Dated: February 18, 2021
The annual budget speech of the Union Finance Minister is the topic of great interest and discussion for many. The devil lies in the specifics, however, for practitioners like advocates, chartered accountants, etc. The Finance Bill, 2021 contains several such specifics, true to its design, that have the effect of over-ruling many judicial precedents. The present article is an attempt to address this briefly.
Judicial Precedents overruled under Direct Taxes
1. Slump Exchange of undertaking is now taxable
In the form of slump sales, the Income Tax Act, 1961 provides for the taxability of the transfer of a company undertaking. In essence, these transactions are restructuring exercises carried out by institutions in which an activity is exchanged for lump sum consideration without assigning individual values to the respective assets and liabilities. Slump sales are taxable as capital gains under section 50B under the Income Tax Act, 1961. Section 2(42C) provides for the statutory definition of slump sales to signify, inter alia, a transfer as a result of the sale for this reason.
Under Section 50B, ingenious practitioners have devised a way to avoid such capital gains by arranging the transaction in such a way that it does not meet the “sale” test. If the transfer is not “sale” , it goes outside the meaning of Section 2(42C) and is thus not subject to capital gains tax. This was achieved in exchange for a company undertaking through the issuance of non-monetary/cash properties. For instance, quite recently, in the case of Areva T&D Ind Ltd. vs. CIT, the Madras High Court held that a transaction to qualify as a ‘sale’ requires monetary consideration. Thus, a transfer of an undertaking in lieu of issuance of shares by a company as consideration does not amount to a ‘sale’ and therefore, cannot be considered a ‘slump sale’ under the Income Tax Act, 1961.
Similarly, in the case of CIT vs. Bharat Bijlee Ltd., the Bombay High Court held that if an undertaking has been transferred to a corporation that has assigned preference shares and bonds as consideration, the same is not a ‘sale’ for the purposes of section 2(42C). In the case of CIT v/s Motor & General Stores (P) Ltd (6 ITR 692), these decisions along with the dictum of the Supreme Court on the same lines back in 1967 established a basis for taxpayers to prepare their commercial affairs accordingly.
However, by way of an amendment to the definition of slump sales the Finance Bill, 2021 now proposes to overrule the above-mentioned settled position under section 2(42C).
It is suggested that the reference to “sale” be omitted and replaced with “any means” thus eliminating the need for monetary consideration. In addition, a new clarification is given in order to extend the meaning of Section S in order to nullify any other tax schedule relating to such transactions. By means of the new amendment, the above modus operandi is now captured within the tax net.
It is of utmost importance to note that the amendment is effective from FY 2020-21 and therefore any structuring which has already taken place on the basis of the previous decisions in the current annual year is also taxed. This is one of the retrospective adjustments introduced in this budget.
2. Delayed deposit of employee's contribution to PF/ESI not allowable as business expenditure
Section 36(va) of the Income Tax Act, 1961 provides for the deduction of the contribution of the employee to PF/ESI if that balance is credited on or before the ‘due date’ to the employee's account in the applicable fund by the assessee. The explanation of that provision provides that “due date” means the date by which the assessee, as an employer, is allowed to credit the contribution of an employee to the employee's account in the respective fund under the applicable Act.
Section 43B deals with the allowability on the basis of payment on or before the ‘due date’ of employer contribution to PF/ESI. However, for the purposes of section 43B, the word ‘due date’ has been deemed to mean the due date on which the income tax return was furnished. Therefore, it can also be a deferred deposit before the due date of filing of return for the purpose of depositing employer contribution, but it can only be the due date under the respect fund for depositing employee contribution and not the date of filing of return for depositing employee contribution. The Delhi High Court, however, transposed the definition of 'due date' under section 43B to section 36(va) in the case of CIT vs. AIMIL Ltd.
Thus, the ruling helped the taxpayers even though they postponed the deposit of the contribution of the employee. By way of amendment to Section 36(va), this deficiency has now been remedied to clarify that Section 43B does not apply and is considered never to have been enforced for the purpose of deciding the ‘due date’. This is a welcome amendment since the employers were unjustly rewarded by the late deposit of employee contribution, retaining the money belonging to the workers and also earning deductions under the tax law.
3. No depreciation can be claimed on Goodwill
A very successful business/professional setup will create a great deal of goodwill/reputation in the sector. This credibility as an intangible benefit synonymous with the company’s success is quite subjective to value. The seller specifically charges a premium on account of the transfer of reputation/goodwill that will support the purchase if successful businesses are sold in a deal.
This premium was known in the account books as “goodwill” in monetary terms. There has been a debate about whether this accumulated goodwill for tax purposes is a depreciable asset. In the case of CIT vs. Smifs Securities Ltd., this dispute was settled by the Supreme Court in favour of taxpayers in which it was held that “Goodwill” is an asset on which the depreciable benefit can be claimed. Such transactions then were in the hands of the buyers a very tax efficient weapon. However, Budget 2021 now intends to change Section 32 to exclude goodwill in order to overrule this decision. Goodwill must, therefore, no longer be a depreciable commodity. This is also one of the retrospective changes introduced in the budget for this year.
4. Beneficial rate under DTAA to be considered for FIIs while deducting tax at source
The Income Tax Ac 1961 provides for a special rate of tax which may often be higher than the beneficial tax rate provided for in the DTAA with regard to a certain class of non-residents and incomes. Under domestic law, however, non-residents are obliged to be subject to TDS at the higher rate defined in the special provisions. In PILCOM vs. CIT, the Supreme Court issued a landmark judgement affirming this principle, in which it ruled that the DTAA is not impaired by the duty to withhold taxes under the special clause.
The benefit of the DTAA will be considered by the payee and can be asserted as a refund with interest if found true the taxes withheld. Such a treatment does not, however, exclude the payer from fulfilling withholding duties under the Act. With a view to encouraging international capital flow, it is now suggested that the Supreme Court's decision be partly overruled in FII cases. Therefore, it is now suggested that the laws relating to TDS be changed by deducting the tax at the rate specifically charged or at the rate below the DTAA, whichever is lower. Therefore, when deducting TDS, the underlying DTAA can be taken into account. This is one of the only taxpayer-friendly reforms.
Judicial Precedents overruled under Indirect Taxes
1. Doctrine of mutuality no longer applicable under CGST Act, 2017
For a long time, practises or transactions involving the supply of products or services by clubs to their members have been the subject of lawsuits under different tax laws. Quite recently, in the State of West Bengal vs. Calcutta Club Limited, a 3-judge bench of the Supreme Court held that there can be no selling transaction between the club of an incorporated and unincorporated member and its members. There is no legal difference between a club and its members under the mutuality doctrine. The same was confirmed by the Supreme Court in the judgement referred to above, with the result that certain transactions were not taxable.
In order to overrule the said decision in the sense of GST, the Finance Bill, 2021 proposes to amend the definition of ‘supply’ to include the supply of goods or services by a club to its members under Section 7 of the CGST Act, 2017. Hence, the said transaction was brought under the scope of GST by way of an artificial definition. It is important to remember that it is retrospective with this amendment.
2. Wholesome changes to the law of provisional attachment under CGST Act, 2017
Section 83 of the CGST Act, 2017 provides the department with the power to temporarily attach land, including a taxable person's bank accounts. In extreme and more obvious situations, this is with a view to safeguarding the interest in sales. In the case of Proex Fashion Private Limited v. Govt. of India & Ors, the Delhi High Court has held that the action referred to in section 83 is based on pending proceedings pursuant to Sections 62, 63, 64, 67, 73 or 74 of the Act. Therefore, for any other proceeding, provisional attachment (even though it applies to the above sections) is not legitimate and is liable to be quashed.
Similarly, in the case of Kaish Impex Private Limited Vs UOI, the Bombay High Court held that Section 83 does not allow for an immediate extension of the investigation expressly instituted against a taxable person to any other taxable person pursuant to those provisions. It further held that it was not necessary to bind bank accounts solely on the basis of the summons given under section 70.
In this sense, the Finance Bill 2021 proposed that these decisions be overcome and that the whole of section 83(1) be replaced by the current section 83(1).
There are three main consequences of the aforementioned amendment. First, it must be noted that the reference to individual sections has been removed and that, in its place, a wider reference has been made to chapters under the 2017 CGST Act. Secondly, the scope was further extended by adding, in addition to the taxable individual, the automated extension of certain powers in relation to certain other persons.
Thirdly, the wording of the clause applies to the “initiation of any proceeding” rather than the continuation of that proceeding. Consequently, if a property has been provisionally annexed, it will remain annexed until the statutory time permitted under section 83(2), even if the proceedings are no longer pending.
Therefore, among other courts, the impact of the judgments of the High Court of Delhi and the High Court of Bombay has been done away with.
The effect of these amendments on pending transactions and also on their respective advice to customers is of the utmost importance for fellow professionals to remember. The well-established roles have now been suggested to be altered, so the same case laws might no longer be applicable. It should be remembered that, with retrospective effect, some of the big reforms were brought in. In light of this, learning about these developments and advising accordingly becomes all the more important.