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.
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