Impact of Direct Tax Code on small companies
Small Scale industries are an important and crucial segment of the Indian industry sector. The Indian Government has accorded high priority to this sector as it plays a vital role in balanced and sustainable economic growth. In the current context of rapid economic development, one must view taxation benefits in relation to the need for increasing investment in small-scale and ancillary industry. Here are a few key proposals of the Direct Tax Code, 2010, (DTC).
Income Expense Model
In terms of the DTC, besides the presumptive and special taxation regimes for specified businesses, the profits from all other business will be equal to the gross earning from the business minus the amount of allowable deduction.
Gross earnings from the business
All accruals and receipts from the business, besides those derived from business assets; make up the gross earnings of the business of the tax payer. For instance, profit on sale of an undertaking under a slum sale; advance or security deposit on a long term lease of business assets; or reimbursement of any expenditure etc.
Generally, all operating expenses incurred essentially for all business purposes are deductible from gross total income. The requisite for deductibility of expenses is that expenses must be: wholly and exclusively incurred for business purposes; and incurred or paid during the previous year and supported by pertinent paper and records.
Expenses of a personal and capital nature, remunerations payable to a ‘non working participant’, any unascertained liabilities etc. are not deductible.
Expenditure incurred by way of land revenue, local rates or municipal taxes, sales tax duty, cess, fees, bonus or commission to employees, leave encashment id deductible in the financial year or by the due date of filing the return of tax bases for that financial year. Otherwise it will be allowed in the financial year in which it is actually paid. Expenditure incurred by way of interest on loan or borrowing from permitted financial institutions is deductible in the year of accrual or payment, whichever is later.
Depreciation business capital assets (including acquired by the lessee under financial lease) is calculated on the declining balance method and is based on the ‘block of assets’. The ‘block of assets’ concept suggests aggregation of all assets with the same depreciation rate into a common block for calculation of depreciation. Depreciation is computed at varying rates as prescribed and in the year of purchase, is available for the full year if an asset is used for more than 180 days. In other cases, depreciation is allowed a half the normal rates.
Besides depreciation, a manufacturer or producer of an article of thing is allowed initial depreciation on the new machinery and plant (except ‘office appliances’ and assets not installed in the office premises, guest house, or any other residential premises) at the rate of 20% of the original cost of the asset for the full year if the asset is used for more than 180 days. In other cases, initial depreciation is allowed at half the normal rates.
Deferred revenue expenditure by ay of non-compete fee, premium paid on lease or rental asset, amount paid to an employee under voluntary retirement scheme, expenses incurred by an Indian company wholly and exclusively, preliminary expenditure, etc., will be allowed deduction in six financial years starting the year of actual payment, or year of business reorganisation, or year of start of business, extension of business or set up of new business, as the case may be.
The DTC has granted, though restrictive, the tax holidays to all Special Economic Zone units for the unexpired period out of 15 years, including new such unit that start operations on or before 31 March 2014. The tax holiday will be computed on the lines discussed in the above model with two exceptions, namely; capital expenditure and expenditure incurred prior to the start of the business.
Unfortunately there is no exception for SEZ unites from MAT. Absence of MAT exemption under DTC would mean that SEZ unites would need to pay a minimum tax of 20% on book profits.
It covers transactions between two or more residents involved in amalgamation or de-merger. Reorganisation, ordinarily being tax neutral is subject to ‘test of continuity of business’, and other conditions are necessary to prevent abuse of the Code. The successor of business will pass the ‘test of community business’ if he
1) Continuously holds at least 75% of the book value of the fixed assets of the predecessor acquired through business organisation for at least five financial years immediately succeeding the year in which the business reorganisation takes place
2) Continues the business of the predecessor for at least five financial years immediately succeeding the financial year in which the business reorganisation takes place, and
3) Meets other such conditions as may be prescribed o ensure the revival of the business of the predecessor or to ensure that the business reorganisation is for genuine business purpose.
In the case of de-merger, the resulting company must issue only its equity shares to the shareholders of the de-merged company on a proportionate basis to avail of tax exemption and benefit of carry forward of unabsorbed tax losses.