Golden Jubilee Residential Refresher Course (GJRRC)

Transcription

1 Golden Jubilee Residential Refresher Course (GJRRC) Case Studies on International Taxation (including Royalty & Capital Gains) Pinakin Desai

2 Case study 1: Monetising demonetisation: Section 115BBE

3 Monetising demonetisation: Section 115BBE Section 115BBE: Total income of taxpayer consisting of income referred u/s 68, 69 to 69D, whether reflected in return of income or not, 60% In addition to 60%, surcharge (25% of tax) and cess (3% of tax and surcharge), totaling to 77.25%. (Refer sixth proviso to section 2(9) of Finance Act 2016) No deduction for expenditure, allowance or set off of loss Section not restricted to cash deposits made between 8 November 2016 and 30 December 2016 Provisions are effective from Assessment Year as an ongoing provision. Section 271AAC: In addition to tax payable u/s 115BBE, penalty may be 10% of tax amount (6% of income) No penalty if and taxes are duly 60%+SC+EC before end of previous year and income declared in ROI However, no immunity even if income is included in ROI1 and taxes paid as SA tax No penalty u/s 270A, if penalty is leviable u/s 271AAC (S. 270A(2)) Penalty is discretionary as section uses the term may AO to grant opportunity for levying the penalty (Section 274) 1 If income is offered to tax, penalty may not be leviable u/s 270A of ITA. slide 3 Case Studies on International Taxation (including Royalty & Capital Gains)

4 Monetising demonetisation: Section 115BBE Scrap Sale: Onus on taxpayer to substantiate that amount is received from scrap sale Where scrap is over and above the normal level, taxpayer may need to provide reasons for the same. In case where scrap is generated during the production, taxpayer may relate the same with excise returns. Unexplained amount may be charged u/s 68 Deposit of High Denomination Notes: Addition to income only if source remains unexplained. Onus on taxpayer to provide proof of sufficient cash balance Taxpayer s claim supported by evidence, no case for to income. Loan receipt: Heavy onus on taxpayer to prove genuineness of transaction when lender is a close relative Non co-operation of lender during the assessment proceedings may be a negative factor slide 4 Case Studies on International Taxation (including Royalty & Capital Gains)

5 Monetising demonetisation: Section 115BBE Amount represented by cash sales: Onus on taxpayer to prove that amount represented by cash sales AO can verify the correctness of transaction by checking regular trend of business in past, invoices, purchase and sale of goods verified with inventory records etc. Mere non maintenance of address of buyer may not be sufficient for making additions. Taxpayer to maintain PAN of taxpayer if value cash sales (per transaction) exceeds INR 2 lakhs Failure to collect PAN may call for levy of penalty u/s 272B of Rs. 10,000 Failure to report cash sales > 2 lakhs may call for penalty u/s 271FA of Rs. 100 for every day where failure continues. Difference in value of building based on DVO report: AO may make reference to DVO without rejecting book u/s 142A No addition merely based on DVO report in absence of cogent evidence Addition justified u/s 69B if based on cogent evidence. slide 5 Case Studies on International Taxation (including Royalty & Capital Gains)

6 Monetising demonetisation: Section 115BBE Discrepancy in stock statement submitted to bank: Alternative 1: Stock reported to bank did not exist and was fictitious Onus on taxpayer to prove that stock did not exist and was inflated to obtain higher credit facilities In absence of any evidence with taxpayer, AO may include in total income of taxpayer u/s 69 of ITA Tax Authority and Court may not accept the claim of taxpayer that stock did not exist as authorities may not recognize sub standard morality of taxpayer [Refer, Coimbatore Spinning and Weaving (95 ITR 375)(Mad)] Alternative 2: Reported correct stock to bank but by over stating consumption in ROI Taxable as business income Liable to levy penalty u/s 270A Alternative 3: Excess reported stock acquired out of unexplained source If source of funds not explainable addition may be justified u/s 69 Income 60% u/s 115BBE slide 6 Case Studies on International Taxation (including Royalty & Capital Gains)

7 Case study 2: Fair value of shares issued by a company: S. 56(2)(viib)

8 Fair value of shares issued by a company: S. 56(2)(viib) Apr 14 Subscription to 10,000 shares at par (Rs. 10) by the promoters of Rs. 1 Lakh Development of IP technology July 16 Jan 17 Mar 17 Mar 17 Apr 17 Contribution of Rs. 10L by unrelated domestic investor (1000 shares of Rs. 10 issued at premium of Rs. 990) Subscription of Rs. 10L of CCD by S of par value of 100 at premium of 400 basis internal DCF valuation of share at Rs. 500 (Rs. 10 L). Better technology development by the competitor Founder promoters lost hope in future of the company Conversion of CCD into equity (1:1) at the insistence of new buyer Apr 17 Transfer of all shares to competitor at Rs. 200 slide 8 Case Studies on International Taxation (including Royalty & Capital Gains)

9 Fair value of shares issued by a company: S. 56(2)(viib) S. 56(2)(viib) taxes CHC in respect of excess consideration received for issue of shares from residents (other than VCU) Tax u/s. 56(2)(viib) = aggregate consideration received (minus) FMV of sharesdate Chronology R.W. Rule 11UA, FMV of shares at the option of company is higher of the following as at the date of receipt of consideration for share issue: Determined as per Rule 11UA. Break up value as per normative formula linked to the audited balance sheet As substantiated by the company to A.O s satisfaction basis its assets including intangibles The FMV under DCF determined by merchant banker / accountant slide 9 Case Studies on International Taxation (including Royalty & Capital Gains)

10 Issues under consideration What is the scope of trigger of charge u/s. 56(2)(viib) viewed in light of object and purpose of the section? Is it a SAAR to discourage issue of shares at huge premium? Is infusion at premium in July 2016 at value > 11UA valuation from an unrelated party basis negotiation covered by s. 56(2)(viib)? Is CCD infusion covered by s. 56(2)(viib)? Can the charge triggered get evaluated at the stage of conversion? How is the amount received determined at the stage of conversion of CCD? slide 10 Case Studies on International Taxation (including Royalty & Capital Gains)

11 Fair value of shares issued by a company: S. 56(2)(viib) Par value issue at formation stage for cash is beyond s. 56(2)(viib) July 16 issue to an unrelated party based on intense negotiations but not supported by formal valuation Normative 11UA value is only one of the specified alternative method available at the option of the company Value can also be substantiated by the company independent of valuation report Onus of substantiating value to the satisfaction of A.O. is on taxpayer Fiercely negotiated value with third party and contemporaneous correspondence may prima facie support bonafide of valuation; expert valuation is not must Company may be advised to formalise the valuation as of July 2016 Valuation report as of January 2017 of an Expert valuing share at Rs. 500 (as against valuation of Rs. 1,000) needs to be explained slide 11 Case Studies on International Taxation (including Royalty & Capital Gains)

12 Fair value of shares issued by a company: S. 56(2)(viib) January 2017 : Issue of CCD CCD is not shares Supported by an internal valuation report though, valuation is not by an accountant / merchant banker Company will need to substantiate valuation unless it can obtain expert valuation report of an amount Rs. 500 If supported by well-reasoned opinion of accountant / merchant banker, A.O. cannot ignore the same unless report is proved to be perverse Conversion of CCD into equity may be regarded at fair value having regard to intrinsic value which may be obtained from the third party: Company had liability to return CCD: Rs. 100 on liquidation Company had inability to convert CCD worth Rs. 200 into share Company extinguishes liability of Rs. 200 and receives Rs. 200 towards shares slide 12 Case Studies on International Taxation (including Royalty & Capital Gains)

13 Case study 3 : Exit from business enterprise GAAR implications

14 Facts P Q R J1 family RRL Business Option 2 Option 1 U family J2 family Option 1: J2 family offer to buy RRL business Option 2: U family offer to buy RRL shares J1 (Jaipuria) family (comprising of P, Q and R), wishes to divest business of RRL J2 (Jodhpuria) family had insisted on slump sale of business by RRL (Option 1) U family offers to purchase shares of RRL (Option 2) Concern on transfer of business license J1 family did not agree to dividend declaration by RRL prior to share transfer to U family Contemporaneous discussions with tax advisors: Net of tax returns higher for share sale Tax efficiency was one of the motivating factors for share sale option Each of the sellers (P, Q and R) invested the proceeds in residential house (s.54f) slide 14 Case Studies on International Taxation (including Royalty & Capital Gains)

15 A.O. s SCN in assessment of RRL P Q R Main purpose of implemented arrangement is tax benefit for RRL as there is avoidance of: J1 family Option 2 U family 30% tax on STCG payable on itemised sale (or) 20% tax on LTCG payable on slump sale (or) Avoidance of applicability of s.50c (or) Consequential avoidance of DDT RRL Option 1 J2 family Facilitated s.54f exemption by promoters Substance of the transaction (i.e. acquisition of business) is different from the form [s.96(1)(c)] Transfer of business is by means and manner Business not ordinarily employed for bona fide purpose [s.96(1)(d)] Option 1: J2 family offer to buy RRL business Option 2: U family offer to buy RRL shares Tax benefits 9 to 11 Cr. (being difference of tax incidence between Option 1 and Option 2) slide 15 Case Studies on International Taxation (including Royalty & Capital Gains)

16 Possible arguments of Tax Counsel of RRL Defenses against main purpose being tax benefit: GAAR to be applied in cases of aggressive abuse, as a weapon of last resort: GAAR is not a weapon to extract maximum possible tax Evaluate main purpose from arm-chair of a businessman GAAR does not foreclose choice principle - share transfer resulted in better net-of-tax return Main purpose of the arrangement was to transfer shares and is implemented in absolute transparent manner and at ALP Tax reduction if at all is only incidental slide 16 Case Studies on International Taxation (including Royalty & Capital Gains)

17 Possible arguments of Tax Counsel of RRL Defenses against main purpose being tax benefit (continued): Share transfer consequences materially different compared to transfer of business: Past litigations, tax demands, historical cost, etc. inherited by new shareholders; Corporate entity and associated goodwill is preserved for new shareholders; Concerns on transfer of critical license, employees, assets, contracts, etc. Mechanics of integration with buyer s business may vary Stamp duty / VAT implications may differ To invoke GAAR, A.O. should indicate a reasonable alternative ( counter factual ) - Sale of business by RRL is not an effective counter factual as business licenses are not transferred to buyer slide 17 Case Studies on International Taxation (including Royalty & Capital Gains)

18 Possible arguments of Tax Counsel of RRL Defenses against tainted element tests: Substance of share transfer is no different from its legal form Sale of shares is one of the ordinarily accepted modes of bona fide business transfer Other defenses: Chapter X-A is subject to charging provisions - GAAR cannot result in tax on notional income (In reality, RRL has not earned any income at all) No DDT on RRL in absence of actual distribution or declaration of dividend in terms of s.115-o slide 18 Case Studies on International Taxation (including Royalty & Capital Gains)

19 In the assessment of Mr. R H1 (let out R H1 (let out) R H2 (SO) 2 Sale of shares H3 (self occupied) 1 Gift R s Son 3 Investment in residential house to claim s.54f H2 gifted to son a week prior to share sale sale of shares was virtually decided R occupied H2 for six months post the gift while H3 was acquired and getting furnished Son got married a year after sale of shares (marriage fixed as of date of gift) H2 continued to be occupied by son s family and not sufficient to house the joint family Son is in independent occupation of H2 post marriage; meets cost of H2 A.O. alleges that: Gift was with main purpose of s.54f exemption Gift lacks commercial substance, Mr. R stayed in H2 post gift slide 19 Case Studies on International Taxation (including Royalty & Capital Gains)

20 In the assessment of Mr. R R Mr. R s defenses: H1 (let out H2 (SO) 1 Gift R s Son H2 was gifted so that son has his own house Mr. R has divested himself of ownership rights in H2 2 Sale of shares H3 was acquired to accommodate the family s needs R H1 (let out) H3 (self occupied) 3 Investment in residential house to claim s.54f Tax exemption, an incidental advantage Availing s.54f exemption in terms of express provisions in the Act is not reduction or avoidance of tax per s.102(10) slide 20 Case Studies on International Taxation (including Royalty & Capital Gains)

21 Case study 4: S.79 and carry forward

22 Section 79 ICo1 Listed Co. ICo 5 Pvt Co. Facts ICo3 is a manufacturing company 100% It has substantial accumulated losses and ICo 2 unabsorbed depreciation shown as under: Pvt. Co. 100% ICo 3 Unlisted Public Co. 76% 24% Ico 4 Pvt Co. Financial Years Business Loss Unabsorbed depreciation FY Cr. 50 Lacs FY Cr. 60 Lacs FY Cr. 70 Lacs FY Cr. 20 Lacs Total 30 Cr. 2 Cr. Mfg. business ICo2 to sell certain percentage of its stake in ICo3 in FY slide 22 Case Studies on International Taxation (including Royalty & Capital Gains)

23 Section 79 (contd ) General principles Section 79: shareholders carrying voting power of atleast 51% in the year of incurrence of loss must remain same till losses of CHC are set off Section 79 overrides the provisions contained in Chapter VI (ie S. 66 to S.80) but does not override Section 32 which provides for depreciation/ unabsorbed depreciation Section 79 does not apply to WHC as defined under Section 2(18) Is ICo3 WHC today? Particulars Is ICo3 Public Company? Is ICo3 Listed company? Held by 100% subsidiary of List Co throughout the year Yes/ No Yes No Yes > 40% held by 100% subsidiary of List CO Had ICo2 been public Co; List Co holding > 50%/ 40% of ICo2 would suffice Change in shareholding from one qualifying to another qualifying holder is permissible If post change in such shareholding, WHC turns CHC in that FY, section 79 likely to apply slide 23 Case Studies on International Taxation (including Royalty & Capital Gains)

24 Section 79 Proposed scenarios (contd ) ICo1 Listed Co. ICo 5 Pvt Co. Scenarios Current % (ICo2) Sale % Proposed Buyer Resid ual % (ICo2) Reasoning Section % ICo 2 Pvt. Co. 100% 76% 24% Scenario 1 100% 51% Investor (CHC) Scenario 2 100% 76% Investor (CHC) 49% Atleast 40% of ICo3 (being mfg. company) is with ICo2. Thus, ICo3 continues to be WHC under 2(18). 24% ICo3 cease to be 2(18) company and change in shareholding >49% Not attracted Applicable ICo 3 Unlisted Public Co. Mfg. business ICo 4 Pvt Co. Scenario 3 100% 76% WOS of any listed company 24% WOS of listed Co. is 2(18) company and hence ICo3 continues to be WHC under 2(18) Scenario 4 100% 76% ICo 4 24% ICo3 cease to be CHC and change in shareholding >49% Scenario 5 100% 76% Investor buying at close of FY (ie 31 March) 24% ICo 3 continues to be WHC under 2(18), since held throughout the year by WHC and no 79 limitation Not attracted Applicable Not attracted slide 24 Case Studies on International Taxation (including Royalty & Capital Gains)

25 Case study 5: Can you earn income from your own contribution? [Section 56(2)(vii)]

26 Can you earn income from your own contribution? [Section 56(2)(vii)] Mr. Flipdealzone Pvt Ltd was formed by Mr. Master with initial capital of Rs. 1,000 contributed at Par Date Chronology: Equity issue to Mr. M Date No. of shares Par value Premium Amount contributed Book value post allotment Dec 14 10, L 10 Jan 15 1, L Dec 15 1,00,00 10 Nil 10 L (Aprx) 20 Issue of CCPs (Convertible Post 2 as of date of conversion) Date No. of shares Par value Amount contributed 29 Dec 15 10, L slide 26 Case Studies on International Taxation (including Royalty & Capital Gains)

27 Issues Likely objections of tax officers Basis Mumbai ITAT decision and having regard to the object and purpose of the section, fresh issue of shares is covered by s. 56(2)(vii) Infusion in December 2015 at Rs. 10 triggered s. 56(2)(vii) taxation by considering 11UA value of Rs. 910 basis balance sheet prior to the date of issue: CCPS infusion on 29 December will need to be treated at par with equity and having regard to conversion rate as per Rule 11UA valuation. Tax and treaty implications and TDS obligation in respect of CCPS issue to the NR HNI slide 27 Case Studies on International Taxation (including Royalty & Capital Gains)

28 Can you earn income from your own contribution? [Section 56(2)(vii)] Scope of section 56(2)(vii) Taxation of shares for a consideration < normative Rule 11UA value. Introduced to plug loop holes to prevent money laundering purported gifts from unrelated persons now to be taxed as income (FM speech on budget). To curb bogus capital building and money laundering and to act as an antiavoidance measure (Circular no. 5 of 2005 and 5 of 2010) SC in K. P. Verghese struck down literal interpretation of section 52(2) to avoid manifestly absurd consequences Deeming fictions need strict construction; benefit and benefit of doubt to go to the taxpayer Taxation is of real enrichment and real benefit after considering all economic sacrifices of the shareholder slide 28 Case Studies on International Taxation (including Royalty & Capital Gains)

29 Can you earn income from your own contribution? [Section 56(2)(vii)] Is fresh issue covered by section 56(2)(vii): Is fresh issue / allotment of shares equal to receipt of shares? Arguably, no as: Receipt by individual of a property from any person In the context to be restricted to transfer of existing shares Shares are inchoate right and do not come into existence till the stage of issue or allotment Likely objections of tax officer It is inconsistent, to restrict the scope of the term receipt to cases only of transfer, considering the unambiguous and clear intent, conveyed by the literal reading of S. 56(2)(vii). Receipt is of wide import and includes acquisition by modes other than by way of transfer. slide 29 Case Studies on International Taxation (including Royalty & Capital Gains)

30 Can you earn income from your own contribution? [Section 56(2)(vii)] Issue on 30 December 2015 at par when pre-issue 11UA value is Rs. 910: Rights to the existing shareholder and hence diminution in existing value to consider No enrichment no property received cannot receive from self Even as per Sudhir Menon HUF (148 ITD 260), rights to the existing shareholders on proportionate basis does not trigger s. 56(2)(vii). Valuation for freshly issued shares need to be based on balance sheet post issue: Rule 11UA values shares as of the date of receipt of shares. Non existing shares cannot be valued Valuation date covers the whole of the day slide 30 Case Studies on International Taxation (including Royalty & Capital Gains)

31 Can you earn income from your own contribution? [Section 56(2)(vii)] Impact analysis for issue of preference shares to HNI (unrelated party): Preference shares to be valued as per Rule 11UA on commercial principles by Merchant Banker Different from equity in terms of voting, preferential dividend and repayment of capital, etc. No exemption for NR unless treaty relieves charge US treaty may not relieve charge: Benefit is accruing or arising in India Meaning of income interpreted on an ambulatory basis In any case, no obligation of TDS as company neither makes payment nor credits the shareholder in respect of income taxed u/s. 56(2)(vii) slide 31 Case Studies on International Taxation (including Royalty & Capital Gains)

32 Case study 6 : Interest free lending from holding company Ind-AS / GAAR implications

33 Facts Issue ZOFCD HCo WOS HCo (Direct) 100% Funds infusion for commercial purposes In 2015, HCo (a listed company) infused funds in its direct and indirect WOS by way of ZOFCD (0% optionally fully convertible debentures). ZOFCD s terms: 0% coupon rate Tenure of 20 years Convertible into equity at option of issuer 100% Fixed conversion rate WOS deployed funds into operating assets WOS are currently loss-making WOS HCo (Indirect) Under Ind-AS, WOS records ZOFCD as equity equivalent (as WOS does not have a contractual obligation to repay ZOFCD holder). slide 33 Case Studies on International Taxation (including Royalty & Capital Gains)

34 Issues Issues around Ind-AS/GAAR: HCo Can A.O. impute notional interest 100% income on ZOFCD in hands of Hco under GAAR? Issue ZOFCD WOS HCo (Direct) Funds infusion for commercial purposes Can HCo urge that ZOFCD is to be regarded as equity investment for tax purposes to resist notional taxation? 100% WOS HCo (Indirect) slide 34 Case Studies on International Taxation (including Royalty & Capital Gains)

35 Can A.O. impute notional interest income on ZOFCD in hands of HCo? Tax Authority s contentions: Consistent with legal form, the instrument is a debt instrument A part of the arrangement has main purpose of tax avoidance [s.96(2) r.w.s.102(1)] There is reduction or avoidance of tax and/or reduction in total income [s.102(10)] Such rights / obligations are not ordinarily created in an arm s length dealing [s.96(1)(a)] Interest charge may or may not result in tax neutrality on an overall basis But, tax benefit to be calculated qua impact on HCo s current income alone slide 35 Case Studies on International Taxation (including Royalty & Capital Gains)

36 Can A.O. impute notional interest income on ZOFCD in hands of HCo? Likely contentions of HCo: GAAR codifies substance-over-form rule and targets egregious structures; tax consequences cannot overstep commercial realities of arrangement Interest-free lending by Parent to WOS is an ordinary feature; not irrational to expect such arrangement in case particularly of loss incurring WOS No tax in absence of real income, Chapter X-A cannot override ss.4/5 Tax benefit is when there is reduction of tax payable on accrued income: GAAR is not a revenue spinner; it does not widen scope of charging provisions S.98 only permits re-allocation of accrued of income and does not authorize increase of income base GAAR does not foreclose choice principle slide 36 Case Studies on International Taxation (including Royalty & Capital Gains)

37 Can HCo urge that ZOFCD is equity investment for tax purposes? Ind-AS impact Likely contentions of HCo: Commercial accounting principles govern tax unless specific provisions exist to the contrary Skewed debt equity ratio suggests that ZOFCD is quasi equity and hence equity capital Substance-over-form principles common to both GAAR and Ind-AS, treatment under Ind-AS is relevant for tax purposes also Such contentions may be counter productive in certain other facts slide 37 Case Studies on International Taxation (including Royalty & Capital Gains)

38 Is charging interest a soother? Without prejudice, if OFCD is interest bearing, can A.O. suggest that OFCD is equity and hence payment to OFCD holder is effectively dividend which is not deductible and also subject to DDT? Likely contentions of borrower (WOS): Judicial principle: Legal form and look at approach relevant for tax purposes, unless transaction is a sham or tax avoidant1 Ind-AS classification has no bearing on legal rights and obligations instrument continues as debt for corporate law purposes In any case, DDT levy is on distribution of dividend; notional GAAR implications is not the basis for DDT levy 1 Vodafone International Holdings B. V. v. UOI (2012)(341 ITR 1)(SC) slide 38 Case Studies on International Taxation (including Royalty & Capital Gains)

39 Thank You This Presentation is intended to provide certain general information existing as at the time of production. This Presentation does not purport to identify all the issues or developments. This presentation should neither be regarded as comprehensive nor sufficient for the purposes of decisionmaking. The presenter does not take any responsibility for accuracy of contents. The presenter does not undertake any legal liability for any of the contents in this presentation. The information provided is not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of the presenter, this document may not be quoted in whole or in part or otherwise.