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Direct Tax Code — The M&A Perspective

31 August, 2009
The Direct Taxes Code Bill, 2009 (‘Code’) unveiled on August 12, 2009 is a bold attempt to create a robust tax system in India.  The Code, open for public comments, is expected to be implemented from April 1, 2011.

This article deals with the salient features of the Code from an M&A perspective. Reference to the Act in this article indicates the current provisions as contained in the Income-tax Act, 1961.

Sale of assets

Capital assets have been classified into two categories – business capital assets and investment assets. While the tax rate for income from sale of both the categories is identical (except for capital gains in case of non residents), some key differences are tabulated below: 

 
Other key features of the Code are:
No distinction between long term and short term capital gains.  The period of holding is relevant only for ascertaining the indexation and rollover benefits.

Abolition of the Securities Transaction Tax regime. In line with this, capital gains arising from sale of listed shares will henceforth be treated on par with sale of unlisted shares.

Base year for calculation of capitals gain tax has been shifted to April 1, 2000 from April 1, 1981. As a result, notional gains earned but unrealized till April 1, 2000 will effectively be tax exempt.

Cost of acquisition / improvement to be deemed as ‘NIL’ in all cases where the same is indeterminable.

Slump sale
Profit on sale of an undertaking (slump sale) is also considered as business income under the Code. While the consideration is to be credited to gross earnings, the “net worth’ of the undertaking (the term will be defined once the Rules are published under the Code) will be allowed as a deduction. This is similar to the existing provisions, except that the difference between the consideration and net worth is chargeable to capital gains tax under the Act.

It is interesting to note that the commentary attached with the Code indicates that the loss on sale of the business capital asset will be treated as an intangible asset for which deduction would be allowed on a deferred basis. The deferment of loss is intended to serve as a disincentive for asset stripping and loss manipulation.  However, since, the gross consideration and net worth are to be added to the gross earnings and deductions respectively while computing the taxable income, it appears that the loss incurred on sale of the undertaking should also be fully allowed in the year of sale itself. Thus, the dichotomy between the commentary and the provisions will need to be resolved.

The Code also provides that the tax base of the assets in the hands of the buyer would be the tax base in the hands of the seller. Presently, under the Act, the buyer of an undertaking in a slump sale allocates the consideration to the assets (tangible and intangible) at their fair values and claims depreciation accordingly. Hence, after the Code comes into effect, the buyer will not get any tax breaks for the enhanced amount paid for acquisition of the undertaking. The notional written down value of the assets will get reduced for computing the value of the block of assets in the hands of the seller.

Business reorganisation
Business reorganisation includes amalgamation and demerger. The provisions are largely similar to the provisions contained in the Act and provide for tax neutrality in the hands of the transferor and transferee entities and their shareholders / partners / proprietors. However, the key differences are summarized below:
– The Code envisages, subject to compliance with specified conditions, amalgamation of unincorporated bodies such as firms and proprietary concerns into companies;
– The successor, is entitled to carry forward business losses of the predecessor, in a manner similar to that presently applicable under the Act, except for the following key differences:
 – The test of continuity of business, which was prescribed under the Act only in the case of an amalgamation of a company has also been extended to include demerger;
Under the Act, in an amalgamation, the losses could be carried forward only if the predecessor owned an industrial undertaking / hotel / ship. The Code does not stipulate any such restriction;
– Expenses incurred in connection with business reorganisation are allowed as a deduction under the Act over a 5 year period on a straight line basis. Under the Code, for companies, such expenditure would be deductible @ 25% on a written down value basis. For other entities, the entire expenditure would be allowed fully in the year in which it is incurred. 
(Amit Jain is Partner, BMR Advisors. The views are personal. Ketan Malkan contributed to the article.

 


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3 Comments
krishan . 6 years ago

whether without the prior approval of the CBDT, who is still the sole policy making body, can any committee be constituted to make direct taxes code bill? Some one should ask for the file noting under the RTI Act-2005

What makes not including CBDT as Income Tax Authority? paving ways for politician, CAs and IAS to be member of CBDT.

Charging section of the code bill is itself is bad in law

Specified securities are not part of charitable institution

Bobby . 6 years ago

20 per cent and 30 per cent Tax on Income are not advisable, as higher income groups may consider it painful to pay high taxes and there are chances that they may opt to evade taxes in one way or the other.

Well, Income Tax may be considered to be charged at a single flat rate of 10 per cent on total Gross Income as TDS just like a Service Tax only, the minimum.

However, for lower middle class/poor people, this 10 per cent Income Tax on total gross income may be borne by Employer and Employee in the following ratio:

Gross Income Employer : Employee

upto 50,000 Borne by Employer-Full

50,000 to 1 lac 3 : 1

lac to 1.5 lacs 2 : 2

1.5 lacs to 2 lacs 1 : 3

More than 2 lacs Borne by Employee-Full

The implementation of the above System of bearing the tax burden both by the Employer and Employees may be considered as an effective tool for reducing the tax liability on employees (individuals) and reduces the chances of evasion of Tax by Employers, as sometimes, employers show inflated/bogus/more salaries in their accounts to reflect less income or profits.

Moreover, Government may consider reduced/lower single slab Income Tax rates i.e. 2 per cent, 4 per cent, 6 per cent and 8 per cent on Total Gross Income upto Rs.50,000, Rs.1,00,000, Rs.1,50,000, Rs.2,00,000 respectively, in the form of TDS for lower income groups.

Alternatively, Government may consider for single Income Tax slab rates i.e. 2 per cent and 4 per cent on Total Gross Income upto Rs. 1,00,000/- and Rs.2,00,000/- respectively borne by the Employer and Employee in equal proportion.

However, people below the poverty line may be given exemption of this 10 per cent Tax.

Incomes of All small firms, different businessmen, wholesalers, retailers, Actors, Musicians, etc. may be considered to be charged at a single flat rate of 10 per cent either it is 25 lacs or 50 lacs or more.

Spiritual organizations, Charitable Institutions, Clubs, Welfare Organizations etc. may be considered to be liable to Pay Tax at a single flat rate of 10 per cent on all incomes/donations/receipts.

Incomes from 1. Interest 2. Dividends 3. Short / Long Capital Gain 4. House Property may be considered to be charged at a single flat rate of 10 per cent as TDS just like a Service Tax. However, people below the poverty line may be given exemption of this 10 per cent Tax.

Initially, Income Tax of single flat rate of 10 per cent on total Gross Income as TDS may be considered to be applicable for employees of Government, Public Sector Undertakings and Public Limited Companies. Its scope may be further extended to Private Limited Companies, then small firms, then different businessmen, then wholesalers, then retailers and so on.

Wealth Tax may be considered to be abolished.

STT may be considered to be allowed to be continued and may not be considered to abolish the same.

When all the incomes are charged at a single flat rate of 10 per cent, then ultimately, the revenue from Income Tax shall definitely be manifold. Then there are chances of less Tax evasion, less burden of filing returns.

All investments and purchases should be free from any compulsion in liberalized economy and as such, all Tax Saving Investment Schemes may be considered to be abolished. People should decide its own priorities for purchases and investments with 90 per cent amount available at its disposal – after paying 10 per cent Income Tax. Then People shall have the option either to invest the savings or purchase some more items/things out of the savings. In both the cases, the Government will earn revenue either in the form of Tax on interests/Dividends or Tax on Excise/Sales Tax.

The implementation of this single flat rate of 10 per cent Tax on Total Gross Income may be considered to be an effective tool for overcoming recession and will definitively increase production, employment opportunities and investments, in addition to reduction of black-money, un-accounted income and tax evasion.

With regards

Bobby

sushil singhi . 6 years ago

As per the current provisions of the Income tax Act 1961, where the person is carrying on any business, the total turnover or the gross receipts, as the case may be, of business exceeds forty lakes and a professional person having gross receipts over Rs 10lakhs in any financial year shall get his account audited under section 44AB of The Income Tax Act 1961 was introduced in the year 1984 w.e.f.01.04.1985.

Since then, inflation has eroded the value of money further. Hence it is absolutely necessary that the upper limit for compulsory tax audit should be increased to at least 100 Lakhs for business income and Rs 25 lakhs for professional income. The present direct Tax code 2009 has made significant change in many sections but the turnover limit for tax audit remains the same. In this Global competitive business scenario profitability or net margin have become lower and lower. Generally, the net margin lies between 2 to 3% and in some case it is even lower.

As per the new provision of the Direct tax code 2009 an individual having income up to Rs 3 lakhs need not pay any tax of his income but shall get his accounts audited as his turnover exceeds the limit of 40 lakhs . In this case assesses has to pay a huge amount of money to his tax auditor and at the same time Govt does not generate any revenue from the assesses. If this limit is increased to 100 lakhs and a small alternate tax is levied for the turnover between 40 lakhs to 100 lakhs will bring large amount of revenue to the tax department and a great relief for the tax payers. The tax system should be made simple and stable. Further, the tax rate structure is still very heavy and forces the tax payers to resort tax evasion leading to black money. However, the recent Direct Tax Code 2009 initiatives of the Government have given the tax payers a hope that the Government may reduce the harassment of innocent tax payers.

Direct Tax Code — The M&A Perspective

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