The Finance Bill, 2021 received its Presidential assent on March 28, 2021. It has undergone more than 100 amendments before being passed by the Parliament. In this context, Nitish Ranjan and  Richa Bakiwala (Manager – Taxation at Manohar Chowdhry & Associates), discuss some of the significant amendments to the original bill. 

Discussing the amendments brought in with respect to taxation of income arising from reconstitution of firm / AOI / BOI, the authors highlight that the intention behind substituting 45(4) and inserting new sub-section 4A and deeming provision u/s 9B is to overcome the decisions of the Courts wherein it was held that the distribution, division or allotment of assets of the partnership is nothing but a mutual adjustment of rights between the partners. The authors also touch upon the slew of measures taken to further encourage IFSCs such as incentivizing aircraft leasing u/s 10(4F), facilitating relocation of foreign funds to IFSC u/s 10(23FF), setting up of investment divisions in IFSC by Offshore banking units u/s 10(4D) and Sec. 115AD, taxing income from GDRs as provided by Sec. 115ACA, and regulating Category-I and Category-II AIFs. The authors also comment on topic of amendment in slump sale and opine “While one need to wait for the Government to prescribe the manner for arriving at the fair market value of the capital assets, the amendment would lead to a higher tax liability in cases where transfer of division or undertaking is made at lower than its fair market value.” The authors also touch upon amendments to definition of liable to tax, disallowance of self-generated goodwill, etc, deeming provision u/s 9B, etc.

Key Amendments to the Finance Act, 2021

1. Income arising on account of reconstitution of Firm/AOP/BOI [Section 9B, Section 45(4) and Section 48]

Currently, the income arising on account of distribution of assets by a firm/AOP/BOI is dealt by section 45(4) of the ITA. As for the history, up to the assessment year 1987-88, distribution of assets on dissolution of firm was not subjected to taxation. As a matter of fact, clause (ii) of section 47 of the ITA specifically provided for such transaction not to be considered as a transfer. It was with the deletion of clause (ii) of section 47 and with induction of the existing sub-section (4) of section 45 of the ITA, w.e.f. 1^st April 1988 that the distribution of assets was brought into the tax net. The reason was explained by Circular No. 495, dated 22-9-1987, vide para 24.3 wherein it was said that the route of dissolution was used in a scheme of tax avoidance, which enabled the participants of the scheme to transfer assets from one hand to another hand without payment of legitimate tax.

Since then, the provision of section 45(4) has been subject to decades of debates and litigations. Issues like, interpretation of the term ‘otherwise’, computation mechanism of profits or gains arising from transfer of capital asset in case of ‘revaluation of asset’ and its applicability in case of the time of admission of a new partner, have been subject matter for adjudication in plethora of judicial decisions.

With the intention to rest all the controversaries, the Bill proposed two amendments - substitution of existing provision of sub-section (4) of section 45 and insertion of a new sub-section (4A) of section 45. While the former dealt with gain arising upon transfer of right by a partner or member, at the time of dissolution or reconstitution of firm/AOP/BOI in consideration of receipt of capital asset, the latter intended to tax the gain arising upon transfer of property of the firm to the partner or member, at the time of dissolution or reconstitution of firm/AOP/BOI.

The Finance Act, 2021 has reworded the proposed provisions of section 45(4) and dropped the proposal of inserting the new sub-section (4A) of section 45 of the ITA but has rather introduced a similar but a deeming provision by way of a new section 9B to the ITA.

Deeming provision of section 9B

Section 9B provides that where a specified person receives, during the previous year, any capital asset or stock in trade or both from a specified entity in connection with the dissolution or reconstitution of such specified entity, then the specified entity shall be deemed to have transferred such capital asset or stock in trade or both, as the case may be, to the specified person in the year, in which such capital asset or stock in trade or both are received by the specified person.

The term ‘specified entity has been defined as a firm, or association of persons or body of individuals (not being company or co-operative society) and the term ‘specified person’ has been defined as a person, who is a partner or member of a firm or AOP or BOI in any previous year.

The section 9B provides that such deemed income would arise in the hands of such firm, AOP or BOI in the year in which such capital asset or stock in trade has been received by the partner or member and should be chargeable to tax under the head ‘Profits and gains from business or profession’ or ‘Capital Gains’, in accordance with the provisions of the ITA. The fair market value of such asset would be considered as the full value of consideration for the purpose of computing the income arising from the deemed transfer.

In order to remove any ambiguity as have arisen in past, the Finance Act, 2021 seeks to describe the term ‘reconstitution of the specified entity’ as –

a) where one or more partners or members of such specified entity cease to be partners or members;

b) where one or more new partners or members are admitted in such specified entity where existing partners or members before the change, continue to be partners or members after the change;

c) all the partners or members, as the case may be, of such specified entity continue with a change in their respective share or in change of the shares of some of them;

The objective behind bringing the above provision by way of a deeming section 9B and not under section 45(4A) has not been explained in the Finance Act, 2021. Though it appears that the intention could be to overcome the decisions of the Courts wherein it has been held that the distribution, division or allotment of assets of the partnership is nothing but a mutual adjustment of rights between the partners, and there is no question of any extinguishment of the firm's rights in the partnership assets amounting to a transfer of assets within the meaning of section 2(47) of the ITA.

The Finance Act, 2021 also empowers to the Board to issue guidelines for the purpose of removing difficulty arising while giving effect to the provision of this section and new sub-section (4) of section 45 of the ITA.

Substitution of section 45(4)

The amended provision of section 45(4), vide Finance Act, 2021 provides that where a specified person receives during the previous year any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from receipt of such money by the specified person shall be chargeable to income-tax as income of such specified entity under the head ‘Capital Gains’ and shall be deemed to income of the specified entity in which such money or capital asset is received by the specified person.

Meaning of the terms ‘specified entity’, ‘specified person’ and ‘reconstitution of the specified entity’ are same as assigned to them under section 9B of the ITA.

To bring further clarity, the provision also lays down the mechanism for computation of capital gains as under – 

It has been provided that the balance in the capital account is to be considered without taking into account the increase in the capital account due to revaluation of any asset or due to any self-generated assets, including goodwill.

The Finance Act, 2021 further clarifies that the provision of section 45(4) shall operate independently and in addition to the provision of section 9B of the ITA.

Measure to avoid double taxation

In order to avoid double taxation, a new clause (iii) has been inserted in section 48 of the ITA to provide that the amount chargeable to income-tax as income of the specified entity under section 45(4) of the Act, on the capital asset being transferred by the specified entity shall be reduced from the full value consideration while computing income under section 9B of the ITA with respect to such capital asset.

Interplay between section 9B and section 45(4)

Section 9B effectively deals with income arising from receipt of capital asset or stock in trade by partners or members upon transfer/extinguishment of their right in the firm or AOP or BOI, whereas section 45(4) deals with income arising in the hands of the firm or AOP or BOI upon transfer of its property to the partner or member.

The provision of section 9B of the Act comes into play in case of dissolution and reconstitution of the entity whereas the provision of section 45(4) applies only to reconstitution of the firm and thus, where the firm or AOP or BOI has been dissolved, one needs to look only at the provision of section 9B of the ITA.

2. Tax Incentives for International Financial Services Centre

In 2015, the Government announced establishment of Gujarat International Financial Tec-City (“GIFT City”), in Gujarat as India’s first International Financial Service Centre (“IFSC”). The IFSC in GIFT City seeks to bring to the Indian shores, those financial services transactions that are currently carried on outside India by overseas financial institutions and overseas branches / subsidiaries of Indian financial institutions. The Bill had proposed slew of measures in order to further spur to IFSC.

Incentivising aircraft leasing [Section 10(4F)]

The Bill proposed to insert section 10(4F) so as to exempt any income of a non-resident by way of royalty on account of lease of an aircraft paid by a unit located in an International Financial Services Centre (IFSC) if -

i) The unit of IFSC is eligible for deduction under section 80LA for the previous year and

ii) The unit of IFSC has commenced operations on or before 31-03-2024.

The Finance Act, 2021 has made the following changes to the said proposed section:

a) As the income from leasing may also be in the nature of interest, section 10(4F) is amended appropriately to provide exemption in respect of interest income, in addition to royalty, arising to a non-resident on account of leasing of aircraft to a unit of an IFSC.

b) The condition that the unit of IFSC should be eligible for deduction under section 80LA for the previous year in which aircraft is leased, has been removed. Thus, a non-resident shall be able to claim exemption under section 10(4F) even if the aircraft is leased to a unit of an IFSC, which is not eligible for deduction under section 80LA.

c) Further, an Explanation has been inserted to section 10(4F) to define the meaning of aircraft. It provides that the ‘aircraft’ means an aircraft or a helicopter, or an engine of an aircraft or a helicopter, or any part thereof.

The above amendment is applicable from the Assessment Year 2022-23.

Facilitating relocation of foreign funds to IFSC [Section 10(23FF)]

In order to encourage transfer or relocation of capital asset by the original fund located outside India, to a resultant fund in IFSC, a new section 10(23FF) was proposed to be inserted to provide exemption in respect of income in the nature of capital gains, arising or received by a non-resident, which is on account of transfer of share of a company resident in India by the resultant fund where such shares were transferred from the original fund to the resultant fund in relocation, if capital gains on such shares were not chargeable to tax had that relocation not taken place. The clause is introduced for providing exemption to the non-resident who are liable to tax due to the pass-through status of the AIFs. However, Category – III AIF do not enjoy the pass-through status and thus, the non-resident in such cases could not have been benefited from section 10(23FF).

Hence, the Finance Act, 2021 amended the proposed section 10(23FF) to provide exemption also to Category-III AIF if it fulfils the condition of a ‘specified fund’ under clause (c) of Explanation to section 10(4D).

It is further provided vide the Finance Act, 2021 that the exemption under section 10(23FF) shall apply even where the resultant fund received shares of a company resident in India from wholly owned special purpose vehicle of the original fund. Consequential amendment is made to the definition of ‘relocation’ and ‘resultant fund’.

The above amendment is applicable from the Assessment Year 2022-23.

Promotion of setting up of investment divisions in IFSC by offshore banking units[Sections 10(4D) and 115AD]

The Bill proposed to amend clause (4D) of section 10 of the Act so as toprovide that the exemption under this clause shall also be available in case ofinvestment division ofoffshore banking unit.

The ‘investment division of offshore banking unit’ has been proposed to be defined as a unit wherein one of the conditions was that it is granted a certificate of registration as a Category-III AIF and is regulated under the SEBI (AIF) Regulations, 2012.Consequential amendment has also been proposed to section 115AD for extending the benefit of concessional tax rate.

As the SEBI (FPI) Regulations, 2019, allows an FPI to be registered only under 2 categories only - Category-I FPIs and Category-II FPIs. Thus, reference of Category-III FPI under section 115AD was inadvertently made. Proposed provisions of section 10(4D) and section 115AD have been rectified vide the Finance Act, 2021.

In addition, since these AIFswould be located in an International Financial Services Centre (IFSC) and regulated under the International Financial Services Centre Authority Act, 2019, the Finance Act, 2021 has amended the said definition to also include the AIFs regulated under International Financial Services Centre Authority Act, 2019.

The above amendment is applicable from the Assessment Year 2022-23.

Taxation of Income from GDRs issued by Overseas Depository Bank situated outside India or IFSC [Section 115ACA]

The Finance Act, 2021 has amended the definition of GDRs to provide that –

a) They can also be created by the Overseas Depository Bank in an International Financial Services Centre (IFSC).

b) Further, GDRs can also be issued against the issue of ordinary shares of issuing company, being a company incorporated outside India, if such depository receipt or certificate is listed and traded on any IFSC.

The above amendment is applicable from the Assessment Year 2022-23.

Regulations applicable in case of Category-I and Category-II AIFs [Section 115UB] [Applicable from Assessment Year 2022-23]

In line with the above amendments, the Finance Act, 2021 has made an amendment to section 115UB to also include the AIFs regulated under International Financial Services Centre Authority Act, 2019.

The above amendment is applicable from the Assessment Year 2022-23.

3) Clarity on disallowance of Goodwill for the Assessment Year 2021-22 [Section 43(6)

Denial of depreciation of goodwill was one of the most significant amendments proposed in the Finance Bill, 2021. The Bill sought to deny depreciation on goodwill, whether purchased or self-generated. To give effect, it proposed to carry out amendments to as much as five sections of the ITA, namely, section 2(11) which defines block of assets, section 32(1)(ii) which allows for claim of depreciation, section 50 that contains special provision for computing capital gain in case of deprecation assets, section 55 to the extent it deals with cost of acquisition of capital assets acquired from previous owner through modes referred under section 47 (i) to (iv) of the ITA.

The above amendments are said to be in effect from the previous year 2020-21. However, there were certain ambiguities for allowance of depreciation on the written down value of the goodwill, already forming part of the block of assets as on the 31^st of March, 2020.

To clarify the position, the Finance Act, 2021 has further amended the meaning of term, ‘written down value’ included in section 43(6) of the ITA, by providing that the term ‘written down value’ shall not be increased on account of acquisition of goodwill of a business or profession and that the term ’written down value’ shall be reduced by an amount equal to the actual cost of the goodwill falling within that block as decreased by the amount of depreciation actually allowed or allowable to the assessee, as if the goodwill was the only asset in the relevant block of assets. It further provides that the amount of reduction so calculated shall not exceed the written down value of the block.

This above amendment would be applicable from the Assessment Year 2021-22 onwards.

4) Slump Sale to be carried at Fair Market Value [Section 50B]

Section 50B of the ITA deals with capital gains arising from slump sale. Currently, it does not possess any specific method for computation of full value consideration to be considered for the purpose of computation of capital gains. The Finance Act, 2021 has made an amendment to section 50B of the Act by way of amending sub-section (2) thereof, to provide that fair market value of the capital assets as on the date of transfer shall be deemed to be the full value of the consideration received or accruing as a result of the transfer such capital assets. A new clause in Explanation to the above section has been included to provide that the value of any self-generated goodwill of a business or profession shall be considered to be Nil, while computing the net worth of the undertaking or division transferred under section 50B of the ITA.

While one need to wait for the Government to prescribe the manner for arriving at the fair market value of the capital assets, the amendment would lead to a higher tax liability in cases where transfer of division or undertaking is made at lower than its fair market value.

As for the transferee, excess consideration paid would be considered as goodwill, which with the effect of amendment proposed vide the Bill would not be considered for depreciation but will result into capital gain upon subsequent transfer.

Further, in cases where transfer of a division or an undertaking is made at below fair market value, one needs to assess taxability under section 56(2)(x) of the ITA in the hands of the transferee. Since the term ‘property’ has not been defined under the ITA, it could be a matter of debate and litigations, whether an undertaking or a division can be construed as a ‘property’.

The above amendment is applicable from the Assessment Year 2021-22..

5) Limiting exemption on excess PF Contribution [Section 10(11) and 10(12)]

Section 10(11) and 10(12) of the ITA provides for exemption relating to statutory provident fund and recognized provident fund, respectively. As the exemption is available without any threshold, it allows excessive benefit to those who can contribute large amount to these funds as their share.

The Bill sought to put a cap on the exemption available to the taxpayers from tax payable on the interest accrued/earned in a statutory provident fund, by inserting a new proviso to section 10(11) of the Act, to provide that the exemption available by way of the aforesaid clause shall not apply to the interest income, to the extent it relates to the amounts of contribution made in that fund, on or after the 1^st day of April, 2021, by that person, exceeding two lakh and fifty thousand rupees in any previous year. Similar proviso was also proposed to section 10(12) of the Act, to limit the exemption available to the taxpayer with respect to the accumulated balance due and becoming payable to an employee.

The above limitation has been retained in the Finance Act, 2021 but subject to certain relaxations, by inserting another set of provisos, to increase the contribution threshold to five lakh rupees, if there is no contribution by the employer of such person in that fund.

As the term used in the above proviso is “……. amounts of contribution made in that fund”, the contribution made by a person in multiple funds would not be required to be aggregated for the purpose of calculating threshold of two lakh and fifty thousand rupees/five lakh rupees. The above amendments may not have much of an effect to public provident funds which already have a cap on contribution of one lakh and fifty thousand rupees per year.

These above amendments would come into effect from 1^st of April, 2022.

6) Enhancement in Tax audit limit [Section 44AB]

In order to reduce the compliance burden on small and medium enterprises, through Finance Act, 2020, the threshold limit for requirement of audit under section 44AB of the ITA was increased from one crore rupees to five crore rupees in cases where -

a) aggregate of all receipts in cash during the previous year does not exceed five per cent of such receipt; and

b) aggregate of all payments in cash during the previous year does not exceed five per cent of such payment.

In order to further incentivize non-cash transactions and to reduce compliance burden of small and medium enterprises, the Bill proposed to further enhance the threshold for the tax audit required under section 44AB of the ITA from the existing five crores rupees to ten crore rupees.

The wordings of provisos referred above allowed a person to carryout transaction through bearer cheque or bank draft as terms used therein are “… receipts in cash” and “….. payments in cash”, the Finance Act, 2021 cures this defect by inserting a proviso to provide that for the purpose of calculating the threshold, payment or receipt as the case may be, by a cheque drawn on bank or by a bank draft, which is not account payee, shall be deemed to be payment or receipt, as the case may be, in cash.

This above amendment would be applicable from the Assessment Year 2021-22 onwards.

7) Applicability of Presumptive taxation [Section 44ADA]

The scheme of presumptive taxation was extended to professionals by introduction of section 44ADA of the ITA w.e.f. Assessment Year 2017-18. It was made applicable to all assessees, being a resident in India, who is engaged in the profession referred to in sub-section (1) of section 44AA of the ITA.

However, in the memorandum explaining the provisions in the Bill, it is clarified that section 44ADA of the Act are applicable only to individual, Hindu Undivided Family and partnership firm, but not a Limited Liability Partnership (LLP). Accordingly, the Bill proposed to amend sub-section (1) of section 44ADA of the ITA to provide that the provisions of section 44ADA of the ITA shall apply only to an assessee, being an individual, Hindu Undivided Family or a partnership firm, other than a limited liability partnership, who is a resident in India.

However, the Finance Act, 2021 has surprisingly and without any explanation has excluded ‘Hindu Undivided Family’ from the list of assessee, who would be eligible to opt for the presumptive scheme.

The above amendment is applicable from the Assessment Year 2021-22.

8) Tax benefits to ‘DFI’ and ‘Institution’ established for financing infrastructure and development

A professionally managed Developmental Financing Institution (DFI) was necessary to finance the infrastructure needs of the country. DFI is an institution promoted or assisted by the Government mainly to provide development finance to one or more sectors or sub-sectors of the economy, where the risks are higher and which require long term debt financing. The Finance Act, 2021 inserted two new clauses (48D) and (48E) to Section 10 to provide tax benefits to such institutions.

Financial Institution [Section 10(48D)]

Aninstitution established for financing the infrastructure and development is exempt from tax on any income accruing or arising to such an institution as per Section 10(48D) as inserted by the Finance Act, 2021. This exemption shall be available for a period of 10 consecutive assessment years commencing from the assessment year relevant to the previous year in which such institution is set up.

Exemption to DFI [Section 10(48E)]

The Finance Act, 2021 has also inserted clause (48E) to Section 10 to grant exemption to any income accruing or arising to a DFI licensed by the Reserve Bank of India. This exemption shall be available for 5 consecutive assessment years beginning from the assessment year relevant to the previous year in which the DFI is set up. The Central Government may, however, extend the period of exemption of 5 years for a further period, not exceeding 5 more consecutive assessment years, subject to fulfilment of such conditions as may be specified.

The above amendmentsare applicable from the Assessment Year 2022-23.

9) Transfer of capital assets by IIFC to IFID [Section 47(viiae)

On 23^rd of March, 2021, the Lok Sabha passed the National Bank for Financing Infrastructure and Development (NBFID) Bill, 2021, seeking to establish a development finance institution (DFI) to fund infrastructure. This was finance minister Nirmala Sitharaman fulfilling her budget promise wherein the government will initially own 100% of the proposed NBFID’s ₹20,000-crore share capital, which will be reduced later to 26% by selling equity to banks, multilateral institutions, sovereign wealth funds, pension funds and insurers.

In order to facilitate transfer of capital asset by Indian Infra Finance Co. to development finance institution, the Finance Act, 2021 has inserted a new clause (viiae) to section 47 to provide that any transfer of a capital asset by Indian Infrastructure Finance Company Limited to institution established for financing infrastructure and development, set up under an Act of Parliament and notified by the Central Government, shall not be regarded as transfer. Consequential amendments have been made to section 49 to provide that the cost of a capital asset in the hands of the transferee shall be the same as in the hands of the transferor. Further, exception has been carved out under section 56(2)(x) in respect of transfer referred to in section 47(viiae).

10) Extended scope of investment for Sovereign Wealth Fund (SWF) and Pension Fund (PF) [Section 10(23FE)]

The Bill proposed to enhance the scope of investment for Sovereign Wealth Fund (SWF) and Pension Fund (PF) for benefiting from the exemption available under section 10(23FE) of the ITA.

It, inter alia, proposed to allow investment by SWFs/PFs through a holding company on the conditions that:

i) Holding company should be a domestic company.

ii) It should be set up and registered on or after 1st April, 2021.

iii) It should have minimum 75% investments in one or more infrastructurecompanies.

iv) Exemption under this clause shall be calculated proportionately, in case ifaggregate investment of holding company in infrastructure company orcompanies is less than 100%.

It further provided for investment through NBFC - IDF/IFC (non-banking finance company-infrastructuredebt fund/Infrastructure finance company) on the conditions that:

i) NBFC-IDF/IFC should have minimum 90% lending to one or moreinfrastructure entities.

ii) Exemption under this clause shall be calculated proportionately, in case ifaggregate lending of NBFC-IDF or NBFC-IFC in infrastructure company orcompanies is less than 100%.

In addition to the above, the Finance Act, 2021 has further extended the scope by allowing them to investment by any Category I or II AIFs which in turn invests in a domestic company or NBFC, which meets the above criteria.

11) Liable to tax [Section 2(29A)]

The Bill proposed to define the term ‘liable to tax’ by introducing clause (29A) in section 2 of the ITA. Though the notes on clauses and the memorandum explaining the provisions in the Bill do not explain the objectives behind the definition, the term ‘liable to tax’ is not new to the taxation world or to the ITA. It has been used in many of the agreements entered by the Government of India under section 90 or section 90A of the ITA, and also, in the recently introduced clause (1A) in section 6 dealing with deemed residency and clause (23FE) in section 10 providing exemption to specified sovereign wealth fund and pension fund.

The unstated objective behind defining the term ‘liable to tax’ is to settle the controversy over its interpretation and to overcome the rather settled judgement of the Hon’ble Supreme Court in the case of Union of India vs. Azadi Bachao Andolan in [TS-5033-SC-2002-O], wherein their lordships while interpreting the term, in reference to the India-Mauritius DTAA, upheld the Ruling of Hon’ble AAR in the case of Mohsinally Alimohammed Rafik vs. CIT in [TS-5003-AAR-1994-O] which had observed that, a tax treaty not only prevents ‘current’ but also ‘potential’ double taxation. While referring to the erstwhile DTAA between India and UAE, it held that, irrespective of whether or not the UAE actually levies taxes on non-corporate entities, once the right to tax UAE residents in specified circumstances vests only with the Government of UAE, that right, whether exercised or not, continues to remain exclusive right of the Government of UAE.

Definition of the term ‘liable to tax’ as originally proposed by the Bill, in relation to a person meant that there is a liability of tax on such person under any law for the time being in force in any country, and shall include a case where subsequent to imposition of tax liability, an exemption has been provided.

The above definition could have possibly allowed a person to claim that he is ‘liable to tax’ in a country if he is liable to tax in any other country, since the definition is not with reference to a country. Further, the definition does not specify the nature of tax. Thus, a person could claim to be liable to tax in a country, if he is liable to tax in the said country with respect to any type of tax, which need not necessarily be ‘income-tax’.

In order to ensure that the definition does not lead to any such possible misinterpretation, the amended definition in the Finance Act, 2021 ensures that the term ‘liable to tax’ is interpreted with reference to ‘a country’. It provides that the term ‘liable to tax’, in relation to a person and with reference to a country, means that there is an income-tax liability on such person under the law of that country for the time being in force and shall include a person, who has subsequently been exempted from such liability under the law of that country’.