Bombay Chartered Accountants Society. Taxation of securities. Presentation by Yogesh Thar July 11, 2018

Transcription

1 Bombay Chartered Accountants Society Taxation of securities Presentation by Yogesh Thar July 11, 2018

2 1. Business Income v. Capital Gains

3 Relevant Judicial Pronouncements and Legislations Tests laid down in: Instruction No dated August 31, 1989 Circular no. 4/2007 dated June 15, 2007 Circular no. 6/2016 dated February 29, 2016 CBDT Letter F. No. 225/12/2016 of May

4 Tests summarised Considering the judicial pronouncements, instructions and circulars above, the tests are summarised as under : Past Assessment Records Treatment in the books of account (i.e. whether shown as investment or as stock-in-trade) Method of valuation Nature and Quantum of purchase and sale Ratio between purchase and sales Period of Holding 3

5 Tests summarised (contd ) Considering the judicial pronouncements, instructions and circulars above, the tests are summarised as under: Frequency, continuity and regularity of transactions Motive or intention behind acquisition / sale of securities Source of Acquisition Whether from owned or borrowed funds It is possible to have two portfolios - one for investment and the other for stock-in-trade Any act subsequent to the purchase thereby making it more readily resalable Any act prior to purchase making showing a design or purpose 4

6 Case Laws Summary Chart demonstrating the facts in various case laws numerically and the judgement thereof Sr. no Criteria Period of holding Nailesh Dalal Pargro Investment Pvt Ltd S.K. Finance Dhiraj Kenia Bharat Kenia Kunverji Kenia Hriday Nailesh Dalal Naishadh v. Vachharajani over 6 months (avg) 1 to 9 months 106 days 107 days 116 days 124 days over 6 months 2 to 5 months No. of scripts purchased No. of scripts ,00,066 shares traded sold Value of purchases (Amt in lakh) Value of sales (Amt in lacs) No. of purchase days transactions 7 No. of sale days

7 Case Laws Summary (contd ) Case laws referred to in the Chart: Nailesh Dalal (ITA No. 3337/M/2009) M/s Pargro Investments Pvt. Ltd. v. ITO (ITA No. 829/M/2010,ITA No.637/M/2010) M/s S.K. Finance v. Dy. CIT (ITA No.6190/M/2008) Bharat Kunverji Kenia v. ACIT (130 TTJ 86) Kunverji Nanji Kenia v. ACIT (43 SOT 87) ITO v. Hriday Nailesh Dalal (ITA No. 3469/M/2009) ACIT v. Naishadh V. Vachharajani (ITA No.6429/M/2009) 6

8 Impact of Circular No. 6/2016 dt and F. No. 225/12/2016-ITA-II dt Types of securities Listed Unlisted Treatment by Assessee in ROI: Stock in Trade Holding Period - Less than 12 months Taxable as Business Income To decide based on established tests Capital Asset More than 12 months Capital Gains but consistency desired Irrespective of period of holding Capital Gains Bogus transactions to deal on merits. Above circular not applicable ; Transfer of unlisted shares requiring lifting of corporate veil ; The transfer of unlisted shares is made along with the control and management of underlying business 7

9 Transfer of Control and Management alongwith the shares Ramnarain Sons (P.) Ltd. v. CIT (41 ITR 534) (SC) If the shares were acquired for obtaining control over the managing agency of the Mills, the fact that the acquisition of the shares was integrated with the acquisition of the managing agency did not affect the character of the acquisition of the shares Shares acquired formed a capital asset The loss suffered by sale of some of those shares in the year of account is a capital loss 8

10 Bonus Stripping Dividend stripping is covered under specific s. 94(7). However, Bonus stripping not covered Intention at the time of acquisition A vital factor in determining the nature of investment Whether capital asset or stock-in-trade Acquisition of shares with a view to sell them post issue of bonus To claim STCL Bonus shares sold after 12 months amounts to LTCG (earlier exempt - Now subject to 10% tax) Overall Commercial gain Can the Department treat the transaction of acquisition as business on the ground that the intention at the time of purchase is to sell? Can GAAR provisions be invoked? 9

11 Finance Act, 2018 ICDS VIII ICDS VIII - Securities held as stock-in-trade to be valued at lower of cost or NRV - To determine category-wise (For other than Banks) Held - Contrary to Accounting Standards Pre-amended s. 145A - non-obstante clause Delhi HC - Held ICDS ultra vires S. 145A substituted by FA

12 S. 145A Amendment to s. 145A Non-obstante clause removed Section itself provides for valuing inventory of securities category-wise Unlisted / thinly traded securities to be valued only at actual cost (NRV not permitted) Banks to value inventory of securities as per RBI guidelines Affected entities: NBFCs Other traders in shares and securities All holdings of unlisted / thinly traded shares / securities 11

13 S. 145A (contd ) Units of mutual funds held as S-I-T Securities not listed on BSE Hence, covered under the mischief of this amendment 12

14 S. 145A (contd ) Illustration of impact: NRV has to be done category wise not individual asset wise. Individual Security Cost NRV Lower Company P Company Q Company R Company S Valuation (A.S.) 230 Valuation (under 145A)

15 2. Ind-AS Impact on taxation of transaction in securities

16 Investment in Units of Equity Mutual Fund AS 13: Value long term investments at cost - Long term diminution to be recorded at NRV Ind AS 109: Financial Assets measured at Amortised Cost: Hold FA to collect contractual cash flows Contractual cash flows = Principal + Return Financial Asset measured at FVTOCI Hold FA to collect contractual cash flows + Sale Contractual cash flows = Principal + Return Other Financial Assets Measured at FVTPL (Exception: Equity instruments Option to FVTOCI) EAC Opinion: Equity Mutual Fund Units are NOT Equity instruments. Hence, FVTPL is mandatory 15

17 Purpose of MAT Hon ble Finance Minister s speech explaining the rationale for introducing s. 80VVA in the year 1983, vide Finance Act, Hon ble Members must be aware of the phenomenon of companies which are flourishing, but are paying no tax at all, or only nominal tax. This is largely due to these companies availing of the tax incentives and concessions available under the provisions of the Incometax Act. It has been a matter of concern to us that our tax system several highly profitable companies are able to reduce their tax liability to zero even though they continue to pay high dividends. It seems reasonable that profitable and prosperous companies should contribute at least a small portion of their profits to the national exchequer at a time when other and less better off sections of society are bearing burden. I, therefore, propose to provide that fiscal incentives and concessions shall not absorb more than 70 per cent of the profits. This would secure that companies pay a minimum tax, on at least 30 per cent of their profits. 16

18 Purpose of MAT (contd ) Para 83 of the Explanatory Memorandum to the Finance Bill, 1983 With a view to securing that the various deductions in respect of tax concessions admissible under the Income-tax Act do not result in reducing the taxable income of companies to the extent that no tax or only negligible tax is paid by profit-making companies, it is proposed to make a provision in the Income-tax Act to the effect that where in the case of companies the aggregate amount of deductions admissible under certain specified provisions of the Incometax Act exceeds 70 per cent of the amount of total income computed before making such deductions, the amount to be deducted under those provisions will be restricted to 70 per cent of the total income as computed before making such deductions 17

19 Purpose of MAT (contd ) Rationale of s. 115J - Surana Steel Pvt Ltd. v. CIT (104 Taxman 188) Section 115J was introduced in the assessment year to take care of the phenomenon of prosperous zero tax companies which had continued in spite of the enactment of section 80VVA. There were companies which were paying no income-tax though they had profits and were declaring dividends. A minimum corporate tax was sought to be ensured on prosperous companies. Proviso to s. 123(1)(a) of the Companies Act, 2013 Provided that in computing profits any amount representing unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair value shall be excluded, or 18

20 Purpose of MAT (contd ) 1st Report of the MAT-Ind AS Committee (under the convenorship of M P Lohia) dated March 18, 2016 : 2. The provisions of section 115JB of the Act provide for levy of MAT on the basis of "book profit" i.e. the net profit disclosed in the profit and loss account prepared in accordance with the provisions of the Companies Act. For determining the book profit, section 115JB of the Act provides for certain adjustments mainly for items relating to income-tax, appropriation of profit, adjustment for brought forward loss/unabsorbed depreciation, revaluation of assets, distribution of dividend, etc. The adjustment for brought forward loss/unabsorbed depreciation is provided on the basis of the provisions contained in section 205 of the Companies Act, 1956 which provides computation machinery for determining the amount available for distribution of dividend. The adjustments indicate that the provisions of section 115JB of the Act seek to compute the realised profit before tax which is available for appropriation/distribution. Hence, there appears to be an implicit relation between the distributable profits which is available for payment of dividend under the Companies Act and the tax base for levying MAT under section 115JB of the Act. 19

21 One-time Settlement Agreement Co. A (facing financial difficulties) has a loan liability of Rs. 100 currently repayable Bank B agreed to convert the loan liability to 0.01% preference shares (face value of Rs. 100) which will be redeemed at par after 10 years On the date of conversion, the fair value of preference shares amounts to Rs. 40 Accordingly, Co. A to pass the following entry: Entry Loan Liability Dr. 100 To 0.01% Preference Shares 40 To Profit or Loss 60 No dividend can be declared on Rs. 60 ; If MAT levied on such amount, it will be against the objective of helping companies which are facing financial difficulty Can Para 19 of Ind AS 1 be invoked? 20

22 Accounting Policies and Changes Deviation from Ind AS is permitted in extremely rare circumstances Para 19 of Ind AS 1 Presentation of Financial Statements In the extremely rare circumstances in which management concludes that compliance with a requirement in an Ind AS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in paragraph 20 if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure. Objectives of Financial Statements Framework for the Preparation and Presentation of Financial Statements in accordance with Ind AS ( Framework ) To provide information about financial position, performance and cash flows To provide information that users may need to make economic decisions 21

23 Demergers Resulting Company (Not under common control): Required to record the assets and liabilities at fair values Contrary to s. 2(19AA) Can Scheme provide for recording at Book Values? Auditors certificate? Way out? Two stage accounting treatment 1 st stage: Record at Book Values 2 nd stage: Bring it in line with Ind AS 22

24 Debentures (Profit or Loss) Assume Co. A invested Rs. 150 in debentures (maturity = 5 years) of Co. B on April 1, 2015 Under AS, Co. A had recorded Rs. 150 as long-term investments (as per AS 13) Under Ind AS 32 / 109, Co. A elected to measure the investment at fair value through profit or loss The fair value of such investments is as under: Dates Fair Value April 1, March 31, Co. A to pass the following entry on April 1, 2017 (transition date) Retained Earnings 30 To Investment in Debentures (Rs. 150 Rs. 120) 30 23

25 Debentures (Profit or Loss) (contd ) On March 31, 2018, Co. A to pass the following entry: Profit or Loss 10 To Investment in Debentures (Rs. 120 Rs. 110) 10 Under AS, if the amount of Rs. 40 were to be debited to the Statement of Profit or Loss as provision for diminution in the value of asset, it would have to be added back as per clause (i) of Explanation 1 to s. 115JB Would the above position change u/s. 115JB for Ind AS compliant companies or would Rs. 40 be deducted from the book profits? Yes - The amount of Rs. 40 would be considered as transition amount and be deducted from book profits over 5 years Q. 1 r.w. Q. 6 of the CBDT Circular 24/2017 dated July 25,

26 2. Re-introduction of long term capital gains tax

27 Provisions prior to introduction of s. 112A PROVISIONS FOR & UPTO A.Y Exemption of LTCG arising on transfer of Equity shares; unit of equity oriented fund, unit of business trust on transfer happening on or after October 1, 2004, subject to payment of STT No exemption for MAT Exemption from LTCG arising on sale of equity shares which were acquired on or after October 1, 2004 only if: a) STT is paid on acquisition; or b) The transaction is notified as exempt PROVISIONS for A.Y

28 S. 112A Applicability (from AY ) Chargeable under the head capital gains Income Asset transferred Acquisition and An equity share in a company or Unit of an equity oriented fund or Unit of a business trust transfer, in case of LTCA being an equity share STT has been paid Tax Computation = Long term capital gains would be 10% in excess of Rs. 1 lakh 27

29 Analysis Indexation benefit and benefit of exchange fluctuation as provided in the 1 st and 2 nd proviso to s. 48 not to be applicable to LTCG as computed u/s. 112A (3 rd proviso to s. 48) Benefit of grandfathering u/s. 55(2)(ac) - Applicable for shares acquired on or before February 1, 2018 CBDT vide notification dated April 24, specifies the nature of acquisitions in respect of which STT need not have been paid to avail the provision of S. 112A. 28

30 Start Was STT paid on transfer N Y Was STT paid on acquisition N Was acquisition < N Acquisition in delisting period N Y Y Y Was share listed on date of acquisition N Y Not frequently traded? Preferential issue Y Y Permissible Mode A Y N N Acqn on RSE Y Permissi ble Mode B (1 to 8) Permiss ible Mode B(9) N N N Y Y Run Chart Test For P.O. P.O. Result Section 112A applies COA- s. 55(2)(ac) 112A N.A. Apply S.112

31 Mode A Sr. Exceptions to Clause (a) Acquisition through a preferential issue - Shares not frequently traded 1. Acquisition which has been approved by SC, HC, NCLT, SEBI or RBI 2. Acquisition by any non-resident in accordance with FDI guidelines issued by the Government of India 3. Acquisition by a Category I or Category II Alternate Investment Fund (AIF) or a Venture Capital Fund (VCF) or a Qualified Institutional Buyer (QIB) 4. Acquisition through a preferential issue to which provisions of Chapter VII of the ICDR Regulations, 2009 do not apply Conversion of loan or option attached to convertible debt instruments in terms of s. 81(3) and 81(4) of the Companies Act, 1956 or s. 62(3) and 62(4) of the Companies Act, 2013; Scheme approved by a HC (u/s. 391 to 394 of the Companies Act, 1956) or NCLT (u/s. 230 to 234 of the Companies Act, 2013) Rehabilitation scheme approved by Board of Industrial and Financial Reconstruction under the Sick Industrial Companies (Special Provisions) Act, 1985 or NCLT under the Insolvency and Bankruptcy Code, 2016; and Acquisition by secured lenders pursuant to conversion of their debt into equity shares under the strategic debt restructuring scheme in accordance with the guidelines specified by the RBI 30

32 Mode B Sr. Exceptions to Clause (b) Acquisition not through a RSE 1. Acquisition through an issue of share by a company other than preferential issue of non-frequently traded shares 2. Acquisition by scheduled banks, reconstruction or securitisation companies or public financial institutions during their ordinary course of business 3. Acquisition which has been approved by the SC, HC, NCLT, SEBI or RBI in this behalf 4. Acquisition under employees stock option scheme or employee stock purchase scheme framed under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, Acquisition by any non-resident in accordance with FDI guidelines of the Government of India 6. Acquisition of shares of company under SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, Acquisition from the Government 8. Acquisition by a Category I or II AIF or a VCF or a QIB 9. Acquisition by mode of transfer referred to in s. 47 (transactions not regarded as transfers ) or s. 50B (slump sale) of the Act if the acquisition by the previous owner was not an Improper Acquisition 31

33 Determination of Cost of Acquisition u/s. 55(2)(ac) A long-term capital asset, referred in s. 112A, acquired before the 1st day of February, 2018 shall be: Higher of : (i) Cost of Acquisition of the long term capital asset; or (ii) Lower of : (i) - Fair market value of the long term capital asset or (ii)- Full value of consideration received or accrued Determination of Fair market value Asset Transferred Determination 1) Listed on the RSE as on Highest price quoted on that date 2) Not Listed on the RSE as on , but listed on date of transfer COA * CII of FY ) Listed on date of transfer and which became the property of the assessee in consideration of share which is not listed on such exchange as on the 31st day of January, 2018 by way of transaction not regarded as transfer u/s. 47 CII of Year of acquisition or 2001 whichever is later 32

34 Illustrations (1/3) As per clause (b)(ix) of the Notification, if the previous owner has acquired the shares through qualifying acquisitions, the assessee is covered by the said notification Therefore, if the provisions of s. 112A were applicable to the previous owner, the provisions of s. 112A would apply to the donee COA - Cost to previous owner, FMV as on , Grandfathering allowable No indexation benefit Particulars Date of Transfer June 1, 2018 STT paid on acquisition Listed on date of transfer Date of acquisition April 2018 Mode of acquisition No Yes Gift 33

35 Illustrations (2/3) Date of Transfer STT paid on acquisition Listed on date of transfer Particulars July 2018 in Offer for Sale in IPO No No, but STT payable u/s 97(13) of FA 2004 Date of acquisition April 1996 Section 112A would apply. Therefore indexation not available. Computing COA- Since, the shares not listed on the date of transfer, grandfathering u/s 55(2)(ac) not available (Expln (a)(iii)(a) and (B) apply only to shares listed on date of transfer. However, substitution of FMV as on available because 55(2)(ac) is subject to 55(2)(b) 34

36 Illustrations (3/3) Co A has demerged its Real estate Undertaking to Co B, with Appointed Date being , In consideration of the demerger, Co B has issued its shares to shareholders of Co. A. A shareholder transfers shares of both the companies, COA to be as per s.49(2c) Particulars Demerged Company Resulting Company Date of Transfer 1 January January 2019 Listed or unlisted Unlisted Listed in December 2018 Listed on date of transfer No Yes Date of acquisition Prior to Record date November A would apply No Yes Indexation Yes, since covered by section 112 No Grandfathering available NA No, since 55(2)(ac) applies for acquisition of securities referred to in 112A, prior to FMV as on whether available Yes. Bifurcation of COA as per s. 49(2C) is done after substituting FMV as on Yes 35

37 4. Section 50CA& Section 56(2) & Valuation Rules?

38 Interplay between section 50CA and 56(2)(x) Finance Act, 2017 Section 50CA Provision to tax the difference between the FMV and the consideration received for transfer of unquoted shares as capital gains in the hands of transferor Section 56(2)(x) Provisions to tax the difference between the FMV and the consideration paid for transfer of unquoted shares (also covers sum of money, immovable property, other property) as income from other sources in the hands of transferee Incidence of double taxation Both in the hands of transferor as well as transferee subject to section 49(4) 37

39 Interplay between section 50CA and 56(2)(x) (contd ) Example Transferee/Buyer : A Ltd. Transferor/Seller : B Ltd. A Ltd. purchased 100 shares of a private company from B Ltd. for a price of INR 600 per share; total consideration = INR 60,000 B Ltd. had acquired such shares at INR 500 per share; gross amount paid = INR 50,000 Say, the FMV of said shares on transfer date is INR 700 What would be the implications of provisions of section 50CA and 56(2)(x) under the mentioned circumstances? 37

40 Interplay between section 50CA and 56(2)(x) (contd ) Prior to amendment Impact on Transferor B Ltd. Impact on Transferee A Ltd. Sale consideration 60,000 Less: Cost of acquisition (50,000) Capital gains 10,000 No impact Post amendment Impact of Sec. 50CA Transferor B Ltd. Impact of Sec. 56(2)(x) Transferee A Ltd. FMV 70,000 Less: Cost of acquisition (50,000) Capital gains 20,000 FMV of shares 70,000 Less: Actual consideration (60,000) IFOS 10,000 39

41 Interplay between section 50CA and 56(2)(x) (contd ) Impact u/s 49(4) :- When A Ltd sells the shares at (say) Rs.800 (which is also its FMV) ; FMV of shares (when sold) 80,000 Less: FMV(when purchased) (70,000) Capital gains 10,000 40

42 50CA presupposes consideration Applicability of the provisions in the absence of consideration In case no consideration is received or accruing, section is not applicable :- Transfer by a partner to the firm as capital consideration ; In case of a gift (no consideration at all) ; No capital gains, therefore section is not applicable Transfer should be in relation to transfer of a capital asset only 41

43 Rights and Bonus issue and s. 56(2)(x) Section 56(2)(x) Any person receives any property without consideration or for inadequate consideration ; Property includes shares and securities ; Receives presupposes the existence of the shares at the time when the person receives Right issue and bonus shares are fresh allotments by the Company Can such receipt of shares be regarded as receipt of property without consideration or for inadequate consideration? Sudhir K Menon (HUF) v. ACIT (162TTJ 425)(Mum) Issue of bonus shares merely capitalisation of profits of a company; no receipt of property Proportionate allotment in case of rights issue, no receipt of property DCIT v. Dr. Rajan Pal (180 TTJ 714) (BangT) 42

44 Convertible Instruments and s. 56(2)(x) Receipt of equity shares is in consideration of extinguishment of rights in bonds/preference shares :- Hence, not without consideration ; Also not inadequate consideration sacrifice = gain ; Ratio of CIT v. Bai Shrinibai K. Kooka (46 ITR 86) (SC) and CIT v. Groz-Beckert Saboo (116 ITR 125) (SC) Taxing event arises when convertible instrument is issued. Upon conversion: Mere working out of pre-exiting rights of the investor or mere discharging of pre-existing obligation by the issuer Ratio of CIT v Mohanbhai Pamabhai (165 ITR 393) and CIT v. R.M. Amin (106 ITR 368) (SC) 43

45 Other Issues What would be the position in case of buy-back of shares? M/s. Vora Financial Services P. Ltd v. ACIT (ITA No. 532/Mum/2018) What happens in case of rights renunciation? Receipt of shares on amalgamation of foreign company by virtue of holding shares in amalgamated company Whether s. 56(2) applicable? Whether capital gains payable? 44

46 Rules Whether fair Empirical studies show that market value of equity shares of an investment company does not capture the full market value of its investments in other companies. The value leakages are on account of distance of time and control of ownership, which, thereafter results in an inevitable discount especially because of the economic concept of liquidity preference which requires converting a future inflow to its present value by using a rate of discount. Also, erosion on account of tax leakages normally get factored in such valuation. The rule is unrealistic and would result in notional taxation in cases where the transaction has happened at fair value considering the above aspects. Valuation of equity shares of a company which carries on business as a going concern cannot be made based on present market value of its immovable property. Market value of an immovable property may be considered only in case the valuation is for the purpose of liquidation, or when the property is in surplus and is not actively used in business. For immovable property the value adopted or assessed will never exist in case of sale/transfer of shares of a company. It will always be the value assessable. Indeed, value assessable as per ready reckoner/circle rate does not always reflect the fair market value. There have to be enough safeguards like in s. 50C if Stamp Duty value is to be considered even for share valuation. 45

47 Issues on Rules Valuation in cases of cross holdings is not addressed in the rules ; As per the rules, equity shares of a foreign company would be unquoted equity share even if it is listed on a foreign stock exchange. The rules come into force from i.e. AY Rule Notified on 12 July For Transaction between 1 April 2017 and 12 July will Rules apply; The rules shall apply irrespective of the valuation methodology agreed upon in Shareholder s Agreement/ J.V. Agreement; 46

48 Issues on Rules (contd ) The rules may apply irrespective of lock-in-period under such Shareholder s Agreement/ J.V. Agreement where internal transfer to Affiliates is permitted ; Leasehold rights in land whether to be considered for computing the value of shares for the purpose of section 56(2)(x) / 50CA r.w. Rule 11UA Acquisition of shares in tranches what would be the date of valuation As per Rule 11U of the Rules valuation date" means the date on which the property or consideration, as the case may be, is received by the assessee Question : In case of receipt of staggered consideration on different dates- what would be the date of valuation 47

49 Applicability to transfer of Indian company shares between foreign companies either by way of gift or sale FC 1 Gifts shares of IC FC 2 Section 56(2)(x) Where any person receives in any previous year, from any person Receipt of shares by FC 2/ FC 1 IC FC 1 WOS Gifts shares of IC Section 5 Since change of name in IC s Share Register - the receipt is in India Falls within the scope of total income FC 2 IC Therefore receipt taxable in India u/s 56(2)(x) Even in Case of WOS, FC1 is not an Indian Company hence 56(2)(x) applicable 48

50 Applicability to transfer of Indian company shares between foreign companies either by way of gift or sale FC 1 Gifts shares of FC 2 FC (3) Section 56(2)(x) Where any person receives in any previous year, from any person Receipt of shares by FC (3) FC 2 Section 5 Since, the receipt is not in India, it is outside the scope of total income IC Section 9(1) Income accruing or arising directly or indirectly through the transfer of a capital asset situated in India Taxability u/s 56(2)(x) is triggered on receipt and not on transfer 49

51 Applicability to S.8 Companies Co A Issue of 1000 shares at Rs. 10 per share X Ltd Co. A is registered under section 8 of the Companies Act, 2013 The Balance Sheet of Co. A as on the valuation date is as under: Liabilities Share capital (10000 shares of Rs. 10 each) 1,00,000 Movable Fixed Assets Assets 20,00,000 Surplus 24,00,000 Current Assets 4,00,000 Cash/ Bank Balance 1,00,000 25,00,000 25,00,000 Questions : What would be the addition under section 56(2)(x) in the hands of X Ltd.? Would the position differ if Co. A is registered under section 12A/AA of the Act? Would the position differ if X Ltd. was registered under section 8 of the Companies Act, 2013 and not Co. A? 50

52 Applicability of Rule- Pre or Post Issue Balance Sheet of P Ltd. Pre issue Liabilities Share capital (5000 shares of Rs. 10 each) 50,000 Plant & Machinery Assets 30,00,000 Loans 25,00,000 CAs 20,00,000 Surplus 29,50,000 Bank Balance 5,00,000 55,00,000 55,00,000 Net Worth of the company: A L = Rs. 30,00,000 Questions : Would Rule 11UA apply even in case of issue of shares? If yes, what would be the Rule 11UA value of the shares issued to Mr. A? (Pre-issue: =590 for 5000 shares = 29,50,000 As against this, what would be the holding of Mr. A in P Ltd. post acquisition of the shares? Value as per Rule 11UA: A L No. of shares = Rs. 600/share Can addition under section 56(2)(x) exceed the real benefit? Mr. A has been allotted 5000 shares of P Ltd. at face value on preferential basis 51

53 Applicability of Rule- Pre or Post Issue (contd ) Share capital (10,000 shares of Rs. 10 each) Liabilities Assets 100,000 Plant & Machinery 30,00,000 Loans 25,00,000 CAs 20,00,000 Surplus 29,50,000 Bank Balance 5,50,000 55,50,000 55,50,000 Shareholding of Mr. A in P Ltd shares % shareholding of Mr. A in P Ltd. (5000/10000*100) 50% Net worth of P Ltd. post issue of shares Value of shareholding of Mr. A based on post issue balance sheet A-L : 55,50,000 25,00,000 Rs. 30,50,000 50% of 30,50,000 Rs. 15,25,000 Actual Benefit to Mr. A 15,25,000 50,000 Rs. 14,75,000 Addition u/s. 56(2)(x) based on preissue balance sheet 30,00,000 50,000 Rs. 29,50,000 52

54 Multi layered shareholdings A Ltd B Ltd Would Mr. Z be required to compute FMV of C Ltd. while computing Rule 11UA value of A Ltd.? If yes, as on which date? Similarly, would he require to compute the fair market value of B s interest in P-LLP? C Ltd P-LLP Would the position change if P-LLP held immovable properties? Mr. Z is to purchase shares of A Ltd. In case, A Ltd. holds leasehold rights in a plot of land, would its fair market value be considered under Rule 11UA? 53

55 5. TAXABILITY OF ESOPS

56 Taxability of ESOPs Grant of Options No income tax implication in the hands of the employee Vesting of Options No income tax implication in the hands of the employee Exercise of Options Difference between fair market value and the exercise price - Taxed as perquisites Determine FMV as per the Income-tax Rules, 1962 Tax deduction at source u/s. 192 of the Income-tax Act,

57 Taxability of ESOPs (contd ) Sale of shares Capital gains tax liability - Difference between consideration received and cost of acquisition Cost of acquisition = FMV taxed as perquisite Determine period of holding from date of allotment / transfer Recent development in taxability of Stock Appreciation Rights (SARS) ACIT v. Bharat V. Patel (Civil Appeal No of 2018) (SC) Amount received on redemption of SARs prior to amendment in s. 17(2) is not taxable as perquisite in the absence of an express provision of retrospective effect Further, the said amount is not taxable u/s. 28(iv) since s. 28 only deals with any business or profession related transactions 56

58 Issues under DTAA Timing mismatch in taxing the ESOP benefit Distinguishing employment income from Capital Gains Difficulty in linking ESOP benefit to employment Difficulty due to exercise of employment in multiple states Multiple residence taxation Compliance issue 57

59 Deductibility of ESOP expenses Accounting treatment and SEBI guidelines permit amortisation Allowability u/s. 37: Law getting settled in favour of allowability of the amount debited to P&L Allow CIT v. PVP Ventures Ltd. [TC (A) No of 2005 (Mad HC)] CIT v. Lemon Tree Hotels Ltd. (ITA No. 107/2015) (Del HC) CIT v. People Interactive India P. Ltd. (ITA Nos. 6990, 6986, 4979/M/2015) Quantum of deduction Biocon Ltd. v. DCIT (ITA Nos 368/369/370/371/1206/Bang/2010) 58

60 Deductibility of ESOP expenses (contd ) No cash payout by Indian company to foreign parent of discount amount incurred by foreign parent Whether deductible by Indian company? Indian company issues shares to employees of foreign subsidiary at discount Whether deductible by Indian company? Transfer Pricing implications? 60

61 Ind AS MAT implications Hold Co. grants 200 share options to each of 100 employees of Sub Co., conditional upon the completion of 2 years service with Sub Co The fair value of the share options on grant date is Rs. 30 each At grant date, Sub Co. estimates that 80% of the employees will complete 2-year service period At the end of the vesting period, 81 employees complete 2 years of service Hold Co. does not require Sub Co. to pay for the shares needed to settle the grant of share options Sub Co. to pass the following entries as per Ind AS 102: Year 1 Remuneration expense 2,40,000 To Other Equity (Deemed Capital Contribution) 2,40,000 (200 options x 100 employees x Rs. 30 x 0.8/2 years) 60 61

62 Ind AS MAT implications (contd ) Hold Co. to pass the following entries as per Ind AS 102: Year 1 Investment in Sub Co. 2,40,000 To ESOP O/s Account 2,40,000 (200 options x 100 employees x Rs. 30 x 0.8/2 years) Sub Co. Amount debited to profit or loss as remuneration expenses Allowable under MAT Amount credited to Other Equity Taxable under MAT if suggestion of Ind AS Committee Report is accepted - Therefore, net impact on book profits will be NIL Hold Co. No amount is debited / credited to profit or loss. Therefore, no question of MAT However, amount credited to ESOP O/s. Account will form part of Other Equity Will credit be taxable under MAT if suggestion of Ind AS Committee Report is accepted? 59

63 6. GAAR applicability to transactions in securities - in particular for FPIs?

64 Circular no.7 of 2017 dated 27/01/2017 Central Board of Direct Taxes ( CBDT ) has issued the said circular providing clarification on implementation of GAAR Question no. 4: Will GAAR apply where the jurisdiction of FPI is based on non-tax commercial consideration, and such foreign portfolio investor (FPI) has issued P-notes referencing Indian securities? Will GAAR apply to deny treaty benefits to a Special Purpose Vehicle (SPV) on the ground that it is located in a tax friendly jurisdiction, or on the ground that it does not have its own premises or employees? Answer: GAAR shall not be invoked merely on the ground that the entity is located in a tax efficient jurisdiction. If the jurisdiction of the FPI is finalised based on non-tax commercial considerations and the main purpose of the arrangement is not to obtain tax benefit, GAAR will not apply. 63

65 Draft guidelines for GAAR implementation under Direct Tax Code Bill, 2010 ( DTC ) A foreign investor has invested in India through a holding company situated in a low tax jurisdiction X The holding company is doing business in the country of incorporation, i.e. X, has a Board of Directors that meets in that country and carries out business with adequate manpower, capital and infrastructure of its own and therefore, has substantial commercial substance in the said country X Would GAAR be invocable or would the arrangement be permissible? In view of the factual substantive commercial substance of the arrangement, Revenue would not invoke the GAAR provisions. 64

66 Under the Act As per section 97 of the Act : An arrangement shall be deemed to lack commercial substance, if. a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction 65

67 Case Study 100% 49% A Ltd. B Ltd. C Ltd. Country A India Mechanics : It is proposed to sell the shares of C Ltd to another company D Ltd ; In case the shares of C Ltd are directly sold to D Ltd, B Ltd would be liable to tax in India. Plausible option : B Ltd. is liquidated and A Ltd being the shareholder of B Ltd would be liable to tax u/s 46(2) of the Act ; but A Ltd. can avail the treaty benefit (assuming grandfathering) and such liquidation proceeds would be taxable in country of residence Country A; Subsequently, A Ltd. sells shares of C Ltd. to D Ltd. Transfer of shares not chargeable to tax in Country A There would be negligible capital gains on such transfer in India, since COA of shares in C Ltd. would be the FMV on the date of liquidation of B Ltd. Can GAAR provisions be invoked 66

68 Example-10- Final Report on GAAR in the Act FACTS : Country- C1 India Y Ltd Z Ltd 51% 100% A Ltd 49% Country- FI- LTJ X Ltd Debt Y Ltd is a company incorporated in country C1 and is a non-resident in India. Z Ltd is a company resident in India. A Ltd. is a company incorporated in country F1 and it is a 100% subsidiary of Y Ltd. A Ltd and Z Ltd form a joint venture company X Ltd in India after the date of commencement of GAAR provisions. There is no other activity in A Ltd; Can GAAR provisions be invoked The India-F1 tax treaty provides for non-taxation of capital gains in the source country and country F1 charges no capital gains tax in its domestic law. A Ltd is also designated as permitted transferee of Y Ltd. Permitted transferee means that though shares are held by A Ltd, all rights of voting, management, right to sell etc., are vested in Y Ltd. As per the joint venture agreement, 49% of X Ltd s equity is allotted to A Ltd and 51% is allotted to Z Ltd. Thereafter, the shares of X Ltd held by A Ltd are sold to C Ltd., a company connected to Z Ltd. group. As per the tax treaty with country F1, capital gain arising to A Ltd are not taxable in India. 67

69 Analysis The arrangement of routing investment through country F1 results into a tax benefit. Since there is no business purpose in incorporating company A Ltd. in country F1 which is a LTJ, it can be said that the main purpose of the arrangement is to obtain tax benefit. The alternate course available in this case is direct investment in X Ltd. joint venture by Y Ltd. The tax benefit would be the difference in tax liabilities between the two alternate courses. The next question is, does the arrangement have any tainted element? It is evident that there is no commercial substance in incorporating A Ltd. as it does not have any effect on the business risk of Y Ltd. or cash flow of Y Ltd. As the twin condition of main purpose being tax benefit and existence of a tainted element are satisfied, GAAR may be invoked. Additionally, as all rights of shareholders of X Ltd are being exercised by Y Ltd instead of A Ltd. it again shows that A Ltd. lacks commercial substance. Hence, GAAR may be invoked. 68

70 7. Penny stocks

71 Taxability u/s.115bbe Total income of an assessee : includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D and reflected in the return of income furnished under section 139; or determined by the Assessing Officer includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D, if such income is not covered under clause (a) Tax Computation = on the income computed 60% No deduction in respect of any expenditure or allowance or set off of any loss allowed in computing the income u/s 115BBE S.271AAC provides for a penalty of 10% of the tax payable under section 115BBE, in case an addition has been made by the AO. No penalty would be leviable if assessee suomotu makes an addition in the return of income; Thus effective tax Computation = 60%+ effective tax rate =66% 70

72 Safeguards against transactions being treated as fictitious The shares are traded on the Stock Exchange The payments and receipts are routed through the bank There is no evidence to indicate it is a closely held company The trading on the Stock Exchange was not manipulated Lack of adverse material produced by the Department 71

73 Documents required to prove genuineness Contract notes for sale and purchase Bank statements of broker Demat account showing transfer in and out Abstract of transactions furnished by stock exchange Audited Balance sheet of previous years 72

74 Judicial Analysis In favour of the assessee: Pr CIT vs. Prem Pal Gandhi (P&H High Court)(ITA ) Shyam R Pawar v CIT (229 Taxman 256 (Bom HC) CIT v Jamna Dev Agarwal (328 ITR 656) (Bom HC) CIT v Vivek Mehta (204 Taxmann 177) (P&H HC) CIT v Mahesh Chandra G. Vakil (220 Taxmann 166) (Guj HC) Smt. Anjli Pandit v ACIT (188 TTJ 645) (Mumbai - Trib.) ITO v Arvind Kumar Jain HUF (ITA No. 4862/Mum/2014) In favour of the revenue: Sanjay Bimalchand Jain v PCIT (89 taxmann.com 196) (Bom HC) ITO v Shamim M Bharwani (170 TTJ 238)(MumT) 73

75 8. Transfer Pricing

76 Transfer Pricing Inbound Investments Whether subscription to shares of Indian Subsidiary by Foreign Co. considered as international transaction Vodafone India Services (P.) Ltd v. UOI (368 ITR 1) (BOM) TP provisions only apply if there is chargeable income resulting from the transaction Capital investments, which do not create chargeable income, cannot therefore be brought within the scope of transfer pricing provisions 75

77 Transfer Pricing (contd ) Outbound Investments Whether subscription to shares of Foreign Subsidiary by Indian Holding Company considered as international transaction M/s PMP Auto Components v DCIT (ITA 7724/Mum/2014) Investments in share capital outside India were in the nature of capital investments, and such transactions are not in the nature of "international transactions" within the meaning of s. 92B Whether Rule 11UA value is a proper benchmark for transfer pricing? FEMA requires internationally accepted valuation methodology ; Whether transfer pricing provisions would apply for buy-back taxable u/s 115-QA 76

78 Thank You