable  if  a  company  opts  for  concessional tax regime and in case of others the MAT is payable at the rate of 15% instead of 18.5% which was applicable up to AY 2019-20.

On the other hand, the maximum tax rate in case of firm/LLP comes out to be 34.94% and in case of other assessees, it comes out to be 42.74% which is higher than the new corporate tax regime. Beside this, they are also liable to pay Alternate Minimum Tax (AMT) at the rate of 18.5%.

For the existing business entities, the benefit of new tax regime can be  availed  by opting for any of the following modes:

(a)      By converting an existing entity (e.g., LLP/Firm) into a company; or

(b)      By incorporating a new company.

Conversion of an existing entity into a company:

5.   The Companies Act, 2013 allows conversion of an existing business entity into a Company. The Income-tax Act, 1961 also recognizes such conversion. Thus, legally an existing business entity may convert its legal entity into a company for availing the

benefit   of   reduced   corporate   tax   rate   available   under   section   115BAA.   Such conversions are tax neutral in respect of following, if certain conditions are satisfied.

(a)     No capital gains – where a business entity is converted into a company, all the assets and liabilities of the business entity immediately before the conversion become the assets and liabilities of the company. Such transfer    of capital assets (whether tangible or intangible) to the company will not be charged to capital gains tax subject to fulfilment of prescribed conditions.

(b)      Carry forward & set-off of loss & unabsorbed depreciation – Entities fulfilling the prescribed conditions are also eligible to carry forward and set- off the accumulated losses and unabsorbed depreciation.

What are the prescribed conditions?

5.1.    Section 47 of the I-T Act provides that when a sole proprietary concern or a partnership firm (including LLP) is succeeded by a company then any transfer of  capital assets (whether tangible or intangible) shall not be deemed to be transfer for   the purpose of capital gains if the following conditions are satisfied:

(a)     Whole business devolves - The whole business of the firm/proprietary concern devolves on the successor company and the same business should   be carried on by the company.

(b)      All assets & liabilities are taken - All assets and liabilities of the firm/ proprietary concern should be taken over by the company.

(c)      Shareholdings - All partners of the firm become shareholders of  the successor company in the same proportion in which their capital accounts stood in the books of the firm on the date of succession.

(d)      50% Shareholding for 5 years - The aggregate shareholding of partners of firm or proprietor in the company should not be less than 50% of its total voting power and the partners should continue to hold 50% voting power in the company for a period of 5 years.

(e)      Consideration in shares only - The partners of the firm or proprietor should not receive any consideration or benefit, directly or indirectly, other than by the way of allotment of shares (equity or preference shares) in the company.

Who cannot avail of the tax benefit?

5.2.    The provision of Section 47 applies only in case of conversion of a firm or proprietary concern engaged in business into a company. Thus, professional or consultancy firm/proprietary concern, etc., are not covered under this scheme.

Whether conversion is beneficial?

5.3.    In terms of mathematical formula, it may appear that a company  which  has  opted for section 115BAA has to pay tax at lesser rate and also there is no liability to   pay MAT. However, this may not be true for everyone.

Though the tax rate for a company, opting for section 115BAA, is lower but that rate is calculated  on  the  total  income  without  claiming  specified  deductions,  incentives, exemptions and additional depreciation available under the Income-tax Act.

If  a  business  entity  pays  tax  at  pre-amended  rate  then  tax  is  computed  on  the  total income calculated after allowing all such eligible deductions, incentives, exemptions, etc.  One  has  to  list  down  all  the  eligible  exemptions  &  deductions  which  shall  be forgone by the domestic company while opting for section 115BAA regime.

Further,  if  an  existing  business  entity  has  MAT  credit  or  brought  forward  losses  on account of additional depreciation, same is not eligible to adjustment after opting for section 115BAA. The CBDT vide Circular no. 29/2019, dated 02-10-2019 has made it clear  that  tax  credit  of  MAT  and  set  off  of  any  brought  forward  loss  on  account  of additional  depreciation  shall  not  be  available  once  the  option  under  section  115BAA has been exercised by a domestic company.

However,   a   domestic   company,   having   brought   forward   losses   on   account   of additional  depreciation  or  credit  of  MAT,  if  it  so  desires,  exercises  the  option  under section 115BAA after set off of the losses so accumulated or after utilizing MAT credit against regular tax payable under the taxation regime existing prior to promulgation of the Ordinance.

Forming a new company:

6.   Section 115BAB provides for reduced tax rate of 15% for the domestic companies    but this regime shall be available only for the manufacturing companies incorporated   in India on or after 01-10-2019. Hence, old companies will not be able to take the  benefit of this section. Further, the benefit is available only to a domestic company which is engaged in the business of manufacturing. All other types of business like, consultancy, trading, etc., aren't covered by this tax regime.

If an existing business entity has been engaged in the business of manufacturing, then instead of conversion such entities may contemplate creation of new company to get  the benefit of reduced tax rates.

Conditions for availing of the benefit of section 115BAB

6.1.A  domestic company can avail of the benefit of section 115BAB only if it fulfils the following conditions:

(a)      The domestic company should be incorporated on or after 01-10-2019 and commence the manufacturing before 31-03-2023;

(b)      It must be engaged in the business of manufacture or production of any article or thing and research in relation to, or distribution of such article or thing manufactured or produced by it;

(c)      It must not be formed by splitting-up or reconstruction of an existing business. However, this condition is not applicable in  case  of  an  undertaking formed as a result of  re-establishment,  reconstruction  or revival in accordance with the provisions of section 33B;

(d)      It does not use any building which was previously used as a hotel or a convention centre;

(e)     It does not use any machinery or plant previously used for any purpose. Any plant or machinery which was used outside India shall not  be  treated as used for any other purpose, if following conditions are satisfied:

♦      Before the date of installation they were not used in India;

♦      These assets were imported into India; and

♦      No deduction on account of depreciation has been allowed or allowable on such plant and machinery before they were installed    by the assessee

However,  this  condition  shall  be  deemed  to  have  been  complied  with  if value of plant and machinery previously used does not exceed 20% of total value of plant and machinery;

(f)      The total income of the company has been computed without claiming specified deduction, exemption or incentives.

Only manufacturing company can avail of the benefit

6.2.     The benefit of section 115BAB can be availed only by a manufacturing company. Thus, if an existing entity forms a new company which is not engaged in the business    of manufacturing, cannot avail of the benefit of said section.

Whether forming a new company by an existing business entity amounts   to splitting-up or reconstruction?

6.3.  On literal reading of section 115BAB, it appears that benefit of reduced tax regime under this section is available if a new domestic company is formed on or after 01-10- 2019 which commences its manufacturing business before 31-03-2023.

There  is  no  restriction  placed  in  the  section  that  an  existing  business  entity  cannot create  a  new  company  to  claim  the  benefit  of  section  115BAB.  The  key  restriction placed by the section 115BAB is that new company should not be formed by splitting- up or reconstruction of a business already in existence.

Section  115BAB  doesn't  define  what  constitutes  'splitting-up  or  reconstruction  of  a business already in existence'. So we have to rely upon judicial rulings to understand these expressions

The Supreme Court in the case of CIT v. Orient Paper Mills Ltd. [1989] 176 ITR 110 (SC)has held that in order to hold that the new undertaking is not formed out of the already existing business, there must be a new emergence of a physical separate industrial unit which may exist on its own as a viable unit. The new activity may produce the same commodities of the old business or it may produce some other distinct marketable products, even commodities which may feed the old business.  These products may be consumed by the assessee in his old business or may be sold in the open market. One thing is certain that the new undertaking must be an integrated unit by itself.

Relying  on  the  Apex  Court  Ruling,  it  can  be  concluded  that  any  existing  business entity's  creating  its  subsidiary  in  the  form  of  a  new  domestic  company,  which  shall undertake business of manufacturing, shall be eligible to claim the benefit of section 115BAB.

Invoking provisions of transfer pricing

6.4.     Since the tax rate of the company opting for section 115BAB is very low as compared to other form of business, it may happen that many business entities will form a new subsidiary companies and shift their profit to  new  company  to  reduce their overall tax burden.

In order to hold such situation, section 115BAB also provides that where the course of business  between  company  opting  for  section  115BAB  and  any  other  person  is  so arranged   that   it   produces   to   the   company   more   than   the   ordinary   profits,   the Assessing Officer can re-compute the profit which may be reasonably deemed to have been derived therefrom.

Further, the profit from such transaction shall be determined having regard to arm's length  price  if  such  transaction  is  covered  under  the  ambit  of  'Specified  Domestic Transaction' defined under section 92BA of the Act.

Section 92BA of the Income-tax Act, 1961 has also been amended to include 'business transacted  between  persons  referred  to  in  section  115BAB'  within  the  ambit  of 'Specified  Domestic  Transaction'.  Thus,  if  an  existing  business  entity  creates  its subsidiary in the form of a new manufacturing company which has opted for section 115BAB,  the  transfer  pricing  provisions  can  be  invoked  if  aggregate  of  business transacted  between  existing  entity  and  newly  incorporated  company  exceeds  the threshold limit of Rs. 20 crores in a previous year.

In nutshell, an existing business entity may form a new manufacturing company to get the benefit of section 115BAB.

Conclusion:

7. Based on the above discussions, it can be concluded that one has to do a complete analysis before making the right choice. Though the rate of tax under both the sections is low and also there is MAT exemption but this benefit is available only after losing some specified deductions or exemptions.

Further, once an assessee has opted for the concessional tax regime of section 115BAA or section 115BAB, it can't opt out from the same regime. Thus, one has to take a long term view and decide accordingly.