Finance Bill (FB) for 2016-17 makes an interesting and novel provision with respect to determining rate of tax applicable to a company. So far we have seen classification based on gender (Male, Female), nature of entity (PP, Company), nature of shareholding (Listed co. and Closely held), Domestic and Foreign company etc. For the first time, classification for determining rate of tax applicable to a company has been proposed on the basis of Turnover (TO) / Gross Receipt (GR). Secondly, TO/GR are required to be checked with that of the Financial Year (FY 2015-16).

In Para No. 156 of the Budget speech, justifying the provision in this respect, the Finance Minister (FM) has observed as under:

156. In order to make MSME companies more viable and also to encourage firms to migrate to company format, I propose to reduce the income tax for smaller companies with annual turnover upto ` 50 crore to 25%.

Salient features of the proposal in FB read with the objective as spelt out are as under:

1. Objective is to provide relief to companies only.
2. Companies should belong to MSME sector.
3. Incentive is in the form of lower rate of tax
4. Criteria for applicability is based on TO/GR of the FY 2015-16.

While the objective is laudable, its provision, in the proposed format, raises many issues. Before analysing its implications and the directions in which it may misfire, let us understand the provision in this respect.

• It is applicable in the case of a “domestic company”e. Proprietorship and PP/LLP Firm, foreign company etc. are not covered.

• Although the FB does not say so specifically, as per the FM, the objective is to help MSME sector. Determining criteria for the MSMSE sector has been linked with TO/GR.

• TO/GR of the relevant Assessment Year (AY) is not required to be considered. It has been fixed with reference to Previous Year (PY) 2015-16 (AY 2016-17). Provisions in this respect will be applicable at the time of determining rate of tax for PY 2017-18 (AY 2018-19). It should be noted that TO / GR of PY 2017-18 need not be considered at all.

• In view of above, following scenario will emerge:

a. Companies having TO/GR for FY 2015-16 not exceeding 50.00 cr.

In the context of FY 2017-18, let us visualise various scenarios.

1. Companies having TO/GR for FY 2017-18 not more than Rs. 50 cr.

In such cases, since TO/GR for FY 2015-16 was not more than Rs. 50 cr., rate of tax applicable will be 25.00%

2. Companies having TO/GR for FY 2017-18 more than Rs. 50 cr.

In such cases also, since TO/GR for FY 2015-16 was not more than Rs. 50 cr., rate of tax applicable will be 25.00%

b. Companies having TO/GR for FY 2015-16 exceeding 50.00 cr.

1. Companies having TO/GR for FY 2017-18 less than 50 cr.

In such cases, since TO/GR for FY 2015-16 was more than Rs. 50 cr., rate of tax applicable will be 30.00%. This may sound strange. However, it is a fact. Such Assessees are being punished on two counts viz. lower profit due to lower TO/GR and higher rate of tax. The problem gets aggregated if the taxable income is more than Rs. 1.00 cr. but more about it later. This is for the reason that Surcharge (SC) and Cesses are computed with reference to tax liability which in this case will be relatively substantially higher due to higher rate of tax.

2. Companies having TO/GR for FY 2017-18 more than Rs. 50 cr.

In such cases, since TO/GR for FY 2015-16 was more than Rs. 50 cr., rate of tax applicable will be 30.00%. This stigma of having TO/GR of more than Rs. 50 cr. in FY 2015-16 will continue till the company survive or some amendments are made in this respect.

• Although it is not known, whether the same type of provision will continue in FB for FY 2018-19 and, thereafter.

• Since the FY 2015-16 has been considered as the base, the Government is fully aware about the number of cases in which benefit of lower tax will be given and amount of revenue loss on account of the same. However, as explained later, revenue loss will be substantially more as there will be exodus by the companies not entitled to lower rate to the one entitled for.

Let us analyse the issues involved, implications and anomalies.

• How to determine TO/GR? Should it be with Excise Duty(ED), Service Tax (ST) and VAT or without it?

• Since in majority of the cases, Return of Income (RoI) for AY 2016-17 have already been filed reporting TO/GR, both the Assessee and the Government are aware about the amount reported as TO/GR. Should the said amount be considered as final without making any adjustment therein?

• If TO/GR reported in the RoI for AY 2016-17 are exclusive of ED,ST,VAT etc. whether the AO can make any adjustments therein and deny benefit of lower rate of tax?

• If during the course of assessment proceedings, the AO finds concealed TO/GR, can the amount so detected be added to TO/GR for determining eligibility for lower rate of tax?

• Whether “Other Income” consisting of Duty Drawback, Export Incentive, Foreign Exchange Fluctuations Gain etc. reported in the RoI be considered for computing TO/GR?

• Whether rent received considered by the Assessee as part of business income should be considered for computing TO/GR?

• What will happen if the AO has in the past not considered rent income as business income but treated as “Income from Property”? Whether such amount be deducted from TO/GR?

• There is no clarity about the companies incorporated on or after 1^st April, 2016. In such cases, the AO would not like such companies to be entitled for lower rate of tax. However, one can argue that since such companies were not in existence on 31^st March, 2016, they should be entitled for the benefit of lower rate of tax as their TO/GR for FY 2015-16 was nil.

• The Micro, Small and Medium Enterprises Development Act (MSME) defines MSME unit with reference to investment in Plant and Machineries, Equipment (excluding land, building). However, the FB provides the relief with reference to TO/GR. There is disconnect between the two leading to absurdities.

Let us look at certain anomalies:

• Rate of tax for Partnership (PP) and Limited Liability Partnership (LLP) has not been changed i.e. it is @30.00%. Is it not discriminatory? What about MSME entities being PP/LLP?

• In the case of an individual, maximum rate of tax is @30.00%. Hence, in the case of business income from a proprietary firm, rate of tax applicable will be @30.00%.

• In the case of an individual having proprietary business with TO/GR of less than Rs. 50 cr. and having taxable income of more than Rs. 50 lacs will have additional problem. This is for the reason that Surcharge (SC) @ 10.00% has been imposed on income exceeding Rs. 50 lacs.

• The FB contains provision for Marginal Relief (MR), with reference to total income exceeding Rs. 1.00 cr. It should be noted that basis for applying rate of tax is TO/GR but marginal relief is computed with reference to taxable income.

• As far as SC and Cess are concerned, in the case of the Companies having TO/GR of more than Rs. 50 cr. in FY 2015-16, relatively speaking, burden in this respect will be high as the quantum of tax will be more.

• Visualise the cases of the MSME companies having TO/GR for FY 2015-16 of say Rs. 51.00 / Rs. 52.00 cr. What impact it can have on its tax liability for PY 2017-18 and onwards? What is the cost of additional TO/GR of Rs. 1.00 / 2.00 cr.? See the Table below.

As can be seen from the above Table, in Case No. 2, TO/GR is Rs. 51.00 cr. both in FY 2015-16 and 2017-18. Since TO/GR in FY 2015-16 is more than Rs. 50 cr., benefit of lower rate of tax will not be available for FY 2017-18. Here, additional profit on incremental TO/GR is Rs. 0.10 cr. However, incremental tax liability due to non-entitlement of lower rate of tax is Rs. 0.31 cr. meaning thereby rate of tax due to additional TO/GR of Rs. 1.00 cr. works out to 314% 

Let us consider another case wherein TO/GR for FY 2017-18 is Rs. 49.00 cr. i.e. lower by Rs. 2.00 Cr. as compared to FY 2015-16. As compared to FY 2015-16, loss of profit is Rs. 0.20 cr. and burden of tax due to higher rate of tax will be Rs. 0.30 cr. i.e. total loss of Rs. 0.40 cr. This is just for the reason that TO/GR for FY 2015-16 was Rs. 51.00 cr. So you are damned for having TO/GR of Rs. 51.00 cr. in FY 2015-16.

Unfortunately it has not been appreciated that TO/GR of the business is fluctuating every year and any arrangement wherein rate of tax is levied with reference point of a particular year, as explained above, can lead to absurd results.

Now, let us visualise future scenario.

• Since difference in rate of tax @ 5.00% can make substantial difference, there is bound to be shifting of the profit from higher rate tax company, PP, LLP and Proprietary Firm to another entity within the Group companies wherein such benefit is available.

• One should not be surprised after few days, advertisement in the news papers with the headline “For Sale - Pvt. Ltd. company having TO/GR for FY 2015-16 of less than Rs. 50 cr.”. Such dummy companies (khokhas) will be fetching premium in the market.

Whether the proposed provision can achieve the Objective?

While there is no doubt that companies entitled for lower rate of tax based on the TO/GR for FY 2015-16 will be benefitted, for obvious reasons, others not entitled for the benefit, will make strenuous efforts to join the bandwagon.

Migration of MSME PP/LLP Firm

As per the speech, the objective of the proposal is to encourage firms to migrate to corporate structure. It is true that lower rate of tax may induce many PP and Proprietary firm to think about migration provided the Government, as a policy, consistently follow the said practice. However, before rushing to conversion, following issues will also have to be considered.

a. Uncertainty on account of cost of conversion to company, in the form of capital gain tax liability, stamp duty etc., time involved therein and the administrative hassles.

b. Most important aspect is whether the Assessing Officer (AO) will consider such migrated cases for lower rate of tax. Here, two scenarios will have to be visualised.

a. PP/LLP being converted in FY 2017-18 and thereafter to Company having TO/GR in FY 2015-16 of more than Rs. 50 cr.

In such cases, if the benefit of lower rate is not allowed on the ground that TO/GR for FY 2015-16 was more than Rs. 50 cr. why should they migrate to private limited company? Whether, in such cases, GAAR will apply?

b. PP/LLP being converted in FY 2017-18 and thereafter, to Company having TO/GR in FY 2015-16 of less than Rs. 50 cr.

Can the AO disallow the benefit to such migrated company on the ground that since company was not in existence as on 31^st March, 2016?

Unfortunately, both the FM and FB are silent on this vital aspect. If there is going to be so much uncertainty, why should one migrate as expected by the FM?

Will it not be more easy and advantageous to shift the profit to some other company? One may not like to see such a scenario, but this is bound to happen.

c. The Prime Minister and the FM in their speeches at various forums have been emphasising rewarding honest tax payers and punishing dishonest one. With this kind of provision and uncertainty, will it not compel the honest one to become unethical and dishonest?

Suggestion

There is no doubt that the objective of the FM of having lower rate of tax is laudable one. However, what pains is the way in which it is being implemented. With the lower rate of tax, the Government will be loosing tax revenue and it is open ended i.e. no one knows how much tax revenue will be lost. If that is the case, why should it not be given to all the assessees in a phased manner? It is true that providing benefit of lower rate of tax to individuals, PP, LLP and others will result into loss of revenue. However, benefit in that respect can be restricted to fixing the rate @ 27.50% for all rather than the proposed one. Based on the experience, it can be further reduced to @25.00% for all in a phased manner. In that case, no one will feel being discriminated and no incentive for any one to evade the tax liability.